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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.

Apr 08

How to Document the Use of a Specialist

By Charles Hall | Auditing

As an auditor, you often use the work of specialists such as actuaries, appraisers, and engineers. Such work can seem mystical, like something conjured up from a mathematical soup. And since we don’t always understand their incantations, we wonder, “Can we rely on the information?” Thankfully, the audit standards provide guidance.

Picture is courtesy of DollarPhotoClub.com

Picture is courtesy of DollarPhotoClub.com

A specialist can be hired by your audit firm or by management. If you audit banks, you might hire an appraiser to assist with loan collateral reviews–an example of an auditor’s specialist. If your client uses an actuary, then you will obtain audit evidence from a specialist hired by management. As we begin our look into the use of specialists, let’s define the terms auditor’s specialist and management’s specialist.

Definitions

AU-C 620 provides the following definitions:

Auditor’s specialist. An individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence. An auditor’s specialist may be either an auditor’s internal specialist (who is a partner or staff, including temporary staff, of the auditor’s firm or a network firm) or an auditor’s external specialist.

Management’s specialist. An individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements.

Now let’s take a look at audit considerations for both the auditor’s specialist and management’s specialist.

Use of Auditor’s Specialist

AU-C Section 620–Using the Work of an Auditor’s Specialist provides guidance on the use of an auditor’s specialist.

Is the Specialist Needed?

AU-C 620.07 states, “If expertise in a field other than accounting or auditing is necessary to obtain sufficient appropriate audit evidence, the auditor should determine whether to use the work of an auditor’s specialist.” Before using the services of a specialist, consider the significance of the information for which you might need a specialist. If the (specialist) information has little impact on the financial statements, then the specialist issue will be of less importance.

Specialist Considerations

AU-C 620.09 says, “The auditor should evaluate whether the auditor’s specialist has the necessary competence, capabilities, and objectivity for the auditor’s purposes.” So if you hire an investment pricing specialist, you want to know if she is reputable, what her experience is, whether she can perform the work appropriately, and whether she can be objective.

Auditor's Specialist

Picture is courtesy of Adobe Stock

According to AU-C 620.A16, information regarding the competence, capabilities, and objectivity of an auditor’s specialist may come from the following:

  • Personal experience with previous work of that specialist
  • Discussions with that specialist
  • Discussions with other auditors or others who are familiar with that specialist’s work
  • Knowledge of that specialist’s qualifications, membership in a professional body or industry association,   license to practice, or other forms of external recognition
  • Published papers or books written by that specialist
  • The quality control policies and procedures of the auditor’s firm and such other procedures the auditor considers necessary in the circumstances

If you’ve previously worked with the aforementioned pricing specialist, you have personal experience with her work. This helps. You might call her with regard to current year issues, and since you already know her, you probably already know her qualifications.

Regarding objectivity, the auditor should inquire about any relationships that the specialist may have with the client, and if necessary, obtain a signed representation letter– from the specialist–concerning their objectivity. Continuing with our pricing specialist illustration, you want to ask her if she has any business relationships with the auditee. Are there any family relationships? Is there any reason her objectivity might be lessened?

Engagement Letter with Specialist

Does the audit firm need an engagement letter with its specialist?

Though not required, the auditor can use a written engagement letter to define the work of the specialist. AU-C 620.A45 provides suggestions for the engagement letter as follows:

  • Nature, Scope, and Objectives of the Auditor’s External Specialist’s Work
  • The Respective Roles and Responsibilities of the Auditor and the Auditor’s External Specialist
  • Communications and Reporting
  • Confidentiality

When an engagement letter is not used, document the work of the specialist in a memorandum or other audit work papers such as an audit program.

Adequacy of the Specialist’s Work

Auditors must evaluate the adequacy of the specialist’s work.

AU-C 620.12 says:

The auditor should evaluate the adequacy of the work of the auditor’s specialist for the auditor’s purposes, including:

  1. The relevance and reasonableness of the findings and conclusions of the auditor’s specialist and their consistency with other audit evidence.
  2. If the work of the auditor’s specialist involves the use of significant assumptions and methods,
    • obtaining an understanding of those assumptions and methods and
    • evaluating the relevance and reasonableness of those assumptions and methods in the circumstances, giving consideration to the rationale and support provided by the specialist, and in relation to the auditor’s other findings and conclusions.
  3. If the work of the auditor’s specialist involves the use of source data that is significant to the work of the auditor’s specialist, the relevance, completeness, and accuracy of that source data.

