AS2, 404: Up for Debate at Year End?

Revisions to Auditing Standard No. 2 and new SEC guidance for Section 404 could be ready for public comment by December.
Sarah JohnsonOctober 17, 2006

The Securities and Exchange Commission and the Public Company Accounting Oversight Board may simultaneously ask for public feedback regarding two controversial standards later this year.

The SEC has been developing management guidance for Sarbanes-Oxley’s Section 404. The commission will hear its staff’s recommendations for the internal-control provision during a December 13 open meeting, which will turn over the issue for public comment, says SEC spokesman John Nester.

Meanwhile, the PCAOB, which oversees the auditing profession, plans to propose a new version of Auditing Standard No. 2 later this fall. It has shared an informal draft of the changes with its overseer, the SEC, as reported last month. The PCAOB has not yet made the revisions public but does expect to eventually release a final draft for 60 days of public comment.

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PCAOB president Mark Olson is hoping these public comment periods can overlap “because there is great deal of value in these two initiatives being available for public consideration concurrently,” he said during a speech on Tuesday.

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

More than half of finance chiefs, controllers, and internal auditors mainly rely on AS2 for complying with Section 404, according to an Institute of Management Accountants survey, rather than the 1992 Internal Control Integrated Framework (COSO). COSO provides guidance for managers and external auditors in assessing a corporation’s internal controls. And managers and auditors have continually asked that the SEC provide more guidance on how to complete their assessment of internal controls over financial reporting.

Since PCAOB implemented AS2 nearly two years ago, it’s been a hot topic among government and corporate officials, according to Olson. Earlier this month, the PCAOB’s chief auditor announced that revising AS2 is its highest priority.

During his speech, Olson said the revised standard will encourage auditors to focus “on what really matters, which is identifying material weaknesses in a company’s system of internal control before those weaknesses result in material misstatements in the company’s published financial statements.”

The new standard will be easier to understand and tailored to scale, keeping auditors focused only on areas of “greatest importance,” Olson said at the National Association of Corporate Directors’ annual corporate governance conference. The PCAOB also plans to evaluate every area of audits to determine whether auditors do unnecessary work.

The AS2 revisions will be available for public comment once the PCAOB makes its final approvals, says PCAOB spokesman Michael Shore. After the board reviews the comments, makes subsequent changes, and gets final approval, the changes will go through the SEC process. The commissions work will likely involve another public comment period.

Several CEOs of public companies have told Olson, who became the PCAOB’s leader in July, that their companies have improved in the past three years from implementing the government’s internal control framework. But “virtually all also believe that the incremental cost to date has exceeded the incremental benefit,” Olson said. “In my opinion, this underscores the need for the PCAOB to take another look, and build into its standard clearer guidance regarding efficient, risk-based, scalable implementation.”