Document ID: SEC-2012-1528-0001
Agency: sec
Document Type: Notice
Title: Public Company Accounting Oversight Board; Auditing Standards: Communications with Audit Committees and Related and Transitional Amendments to Standards
Posted Date: 2012-09-17T04:00Z

[Federal Register Volume 77, Number 180 (Monday, September 17, 2012)]
[Notices]
[Pages 57407-57449]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-22632]

[[Page 57407]]

Vol. 77

Monday,

No. 180

September 17, 2012

Part IV

Securities and Exchange Commission

-----------------------------------------------------------------------

Public Company Accounting Oversight Board; Notice of Filing of Proposed 
Rules on Auditing Standard No. 16, Communications With Audit Committees 
and Related and Transitional Amendments to PCAOB Standards; Notice

  Federal Register / Vol. 77, No. 180 / Monday, September 17, 2012 / 
Notices  

[[Page 57408]]

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-67807; File No. PCAOB-2012-001]

Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Rules on Auditing Standard No. 16, Communications With Audit 
Committees and Related and Transitional Amendments to PCAOB Standards

September 10, 2012.

    Pursuant to Section 107(b) of the Sarbanes-Oxley Act of 2002 (the 
``Sarbanes-Oxley Act''), notice is hereby given that on August 28, 
2012, the Public Company Accounting Oversight Board (the ``Board'' or 
the ``PCAOB'') filed with the Securities and Exchange Commission (the 
``Commission'' or ``SEC'') the proposed rules described in items I and 
II below, which items have been prepared by the Board. The Commission 
is publishing this notice to solicit comments on the proposed rules 
from interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rules

    On August 15, 2012, the Board adopted Auditing Standard No. 16, 
Communications with Audit Committees, related amendments to its interim 
auditing standards, and transitional amendments to AU sec. 380, 
Communication with Audit Committees, (collectively, ``the proposed 
rules''). The text of the proposed rules is set out below.

Auditing Standard No. 16

Communications With Audit Committees
Introduction
    1. This standard requires the auditor to communicate with the 
company's audit committee \1\ regarding certain matters related to the 
conduct of an audit \2\ and to obtain certain information from the 
audit committee relevant to the audit. This standard also requires the 
auditor to establish an understanding of the terms of the audit 
engagement with the audit committee and to record that understanding in 
an engagement letter.
---------------------------------------------------------------------------

    \1\ Terms defined in Appendix A, Definitions, are set in 
boldface type the first time they appear.
    \2\ For purposes of this standard, an audit is either an audit 
of internal control over financial reporting that is integrated with 
an audit of financial statements or an audit of financial statements 
only.
---------------------------------------------------------------------------

    2. Other Public Company Accounting Oversight Board (``PCAOB'') 
rules and standards identify additional matters to be communicated to a 
company's audit committee (see Appendix B). Various laws or regulations 
also require the auditor to communicate certain matters to the audit 
committee.\3\ The communication requirements of this standard do not 
modify or replace communications to the audit committee required by 
such other PCAOB rules and standards, and other laws or regulations. 
Nothing in this standard precludes the auditor from communicating other 
matters to the audit committee.
---------------------------------------------------------------------------

    \3\ See e.g., Section 10A(k) of the Securities Exchange Act of 
1934 (``Exchange Act''), 15 U.S.C. 78j-1(k); Rule 2-07 of Regulation 
S-X, 17 CFR 210.2-07; and Rule 10A-3 under the Exchange Act, 17 CFR 
240.10A-3.
---------------------------------------------------------------------------

Objectives
    3. The objectives of the auditor are to:
    a. Communicate to the audit committee the responsibilities of the 
auditor in relation to the audit and establish an understanding of the 
terms of the audit engagement with the audit committee;
    b. Obtain information from the audit committee relevant to the 
audit;
    c. Communicate to the audit committee an overview of the overall 
audit strategy and timing of the audit; and
    d. Provide the audit committee with timely observations arising 
from the audit that are significant to the financial reporting process.

    Note:  ``Communicate to,'' as used in this standard, is meant to 
encourage effective two-way communication between the auditor and 
the audit committee throughout the audit to assist in understanding 
matters relevant to the audit.

Appointment and Retention
Significant Issues Discussed With Management in Connection With the 
Auditor's Appointment or Retention
    4. The auditor should discuss with the audit committee any 
significant issues that the auditor discussed with management in 
connection with the appointment or retention of the auditor, including 
significant discussions regarding the application of accounting 
principles and auditing standards.
Establish an Understanding of the Terms of the Audit
    5. The auditor should establish an understanding of the terms of 
the audit engagement with the audit committee. This understanding 
includes communicating to the audit committee the following:
    a. The objective of the audit;
    b. The responsibilities of the auditor; and
    c. The responsibilities of management.
    6. The auditor should record the understanding of the terms of the 
audit engagement in an engagement letter and provide the engagement 
letter to the audit committee annually. The auditor should have the 
engagement letter executed by the appropriate party or parties on 
behalf of the company.\4\ If the appropriate party or parties are other 
than the audit committee, or its chair on behalf of the audit 
committee, the auditor should determine that the audit committee has 
acknowledged and agreed to the terms of the engagement.
---------------------------------------------------------------------------

    \4\ Absent evidence to the contrary, the auditor may rely on the 
company's identification of the appropriate party or parties to 
execute the engagement letter.

    Note:  Appendix C describes matters that the auditor should 
include in the engagement letter about the terms of the audit 
---------------------------------------------------------------------------
engagement.

    7. If the auditor cannot establish an understanding of the terms of 
the audit engagement with the audit committee, the auditor should 
decline to accept, continue, or perform the engagement.
Obtaining Information and Communicating the Audit Strategy
Obtaining Information Relevant to the Audit
    8. The auditor should inquire of the audit committee about whether 
it is aware of matters relevant to the audit,\5\ including, but not 
limited to, violations or possible violations of laws or 
regulations.\6\
---------------------------------------------------------------------------

    \5\ In addition to this inquiry, paragraphs 5.f. and 54-57 of 
Auditing Standard No. 12, Identifying and Assessing Risks of 
Material Misstatement, describe the auditor's inquiries of the audit 
committee, or equivalent (or its chair) regarding the audit 
committee's knowledge of the risks of material misstatement, 
including fraud risks. These inquiries include, among other things, 
whether the audit committee is aware of tips or complaints regarding 
the company's financial reporting.
    \6\ See AU sec. 317, Illegal Acts by Clients, for a description 
of the auditor's responsibilities when a possible illegal act is 
detected. For audits of issuers, see also Section 10A(b) of the 
Exchange Act, 15 U.S.C. 78j-1(b), and Rule 10A-1 under the Exchange 
Act, 17 CFR 240.10A-1.
---------------------------------------------------------------------------

Overall Audit Strategy, Timing of the Audit, and Significant Risks
    9. The auditor should communicate to the audit committee an 
overview of the overall audit strategy, including the timing of the 
audit,\7\ and discuss with the audit committee the significant risks 
identified during the auditor's risk assessment procedures.\8\
---------------------------------------------------------------------------

    \7\ See paragraphs 8-9 of Auditing Standard No. 9, Audit 
Planning, for a description of the auditor's responsibilities for 
establishing an overall audit strategy.
    \8\ Auditing Standard No. 12 requires the auditor to determine 
whether identified and assessed risks are significant risks. A 
significant risk is defined as a risk of material misstatement that 
requires special audit consideration.

[[Page 57409]]

---------------------------------------------------------------------------

    Note:  This overview is intended to provide information about 
the audit, but not specific details that would compromise the 
effectiveness of the audit procedures.

    10. As part of communicating the overall audit strategy, the 
auditor should communicate the following matters to the audit 
committee, if applicable:
    a. The nature and extent of specialized skill or knowledge needed 
to perform the planned audit procedures or evaluate the audit results 
related to significant risks; \9\
---------------------------------------------------------------------------

    \9\ See paragraph 16 of Auditing Standard No. 9 for the 
requirement for the auditor to determine whether specialized skill 
or knowledge is needed to perform appropriate risk assessments, plan 
or perform audit procedures, or evaluate audit results.
---------------------------------------------------------------------------

    b. The extent to which the auditor plans to use the work of the 
company's internal auditors in an audit of financial statements; \10\
---------------------------------------------------------------------------

    \10\ See AU sec. 322, The Auditor's Consideration of the 
Internal Audit Function in an Audit of Financial Statements, which 
describes the auditor's responsibilities related to the work of 
internal auditors.
---------------------------------------------------------------------------

    c. The extent to which the auditor plans to use the work of 
internal auditors, company personnel (in addition to internal 
auditors), and third parties working under the direction of management 
or the audit committee when performing an audit of internal control 
over financial reporting; \11\
---------------------------------------------------------------------------

    \11\ See paragraphs 16-19 of Auditing Standard No. 5, An Audit 
of Internal Control Over Financial Reporting That Is Integrated with 
An Audit of Financial Statements, which describe the auditor's 
responsibilities related to using the work of others in an audit of 
internal control over financial reporting.
---------------------------------------------------------------------------

    d. The names, locations, and planned responsibilities \12\ of other 
independent public accounting firms or other persons, who are not 
employed by the auditor, that perform audit procedures in the current 
period audit; and
---------------------------------------------------------------------------

    \12\ See paragraphs 8-14 of Auditing Standard No. 9, which 
discuss the auditor's responsibilities for determining the audit 
strategy, audit plan, and extent to which audit procedures should be 
performed at selected locations or business units involving multi-
location engagements.

    Note: The term ``other independent public accounting firms'' in 
the context of this communication includes firms that perform audit 
procedures in the current period audit regardless of whether they 
---------------------------------------------------------------------------
otherwise have any relationship with the auditor.

    e. The basis for the auditor's determination that the auditor can 
serve as principal auditor, if significant parts of the audit are to be 
performed by other auditors.\13\
---------------------------------------------------------------------------

    \13\ See AU sec. 543, Part of Audit Performed by Other 
Independent Auditors, which discusses the professional judgments the 
auditor makes in deciding whether the auditor may serve as principal 
auditor.
---------------------------------------------------------------------------

    11. The auditor should communicate to the audit committee 
significant changes to the planned audit strategy or the significant 
risks initially identified and the reasons for such changes.\14\
---------------------------------------------------------------------------

    \14\ See paragraph 15 of Auditing Standard No. 9, which 
discusses changes in audit strategy and the audit plan during the 
course of the audit.
---------------------------------------------------------------------------

Results of the Audit
    Accounting Policies and Practices, Estimates, and Significant 
Unusual Transactions
    12. The auditor should communicate to the audit committee the 
following matters:
    a. Significant accounting policies and practices.\15\
---------------------------------------------------------------------------

    \15\ See, e.g., Financial Accounting Standards Board Accounting 
Standards Codification, Topic 235, Notes to Financial Statements, 
paragraph 235-10-50-1, which requires the entity to disclose a 
description of all significant accounting policies as an integral 
part of the financial statements, and paragraph 235-10-50-3, which 
describes what should be disclosed.
---------------------------------------------------------------------------

    (1) Management's initial selection of, or changes in, significant 
accounting policies or the application of such policies in the current 
period; and
    (2) The effect on financial statements or disclosures of 
significant accounting policies in (i) controversial areas or (ii) 
areas for which there is a lack of authoritative guidance or consensus, 
or diversity in practice.
    b. Critical accounting policies and practices. All critical 
accounting policies and practices to be used, including: \16\
---------------------------------------------------------------------------

    \16\ See also Section 10A(k) of the Exchange Act, 15 U.S.C. 78j-
1(k), and Rule 2-07(a)(1) of Regulation S-X, 17 CFR 210.2-07(a)(1).
---------------------------------------------------------------------------

    (1) The reasons certain policies and practices are considered 
critical; and
    (2) How current and anticipated future events might affect the 
determination of whether certain policies and practices are considered 
critical.

    Note:  Critical accounting policies and practices, as defined in 
Appendix A, are a company's accounting policies and practices that 
are both most important to the portrayal of the company's financial 
condition and results, and require management's most difficult, 
subjective, or complex judgments, often as a result of the need to 
make estimates about the effects of matters that are inherently 
uncertain. Critical accounting policies and practices are tailored 
to specific events in the current year, and the accounting policies 
and practices that are considered critical might change from year to 
year.

    c. Critical accounting estimates.
    (1) A description of the process management used to develop 
critical accounting estimates; \17\
---------------------------------------------------------------------------

    \17\ See AU sec. 342, Auditing Accounting Estimates, which 
discusses the auditor's responsibilities to obtain and evaluate 
sufficient appropriate audit evidence to support significant 
accounting estimates in an audit of financial statements.
---------------------------------------------------------------------------

    (2) Management's significant assumptions used in critical 
accounting estimates that have a high degree of subjectivity; \18\ and
---------------------------------------------------------------------------

    \18\ Id.
---------------------------------------------------------------------------

    (3) Any significant changes management made to the processes used 
to develop critical accounting estimates or significant assumptions, a 
description of management's reasons for the changes, and the effects of 
the changes on the financial statements.\19\
---------------------------------------------------------------------------

    \19\ Id.
---------------------------------------------------------------------------

    d. Significant unusual transactions.
    (1) Significant transactions that are outside the normal course of 
business for the company or that otherwise appear to be unusual due to 
their timing, size, or nature; \20\ and
---------------------------------------------------------------------------

    \20\ See paragraph 71.g. of Auditing Standard No. 12.
---------------------------------------------------------------------------

    (2) The policies and practices management used to account for 
significant unusual transactions.

    Note:  As part of its communications to the audit committee, 
management might communicate some or all of the matters in paragraph 
12. If management communicates any of these matters, the auditor 
does not need to communicate them at the same level of detail as 
management, as long as the auditor (1) participated in management's 
discussion with the audit committee, (2) affirmatively confirmed to 
the audit committee that management has adequately communicated 
these matters, and (3) with respect to critical accounting policies 
and practices, identified for the audit committee those accounting 
policies and practices that the auditor considers critical. The 
auditor should communicate any omitted or inadequately described 
matters to the audit committee.

Auditor's Evaluation of the Quality of the Company's Financial 
Reporting
    13. The auditor should communicate to the audit committee the 
following matters:
    a. Qualitative aspects of significant accounting policies and 
practices.
    (1) The results of the auditor's evaluation of, and conclusions 
about, the qualitative aspects of the company's significant accounting 
policies and practices, including situations in which the auditor 
identified bias in management's judgments about the amounts and 
disclosures in the financial statements; \21\ and
---------------------------------------------------------------------------

    \21\ See paragraphs 24-27 of Auditing Standard No. 14, 
Evaluating Audit Results, which describe the auditor's 
responsibilities related to evaluating the qualitative aspects of 
the company's accounting practices.
---------------------------------------------------------------------------

    (2) The results of the auditor's evaluation of the differences 
between (i) estimates best supported by the audit evidence and (ii) 
estimates included in the financial statements, which are

[[Page 57410]]

individually reasonable, that indicate a possible bias on the part of 
the company's management.\22\
---------------------------------------------------------------------------

    \22\ See paragraph 27 of Auditing Standard No. 14.
---------------------------------------------------------------------------

    b. Assessment of critical accounting policies and practices. The 
auditor's assessment of management's disclosures related to the 
critical accounting policies and practices, along with any significant 
modifications to the disclosure of those policies and practices 
proposed by the auditor that management did not make.
    c. Conclusions regarding critical accounting estimates. The basis 
for the auditor's conclusions regarding the reasonableness of the 
critical accounting estimates.\23\
---------------------------------------------------------------------------

    \23\ See AU sec. 342, which discusses the auditor's 
responsibilities to obtain and evaluate sufficient appropriate audit 
evidence to support significant accounting estimates in an audit of 
financial statements.
---------------------------------------------------------------------------

    d. Significant unusual transactions. The auditor's understanding of 
the business rationale for significant unusual transactions.\24\
---------------------------------------------------------------------------

    \24\ See paragraph .66 of AU sec. 316, Consideration of Fraud in 
a Financial Statement Audit.
---------------------------------------------------------------------------

    e. Financial statement presentation. The results of the auditor's 
evaluation of whether the presentation of the financial statements and 
the related disclosures are in conformity with the applicable financial 
reporting framework, including the auditor's consideration of the form, 
arrangement, and content of the financial statements (including the 
accompanying notes), encompassing matters such as the terminology used, 
the amount of detail given, the classification of items, and the bases 
of amounts set forth.\25\
---------------------------------------------------------------------------

    \25\ See paragraphs 30-31 of Auditing Standard No. 14, which 
describe the auditor's responsibilities related to the evaluation of 
whether the financial statements are presented fairly, in all 
material respects, in conformity with the applicable financial 
reporting framework. Other PCAOB standards, such as AU sec. 334, 
Related Parties, and AU sec. 341, The Auditor's Consideration of an 
Entity's Ability to Continue as a Going Concern, describe the 
auditor's responsibilities related to evaluation of specific 
disclosures in financial statements.
---------------------------------------------------------------------------

    f. New accounting pronouncements. Situations in which, as a result 
of the auditor's procedures, the auditor identified a concern regarding 
management's anticipated application of accounting pronouncements that 
have been issued but are not yet effective and might have a significant 
effect on future financial reporting.
    g. Alternative accounting treatments. All alternative treatments 
permissible under the applicable financial reporting framework for 
policies and practices related to material items that have been 
discussed with management, including the ramifications of the use of 
such alternative disclosures and treatments and the treatment preferred 
by the auditor.\26\
---------------------------------------------------------------------------

    \26\ See also Section 10A(k) of the Exchange Act, 15 U.S.C. 78j-
1(k), and Rule 2-07(a)(2) of Regulation S-X, 17 CFR 210.2-07(a)(2).
---------------------------------------------------------------------------

Other Information in Documents Containing Audited Financial Statements
    14. When other information is presented in documents containing 
audited financial statements, the auditor should communicate to the 
audit committee the auditor's responsibility under PCAOB rules and 
standards for such information, any related procedures performed, and 
the results of such procedures.\27\
---------------------------------------------------------------------------

    \27\ See, e.g., AU sec. 550, Other Information in Documents 
Containing Audited Financial Statements. In addition to AU sec. 550, 
discussion of the auditor's consideration of other information is 
included in AU sec. 558, Required Supplementary Information, and AU 
sec. 711, Filings Under Federal Securities Statutes.
---------------------------------------------------------------------------

Difficult or Contentious Matters for Which the Auditor Consulted
    15. The auditor should communicate to the audit committee matters 
that are difficult or contentious for which the auditor consulted 
outside the engagement team and that the auditor reasonably determined 
are relevant to the audit committee's oversight of the financial 
reporting process.
Management Consultation With Other Accountants
    16. When the auditor is aware that management consulted with other 
accountants about significant auditing or accounting matters and the 
auditor has identified a concern regarding such matters, the auditor 
should communicate to the audit committee his or her views about such 
matters that were the subject of such consultation.
Going Concern
    17. The auditor should communicate to the audit committee, when 
applicable, the following matters relating to the auditor's evaluation 
of the company's ability to continue as a going concern: \28\
---------------------------------------------------------------------------

    \28\ See AU sec. 341 for the requirements regarding an auditor's 
responsibility to evaluate whether there is substantial doubt about 
a company's ability to continue as a going concern for a reasonable 
period of time, not to exceed one year beyond the date of the 
financial statements being audited. Additionally, AU secs. 341.03a-c 
provide the auditor with an overview of the requirements for 
evaluating whether there is substantial doubt about the company's 
ability to continue as a going concern for a reasonable period of 
time.
---------------------------------------------------------------------------

    a. If the auditor believes there is substantial doubt about the 
company's ability to continue as a going concern for a reasonable 
period of time, the conditions and events that the auditor identified 
that, when considered in the aggregate, indicate that there is 
substantial doubt; \29\
---------------------------------------------------------------------------

    \29\ See AU sec. 341.06, which provides examples of such 
conditions and events and AU sec. 341.07, which discusses the 
auditor's procedures if the auditor believes there is substantial 
doubt about the company's ability to continue as a going concern for 
a reasonable period of time.
---------------------------------------------------------------------------

    b. If the auditor concludes, after consideration of management's 
plans, that substantial doubt about the company's ability to continue 
as a going concern is alleviated, the basis for the auditor's 
conclusion, including elements the auditor identified within 
management's plans that are significant to overcoming the adverse 
effects of the conditions and events; \30\
---------------------------------------------------------------------------

    \30\ See AU sec. 341.08, which discusses the auditor's 
responsibilities related to the auditor's evaluation of management's 
plans.
---------------------------------------------------------------------------

    c. If the auditor concludes, after consideration of management's 
plans, that substantial doubt about the company's ability to continue 
as a going concern for a reasonable period of time remains: \31\
---------------------------------------------------------------------------

    \31\ See AU sec. 341.12, which describes the effects on the 
auditor's report. See also AU sec. 341.03c, which discusses the 
auditor's evaluation of factors that indicate there is substantial 
doubt about the company's ability to continue as a going concern.
---------------------------------------------------------------------------

    (1) The effects, if any, on the financial statements and the 
adequacy of the related disclosure; \32\ and
---------------------------------------------------------------------------

    \32\ See AU sec. 341.10, which discusses the possible effects on 
the financial statements and the adequacy of the related disclosure.
---------------------------------------------------------------------------

    (2) The effects on the auditor's report.\33\
---------------------------------------------------------------------------

    \33\ See AU secs. 341.12-.16, which discuss the auditor's 
consideration of the effects on the auditor's report when the 
auditor concludes that substantial doubt exists about the company's 
ability to continue as a going concern for a reasonable period of 
time.
---------------------------------------------------------------------------

Uncorrected and Corrected Misstatements
    18. The auditor should provide the audit committee with the 
schedule of uncorrected misstatements related to accounts and 
disclosures\34\ that the auditor presented to management.\35\ The 
auditor should discuss with the audit committee, or determine that 
management has adequately discussed with the audit committee, the basis 
for the determination that the uncorrected

[[Page 57411]]

misstatements were immaterial, including the qualitative factors\36\ 
considered. The auditor also should communicate that uncorrected 
misstatements or matters underlying those uncorrected misstatements 
could potentially cause future-period financial statements to be 
materially misstated, even if the auditor has concluded that the 
uncorrected misstatements are immaterial to the financial statements 
under audit.
---------------------------------------------------------------------------

    \34\ Footnote 13 to paragraph 20 of Auditing Standard No. 14 
indicates that misstatements include omission and presentation of 
inaccurate or incomplete disclosures.
    \35\ See Section 13(i) of the Exchange Act, 15 U.S.C. 78m(i), 
which states, in part, that financial statements prepared in 
accordance with generally accepted accounting principles and filed 
with the Securities and Exchange Commission ``shall reflect all 
material correcting adjustments that have been identified by a 
registered public accounting firm * * *.''
    \36\ Appendix B of Auditing Standard No. 14 discusses the 
qualitative factors related to the evaluation of the materiality of 
uncorrected misstatements.
---------------------------------------------------------------------------

    19. The auditor should communicate to the audit committee those 
corrected misstatements, other than those that are clearly trivial,\37\ 
related to accounts and disclosures that might not have been detected 
except through the auditing procedures performed, and discuss with the 
audit committee the implications that such corrected misstatements 
might have on the company's financial reporting process.
---------------------------------------------------------------------------

    \37\ See paragraph 10 of Auditing Standard No. 14, which 
requires the auditor to accumulate misstatements identified during 
the audit, other than those that are clearly trivial.
---------------------------------------------------------------------------

Material Written Communications
    20. The auditor should communicate to the audit committee other 
material written communications between the auditor and management.\38\
---------------------------------------------------------------------------

    \38\ See also Section 10A(k) of the Exchange Act, 15 U.S.C. 78j-
1(k) and Rule 2-07(a)(3) of Regulation S-X, 17 CFR 210.2-07 (a)(3).
---------------------------------------------------------------------------

Departure From the Auditor's Standard Report
    21. The auditor should communicate to the audit committee the 
following matters related to the auditor's report:
    a. When the auditor expects to modify the opinion in the auditor's 
report, the reasons for the modification, and the wording of the 
report; and
    b. When the auditor expects to include explanatory language or an 
explanatory paragraph in the auditor's report, the reasons for the 
explanatory language or paragraph, and the wording of the explanatory 
language or paragraph.
Disagreements With Management
    22. The auditor should communicate to the audit committee any 
disagreements with management about matters, whether or not 
satisfactorily resolved, that individually or in the aggregate could be 
significant to the company's financial statements or the auditor's 
report. Disagreements with management do not include differences of 
opinion based on incomplete facts or preliminary information that are 
later resolved by the auditor obtaining additional relevant facts or 
information prior to the issuance of the auditor's report.
Difficulties Encountered in Performing the Audit
    23. The auditor should communicate to the audit committee any 
significant difficulties encountered during the audit. Significant 
difficulties encountered during the audit include, but are not limited 
to:
    a. Significant delays by management, the unavailability of company 
personnel, or an unwillingness by management to provide information 
needed for the auditor to perform his or her audit procedures;
    b. An unreasonably brief time within which to complete the audit;
    c. Unexpected extensive effort required by the auditor to obtain 
sufficient appropriate audit evidence;
    d. Unreasonable management restrictions encountered by the auditor 
on the conduct of the audit; and
    e. Management's unwillingness to make or extend its assessment of 
the company's ability to continue as a going concern when requested by 
the auditor.

    Note:  Difficulties encountered by the auditor during the audit 
could represent a scope limitation,\39\ which may result in the 
auditor modifying the auditor's opinion or withdrawing from the 
engagement.

    \39\ See paragraphs .22-.32 of AU sec. 508, Reports on Audited 
Financial Statements, for a discussion of scope limitations.
---------------------------------------------------------------------------

Other Matters
    24. The auditor should communicate to the audit committee other 
matters arising from the audit that are significant to the oversight of 
the company's financial reporting process. This communication includes, 
among other matters, complaints or concerns regarding accounting or 
auditing matters that have come to the auditor's attention during the 
audit and the results of the auditor's procedures regarding such 
matters.\40\
---------------------------------------------------------------------------

    \40\ AU secs. 316.79-.81 and AU sec. 317.17 include specific 
communication requirements relating to fraud or illegal acts, 
respectively.
---------------------------------------------------------------------------

Form and Documentation of Communications
    25. The auditor should communicate to the audit committee the 
matters in this standard, either orally or in writing,\41\ unless 
otherwise specified in this standard. The auditor must document the 
communications in the work papers, whether such communications took 
place orally or in writing.\42\
---------------------------------------------------------------------------

    \41\ See paragraphs .07-.11 of AU sec. 532, Restricting the Use 
of an Auditor's Report, which apply to certain written reports on 
matters coming to the auditor's attention during the course of the 
audit.
    \42\ Consistent with the requirements of Auditing Standard No. 
3, Audit Documentation, the audit documentation should be in 
sufficient detail to enable an experienced auditor, having no 
previous connection with the engagement, to understand the 
communications made to comply with the provisions of this standard.

    Note:  If, as part of its communications to the audit committee, 
management communicated some or all of the matters identified in 
paragraphs 12 or 18 and, as a result, the auditor did not 
communicate these matters at the same level of detail as management, 
the auditor must include a copy of or a summary of management's 
communications provided to the audit committee in the audit 
---------------------------------------------------------------------------
documentation.

Timing
    26. All audit committee communications required by this standard 
should be made in a timely manner and prior to the issuance of the 
auditor's report.\43\ The appropriate timing of a particular 
communication to the audit committee depends on factors such as the 
significance of the matters to be communicated and corrective or 
follow-up action needed, unless other timing requirements are specified 
by PCAOB rules or standards or the securities laws.
---------------------------------------------------------------------------

    \43\ Consistent with Rule 2-07 of Regulation S-X, 17 CFR 210.2-
07, in the case of a registered investment company, audit committee 
communication should occur annually, and if the annual communication 
is not within 90 days prior to the filing of the auditor's report, 
the auditor should provide an update in the 90-day period prior to 
the filing of the auditor's report, of any changes to the previously 
reported information.

    Note:  An auditor may communicate to only the audit committee 
chair if done in order to communicate matters in a timely manner 
during the audit. The auditor, however, should communicate such 
matters to the audit committee prior to the issuance of the 
---------------------------------------------------------------------------
auditor's report.

Appendix A--Definitions

    A1. For purposes of this standard, the terms listed below are 
defined as follows:
    A2. Audit committee--A committee (or equivalent body) 
established by and among the board of directors of a company for the 
purpose of overseeing the accounting and financial reporting 
processes of the company and audits of the financial statements of 
the company; if no such committee exists with respect to the 
company, the entire board of directors of the company.
    For audits of nonissuers, if no such committee or board of 
directors (or equivalent body) exists with respect to the company, 
the person(s) who oversee the accounting and financial reporting 
processes of the company and audits of the financial statements of 
the company.
    A3. Critical accounting estimate--An accounting estimate where 
(a) the nature of

[[Page 57412]]

the estimate is material due to the levels of subjectivity and 
judgment necessary to account for highly uncertain matters or the 
susceptibility of such matters to change and (b) the impact of the 
estimate on financial condition or operating performance is 
material.
    A4. Critical accounting policies and practices--A company's 
accounting policies and practices that are both most important to 
the portrayal of the company's financial condition and results, and 
require management's most difficult, subjective, or complex 
judgments, often as a result of the need to make estimates about the 
effects of matters that are inherently uncertain.

Appendix B--Communications With Audit Committees Required by Other 
PCAOB Rules and Standards

    This appendix identifies other PCAOB rules and standards related 
to the audit that require communication of specific matters between 
the auditor and the audit committee.
    a. Auditing Standard No. 4, Reporting on Whether a Previously 
Reported Material Weakness Continues to Exist, paragraphs 60, 62, 
and 64.
    b. Auditing Standard No. 5, An Audit of Internal Control Over 
Financial Reporting That Is Integrated with An Audit of Financial 
Statements, paragraphs 78-81, 91, C7, and C14.
    c. Auditing Standard No. 12, Identifying and Assessing Risks of 
Material Misstatement, paragraphs 5.f. and 54-57.
    d. PCAOB Rule 3524, Audit Committee Pre-approval of Certain Tax 
Services.
    e. PCAOB Rule 3525, Audit Committee Pre-approval of Non-audit 
Services Related to Internal Control Over Financial Reporting.
    f. PCAOB Rule 3526, Communication with Audit Committees 
Concerning Independence.
    g. AU sec. 316, Consideration of Fraud in a Financial Statement 
Audit, paragraphs .79-.81.
    h. AU sec. 317, Illegal Acts by Clients, paragraphs .08, .17, 
and .20.
    i. AU sec. 325, Communications About Control Deficiencies in an 
Audit of Financial Statements, paragraphs 4-7 and 9.
    j. AU sec. 328, Auditing Fair Value Measurements and 
Disclosures, paragraph .50.
    k. AU sec. 333, Management Representations, paragraph .05.
    l. AU sec. 550, Other Information in Documents Containing 
Audited Financial Statements, paragraphs .04 and .06.
    m. AU sec. 711, Filings Under Federal Securities Statutes, 
paragraph .13.
    n. AU sec. 722, Interim Financial Information, paragraphs 
.08-.09, .30-.31, and .33-.36.

