Investment Company Notebook

Practical insight and analysis on the accounting, audit and tax issues impacting investment companies.

PCAOB Issues New Standard for Auditor Communications With Audit Committees: What You Need To Know

Effective two-way communication between audit committees and external auditors is an integral part of the audit process. Such communications improve the ability of the audit committee to provide oversight and provide an opportunity for the auditors to discuss relevant matters with a forum other than management. These types of communications are essential to a high quality audit.

The Public Company Accounting Oversight Board ("PCAOB”) has recognized the importance of this topic with the recent adoption of Auditing Standard No. 16, Communications with Audit Committees (“AS 16”). The new standard, currently pending SEC approval, is designed to improve the existing communication requirements of other PCAOB standards, incorporate SEC communication requirements, and create new requirements in an effort to better inform audit committees.

Enhancements of previous communication requirements include the discussion of:

  • Matters relating to the company’s accounting policies and practices. Requirements have been expanded to include reasons why certain accounting policies and practices are considered critical.
  • Estimates made by management and the process used to develop these estimates. Requirements have been expanded to include significant changes to the process used by management to develop estimates, reasons for the changes, and the effects on the financial statements.
  • The auditor’s judgment about the quality of the entity’s financial reporting. Requirements have been expanded to include auditor’s evaluation of, and conclusions about, the qualitative aspects of the company’s significant accounting policies and practices. Auditors should also discuss significant unusual transactions and their opinion on the business rationale thereof.
  • Whether the committee is aware of matters relevant to the audit including, but not limited to, violations or potential violations of laws or regulations. This complements other standards relating to inquiry of fraud risks.

AS 16 creates additional communication requirements aimed at providing audit committees with further information relevant to the audit. Many of these relate to procedures already performed by auditors, but that were not specifically required to be communicated. These additions include:

  • An overview of the overall audit strategy including the significant risks identified by the auditor. While audit planning and risk assessment have been required to be performed by auditors, comprehensive communication of the results was not mandatory. In addition, auditors must communicate changes to the audit strategy, specialized skills needed, and the basis for the auditor’s determination that they can serve as principal auditor.
  • Establish an understanding of the terms of the engagement with the audit committee and record such terms in the engagement letter. Previously, written communication was preferred – not required. AS 16 also specifies that the understanding must be established with the audit committee, rather than the “client.”
  • Discuss difficult or contentious matters for which the auditor consulted persons outside the engagement team. There are complex or unusual scenarios that an auditor decides to discuss with other firm personnel, industry specialists, or other external parties. Auditors are now required to inform the audit committee if such consultations occur when they are relevant to the audit committee’s oversight.
  • Discuss the nature and extent of the involvement of "other persons not employed by the auditor." This should be communicated in connection with the overall audit strategy and must include specifics regarding third parties, company personnel, and other independent public accounting firms involved in the audit.
  • Other matters pertinent to the audit committee's oversight role including a schedule and discussion of uncorrected and corrected misstatements, disagreements with management, and other situations or difficulties encountered during the audit. These are various subtle additions to previously required communications.

In order for communications to be most effective, they should occur in a timely manner throughout the audit engagement. The seamless flow of two-way dialogue between auditor and audit committee during the entire process allows everyone to respond and adjust accordingly. In fact, AS 16 states that all of the required communications must take place prior to issuing the auditor's report. However, there is an exception for a registered investment company that is consistent with Rule 2-07 of SEC Regulation S-X. While annual communications are required, if they do not occur within 90 days prior to the issuance of the audit report, then the auditor should update the audit committee within the 90-day window.

While in the past communications between auditor and audit committee have been deemed an incidental part of the audit process, it is now recognized as an essential and required aspect of an effective and efficient audit. A company's audit committee is the primary link between the Board of Directors, management, and the independent auditors. Improving communication among these parties will play a vital role in improving the overall value of the audit for all stakeholders.