The New World of Auditing Standards

ver the past several years the Sarbanes-Oxley Act and other events have dramatically affected the setting of auditing standards and the focus of the audit process. While the act requires auditors of public companies—the issuers—to follow the Public Company Accounting Oversight Board’s (PCAOB) auditing standards, generally accepted auditing standards (GAAS) issued by the AICPA’s Auditing Standards Board (ASB) apply to all audits of non-SEC-registered entities—nonissuers. To explain how this altered environment and the ASB’s new role affect auditors, their clients and financial statement users, the JofA interviewed John A. Fogarty, ASB chairman, and Harold L. Monk, vice-chairman, and Chuck Landes, AICPA vice-president and director of the audit and attest standards team. (For another perspective on how GAAS and PCAOB auditing standards can affect CPA firms, see “ Stay Out of Trouble, ” JofA , Aug.05, page 67.)

JofA : The ASB achieved several important things at its October 2005 meeting. What were they?

Chuck Landes : The recently reorganized ASB approved 10 new auditing standards, a new attestation standard and an attestation exposure draft (ED). The auditing standards include a documentation standard, a suite of eight risk assessment standards and a standard that defines professional requirements in statements on auditing standards and statements on standards for attestation engagements.

JofA : Would you describe the reorganization of the ASB?

Landes : Several years ago, the AICPA’s board of directors and council approved increasing the ASB’s membership to 19 from 15 to better represent our constituency, which includes small and large firms, educators, the state boards of accountancy, the government community, other federal and state regulators, private investors and other users of nonissuer financial statements, whose support the ASB needs to effectively serve private business and government entities.

JofA : How will the ASB fulfill its mission?

John Fogarty : The ASB is responsible for developing and communicating comprehensive performance, reporting and quality control standards and practice guidance that enable auditors of nonissuers to provide high-quality, objective audit and attestation services at a reasonable cost. The ASB must act in the best interests of the profession, clients, employers and the public by improving existing standards and facilitating the development of new ones.

The board will continue its leadership role in the development of auditing guidance, such as its risk assessment standards, while working more closely than ever with regulators and external stakeholders.

It will do this by

Acting as the profession’s voice on auditing standards related to audits of nonissuers and when commenting on the proposed standards of other auditing standard setters, such as the International Auditing and Assurance Standards Board (IAASB).

Serving as the profession’s “think tank” on the strategic direction of auditing standards.

Helping rebuild public trust in the CPA’s audit report.

Commissioning research to continuously improve the auditing profession.

Addressing the assurance needs of users of nonissuers’ financial statements.

Promulgating audit, attest and quality control standards for engagements involving nonissuers.

Issuing clear authoritative guidance for auditors of nonissuers.

Working with the AICPA staff to develop nonauthoritative guidance for practitioners.

JofA : Now that there are multiple standard setters, whose standards are CPAs required to follow?

Harold Monk : The creation of the PCAOB necessitated changes in the AICPA Code of Professional Conduct. The code requires members who perform audits and other professional services to comply with the standards promulgated by bodies designated by the AICPA council. In spring 2004, the council

Amended the ASB’s current designation to recognize it as a body with the authority to promulgate auditing, attestation and quality control standards related to the preparation and issuance of audit reports for nonissuers.

Designated the PCAOB as a body with the authority to promulgate auditing standards as well as attestation, quality control, ethics, independence and other standards related to the preparation and issuance of audit reports for issuers.

If a nonissuer requests that a CPA perform an audit following PCAOB auditing standards, the auditor must follow both ASB auditing standards and all applicable PCAOB auditing standards.

JofA : Has the ASB issued any guidance on how companies should report under these new circumstances?

Fogarty : Yes. In June 2004 the ASB issued two interpretations of Statement on Auditing Standards (SAS) no. 58, Reports on Audited Financial Statements (AU section 508 of AICPA Professional Standards ). Interpretation no. 17, “Clarification in the Audit Report of the Extent of Testing of Internal Control Over Financial Reporting in Accordance With Generally Accepted Auditing Standards,” provides illustrative language for use in the auditor’s report to clarify that an audit performed in accordance with GAAS does not require the same level of testing and reporting on internal control over financial reporting as an audit of an issuer to which section 404(a) of the Sarbanes-Oxley Act applies. Interpretation no. 18, “Reference to PCAOB Standards in an Audit Report on a Nonissuer,” clarifies the applicability of GAAS and provides illustrative language for a dual-reference reporting situation in which an audit has been conducted in accordance with GAAS as well as with the auditing standards of the PCAOB. These interpretations are available at www.aicpa.org/members/div/auditstd/announce/index.htm .

This dual reporting model is similar to what the ASB adopted when auditing financial statements in accordance with generally accepted government auditing standards (GAGAS, or the Yellow Book) and the international standards on auditing (ISAs). This conclusion is based on recognition of SASs as the standards the AICPA council has designated as appropriate for audits of nonissuers’ financial statements.