Appendix C--Matters Included in the Audit Engagement Letter

    C1. The auditor should include the following matters in the 
engagement letter.\44\ The auditor's description of these matters 
will vary depending on whether the auditor is engaged in a financial 
statement audit or in an audit of internal control over financial 
reporting that is integrated with an audit of financial statements 
(``integrated audit'').
---------------------------------------------------------------------------

    \44\ Certain matters should not be included in an engagement 
letter; for example, under Securities and Exchange Commission, 
Section 602.02.f.i. of the Codification of Financial Reporting 
Policies, indemnification provisions are not permissible for audits 
of issuers.
---------------------------------------------------------------------------

    a. The objective of the audit is:
    a. Integrated audit: The expression of an opinion on both the 
effectiveness of internal control over financial reporting and the 
financial statements.
    b. Audit of financial statements: The expression of an opinion 
on the financial statements.
    b. Auditor's responsibilities:
    a. The auditor is responsible for conducting the audit in 
accordance with the standards of the Public Company Accounting 
Oversight Board. Those standards require that the auditor:
    a. Integrated audit: Plan and perform the audit to obtain 
reasonable assurance about whether the financial statements are free 
of material misstatement, whether caused by error or fraud, and 
whether effective internal control over financial reporting was 
maintained in all material respects. Accordingly, there is some risk 
that a material misstatement of the financial statements or a 
material weakness in internal control over financial reporting would 
remain undetected. Although not absolute assurance, reasonable 
assurance is a high level of assurance. Also, an integrated audit is 
not designed to detect error or fraud that is immaterial to the 
financial statements or deficiencies in internal control over 
financial reporting that, individually or in combination, are less 
severe than a material weakness. If, for any reason, the auditor is 
unable to complete the audit or is unable to form or has not formed 
an opinion, he or she may decline to express an opinion or decline 
to issue a report as a result of the engagement.
    b. Audit of financial statements: Plan and perform the audit to 
obtain reasonable assurance about whether the financial statements 
are free of material misstatement, whether caused by error or fraud. 
Accordingly, there is some risk that a material misstatement would 
remain undetected. Although not absolute assurance, reasonable 
assurance is a high level of assurance. Also, a financial statement 
audit is not designed to detect error or fraud that is immaterial to 
the financial statements. If, for any reason, the auditor is unable 
to complete the audit or is unable to form or has not formed an 
opinion, he or she may decline to express an opinion or decline to 
issue a report as a result of the engagement.
    d. An audit includes:
    c. Integrated audit: In fulfillment of the responsibilities 
noted above, the auditor communicates:
     To the audit committee and management: All material 
weaknesses in internal control over financial reporting identified 
during the audit, in writing.
     To the audit committee: All significant deficiencies 
identified during the audit, in writing, and informs the audit 
committee when the auditor has informed management of all internal 
control deficiencies.
     To management: All internal control deficiencies 
identified during the audit and not previously communicated in 
writing by the auditor or by others, including internal auditors or 
others within the company.
     To the board of directors: Any conclusion that the 
audit committee's oversight of the company's external financial 
reporting and internal control over financial reporting is 
ineffective, in writing.
    d. Audit of financial statements: Obtaining an understanding of 
internal control sufficient to plan the audit and to determine the 
nature, timing, and extent of audit procedures to be performed.\45\ 
An audit of financial statements is not designed to provide 
assurance on internal control or to identify internal control 
deficiencies. However, the auditor is responsible for communicating:
---------------------------------------------------------------------------

    \45\ AU sec. 325, Communications About Control Deficiencies in 
an Audit of Financial Statements, provides direction on control 
deficiencies identified in an audit of financial statements.
---------------------------------------------------------------------------

    1. To the audit committee and management: All significant 
deficiencies and material weaknesses identified during the audit, in 
writing.
    2. To the board of directors: If the auditor becomes aware that 
the oversight of the company's external financial reporting and 
internal control over financial reporting by the audit committee is 
ineffective, that conclusion, in writing.
    c. Management's responsibilities:
    f. Management is responsible for the company's financial 
statements, including disclosures.
    g. Management is responsible for establishing and maintaining 
effective internal control over financial reporting.
    h. Management is responsible for identifying and ensuring that 
the company complies with the laws and regulations applicable to its 
activities.
    i. Management is responsible for making all financial records 
and relevant information available to the auditor.
    j. At the conclusion of the engagement, management will provide 
the auditor with a letter that confirms certain representations made 
during the audit.
    k. Management is responsible for adjusting the financial 
statements to correct material misstatements relating to accounts or 
disclosures and for affirming to the auditor in the representation 
letter that the effects of any uncorrected misstatements aggregated 
by the auditor are immaterial, both individually and in the 
aggregate, to the financial statements taken as a whole.
    C2. In connection with a review of interim financial 
information, to confirm and document the understanding, the auditor 
should either: (a) Document in the audit engagement letter the 
nature and objectives of the engagement to review interim financial 
information and the responsibilities of management and the auditor 
or (b) issue a separate engagement letter that addresses such 
matters.\46\

    \46\ Paragraphs .08-.09 of AU sec. 722, Interim Financial 
Information, discuss the auditor's responsibilities related to 
establishing an understanding with the audit committee in connection 
with a review of the company's interim financial information.

---------------------------------------------------------------------------

[[Page 57413]]

Amendments to PCAOB Standards
Auditing Standards
Auditing Standard No. 5, An Audit of Internal Control Over Financial 
Reporting That Is Integrated With An Audit of Financial Statements
    Auditing Standard No. 5, An Audit of Internal Control Over 
Financial Reporting That is Integrated with An Audit of Financial 
Statements, as amended, is amended as follows:
     The following sentence is added at the end of paragraph 
80: This communication should be made in a timely manner and prior to 
the issuance of the auditor's report on internal control over financial 
reporting.
     The following sentence is added after the first sentence 
of paragraph 81: The auditor should communicate this information to the 
audit committee in a timely manner and prior to the issuance of the 
auditor's report on internal control over financial reporting.
Auditing Standard No. 9, Audit Planning
    Auditing Standard No. 9, Audit Planning, is amended as follows:
     Paragraph 6.c. is replaced with: Establish an 
understanding of the terms of the audit engagement with the audit 
committee in accordance with Auditing Standard No. 16, Communications 
with Audit Committees.
     Footnote 4 to paragraph 6 is deleted.
     In footnote 7 to paragraph 9.a., the references to AU sec. 
310 and AU sec. 380, Communication with Audit Committees, are replaced 
with a reference to Auditing Standard No. 16, Communications with Audit 
Committees.
Auditing Standard No. 13, The Auditor's Responses to the Risks of 
Material Misstatement
    Auditing Standard No. 13, The Auditor's Responses to the Risks of 
Material Misstatement, is amended as follows:
    The note to paragraph 5.d. is deleted.
AU sec. 310, ``Appointment of the Independent Auditor''
    SAS No. 1, ``Codification of Auditing Standards and Procedures'' 
section 310, ``Appointment of the Independent Auditor'' (AU sec. 310, 
``Appointment of the Independent Auditor''), as amended, is superseded.
AU sec. 316, ``Consideration of Fraud in a Financial Statement Audit''
    SAS No. 99, ``Consideration of Fraud in a Financial Statement 
Audit'' (AU sec. 316, ``Consideration of Fraud in a Financial Statement 
Audit''), as amended, is amended as follows:
    a. The third sentence of paragraph .79 is replaced with: Fraud 
involving senior management and fraud (whether caused by senior 
management or other employees) that causes a material misstatement of 
the financial statements should be reported directly to the audit 
committee in a timely manner and prior to the issuance of the auditor's 
report.
    b. The second sentence of paragraph .81 is replaced with: Such a 
communication may be a part of an overall communication to the audit 
committee of business and financial statement risks affecting the 
entity and/or in conjunction with the auditor communication about the 
qualitative aspects of the entity's accounting policies and practices 
(see paragraphs 12-13 of Auditing Standard No.16, Communications with 
Audit Committees). The auditor should communicate these matters to the 
audit committee in a timely manner and prior to the issuance of the 
auditor's report.
    c. Within footnote 10 to paragraph .88, the reference to section 
380, Communication With Audit Committees, is replaced with a reference 
to Auditing Standard No.16, Communications with Audit Committees.
AU sec. 317, ``Illegal Acts by Clients''
    SAS No. 54, ``Illegal Acts by Clients'' (AU sec. 317, ``Illegal 
Acts by Clients''), as amended, is amended as follows:
     The fourth sentence of paragraph .08 is replaced with:
    The auditor should make inquiries of management and the audit 
committee1 concerning the client's compliance with laws and regulations 
and knowledge of violations or possible violations of laws or 
regulations.
     Footnote 1 is added to paragraph .08 after the term 
``audit committee'': For this standard, audit committee is defined as a 
committee (or equivalent body) established by and among the board of 
directors of an entity for the purpose of overseeing the accounting and 
financial reporting processes of the entity and audits of the financial 
statements of the entity; if no such committee exists with respect to 
the entity, the entire board of directors of the entity. For audits of 
nonissuers, if no such committee or board of directors (or equivalent 
body) exists with respect to the entity, the person(s) who oversee the 
accounting and financial reporting processes of the entity and audits 
of the financial statements of the entity.
     The first sentence of paragraph .17 is replaced with:
    The auditor should assure himself that the audit committee is 
adequately informed as soon as practicable and prior to the issuance of 
the auditor's report with respect to illegal acts that come to the 
auditor's attention.
     Footnote 1 to paragraph .17 is deleted.
AU sec. 328, ``Auditing Fair Value Measurements and Disclosures''
    SAS No. 101, ``Auditing Fair Value Measurements and Disclosures'' 
(AU sec. 328, ``Auditing Fair Value Measurements and Disclosures''), as 
amended, is amended as follows:
    Paragraph .50 is replaced with:
    Paragraphs 12-13 of Auditing Standard No. 16, Communications with 
Audit Committees, require the auditor to communicate to the audit 
committee matters related to critical accounting estimates, which may 
include fair value measurements.
AU sec. 333, ``Management Representations''
    SAS No. 85, ``Management Representations'' (AU sec. 333, 
``Management Representations''), as amended, is amended as follows:
    The following sentence is added as the last sentence of paragraph 
.05: The auditor should provide a copy of the representation letter to 
the audit committee if management has not already provided the 
representation letter to the audit committee.
AU sec. 341, ``The Auditor's Consideration of an Entity's Ability To 
Continue as a Going Concern''
    SAS No. 59, ``The Auditor's Consideration of an Entity's Ability to 
Continue as a Going Concern'' (AU sec. 341, ``The Auditor's 
Consideration of an Entity's Ability to Continue as a Going Concern''), 
as amended, is amended as follows:
    Paragraph .17A is added, along with the heading preceding this 
paragraph: Communications with Audit Committees.
    Paragraph 17 of Auditing Standard No. 16, Communications with Audit 
Committees, describes matters an auditor is required to communicate to 
the audit committee related to the auditor's evaluation of a company's 
ability to continue as a going concern for a reasonable period of time.
AU sec. 380, ``Communication With Audit Committees''
    SAS No. 61, ``Communication With Audit Committees'' (AU sec. 380, 
``Communication With Audit Committees''), as amended, is superseded.

[[Page 57414]]

AU sec. 9380, ``Communication With Audit Committees: Auditing 
Interpretations of Section 380''
    AU sec. 9380, ``Communication With Audit Committees: Auditing 
Interpretations of Section 380,'' is superseded.
AU sec. 532, ``Restricting the Use of an Auditor's Report''
    SAS No. 87, ``Restricting the Use of an Auditor's Report (AU sec. 
532, ``Restricting the Use of an Auditor's Report''), as amended, is 
amended as follows:
    In the second bullet point of paragraph .07, the reference to 
Section 380, Communication With Audit Committees, is replaced with a 
reference to Auditing Standard No. 16, Communications with Audit 
Committees.
AU sec. 550, ``Other Information in Documents Containing Audited 
Financial Statements''
    SAS No. 8, ``Other Information in Documents Containing Audited 
Financial Statements'' (AU sec. 550, ``Other Information in Documents 
Containing Audited Financial Statements''), as amended, is amended as 
follows:
    a. The sixth sentence of paragraph .04 is replaced with: If the 
other information is not revised to eliminate the material 
inconsistency, he should communicate the material inconsistency to the 
audit committee and consider other actions, such as revising his report 
to include an explanatory paragraph describing the material 
inconsistency, withholding the use of his report in the document, and 
withdrawing from the engagement.
    b. The second sentence of paragraph .06 is replaced with: He should 
communicate the material misstatement of fact to the client and the 
audit committee, in writing, and consider consulting his legal counsel 
as to further appropriate action in the circumstances.
AU sec. 711, ``Filings Under Federal Securities Statutes''
    SAS No. 37, ``Filings Under Federal Securities Statutes'' (AU sec. 
711, ``Filings Under Federal Securities Statutes''), as amended, is 
amended as follows:
    The last sentence of paragraph .13 is replaced with:
    In either case, the accountant should communicate the matter to the 
audit committee and also consider withholding his consent to the use of 
his report on the audited financial statements in the registration 
statement.
AU sec. 722, ``Interim Financial Information''
    SAS No. 100, ``Interim Financial Information'' (AU sec. 722, 
``Interim Financial Information''), as amended, is amended as follows:
    The heading preceding paragraph .08, ``Establishing an 
Understanding With the Client'' is replaced with the heading, 
``Establishing an Understanding with the Audit Committee.''
    Paragraph .08 is replaced with:
    The accountant should establish an understanding of the terms of an 
engagement to review interim financial information with the audit 
committee or others with equivalent authority and responsibility 
(hereafter referred to as the audit committee).6 This understanding 
includes the objective of the review of interim financial information, 
the responsibilities of the accountant, and the responsibilities of 
management. Such an understanding reduces the risk that either the 
accountant or the audit committee may misinterpret the needs or 
expectations of the other party. The accountant should record this 
understanding of the terms of the engagement in an engagement letter 
and should provide the engagement letter to the audit committee. The 
accountant should have the engagement letter executed by the 
appropriate party or parties on behalf of the company. If the 
appropriate party or parties are other than the audit committee, or its 
chair on behalf of the audit committee, the accountant should determine 
that the audit committee has acknowledged and agreed to the terms of 
the engagement. If the accountant believes he or she cannot establish 
an understanding of the terms of an engagement to review interim 
financial information with the audit committee, the accountant should 
decline to accept, continue, or perform the engagement.
    Footnote 6 to paragraph .08 is replaced with: See paragraph .16 of 
QC sec. 20, System of Quality Control for a CPA Firm's Accounting and 
Auditing Practice.
    In the first sentence of paragraph .09, the word ``client'' is 
replaced with the words ``audit committee.''
    Paragraph .30 is replaced with:
    If management does not respond appropriately to the accountant's 
communication within a reasonable period of time, the accountant should 
communicate these matters to the audit committee as soon as practicable 
and prior to the registrant filing its periodic report with the SEC. 
The communications to the audit committee should be made and documented 
in accordance with paragraph 25 of Auditing Standard No. 16, 
Communications with Audit Committees.
    f. The following sentence is added at the end of paragraph .33:
    The accountant should communicate significant deficiencies or 
material weaknesses of which the accountant has become aware to the 
audit committee or those responsible for oversight of the company's 
financial reporting in a timely manner and prior to the registrant 
filing its periodic report with the SEC.
    g. Paragraph .34 is replaced with:
    When conducting a review of interim financial information, the 
accountant also should determine whether any of the matters described 
in Auditing Standard No. 16, Communications with Audit Committees, as 
they relate to interim financial information, have been identified. If 
such matters have been identified, the accountant should communicate 
them to the audit committee in a timely manner and prior to the 
registrant filing its periodic report with the SEC. For example, the 
accountant should communicate a description of the process management 
used to develop the critical accounting estimates; a change in a 
significant accounting policy affecting the interim financial 
information; misstatements that, either individually or in the 
aggregate, could have a significant effect on the entity's financial 
reporting process; and uncorrected misstatements aggregated by the 
accountant that management determined to be immaterial, both 
individually and in the aggregate, to the interim financial statements 
taken as a whole.23 As part of its communications to the audit 
committee, management might communicate some or all of the matters 
related to the company's accounting policies, practices, estimates, and 
significant unusual transactions described in paragraph 12 of Auditing 
Standard No. 16, Communications with the Audit Committees. If 
management communicates any of these matters, the accountant does not 
need to communicate them at the same level of detail as management, as 
long as the accountant (1) participated in management's discussion with 
the audit committee, (2) affirmatively confirmed to the audit committee 
that management has adequately communicated these matters, and (3) with 
respect to critical accounting policies and practices, identified for 
the audit committee those accounting policies and practices that the 
accountant considers critical. The accountant should communicate any 
omitted or inadequately described matters to the audit committee.

[[Page 57415]]

    h. Footnote 23 to paragraph .34 is replaced with:
    The schedule of uncorrected misstatements related to accounts and 
disclosures provided to the audit committee should be the same schedule 
that was included in or attached to the management representation 
letter that is described in paragraph .24(k) of this section.
    i. The last two sentences of paragraph .35 are replaced with:
    Therefore, any communication the accountant may make about the 
entity's accounting policies, practices, estimates, and significant 
unusual transactions as applied to its interim financial reporting, 
generally would be limited to the effect of significant events, 
transactions, and changes in accounting estimates that the accountant 
considered when conducting the review of interim financial information. 
Further, interim review procedures do not provide assurance that the 
accountant will become aware of all matters that might affect the 
accountant's judgments about the qualitative aspects of the entity's 
accounting policies and practices that would be identified as a result 
of an audit.
    j. Paragraph .36 is replaced with:
    If the accountant has identified matters to be communicated to the 
audit committee, the accountant should communicate such matters to the 
audit committee, or at least its chair, in a timely manner and prior to 
the registrant filing its periodic report with the SEC. The 
communications to the audit committee should be made and documented in 
accordance with paragraph 25 of Auditing Standard No. 16, 
Communications with Audit Committees.
Transitional Amendments to AU sec. 380, Communication With Audit 
Committees
AU sec. 380, Communication With Audit Committees
    SAS No. 61, ``Communication With Audit Committees'' (AU sec. 380, 
``Communication With Audit Committees''), as amended, is amended as 
follows:
    The last sentence of paragraph .01 is replaced with:
    The communications required by this section are applicable to the 
audits of (i) issuers and (ii) brokers and dealers, as those terms are 
defined in the Sarbanes-Oxley Act of 2002, as amended.\2\
    Footnote 2 to paragraph .01 is replaced with:
    See Sections 2(a)(7), 110(3), and 110(4) of the Sarbanes-Oxley Act 
of 2002.

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rules and 
discussed any comments it received on the proposed rules. The text of 
these statements may be examined at the places specified in Item IV 
below. The Board has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements. The 
Board is also requesting that the Commission approve the proposed 
rules, pursuant to Section 103(a)(3)(C) of the Sarbanes-Oxley Act, for 
application to audits of emerging growth companies (``EGCs''), as that 
term is defined in Section 3(a)(80) of the Securities Exchange Act of 
1934 (``Exchange Act''). The Board's request is set forth in section D.

A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rules

(a) Purpose
    Section 103(a) of the Sarbanes-Oxley Act directs the Board, by 
rule, to establish, among other things, ``auditing and related 
attestation standards * * * to be used by registered public accounting 
firms in the preparation and issuance of audit reports, as required by 
th[e] [Sarbanes-Oxley] Act or the rules of the Commission, or as may be 
necessary or appropriate in the public interest or for the protection 
of investors.'' The Board adopted Auditing Standard No. 16, 
Communications with Audit Committees (the ``standard''), and related 
amendments to improve the audit by enhancing communications between 
auditors and audit committees.
    As discussed more fully in Exhibit 3, the Board adopted Auditing 
Standard No. 16 because it believes that the standard is in the public 
interest because the standard establishes requirements that enhance the 
relevance, timeliness, and quality of the communications between the 
auditor and the audit committee. The enhanced relevance, timeliness, 
and quality of communications should facilitate audit committees' 
financial reporting oversight, fostering improved financial reporting, 
thereby benefitting investors.
    With the passage of the Sarbanes-Oxley Act and the establishment of 
the PCAOB, Congress acknowledged that auditors play an important role 
in protecting the interests of investors by preparing and issuing 
informative, accurate, and independent audit reports.\47\ The audit 
committee \48\ also plays an important role in protecting the interests 
of investors by assisting the board of directors in fulfilling its 
responsibility to a company's shareholders and others to oversee the 
integrity of a company's accounting and financial reporting processes 
and audits. The audit committee, among other things, serves as the 
board of director's principal interface with the company's auditors and 
facilitates communications between the company's board of directors, 
its management, and its independent auditors on significant accounting 
issues and policies. The roles of auditors and audit committees are 
critical to the efficiency and integrity of the capital markets.
---------------------------------------------------------------------------

    \47\ See Section 101(a) of the Sarbanes-Oxley Act, 15 U.S.C. 
7211(a); Senate Report No. 107-206, at 5-6 (July 3, 2002).
    \48\ The term ``audit committee,'' as defined in Auditing 
Standard No. 16, is a committee (or equivalent body) established by 
and among the board of directors of a company for the purpose of 
overseeing the accounting and financial reporting processes of the 
company and audits of the financial statements of the company; if no 
such committee exists with respect to a company, the entire board of 
directors of the company. For audits of nonissuers, if no such 
committee or board of directors (or equivalent body) exists with 
respect to the company, the person(s) who oversee the accounting and 
financial reporting processes of the company and audits of the 
financial statements of the company.
---------------------------------------------------------------------------

    Both the auditor and the audit committee benefit from a meaningful 
exchange of information regarding significant risks of material 
misstatement in the financial statements and other matters that may 
affect the integrity of the company's financial reports. Communications 
between the auditor and the audit committee allow the audit committee 
to be well-informed about accounting and disclosure matters, including 
the auditor's evaluation of matters that are significant to the 
financial statements, and to be better able to carry out its oversight 
role. Communications with the audit committee provide auditors with a 
forum separate from management to discuss matters about the audit and 
the company's financial reporting process.
    Auditing Standard No. 16 is aligned with the requirements of the 
Sarbanes-Oxley Act. For many public companies, the Sarbanes-Oxley Act 
served to strengthen and expand the role of the audit committee in the 
financial reporting process. For example, the Sarbanes-Oxley Act 
requires that audit committee members of listed companies be 
independent and that audit committees be responsible for the 
appointment, compensation, and oversight of the work of the external 
auditor for the purpose of preparing or

[[Page 57416]]

issuing an audit report or related work.\49\ These requirements place 
the audit committee at the center of the relationship between 
management of a public company and its auditor.
---------------------------------------------------------------------------

    \49\ See Section 301 of the Sarbanes-Oxley Act and Section 
10A(m)(2) of the Exchange Act, 15 U.S.C. 78j-1(m)(2).
---------------------------------------------------------------------------

    Auditing Standard No. 16 is intended to improve the audit \50\ by 
fostering constructive dialogue between the auditor and the audit 
committee about significant audit and financial statement matters. The 
standard requires the auditor to communicate certain matters regarding 
the audit and the financial statements to the audit committee, which 
should assist the audit committee in fulfilling its oversight 
responsibilities regarding the financial reporting process. Effective 
two-way communication between the auditor and the audit committee on 
such relevant matters also will benefit the auditor in performing an 
effective audit.
---------------------------------------------------------------------------

    \50\ For purposes of this release and standard, an audit is 
either an audit of internal control over financial reporting that is 
integrated with an audit of financial statements or an audit of 
financial statements only.
---------------------------------------------------------------------------

    Auditing Standard No. 16 encourages effective two-way communication 
between the auditor and the audit committee throughout the audit to 
assist both parties in understanding matters relevant to the audit. 
Communications that are tailored to the circumstances and informative, 
rather than ``boiler-plate'' or standardized, will enable the auditor 
and the audit committee to engage in a dialogue that is more likely to 
benefit both the audit committee, in conducting its oversight 
responsibilities, and the auditor, in conducting an effective audit. 
Effective communication between the auditor and the audit committee may 
involve many forms of communication, such as presentations, charts, 
written reports, or robust discussions.
    AU sec. 380, which became effective in January 1989, indicated that 
audit committee communications are incidental to the audit and are not 
required to occur prior to the issuance of the auditor's report. In 
contrast, Auditing Standard No. 16 recognizes the importance of the 
auditor's communications with the audit committee in today's business 
and regulatory environment; therefore, Auditing Standard No. 16 
requires the auditor to communicate the audit strategy and results of 
the audit to the audit committee in a timely manner and prior to the 
issuance of the auditor's report to provide an opportunity for the 
audit committee and the auditor to take appropriate action to address 
the matters communicated.
    Timely communications with the audit committee help the auditor 
improve the audit by, among other things (i) informing the audit 
committee, which has responsibility for the oversight of financial 
reporting, about significant matters related to the audit and the 
financial statements, (ii) enabling the auditor to obtain the audit 
committee's insights and information about transactions and events, 
(iii) enabling the auditor to learn about complaints regarding 
accounting or auditing matters, and (iv) assisting the auditor in 
gaining a better understanding of the company and its control 
environment.
    Auditing Standard No. 16 generally links the new communication 
requirements to the results of related audit performance requirements 
in other PCAOB standards, or the conduct of the audit. The standard 
does not otherwise impose new performance requirements, other than 
communications. Because other PCAOB standards already require the 
auditor to perform procedures underlying the communications required in 
Auditing Standard No. 16, and the standard primarily requires 
communication of the results of the auditor's procedures, the Board 
does not anticipate a significant increase in cost as a result of the 
implementation of the standard.
    Some of the matters to be communicated under Auditing Standard No. 
16 relate specifically to matters involving management's preparation of 
the company's financial statements. In many companies, management might 
communicate these matters or take the lead on communicating these 
matters to the audit committee. The PCAOB does not have the authority 
to require management to communicate to the audit committee. 
Additionally, certain communications by the auditor are mandated by 
federal securities laws and Commission rules.\51\ Therefore, Auditing 
Standard No. 16 establishes required communications by the auditor to 
the audit committee but, at the same time, clearly recognizes and 
acknowledges that management might communicate to the audit committee 
certain matters related to the company's financial statements. In such 
circumstances, the auditor does not need to communicate those matters 
at the same level of detail as management, as long as certain 
conditions are met, as specified in the standard.
---------------------------------------------------------------------------

    \51\ See e.g., Section 10A(k) of the Exchange Act, 15 U.S.C. 
78j-1(k); SEC Rule 2-07 of Regulation S-X (``SEC Rule 2-07''), 17 
CFR 210.2-07; and Rule 10A-3 under the Exchange Act, 17 CFR 240.10A-
3.
---------------------------------------------------------------------------

    Auditing Standard No. 16 is scalable for audits of companies of 
various sizes and complexities. A company's size and complexity might 
affect the risks of misstatements, the audit strategy, and other 
significant matters that warrant the attention of the audit committee. 
Based on the specific company's circumstances, the standard requires 
communications only to the extent that the matters are relevant to the 
audit of the financial statements of the company or of internal control 
over financial reporting. For example, an auditor of a smaller, less 
complex company with fewer difficult auditing or financial reporting 
issues may have fewer matters to communicate than the auditor of a 
larger, more complex company.
    The proposed rules also amend the Board's interim standards 
including superseding interim standards AU sec. 380, Communication With 
Audit Committees, and AU sec. 310, Appointment of the Independent 
Auditor (``AU sec. 310'').
(b) Statutory Basis
    The statutory basis for the proposed rules is Title I of the 
Sarbanes-Oxley Act.

B. Board's Statement on Burden on Competition

    Not applicable.

C. Board's Statement on Comments on the Proposed Rules Change Received 
From Members, Participants or Others

    The Board released the proposed rules for public comment in PCAOB 
Release No. 2010-001 (March 29, 2010). The Board received 35 comment 
letters. On September 21, 2010, the Board held a roundtable to obtain 
insight from additional stakeholders, including investors, audit 
committee members, auditors, and preparers. The Board reopened the 
public comment period on the original proposed rules to allow for 
interested parties to provide additional comments on the topics 
discussed at the roundtable. The Board received nine additional comment 
letters during this extended comment period.
    The Board considered the comments received relating to its initial 
proposed rules and at the roundtable and made changes to the initial 
proposed rules. As a result, the Board again sought public comment on 
the proposed rules on December 20, 2011. The Board received 39 written 
comment letters relating to its reproposal of the proposed rules.
    The Board has carefully considered all comments received. The 
Board's response to the comments it received

[[Page 57417]]

and the changes made to the rules in response to the comments received 
are discussed below.
Overview of Auditing Standard No. 16
    Auditing Standard No. 16 provides a definition of audit committee, 
retains or enhances existing communication requirements, incorporates 
certain SEC auditor communication requirements to audit committees, and 
adds new communication requirements that are generally linked to 
performance requirements in other PCAOB standards.
    For audits of issuers, Auditing Standard No. 16 incorporates the 
Sarbanes-Oxley Act's definition of audit committee as a committee (or 
equivalent body) established by and among the board of directors of a 
company for the purpose of overseeing the accounting and financial 
reporting processes of the company and audits of the financial 
statements of the company; if no such committee exists with respect to 
the company, then the audit committee is the entire board of directors 
of the company. For audits of nonissuers, the definition of audit 
committee contained in Auditing Standard No. 16 provides that if no 
audit committee or board of directors (or equivalent body) exists with 
respect to the company, then the audit committee is the person(s) who 
oversee the accounting and financial reporting processes of the company 
and audits of the financial statements of the company.
    AU sec. 310 requires the auditor to establish an understanding with 
the client regarding the services to be performed. Auditing Standard 
No. 16 requires the auditor to establish the understanding of the terms 
of the audit engagement with the audit committee. This requirement 
aligns the auditing standard with the provision of the Sarbanes-Oxley 
Act that requires the audit committee of listed companies to be 
responsible for the appointment of the external auditor.\52\
---------------------------------------------------------------------------

    \52\ See Section 301 of the Sarbanes-Oxley Act, and Sections 
10A(m)(2) of the Exchange Act, 15 U.S.C. 78j-1(m)(2).
---------------------------------------------------------------------------

    Additionally, Auditing Standard No. 16 requires the auditor to 
record the terms of the engagement in an engagement letter and to have 
the engagement letter executed by the appropriate party or parties on 
behalf of the company and determine that the audit committee has 
acknowledged and agreed to the terms. These requirements are an 
expansion of the requirement in AU sec. 310 for the auditor to document 
the understanding in the working papers, preferably through a written 
communication with the client.
    Auditing Standard No. 16 retains many of the communication 
requirements in AU sec. 380 and also incorporates the SEC communication 
requirements.\53\ The standard improves the current communication 
requirements of AU sec. 380 by requiring the communications with the 
audit committee to occur before the issuance of the audit report. 
Additionally, the standard enhances certain existing auditor 
communication requirements by requiring the auditor to communicate:
---------------------------------------------------------------------------

    \53\ See Section 10A(k) of the Exchange Act, 15 U.S.C. 78j-1(k) 
and SEC Rule 2-07(a)(1)-(3).
---------------------------------------------------------------------------

    d. Certain matters regarding the company's accounting policies, 
practices, and estimates;
    e. The auditor's evaluation of the quality of the company's 
financial reporting;
    f. Information related to significant unusual transactions, 
including the business rationale for such transactions; and
    g. The auditor's views regarding significant accounting or auditing 
matters when the auditor is aware that management consulted with other 
accountants about such matters and the auditor has identified a concern 
regarding these matters.
    Auditing Standard No. 16 expands the inquiries of the audit 
committee required by Auditing Standard No. 12, Identifying and 
Assessing Risks of Material Misstatement, which requires the auditor to 
inquire of the audit committee regarding the matters important to the 
identification and assessment of risks of material misstatement and 
fraud risks. The additional inquiries in Auditing Standard No. 16 
address whether the audit committee is aware of matters relevant to the 
audit, including, but not limited to, violations or possible violations 
of laws or regulations.
    Additionally, Auditing Standard No. 16 adds new communication 
requirements that provide the audit committee with additional 
information about significant aspects of the audit. These 
communications are generally linked to the results of the audit 
procedures or the conduct of the audit. Under Auditing Standard No. 16 
the auditor would be required to communicate:
    h. An overview of the overall audit strategy, including timing of 
the audit, significant risks the auditor identified, and significant 
changes to the planned audit strategy or identified risks;
    i. Information about the nature and extent of specialized skill or 
knowledge needed in the audit, the extent of the planned use of 
internal auditors, company personnel or other third parties, and other 
independent public accounting firms, or other persons not employed by 
the auditor that are involved in the audit;
    j. The basis for the auditor's determination that he or she can 
serve as principal auditor, if significant parts of the audit will be 
performed by other auditors;
    k. Situations in which the auditor identified a concern regarding 
management's anticipated application of accounting pronouncements that 
have been issued but are not yet effective and might have a significant 
effect on future financial reporting;
    l. Difficult or contentious matters for which the auditor consulted 
outside the engagement team;
    m. The auditor's evaluation of going concern;
    n. Departure from the auditor's standard report; and
    o. Other matters arising from the audit that are significant to the 
oversight of the company's financial reporting process, including 
complaints or concerns regarding accounting or auditing matters that 
have come to the auditor's attention during the audit.

