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June 13, 2007
The SEC recently approved the PCAOB’s Auditing Standard #5 for Independent Auditors opining on internal controls for financial reporting (ICFR) for SEC reporting companies. As the PCAOB had released the standard 2 weeks ago, pending SEC approval, the ramifications of that pronouncement have been studied and interpreted. The principal effects on you and your auditors are:
The independent auditors need render their opinion only on ICFR and not a separate opinion on management’s process to evaluate the same controls. Presumably a big cost savings for SEC filers.
Auditors MUST use a top down, risk based approach to their audit. They must start with identifying financial statement accounts that have a reasonable possibility of a material misstatement, based upon a number of criteria, including related party transactions, subjective accounting policies, transactions requiring large adjustments, etc. Then they must identify the business processes and sub-process that generate those financial statement accounts.
- Emphasis on Most Important Controls
- Entity Level Controls (ELC’s) must be evaluated and the impact on high risk business processes evaluated and integrated into the audit process.
- The auditors MUST integrate the ICFR’s audit with the financial statements audit, including planning and testing.
- Auditors need document ONLY ICFR’s and not all process controls and, where ICFR’s are redundant, the redundancy need not be documented, unless redundancy is a control objective for the process.
- Auditors should, but are not required, to use walk-throughs to validate the design efficiency of the respective ICFR’s.
- Operating effectiveness of the controls may be tested in a number of ways; inquiry & observation, re-performance or documentation review. ELC’s should be evaluated for their impact on control effectiveness. Different controls within the same process may be tested in different manners, depending on the characteristics of the control.
- Using the work of Others
Auditors may use the work of others, including employees and independent third parties, provided the personnel performing the work are both objective and competent. The more objective the personnel performing the work, the more reliance the auditors may place on the work product. This work can also be used in the financial statement audit, if the evidence gathered is pertinent. i.e. evidence is gathered on impairment testing for goodwill and reviewed by objective personnel. Auditors may chose to review that work and not perform their own. This is a potential cost saver for both audits.
The SEC has previously issued interpretative guidance for management in their evaluation of ICFR’s, in December 2006. Taylor White issued an interpretation of that release during December. The SEC also stated that it would NOT grant further extensions for compliance to non-accelerated filers.
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