Chap012 - Chapter 12 - Auditing of Governmental and...

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Unformatted text preview: Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations CHAPTER 12: AUDITING OF GOVERNMENTAL AND NOT-FORPROFIT ORGANIZATIONS OUTLINE Number Topic Type/Task Status (re: 14/e) Questions: 12-1 12-2 12-3 12-4 12-5 12-6 12-7 12-8 12-9 12-10 Levels of audit Opinion units GAGAS GAGAS versus GAAS GAGAS audits GAGAS and not-for-profits GAGAS versus single audit Risk-based approach Audit quality Audit committee Define and Explain Explain Explain Explain Identify and compare Explain Compare Explain Explain Describe New New New 11-3 11-4 New New 11-7 New 11-10 Cases: 12-1 12-2 12-3 12-4 12-5 12-6 12-7 Audit risk Single audit Government audit considerations Single audit and major programs Federal awards and resources Audit quality Audit committees Assess Evaluate Evaluate Evaluate Internet Analysis Locate New 11-1 New New 11-3 New Same Examine Multiple Choice Analysis Analysis Match Error analysis 11-1 11-2 New 11-4 revised 11-6 revised New Exercises/Problems: 12-1 Examine the CAFR 12-2 Various 12-3 Continuing professional education 12-4 Single audit 12-5 GAO independence standards 12-6 Audit report 12-1 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations CHAPTER 12: AUDITING OF GOVERNMENTAL AND NOT-FORPROFIT ORGANIZATIONS Answers to Questions 12-1. The three levels of audit are generally accepted auditing standards (GAAS), generally accepted governmental auditing standards (GAGAS), and the single audit. GAAS standards are established by the AICPA, while the Government Accountability Office (GAO) establishes GAGAS. The single audit is the result of a law enacted by Congress. However, regulation related to implementation of the law is established by the Office of Management and Budget (OMB) and is available to users in Circular A-133 and the related Compliance Supplement. 12-2. An opinion unit is related to the financial reporting format of governments. Opinion units include: governmental activities, business-type activities, aggregate discretely presented component units, each major governmental and enterprise fund, and the aggregate remaining funds. Auditors need to know the number of the client’s opinion units since the auditor is required to opine on each unit. Because an opinion is needed on each unit, GAAS requires that materiality determinations be made for each opinion unit. The number of opinion units affects the complexity, time, and cost of an audit. 12-3. The government audit report is longer due to increased audit requirements. The audit report of a government will include one or more explanatory paragraphs explaining: 1) that supplemental information included as part of the government’s annual report is not part of the basic financial statements, 2) whether auditors applied auditing or certain limited procedures to the supplemental information, and 3) whether the auditors express an opinion on the supplemental information. Additionally, recall from Chapter 9 that certain parts of the annual report, such as the MD&A, are required supplementary information (RSI) and as such, the auditors will need to conduct and report on certain limited procedures applied to the RSI. Even the introductory, scope and opinion paragraphs can be longer in a government audit report since the auditor is opining on a number of opinion units. 12-4. GAGAS is the acronym for generally accepted government auditing standards (also referred to as GAS), the standards set forth by the Comptroller General in the "yellow book." GAAS is the acronym for generally accepted auditing standards established by the AICPA. GAAS are designed to enable an auditor to express an opinion on the financial statements. GAGAS are designed to enable auditors to report on financial statement audits, attestation engagements, and performance audits (e.g., operational audits to assess the efficiency and effectiveness of an organization). In effect, GAGAS is broader than GAAS and generally encompasses and expands on the AICPA’s generally accepted auditing standards. (See Illustration 12-6.) The AICPA also has standards on Attestation Engagements (SSAEs) and Standards on Consulting Services. 12-2 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Answers (Cont’d) 12-5. Government Auditing Standards defines three major types of services performed by auditors: financial statement audits, attestation engagements, and performance audits. Financial audits provide an auditor's opinion that financial statements present fairly an entity's financial position, changes in financial position, and, where applicable, cash flows in conformity with generally accepted accounting principles and informs users that they can rely on that information. Attestation engagements are examinations or reviews on subject matter that provide various levels of assurance on financial or nonfinancial matters depending upon the user’s needs. Performance audits provide an auditor's independent assessment (but not an opinion) of the extent to which government officials are efficiently, economically, and effectively carrying out their responsibilities. 