July 25, 2007
Audit Standard #5 and New Definitions Approved today by the SEC
The SEC had a web cast today and they were discussing several items that are important to public filers. The first item on the agenda was the approval of audit Standard No. 5. The second item on the agenda was the approval and addition to Regulation SX of definitions for significant deficiency and for material weakness as they appear in Audit Standard No. 5 and Sarbanes Oxley 404.
Chairman Cox as well as the other four commissioners were all present. The SEC staff was there in force. This was an important meeting for the SEC and the PC 80 b. The United States Congress is subjecting the SEC to a great deal of scrutiny right now. This is to to all of the uproar about Sarbanes Oxley 404.
Commissioner Atkins was probably the most outspoken of all the commissioners on his concerns about the new audit standard and the behavior of the public accounting firms as it relates to this new audit standard. He mentioned that he had recently seen a full-page ad in a newspaper by one of the Big Four accounting firms bragging about the fact that they had to record earnings and had done so for the last five years. He noted that this was interesting since the five-year anniversary of Sarbanes Oxley coincides with these record earnings.
He quoted a Chinese proverb that said " rotten wood cannot be carved". And he indicated that this was regarding Audit Standard No. 2 and he was glad to see go. Commissioner Atkins wanted a clean break with the past. He indicated that there should be no sitting back and relax and now that this tough job of creating Audit Standard No. 5 has been completed.
He indicated that his expectation would be that if Audit standards No. 5 does not work properly, then the PCAOB must fine-tune it. Commissioner Atkins indicated that he is in favor of a another delay of one year for smaller cap firms. He recommended a delay of Section 404 non-accelerated filers on paragraph be made for fiscal years ending on or after December 15, 2009.
He indicated that management and auditors should only work on material weaknesses not significant deficiencies. Significant deficiencies are important enough to merit attention but they should not be part of an overall public accounting audit. He registered concern about paragraph 30 of audit Standard No. 5 the question regarding what could go wrong? He asked for clarification about this from SEC staff.
The SEC staff indicated that paragraph 30 should be taken into the context of significant accounts only. It is in the context of significant accounts only and should be considered as likely sources of misstatements. This should help focus on what matters most stated the SEC staff. Further under the SEC management guidance for Section 404 registrants, management is not required to link assertions to significant accounts. The question of what could go wrong is most important regarding significant financial statement accounts and should focus the work management does in this direction.
Paragraph 29 qualitative and quantitative scoping are both very important per SEC staff. The SEC is working on more clarification in the area of materiality specifically around qualitative and quantitative scoping. A further comment was made concerning material weaknesses in paragraphs 69 and 70. This related to the fact that if a company has a misstatement of their financial reports this does not necessarily mean that there is a material weakness in internal control over financial reporting. This conclusion should be based on facts and circumstances by management and by auditors. Restatements or misstatements could be indicators of internal controls over financial reporting weaknesses but are not a definitive conclusion on their own.
Scoping is meant to be based on an annualized approach. Interim financial reporting is important as well of course. While interim reporting might have to disclose significant deficiencies or material weaknesses that could impact interim or annual financial reports. This is a change from the prior audit standard.
A question was asked why there were not going to be "bright lines" for defining small companies so that scaling of audits and by size of company could be done more easily. The SEC staff indicated that they did not want to have a " bright lines and " because this allows auditors to do more check box accounting and audits rather than scaling the audit appropriately to the particular company. Scaling the audit works for every size of company. This is the intent.
Commissioner Campos seemed very excited about the development of a framework to evaluate complex accounting matters which he believes Audit Standard No. 5 accomplishes. The SEC and the PCAOB have done everything promised. Guidelines and standards for management and auditors have been revised and adopted. Commissioner Campos is confident that Audit Standard No. 5 will help small companies comply and minimize material misstatements. It is principles based and will allow auditors to scale the audits are appropriately. Sarbanes Oxley 404 is a great protector of capital.
Audit Standard No. 5 is more principles based and appropriate as necessary. Commissioner Campos especially likes the fact that fraud risk is addressed in the planning stages of an audit. Audit Standard No. 5 provides examples on how to reduce fraud risk. A public company's 10 Q should disclose significant deficiencies in an interim statements. Public companies with fiscal years ending on or after November 15th can use the new audit Standard No. 5.