Bottom line: Does the work of the specialist provide sufficient and appropriate audit evidence with regard to the issue at hand (e.g., investment pricing)?

When to Start Thinking About a Specialist

When should an auditor begin to think about the use of a specialist? Before the engagement is accepted. Why? If we accept an audit without the necessary skill sets, we have a problem. As we consider our acceptance of an audit, we should consider if there is a need to hire a specialist–and whether such a specialist is available at a reasonable price.

Reference to a Specialist in an Auditor’s Opinion

AU-C 620.14-15 says the following about references to a specialist’s work in an audit opinion:

The auditor should not refer to the work of an auditor’s specialist in an auditor’s report containing an unmodified opinion.

If the auditor makes reference to the work of an auditor’s external specialist in the auditor’s report because such reference is relevant to an understanding of a modification to the auditor’s opinion, the auditor should indicate in the auditor’s report that such reference does not reduce the auditor’s responsibility for that opinion.

What does this mean? Regardless of the use of a specialist, the opinion is the auditor’s (and not the specialist’s). We may use the specialist’s work as audit evidence, but the audit opinion is ours.

The audit standards do allow auditors to reference the work of a specialist when the opinion is modified, but if you do so, get the specialist’s permission (consider getting written authorization).

Confidentiality Language in the Client Engagement Letter

When an auditor hires an external specialist, should the audit engagement letter change?

Picture is courtesy of AdobeStock

Picture is courtesy of AdobeStock

When an audit firm hires an external specialist, the firm should follow the Code of Conduct section ET 1.700.040, Disclosing Information to a Third-Party Service Provider. How can you comply with this ethical requirement? By including additional language in your engagement letter advising the client that you might provide confidential information to an outside party; in effect, you are gaining consent to share client information. If you are not using an outside specialist, but someone who works for your firm, then no such consent is necessary.

Use of Management’s Specialist

AU-C Section 500–Audit Evidence provides guidance on the use of information from management’s specialist.

Your audit client might use their own specialist such as a pension plan actuary. To rely on the actuary, you need to know if she is competent and objective. You also need to understand–at least in a general sense–what the actuary is doing.

Specialist Considerations

AU-C 500.08 states:

If information to be used as audit evidence has been prepared using the work of management’s specialist, the auditor should, to the extent necessary, taking into account the significance of that specialist’s work for the auditor’s purposes,

  1. evaluate the competence, capabilities, and objectivity of that specialist;
  2. obtain an understanding of the work of that specialist; and
  3. evaluate the appropriateness of that specialist’s work as audit evidence for the relevant assertion.

AU-C 500.A39 provides the following insights into evaluating competence, capabilities, and objectivity:

Information regarding the competence, capabilities, and objectivity of management’s specialist may come from a variety of sources, such as the following:

  • Personal experience with previous work of that specialist
  • Discussions with that specialist
  • Discussions with others who are familiar with that specialist’s work
  • Knowledge of that specialist’s qualifications, membership in a professional body or industry association, license to practice, or other forms of external recognition
  • Published papers or books written by that specialist

Representation Letter

Exhibit B of AU-C 580, Written Representations, provides the following example of language that an auditor might include in the representation letter:

We agree with the findings of specialists in evaluating the [describe assertion] and have adequately considered the qualifications of the specialists in determining the amounts and disclosures used in the financial statements and the underlying accounting records. We did not give or cause any instructions to be given to specialists with respect to the values or amounts derived in an attempt to bias their work, and we are not otherwise aware of any matters that have had an effect on the independence or objectivity of the specialists.

Conclusion

So how do you document your use of a specialist? As you can tell, the audit standards provide a framework, and the documentation will vary depending on the type of specialist used and the importance of the information. At a minimum, consider documenting:

  1. Why you need the specialist (or their work product)
  2. The abilities, reputation, and experience of the specialist
  3. The objectivity of the specialist
  4. The adequacy of the work provided

At the end of the day, auditing is all about obtaining reasonable assurance by obtaining audit evidence. As you consider the use of a specialist, ask yourself how their work impacts your risk assessment, your audit procedures, and finally your opinion.

Feb 24

Group Audit Standards Applicability When One Firm Audits Consolidated Financial Statements?

By Charles Hall | Auditing

Do the group audit standards apply when one firm audits all of the entities comprising a consolidated whole?

Yes.

You say, “confusing.” I say, “I agree.”

