Current SEC and PCAOB Developments


Once again, it is great to be here at this important conference and to have this opportunity to address such a distinguished gathering of professionals.

What a year it has been! This probably is the most challenging time in our professional careers. Many of the speakers before me already have amply made that point, so I won't dwell on it in my opening remarks.

I do plan, however, to take some time this afternoon to speak about risks of misstatement to financial statements that might arise from the current economic environment and the recent events in the US and global capital markets. Last week, the PCAOB issued Staff Audit Practice Alert No. 3, "Audit Considerations in the Current Economic Environment," that highlights such risks and how auditors can respond to them. I think it would be helpful for me to bring a number of those risks to your attention this afternoon.

I also plan to describe our current standards setting activities. In October, the Board issued for public comment seven proposed auditing standards that address how the auditor should assess and respond to risk in an audit. This is a substantial and significant project. We also have numerous other projects underway, and I plan to highlight certain of their key aspects.

Finally, I will close with some of my thoughts on how auditors can effectively perform audits in the kind of environment we are now faced with. 


Of course, the views I express today are my own, and do not necessarily represent the views of the PCAOB, PCAOB board members, or other members of the PCAOB staff. 

Audit Risks in the Current Economic Environment

Recent events in the financial markets and the current economic environment may affect companies' financial reporting. This, in turn, may have implications for audits of financial statements and internal control over financial reporting. Audit risks that may have been identified previously may become more significant or new risks may exist due to current events. Among other things, the current uncertainties in the market and economy may create questions about the valuation, impairment, or recoverability of certain assets and the completeness or valuation of certain liabilities reflected in financial statements.

The purpose of the staff audit practice alert is to assist auditors in identifying matters related to the current economic environment that might affect audit risk and require additional emphasis. While the alert highlights certain areas, it is not intended to identify all areas that might affect audit risk or serve as a substitute for the relevant auditing standards.

Also, while the alert necessarily describes generally accepted accounting principles applied by public companies in various areas, the PCAOB is neither establishing nor interpreting GAAP through the alert. Questions about the application of GAAP by public companies should be directed to the SEC and FASB.

General Considerations

Fraud risk considerations

Let me start out by saying that the current economic environment may affect the risk of misstatement due to fraud. As you know, the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. Factors that may increase the incentives, pressures and opportunities to commit fraud include, for example –

  • Financial stability or profitability of the company: are they threatened by economic, industry, or company operating conditions?
  • Does excessive pressure exist for management to meet the requirements or expectations of third parties?
  • Does information available indicate that management or the board of directors' personal financial situation is threatened by the company's financial performance?
  • Is excessive pressure placed on management or operating personnel to meet financial targets set up by the board of directors or management, including sales or profitability incentive goals?
  • Is there ineffective monitoring of management?

Internal control considerations

The current environment and resulting risks may require additional auditor attention and audit evidence regarding the effective operation of internal controls. Marc Panucci of the SEC staff spoke about this subject yesterday.

Areas in which additional evidence may be required include the company's entity-level controls, such as, among other things, controls related to the control environment, and the company's risk assessment process.

Additional attention also may be warranted on the controls related to certain significant accounts and disclosures and their relevant assertions, such as controls over the development of inputs and assumptions for the valuation of significant assets and liabilities; controls over the identification and review of assets for recoverability or impairment; and controls over the company's use of external specialists (for example, valuation specialists) who assist in the determination of recorded amounts of certain assets or liabilities.

Some companies are responding to the current economic conditions by eliminating jobs. The loss of employees integral to the operation of internal controls may increase the risk of deficiencies in internal control over financial reporting because of, for example, lack of segregation of duties, lack of effective monitoring, and lack of necessary skills.

Effect on substantive procedures

Because the current environment may increase inherent and control risks, the auditor might need to modify his or her planned substantive procedures or perform additional substantive procedures to reduce the level of detection risk to an acceptable level.

Communications with audit committees

The auditor also has a responsibility to communicate certain matters related to the conduct of the audit to the audit committee. Some of the required communications that may be affected by current economic conditions include discussions about accounting estimates as well as the auditor's judgments about the quality, not just the acceptability, of the company's accounting principles.

Also, the auditor is not precluded from communicating other matters to the audit committee in addition to those things required by law or the professional standards that may assist the committee members in discharging their duties.

