Auditor's Letter Handbook by ABA: Audit Responses Committee - Read Online
Auditor's Letter Handbook
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The Auditor’s Letter Handbook, Second Edition contains the original 1975 Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information. Much has changed since the American Bar Association Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information (the ABA Statement) and the American Institute of Certified Public Accountants’ (AICPA) related Statement of Auditing Standards No. 12 (SAS 12) were approved in December 1975 and January 1976, respectively.

The Second Edition addresses the increased emphasis on:
• the quality of loss contingency disclosure;
• a new regulatory regime for the accounting profession established by the Sarbanes-Oxley Act of 2002;
• the increasing relevance of international accounting and auditing standards;
• the expansion of cross-border practice by law firms;
• and much more!

This resource is a must-have for inside and outside counsel in dealing with the auditor's need for corroboration of information furnished by management concerning litigation, claims, and assessments. It comprises a consolidated presentation of the principal official pronouncements and unofficial commentaries on the subject of audit inquiries and lawyers' responses.
Published: American Bar Association an imprint of NBN Books on
ISBN: 9781614389743
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Auditor’s Letter Handbook

Second Edition

Audit Responses Committee

Cover design by Mary Anne Kulchawik/ABA Publishing.

Page layout by Quadrum Solutions.

The materials contained herein represent the opinions of the authors and editors and should not be construed to be the views or opinions of the law firms or companies with whom such persons are in partnership with, associated with, or employed by, nor of the American Bar Association or the Business Law Section unless adopted pursuant to the bylaws of the Association.

Nothing contained in this book is to be considered as the rendering of legal advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. This book and any forms and agreements herein are intended for educational and informational purposes only.

© 2013 American Bar Association. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. For permission contact the ABA Copyrights & Contracts Department, copyright@americanbar.org or via fax at 312 988-6030, or complete the online form at www.americanbar.org/utility/reprint.

Articles from The Business Lawyer and Business Law Today appear with permission. All rights reserved.

Statement on Auditing Standards No. 12: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments and AU Section 9337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments: Auditing Interpretations of AU Section 337 © 2013, American Institute of CPAs. All rights reserved. Used with Permission. http://www.aicpa.org

Inclusion of AU Section 337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments and AU Section 9337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments: Auditing Interpretations of Section 337 complies with the publication requirements of the Public Company Accounting Oversight Board (PCAOB). http://pcaobus.org/

Library of Congress Cataloging-in-Publication Data

Auditor’s letter handbook / Audit Responses Committee, Rosenhauer, James J., Thomas W. White, and Stanley Keller, eds. - 2nd edition.

pages cm

Includes bibliographical references and index.

ISBN 978-1-61438-974-3

1. Auditing-Law and legislation—United States. 2. Accounting-Law and legislation-United States. 3. Corporations-Auditing-Law and legislation-United States. 4. Corporations-United States-Auditing. I. Rosenhauer, James J., Thomas W. White, and Stanley Keller, eds. II.

American Bar Association. Business Law Section Audit Responses Committee.

KF1357.A95 2013

346.73’06648-dc23

2013013877

Discounts are available for books ordered in bulk. Special consideration is given to state bars, CLE programs, and other bar related organizations. Inquire at Book Publishing, ABA Publishing, American Bar Association, 321 N. Clark Street, Chicago, Illinois 60654-7598.

www.ShopABA.org

CONTENTS

An Introductory Update by the ABA Business Law Section Audit Responses Committee (April 2013)

Introduction to the Auditor’s Letter Handbook, First Edition (December 1976)

Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information (31 BUS. LAW. 1709 [1976])

PREAMBLE

STATEMENT OF POLICY

COMMENTARY

APPENDIX A – Excerpts from Statement of Financial Accounting Standards No. 5 (Accounting for Contingencies)*

ANNEX A:

Illustrative form of letter for use by outside practitioner or law firm

Illustrative form of letter for use by inside counsel

First Report of the Committee on Audit Inquiry Responses Regarding Introductory Analysis and Guides to Statement of Policy (31 BUS. LAW. 1737 [1976])

Introductory Analysis and Guides

Illustrative Form of Letter of Audit Inquiry

Second Report of the Committee on Audit Inquiry Responses Regarding Initial Implementation of the Statement of Policy (32 BUS. LAW. 177 [1976])

A lawyer’s professional responsibility with respect to unasserted possible claims

Disclosure advice does not require determinations regarding content of financial statements

