Communications with Audit Committees
Effective communication between the auditor and those charged with governance is essential to a high-quality audit. The auditor is required to communicate specific matters arising from the audit to the audit committee (or equivalent body) to help governance bodies fulfill their oversight responsibilities. For nonissuers, this is governed by AU-C 260; for issuers, by PCAOB AS 1301 (Communications with Audit Committees).
Those charged with governance refers to the person(s) or organization(s) with responsibility for overseeing the entity's financial reporting process. In most cases, this is the audit committee of the board of directors. For smaller entities, it may be the full board or even the owner-manager.
Required Communications — Overview
The auditor must communicate a range of matters to those charged with governance. These communications promote transparency, facilitate the audit, and help governance bodies exercise effective oversight.
Key Matters to Communicate
| Category | Examples |
|---|---|
| Auditor's responsibilities | The auditor's responsibility for forming and expressing an opinion on the financial statements; the audit does not relieve management of its responsibilities |
| Planned scope and timing | Overview of the nature and extent of planned audit procedures, including the auditor's approach to internal control and areas of higher risk |
| Significant audit findings | Qualitative aspects of accounting practices, significant difficulties encountered, significant unusual transactions, uncorrected misstatements |
| Independence | For issuers: written communication of all relationships that may bear on independence (required annually by AS 1301 and PCAOB Rule 3526) |
Example: Before beginning fieldwork at Gies Co., the auditor meets with the audit committee to discuss the planned audit approach, key risk areas (including revenue recognition and inventory valuation), and the expected timeline. This communication establishes the foundation for a productive engagement.
Auditor Responsibilities Communication
The auditor should communicate:
- That the auditor is responsible for forming and expressing an opinion on the financial statements
- That the audit is designed to obtain reasonable (not absolute) assurance about whether the financial statements are free from material misstatement
- That the audit includes consideration of internal control relevant to the preparation of the financial statements, but not for the purpose of expressing an opinion on the effectiveness of internal control (unless performing an integrated audit)
- That the auditor is responsible for communicating significant matters arising from the audit
The communication about auditor responsibilities helps set expectations. A common exam scenario describes a board member who believes the auditor guarantees the accuracy of the financial statements. The correct answer is that the auditor provides reasonable assurance, not a guarantee, and this distinction should be communicated to governance.
Planned Scope and Timing
The auditor communicates an overview of:
- The nature and extent of planned audit procedures
- The auditor's approach to significant risks identified
- How the auditor plans to address the risk of material misstatement due to fraud
- The auditor's approach to internal control (planned reliance on controls, if any)
- Materiality levels used in planning the audit
- The expected timing of the audit and any interim procedures
This communication is typically made at the start of the engagement (during the planning phase), though updates may be communicated throughout the audit as circumstances change.
Example: MAS Inc.'s auditor communicates to the audit committee that the audit team plans to take a substantive approach to accounts receivable (rather than relying on controls) because MAS Inc. has experienced significant turnover in its billing department during the year, increasing the risk of misstatement.
Significant Audit Findings
This is the most substantive category of required communications. The auditor must communicate:
Qualitative Aspects of Accounting Practices
- The entity's significant accounting policies and whether they are appropriate
- Significant accounting estimates and the process used to develop them
- The effect of significant new accounting standards adopted during the period
- Disclosures in the financial statements and whether they are neutral, consistent, and clear
Significant Difficulties Encountered
- Unreasonable delays by management in providing needed information
- An unnecessarily brief time in which to complete the audit
- Unavailability of expected information or personnel
- Management's unwillingness to provide information about management's assessment of going concern
Disagreements with Management
- Disagreements about the application of accounting principles to the entity's specific facts
- Disagreements about the scope of the audit
- Disagreements about the wording of the audit report
- Any disagreements that were satisfactorily resolved must still be communicated
Even if a disagreement with management was ultimately resolved in the auditor's favor, it must still be communicated to those charged with governance. The governance body needs to understand these discussions to fulfill its oversight role.