In addition to the communication requirements included in Auditing 
Standard No. 16, other PCAOB standards and rules that require the 
auditor to communicate specific matters to the audit committee are 
referenced in Appendix B to Auditing Standard No. 16.
    While the standard establishes certain requirements regarding 
auditor communications to the audit committee, Auditing Standard No. 16 
does not preclude the auditor from providing additional information to 
the audit committee. Nor does the standard preclude the auditor from 
responding to audit committee requests for additional information from 
the auditor.
Definition of Audit Committee (Paragraph A-2 of Auditing Standard No. 
16)
    Auditing Standard No. 16 defines an audit committee as a committee 
(or equivalent body) established by and among the board of directors of 
a company for the purpose of overseeing the accounting and financial 
reporting processes of the company and audits of the financial 
statements of the company; if no such committee exists with respect to 
the company, the entire board of directors of the company. This 
definition largely incorporates the

[[Page 57418]]

definition of ``audit committee'' from the Sarbanes-Oxley Act.\54\ The 
parenthetical phrase ``or equivalent body'' after the term 
``committee'' clarifies that entities with bodies performing a function 
similar to that of an audit committee would fit within this category.
---------------------------------------------------------------------------

    \54\ Section 2(a)(3) of the Sarbanes-Oxley Act, 15 U.S.C. Sec.  
7201.
---------------------------------------------------------------------------

    The standard modifies the Sarbanes-Oxley Act's version of the 
definition of an audit committee as it relates to audits of nonissuers. 
Specifically, for audits of nonissuers, Auditing Standard No. 16 states 
that, if no such committee or board of directors (or equivalent body) 
exists with respect to the company, the audit committee would be 
considered the person(s) who oversee the accounting and financial 
reporting processes of the company and audits of the financial 
statements of the company. This modification was made to recognize that 
some nonissuers, including brokers and dealers, may have governance 
structures that do not include boards of directors or audit committees. 
In those cases, the auditor would identify those persons at the 
nonissuer company who oversee the company's accounting and financial 
reporting processes and audits. This modification is meant to indicate 
that senior persons in an oversight role in such circumstances would be 
the recipients of the auditor communications.
    Using the definition of ``audit committee,'' the auditor would 
identify the bodies or persons that oversee the company's accounting, 
auditing, and financial reporting processes to find the appropriate 
recipient of the communications under the standard.\55\ For issuers, 
the definition is the same as the definition included in the Sarbanes-
Oxley Act.\56\ For nonissuers, the definition contains three categories 
of bodies or persons. The first two categories (audit committee and the 
entire board of directors of the company) are the same as those 
included in the definition of audit committee for an issuer. The third 
category covers situations in which the company does not have an audit 
committee, board of directors, or equivalent body, such as certain non-
public brokers and dealers. The parenthetical phrase ``or equivalent 
body'' after the term ``board of directors'' clarifies that entities 
with bodies performing a function similar to that of a corporate board 
of directors would fit within this category.
---------------------------------------------------------------------------

    \55\ The Board's proposed definition is not intended to conflict 
with or affect any requirements, or the application of any 
requirements, under federal law, state law, foreign law, or an 
entity's governing documents regarding the establishment, approval, 
or ratification of board of directors or audit committees, or the 
delegation of responsibilities of such a committee or board.
    \56\ Section 2(a)(3) of the Sarbanes-Oxley Act, 15 U.S.C. Sec.  
7201.
---------------------------------------------------------------------------

    The reproposed standard required the auditor to communicate to 
those persons designated to oversee the financial reporting processes 
of the company in situations in which a nonissuer does not have an 
audit committee, board of directors, or equivalent body. Some 
commenters indicated that, for certain nonissuers, the person 
designated to oversee the accounting and financial reporting processes 
of the company could be the chief financial officer, in which case the 
communication would be made to the person preparing the financial 
statements. Therefore, commenters suggested that the auditor should 
make relevant communications to the chief executive officer, or 
equivalent officer of the company.
    Some commenters suggested that the standard should clarify to whom 
the auditor should communicate when the company is a subsidiary of 
another entity. Auditing Standard No. 16 does not require communication 
outside the governance structure of the audited entity because the 
standard designates the appropriate party to receive the auditor 
communications within the audited entity. If directed by the audit 
client, or if the auditor otherwise deems it appropriate, the auditor 
could also communicate to a parent company audit committee or 
equivalent body.
Objectives (Paragraph 3 of Auditing Standard No. 16)
    Auditing Standard No. 16 states that the objectives of the auditor 
are to (a) communicate to the audit committee the responsibilities of 
the auditor in relation to the audit and establish an understanding of 
the terms of the audit engagement with the audit committee; (b) obtain 
information from the audit committee relevant to the audit; (c) 
communicate to the audit committee an overview of the overall audit 
strategy and timing of the audit; and (d) provide the audit committee 
with timely observations arising from the audit that are significant to 
the financial reporting process. The objectives of the standard are 
intended to highlight the overall context for the requirements in the 
standard.
Significant Issues Discussed with Management in Connection With the 
Auditor's Appointment or Retention (Paragraph 4 of Auditing Standard 
No. 16)
    Auditing Standard No. 16 requires the auditor to discuss with the 
audit committee any significant issues that the auditor discussed with 
management in connection with the appointment or retention of the 
auditor, including significant discussions regarding the application of 
accounting principles and auditing standards. This requirement was 
retained from AU sec. 380.\57\
---------------------------------------------------------------------------

    \57\ AU sec. 380.15.
---------------------------------------------------------------------------

    This requirement is included in the standard because the audit 
committee might ask management for its views concerning the appointment 
or retention of the auditor. Management's views might be influenced by 
the interaction between the auditor and management and the auditor's 
evaluations and conclusions regarding the application of accounting 
principles or auditing standards.
    Some commenters suggested that these discussions should include a 
robust fee discussion or a discussion about the results of the 
auditor's considerations during the client acceptance and continuance 
process, such as the auditor's views of the entity's accounting and 
financial reporting practices or management's integrity. The standard 
was not revised to include such additional matters because the 
requirement in the standard specifically addresses the auditor's 
discussions with management related to accounting and auditing matters 
in connection with the appointment or retention of the auditor. 
However, Auditing Standard No. 16 requires the auditor to communicate 
any matters arising from the audit to the audit committee that the 
auditor believes are significant to the audit committee's oversight of 
the company's financial reporting process.\58\
---------------------------------------------------------------------------

    \58\ Paragraph 24 of Auditing Standard No. 16.
---------------------------------------------------------------------------

Establish an Understanding of the Terms of the Audit (Paragraphs 5-7 of 
Auditing Standard No. 16)
    Auditing Standard No. 16 includes a specific requirement for the 
auditor to establish an understanding of the terms of the audit 
engagement with the audit committee. Having a mutually clear 
understanding of the terms of the engagement, including the objectives 
of the audit, the responsibilities of the auditor, and the 
responsibilities of management in connection with the audit, should 
benefit both the auditor and the audit committee.

[[Page 57419]]

    The requirement in Auditing Standard No. 16 is similar to the 
requirement in AU sec. 310, Appointment of the Independent Auditor 
(``AU sec 310''), which requires the auditor to establish an 
understanding with the client regarding the services to be performed. 
However, Auditing Standard No. 16 more specifically requires that the 
understanding be with the audit committee due to the audit committee's 
financial reporting and audit oversight role, rather than with the 
``client,'' which could be understood to mean others besides the audit 
committee in certain circumstances.
    Auditing Standard No. 16 also requires the auditor to record the 
understanding of the terms of the audit engagement in an engagement 
letter. Appendix C of Auditing Standard No. 16 describes matters that 
should be included in an engagement letter, including the objective of 
the audit and the responsibilities of the auditor and management. This 
is an expansion of the requirement in AU sec. 310, which requires the 
auditor to document the understanding of the engagement in the working 
papers, preferably through a written communication with the client.
    Some commenters indicated that the engagement letter should 
describe the responsibilities of the audit committee related to the 
audit. The Board considered this suggestion and did not change the 
standard to include the responsibilities of the audit committee, as 
those responsibilities are governed by the rules of other 
organizations, such as the Commission and the national securities 
exchanges.\59\ However, the standard does not prohibit the auditor from 
including other matters in the engagement letter, as agreed upon by the 
auditor and the audit committee, so long as those matters are not in 
violation of other standards or rules, for example, independence 
requirements.
---------------------------------------------------------------------------

    \59\ See, e.g., New York Stock Exchange, Listed Company Manual 
at Section 303A.07, Audit Committee Additional Requirements.
---------------------------------------------------------------------------

    Auditing Standard No. 16 requires the auditor to provide the 
engagement letter to the audit committee annually. Additionally, the 
auditor should have the engagement letter executed by the appropriate 
party or parties on behalf of the company.\60\ The standard also states 
that if the appropriate party or parties are other than the audit 
committee, or its chair on behalf of the audit committee, the auditor 
also should determine that the audit committee has acknowledged and 
agreed to the terms of the engagement. This acknowledgment may be 
obtained in a variety of ways, such as obtaining the audit committee 
members' signatures, or its chair's signature on behalf of the audit 
committee, or obtaining another form of acknowledgement and agreement 
by the audit committee regarding the terms of the audit engagement. 
Obtaining this acknowledgement reduces the risk that either the auditor 
or the audit committee might misinterpret the needs or expectations of 
the other party. An acknowledgement by the audit committee, the 
signatures of the audit committee members, or the signature of its 
chair on behalf of the audit committee on the engagement letter is not 
intended to conflict with or affect any requirements, or the 
application of any requirements, under federal law, state law, foreign 
law, applicable exchange requirements, or the company's governing 
documents, regarding the authority or lack of authority of the audit 
committee to enter into any contract or agreement with the auditor.
---------------------------------------------------------------------------

    \60\ Absent evidence to the contrary, the auditor may rely on 
the company's identification of the appropriate party or parties to 
execute the engagement letter.
---------------------------------------------------------------------------

    Several commenters suggested that the standard should specify that 
the engagement letter should be executed by management in addition to 
the audit committee or by management alone, along with a representation 
that it has the authority to do so on behalf of the audit committee. 
The Board considered these comments and decided that, absent evidence 
to the contrary, the auditor may rely on the company's identification 
of the appropriate party or parties to execute the engagement letter. 
Therefore, the standard does not specify the party that should execute 
the engagement letter on behalf of the company.
    Some commenters suggested that the standard should indicate that 
the audit committee's acknowledgement can be either written or oral. 
Other commenters suggested that the audit committee's acknowledgement 
should be written, either evidenced by a signature on the engagement 
letter or in the audit committee's minutes, to avoid the potential for 
subsequent misunderstandings of whether the audit committee's 
acknowledgement has been obtained.
    The Board considered these comments and determined that the audit 
committee's acknowledgement may be provided in writing, such as a 
signed engagement letter or through the minutes of the audit committee 
meeting, or orally. The primary focus of this requirement is that the 
auditor receives acknowledgment and agreement from the audit committee 
rather than the method the audit committee uses to provide that 
acknowledgement; therefore, a change to the standard was not warranted. 
The reproposed standard did not specify the form of acknowledgment and, 
therefore, the standard was not revised. However, the auditor could 
request that the audit committee acknowledge the terms of the audit 
engagement in writing. If the audit committee's acknowledgement is 
received orally, in accordance with paragraph 25 of Auditing Standard 
No. 16, the auditor is required to document the acknowledgement in the 
auditor's work papers.
Obtaining Information Relevant to the Audit (Paragraph 8 of Auditing 
Standard No. 16)
    Auditing Standard No. 16 includes a requirement for the auditor to 
inquire of the audit committee about whether it is aware of matters 
relevant to the audit, including, but not limited to, violations or 
possible violations of laws or regulations. This inquiry contributes to 
a two-way dialogue between the auditor and the audit committee 
concerning matters relevant to the audit. This inquiry would complement 
the requirement for the auditor to make inquiries of the audit 
committee (or its chair) about risks of material misstatement, 
including inquiries related to fraud risks, in accordance with Auditing 
Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement.\61\ This requirement is included in the standard because, 
in addition to the inquiries required as part of the risk assessment 
procedures, audit committees may be aware of other matters relevant to 
the auditor in performing audit procedures.
---------------------------------------------------------------------------

    \61\ See paragraph 5.f. and 54-57 of Auditing Standard No. 12.
---------------------------------------------------------------------------

    Auditing Standard No. 16 does not include the reference to 
``complaints or concerns received by the audit committee regarding 
financial reporting matters'' previously included in the reproposed 
standard. This change is not intended to signal a change in the scope 
of this communication between the audit committee and the auditor. 
Rather, the Board notes that such inquiry by the auditor of the audit 
committee is already included in paragraph 56.b(3) of Auditing Standard 
No. 12, which requires the auditor to inquire of the audit committee 
about tips or complaints regarding the company's financial 
reporting.\62\ Since the inquiry

[[Page 57420]]

in the reproposed standard was similar to the inquiries in Auditing 
Standard No. 12, Auditing Standard No. 16 was revised to remove the 
inquiry regarding complaints or concerns.
---------------------------------------------------------------------------

    \62\ Auditing Standard No. 12 also includes inquiries regarding 
the audit committee's views about fraud risks, its knowledge of 
fraud, and the audit committee's response to tips or complaints 
regarding the company's financial reporting, and how the audit 
committee exercises oversight of the company's assessment of fraud 
risks. See paragraphs 56.b(1)-(4) of Auditing Standard No. 12.
---------------------------------------------------------------------------

    Auditing Standard No. 16 does not provide specific timing for these 
inquiries to be made. Depending on the circumstances of the audit, it 
may be appropriate for the auditor to conduct such inquiries of the 
audit committee at the outset of the audit and/or at other various 
stages of the audit. For example, the auditor may want to conduct these 
inquiries early in the audit to consider any information received from 
the audit committee in designing the nature, timing, and extent of 
audit procedures. In other circumstances, as the audit progresses, an 
auditor may want to inquire of the audit committee as to whether any 
additional matters or concerns relevant to the audit have come to the 
attention of the audit committee not previously discussed with the 
auditor.
    The reproposed standard required the auditor to inquire of the 
audit committee about ``whether it is aware of matters that might be 
relevant to the audit.'' One commenter raised concerns about this 
provision of the reproposed standard as being ``too broad and 
overreaching,'' which could obscure information that is truly relevant 
to the audit. Other commenters suggested that the inquiries of the 
audit committee should be expanded to include other matters, such as 
the audit committee's awareness of significant changes in company 
conditions or activities.
    After considering the comments received on the scope of the 
information to be communicated under this provision, the term ``might 
be'' was excluded from this paragraph of the standard. The deletion of 
the term ``might be'' is appropriate to avoid an overly broad 
interpretation of the standard to require discussion of matters that 
may not be directly connected to the audit.
    Although the Board did not revise the requirement to list all the 
matters of which the auditor could inquire in this provision, the 
requirement in the standard is not meant to be limited only to matters 
that are related to violations or possible violations of laws. The 
Board did not consider it practical to revise the requirement in an 
attempt to list all the matters of which the auditor could inquire in 
this provision. Such matters can and should vary from audit to audit. 
Rather, the inclusion of such matters was meant to serve only as an 
example of a matter that the auditor should discuss with the audit 
committee.
    The same commenter who objected to the breadth of the inquiry also 
raised concerns related to the audit committee providing information to 
the auditor about violations or possible violations of laws or 
regulations and complaints or concerns received regarding financial 
reporting matters contained in the reproposed standard. The commenter 
indicated that the audit committee's communication of such information 
could cause the information to lose its confidentiality status with 
potential significant harmful consequences to the company, such as 
reducing the candor and chilling communications between management, 
employees, and the audit committee. The commenter also indicated that 
if the audit committee discloses information covered by privileged 
attorney-client communications or attorney work product to the auditor 
as part of this communication, the company may face a risk that a court 
may later deem the company to have waived the protection of such 
privilege or work product doctrine.
    The Board did not change the requirement to exclude inquiries 
regarding violations or possible violations of laws or regulations that 
are relevant to the audit. Limiting the scope of information that the 
audit committee might provide to the auditor could severely affect the 
auditor's ability to conduct an effective audit.
    The purpose of this requirement is to enable the auditor to have 
the information necessary to conduct the audit to support the auditor's 
opinion on the company's financial statements. Due to the audit 
committee's oversight responsibilities, it is appropriate for the 
auditor to ask the audit committee for information relevant to the 
audit, including matters related to violations or possible violations 
of laws or regulations. Without such inquiry, the auditor may not have 
information that could influence the performance of the audit.
    The same commenter also indicated that if the audit committee 
provides information relevant to the audit, the audit committee's role 
would change fundamentally from overseeing the accounting and financial 
reporting process of the company and audits of financial statements to 
becoming the original source of information for the auditor and 
guarantor of the accuracy and completeness of the financial statements, 
a role that historically has been that of management. It is possible, 
that in some situations, the communication from the audit committee is 
the first instance in which a matter is brought to the attention of the 
auditor. For example, in some situations the audit committee may have 
unique insight into management's performance. By providing the 
opportunity for the audit committee to discuss information with the 
auditor, the standard enables the auditor to obtain the audit 
committee's perspective on matters which may be different from 
management's perspective.
Overall Audit Strategy, Timing of the Audit, and Significant Risks 
(Paragraphs 9-11 of Auditing Standard No. 16)
    Auditing Standard No. 16 includes a requirement for the auditor to 
communicate to the audit committee an overview of the overall audit 
strategy, including the timing of the audit, and to discuss with the 
audit committee the significant risks \63\ identified during the 
auditor's risk assessment procedures. Under this requirement, the 
auditor communicates to the audit committee the results of audit 
procedures performed in accordance with other PCAOB standards, such as 
Auditing Standard No. 9, Audit Planning, which requires the auditor to 
establish an overall audit strategy that sets the scope, timing, and 
direction of the audit and guides the development of the audit plan. As 
part of the auditor's risk assessment process, the auditor is required 
to identify and assess the risk of material misstatement, including 
significant risks.\64\
---------------------------------------------------------------------------

    \63\ See paragraph A5 of Auditing Standard No. 12, which defines 
significant risk as a risk of material misstatement that requires 
special audit consideration.
    \64\ See paragraphs 59, 70, and 71 of the Auditing Standard No. 
12.
---------------------------------------------------------------------------

    The timing of communications related to the audit strategy may vary 
from audit to audit based on the facts and circumstances. However, 
early communication of these matters might enable the audit committee 
to understand the auditor's views regarding risk and thereby provide an 
opportunity for the audit committee to communicate insights regarding 
additional risks that the auditor did not identify and allow the 
auditor to more effectively incorporate the additional risks into the 
audit strategy.
    Some commenters indicated that the requirement for the auditor to 
communicate the audit strategy might result in the audit committee 
second guessing the auditor's strategy and the scope of the audit. 
These commenters suggested that the standard should

[[Page 57421]]

emphasize that the auditor should not disclose details about the audit 
strategy that would allow management or the audit committee to take 
steps that could reduce the effectiveness of the audit strategy. 
Another commenter suggested the standard should require the auditor to 
provide specific details about the type and timing of procedures. 
Auditing Standard No. 16 includes a note, which indicates that the 
overview of the audit strategy is intended to provide information about 
the audit, but not specific details that would compromise the 
effectiveness of the audit procedures. Communicating certain details 
might reduce the effectiveness of those audit procedures. The Board 
considers that the language in Auditing Standard No. 16 strikes the 
appropriate balance; therefore, the standard was not revised.
    Some commenters suggested that significant risks should be 
communicated throughout the audit rather than communicating just those 
significant risks identified during the auditor's risk assessment 
procedures. It is not the intent of the standard for the auditor to 
communicate only the significant risks that are identified during the 
auditor's risk assessment procedures. Paragraph 11 of Auditing Standard 
No. 16 requires the auditor to communicate significant changes to the 
planned audit strategy or the significant risks initially identified 
and the reasons for such changes.
    A commenter suggested that the communication of risks be expanded 
to include business risks and the auditor's views of the company's 
internal controls, in addition to the significant risks of material 
misstatement to the financial statements. As part of obtaining an 
understanding of the company and its environment, Auditing Standard No. 
12 requires the auditor to obtain an understanding of the company's 
objectives, strategies, and related business risks that could 
reasonably be expected to result in risks of material misstatement.\65\ 
Under Auditing Standard No. 16, the auditor is required to communicate 
significant risks to the audit committee. If the auditor determines 
that a business risk results in a significant risk of material 
misstatement, the auditor should communicate the significant risk to 
the audit committee. Additionally, under Auditing Standard No. 5, An 
Audit of Internal Control Over Financial Reporting That Is Integrated 
with An Audit of Financial Statements, and AU sec. 325, Communications 
About Control Deficiencies in an Audit of Financial Statements, the 
auditor is required to communicate to the audit committee material 
weaknesses and significant deficiencies in internal control over 
financial reporting identified during the audit.\66\ Therefore, the 
standard was not revised.
---------------------------------------------------------------------------

    \65\ See paragraph 14 of Auditing Standard No. 12.
    \66\ See paragraphs 78 and 80 of Auditing Standard No. 5 and 
paragraph 4 of AU sec. 325.
---------------------------------------------------------------------------

    Auditing Standard No. 16 also requires communications regarding 
others involved in the audit, such as persons with specialized skill or 
knowledge, internal audit, and other firms or persons performing audit 
procedures. Communications of others involved in the audit might be 
important for an audit committee to understand as part of the audit 
committee's oversight of the financial reporting process.
Specialized Skill or Knowledge (Paragraph 10.a. of Auditing Standard 
No. 16)
    Auditing Standard No. 16 includes a requirement for the auditor to 
communicate to the audit committee the nature and extent of specialized 
skill or knowledge needed to perform the planned audit procedures or 
evaluate the audit results related to significant risks. This 
requirement is designed for the auditor to communicate the 
determination the auditor is required to make as part of developing the 
audit strategy in Auditing Standard No. 9.\67\ Many audit firms have 
employees with specialized skill or knowledge that the engagement team 
can utilize. However, other firms might not have such in-house 
expertise. The focus of this requirement is on the communication about 
the need for specialized skill or knowledge, regardless of whether the 
specialist is from within the firm or outside the firm.
---------------------------------------------------------------------------

    \67\ See paragraph 16 of Auditing Standard No. 9 for the 
requirement for the auditor to determine whether specialized skill 
or knowledge is needed to perform appropriate risk assessments, plan 
or perform audit procedures, or evaluate audit results.
---------------------------------------------------------------------------

Internal Audit (Paragraphs 10.b. and 10.c. of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee the extent to which the auditor plans to use the work 
of the company's internal auditors in an audit of financial statements, 
including when internal audit provides direct assistance to the 
auditor. In addition, Auditing Standard No. 16 requires the auditor to 
communicate the extent to which the auditor plans to use the work of 
internal auditors, company personnel (in addition to internal 
auditors), and third parties working under the direction of management 
or the audit committee when performing an audit of internal control 
over financial reporting.
    Auditing Standard No. 9 requires the auditor to establish an 
overall audit strategy that sets the scope, timing, and direction of 
the audit and guides the development of the audit plan, including the 
nature, timing, and extent of resources necessary to perform the 
engagement.\68\ Other standards, including AU sec. 322, The Auditor's 
Consideration of the Internal Audit Function in an Audit of Financial 
Statements, and Auditing Standard No. 5, provide additional 
requirements and impose limits on the use of internal audit staff. The 
requirement in Auditing Standard No. 16 is to communicate to the audit 
committee the extent to which the auditor plans to use the work of the 
company's internal auditors and others as determined in the audit plan.
---------------------------------------------------------------------------

    \68\ See paragraphs 8-9 of Auditing Standard No. 9.
---------------------------------------------------------------------------

Other Firms or Persons Performing Audit Procedures (Paragraph 10.d. of 
Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee the names, locations, and planned responsibilities of 
other independent public accounting firms or other persons, who are not 
employed by the auditor, that perform audit procedures in the current 
period audit. The standard includes a note stating the term ``other 
independent public accounting firms'' includes firms that perform audit 
procedures in the current period audit regardless of whether they 
otherwise have any relationship with the auditor.
    In planning and performing the audit, the auditor determines 
whether to use other auditors or other persons to perform audit 
procedures at individual client locations, business units, or to 
perform work related to specific audit areas or procedures. Those other 
auditors might be affiliated firms, non-affiliated firms, or other 
persons not employed by the auditor.
    The note to Auditing Standard No. 16 was revised from the 
reproposed standard to clarify that the communication regarding other 
independent public accounting firms is not based on the type of 
relationship the auditor otherwise has with the other firms. Rather, 
the requirement for the auditor to communicate the names, locations, 
and planned responsibilities of other independent public accounting 
firms and other persons is to provide information to the audit 
committee regarding the parties involved in the

[[Page 57422]]

audit. This requirement also might facilitate a discussion of how the 
work of other parties would affect the audit.
    The reproposed standard also required the auditor to communicate to 
the audit committee the ``planned roles'' of others involved in the 
audit and the ``scope of audit procedures.'' One commenter suggested 
that the requirement to communicate the ``scope of audit procedures'' 
should be clarified in the standard. Another commenter suggested that 
the communication should be expanded to be more robust when other 
participants are used to audit foreign components of a company. 
Auditing Standard No. 10, Supervision of the Audit Engagement, requires 
the auditor to inform engagement team members of their responsibilities 
\69\ and AU sec. 543, Part of Audit Performed by Other Independent 
Auditors, discusses situations in which the auditor uses the work and 
reports of other independent auditors who have audited financial 
statements of one or more subsidiaries, divisions, branches, components 
or investments included in the financial statements.\70\ To align with 
these requirements, the standard was revised to require the auditor to 
communicate only the ``planned responsibilities'' of other participants 
involved in the audit, the requirements to communicate the ``planned 
roles'' of others involved in the audit and the ``scope of audit 
procedures'' were removed from the standard, and the standard was not 
expanded to include other considerations.
---------------------------------------------------------------------------

    \69\ See paragraph 5.a. of Auditing Standard No. 10.
    \70\ See AU sec. 543.01.
---------------------------------------------------------------------------

    Many commenters suggested that the standard provide a threshold for 
determining when to make communications regarding others involved in 
the audit, such as when another auditor performs procedures related to 
a percentage of the company's total assets or addresses significant 
risks. Others suggested that the communication include only non-
affiliated accounting firms. The standard was not revised because audit 
committees have oversight of the entire audit engagement, which 
includes work performed by other auditors. The audit committee should 
be aware of all the participants in the audit. This communication 
regarding other participants in the audit would enable the audit 
committee to inquire or otherwise determine, for example, whether the 
other participants are registered with the Board and are subject to 
PCAOB inspections and whether they have disciplinary history with the 
Board or other regulators.
    This communication requirement is intended to be scalable. For 
example, the amount of detail the auditor generally would communicate 
to the audit committee regarding the participation of other auditors 
would be greater for participants that perform a significant portion of 
the audit or that perform procedures related to significant risks.
Principal Auditor (Paragraph 10.e. of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee the basis for the auditor's determination that the 
auditor can serve as principal auditor, if significant parts of the 
audit are to be performed by other auditors. This communication 
requirement is based on the auditor's determination that the auditor 
can serve as the principal auditor in accordance with AU sec. 543. This 
communication would enable the audit committee to evaluate the extent 
of work performed by the principal auditor in relation to work 
performed by other auditors.
    The reproposed standard included a note to describe situations 
where such communications would be required. The Board determined that 
this note was not necessary because AU sec. 543, governs the 
determination of whether the auditor can serve as the principal 
auditor.
Accounting Policies and Practices, Estimates, and Significant Unusual 
Transactions (Paragraph 12 of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee certain matters related to the company's accounting 
policies and practices, estimates, and significant unusual 
transactions. However, the standard recognizes that management also 
might make communications to the audit committee regarding these 
matters and that the auditor might not need to communicate the 
information at the same level of detail as management as long as the 
auditor meets certain criteria specified in the standard. In such 
circumstances, the auditor should communicate any omitted or 
inadequately described matters to the audit committee.
Accounting Policies and Practices (Paragraphs 12.a. and 12.b. of 
Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee certain information regarding the company's significant 
accounting policies and practices and also critical accounting policies 
and practices.
    The standard uses the terms ``significant accounting policies and 
practices'' and ``critical accounting policies and practices.'' The 
Financial Accounting Standards Board's (``FASB'') Accounting Standards 
Codification (``ASC'') and the International Accounting Standards 
Board, require that companies disclose a description of all significant 
accounting policies as an integral part of the financial 
statements.\71\ For example, the FASB ASC recognizes that an entity's 
description of its significant accounting policies is an integral part 
of the financial statements.\72\ Additionally, the term ``significant 
accounting policies and practices'' is consistent with the term used in 
AU sec. 380 and understood in practice and, therefore, has not been 
separately defined.
---------------------------------------------------------------------------

    \71\ See FASB ASC, Topic 235, Notes to Financial Statements, 
section 235-10-50. As part of this disclosure, the entity is 
required to disclose accounting policies and to describe the 
accounting principles followed by the entity and the methods of 
applying those principles that materially affect the determination 
of financial position, cash flows, or results of operations. 
Additionally, see paragraph 117 of International Accounting Standard 
1, Presentation of Financial Statements, which requires the entity 
to disclose the summary of significant accounting policies, 
including the measurement basis used in preparing the financial 
statements and other accounting policies that are relevant to 
understanding the financial statements.
    \72\ See FASB ASC paragraphs 235-10-50-1 through 235-10-50-6.
---------------------------------------------------------------------------

    The definition of ``critical accounting policies and practices'' in 
Auditing Standard No. 16 is based on the SEC's description of the term 
``critical accounting policies and practices'' as a company's 
accounting policies and practices that are both most important to the 
portrayal of the company's financial condition and results and require 
management's most difficult, subjective, or complex judgments, often as 
a result of the need to make estimates about the effects of matters 
that are inherently uncertain.\73\ The selection of significant 
accounting policies and practices involves a broader range of 
transactions and events over time, while the selection of critical 
accounting policies and practices is tailored to specific events in the 
current year. Therefore, critical accounting policies and practices 
might be viewed as a subset of significant accounting policies and 
practices.
---------------------------------------------------------------------------

    \73\ See SEC, Strengthening the Commission's Requirements 
Regarding Auditor Independence, Securities Act Release No. 8183 
(Jan. 28, 2003).
---------------------------------------------------------------------------

Significant Accounting Policies and Practices (Paragraph 12.a. of 
Auditing Standard No. 16)
    Auditing Standard No. 16 generally retains the requirements from AU 
sec.

