[Federal Register Volume 69, Number 147 (Monday, August 2, 2004)]
[Notices]
[Pages 46189-46192]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-17461]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50077; File No. PCAOB-2004-06]


Public Company Accounting Oversight Board; Notice of Filing of 
Proposed Rule 3101, Certain Terms Used in Auditing and Related 
Professional Practice Standards

July 26, 2004.
    Pursuant to section 107(b) of the Sarbanes-Oxley Act of 2002 (the 
``Act''), notice is hereby given that on June 18, 2004, the Public 
Company Accounting Oversight Board (the ``Board'' or the ``PCAOB'') 
filed with the Securities and Exchange Commission (the ``Commission'' 
or ``SEC'') the proposed rule described in items I and II below, which 
items have been prepared by the Board and are presented here in the 
form submitted by the Board. The Commission is publishing this notice 
to solicit comments on the proposed rule from interested persons.

I. Board's Statement of the Terms of Substance of the Proposed Rule

    On June 9, 2004, the Board adopted Rule 3101, Certain Terms Used in 
Auditing and Related Professional Practice Standards (``the proposed 
rule''). The proposed rule text is set out as follows:
RULES OF THE BOARD
SECTION 1. GENERAL PROVISIONS
    Rule 1001. Definitions of Terms Employed in Rules.
    (a)(xii) Auditor
    The term ``auditor'' means both public accounting firms registered 
with the Public Company Accounting Oversight Board and associated 
persons thereof.
SECTION 3. PROFESSIONAL STANDARDS
Part 1--General Requirements
    Rule 3101. Certain Terms Used in Auditing and Related Professional 
Practice Standards
    (a) The Board's auditing and related professional practice 
standards use certain terms set forth in this rule to describe the 
degree of responsibility that the standards impose on auditors.
    (1) Unconditional Responsibility: The words ``must,'' ``shall,'' 
and ``is required'' indicate unconditional responsibilities. The 
auditor must fulfill responsibilities of this type in all cases in 
which the circumstances exist to which the requirement applies. Failure 
to discharge an unconditional responsibility is a violation of the 
relevant standard and Rule 3100.
    (2) Presumptively Mandatory Responsibility: The word ``should'' 
indicates responsibilities that are presumptively mandatory. The 
auditor must comply with requirements of this type specified in the 
Board's standards unless the auditor demonstrates that alternative 
actions he or she followed in the circumstances were sufficient to 
achieve the objectives of the standard. Failure to discharge a 
presumptively mandatory responsibility is a violation of the relevant 
standard and Rule 3100 unless the auditor demonstrates that, in the 
circumstances, compliance with the specified responsibility was not 
necessary to achieve the objectives of the standard.
    Note: In the rare circumstances in which the auditor believes the 
objectives of the standard can be met by alternative means, the 
auditor, as part of documenting the planning and performance of the 
work, must document the information that demonstrates that the 
objectives were achieved.
    (3) Responsibility To Consider: The words ``may,'' ``might,'' 
``could,'' and other terms and phrases describe actions and procedures 
that auditors have a responsibility to consider. Matters described in 
this fashion require the auditor's attention and understanding. How and 
whether the auditor implements these matters in the audit will depend 
on the exercise of professional judgment in the circumstances 
consistent with the objectives of the standard.
    Note: If a Board standard provides that the auditor ``should 
consider'' an action or procedure, consideration of the action or 
procedure is presumptively mandatory, while the action or procedure is 
not.
    (b) The terminology in paragraph (a) of this rule applies to the 
responsibilities imposed by the auditing and related professional 
practice standards, including the interim standards adopted in Rules 
3200T, 3300T, 3400T, 3500T, and 3600T.
    (c) The documentation requirement in paragraph (a)(2) is effective 
for audits of financial statements or other engagements with respect to 
fiscal years ending on or after [insert date the later of November 15, 
2004, or 30 days after approval of this rule by the Securities and 
Exchange Commission].

II. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rule

    In its filing with the Commission, the Board included statements 
concerning the purpose of, and basis for, the proposed rule and 
discussed any comments it received on the proposed rule. The text of 
these statements may be examined at the places specified in item IV 
below. The Board has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Board's Statement of the Purpose of, and Statutory Basis for, the 
Proposed Rule

    (a) Purpose.
    The Commission understands from the PCAOB staff that Rule 
1001(a)(xii) would define the term ``auditor'' to mean both public 
accounting firms registered with the Public Company Accounting 
Oversight Board and associated persons thereof. A similar definition 
was included in PCAOB Auditing Standard No. 1, References in Auditors' 
Reports to the Standards of the Public Company Accounting Oversight 
Board (approved by the SEC on May 14, 2004) and PCAOB Auditing Standard 
No. 2, An Audit of Internal Control Over Financial Reporting Performed 
in Conjunction with An Audit of Financial Statements (approved by the 
SEC on June 17, 2004). Instead of continuing to repeat the definition 
of this term in future standards, the Board approved the inclusion of 
this defined term in Rule 1001, Definitions of Terms Employed in Rules. 
Other than its use in these standards, the term ``auditor'' is not used 
in the Board's currently effective rules in a context in which this 
definition would apply. Accordingly, the definition in Rule 1001 does 
not change the meaning of any currently effective PCAOB rule or 
standard. Also, while the new definition of ``auditor'' in Rule 1001 
would apply to any auditing and related professional practice standard 
established by the Board, including a PCAOB standard that amends an 
interim standard, it would not apply to the auditing and professional 
standards that the Board adopted as its interim standards in PCAOB 
Rules 3200T through 3600T. To

[[Page 46190]]

the extent the Board has amended an interim standard subsequent to its 
adoption, the definition in Rule 1001 would apply to the amended 
language of the interim standard but not to the unchanged language of 
that standard.
    Section 103(a)(1) of the Act authorizes the PCAOB to establish, by 
rule, auditing standards to be used by registered public accounting 
firms in the preparation and issuance of audit reports, as required by 
the Act. PCAOB Rule 3100, ``Compliance with Auditing and Related 
Professional Practice Standards,'' requires auditors to comply with all 
applicable auditing and related professional practice standards 
established by the PCAOB. The Board has adopted as interim standards, 
on an initial, transitional basis, the generally accepted auditing 
standards described in the American Institute of Certified Public 
Accountants' (``AICPA'') Auditing Standards Board's Statement on 
Auditing Standards No. 95, Generally Accepted Auditing Standards, as in 
existence on April 16, 2003 (the ``interim standards'').
    The proposed rule sets forth terminology the Board will use in 
auditing and related professional practice standards established or 
adopted by the Board.
    (b) Statutory Basis.
    The statutory basis for the proposed rule is Title I of the Act.

B. Board's Statement on Burden on Competition

    The Board does not believe that the proposed rule will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act. Pursuant to the Act and PCAOB 
Rule 3100, auditing and related professional practice standards 
established by the PCAOB must be complied with by all registered public 
accounting firms.

