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Insight into New PCAOB Auditing Standard No. 16

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Insight into New PCAOB Auditing Standard No. 16

Communications with Audit Committees, and Amendments to other PCAOB Standards – PCAOB Auditing Standard No. 16 (Release No. 2012-004)

On August 15, 2012 the Public Company Accounting Oversight Board (PCAOB) adopted Auditing Standard No. 16 (AS 16), Communications with Audit Committees, and Amendments to other PCAOB Standards specifying requirements that will govern a registered auditor's communications with the audit committee of a public company. The new standard replaces and expands the PCAOB's interim auditing standards AU sec. 310, Appointment of the Independent Auditor, and AU sec. 380, Communication With Audit Committees. The Board initially proposed the standard on March 29, 2010, and re-proposed the standard on Dec. 20, 2011. The proposed standard was revised in response to comments received in comment letters and at a roundtable on Sept. 21, 2010. The new standard establishes requirements that enhance the relevance and timeliness of the communications between the auditor and the audit committee, and is intended to foster constructive dialogue between the two on significant audit and financial statement matters. The PCAOB anticipates, subject to SEC approval, that AS 16 and related amendments will be effective for public company audits of fiscal years beginning on or after December 15, 2012. The release also discusses the applicability of AS 16 to the audits of brokers and dealers and emerging growth companies.

The new standard provides a definition of audit committee. For issuers, AS 16 incorporates the definition of “audit committee” as established by the Sarbanes-Oxley Act. For non-issuers, AS 16 provides that if no audit committee or board of directors (or equivalent) exists, then the audit committee is the person(s) overseeing the accounting and financial reporting processes of the company and audits of the financial statements.

Under previous auditing standards, the auditor was required to establish an understanding with the company's management regarding the audit services it would perform. With the new standard, the auditor must establish the audit engagement terms with the audit committee and not with management. This requirement is designed to align the auditing standard with the Sarbanes-Oxley Act, which requires the audit committee of listed companies to be responsible for the appointment of the external auditor. Additionally, AS 16 requires the auditor to record the terms of the engagement in an engagement letter and to have the engagement letter executed on behalf of the company with the audit committee’s acknowledgment and agreement.

AS 16 retains many of the communication requirements in AU sec. 380 and also incorporates the SEC communication requirements. The new standard requires the communications with the audit committee to occur before the issuance of the audit report.

The new standard also expands the auditor's inquiries to the audit committee with respect to the committee's identification and assessment of risks of material misstatements and fraud including, but not limited to, whether the audit committee is aware of violations or possible violations of laws or regulations and other matters relevant to the audit.

AS 16 adds new communication requirements that provide the audit committee with additional information about significant aspects of the audit. These communications are generally linked to the results of the audit procedures or the conduct of the audit and would include such matters as:

• Certain matters regarding the company’s accounting policies, practices, and estimates;

• The auditor’s evaluation of the quality of the company’s financial reporting;

• Information related to significant unusual transactions, including the business rationale for such transactions;

• The auditor's views regarding significant accounting or auditing matters when the auditor is aware that management consulted with other accountants about such matters and the auditor has identified a concern regarding these matters;

• An overview of the overall audit strategy, including timing of the audit, significant risks the auditor identified, and significant changes to the planned audit strategy, or identified risks;

• Information about the nature and extent of specialized skill or knowledge needed in the audit; the extent of the planned use of internal auditors, company personnel or other third parties, and other independent public accounting firms, or other persons not employed by the auditor that are involved in the audit;

• The basis for the auditor's determination that he or she can serve as principal auditor, if significant parts of the audit will be performed by other auditors;

• Situations in which the auditor identified a concern regarding management's anticipated application of accounting pronouncements that have been issued but are not yet effective and might have a significant effect on future financial reporting;

• Difficult or contentious matters for which the auditor consulted outside the engagement team;

• The auditor's evaluation of going concern;

• Departures from the auditor's standard report; and

• Other matters arising from the audit that are significant to the oversight of the company’s financial reporting process, including complaints or concerns regarding accounting or auditing matters that have come to the auditor’s attention during the audit.

In regards to other amendments to PCAOB standards, the PCAOB is making a transitional amendment to AU sec. 380 to delete its current applicability exception for audits of brokers and dealers that do not have an audit committee or are registered with the SEC only because of Section 15(a) of the Exchange Act. And pursuant to the requirements of the JOBS Act, the PCAOB will request that the SEC approve the application of AS 16, and the related amendments, to the audits of emerging growth companies.

Appendices Appendix 1 to the release contains the text of AS 16, which has three appendices: Appendix A - Definitions, Appendix B - Communications with Audit Committees Required by Other PCAOB Rules and Standards, and Appendix C - Matters Included in the Audit Engagement Letter. Appendix 2 to the release contains the transitional amendments to AU sec. 380. Appendix 3 contains amendments to other existing PCAOB standards. Appendix 4 provides additional discussion of AS 16, the amendments to other PCAOB standards, and comments received on the re-proposed standard. Appendix 5 to the release discusses certain significant differences between the objectives and requirements of AS 16 and the analogous standards of the International Auditing and Assurance Standards Board ("IAASB") and the Auditing Standards Board of the AICPA. In developing the standard, the Board considered the requirements of the relevant standards of the IAASB and the ASB.

The full text of Auditing Standard No. 16 (PCAOB Release No. 2012-004) is available at www.pcaobus.org

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