PCAOB FLASH REPORT
Board Approves New Auditor Communication Standard and
Amends Various Standards
August 17, 2012
The Public Company Accounting Oversight Board (PCAOB) has unanimously approved Auditing
Standard No. 16 (AS16) to address auditor communications with audit committees and make
related transitional amendments to the Board’s standards. The press release announcing the
Board’s actions is located at http://pcaobus.org/News/Releases/Pages/AS16Adoption.aspx. The
new standard must be approved by the U.S. Securities and Exchange Commission (SEC) and
that approval is expected. See http://pcaobus.org/Rules/Rulemaking/Docket030/Release_2012004.pdf for the final standard.
Depending on the timing of the SEC’s approval, the new standard and related amendments will
be effective as early as audits of fiscal years beginning on or after December 15, 2012. Because
the standard has been exposed for several months and has been the subject of several public
roundtables, early adoption is permitted. It is reasonable to expect that some audit firms will
elect early adoption.
Overview of AS16
As context, the audit committee provides oversight of management’s financial reporting and
certification of the effectiveness of internal controls over financial reporting. The auditors attest
to the fairness of presentation of the financial statements and the effectiveness of internal
control over financial reporting. As both focus on the reliability of financial reporting, it is
expected that effective communications would benefit each in the discharge of their respective
functions.
AS16 expands the auditor’s inquiries of the audit committee to determine whether the
committee is aware of matters relevant to the audit, including, but not limited to, violations or
possible violations of laws or regulations.1 In addition, AS16 adds new communication
requirements that provide the audit committee with additional information about significant
aspects of the audit, including the results of audit procedures and the conduct of the audit.
1
Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement, requires the auditor to inquire
of the audit committee regarding the matters important to the identification and assessment of risks of material
misstatement and fraud risks. These inquiries will continue. However, AS16 replaces the predecessor standard,
AU 380 (originally developed by the AICPA's Auditing Standards Board).
The standard is intended to reduce the instances when significant matters arise and the audit
committee doesn’t find out until it is too late, leaving directors to wonder why the auditors didn’t
inform or report to them about the matters on a timely basis. The premise under AS16 is that
good communications between the audit committee and the auditor, with no constraints of any
kind, can reduce the risk of financial reporting failures. The goal under AS16 is to eliminate
perceived constraints and foster robust communication.
Both the auditors and the audit committee play a vital role in contributing to the corporate
governance processes that ensure fair reporting to investors. The audit committee provides
oversight of management’s financial reporting and the auditors attest to the fairness of
presentation of the financial statements. Therefore, both auditors and audit committees should
support each other’s work with an open dialogue about how to protect investors from misleading
or inadequate management reports.
In issuing AS16, the PCAOB is of the view that no new audit work is required to implement it.
Enhanced and Additional Communications Required of the Auditor
AS16 retains many of the communication requirements in AU Sec. 380 and also incorporates
the SEC’s communication requirements.2 More importantly, it improves the current
communication requirements of AU Sec. 380 by requiring the auditor’s communications with the
audit committee to occur before the issuance of the audit report. In addition, the standard
enhances certain existing auditor communication requirements by requiring the auditor to
communicate:

Certain matters regarding the company’s accounting policies, practices and estimates

The auditor’s evaluation of the quality of the company’s financial reporting

Information related to significant unusual transactions, including the business rationale
for such transactions3

The auditor's views regarding significant accounting or auditing matters when the auditor
is aware that management consulted with other accountants about such matters and the
auditor has identified a concern regarding these matters
Under AS16, the auditor is required to communicate:

An overview of the overall audit strategy, including timing of the audit, significant risks
the auditor identified, and significant changes to the planned audit strategy or identified
risks4
2
See Section 10A(k) of the 1934 Securities Exchange Act, 15 U.S.C. § 78j-1(k) and SEC Rule 2-07(a)(1)-(3). For
example, certain communications included in SEC Rule 207, as originally set forth in the Sarbanes-0xley Act, are
incorporated in AS16 (e.g., communications relating to such matters as critical accounting policies, use of alternative
disclosures and other material written communications between the auditor and management).
3
Some transactions lack substance and are entered into for an accounting result. Therefore, those transactions may
fall into the bucket of significant transactions outside the normal course of business if they are designed to achieve an
earnings result or affect disclosures regarding debt and equity. AS16 requires the auditor and audit committee to
discuss the business rationale and reflect on the appropriate disclosures to be made to assist investors in
understanding the underlying economics of the transaction.
4
“Significant risks” applies to risks of material misstatement of the financial statements versus, for example,
significant operational risks inherent in the company’s business. To illustrate, “significant risks” may apply to the
allowance for loan losses or warranty reserves. It may also apply to increased exposure to material misstatement of
the financial statements because of complexity, conflicts of interests and other sensitive matters.
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
Information about the nature and extent of specialized skills or knowledge needed during
the audit, the extent of the planned use of internal auditors, company personnel or other
third parties, and other independent public accounting firms, or other persons not
employed by the auditor that are involved in the audit process