Auditing Fair Value Measurements

Auditing the fair value of financial instruments continues to be a particular challenge. Yesterday, in his remarks, Chairman Olson noted that the PCAOB issued a report last week that discusses observations identified in the course of our inspections of the eight firms we have been inspecting annually since the PCAOB began the full inspection program in 2004. In this report, we noted deficiencies in auditing fair value measurements, as well as other accounting estimates. I expect that George Diacont, our Director of Registration and Inspections, will have more to say about this report during the conference tomorrow.

PCAOB Staff Audit Practice Alert No. 2, Matters Related to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists, which was issued last December, remains relevant in the current environment and I encourage you to read that document again. It reminds auditors of their responsibilities with regard to –

  • Auditing fair value measurements,
  • Classification within the fair value hierarchy under FAS 157,
  • Using the work of specialists, and
  • Use of a pricing service.

Auditing Accounting Estimates

Auditing other types of accounting estimates also will be a challenge in the current environment. Examples of accounting estimates include, of course, the net realizable value of inventories, allowances for uncollectible accounts receivable, valuation allowance for deferred tax assets, actuarial assumptions in pension and other postretirement benefit costs, the impairment analysis and estimated useful lives of long-lived assets, restructuring accruals, and assumptions used in option-pricing models for share-based payments.

In auditing accounting estimates, the auditor normally considers, among other things, the company's historical experience in making past estimates as well as the auditor's experience in the industry. However, the auditing literature also points out that changes in facts, circumstances, or a company's procedures may cause factors different from those considered in the past to become significant to the accounting estimate. The significance of the recent changes in the economy and the financial markets increases the likelihood that this will be the case.

Auditing the Adequacy of Disclosures

The current economic environment might result in increased risks regarding the adequacy of disclosures, including the disclosures surrounding a company's risks and uncertainties, which in turn may warrant additional auditor attention.

AICPA Statement of Position 94-6, Disclosure of Certain Significant Risks and Uncertainties, focuses on disclosures about risks and uncertainties that in the near term could affect the amounts reported in the financial statements or the functioning of the reporting entity. SOP 94-6 provides that companies should make disclosures in their financial statements about the risks and uncertainties in the following areas –

  • Nature of operations
  • Use of estimates in the preparation of financial statements
  • Certain significant estimates
  • Current vulnerability due to certain concentrations

The presentation of financial statements in conformity with GAAP includes adequate disclosure of material matters, related to the form, arrangement, and content of the financial statements and their notes. The auditor considers whether a particular matter should be disclosed in light of the circumstances and facts of which he or she is aware at the time. If management omits from the financial statements, including the accompanying notes, information that is required by GAAP, the auditor should appropriately modify his or her report.

The Auditor's Consideration of a Company's Ability to Continue as a Going Concern

In the current economic environment, some companies are facing challenges in their ability to continue operating as a going concern.

As you know, the auditor has a responsibility to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, not to exceed one year beyond the date of the financial statements being audited. The auditor's evaluation is based on his or her knowledge of relevant conditions and events that exist at or have occurred prior to the date of the auditor's report.

Conditions or events that may indicate there is substantial doubt about the company's ability to continue as a going concern for a reasonable period of time include, for example –

  • Negative trends – for example, recurring operating losses, working capital deficiencies, negative cash flows from operating activities, and adverse key financial ratios
  • Other indications of possible financial difficulties – for example, default on loan or similar agreements, denial of usual trade credit from suppliers, noncompliance with statutory capital requirements, and the need to seek new sources or methods of financing or to dispose of substantial assets
  • Internal matters – for example, work stoppages or other labor difficulties, uneconomic long-term commitments, and the need to significantly revise operations

If you have been reading the financial press over the past several months, I imagine these types of things sound familiar to you. I think it is reasonable to assume that more companies than in the past will exhibit one or more indicators of substantial doubt. If such indicators are present, I encourage you to engage in a dialog with your client's management and audit committee about these matters as soon as possible.

Additional Audit Considerations for Selected Financial Reporting Areas

The Alert also highlights selected financial reporting areas that may be affected by the current economic environment. I will mention several of the examples we have highlighted.


As a result of the economic environment, some companies have provided financial support or guarantees, or taken other actions that may cause them to have a variable interest in an entity or to otherwise change their relationship with such companies. Such commitments to provide financial support or guarantees might be found in various contractual arrangements, such as leasing arrangements, supply contracts, service contracts or derivative contracts.