SEC Regulation S X which provides the new definitions for significant deficiencies and material weaknesses is effective August 27, 2007. Auditors can file a single opinion on or after August 27, 2007. SEC staff was asked by the commissioner if they thought the new Audit Standard No. 5 would be used as soon as possible. SEC staff indicated they believed that it would be used as soon as possible.
There was discussion about micro cap companies and specifically electronics companies and their ability to comply with this new standard. There was concern raised by some of the SEC staff that auditors for smaller public companies are not as up to speed as Big Four audit forms. There was advice to the PCAOB to help get smaller public audit firms up to speed on the new audit standard. The SEC staff further indicated the guidance for small companies for Section 404 section be will be in place prior to the smaller audits. Audit Standard #5 focuses on an integrated audit, the SEC staff indicated. The evidence from an internal control review feeds evidence back to the substantive audit and vice versa. Both sections of the integrated audit feed data back and forth to each other. This is both cost-effective and time effective.
Commissioner Nazareth indicated her support for the new audit Standard No. 5. She indicated that she was concerned about the SEC and PCAOB should be listening to data as it comes forth from the implementation of Audit Standard No. 5. She indicated that this would be important to success.
Commissioner Casey wanted to make sure that box checking audits were gone. She indicated her support for audit Standard No. 5 believing that this is been accomplished with this audit standard. She registered to register her concern for commenters wanting Audit Standard No. 5 to provide more guidance. The problem with more clarity she indicated is that the answers become more prescriptive and more rules based. Audit Standard No. 5 is more principles based and is meant to be.
Commissioner Casey asked whether these SEC staff were sure that they had eliminated the right opinion from the auditors. In Audit Standard No. 2 there were two audit opinions required. The auditors had to attest to the effectiveness of central controls over financial reporting for a registrant as well as to test or opine as to the effectiveness of a registrant's process for evaluating its internal control over financial reporting. This was ineffective and expensive.
The SEC staff assured commissioner Casey that the correct opinion had been retained. Indications were that it does not make a lot of sense to opine on a process that management used to determine its process for determining the process used for determining the effectiveness over interim control over financial reporting, but rather to opine on the effectiveness of internal control over financial reporting itself. This assures investor confidence and that the risk of misstatements and fraud are reduced.
The new Audit Standard No. 5 seeks to evaluate high risk controls only and test them for effectiveness.
Commissioner Casey further asked that if Audit Standard No. 5 does not produce the efficiencies that she expects, what will you do to assure that it is efficient? The SEC staff indicated that they would monitor the effectiveness of Audit Standard No. 5, but it was difficult to answer the question when there was no evidence to support at this time whether the new audit standard was effective or not.
Commissioner Casey further asked about the ability of small companies to apply management guidance and could the SEC be available for answers for small companies? The SEC staff indicated that they are currently available to answer small-company questions and further, June of 2006, the Committee of sponsoring organizations or COSO had developed a standard for small companies. The SEC is further working on a brochure to provide guidance and it is supposed to be a user friendly document that will help small companies confronting how to perform their 404 a valuation.
Following commissioner Casey's questions, Christopher Cox took the floor back and requested a vote on the two items that were before the commission. The first item to be approved by the commission was Audit Standard No. 5.
The commissioners were in favor of the Audit Standard No. 5.
The second item on the agenda was to amend regulations SX which will now contain the new definitions for significant deficiencies and material weaknesses which will be in both SEC regulations and in Audit Standard No. 5.
This now synchs up the PCAOB Audit Standard #5 with the SEC management guidance for Sarbanes Oxley Section 404. All commissioners approved this item as well.
While two commissioners requested delays of the Section 404 for smaller companies, this was not approved so at this time the deadlines are in place as is.
If your company has to comply with SOX 404 or NI 52-109, and wants to do it in a sensible and cost effective way, contact http://www.issuescentral.com/ for more information on Compliance Playbook® for companies based outside of Canada. For Canadian based companies, see http://www.compliancepartner.ca/ for more information on Compliance Partner™ from Thomson Carswell.
Chairman Cox as well as the other four commissioners were all present. The SEC staff was there in force. This was an important meeting for the SEC and the PC 80 b. The United States Congress is subjecting the SEC to a great deal of scrutiny right now. This is to to all of the uproar about Sarbanes Oxley 404.
