SECURITIES AND EXCHANGE COMMISSION
(Release No. 34-50331; File No. PCAOB-2004-06)
September 8, 2004
Public Company Accounting Oversight Board; Order Approving Proposed Rule 3101, Certain Terms Used in Auditing and Related Professional Practice Standards and an Amendment to Rule 1001, Definitions of Terms Employed in Rules
On June 18, 2004, the Public Company Accounting Oversight Board (the "Board" or the "PCAOB") filed with the Securities and Exchange Commission (the "Commission") proposed Rule 3101, Certain Terms Used in Auditing and Related Professional Practice Standards ("Rule 3101"), and an amendment to paragraph (a)(xii) of Rule 1001, Definitions of Terms Employed in Rules ("Rule 1001(a)(xii)"), pursuant to the Sarbanes-Oxley Act of 2002 (the "Act")1 and Section 19(b) of the Securities Exchange Act of 1934 (the "Exchange Act"). Rule 3101 sets forth the terminology the PCAOB will use to describe the degree of responsibility that the auditing and related professional practice standards impose on auditors that conduct engagements pursuant to the standards of the PCAOB and Rule 1001(a)(xii) defines the term "auditor" when applied to rules and standards adopted by the PCAOB. Notice of proposed Rule 3101 and Rule 1001(a)(xii) was published in the Federal Register on August 2, 20042, and the Commission received five comment letters. For the reasons discussed below, the Commission is granting approval of Rule 3101 and Rule 1001(a)(xii).
The Act establishes the PCAOB to oversee the audits of public companies and related matters, to protect investors, and to further the public interest in the preparation of informative, accurate and independent audit reports.3 Section 103(a)(3) of the Act also states that the Board may adopt any statement of auditing or related professional practice standards developed by a professional group of accountants as interim or transitional standards, with the Board retaining full authority to modify, supplement, revise or subsequently amend, modify or repeal, in whole or in part, any such statements. Pursuant to this authority, the PCAOB adopted the auditing and related professional practice standards of the American Institute of Certified Public Accountants, as they existed on April 16, 2003, as interim or transitional standards (the "interim standards").4
The Board's proposed Rule 3101 sets forth the terminology the PCAOB will use to describe the degree of responsibility that the auditing and related professional practice standards impose on auditors that conduct engagements pursuant to the standards of the PCAOB. The accounting profession had not previously defined imperative terms, such as "should" or "must," used to describe different degrees of auditor responsibility when conducting engagements in accordance with professional standards. The PCAOB determined that defining the level of imperatives would assist auditors with their work by clarifying their responsibilities and thus would enhance the consistency of the work and the quality of the audits. In addition, clear definitions would aid the PCAOB in writing new standards in a uniform and understandable language. Thus, the PCAOB decided that it was important to clarify the meaning of these imperatives, since they are an integral part of every standard adopted or established by the PCAOB.
The general requirements of the proposed rule create three categories of imperatives, which impose different degrees of responsibility on the part of the auditor:
Proposed Rule 1001(a)(xii) defines the term "auditor," which means both public accounting firms registered with the PCAOB and associated persons thereof.
The Commission's comment period on the proposed rules ended on August 23, 2004, with the Commission receiving five comment letters. The comment letters came from four registered public accounting firms and one professional association.
In general, commenters were supportive of the changes made by the PCAOB to its initially proposed rules. Two of the comment letters expressed general support and contained no suggestions. However, regarding Rule 3101, one commenter expressed concern about the requirement for auditors to document their decisions not to perform actions or procedures in the Board's standards that are presumptively mandatory. The commenter indicated that the lack of specificity in the proposed rule may prompt auditors to produce extensive and unnecessary documentation in circumstances where a procedure is not followed simply because it is not applicable. In its adopting release, the PCAOB concluded that for a presumptively mandatory responsibility, circumstances will be rare in which the auditor will perform an alternative procedure, thus, the documentation requirement ought not to result in unduly onerous consequences. The same commenter also was concerned that standard setters may be inclined to over use the terms "must," "shall," or "is required" in formulating new standards, which could ultimately be counterproductive and detrimental to audit quality, because the use of mandated procedures in inappropriate circumstances may provoke unthinking performance on the part of auditors. We note, however, that in proposing this rule, the PCAOB concluded that "must" appears infrequently in the interim standards, and that it expects unconditional responsibilities will be used sparingly in future PCAOB standards.
Two comment letters focused on the effective date. Proposed Rule 3101 provides that the documentation requirement for not performing a presumptively mandatory responsibility would apply to audits or other engagements performed for fiscal years ending (as opposed to "beginning") on or after the later of November 15, 2004 or 30 days after the date of approval of the final rule by the Commission. The commenters indicated that in many instances audit procedures are performed throughout the period of audit, and documentation to support these procedures is prepared contemporaneously with the audit, creating the potential need to update already created documentation. As previously noted, the PCAOB concluded that circumstances will be rare in which the auditor will perform an alternative procedure for a presumptively mandatory responsibility. Based on that conclusion, the frequency of such situations occurring during the transition period should be limited. The PCAOB also concluded that the documentation requirements in the proposed rule for a presumptively mandatory responsibility should coincide with the effective date for PCAOB Auditing Standard No. 3, Audit Documentation.
On the basis of the foregoing, the Commission finds that proposed Rule 3101 and Rule 1001(a) (xii) are consistent with the requirements of the Act and the securities laws and are necessary and appropriate in the public interest and for the protection of investors.
IT IS THEREFORE ORDERED, pursuant to Section 107 of the Act and Section 19(b)(2) of the Exchange Act, that proposed Rule 3101, Certain Terms Used in Auditing and Related Professional Practice Standards, and amendment to Rule 1001, Definitions of Terms Employed in Rules (File No. PCAOB-2004-06), be and hereby are approved.
By the Commission.
Margaret H. McFarland
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