12-6. Disagree. Government auditing standards (GAGAS) can apply to any entity receiving federal funds. If the not-for-profit organization received federal funds and expended $500,000 or more in federal program funds it is subject to GAGAS. Additionally, the entity needs to consider whether it has entered into a legal or contractual agreement that requires GAGAS. For example, the not-for-profit may receive state grant funds and be operating in a state that requires GAGAS audits of entities receiving and/or expending state funds. 12-7. An OMB A-133 audit has financial and program compliance components. The financial component of an A-133 audit is conducted using GAGAS. Thus, an A-133 audit encompasses GAGAS. Unique to an A-133 audit is the program compliance component. The purpose of the program compliance component is to ensure that funds are being expended in accordance with law, regulation, and grant or contract provisions. A program compliance audit goes beyond an audit of financial data. 12-8. The risk-based approach (see Illustration 12-9) is applied as follows: First, the “larger” (per the sliding scale presented in Chapter 12) federal programs are identified as “Type A.” All other programs are identified as “Type B” programs. Second, any low risk Type A programs are identified. This involves auditor judgment after fully considering the factors discussed in Chapter 12. Third, high risk Type B programs are identified. However, the auditor is not expected to perform risk assessments on relatively small federal programs, as defined in Chapter 12. At a minimum, the auditor should audit as major programs all Type A programs not identified as low risk and certain of the high risk Type B programs, using one of the following options: (a) audit at least half of the high risk Type B programs, but not required to audit more Type B than Type A programs identified as low risk; or (b) audit one high-risk Type B program for each Type A program identified as a low risk program. As many major programs as necessary must be audited to ensure that at least 50% of total federal awards expended are audited. 12-9. The National Single Audit Sampling Project was undertaken by the Audit Committee of the President’s Council on Integrity and Efficiency to determine the quality of single audits and to establish a statistically based measure of audit quality. The Project was also charged with recommending changes that would improve single audit quality. Results of 12-3 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Answers, 12-9 (Cont’d) the project are important to the auditing profession since the results indicate that 35.5% of single audits for the period covered by the Project were considered unacceptable. Given the large amount of tax dollars subject to single audit requirements, it is imperative that policymakers and other users be able to rely on the single audits conducted. Therefore, recommendations that will improve audit quality are being considered for implementation. Possible changes include increased education requirements, increased single audit guidance and increased sanctions for poor single audit performance. 12-10. Audit committees, when properly organized and utilized, can provide substantial benefit to all concerned parties. These benefits include: (1) strengthening the stewardship reporting function of the governing board; (2) improving communication between the independent auditor and management; and (3) enhancing the auditor's independence by serving as an objective buffer between the auditor and management. For taxpayers and creditors, audit committees help ensure maximum value and benefit from the audit. The Sarbanes-Oxley Act of 2002 requires audit committees for publicly traded companies and many governments and not-for-profit organizations are establishing audit committees as a good practice. The AICPA has a resource called Government Audit Committee Toolkit available at that should provide useful information to governments. Solutions to Cases 12-1. Reading something like this about an audit client may cause you to reassess whether you want the client. It will definitely cause you to reevaluate any audit plans that have been made to date. Additionally, given that the item has made the newspaper, you will want to keep in mind the increased political visibility of the audit. While there are numerous factors you would want to consider, factors related to the SAS risk assessment suite (SAS 104-111) and other information discussed in the chapter include: 1. Management assertions, particularly with regard to internal control procedures for data systems security and capital asset management procedures. 2. Risk assessment – it would appear that the probability of the risk of material misstatement is high. To determine the risk of material misstatement a better understanding is needed concerning what the theft indicates and the impact on the financial reports. Following the risk assessment suite: • You will want an in-depth understanding of the entity. What is the tone at the top? Are policies and procedures implemented and monitored? • You will want an in-depth understanding of internal control. Do control problems extend beyond the tax collector and or property management (exactly who was responsible)? How was someone able to walk off with two servers? What impact does the data or the pervasiveness of the problem have on material misstatement in the financial reports? 3. Once risks are assessed, further audit procedures will likely need to be performed in response to the identified risks. 