NDI Executive Exchange

Transcription

1 National Directors Institute NDI Executive Exchange DI The New Normal An Interactive Exchange About the Future of Governance Audit Committee Hot Topics Co-Sponsors In-Kind Sponsors

2 Audit Committee Panel November 13, Mark T. Plichta Foley & Lardner LLP Panelists H. David Sherman Northeastern University D Amore-McKim School of Business Daragh Watson KPMG LLP Mark A. Zorko 2013 Foley & Lardner LLP 1

3 PCAOB Matters Real Life Scenarios 2

4 SEC Regulatory Developments 6 Conflict Minerals Final rules issued by the SEC in August 2012, effective January 1, 2013 Rules apply directly to public companies for which Conflict Minerals are used in production Indirect effects on many private companies No de minimis exceptions 2013 Foley & Lardner LLP 3

5 7 Conflict Minerals Columbite-tantalite Cassiterite Gold Wolframite Conflict Minerals Derivatives (tantalum, tin and tungsten) Covered Countries Democratic Republic of Congo and any adjoining countries 2013 Foley & Lardner LLP 8 Conflict Minerals - Process Step 1 Determine if Conflict Minerals are necessary to functionality or production of products If No, process is complete Step 2 Conduct a reasonable country of origin inquiry to determine if origination in a Covered Country OR if from scrap/recycled sources If not originated in a Covered Country OR if from recycled or scrap sources, complete process by filing Form SD disclosing results and describing inquiry Step 3 Conduct supply chain due diligence If not originated in a Covered Country OR if from recycled or scrap sources, file Form SD disclosing results and describing inquiry and due diligence If otherwise, file Form SD with a Conflict Minerals Report, including a private sector audit in many circumstances 2013 Foley & Lardner LLP 4

6 9 Conflict Minerals Questions for the Audit Committee What is the purpose of our Conflict Minerals program? Compliance with SEC requirements? Social Change? Short-term vs. long-term purposes How do we expect our investors, suppliers and direct / indirect customers to respond to our Conflict Minerals inquiry and due diligence? Sufficient? Cost burden? Who is running our Conflict Minerals program? What is the response rate / quality of responses from our suppliers? What are we doing to make compliance easier in the future? Building provisions into new supply contracts Are we expecting an audit? Who are our auditors? 2013 Foley & Lardner LLP 10 Accounting Quality Model (AQM) Robo-Cop Analytical tool / predictive model that identifies and flags high-risk activity or inaccuracies Fully automated Reviews filings and provides a risk score within 24 hours from posting to EDGAR Risk score informs of likelihood of fraudulent activity or other errors Likely will form the basis for enforcement scheduling and allocation of resources by the SEC 2013 Foley & Lardner LLP 5

7 11 Accounting Quality Model (AQM) Analysis of Accounting Policies AQM compares accounting choices against those of their peer group to assess the likelihood of fraudulent activity or other errors Examples of risk indicators: Policy that results in high book earnings while tax treatment minimizes taxable income High proportion of transactions structured as offbalance sheet Relies on XBRL data, underscoring the need for careful attention 2013 Foley & Lardner LLP 12 Accounting Quality Model (AQM) Analysis of MD&A AQM also scans the MD&A sections of annual reports for fraudulent filing indicators SEC determined based on a review of fraudulent filings that fraudulent filers often use common words and phrasing 2013 Foley & Lardner LLP 6

8 PCAOB activities

9 PCAOB Recent Inspection Observations PCAOB Report of 12/10/2012: OBSERVATIONS FROM 2010 INSPECTIONS OF (8) DOMESTIC ANNUALLY INSPECTED FIRMS REGARDING DEFICIENCIES IN AUDITS OF INTERNAL CONTROL OVER FINANCIAL REPORTING 15% (46 audits) failed to obtain sufficient audit evidence to support ICOFR opinion 13% (39 audits) failed to obtain sufficient audit evidence to support opinion on financial statements 16% (50 audits) involved deficiencies in firms quality control that required remediation 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

10 PCAOB Inspection Observations Most pervasive comments: failure to Identify and sufficiently test controls that are intended to address the risks of material misstatement Sufficiently test the design and operating effectiveness of management review controls that are used to monitor the results of operations, such as: (1) monthly comparisons of budget and actual results to forecasts for revenues and expenses; (2) comparisons of other metrics, such as profit margins and certain expenses as a percentage of sales; and (3) quarterly balance sheet reviews Obtain sufficient evidence to update the results of testing of controls from an interim date to the company's year end (i.e., the roll-forward period) Sufficiently test the system-generated data and reports that support important controls Sufficiently perform procedures regarding the use of the work of others Sufficiently evaluate identified control deficiencies and consider their effect on both the financial statement audit and on the audit of internal control 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

11 3 Audit Transparency- Improvements Key changes proposed Required communication in the auditors report of critical matters. Enhance auditors responsibility as it relates to other information in the 10-K Require communication in the auditors report regarding the auditors responsibility for, and the results of, the auditors evaluation of other information See KPMG Defining issues for further insights 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

