The Government Accountability Office just issued the new Yellow Book titled Government Auditing Standards 2018 Revision.
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An electronic version of the 2018 Yellow Book can be accessed on GAO’s Yellow Book web page at http://www.gao.gov/yellowbook.
Major Changes
The introduction to the new Yellow Book summarizes the significant changes as follows:
This revision contains major changes from, and supersedes, the 2011 revision. These changes, summarized below, reinforce the principles of transparency and accountability and strengthen the framework for high quality government audits.
All chapters are presented in a revised format that differentiates requirements and application guidance related to those requirements.
Supplemental guidance from the appendix of the 2011 revision is either removed or incorporated into the individual chapters.
The independence standard is expanded to state that preparing financial statements from a client-provided trial balance or underlying accounting records generally creates significant threats to auditors’ independence, and auditors should document the threats and safeguards applied to eliminate and reduce threats to an acceptable level or decline to perform the service.
The peer review standard is modified to require that audit organizations comply with their respective affiliated organization’s peer review requirements and GAGAS peer review requirements. Additional requirements are provided for audit organizations not affiliated with recognized organizations.
The standards include a definition for waste.
The performance audit standards are updated with specific considerations for when internal control is significant to the audit objectives.
Effective with the implementation dates for the 2018 revision of Government Auditing Standards, GAO is also retiring Government Auditing Standards: Guidance on GAGAS Requirements for Continuing Professional Education (GAO-05-568G, April 2005) and Government Auditing Standards: Guidance for Understanding the New Peer Review Ratings (D06602, January 2014).
Effective Dates
The 2018 revision of Government Auditing Standards is effective for financial audits, attestation engagements, and reviews of financial statements for periods ending on or after June 30, 2020, and for performance audits beginning on or after July 1, 2019.
Early implementation is not permitted.
The 2018 revision of Government Auditing Standards supersedes the 2011 revision (GAO-12-331G, December 2011), the 2005 Government Auditing Standards: Guidance on GAGAS Requirements for Continuing Professional Education (GAO-05-568G, April 2005), and the 2014 Government Auditing Standards: Guidance for Understanding the New Peer Review Ratings (D06602, January 2014).
Are you preparing financial statements and wondering whether you need to include going concern disclosures? Or maybe you’re the auditor, and you’re wondering if a going concern paragraph should be added to the audit opinion. You’ve heard there are new requirements for both management and auditors, but you’re not sure what they are.
This article summarizes (in one place) the new going concern accounting and auditing standards.
Going Concern Standards
For many years the going concern standards were housed in the audit standards–thus, the need for FASB to issue accounting guidance (ASU 2014-15). It makes sense that FASB created going concern disclosure guidance. After all, disclosures are an accounting issue.
Going Concern Accounting Standard
ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, provides guidance in preparing financial statements. This standard was effective for years ending after December 15, 2016.
GASB Statement 56, Codification of Accounting and Financial Reporting Guidance Contained in the AICPA Statements on Auditing Standards, is the relevant going concern standard for governments. GASB 56 was issued in March 2009. (GASB 56 requires financial statement preparers to evaluate whether there is substantial doubt about a governmental entity’s ability to continue as a going concern for 12 months beyond the date of the financial statements. As you will see below, this timeframe is different from the one called for under ASU 2014-15. This post focuses on ASU 2014-15 and SAS 132.)
Meanwhile, the Auditing Standards Board issued their own going concern standard in February 2017: SAS 132.
Going Concern Auditing Standard
Auditors will use SAS 132, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern, to make going concern decisions. This SAS is effective for audits of financial statements for periods ending on or after December 15, 2017. SAS 132 amends SAS 126, The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern.
So, let’s take a look at how to apply ASU 2014-15 and SAS 132.
Two Going Concern Decisions
In the past, the going concern decisions were made by auditors in a single step. Now, it is helpful to think of going concern decisions in two steps:
Management decisions concerning the preparation of financial statements
Auditor decisions concerning the audit of the financial statements
First, we’ll consider management’s decisions.
