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

Federal RegisterSep 17, 2012

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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

regarding certain matters related to the conduct of an audit

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.

Terms defined in Appendix A,

Definitions,

are set in boldface type the first time they appear.

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.

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.

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.

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.

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,

including, but not limited to, violations or possible violations of laws or regulations.

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.

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(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.

Critical accounting estimates.

(1) A description of the process management used to develop critical accounting estimates;

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;

and

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.

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;

and

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;

and

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

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

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.

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.

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.

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.

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.

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:

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;

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;

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:

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;

and

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.

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

that the auditor presented to management.

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

misstatements were immaterial, including the qualitative factors

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.

Footnote 13 to paragraph 20 of Auditing Standard No. 14 indicates that misstatements include omission and presentation of inaccurate or incomplete disclosures.

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 * * *.”

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,

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.

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.

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,

which may result in the auditor modifying the auditor's opinion or withdrawing from the engagement.

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.

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,

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.

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.

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.

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.

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

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.

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”).

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:

Integrated audit:

The expression of an opinion on both the effectiveness of internal control over financial reporting and the financial statements.

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:

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.

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.

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:

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.

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.

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.

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.

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(

) 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.

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.

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. 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.

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).

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

issuing an audit report or related work.

These requirements place the audit committee at the center of the relationship between management of a public company and its auditor.

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

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.

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.

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.

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

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.

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.

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:

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

definition of “audit committee” from the Sarbanes-Oxley Act.

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.

Section 2(a)(3) of the Sarbanes-Oxley Act, 15 U.S.C. § 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.

For issuers, the definition is the same as the definition included in the Sarbanes-Oxley Act.

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.

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.

Section 2(a)(3) of the Sarbanes-Oxley Act, 15 U.S.C. § 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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

Since the inquiry

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.

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

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.

See

paragraph A5 of Auditing Standard No. 12, which defines significant risk as a risk of material misstatement that requires special audit consideration.

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

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.

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.

Therefore, the standard was not revised.

See

paragraph 14 of Auditing Standard No. 12.

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.

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.

See

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.

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.

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

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

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.

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.

See

paragraph 5.a. of Auditing Standard No. 10.

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.

For example, the FASB ASC recognizes that an entity's description of its significant accounting policies is an integral part of the financial statements.

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.

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.

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.

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.

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.

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.

Based on this evaluation, the auditor should be in a position to make such communication.

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.

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.

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.

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.

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.

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.

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

replace the term “particularly sensitive” in AU sec. 380.

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).

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.

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.

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.

AU sec. 380.08.

See

AU sec. 342.10.

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.

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.

The commenter's concerns, therefore, may be addressed through a company's MD&A disclosures.

See

Securities Act Release No. 8350.

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.

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.

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;

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.

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.

Under Auditing Standard No. 16, such communication also would include the identification of significant unusual transactions.

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.

Therefore, the standard was not revised to further define significant unusual transactions.

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.

In addition, Auditing

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

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,

(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.

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.

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.

AU sec. 380.11.

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,

including potential bias in management's judgments about the amounts and disclosures in the financial statements.

See

paragraphs 24-27 of Auditing Standard No. 14.

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.

Linking the communication requirements with performance requirements in Auditing Standard No. 14 provides context regarding the matters to be communicated.

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

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.

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.

See

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

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.

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.

Communicating these results will provide the audit committee with the auditor's assessment of the critical accounting estimates based on the auditor's procedures.

See

AU sec. 380.08.

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

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

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

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

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

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

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

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 ma

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