C. Board's Statement on Comments on the Proposed Rule Received From 
Members, Participants or Others

    The Board released the proposed rule for public comment in PCAOB 
Release No. 2003-018 (October 7, 2003). A copy of PCAOB Release No. 
2003-018 and the comment letters received in response to the PCAOB's 
request for comment are available on the PCAOB's Web site at http://www.pcaobus.org. The Board received 12 written comments. The Board has 
modified certain aspects of the proposed rule in response to comments 
it received, as discussed below:
Rule 3101(a)
    The Board added the following captions to Rule 3101(a): 3101(a)(1) 
Unconditional Responsibility, 3101(a)(2) Presumptively Mandatory 
Responsibility, and 3101(a)(3) Responsibility To Consider. Proposed 
Rule 3101(a) did not have a caption or designation for each category of 
terms. Rather, the proposed rule simply referenced the category of 
certain terms by using the standard format in PCAOB rulemaking. The 
Board added the captions in response to a commenter's recommendation 
that a caption be added to each category of certain terms for ease of 
reference and clarity.
    One commenter recommended replacing the term ``obligation'' in Rule 
3101 with a comparable term because the commenter believed that the 
term ``obligation'' in legal and governmental environments has a 
connotation that is inconsistent with the intent of Rule 3101 and may 
be misinterpreted by legal or governmental officials. After considering 
this comment, the Board replaced the term ``obligation'' with the 
synonym ``responsibility'' in Rule 3101.
    Rule 3101(a)(2) defines a presumptively mandatory responsibility as 
a requirement that the auditor must comply with ``unless the auditor 
demonstrates that alternative actions he or she followed in the 
circumstances were sufficient to achieve the objectives of the 
standard.'' Furthermore, Rule 3101(a)(2) states that ``failure to 
discharge a presumptively mandatory responsibility is a violation of 
the relevant standard and Rule 3100 unless the auditor demonstrates 
that, in the circumstances, compliance with the specified 
responsibility was not necessary to achieve the objectives of the 
standard.''
    The Board also added a note to Rule 3101(a)(2) to require auditors 
to document compliance with presumptively mandatory responsibilities by 
alternative means. The Board originally proposed that the auditor be 
required to ``demonstrate by verifiable, objective, and documented 
evidence'' that the alternative procedures he or she followed were 
sufficient in the specific circumstances. Commenters stated that they 
believed that the documentation requirement was important, both to 
promote discipline of thought and to provide a uniform basis for 
evaluating compliance with the standards. Several of these commenters 
went even further to recommend that the Board strengthen the 
documentation requirement by adding language such as 
``contemporaneous'' and ``memorialized at the time of the audit'' to 
the rule.
    Conversely, other commenters suggested that the documentation 
requirement was unduly onerous and placed too great a documentation 
burden on the auditors. The commenters argued that the documentation 
would be too voluminous and would add very little value to the audit. 
Some of these commenters further recommended that, in lieu of the 
proposed documentation requirement, the rule require that the auditor 
consider the significance of the particular audit area and document 
only the significant issues or findings. A commenter also recommended 
that other evidence, such as oral explanation, should be allowed as 
support for the reasons why the auditor chose not to perform a 
presumptively mandatory responsibility. Additionally, some commenters 
recommended that the documentation requirement should be addressed in 
the standard on audit documentation.
    The integrity of the audit depends, in large part, on the existence 
of a complete and understandable record of the work performed, the 
conclusions reached, and the evidence obtained to support those 
conclusions. Clear, complete, and comprehensive audit documentation 
enhances the quality of the audit. Audit documentation should 
demonstrate compliance with professional standards and justify the 
reasons for any variations in procedures performed.
    The PCAOB standards require the auditor to document the procedures 
performed, evidence obtained, and conclusions reached during an 
engagement. To further enhance the quality of the audit, Rule 
3101(a)(2) adds a specific documentation requirement to achieve 
complete and comprehensive audit documentation in engagement working 
papers for situations in which the auditor does not perform a 
presumptively mandatory responsibility. In those instances, it is 
essential that auditors document the reasons they chose not to perform 
the presumptively mandatory responsibility and how the alternative 
procedure they performed sufficiently achieved the objectives of the 
specific standard.
    Because circumstances will be rare in which the auditor will 
perform an alternative procedure, the Board anticipates that the 
documentation requirement in the rule ought not to result in unduly 
onerous consequences or too voluminous documentation. Furthermore, 
since the auditor must already document the work performed as part of 
the audit, adding a concise explanation as to why the auditor chose to 
perform the alternative procedure

[[Page 46191]]

