Auditing


  The PCAOB issued a concept release on possible changes to the auditor’s reporting model including the addition of an auditor’s discussion and analysis (AD&A), mandatory emphasis paragraphs, assurance on non-GAAP information and clarification of standard language.

 

A fact sheet summarizing each of the possible changes is available at tinyurl.com/679h8ku. What follows is a brief description of each proposal:

 

Auditor’s discussion and analysis (AD&A ) . This supplemental narrative report to the auditor’s report would allow the auditor to discuss his or her views regarding significant matters. The board says the AD&A could include information such as audit risks identified in the audit, audit procedures and results, and auditor independence. It also could include a discussion of the auditor’s views regarding the company’s financial statements, such as management’s judgments and estimates, accounting policies and practices, and difficult or contentious issues, including “close calls.”

 

“An AD&A, as contemplated in the concept release, is not intended to provide separate assurance on individual balances, disclosures, transactions, or any other matters discussed,” the fact sheet says. “Rather, an AD&A is intended to facilitate an understanding of the auditor’s opinion on the financial statements taken as a whole.”

 

Required and expanded use of emphasis paragraphs. This would require inclusion of an expanded emphasis paragraph (currently optional) in all audit reports. The emphasis paragraph would highlight the most significant matters in the financial statements and identify where these matters are disclosed in the financial statements.

 

The board says “emphasis paragraphs could be required in areas of critical importance to the financial statements, including significant management judgments and estimates, areas with significant measurement uncertainty and other areas that the auditor determines are important for a better understanding of the financial statement presentation. With respect to each matter of emphasis under this alternative, the auditor also could be required to comment on key audit procedures performed pertaining to the identified matters.”

 

Auditor assurance on other information outside the financial statements. This would require auditors to provide assurance on information outside the financial statements, such as management’s discussion and analysis (MD&A) or other information (for example, non-GAAP information or earnings releases).

 

The board says the additional reporting “could be based on certain aspects of the current attest standard and report, but [current PCAOB attest standards] do not represent the only alternative for reporting on MD&A or portions thereof.”

 

Clarification of language in the standard auditor’s report. Another enhancement to the current auditor’s report, the board says, could involve clarifying what an audit represents and auditor responsibilities. Language and concepts that could be clarified include: reasonable assurance, auditor’s responsibility for fraud, auditor’s responsibility for financial statement disclosures, management’s responsibility for the preparation of the financial statements, auditor’s responsibility for information outside of the financial statements, and auditor independence.

 

The board says the four potential changes outlined above, which it calls “alternatives,” are not mutually exclusive. “A revised auditor’s report could include one or a combination of the alternatives, elements within the alternatives, or alternatives not currently presented in the concept release,” the fact sheet says.

 

“These alternatives are not intended to alter, in any way, the auditor’s ultimate responsibility to obtain sufficient appropriate audit evidence to support the audit opinion,” the fact sheet says. “Nor are these alternatives intended to qualify or piecemeal the auditor’s opinion or to shift the requirement to assess the risk of material misstatement of the financial statements from the auditor to investors or other users of financial statements.”

 

“I think expanding emphasis paragraphs, clarifying the meaning of the audit report and having auditors associated with Management’s Discussion and Analysis (MD&A) could give investors more confidence in financial reports,” said Cindy Fornelli, executive director for the Center for Audit Quality, which is affiliated with the AICPA.

 

The changes outlined above, the PCAOB acknowledges, would likely require the development of additional auditing standards or rules through collaboration with the SEC.

 

Comments on the concept release are due Sept. 30. The board also announced that it plans to hold a public round table to discuss the concept release in the third quarter. To comment or for more information, go to tinyurl.com/5vvet8b.

 

 

  The SEC proposed rules that it said would strengthen the annual audits of broker-dealers by requiring an increased focus on their custody activities. Current rules require broker-dealers to protect and account for customer assets. The proposed rule amendments would mandate an audit of those controls.

 

Comments on the proposal, which is available at tinyurl.com/3ndreyd, are due 60 days after publication in the Federal Register. The PCAOB in June approved a temporary rule to create an interim inspection program for registered public accounting firms’ audits of securities brokers and dealers.

 

The introduction to the proposed rules outlines three sets of amendments to the broker-dealer financial reporting rule under the Securities Exchange Act of 1934 (the “Exchange Act”). They include:

1. Updating the existing requirements of Exchange Act Rule 17a–5, to facilitate the ability of the PCAOB to implement oversight of independent public accountants of broker-dealers as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, and eliminate potentially redundant requirements for certain broker-dealers affiliated with, or dually registered as, investment advisers.

 

2. Requiring broker-dealers that either clear transactions or carry customer accounts to consent to allowing the SEC and designated examining authorities (DEAs) to have access to independent public accountants to discuss their findings with respect to annual audits of the broker-dealers and to review related audit documentation.

 

3. Enhancing the ability of the SEC and DEA examiners to oversee brokerdealers’ custody practices by requiring broker-dealers to file a new form.

The SEC said in a press release that the proposal would strengthen oversight of broker-dealer custody practices by requiring broker-dealers that maintain custody of customer assets or self-clear transactions to allow SEC staff and the relevant designated examining authority to review workpapers of the public accounting firm that audits the broker-dealer and discuss any findings with the accounting firm. The proposed amendments also would require all broker-dealers to file quarterly a proposed new form containing information about their custody practices. This form would be used as a starting point for regulatory examinations.

 

Broker-dealers that maintain custody of a customer’s securities and cash are subject to requirements of the Securities Exchange Act of 1934. The requirements designed to protect and account for these assets include:

 

  • The Net Capital Rule (Rule 15c3-1). This requires a broker-dealer to maintain more than a dollar of highly liquid assets for each dollar of liabilities.
  • The Customer Protection Rule (Rule 15c3-3). This requires a broker- dealer to segregate customer securities and cash from the firm’s proprietary business activities.
  • The Quarterly Security Count Rule (Rule 17a-13). This requires a broker- dealer on a quarterly basis to count, examine and verify the securities it actually holds for customers and for itself—and compare that with the amounts of such securities it should be holding as indicated by its records.
  • The Account Statement Rule. This requires a broker-dealer to send a statement—at least quarterly—to each customer, reflecting the customer’s securities and cash positions held at the broker-dealer, as well as the activity in the account.

 

The proposal would require a broker-dealer that maintains custody of customer securities and cash to undergo an examination—by a PCAOB-registered public accounting firm—of:

 

  • Whether it is in compliance with the four rules described above; and
  • Its controls for complying with these rules.

 

A broker-dealer that does not maintain custody of customer securities and cash would be required to undergo a review by an independent public accountant of its assertion that it is not subject to segregation requirements because it does not maintain custody of customer securities and cash.

 

The SEC said the proposed amendments would enhance these broker-dealer examinations by requiring a broker-dealer that maintains custody of customer securities and cash or clears transactions to allow SEC and self-regulatory organization (SRO) examiners to:

 

  • Access the workpapers of the registered public accounting firm that audits the broker-dealer.
  • Discuss any findings with the personnel of the registered public accounting firm.

 

The SEC said examiners could use this information to better focus their examinations.

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