Does Your Yellow Book Client Have Sufficient SKE?

By Charles Hall | Auditing

Sep 30

Are you a CPA that prepares city or county financial statements for an audit client? If yes, are you independent under the Yellow Book independence standards?

sufficient SKE

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Yellow Book Independence

The 2011 Yellow Book (effective for periods ending after December 15, 2012; requires that the external auditor document the CPA firm’s independence when the firm also provides nonaudit services (such as preparation of financial statements).  Many small governments have their external auditors prepare their financial statements.

When such a service is provided by the audit firm, the audit client has to have someone with sufficient skill, knowledge and experience to oversee the nonattest service.

If the government has no one with sufficient SKE, then the external auditor is not independent and can’t ethically perform the audit.

Examples of SKE

Consider the following potential reviewer scenarios:

1. A 15 year mayor who is a businessman, no accounting education, no formal training in reading governmental financial statements, he understands the fund level statements but can’t grasp the reconciliation between the government-wide financial statements and the fund level financial statements.

2. Second year finance director with no prior accounting experience, graduated from a two year college with a degree in general business.

3. Finance director with 25 years experience and is a CPA, member of GFOA, trains others in governmental accounting.

4. Finance director with a high school education but has extensive governmental accounting training from the Carl Vinson Institute, could if he liked, create the financial statements from scratch.

As you can see, the independence assessment will sometimes be black and white, but sometimes there will be shades of gray.

An Alternative

If the auditor can’t get comfortable with the SKE of the government’s financial statement reviewer, there is one alternative: the local government can hire someone outside the government with sufficient SKE to be the reviewer (for example a CPA not affiliated with the external audit firm).

At the end of the day, the local government must have a designated person (either internally or externally) with sufficient SKE for the audit firm to be independent.

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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.

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(4) comments

Charles Hall October 1, 2014

Yes, Armando. The smaller an organization is, the worse this situation is. The smaller entities don’t have the expertise or the money to solve the independence issue.

Armando Balbin October 1, 2014

This situation is worse for the typical NFP, having a Single Audit. Some of the NFPs have no problem as they either outsource their accounting to an external CPA, or if big enough, they may have an internal CPA; however, others just have an in-house accountant, who regardless of how otherwise competent this person may be, generally he/she does not have enough GAAP knowledge to properly prepare the financial statements including the required disclosures. And I believe that the executive directors will consider a waste of money engaging a CPA to prepare and/or review the financial statements.

Russ Lam October 4, 2016

Charles, hopefully not 50 shades of gray… 🙂 Good advice!

Charles Hall October 4, 2016

Thanks Russ. Hope you are doing well.

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