Statement on Auditing Standard Related to Communications with Audit Committees 

Mr. Chairman, I support the Board´s adoption of Auditing Standard No. 16 (AS No. 16) and the related amendments on Communications with Audit Committees. I believe this standard will benefit investors because it strengthens the audit committee´s oversight function by clarifying the types and timing of communications an auditor is required to make to the audit committee.

Justifying a New Standard

AS No. 16 replaces two standards that, until now, defined the relationship between auditors and the audit committees.  These standards were adopted prior to the passage of the Sarbanes-Oxley Act, when corporate management of a listed company typically hired, retained and had oversight of the work of the auditor.  In those days, the audit committee served a less prominent role.

During the testimony that led to the passage of the Sarbanes-Oxley Act, however, Congress heard reports of clear conflicts of interest that led to financial reporting failures by, among others, corporate management and a self-regulated auditing profession.  Congress also heard reports of weak audit committees and ineffective oversight of companies´ financial reporting processes.  Investors and employees bore the ultimate cost of these failures in lost jobs, lost investments, lost pensions, and lost confidence in our country´s securities  markets.

The Sarbanes-Oxley Act addressed these conflicts and failures in a variety of ways, including strengthening audit committees by making them independent of management. The Act also made clear the need for timely, consistent and substantive communications between auditors and audit committees. 

The original standards being replaced today simply do not reflect the responsibilities and communication requirements of auditors and audit committees following the enactment of the Sarbanes-Oxley Act.  For example, they refer to communications by an auditor to an audit committee as merely "incidental" to the audit, and not required before the auditor´s report is issued. 

The Act makes clear that communications of matters that may pose significant risks for the company are a necessary part of an effective audit and effective audit committee oversight.  AS 16 requires auditors to communicate the audit strategy and results of the audit in a timely manner, before the report is completed.  This enables the auditor and audit committee to take appropriate action to address the matters discussed.   

The need for improved communications between auditors and audit committees has only grown since the Act was passed in 2002.  Given today´s economic environment, it is vitally important that auditors and audit committees be fully informed about matters that may affect the assumptions, estimates, events, and conditions reflected in a company´s financial reports.  The standards we are considering today are designed to assist in achieving that goal.

Investor Benefits

The ultimate beneficiaries of these standards are investors, as better informed audit committees and auditors should enhance both the quality of the audit and the audit committee´s oversight of financial reporting.  Though this standard includes a number of requirements that should directly benefit investors, I would like to highlight three in particular.

First, this standard requires auditors to communicate significant unusual transactions to the audit committee on a timely basis. Auditors will be required to explain their understanding of the business rationale for such transactions. Communication between the auditor and the audit committee will allow the audit committee to gain insight and take appropriate actions, if necessary, to address the financial statement or disclosure impact of these transactions.

Second, this standard requires the auditor to communicate to the audit committee its opinion on the company´s ability to continue as a going concern. Such communications benefit investors because they bolster the independent audit committee´s role in overseeing the company´s financial reporting process. 

Third, this standard requires the auditor to inform the audit committee of the auditor´s plans to use other firms to perform required audit procedures. This provision is particularly important in today´s business environment where key segments of many audits are conducted in isolated locations around the world.

Knowing that another firm is performing that work may lead to additional questions from the audit committee about the quality of the work performed and, possibly, whether that firm´s work has been inspected by the PCAOB.
Finally, this standard encourages robust, two-way communications between the auditor and audit committee which should improve the quality and integrity of the audit.

As the Board made clear recently in its release titled "Information for Audit Committees about the PCAOB Inspection Process," any "full and frank" discussion between auditors and audit committees also should include a review of the firms´ PCAOB inspection reports.  Those inspection reports, combined with the new communications required by this standard, should further enhance the role of the independent audit committee, and thereby benefit investors. 

Cost vs. Benefit

This standard, in my view, updates and improves the prior standard. But the Board´s analysis obviously cannot stop there. The remaining question is – at what cost?

I believe that the costs associated with this standard are likely to be minimal because AS No. 16 focuses on communicating the results of audit procedures that the auditor is already required to perform. In addition, the communications under this standard can be ‘scaled´ up or down to fit the size and complexity of the company being audited. 

The value to investors of this improved two-way dialogue, while not easily quantifiable, seems clear. An informed audit committee will be in a much better position to execute its responsibilities to oversee the financial reporting process, more effectively manage the auditor relationship, and enhance investor protection by helping to ensure the integrity of the financial statements.  And, a better informed auditor should perform a more effective audit.

Before closing I would like to state that, as a general proposition, I believe that targeted regulation is key to effectively balancing the costs of improving audit quality with the benefits of protecting investors. With this in mind, I believe we must continue to work to explicitly design our standards to address clearly defined problems and known areas of weakness in the audit process and, to the extent possible, make them shorter and less complex. I believe that AS No. 16 is a step in the right direction.

Closing

I would also like to recognize the work done by Jennifer Rand, Jessica Watts, Hasnat Ahmad and Karen Burgess under the direction of our Chief Auditor, Marty Baumann, as well as Bob Burns and Nina Mojiri-Azad from our General Counsel´s office.