The overview of the meeting is as follows: There used to be no guidance for management regarding their section 404 A and D filings. Under audit Standard No. 2 public accounting firms had to attest to the process that the registrants used for the evaluation of internal controls over financial reporting as well as the effectiveness of the internal controls over financial reporting.
The new Audit Standard No. 5 has been designed to eliminate some of the cost associated with Audit Standard No. 2, as well as allowing Audit Standard #5 to scale more appropriately for smaller public companies. The SEC noted in this web cast that the number of comments for Audit Standard No. 5 from the public, was down substantially from the comments received previously for Audit Standard No. 2 specifically.
Specifically Audit Standard No. 5 had 80% fewer comments for current draft of Audit Standard No. 5 compared to when it was first posted in December 2006. They believed this means the market is more "content" with this new audit standard.
Commissioner Cox was eloquent and articulate as usual and seemed actually quite excited to get this audit standard and the definitions approved. In watching the web cast it was apparent that there were not many people present in the room from the public to listen to the meeting live. One would assume that the audience was largely on vacation and listening from afar. Certainly this topic is very important to both public accounting firms and publicly traded firms.Commissioner Atkins was probably the most outspoken of all the commissioners on his concerns about the new audit standard and the behavior of the public accounting firms as it relates to this new audit standard. He mentioned that he had recently seen a full-page ad in a newspaper by one of the Big Four accounting firms bragging about the fact that they had to record earnings and had done so for the last five years. He noted that this was interesting since the five-year anniversary of Sarbanes Oxley coincides with these record earnings.
He quoted a Chinese proverb that said " rotten wood cannot be carved". And he indicated that this was regarding Audit Standard No. 2 and he was glad to see go. Commissioner Atkins wanted a clean break with the past. He indicated that there should be no sitting back and relax and now that this tough job of creating Audit Standard No. 5 has been completed.
He indicated that his expectation would be that if Audit standards No. 5 does not work properly, then the PCAOB must fine-tune it. Commissioner Atkins indicated that he is in favor of a another delay of one year for smaller cap firms. He recommended a delay of Section 404 non-accelerated filers on paragraph be made for fiscal years ending on or after December 15, 2009.
He indicated that management and auditors should only work on material weaknesses not significant deficiencies. Significant deficiencies are important enough to merit attention but they should not be part of an overall public accounting audit. He registered concern about paragraph 30 of audit Standard No. 5 the question regarding what could go wrong? He asked for clarification about this from SEC staff.
The SEC staff indicated that paragraph 30 should be taken into the context of significant accounts only. It is in the context of significant accounts only and should be considered as likely sources of misstatements. This should help focus on what matters most stated the SEC staff. Further under the SEC management guidance for Section 404 registrants, management is not required to link assertions to significant accounts. The question of what could go wrong is most important regarding significant financial statement accounts and should focus the work management does in this direction.
Paragraph 29 qualitative and quantitative scoping are both very important per SEC staff. The SEC is working on more clarification in the area of materiality specifically around qualitative and quantitative scoping. A further comment was made concerning material weaknesses in paragraphs 69 and 70. This related to the fact that if a company has a misstatement of their financial reports this does not necessarily mean that there is a material weakness in internal control over financial reporting. This conclusion should be based on facts and circumstances by management and by auditors. Restatements or misstatements could be indicators of internal controls over financial reporting weaknesses but are not a definitive conclusion on their own.
Scoping is meant to be based on an annualized approach. Interim financial reporting is important as well of course. While interim reporting might have to disclose significant deficiencies or material weaknesses that could impact interim or annual financial reports. This is a change from the prior audit standard.
A question was asked why there were not going to be "bright lines" for defining small companies so that scaling of audits and by size of company could be done more easily. The SEC staff indicated that they did not want to have a " bright lines and " because this allows auditors to do more check box accounting and audits rather than scaling the audit appropriately to the particular company. Scaling the audit works for every size of company. This is the intent.
Commissioner Campos seemed very excited about the development of a framework to evaluate complex accounting matters which he believes Audit Standard No. 5 accomplishes. The SEC and the PCAOB have done everything promised. Guidelines and standards for management and auditors have been revised and adopted. Commissioner Campos is confident that Audit Standard No. 5 will help small companies comply and minimize material misstatements. It is principles based and will allow auditors to scale the audits are appropriately. Sarbanes Oxley 404 is a great protector of capital.