1. Management Decisions about Going Concern Accounting
ASU 2014-15 provides guidance concerning management’s determination of whether there is substantial doubt regarding the entity’s ability to continue as a going concern.
What is the Going Concern Accounting Definition?
FASB defines going concern with the words substantial doubt. So, how does FASB define substantial doubt?
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.
What is Probable?
So, how does management determine if “it is probable that the entity will be unable to meet obligations when due within one year”?
Probable means likely to occur.
If for example, a company expects to miss a debt service payment in the coming year, then substantial doubt exists. This initial assessment is made without regard to management’s plans to alleviate going concern conditions.
ASC 205-40-50-4 says:
The evaluation initially shall not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date that the financial statements are issued (for example, plans to raise capital, borrow money, restructure debt, or dispose of an asset that have been approved but that have not been fully implemented as of the date that the financial statements are issued).
But what factors should management consider?
Factors to Consider
Management should consider the following factors when assessing going concern:
The reporting entity’s current financial condition, including the availability of liquid funds and access to credit
Obligations of the reporting entity due or new obligations anticipated within one year (regardless of whether they have been recognized in the financial statements)
The funds necessary to maintain operations considering the reporting entity’s current financial condition, obligations, and other expected cash flows
Other conditions or events that may affect the entity’s ability to meet its obligations
Moreover, management is to consider these factors for one year. But from what date?
Timeframe
The financial statement preparer (i.e., management or a party contracted by management) should assess going concern in light of one year from the date “the financial statements are issued or are available to be issued.”
So, if December 31, 2017, financial statements (for a nonpublic company) are available to be issued on March 15, 2017, the preparer looks forward one year from March 15, 2017. Then, the preparer asks, “Is it probable that the company will be unable to meet its obligations through March 15, 2018?” If yes, substantial doubt is present and disclosures are necessary. If no, then substantial doubt does not exist. As you would expect, the answer to this question determines whether going concern disclosures are to be made and what should be included.
Substantial Doubt Answer Determines Disclosures
If substantial doubt does not exist, then going concern disclosures are not necessary.
If substantial doubt exists, then the company needs to decide if management’s plans alleviate the going concern issue. This decision determines the disclosures to be made. The required disclosures are based upon whether:
Management’s plans alleviate the going concern issue
Management’s plans do not alleviate the going concern issue
What if Management’s Plans Alleviate the Going Concern Issue?
If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, but the substantial doubt is alleviated as a result of consideration of management’s plans, the entity should disclose information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):
Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)
Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern
Management’s plans should be considered only if is it probable that they will be effectively implemented. Also, it must be probable that management’s plans will be effective in alleviating substantial doubt.
So, if management’s plans are expected to work, does the company have to explicitly state that management’s plans will alleviate substantial doubt? No.
When management’s plans alleviate substantial doubt, companies need not use the words going concern or substantial doubt in the disclosures. And as Sears discovered, it may not be wise to do so (their shares dropped 16% after using the term substantial doubt even though management had plans to alleviate the risk). Rather than using the term substantial doubt, consider describing conditions (e.g., cash flows are not sufficient to meet obligations) and management plans to alleviate substantial doubt.
The Company had losses of $4,525,123 in the year ending March 31, 2017. As of March 31, 2017, its accumulated deficit is $11,325,354.
Management believes the Company’s present cash flows will not enable it to meet its obligations for twelve months from the date these financial statements are available to be issued. However, management is working to obtain new long-term financing. It is probable that management will obtain new sources of financingthat will enable the Company to meet its obligations for the twelve-month period from the date the financial statements are available to be issued.
Notice this example does not use the words substantial doubt.
What if Management’s Plans Do Not Alleviate the Going Concern Issue?
