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March 18, 2003

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AICPA Issues Draft Guidance for Auditing Internal Control over Financial Reporting

The Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) issued an exposure draft March 18 that proposes rules for implementing certain provisions of the Sarbanes-Oxley Act of 2002. The draft also provides guidance to public accountants for all other engagements to report on internal controls over financial reporting.

The draft defines internal control deficiency and clarifies the definitions of significant deficiency and material weakness. According to the draft:

• An internal control deficiency may consist of either a design or operating deficiency. A design deficiency exists when either a necessary control is missing or an existing control is not properly designed so that even when the control is operating as designed the control objective is not always met. An operating deficiency exists when a properly designed control either is not operating as designed or the person performing a control does not possess the necessary authority or qualifications to perform the control effectively. Internal control deficiencies range from inconsequential internal control deficiencies to material weaknesses in internal control.
  
• A significant deficiency is an internal control deficiency that could adversely affect the entity's ability to initiate, record, process, and report financial data consistent with the assertions of management in the financial statements. A significant deficiency could arise from a single deficiency or an aggregation of deficiencies.
  
• A material weakness is a significant deficiency in one or more of the internal control components that alone or in the aggregate precludes the entity's internal control from reducing to an appropriately low level the risk that material misstatements in the financial statements will not be prevented or detected on a timely basis.

Comments on the exposure draft should be received by the AICPA no later than May 15. The draft is intended to result in final standards by August, but the implementation date is still in doubt. Currently, standards for external auditors in the United States are issued by the Auditing Standards Board. Under the Sarbanes-Oxley Act, however, the new Public Company Accounting Oversight Board (PCAOB) must assume responsibility for external audit standards. The PCAOB is required to be operational by April 26 but has not yet assumed responsibility for audit standards. New SEC regulations may also delay issuance of final rules.

Also on March 18, the Auditing Standards Board issued a proposed Statement on Auditing Standards (SAS) titled Communication of Internal Control Related Matters Noted in an Audit. The proposed SAS establishes standards and provides guidance to enhance the auditor's communication responsibility to the audit committee or its equivalent concerning significant deficiencies and material weaknesses in internal control noted in a financial statement audit. The ASB believes that the proposed guidance will strengthen the quality of auditor communications concerning such matters. Comments on this draft should be received by AICPA no later than May 30.

For more information on the draft requirements, visit the AICPA's Web site at http://www.aicpa.org.