As you know, FASB Interpretation No. 46(R) (as amended), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, addresses consolidation by the primary beneficiary of variable interest entities. As Russ Golden just mentioned, the FASB plans to issue soon a FASB Staff Position on this subject that will enhance disclosure requirements.

Contingencies and guarantees

Recent events in the credit markets may expose companies to additional contingencies and guarantees, which could increase the risk of unidentified or undisclosed contingencies related to, for example 

  • Guarantees of indebtedness of others
  • Guarantees to repurchase receivables or property previously sold or otherwise assigned
  • Guarantees of contractual performance of others
  • Outstanding purchase commitments at prices in excess of market values

Deferred tax assets

Companies may need to record valuation allowances for their deferred tax assets. Deferred tax assets are required to be reduced "by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized."

The accounting literature provides direction on the evidence that is necessary to support a conclusion that a valuation allowance is not needed for some portion or all of the deferred tax asset. The accounting literature also provides guidance on measurement, recognition, de-recognition, classification, and disclosure, among other things.

Goodwill, intangible assets and other long-lived assets

Current market conditions may call into question whether there is impairment of goodwill, other indefinite-lived intangible assets and other long-lived assets. Goodwill and indefinite-lived intangible assets are required to be tested for impairment annually, or more frequently if events or changes in circumstances indicate. Similarly, other long-lived assets are required to be tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Examples of such events and changes in circumstances, some of which may be more prevalent in today's environment, are provided in the accounting literature.

In addition to valuation, there may be a need to reassess the useful life of these intangible and other long-lived assets.

Other-than-temporary impairment

Many debt and equity securities have experienced significant declines in fair value. These declines in fair value may raise questions about whether such declines are other-than-temporary. The auditor should evaluate management's conclusion about the need to recognize in earnings an impairment loss for a decline in fair value that is other than temporary.

Pension and other postretirement benefits ("OPEB")

The current economic environment also might have significantly affected the fair value of assets held by pension and other post retirement benefit plans and will likely need to be factored into the assumptions used to measure pension and OPEB obligations. This may, in turn, have an effect on the financial statements of companies that sponsor such plans.

Revenue recognition

Some companies may be faced with increased pressure to meet revenue targets and analysts' expectations. These pressures may cause companies to change business practices, which could affect the amount and timing of revenue recognition. Examples of business practices that could affect revenue recognition and the necessary audit procedures include, among other things, rights of return, bill-and-hold arrangements, change in payment terms, and consignment arrangements. Also, in accordance with SAS No. 99, the auditor should ordinarily presume that there is a risk of material misstatement due to fraud relating to revenue recognition.

Other areas addressed in the Practice Alert

The Staff Audit Practice Alert addresses the topics I have mentioned in much more detail, and provides helpful references to relevant accounting and auditing direction. It also addresses additional topics that I have not mentioned, including planning considerations, credit derivatives, debt obligations, deferred tax assets, derivatives, inventories, receivables, restructuring, and share-based payments. Accordingly, I urge you to obtain and read the document, which is available on our Web site.

Current Standards Setting Activities

I now will turn to our current standards setting activities.

The Board was very active in standards setting during the past year. The Board adopted Auditing Standard No. 6, Evaluating Consistency of Financial Statements; amendments to remove the hierarchy of generally accepted accounting principles from the auditing standards; a new ethics and independence rule, Rule 3526, Communications with Audit Committees Concerning Independence; an amendment of one of the Board's existing ethics and independence rules, Rule 3523, Tax Services for Persons in Financial Reporting Oversight Roles; and various amendments to its rules and standards related to these matters.

The Board also issued for public comment eight proposed new auditing standards. One of these is a proposed auditing standard on what we call Engagement Quality Review, which, if adopted by the Board and approved by the SEC, would supersede the Board's interim quality control standard on concurring partner review. The other seven proposed auditing standards are related to the auditor's assessment of and response to risk in an audit. These seven standards would supersede five of the Board's interim auditing standards. It is this last project that I would like to speak about first.

Auditors' assessment of and response to risk

In October, the Board proposed seven new auditing standards that generally are related to the auditor's assessment of and response to risk in an audit.

