1

Conference on Accountants’ LiabilityConference on Accountants’ LiabilityALI-ABAALI-ABA

Zoe-Vonna PalmroseZoe-Vonna PalmroseDeputy Chief Accountant Deputy Chief Accountant

Professional PracticeProfessional Practice

Office of the Chief AccountantOffice of the Chief AccountantU.S. Securities and Exchange CommissionU.S. Securities and Exchange Commission

May 4, 2007May 4, 2007

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any

of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s

colleagues upon the staff of the Commission.

2

OutlineOutline

I.Introductory Remarks

II.II.Improving Sarbanes-Oxley Section 404 ImplementationImproving Sarbanes-Oxley Section 404 Implementation

I. Activities preceding the December 2006 proposals

II. ICFR reporting: Descriptive statistics

III. Brief overview of the SEC’s Proposed Interpretive Guidance For Management (December 2006)

IV. Moving forward: Current ICFR activities and next-steps

III. Auditor Independence

IV. Accounting Complexity Initiative

3

Improving the Implementation of SOX Section 404:Improving the Implementation of SOX Section 404:Activities Preceding the December 2006 ProposalsActivities Preceding the December 2006 Proposals

2005 and 2006 Roundtables

Recommendations of SEC Advisory Committee on Smaller Public Companies (April 2006)

GAO Report (April 2006) “Sarbanes-Oxley Act: Consideration of Key Principles Needed in

Addressing Implementation for Smaller Public Companies”

Commission Announced Next Steps on SOX 404 Improvement (May 2006)

PCAOB Announced Four-Point Plan to Improve Implementation (May 2006)

COSO ICFR Guidance for Small Companies (July 2006) Three Volumes (Executive Summary, Guidance, Evaluation Tools)

Extensions for SOX 404 Compliance

4

ICFR: Reporting Results in Year 3ICFR: Reporting Results in Year 3

Year Three Filers Year Three Filers

Approximately 2,838 filings(Companies with year-ends after 11/14/06 and filed through 3/31/07)(Companies with year-ends after 11/14/06 and filed through 3/31/07)

• 147 (5.2%) reported material weaknesses (i.e., ineffective ICFR) – Disproportionate number of smaller registrants (revenues below

$500 million) had material weaknesses

– 30% of registrants with ineffective ICFR were also ineffective during years 1 and 2

• Comparison to Years 1 & 2 – 10.6% reported ineffective ICFR in Year 2– 15.8% reported ineffective ICFR in Year 1

5

Ineffective ICFR:Ineffective ICFR:Financial Statement Elements InvolvedFinancial Statement Elements Involved

Year 1Year 1 Year 2Year 2 Year 3Year 3

Income taxesIncome taxes 35%35% 37%37% 38%38%

Revenue recognitionRevenue recognition 33%33% 34%34% 36%36%

Liabilities and payablesLiabilities and payables 26%26% 28%28% 37%37%

Accounts and loans receivableAccounts and loans receivable 26%26% 27%27% 36%36%

Inventory and cost of salesInventory and cost of sales 28%28% 25%25% 24%24%

PPE/Fixed/Intangible Assets PPE/Fixed/Intangible Assets ValuationValuation

26%26% 18%18% 17%17%

Consolidation/Foreign Consolidation/Foreign Cur/Related Party/Sub IssuesCur/Related Party/Sub Issues

25%25% 16%16% 10%10%

6

Ineffective ICFR: Other Specific Issues IdentifiedIneffective ICFR: Other Specific Issues Identified

Year 1Year 1 Year 2Year 2 Year 3Year 3

Material/Material/

numerous ..anumerous ..auditor/YE uditor/YE adjustmentsadjustments

50%50% 63%63% 78%78%

Restatement Restatement or or nonreliance nonreliance on co. filingson co. filings

44%44% 48%48% 42%42%

7

SEC’s Proposed Interpretive Guidance for ManagementSEC’s Proposed Interpretive Guidance for Management

Key Attributes of the Proposed Guidance: Principles-based Does not replace requirements of framework Directs efforts to areas of highest risk of material

misstatement to financial statements Allows management to tailor the evaluation process

to their facts and circumstances Provides guidance on supporting the assessment Provides framework for evaluating deficiencies Non-exclusive safe harbor

8

SEC’s and PCAOB’s Proposed Guidance: SEC’s and PCAOB’s Proposed Guidance: Auditor’s ICFR OpinionAuditor’s ICFR Opinion

PCAOB proposed standardPCAOB proposed standard

Removes the requirement to evaluate management’s processRemoves the requirement to evaluate management’s process

