“No surprises” has long been a goal–and the hallmark–of effective communications and a strong relationship between the audit committee and auditor, so any measures that increase transparency and effective communication around the audit is a step forward in enhancing audit quality and strengthening governance.
The Public Company Accounting Oversight Board’s new Auditing Standard No. 16, “Communications with Audit Committees” (still subject to SEC approval) is just such a step. While the auditor communications required by Standard No. 16 largely take place today–in practice and as a result of SEC and stock exchange rules–the new standard incorporates these communications (with some enhancements and additions) to ensure that the audit committee is provided with key information related to the audit.
KPMG’s Defining Issues® No. 12-40 provides a detailed summary of these communications requirements, including which elements are enhancements to current communications practices and requirements. But at a high level, the new standard has four objectives for the auditor’s communications with the audit committee:
- Communicate the auditor’s responsibilities and establish an understanding of the terms of the audit engagement with the audit committee
- Obtain information from the audit committee that is relevant to the audit
- Communicate an overview of the overall audit strategy and timing
- Provide timely observations arising from the audit that are significant to the financial reporting process.
Collectively, the communications that are incorporated into the new PCAOB standard help ensure transparency and a good understanding of the audit, the integrity of financial reporting, and the state of the business – and clearly a well-informed audit committee is better equipped to monitor auditor performance and gauge audit quality. But beyond any specific communication requirements, it’s critical that the audit committee and auditor have an open line of communication – particularly in today’s business and regulatory environment with financial reporting and disclosures becoming more complex. This new PCAOB Standard is more about meaningful conversations between the audit committee and auditor than it is about new information going to the audit committee.
As we emphasized in the 2010 Report of the NACD Blue Ribbon Commission on the Audit Committee (Appendix F, page 73), a strong relationship – including frequent informal communications – between the audit committee chair and the lead engagement partner is critical, and often includes:
- Seeking the auditor’s input on committee agendas, walking through pre-meeting materials, discussing developments on a real-time basis, and promoting an understanding of key matters from the perspective of the external auditor.
- Conducting an executive session with the external auditor at each formal meeting – to gain insight into the strengths and weaknesses of the company’s financial reporting and control processes, and other relevant observations or concerns.
- Maintaining robust, two-way communications with the external auditor about a range of financial reporting, internal control, and risk-related issues that may impact the company’s financial reporting and internal controls.
- Establishing clear expectations with the auditor regarding communications and interactions with the audit committee (related to the audit, progress reporting, issue resolution, the auditor’s support of the audit committee, etc.) and with management.
If adopted by the SEC, Auditing Standard No. 16 would go into effect for public company audits of fiscal periods beginning after Dec. 15, 2012. But audit committees and auditors alike should already have high expectations for the type of robust, two-way communications that are vital for each to carry out their responsibilities to investors and the capital markets.
Dennis T. Whalen is Partner in Charge and Executive Director of KPMG’s Audit Committee Institute (ACI). Learn more about KPMG’s ACI.