If conditions or events raise substantial doubt about an entity’s ability to continue as a going concern, and substantial doubt is not alleviated after consideration of management’s plans, an entity should include a statement in the notes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are available to be issued (or issued when applicable). Additionally, the entity should disclose information that enables users of the financial statements to understand all of the following:
Principal conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations
Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern
Sample Going Concern Disclosure – Substantial Doubt Not Alleviated
An example disclosure follows:
Note 2 – Going Concern
The financial statements have been prepared on a going concern basis which assumes the Company will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. The Company had losses of $1,232,555 in the current year. The Company has incurred accumulated losses of $2,891,727 as of March 31, 2017. Cash flows used in operations totaled $555,897 for the year ended March 31, 2017.
Management believes these conditions raise substantial doubt about the Company’s ability to continue as a going concern within the next twelve months from the date these financial statements are available to be issued. The ability to continue as a going concern is dependent upon profitable future operations, positive cash flows, and additional financing.
Management intends to finance operating costs over the next twelve months with existing cash on hand and loans from its directors. Management is also working to secure new bank financing. The Company’s ability to obtain the new financing is not known at this time.
Notice this note includes a statement that substantial doubt is present. Though management’s plans are disclosed, the probability of success is not provided.
Going Concern Accounting Summary
ASU 2014-15 focuses on management’s assessment regarding whether substantial doubt exists. If substantial doubt exists, then disclosures are required. Here’s a short video summarizing 2014-15:
Thus far, we’ve addressed the stage 1. management decisions. As you can see management’s considerations focus on disclosures. By contrast, auditors focus on the audit opinion. Now, let’s look at what auditors must do.
2. Auditor Decisions Regarding Going Concern
SAS 132 provides guidance concerning the auditor’s consideration of an entity’s ability to continue as a going concern.
Auditing Going Concern Accounting
SAS 132, paragraph 10, states the objectives of the auditor are as follows:
Obtain sufficient appropriate audit evidenceregarding, and to conclude on, the appropriateness of management’s use of the going concern basis of accounting, when relevant, in the preparation of the financial statements
Conclude, based on the audit evidence obtained, whether substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time exists
Evaluate the possible financial statement effects, including the adequacy of disclosure regarding the entity’s ability to continue as a going concern for a reasonable period of time
Report in accordance with this SAS
These objectives can be summarized as follows:
Conclude about whether the going concern basis of accounting is appropriate
Determine whether substantial doubt is present
Determine whether the going concern disclosures are adequate
Issue an appropriate opinion
In light of these objectives, certain audit procedures are necessary.
Risk Assessment Procedures
In the risk assessment phase of an audit, the auditor should consider whether conditions or events raise substantial doubt. In doing so, the auditor should examine any preliminary management evaluation of going concern. If such an evaluation was performed, the auditor should review it with management. If no evaluation has occurred, then the auditor should discuss with management the appropriateness of using the going concern basis of accounting (the liquidation basis of accounting is required by ASC 205-30 when the entity’s liquidation is imminent) and whether there are conditions or events that raise substantial doubt.
The auditor is to consider conditions and events that raise substantial doubt about an entity’s ability to continue as a going concern for areasonable period of time. What is a reasonable period of time? It is the period of time required by the applicable financial reporting framework or, if no such requirement exists, within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable). The governmental accounting standards require an evaluation period of “12 months beyond the date of the financial statements.”
Auditors should consider negative financial trends or factors such as:
Working capital deficiencies
Negative cash flows from operating activities
Default on loans
A denial of trade credit from suppliers
Need to restructure debt
Need to dispose of assets
Work stoppages or other labor problems
Need to significantly revise operations
Legal problems
Loss of key customers or suppliers
Uninsured catastrophes
The need for new capital
The risk assessment procedures are a part of planning an audit. You may obtain new information as you perform the engagement.
Remaining Alert Throughout the Audit
The auditor should remain alert throughout the audit for conditions or events that raise substantial doubt. So, after the initial review of going concern issues in the planning stage, the auditor considers the impact of new information gained during the subsequent stages of the engagement.
