The Auditors Report

ASB Update as of January 31, 2003

William F. Messier, Jr., Georgia State University
Academic Member of the Auditing Standards Board

It is a pleasure for me to serve as the new academic member of the Auditing Standards Board (ASB). Auditing Section members owe Ray Whittington a big round of applause for his outstanding service during his term on the ASB. The upcoming year will be very challenging for the Board as we address the proposed changes to the auditor’s risk assessment process and respond to the requirements of the Sarbanes-Oxley Act of 2002.

At the October meeting, the ASB unanimously approved SAS No. 100, Interim Financial Information, and issued an exposure draft related to the risk assessment process. At the December meeting, the ASB approved SAS No. 101, Auditing Fair Value Measurements and Disclosures. The February ASB meeting will focus mainly on exposure drafts for standards to respond to Sarbanes-Oxley. I will briefly review each of these topics. More information can be obtained from the AICPA’s website – http://www.aicpa.org.

SAS No. 100—Interim Financial Information
SAS No. 100, Interim Financial Information, supersedes SAS No. 71. It was issued to provide additional guidance on performing reviews of interim financial information, and include the requirement of the Securities and Exchange Commission (SEC) for timely filings of interim financial information, incorporate recommendations of the Public Oversight Board’s Panel on Audit Effectiveness and the AICPA’s Professional Issues Task Force in Practice Alert 2000-4, “Quarterly Review Procedures for Public Companies.”

The SAS revises SAS No. 71 by:

  • Clarifying the applicability of generally accepted auditing standards to a review of interim financial information.
  • Citing the SEC requirement that a registrant engage an independent accountant to review the registrant’s interim financial information before the registrant files its quarterly report on Form 10-Q or Form 10-QSB, and modifying the relevant guidance in the SAS to reflect this requirement.
  • Providing guidance to an accountant performing an initial review of interim financial information.
  • Requiring an accountant to establish an understanding with the client regarding the services to be performed in an engagement to review interim financial information.
  • Requiring the accountant to perform certain additional specified procedures in an interim review engagement, including:
    – Comparing disaggregated revenue data; for example, comparing revenue reported by month and by product line or business segment for the current interim period with that of comparable prior periods.
    – Obtaining evidence that the interim financial information agrees or reconciles with the accounting records.
    – Inquiring of members of management who have responsibility for financial and accounting matters about their knowledge of any fraud or suspected fraud affecting the entity, and whether they are aware of allegations of fraud or suspected fraud affecting the entity, received in communications from employees, former employees, analysts, regulators, short sellers, or others.
  • Providing an illustrative report for a review of comparative interim financial information.
  • Providing guidance on the accountant’s consideration, in an interim review engagement, of matters related to an entity’s ability to continue as a going concern, and presenting reporting options related to such matters.
  • Adding appendices that present examples of analytical procedures, and unusual or complex situations the accountant may consider performing in a review of interim financial information. The appendices also include illustrative representation letters for a review of interim financial information.

SAS No. 101, Auditing Fair Value Measurements and Disclosures
Statement on Auditing Standards No. 101, Auditing Fair Value Measurements and Disclosures, is effective for audits of financial statements for periods beginning on or after June 15, 2003. It contains significantly expanded guidance on the audit procedures for fair value measurements and disclosures. In recent years, the number of accounting standards requiring fair value measurements and disclosures has increased significantly. Practitioners have used the guidance in SAS No. 57, Auditing Accounting Estimates, when evaluating fair value measurements and disclosures. However, the ASB believed that, with the proliferation of accounting standards requiring fair value measurements and the complexity and significance of some of these estimates to the financial statements, auditing guidance that was specific to fair value measurements was necessary.