These proposals were informed by a number of factors and developments since the corresponding interim standards were developed. These factors and developments include improvements that many firms have made in their audit methodologies; recommendations to the profession on ways in which auditors could improve risk assessment, including recommendations from the Panel on Audit Effectiveness; advice from the Board's Standing Advisory Group; the adoption of Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements; and observations from the Board's oversight activities.

The proposals build upon and attempt to improve the framework established by the existing standards, rather than replacing that framework altogether. Accordingly, while the Board is proposing to supersede several of its interim standards, the concepts underpinning the proposed standards should be familiar to most auditors. The Board believes that the proposed standards, if adopted, would result in improvements to audits of issuers in several areas.

First, the proposed standards would update the existing requirements to take account of improved risk-based audit methodologies currently in use by some auditors. While some firms are already applying many of the procedures described in the proposed standards, the Board believes that improvements in risk assessment methods should be reflected in all public company audits.

This does not mean, however, that the Board is proposing a one-size-fits-all approach to risk assessment. The Board recognized in Auditing Standard No. 5 that "[t]he size and complexity of the company…might affect the risks of misstatement and the controls necessary to address those risks." Accordingly, the proposed standards describe a risk assessment process that should result in audit procedures tailored to the company's size and complexity.

The proposed standards also reflect the Board's recognition of the importance to the audit process of sound professional judgment. As under the PCAOB's existing auditing standards, auditors would have to exercise professional judgment to determine how best to fulfill the requirements of the proposed standards under particular circumstances.

Second, the proposed standards would serve as an improved foundation for future standard setting. The proposed standards set forth the auditor's responsibilities for certain fundamental aspects of the audit process, such as assessing risk and performing tests of controls and substantive procedures. Future auditing standards that address auditing procedures would build on the foundational principles in the proposed standards.

Third, improvements in the requirements related to risk assessment should enhance integration of the audit of the financial statements with the audit of internal control over financial reporting. Because the proposed standards describe the auditor's responsibilities for assessing risk, responding to risk, and evaluating audit results in the context of an integrated audit of financial statements and internal control over financial reporting, they include certain foundational risk assessment principles from Auditing Standard No. 5. This should help auditors better understand how certain procedures required by Auditing Standard No. 5 can be integrated with financial statement audit procedures.

We also recognize that some public companies are not required to have an integrated audit of financial statements and internal control. Accordingly, we have drafted the standards to permit an audit of financial statements only.

Fourth, the proposed auditing standards are intended to emphasize the auditor's responsibilities for considering the risk of fraud during the audit. Inspections of registered firms have identified many deficiencies in auditors' compliance with AU sec. 316, Consideration of Fraud in a Financial Statement Audit, including a tendency to perform the procedures required in AU sec. 316 mechanically, without using the procedures to develop insights on fraud risk or modify the audit plan to address the risk. Inspections also have observed failures to respond appropriately to identified fraud risk factors.

These kinds of deficiencies suggest that some auditors may view the consideration of fraud as an isolated, mechanical process rather than an integral part of the audit.

The proposed standards would integrate certain requirements regarding the auditor's consideration of fraud risk, as set forth in AU sec. 316, into the risk assessment standards. This integration would emphasize to auditors that assessing the risk of fraud is a central part of the audit process, rather than a separate consideration. It also should prompt auditors to make a more thoughtful and thorough assessment of the risks affecting the financial statements, including fraud risks, and develop appropriate audit responses.

Finally, the proposed standards reflect an effort to avoid unnecessary differences between the Board's risk assessment standards and other financial statement audit risk assessment standards. The Board believes that such an effort is particularly appropriate in light of the foundational nature of these proposed standards.

In recent years, the International Auditing and Assurance Standards Board (the "IAASB") updated its auditing standards regarding risk assessment. The Board has taken into account the IAASB risk assessment standards in developing these proposals.

Specifically, the Board began by considering whether the objectives and requirements of the IAASB's standards are appropriate for audits of issuers and consistent with the Board's statutory mandate. While many of the procedures described in the IAASB standards appear to be generally suitable for audits of issuers, the Board believes that certain changes to those standards would be necessary for the Board to adopt them as standards of the PCAOB. Accordingly, there is a degree of commonality between the proposed standards and the IAASB’s risk assessment standards, but they do not mirror them word-for-word.

Significant differences between the proposed standards and the IAASB's risk assessment standards are described in the Board's proposing Release.

