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New Rules for Auditors that Affect Your Audit Experience
 

The American Institute of Certified Public Accountants (AICPA) recently issued two new auditing standards which will be effective for fiscal years ending on or after December 15, 2006.

Statement on Auditing Standards (SAS) No. 103, “Audit Documentation”, requires auditing firms to date their reports as of the date they have gathered sufficient evidence to render their opinion. Under most circumstances, this will likely be at or near the date the audit report is issued to clients, which will require the following additional procedures to be performed on or near the issuance date:

  • Obtaining a client representation letter dated as of the report date.
  • Subsequent events review through the report date, which may include obtaining legal updates from attorneys, examining the latest interim financial information, etc. This could require the auditor to have phone conversations with the company’s attorneys on or near the date of issuance.

Generally, this standard will create an additional responsibility for auditors regarding events that occur between the date of audit fieldwork and the date they issue final financial statements to clients, and will require more planning to coordinate the activities to be completed on the issuance dates.

SAS No. 112, “Communicating Internal Control Related Matters Identified in an Audit”, requires auditors to communicate significant deficiencies and/or material weaknesses noted during an audit to management and to those charged with governance (board of directors, management committee, owners, etc.) in writing within 60 days of issuing final financial statements.

A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the entity's ability to initiate, authorize, record, process, or report financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the entity's financial statements that is more than inconsequential will not be prevented or detected.

A misstatement is inconsequential if a reasonable person would conclude, after considering the possibility of further undetected misstatements, that the misstatement, either individually or when aggregated with other misstatements, would clearly be immaterial to the financial statements. If a reasonable person would not reach such a conclusion regarding a particular misstatement, that misstatement is more than inconsequential.

A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the financial statements will not be prevented or detected.

Deficiencies in the following areas ordinarily will be considered at least significant deficiencies in internal control:

  • Controls over the selection and application of accounting principles that are in conformity with generally accepted accounting principles. Having sufficient expertise in selecting and applying accounting principles is an aspect of such controls.
  • Antifraud programs and controls.
  • Controls over nonroutine and nonsystematic transactions.
  • Controls over the period-end financial reporting process, including controls over procedures used to enter transaction totals into the general ledger; initiate, authorize, record, and process journal entries into the general ledger; and record recurring and nonrecurring adjustments to the financial statements.

Each of the following is an indicator of a control deficiency that should be regarded as at least a significant deficiency and a strong indicator of a material weakness in internal control (note: this is not an all-inclusive list):

  • Ineffective oversight of the entity's financial reporting and internal control by those charged with governance.
  • Restatement of previously issued financial statements to reflect the correction of a material misstatement. (The correction of a misstatement includes misstatements due to error or fraud; it does not include restatements to reflect a change in accounting principle to comply with a new accounting principle or a voluntary change from one generally accepted accounting principle to another generally accepted accounting principle.)
  • Identification by the auditor of a material misstatement in the financial statements for the period under audit that was not initially identified by the entity's internal control. This includes misstatements involving estimation and judgment for which the auditor identifies likely material adjustments and corrections of the recorded amounts. (This is a strong indicator of a material weakness even if management subsequently corrects the misstatement.)
  • Identification of fraud of any magnitude on the part of senior management.
  • Failure by management or those charged with governance to assess the effect of a significant deficiency previously communicated to them and either correct it or conclude that it will not be corrected.
  • An ineffective control environment. Control deficiencies in various other components of internal control could lead the auditor to conclude that a significant deficiency or material weakness exists in the control environment.