Treatment of pending investigations where no overtly threatened charges

Gain contingencies

Report of the Subcommittee on Audit Inquiry Responses Regarding Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments: Auditing Interpretation AU Section 337 (45 BUS. LAW. 2245 [1990])

Report of the Committee on Law and Accounting, December 17, 1996, Regarding Guidance on the Privilege Issue (with discussion from Lawyers’ Replies to Auditors: Guidance on the Privilege Issue, BUSINESS LAW TODAY Sept./Oct. 1996, 64)

Committee on Audit Responses, Statement on Effect of FIN 48 on Audit Response Letters (64 BUS. LAW. 389 [2009])

Committee on Audit Responses, Statement on the Effect of the FASB Codification on Audit Response Letters (65 BUS. LAW. 491 [2010])

AICPA AU Section 337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments

AU 337A: Appendix—Illustrative Audit Inquiry Letter to Legal Counsel**

AU 337B: Exhibit I—Excerpts from FASB Accounting Standards Codification 450, Contingencies

AU 337C: Exhibit II—ABA Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information

AICPA AU Section 9337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments: Auditing Interpretations of Section 337

PCAOB AU Section 337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments

AU 337A: Appendix—Illustrative Audit Inquiry Letter to Legal Counsel

AU 337B: Exhibit I—Excerpts from Statement of Financial Accounting Standards No. 5: Accounting for Contingencies

AU 337C: Exhibit II—ABA Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information

PCAOB AU Section 9337: Inquiry of a Client’s Lawyer Concerning Litigation, Claims, and Assessments: Auditing Interpretations of Section 337

* Subsequently codified as Accounting Standards Codification Subtopic 450-20, excerpts of which are set forth in Exhibit I to AU 337 as adopted by the American Institute of Certified Public Accountants and reprinted herein. See also the Statement on the Effect of the FASB Codification on Audit Responses by the ABA Audit Responses Committee, published in February 2010 and reprinted herein.

** Compare to the illustrative form of Letter of Audit Inquiry attached to the First Report above.

Introductory Update, Second Edition

Much has changed since the American Bar Association Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information (the ABA Statement) and the American Institute of Certified Public Accountants’ (AICPA) related Statement of Auditing Standards No. 12 (SAS 12) were approved in December 1975 and January 1976, respectively. We have seen, for example, an increased emphasis on the quality of loss contingency disclosure, an expansion of private litigation and SEC enforcement actions against accountants and other professionals, and a new regulatory regime for the accounting profession established by the Sarbanes-Oxley Act of 2002. Despite these changes, the ABA Statement has stood the test of time and shown its flexibility to adapt to meet changing circumstances.

BACKGROUND

The ABA Statement is intended to balance two objectives: (i) to facilitate effective auditing as the underpinning for public confidence in financial reporting, and (ii) to preserve client confidences as mandated by attorney ethics rules and to protect attorney-client privilege, each of which is a critical component of our legal system. The preservation of client confidences and the protection of attorney-client privilege encourage client consultation with counsel and thus promote voluntary legal compliance. The ABA Statement’s objectives are at least as important today as they were when the ABA Statement was approved. These objectives are achieved by requiring lawyers to identify pending and threatened claims they are handling, but permitting them to assess the likely outcome only when an adverse result is either probable or remote (as defined in the ABA Statement); by limiting when lawyers address unasserted claims; and, when appropriate in connection with their engagement, by having lawyers acknowledge to the auditors their professional responsibility with respect to their client’s disclosures, thereby providing a basis for the auditors to know that the lawyers who advise the client on disclosure matters continue to be involved.

IMPACT OF SARBANES-OXLEY ACT

The Sarbanes-Oxley Act, which was enacted in response to a series of accounting scandals, imposed new regulations on both the accounting and legal professions and on their clients. These include creation of the Public Company Accounting Oversight Board (the PCAOB) to regulate the accounting profession and the adoption by the Securities and Exchange Commission (the SEC) of rules governing attorney professional conduct. The PCAOB’s authority to conduct inspections and issue reports and to take disciplinary actions against accountants, along with increased private litigation against accountants, has heightened the pressure on auditors to seek more information about loss contingencies to support their audits of management’s assertions and have put a premium on lawyers’ providing appropriate information as contemplated by the ABA Statement.

