Although they are supporting new audit rules that give public companies the option to report the elimination of a material weakness in internal control over financial reporting, the Big Four accounting firms have called on the Securities and Exchange Commission to issue more detailed guidance for making these disclosures.At issue: the Public Company Accounting Standards Board's new Auditing Standard No. 4, which recently won SEC approval. That standard allows the management of audited companies to voluntarily commission their auditors to report whether a previously reported material weakness continues to exist - an option that accountants at PricewaterhouseCoopers described as "a useful tool" for providing the public with assurance that a previously reported internal control problem no longer exists.
The PCAOB, which adopted the statement in July, will issue a concise outline of the affirmative audit steps set forth in Auditing Standard No. 4, as ordered by the SEC.
Under current procedures, investors typically learn of the successful remediation of a previously reported material weakness only when the company files its 10-K or other regular report. The new AS No. 4 would allow companies to make such disclosures on "any reasonable date selected by management," the SEC explained.
While the large accounting firms welcomed that new flexibility, several major firms complained that a lack of specific guidance from the SEC could create problems for auditors and their clients who make AS No. 4 disclosures.
Ernst & Young expressed "significant reservations regarding the possibility of misinterpretations if auditors provide reports with positive assurance at interim dates when an integrated audit has not been performed."
In voicing "concerns regarding an auditor's issuance of interim reports on narrow aspects of a company's overall internal control over financial reporting," Ernst & Young suggested that the investing public could be misled by corporate reports of corrected material weaknesses.
Because "internal control is dynamic and changes over time," E&Y reasoned that "at the same time that a previously identified material weakness is eliminated, it is possible that other controls might no longer be operating effectively."
Deloitte & Touche expressed similar reservations, stressing that, "We are concerned that lack of specific guidance from the SEC related to the form of management's assertion and how to include management's assertion and the auditor's report in SEC filings will lead to confusion, frustration and diversity in practice."
In formal comments on the new audit standard, Big Four firm Deloitte told the SEC, "We believe that it would not be appropriate for management to assert in its report that 'internal control is effective' because a material weakness no longer exists. In order to make such a statement," D&T said, "we believe it would be necessary for management to assess the effectiveness of internal control over financial reporting in its entirety, not simply the controls related to the area with the material weakness."
For their part, officials at KPMG agreed that the commission should provide additional guidance on "the form and content of management's report," as well as on the acceptable SEC forms to use for AS No. 4 disclosures.
"In addition, we believe that the commission should stipulate that management's report asserting that an identified material weakness no longer exists, when submitted to the commission, is not required to be included in the registration statements filed" with the SEC, KPMG said.
No new guidance
Despite the concerns raised by the accounting industry, the SEC declined to issue additional guidance on how companies should make AS No. 4 disclosures: "Since the commission's rules do not specifically address the filing of such voluntary information, if an issuer wishes to publicly disseminate the reports of management and the auditor on whether a previously reported material weakness continues to exist, an issuer can use any Exchange Act form it believes is appropriate."
The regulator did, however, address accounting firm concerns that corporate disclosures of material weakness corrections could give investors a false sense of security.
An AS No. 4 "disclosure should not amend management's conclusion on the effectiveness of internal control over financial reporting as of the end of the fiscal year," the SEC said. "Further, management can only conclude that internal control over financial reporting is effective if as of the time of remediation of a material weakness ... an assessment of effectiveness pursuant to those rules is performed as of that time."
Whether many companies will use the new accounting standard to inform investors that internal control problems had been corrected remains to be seen.
"At this time, we don't have sufficient basis to conclude whether our clients will use [Accounting Standard 4] or not," Deloitte & Touche told the SEC.
Ernst & Young, however, predicted that "issuers will rarely engage auditors to report on the elimination of a material weakness pursuant to the standard," and PricewaterhouseCoopers agreed.
"We do not anticipate that companies that previously reported material weaknesses will frequently elect for their auditors to report under AS 4," officials at PwC said. "Instead, we believe that most companies will conclude that the current Section 302 requirement for management to periodically report material changes in internal control over financial reporting is sufficient."
That decision could come down to economics.
"Companies are required to provide disclosures about material changes in their internal control in their quarterly and annual filings with the SEC," Deloitte & Touche said. "Accordingly, they may not perceive a need to obtain assurance as to whether a material weakness no longer exists."
"Based on their analysis of the costs and perceived benefits of obtaining such assurance, they may not believe that the associated costs are warranted given that they already have the ability to make complete disclosure about the remediation activities, and have been strongly encouraged to so by the SEC," the firm said.
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