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Management vs. Auditor Responsibilities
Whose Financial Statements are They Anyway?
Nancy E. Shelmon, CPAPartner, PricewaterhouseCoopers, Los Angeles, CA
Douglas K. Risser, CPAGlobal Controller, World Vision, Federal Way, WA
AICPA National Not-for-Profit Industry Conference
AGENDA
1. Background leading to this discussion
2. Impact of SAS 112 on management’s responsibilities
3. Use of Estimates
4. Closing the Books
5. Other Tools Available
6. Role of Audit Committee
7. Questions
Top Ten Auditor Frustrations
10. The auditor’s room is like being in solitary confinement.
9. The client likens auditors to the Bermuda Triangle – anything lost, the auditor did it.
8. Last year’s adjustments were never made. 7. Each year, the auditors become the temporary
bookkeepers. 6. The Accounting department is told only to give
name, rank, and serial number to any questions asked.
Top Ten Auditor Frustrations, Cont’d.
5. The audit is a great time to schedule vacations. 4. The client contact is like Sergeant Shultz on
Hogan’s Heroes – “I know nothing.” 3. Typical response to management letter – “We’ll
consider it next year.” 2. Standard reconciling item – “unexplained
difference.” 1. Client’s perspective of fixed fees means “I can
cause unto you delays, inefficiencies, etc., but you cannot increase billings unto me.”
Top Ten Client Frustrations
10. Your Accountant’s definition of GAAP is a place where you
buy jeans.
9. The temporary employee filed the A/P invoices using the
Russian alphabet.
8. Auditor leaves the conference room looking like the streets of
New Orleans the day after Mardi Gras.
7. You exceed the FDIC insurance cash limit one day during the
entire year and it happens on the last day of the year.
6. Auditor won’t accept “plug” as an explanation for a journal
entry.
Top Ten Client Frustrations, Cont’d.
5. The auditor’s definition of lead time for requesting information
can be measured with the second hand of your watch.
4. Audit assistant’s materiality is based on their average college
checkbook balance.
3. Auditor’s definition of divisible is the parting of the Red Sea.
2. Audit Assistant appears younger than your teenage son who
just entered high school.
1. That same audit assistant drives a nicer car than you do.
Internal Controls and SAS 112
What is the most valuable asset of
any organization?
Internal Controls and SAS 112
What is the most valuable asset of any organization?
The typical response is “people,” “staff,” or
“employees.”
This is not correct, at least not totally correct.
Internal Controls and SAS 112
The most valuable asset of any organization is
Knowledge Capital.
However, Knowledge Capital is always invested in our
people, and maintained by our people.
Internal Controls and SAS 112
Therefore, we find that in order to maximize Knowledge
Capital we must:
Continually develop and invest in our people, and
Document and maintain processes and procedures.
Take the opportunity we have in readying for SAS 112 to
create and/or enhance our documentation of Internal
Controls.
Internal Controls and SAS 112
What will change as a result of SAS 112:
More control deficiencies will be considered severe.
The auditor must consider the “potential” magnitude
of a control deficiency rather than the actual
magnitude as follows:
Does a control deficiency—or a combination of
deficiencies—constitute a significant deficiency or a
material weakness?
Internal Controls and SAS 112
Would prudent officials with knowledge of the facts and
circumstances agree with the auditor’s assessment?
Are effective compensating or complementary controls in
place?
What is “material” to the financial statements from a
quantitative and qualitative perspective?
Internal Controls and SAS 112
In summary, under SAS 12:
More control deficiencies will likely be considered
significant and/or material and will be communicated
more broadly to stakeholders.
The auditor has less judgment and will require more
evidence and documentation from management to
support his conclusions about the effectiveness of
internal controls.
Internal Controls and SAS 112
See “SAS 112 internal controls readiness: a PwC
perspective” published by PricewaterhouseCoopers LLP
www.pwc.com/extweb/pwcpublications.nsf/docid/
0D87C5D88D5E10D5852571E6005A3E92
Internal Controls and SAS 112
Internal Control Maturity Framework
Under SAS 112, controls must be documented in order for auditors to rely on them. Moving to the right on the maturity framework will take on greater urgency in the new environment.
UnreliableUnpredictableenvironment where control activities are not designed or in place
Informal Control activities are designed and in place, but are not adequately documented
Standardized Control activities are designed, in place and are adequately documented
Monitored Standardized controls with periodic testing for effective design and operation with reporting to management
Optimized Integrated Internal controls with real time monitoring by management and continuous improvement
Internal Controls and SAS 112
What should you do to prepare for the implementation of
SAS 112?
Educate your board.
Inventory the significant accounts, disclosures, and
components as well as the processes and cycles.
Year One: Consider documenting IT controls, Payroll
Controls and Preparation of Financial Statements
Internal Controls and SAS 112
Information technology (IT) controls over significant
systems Are controls automated or manual? Are controls documented? Controls over program security, program access, program
changes? Monitoring or mitigating controls at the process level might
compensate for weaknesses in IT controls. Audit trail evidence that controls were executed.
Internal Controls and SAS 112
Payroll (including for government grants) What controls are in place? Are controls automated or manual? Are controls documented? Are periodic reconciliations performed? Is the review and approval evidenced? Review written policies and procedures for pre-award and
post-award grants and contracts. Effort reporting.
Internal Controls and SAS 112
1. Preparation of Financial Statements What controls are in place? Who reviews estimates? What documentation exists? What adjustments does the auditor propose as a
result of the annual independent audit? Review adjustments and unadjusted differences
proposed over the last three to five years.