Audit Standard No. 5 is more principles based and appropriate as necessary. Commissioner Campos especially likes the fact that fraud risk is addressed in the planning stages of an audit. Audit Standard No. 5 provides examples on how to reduce fraud risk. A public company's 10 Q should disclose significant deficiencies in an interim statements. Public companies with fiscal years ending on or after November 15th can use the new audit Standard No. 5.
SEC Regulation S X which provides the new definitions for significant deficiencies and material weaknesses is effective August 27, 2007. Auditors can file a single opinion on or after August 27, 2007. SEC staff was asked by the commissioner if they thought the new Audit Standard No. 5 would be used as soon as possible. SEC staff indicated they believed that it would be used as soon as possible.
There was discussion about micro cap companies and specifically electronics companies and their ability to comply with this new standard. There was concern raised by some of the SEC staff that auditors for smaller public companies are not as up to speed as Big Four audit forms. There was advice to the PCAOB to help get smaller public audit firms up to speed on the new audit standard. The SEC staff further indicated the guidance for small companies for Section 404 section be will be in place prior to the smaller audits. Audit Standard #5 focuses on an integrated audit, the SEC staff indicated. The evidence from an internal control review feeds evidence back to the substantive audit and vice versa. Both sections of the integrated audit feed data back and forth to each other. This is both cost-effective and time effective.
Commissioner Nazareth indicated her support for the new audit Standard No. 5. She indicated that she was concerned about the SEC and PCAOB should be listening to data as it comes forth from the implementation of Audit Standard No. 5. She indicated that this would be important to success.
Commissioner Casey wanted to make sure that box checking audits were gone. She indicated her support for audit Standard No. 5 believing that this is been accomplished with this audit standard. She registered to register her concern for commenters wanting Audit Standard No. 5 to provide more guidance. The problem with more clarity she indicated is that the answers become more prescriptive and more rules based. Audit Standard No. 5 is more principles based and is meant to be.
Commissioner Casey asked whether these SEC staff were sure that they had eliminated the right opinion from the auditors. In Audit Standard No. 2 there were two audit opinions required. The auditors had to attest to the effectiveness of central controls over financial reporting for a registrant as well as to test or opine as to the effectiveness of a registrant's process for evaluating its internal control over financial reporting. This was ineffective and expensive.
The SEC staff assured commissioner Casey that the correct opinion had been retained. Indications were that it does not make a lot of sense to opine on a process that management used to determine its process for determining the process used for determining the effectiveness over interim control over financial reporting, but rather to opine on the effectiveness of internal control over financial reporting itself. This assures investor confidence and that the risk of misstatements and fraud are reduced.
The new Audit Standard No. 5 seeks to evaluate high risk controls only and test them for effectiveness.
Commissioner Casey further asked that if Audit Standard No. 5 does not produce the efficiencies that she expects, what will you do to assure that it is efficient? The SEC staff indicated that they would monitor the effectiveness of Audit Standard No. 5, but it was difficult to answer the question when there was no evidence to support at this time whether the new audit standard was effective or not.
Commissioner Casey further asked about the ability of small companies to apply management guidance and could the SEC be available for answers for small companies? The SEC staff indicated that they are currently available to answer small-company questions and further, June of 2006, the Committee of sponsoring organizations or COSO had developed a standard for small companies. The SEC is further working on a brochure to provide guidance and it is supposed to be a user friendly document that will help small companies confronting how to perform their 404 a valuation.
Following commissioner Casey's questions, Christopher Cox took the floor back and requested a vote on the two items that were before the commission. The first item to be approved by the commission was Audit Standard No. 5.
The commissioners were in favor of the Audit Standard No. 5.
The second item on the agenda was to amend regulations SX which will now contain the new definitions for significant deficiencies and material weaknesses which will be in both SEC regulations and in Audit Standard No. 5.
This now synchs up the PCAOB Audit Standard #5 with the SEC management guidance for Sarbanes Oxley Section 404. All commissioners approved this item as well.
While two commissioners requested delays of the Section 404 for smaller companies, this was not approved so at this time the deadlines are in place as is.
If your company has to comply with SOX 404 or NI 52-109, and wants to do it in a sensible and cost effective way, contact http://www.issuescentral.com/ for more information on Compliance Playbook® for companies based outside of Canada. For Canadian based companies, see http://www.compliancepartner.ca/ for more information on Compliance Partner™ from Thomson Carswell.