The basis for the auditor's determination that he or she can serve as principal auditor, if
significant parts of the audit will be performed by other auditors

Situations in which the auditor identified a concern regarding management's anticipated
application of accounting pronouncements that have been issued but are not yet
effective and might have a significant effect on future financial reporting

Difficult or contentious matters for which the auditor consulted outside the engagement
team

The auditor's evaluation of going concern5

Departure from the auditor's standard report

Other matters arising from the audit that are significant to the oversight of the company’s
financial reporting process, including complaints or concerns regarding accounting or
auditing matters that have come to the auditor’s attention during the audit
In essence, the audit committee can expect information that provides insights from the
attestation process, including, among other things, identification of high-risk areas, going
concern issues, perspectives on judgmental issues, discussion of the summary of passed
adjustments, concerns with respect to the internal control structure and areas of disagreement
with management.6 AS16 requires auditors to communicate significant, unusual
communications to the audit committee on a timely basis and encourages robust, two-way
communications between the auditor and audit committee, both of which improves the integrity
of the audit process. Also, it would be expected that auditor and audit committee discussions
include a review of any significant matters arising from the audit firm’s PCAOB inspection
reports, and that the Board encourages audit firms to communicate effectively with audit
committees regarding inspection matters.
Communications Should Be “Two-Way” and May Be Verbal
While much of the communication will be from the auditor to the audit committee, there is
certain language in the final standard specifying what the audit committee should communicate
to the auditor as well. The standard encourages effective two-way communication between the
auditor and the audit committee throughout the audit process to assist both parties in
understanding matters relevant to the audit and assists the auditor in conducting an effective
audit. In the past, auditors have been required to inquire of the audit committee if there are any
significant matters relevant to the audit. Communications can be verbal, although the audit firm
will have to document that those discussions took place.7
5
For example, if the auditor is weighing at an interim stage whether there is substantial doubt regarding going
concern, the auditor must report to the audit committee at an interim stage so the audit committee can also weigh in
on what the company is doing.
6
In addition to the communication requirements included in AS16, other PCAOB standards and rules that require the
auditor to communicate specific matters to the audit committee are referenced in Appendix B to AS16.
7
Such documentation is required by existing PCAOB rules on auditor documentation.
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Applicability to Entities That Are Not Public Companies
AS16 defines the term "audit committee" as a “committee (or equivalent body) established by
and among the board of directors of a company for the purpose of overseeing the accounting
and financial reporting processes of the company and audits of the financial statements of the
company.” The standard doesn’t apply to non-issuers if an audit committee or board of directors
(or equivalent body) does not exist with respect to the company, e.g., there isn’t anyone who
oversees the accounting and financial reporting processes of the company and audits of the
financial statements of the company. That said, a non-issuer may voluntarily adopt a PCAOB
standard for use by its auditor. This may be an important matter as non-issuers prepare to go
public and want to be in compliance with PCAOB standards, as well as SEC rules.
Applicability to Emerging Growth Companies
AS16 is the first standard issued by the PCAOB since the Jumpstart Our Business Startups Act
(JOBS) was enacted. Pursuant to Section 104 of JOBS, any rules adopted by the Board
subsequent to April 5, 2012, do not apply to the audits of an emerging growth company (EGC)
(as defined), unless the SEC "determines that the application of such additional requirements is
necessary or appropriate in the public interest, after considering the protection of investors, and
whether the action will promote efficiency, competition, and capital formation." Therefore, AS16
is subject to this separate determination by the SEC regarding its applicability to the audit of an
EGC. In submitting AS16 for approval by the SEC, the Board is requesting that the SEC
approve its application to the audit of an EGC.
Amendments to Other Standards
AS16 impacts other PCAOB standards. Appendix 2 to AS16 contains the transitional
amendments to AU Sec. 380. Appendix 3 contains amendments to other existing PCAOB
standards.
Summary
The Board has been working on this standard for a long time. The PCAOB initially proposed the
standard in March 2010 and, after making revisions in response to comments received in
comment letters and at a September 2010 roundtable, it re-proposed it nearly eight months ago.
According to the Board’s press release, James R. Doty, PCAOB Chairman, stated, “Open lines
of communication between auditors and audit committees improve the quality of audits, and
[AS16] enhances the quality and relevance of those communications.”
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