[[Page 57423]]

380 related to communication of the company's significant accounting 
policies and practices, including:
    1. Management's initial selection of, or changes in, significant 
accounting policies or the application of such policies in the current 
period; and
    2. The effect on financial statements or disclosures of significant 
accounting policies in (i) controversial areas or (ii) areas for which 
there is a lack of authoritative guidance or consensus, or diversity in 
practice.
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee certain matters related to significant accounting 
policies and practices, whereas, AU sec. 380 required the auditor only 
to determine that the audit committee was ``informed.'' This change in 
wording is intended to indicate that the auditor should make these 
communications, rather than determine that the audit committee was 
informed, as required in AU sec. 380. However, the note to paragraph 12 
of Auditing Standard No. 16 acknowledges that such communications may 
be made by management, and if the auditor meets certain conditions, 
these communications need not be duplicated by the auditor.
    Some commenters suggested that it was unclear whether the 
communication of the initial selection of, or changes in, significant 
accounting policies or the application of such policies in the current 
period would require communication annually if there is no change. 
Another commenter indicated that the auditor may not be in a position 
to provide information on areas for which there is diversity in 
practice because the auditor may not be knowledgeable of accounting 
practices used by other entities.
    Auditing Standard No. 16 was not revised in response to these 
comments. The standard indicates that the auditor should communicate to 
the audit committee the initial selection in the current period of 
significant accounting policies. The standard also indicates that the 
auditor should communicate to the audit committee changes in those 
policies or changes in the application of those policies in the current 
period if they differ from those policies that management previously 
utilized or how they were previously applied.
    Additionally, the auditor's responsibility to communicate the 
effect of significant accounting policies includes (i) controversial 
areas or (ii) areas for which there is lack of authoritative guidance 
or consensus, or diversity in practice. The auditor should be aware of 
diversity in practice related to significant accounting policies and 
practices used by the company because Auditing Standard No. 12 requires 
the auditor to evaluate whether the company's selection of and 
application of accounting principles are appropriate for its business 
and consistent with the applicable financial reporting framework and 
accounting principles used in the relevant industry.\74\ Based on this 
evaluation, the auditor should be in a position to make such 
communication.
---------------------------------------------------------------------------

    \74\ Paragraph 12 of Auditing Standard No. 12.
---------------------------------------------------------------------------

Critical Accounting Policies and Practices (Paragraph 12.b. of Auditing 
Standard No. 16)
    Auditing Standard No. 16 incorporates the Exchange Act requirement 
for the auditor to communicate to the audit committee all critical 
accounting policies and practices to be used.\75\ Auditing Standard No. 
16 also requires the auditor to communicate the reasons certain 
accounting policies and practices are considered critical and how 
current and anticipated future events might affect the determination of 
whether certain policies and practices are considered critical.\76\
---------------------------------------------------------------------------

    \75\ Section 10A(k) of the Exchange Act, 15 U.S.C. 78j-1(k), 
requires the auditor to report this information to the audit 
committee. See also SEC Rule 2-07 of Regulation S-X (``SEC Rule 2-
07''), 17 CFR 210.2-07.
    \76\ See Securities Act Release No. 8183, which describes the 
SEC's expectations regarding the discussion related to critical 
accounting policies and practices. In this release, the SEC 
indicated that it anticipated that the discussion of accounting 
policies and practices would include how current and anticipated 
future events might affect the determination of whether certain 
policies and practices are considered critical.
---------------------------------------------------------------------------

    Some commenters recommended deleting the requirement for the 
auditor to communicate how anticipated future events might affect the 
determination of whether certain policies and practices are considered 
critical since the auditor cannot predict the future. The standard 
retains the SEC requirement regarding communication of anticipated 
future events related to critical accounting policies and practices, as 
this is a component of the required communication the SEC identified in 
adopting SEC Rule 2-07.\77\ The standard notes that critical accounting 
policies and practices are tailored to specific events in the current 
year and that the accounting policies and practices that are considered 
critical might change from year to year. For example, a significant 
merger or acquisition may result in the related accounting policy being 
considered critical in the current year in which the related 
transaction occurs, but not in subsequent years. Auditing Standard No. 
16 is aligned with the SEC requirement, therefore the standard was not 
revised.
---------------------------------------------------------------------------

    \77\ Id.
---------------------------------------------------------------------------

Critical Accounting Estimates (Paragraph 12.c. of Auditing Standard No. 
16)
    Auditing Standard No. 16 requires the auditor to communicate the 
following matters related to critical accounting estimates:
    7. A description of the process management used to develop critical 
accounting estimates;
    8. Management's significant assumptions used in critical accounting 
estimates that have a high degree of subjectivity; and
    9. Any significant changes management made to the processes used to 
develop critical accounting estimates or significant assumptions, a 
description of management's reasons for the changes, and the effects of 
the changes on the financial statements.
    As the term ``critical accounting estimate'' implies, the 
communication is not designed to encompass a long list of accounting 
estimates resulting from the application of accounting policies that 
cover a substantial number of line items in the company's financial 
statements. Rather, Auditing Standard No. 16 defines the term 
``critical accounting estimate'' as an accounting estimate where (a) 
the nature of the estimate is material due to the levels of 
subjectivity and judgment necessary to account for highly uncertain 
matters or the susceptibility of such matters to change and (b) the 
impact of the estimate on financial condition or operating performance 
is material.
    The definition of ``critical accounting estimate'' is based on SEC 
interpretive guidance in connection with management's discussion and 
analysis (``MD&A'') of the company's financial condition and results of 
operations.\78\ The alignment of the term critical accounting estimates 
in PCAOB standards with the same term in the SEC's interpretive 
guidance allows auditors to use the same concept under SEC requirements 
and PCAOB standards when communicating matters to the audit committee. 
The term critical accounting estimate is used to help focus the 
communication to the audit committee on those estimates that might be 
subject to a higher risk of material misstatement, such as certain fair 
value estimates. The definition of a critical accounting estimate is 
intended to

[[Page 57424]]

replace the term ``particularly sensitive'' in AU sec. 380.\79\
---------------------------------------------------------------------------

    \78\ See SEC, Interpretation: Commission Guidance Regarding 
Management's Discussion and Analysis of Financial Condition and 
Results of Operations, Securities Act Release No. 8350 (Dec. 19, 
2003).
    \79\ See AU sec. 380.08, which stated in part, ``[c]ertain 
accounting estimates are particularly sensitive because of their 
significance to the fin018ial statements and because of the 
possibility that future events affecting them may differ markedly 
from management's current judgments.''
---------------------------------------------------------------------------

    The requirement to communicate the process management used to 
develop critical accounting estimates is adapted from the requirement 
in AU sec. 380 related to particularly sensitive accounting 
estimates.\80\ Additionally, the communication requirements are 
designed to communicate the results of the auditor's performance 
requirements under AU sec. 342, Auditing Accounting Estimates, which 
requires the auditor to evaluate the reasonableness of accounting 
estimates. In evaluating the reasonableness of the accounting estimate, 
AU sec. 342 also requires the auditor to obtain an understanding of how 
management developed the estimate.\81\ AU sec. 342 also states that in 
evaluating the reasonableness of an estimate, the auditor normally 
concentrates on key factors and assumptions that are (a) significant to 
the accounting estimate, (b) sensitive to variations, (c) deviations 
from historical patterns, and (d) subjective and susceptible to 
misstatement and bias.\82\
---------------------------------------------------------------------------

    \80\ AU sec. 380.08.
    \81\ See AU sec. 342.10.
    \82\ See AU Sec. 342.09.
---------------------------------------------------------------------------

    One commenter suggested that the communication requirement also 
include how management subsequently monitors critical accounting 
estimates and, when critical accounting estimates involve a range of 
possible outcomes, how the recorded estimates relate to the range and 
how various selections within the range would affect the company's 
financial statements. Although these requirements are not included in 
Auditing Standard No. 16, the Board notes that the SEC has stated that 
management should disclose the company's critical accounting estimates 
in MD&A.\83\ According to the related SEC release, management's 
discussion should present, among other matters, the company's analysis 
of the uncertainties involved in applying a principle at a given time 
or the variability that is reasonably likely to result from its 
application over time and analyze an estimate's specific sensitivity to 
change based on other outcomes that are reasonably likely to occur and 
would have a material effect.\84\ The commenter's concerns, therefore, 
may be addressed through a company's MD&A disclosures.
---------------------------------------------------------------------------

    \83\ See Securities Act Release No. 8350.
    \84\ Id.
---------------------------------------------------------------------------

    AU sec. 550, Other Information in Documents Containing Audited 
Financial Statements, requires the auditor to read the other 
information, such as MD&A in documents containing audited financial 
statements, and consider whether the information, or the manner of its 
presentation, is materially inconsistent with information in the 
financial statements or is a material misstatement of fact.\85\ 
Auditing Standard No. 16 includes a requirement for the auditor to 
communicate to the audit committee the results of such procedures. 
Accordingly, no change was made to the standard.
---------------------------------------------------------------------------

    \85\ AU secs. 550.04-.05.
---------------------------------------------------------------------------

Significant Unusual Transactions (Paragraph 12.d. of Auditing Standard 
No. 16)
    Auditing Standard No. 16 includes requirements for the auditor to 
communicate to the audit committee (1) significant transactions that 
are outside the normal course of business for the company or that 
otherwise appear to be unusual due to their timing, size, or nature; 
\86\ and (2) the policies and practices management used to account for 
significant unusual transactions. Communication of significant unusual 
transactions would enable the audit committee to gain the auditor's 
insight into those transactions and to take any appropriate action.
---------------------------------------------------------------------------

    \86\ See paragraph 71.g. of Auditing Standard No. 12.
---------------------------------------------------------------------------

    The requirement in the standard for the auditor to communicate the 
policies and practices management used to account for significant 
unusual transactions is similar to the requirement in AU sec. 380.\87\ 
Under Auditing Standard No. 16, such communication also would include 
the identification of significant unusual transactions.
---------------------------------------------------------------------------

    \87\ AU sec. 380.07.
---------------------------------------------------------------------------

    The reproposed standard required the auditor to communicate 
significant unusual transactions, of which the auditor is aware, that 
are outside the normal course of business for the company or otherwise 
appear to be unusual due to their timing, size, or nature. Many 
commenters indicated that management also might communicate matters 
related to significant unusual transactions to the audit committee and 
that the standard should acknowledge that management might make the 
communications related to significant unusual transactions. The 
standard was revised to recognize that management might make these 
communications to the audit committee and that, in those situations, 
the auditor might not need to communicate the information at the same 
level of detail as management as long as certain criteria specified in 
the standard are met. However, the auditor should communicate any 
omitted or inadequately described matters to the audit committee.
    Additionally, some commenters suggested that the communication 
should be limited to significant unusual transactions that are 
considered significant risks. While a significant unusual transaction 
might also be considered a significant risk, this communication 
provides the audit committee with additional information regarding the 
significant unusual transactions and the policies and practices 
management used to account for such transactions, even if such 
transactions do not constitute significant risks. Significant unusual 
transactions, at times, have been considered to be a contributing 
factor in attempts to mislead investors about a company's financial 
condition. Therefore, providing the audit committee with information 
regarding significant unusual transactions could benefit the audit 
committee in its oversight of the financial reporting process.
    Some commenters suggested that the standard include a definition of 
the term ``significant unusual transactions.'' Auditing Standard No. 16 
describes significant unusual transactions as significant transactions 
that are outside the normal course of business for the company or that 
otherwise appear to be unusual due to their timing, size, or nature, 
which is consistent with the description of this term in other PCAOB 
standards, such as Auditing Standard No. 12.\88\ Therefore, the 
standard was not revised to further define significant unusual 
transactions.
---------------------------------------------------------------------------

    \88\ Paragraph 71.g. of Auditing Standard No. 12.
---------------------------------------------------------------------------

Consideration of Communications Made by Management (Note to Paragraph 
12 of Auditing Standard No. 16)
    Auditing Standard No. 16 retains the substance of the communication 
requirements in AU sec. 380 regarding accounting policies, practices, 
and estimates. The requirement in the standard for the auditor to 
communicate critical accounting policies and practices is consistent 
with Section 10A(k) of the Exchange Act, which requires auditors of 
issuers to report all critical accounting policies and practices to the 
issuer's audit committee.\89\ In addition, Auditing

[[Page 57425]]

Standard No. 16 includes a new requirement related to the communication 
of significant unusual transactions.
---------------------------------------------------------------------------

    \89\ See also SEC Rule 2-07.
---------------------------------------------------------------------------

    Many commenters suggested that the standard should recognize that 
management has the primary responsibility for reporting to the audit 
committee and that the auditor's responsibility should be to confirm 
that management has appropriately communicated. No change was made in 
response to this comment because, similar to AU sec. 380, Auditing 
Standard No. 16 acknowledges that management also may be communicating 
certain matters related to the financial reporting process to the audit 
committee. The Board recognizes that management as well as the auditor 
might discuss accounting policies, practices, estimates, and 
significant unusual transactions with the audit committee and that it 
would not be cost-effective or practical for the audit committee to 
listen to essentially the same presentation twice. Therefore, Auditing 
Standard No. 16 indicates that, in situations in which management 
communicates matters in paragraph 12, the auditor's communication 
requirement under the standard would be met if the auditor: (1) 
Participates in management's discussion with the audit committee,\90\ 
(2) affirmatively confirms to the audit committee that management has 
adequately communicated these matters, and (3) with respect to critical 
accounting policies and practices, identifies for the audit committee 
those accounting policies and practices that the auditor considers 
critical. In addition, the auditor should communicate any omitted or 
inadequately described matters to the audit committee.
---------------------------------------------------------------------------

    \90\ The auditor's participation in management's discussion with 
the audit committee could be satisfied in person or via audio or 
video conference.
---------------------------------------------------------------------------

    In situations in which management makes those communications to the 
audit committee, in order to satisfy the communication requirement in 
Auditing Standard No. 16, the auditor would be required to participate 
during discussions between management and the audit committee regarding 
accounting policies, practices, estimates, and significant unusual 
transactions, which may include discussions of the importance of 
critical accounting policies, practices or estimates, or the difficult, 
subjective, or complex nature of the judgment involved in significant 
unusual transactions, or the selection or application of accounting 
policies, practices, or estimates. If the auditor to identifies the 
accounting policies and practices that the auditor considers critical 
to the portrayal of the company's financial condition and results and 
affirmatively confirms that management has adequately communicated the 
accounting policies, practices, estimates, and significant unusual 
transactions to the audit committee in a meeting in which the auditor 
participated the auditor would be deemed to satisfy the requirement for 
the auditor to report all critical accounting policies and practices to 
the audit committee, without the need for the auditor to repeat 
management's presentation on the same topic.
    Conversely, if the auditor (1) did not participate in management's 
meeting with the audit committee in which communication regarding 
accounting policies, practices, estimates, and significant unusual 
transactions occurred, (2) did not affirmatively confirm that 
accounting policies, practices, estimates, and significant unusual 
transactions had been discussed adequately by management, or (3) with 
respect to critical accounting policies and practices, did not identify 
those accounting policies and practices that the auditor considers 
critical, then the auditor would be required to communicate to the 
audit committee the matters described in paragraph 12 of Auditing 
Standard No. 16, regardless of any management communication regarding 
those matters.
Auditor's Evaluation of the Quality of the Company's Financial 
Reporting (Paragraph 13 of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate 
certain matters to the audit committee regarding the auditor's views of 
the audit and the financial statements as described below.
Qualitative Aspects of Significant Accounting Policies and Practices 
(Paragraph 13.a. of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate the 
results of the auditor's evaluation of, and conclusions about, the 
qualitative aspects of the company's significant accounting policies 
and practices, including situations in which the auditor identified 
bias in management's judgments about the amounts and disclosures in the 
financial statements. This requirement is similar to certain 
communication requirements that have been superseded. AU sec. 380 
required the auditor to discuss with the audit committee the auditor's 
judgments about the quality, not just the acceptability, of the 
company's accounting principles.\91\ Additionally, AU sec. 9312, Audit 
Risk and Materiality in Conducting an Audit: Auditing Interpretations 
of Section 312, required the auditor to consider whether matters 
related to management bias should be communicated to the audit 
committee.\92\
---------------------------------------------------------------------------

    \91\ AU sec. 380.11.
    \92\ Following the original proposal of this standard, AU sec. 
9312 was superseded when the Board adopted the risk assessment 
standards. The performance requirement of AU sec. 9312, however, was 
substantially included in the risk assessment standards.
---------------------------------------------------------------------------

    The requirement in Auditing Standard No. 16 is designed for the 
auditor to communicate the results of the auditor's procedures under 
Auditing Standard No. 14, Evaluating Audit Results, which requires the 
auditor to, among other things, evaluate the qualitative aspects of the 
company's accounting practices,\93\ including potential bias in 
management's judgments about the amounts and disclosures in the 
financial statements.\94\
---------------------------------------------------------------------------

    \93\ See paragraphs 24-27 of Auditing Standard No. 14.
    \94\ Id.
---------------------------------------------------------------------------

    Additionally, Auditing Standard No. 16 requires the auditor to 
communicate to the audit committee the results of the auditor's 
evaluation of the differences between (i) estimates best supported by 
audit evidence and (ii) estimates included in the financial statements, 
which are individually reasonable, that indicate a possible bias on the 
part of the company's management. This communication is designed for 
the auditor to discuss the results of the auditor's evaluation of these 
matters as required under Auditing Standard No. 14.\95\ Linking the 
communication requirements with performance requirements in Auditing 
Standard No. 14 provides context regarding the matters to be 
communicated.
---------------------------------------------------------------------------

    \95\ See paragraph 27 of Auditing Standard No. 14.
---------------------------------------------------------------------------

    Some commenters suggested that the standard should retain the 
requirement in AU sec. 380 for the auditor to discuss with the audit 
committee the auditor's judgments about the quality, not just the 
acceptability, of the entity's accounting principles. Auditing Standard 
No. 16 modifies the requirement from AU sec. 380 by requiring the 
auditor to communicate to the audit committee the results of the 
auditor's evaluation of, and conclusions about, the qualitative aspects 
of the company's significant accounting policies and practices, while 
linking the communication requirement to the performance requirement in 
Auditing Standard No. 14. Therefore, no

[[Page 57426]]

change was made in response to these comments.
Assessment of Critical Accounting Policies and Practices (Paragraph 
13.b. of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee the auditor's assessment of management's disclosures 
related to the critical accounting policies and practices, along with 
any significant modifications to the disclosures of those policies and 
practices proposed by the auditor that management did not make. This 
requirement is based on the Exchange Act's requirement that the auditor 
report to the audit committee all critical accounting policies and 
practices.\96\ In the release adopting the SEC's related rule, the SEC 
indicated that it anticipated that the auditor's communications to the 
audit committee regarding critical accounting policies would include an 
assessment of management's disclosures along with any significant 
proposed modifications by the auditor that were not included in those 
disclosures.\97\
---------------------------------------------------------------------------

    \96\ See Section 10A(k) of the Exchange Act, 15 U.S.C. 78j-1(k); 
and SEC Rule 2-07.
    \97\ See Securities Act Release No. 8183.
---------------------------------------------------------------------------

Conclusions Regarding Critical Accounting Estimates (Paragraph 13.c. of 
Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate the 
basis for the auditor's conclusions regarding the reasonableness of the 
critical accounting estimates. This requirement is similar to a 
requirement in AU sec. 380.\98\ This requirement is designed to require 
the auditor to communicate the results of the auditor's procedures 
regarding critical accounting estimates under PCAOB standards, such as 
AU sec. 342.\99\ Communicating these results will provide the audit 
committee with the auditor's assessment of the critical accounting 
estimates based on the auditor's procedures.
---------------------------------------------------------------------------

    \98\ See AU sec. 380.08.
    \99\ See AU secs. 342.04, 09-.10.
---------------------------------------------------------------------------

Significant Unusual Transactions (Paragraph 13.d. of Auditing Standard 
No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee the auditor's understanding of the business rationale 
for significant unusual transactions. This communication requirement is 
aligned with the performance requirement in AU sec. 316, Consideration 
of Fraud in a Financial Statement Audit, which requires the auditor to 
gain an understanding of the business rationale regarding significant 
transactions that are outside the normal course of business or that 
otherwise appear unusual.\100\ This communication would provide the 
audit committee with an opportunity to receive the auditor's 
perspective of such transactions.
---------------------------------------------------------------------------

    \100\ See AU sec. 316.66.
---------------------------------------------------------------------------

    In a separate rulemaking project, the Board has proposed amendments 
to AU sec. 316 that would require the auditor to design and perform 
procedures to obtain an understanding of the business purpose (or lack 
thereof) of each significant unusual transaction and evaluate whether 
the business purpose (or the lack thereof) indicates that the 
significant unusual transaction may have been entered into to engage in 
fraudulent financial reporting or conceal misappropriation of 
assets.\101\ If, at the conclusion of that rulemaking project, the 
Board adopts the proposed amendments to AU sec. 316, the Board will 
consider, as appropriate, amending Auditing Standard No. 16 to align 
the communication with any new performance requirements.
---------------------------------------------------------------------------

    \101\ Proposed Auditing Standard--Related Parties, Proposed 
Amendments to Certain PCAOB Auditing Standards Regarding Significant 
Unusual Transactions, and Other Proposed Amendments to PCAOB 
Auditing Standards, PCAOB Release No. 2012-001 (Feb. 28, 2012).
---------------------------------------------------------------------------

Financial Statement Presentation (Paragraph 13.e. of Auditing of 
Auditing Standard No. 16)
    Similar to AU sec. 380.11, Auditing Standard No. 16 requires the 
auditor to communicate to the audit committee the results of the 
auditor's evaluation of whether the presentation of the financial 
statements and the related disclosures are in conformity with the 
applicable financial reporting framework, including the auditor's 
consideration of the form, arrangement, and content of the financial 
statements (including the accompanying notes), encompassing matters 
such as the terminology used, the amount of detail given, the 
classification of items, and the bases of amounts set forth. This 
communication requirement relates to the auditor's evaluation of 
whether the financial statements are presented fairly, in all material 
respects, in conformity with the applicable financial reporting 
framework, as required by Auditing Standard No. 14.\102\
---------------------------------------------------------------------------

    \102\ See paragraphs 30-31 of Auditing Standard No. 14, which 
describe the auditor's responsibility relating to the evaluation of 
whether the financial statements are presented fairly, in all 
material respects, in conformity with the applicable financial 
reporting framework.
---------------------------------------------------------------------------

    Some commenters suggested that the standard should retain the 
requirement in AU sec. 380 for the auditor to discuss with the audit 
committee the auditor's views about the clarity and completeness of the 
company's financial statements and disclosures. However, commenters on 
the original proposed standard indicated it was not clear what was 
meant by the clarity and completeness of the company's financial 
statements and related disclosures. Commenters also expressed concern 
as to what should be included in the communications to the audit 
committee. The communication requirement in Auditing Standard No. 16 
avoids possible confusion 0regarding the meaning of the phrase 
``clarity and completeness'' by linking it to the auditor performance 
requirements included in Auditing Standard No. 14 for the auditor to 
evaluate the presentation of the financial statements, including 
disclosures. The performance requirements in Auditing Standard No. 14 
\103\ provide context regarding the matters to be communicated under 
Auditing Standard No. 16.
---------------------------------------------------------------------------

    \103\ Id.
---------------------------------------------------------------------------

New Accounting Pronouncements (Paragraph 13.f. of Auditing Standard No. 
16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee situations in which, as a result of the auditor's 
procedures, the auditor identified a concern regarding management's 
anticipated application of accounting pronouncements that have been 
issued but are not yet effective and might have a significant effect on 
future financial reporting. This requirement is based on the situations 
in which, as a result of the auditor's procedures, the auditor has 
identified a concern regarding the anticipated application of a new 
accounting pronouncement. Auditing Standard No. 16 does not require the 
auditor to perform additional procedures to identify such concerns.
    Some commenters noted that management generally discloses in the 
financial statements the potential effects of adoption of new 
accounting standards and that this auditor communication to the audit 
committee should be related to the auditor's evaluation of management's 
disclosures related to new accounting pronouncements. The intent of the 
required communication to the audit committee is not meant to provide 
an additional evaluation of management's disclosures. Rather, the 
intent is to inform the audit committee when the auditor ``has 
identified a concern'' regarding the planned implementation of a new 
accounting pronouncement or

[[Page 57427]]

whether management has devoted adequate resources to prepare its 
accounting and disclosure processes, and other financial reporting 
systems, for the timely implementation of the new accounting 
pronouncement. This communication might inform the audit committee's 
oversight of the company's financial reporting process. Requiring the 
discussion of such matters is intended to allow the audit committee to 
properly consider the auditor's concerns regarding future financial 
statements. Accordingly, no change to the standard was made.
Alternative Accounting Treatments (Paragraph 13.g. of Auditing Standard 
No. 16)
    Auditing Standard No. 16 requires the auditor to communicate all 
alternative treatments permissible under the applicable financial 
reporting framework for policies and practices related to material 
items that have been discussed with management, including the 
ramifications of the use of such alternative disclosures and 
treatments, and the treatment preferred by the auditor. This 
requirement is consistent with Section 10A(k) of the Exchange Act and 
with SEC Rule 2-07, which requires the auditor to report to the audit 
committee all alternative treatments that are related to material 
items, were discussed with management, and are permissible under the 
applicable financial reporting framework.\104\
---------------------------------------------------------------------------

    \104\ See SEC Rule 2-07, Section 10A(k) of the Exchange Act, 15 
U.S.C. 78j-1(k), and Securities Act Release No. 8183.
---------------------------------------------------------------------------

Other Information in Documents Containing Audited Financial Statements 
(Paragraph 14 of Auditing Standard No. 16)
    Auditing Standard No. 16 retains the requirement from AU sec. 
380.12 for the auditor to communicate to the audit committee the 
auditor's responsibility under PCAOB rules and standards for other 
information presented in documents containing audited financial 
statements, any related procedures performed, and the results of such 
procedures. Such other information would include documents described in 
AU sec. 550, AU sec. 558, Required Supplementary Information, and AU 
sec. 711, Filings Under Federal Securities Statutes.
    The auditor's responsibility under AU sec. 550 requires the auditor 
to read the other information and consider whether such information, or 
the manner of its presentation, is materially inconsistent with 
information, or the manner of its presentation, in the financial 
statements.\105\ One commenter suggested that Auditing Standard No. 16 
should also include a requirement to communicate any identified 
material inconsistencies or misstatements of facts, including the 
auditor's response to such matters.
---------------------------------------------------------------------------

    \105\ See generally, AU secs. 550.04-.07, which require that the 
auditor read the information and consider whether it is materially 
inconsistent with information in the financial statements or whether 
it contains any material misstatements of fact.
---------------------------------------------------------------------------

    Auditing Standard No. 16 requires the auditor to communicate the 
results of the auditor's procedures related to other information in 
documents containing audited financial statements, which would require 
the auditor to communicate identified inconsistencies or misstatements 
of facts to the audit committee. The Board is amending AU sec. 550 to 
require the auditor to communicate to the audit committee the material 
inconsistency between the other information and the financial 
statements in situations in which the information is not revised to 
eliminate the material inconsistency. The Board also is amending AU 
sec. 550 to require the auditor to communicate to the client and the 
audit committee, in writing, a material misstatement of fact in the 
other information. Thus, it was not necessary to revise the standard in 
response to commenters.
Difficult or Contentious Matters for Which the Auditor Consulted 
(Paragraph 15 of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee matters that are difficult or contentious for which the 
auditor consulted outside the engagement team and that the auditor 
reasonably determined are relevant to the audit committee's oversight 
of the financial reporting process. The required communications of 
difficult or contentious matters are based on the results of the 
procedures the auditor performed regarding such matters during the 
course of the audit and do not require the performance of new or 
additional procedures.
    Many matters that arise during an audit can be complex or unusual, 
and the auditor might consult on such matters with the firm's national 
office, industry specialists, or external parties. Difficult or 
contentious issues can arise in various stages of the audit, including 
in the auditor's evaluation of management's judgments, estimates, 
accounting policies, or assessment of identified control deficiencies. 
Difficult or contentious issues generally are the critical matters that 
concern the auditor when he or she is making the final assessment of 
whether the financial statements are presented fairly.
    A difficult issue might not always be synonymous with a contentious 
issue. Rather, a difficult issue might be a matter that requires 
consultation. A contentious issue might be a matter that not only 
requires consultation but also leads to significant points of 
disagreement, debate, or deliberation between the auditor and 
management. Audit committees might better appreciate the importance of 
difficult or contentious matters if they are aware that such 
consultations took place.
    During the course of the audit difficult or contentious issues 
might arise for which the auditor did not consult, but which the 
auditor believes are relevant to the audit committee's oversight of the 
financial reporting process. Auditing Standard No. 16 does not preclude 
the auditor from communicating to the audit committee difficult or 
contentious matters for which the auditor did not consult outside the 
engagement team.
    Some commenters suggested that the standard should define difficult 
or contentious matters. The term ``difficult or contentious matter'' is 
used in Auditing Standard No. 7, Engagement Quality Review. Therefore, 
the term ``difficult or contentious matter'' is not defined in this 
standard.
    Some commenters suggested that the standard should exclude the 
discussions between the auditor and the engagement quality reviewer 
from communications to the audit committee regarding consultation 
outside the engagement team on difficult or contentious matters. The 
communication to the audit committee in Auditing Standard No. 16 
focuses on the difficult or contentious matters on which the auditor 
consulted, not on the parties involved in the consultation. Therefore, 
the standard was not revised.
Management Consultation With Other Accountants (Paragraph 16 of 
Auditing Standard No. 16)
    When the auditor is aware that management consulted with other 
accountants about significant auditing or accounting matters and the 
auditor has identified a concern regarding such matters, Auditing 
Standard No. 16 requires the auditor to communicate to the audit 
committee the auditor's views about such matters that were the subject 
of such consultation. This requirement is similar to a requirement in 
AU sec. 380.\106\ Communicating matters that

[[Page 57428]]

were the subject of consultations only when the auditor has identified 
a concern about those matters should allow the audit committee to focus 
its efforts on important accounting and auditing issues.
---------------------------------------------------------------------------

    \106\ AU sec. 380.14.
---------------------------------------------------------------------------

    Some commenters suggested that communicating management 
consultations with other accountants should be management's 
responsibility and that the standard should clarify that the auditor 
should comment only on what management has communicated regarding such 
consultations. The standard does not impose a communication requirement 
on management. The requirement in Auditing Standard No. 16 is 
specifically related to the auditor's responsibilities when management 
has consulted with other accountants and only when the auditor has a 
concern regarding the accounting and auditing matters that were the 
subject of management's consultations. Therefore, Auditing Standard No. 
16 was not revised.
    As part of the comment process, the Board asked whether the 
requirement to communicate about consultations should be expanded to 
include consultations on accounting or auditing matters with non-
accountants, such as consulting firms or law firms. Some commenters 
suggested that communication regarding management's consultations with 
non-accountants should be required, while others suggested that 
communication about these consultations should be made at the auditor's 
discretion depending on the facts or circumstances and the significance 
of the consultation to the financial statements. However, many 
commenters indicated that this communication should not be expanded to 
include consultations with non-accountants, as the auditors would not 
be in position to know about all management consultations with non-
accountants. Some commenters indicated that this requirement could 
result in the auditor expending significant effort to identify and 
evaluate management's consultations with non-accountants. After 
consideration of these comments, the standard was not revised to 
require the auditor to communicate management's consultation with non-
accountants.
Going Concern (Paragraph 17 of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee certain matters related to the auditor's evaluation of 
the company's ability to continue as a going concern. The communication 
requirements in Auditing Standard No. 16 are based on the auditor's 
performance requirements under AU sec. 341, The Auditor's Consideration 
of an Entity's Ability to Continue as a Going Concern, which requires 
the auditor to evaluate whether there is substantial doubt about the 
company's ability to continue as a going concern for a reasonable 
period of time.\107\ The auditor's communication to the audit committee 
regarding the auditor's evaluation of the company's ability to continue 
as a going concern can serve to further inform the audit committee, in 
certain circumstances, regarding difficult conditions and events that 
the company is encountering.
---------------------------------------------------------------------------

    \107\ See AU sec. 341.06, which provides examples of such 
conditions and events and AU sec. 341.07, which discusses the 
auditor's procedures if the auditor believes there is substantial 
doubt about the company's ability to continue as a going concern for 
a reasonable period of time.
---------------------------------------------------------------------------

