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 Statement on Auditing Standard Related to Communications with Audit Committees 

DATE: Aug. 15, 2012 
SPEAKER: Lewis H. Ferguson, Board Member 
EVENT: PCAOB Open Board Meeting 
LOCATION: Washington, DC 

I support the issuance of Auditing Standard No. 16 in the form that has been proposed. This standard is the culmination of a process that began more than two years ago on March 29, 2010 when the Public Company Accounting Oversight Board proposed a standard, Communications with Audit Committees. The Board’s concern at that time was to improve audits by enhancing the relevance and effectiveness of the communications between the auditor and the audit committee. The Board received 35 comment letters on that proposed standard, and also held a roundtable on the subject of auditor communications with audit committees and received additional comments from the Board’s Standing Advisory Group on the proposed standard. In addition, after the issuance of the proposed standard, the Board adopted new risk assessment standards and the U.S. Congress enacted the Dodd-Frank Act giving the Board jurisdiction over the audits of brokers and dealers registered with the Securities and Exchange Commission. Taking into account all of these things, the Board re-proposed the standard on December 20, 2011 and received an additional 39 comment letters. The result of this lengthy process is the standard which is before the Board today.

This standard retains many of the existing requirements for auditors to communicate certain matters to the  audit committees who employ them. These requirements are included in AU sec. 380 and include matters such as communications concerning the company’s accounting policies, practices and estimates; the auditor’s evaluation of the quality of the company’s financial reporting; information relating to significant unusual transactions, including their business rationale and the auditor’s view of certain matters where management has consulted other auditors. The standard before us this morning enhances the existing rules by requiring such communications to be made to the audit committee before the audit report is issued. In addition, the standard adds new requirements, including communications about the overall audit strategy, information about specialized skills required in the audit, the use of the company’s internal audit function in the course of the audit, difficult or contentious matters with respect to which the auditor believed it was necessary to consult outside the audit team, the auditor’s evaluation of going concern issues, and any departures from the standard auditor’s report.

A fundamental point to keep in mind in considering this standard is that it does not require the auditor to do any additional audit work and additional audit costs should be minimal. All of the matters that the standard requires to be communicated to the audit committee should have been matters of focus for the auditor in conducting the audit under existing PCAOB auditing standards. These are matters on which the auditor should have focused in a PCAOB compliant audit. What the standard requires is communication to the audit committee by the auditor of certain matters that the Board believes are particularly important in understanding the audit and the audit risks that the company faces.

In adopting this standard, the Board is fully cognizant of the complex relationship between federal and state law and the intersecting jurisdiction of different legal regimes and regulatory bodies in the matter of corporate governance. State corporation laws and the legal precedents that have interpreted those laws generally determine the duties of boards of directors as the governing authorities of corporations. The federal securities laws, particularly as expressed in the Sarbanes-Oxley Act and as interpreted in the rules of the Securities and Exchange Commission, have required the creation and mandated the membership of audit committees of boards of directors for U.S. public companies. The rules of the Board, as well as certain rules of the SEC, have set forth the duties that auditors of U.S. public companies must perform in connection with audits of U.S. public companies including communications between auditors and audit committees of certain matters deemed particularly important by the Board.

Some commentators on the re-proposed standard have suggested that it should be left to audit committees to inquire about what they want to know about the audit and auditors should not be forced to give them information they may find superfluous. There are two answers to this question. The first is that the Board’s experience through its inspection and standard setting processes has convinced at least this Board member that the quality and experience of auditors and audit committees of U.S. public companies varies widely. Many skilled auditors already routinely communicate to their audit committee member clients all of the matters that this standard would require to be communicated. Some auditors, however, do not and some audit committee members do not have either the knowledge or experience to inquire on their own into these matters that the Board believes are critical components of the assessment of audit risk. By mandating communications about areas of critical audit risk by the auditor to the audit committee, the Board believes that all audit committees of U.S. public companies will be informed of these matters and that there will be a resulting improvement to audit quality.

The second answer is that audit committee members remain free to use or ignore the communicated information as they deem appropriate. Nothing in this standard limits the communications between auditors and audit committees. The standard sets minimum but not maximum standards for communications. If the communicated information is deemed irrelevant, it can be overlooked. If audit committees want additional or more detailed information about particular topics, their members remain free to ask their auditors any questions they believe would help them understand the audit and the finances of the companies they oversee. If there are areas not included in the required communications that audit committees believe would be informative to their work, they remain free to inquire of their auditors about those matters as well. In short, arguments that this standard somehow inhibits the free flow of information between auditors and audit committees are unpersuasive.   

For all of these reasons, I support the adoption of the standard in the form presented to the Board.