12-4 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, Case 12-1 (Cont’d) 4. GAGAS requirements would encompass all risk assessment performed for a GAAS audit. However, when assessing the risk of material misstatement, GAAS does not ask the auditor to consider abuse as a possible source of risk. Given the information in the news article it is possible abuse is occurring or has occurred. 12-2. This case highlights two issues: (1) determining whether an organization has expended sufficient federal awards to require either a single audit or program-specific audit (not always an easy task); and (2) the auditor’s responsibilities to communicate to the auditee that a single audit is required and to exercise due professional care in planning and conducting the audit. These issues are addressed in the following solutions to the three requirements of the case. a. Analysis of expenditures of federal awards shows that Mountain Lake Mental Health Affiliates expended more than $500,000 in federal awards and therefore is required to have a single audit. Total expenditures of federal awards is determined as follows: Item 1. 2. 3. 4. 5. Grant from City Private gifts Medicare services Free rent Counseling services Total b. Federal Awards Expended $ 75,000 -0-030,000 400,000 (50% of $150,000 expended) (not applicable) (excluded) (maximum) $505,000 As with any good case, formulating a solution for this requirement may require some independent research of the authoritative literature (AICPA Professional Standards, the yellow book, and OMB Circular A-133). Based on such research, one could conclude that Mr. Wise would be unwise to accept this engagement for $5,000 since a single audit conducted in accordance with GAGAS and OMB Circular A-133 requires considerably more audit planning, audit work, and audit reporting than a financial statement audit conducted in accordance with GAAS. Mr. Wise should prepare an engagement letter stating that the audit will be a single audit to be conducted in accordance with GAAS, GAGAS, and OMB requirements. Ideally, the audit contract would specify Mr. Wise’s hourly billing rate and that of any audit staff and provide for payment based on actual hours of audit work performed. However, audit contracts often provide for a maximum audit fee to protect the auditee. More often than not the actual fee is the maximum allowed under the contract. 12-5 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, Case 12-2 (Cont’d) If Mountain Lake refused to contract for a full-scope single audit, Mr. Wise would be obligated under AICPA Professional Standards, AU §801.04, to communicate to Mountain Lake’s management and audit committee (or, if no audit committee, to the governing board) that an audit in accordance with GAAS does not meet the legal and regulatory requirements established by the federal government for recipients who expend $500,000 or more in federal awards. Further, the auditor should consider the implications of the illegal act (of not having the required audit) and the potential that the auditee may be attempting to cover other illegal acts or other noncompliance by avoiding the single audit. In such a case, Mr. Wise would be obligated by GAGAS to report the auditee’s refusal to contract for a single audit to an appropriate federal official. OMB Circular A-133 provides for a variety of sanctions if a nonfederal entity does not obtain a required single audit. Preferably, in this case, Mr. Wise would withdraw from the engagement; but if he should decide to conduct the audit in accordance with GAAS, he would be required to issue a qualified or adverse opinion, or disclaim an opinion if he was unable to perform needed audit work. c. Yes, preparing routine tax filings are explicitly listed in the GAO’s Amendment No. 3 to the 1996 Government Auditing Standards on independence as an example of a service that would not impair the independence of an auditor. 12-2. There is a great deal more information you will want before making your bid. Some of the factors affecting price that you might have on your list include: 1. Number of major programs. The larger the number of major programs the more opinion units on which you will need to determine materiality and opine. 2. The amount of aid received from the federal government. If the city expends over $500,000 in federal funds it is subject to a single audit, increasing the complexity of the audit. 3. The number of federal programs and the amount of funds expended by each program. The number and size of federal programs can affect the major programs selected for program compliance review, and thus the complexity of the audit. 4. Other than the new administration, other risk factors. The new controller is a CPA with government audit experience, which may help mitigate some risk. However, the controller is new to the culture and environment of the city government. Item 4 indicates that other risk factors could include a budgetary deficit and the adequacy of financial reserves. Risk factors can increase the amount of testing required, thus driving up the price. 12-4. The objectives of this case are to familiarize you with government audit resources available on the Internet and to illustrate the process for selecting major programs for audit using the risk-based approach. 