All Posts by Charles Hall

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About the Author

Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses.He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events.Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.

Seven Deadly Audit Sins
Feb 26

Seven Deadly Audit Sins

By Charles Hall | Auditing

Seven deadly audit sins can destroy you.

You just completed an audit project, and you have another significant write-down. Last year’s audit hours came in well over budget, and at the time you thought, “This will not happen again.” But here it is–again.

Here are seven deadly (audit) sins that cause our engagements to fail.

Seven Deadly Audit Sins

Picture is courtesy of DollarPhotoClub.com

1. We don’t plan.

Rolling over the prior year file does not qualify as planning. Including PPC programs–though I use them myself–is not planning.

What do I mean? The engagement has not been properly scoped. We don’t know what has changed and what is required. Each year, audits have new wrinkles.

Are there any fraud rumors? Has the CFO left without explanation? Have cash balances decreased while profits increased? Does the client have a new accounting program? Can you still obtain the reports you need? Are there any new audit or accounting standards?

Anticipate issues and be ready for them.

2. SALY lives.

Elvis may not be in the house, but SALY is.

Performing the same audit steps is wasteful. Just because we needed the action ten years ago does not mean we need it today. Kill SALY. (No, I don’t mean your staff member; SALY stands for Same As Last Year).

I find that audit files are like closets; we allow old thoughts (clothes) to accumulate without purging. It’s time for a Goodwill visit. Are all of the prior audit procedures relevant to this year’s engagement?

Will better planning require us to think more in the early phases of the engagement? Yes. Is this hard work? Yes. Will it result in less thinking and effort (for the overall project)? Yes.

3. We use weak staff.

Staffing your engagement is the primary key to project success. Excellent staff makes a challenging engagement pan out well. Poor staff causes your engagement time to balloon–lots of motion, but few results.

4. We don’t monitor.

Partners must keep an eye on the project. And I don’t mean just asking, “how’s it going?” Look in the audit file. See what is going on. In-charges will usually tell you what you want to hear. They hope to save the job on the final play, but a Hail Mary pass often results in a lost game.

Charles’ maxim: Monitor that which you desire to improve.

Or as Ronald Reagan once said: Trust but verify.

5. We use outdated technology.

Are you paperless? Using portable scanners and monitors? Are your auditors well versed in Adobe Acrobat (here’s a free short course)? Are you electronically linking your trial balances to Excel documents? Do you use project management software (e.g., Basecamp)? How about conferencing software (e.g., Zoom)? Do you have secure remote access to audit files?

6. Staff (intentionally) hide problems.

Remind your staff that bad news communicated early is always welcome.

Early communication of bad news should be encouraged and rewarded (yes, rewarded, assuming the employee did not cause the problem).

Sometimes leaders unwittingly cause their staff to hide problems; in the past, we may have gone ballistic on them–now they fear the same.

7. No post-reviews.

Once our audit is complete, we should honestly assess the project. Then make a list of inefficiencies or failures for future reference.

If you are a partner, consider a fifteen-minute meeting with staff to go over the list.

Your Ideas

What do you do to keep your audits within budget?

Fraud Prevention for Small Governments
Feb 06

Fraud Prevention for Small Governments

By Charles Hall | Fraud , Local Governments

Many small governments suffer losses from theft since they lack a sufficient number of employees to segregate accounting duties. There are, however, steps you can take to protect your resources. In this post, I provide ideas for fraud prevention in small governments.

Most government officials don’t realize that external audits are not designed to detect immaterial fraud (immaterial can be tens of thousands of dollars – sometimes even more). Such officials incorrectly believe that a clean opinion means no fraud is occurring in their locale – this is a mistake. External financial statement opinion audits are not designed to look for fraud at immaterial levels. Even if your government has an external audit, consider implementing fraud prevention procedures.