Notably, the SEC’s professional conduct rules adopted to implement Section 307 of the Sarbanes-Oxley Act and changes to related state legal ethics rules provide an even firmer basis than existed when the ABA Statement was approved for auditors to be able to rely on the performance by lawyers of their professional responsibilities. Under the SEC’s Part 205 Rules on Attorney Professional Conduct, a lawyer appearing and practicing before the SEC in the representation of a public company is required to report up the ladder (ultimately to the board or an appropriate board committee if necessary) evidence of a material violation of federal securities and certain other laws, and is authorized in some situations to report such violations to the SEC. These rules supplement state ethics rules, which also govern lawyer conduct. In that connection, about the same time as the SEC was issuing its Part 205 Rules, the ABA approved related changes to the Model Rules of Professional Conduct, which do not themselves govern lawyer conduct until adopted by the applicable state. These changes extend permissible disclosure under Rule 1.6 to reach client conduct that causes substantial financial injury and require lawyers under Rule 1.13 to pursue remedial measures for corporate misconduct and to communicate with higher authority within the client organization if necessary to prevent or rectify the problem, with permission to disclose if necessary client information outside the client organization. These rules complement Rule 1.2(d), which prohibits a lawyer from assisting a client to engage in a crime or fraud, and Rule 4.1(b), which requires a lawyer to make disclosures necessary to avoid assisting a client’s crime or fraud.

In addition, the Sarbanes-Oxley Act heightened the legal prohibitions against misleading auditors in connection with an audit of a public company, and the SEC implemented this legislation in Rule 13b2-2. That rule applies to officers and directors of an issuer and persons acting under their direction, which can encompass a broad range of participants in the audit process, including lawyers communicating with auditors.

CHANGES IN ACCOUNTING AND AUDITING STANDARDS

In recent years, we have seen changes in the accounting standard applicable to income tax contingencies with the adoption by the Financial Accounting Standards Board (the FASB) of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 removed these contingencies from the scope of Financial Accounting Standards No. 5 (now Accounting Standards Codification Item 450-20 (ASC 450-20)). We also saw the codification of accounting standards that changed the nomenclature and references used in the ABA Statement. In each case, the Audit Responses Committee of the ABA’s Section of Business Law issued reports addressing how these changes affect the ABA Statement. These reports are included in this updated Handbook.

In 2008, the FASB also proposed to change the requirements for disclosure of loss contingencies. After modifying its proposal in 2010 in response to adverse comments, in July 2012 the FASB decided to terminate this effort, concluding that any inadequacies in disclosures did not necessitate new standards but rather improved implementation of existing standards. This action by the FASB followed an initiative by the SEC to seek improvement in disclosure of loss contingencies, particularly those involving litigation, in accordance with the existing standards, principally through its comment letter process. Although the FASB decided not to pursue changes in the standards, we can expect auditors and the SEC to continue to look closely at companies’ accounting for and disclosure of loss contingencies.

Changes in accounting and auditing standards relating to treatment of subsequent events and the dating of the auditors’ report have also affected audit responses. Previously, auditors typically dated their reports as of the date they completed their audit work, even if that date was before the date the financial statements were issued. Now auditors date their reports on the same date that the financials are issued, and they now often seek lawyers’ responses through that date. In practice, this change has resulted in more requests that lawyers update the audit response letters they previously have furnished the auditors. As a general matter, lawyers treat update requests the same as original requests.

The Sarbanes-Oxley Act also gave the PCAOB authority to prescribe auditing standards governing the performance of audits of companies that are required to file reports with the SEC under the Securities Exchange Act of 1934 or that have a registration statement pending under the Securities Act of 1933. The PCAOB adopted SAS 12 (now codified as AU Section 337) as an interim audit standard in 2003. Except for a change related to the dating of the auditors’ report, the PCAOB has not adopted or proposed any significant changes to that standard. However, while essentially the same substantively, the AICPA version of AU Section 337 applies to private company audits, and the PCAOB version applies to public companies. Both standards are included in this Handbook.

INTERNATIONAL ASPECTS

Another development since the ABA Statement was approved has been the increasing relevance of international accounting and auditing standards and the expansion of cross-border practice by law firms. International Financial Reporting Standards (IFRS) adopted by the International Accounting Standards Board have become the accounting standards in many countries throughout the world other than the United States. Canada, for example, recently converted to IFRS for publicly-traded companies. The SEC has been considering whether the United States should adopt IFRS or take some other approach to bringing U.S. standards into line with those of countries that use IFRS, but as of this date