AS5: More Flexible, Less Effective?

Does the PCAOB's proposed replacement for Auditing Standard No. 2 offer too much leeway for professional judgment?

With just a few days until the comment period ends, the Public Company Accounting Oversight Board got an earful from its advisory board on Thursday about the new standard for auditors’ attestation of corporate internal controls. In a nutshell, the corporate executives and accounting experts questioned whether the more-flexible standard will lead to less-effective audits.

The PCAOB is attempting to simplify its most-contentious auditor guideline, Auditing Standard No. 2, in response to concerns in the business community that audits under the Sarbanes-Oxley Act have become too onerous and costly. The proposed standard — commonly referred to by the board as AS5 — encourages auditors to take a “top down, risk-based approach” by focusing on only those areas in which a material weakness could lead to a misstatement.

While AS5 is not a dramatic stretch from its predecessor, it more explicitly gives auditors and their clients more latitude in their professional judgment, notes John Morrissey, operating controller at General Electric and a member of the PCAOB’s Standing Advisory Group. At the same time, that leeway could open the door for more lax audits. “People have a concern that this could be an excuse to cut back on work and not focus on quality,” he says.

Ed Trott, a member of the Financial Accounting Standards Board, similarly worries that the PCAOB hasn’t done enough to explain the new standard’s true intentions. Trott, like other advisory group members, wonders if AS5 is promoting the idea of better efficiency in audits and, inadvertently, sacrificing their effectiveness. That concern has many financial-statement users and preparers thinking that AS5 is a “relaxation” of AS2, he says. “Unfortunately, your actions are likely to be misinterpreted and deemed to be a back-off of the objectives that you set with AS2.”

During the daylong meeting, the PCAOB board members and staff remained quiet, for the most part, as they listened to the advisory group members, which comprised executives, directors, and audit-firm representatives. The meeting’s objective was to collect the advisory group’s opinions regarding inconsistencies or duplication in the standard, says PCAOB chairman Mark Olson. Still, board member Kayla Gillian addressed the issue raised by Trott and others: AS5 specifically calls for high-quality audits with the least amount of resources possible, she explained. “This is not intended in any way to water down the standard.”

AS2 has become the de facto guidance for management compliance with Sarbox’s internal-control provision, Section 404. The rewrite of the standard came amid a recent flurry of sharp criticism by business groups and politicians lobbying for a rollback of corporate regulations; namely, Sarbox. In fact, the Securities and Exchange Commission proposed a so-called lighter version of Section 404 about the same time the PCAOB introduced AS5. As a result, the two 70-day comment periods coincide.

Like AS5, which requires SEC approval, the commission’s Section 404 revisions call for companies to focus on issues of materiality. But the differences in the two regulations highlight the need for more communication between management and auditors, Robert Tarola, senior vice president and CFO of W.R. Grace, told the PCAOB. “Heretofore there has been very little collaboration, and we’ve pretty much been in a ‘gotcha’ situation,” he said. “To avoid that, audit teams and auditors need to work together to protect investors and agree on the important areas to review and complement each other.”

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