Olson: Guidance For Implementing AS5 Coming

Audit firms and issuers take note: Guidance on implementing the new Auditing Standard No. 5 is coming.

During remarks at Compliance Week 2007 on Thursday, Public Company Accounting Oversight Board Chairman Mark Olson noted that the board is “working with practitioners to develop tailored implementation guidance for audits of internal controls in smaller companies.”

Olson said that guidance will be released later this year, well in advance of the Section 404 compliance deadline for non-accelerated filers, who are slated to comply with the management requirements for fiscal years ending on or after Dec.15, 2007, and the required auditor assessment a year later.

The PCAOB's Mark Olson at Compliance Week 2007

AS5 takes effect for fiscal years ending on or after Nov. 15, 2007. However, once the Securities and Exchange Commission approves the standard (which must still be published for comment by the Commission), earlier adoption will be permitted, Olson said.

Noting that the Board’s work around implementation of the new standard is “far from over,” Olson said the PCAOB in the coming months will work to communicate to audit firms its expectations on implementation of the new standard. The Board’s inspection program will also be adjusted to be consistent with the new standard.

Olson urged audit firms that have already done internal control audits to “take a step back and re-challenge every aspect of their methodology” to ensure that it’s appropriately risk focused, to ensure it takes adequate advantage of the top-down approach, and to ensure that it encourages audit professionals to exercise judgment.

While “the market will bear out how the new standard affects overall audit costs,” Olson said the PCAOB will monitor AS5 implementation carefully to make sure it allows “room for companies and auditors to evolve.”

While substantially similar to the proposal issued in December with some refinements, Olson noted that the new audit standard is a departure from its predecessor, the overly prescriptive—and highly criticized—AS2. For instance, AS5 does not require auditors to evaluate or opine on management’s process for assessing the effectiveness of its internal controls over financial reporting.

AS5 also includes an added emphasis on fraud risk and anti-fraud controls that Olson said “should make it clear to auditors the importance of assessing fraud risk throughout the audit process.”

Olson said that since AS5 is written “in English instead of audit speak,” audit committees, CFOs, and senior management are in “a better position to dialogue with their external auditors when scoping their examinations.”

Mark Olson fields questions from attendees of Compliance Week 2007, with the help of Compliance Week editor and publisher Scott Cohen

Companies and auditors have already begun preparing for the new standard, Olson said. Since the PCAOB issued its proposed standard in December, “Companies have been looking at their individual controls, and the accounting profession has already started building changes into their training.”

The more top-down, risk-focused approach has “eliminated the need to look at many lower-level risk exposures,” Olson said. “For multinational companies, that’s had a huge impact.”

Separately, he noted that the increased use of fair value accounting by issuers poses challenges for auditors and the PCAOB.

While advocates of fair value accounting maintain that it gives investors more relevant information by providing more current values of companies’ assets and liabilities, Olson warned listeners to “be mindful that any apparent improvement from providing investors more relevant fair value information will be lost if the information isn’t also reliable.”

He cited three challenges confronting auditors as issuers transition to fair value. First, he noted that valuation requires training that many auditors may not have. In addition, auditors must remember that financial statement preparers can be biased in their assessment of fair value, and as a result, may fail to consider alternative valuation scenarios. Finally, he said, internal controls surrounding fair value measure may be different from those over typical business transactions.

As issuers move to adopt Financial Accounting Standards No. 157 and 159, “auditors should be prepared for these challenges,” Olson said.

While FAS 157, the standard that governs how fair value should be measured, doesn’t expand the use of fair value, Olson noted that it does apply to most other standards that require or permit fair value measure.

“That application will require a change in practice for many issuers,” he said.

Under FAS 159, companies can elect fair value accounting for certain instruments previously accounted for at amortized costs. While the effect on audit risk isn’t yet known, Olson said it raises concerns about comparability in financial reporting within and among institutions.

“Fair value accounting, while presenting the promise of greater relevance, also represents an area of potential audit risk,” Olson said. “We're monitoring this area to see how audit firms are addressing that potential risk.”