Law & Regulation
Developments Affecting Audit Committees
By Ernst & Young BoardMatters Quarterly, September 2012
Sep 25, 2012 - 9:18:35 AM

The Public Company Accounting Oversight Board (the PCAOB or the Board) continues to seek input on enhancing auditor independence, objectivity and professional skepticism, including its consideration of mandatory audit firm rotation and other alternatives.

At a public roundtable in June 2012 in San Francisco, most participants expressed support for ongoing efforts to further improve audit quality, while many opposed mandatory audit firm rotation. They cited concerns about cost and the lack of evidence linking audit firm tenure to possible weaknesses in independence.

Many panelists supported strengthening audit committees and improving transparency and communications between auditors, audit committees, the PCAOB and shareholders.

Questions for the audit committee to consider                        

Inspections of independent auditors
In August 2012, the PCAOB issued a release¹ to help public company audit committees understand its inspections of registered public accounting firms and to help them gather useful information about those inspections from their independent auditors.

The release was motivated, in part, by feedback the Board received from audit committee members who said that they would welcome more dialogue about the inspection process and the results of inspections.

The release encourages audit committees to consider asking their auditors a number of questions, including the following:

• Was the company’s audit selected for PCAOB inspection?
• If so, has anything come to the firm’s attention suggesting the possibility that its audit opinion is not sufficiently supportedor that its independence or the fairness of the company’s financial statements and disclosures is being questioned?
• Has the PCAOB identified deficiencies in the company’s audit or in other audits that involved auditing or accounting issues similar to issues presented in the company’s audit?
• What were the audit firm’s responses to the PCAOB’s findings?
• What topics are included in the audit firm’s Part II findings, what steps is the firm takingto address them and has the PCAOB determined that such findings have been addressed to its satisfaction?

Communications with audit committees
The PCAOB adopted Auditing Standard No. 16, Communications with Audit Committees, and amendments to other PCAOB standards that are intended to enhance the relevance and timeliness of communications between the auditor and the audit committee.

Pending approval from the Securities and Exchange Commission (the SEC), the standard and the amendments will be effective for public company audits of fiscal periods that begin after December 15, 2012. The standard would also apply to the audits of brokers and dealers when the SEC directs those audits to comply with PCAOB standards.

The standard is substantially consistent with the re-proposal issued in December 2011 and does not add any new performance requirements for auditors other than communications. The PCAOB is requesting that the standard and the amendments apply to the audits of “emerging growth companies,” as defined in the Jumpstart Our Business Startups Act.

European activity
In Europe, audit committee members have expressed opposition to the European Commission’s proposals to address concerns about concentration in the audit industry and the independence of audit firms.²

In meetings with members of the European Parliament, European audit committee members explained their opposition to joint audits and mandatory audit firm rotation. One member noted that this approach would be “very expensive and not good for quality.” The European Parliament continues to evaluate these proposals.

The Dodd-Frank Act
Ten years after the passage of SOX, the recent financial crisis prompted another fundamental change in financial regulation. Among the many provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) are requirements that fundamentally change the structure and operations of the over-the- counter derivatives market.

In July 2012, the Commodity Futures Trading Commission (in conjunction with the SEC) finalized rules required by Dodd-Frank that will trigger new reporting, clearing, trading and record-keeping requirements. These new rules can have an effect on an entity’s liquidity, operations and technology for its hedging activities.

In August 2012, the SEC approved final disclosure rules related to conflict minerals, as requiredby Dodd-Frank Section 1502. The SEC voted 3-2 to require disclosures by a registrant that uses specified “conflict” minerals (gold, tin, tungsten and tantalum) because they are necessary to the functionality or production of a product that it either manufactures or contracts to be manufactured.

Companies have until May 31, 2014 to make their first filings on a newly created annual report on Form SD to disclose whether their products were “conflict free” during calendar year 2013.

For the first two years (four years for smaller reporting companies), companies are permitted to disclose that their products were “conflict undeterminable” if they are unable to ascertain whether the minerals their products contain helped finance fighting in the Democratic Republic of the Congo and neighboring countries.

Financial reporting update
The SEC staff issued its Final Report on its IFRS Work Plan summarizing what it has learned. The report does not include a recommendation to the SEC about whether or how to incorporate IFRS into the US financial reporting system.

The report focuses primarily on methods other than adoption of the International Accounting Standards Board’s (the IASB) standards and indicates that an endorsement approach that retains a role for the Financial Accounting Standards Board (the FASB) may reduce or eliminate many of the concerns expressed by constituents about moving to a single set of global accounting standards.

The SEC said that additional analysis is required before it makes a final decision on whether and, if so, how to incorporate IFRS into the US financial reporting system. As a result, we do not expect the SEC to make a decision this year.

Revenue recognition
The FASB and the IASB (the Boards) completed their evaluation of feedback received on their joint revenue recognition proposal. While respondents generally support the Boards’ progress, many expressed significant concerns about certain aspects of the proposal, including onerous performance obligations, interim and annual disclosure requirements and transition.

Respondents also asked for additional implementation guidance. New deliberations began in June 2012 and are expected to last through December 2012, with a final standard issued in the first half of 2013.

Leases
The Boards have made progress on a proposed lease accounting model and have tentatively agreed to change the expense recognition pattern and related income statement presentation for some leases. No other aspect of the lessee model was changed. In other words, all leases (other than short-term leases) still would be recognized on the balance sheet.

The nature of the underlying asset generally would be used to determine which leases have an accelerated recognition pattern and which have a straight-line recognition pattern. The Boards decided that lease expense for leases that convey a relatively small percentage (i.e., an insignificant portion) of the life or value of the leased asset should be recognized evenly over the lease term.

For example, real estate leases would generally have a straight-line expense recognition pattern, while equipment leases would generally have an accelerated recognition pattern. The Boards expect to issue a new exposure draft for comment during the fourth quarter of 2012.
 
 
¹ Information for audit committees about the PCAOB inspection process, PCAOB Release No. 2012-003, August 1, 2012, available athttp://pcaobus.org/Inspections/Documents/Inspection_Information_for_Audit_Committees.pdf .
² “Audit policy initiatives in the European Union and the United States ,” Viewpoints for the audit committee leadership summit, Tapestry Networks, May 2012.

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