Internal Controls and SAS 112
Preparation of Financial Statements (con’t) Consider developing a financial statement binder.
Work papers that support the financial statements
Accounting and disclosure checklists Proof of the accuracy and completeness of
“release of restrictions” transfer, etc.
Internal Controls and SAS 112
In the second year, consider reviewing controls over other areas, such as:
Contributions and fund-raising Revenue recognition Cut-off UBTI assessment
Endowment Board approval Spending formulas Honoring donor restrictions
Internal Controls and SAS 112
In the second year, consider reviewing controls over
other areas, such as (con’t):
Property, plant and equipment Capitalization of expenditures Evidence of compliance Capitalized interest, other borrowing-related
activities
Internal Controls and SAS 112
As you review the controls, consider the following
questions:
How do you know your controls are effective?
Is there adequate segregation of duties?
Are reviews documented?
Internal Controls and SAS 112
As you review the controls, consider the following questions (con’t):
Are spreadsheet controls in place for key management reports?
What constitutes good documentation? Are the estimates that management has made
documented? Does the documentation accurately depict what
happens on a daily basis?
Internal Controls and SAS 112
As you review the controls, consider the following questions (con’t):
Are all SAS 70 reports of outside service organizations reviewed and documented?
Is the level of communication among management, internal and external auditors, and the audit committee adequate?
Internal Controls and SAS 112
Time is rapidly passing since SAS 112 became effective for December 31, 2006 year-end audits and will be effective for all June 30, 2007 year ends
Use of Estimates
Where are the “estimates” in the financial statements of
most organizations?
Collectibility of pledges and/or accounts receivable Discount rate on pledges Estimated useful lives of fixed assets Fair value of other assets Allocation of joint costs Functional allocation of expenses
Use of Estimates
Auditor’s role with Estimates: Discuss with management the method of determining
balance;
Evaluate whether the assumptions used are
consistent with each other, the prior year, supporting
data, relevant historical data, and industry data;
Determine whether accounting estimates are in
compliance with GAAP;
Closing the Books
Closing the books is the process that an organization uses to reconcile, consolidate, and report financial information on a periodic basis.
Each organization defines the process a little differently; not all organizations complete the same list of tasks to close their books.
Among the tasks that organizations may include in the process are the following:
Ensuring validity and consistency in the company's charts of accounts
Closing the Books
Among the tasks that organizations may include in the process are the following (con’t):
Completing journal entries.
Consolidating data from outlying business units.
Preparing trial balances
Correcting errors
Reconciling and analyzing accounts
Calculating taxes
Closing the Books
Among the tasks that organizations may include in the
process are the following (con’t): Preparing and distributing reports Supervising closing tasks and reviewing key accounts
and reports An investigation of the process of closing the books
usually reveals opportunities to improve speed and
accuracy.
Closing the Books
A fast, accurate close-the-books process provides
multiple benefits for the finance function and for the
organization.
Utilize a monthly and annual closing checklist to
document assignments, control points as well as
approvals
Closing the Books
Sample checklist provided in your book
Other tools may be found in the AICPA Not-for-Profit
Toolkit
Audit Committee Toolkit
Actionable tools (matrices,
questionnaires, RFPs,
evaluations, how-to, etc.)
Distributed in print
Customizable
Audit Committee Toolkit
Tools are available on
website
www.aicpa.org/Audcomm
ctr/toolkitsnpo/homepage
.htm
Audit Committee Toolkit
Administrative Tools Audit Committee Charter Matrix* Financial Expertise* Sample RFP for CPA Services Independence and Related Issues* Peer Review of CPA Firms Evaluating the Auditor’s Engagement Letter Hiring the Chief Audit Executive Hiring External Experts
Audit Committee Toolkit
Audit Process Tools Internal Control Fraud and the Audit Committee* Whistleblower Tracking Report* Conducting an Audit Committee Executive
Session* Issues Report From Management Discussions With the Independent Auditors*
Audit Committee Responsibilities As Related to Financial Statements
13. Inquire of the executive director and CFO regarding the sources of support and revenue of the organization from a subjective as well as an objective standpoint.
14. Review with the independent auditors and the CAE: The adequacy of the organization’s internal controls,
Any related significant findings and recommendations
Audit Committee Responsibilities As Related to Financial Statements, Cont’d.
17. Review with each public accounting firm that performs an audit: All critical accounting policies and practices used by
the organization.
All alternative treatments of financial information
18. Review all material written communications between the independent auditors and management, such as any management letter or schedule of unadjusted differences.
Audit Committee Responsibilities As Related to Financial Statements, Cont’d.
19. Review with management and the independent auditors: annual financial statements and related footnotes independent auditors’ audit of the financial statements and their report thereon judgments about the quality, not just the acceptability, of the organization’s accounting principles as applied in its financial reporting Any significant changes required in the independent auditors’ audit plan Any serious difficulties or disputes with management
Audit Committee Responsibilities As Related to Financial Statements, Cont’d.
20. Review with the general counsel and the CAE, legal and regulatory matters that, in the opinion of management, may have a material impact on the financial statements, related organization compliance policies, and programs and reports received from regulators.
Client Expectations
Qualified Staff Minimal Turnover Knowledgeable About Business Flexibility of Audit Schedule Formats More Value Out of Audit Keep Informed on Current Events Training of Client Personnel Effective and Timely Communication
Auditor Expectations
Take Ownership of Financial Statements
Adhere to Deadlines
Early Identification and Communication of
Accounting/Audit Issues
Proactive View of Internal Controls
Optimize Audit Process
Responsive to Auditor’s Concerns and Comments
QUESTIONS?????