should not increase the volume of documentation to an unreasonable 
level.
    During an internal or external review of the engagement, other 
evidence, including oral explanation, may help substantiate the 
procedures performed by the auditor during the audit. However, because 
the auditor is required to document his or her work in the engagement 
working papers during the audit, oral explanation should be used only 
to clarify the documented work performed. The justification as to why 
the alternative procedure was performed rather than the presumptively 
mandatory responsibility must be documented in the working papers. 
Furthermore, the reviewer should give appropriate consideration to the 
credibility of the individual(s) providing the oral explanation, and 
the oral explanation should be consistent with the documented evidence 
in the engagement working papers.
    Moreover, the Board concluded that applying the documentation 
requirement only to significant issues, findings, or procedures is 
impractical because it will not be efficient or effective to determine, 
each time, whether the level of significance of an audit area warranted 
the auditor to document the reasons for choosing to perform an 
alternative procedure instead of the presumptively mandatory procedure. 
The purpose of Rule 3101 is to bring uniformity to definitions and 
requirements that auditors have to follow. In addition, the Board 
determined that moving Rule 3101(a)(2)'s documentation requirement to 
the audit documentation standard would not be appropriate because of 
its specific subject matter.
    Additionally, the Board has added a note, originally a footnote in 
the Board's proposing release accompanying its proposed rule, 
describing an auditor's responsibility in a ``should consider'' 
scenario to the text of Rule 3101(a)(3), Responsibility to Consider. 
Some commenters recommended that this footnote be added directly to the 
text of the rule because they saw it as an important clarification that 
was not included in the original proposed rule. A commenter further 
urged the Board to elaborate on its applicability and the documentation 
requirements for a ``should consider'' action.
    Another commenter suggested that the ``should consider'' footnote 
be excluded from the rule because it implies that the action would 
require the auditor to document every instance of compliance with a 
``should consider'' action. The commenter, instead, recommended that 
Rule 3101(a)(3) be revised to apply to all considerations regardless of 
how the obligation is expressed (for example, whether it is preceded by 
a ``should,'' ``may,'' ``could,'' or ``might'').
    Because the ``should consider'' terminology is widely used in the 
interim standards, the Board determined that it is important to state 
the Board's expectation for compliance and, therefore, agreed with 
commenters who recommended adding the ``should consider'' footnote to 
the text of Rule 3101(a)(3). Furthermore, the Board concluded that 
there is an important difference between a ``should consider'' and a 
``may consider'' action or procedure. The difference is a direct 
correlation to the definitions of ``should'' and ``may.'' The auditor 
has a greater responsibility in a ``should consider'' action because 
the auditor has a presumptively mandatory responsibility to consider 
the action or procedure versus just having a responsibility to consider 
the action. Therefore, Rule 3101(a)(3) was not revised to apply to all 
considerations regardless of how the obligation is expressed.
    Additionally, the Board determined that the documentation 
requirement relating to a procedure that an auditor ``should consider'' 
is not the same as the documentation requirement for a presumptively 
mandatory responsibility because in a ``should consider'' situation, 
only the consideration of the action is presumptively mandatory, while 
the action or procedure itself is not. In these situations, the auditor 
should use his or her professional judgment in determining how to 
document his or her consideration of the specific action or procedure.
Rule 3101(b)
    Some commenters on the proposed rule stated that the imperatives 
the Board identified are consistent with the way auditors currently 
interpret existing auditing and related professional practice 
standards, while other commenters recommended that Rule 3101(a) not 
apply to the interim standards on the grounds that the new definitions 
could create confusion or have unintended consequences. Because the 
accounting profession previously had not expressly defined these terms, 
commenters further recommended that the Board perform a comprehensive 
analysis of how and in what context the interim standards use the 
defined terms to determine whether current practice is consistent with 
the Rule 3101(a) definitions.
    The Board concluded that the terminology defined in Rule 3101 is 
consistent with the existing interpretation regarding the application 
of the terminology in the interim standards. Rule 3101 creates a common 
understanding among the auditors as to what is expected of them when 
performing engagements in accordance with the PCAOB standards and, 
therefore, Rule 3101 will apply to the interim standards.
    Furthermore, a commenter recommended that the Board clarify the 
level of authority the appendices carry when accompanying the Board's 
standards. Because the Board adopts the appendices to its permanent 
standards as rules, the appendices to the Board's permanent standards 
carry the same level of authority as the standards themselves. In 
addition, the appendices to the interim standards, which in certain 
circumstances carry a different level of authority, retain their 
original level of authority as adopted on April 16, 2003.
Rule 3101(c)
    Rule 3101(c) establishes an effective date for the documentation 
requirement in paragraph (a)(2). The Board agreed with commenters who 
recommended establishing an effective date to provide a reasonable 
amount of time for auditors to implement procedures to properly comply 
with the new documentation requirement.

III. Date of Effectiveness of the Proposed Rule and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the Board consents the Commission will:
    (a) By order approve such proposed rule; or
    (b) Institute proceedings to determine whether the proposed rule 
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
is consistent with Title I of the Act. Comments may be submitted by any 
of the following methods:

Electronic comments:

     Use the Commission's Internet comment form (http://www.sec.gov/rules/pcaob.shtml); or
     Send an e-mail to [email protected]. Please include 
File

[[Page 46192]]

No. PCAOB-2004-06 on the subject line.

Paper comments:

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File No. PCAOB-2004-06. This file 
number should be included on the subject line if e-mail is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/pcaob.shtml). Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule that are filed 
with the Commission, and all written communications relating to the 
proposed rule change between the Commission and any person, other than 
those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Section, 450 Fifth Street, 
NW., Washington, DC 20549. Copies of such filing also will be available 
for inspection and copying at the principal office of the PCAOB. All 
comments received will be posted without change; we do not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly. All 
submissions should refer to File No. PCAOB-2004-06 and should be 
submitted on or before August 23, 2004.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-17461 Filed 7-30-04; 8:45 am]
BILLING CODE 8010-01-P