JofA : What issues should a firm consider if asked to report under both ASB and PCAOB standards?

Monk : When a nonissuer’s financial statements have been audited in accordance with GAAS and PCAOB auditing standards, users of the auditor’s report may erroneously believe the entity and the auditor are in compliance with the entire system of PCAOB and SEC regulations—that is, quality control, ethics and independence standards. Such users also may incorrectly assume that the CPA firm that performed the engagement is registered with the PCAOB and subject to its inspection and enforcement structure. These potential misconceptions make it absolutely essential that auditors ensure clients clearly understand PCAOB and ASB requirements. Firms also should bear in mind that audits that undergo peer review and are found not in compliance with all PCAOB auditing standards may be deemed substandard engagements—depending upon the severity of the deficiencies—even if they comply with all AICPA auditing standards.

JofA : Has the ASB agenda grown?

Landes : The ASB is working on more projects than at any time in nearly five years. Among them are an exposure draft (ED) on communicating internal control deficiencies noted during an audit, a companion ED on examining the effectiveness of internal control over financial reporting and guidance on auditor reports and compliance auditing considerations related to government entities. Other ASB projects address auditing accounting estimates, auditing related parties, group audits, auditor communications with those responsible for governance and revisions to the AICPA’s quality control standards. More information on these projects is available in the AICPA auditing standards staff’s quarterly newsletter, In Our Opinion ( www.aicpa.org/members/div/auditstd/opinion/index.htm ).

JofA : How does the ASB intend to monitor the work of other standard setters?

Fogarty : In its words and actions, the ASB has been very clear it doesn’t intend to create gratuitous differences between its standards and those of the PCAOB. In order to help coordinate agendas among the ASB, the PCAOB and the GAO, the chairs of each of these standard setters and their staffs meet at least three times a year. The most recent was in December 2005, with the GAO as host. These meetings provide a valuable forum for discussing projects, timetables and goals. In addition to monitoring PCAOB standards and working closely with the GAO, the ASB is collaborating with the IAASB to harmonize ASB standards and ISAs wherever possible.

JofA : Is it important for U.S. auditors—especially those from smaller firms—to stay abreast of developments that are related to ISAs?

Monk : Absolutely. As international standards in audit and attest services gain worldwide acceptance in cross-border operations and financing, U.S. CPAs, including small firm practitioners, will have to become familiar with ISAs in order to perform engagements in accordance with international standards or equivalent national standards.

For many years the AICPA has been a leader in financial reporting and assurance. It must continue to support its members and the accountancy profession worldwide through its standard-setting process, educational programs and public relations. It also must increase members’ understanding of the international standard-setting process, the body of international auditing standards and implementation issues.

JofA : How have international activities affected the ASB’s work?

Fogarty : In many parts of the world, as in the United States, auditors from firms of all sizes use international auditing standards that serve the public interest and improve the transparency of cross-border financial reporting. But creating such guidance requires cooperation among national and international standard-setting bodies. To that end, ASB task force and subcommittee members serve as representatives to the IAASB.

For example, I’m the AICPA member on the IAASB, and Harold Monk serves on another international committee, which focuses on small company auditing issues. Other ASB members serve on numerous international projects and subcommittees, and we all review and comment on proposed international audit standards and help the IAASB identify emerging national issues with international implications.

To speed our evaluations and commentary on international auditing proposals, we’ve aligned the ASB’s agenda with that of the IAASB, and we’re matching the board’s standard-setting process and body of knowledge with their international counterparts. At the same time, we’re carefully ensuring the ASB retains its ability to develop auditing, attestation and quality control standards that serve U.S. auditors of nonissuers and inspire public trust.

JofA : Is there anything else you want to emphasize here to JofA readers?

Monk : It’s important that practitioners share with us their thoughts on ASB exposure drafts. We take each comment letter seriously and aim to be particularly responsive to those that seek to improve the quality of our standards.

We also want members—especially smaller firms—to understand they will not be affected by changes made to align ASB and international standards. The ASB will continue to issue statements on auditing standards (SASs), and the AICPA will continue to publish the codification of auditing standards. This guidance will continue to govern audits of nonissuers.

JofA : How can members best stay informed about these different standards and the ASB’s projects and activities?

Landes : The AICPA’s auditing standards are posted on its Web site ( www.aicpa.org/members/ ) and are updated each June. In addition the Institute has developed publications to provide practitioners with standards applicable to both nonissuers and issuers. Codification of Statements on Auditing Standards provides GAAS standards applicable to audits of nonissuers and identifies differences between GAAS and PCAOB standards. The new PCAOB Standards and Related Rules contains applicable guidance from the PCAOB.

Members also should frequently visit the Web page of the AICPA audit and attest standards team ( www.aicpa.org/members/div/auditstd/index.htm ), which contains its quarterly newsletter, the ASB’s agendas and materials, and the highlights of ASB meetings.