The Hindu Business Line : Raising the standard

Auditing Standard 2 — an Audit of Internal Control over Financial Reporting — issued by the Public Company Accounting Oversight Board (PCAOB) in the US is two years old. These two years have been tumultuous to say the least, with companies spending millions of dollars on complying with the standard but few being benefited by it. Critics of the Standard have always grudged about the cost-benefit ratio being skewed in favour of costs. Being an annual requirement, company CFOs (chief financial officers) worried about recurring costs. The PCAOB reacted recently and announced a four-point plan to improve auditor's implementation of the internal control reporting provisions of the Sarbanes-Oxley Act, 2002.

Auditor's primary focus

While preserving the principles of Auditing Standard No. 2, the Board plans to consider amendments that would ensure that auditor's primary focus during an integrated audit is on areas that pose higher risk of fraud or material error. The amendments to be proposed would reinforce the Board's expectation that the integrated audit be conducted in the most efficient manner, while achieving the objectives of the standard, by incorporating key concepts contained in the guidance issued by the PCAOB on May 16, 2005.

The Board also plans to revisit and clarify the auditor's role, if any, with respect to evaluation of the process that a company uses to reach its own conclusion about the effectiveness of company controls.

Additional amendments to Auditing Standard No. 2 being considered by the Board include clarifying the definitions of significant deficiency and material weakness in internal control, reconsidering the "strong indicators of a material weakness" to allow for more judgment in determining whether a deficiency exists, guiding auditors to increase their use of the work of others where appropriate, clarifying materiality and scoping decisions, emphasising the integration of the audit of internal control with the audit of the financial statements, and allowing for and promoting auditors' use of experience gained in previous years' audits to focus and make most efficient the work in subsequent years.

Reinforce auditor efficiency through PCAOB inspections

As the Board described in a statement issued on May 1, the Board's 2006 inspections of registered public accounting firms will focus on the firm's efficiency in conducting internal control audits, as stated in the Board's policy statement.

Guidance and education for auditors of small companies

The Board plans to develop or facilitate development of implementation guidance for auditors of smaller public companies. In addition, the Board plans to explore various means of facilitating opportunities for auditors of smaller public companies to obtain effective training on auditing internal control over financial reporting.

Continue PCAOB fora on auditing in the small business environment

The Board will hold a total of eight fora during 2006 for the auditors, directors and financial officers of smaller public companies. In addition to providing general education about PCAOB issues, the Board will use these fora to monitor real-time reaction to the various internal control-related implementation changes that are announced throughout the year.

The moves by the PCAOB could certainly be considered to be a relaxation from the taxing norms of Section 404.

However, as the recent happenings at HP have shown, pure-as-snow internal controls, best-in-class corporate governance norms are all but reflections of the state of mind. Laws and regulations can only facilitate them.

(The author is a Hyderabad-based chartered accountant.)

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