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William McDonough, the first chairman of the audit industry’s federal watchdog, stepped down from the Public Company Accounting Oversight Board Wednesday, acknowledging that his agency still has a way to go before it can accurately gauge the effectiveness of public companies’ internal controls. A PCAOB report issued the same day McDonough’s tenure drew to a close found that in 2004 some audits of public companies’ internal controls were not as effective or efficient as regulators expected, but that many of the problems can be corrected with experience. “While our inspections identified several opportunities for auditors to improve audit quality and efficiency, the Board remains confident that auditors will be able to perform more effective and efficient audits in future years,” McDonough said in a statement. “These improvements are already appearing as auditors and their clients gain experience and as challenges that were unique to the first year’s implementation abate.” A provision of the Sarbanes-Oxley Act of 2002, enacted after a rash of accounting scandals, requires public companies to conduct an annual assessment of the internal controls over financial reporting and to submit to further review by an outside, independent auditor. Larger U.S. companies were required to implement the audits last year, and many complained the process was burdensome and onerous. The Securities and Exchange Commission, which oversees the PCAOB, recently gave smaller companies, those with less than a $75 million public float, until July 2007 to comply. In its new report, the accounting oversight board noted that companies and auditors faced enormous challenges in complying with the requirement last year, including a lack of experienced staff and limited time to complete work. Some companies also needed to make significant improvements to their internal controls to make up for “deferred maintenance of those systems.” According to the report, the most common reasons for less efficient audits were failure to integrate audits of internal controls with audits of financial statements; ineffectively applying a top-down approach by evaluating significant accounts at the financial statement level and working down to the transaction level; neglecting to alter the nature, timing and extent of testing to reflect the level of risk; walkthroughs of major transactions without sufficient questioning of company personnel; and auditors’ failure to use the work of others to the full extent permitted. The oversight board said its inspections of public company audit firms have identified areas where auditors should improve their internal-controls audits, and it said it appears that with one year’s experience to look back on, some firms already have modified their methods and training materials. Separately, SEC Chairman Christopher Cox said earlier this week he will name an acting head of the PCAOB after McDonough steps down. Cox also promised the commission would spell out the process for selecting McDonough’s replacement, but he did not say how long it would take. “I expect it to be a very well-defined process,” Cox told reporters after a recent SEC public meeting. McDonough, 71, joined the PCAOB after 10 years as president of the New York Federal Reserve Bank. He was tapped as the board’s chairman after the resignation of the SEC’s earlier choice, former FBI and CIA director, William Webster. In addition to replacing McDonough, the SEC also is considering whether to approve a second five-year term for oversight board member Kayla Gillan. Copyright �2005 TDD, LLC. All rights reserved.

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