For example, the Board made changes necessary to make the proposed standards consistent with relevant provisions of the federal securities laws. In addition, consistent with other PCAOB standards, the proposed standards do not include an "Application and Other Explanatory Material" section. That section, included in the IAASB's redrafted International Standards on Auditing ("ISAs"), "does not in itself impose a requirement," but "is relevant to the proper application of the requirements of an ISA." Rather than including a significant amount of application material in the proposed standards, the Board reviewed the application and other material in the ISAs, adapted those provisions that the Board believed are necessary for audits of issuers, and included them in the proposed standards themselves.

I also made reference earlier to drafting the standards to describe an integrated audit of financials statements and internal control, and the integration of direction on fraud within the risk assessment standards. These also result in differences between the Board's proposal and corresponding standards of the IAASB.

Finally, some differences reflect the Board's view that particular procedures described in the ISAs are not necessary for audits of issuers, or that additional procedures not described in the ISAs are necessary. As you know, our Board was created by the U.S. Congress as an entity that is independent of the audit profession. The PCAOB was entrusted by the Congress with the responsibility to adopt standards that, when implemented, will protect investors in U.S. public companies. It is, therefore, necessary to specifically consider the U.S. auditing environment when adopting auditing and related professional practice standards. There might be areas in which different requirements are needed to address risks in this environment.

The Board has issued the proposed standards for a 120-day comment period, which ends on February 18, 2009.

Engagement Quality Review

In February, the Board proposed for public comment a new auditing standard, "Engagement Quality Review," that, if adopted by the Board and approved by the SEC, would supersede the Board's interim quality control standard on concurring partner review.

As proposed, the standard would apply to all firms registered with the PCAOB for all engagements conducted pursuant to the standards of the PCAOB. Currently, the interim concurring partner review standard applies only to those firms that were members of the AICPA SEC Practice Section at the time the PCAOB adopted the SECPS requirement as the Board's interim standard.

In the Board's view, well-performed engagement quality reviews are an important element in establishing a basis for investor reliance on audits. An engagement quality review is conducted contemporaneously with the engagement and, thus, may correct a problem before the engagement is completed.

Many aspects of the proposed standard are similar to either the requirement it supersedes or to the corresponding requirements of the IAASB. There are, of course, some differences, as well, and I am going to touch on two of those differences this afternoon.

The first is an explicit risk focus. After performing certain procedures that are required for every engagement quality review, the reviewer is directed to consider those procedures and other relevant knowledge and to assess whether there are areas within the engagement that pose a higher risk that the engagement team either failed to obtain sufficient competent evidence or reached an inappropriate conclusion.

This assessment is bounded by the procedures required in the proposed standard. It also recognizes that a qualified engagement quality reviewer will possess considerable knowledge and experience. The intent is for the reviewer to "take a step back" and determine whether there are additional areas or risks in an engagement that warrant his or her further attention.

The assessment also is focused on potential failings by the engagement team. It is important to recognize that the reviewer's assessment is directed to the engagement rather than directly to the client's financial statements. In other words, given what the reviewer knows, did the team do what it should have done in significant areas, and is it likely that their conclusions were reasonable?

The other difference is related to what is called the concurring approval of issuance. The Sarbanes-Oxley Act directed the Board to adopt in its standards a requirement for a concurring or second partner review and approval of each audit report and concurring approval in its issuance.

Significantly, the reviewer is directed to withhold concurring approval of issuance if he or she knows, or should know based upon the requirements of the proposed standard, that there was a significant failure in the engagement. Again, the reviewer's responsibility for what he or she should know is intended to be bounded by the requirements set forth in the proposed standard.

The comment period on the proposal ended on May 12th. We received considerable comment on the proposed standard and on these two areas, in particular. The staff is continuing to consider the comments received and is working with the Board to address them.

Evaluating Consistency of Financial Statements

In January, the Board adopted Auditing Standard No. 6, "Evaluating Consistency of Financial Statements," and conforming amendments to the Board's other standards. These have been approved by the SEC and are now effective.

AS 6, which superseded AU section 420, "Consistency of Application of Generally Accepted Accounting Principles," and its related auditing interpretations, brings the auditing standards into line with FASB Statement No. 154, "Accounting Changes and Error Corrections" ("FAS 154").

There are several matters I would like to draw to your attention.