Audit Procedures When Substantial Doubt is Present
If events or conditions do give rise to substantial doubt, then the audit procedures should include the following (SAS 132, paragraph 16.):
Requesting management to make an evaluation when management has not yet performed an evaluation
Evaluating management’s plans in relation to its going concern evaluation, with regard to whether it is probable that:
management’s plans can be effectively implemented and
the plans would mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time
When the entity has prepared a cash flow forecast, and analysis of the forecast is a significant factor in evaluating management’s plans:
evaluating the reliability of the underlying data generated to prepare the forecast and
determining whether there is adequate support for the assumptions underlying the forecast, which includes considering contradictory audit evidence
Considering whether any additional facts or information have become available since the date on which management made its evaluation
Sometimes management’s plans to alleviate substantial doubt include financial support by third parties or owner-managers (usually referred to as supporting parties).
Financial Support by Supporting Parties
When financial support is necessary to mitigate substantial doubt, the auditor should obtain audit evidence about the following:
The intent of such supporting parties to provide the necessary financial support, including written evidence of such intent, and
The ability of such supporting parties to provide the necessary financial support
If the evidence in a. is not obtained, then “management’s plans are insufficient to alleviate the determination that substantial doubt exists.”
Intent of Supporting Parties
The intent of supporting parties may be evidenced by either of the following:
Obtaining from management written evidence of a commitment from the supporting party to provide or maintain the necessary financial support (sometimes called a “support letter”)
Confirming directly with the supporting parties (confirmation may be needed if management only has oral evidence of such financial support)
If the auditor receives a support letter, he can still request a written confirmation from the supporting parties. For instance, the auditor may desire to check the validity of the support letter.
If the support comes from an owner-manager, then the written evidence can be a support letter or a written representation.
Support Letter
An example of a third party support letter (when the applicable reporting framework is FASB ASC) is as follows:
(Supporting party name) will, and has the ability to, fully support the operating, investing, and financing activities of (entity name) through at least one year and a day beyond [insert date] (the date the financial statements are issued or available for issuance, when applicable).
You can specify a date in the support letter that is later than the expected date. That way if there is a delay, you may be able to avoid updating the letter.
The auditor should not only consider the intent of the supporting parties but the ability as well.
Ability of Supporting Parties
The ability of supporting parties to provide support can be evidenced by information such as:
Proof of past funding by the supporting party
Audited financial statements of the supporting party
Bank statements and valuations of assets held by a supporting party
After examining the intent and ability of supporting parties regarding the one-year period, you might identify potential going concern problems that will occur more than one year out.
Conditions and Events After the Reasonable Period of Time
So, should an auditor inquire about conditions and events that may affect the entity’s ability to continue as a going concern beyond management’s period of evaluation (i.e., one year from the date the financial statements are available to be issued or issued, as applicable)? Yes.
Suppose an entity knows it will be unable to meet its November 15, 2018, debt balloon payment. The financial statements are available to be issued on June 15, 2017, so the reasonable period goes through June 15, 2018. But management knows it can’t make the balloon payment, and the bank has already advised that the loan will not be renewed. SAS 132 requires the auditor to inquire of management concerning their knowledge of such conditions or events.
Why? Only to determine if any potential (additional) disclosures are needed. FASB only requires the evaluation for the year following the date the financial statements are issued (or available to be issued, as applicable). Events following this one year period have no bearing on the current year going concern decisions. Nevertheless, additional disclosures may be merited.
Thus far, the requirements to evaluate the use of the going concern basis of accounting and whether substantial doubt is present have been explained. Now, let’s see what the requirements are for:
Written representations from management
Communications with those charged with governance
Documentation
Written Representations When Substantial Doubt Exists
When substantial doubt exists, the auditor should request the following written representations from management:
A description of management’s plans that are intended to mitigate substantial doubt and the probability that those plans can be effectively implemented
That the financial statements disclose all the matters relevant to the entity’s ability to continue as a going concern including conditions and events and management’s plans
Communications with Those Charged with Governance
Remember that you may need to add additional language to your communication with those charged with governance.
