PCAOB and Sarbanes Oxley Act


The Public Company Accounting Oversight

Board (PCAOB) is charged with overseeing the audits of SEC registrants (hereafter public companies).

All accounting firms auditing publiccompanies must register with the PCAOB. The PCAOB
is required to establish or adopt auditing, quality control, ethics, and independence standards forauditors of public companies. In addition, the PCAOB conducts inspections of registered public
accounting firms. Finally, the PCAOB will investigate accounting firms for allegations of substandardperformance and will have the power to discipline accounting firms and individual auditors.

Members of PCAOB

The PCAOB has five full-time members, only two of whom can be licensed CPAs. Board
members will be appointed by the SEC, after consulting with the Chairman of the Board of
Governors of the Federal Reserve System and the Secretary of Treasury. The term of service is
five years and board members are limited to two terms.

Provisions Required by SOX

The PCAOB assesses and collect a registration fee and an annual fee from each registered public accounting firm. These fees are to be sufficient to recover the cost of both processing registrations and the required annual report that each registered accounting firm is to file with the PCAOB. Although the PCAOB is charged with promulgating auditing standards, the Sarbanes-Oxley Act specifically requires that these standards include the following provisions:

• Registered public accounting firms must maintain work papers in sufficient detail to support their conclusions in the audit report, and these work papers must be retained for at least seven years.

• The issuance of an audit report must be approved by a concurring or second partner.

• Each audit report must describe the scope of the auditor’s internal control testing.

The auditor  must include, either in the audit report or in a separate report, the following items: (1) the auditor’s findings from the internal control testing, (2) an overall evaluation of the entity’s internal control structure and procedures, and (3) a description of any material weaknesses in internal controls.

• Quality control standards related to required internal firm consultations on accounting and auditing questions.

In partial response to these requirements, the PCAOB implemented three auditing standards, effective in 2004. One on the auditor’s report (AS 1), one on audits of internal control (AS 2), and one on audit documentation (AS 3).

The PCAOB inspects public accounting firms that regularly audit more than 100 public companies on an annual basis. It is intended that other public accounting firms be inspected no less often than once every three years. Inspections involve reviews of audit engagements and of the firm’s quality control system. The PCAOB can report any violation of: 

(1) the Sarbanes-Oxley Act,

 (2) PCAOB and SEC rules, 

(3) the firm’s own quality control standards, and 

(4) professional standards, to the SEC and to each appropriate state regulatory authority. The auditor’s specific State regulations and a company’s stock exchange regulations are also included in the scope of the inspections.

Registered public accounting firms and their employees are required to cooperate with PCAOB
investigations. Firms that fail to cooperate in PCAOB investigations can be suspended, or disbarred, from being able to audit public companies, as can individual CPAs. Although the PCAOB does not have subpoena power (the PCAOB is specifically designated as a nongovernmental entity), there are procedures for the PCAOB to obtain needed information for an investigation via an SEC-issued subpoena. Documents and information gathered by the PCAOB in the course of an investigation are not subject to civil discovery. PCAOB sanctions include the ability to suspend or
disbar firms or individual CPAs from auditing public companies, as well as monetary penalties as high as $750,000 for individuals and $15 million for firms.
The Sarbanes-Oxley Act amends the Securities Acts of 1933 and 1934 to define as GAAP those principles promulgated by a standard-setting body where the standard-setting body meets a number of requirements set out in the Act. The FASB’s current structure meets the requirements set out in the Sarbanes-Oxley Act.

The PCAOB’s funding, as well as the funding of the accounting standard-setting body (currently the FASB), are to be recoverable from annual accounting support fees. These annual accounting support fees are to be assessed against and recoverable from public companies, where the amount of the fee due from each issue is a function of the issuer’s relative market capitalization.

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