    Auditing Standard No. 16 requires the auditor to communicate the 
conditions and events the auditor identified that, when considered in 
the aggregate, lead the auditor to believe that there is substantial 
doubt about the company's ability to continue as a going concern for a 
reasonable period of time. Information about such conditions and events 
is obtained from the application of auditing procedures planned and 
performed to achieve audit objectives that are related to management's 
assertions in the financial statements.\108\ Examples of such 
conditions and events include, but are not limited to, negative trends, 
other indications of possible financial difficulties, internal matters, 
or external matters that have occurred.\109\
---------------------------------------------------------------------------

    \108\ See AU sec. 341.02.
    \109\ See AU sec. 341.06, which provides examples of such 
conditions and events.
---------------------------------------------------------------------------

    Under AU sec. 341, if after considering the identified conditions 
and events, in the aggregate, the auditor believes that there is 
substantial doubt about the entity's ability to continue as a going 
concern for a reasonable period of time, the auditor should consider 
management's plans for dealing with the adverse effects of the 
conditions and events.\110\ Additionally, the auditor should obtain 
information about the plans and consider whether it is likely that the 
adverse effects will be mitigated for a reasonable period of time, and 
that such plans can be effectively implemented.\111\ Auditing Standard 
No. 16 requires that if the auditor concludes, after consideration of 
management's plans, that substantial doubt about the company's ability 
to continue as a going concern is alleviated, the auditor should 
communicate to the audit committee the basis for the auditor's 
conclusion, including elements the auditor identified within 
management's plans that are significant to overcoming the adverse 
effects of the conditions and events.\112\
---------------------------------------------------------------------------

    \110\ See AU sec. 341.07, which discusses the auditor's 
procedures if the auditor believes there is substantial doubt about 
the company's ability to continue as a going concern for a 
reasonable period of time.
    \111\ See AU sec. 341.03b.
    \112\ See AU sec. 341.08, which discusses the auditor's 
responsibilities related to the auditor's evaluation of management's 
plans.
---------------------------------------------------------------------------

    Under AU sec. 341, if the auditor concludes that substantial doubt 
about the company's ability to continue as a going concern for a 
reasonable period of time remains, the audit report should include an 
explanatory paragraph to reflect the auditor's conclusion that there is 
substantial doubt about the company's ability to continue as a going 
concern for a reasonable period of time.\113\ Additionally, Auditing 
Standard No. 16 requires that if the auditor concludes that substantial 
doubt about the company's ability to continue as a going concern for a 
reasonable period of time remains,\114\ the auditor should communicate 
to the audit committee: (1) The effects, if any, on the financial 
statements and the adequacy of the related disclosure; \115\ and (2) 
the effects on the auditor's report.\116\
---------------------------------------------------------------------------

    \113\ See AU sec. 341.12.
    \114\ See AU sec. 341.03c, which discusses the auditor's 
evaluation of factors that indicate there is substantial doubt about 
the company's ability to continue as a going concern.
    \115\ See AU sec. 341.10, which discusses the possible effects 
on the financial statements and the adequacy of the related 
disclosure.
    \116\ See AU secs. 341.12-.16, which discuss the auditor's 
consideration of the effects on the auditor's report when the 
auditor concludes that substantial doubt exists about the company's 
ability to continue as a going concern for a reasonable period of 
time.
---------------------------------------------------------------------------

    The reproposed standard required the auditor to communicate the 
conditions and events the auditor identified that, when considered in 
the aggregate, indicate that there ``could be'' substantial doubt about 
the company's ability to continue as a going concern for a reasonable 
period of time. Some commenters suggested that the threshold for 
communication to the audit committee should be when the auditor 
believes there ``is'' substantial doubt about the company's ability to 
continue as a going concern, rather than when there ``could be'' 
substantial doubt. Those commenters suggested that threshold because, 
under AU sec. 341, the auditor is required to consider management's 
plans for addressing the adverse effects of the events and conditions 
when the auditor believes there ``is'' substantial doubt.
    Auditing Standard No. 16 was revised to require the threshold for 
the auditor's

[[Page 57429]]

initial communication to the audit committee to be when the auditor 
``believes there is'' substantial doubt about the company's ability to 
continue as a going concern. This aligns more closely the communication 
requirement about the conditions and events with the other 
communication requirements in paragraph 17 of Auditing Standard No. 16. 
Under paragraph 17 of Auditing Standard No. 16 the auditor is required 
to communicate conditions and events, along with the auditor's 
conclusion regarding whether either management's plans alleviate the 
adverse effects of the conditions and events (item b) or substantial 
doubt remains (item c).
Uncorrected and Corrected Misstatements (Paragraphs 18-19 of Auditing 
Standard No. 16)
    Auditing Standard No. 16 requires the auditor to provide the audit 
committee with the schedule of uncorrected misstatements\117\ relating 
to accounts and disclosures that was presented to management. Several 
commenters indicated that audit committees would not find value in 
information presented at the same level of detail as presented to 
management, and that the auditor, therefore, should provide a summary 
of misstatements to the audit committee.
---------------------------------------------------------------------------

    \117\ Footnote 13 to paragraph 20 of Auditing Standard No. 14 
indicates that misstatements include both omissions and the 
presentation of inaccurate or incomplete disclosures.
---------------------------------------------------------------------------

    The Board decided to retain the requirement because presenting a 
schedule that shows only a summary of the uncorrected misstatements 
rather than the individual misstatements might not be informative for 
the audit committee. In addition, the requirement in Auditing Standard 
No. 16 is not a significant change from AU sec. 380.10, which required 
the presentation to the audit committee of a schedule of uncorrected 
misstatements.
    The schedule of uncorrected misstatements required by Auditing 
Standard No. 16 is similar to the summary of uncorrected misstatements 
included in or attached to the management representation letter.\118\ 
Additionally, the Exchange Act and SEC Rule 2-07 require the auditor to 
provide to the audit committee other material written communications 
between the auditor and management, which would include the schedule of 
unadjusted audit differences and a listing of adjustments and 
reclassifications not recorded, if any.\119\
---------------------------------------------------------------------------

    \118\ See paragraph .06g of AU sec. 333, Management 
Representation.
    \119\ See Section 10A(k)(3) of the Exchange Act, 15 U.S.C. 78j-
1(k)(3), SEC Rule 2-07(a)(3) and Securities Act Release No. 8183.
---------------------------------------------------------------------------

    Auditing Standard No. 14 requires the auditor to accumulate 
misstatements identified during the audit, other than those that are 
clearly trivial, and to communicate those to management on a timely 
basis.\120\ According to Auditing Standard No. 14, a misstatement may 
relate to a difference between the amount, classification, 
presentation, or disclosure of a reported financial statement item and 
the amount, classification, presentation, or disclosure that should be 
reported in conformity with the applicable financial reporting 
framework.\121\ The requirement in Auditing Standard No. 16 to 
communicate misstatements related to accounts and disclosures relates 
only to those misstatements that the auditor has accumulated throughout 
the audit that are not clearly trivial and have been reported to 
management.
---------------------------------------------------------------------------

    \120\ See paragraphs 10 and 15 of Auditing Standard No. 14.
    \121\ See paragraph A2 of Auditing Standard No. 14.
---------------------------------------------------------------------------

    Auditing Standard No. 16 also requires the auditor to discuss with 
the audit committee, or determine that management has adequately 
discussed with the audit committee, the basis for the determination 
that the uncorrected misstatements were immaterial, including the 
qualitative factors\122\ considered. In addition, the auditor also 
should communicate to the audit committee that uncorrected 
misstatements or matters underlying those uncorrected misstatements 
could potentially cause future-period financial statements to be 
materially misstated, even if the auditor has concluded that the 
uncorrected misstatements are immaterial to the financial statements 
under audit.
---------------------------------------------------------------------------

    \122\ See Appendix B of Auditing Standard No. 14, which 
discusses the qualitative factors related to the evaluation of the 
materiality of uncorrected misstatements.
---------------------------------------------------------------------------

    Auditing Standard No. 16 also requires the auditor to communicate 
those corrected misstatements, other than those that are clearly 
trivial, related to accounts and disclosures that might not have been 
detected except through the auditing procedures performed and discuss 
with the audit committee the implications that such corrected 
misstatements might have on the financial reporting process.
    One commenter suggested that the standard should require the 
auditor to communicate management's adjusting entries recorded at the 
end of the period or other entries to reconcile accounts. The release 
accompanying the original proposed standard included a question that 
asked whether all corrected misstatements, including those detected by 
management, should be communicated to the audit committee. Many 
commenters responding to the question were not supportive of the 
auditor communicating misstatements detected by management or 
management's period-end adjusting entries, because the auditor may not 
have knowledge of all such adjustments due to the nature of a company's 
financial statement close process and the timing of the auditor's 
procedures. Commenters suggested that such a requirement would likely 
result in the auditor expending significant effort to identify 
misstatements or adjusting entries that the company's internal controls 
previously identified in the financial close process. Accordingly, the 
standard does not include a requirement for the auditor to communicate 
misstatements detected by management.
    Some commenters suggested that the standard should be revised to 
require the auditor to communicate only corrected misstatements that 
individually or in the aggregate could be significant to the company's 
financial statements. As noted previously, Auditing Standard No. 14 
requires the auditor to accumulate misstatements identified during the 
audit, other than those that are clearly trivial. The misstatements the 
auditor accumulated and management corrected are those that are other 
than clearly trivial and could be significant to the company's 
financial statements, either quantitatively or qualitatively. Auditing 
Standard No. 16 also requires the auditor to communicate those 
corrected misstatements that might not have been detected except 
through the auditing procedures performed. The intent of this 
requirement is to inform the audit committee of misstatements, which 
might have certain implications on the company's financial reporting 
process, that were detected only through audit procedures. Therefore, 
Auditing Standard No. 16 was not revised.
    Another commenter suggested that the standard should specifically 
require the auditor to request management to correct the uncorrected 
misstatements. The Board did not make this change because management 
has its own legal responsibilities in relation to the preparation and 
maintenance of the company's books, records, and financial statements. 
Section 13(i) of the Exchange Act requires the financial statements 
filed with the SEC to reflect all material correcting adjustments 
identified by the auditor.\123\
---------------------------------------------------------------------------

    \123\ Section 13(i) of the Exchange Act, 15 U.S.C. 78j-1(m)(i).

---------------------------------------------------------------------------

[[Page 57430]]

Material Written Communication (Paragraph 20 of Auditing Standard No. 
16)
    Auditing Standard No. 16 incorporates the Exchange Act's 
requirement for the auditor to communicate other material written 
communications between the auditor and management to the audit 
committee.\124\ This requirement is intended to capture other possible 
material written communications that might occur but are not addressed 
by requirements in the standard or by other PCAOB standards, such as 
the management representation letter.\125\
---------------------------------------------------------------------------

    \124\ Section 10A(k)(3) of the Exchange Act, 15 U.S.C. 78j-
1(k)(3), requires the auditor to report this information to the 
audit committee; see also SEC Rule 2-07.
    \125\ See Securities Act Release No. 8183 for a discussion of 
the substance of other material written communications.
---------------------------------------------------------------------------

Departure From the Auditor's Standard Report (Paragraph 21 of Auditing 
Standard No. 16)
    Auditing Standard No. 16 includes a requirement for the auditor to 
communicate to the audit committee when the auditor expects to modify 
the opinion in the auditor's report or include explanatory language or 
an explanatory paragraph in the auditor's report.\126\ The auditor is 
required to communicate the reasons for and the wording of the 
modification, explanatory language, or explanatory paragraph. The 
requirement is intended to provide the basis for a discussion between 
the auditor and the audit committee in those circumstances in which the 
auditor expects to add explanatory language or modify the opinion in 
the auditor's standard report.
---------------------------------------------------------------------------

    \126\ See paragraphs .11-.74 and .76 of AU sec. 508, Reports on 
Audited Financial Statements.
---------------------------------------------------------------------------

    As part of overseeing the audit and the financial reporting 
process, it might be important for the audit committee to understand 
the reasons an auditor adds explanatory language or modifies the 
opinion in the auditor's standard report. Such communication enables 
the audit committee to be aware of the nature of any specific matters 
that the auditor expects to highlight in the auditor's report. In 
addition, these communications provide the audit committee with an 
opportunity to obtain further clarification from the auditor about the 
modification. This communication also provides the audit committee with 
an opportunity to provide the auditor with further information and 
explanations regarding the matters that are expected to be included in 
the auditor's report.
Disagreements With Management (Paragraph 22 of Auditing Standard No. 
16)
    Auditing Standard No. 16 includes a requirement for the auditor to 
communicate to the audit committee any disagreements with management 
about matters, whether or not satisfactorily resolved, that 
individually or in the aggregate could be significant to the company's 
financial statements or the auditor's report. This requirement is 
retained from AU sec. 380.13.
    Examples of disagreements might include disagreements with 
management about the application of accounting principles to the 
company's specific transactions and events and the basis for 
management's judgments about accounting estimates. Disagreements might 
also arise regarding the scope of the audit, disclosures to be made in 
the company's financial statements, or the wording of the auditor's 
report. For purposes of Auditing Standard No. 16, disagreements do not 
include differences of opinion based on incomplete facts or preliminary 
information that are later resolved by the auditor obtaining 
additional, relevant facts or information prior to the issuance of the 
auditor's report.
    One commenter suggested that disagreements that are satisfactorily 
resolved should not be communicated to the audit committee unless the 
auditor determines that these matters warrant the audit committee's 
attention. As noted previously, this communication requirement is not 
new. As part of conducting the oversight of the audit and the financial 
reporting process, it might be important for the audit committee to 
know the areas of tension between the auditor and management regarding 
matters that could be significant to the company's financial 
statements, such as accounting principles and practices, financial 
statement disclosures, auditing scope or procedures, or similar 
matters. Accordingly, no change was made in response to this comment. 
Additionally, SEC Form 8-K requires that a registrant report certain 
disagreements between management and the auditor, whether or not such 
disagreements are satisfactorily resolved, when there is a change in 
the auditor.\127\ The requirement in Auditing Standard No. 16 provides 
the audit committee with information regarding important matters that 
might need to be reported subsequently in an SEC filing.
---------------------------------------------------------------------------

    \127\ See e.g., Exchange Act Form 8-K, Item 4.01. See also Item 
304(a)(1)(iv) of Regulation S-K, 17 CFR Sec.  229.304(a)(1)(iv), and 
Instructions 4 and 5 to that item, which require disclosure of 
disagreements, or differences of opinion, at the ``decision-making 
level,'' that, if not resolved to the auditor's satisfaction, would 
have caused the auditor to make reference to the subject matter of 
the disagreement in connection with his or her report.
---------------------------------------------------------------------------

Difficulties Encountered in Performing the Audit (Paragraph 23 of 
Auditing Standard No. 16)
    Auditing Standard No. 16 includes the requirement from AU sec. 
380.16 for the auditor to communicate to the audit committee any 
significant difficulties encountered during the audit. Significant 
difficulties encountered during the audit include, but are not limited 
to:
    d. Significant delays by management, the unavailability of company 
personnel, or an unwillingness by management to provide information 
needed for the auditor to perform his or her audit procedures;
    e. An unreasonably brief time within which to complete the audit;
    f. Unexpected extensive effort required by the auditor to obtain 
sufficient appropriate audit evidence;
    g. Unreasonable management restrictions encountered by the auditor 
on the conduct of the audit; and
    h. Management's unwillingness to make or extend its assessment of 
the company's ability to continue as a going concern when requested by 
the auditor.
Other Matters (Paragraph 24 of Auditing Standard No. 16)
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee other matters arising from the audit that are 
significant to the oversight of the company's financial reporting 
process. This communication includes, among other matters, complaints 
or concerns regarding accounting or auditing matters that have come to 
the auditor's attention during the audit and the results of the 
auditor's procedures regarding such matters. Communication of the other 
matters is based on the results of audit procedures or the conduct of 
the audit and does not require the auditor to perform new or additional 
procedures beyond the communication itself.
    The Sarbanes-Oxley Act requires that audit committees of listed 
companies establish procedures for the receipt, retention, and 
treatment of complaints received by the company regarding accounting, 
internal accounting control, or auditing matters, and for the 
confidential, anonymous submission by employees of the company of 
concerns

[[Page 57431]]

regarding questionable accounting or auditing matters.\128\
---------------------------------------------------------------------------

    \128\ See Section 301 of the Sarbanes-Oxley Act, and Section 
10A(m)(4) of the Exchange Act, 15 U.S.C. 78j-1(m)(4).
---------------------------------------------------------------------------

    Auditing Standard No. 12 requires the auditor to inquire of the 
audit committee regarding tips or complaints received by the audit 
committee regarding financial reporting matters. The auditor might 
become aware of complaints or concerns regarding financial reporting 
matters that were not received through the audit committee's process, 
and, therefore, are unknown to the audit committee. The audit committee 
might be better able to exercise its oversight activities if the 
auditor informed the audit committee of these matters. Paragraph 24 of 
Auditing Standard No. 16 requires the auditor to communicate these 
matters to the audit committee.
    AU sec. 380 required the auditor to ensure that the audit committee 
receives additional information regarding the scope and results of the 
audit that may assist the audit committee in overseeing the financial 
reporting and disclosure process. Auditing Standard No. 16 enhances the 
requirement in AU sec. 380 for the auditor to communicate to the audit 
committee the results of the audit procedures regarding the accounting 
or auditing matters that have been the subject of complaints or 
concerns.
    The standard acknowledges that there might be other matters known 
to the auditor that may be beneficial to the audit committee's 
oversight of the financial reporting process. This communication could 
provide the audit committee with an opportunity to better understand 
management's intentions regarding such matters.
    Several commenters suggested that Auditing Standard No. 16 should 
require the auditor to communicate to the audit committee the results 
of PCAOB inspection findings and any necessary remediation by the audit 
firm. With respect to inspections, the Sarbanes-Oxley Act restricts 
what the Board may publicly disclose,\129\ and the Sarbanes-Oxley Act 
makes no exception for disclosure to an audit committee even if a Board 
inspection has reviewed an audit of the financial statements overseen 
by that audit committee. The Board cannot compel a firm to disclose 
nonpublic inspection information to an audit committee. This need not 
prevent an audit committee from discussing inspection results with its 
auditor. The Board encourages firms to communicate effectively with 
audit committees about inspection matters. The Sarbanes-Oxley Act does 
not restrict a firm from disclosing to an audit committee nonpublic 
information regarding PCAOB inspections (including quality control 
deficiencies and the firm's remediation of those deficiencies) or PCAOB 
disciplinary matters.\130\
---------------------------------------------------------------------------

    \129\ See Section 104(g)(2) of the Sarbanes-Oxley Act (providing 
that the Board shall make inspection reports available to the public 
in appropriate detail ``subject to,'' among other things, the broad 
disclosure restrictions of Section 105(b)(5)(A)).
    \130\ See Information for Audit Committees About the PCAOB 
Inspection Process, PCAOB Release No. 2012-003 (Aug. 1, 2012).
---------------------------------------------------------------------------

Form and Documentation of Communications (Paragraph 25 of Auditing 
Standard No. 16)
    Auditing Standard No. 16 retains from AU sec. 380 the ability for 
auditors to communicate to the audit committee either orally or in 
writing, unless otherwise specified in the standard. Some commenters 
suggested that the standard should require all communications to be in 
writing, while other commenters indicated that the standard should 
continue to provide flexibility in the manner of communication.
    Auditing Standard No. 16 was not revised to require all 
communications to be in writing. The Board's intention is to promote 
effective two-way communication between the auditor and the audit 
committee, whether through presentations, written reports, or 
interactive discussions. Written communications might provide the 
auditor with a basis to lead an active two-way discussion with the 
audit committee.
    In addition, the form of communication may depend on the nature of 
the matter to be communicated. For example, written information often 
makes it easier for the audit committee to understand highly complex 
information (for example, information about critical accounting 
estimates). However, having a dialogue on key matters often is an 
important factor in effective communications between the auditor and 
the audit committee.
    Auditing Standard No. 16 also requires the auditor to document the 
communications in the work papers, whether such communication took 
place orally or in writing. The standard further requires the auditor 
to include a copy of or a summary of management's communications 
provided to the audit committee in the audit documentation if, as part 
of its communications to the audit committee, management communicated 
some or all of the matters identified in paragraphs 12 or 18 and, as a 
result, the auditor did not communicate these matters at the same level 
of detail as management.
Timing (Paragraph 26 of Auditing Standard No. 16)
    The Board considers communications with audit committees to be an 
integral part of the audit process. AU sec. 380 stated that audit 
committee communications are incidental to the audit and are not 
required to occur before the issuance of the auditor's report on the 
entity's financial statements so long as the communications occur on a 
timely basis.\131\ Auditing Standard No. 16 requires the auditor to 
communicate the matters required by the standard in a timely manner and 
prior to the issuance of the auditor's report. This requirement aligns 
the timing of communications with SEC Rule 2-07, which requires the 
auditor to communicate matters to the audit committee prior to the 
filing of the auditor's report with the SEC.\132\ The appropriate 
timing of a particular communication to the audit committee depends on 
factors such as the significance of the matters to be communicated and 
corrective or follow-up actions needed, unless other timing 
requirements are specified by PCAOB rules or standards or the 
securities laws.
---------------------------------------------------------------------------

    \131\ AU sec. 380.04.
    \132\ See SEC Rule 2-07.
---------------------------------------------------------------------------

    The reproposed standard specified that all communications be made 
in a timely manner and prior to the issuance of the auditor's report, 
unless other timing requirements are specified by PCAOB rules or 
standards or the rules or regulations of the SEC. One commenter 
suggested that the ``rules and regulations of the SEC'' should be 
modified to the ``federal securities laws,'' since timing of certain 
communications to the audit committee also is specified in securities 
laws. The standard was updated to reference ``securities laws.'' \133\
---------------------------------------------------------------------------

    \133\ The term ``securities laws'' is defined in section 
2(a)(15) of the Sarbanes-Oxley Act, 15 U.S.C. 7201, to mean the 
provisions of law referred to section 3(a)(47) of the Exchange Act, 
15 U.S.C. 78c(a)(47), as amended by the Sarbanes-Oxley Act, and 
includes the rules, regulations, and orders issued by the SEC 
thereunder.
---------------------------------------------------------------------------

    Commenters generally agreed that audit committee communications 
should occur in a timely manner and prior to the issuance of the 
auditor's report. Some commenters suggested that the standard should 
specify the timing of the communication about certain matters, such as 
during planning or prior to the earnings release.
    Auditing Standard No. 16 does not emphasize the specific timing of 
certain

[[Page 57432]]

communications because the appropriate timing might vary depending on 
the circumstances. As noted in the standard, the appropriate timing of 
a particular communication to the audit committee depends on factors 
such as the significance of the matters to be communicated and any 
corrective or follow-up action needed, unless other timing requirements 
are specified by PCAOB rules or standards or the securities laws. 
However, in all events, the timing of the communication should be prior 
to the issuance of the auditor's report.
    Providing communications required by Auditing Standard No. 16 to 
the audit committee in a timely manner and prior to the issuance of the 
auditor's report will allow the audit committee and the auditor the 
opportunity to take any action they may deem appropriate to address the 
matters communicated prior to the issuance of the auditor's report.
    The reproposed standard noted that an auditor may communicate to 
only the audit committee chair if done in order to communicate matters 
in a timely manner during the audit; however, the auditor should 
communicate such matters to the full audit committee prior to the 
issuance of the auditor's report. Several commenters suggested that the 
auditor's responsibility to subsequently communicate to the ``full'' 
audit committee was an unnecessary burden and that the word ``full'' 
should be deleted to allow the auditor to communicate to the audit 
committee when a quorum is present. The standard was revised 
accordingly to eliminate the word ``full.''
Adequacy of the Two-Way Communication Process
    The original proposed standard included a requirement for the 
auditor to evaluate whether the two-way communication between the 
auditor and the audit committee was adequate to support the objectives 
of the audit. The requirement was included to emphasize that effective 
two-way communication is beneficial to achieving the objectives of the 
audit.
    Many commenters on the original proposed standard noted that an 
evaluation of the adequacy of the two-way communications can only be 
effective if both parties are involved in the evaluation. These 
commenters also suggested that if only the auditor evaluates the 
effectiveness based on his or her understanding of what was 
communicated, that evaluation would not provide information about the 
audit committee's understanding of that communication. In response to 
commenters, the Board removed this requirement in the reproposed 
standard.
    Some commenters on the reproposed standard indicated that the Board 
should reinstate the requirement for the auditor to evaluate the 
adequacy of the two-way communication between the auditor and the audit 
committee to encourage the auditor to determine whether there is 
effective two-way communication. Additionally, some commenters 
suggested that the standard should be revised to change certain 
requirements for the auditor to communicate ``with'' the audit 
committee instead of ``to'' the audit committee in situations in which 
two-way discussion would be appropriate for the auditor to obtain 
information on particular matters relevant to the audit.
    The note in paragraph 3 of Auditing Standard No. 16 states that the 
requirement for the auditor to ``communicate to'' the audit committee 
is meant to encourage effective two-way communication between the 
auditor and the audit committee throughout the audit to assist in 
understanding matters relevant to the audit. The importance of 
effective two-way communications remains in the standard; therefore, no 
change was considered necessary.
    In addition, as part of understanding the company's control 
environment in Auditing Standard No. 12, the auditor assesses whether 
the board or audit committee understands and exercises oversight 
responsibility over financial reporting and internal control.\134\ 
Other PCAOB standards require that, in an audit of financial 
statements, if the auditor becomes aware, or in an integrated audit, if 
the auditor concludes that the oversight of the company's external 
financial reporting and internal control over financial reporting by 
the company's audit committee is ineffective, the auditor must 
communicate that information in writing to the board of directors.\135\ 
Not including a requirement for the auditor to evaluate the adequacy of 
a two-way communication in this standard does not change the auditor's 
responsibility for assessing the audit committee's effectiveness under 
existing PCAOB standards.
---------------------------------------------------------------------------

    \134\ See paragraphs 23-24 of Auditing Standard No. 12.
    \135\ See paragraph 79 of Auditing Standard No. 5 and paragraph 
5 of AU sec. 325.
---------------------------------------------------------------------------

Amendments to PCAOB Standards
    With the adoption of Auditing Standard No. 16, the Board adopted 
related communication requirements to other PCAOB standards. These 
amendments were made to the following standards, among others:
     Auditing Standard No. 5, An Audit of Internal Control Over 
Financial Reporting That Is Integrated with An Audit of Financial 
Statements;
     AU sec. 316, Consideration of Fraud in a Financial 
Statement Audit;
     AU sec. 317, Illegal Acts by Clients;
     AU sec. 550, Other Information in Documents Containing 
Audited Financial Statements; and
     AU sec. 722, Interim Financial Information.
    The Board is amending AU sec. 722 to be consistent with Auditing 
Standard No. 16. Some commenters suggested that the amendments to AU 
sec. 722 should clarify that the accountant (``accountant'' is the term 
used in AU sec. 722) is not required to repeat communications that were 
made as part of the annual audit. Other commenters suggested that the 
amendments to AU sec. 722 should become effective for interim periods 
following the first annual period in which Auditing Standard No. 16 
becomes effective and that, otherwise, implementing the amendments 
prior to the first annual communication under Auditing Standard No. 16 
would likely result in unnecessarily expanding the communication 
requirements related to the auditor's review of interim information.
    The objective of a review of interim financial information pursuant 
to AU sec. 722 is to provide the accountant with a basis for 
communicating whether the accountant is aware of any material 
modifications that should be made to the interim financial information 
for it to conform with generally accepted accounting principles.\136\ 
Procedures for conducting a review of interim financial information 
generally are limited to analytical procedures, inquiries, and other 
procedures that address significant accounting and disclosure matters 
relating to the interim financial information to be reported.\137\ A 
review may bring to the accountant's attention significant matters 
affecting the interim financial information, but it does not provide 
assurance that the accountant will become aware of all significant 
matters that would be identified in an audit.\138\
---------------------------------------------------------------------------

    \136\ AU sec. 722.07.
    \137\ AU sec. 722.15.
    \138\ AU sec. 722.07.
---------------------------------------------------------------------------

    AU sec. 722.18 requires the accountant to make inquiries of members 
of management who have responsibility for financial and accounting 
matters, including but not limited to, matters concerning unusual

[[Page 57433]]

or complex situations that may have an effect on the interim financial 
information. Examples of situations about which the accountant would 
ordinarily inquire of management include, among other things, 
significant, unusual, or infrequently occurring transactions; 
application of new accounting principles; changes in accounting 
principles or the methods of applying them; and trends and developments 
affecting accounting estimates.\139\
---------------------------------------------------------------------------

    \139\ AU sec. 722.55.
---------------------------------------------------------------------------

    An amendment to AU sec. 722 states that when conducting a review of 
interim financial information, the accountant also should determine 
whether any of the matters described in Auditing Standard No. 16, as 
they relate to interim financial information, have been 
identified.\140\ This requirement is similar to the current requirement 
for the accountant to refer to AU sec. 380 for matters to communicate 
to the audit committee when conducting an interim review.\141\
---------------------------------------------------------------------------

    \140\ Amendment to AU sec. 722.34.
    \141\ Id.
---------------------------------------------------------------------------

    Additionally, the amendments to AU sec. 722 recognize that 
management might communicate some or all of the matters related to the 
company's accounting policies, practices, estimates, and significant 
unusual transactions described in paragraph 12 of Auditing Standard No. 
16. If management communicates any of these matters, the accountant 
does not need to communicate them at the same level of detail as 
management, as long as certain criteria are met. However, any omitted 
or inadequately described matters should be communicated to the audit 
committee.
    The amendment to AU sec. 722.35 also indicates that any 
communication the accountant may make about the entity's accounting 
policies, practices, estimates, and significant unusual transactions as 
applied to its interim financial reporting generally would be limited 
to the effect of significant events, transactions, and changes in 
accounting estimates that the accountant considered when conducting the 
review of interim financial information. The amendments to AU sec. 722 
do not require that the communications to the audit committee repeat 
the annual communications but, rather, that the communication be 
related to the accountant's findings while performing the interim 
review procedures.
    The Board determined not to defer the effective date for quarterly 
reviews as suggested by some commenters. Deferral of the effective date 
would result in AU sec. 380 continuing to apply to communications 
relevant to quarterly reviews, while Auditing Standard No. 16 
simultaneously would require communications relating to the annual 
audit. Auditing Standard No. 16 requires timely communications of 
matters in connection with the annual audit to be made throughout the 
year under audit. These communications would, therefore, be made at or 
near the time that related communications are required in connection 
with quarterly reviews. Applying Auditing Standard No. 16 for the 
annual audit and AU sec. 380 for quarterly reviews could cause some 
degree of complexity because auditors would be required to apply two 
different standards when communicating important information to the 
audit committee. Therefore, the Board is making Auditing Standard No. 
16 effective for quarterly reviews of fiscal years beginning on or 
after December 15, 2012.
    In addition to avoiding having two co-existing and differing 
standards, implementing Auditing Standard No. 16 in the first quarter 
of 2013 should benefit audit committees by providing for the 
communication of significant information during the most current 
period. Also, and as discussed above, the objective of a review of 
interim financial information differs significantly from that of an 
audit, and any communication the accountant would make pertaining to 
interim financial reporting would be limited, as discussed in AU sec. 
722, to matters the accountant considered when conducting the review of 
interim financial information.
    The proposed amendments to other PCAOB standards accompanying the 
reproposed standard included an amendment to AU sec. 551, Reporting on 
Information Accompanying the Basic Financial Statements in Auditor-
Submitted Documents. This amendment would have required the auditor to 
communicate to the audit committee material misstatements if the client 
did not agree to revise the accompanying information. This amendment 
was removed from the amendments accompanying Auditing Standard No. 16 
because the Board has proposed to supersede AU sec. 551 as part of its 
standard-setting project related to auditing supplemental 
information.\142\
---------------------------------------------------------------------------