Other Significant Matters
- Fraud involving senior management or fraud (whether or not material) involving others that causes a material misstatement
- Significant matters discussed with management in connection with the appointment or retention of the auditor
- Written communications between the auditor and management, such as the management letter and the representation letter
Uncorrected Misstatements
The auditor must communicate all uncorrected misstatements accumulated during the audit (other than those that are clearly trivial) and request that management correct them. This communication includes:
- The individual misstatements identified, including a description of each
- The auditor's assessment of why each uncorrected misstatement is or is not material
- The aggregate effect of uncorrected misstatements on the financial statements
- A request that management correct the misstatements
Example: During the audit of BIF Partners, the auditor identifies three misstatements totaling $85,000 that management has declined to correct. While each misstatement is individually immaterial and their aggregate is below the auditor's materiality threshold, the auditor communicates all three to the audit committee along with the rationale for why they are considered immaterial. The audit committee may still direct management to make corrections.
The auditor communicates uncorrected misstatements to governance regardless of whether they are material. The key phrase is "other than those that are clearly trivial." If the auditor accumulates misstatements and management does not correct them, governance must be informed so they can exercise their own judgment.
Independence Communications
For issuers, the auditor must provide written communication to the audit committee regarding independence. This includes:
- A written statement that the firm is independent within the meaning of the Securities Act and PCAOB rules
- All relationships between the firm (and its affiliates) and the entity (and its affiliates) that may reasonably be thought to bear on independence
- Discussion of any threats to independence and the safeguards applied to address them
- Total fees for audit and non-audit services rendered during the period
For nonissuers, AU-C 260 requires communication of independence matters when the auditor is aware of relationships or services that may affect independence. While the requirement is less prescriptive than for issuers, the auditor must still address threats and safeguards.
Two-Way Communication
The communication between the auditor and those charged with governance should be two-way:
- The auditor communicates required matters to governance
- Governance communicates matters relevant to the audit to the auditor, including concerns about risks, suspected fraud, or areas they want the auditor to focus on
- The auditor should establish a constructive working relationship with the audit committee
If the auditor determines that the two-way communication is inadequate, the auditor must consider:
- The effect on the auditor's risk assessment
- Whether sufficient appropriate audit evidence can be obtained
- The need to modify the opinion or withdraw from the engagement
Example: Illini Entertainment's audit committee chairperson informs the auditor during a private session that several employees have raised concerns about the CFO overriding expense approval controls. The auditor incorporates this information into the fraud risk assessment and expands testing of management override controls.
Form of Communication
| Form | When Appropriate |
|---|---|
| Written | Required for significant audit findings, uncorrected misstatements, independence communications (issuers), and significant deficiencies/material weaknesses |
| Oral | Permitted for routine matters, such as planned scope and timing. However, the auditor must document oral communications in the audit workpapers |
If a matter is required to be communicated in writing, oral communication alone is not sufficient—even if governance acknowledges the oral communication. Written communication creates a formal record and is required for the most significant matters.
Timing of Communications
The timing of communications varies by topic:
| Matter | Timing |
|---|---|
| Planned scope and timing | Early in the engagement (planning phase) |
| Significant audit findings | On a timely basis during or at the conclusion of the audit |
| Uncorrected misstatements | Before issuance of the audit report |
| Independence (issuers) | At least annually; before acceptance of the engagement or shortly thereafter |
| Internal control deficiencies | Within 60 days of the report release date (for nonissuers); before report issuance (for issuers) |
Summary
| Topic | Key Point |
|---|---|
| Governing standards | AU-C 260 (nonissuers); AS 1301 (issuers) |
| Primary recipient | Audit committee or those charged with governance |
| Key topics | Auditor responsibilities, planned scope, significant findings, independence |
| Significant findings | Qualitative aspects, difficulties, disagreements, uncorrected misstatements |
| Independence | Written communication required for issuers |
| Form | Written required for key matters; oral acceptable for routine matters |
| Two-way | Both auditor and governance share relevant information |
| Timing | Varies — some matters early, some during, some before report issuance |