Fraud Prevention for Small Governments

In a typical small government accounting setting, the city of In Between (as in between two stop lights) (population 1,202) has a mayor and three council members. The city has one bookkeeper (we’ll call him Dale) who orders and receives all purchased items; he writes all checks, reconciles bank statements, and keys all transactions into the accounting system. Dale also receipts all collections and makes all deposits. Mayor Chester signs all checks (vendor and payroll). (In a long-standing tradition, the mayor also graces the city Christmas parade float as Santa Claus.) With so little segregation of duties, what can be done?

The smaller the government, the greater the need for fraud prevention – even if Santa Claus in involved. And yet, these are the governments that most often don’t have the resources–whether the money to pay for outside assistance or employees to segregate duties–to prevent fraud. Here are few ideas for even the smallest of governments.

Low-Cost Fraud Prevention

First, let’s look at low-cost fraud prevention options:

  • Have all bank statements mailed directly to Mayor Chester who will open and inspect the bank statement activity before providing the bank statements to Dale; alternatively, provide online access to Mayor Chester who reviews bank statement activity and signs a monthly memo documenting his review
  • Once or twice a year, have council members pick two months at random (e.g., May and September) and review key bank statement activity (e.g., the operating and payroll accounts)
  • Once or twice a year, have council members randomly select checks (e.g., ten vendor checks and ten payroll checks) and review supporting documentation (e.g., invoices and time sheets)
  • Once or twice a year, have the mayor and council review receipt collections and related documentation (e.g., for two days deposits); agree receipts to bank deposits and to the general ledger
  • Provide monthly budget to actual reports to mayor and council
  • Provide monthly overtime summaries to mayor and council
  • Do not allow Dale to sign checks
  • Require two signatures on checks above a certain level (e.g., $5,000); have two of the council members (in addition to the mayor) on the bank signature cards; supporting documentation (e.g., invoice) should be provided to check signers for review
  • Require Mayor Chester and Dale to authorize any wire transfers
  • Have Dale provide the mayor with monthly bank reconciliations; the mayor should document (e.g., initial the reconciliation) his review
  • Don’t provide Dale with a credit card
  • If Dale is provided a credit card, provide him with one card; use a low maximum credit limit (e.g., $1,000); Dale’s credit card statements should be provided to the mayor when he signs the related check for payment
  • Use a centralized receipting location (if possible); receipts should always be written upon collection of a payment

Higher Cost Fraud Fraud Prevention

Now let’s examine some higher cost options (that are probably more effective):

  • Have an outside CPA or Certified Fraud Examiner (CFE) perform the receipting and payment tests listed above
  • Have an outside CPA or CFE map your internal control system and make system-design recommendations
  • Have an outside CPA or CFE make surprise unannounced visits (e.g., two per year) to examine the receipting system, payroll, and the payment system; at the beginning of the year, tell Dale that the surprise visits will occur (details of what will be tested should not be communicated to Dale)
  • Install a security camera to record all of Dale’s collection and receipting activity
  • Purchase fidelity bond to cover elected officials and Dale

Keep in mind that you can limit the cost of the outside CPA. The contract might read Surprise audit of vendor payments with cost limited to $1,500. Try to contract with a CPA or CFE with governmental experience. The surprise audits and the fidelity bond recommendations are, in my opinion, the most critical steps.

Some states like New York audit local governments for fraud; consequently, if your local government is frequently audited by a state agency, there may be less of a need to hire an outside CPA or CFE to perform fraud prevention procedures.

Additional Fraud Prevention Resources

Click here for a list of local government controls to consider.

For additional insights into preventing fraud in your government, get The Little Book of Local Government Fraud Prevention on Amazon.

Yellow Book Independence
Feb 02

Yellow Book Independence and Preparing Financial Statements

By Charles Hall | Auditing , Local Governments

Yellow Book independence is a big deal. And if you prepare financial statements in a Yellow Book audit, you need to be aware of the independence rules. Below I tell you how to maintain your independence—and stay out of hot water,

Yellow Book Independence

Yellow Book Independence Impairment in Peer Review

Suppose that--during your peer review--it is determined your firm lacks independence in regard to a Yellow Book engagement.