12-6 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, Case 12-4 (Cont’d) a. The Department of Education sponsors Title I (CFDA 84.010) and Early Reading First (CFDA 84.359). The National School Lunch Program (CFDA 10.555), School Breakfast Program (CFDA 10.553) and Child and Adult Care Food Program (CFDA 10.558) are sponsored by the Department of Agriculture. Head Start (93.600) is sponsored by the Department of Health and Human Services. b. Two of the Department of Agriculture sponsored programs can be treated as a cluster for audit purposes. They are the National School Lunch Program and the National School Breakfast program. c. Total expenditures are $896,261; therefore, the criterion for selecting a major Type A program would be $300,000 in federal funds expended. Head Start is the only program that meets this requirement. The cluster of programs (School Lunch and School Breakfast) at $33,149, the Early Reading First program at $55,000 and the Child and Adult Care Food Program at $28,112 fall below the $100,000 threshold and would be exempt from consideration based on their size. d. Based on size alone, it would be reasonable to select the Head Start program. Head Start is a Type A program and the resources expended are over half of those received by the entity. Since there are no low-risk Type A programs, only the Head Start program would need to be audited. e. This is a difficult question. Notice that the only way the 50 percent coverage rule can be met is by auditing the Head Start program. One single audit problem that OMB and GAO have identified in the past relates to the same programs always being audited. This presents one situation where the auditor may continue to audit a lowrisk program just to meet A-133 requirements. The auditor should analyze the auditee to determine if the auditee would qualify as a low-risk auditee. If the auditee is low-risk the auditor need audit 25 percent of federal funds expended. The auditor must still select at least one Type B for each low risk Type A. Using the low-risk criterion, $224,066 of expended funds would need to be audited. To meet the requirements the auditor could select the Title I program. f. All of the programs identified exist to serve economically disadvantaged children (Title I, Head Start, and the reading program), or funding is increased if economically disadvantaged children are served (the food programs). The income eligibility of the children served becomes an important compliance issue since a violation of this compliance requirement indicates federal funds have been misspent with regard to program purpose. 12-5. Although this case requires no analysis, it is a useful exercise to give students a feel for the resources auditors use to test for compliance in performing single audits. a. The Catalog of Federal Domestic Assistance (CFDA) number for this program is readily determinable from the Catalog: 14.157. 12-7 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, Case 12-5 (Cont’d) b. The program’s objectives are to expand the supply of housing with supportive services for the elderly including the frail elderly. The eligible beneficiaries are people who are 62 years of age or older and have very low incomes. Source: Catalog of Federal Domestic Assistance). c. Based on the matrix provided in Part 2 of the March 2008 A-133 Compliance Supplement, the description of compliance requirements in Part 3 of the Compliance Supplement, and the more detailed compliance requirements in Part 4, the following generic compliance requirements are applicable to the program. [Note: these are assigned the same identifying letters as shown in the Compliance Supplement. It will be informative to take the time to read some of the requirements under each category] A. B. C. D. E. F. I. K. N. 12-6. Activities Allowed or Unallowed Allowable Costs/Cost Principles Cash Management Davis-Bacon Act Eligibility Equipment and Real Property Management Procurement and Suspension and Debarment Real Property Acquisition and Relocation Assistance Special Tests and Provisions a. There are many ideas that can be provided on why there are problems with the quality of the single audit. Problems with single audit quality have been ongoing. Some ideas meriting discussion include: • The complexity of the single audit. • Auditor unfamiliarity with program compliance (i.e., it is not a part of the auditor’s training). • Lack of on-going exposure to the single audit. Many audit firms may only conduct one or two single audits a year, preventing them from developing expertise in the area. • Lack of liability. Many auditors may perceive a reduced risk related to a government audit since government audits due not subject the auditor to shareholder litigation or SEC oversight. • Pricing. Auditors have argued that the bidding process used by governments reduces the quality of audits since governments appear to be interested in the lowest priced audit available. b. Each party involved in the single audit has a stake in finding workable solutions to the single audit quality problem. Again, many solutions are possible, listed below are ideas that are being considered. 12-8 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, Case 12-6 (Cont’d) (1) Office of Management and Budget – clarify the confusing areas of Circular A133, provide additional guidance for auditors. (2) Auditee – provide clear Requests for Proposal that indicate that quality is more important than price alone, improve governance through the establishment of audit committees and other oversight mechanisms. (3) Audit profession – increase education, increase sanctions for poor quality audits. (Note: the AICPA has a Governmental Audit Quality Center; the mission of which is to promote the importance of quality governmental audits. It provides resources, events, and activities that help provide quality governmental audits.) 