12 Concept release on auditor independence and audit firm rotation 4 August 2011 Concept release issued for public comment 14 December 2011 Comment period closed 2012: - three public meetings/roundtables In connection with the March public roundtables, the comment period was reopened Overview Concept release requested input on how to enhance auditor independence, objectivity, and professional skepticism but is primarily focused on mandatory audit firm rotation In light of the PCAOB s experiences since its inception and the various proposals that are being considered outside the United States for auditor regulation, including mandatory audit firm rotation, the PCAOB believed it was time to reconsider this matter and therefore solicited comments on the issue The PCAOB also requested comments about other measures that could enhance auditor independence, objectivity, and professional skepticism Through May 10, 2013 Staff analyzing 684 public comments and additional public meetings and outreach to be conducted 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

13 5 PCAOB information release Information for Audit Committees about Its Inspection Process Issued PCAOB Release No , Information for Audit Committees about the PCAOB Inspection Process, in August 2012 Intended to assist audit committees in Understanding the PCAOB s inspection of their audit firms Gathering useful information from their audit firms about those inspections Encourages audit firms to communicate effectively with audit committees about inspection matters 2013 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

14 For further information on the topics discussed as well as current issues facing audit committees please go to 6 KPMG Audit Committee Institute for thought leadership as well as periodic webcasts KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. NDPPS

15 Defining Issues August 2013, No PCAOB Proposes Two Auditing Standards to Enhance Auditor s Report The Public Company Accounting Oversight Board (PCAOB) recently proposed two new auditing standards and related amendments that are intended to enhance the auditor s reporting model. 1 The new standards, which are referred to below as the proposed auditor reporting standard and the proposed other information standard, would: Contents Proposed Auditor Reporting Standard 2 Auditor s Responsibility Regarding Other Information 4 Auditor s Evaluation of Other Information 4 Effective Date 5 Require communication in the auditor s report of critical audit matters; Add new elements to, and enhance some standardized language in, the auditor s report; Enhance the auditor s responsibility with respect to other information outside the financial statements in annual reports (e.g., Form 10-K) by adding procedures for the auditor to perform in evaluating the other information based on relevant audit evidence obtained and conclusions reached in the audit; and Require communication in the auditor s report regarding the auditor s responsibility for, and the results of, the auditor s evaluation of the other information. The PCAOB intends that the proposed changes and additional requirements will provide more useful information in the auditor s report and make the audit and the auditor s report more relevant to investors. To develop the proposed standards, the PCAOB conducted extensive outreach and reviewed stakeholders input on its Concept Release No The concept release discussed alternatives for changing the auditor s reporting model to increase its transparency and relevance to financial statement users, without compromising audit quality. Next Steps 5 1 PCAOB Release No , August 13, 2013, Proposed Auditing Standards - The Auditor s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion; The Auditor s Responsibilities Regarding Other Information in Certain Documents Containing Audited Financial Statements and The Related Auditor s Report; and Related Amendments to PCAOB Standards, available at 2 PCAOB Release No , Concept Release on Possible Revisions to PCAOB Standards Related to Reports on Audited Financial Statements, available at Also see KPMG Defining Issues No , PCAOB Requests Feedback on Auditor s Reporting Model, available at KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

16 Proposed Auditor Reporting Standard The proposed auditor reporting standard would retain the pass/fail model of the existing auditor s report. Significant changes to the auditor s report arising from the proposed auditor reporting standard would include: Requiring the auditor to communicate critical audit matters that were addressed during the audit of the current period s financial statements, or determine and then state that there are no critical audit matters; Adding new elements related to the auditor s independence, tenure, and responsibility for, and the results of, the auditor s evaluation of other information outside the financial statements in annual reports containing the audited financial statements and the auditor s report; and Enhancing some standardized language. Critical Audit Matters Critical audit matters are those matters addressed during the audit that: (1) involve the most difficult, subjective, or complex auditor judgments; (2) pose the most difficulty to the auditor in obtaining sufficient appropriate audit evidence; or (3) pose the most difficulty to the auditor in forming the opinion on the financial statements. Critical audit matters ordinarily are matters of such importance that they are included in the matters required to be documented in the engagement completion document that summarizes the significant issues and findings from the audit, reviewed by the engagement quality reviewer, communicated to the audit committee, or any combination of the above. Communicating these critical audit matters is intended to improve the relevance of the auditor s report by providing more insight about the most significant matters that the auditor addressed in the audit. This communication would be based on information known to the auditor and procedures the auditor has already performed as part of the audit. However, the proposed auditor reporting standard does impose new audit performance requirements related to the determination, communication, and documentation of critical audit matters. Factors for the auditor to consider in determining whether a matter is a critical audit matter would include the: Degree of subjectivity involved in determining or applying audit procedures to address the matter or in evaluating their results; Nature and extent of audit effort required to address the matter; Nature and amount of available relevant and reliable evidence about the matter or the degree of difficulty in obtaining the evidence; Severity of control deficiencies identified relevant to the matter, if any; Degree to which the results of audit procedures to address the matter resulted in changes to the auditor s risk assessments, including risks that 2 / Defining Issues / August 2013 / No KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

