Under Fire: Auditing Standard Number Two

This week's second roundtable on Sarbox 404 may lead to a rewrite of Auditing Standard No. 2.

While the focus of the upcoming May 10 roundtable to be jointly held by the Securities and Exchange Commission and the Public Company Accounting Oversight Board will be Section 404 of the Sarbanes-Oxley Act, the finger-pointing amid complaints of cost burdens might lead some to rethink the PCAOB’s Auditing Standard No. 2.

Known as AS2, the standard is used by external auditors when auditing internal controls over financial reporting as required by Sarbox Section 404. Last year’s roundtable was marked by vigorous complaints that audit firms were interpreting AS2 too conservatively. Recent public speeches by regulators imply that regulators might review accounting standards in an effort to reduce complexity in financial reporting.

“Before the problems surrounding Section 404 can be solved, the PCAOB will have to reopen AS2,” SEC Commissioner Paul Atkins stated in prepared remarks before the Investment Adviser Association on April 27. “We will work with them on revising the standard,” he said.

Atkins also noted that the SEC should have been more explicit in providing guidance for management on making internal controls assessments. “Without that sort of guidance, management has had to look to AS2 for guidance and defer to auditor directives about the steps they needed to take in strengthening, documenting, and testing their internal controls,” noted Atkins.

That comment mirrors one made last week by Scott Taub, acting chief accountant of the SEC. Speaking at the Fifth Annual Financial Reporting Conference at the Zicklin School of business at Baruch College, Taub said one reason 404 costs may have been so high last was that companies were testing too many controls. “There’s no [SEC] testing requirement in terms of the percentage of controls” companies must examine, he said. Unlike Atkins, Taub did not explicitly refer to AS2, but many observers have blamed such testing overkill on the fact that companies also used AS2 to guide them in their 404 work.

Indeed, last week the PCAOB warned audit firms that its investigations of audit firms this year will focus on how well they have adopted guidance urging them to focus on controls posing the greatest risks.

PCAOB board member Daniel Goelzer, who spoke at a meeting of the National Association of Corporate Directors in Minneapolis on April 27, said the PCAOB will focus on uncovering control weaknesses that are likely to lead to material misstatements rather than matters that are trivial, he said. “That may well require amending AS No. 2.” Goelzer did not describe how the auditing standard could be changed, but he stated that the PCAOB will be more aggressive in ensuring that audits of internal controls by outside auditors are performed efficiently.

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