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Rewriting AS2 Tops PCAOB's To-Do List

The PCAOB's top priority is its revision of AS2, the controversial auditing standard blamed for soaring Sarbanes-Oxley 404 compliance costs. The board also plans to re-examine how auditors assess risk.
Sarah Johnson, CFO.com | US
October 5, 2006

Revising the controversial Auditing Standard No. 2 is the highest priority on the Public Company Accounting Oversight Board's list of standard-setting projects, its chief auditor said today.

As CFO.com reported last month, the PCAOB recently submitted a draft of changes to AS2 to the Securities and Exchange Commission. The proposed changes reportedly fix what the PCAOB considers confusing definitions and clarify that auditors do not need to evaluate how CFOs come up with their assessments of internal controls.

The PCAOB, which oversees the auditing profession, is also working on guidance for how auditors of small public companies implement AS2, said PCAOB chief auditor Thomas Ray during Tuesday's annual Standard Advisory Group meeting. He expects the board's work on AS2 to take up "a considerable portion of our resources over the next 12 months," he said.

AS2 has been criticized because auditors, who use it to audit a company's internal controls over financial reporting, appear to use it too conservatively. At the same time, companies that used AS2 as a default framework to prepare for such audits appear to have done far more work than necessary.

The PCAOB tinkered with how "significant deficiency" and "material weakness" are defined, for example, to clarify where control holes, if any, lie. And the board has attempted to explain that materiality for an internal control audit and the audit of financial statements are the same concept, even though many have assumed AS2 mandates should be separate.

The PCAOB has not yet made the informal draft of revisions public but does expect to eventually release it for 60 days of public comment. "For the AS2 revisions, sooner is better than later. We're anxious to see where that's going," said Nick Cyprus, a consultant and former controller who sits on the advisory group.

In addition to its AS2 at revisions, PCAOB has three other priorities for its 2007 standards-setting activities:

• Review principles of reporting: In the wake of the Financial Accounting Standards Board's Statement No. 154, regarding accounting changes and error corrections, the PCAOB may revise its guidance to auditors so that auditors are following the same rules as issuers. The PCAOB would also remove from its rules the GAAP hierarchy — that is, the relative authority of accounting pronouncements and opinions issued by different bodies over the years — if FASB follows through on its plan to incorporate the GAAP hierarchy into accounting standards.

• Set a requirement for engagement quality review: Section 103 of the Sarbanes-Oxley Act requires audit firms to have a "concurring or second partner" review audit work, and the PCAOB is setting a standard for the conduct of this review.

• Reevaluate the auditor's risk assessment process: the board will look into integrating the auditors' fraud risk assessment with their overall risk assessment. One of most persistent company complaints about the cost of 404 was that auditors indiscriminately tested controls, regardless of risk. The PCAOB is also evaluating the recently revised standards put out by the International Auditing and Assurance Standards Board and the U.S. Auditing Standards Board regarding the auditor's risk assessment process.

The PCAOB also listed three projects that are lower on its priorities list. Work on these projects will begin next year:

• Reevaluate how auditors identify related parties and related-party transactions. After Enron exposed the danger of related party transactions, FASB released Fin 46 and Fin 46R, creating a multi-step test for identifying related parties. It is an area that has proven challenging for companies, and apparently their auditors feel the same. Ray noted that "auditors sometimes rely primarily on management and the company's principal owners to identify related-parties and related-party transactions."

• Take another look at confirmation standards: PCAOB plans to address the way auditors corroborate a company's account balances and transactions with third parties. For example, the board may answer the questions of what should auditors do if management asks them not to confirm. And how should auditors authenticate electronic confirmation responses?

• Look into how auditors use specialists' work as evidential matter.

The PCAOB also removed several items from its priorities list:

• Setting a standard for how auditors and auditor committees communicate. Ray noted that "auditors do not seem to be having trouble identifying matters that must be communicated to audit committees."

• Reevaluating interim quality control standards for firms.

• Evaluating how PCAOB's standards are organized and defining the authority of certain interim standards.

Some members of the advisory group requested that the PCAOB put fair value accounting high on its priority list, particularly because of FASB's new standard on fair value measurements, FASB Statement No. 157. "It is important to look at that accounting guidance and fully digest it," said Gerald Edwards, the senior adviser on accounting and auditing policy for the Financial Stability Forum.


Ray emphasized that guidance on fair value of accounting is abundant, but PCAOB will assess whether it should add to the standards pile and submit its own guideline.




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