  • Consistent with the interim standard that was superseded, AS 6 requires the auditor to evaluate the consistency of the company's financial statements and to report on inconsistencies, and describes the periods that are subject to the evaluation.
  • The new standard also requires the auditor to evaluate a change in accounting principle that has a material effect on the financial statements, and provides direction on that evaluation.
  • AS 6 requires the auditor to recognize in his or her report, through the addition of an explanatory paragraph, the correction of a material misstatement in previously issued financial statements. AS 6 explicitly requires the auditor to state in his or her report that the financial statements were restated to correct a material misstatement.
  • AS 6 generally does not require the auditor to recognize in his or her report a change in classification in previously issued financial statements. There are two exceptions. The first is a reclassification that is also a change in accounting principle and the second is a reclassification that is the correction of a material misstatement in the previously issued financial statements.

Hierarchy of Generally Accepted Accounting Principles

Also in January, the Board adopted amendments to the interim auditing standards to remove the hierarchy of generally accepted accounting principles from the auditing standards.

Historically, the auditing standards have provided direction on how to apply the various recognized sources of GAAP, in the form of a hierarchy of those sources.

Because the FASB has now incorporated the GAAP hierarchy into its own standards, the Board has replaced the GAAP hierarchy with a direction that the auditor should look to the requirements of the SEC for the company under audit to identify the accounting principles that are applicable to that company.

This change accommodates both the movement of the GAAP hierarchy to the accounting standards and situations in which a company is permitted by the SEC to file financial statements in accordance with another accounting framework.

When you look at the revised AU section 411, "The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles," you will notice at least two things. One is that we have removed quite a bit of text related to the GAAP hierarchy, so the section is now much shorter. The other thing that you should notice is that what remains is very important. It describes the auditor's responsibility to evaluate the fairness of the overall presentation of the financial statements, noting that such evaluation is made within the framework of generally accepted accounting principles.

I point you to AU sec. 411.04, which provides direction on the auditor's judgment in this area. Among other things, this section points out that the auditor's judgment on the fairness of the presentation includes whether the accounting principles selected and applied have general acceptance; the accounting principles are appropriate in the circumstances; and the financial statements, including the related notes, are informative of matters that may affect their use, understanding, and interpretation.

I also want to take this opportunity to point out AU sec. 431, which further describes the auditor's responsibility to evaluate the adequacy of disclosure.


In April, the Board adopted a new ethics and independence rule, Rule 3526, "Communication with Audit Committees Concerning Independence," and an amendment to the Board's Rule 3523, "Tax Services for Persons in Financial Reporting Oversight Roles." These have been approved by the SEC and are now effective.

Rule 3626 superseded the similar requirement adopted by the Board as one of its interim standards, Independence Standards Board Standard No. 1, and its related interpretations.

Like ISB No. 1, Rule 3526 requires the auditor to communicate to the audit committee relationships that might reasonably be thought to bear on the auditor's independence. The auditor is now required to make this communication prior to accepting an initial engagement to audit the financial statements pursuant to the standards of the PCAOB. The intent is to help the audit committee obtain the information it needs to discharge its obligation to engage an independent registered public accounting firm.

Like ISB No. 1, the auditor also is required to make the communication annually. The rule does not specify the timing of this communication. Rather, the auditor can determine with the audit committee the time of the year that makes most sense.

Rule 3526 requires that the communication be in writing; that the auditor discuss with the audit committee the potential effects of the relationships on the auditor's independence; to document the substance of the discussion; and to annually affirm to the audit committee that the audit firm is independent in compliance with the Board's Rule 3520.

The Board also amended its Rule 3523, which prohibits a registered firm from providing tax services to executives in financial reporting oversight roles at its public company audit clients. As initially adopted by the Board, a firm that provides tax services to persons in a financial reporting oversight role would be prohibited from auditing the company's financial statements for any year during which such services were provided. That prohibition would apply even if the firm ceased providing the services prior to becoming the company's auditor. As amended, Rule 3523 will not prohibit tax services provided during the portion of the audit period that precedes the professional engagement period.

Other priorities

There are several other priority projects we currently are working on and other matters that are likely to affect our priorities in the coming year.

With respect to our current standards-setting projects, the proposed standards on engagement quality review and risk assessment will remain a priority for us. We intend to complete engagement quality review in 2009. We similarly intend to complete the risk assessment standards in 2009, although the timing is subject to the comments we receive from exposure.

