The Securities and Exchange Commission (SEC) and the stock exchanges require that all listed companies have an audit committee of independent directors to appoint and oversee the work of the company’s auditor who must be registered with the Public Company Accounting Oversight Board (PCAOB). On August 15, 2012 the PCAOB adopted Auditing Standard No. 16 (AU 16), subject to SEC approval, which will apply to audits for fiscal years beginning on or after December 15, 2012. AU 16 will supersede AU sec. 310, Appointment of the Independent Auditor, and AU sec.380, Communication with Audit Committees.
AU 16 requires the auditor to communicate to the audit committee its responsibilities in conducting the audit and the terms of the audit engagement. The auditor is to obtain information from the audit committee relevant to the audit, and to inform the audit committee of its overall strategy and timing to conduct the audit. The auditor is also required to provide the audit committee with timely observations arising from the audit that are significant to the financial reporting process. AU 16 does not preclude auditors from providing additional information to the audit committee.
AU 16 requires that the company’s auditor report to the audit committee the following specified items:
Terms of the Audit:
The auditor is to establish an understanding of the terms of the audit engagement. This includes:
- the objective of the audit
- the responsibilities of the auditor
- the responsibilities of management
The terms of engagement must be documented in an engagement letter executed on behalf of the company
Obtain Information and Communicate the Audit Strategy
The auditor is to obtain information from the audit committee relevant to the audit, including, among others, if the committee is aware of any violations or possible violations of law by the company. The auditor is to advise the committee of its audit strategy and any significant risks identified during the auditor’s risk assessment procedures. The strategy includes the timing of the audit, the roles, responsibilities and location of firms participating in the audit and any planned use of the internal audit functions in auditing the company’s internal controls over financial reporting. If there are any significant changes to the planned strategy or significant risks not initially identified, the auditor is to report these to the audit committee and the reasons for such changes.
Results of the Audit
Before issuing its final report, the auditor is to report to the audit committee regarding matters that arise during the audit. These include:
- the company's critical accounting policies, practices and estimates
- critical accounting estimates
- significant unusual transactions not in the ordinary course of business or that otherwise appear to be unusual and the auditor's understanding of the business rationale for those transactions
- the auditor's evaluation of the quality of the company’s financial reporting
- the auditor's evaluation of the company's ability to continue as a going concern
- any difficulties the auditor encountered during the audit, such as significant delays by management or unreasonably brief time to complete the audit
Difficult or Contentious Matters for the Auditor Consulted
The auditor must report to the audit committee matters that are difficult or contentious for which the auditor consulted with personnel outside the engagement team and that are relevant to the audit committee’s oversight of the financial reporting process.
Disagreements with Management
The auditor must communicate to the audit committee disagreements with management about matters, whether or not satisfactorily resolved, that individually or in the aggregate could be significant to the company’s financial statements or the auditor’s report.
The auditor should communicate to the audit committee other matters arising from the audit that are significant to the oversight of the company’s financial reporting process.
Form and Documentation of Communications
The communications to the audit committee required by AU 16, other than the engagement letter, may be made orally or in writing. The auditor must retain in its work papers documentation of all oral communications. The engagement letter, by its terms, must be in writing.
All required communications must be made on a timely basis, and, in any event, before issuance of the auditor’s report. If in order that a communication be made in a timely manner during the audit, the auditor may report only to the audit committee chair.
JOBS Act Impact
The Jumpstart Our Business Startups Act requires that pronouncements of the PCAOB do not apply to emerging growth companies unless the SEC determines that to do so is in the public interest and necessary to protect the public. In announcing AU 16, the PCAOB said it would ask the SEC to make it applicable to emerging growth companies.