Thank you, Mr. Chairman. I support this proposed auditing standard on Communications with Audit Committees.
It is well known that auditor independence is essential to the integrity of an audit of financial statements. Auditor independence was a core principle underlying the Sarbanes-Oxley Act of 2002. In hearings leading up to the passage of the Act witnesses suggested that when auditors view their main responsibility as serving the company’s management rather than its full board of directors or its audit committee, the auditing process could be compromised. For this reason, the Act requires audit committees of listed companies to be directly responsible for the appointment, compensation, and oversight of the work of auditors, and requires auditors to report directly to the audit committee. It also requires audit committees to be independent.
This audit committee and auditor reporting relationship – with its independence from management – is fundamental to the spirit of the Act. I believe that the proposal before us today furthers the Act’s intentions by strengthening that relationship. The proposed standard supports the audit committee’s role in managing the work of the auditors. It does this by clearly identifying the auditor’s duties when communicating with the audit committee. In short, the proposed standard updates and enhances existing auditor communication requirements to ensure that the audit committee has access to the critical knowledge an auditor gains during the course of the audit. As such, I expect that audit committees and investors alike will welcome this proposed standard.
Objectives of the Proposed Standard
As described in the proposed standard, in addition to updating the interim auditing standards to reflect the requirement that the auditor report directly to the audit committee, there are four overarching objectives contemplated with this proposal. These objectives are:
- establishing a mutual understanding of the terms of the audit engagement;
- providing the audit committee with an overview of the audit strategy and audit timing;
- providing timely observations arising during the audit about significant issues surrounding the financial reporting process; and
- assessing whether the two-way communications between the auditor and the audit committee have been adequate to support the objectives of the audit.
Given auditor compliance with the requirements of this proposed standard, I believe that the audit committee’s oversight of the auditor will be strengthened and the type of independent discussion between the audit committee and the auditor that was envisioned by the Act will become more of a reality.
Matters to be Communicated
While each of the requirements in the proposed standard is important, I want to emphasize a few key areas in the standard that address the third objective of providing timely observations to the audit committee about significant issues.
The requirement to ensure that the audit committee is informed about critical accounting policies is not new. In fact, the Act requires auditors to report to the audit committee "all critical accounting policies and practices to be used." Also not new is the requirement to inform the audit committee about the process used by management to develop critical accounting estimates, including how management subsequently monitors those estimates.
The proposed standard adds value to the existing standard by emphasizing the need to discuss the significant assumptions used in these estimates when there is a high degree of subjectivity. The auditor will also need to discuss material changes to these estimates made during the year and the range of possible outcomes. These requirements are designed to ensure that the audit committee is knowledgeable of critical financial reporting decisions made by management. This knowledge, I believe, is vital for an audit committee to effectively oversee the financial reporting and auditing process.
In addition, specifically requiring the auditor to have a thorough discussion with the audit committee about the judgments made in developing these critical estimates prior to the issuance of the auditor’s report I believe will serve investors well. This will also be a required discussion with the audit committee before the quarterly financial statements are filed. Again, I believe that audit committees and investors alike will be very supportive of such a timeline for requiring these types of communications to take place.
Comparison with Other Standards
The proposed standard also requires the auditor to evaluate the communications made by management to the audit committee to determine whether the communication requirements of the standard have been met. If the auditor determines that management’s communications are not adequate, then it is the auditor’s responsibility to communicate any omitted issues to the audit committee. Standards issued by other standard- setting bodies do not require the auditor to make additional communications regarding specific accounting matters if management has not communicated them.
Appendix 3 compares the requirements of the proposed standard to similar standards issued by the International Auditing and Assurance Standards Board and the Auditing Standards Board. I think it is important that every PCAOB proposed standard include such an analysis, together with an explanation of why our standards are in the best interests of investors.
As always, I am very interested in hearing from all interested parties, and particularly investors, during this sixty-day comment period. And given the topic, I also want to especially encourage audit committee members to comment.
In closing, I join you, Mr. Chairman and the other Board members, in acknowledging the work done by Barbara Vanich, Jessica Watts, and Jennifer Rand, under the direction of Marty Baumann, in developing this proposed standard on audit committee communications. I would also like to thank Bob Burns and Nina Mojiri-Azad from our General Counsel’s office for their work on this standard.
 See Report of the Committee on Banking, Housing, and Urban Affairs United States Senate; July 3, 2002; page 23.
 See Sarbanes-Oxley Act of 2002; §301.
 See Sarbanes-Oxley Act of 2002; §204.