What could happen? Well, I can't say for sure, but I think it would be nasty. At a minimum, you would probably receive a finding for further consideration--or worse, a negative peer review report. The engagement is definitely nonconforming (not conforming to professional standards).

Then, you'd need to provide a response--explaining what you intend to do about the lack of independence. And this could get very interesting. Not where you want to be.

Preparation of Financial Statements is a Significant Threat

If you prepare financial statements (a nonattest service) for your audit client, you have a significant threat. Why? You are auditing something (the financial statements) that you created. There is a self-review threat. 

When there is a significant threat, you must use a safeguard (to lessen the threat). Such as? A second partner review. So, for example, you might have a second audit partner (someone not involved in the audit) review the financial statements. Since the second partner did not create the financial statement, the self-review threat is mitigated.

Notice the safeguard (the second partner review) is something the audit firm does--and not an action of the audit client. Therefore, it qualifies as a safeguard.

2018 Yellow Book

The 2018 Yellow Book states the following in paragraph 3.88:

Auditors should conclude that preparing financial statements in their entirety from a client-provided trial balance or underlying accounting records creates significant threats to auditors' independence, and should document the threats and safeguards applied to eliminate and reduce threats to an acceptable level...or decline to provide the services. (CPAHallTalk bolded the preceding words in this section.)

But My Client has Sufficient SKE

You've heard your audit client must have sufficient skill, knowledge and experience (SKE) and that they must oversee and assume responsibility for nonattest services. This is true and is always required when nonattest services are provided to an audit client. 

Even so, the client's SKE does not address the self-review threat

Think of the SKE issue as a minimum requirement. Do not pass "go" if the client does not assign someone (with SKE) to oversee the nonattest service. You are not independent. End of discussion. 

SKE is not a safeguard

The January AICPA Reviewer Alert distinguishes the SKE requirement from safeguards saying, "Client SKE should not be viewed as a safeguard, but rather a mandatory condition before performing any nonaudit services."

Once the client SKE issue is dealt with, consider if safeguards are necessary. If you are asked to prepare the financial statements, a second issue arises--the self-review threat. And this threat has to be addressed. A second review--whether a second partner review or an EQCR--is a good way to do so. 

The AICPA (in its AICPA Yellow Book Pratice aid) provides examples of safeguards including:

  • Obtaining secondary reviews of the nonaudit services by professional personnel who were not involved in planning or supervising the audit engagement.
  • Obtaining secondary reviews of the nonaudit services by professional personnel who were not members of the audit engagement team.

See Appendix E of the AICPA Yellow Book Practice Aid for additional examples of safeguards and how to apply them.

Independence Documentation is Required

The Yellow Book requires that your independence be documented. If it is not, a violation of professional standards exists. 

So, document the SKE of the client and the safeguards used to address significant threats. Also, document which nonattest services are signficiant threats.

Document Significant Threats

The January 2019 Reviewer Alert (an AICPA newsletter provided to peer reviewers) provides a scenario where an audit firm performs a Yellow Book audit and prepares financial statements. Then the firm has an engagement quality control review (EQCR) performed, but it does not identify the preparation of financial statements as a significant threat. The newsletter states "the engagement would ordinarily be deemed nonconforming for failure to document identification of a significant threat." So, even if a safeguard (e.g., a second partner review) is in use, the lack of documentation makes the engagement nonconforming.

In Summary

Here's the lowdown to protect your firm:

  1. Document the nonattest services you are to perform
  2. Document the client person that will oversee and assume responsibility for the nonattest service
  3. Document the SKE of the designated person
  4. Consider whether any nonattest services are significant threats 
  5. Document which, if any, nonattest services are significant threats
  6. Use (and document) a safeguard to address each significant threat (examples of safeguards include an EQCR or a second-partner review)

Looking for a tool to document Yellow Book independence? Consider the AICPA's practice aid. Here is the free PDF version. You can also purchase the fillable version here. (Cost is $39 for AICPA members.) This is the 2011 Yellow Book aid. I am thinking the AICPA will create a 2018 Yellow Book version as well. 