The confusion–at least for me–lies in the pre-clarity auditing standard, AU 543, Part of Audit Performed by Other Independent Auditors, which focused on who was performing the audit. The clarity standard, AU-C 600 Special Considerations — Audits of Group Financial Statements, focuses on what is being audited. The word group (as applied to the group audit standards) does not mean more than one auditor.

Regarding applicability (of the group audit standards), we look at the entities and business activities being audited rather than how many audit firms are involved. We used to focus on the interaction with other auditors; now we focus on the risks associated with the group financial statements.

Businessman holding a transparent screen with an inscription a auditing. Business, technology, internet and networking concept.

The picture is courtesy of DollarPhotoClub.com.

Group Audit Standards When There is Only One Audit Firm

The AICPA’s Technical Questions and Answers (8800.24) says the following about the applicability of AU-C Section 600 (Audits of Group Financial Statements) when only one engagement team is involved:

Inquiry—Company X consolidates the operations of Entity A. The same group engagement team that audits Company X also audits Entity A. Because only one engagement team is involved, does AU-C section 600 apply? If so, what does AU-C Section 600 require that is not already covered by other auditing standards?

ReplyAU-C section 600 applies to all audits of group financial statements, which are financial statements that contain more than one component. In the circumstances when the same engagement team audits all components of the group, the considerations addressed in AU-C Section 600 that relate to component auditors are not relevant. However, considerations addressed in AU-C section 600, such as understanding the components; identifying components that are significant due to individual financial significance and the significant risk of material misstatement; determining component materiality; understanding the consolidation process; and addressing the risks, including aggregation risk, of material misstatement in the group financial statements; are relevant in all group audits.

What does this mean?

If your firm audits consolidated financial statements, then the group audit standards apply, and you do need to comply with certain provisions (even though your firm audits all entities included in the consolidation). Consequently, you have some additional documentation requirements. Your audit file should contain the following documentation:

  • Your understanding of the components
  • Your identification of significant components (due to financial significance or risk)
  • Component materiality
  • Your understanding of the consolidation process
  • How you plan to address the identified risk of material misstatement (including aggregation risk)

Group Financial Statements

What are group financial statements? They are statements that include the financial information of more than one component.

Here are examples of components:

  • Subsidiaries
  • Geographical locations
  • Divisions
  • Investments (equity method)
  • Products or services
  • Component units of a state or local government

You can see from these examples of components, the concept of group financial statements is broader than that of consolidated or combined financial statements.

The idea behind the group audit standards is to highlight the risk of material misstatement whether at the group level or a lower level. If for example, a component is not financially significant but it has particularly risky assets (e.g., derivatives), then the group audit standards direct our attention here.

Examples of When Group Audit Standards are Applicable

Here are examples of when the group audit standards are in play:

  • Consolidated subsidiary
  • Combined financial statements due to common control
  • Investment accounted for using the equity method
  • Consolidated affiliate (due to variable-interest considerations)

Notice we made no mention of other auditors in these examples. It is possible that another firm may audit a subsidiary (for example), but this factor is not the determinant of when the group audit standards apply.

Single Audit under the Uniform Guidance
May 04

Single Audits under the Uniform Guidance

By Charles Hall | Accounting and Auditing , Local Governments

Recently I listened to the AICPA Governmental Audit Quality Center (GAQC) webcast titled: Uniform Guidance for Federal Awards: Auditor Planning Considerations for the New Single Audit Rules.

The presenters, Diane Edelstein, Mandy Nelson, and Mary Foelster, did a great job in providing helpful information. I made a few summary notes that are presented below; the notes are not intended to be comprehensive. The GAQC archived the presentation on their website.

Single Audit under the Uniform Guidance

Applicability of Uniform Guidance

Here’s a summary of when the new guidance is applicable.

Type of EntityEffective Date
Federal AgenciesMust implement policies and procedures by issuing regulations to be effective December 26, 2014 (accomplished with the issuance of the Joint Interim Final Rule)
Non-federal EntitiesImplement the new administrative requirements and cost principles for all new Federal awards made after December 26, 2014, and to additional funding related to existing awards ("increments") made after that date
AuditorsAudit requirements are effective for fiscal years beginning on or after December 26, 2014 (early implementation not permitted)

Continue reading

deferred inflows and deferred outflows
Oct 24

GASB 63 and 65 (Deferred Outflows and Deferred Inflows) – A Summary

By Charles Hall | Accounting , Local Governments

GASB 63 and 65 provide guidance regarding deferred outflows and inflows in governments. This article provides an overview of those standards.