Proposes one audit report on ICFR (not two)Proposes one audit report on ICFR (not two)

SEC Proposed Amendments to Regulation S-XSEC Proposed Amendments to Regulation S-X

Accountant’s ICFR ReportAccountant’s ICFR Report

Proposal would require that auditor’s report express only Proposal would require that auditor’s report express only oneone audit opinion (directly on the effectiveness of internal audit opinion (directly on the effectiveness of internal control over financial reporting)control over financial reporting)

9

SEC’s Proposed Interpretive Guidance for Management: SEC’s Proposed Interpretive Guidance for Management: OverviewOverview

Phase 1Phase 1

Involves identifying the financial reporting risks and the Involves identifying the financial reporting risks and the controls that adequately address these risks.controls that adequately address these risks.

Phase 2Phase 2

Involves evaluating the operating effectiveness of the Involves evaluating the operating effectiveness of the controls identified in Phase 1, and determining the controls identified in Phase 1, and determining the evidence needed to support the assessment, using evidence needed to support the assessment, using evaluation procedures tailored to the risk assessment.evaluation procedures tailored to the risk assessment.

Phase 3Phase 3

Involves reporting on the effectiveness of ICFR, including Involves reporting on the effectiveness of ICFR, including disclosing any material weaknesses identified during the disclosing any material weaknesses identified during the evaluation process. evaluation process.

10

Compliance Dates Compliance Dates (Amendments Adopted on December 15, 2006)(Amendments Adopted on December 15, 2006)

Revised Compliance Dates and Final Rules Regarding the I nternal Control Over Financial

Reporting Requirements

Accelerated Filer Status Management's Report Auditor's Attestation

Large Accelerated Filer OR Accelerated Filer

($75MM or more)

Already complying (Annual reports for fiscal years ending on

or after November 15, 2004)

Already complying (Annual reports for fiscal years ending

on or after November 15, 2004) U.S.

I ssuer

Non-accelerated Filer (less than $75MM)

Annual reports for fiscal years ending on or after December 15,

2007

Annual reports for fiscal years ending on or after December

15, 2008

Large Accelerated Filer ($700MM or more)

Annual reports for fiscal years ending on or after J uly 15, 2006

Annual reports for fiscal years ending on or after J uly 15,

2006

Accelerated Filer ($75MM or more and less than $700MM)

Annual reports for fiscal years ending on or after J uly 15, 2006

Annual reports for fiscal years ending on or after J uly 15,

2007

Foreign I ssuer

Non-accelerated Filer (less than $75MM)

Annual reports for fiscal years ending on or after December 15,

2007

Annual reports for fiscal years ending on or after December

15, 2008

U.S. or Foreign

Newly Public Company Second Annual Report Second Annual Report

11

SEC’s and PCAOB’s Proposed Guidance: Comment SEC’s and PCAOB’s Proposed Guidance: Comment LettersLetters

Comment period for both ended February 26, 2007Comment period for both ended February 26, 2007

SEC (PCAOB) received over 200 (170) comment lettersSEC (PCAOB) received over 200 (170) comment letters

Overarching themes covered by comment lettersOverarching themes covered by comment letters

Generally supportive of principles-based approach Generally supportive of principles-based approach

Alignment of SEC and PCAOB proposalsAlignment of SEC and PCAOB proposals

PrescriptivenessPrescriptiveness

TerminologyTerminology

12

Recent ActivitiesRecent Activities

SEC Open Commission Meeting

Held on April 4, 2007 (4-04)

Provided a forum for Commission feedback to staff on the following areas of the PCAOB proposal:

Alignment between PCAOB and SEC proposals

Scaling the Audit

Auditor Ability to Use Judgment to Determine Amount of Testing

Using the Work of Others

13

Next Steps on December ProposalsNext Steps on December Proposals

Consideration of comment letters submitted to Commission and PCAOB

Finalization of proposed standards and guidance by PCAOB and SEC

Ongoing monitoring as standards and guidance are implemented

14

Addressing Accounting ComplexityAddressing Accounting ComplexityPotential Benefit to Investors (and Other Users)Potential Benefit to Investors (and Other Users)

• Refocus the reporting of transactions based upon their Refocus the reporting of transactions based upon their economic reality;economic reality;

• Lessen the ability to structure around accounting rules;Lessen the ability to structure around accounting rules;

• Lower the cost of financial reporting (especially for smaller Lower the cost of financial reporting (especially for smaller entities); andentities); and

• Result in accounting and reporting more easily understood Result in accounting and reporting more easily understood by more investors, analysts, and others and not just the by more investors, analysts, and others and not just the subject matter of accounting experts.subject matter of accounting experts.