New Audit Standards: How Will They Impact the Audit
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1 New Audit Standards: How Will They Impact the Audit Process? Presented by Robinson, Farmer, Cox Associates The Commonwealth s premier source of financial expertise since 1953.
2 Presentation Objectives Discuss background and reasons for enacting selected new Statements on Auditing Standards (SAS s). Review specific per-sas requirements. Convey the impacts of the new requirements on localities.
3 Risk Assessment Standards (SAS ) - Overview The AICPA s Auditing Standards Board has issued eight Statements on Auditing Standards (SAS) relating to the assessment of risk in an audit of financial statements: SAS No. 104, Amendment to Statement on Auditing Standards No. 1,Codification of Auditing Standards and Procedures ( Due Professional Care in the Performance of Work ) SAS No. 105, Amendment to Statement on Auditing Standards No. 95, Generally Accepted Auditing Standards SAS No. 106, Audit Evidence SAS No. 107, Audit Risk and Materiality in Conducting an Audit SAS No. 108, Planning and Supervision SAS No. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement SAS No. 110, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained SAS No. 111, Amendment to Statement on Auditing Standards No. 39, Audit Sampling
4 Why? The Accounting Standards Board (ASB) believes these standards are significantly more strengthened and will lead to a more quality audit product.
5 Objectives Objective is to improve the audit s effectiveness by providing: A more detailed entity-wide understanding of processes and controls A more rigorous assessment of the risks of material misstatement (either by fraud or error) in the financial statement A linkage between assessed risks and the nature, timing, i and extent t of the audit procedures performed in response to those risks.
6 Audit Benefits Enhances the use of the audit risk model in practice by requiring: A more detailed understanding of the entity, its processes, and controls Ability to default to maximum control risk is removed Improved linkage between entity risk and the resulting audit procedures performed.
7 Risk Assessment Standards Enhances the auditor s application of the audit risk model: AR = [CR x IR] x DR [CR x IR] = RMM AR = Audit Risk CR = Control Risk IR = Inherent Risk DR =Detection Risk RMM = risk of material misstatement Source: AICPA Risk Assessment Standards Presentation
8 Risk Assessment Standards Retain the use of the Internal Control Framework:
9 Risk Assessment Standards Auditors must: Assess internal control for strength and functionality Assess whether or not these controls were in use Assess the risk of material misstatement at both the financial statement level and at the assertion level.
10 Risk Assessment Standards New Assertion Framework Classes of Transactions Account Balances Presentation and Disclosures Occurrence Existence Occurrence and Rights / obligations Completeness Rights and Completeness obligations Accuracy Completeness Classification and understandability Cutoff Classification Valuation and allocation Accuracy and valuation
11 Risk Assessment Standards Audit Risk Auditor s Response Financial Statement Overall responses Account level Further Audit Procedures (Tests of fcontrols and dsubstantive ti Tests) Testing of controls is encouraged. Enhanced requirement to link risks and audit procedures in response to those risks is improved. Risk assessment as a continuous process.
12 Risk Assessment Standards Summary of Significant Changes to Existing Practices Identifying and assessing risks of material misstatement at the financial statement and the relevant assertion level. Designing and specific audit procedures based on assessed risks at the relevant assertion level. Linkage of audit procedures to the risk of material misstatement.
13 Risk Assessment Standards SAS 104 SAS 104, Amendment to SAS 1 Expands the definition of reasonable assurance to high level of assurance.
14 Risk Assessment Standards SAS 105 SAS 105, Generally Accepted Auditing Standards Amends SAS 95 Update of older terminology (e.g. Audit Evidence replaces Evidential Matter, The entity and its environment, including internal control replaces internal control.
15 Risk Assessment Standards SAS 106 SAS 106, Audit Evidence (amends SAS 31) States that the auditor must obtain significant audit evidence by performing audit procedures to give a reasonable basis for an opinion Evidence includes accounting records, confirmations, minutes, industry reports, audit procedures such as inspections and inquiries, etc.
16 Risk Assessment Standards SAS 106 Audit Procedures Risk Assessment Procedures Inquiries Analytical procedures Inspection and observation Further Audit Procedures Test of controls Substantive procedures Test of details Substantive analytical procedures
17 Risk Assessment Standards SAS 106 Assertions The use of assertions in obtaining audit evidence these are management s implicit or explicit assertions regarding the recognition, measurement, presentation and disclosure of information in the financial statements and related disclosures. Types of Assertions a. Classes of transactionsti b. Account balances c. Presentation and disclosure
18 Risk Assessment Standards SAS 107 SAS 107, Audit Risk and Materiality Amends SAS 47 The auditors should perform the audit to reduce audit risk to a low level that is (in his or her judgment) appropriate for expressing an opinion on the financial statements.
19 Risk Assessment Standards SAS 107 Risk must be assessed at the financial statement level Fraud Incompetent t management Related party transactions Risk must also be assessed at the assertion level: a. Combined risk assessment, which consists of: 1. Inherent risk 2. Control risk b. Detection risk
20 Risk Assessment Standards SAS 107 Materiality Is assessed using professional judgment Is determined in order to Perform risk assessment procedures Identify and assess risk Design/perform further audit procedures Evaluate the fair overall presentation ti of financial i statements Is assessed using benchmarks such as total revenues and net assets Is used to create tolerable misstatement, which is the amount of acceptable error.