We also have begun standards setting projects on auditing fair value measurements and disclosures, auditing accounting estimates, using the work of specialists, the use of audit confirmations, and auditing related parties and related party transactions. I expect you will see proposed standards on these projects in 2009.

In addition to these standards-setting projects, we plan to issue a concepts release with respect to our overall consideration of the Board’s interim standards. As you are aware, shortly after the Board's inception, the Board adopted the existing standards of the AICPA on an initial, transitional basis, and indicated that a schedule and procedure for the review of the interim standards would be established. In fulfilling the Board's objective, we plan to develop a concept release to obtain public comment and feedback regarding the Board's review of the interim standards.

We also plan to finalize the staff guidance we issued last year for public comment on auditing internal control over financial reporting for smaller public companies. We expect that guidance to be issued shortly.

In addition to our current priorities, there are other matters that may affect our standards-setting activities. Those relate to recommendations from the two federal advisory committees, and activities of the SEC and FASB that may affect auditing standards.

First, the PCAOB received a number of recommendations from the two federal advisory committees that completed their work this year – the SEC's Committee on Improvements to Financial Reporting ("CIFiR") and the U.S. Department of the Treasury Advisory Committee on the Auditing Profession - some of which will affect our standards setting priorities. At the February 2008 meeting of our Standing Advisory Group, the SAG discussed the CIFiR recommendation relating to professional judgment, and in October 2008 the SAG discussed recommendations from the Treasury Advisory Committee relating to signing the auditor's report and the feasibility of developing key indicators of audit quality and effectiveness. At this time the Board is in the process of evaluating other recommendations directed to us from these two federal advisory committees.

The staff is also monitoring SEC projects that might have implications for our program. These include the SEC's initiatives on IFRS and XBRL.

Finally, the staff works closely with and monitors FASB projects because changes in accounting standards may affect the Board's auditing and related professional standards. For example, in October 2008, the FASB issued exposure drafts for two proposed accounting standards – Going Concern and Subsequent Events. We are evaluating these exposure drafts and considering whether the Board's auditing standards will need to be amended in light of these proposals. The staff is also closely monitoring the FASB efforts relating to accounting for loss contingencies.


At the beginning of my remarks, I said I would conclude by providing some thoughts on how auditors can effectively operate in the kind of environment with which we are now faced. I am going to turn to a subject about which I speak frequently, and that is auditor independence.

In this context, I am not referring to the rules auditors are required to observe. Those rules are important, however, in that they help the auditor and the auditing profession protect the appearance of independence, which is vital to the public having confidence in the role of the independent auditor, and to help the auditor avoid conflicts that can threaten the auditor's judgment. My focus now is the latter objective.

I think it is significant that AU sec. 220 of the auditing standards talks about independence. It makes it clear that the auditor cannot perform an audit without possessing that quality. Section 220 specifically requires the auditor to maintain an independent mental attitude throughout the audit, that is, to be intellectually honest and without bias.

This independence of mental attitude is the foundation for the proper application of the professional standards and for making sound judgments. The auditor must make independent judgments about the nature, timing, and extent of auditing procedures. Essentially, he or she must do the work that is necessary in the circumstances.

The auditor also must exercise professional skepticism, a close cousin of independence, when evaluating audit evidence. And, of course, the auditor must make an independent judgment as to whether the company's financial statements are presented fairly in accordance with GAAP.

Even after you have satisfied yourself that you have complied with the principles and rules related to independence, you have to ask yourself, am I truly independent of this audit client? Can I make objective decisions related to this engagement?

The more I speak with auditors about their experiences, the more I read about audit failures, the more I think about the role of auditing standards in performing high quality audits, the more I believe that independence is the most important attribute the auditor brings to the financial reporting process. Being independent will make it possible for you to make and live with the tough decisions you will no doubt be faced with this year.


I have one additional thing I would like to say.

Conrad [Hewitt] and John [White], in their "farewell" speeches at the conference yesterday, recognized and thanked their talented staff for the significant contributions they made to the SEC's accomplishments. It reminded me of the outstanding people that I work with at the PCAOB, and I thought I would take a moment to recognize their hard work over this past year. The PCAOB is blessed with an extraordinarily talented and dedicated group of individuals, and it is truly an honor and a pleasure to work with all of you.

Thank you for your attention this afternoon.

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