PCAOB Proposes Significant Changes to Audit Standards

Amy Goodman is a partner and co-chair of the Securities Regulation and Corporate Governance practice group at Gibson, Dunn & Crutcher LLP. The following post is based on a Gibson Dunn alert by Ms. Goodman and Michael J. Scanlon.

Today, the Public Company Accounting Oversight Board (“PCAOB”) proposed for public comment two audit standards that, if adopted, would significantly change the audit report model, and dramatically expand the auditor’s responsibilities in reporting on management’s disclosures outside the financial statements. PCAOB Chairman Doty remarked that the proposed standards—running to almost 300 pages—mark a “watershed moment” for auditing in the United States.

The first proposal—The Auditor’s Report on an Audit of Financial Statements—moves well beyond the traditional audit report and would require the following additional statements:

  • Disclosure of “critical audit matters” encountered by the auditor during the course of the audit. Critical audit matters are defined in the proposal as those matters that involved the most difficult, subjective, and complex auditor judgments; posed the most difficulty to the auditor in obtaining audit evidence; or posed the most difficulty to the auditor in forming an opinion regarding the financial statements. The proposal states that critical audit matters will be determined based on the facts and circumstances of each audit and it is anticipated that in most audits the auditor would identify critical audit matters. In those limited circumstances where the auditor concludes there are no critical audit matters, the auditor would have to document this conclusion in its workpapers.
  • Disclosure of the standards that require the auditor to maintain its independence from the issuer, and identification of the year in which the auditor began its tenure with the company.
  • Disclosure of the auditor’s responsibilities for evaluation of information in annual reports filed with the SEC beyond that contained in the financial statements and audit report, and a statement about the results of the auditor’s evaluation. This aspect of the first proposal bootstraps in what is likely to be one of the key flashpoints from the second proposal, discussed below.

The second proposal—The Auditor’s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and the Related Auditor’s Report—would take the auditor and issuer into unchartered territory, requiring the auditor to report on “other information” included in annual reports filed with the SEC under the Securities Exchange Act of 1934. The proposal observes that the PCAOB’s current standards require the auditor to “read and consider” information contained in certain filings, but there is no current reporting obligation related to these requirements. The proposal sets out to extend the auditor’s responsibilities for reporting by noting that the other information would include, among other items, the selected financial information, MD&A, exhibits and other information incorporated by reference into the filing. The proposal then includes specific procedures the auditor would have to apply in evaluating the other information based on relevant audit evidence obtained and conclusions reached during the audit. Once these procedures are applied, the auditor would have to evaluate whether any of the other information contains a material misstatement of fact, or a material inconsistency, with the amounts or information, or the manner of presentation, in the audited financial statements. As noted above, the audit report then has to include a statement as to whether the auditor identified a material inconsistency or a material misstatement of fact in the other information.

The PCAOB’s proposals raise issues that could have significant impacts on the conduct of audits and disclosures required in issuer filings—including, among others, impacts on the auditor-Audit Committee-management relationship, disclosures of matters that are otherwise resolved through the audit process (e.g., significant deficiency v. material weakness determinations, internal investigations, etc.), timing for filings and completion of the audit, and costs. Indeed, PCAOB Members Ferguson, Franzel, and Hanson—although supporting issuance of the proposals—raised numerous questions and concerns regarding various aspects of the proposals. One Board Member also noted that the proposals are likely to lead to roundtables, and even to re-proposals before the adoption of any final standards.

We encourage issuers to review the proposal and consider commenting in light of the dramatic changes proposed. Comments are due on the proposals on December 11, 2013.

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