When conditions and events raise substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time, the auditor should communicate the following (unless those charged with governance manage the entity):
Whether the conditions or events, considered in the aggregate, that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time constitute substantial doubt
The auditor’s consideration of management’s plans
Whether management’s use of the going concern basis of accounting, when relevant, is appropriate in the preparation of the financial statements
The adequacy of related disclosures in the financial statements
The implications for the auditor’s report
Documentation Requirements
When substantial doubt exists before consideration of management’s plans, the auditor should document the following (SAS 132, paragraph 32.):
The conditions or events that led the auditor to believe that there is substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time.
The elements of management’s plans that the auditor considered to be particularly significant to overcomingthe conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern, if applicable.
The audit procedures performed to evaluate the significant elements of management’s plans and evidence obtained, if applicable.
The auditor’s conclusion regarding whether substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time remains or is alleviated. If substantial doubt remains, the auditor should also document the possible effects of the conditions or events on the financial statements and the adequacy of the related disclosures. If substantial doubt is alleviated, the auditor should also document the auditor’s conclusion regarding the need for, and, if applicable, the adequacy of, disclosure of the principal conditions or events that initially caused the auditor to believe there was substantial doubt and management’s plans that alleviated the substantial doubt.
The auditor’s conclusion with respect to the effects on the auditor’s report.
Opinion – Emphasis of Matter Regarding Going Concern
If the auditor concludes that there is substantial doubt concerning the company’s ability to continue as a going concern, an emphasis of a matter paragraph should be added to the opinion.
An example of a going concern paragraph is as follows:
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency, and has stated that substantial doubt exists about the company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.
The auditor should not use conditional language regarding the existence of substantial doubt about the entity’s ability to continue as a going concern.
Opinion – Inadequate Going Concern Disclosures
Paragraph 26. of SAS 132 states that an auditor should issue a qualified opinion or an adverse opinion, as appropriate, when going concern disclosures are not adequate.
Going Concern Auditing Summary
Now, let’s circle back to where we started and review the objectives of SAS 132.
The objectives are as follows:
Conclude about whether the going concern basis of accounting is appropriate
Determine whether substantial doubt is present
Determine whether the going concern disclosures are adequate
Issue an appropriate opinion
Conclusion
As you can see ASU 2014-15 and SAS 132 are complex. So, make sure you are using the most recent updates to your disclosure checklists and audit forms and programs.
What’s the difference in supplementary information, additional information, and required supplementary information? What language should be included in the audit opinion when such information is included in the financial statements? What audit procedures must be performed? Below I provide the answers.
1. Supplementary Information
Supplementary information is defined as information presented outside the basic financial statements, excluding required supplementary information (see below), that is not considered necessary for financial statements to be fairly-presented in accordance with the applicable financial reporting framework (e.g. FASB). (See AU-C 725 for more guidance about supplementary information.)
Supplementary information may include:
Accounting information and
Nonaccounting information
Supplementary information examples include:
Detail of “Other Income” as shown in the statement of operations*
Detail of “General and Administrative” expenses as shown in the statement of operations*
Number of employees in a given payroll period**
* Derived from financial statements
** Not derived from the financial statements
Procedures to Perform
Procedures to be performed include:
Determine whether the information is fairly stated, in all material respects, in relation to the financial statements as a whole
Sample Opinion Language
Example auditor’s report paragraph:
The [identify accompanying supplementary information] is presented for purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. The information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the information is fairly stated in all material respects in relation to the financial statements as a whole.
For examples of presenting the supplementary language (1) in the standard opinion or (2) separately, click here.
Notice that an opinion is rendered on supplementary information. No opinion is given in regard to other information.
2. Other Information
Other information is financial and nonfinancial information (other than the financial statements and the audit report) that is included in a document containing audited financial statements and the audit report (e.g., an annual report), excluding required supplementary information. An auditor can use this option when he or she is not engaged to render an opinion on such information. (See AU-C 720 for more guidance about other information.)