Excuses for unnecessary workpapers
Jan 27

Seven Excuses for Unnecessary Audit Work Papers

By Charles Hall | Auditing

Unnecessary audit work papers create clutter and can create legal problems.

I see two problems in most audit work paper files:

(1) Too much documentation, and
(2) Not enough documentation

I recently wrote a post tilted: Audit Documentation: If It’s Not Documented, It’s Not Done. Since I have already covered the “not enough documentation” issue, today we’ll look at the other problem, too much documentation.

unnecessary audit work papers

Seven Excuses for Unnecessary Audit Work Papers

Over the last thirty years, I have reviewed audit files for CPA firms and have commonly asked this question: Why is this work paper in the file?

Here are a few standard answers.

1. It was there last year.

But is it relevant this year? Resist the temptation just to copy or bring forward work papers from the prior year. Performing a proper audit entails risk assessment (e.g., walkthroughs, analytics), planning (i.e., creating an audit plan), and execution (i.e., carrying out the audit plan). Likewise, compilations and reviews should reflect current year planning and performance.

2. The client gave it to me.

For some reason, young auditors tend to put everything given to them in the file. I think they believe, “if the client gave it to me, it must be important.”

There is one reason to place documentation is the file: It provides audit evidence to support the opinion.

3. I may need it next year.

Then save it—somewhere other than the audit file—for next year. If the information does not provide current year engagement evidence, then it does not belong in the current year file.

Consider setting up a file for next year and placing next year’s information in that file. Or create a folder in the current year file titled: next year’s work papers; then move this section from the current year file as you wrap up the engagement.

4. I might need it this year.

Before going paperless (back in the days of moving work papers with a hand truck), I kept a manila folder titled: File 13. The physical folder was my hang-on-to-it-in-case-I-need-it repository.

Since my files are now paperless, I create an electronic folder titled “Recycle Bin” that sits at the bottom of my file. If I receive information that is not relevant to the current year work, I move it to the recycle bin, and while I am wrapping up the engagement, I dispose of the entire folder.

5. It’s an earlier version of an existing work paper.

Move earlier versions of work papers (e.g., initial financial statements) to your recycle bin.

6. I need it for my tax work.

Then it belongs in the tax file (unless it’s related to your attestation work – e.g., deferred taxes).

7. We missed a fraud ten years ago, so we always include these work papers.

Fraud procedures (and all procedures for that matter) should reflect the current year audit risk assessment and planning.

Closing Comments

The most important reason for minimizing work paper content is to reduce your legal exposure. Excess work papers may provide an attorney ammunition. “Mr. Hall, here’s a work paper from your own audit file that reveals fraud was occurring, and you didn’t see it?” (So don’t, for example, leave the full general ledger in your work papers.)

What are your thoughts about removing unnecessary audit work papers?

wrapping up audits
Jan 26

Wrapping Up Audits: The Why and How

By Charles Hall | Auditing

Do you ever have the almost-done illusion? You think you’re almost done, but you’re not—and you’re not even close. Frustrating! Completing audits is not easy, but—in this article—you’ll learn how to cross the finish line with applause.

wrapping up audits

What? I’m Not Done?

I remember my boss asking me, “what’s the status of the audit?” I answered, “oh, I’m about 90% done.” But actually I was—at best—75% through. Why the miscalculation? I mistakenly thought if the planning and transaction areas (e.g., cash) were complete, that I was nearly finished. I was wrong. Wrap-up takes (or least can take) a significant amount of time. 

Wrapping Up Audits — An Overview

In the final stages of an audit, we are (among other things):

  • Updating subsequent events
  • Considering going concern
  • Creating final analytics
  • Providing audit entries to the client
  • Summarizing passed journal entries
  • Reviewing the file
  • Creating financial statements
  • Completing the disclosure checklist
  • Reviewing financial statements
  • Obtaining a management representation letter
  • Creating your audit opinion
  • Creating a management letter
  • Communicating control deficiencies

There is no required order for these steps. The sequence provided below is simply my normal method.