  • Statement No. 63 – Financial Reporting of Deferred Outflows of Resources, Deferred Inflows of Resources, and Net Position
  • Statement No. 65 – Items Previously Reported as Assets and Liabilities

deferred inflows and deferred outflows

 

What are the effective dates for Statements 63 and 65?

  • GASBS 63 is effective for periods beginning after December 15, 2011; earlier application encouraged
  • GASBS 65 is effective for periods beginning after December 15, 2012; earlier application encouraged

It is best to implement GASBS 63 and 65 at the same time.

What is the purpose of these changes?

To put it succinctly, GASB is using one of its conceptual statements (specifically Concepts Statement 4) to make revisions to reporting requirements (to include deferred outflows and deferred inflows).

Prior to GASBS 63 and 65, debit balances were reported on the statement of net position (balance sheet) as assets; similarly, all non-equity credits were reported as liabilities. The new standards add deferred outflows and deferred inflows to the mix.

All debit balances in the statement of net position will be reported as:

  • Assets
  • Deferred Outflows

Assets represent present service capacity to the government; deferred outflows (e.g., prepaid bond insurance) represent the consumption of net position applicable to future reporting periods.

Liabilities represent amounts to be paid; however, some amounts previously reported as liabilities (e.g., deferred property taxes) involve no future payment. Consequently, with the implementation of GASB 63, all non-equity credits in the statement of net position will be reported as:

  • Liabilities
  • Deferred Inflows

The difference in liabilities and deferred inflows is primarily resources that are going out and resources that are coming in. Liabilities normally represent a future surrender of resources; deferred inflows do not.

What are the main points of GASB 63?

This statement distinguishes assets from deferred outflows of resources and liabilities from deferred inflows of resources.

Additionally, many of your financial statement titles (e.g., Statement of Net Position), categories (e.g., Assets and Deferred Outflows of Resources), and notes will change. Net Assets will now be labeled Net Position.

The five elements of the statement of net position are:

  1. Assets
  2. Deferred Outflows of Resources
  3. Liabilities
  4. Deferred Inflows of Resources
  5. Net Position

The three categories of net position are:

  1. Net Investment in Capital Assets
  2. Restricted
  3. Unrestricted

Note – The requirement to change to a statement of net position (rather than a statement of net assets) – a GASBS 63 change – occurs one year earlier than the requirements of GASBS 65; you are required to change the term net assets to net position even though you may not have any deferred outflows or inflows until GASBS 65 is implemented – possibly a year later. Again it is easier to simply implement both GASBS 63 and 65 at the same time (both can be early adopted).

What are the main points of GASB 65?

  • It identifies the specific items to be categorized as deferred inflows and deferred outflows.
  • It clarifies the effect of deferred inflows and deferred outflows on the major fund determination.
  • It limits the use of the term deferred in financial statements.

What are some examples of specific items to be categorized as deferred inflows and deferred outflows?

  • The gain or loss from current or advance refundings of debt (the gain or loss will no longer be netted with the related debt but will be shown separately as a deferred outflow or a deferred inflow)
  • Prepaid insurance related to the issuance of debt
  • Property taxes received or accrued prior to the period in which they will be used

How should debt issuance costs be treated?

Debt issuance costs should be expensed when incurred. GASB concluded that debt issuance costs do not relate to future periods, and, therefore, should be expensed.

If your government has debt issuance costs (recorded as assets), you will need to remove them as you implement these standards (using a prior period adjustment).

How should cash advances related to expenditure-driven grants be recorded?

Cash advances from expenditure-driven grants should be recorded as unearned revenue (a liability). The key eligibility requirement for an expenditure-driven grant is the use of funds (which does not occur until funds are spent). Any grant funds received prior to meeting eligibility requirements will be shown as a liability. It is improper to use the word deferred for this line item; for example, deferred revenue is not appropriate. The more appropriate title is unearned revenue.

How do these standards affect the determination of major funds?

Assets should be combined with deferred outflows of resources and liabilities should be combined with deferred inflows of resources for purposes of determining which elements meet the criteria for major fund determination.

Sep 11

Yellow Book CPE Requirements – A Summary

By Charles Hall | Accounting and Auditing , Local Governments

What are the requirements for Yellow Book continuing professional education (CPE)?

Below we will address (1) who is subject to the Yellow Book CPE requirements and (2) what CPE classes satisfy those requirements.