Other informationexamples include:
Financial summaries
Employment data
Planned capital expenditures
Names of officers and directors
Procedures to Perform
Procedure to be performed:
Reading the other information in order to identify any material inconsistencies with audited financial statements
Sample Opinion Language
The auditor can use an other-matter paragraph to disclaim an opinion regarding other information. Sample language follows:
Our audit was conducted for the purpose of forming an opinion on the basic financial statements as a whole. The [identify the other information] is presented for purposes of additional analysis and is not a required part of the basic financial statements. Such information has not been subjected to the auditing procedures applied in the audit of the basic financial statements, and accordingly, we do not express an opinion or provide any assurance on it.
3. Required Supplementary Information
Required supplementary information (RSI) is information that a designated accounting standard-setter (e.g., FASB, GASB) requires to accompany the basic financial statements. RSI is not part of the basic financial statements. However, the designated accounting standard-setter has determined that the information is an essential part of financial reporting. (See AU-C 730 for more guidance about required supplementary information.)
Required supplementary information examples include:
Management discussion and analysis (MD&A) for governments
Estimates of current or future costs of future major repairs and replacements for common interest realty associations
Procedures to Perform
Procedures to be performed include:
Inquiry of management about methods used to create information
Comparing the information for consistency with management responses and the financial statements
Obtaining written representations from management
Sample Opinion Language
Example auditor’s report paragraph:
Accounting principles generally accepted in the United States of America require that the [identify the required supplementary information] on page XX be presented to supplement the basic financial statements. Such information, although not a part of the basic financial statements, is required by the Financial Accounting Standards Board who considers it to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. We have applied certain limited procedures to the required supplementary information in accordance with auditing standards generally accepted in the United States of America, which consisted of inquiries of management about the methods of preparing the information and comparing the information for consistency with management’s responses to our inquiries, the basic financial statements, and other knowledge we obtained during our audit of the basic financial statements. We do not express an opinion or provide any assurance on the information because the limited procedures do not provide us with sufficient evidence to express an opinion or provide any assurance.
Today we talk about four keys to better CPA client interviews.
Many times I have interviewed accounting staff and walked away thinking, “I have no idea what they just said to me.” Do you ever have this problem? If yes, this article is for you. Below I provide four keys to better client interviews.
In my early years–fresh out of college–I would think: “I must be stupid. It’s obvious, he understands what he just said, but I don’t.” Often my anxiety would increase when I realized the interviewee (e.g, accounts payable clerk) had no college degree (and me, a masters in accounting).
Reasons We Don’t Understand
After years of performing client interviews, I realized that I wasn’t dense (at least, not as much as I thought), and that I was encountering what The Art of Explanation calls, the “curse of knowledge.”
What is the “curse of knowledge?” It’s when someone knows a subject very well, and, consequently, has a difficult time imagining what it is like to not know it. I was experiencing the “curse of knowledge.” Those I interviewed thought I knew what they knew. As a result, they left out details.
Also, those I interviewed had years of experience doing the same job day after day. Of course they understood what they did. But I had less than an hour, in many cases, to grasp their duties.
Additionally, those I interviewed used a language unique to their office, and I, mistakenly, tried to use a different language—one I had learned in college. The result: we did not understand one another. So how can I communicate and comprehend better?
Here are four CPA client interview ideas guaranteed to to help.
Four Keys to CPA Client Interviews
1. Pay attention to their language and use it.
If they call it a thingy, then I call it a thingy.
2. Seek understanding more than trying to impress.
I often want to impress more than I desire to understand. The remedy: Admit (maybe even out loud) I don’t know everything.
I tell the clerk, “Treat me like I don’t know anything. I’ve never been here, so I need your help in understanding what you do.”
To higher level personnel (e.g., CFO), I might say, “I have worked in this industry for fifteen years, but I need your help to understand how you guys operate.”
3. Repeat what is said to you.
For example, “May I repeat what you just said to make sure I understand? ‘The thingy is created once per week on Mondays to ensure that total receipts agree with deposits.’”
4. Use your cell phone to take pictures and to record parts of the interview.
Just last week, I reviewed a complex accounting system (for about three hours). As I did so, I used my cell phone Evernote app to take pictures of computer screens and printed reports. I also used the app to record parts of the conversation. Later, I summarized the conversation in memo form (complete with pictures).