SAS No. 101 provides guidance on auditing specific assets, liabilities, components of equity, transactions, or industry-specific practices. This standard requires that the auditor’s substantive tests of fair value measurements involve: (1) testing management’s significant assumptions, the valuation model, and the underlying data, (2) developing independent fair value estimates for corroborative purposes, or (3) examining subsequent events and transactions that confirm or disconfirm the estimate. In testing management’s significant assumptions, the valuation model, and the underlying data, the auditor evaluates whether:

  • Management’s assumptions are reasonable and reflect, or are not inconsistent with, market information.
  • The fair value measurement was determined using an appropriate model, if applicable.
  • Management used relevant information that was reasonably available at the time.

Proposed Statements on Auditing Standards for Audit Risk Assessments
For nearly two years, the Joint Risk Assessment Task Force has been working on a set of auditing standards that revise the auditor’s risk assessment process. These standards are to serve as a basis for both international and U.S. standards. The International Auditing and Assurance Standards Board and the ASB issued their respective exposure drafts in October 2002. The U.S. exposure draft contains the following amendments to existing Statements on Auditing Standards and new standards:
Amendment to Statement on Auditing Standards No. 95, Generally Accepted Auditing Standards
Audit Evidence
Audit Risk and Materiality in Conducting an Audit
Planning and Supervision
Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement
Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained
Amendment to Statement on Auditing Standards No. 39, Audit Sampling

The requirements and guidance provided in the proposed Statements on Auditing Standards will result in a substantial change in audit practice. They require:

  • More in-depth understanding of the entity and its environment, including its internal control, to identify the risks of material misstatement in the financial statements and what the entity is doing to mitigate them.
  • More rigorous assessment of the risks of material misstatement of the financial statements based on that understanding.
  • Improved linkage between the assessed risks and the nature, timing, and extent of audit procedures performed in response to those risks.

The proposed standards were developed in response to the report of the Public Oversight Board Panel on Audit Effectiveness and recent corporate failures that have led to increased scrutiny of the work of auditors. The Explanatory Memorandum at the beginning of the exposure draft presents commentary on how the proposed Statements on Auditing Standards collectively are expected to affect practice, a summary of the significant provisions in each of the proposed Statements on Auditing Standards, and a summary of the major changes to the organization of guidance in the existing standards and reasons for which the changes are proposed. Members of the Auditing Section are encouraged to comment on the exposure draft. The deadline for comments is April 30, 2003. Responses also may be sent by email to jdilley@aicpa.org.

Responses to the Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 requires auditing standards in three areas:

  • Second (concurring) partner review.
  • Documentation retention.
  • Internal control reporting by management with auditor attestation.

The ASB has two task forces working on standards to respond to the requirements of Sarbanes-Oxley. The Omnibus SAS Task Force has drafted an exposure draft for a new SAS on second partner review. The exposure draft is based on SECPS Practice Manual, Appendix E—Concurring Partner Review Requirements. The exposure draft includes guidance for second partner qualifications; the nature, timing, and extent of the review; and documentation. The task force is also drafting requirements to comply with the SEC’s final rule on documentation (release number 33-8180). The final rule requires “accounting firms to retain for seven years certain records relevant to their audits and reviews of issuers’ financial statements. Records to be retained include an accounting firm’s work papers and certain other documents that contain conclusions, opinions, analyses, or financial data related to the audit or review.”

The Internal Control Task Force is charged with developing standards to comply with Sarbanes-Oxley Sections 103, 302, and 404. Those sections essentially require management to provide an assertion on the effectiveness of internal control and the entity’s auditor to issue an “audit” report on management’s assertion. Note that these requirements only apply to public companies with some exceptions. The task force has developed a new proposed standard that will provide overall guidance for auditors conducting “audits” of internal control. The performance requirements for this SAS will be included in a revision to AT 501—Reporting on an Entity’s Internal Control over Financial Reporting. There also will be a standard that provides guidance for identifying and reporting matters that relate to an entity’s internal control to the entity’s audit committee. The proposed draft distinguishes between internal control deficiencies, significant deficiencies (formerly called reportable conditions), and material weaknesses. It is very likely that the requirement under Sarbanes-Oxley and related auditing guidance on internal control reporting will result in increased work for management and auditors.

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