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AICPA Issues Draft on Sarbanes-Oxley Audit Controls

The Auditing Standards Board of the American Institute of Certified Public Accountants has begun to implement a provision of the Sarbanes-Oxley Act dealing with management's assessment of internal controls. Section 404 of the act requires a company to include in its annual report management's assessment of the effectiveness of the internal control structure and procedures for financial reporting. The outside auditor must attest to, and report on, that assessment. Congress intends that the auditor's assessment of the corporate system of internal controls should be a core responsibility of the auditor, as well as an integral part of the audit report. In October 2002, the SEC issued a proposed rule for Section 404 that would set an effective date of September 15, 2003.

Responding to the initiative, SEC Acting Chief Accountant Jackson M. Day reminded the AICPA that Sarbanes-Oxley authorizes the Public Company Accounting Oversight Board to set auditing standards to be used by accounting firms in the preparation and issuance of audit reports. Mr. Day added that the ASB standards would not be included in the initial or transitional PCAOB standards.

The ASB exposure draft provides standards and guidance to auditors in fulfilling their obligation to report on the effectiveness of management's internal control over financial reporting. The draft also establishes standards to strengthen the performance requirements applicable to all engagements to report on an entity's internal control over financial reporting. Specifically, the draft describes a public company audit as an integrated activity consisting of an audit of the financial statements and an audit of internal control. In this spirit, the auditor would be required to use the same date for the opinion on the financial statements and the opinion about the effectiveness of internal control. The issuance of a combined report would be permitted.

While recognizing and respecting that Sarbanes-Oxley authorizes the PCAOB to set auditing standards for public companies, the ASB believes that it is critical to get its proposal out so that auditors can prepare for the SEC's final rule. Mr. Day, however, expressed the SEC's concern that a misleading impression has been created that the ASB will adopt final standards in this area applicable to the audits of corporate financial statements.

In a letter to the AICPA, Mr. Day explained that, when the Commission determines that the PCAOB has the capacity to carry out and enforce compliance with the act, the Commission may approve the PCAOB's adoption of initial or transitional auditing standards without going through the statutory rulemaking process. Currently, it is expected that the Commission's determination, and the adoption of the initial or transitional auditing standards, will occur by April 26, 2003. After that date, emphasized the chief accountant, auditing standards may be adopted only pursuant to statutory procedures that require rulemaking by the PCAOB and by the Commission.

Because the ASB will not adopt the draft standards before April 26, 2003, said Mr. Day, those standards will not be included in the initial or transitional PCAOB standards. Before any standard in this area may take effect, therefore, it must be subject to the PCAOB's full rulemaking processes and to subsequent publication for comment and SEC approval. The AICPA has the discretion, however, to forward to the PCAOB copies of its exposure drafts, the comment letters it receives, and any proposed modifications to the drafts in response to those comments. The PCAOB may, but would not be required to, make use of those materials in formulating its proposals.