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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Dec 15

Written by: Jack Ciesielski
12/15/2006 6:59 AM 

The SEC voted on Wednesday to "propose interpretive guidance for management to improve Sarbanes-Oxley 404 implementation."

The actual proposal isn't yet posted to the SEC's website, but you can get the drift from the press release: more judgment will be exercised in what to test (as it always has been allowed, really) with an emphasis on risk and materiality. The proposal intends for management to:

1) Evaluate the design of the controls to determine if it's reasonably possible that a material misstatement in the financial statements wouldn't be contained in a timely manner.

2) Gather and analyze evidence about the operation of the controls being evaluated based on a risk assessment of those controls.

Now that those principles will be spelled out in black and white (actually, making them rules - watch out what you wish for!), then managers and their auditors might feel more comfortable about actually exercising judgment. Maybe.

The proposed document intends to be more specific about how to handle four problem areas the SEC has identified in existing 404 examinations: identification of risks to reliable financial reporting and the related controls; evaluation of the operating effectiveness of controls; reporting the overall results of management's evaluation; and documentation.

All to be developed in coordination with the PCAOB as it reviews auditing standards for the same kind of streamlining.

It's kind of ironic that more rules are being written to espouse the principles built into the existing standards. You almost have to believe that as the SEC and PCAOB write more such "principle-based guidance," there'll be more and more requests for "examples." This, as we head into the third season of internal control reviews - and farther down the learning curve.