Let’s start with subsequent events.

Updating Subsequent Events

The financial statements should disclose material subsequent events such as legal settlements, the issuance of debt, the adoption of a benefit plan, or the sale of stock. And while disclosure is important, subsequent events—such as legal settlements—can affect the year-end balance sheet. Some subsequent events trigger the accrual of liabilities.

Here are common subsequent event procedures:

  • Inquire of management and company attorneys about subsequent events
  • Review subsequent receipts and payments
  • Read the minutes created after period-end
  • Review subsequent interim financial statements
  • Review the subsequent year’s budget
  • Obtain an understanding of management’s methods for accumulating subsequent event information

In performing these procedures, obtain subsequent event information through the audit report date. 

If you’ve sent attorneys’ letters asking about potential litigation, you may need to get an update to coincide with the audit report date. You want the attorney’s written response to be as close to the audit report date as possible. How close? Usually within two weeks. If there are significant issues, you may want to bring the written response through the audit report date.

Another critical issue during wrap-up is going concern.

Considering Going Concern

Even in the planning stage, auditors should consider going concern, especially if the entity is struggling financially. But as you approach the end of the audit, going concern should crystallize. Now you have your audit evidence, and it’s time to determine if a going concern opinion is necessary. Also, consider whether going concern disclosures are sufficient. If substantial doubt is present, then the entity should include going concern disclosures (even if substantial doubt is alleviated by management’s plans).

And what is substantial doubt? The Financial Accounting Standards Board defines it this way:

Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.

So, for nongovernmental entities, ask “Is it probable that the company will meet its obligations for one year from the opinion date?” If it is probable that the entity will meet its obligations, then substantial doubt does not exist. If it is not probable that the entity will meet its obligations, then substantial doubt exists.

And what is the period of time to be considered when assessing going concern? One year from the audit report date—unless the entity is a government. If the entity is a government, then the evaluation period is one year from the financial statement date (though this period can lengthen in certain circumstances).

The going concern evaluation is one that management makes as it considers whether disclosures are necessary. 

Then the auditor considers going concern from an audit perspective. If substantial doubt is present, the auditor issues a going concern opinion. Also, if going concern disclosures are incorrect or inadequate, the auditor may need to modify the opinion.

Wrap-up also includes the creation and review of final analytics.

Creating Final Analytics

Auditors create planning analytics—the comparison of key numbers—early in the audit. Why? To look for the risk of material misstatement. Unexpected changes in numbers are indicators of potential error or fraud. They create questions. When unexpected variations exist, auditors plan procedures to test why. 

wrapping up audits

So, what is the purpose of final analytics? To determine whether unanswered questions still exit. Auditors want to know, given the audit evidence in hand, that the numbers are fairly stated.

What analytics should you use? Audit standards don’t specify particular analytics. Some auditors read the financial statements (when comparative periods are presented). Others review key ratios. And some compare current year trial balance numbers with the prior year. 

My final analytics are often the same as those in the beginning. For example, if my planning analytics include a comparison of trial balance numbers, so will my final analytics. Why do I use the same analytics? I want to know that the questions raised in the beginning are now answered. 

In creating analytics, consider the numbers important to your client. Many auditors—in an exit conference—provide key analytics to management and board members, such as performance indicators or liquidity ratios. Consider whether these numbers should be a part of your final (and planning) analytics. 

Now, you are ready to provide your proposed audit entries.

Providing Audit Entries to the Client

Give your audit entries to your client. Hopefully, you discussed these adjustments with your client when you discovered them. If you did, this part is easy. You’re just giving your client the entries. If not, review the proposed adjustments with the client and see if they agree.

Your client may desire to pass on (not post) some immaterial entries. 