Yellow Book CPEOverview

First realize there are two rules:

  1. The 80-hour rule (every two years)
  2. The 24-hour rule (every two years)

Then you must answer:

  1. Who is subject to each rule?
  2. What classes qualify for each rule?

The 24 Hour Rule – Who is Subject?

The answer: each auditor performing work on a Yellow Book audit; if as an auditor you work on the engagement, you are subject to this rule. If your audit report contains a Yellow Book report (usually located just after the notes to the financial statements), then that engagement is subject to generally accepted government auditing standards (GAGAS).

The 80-Hour Rule – Who is Subject?

The answer: Auditors who are involved in any amount of:

1. Planning,
2. Directing, or
3. Reporting on GAGAS assignments
and
4. Those auditors who are not involved in those activities but charge 20 percent or more of their time annually to GAGAS assignments.

I interpret 1., 2. and 3. as mainly partners, managers, and in-charges. 4. relates to staff who support the audit.

So a staff person that does not meet the criteria in 4., but still works on a Yellow Book engagement must still satisfy the 24-hour rule (but not the 80-hour rule).

What Classes Qualify?

The Yellow Book states, “Determining what subjects are appropriate for individual auditors to satisfy both the 80-hour and the 24-hour requirements is a matter of professional judgment to be exercised by auditors in consultation with appropriate officials in their audit organizations.”

First we see that there is judgment in what qualifies (no bright yellow lines). But there are differences in the 80-hour rule and the 24-hour rule; otherwise, there would be only one category.

The 80-Hour Rule – Classes that Qualify

The 80-hour rule is broad (encompassing any CPE that enhances the auditor’s professional proficiency); so, for example, CPE classes about writing skills or using Excel would qualify. (Taxation CPE usually does not qualify unless the class addresses audit-related issues. For example, a 1040 tax class does not qualify.)

For those subject to the 80 hour rule, at least 20 hours of CPE should be taken in each year of the two-year period; a total of 80 hours is to be taken in the two-year period.

The 24-Hour Rule – Classes that Qualify

Each auditor performing work under GAGAS should complete, every 2 years, at least 24 hours of CPE that directly relates to government auditing, the government environment, or the specific or unique environment in which the audited entity operates.

The 24-hour rule is specific to:
(1) Government auditing,
(2) The government environment or
(3) To the specific or unique environment in which the audited entity operates.

Government Auditing

Classes directly related to standards used in governmental auditing qualify; since GAGAS incorporates the AICPA statements on auditing standards (SASs) for field work and reporting, then audit classes that include a study of the SASs as they relate to the audit of your governmental entity would qualify. The same is true of pronouncements issued by the FASB. Single Audit classes also obviously qualify.

Government Environment

CPE dealing with Governmental Accounting Standards (GASB pronouncements) will qualify for the 24-hour rule since the class focuses on accounting standards in the government environment.

If you audit a county or a city, then most any CPE dealing with GASB pronouncements or governmental issues (e.g., sales taxes) will satisfy the 24-hour rule; also classes dealing with compliance with laws and regulations qualify.

Classes addressing economic conditions, fiscal trends, and pressures facing the governmental entity qualify.

Specific or Unique Environment in Which the Audited Entity Operates

Suppose you audit electric membership corporations (EMCs) subject to the Yellow Book; a CPE class about electrical supply grids qualifies. Or if you audit banks subject to Yellow Book requirements (e.g., FHA loans), then a CPE class dealing with lending qualifies. These classes address issues in the unique environment in which the audited entity operates.

Two-Year Cycle

An audit organization can adopt a standard 2-year period for all of its auditors to simplify administration of the CPE requirements.

Carryover Credit

Auditors are not allowed to carry over hours taken in excess of the 24-hour or 80-hour rule to the next reporting period.

Proration of Hours for New-Hires (or Those Newly Assigned to a Yellow Book Audit)

You will prorate the hourly requirements based on the remaining 6-month intervals in your two-year reporting period. For example, you hire someone on May 1, 2013 and your two-year cycle ends December 31, 2013. There is only one remaining 6-month period. If you are subject to the 24 hour rule, then you will multiply 25% (one six-month period divided by the four six-month periods in the two-year cycle) times 24 to compute the hours required: 6 hours.

GAO Guidance

Click here for the April 2005 GAO publication: Government Auditing Standards, Guidance on GAGAS Requirements for Continuing Professional Education.

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