    \142\ See Proposed Auditing Standard, Auditing Supplemental 
Information Accompanying Audited Financial Statements and Related 
Amendments to PCAOB Standards. PCAOB Release No. 2011-005 (July 12, 
2011).
---------------------------------------------------------------------------

    QC sec. 20, System of Quality Control for a CPA Firm's Accounting 
and Auditing Practice, states that to minimize the risk of 
misunderstandings regarding the nature, scope, and limitations of 
services to be performed, policies and procedures should provide for 
obtaining an understanding with the client regarding those 
services.\143\ To align with Auditing Standard No. 16, the reproposed 
standard proposed an amendment to QC sec. 20 to change ``client'' to 
``audit committee.'' One commenter indicated that QC sec. 20 applies to 
attest engagements as well as to audit engagements. This commenter 
suggested that instead of replacing ``client'' with ``audit 
committee,'' a clarifying footnote be added to the word ``client'' to 
indicate that with respect to a financial statement audit or an audit 
of internal control over financial reporting, the auditor is required 
to establish an understanding of the terms of the audit engagement with 
the audit committee. The Board considered this comment and decided not 
to amend QC sec. 20 at this time. Changes to the Board's quality 
control standards will be considered as part of the Board's quality 
control standard-setting project.
---------------------------------------------------------------------------

    \143\ QC sec. 20.16.
---------------------------------------------------------------------------

Audits of Brokers and Dealers
    Section 982 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Dodd-Frank Act'') \144\ gave the Board oversight of 
the audits of brokers and dealers registered with the SEC. In September 
2010, the Commission issued interpretive guidance clarifying that the 
references in Commission rules and staff guidance and in the federal 
securities laws to generally accepted auditing standards (``GAAS'') or 
to specific standards under GAAS, as they relate to nonissuer brokers 
or dealers, should continue to be understood to mean the auditing and 
attestation standards established by the American Institute of 
Certified Public Accountants (``AICPA''), but noted that it intended to 
revisit this interpretation in connection with a SEC rulemaking project 
to update the audit and attestation requirements for brokers and 
dealers in light of the Dodd-Frank Act.\145\ On June 15, 2011, the SEC 
proposed to amend its rules, including SEC Rule 17a-5 under the 
Exchange Act, to require, among other things, that audits of brokers' 
and dealers' financial statements and examinations of reports regarding 
compliance with SEC requirements be

[[Page 57434]]

performed in accordance with the standards of the PCAOB.\146\
---------------------------------------------------------------------------

    \144\ Public Law 111-203, 124 Stat. 1376 (July 21, 2010).
    \145\ SEC, Commission Guidance Regarding Auditing, Attestation, 
and Related Professional Practice Standards Related to Brokers and 
Dealers, Exchange Act Release No. 62991 (Sept. 24, 2010).
    \146\ SEC, Broker-Dealer Reports, Exchange Act Release No. 64676 
(June 15, 2011).
---------------------------------------------------------------------------

    If the SEC adopts its proposed amendments to SEC Rule 17a-5 or 
provides other direction that auditors of brokers and dealers are to 
comply with PCAOB professional standards, the Board's auditing, 
attestation, quality control, and, where applicable, independence 
standards would then apply to audits of brokers and dealers as required 
by Section 17 of the Exchange Act and SEC Rule 17a-5.\147\
---------------------------------------------------------------------------

    \147\ 17 CFR 240.17a-5.
---------------------------------------------------------------------------

    Further, if the SEC adopts its proposed amendments to SEC Rule 17a-
5 or provides other direction that auditors of brokers and dealers are 
to comply with PCAOB standards, prior to the effective date of Auditing 
Standard No. 16,\148\ the Board's interim standard, AU sec. 380, would 
be in effect for audits of brokers and dealers conducted for periods 
prior to the effective date of Auditing Standard No. 16. The Board's 
interim standard, AU sec. 380, which was last amended in 1999, 
indicates that it is not applicable to the audit of a broker or dealer 
if the broker or dealer does not have an audit committee \149\ or is 
registered with the SEC only because of Section 15(a) of the Exchange 
Act.\150\ Conversely, the auditor communication requirements under 
GAAS, which are contained in Statement on Auditing Standards (``SAS'') 
114, The Auditor's Communication With Those Charged With Governance, 
which was issued by the Auditing Standards Board (``ASB'') of the AICPA 
in 2006, are applicable to audits of all brokers and dealers.\151\ 
Because of this difference in the applicability of the auditor 
communication standards to the audits of brokers and dealers, there 
could be a gap in required audit committee communications if the SEC 
amendments to SEC Rule 17a-5 are adopted and become effective prior to 
the effective date of Auditing Standard No. 16. To eliminate this gap, 
the Board is amending AU sec. 380 to delete the current exception for 
audits of brokers and dealers that do not have an audit committee or 
are registered with the SEC only because of Section 15(a) of the 
Exchange Act. The transitional amendment would eliminate the above-
referenced gap in audit committee communications by making the 
communication requirements in AU sec. 380 applicable to audits of 
issuers and brokers and dealers, as those terms are defined in the 
Sarbanes-Oxley Act, prior to the effective date of Auditing Standard 
No. 16.
---------------------------------------------------------------------------

    \148\ As noted in this release, the Board anticipates that 
Auditing Standard No. 16 will be effective, subject to SEC approval, 
for audits of fiscal years beginning on or after December 15, 2012.
    \149\ AU sec. 380.01 states that the communications required by 
AU sec. 380 are applicable to entities that either have an audit 
committee or that have otherwise formally designated oversight of 
the financial reporting process to a group equivalent to an audit 
committee (such as a finance committee or budget committee).
    \150\ See AU sec. 380.01, which states that the communications 
required by the standard ``are applicable to * * * all Securities 
and Exchange Commission (SEC) engagements.'' As noted in footnote 2 
to AU sec. 380.01, the audits of brokers and dealers do not fall 
within an SEC engagement as defined in AU sec. 380 if the broker or 
dealer is registered only because of Section 15(a) of the Exchange 
Act.
    \151\ See paragraph 1 of SAS 114 which states ``[t]his statement 
* * * establishes standards and provides guidance on the auditor's 
communication with those charged with governance in relation to an 
audit of financial statements,'' and section 5.129 of the AICPA 
Audit & Accounting Guide: Brokers and Dealers in Securities (July 
2010), which states, in part: ``AU section 380, The Auditor's 
Communication with Those Charged with Governance * * * has been 
updated for the issuance of SAS No. 114* * *. AU 380 is applicable 
to all broker-dealers being audited under GAAS, regardless of their 
governance structure or size.''
---------------------------------------------------------------------------

    If PCAOB standards are applicable to audits of brokers and dealers 
prior to the effective date of Auditing Standard No. 16, the 
communication requirements under Auditing Standard No. 16 would be 
applicable to the audits of brokers and dealers upon the effective date 
of the standard.
    The release accompanying the reproposed standard posed a question 
about whether the standard should apply to the audits of all brokers 
and dealers. Many commenters supported the requirement for the standard 
to apply to the audits of all brokers and dealers. However, some 
commenters suggested that it may not be practicable to communicate the 
matters in the standard because they may not be applicable to all 
brokers and dealers due to the varying size and nature of the brokers 
and dealers as well as the difference in their governance structures. 
Some commenters suggested that these brokers and dealers may not have 
an audit committee, board of directors, or equivalent body, or that the 
individual designated to oversee the financial reporting process and 
audits of the company might be the same person preparing the financial 
statements. They suggested, therefore, that the standard should apply 
only to certain types of brokers and dealers, such as carrying brokers 
or dealers. Other commenters suggested that the standard should not be 
applicable to the audits of brokers and dealers.
    The Board acknowledges that there are smaller, less complex brokers 
and dealers that do not have an audit committee, board of directors, or 
equivalent body, but that communicating matters about the audit and the 
financial statements to those overseeing the financial reporting 
process is important. The governance structure of brokers and dealers 
does not change the value of the information regarding the audit or the 
company's financial statements.
    Therefore, as discussed in this release, the definition of audit 
committee was revised for audits of nonissuers to recognize that if no 
such committee or board of directors (or equivalent body) exists with 
respect to the company, the communication should be made to the 
person(s) who oversee the accounting and financial reporting processes 
of the company and audits of the financial statements of the company.
    The release accompanying the reproposed standard posed a question 
about whether there are any communication requirements specific to the 
audits of all brokers and dealers that should be added to the standard. 
Some commenters suggested that the standard should require additional 
communication to the audit committee related to the additional 
attestation reporting to be required for brokers and dealers as 
proposed in pending SEC amendments to its Rule 17a-5.\152\ Once the 
amendments to Rule 17a-5 are adopted in final form, the Board may 
consider adding requirements for communication to the audit committee 
pertaining to such matters.
---------------------------------------------------------------------------

    \152\ SEC, Commission Guidance Regarding Auditing, Attestation, 
and Related Professional Practice Standards Related to Brokers and 
Dealers, Exchange Act Release No. 62991 (Sept. 24, 2010).
---------------------------------------------------------------------------

Emerging Growth Companies
    Pursuant to Section 104 of the Jumpstart Our Business Startups Act 
(``JOBS Act''), any rules adopted by the Board subsequent to April 5, 
2012, do not apply to the audits of EGCs (as defined in Section 
3(a)(80) of the Exchange Act) unless the SEC ``determines that the 
application of such additional requirements is necessary or appropriate 
in the public interest, after considering the protection of investors, 
and whether the action will promote efficiency, competition, and 
capital formation.'' \153\ Auditing Standard No. 16 is the first 
auditing standard adopted by the Board subsequent to enactment of the 
JOBS Act and accordingly is subject to a separate determination by the 
SEC

[[Page 57435]]

regarding its applicability to audits of EGCs.
---------------------------------------------------------------------------

    \153\ Public Law 112-106, 126 STAT. 306 (April 5, 2012). See 
Section 103(a)(3)(C) of the Sarbanes-Oxley Act, 15 U.S.C. 
7213(a)(3)(C), as added by Section 104 of the JOBS Act.
---------------------------------------------------------------------------

    The Board is also requesting that the Commission approve the 
proposed rules, pursuant to Section 103(a)(3)(C) of the Sarbanes-Oxley 
Act, for application to audits of EGCs, as that term is defined in 
Section 3(a)(80) of the Exchange Act. The Board's request is set forth 
in section D.
Effective Date
    The Board anticipates that the transitional amendments to AU sec. 
380 will be effective, subject to SEC approval, for the periods that 
PCAOB standards become applicable to audits of brokers and dealers, as 
designated by the SEC upon adoption of its amendments to SEC Rule 17a-
5, if such periods precede the effective date of Auditing Standard No. 
16.
    The Board anticipates that Auditing Standard No. 16 and related 
amendments, included will be effective, subject to SEC approval, for 
audits of fiscal years beginning on or after December 15, 2012.
Comparison of the Objectives and Requirements of Auditing Standard No. 
16, Communications With Audit Committees, to the Analogous Standards of 
the International Auditing and Assurance Standards Board and the 
Auditing Standards Board of the American Institute of Certified Public 
Accountants
    In developing its original proposed standard, the Board took into 
account, among other things, the analogous standards of the 
International Auditing and Assurance Standards Board (``IAASB'') and 
the ASB of the AICPA. The release accompanying the initial proposed 
standard and reproposed standard included a comparison of the 
objectives and requirements of the initial proposed standard and 
reproposed standards to the analogous standards of the IAASB and ASB.
    The following discussion compares certain significant differences 
between the objectives and requirements of Auditing Standard No. 16 and 
the analogous standards of the IAASB and ASB of the American Institute 
of Certified Public Accountants.
    The analogous IAASB standards are:
    3. International Standard on Auditing (``ISA'') 210, Agreeing the 
Terms of Audit Engagements, and
    4. ISA 260, Communication with Those Charged with Governance.
    The analogous ASB standards \154\ are:
---------------------------------------------------------------------------

    \154\ In October 2011, the ASB issued Statement on Auditing 
Standards (``SAS'') No. 122, Statements on Auditing Standards: 
Clarification and Recodification, which contains the Preface to 
Codification of Statements on Auditing Standards, Principles 
Underlying an Audit Conducted in Accordance with Generally Accepted 
Auditing Standards, and 39 clarified SASs. SAS 122 identifies the 
section within the AICPA codification with ``AU-C'' section numbers. 
See http://www.aicpa.org/RESEARCH/STANDARDS/AUDITATTEST/Pages/audit%20and%20attest%20standards.aspx.
---------------------------------------------------------------------------

    5. AU-C Section 210, Terms of Engagement, and
    6. AU-C Section 260, The Auditor's Communication With Those Charged 
with Governance.
    Other standards of the IAASB and the ASB, respectively, were 
considered in this comparison to the extent that they include 
comparable requirements, including:
    e. ISA 240, The Auditor's Responsibilities Relating to Fraud in an 
Audit of Financial Statements,
    f. ISA 450, Evaluation of Misstatements Identified during the 
Audit,
    g. ISA 570, Going Concern,
    h. ISA 600, Special Considerations--Audits of Group Financial 
Statements (Including the Work of Component Auditors),
    i. ISA 720, The Auditor's Responsibilities Relating to Other 
Information in Documents Containing Audited Financial Statements,
    j. AU-C Section 240, Consideration of Fraud in a Financial 
Statement Audit,
    k. AU-C Section 450, Evaluation of Misstatements Identified During 
the Audit,
    l. AU-C Section 600, Using the Work of Others--Special 
Considerations--Audits of Group Financial Statements (Including the 
Work of Component Auditors),
    m. SAS 118, Other Information in Documents Containing Audited 
Financial Statements, and
    n. SAS 126, The Auditor's Consideration of An Entity's Ability to 
Continue as a Going Concern (Redrafted).
    The information presented does not cover the application and 
explanatory material in the IAASB standards or ASB standards.\155\
---------------------------------------------------------------------------

    \155\ Paragraph A59 of ISA 200, Overall Objectives of the 
Independent Auditor and the Conduct of an Audit in Accordance with 
International Standards on Auditing, indicates that the application 
and other explanatory material section of the ISAs ``does not in 
itself impose a requirement,'' but ``is relevant to the proper 
application of the requirements of an ISA.'' Paragraph A63 of AU-C 
Section 200, Overall Objectives of the Independent Auditor and the 
Conduct of an Audit in Accordance with Generally Accepted Auditing 
Standards, states that although application and other explanatory 
material ``does not in itself impose a requirement, it is relevant 
to the proper application of the requirements of an AU-C section.''
---------------------------------------------------------------------------

    This discussion is provided for informational purposes only. It is 
not a summary of or a substitute for Auditing Standard No. 16 itself. 
This comparison may not represent the views of the IAASB or ASB 
regarding the interpretation of their standards.
Objectives
PCAOB
    Auditing Standard No. 16 supersedes AU sec. 310 and AU sec. 380. 
Given the responsibility of many audit committees for the appointment 
and retention of the auditor, Auditing Standard No. 16 combines the 
requirements from the Board's standards, AU secs. 310 and 380, into one 
auditing standard.
    Auditing Standard No. 16 includes four objectives for the auditor, 
which reflect both the appointment and retention of the auditor as well 
as the overall communication responsibilities. The objectives of the 
auditor are to:
    a. Communicate to the audit committee the responsibilities of the 
auditor in relation to the audit and establish an understanding of the 
terms of the audit engagement with the audit committee;
    b. Obtain information from the audit committee relevant to the 
audit;
    c. Communicate to the audit committee an overview of the overall 
audit strategy and timing of the audit; and
    d. Provide the audit committee with timely observations arising 
from the audit that are significant to the financial reporting process.
IAASB and ASB
    ISA 210 and AU-C Section 210 both include an objective to establish 
whether the preconditions for an audit are present. Auditing Standard 
No. 16 does not include this objective, because some of the related 
requirements in the ISA and SAS are not applicable to audits performed 
under PCAOB standards, such as determining whether the financial 
reporting framework is acceptable. For audits performed under PCAOB 
standards, the auditor should look to the requirements of the 
Securities and Exchange Commission for the company under audit with 
respect to the accounting principles applicable to that company.
    Both ISA 260 and AU-C Section 260 include an objective for the 
auditor to promote effective two-way communication between the auditor 
and those charged with governance. Although Auditing Standard No. 16 
does not include a similar objective, the standard encourages effective 
two-way communication between the auditor and the audit committee. As 
stated in Auditing Standard No. 16,

[[Page 57436]]

``communicate to,'' is meant to encourage effective two-way 
communication between the auditor and the audit committee throughout 
the audit to assist in understanding matters relevant to the audit.
Appointment and Retention
Significant Issues Discussed with Management In Connection with the 
Auditor's Appointment or Retention
PCAOB
    Auditing Standard No. 16 requires the auditor to discuss with the 
audit committee any significant issues that the auditor discussed with 
management in connection with the appointment or retention of the 
auditor, including significant discussions regarding the application of 
accounting principles and auditing standards.
IAASB and ASB
    ISA 210 and AU-C Section 210 do not include a similar requirement.
Establish an Understanding of the Terms of the Audit
PCAOB
    Auditing Standard No. 16 requires the auditor to establish an 
understanding of the terms of the audit engagement with the audit 
committee. This understanding includes communicating to the audit 
committee the objective of the audit, the responsibilities of the 
auditor, and the responsibilities of management. Paragraph 6 of 
Auditing Standard No. 16 requires the auditor to record the 
understanding of the terms in an engagement letter and provide the 
engagement letter to the audit committee annually. In addition, 
paragraph 6 of Auditing Standard No. 16 includes a requirement for the 
auditor to have the engagement letter executed by the appropriate party 
or parties on behalf of the company. If the appropriate party or 
parties are other than the audit committee, or its chair on behalf of 
the audit committee, the auditor should determine that the audit 
committee has acknowledged and agreed to the terms of the engagement.
    Additionally, Auditing Standard No. 16 requires the auditor to 
decline to accept, continue, or perform the engagement if the auditor 
cannot establish an understanding of the terms of the audit engagement 
with the audit committee.
IAASB and ASB
    ISA 210 and AU-C Section 210 require the auditor to agree on the 
terms of the audit engagement with management and, where appropriate, 
those charged with governance.
    ISA 210 and AU-C Section 210 require the engagement letter to be in 
writing, although there is no requirement that the engagement letter be 
given to the audit committee or that it be signed by the audit 
committee, or its chair on behalf of the audit committee, or that it 
otherwise be acknowledged by the audit committee. Additionally, ISA 210 
states that for recurring audits, the auditor shall assess whether 
circumstances require the terms of the audit engagement to be revised 
and whether there is a need to remind the entity of the existing terms 
of the audit engagement. Accordingly, ISA 210 permits the auditor to 
not send a new audit engagement letter or other written agreement each 
period.
    AU-C Section 210 requires the auditor to assess whether 
circumstances require the terms of the audit engagement to be revised. 
If the auditor concludes that the terms of the preceding engagement 
need not be revised for the current engagement, the auditor should 
remind management of the terms of the engagement, and the reminder 
should be documented.
    Both ISA 210 and AU-C Section 210 also establish requirements for 
the auditor to determine whether the preconditions for an audit exist. 
Auditing Standard No. 16 does not include similar requirements, as 
these requirements were either not applicable to audits performed under 
PCAOB standards or were addressed through the requirements in Auditing 
Standard No. 16 for establishing an understanding of the terms of the 
audit engagement with the audit committee.
    ISA 210 requires the auditor to determine whether there are any 
conflicts between the financial reporting standards and additional 
requirements supplemented by law or regulation. AU-C Section 210 does 
not include similar requirements. Auditing Standard No. 16 also does 
not include similar requirements as they are not relevant to the audits 
performed under PCAOB standards.
    ISA 210 and AU-C Section 210 also include requirements regarding 
limitation of scope prior to audit engagement acceptance, other factors 
affecting audit engagement acceptance, and acceptance of a change in 
the terms of the audit engagement. Auditing Standard No. 16 does not 
include such requirements as they are not applicable to audits 
performed under PCAOB standards.
    AU-C Section 210 also includes requirements regarding initial 
audits and re-audits. Auditing Standard No. 16 does not include similar 
requirements, although similar requirements are included in the Board's 
standard, AU sec. 315, Communications Between Predecessor and Successor 
Auditors.
    Additionally, ISA 260 and AU-C Section 260 include a requirement 
for the auditor to communicate with those charged with governance the 
form, timing, and expected general content of communications. Auditing 
Standard No. 16 does not include this requirement; however, Auditing 
Standard No. 16 does not preclude the auditor from communicating these 
matters to the audit committee.
Obtaining Information and Communicating the Audit Strategy Obtaining 
Information Relevant to the Audit
PCAOB
    Auditing Standard No. 16 requires the auditor to inquire of the 
audit committee about whether it is aware of matters relevant to the 
audit, including, but not limited to, violations or possible violations 
of laws or regulations. This requirement complements the requirement in 
Auditing Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement, for the auditor to make inquiries of the audit committee, 
or equivalent (or its chair) about risks of material misstatement, 
including inquiries related to fraud risks.\156\
---------------------------------------------------------------------------

    \156\ Paragraphs 5.f. and 54-57 of Auditing Standard No. 12.
---------------------------------------------------------------------------

IAASB and ASB
    ISA 260 and the AU-C Section 260 do not contain a similar 
requirement for the auditor to inquire of matters that might be 
relevant to the audit, including, but not limited to, knowledge of 
violations or possible violations of laws or regulations. However, ISA 
240 and AU-C Section 240 require the auditor to make inquiries of those 
charged with governance to determine whether they have knowledge of any 
actual, suspected, or alleged fraud affecting the entity.
Overall Audit Strategy, Significant Risks, and Timing of the Audit
PCAOB
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee an overview of the overall audit strategy, including 
the timing of the audit, and discuss with the audit committee the 
significant risks identified during the auditor's risk assessment 
procedures. As part of communicating the overall audit strategy, 
paragraph 10 of Auditing Standard No. 16 requires the auditor to 
communicate the following matters to the audit committee, if 
applicable:

[[Page 57437]]

    a. The nature and extent of specialized skill or knowledge needed 
to perform the planned audit procedures or evaluate the audit results 
related to significant risks;
    b. The extent to which the auditor plans to use the work of the 
company's internal auditors in an audit of financial statements;
    c. The extent to which the auditor plans to use the work of 
internal auditors, company personnel (in addition to internal 
auditors), and third parties working under the direction of management 
or the audit committee when performing an audit of internal control 
over financial reporting;
    d. The names, locations, and planned responsibilities of other 
independent public accounting firms or other persons, who are not 
employed by the auditor, that perform audit procedures in the current 
period audit; and
    e. The basis for the auditor's determination that the auditor can 
serve as principal auditor, if significant parts of the audit are to be 
performed by other auditors.
    In addition, Auditing Standard No. 16 requires the auditor to 
communicate to the audit committee significant changes to the planned 
audit strategy or the significant risks initially identified and the 
reasons for such changes.
IAASB and ASB
    ISA 260 and AU-C Section 260 require the auditor to communicate an 
overview of the planned scope and timing of the audit. However, ISA 260 
and AU-C Section 260 do not require the auditor to communicate 
significant changes to the planned scope and timing of the audit. 
Further, ISA 260 and AU-C Section 260 do not include requirements for 
the auditor to communicate information about specialized skill or 
knowledge needed to perform the planned audit procedures or evaluate 
the audit results related to significant risks, the auditor's use of 
the work of internal auditors, or the auditor's use of the work of 
other company personnel and third parties working under the direction 
of management or the audit committee.
    ISA 260 and AU-C Section 260 do not include requirements for the 
auditor to communicate information about the names, locations, and 
planned responsibilities of other independent public accounting firms 
or other persons, who are not employed by the auditor, that perform 
audit procedures in the current period audit.
    However, ISA 600 and AU-C Section 600, include requirements for the 
auditor to communicate certain matters to those charged with governance 
including: an overview of the type of work to be performed on the 
financial information of the components; an overview of the nature of 
the group engagement team's planned involvement in the work to be 
performed by the component auditors on the financial information of 
significant components; instances where the group engagement team's 
evaluation of the work of a component auditor gave rise to a concern 
about the quality of that auditor's work; any limitation on the group 
audit; and fraud or suspected fraud involving group management, 
component management, employees who have significant roles in group-
wide controls or other where the fraud resulted in a material 
misstatement of the group financial statements. In addition, AU-C 
Section 600 also includes a requirement for the auditor to communicate 
the basis for the decision to make reference to the audit of a 
component auditor in the auditor's report on the group financial 
statements.
Results of the Audit
Accounting Policies and Practices, Estimates, and Significant Unusual 
Transactions
PCAOB
    Auditing Standard No. 16 requires the auditor to communicate 
certain matters relating to accounting policies and practices, 
estimates, and significant unusual transactions. However, Auditing 
Standard No. 16 acknowledges that if management communicates matters 
related to accounting policies and practices, estimates, and 
significant unusual transactions to the audit committee, the auditor 
does not need to communicate these matters at the same level of detail 
as management as long as the auditor (1) participated in management's 
discussion with the audit committee, (2) affirmatively confirmed to the 
audit committee that management has adequately communicated these 
matters, and (3) with respect to critical accounting policies and 
practices, identified for the audit committee those accounting policies 
and practices that the auditor considers critical. In addition, the 
auditor is required to communicate any omitted or inadequately 
described matters to the audit committee.
    Matters to be communicated include:
    a. Significant accounting policies and practices--(1) management's 
initial selection of, or changes in, significant accounting policies or 
the application of such policies in the current period; and (2) the 
effect on financial statements or disclosures of significant accounting 
policies in (i) controversial areas or (ii) areas for which there is a 
lack of authoritative guidance or consensus, or diversity in practice.
    b. All critical accounting policies and practices to be used, 
including: (1) the reasons certain policies and practices are 
considered critical; and (2) how current and anticipated future events 
might affect the determination of whether certain policies and 
practices are considered critical.
    c. Critical accounting estimates--(1) a description of the process 
management used to develop critical accounting estimates; (2) 
management's significant assumptions used in critical accounting 
estimates that have a high degree of subjectivity; and (3) any 
significant changes management made to the processes used to develop 
critical accounting estimates or significant assumptions, a description 
of management's reasons for the changes, and the effects of the changes 
on the financial statements.
    d. Significant unusual transactions--(1) significant transactions 
that are outside the normal course of business for the company or that 
otherwise appear to be unusual due to their timing, size, or nature; 
and (2) the policies and practices management used to account for 
significant unusual transactions.
IAASB
    ISA 260 requires the auditor to communicate the auditor's views 
about significant qualitative aspects of the entity's accounting 
practices, including accounting policies, accounting estimates and 
financial statement disclosures.
ASB
    AU-C Section 260 requires the auditor to communicate the auditor's 
views about qualitative aspects of the entity's significant accounting 
practices, including accounting policies, accounting estimates, and 
financial statement disclosures. AU-C Section 260 also provides that, 
when applicable, the auditor should determine that those charged with 
governance are informed about the process used by management in 
formulating particularly sensitive accounting estimates, including fair 
value estimates, and about the basis for the auditor's conclusions 
regarding the reasonableness of those estimates.
    The ISAs and the AU-Cs do not include a similar requirement for 
communicating significant unusual transactions.

[[Page 57438]]

Auditor's Evaluation of the Quality of the Company's Financial 
Reporting
PCAOB
    Auditing Standard No. 16 requires the auditor to communicate the 
following matters to the audit committee:
    a. Qualitative aspects of significant accounting policies and 
practices.
    (1) The results of the auditor's evaluation of, and conclusions 
about, the qualitative aspects of the company's significant accounting 
policies and practices, including situations in which the auditor 
identified bias in management's judgments about the amounts and 
disclosures in the financial statements; and
    (2) The results of the auditor's evaluation of the differences 
between (i) estimates best supported by the audit evidence and (ii) 
estimates included in the financial statements, which are individually 
reasonable, that indicate a possible bias on the part of the company's 
management.
    b. Assessment of critical accounting policies and practices. The 
auditor's assessment of management's disclosures related to the 
critical accounting policies and practices, along with any significant 
modifications to the disclosure of those policies and practices 
proposed by the auditor that management did not make.
    c. Conclusions regarding critical accounting estimates. The basis 
for the auditor's conclusions regarding the reasonableness of the 
critical accounting estimates.
    d. Significant unusual transactions. The auditor's understanding of 
the business rationale for significant unusual transactions.
    e. Financial statement presentation. The results of the auditor's 
evaluation of whether the presentation of the financial statements and 
related disclosures are in conformity with the applicable financial 
reporting framework, including the auditor's consideration of the form, 
arrangement, and content of the financial statements (including the 
accompanying notes), encompassing matters such as the terminology used, 
the amount of detail given, the classification of items, and the bases 
of amounts set forth.
    f. New accounting pronouncements. Situations in which, as a result 
of the auditor's procedures, the auditor identified a concern regarding 
management's anticipated application of accounting pronouncements that 
have been issued but are not yet effective and might have a significant 
effect on future financial reporting.
    g. Alternative accounting treatments. All alternative treatments 
permissible under the applicable financial reporting framework for 
policies and practices related to material items that have been 
discussed with management, including the ramifications of the use of 
such alternative disclosures and treatments and the treatment preferred 
by the auditor.
IAASB
    ISA 260 requires the auditor to communicate the auditor's views 
about significant qualitative aspects of the entity's accounting 
practices, including accounting policies, accounting estimates, and 
financial statement disclosures. The ISA provides that, when 
applicable, the auditor shall explain to those charged with governance 
why the auditor considers a significant accounting practice, that is 
acceptable under the applicable financial reporting framework, not to 
be most appropriate to the particular circumstances of the entity.
    The ISAs do not include a similar requirement for communicating the 
auditor's understanding of the business rationale for significant 
unusual transactions.
ASB
    AU-C Section 260 requires the auditor to communicate the auditor's 
views about qualitative aspects of the entity's significant accounting 
practices, including accounting policies, accounting estimates, and 
financial statement disclosures. When applicable the auditor should:
    a. Explain to those charged with governance why the auditor 
considers a significant accounting practice that is acceptable under 
the applicable financial reporting framework not to be most appropriate 
to the particular circumstances of the entity, and
    b. Determine that those charged with governance are informed about 
the process used by management in formulating particularly sensitive 
accounting estimates, including fair value estimates, and about the 
basis for the auditor's conclusions regarding the reasonableness of 
those estimates.
    The AU-Cs do not include a similar requirement for communicating 
the auditor's understanding of the business rationale for significant 
unusual transactions.
Other Information in Documents Containing Audited Financial Statements
PCAOB
    When other information is presented in documents containing audited 
financial statements, Auditing Standard No. 16 requires the auditor to 
communicate to the audit committee the auditor's responsibility under 
PCAOB rules and standards for such information, any related procedures 
performed, and the results of such procedures.
    AU sec. 550, Other Information in Documents Containing Audited 
Financial Statements, requires that if the auditor identifies a 
material inconsistency in the other information presented in documents 
containing audited financial statements, and the other information is 
not revised by management to eliminate the material inconsistency, the 
auditor should communicate the material inconsistency to the audit 
committee. The auditor should also consider other actions, such as 
revising the audit report to include an explanatory paragraph 
describing the material inconsistency, as described in paragraph .11 of 
AU sec. 508, Reports on Audited Financial Statements, withholding the 
use of the report in the document, and withdrawing from the engagement. 
The auditor should also communicate a material misstatement of fact to 
the client and the audit committee, if the material misstatement of 
fact is not corrected.
IAASB
    ISA 720 requires that if the auditor identifies a material 
inconsistency in the other information in documents containing audited 
financial statements and revision of the other information is necessary 
and management refuses to make the revision, then the auditor shall 
communicate this matter to those charged with governance and (a) 
include in the auditor's report an Other Matter(s) paragraph describing 
the material inconsistency in accordance with ISA 706, Emphasis of 
Matter Paragraphs and Other Matter Paragraphs in the Independent 
Auditor's Report; or (b) withhold the auditor's report; or (c) withdraw 
from the engagement, where withdrawal is possible under applicable law 
or regulation. ISA 720 also requires the auditor to notify those 
charged with governance of the auditor's concern regarding the other 
information and take any further appropriate action if there is a 
material misstatement of fact in the other information which management 
refuses to correct.
ASB
    SAS 118 contains similar requirements to those in Auditing Standard 
No. 16.