Summarizing Passed Journal Entries

Prior to creating the representation letter, the auditor needs to summarize passed journal entries. Why? Audit standards require management to provide a written assertion regarding whether the uncorrected misstatements are material. The summary assists in that determination. 

Once you summarize the uncorrected misstatements, you should consider whether they are material. Review your audit materiality and consider whether the passed adjustments are acceptable. If material uncorrected misstatements exist, consider the effect on your opinion.

In addition to all of the above, you need to review the audit file to make sure everything is in order. 

Reviewing the File

Perform your final review of the work papers and sign off as the reviewer. All preparer and reviewer dates must precede or coincide with the representation letter date (which is the opinion date). Why? Reviews are a part of your evidential matter. Documentation—including reviews—must exist no later than the opinion date. 

See my article titled Seven Excuses for Unnecessary Audit Work Papers.

Once the audit file is ready, it’s time to create the financial statements (if you’ve been engaged to do so).

Creating Financial Statements

Larger entities usually create their own financial statements, but smaller organizations sometimes outsource this work to their auditors. 

wrapping up audits

If the auditor creates the financial statements, the following needs to occur:

  • The audit firm creates the financial statements.
  • The audit firm reviews the financial statements 
  • The client reviews the financial statements 

If you (the auditor) are engaged to create the financial statements, complete them on time. Why? Management must read and take responsibility for the financial statements prior to signing the representation letter. 

Also, the auditor’s review of the financial statements needs to be completed prior to the date of management’s representation letter. Why? All evidential matter, including the audit firm’s review of the financial statements, must be complete before the opinion is issued.

So, management and the auditor must review the financial statements before the opinion is issued. We’ll discuss the financial statement review process for auditors in a moment, but before we do, let’s take a look at completing the disclosure checklist.

Completing the Disclosure Checklist

Whether you or your client creates the financial statements, a disclosure checklist helps ensure the completeness and propriety of the notes. Remember your audit opinion covers the financial statements and the disclosures. 

Since new accounting standards are issued throughout the year, make sure you use a current checklist. Otherwise, you may not be aware of new or amended disclosure requirements.

Now it’s time to review the financial statements.

Reviewing Financial Statements

If your audit firm creates the financial statements, at least two people should be involved—one creating and one reviewing. Why? Two reasons: (1) the self-review threat (an independence issue) and (2) blind spots.

So, what is a self-review threat? It’s the idea that the person creating something (e.g., the financial statements) will not be independent in reviewing the same. Why is this a problem? Well, we are issuing an independent auditor’s opinion. That’s why we need a second-person review of the financial statements—to mitigate the self review threat.

Additionally, a second-person review is useful in overcoming blind spots. If I create financial statements with errors, I may not see my own mistakes. I have a blind spots. Such errors are often readily apparent to a second person.

See my  post about reviewing financial statement on a computer screen.

Once the financial statements have been prepared and reviewed by your audit firm and your client, it’s time to obtain the management representation letter. 

Obtaining a Management Representation Letter

The management letter is usually prepared by the audit firm and is provided to the client for signing. In the letter, the client is making certain assertions regarding issues such as the following:

  • Management’s responsibility for the financial statements
  • Management’s responsibility for internal controls
  • Assurances that all transactions have been recorded
  • Whether known fraud has occurred
  • Whether known non-compliance with laws or regulations occurred
  • The effects of uncorrected misstatements
  • Litigation
  • The assumptions used in computing estimates
  • Related party transactions
  • Subsequent events
  • Supplementary information
  • Responsibility for nonattest services

The representation letter should cover all financial statements and periods referred to in the auditor’s report. If management refuses to provide the management letter, then consider the effect upon the auditor’s report. Such a refusal constitutes a scope limitation and will usually preclude the issuance of an unmodified opinion.

Another part of wrap-up is creating your audit opinion.

Creating Your Audit Opinion

You’ve planned and performed your audit. 

