SEC OKs Auditor Role for Section 404

Newly approved standard will guide how auditors report on companies' assessments of their internal controls.
Stephen TaubJune 21, 2004

The Securities and Exchange Commission approved a new audit standard proposed by the Public Company Accounting Oversight Board for implementing Section 404 of the Sarbanes-Oxley Act.

On June 5, 2003, the SEC amended its rules to require that annual reports must include an assessment by management of companies’ internal control over financial reporting, accompanied by an auditor’s report. The auditing standard approved by the commission provides the professional standards and related performance guidance for independent auditors to attest to and report on that assessment.

For “accelerated filers” — U.S. companies with a market cap over $75 million that have filed annual reports with the SEC — the standard becomes effective with the first fiscal year ending on or after November 15. All other issuers, including small businesses and foreign private companies, must comply beginning with fiscal years ending on or after July 15, 2005.

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“The standard strikes an appropriate balance by providing sufficiently detailed guidance while, at the same time, allowing the auditor to exercise reasonable judgment,” said SEC Chief Accountant Donald Nicolaisen, in a statement. “This standard is an important part of a much broader effort by all parties — issuers, auditors and regulators — to strengthen our system of financial reporting.”

A significant aspect of the proposed standard is the requirement of the independent auditor to attest on two items.

The auditor must evaluate management’s assessment process to be satisfied that management has an appropriate basis for its conclusion. In addition, the auditor must test and evaluate both the design and the operating effectiveness of internal control to be satisfied that management’s conclusion is correct and, therefore, fairly stated.

The auditor’s report on internal control over financial reporting will express two opinions — an opinion on whether management’s assessment of the effectiveness of internal control over financial reporting as of the end of the most recent fiscal year is fairly stated, and an opinion on whether the company has maintained effective internal control over financial reporting as of that date.