[[Page 57439]]

Difficult or Contentious Matters for Which the Auditor Consulted
PCAOB
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee matters that are difficult or contentious for which the 
auditor consulted outside the engagement team and that the auditor 
reasonably determined are relevant to the audit committee's oversight 
of the financial reporting process.
IAASB and ASB
    ISA 260 and AU-C Section 260 do not include a similar requirement.
Management Consultation With Other Accountants
PCAOB
    When the auditor is aware that management consulted with other 
accountants about significant auditing or accounting matters and the 
auditor has identified a concern regarding such matters, Auditing 
Standard No. 16 requires the auditor to communicate to the audit 
committee his or her views about such matters that were the subject of 
such consultation.
IAASB
    ISA 260 does not include a similar requirement.
ASB
    AU-C Section 260 requires the auditor to communicate to those 
charged with governance the auditor's views about matters that were the 
subject of management's consultations with other accountants on 
accounting or auditing matters when the auditor is aware that such 
consultations occurred.
Going Concern
PCAOB
    Paragraph 17 of Auditing Standard No. 16 includes a requirement for 
the auditor to communicate to the audit committee, when applicable, 
certain matters relating to the auditor's evaluation of the company's 
ability to continue as a going concern. These matters include (a) If 
the auditor believes there is substantial doubt about the company's 
ability to continue as a going concern for a reasonable period of time, 
the conditions and events that the auditor identified that, when 
considered in the aggregate, indicate that there is substantial doubt; 
(b) If the auditor concludes, after consideration of management's 
plans, that substantial doubt about the company's ability to continue 
as a going concern is alleviated, the basis for the auditor's 
conclusion, including elements the auditor identified within 
management's plans that are significant to overcoming the adverse 
effects of the conditions and events; (c) if the auditor concludes, 
after consideration of management's plans, that substantial doubt about 
the company's ability to continue as a going concern for a reasonable 
period of time remains, the effects, if any, on the financial 
statements and the adequacy of the related disclosure and the effects 
on the auditor's report.
IAASB
    ISA 570 requires the auditor to communicate events or conditions 
identified that may cast significant doubt on the entity's ability to 
continue as a going concern. This communication includes whether the 
events or conditions constitute a material uncertainty; whether the use 
of the going concern assumption is appropriate in the preparation and 
presentation of the financial statements; and the adequacy of related 
disclosures in the financial statements.
ASB
    SAS 126 requires the auditor to communicate with those charged with 
governance the nature of the conditions or events identified, the 
possible effects on the financial statements and the adequacy of 
related disclosures in the financial statements, and the effects on the 
auditor's report if, after considering identified conditions or events 
in the aggregate and after considering management's plans, the auditor 
concludes that substantial doubt about the entity's ability to continue 
as a going concern for a reasonable period of time remains.
Uncorrected and Corrected Misstatements
PCAOB
    Auditing Standard No. 16 requires the auditor to provide the audit 
committee with the schedule of uncorrected misstatements related to 
accounts and disclosures that the auditor presented to management. 
Auditing Standard No. 16 also requires the auditor to discuss with the 
audit committee, or determine that management has adequately discussed 
with the audit committee, the basis for the determination that the 
uncorrected misstatements were immaterial, including the qualitative 
factors considered. Additionally, Auditing Standard No. 16 requires the 
auditor to communicate that uncorrected misstatements or matters 
underlying those uncorrected misstatements could potentially cause 
future-period financial statements to be materially misstated. Auditing 
Standard No. 16 also requires the auditor to communicate to the audit 
committee those corrected misstatements, other than those that are 
clearly trivial, related to accounts and disclosures that might not 
have been detected except through the auditing procedures performed, 
and discuss with the audit committee the implications that such 
corrected misstatements might have on the company's financial reporting 
process.
IAASB and ASB
    ISA 450 and AU-C Section 260 include requirements for the auditor 
to communicate uncorrected misstatements and the effect that they, 
individually or in aggregate, may have on the opinion in the auditor's 
report. The auditor's communication shall identify the material 
uncorrected misstatements individually. Additionally, under ISA 450 and 
the AU-C Section 260, the auditor is required to communicate the effect 
of uncorrected misstatements related to prior periods on the relevant 
classes of transactions, account balances or disclosures, and the 
financial statements as a whole.
    ISA 450 and AU-C Section 450 require the auditor to request that 
uncorrected misstatements be corrected. Auditing Standard No. 16 does 
not require the auditor to make this request, because under SEC rules 
the financial statements are required to reflect all material 
correcting adjustments identified by the auditor.
    ISA 450 does not include a requirement for the auditor to 
communicate corrected misstatements to those charged with governance. 
AU-C Section 260 requires the auditor to communicate material, 
corrected misstatements that were brought to the attention of 
management as a result of audit procedures.
Material Written Communication
PCAOB
    Auditing Standard No. 16 requires the auditor to communicate to the 
audit committee other material written communications between the 
auditor and management.
IAASB and ASB
    ISA 260 and AU-C Section 260 require the auditor to communicate to 
those charged with governance written representations the auditor is 
requesting.
Disagreements with Management
PCAOB
    Auditing Standard No. 16 includes a requirement for the auditor to

[[Page 57440]]

communicate to the audit committee any disagreements with management 
about matters, whether or not satisfactorily resolved, that 
individually or in the aggregate could be significant to the company's 
financial statements or the auditor's report. Auditing Standard No. 16 
also states that disagreements with management do not include 
differences of opinion based on incomplete facts or preliminary 
information that are later resolved by the auditor obtaining additional 
relevant facts or information prior to the issuance of the auditor's 
report.
IAASB
    The ISAs do not include a similar requirement.
ASB
    AU-C Section 260 requires the auditor to communicate disagreements 
with management, if any.
Other Matters
PCAOB
    Auditing Standard No. 16 includes a requirement for the auditor to 
communicate to the audit committee other matters arising from the audit 
that are significant to the oversight of the financial reporting 
process. This communication includes, among other matters, complaints 
or concerns regarding accounting or auditing matters that have come to 
the auditor's attention during the audit and the results of the 
auditor's procedures regarding such matters.
IAASB and ASB
    ISA 260 and AU-C Section 260 include a similar requirement for the 
auditor to communicate other matters to those charged with governance 
that, in the auditor's professional judgment, are significant and 
relevant to the oversight of the financial reporting process.
Form and Documentation of Communications
PCAOB
    Auditing Standard No. 16 requires the auditor to communicate the 
matters in the standard to the audit committee, either orally or in 
writing, unless otherwise specified in Auditing Standard No. 16. In 
addition, the standard also requires the auditor to document the 
communications in the work papers whether such communications took 
place orally or in writing. Auditing Standard No. 16 also requires the 
auditor to include a copy of or a summary of management's communication 
provided to the audit committee in the audit documentation, if as part 
of its communications to the audit committee, management communicated 
some or all of the matters related to accounting policies and 
practices, estimates, significant unusual transactions, or uncorrected 
misstatements to the audit committee, and, as a result, the auditor did 
not communicate these matters at the same level of detail as 
management.
IAASB
    ISA 260 requires the auditor to communicate in writing with those 
charged with governance regarding significant findings from the audit 
if, in the auditor's professional judgment, oral communication would 
not be adequate. Written communication need not include all matters 
that arose during the course of the audit.
ASB
    AU-C Section 260 requires the auditor to communicate in writing 
with those charged with governance significant findings or issues from 
the audit if, in the auditor's professional judgment, oral 
communication would not be adequate. This communication need not 
include matters that arose during the course of the audit that were 
communicated with those charged with governance and satisfactorily 
resolved.
Timing
PCAOB
    Auditing Standard No. 16 requires the communications to the audit 
committee to be made in a timely manner and prior to the issuance of 
the auditor's report.\157\
---------------------------------------------------------------------------

    \157\ Auditing Standard No. 16 includes the following exception 
for registered investment companies--Consistent with SEC Rule 2-07 
of Regulation S-X, 17 CFR Sec.  210.2-07, in the case of a 
registered investment company, audit committee communication should 
occur annually, and if the annual communication is not within 90 
days prior to the filing of the auditor's report, the auditor should 
provide an update, in the 90-day period prior to the filing of the 
auditor's report, of any changes to the previously reported 
information.
---------------------------------------------------------------------------

IAASB and ASB
    ISA 260 and AU-C Section 260 require that the auditor should 
communicate with those charged with governance on a timely basis.

D. Request To Apply Auditing Standard No. 16 to Audits of Emerging 
Growth Companies

Introduction and Statutory Background
    On August 15, 2012, the Board adopted Auditing Standard No. 16 
(Auditing Standard No. 16 may also be referred to as ``the new 
standard'' in this section)\158\ pursuant to the Board's authority 
under the Sarbanes-Oxley Act.\159\
---------------------------------------------------------------------------

    \158\ Communications with Audit Committees, PCAOB Release No. 
2012-004 (Aug. 15, 2012).
    \159\ Public Law 107-204. Pursuant to Section 101 of the 
Sarbanes-Oxley Act, the mission of the Board is to oversee the audit 
of companies that are subject to the securities laws, and related 
matters, in order to protect the interests of investors and further 
the public interest in the preparation of informative, accurate, and 
independent audit reports. Section 103 of the Sarbanes-Oxley Act 
authorizes the Board to adopt auditing standards for use in public 
company audits ``as required by this Act or the rules of the 
[Securities and Exchange] Commission, or as may be necessary or 
appropriate in the public interest or for the protection of 
investors.'' In addition, Section 982 of the Dodd-Frank Act of 2010 
expanded the authority of the PCAOB to oversee the audits of 
registered brokers and dealers, as defined in the Exchange Act. See 
Public Law 111-203.
---------------------------------------------------------------------------

    Auditing Standard No. 16 requires auditors to communicate certain 
significant audit and financial statement matters to the audit 
committee of the company\160\ under audit. Among other things, the 
required communications include such matters as: (i)The company's 
critical accounting practices; (ii) significant risks identified by the 
auditor's risk assessment procedures; (iii) the company's significant 
unusual transactions; and (iv) when applicable, the auditor's 
evaluation of the company's ability to continue as a going concern. 
Communications may be made orally or in writing, but should be made in 
a timely manner and prior to the issuance of the auditor's report.
---------------------------------------------------------------------------

    \160\ The term ``company'' as used in this section is intended 
to refer to companies whose audits are required to be performed in 
accordance with PCAOB standards.
---------------------------------------------------------------------------

    In the Board's view, the adoption of Auditing Standard No. 16 is in 
the public interest and contributes to investor protection because it 
establishes requirements that enhance the relevance, timeliness, and 
quality of communications between auditors and audit committees. The 
enhanced relevance, timeliness, and quality of communications should 
improve the audit and facilitate audit committees' financial reporting 
oversight, fostering improved financial reporting. The Board's adopting 
release dated August 15, 2012, discusses the record developed by the 
Board in adopting Auditing Standard No. 16 in greater detail.
    In addition, the Sarbanes-Oxley Act was recently amended by Section 
104 of the JOBS Act \161\ to provide that any additional rules adopted 
by the Board subsequent to April 5, 2012, do not apply to the audits of 
EGCs \162\ unless the SEC ``determines that the application of such 
additional requirements is necessary or appropriate

[[Page 57441]]

in the public interest, after considering the protection of investors 
and whether the action will promote efficiency, competition, and 
capital formation.'' \163\ As a result, Auditing Standard No. 16, which 
was adopted by the Board after April 5, 2012, is subject to a separate 
determination by the SEC regarding its applicability to audits of EGCs.
---------------------------------------------------------------------------

    \161\ Public Law 112-106.
    \162\ Section 3(a)(80) of the Exchange Act defines the term 
``emerging growth company.''
    \163\ See Section 103(a)(3)(C) of the Sarbanes-Oxley Act, as 
added by Section 104 of the JOBS Act.
---------------------------------------------------------------------------

    The Board is thus requesting that the Commission also take action 
to apply Auditing Standard No. 16 to audits of EGCs, pursuant to 
Section 104 of the JOBS Act. In this submission, the Board is providing 
information to assist the SEC in its consideration of whether it is 
``necessary or appropriate in the public interest, after considering 
the protection of investors and whether the action will promote 
efficiency, competition, and capital formation,'' to apply Auditing 
Standard No. 16 to audits of EGCs.
    The information provided in this submission summarizes the Board's 
record in adopting Auditing Standard No. 16 and includes a discussion 
of the following areas to assist the SEC in its consideration pursuant 
to Section 104 of the JOBS Act: (i) The background of and reasons for 
the new standard; (ii) the Board's approach to developing the new 
standard, including consideration of alternatives; (iii) key changes 
and improvements from existing audit committee communication 
requirements; and (iv) characteristics of EGCs and economic 
considerations.
Background and Reasons for the New Standard
    The following discussion provides summary information regarding the 
background and reasons for Auditing Standard No. 16. These matters are 
also discussed in greater detail in the Board's adopting release.
    Auditing Standard No. 16 would replace PCAOB interim standards AU 
sec. 380 and AU sec. 310.\164\ The existing PCAOB requirements 
regarding auditor communications with audit committees are primarily in 
AU sec. 380, while AU sec. 310 discusses establishing an understanding 
between the auditor and the client regarding the audit engagement.
---------------------------------------------------------------------------

    \164\ Shortly after its inception, the Board adopted the 
existing standards of the AICPA, as in existence on April 16, 2003, 
on an initial, transitional basis. See PCAOB Release No. 2003-006 
(Apr. 18, 2003). References to AU sections (``AU secs.'') throughout 
this document are to these PCAOB interim auditing standards, which 
consist of generally accepted auditing standards, as described in 
the AICPA Auditing Standards Board's Statement on Auditing Standards 
No. 95, as in existence on April 16, 2003, to the extent not 
superseded or amended by the Board.
---------------------------------------------------------------------------

    AU sec. 380 became effective in January 1989, at a time when 
management typically hired and retained the auditor and had oversight 
of the work of the auditor. AU sec. 380 indicates that audit committee 
communications are ``incidental to the audit'' and are not required to 
occur prior to the issuance of the auditor's report. AU sec. 380 
includes a variety of specified communication requirements.
    Subsequently, changes to the federal securities laws and related 
SEC rules imposed additional communication requirements that are not 
currently reflected in AU sec. 380. Most significantly, in 2002, the 
Sarbanes-Oxley Act changed the role of the audit committee and the 
interaction between the audit committee and the auditor, requiring the 
auditor of a listed company to report directly to the audit committee. 
Section 301 of the Sarbanes-Oxley Act made changes to the federal 
securities laws to require the audit committee of a listed company to 
be directly responsible for the appointment, compensation, and 
oversight of the work of the external auditors, including the 
resolution of disagreements between management and the auditor 
regarding financial reporting. In addition, Section 204 of the 
Sarbanes-Oxley Act made other changes to the federal securities laws to 
require the auditor to report the following matters to the audit 
committee on a timely basis:
     All critical accounting policies and practices to be used;
     All alternative treatments of financial information within 
generally accepted accounting principles that have been discussed with 
management, ramifications of the use of such alternative disclosures 
and treatments, and the treatment preferred by the registered public 
accounting firm; and
     Other material written communications between the 
registered public accounting firm and the management of the issuer, 
such as any management letter or schedule of unadjusted differences.
    Since the adoption of AU sec. 380, certain PCAOB auditing standards 
also have changed as a result of the Board's ongoing efforts to revise 
its interim standards. For example, in 2010 the Board adopted eight 
standards on assessing and responding to risk in an audit (the ``risk 
assessment'' standards), which cover the entire audit process, from 
initial planning activities to evaluating audit evidence to forming the 
opinion to be expressed in the auditor's report.\165\ The risk 
assessment standards address, among other things, requirements for the 
auditor in the areas of audit planning, audit strategy, and risk 
assessment, including requirements for the auditor to identify 
significant risks of material misstatement. As one of the PCAOB's 
interim auditing standards, AU sec. 380's communication requirements 
are not aligned with the procedures performed pursuant to the PCAOB's 
risk assessment standards, which became effective for audits for fiscal 
years beginning after December 15, 2010.
---------------------------------------------------------------------------

    \165\ See PCAOB Release 2010-004 (Aug. 5, 2010).
---------------------------------------------------------------------------

    Additionally, observations from the Board's oversight activities 
raised matters for consideration. For example, some inspection 
observations indicate that auditors have not made all required audit 
committee communications, possibly because they are not aware of the 
varying sources of communication requirements contained throughout the 
Board's standards and rules. Currently, thirteen auditing standards and 
rules require the auditor to communicate with the audit committee, and 
other additional communication requirements are located in the federal 
securities laws and SEC rules.
    In light of these changes and considerations, the Board adopted 
Auditing Standard No. 16 with the goal of improving the audit by 
enhancing communications between auditors and audit committees. With 
the passage of the Sarbanes-Oxley Act and the establishment of the 
PCAOB, Congress acknowledged that auditors play an important role in 
protecting the interests of investors by preparing and issuing 
informative, accurate, and independent audit reports.\166\ The audit 
committee also plays an important role in protecting the interests of 
investors by assisting the board of directors in fulfilling its 
responsibility to a company's shareholders and others to oversee the 
integrity of a company's accounting and financial reporting processes 
and audits.
---------------------------------------------------------------------------

    \166\ See Section 101(a) of the Sarbanes-Oxley Act; Senate 
Report No. 107-206, at 5-6 (July 3, 2002).
---------------------------------------------------------------------------

    In the Board's view, both the auditor and the audit committee 
benefit from a meaningful and timely exchange of information regarding 
significant risks of material misstatement in the financial statements 
and other matters that may affect the integrity of the company's 
financial reports. Communications with the audit committee improve the 
audit by providing auditors with the audit committee's insights about 
the company as well as providing auditors with a forum separate from 
management to

[[Page 57442]]

discuss complex and significant matters about the audit and the 
company's financial reporting process. Communications between the 
auditor and the audit committee allow the audit committee to be well-
informed about accounting, auditing, and disclosure matters, including 
the auditor's evaluation of matters that are significant to the 
financial statements, and to be better able to carry out its oversight 
role.
    Auditing Standard No. 16 also updates the auditing standards to 
reflect the communication requirements mandated by the federal 
securities laws and aligns the audit committee communication 
requirements with auditor performance requirements, including those in 
the risk assessment standards. Bringing these requirements together in 
one place should promote the auditor's compliance with relevant 
statutory and regulatory requirements (as well as facilitating audit 
planning and informing audit scope). Updating auditing standards to 
incorporate new statutory and regulatory requirements can help ensure 
that audit firms update their audit methodologies to include all 
required and relevant procedures. Such updating is particularly 
critical with respect to AU sec. 380 because, as noted earlier, AU sec. 
380 treats audit committee communications as ``incidental,'' and does 
not focus on the important role of the audit committee in the current 
regulatory environment.
The Board's Approach to Development of Auditing Standard No. 16, 
Including Consideration of Alternatives
    Auditing Standard No. 16 was adopted by the Board after several 
years of consideration and public outreach. For example, the issue of 
auditor communications with the audit committee was discussed with the 
Board's Standing Advisory Group (``SAG'') on several occasions prior to 
the Board's decision to propose a new standard.\167\
---------------------------------------------------------------------------

    \167\ The SAG discussed the audit committee communications 
standard at a number of its meetings, including meetings prior to 
proposing a new standard on: June 21-22, 2004, June 8, 2005, Oct. 5-
6, 2005, and Oct. 14-15, 2009.
---------------------------------------------------------------------------

    The Board proposed a new standard on March 29, 2010, which was open 
for comment until May 28, 2010. The comment period reopened on 
September 7, 2010 and was extended until October 21, 2010, to 
accommodate comments received in connection with a public roundtable 
held by the Board on September 21, 2010.
    The standard was then reproposed on December 20, 2011, and open for 
comment until February 29, 2012. The Board adopted the new standard on 
August 15, 2012.
    The Board received and considered 44 comment letters on the 
original proposal, which included the reopened comment period, and 39 
comment letters on the reproposed standard. Most commenters were 
supportive of the Board's efforts to enhance communications between the 
auditor and the audit committee. Those commenters agreed that fuller 
and more relevant communications between the auditor and audit 
committee would allow the auditor to perform a more informed, and thus 
more effective, audit and also would enable the audit committee to more 
effectively fulfill its oversight responsibilities regarding the 
financial reporting process.
    The Board's adopting release explains in greater detail the Board's 
consideration of significant comments received and the reasons for 
making the changes reflected in the new standard. In general, as 
discussed below, the Board made a number of decisions as it developed 
Auditing Standard No. 16 that make the new standard more efficient and 
effective to apply, and avoid unnecessary costs. The following summary 
describes the Board's overall approach and highlights some of the 
choices made, and alternatives considered.
     Auditing Standard No. 16 is scalable, based on a company's 
size and complexity. In developing the new standard, the Board sought 
to promote high-quality audits, while considering the standard's 
overall effect on current audit practice and on audit committees and 
companies. In doing so, the Board sought to achieve the standard's 
intended benefits, without imposing unnecessary costs, and to create a 
standard that is scalable based on the company's size and complexity. A 
company's size and complexity can affect the risks of material 
misstatement, create auditing challenges, and involve other significant 
matters that warrant bringing to the attention of the audit committee. 
Thus, an auditor of a smaller, less complex company with fewer 
difficult auditing or financial reporting issues may have fewer matters 
to communicate than for an audit of a larger, more complex company. 
Accordingly, under Auditing Standard No. 16, in an audit of a small, 
less complex company, an auditor may make less extensive audit 
committee communications than in an audit of a larger, more complex 
company. The original proposal asked for comment on whether any of the 
requirements of the proposed standard were inappropriate based on the 
size or industry of the company. Commenters considered the proposed 
requirements to be applicable and appropriate to companies of different 
sizes and industries.
     Auditing Standard No. 16 has been carefully designed to: 
(i) Retain the pre-existing communication requirements in auditing 
standards; (ii) incorporate the communication requirements already 
imposed by the Sarbanes-Oxley Act and related SEC rules; and (iii) link 
new communications to related performance requirements arising out of 
the Board's existing auditing standards. As a result of this approach, 
the auditor's communications under the new standard are limited to 
communicating the results of the audit or specific audit procedures 
already required under the existing standards. Auditing Standard No. 16 
does not impose new performance obligations on the auditor, other than 
the standard's required communications.
     Auditing Standard No. 16 organizes and compiles 
information regarding other PCAOB auditor communication requirements. 
Auditing Standard No. 16 contains an appendix that lists in one place 
other PCAOB standards and rules that require the auditor to communicate 
specific matters to the audit committee. This aspect of the new 
standard responds to observations from the Board's oversight activities 
that suggest that auditors may not make all required audit committee 
communications because they might not be aware of the varying sources 
of such requirements. This convenient list facilitates auditors' 
identification of other PCAOB standards and rules that contain 
communication requirements.
     Auditing Standard No. 16 focuses on the communication of 
significant matters relating to the audit. In developing the new 
standard, the Board sought to focus on communication of significant 
matters relating to the audit. In response to comments, the 
requirements in Auditing Standard No. 16 were changed from the original 
proposal to focus the auditor on communicating matters that are 
significant to the audit committee's oversight of the financial 
reporting process. For example, changes were made to limit 
communications regarding the need for specialized skill or knowledge in 
the audit to only those relevant to significant audit risks. Similarly, 
the standard was narrowed to require communications relating to matters 
on which the auditor consulted to only those 'difficult or contentious' 
matters that are relevant to the audit committee's oversight of the 
financial reporting process.

[[Page 57443]]

     Auditing Standard No. 16 provides the auditor with 
flexibility to communicate orally or in writing. AU sec. 380 provides 
the auditor with the flexibility to communicate orally or in writing. 
Several commenters to both the original proposal and the reproposal 
suggested that the communications to the audit committee should be 
required to be in writing. The Board considered this approach, but 
determined that requiring all communications to be in writing could 
reduce the effectiveness of the communication process. The Board's goal 
is to promote effective two-way communication between the auditor and 
the audit committee, whether through presentations, written reports, or 
interactive discussions. Allowing different forms of communication also 
makes the communication requirement more flexible for companies of all 
sizes and natures.
     Auditing Standard No. 16 recognizes that management, as 
well as the auditor, may discuss issues relating to the company's 
financial statements with the audit committee, and that it would not be 
cost-effective or practical for the audit committee to receive the same 
communication twice. With respect to certain auditor communications, 
the new standard provides that the auditor need not duplicate 
communications made by management at the same level of detail, so long 
as certain conditions specified in Auditing Standard No. 16 are 
met.\168\ These changes allow for better use of auditor, management, 
and audit committee time and resources while, at the same time, help to 
ensure that the audit committee is informed of important accounting 
issues.
---------------------------------------------------------------------------

    \168\ See note to Paragraph 12 of Auditing Standard No. 16 and 
discussion in PCAOB Release No. 2012-004 (Aug. 15, 2012) at pages 
A4-24 to A4-25.
---------------------------------------------------------------------------

     Auditing Standard No. 16 reflects practical 
considerations. The scope of the new standard was narrowed in response 
to practical concerns raised during the comment process. For example, 
the original proposed standard included a requirement for the auditor 
to evaluate whether the two-way communications between the auditor and 
the audit committee were adequate to support the objectives of the 
audit. Commenters were concerned that the evaluation might not be 
effective, as it would reflect only the auditor's evaluation of the 
communications, and would not provide information about the audit 
committee's understanding of the nature of the communications. The 
Board agreed and did not adopt the requirement.
Key Changes and Improvements From Existing Standards
    The following discussion provides a summary of the existing 
standards relating to auditor communications. The summary also includes 
a discussion of improvements that have been made in the new standard 
that should benefit audit quality. These matters also are discussed in 
greater detail in the Board's adopting release.
    Existing Requirements. As previously noted, the existing 
requirements for communications with the audit committee are primarily 
in AU sec. 380. In addition, AU sec. 310 requires the auditor to 
establish an understanding with the client regarding the audit 
engagement.
    Requirements Retained from Existing Standard. The new standard 
retains from AU sec. 380 the following audit committee communication 
requirements:
     Major issues discussed with management prior to the 
retention of the auditor;
     The company's significant accounting policies and 
practices;
     The auditor's responsibility related to other information 
in documents containing audited financial statements;
     Difficulties encountered in performing the audit; and
     Disagreements with management.
    Incorporation of Statutory Communication Requirements. Auditing 
Standard No. 16 also incorporates the following specific auditor 
communication requirements contained in Exchange Act Section 10A(k) and 
SEC Rule 2-07 of Regulation S-X (``SEC Rule 2-07''):
     All critical accounting policies and practices to be used;
     All alternative treatments of financial information within 
generally accepted accounting principles that have been discussed with 
management, ramifications of the use of such alternative disclosures 
and treatments, and the treatment preferred by the registered public 
accounting firm; and
     Other material written communications between the 
registered public accounting firm and the management of the issuer, 
such as any management letter or schedule of unadjusted 
differences.\169\
---------------------------------------------------------------------------

    \169\ See Section 10A(k) of the Exchange Act, 15 U.S.C. Sec.  
78j-1(k), and implementing changes in Rule 2-07(a)(1)-(3) of 
Regulation S-X, 17 CFR Sec.  210.2-07(a)(1)-(3).
---------------------------------------------------------------------------

    Improvements Made to Existing Communication Requirements. While 
Auditing Standard No. 16 retains many of the communication requirements 
in AU sec. 380, it also revises certain requirements to be consistent 
with existing audit performance requirements or to respond to other 
requirements in the Sarbanes-Oxley Act as well as SEC Rule 2-07. The 
new standard improves current communication requirements in the 
following areas:
     Timing/Shift in Approach to Audit Committee 
Communications. AU sec. 380 provides that audit committee 
communications are ``incidental to the audit.'' While AU sec. 380 
requires auditors to ``discuss'' or determine that the audit committee 
is ``informed'' regarding a range of matters on a timely basis, AU sec. 
380 also provides that communications are not required to occur prior 
to the issuance of the auditor's report. The new standard indicates 
that communications between the auditor and the audit committee are 
integral to the audit and that communications should occur in a timely 
manner and prior to the issuance of the auditor's report. By requiring 
communications prior to the issuance of the auditor's report, Auditing 
Standard No. 16 makes a significant difference in the standard 
regarding the timing of communications by giving auditors and audit 
committees the ability to take appropriate action to address the 
matters communicated, including any effect on the company's financial 
statements. This timing requirement aligns with the timing of 
communications required by Exchange Act Section 10A(k) and SEC Rule 2-
07.
     Understanding the Terms of the Audit and the Engagement 
Letter. AU sec. 310 requires the auditor to establish an understanding 
with the ``client'' regarding the terms of the audit and services to be 
performed. Auditing Standard No. 16 retains the requirement for the 
auditor to establish an understanding of the terms of the audit 
engagement and the services to be performed, but requires the 
understanding to be with the audit committee. The new standard also 
requires that the understanding be recorded in an engagement letter. 
These changes align the new standard with the audit committee's 
oversight of the work of the external auditor.\170\ These new 
requirements also build on the requirement in AU sec. 310 for the 
auditor to document the understanding in the working papers, preferably 
through a written communication with the client. Having a mutually 
clear understanding of the terms of the engagement, including the 
objectives of the audit, the responsibilities of the

[[Page 57444]]

auditor, and the responsibilities of management in connection with the 
audit, should benefit both the auditor and the audit committee.
---------------------------------------------------------------------------

    \170\ See Section 301 of the Sarbanes-Oxley Act, and Section 
10A(m)(2) of the Exchange Act, 15 U.S.C. 78j-1(m)(2).
---------------------------------------------------------------------------

     Definition of ``Audit Committee.'' AU sec. 380 does not 
have a formal definition of audit committee, but describes the audit 
committee as ``those that have responsibility for oversight of the 
financial reporting process.'' Auditing Standard No. 16 incorporates 
the definition of audit committee used in the Sarbanes-Oxley Act and 
modifies the Sarbanes-Oxley Act's definition for companies that are 
nonissuers, such as brokers and dealers.
     Qualitative Aspects of the Company's Financial Reporting. 
AU sec. 380 requires the auditor to discuss with the audit committee 
the auditor's judgments about the quality, not just the acceptability, 
of the entity's accounting principles, including the consistency of the 
entity's accounting policies and their application, and the clarity and 
completeness of the entity's financial statements and related 
disclosures. Many commenters indicated that it was unclear what was 
meant by the quality, clarity, and completeness of the company's 
financial statements and related disclosures. Auditing Standard No. 16 
aligns the communication requirement with an underlying performance 
requirement in Auditing Standard No. 14, Evaluating Audit Results. 
Under this approach, the auditor communicates, among other things: (i) 
the results of the auditor's evaluation of and conclusions about the 
qualitative aspects of the company's significant accounting policies 
and practices, including situations in which the auditor identified 
bias in management's judgments and (ii) the results of the auditor's 
evaluation of whether the presentation of the financial statements and 
the related disclosures are in conformity with the applicable financial 
reporting framework, including such matters as consideration of the 
form, arrangement, and content of the financial statements. This 
approach aligns with existing performance requirements and was favored 
by most commenters.
     Critical Accounting Estimates. AU sec. 380 requires the 
auditor to determine that the audit committee is informed about the 
process used by management in formulating ``particularly sensitive'' 
accounting estimates. Auditing Standard No. 16 largely retains the 
auditor communication requirement from AU sec. 380, but uses the term 
``critical accounting estimates,'' which conforms to the term used by 
the SEC.\171\ Auditing Standard No. 16 adds related requirements to 
communicate matters pertaining to management's significant assumptions 
and changes to the process or assumptions used to develop critical 
accounting estimates. These additional requirements address 
communication of the results of the auditor's procedures performed 
under AU sec. 342, Auditing Accounting Estimates. The purpose of this 
communication is to focus the audit committee's attention on the 
estimates that might be subject to higher risk of material 
misstatement.
---------------------------------------------------------------------------

    \171\ See SEC, Interpretation: Commission Guidance Regarding 
Management's Discussion and Analysis of Financial Condition and 
Results of Operations, Securities Act Release No. 8350 (Dec. 19, 
2003).
---------------------------------------------------------------------------

     Uncorrected and Corrected Misstatements. Auditing Standard 
No. 16 incorporates the communication requirements from AU sec. 380 
related to uncorrected and corrected misstatements. In addition, 
Auditing Standard No. 16 incorporates the requirement from the 
Sarbanes-Oxley Act and SEC Rule 2-07 for the auditor to report to the 
audit committee other material written communications between the 
auditor and management, such as a schedule of unadjusted differences.
     Significant Unusual Transactions. AU sec. 380 requires the 
auditor to determine that the audit committee is informed about the 
methods used to account for significant unusual transactions. Auditing 
Standard No. 16 revises the requirement by adding requirements based on 
the auditor's procedures under AU sec. 316, Consideration of Fraud in a 
Financial Statement Audit, for the auditor to communicate: (i) 
Significant transactions that are outside the normal course of business 
for the company or otherwise appear to be unusual due to their timing, 
size, or nature and (ii) the auditor's understanding of the business 
rationale for significant unusual transactions. Communications of 
significant unusual transactions by the auditor will improve audit 
quality by promoting discussion of such transactions. It will also 
allow the audit committee to gain insight into such transactions and 
take appropriate actions, if necessary, to address the financial 
statement or disclosure impact of such transactions.
     Management Consultations with Other Accountants. When the 
auditor is aware that management consulted with other accountants about 
auditing and accounting matters, AU sec. 380 requires the auditor to 
discuss with the audit committee the auditor's views about significant 
matters that were the subject of such consultation. Auditing Standard 
No. 16 modified this requirement. The new standard requires the auditor 
to communicate to the audit committee only when the auditor has 
identified a concern regarding such consultations. Commenters viewed 
this change as an improvement as they noted that it may be good 
practice for management to consult with other accountants as experts to 
assist them regarding complex accounting matters, but that the audit 
committee need not be informed of all such consultations, rather just 
those matters for which the auditor identified a concern.
     Obtaining Information Relevant to the Audit. Auditing 
Standard No. 12, Identifying and Assessing Risks of Material 
Misstatement, requires the auditor to inquire of the audit committee 
regarding the matters important to the identification and assessment of 
risks of material misstatement, including fraud risks. Pursuant to 
Auditing Standard No. 16, the auditor also inquires about whether the 
audit committee is aware of additional matters relevant to the audit. 
As a result, the auditor has an opportunity to focus on any additional 
matters relevant to the audit, such as possible violations of laws or 
regulations. This inquiry requirement might enable the auditor to learn 
from the audit committee about a possible previously unidentified risk.
    New Communication Requirements. Auditing Standard No. 16 also 
contains new communication requirements that improve the audit by 
promoting discussion about significant aspects of the audit, while also 
providing valuable information to the audit committee. These new 
communications relate to audit procedures that already will be 
performed under existing PCAOB standards, with the auditor 
communicating the results of such procedures to the audit committee. 
The new communication requirements include:
     Overall Audit Strategy and Significant Risks. Auditing 
Standard No. 16 includes a requirement for the auditor to communicate 
to the audit committee an overview of the overall audit strategy, 
including the timing of the audit, and to discuss with the audit 
committee significant risks the auditor identified, and significant 
changes to the planned audit strategy or identified risks. These 
changes are aligned with the results of the audit procedures performed 
under the PCAOB's risk assessment standards, in particular, Auditing 
Standard No. 9, Audit Planning, and Auditing Standard No.

