Changes in the Profession

1. Changes in the Profession Alan Anderson, AICPA Senior Vice President

2. Agenda • What has happened since we last met? • PCAOB • SEC Rule-Making • The Cascade Effect • Internal Controls

3. New PCAOB Chair and other key appointments • New SEC Chairman Donaldson selects new PCAOB Chair. • Selected William McDonough • Chief Auditor Selected, Doug Carmicheal • Deputy Chief Auditor, Tom Ray

4. Public Company Accounting Oversight Board • Overview • Inspections • Discipline • Registration • Audit Standards for Public Companies • Recent Speech by PCAOB Member stating IAASB should be separated from IFAC

5. Sarbanes-Oxley Act Implementation • Requirements of Act take effect from 7/30/2002 -1/2004. • PCAOB & Public Company Auditing Standards. • GAO studies on Audit Firm Rotation and Competition/Firm Consolidation due in July.

6. SEC Proposals and AICPA Comment Letters • AICPA comment letters on each SEC proposal--emphasis on protecting the public interest, as well as concerns of smaller firms. • Comment letters posted to Sarbanes-Oxley Act/ PCAOB Implementation Central on AICPA.org: • http://www.aicpa.org/sarbanes/index.asp

7. SEC Final Rules – Non-Audit Services • Consistent with law. • Tax services clarified. • Audit firms can continue to provide tax compliance, tax planning and tax advice to audit clients, subject to audit committee pre-approval requirements. • Exception for tax court. • Mounting Pressure to revisit the tax preparation decision

8. Prohibited Services • (1) bookkeeping services • (2) financial information systems design and implementation; • (3) appraisal or valuation services, • (4) actuarial services; • (5) internal audit outsourcing services; • (6) management functions or human resources; • (7) broker or dealer, investment adviser, or investment banking services; • (8) legal services and expert services unrelated to the audit; • (9) any other service that the Board determines, by regulation, is impermissible.

9. SEC Final Rules – Independence Auditor Rotation • Lead and reviewing partners are subject to a mandatory 5-year-on, 5-year-off rotation. • Other key partners may work on an account for 7 consecutive years before facing a 2-year cooling-off period. • Small firm alternative. (AICPA pushed hard for small firm relief)

10. Foreign Public Accounting Firms • The bill subjects foreign accounting firms who audit a U.S. company to registrations with the Board. • This also includes foreign firms that perform some audit work, such as in a foreign subsidiary of a U.S. company, that is relied on by the primary auditor. • PCAOB held session to hear views of Foreign Auditors

11. SEC New Rules – Independence Partner Compensation • No specific compensation related to selling non-audit services. • Small firm exemption.

12. SEC New Rules – Independence Fee Disclosures • Disclosures must be made to investors of information related to audit and non-audit services provided by, and fees paid to, the auditor. • Revised “buckets” for the reporting of fees paid are (1) audit services, (2) audit-related services, (3) tax services, and (4) other services.

13. "Audit Committee Financial Expert" • Experience preparing, auditing, analyzing or evaluating financial statements comparable to issues expected to be raised in the registrant's financial statements, or experience actively supervising 1 or more persons engaged in such activities. 

14. "Audit Committee Financial Expert" • Understanding of generally accepted accounting principles and financial statements. • Ability to assess general application of such principles in connection with accounting for estimates, accruals and reserves. • Understanding of internal controls and procedures for financial reporting. • Understanding of audit committee functions.

15. SEC New Rules on Workpaper Retention • Accounting firms must retain for 7 years certain records relevant to their audits and reviews of issuers' financial statements. • Records to be retained include an accounting firm's workpapers and certain other documents that contain conclusions, opinions, analyses, or financial data related to the audit or review. • Contrary opinion documentation must be maintained.

16. SOX-Mandated SEC Enforcement Study • SEC staff studied 5 years of enforcement actions. • In 227 enforcement matters, actions were taken against 164 entities (18 audit firms) and 705 individuals (89 individual auditors). • Of 57 matters with actions against auditors, 16 involved Big Five, 41 smaller firms.

17. SOX-Mandated SEC Enforcement Study • In 140 of 227 enforcement matters, auditor was Big Five. • Actions were predominantly not fraud related. • Study confirms risk areas we were already aware of and have incorporated into SAS 99 and Audit Risk Alerts.

18. SOX-Mandated SEC Enforcement Study • Report recommendations: • Uniform approach to public reporting of restatements. • MD & A reforms beyond those already adopted because of Sarbanes-Oxley. • Allowing issuers to provide SEC with internal reports, including those now covered by attorney client privilege, without waiving privilege.

19. Cascade Impact For Non Public Companies.

20. Principal Themes as we consider cascade impact • The profession should advocate for a “Reasoned Approach to Reform” at the state level. • The complexity of the issues needs to be articulated and communicated. Series of white papers available on AICPA.org

21. A Reasoned Approach to Reform • Allow the process to work (SEC, PCAOB). • Emphasize the work of AICPA technical committees (PEEC, PRB, ASB). • Advocate for protection of small business. • Underscore state economic development issues. • Emphasize that uncoordinated state law changes are ineffective. • The marketplace is already adjusting.

22. Federal Cascade is a Strong Possibility • GAO reaction to legislation • DOL reaction to legislation • Banking and other regulators’ reaction • Pension reform initiatives • Tax shelter focus by Congress

23. Auditing Internal Control • The ASB is issuing an exposure draft that provides and enhances the standards for the auditor to use when reporting on the effectiveness of a registrant’s system of internal control over financial reporting. • The AICPA has long supported this requirement.

24. The New Requirement • Section 404 of Sarbanes-Oxley Act of 2002 requires that auditors of most public companies also attest to management’s assessment of the effectiveness of internal control over financial reporting. • These additional procedures and the attestation report shall not be the subject of a separate engagement. • Audits covering internal control therefore will become an integral part of a public company audit. • Management’s and the auditor’s report will be part of the public filing.

25. Major Provisions of Proposed Standards • Establishes conditions for engagement performance. • Management’s process and responsibilities. • Management’s documentation of controls. • Provides enhanced guidance on planning the engagement, including: • Factors to consider when the entity has multiple locations or business units, • Implications for the engagement when service organizations are used, and the role of the internal audit function. • Provides enhanced guidance on testing and evaluating the operating effectiveness of controls, including : • The nature, timing, and extent of auditor tests and the limits on the auditor’s ability to use the results of management’s or internal auditor’s tests.

26. Major Provisions of Proposed Standards (Continued) • Defines internal control deficiency, significant deficiency (this term replaces and therefore eliminates the term reportable conditions), and material weakness. • Provides enhanced guidance on identifying significant deficiencies and material weaknesses.

27. Major Provisions of Proposed Standards (Continued) • Establishes a requirement that the criteria will be: • Suitable and established through due process, • Example being the framework of internal control established in the report, Internal Control—Integrated Framework (COSO report). • Requires that material weaknesses be disclosed in the auditor’s report even if management discloses in their report. • Requires that significant deficiencies not only be disclosed to the audit committee but disclosed by management in their public report. The auditor’s report will state that significant deficiencies have been identified and communicated to the audit committee. • Provides for issuance of a combined report with two opinions or separate reports and provides examples of both.

28. Other Actions taken by the AICPA in this Environment • New Fraud Standard • Free Corporate Governance Training- How Fraud Hurts you and your organization. Jointly developed by AICPA and ACFE • Anti-Fraud Criteria and Controls • Additional CPE – 10% to fraud training • Institute for Fraud Studies • Fraud Specialist Competency Model