Scanbot is another useful iPhone app if you take pictures of client information. By using your phone to take pictures, you can leave your physical scanner in your office.
Your CPA Client Interview Ideas
Have I left out any key interviewing ideas? Please share your thoughts.
In today’s post, I tell you how to understand and communicate material weaknesses and significant deficiencies.
How do you categorize a control weakness? Is the weakness a material weakness, a significant deficiency or something less? This seems to be the most significant struggle in addressing internal control issues.
And if you’ve been in the business for any time at all, you know that management can take offense regarding control weakness communications. For instance, a CFO may believe that a material weakness reflects poorly upon him. After all, he controls the design of the accounting system. So, communicating control weaknesses can result in disagreements. Therefore, it’s even more important that these communications be correct.
Before telling you how to distinguish material weaknesses from significant deficiencies, let’s review control weakness definitions.
Definitions of Control Weaknesses
A deficiency in internal control is defined as follows: A deficiency in internal control over financial reporting exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing, or (b) an existing control is not properly designed so that, even if the control operates as designed, the control objective would not be met. A deficiency in operation exists when a properly designed control does not operate as designed or when the person performing the control does not possess the necessary authority or competence to perform the control effectively.
Now let’s define (1) material weaknesses, (2) significant deficiencies, and (3) other deficiencies.
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.
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.
Other deficiencies. For the purposes of this blog post, an other deficiency is a control weakness that is less than a material weakness or a significant deficiency.
How to Categorize a Control Weaknesses
Now that we have defined material weaknesses and significant deficiencies, we can discuss how to distinguish between the two.
Material Weakness
First, ask these two questions:
Is there a reasonable possibility that a misstatement could occur?
Could the misstatement be material?
If your answer to both questions is yes, then the client has a material weakness. (By the way, if you propose a material audit adjustment, it’s difficult to argue that there is no material weakness. As you write your control letter, examine your proposed audit entries.)
Significant Deficiency
If your answer to either of the questions is no, then ask the following:
Is the weakness important enough to merit the attention of those charged with governance? In other words, are there board members who would see the weakness as important.
If the answer is yes, then it is a significant deficiency.
If no, then it is not a significant deficiency or a material weakness.
How to Communicate Material Weaknesses and Significant Deficiencies
The following deficiencies must be communicated in writing to management and to those charged with governance:
Material weaknesses
Significant deficiencies
The written communication (according to AU-C section 265) must include:
the definition of the term material weakness and, when relevant, the definition of the term significant deficiency
a description of the significant deficiencies and material weaknesses and an explanation of their potential effects
sufficient information to enable those charged with governance and management to understand the context of the communication
the fact that the audit included consideration of internal control over financial reporting in order to design audit procedures that are appropriate in the circumstances and that the audit was not for the purpose of expressing an opinion on the effectiveness of internal control
the fact that the auditor is not expressing an opinion on the effectiveness of internal control
that the auditor’s consideration of internal control was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies, and therefore, material weaknesses or significant deficiencies may exist that were not identified
an appropriate alert, in accordance with section 905, Alert That Restricts the Use of the Auditor’s Written Communication
Next, I explain how to communicate other deficiencies (those that are less than a material weakness or a significant deficiency).
How to Communicate Other Deficiencies
Other deficiencies can be communicated in writing or orally and need only be communicated to management (and not to those charged with governance). The communication must be documented in the audit file. So if you communicate orally, then follow up with a memo to the file addressing who you spoke with, what you discussed, and the date of the discussion.
Stand-alone management letters are often used to communicate other deficiencies. Since there is no authoritative guidance for management letters, you may word them as you wish. Alternatively, you can, if you like, include other deficiencies in your written communication of significant deficiencies or material weaknesses.
A Key Word of Warning
Always provide a draft of any written communications to management before final issuance. It is much better to provide a draft and find out (before issuance) that it contains an error or a miscommunication. Then, corrections can be made.
Additional Information
Writing your internal control letter is a part of the wrap-up process for audits. Click here for additional information concerning wrapping up an audit.