[[Page 57445]]

12, Identifying and Assessing Risks of Material Misstatement.
     Other Participants in the Audit. Auditing Standard No. 16 
requires the auditor to communicate, as applicable, information about 
specialized skill or knowledge needed for the audit. In addition, the 
auditor is required to communicate: (i) Information regarding other 
participants in the audit, such as the extent of the use of internal 
auditors, company personnel, other third parties (including other 
independent public accounting firms), or other persons not employed by 
the auditor that are involved in the audit and (ii) the basis for the 
auditor's determination that the auditor can serve as the audit 
engagement's principal auditor, if significant parts of the audit are 
performed by other auditors. The communications related to others 
involved in the audit, including the nature and extent of their 
involvement, could be important for an audit committee to understand in 
its oversight of the audit. These communications should reflect the 
results of other audit procedures that the auditor is currently 
required to perform in accordance with PCAOB standards.
     Difficult or Contentious Matters for which the Auditor 
Consulted. Auditing Standard No. 16 requires the auditor to communicate 
to the audit committee matters that are difficult or contentious for 
which the auditor consulted outside the engagement team and that the 
auditor reasonably determined are relevant to the audit committee's 
oversight of the financial reporting process. Audit committees might 
better appreciate the importance of difficult or contentious matters, 
benefiting their governance responsibility, if they are aware that such 
consultations took place. Communications are based on the results of 
the procedures the auditor performed regarding difficult or contentious 
matters.
     Going Concern. Auditing Standard No. 16 requires the 
auditor to communicate to the audit committee certain matters related 
to the auditor's evaluation of the company's ability to continue as a 
going concern. The communication requirements in Auditing Standard No. 
16 are based on the auditor's performance requirements under AU sec. 
341, The Auditor's Consideration of an Entity's Ability to Continue as 
a Going Concern. This communication enables the auditor to improve the 
audit by facilitating discussion between the auditor and the audit 
committee about the company's ability to continue as a going concern. 
This communication also can serve to further inform the audit 
committee, by focusing attention on financial difficulties the company 
is encountering. Through this communication, the auditor can benefit 
from the audit committee's views of the concerns identified by the 
auditor. Such communications also could be significant in terms of the 
audit committee's role in overseeing the company's financial reporting 
process to ensure that the company's financial statements contain the 
necessary disclosures.
     Other Matters. Auditing Standard No. 16 requires the 
auditor to communicate to the audit committee other matters arising 
from the audit that are significant to the oversight of the company's 
financial reporting process, such as complaints or concerns regarding 
accounting or auditing matters that have come to the auditor's 
attention during the audit. The auditor benefits from a robust 
discussion of such complaints or concerns with the audit committee. 
Also, the audit committee should be better able to exercise its 
oversight activities if the auditor informs the audit committee of 
these matters. Communication to the audit committee is based on the 
results of the auditor's procedures relating to such other matters.
     New Accounting Pronouncements. Auditing Standard No. 16 
requires the auditor to communicate to the audit committee situations 
in which, as a result of the auditor's procedures, the auditor 
identified a concern regarding management's anticipated application of 
accounting pronouncements that have been issued but are not yet 
effective and might have a significant effect on future financial 
reporting. This communication informs the audit committee of situations 
relevant to the audit committee's oversight of the company's financial 
reporting process. Auditing Standard No. 16 requires only that the 
auditor communicate concerns identified as a result of existing audit 
performance requirements and does not require the auditor to perform 
additional procedures to identify such concerns.
     Departure from the Auditor's Standard Report. Auditing 
Standard No. 16 requires the auditor to communicate to the audit 
committee when the auditor expects to: (i) Modify the opinion in the 
auditor's report or (ii) include explanatory language or an explanatory 
paragraph in the auditor's report. The requirement is intended to 
provide the basis for a discussion between the auditor and the audit 
committee in those circumstances in which the auditor expects to change 
the auditor's standard report. This requirement is limited to the 
communication of changes to the audit report determined by the auditor 
during the course of the audit and does not require the performance of 
new audit procedures.
    Other Considerations Relating to Changes to the Standard. As part 
of the Board's regular standard-setting process, the Board takes into 
account costs related to its proposed changes based on, among other 
things, the Board's general knowledge of audit firm practice based on 
the Board's oversight activities. The Board did not specifically seek 
or receive comment that attempted to quantify costs related to the new 
standard.\172\
---------------------------------------------------------------------------

    \172\ The discussion in this section reflects the Board's 
qualitative assessment of the new standard's impact based on the 
overall design of the new standard, and the changes made by the 
Board in response to comments, both of which are discussed 
throughout this submission and in the record for Auditing Standard 
No. 16.
---------------------------------------------------------------------------

    The Board has sought to devise an overall framework for auditor 
communications that is sensitive to the new standard's overall effect. 
The Board has sought to avoid unnecessary costs in developing the new 
standard. To the extent that the new standard changes existing or 
imposes new communication requirements, however, the Board recognizes 
that those requirements will impose some incremental costs.
    To avoid unnecessary costs:
     Auditing Standard No. 16 incorporates significant existing 
and new communication requirements into one standard. Bringing these 
requirements together in one place should promote the auditor's 
compliance with relevant statutory and regulatory requirements, as well 
as potentially reducing auditor time searching for requirements. 
Similarly, an appendix to the new standard lists and identifies the 
location of other auditor communication requirements contained in other 
PCAOB rules and standards; and
     The new standard does not impose new auditor performance 
requirements, other than the required communications themselves. In 
other words, the new audit committee communication requirements in 
Auditing Standard No. 16 are based on the results of audit procedures 
performed under existing standards.
    In considering costs, as a threshold matter, the Board notes that 
auditors and audit committees already engage in audit committee 
communications under the federal securities laws and existing auditing 
standards and thus registered firms and companies already incur some 
costs in complying with existing requirements.

[[Page 57446]]

    Registered firms will need to incur the one-time cost to update 
their audit methodologies to reflect the new requirements and conduct 
initial training of their personnel on the new requirements.\173\ In 
addition, registered firms will incur the recurring costs of the 
additional time required to prepare and make the communications in each 
audit in which they are required and to document that those 
communications were made. The Board also recognizes that audit 
committees will need to receive or read, and potentially discuss and 
act upon, the new required communications, which might result in the 
ongoing cost of increased time required for audit committee meetings. 
The Board sought to ensure that the recurring communication 
requirements are scalable--that is, they vary based on the size and 
complexity of the company--in part to avoid unnecessary costs.
---------------------------------------------------------------------------

    \173\ Those firms that in the past did not use an engagement 
letter for audits subject to the standard will now have to develop 
one. In the Board's experience, most firms currently use an 
engagement letter for such audits.
---------------------------------------------------------------------------

    For all the reasons discussed above and in the Board's adopting 
release, the Board does not anticipate the incremental costs imposed by 
the new standard would be significant.
Characteristics of EGCs and Economic Considerations
    The PCAOB has begun to monitor implementation of the JOBS Act in 
order to understand the characteristics of EGCs and inform the Board's 
request to apply Auditing Standard No. 16 to audits of EGCs.\174\
---------------------------------------------------------------------------

    \174\ Pursuant to the JOBS Act, an ``emerging growth company'' 
is defined in Section 3(a)(80) of the Exchange Act. In general 
terms, an issuer qualifies as an EGC if it has total annual gross 
revenue of less than $1 billion during its most recently competed 
fiscal year (and its first sale of common equity securities pursuant 
to an effective Securities Act registration statement did not occur 
on or before December 8, 2011). See JOBS Act Section 101(a), (b), 
and (d). Once an issuer is an EGC, the entity retains its EGC status 
until the earliest of: (i) The first year after it has total annual 
gross revenue of $1 billion or more (as indexed for inflation every 
five years by the SEC); (ii) the end of the fiscal year after the 
fifth anniversary of its first sale of common equity securities 
under an effective Securities Act registration statement; (iii) the 
date on which the company issues more than $1 billion in non-
convertible debt during the prior three year period; or (iv) the 
date on which it is deemed to be a ``large accelerated filer'' under 
the Exchange Act (generally, an entity that has been public for at 
least one year and has an equity float of at least $700 million).
---------------------------------------------------------------------------

    To obtain data regarding EGCs, the PCAOB's Office of Research and 
Analysis has reviewed registration statements and Exchange Act reports 
filed with the SEC with filing dates between April 5, 2012, and June 4, 
2012, for disclosures by entities related to their EGC status. Only 
those entities that have voluntarily disclosed their EGC status have 
been identified.\175\
---------------------------------------------------------------------------

    \175\ The PCAOB has not validated these entities' self-
identification as EGCs. The information presented in this submission 
also does not include data for entities that have confidentially 
submitted draft registration statements to the SEC for confidential 
non-public review in accordance with the JOBS Act. Thus, the data 
and analysis are not based on the complete population of EGCs. The 
Board recognizes that its initial analysis of self-identified EGCs 
does not include all entities that may be EGCs and that, after the 
JOBS Act has been in effect for a longer period of time, additional 
analysis of the characteristics of EGCs may be possible.
---------------------------------------------------------------------------

    Characteristics of Self-Identified EGCs. As of June 4, 2012, based 
on the PCAOB's research, 196 entities have voluntarily identified 
themselves as EGCs in SEC filings. These 196 entities operate in 
diverse industries. The five most common Standard Industrial 
Classification (SIC) codes applicable to these entities are for: blank 
checks; pharmaceutical preparations; prepackaged software services; 
computer processing/data preparations services; and crude petroleum/
natural gas.
    Of the 196 entities, approximately 78% are companies that were 
identified in a registration statement filed to conduct an initial 
public offering. The other 22% were identified through Exchange Act 
filings. Forty-one entities have securities listed on a national 
securities exchange.
    The reported assets for the 196 entities ranged from zero to 
approximately $13 billion, based on filings for the period reported. 
The average and median reported assets of the 196 entities were 
approximately $260.6 million and approximately $24.9 million, 
respectively.\176\ The reported revenue for the 196 entities, based on 
filings for the period reported, ranged from zero to approximately 
$958.1 million. The average and median reported revenue of the 196 
entities was approximately $106.9 million and approximately $6.7 
million, respectively. Seventy-eight of the 196 entities identified 
themselves as ``development stage entities'' in their financial 
statements.\177\ Of the 196 entities, 103 were audited by firms that 
are annually inspected by the PCAOB (i.e., firms that have issued audit 
reports for more than 100 public company audit clients). The remaining 
93 were audited by triennially inspected firms (i.e., firms that have 
issued audit reports for 100 or fewer public company audit clients).
---------------------------------------------------------------------------

    \176\ For purposes of comparison, the PCAOB compared the data 
compiled with respect to the 196 entities with companies listed in 
the Russell 3000 Index in order to compare the EGC population with 
the broader issuer population. The Russell 3000 was chosen for 
comparative purposes because it is intended to measure the 
performance of the largest 3000 U.S. companies representing 
approximately 98% of the investable U.S. equity market (as marketed 
on the Russell Web site). The average and median reported assets of 
issuers in the Russell 3000 was approximately $11.5 billion and 
approximately $1.4 billion, respectively. The average and median 
reported revenue of issuers in the Russell 3000 was approximately 
$4.6 billion and $742.8 million, respectively.
    \177\ According to Financial Accounting Standards Board 
(``FASB'') guidance, development stage entities are entities 
devoting substantially all of their efforts to establishing a new 
business and for which either of the following conditions exists: 
(a) Planned principal operations have not commenced or (b) planned 
principal operations have commenced, but there has been no 
significant revenue from operations.) See FASB Accounting Standards 
Codification, Subtopic 915-10, Development Stage Entities--Overall.
---------------------------------------------------------------------------

    Based on the Board's initial analysis of EGCs, these entities 
appear to represent diverse industries and are audited by a diverse 
group of firms. Although these entities range in size, approximately 
61% or 119 have reported revenue of less than $50 million. Given the 
December 8, 2011, initial starting point for EGC eligibility, one key 
difference between EGCs and other entities appears to be the length of 
time an EGC has been subject to the reporting requirements under the 
Exchange Act.\178\
---------------------------------------------------------------------------

    \178\ The Board notes that its initial analysis is generally 
consistent with the legislative history of the JOBS Act, which 
anticipated that EGCs will be somewhat smaller entities that may 
have less experience in complying with some aspects of the federal 
securities laws. See House Report No. 112-406, at 5-7.
---------------------------------------------------------------------------

    Economic Considerations and Application of Auditing Standard No. 16 
to Audits of EGCs. The Board adopted Auditing Standard No. 16 to 
``further the public interest in informative, accurate, and independent 
audit reports.'' Auditing Standard No. 16 is intended to improve the 
relevance, timeliness, and quality of communications between auditors 
and audit committees. The Board's determination to adopt Auditing 
Standard No. 16 is based on a record developed over several years that 
includes extensive public outreach and comment.
    As discussed above and in the Board's release, improved 
communications should result in both auditors and audit committees 
becoming better informed and, therefore, better equipped to fulfill 
their respective roles in the company's financial reporting. Through 
this communication, the auditor may obtain more complete information 
about the company, enabling the auditor to be more effective in 
identifying and assessing risks of material misstatement in the 
company's financial statements

[[Page 57447]]

and designing and performing audit procedures to address those risks. 
Similarly, a better informed audit committee should contribute to 
management oversight, which may also improve the company's financial 
reporting as well as its oversight of management more generally.
    The Board believes the standard will enhance the quality of the 
audit and the quality of the financial reporting process. In attempting 
to obtain these benefits through the new standard, the Board sought to 
avoid imposing unnecessary costs. The approach used by the Board was to 
consider the new standard's overall effect on current audit practice 
and on audit committees and companies. This approach was used to 
develop a standard that is scalable based on a company's size and 
complexity, thereby avoiding unnecessary costs for audits of smaller or 
less complex companies, including smaller or less complex companies 
that are EGCs.
    The benefits of the standard, which are summarized throughout this 
submission and described more fully in the Board's adopting release, 
should also be applicable to companies of various types and natures. 
For example, auditors and audit committees of all types of companies 
should benefit from a meaningful exchange of information regarding 
significant matters that may affect the integrity of a company's 
financial reports. Communications with the audit committee should 
improve the audit by providing auditors with the audit committee's 
insights about the company, as well as providing auditors with a forum 
that is separate from management to discuss complex and significant 
matters about the audit and the company's financial reporting process. 
Communications between the auditor and the audit committee should allow 
the audit committee to be well-informed about accounting, auditing, and 
disclosure matters that are significant to the company's financial 
statements, and to be better able to carry out its oversight role. 
These general benefits of the new standard should accrue to audits of 
all companies, including EGCs.
    Moreover, enhanced audit committee communications may be of 
particular benefit to EGCs. Based on the Board's preliminary analysis 
of EGC data, EGCs generally appear to be companies that are relatively 
new to the SEC reporting process. Such companies may have new audit 
committee members and may be relatively less familiar with SEC 
reporting requirements, and have relatively more questions regarding 
how to present their financial statements for SEC reporting purposes. 
Similarly, some EGCs may be considering for the first time initial 
choices in their accounting policies and practices that could have 
implications for their financial reporting.
    Another benefit of the new standard is that it provides for 
communications regarding significant matters on a timely basis. Timely 
communications with the audit committee help improve the audit by, 
among other things: (i) Informing the audit committee, which has 
responsibility for the oversight of financial reporting, about 
significant matters related to the audit and the financial statements; 
(ii) enabling the auditor to obtain the audit committee's insights and 
information about transactions and events; (iii) enabling the auditor 
to learn from the audit committee about additional matters relevant to 
the audit, including possible violations of laws or regulations; and 
(iv) assisting the auditor in gaining a better understanding of the 
company and its environment. Timely communications also permit both the 
auditor and the audit committee to take appropriate action to address 
the matters communicated, including any effect on the company's 
financial statements. Again, these benefits were designed to benefit 
audits of all companies, including audits of EGCs.
    The new standard also promotes communications that are tailored to 
the circumstances of the company and informative, rather than ``boiler-
plate'' or standardized. Under Auditing Standard No. 16, required 
communications would vary by the nature and complexity of the company 
being audited. Effective communication between the auditor and the 
audit committee also need not be in writing, but may involve many forms 
of communication, such as presentations, charts, and robust 
discussions, as well as written reports. Such flexibility in the form 
of communications is an important element of the new standard and part 
of what allows the standard to work for audits of companies of varying 
sizes and complexity, including EGCs.
    The Board has also considered other potential economic effects on 
efficiency and capital formation. The Board's overall approach is 
designed to: (i) Scale the required communications to the size and 
complexity of the company being audited; (ii) maintain flexibility (for 
example, with respect to communicating orally or in writing); (iii) 
minimize duplicative or redundant communications to the audit committee 
from the auditor and management; (iv) focus the communications on the 
accounting matters that are significant to the auditor and the audit 
committee; and (v) reduce auditors' search costs (i.e., the costs 
associated with researching the federal securities laws' and auditing 
standards' various communication requirements) by providing a list of 
other PCAOB standards and rules that contain audit committee 
communication requirements in one place. Moreover, as previously 
discussed, the auditor's requirements under the new standard are 
focused on communicating the results of audit procedures that the 
auditor is already required to perform.
    The Board also considered alternatives to the communication 
requirements in the final standard. Before commencing this project, the 
Board considered whether a new standard was necessary, particularly 
since a number of the standard's requirements were already required by 
existing auditing standards or provisions of the federal securities 
laws. The Board also discussed whether to develop a new standard on 
audit committee communications with its SAG, and had subsequent 
discussions with the SAG on the nature and extent of communications in 
a new standard. The Board proposed the standard, extended the 
proposal's comment period, held a roundtable, and reproposed the 
standard to obtain additional public input. As a result of the public 
comment and outreach, through which many commenters were supportive, 
the Board decided to proceed with a new standard. The Board did so 
because it believes that establishing the new communication 
requirements, as well as clarifying, updating and consolidating the 
other communication requirements, would improve audits and audit 
committee oversight with respect to all types of companies, including 
EGCs, without imposing unnecessary costs.
    Many now agree that the interaction between the auditor and the 
audit committee--as mandated by the Sarbanes-Oxley Act--improves audit 
quality and the quality of financial reporting.\179\ Research has 
indicated that improved auditor communications with audit committees 
can enhance the

[[Page 57448]]

quality of the audit and the quality of the financial reporting 
process.\180\ Also, most commenters on the new standard generally 
agreed that fuller and more relevant communications between the auditor 
and audit committee would allow the auditor to perform a more informed, 
and thus more effective audit, and would enable the audit committee to 
more effectively fulfill its oversight responsibilities regarding the 
financial reporting process.\181\
---------------------------------------------------------------------------

    \179\ For example, research conducted by the Center for Audit 
Quality and published in its March 2008, Report on the Survey of 
Audit Committee Members, found that increased audit committee 
oversight was believed to have had a positive impact on the overall 
quality of audits by 92% of its audit committee member respondents. 
As recently as June 12, 2012, the United Kingdom's Financial 
Reporting Council issued its annual report, Audit Quality 
Inspections, which indicate, among other things, that: ``Audit 
committees play an essential role in ensuring the quality of 
financial reporting. In particular, their work with auditors in 
planning the audit and reviewing its results contributes greatly to 
the quality of the audit.''
    \180\ See, e.g., Jeff Cohen, Ganesh Krishnamoorthy, and Arnie 
Wright, Views to Strengthen Auditor Independence and Skepticism, 
PCAOB meeting (March 22, 2012). Among other things, the statement 
provides: ``Our research has validated the very important role the 
audit committee plays in enhancing audit and financial reporting 
quality.'' See also Jeffrey Cohen, Lisa Milici Gaynor, Ganesh 
Krishnamoorthy, and Arnold M. Wright, Auditor Communications with 
the Audit Committee and the Board of Directors: Policy 
Recommendations and Opportunities for Future Research, Accounting 
Horizons, at 183 (June 2007) (``Frequent communications with a well-
informed, financially sophisticated audit committee and 
communications among the audit committee, the auditor and the full 
board improve financial reporting quality.'').
    \181\ For a discussion of comments received on the new 
standards, see PCAOB Release No. 2012-004 (Aug. 15, 2012) and PCAOB 
Release No. 2011-008 (Dec. 20, 2011).
---------------------------------------------------------------------------

    Higher quality financial reporting (as a result of better informed 
auditors, better informed audit committees, or both) improves the 
quality of information available to the markets and reduces the 
information asymmetry that exists about the company among investors as 
well as between investors and the company's management.\182\ Academic 
research indicates that improving the quality of financial reporting 
can reduce investors' uncertainty about the information being provided 
in companies' financial reports and thus increase efficiency in capital 
allocation and foster capital formation.\183\ Higher quality financial 
reporting (and improved corporate governance) can mitigate principal-
agent problems and reduce agency costs.\184\
---------------------------------------------------------------------------

    \182\ Shareholders and other financial statement users possess 
less information about the company than the company's management. 
This information asymmetry can provide an opportunity for management 
to act in ways that are not aligned with the interests of the 
company's investors. See, e.g., Greenwald, B. C., and J. E. 
Stiglitz, Asymmetric Information and the New Theory of the Firm: 
Financial Constraints and Risk Behavior, 80 American Economic Review 
2, at 160-165 (1990). Also, information asymmetry between informed 
and uninformed investors makes the latter less willing to trade and 
require higher risk premiums when they do invest. See, e.g., Easley, 
D., and M. O'Hara, Information and the Cost of Capital, 59 The 
Journal of Finance 4, at 1553-1583 (2004).
    \183\ See, e.g., Lambert R. A., C. Leuz, and R. E. Verrecchia, 
Accounting Information, Disclosure, and the Cost of Capital, 45 
Journal of Accounting Research, at 385-420 (2007). The authors show 
that accounting information influences a company's cost of capital 
directly and indirectly. Improved financial reporting quality can 
reduce a company's cost of capital by increasing precision of 
investors' assessments of a company's future cash flows. The lower 
cost of capital can subsequently affect real investment choices of 
the company, improving future cash flows and increasing the value of 
the company. See also Easley, D., and M. O'Hara, Information and the 
Cost of Capital, 59 The Journal of Finance 4, at 1553-1583 (2004). 
Their model suggests that increasing reliable public information 
about a company reduces the risk premium investors require. Also, 
Lambert et al. (2012) show that cost of capital decreases with 
higher average precision of information. See Lambert R. A., C. Leuz, 
and R. E. Verrecchia, Information Asymmetry, Information Precision, 
and the Cost of Capital, 16 Review of Finance, at 1-29 (2012).
    \184\ In a principal-agent situation, the goals of principals 
and agents generally differ and it is expensive for the principals 
to directly verify the agents' actions. In a corporation, management 
acts as agent for the shareholders (principals), with the audit 
committee and the auditor serving as intermediary agents. Well 
informed intermediary agents can more effectively exercise their 
oversight responsibilities to mitigate undesired behaviors of the 
management and reduce the goal incongruence between management and 
shareholders.
---------------------------------------------------------------------------

    There will be some costs associated with audit committee 
communications under the new standard, including additional costs 
incurred by companies. As previously discussed, the costs for a company 
to operate and maintain an audit committee may increase because of the 
need for additional meetings and increased audit committee member time 
demands. However, for the reasons explained above, the Board does not 
believe these additional costs will significantly expand the time or 
resources companies spend on audit committees.
    With respect to competition, as noted above, the standard is 
designed to be scalable based on a company's size and complexity. The 
required communications can be tailored or adjusted to fit the size and 
nature of the company under audit. By doing so, the Board sought to 
avoid imposing unnecessary costs that could have a disproportionate 
effect on, and thereby potentially have an adverse competitive impact 
on, smaller and less complex public companies. In response to the 
Board's solicitation of comment on the appropriateness of the 
standard's requirements for audits of companies of different sizes and 
in different industries, commenters generally considered the 
requirements of the standard to be applicable and appropriate to 
companies of varying sizes and industries. Commenters did not raise 
concerns regarding the standard's impact on competition and the Board 
has not identified any economic effects on competition.
Conclusion
    As discussed throughout this submission, and in the Board's 
adopting release, the Board believes that Auditing Standard No. 16 will 
contribute to audit effectiveness. In addition, the new standard should 
assist the audit committee in its oversight over financial reporting. 
Moreover, more effective and informed communications between the 
auditor and the audit committee also should help enhance the quality of 
a company's financial reporting.
    In both its proposing and reproposing releases, the Board sought 
comment on all aspects of the standard and as part of the process 
specifically asked questions regarding the appropriateness of the 
standard for companies of all sizes or industries, which include EGCs. 
Commenters considered the requirements of the standard to be applicable 
and appropriate to companies of different sizes and industries. 
Notably, the Board received comments from a wide spectrum of 
commenters, including from auditors that represented the interests of 
both small and large accounting firms and that audit companies of 
various sizes.
    After the enactment of the JOBS Act, the Board compiled data 
available from entities voluntarily identifying themselves as EGCs in 
SEC filings. Based on data available to the Board, it appears that a 
wide range of entities, of differing sizes and industries, identify 
themselves as EGCs. One key difference between EGCs and other issuers 
appears to be the length of time that they have been subject to 
Exchange Act reporting requirements.
    The Board believes that Auditing Standard No. 16 is in the public 
interest, and, for the reasons explained above, after considering the 
protection of investors and the promotion of efficiency, competition, 
and capital formation, recommends that the standard should apply to 
audits of EGCs. Accordingly, the Board requests that the Commission 
determine that it is necessary or appropriate in the public interest, 
after considering the protection of investors and whether the action 
will promote efficiency, competition, and capital formation, to apply 
Auditing Standard No. 16 to audits of emerging growth companies. The 
Board stands ready to assist the Commission in considering any comments 
the Commission receives on these matters during the public comment 
process.

III. Date of Effectiveness of the Proposed Rules and Timing for 
Commission Action

    Pursuant to Section 19(b)(2)(A)(ii) of the Exchange Act, and based 
on its determination that an extension of the period set forth in 
Section 19(b)(2)(A)(i) of the Exchange Act is appropriate in

[[Page 57449]]

light of the PCAOB's request that the Commission, pursuant to Section 
103(a)(3)(C) of the Sarbanes-Oxley Act, determine that the proposed 
rule changes apply to audits of emerging growth companies, as defined 
in Section 3(a)(80) of the Exchange Act, the Commission has determined 
to extend to December 17, 2012 as the date by which the Commission 
should take action on the proposed rule changes.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
is consistent with the requirements of Title I of the Sarbanes-Oxley 
Act.
    In addition, the Board requested that the Commission, pursuant to 
Section 103(a)(3)(C) of the Sarbanes-Oxley Act, determine that the 
proposed rule changes apply to audits of emerging growth companies, as 
defined in Section 3(a)(80) of the Exchange Act. In order for the 
proposed rule changes to apply to audits of emerging growth companies, 
the Commission must determine that the application is necessary or 
appropriate in the public interest, after considering the protection of 
investors and whether the action will promote efficiency, competition, 
and capital formation. Please provide any views you believe will help 
the Commission in making that determination.
    Comments may be submitted by any of the following methods:

Electronic Comments

    1. Use the Commission's Internet comment form (http://www.sec.gov/rules/pcaob.shtml); or
    2. Send an email to rule-comments@sec.gov. Please include File 
Number PCAOB-2012-01 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number PCAOB-2012-01. This file 
number should be included on the subject line if email is used. To help 
the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/pcaob/shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule that are filed 
with the Commission, and all written communications relating to the 
proposed rule between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for Web site viewing and printing in 
the Commission's Public Reference Room, on official business days 
between the hours of 10:00 a.m. and 3:00 p.m. Copies of such filing 
will also be available for inspection and copying at the principal 
office of the PCAOB. All comments received will be posted without 
change; we do not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File No. PCAOB-
2012-01 and should be submitted on or before October 9, 2012.
---------------------------------------------------------------------------

    \185\ 17 CFR 200.30-11(b)(2).

    For the Commission, by the Office of the Chief Accountant, by 
delegated authority.\185\
Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2012-22632 Filed 9-14-12; 8:45 am]
BILLING CODE 8011-01-P