Now you need to consider the type of opinion you’ll issue. If an unmodified opinion is merited, no problem. Use the standard opinion. But if you are going to qualify the opinion, or issue a disclaimer or adverse opinion, there’s more work to be done. Additionally, sometimes you need to add an emphasis-of-matter paragraph or an other-matter paragraph to your opinion.

wrapping up audits

Determine which opinion is appropriate. Most CPAs use sample reports from national publishing companies. Others use sample reports directly from the auditing standards. Regardless, place a copy of the sample report in your audit file. Why? Your peer reviewer—or someone else—might question your report language. Responding to such questions is much easier with the sample report in hand.

Create your opinion and have a second person review the report, comparing the opinion to the sample report. Check and recheck your wording.

Another consideration in wrap-up is whether you’ll issue a management letter. 

Creating a Management Letter

While not required, you can provide a written management letter to your audit client. Why would you do so? To add value to the audit. 

What is a management letter? Suggestions for improving the business. 

What should you include in the letter? It’s up to you (and dependent upon your observations during the audit), but here are a few examples:

  • Suggested monthly reports for the owners or management
  • Warnings regarding cyber attacks and prevention techniques
  • A suggestion that excess cash be used to pay off high interest rate debt
  • Procurement and bidding recommendations
  • A suggestion that security cameras be installed
  • Software recommendations 
  • A recommendation that all equipment be physically inspected and reconciled to the property ledger 
  • A suggestion that the company review its property insurance coverage
  • Best practices for the implementation of new accounting standards

If you provide a management letter, give the client a draft prior to issuance. Why? To avoid the embarrassment of making inappropriate suggestions—maybe they’ve already done what you are suggesting, for example. 

In addition to the management letter, you may also need to communicate significant deficiencies and material weaknesses.

Communicating Control Deficiencies

Audit standards define significant deficiencies and material weaknesses as follows:

  1. Significant deficiency. A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.
  2. Material weakness. A deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented, or detected and corrected, on a timely basis.

Auditing standards require a written communication of significant deficiencies and material weaknesses.

Control deficiencies are often noted during the risk assessment process, particularly as you perform walkthroughs. 

You may also note control weaknesses as you prepare audit journal entries, especially if the adjustments are material. Errors are usually the result of weak internal controls.

Regardless of how you become aware of the control weaknesses, capture them immediately. Otherwise, you may forget them later on. Also, if control weaknesses are material, you may need to communicate them to management when they are discovered (and again at the completion of the audit).

During wrap-up, you create your internal control letter based on the weaknesses noted during the audit.

Consider providing a draft of the internal control letter to management prior to final issuance. Why? To avoid potential misunderstandings. If there’s a disagreement between the client and the auditor, it’s best to clear the issue prior to final issuance of the internal control letter.

One other suggestion: if there are sensitive issues, the senior audit team member (usually the engagement partner) should make this communication. It’s a time to speak the truth with tactfulness—and experience helps.

I started this chapter by saying that wrap-up can take a significant amount of time. As we have seen, there is much to be done in this closing stage of the engagement. 

Wrapping Up Audits - A Simple Summary

  • Perform subsequent event procedures to ensure that all relevant information is included in the financial statements 
  • Consider whether going concern disclosures are necessary and, if required, complete; also consider the need for a going concern opinion
  • Create final analytics and determine if all significant variations in the numbers have been addressed
  • Provide proposed audit entries to the client 
  • Summarize and review all passed journal entries to ensure that material misstatements are not present
  • Review the work paper file 
  • Create the financial statements (if you have been engaged to do so)
  • Complete a current disclosure checklist
  • Review the financial statements 
  • Obtain a signed management representation letter 
  • Create your audit opinion 
  • Create a management letter 
  • Communicate significant deficiencies and material weaknesses 

There you have it: the wrap-up process. Now, when your boss asks, “what’s the status of the audit?” you can say, “I’m at 90 percent”—and be sure of it.

This post is a part of a series of articles title The Why and How of Auditing. Check it out. The series is being compiled into a book that will soon be sold on Amazon--but it's free here. 

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