ASB UPDATE

AS OF SEPTEMBER 10, 1996

In this update I discuss a number of the projects on which the board is currently involved and which I believe may be of interest. As always, feel free to contact me with any questions, comments, and suggestions.

Fraud

The task force addressing fraud is currently considering comment letters received in response to the exposure draft Consideration of Fraud in a Financial Statement Audit. If passed, the draft will supersede SAS No. 53 (AU 316) and modify a number of other portions of the professional standards. I have discussed the exposure draft in detail in the previous update column, and in summary, it is structured as follows:

• Describes fraud (replacing the term "irregularities") and its characteristics.
• Requires the auditor to specifically assess the risk of material misstatement due to fraud and provides categories of fraud risk factors that should be considered by the auditor.
• Provides guidance on how the auditor should respond to the results of the assessment of the risk of fraud.
• Provides guidance on the evaluation of audit attest results as they relate to the risk of material misstatement due to fraud.
• Describes related documentation requirements.
• Provides guidance regarding the auditor's communication about fraud to management, the audit committee and others.

The revised draft will be discussed at the October ASB meeting.

Managementís Discussion and Analysis

The Board is considering the development of proposed new services involving association with a companyís management discussion and analysis (MD&A). Draft procedures for an examination and a review have been designed. MD&A involves a variety of challenging issues, many of which involve non-financial information that is typically included in the presentation. Much of this information is not subject to the controls considered in an audit.

Auditing Investments

The Board issued the exposure draft, Investments in Debt and Equity Securities, which updates AU 332 by incorporating guidance relating to FASB Statement No. 115. The Board is also considering further guidance on the ownership, existence and valuation of investment securities. Among the issues being considered are:

• When should the auditor use a specialist in auditing the values of financial instruments?
• How should a situation be handled in which the most qualified specialist relating to a financial instrument has a business relationship with the client?
• When is a confirmation from a broker sufficient evidence as to the existence of securities? Under which circumstances must the auditor consider the internal control of the broker?

Auditor Communications

The Board voted to issue an exposure draft that includes an audit requirement that CPAs obtain an understanding with their client as to the nature of services to be provided, the objectives of the engagement, auditor responsibilities, client responsibilities and limitations of the engagement. The draft includes illustrations of the understanding as well as other matters that might be included. While the draft suggests that such an understanding should ìpreferablyî be in writing (e.g., in the form of an engagement letter), this is not required. The Board also prepared a similar requirement for general attestation engagements.

Attestation Recodification Task Force

This task force has been formed to evaluate the professionís attestation standards, which are meant to serve as a framework for a variety of attestation services. Although numerous issues are being considered, one important one is consideration of the elimination of the requirement of a ìwritten assertionî to which the CPA attests. Elimination of this requirement would result in allowing assurance-related engagements in which the auditor directly reports on the information, and not on an entityís assertion. Currently it is the existence of this written assertion that in many cases distinguishes attest engagements from consulting engagements.

Electronic Evidence

The Board has considered proposed revisions to SAS No. 31 (AU 326) which replace dated terminology relating to manually obtained evidential matter and update the presentation to include electronic forms of evidence. While much in the exposure draft is relatively straight forward and basic, the draft includes a paragraph with a discussion of the belief that in certain circumstances audit risk might not be appropriately restricted through an entirely substantive approach to an audit. That is, when inherent risk is high, a combination of substantive tests to restrict detection risk and tests of controls to support an assessment of control risk below the maximum might be required to adequately restrict audit risk. Final issuance of this exposure draft is currently being voted upon and, if passed, it will become SAS No. 80.

Predecessor/Successor Auditor Relationships

SAS No. 7 (AU 315) on predecessor/successor auditors is the oldest Statement on Auditing Standards that has not been extensively revised since its issuance approximately 20 years ago. Several studies have shown that it is beginning to show its age and may present a number of practice problems including:

• A question arises as to the degree to which it is appropriate for a successor auditor to rely on the work of the predecessor auditor as sufficient competent evidential matter. A practice problem occurs here since there is a belief that when a predecessor allows access to the working papers it may potentially increase his or her potential liability for lawsuits arising from subsequent audits. This may occur, for example, when the successor auditor relies upon the predecessorís working papers for certain beginning-of-the-year amounts. Not surprisingly, this has resulted in a situation in which access to working papers may be restricted. This becomes particularly problematical given academic research which indicates a disproportionately high rate of audit failure during the first few years of an audit engagement.
• SAS No. 7 discusses allowing access to working papers of significant accounting significance, and does not discuss those with continuing audit significance. How much access to working papers is appropriate? To what extent is it appropriate to restrict access to working papers because a firm has developed and does not wish to disclose proprietary methodologies or software that it believes provides it with a competitive advantage?
• Research would seem to indicate that auditors sometimes do not follow the standard which requires certain communications with the predecessor before the engagement is accepted.
  

Accordingly, the Board is in the process of considering revisions to SAS No. 7.

I am interested in any research in which you may be involved that may provide insights into the above issues. You may either contact me directly or Ray Whittington, the Chair of the AAA Auditing Standards Committee.

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