Audit Committee Communication: What Auditors Must Discuss and Report

The Auditor Relationship with the Audit Committee

Effective communication between the auditor and the audit committee (or those charged with governance) is fundamental to audit quality and corporate governance. Auditing standards, both AICPA and PCAOB, require the auditor to communicate certain matters to those charged with governance as part of every audit engagement. For CPA AUD candidates, understanding the content, timing, and purpose of these communications is directly testable and practically important.

The audit committee serves as the bridge between the external auditor and the board of directors. For public companies, SOX requires that the audit committee be directly responsible for the appointment, compensation, and oversight of the external auditor. This relationship means that the auditor reports to the audit committee, not to management, creating an essential check on management influence over the audit process.

Required Communications

Auditor Responsibilities and Planned Scope

The auditor must communicate an overview of the planned scope and timing of the audit. This communication helps the audit committee understand the auditor approach, including the significant risks identified during planning, the areas of audit focus, and the planned nature, timing, and extent of audit procedures. While this communication does not provide the audit committee with a detailed audit program, it should give them sufficient information to oversee the audit process effectively.

Significant Audit Findings

The auditor must communicate significant findings from the audit, including the auditor views about qualitative aspects of the entity accounting practices, including accounting policies, accounting estimates, and financial statement disclosures. This includes situations where the auditor disagrees with management about the appropriateness of an accounting policy or estimate, or where the auditor believes that disclosures are insufficient or misleading.

Other significant findings that must be communicated include significant difficulties encountered during the audit, such as unreasonable delays by management in providing needed information, disagreements with management about the scope of the audit or the application of accounting principles, significant unusual transactions that are outside the normal course of business, and the auditor assessment of the quality of the entity financial reporting.

Internal Control Deficiencies

The auditor must communicate significant deficiencies and material weaknesses in internal control identified during the audit to those charged with governance in writing. A significant deficiency is a deficiency, or combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance. A material weakness is a deficiency, or combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis.

Independence

For audits of public companies, PCAOB standards require the auditor to communicate in writing all relationships between the firm and the company that may reasonably be thought to bear on independence. This communication must also describe the firm policies and procedures for maintaining independence, the total fees received from the company and its affiliates, and any matters that the audit committee should consider in assessing the auditor independence.

Timing of Communications

Some communications are required before the audit begins, some during the audit, and some at the conclusion. Communications about the planned scope and timing of the audit should occur early enough for the audit committee to provide input. Communications about significant findings and internal control deficiencies should occur on a timely basis, meaning as soon as practicable after the auditor identifies the issue. In some cases, interim communications during the audit are more useful than communications delayed until the audit is complete.

Form of Communication

Certain communications must be in writing, including communications about significant deficiencies and material weaknesses, independence matters, and uncorrected misstatements. Other communications may be oral or written, though the auditor should consider whether written communication is more appropriate given the significance and complexity of the matter. The auditor should document all communications with those charged with governance, regardless of form.

Practical Considerations

Effective communication with the audit committee goes beyond compliance with auditing standards. The best auditors build a constructive relationship with the audit committee by being candid about audit findings and concerns, providing context and industry perspective to help the audit committee understand issues, being responsive to the audit committee questions and requests for information, and communicating proactively about emerging issues rather than waiting until problems develop.

Key Points for CPA Candidates

• Know the specific matters that auditing standards require the auditor to communicate to those charged with governance.
• Understand the difference between significant deficiencies and material weaknesses and the requirement to communicate both in writing.
• Be prepared to identify the appropriate timing and form of communication for different types of matters.
• Recognize the audit committee role in overseeing the external auditor under SOX and the implications for auditor independence.
• Understand that effective communication enhances audit quality and corporate governance.

Communication with those charged with governance is not just a procedural requirement. It is a mechanism that supports the integrity of the audit process and the accountability of management to the board and shareholders.