21 Risk Assessment Standards SAS 108 SAS 108, Planning and Supervision Amends SAS 1 and SAS 22 The auditor must adequately plan the work and properly supervise all assistants. Involves Appointment of an independent auditor Preliminary engagement activities The overall audit strategy t and audit plan The planning of any specialist involvement. Any necessary additional considerations
22 Risk Assessment Standards SAS 109 SAS 109, Assessing Risks The auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to the design the nature, timing, and extent of further audit procedures.
23 Risk Assessment Standards SAS 109 Risk assessment procedures and sources of information about the entity and its internal control are: a. Inquiries b. Analytical procedures c. Observation and inspection Discussion among audit team
24 Risk Assessment Standards SAS 109 Inquiries of management may be directed toward: External parties for example, legal counsel, bankers, valuation experts, etc. Internal for example those charged with governance, internal audit, employees other than accounting personnel, in-house counsel, etc.
25 Risk Assessment Standards SAS 109 Analytical Procedures Use guidance of SAS 56, Analytical Procedures Helpful In identifying unusual transactions or events Assist in determining amounts, ratios, trends in the financial statements
26 Risk Assessment Standards SAS 109 Observation and Inspection of Documentation and manuals Internal reports and minutes Transaction tracing through systems
27 Risk Assessment Standards SAS 109 Attempting to develop an understanding the entity and its environment, including its internal control. Industry, regulatory, and other external factors Nature of the entity Objectives and strategies and the related business risks that t may result in a material misstatement of the financial statements Measurement and review of the entity's financial performance Internal control
28 Risk Assessment Standards SAS 109 Internal Controls Evaluate the design of controls relevant to the audit Determine whether or not the standards are actually in use Controls are tested using observation, inspection, or walkthroughs Inquiry alone is insufficient to evaluate control design and implementation.
29 Risk Assessment Standards SAS 110 SAS 110, Performing Procedures The auditor must obtain sufficient appropriate audit evidence through audit procedures performed to afford a reasonable basis for an opinion regarding the financial statements taken as a whole.
30 Risk Assessment Standards SAS 110 SAS No. 110 provides guidance on: Determining overall responses Designing and performing further audit procedures Overall responses may include: Exercising professional skepticism Assigning more experienced personnel Changing the timing i and extent t of audit procedures Using specialists Leads to the design of additional procedures as necessary and deemed adequate (considering the timing, nature and extent of procedures)
31 Risk Assessment Standards SAS 110 Testing Procedures Control tests may be rotated but each control should be tested at least once every three years. Controls over areas of significant risks should be tested t in the course of each audit
32 Risk Assessment Standards SAS 110 Evaluating audit evidence sufficiency and appropriateness Auditors should not assume that fraud or errors are isolated Auditors will need to determine whether tests are adequate from a reliance standpoint Documentation necessary for Procedures performed Inquiry and testing results Evidentiary conclusions
33 Risk Assessment Standards SAS 110 City of Westfield, Virginia Documentation of Budget Development Process For the fiscal year ended June 30, 2007 In December or January, requests are sent to each Department head to turn in budget requests Department Managers in each dept generate budget requests Each line item must be explained and any increases or additional positions must be justified Documentation ti Flowcharting example Budget requests and recommendations are keyed into the budget document Finance Director reviews all budget requests Departmental budget requests aretransmittedto to the Finance Director Finance Director reviews budget requests against City initiatives and revenue forecasts. Senior Purchasing Technician keys budget into accounting system from Finance Director s Document Accounting Manager Checks budget totals against Departmental requests. Finance Director forecasts 5-year revenue trends using economic data City Manager also makes recommendations on adjusting budgets in accordance with his and Council objectives Accounting Manager reviews budget entry against approved budget prior to posting Final budget posted and budget document sent to all departments. Adopted budget is keyed in by the Senior Accounting Technician Budget Supplement or Transfer? A public hearing must be held before the final budget acceptance vote. SUPPLEMENT: (passed by Council with accept and appropriate ) Budget Proposed to City Council Appropriate accountant writes up budget entry Finance Director reviews requests with each department head. Council has proposed budget at least 2 days prior to the Finance Director s presentation. Proposed budget includes each dept s request and the City Manager s recommendation Accounting Manager reviews this entry TRANSFER: Dept. Head sends transfer request to Finance Dept. Quarterly budget transfer report given to City Council A/P Accountant checks to ensure fund availability, Dept. Head approves request Senior Accounting Technician keys and posts the budget transfer A/P Accountant checks reasonability of request, and ensures fund availability for rest of year Accounting Manager reviews request, and Finance Director signs it as approved by Finance City Manager provides final approval Depending on size, depts either have G/L read-only access to their accounts or get a periodic printout. Entry keyed by Sr. Accounting Technician
34 Risk Assessment Standards SAS 111 SAS 111 Provides additional guidance regarding tolerable misstatement Should generally be less than materiality The use of sample sizes should be chosen on a statistical basis.
35 SAS 114 Auditor Communication With Those Charged With Governance Who is Charged with Governance? Person(s) with responsibility for overseeing and approving the financial reporting process Management
36 SAS 114 (cont d) What is to be communicated (before)? Overview of the planned scope and timing of the audit, significant audit findings / difficulties etc. When to communicate (after)? In a timely manner
37 Conclusions New audit standards significantly change the processes and requirements necessary for the audit process Change the methods by which audits are both planned and executed Create a need for additional preparatory efforts and preliminary fieldwork May create additional preliminary demands on client staff
38 Thank you very much. Questions?
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