17 were not previously identified, or required changes to planned audit procedures, if any; Nature and significance, quantitatively or qualitatively, of corrected and accumulated uncorrected misstatements related to the matter, if any; Extent of specialized skill or knowledge needed to apply audit procedures to address the matter or evaluate the results, if any; and Nature of consultations outside the engagement team about the matter, if any. For each critical audit matter, the auditor would be required within the auditor s report to: Identify the critical audit matter; Describe the considerations that led the auditor to determine that the matter is a critical audit matter; and Refer to the relevant financial statement accounts and disclosures that relate to the critical audit matter, when applicable. The Critical Audit Matters section of the auditor s report would follow the Opinion on the Financial Statements section. Elements of the Auditor s Report The basic elements of the auditor s report contained in existing auditor reporting standards would be retained. New elements would be added to the auditor s report to provide investors and other financial statement users with information about the audit and the auditor, and would include: Auditor independence a statement about the auditor s existing requirement to be independent with respect to the company; Auditor tenure the year the auditor began serving consecutively as the company s auditor; and Other information the auditor s responsibility for, and the results of, the auditor s evaluation of other information outside the financial statements in annual reports (e.g., Form 10-K) containing the financial statements and the related auditor s report. Enhanced Standardized Language The standardized language in the auditor s report would require the addition of the phrase whether due to error or fraud, when describing the auditor s responsibility under PCAOB standards to obtain reasonable assurance about whether the financial statements are free of material misstatements. In addition, the phrase and the related notes would be added to the introductory 3 / Defining Issues / August 2013 / No KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

18 paragraph of the auditor s report to clarify that the financial statements include the related notes to the financial statements. Auditor s Responsibility Regarding Other Information Other information outside the financial statements may be relevant to an audit or the auditor s decision to be associated with a company s annual report. Under current PCAOB standards, the auditor has a responsibility to read and consider other information in documents that contain the audited financial statements and the auditor s report, and consider whether the information is materially inconsistent with information in the financial statements. If there is a material inconsistency, the auditor is required to perform certain procedures to respond to it. Additionally, the current PCAOB standards state that if, while reading the other information for a material inconsistency, the auditor becomes aware of a potential material misstatement of fact in the other information, the auditor should discuss the matter with management and perform certain procedures based on the auditor s judgment. However, there is no reporting requirement to describe the auditor s responsibility with respect to, or to report the results of, the auditor s reading and consideration of the other information. The proposed other information standard is intended to provide financial statements users with useful information including: (1) the nature and scope of the auditor s responsibility with respect to the other information; (2) clarification of what other information was evaluated by the auditor; and (3) a description of the results of the auditor s evaluation of the other information. Auditor s Evaluation of Other Information The proposed other information standard would require the auditor to evaluate whether the information contains: (1) a material inconsistency; (2) a material misstatement of fact; or (3) both, by performing the procedures described below. The auditor should read the other information and, based on relevant audit evidence obtained and conclusions reached during the audit, evaluate the: Consistency of amounts in the other information, and the manner of their presentation, that are intended to be the same as, or to provide greater detail about, the amounts in the financial statements, with the amounts in the financial statements and relevant audit evidence; Consistency of any qualitative statement in the other information, and the manner of its presentation, that is intended to represent or provide greater detail about information in the financial statements, with the financial statements and relevant audit evidence; Other information not directly related to the financial statements as compared to relevant audit evidence obtained and conclusions reached during the audit; and 4 / Defining Issues / August 2013 / No KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.

19 Amounts in the other information that are calculated using amounts in: (1) the other information; (2) the financial statements; or (3) relevant audit evidence, by recalculating the amounts for mathematical accuracy. The proposed other information standard also includes prescribed steps for the auditor to take in situations where he or she identifies a potential material inconsistency, a potential material misstatement of fact, or both. Ultimately, as noted above, the auditor s report would communicate the auditor s responsibility for, and the results of, the auditor s evaluation of the other information. The Auditor s Responsibility Regarding Other Information section of the auditor s report would follow the Critical Audit Matters section. Effective Date The proposed effective date for the new standards and related amendments, subject to SEC approval, would be for audits of financial statements for fiscal years beginning on or after December 15, Next Steps The comment period for the proposed standards and related amendments ends December 11, In its proposing release, the PCAOB notes that it anticipates that both proposed standards will have cost implications for both auditors and companies, including audit committees. In this regard, the PCAOB asks commenters to address a number of questions relative to the economic considerations of its proposal, including both additional costs and possible increases to auditor s liability in private litigation. The Board is considering holding a public roundtable in 2014 to discuss comments on the proposed standards. If the Board decides to hold a roundtable, the comment period related to the proposed standards and amendments would be reopened. Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Robert E. Chevalier Greg R. Lawrie Earlier editions are available at: The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the proposed standards or any other potential or applicable requirements of the accounting or auditing literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.