12-7. Sarbanes-Oxley Act of 2002 brought attention to audit committees, although many organizations have charged subsets of the Board or Council with specific duties relating to the audit and auditors. a. There are many resources, workshops, articles and books on the topic of audit committees in general. For governments, in particular, the AICPA has a resource titled Government Audit Committee Toolkit available at . b. The benefits of an audit committee include helping the auditors remain independent of the management. A council with an audit committee will be able to more closely monitor the work of the auditors and communicate with the wider board about audit findings. Duties will include retaining the public accounting firm that best meets the selection criteria set forth in a request for proposal (RFP), and then meeting periodically throughout the year with the auditors to discuss the audit plan, progress and findings. Board or Council members who serve on the audit committee would be expected to have financial expertise in the area of financial reporting or auditing in order to work effectively with the auditors and report back to the board or council as a whole. The costs of an audit committee might include the time and energy it will take to recruit and orient board or council members to serve on such a committee, as well as the time it takes to meet periodically throughout the year. Each student’s report should demonstrate not only strong written communication skills, but also effective and persuasive language about the benefits and costs of audit committees to guide the city council in its deliberations. Solutions to Exercises and Problems 12-1. Each student should have a different governmental annual report, so will have different answers to questions in this exercise. Some time spent in class to allow students to report on their own answers and to get an idea of the range of the answers of other students is useful. 12-9 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions (Cont’d) 12-2. 1. 2. 3. 4. 5. b. d. b. c. d. 6. 7. 8. 9. 10. a. c. a. c. b. 12-3. 1. Q 6. DNQ* 2. DNQ** 7. Q 3. Q 8. Q 4. Q 9. DNQ** 5. Q 10. Q * This is basic knowledge an accountant should possess. **This is to help individual clients, and is not related to government. 12-4. a. Total federal awards expended for the year are $15,217,000. Using the sliding scale for determining the threshold for a Type A program (found earlier in this chapter), it can be determined that the threshold is $456,510 ($15,217,000*.03). Those programs that would be classified as Type A because they exceed the threshold would be Programs 1, 3, 4, and 9. The Type B programs would be Programs 2, 5, 6, 7 and 10. b. Programs 1, 3, and 9 would be selected for audit in the current year. Program 4 is a low-risk Type A program so it does not need to be audited in the current period. Funds expended for Program 10 have declined making it a Type B program, additionally it is low-risk based on prior audit results. Programs 1, 3 and 9 are Type A programs that have not been classified as low risk so they must be audited. The total funds expended for these programs is $7,584,000, which is short of the 50 percent coverage requirement of $7,608,500; therefore Type B programs must be considered. Since one Type A program was identified as low-risk at a minimum one Type B program should be selected. Any of the Type B programs will meet the 50 percent coverage rule. If there are no risk considerations that would cause 12-10 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, 12-4 (Cont’d) the auditor to select one Type B program over the other, the auditor would probably select Program 7. c. Yes. With a new, inexperienced manager, Program 4 could now be considered high risk. If it was deemed that Program 4 was now high risk, the programs audited would be 1, 3, 4 and 9. This would exceed the 50 percent coverage rule; however, it is a minimum coverage rule and does not take precedence over identification of high-risk Type A programs. 12-5. 1. 2. 3. 4. 5. a. c. c. b. a. 6. 7. 8. 9. 10. b. c. b. c. b. 12-6. Some of the changes that would need to be made to bring the Steele and Steele audit report into conformance with audit standards include: • In the introductory paragraph the opinion units on which the auditor will opine must be identified. • The scope paragraph must identify that the generally accepted auditing standards are U.S. standards. • In the opinion paragraph the auditor must provide an opinion relative to each opinion unit. • The explanatory information is incomplete. The auditor has addressed some supplementary information, however, more than the Statistical Section is considered supplementary. Any introductory information, combining statements or individual nonmajor financial statements should also be mentioned. The auditor also needs to indicate that required supplementary information included in the financial report is 12-11 Chapter 12 - Auditing of Governmental and Not-for-Profit Organizations Ch. 12, Solutions, 12-4 (Cont’d) outside the scope of the audit and address any limited procedures applied to required supplementary information. • Additionally, the report mentions government auditing standards in the scope paragraph. If a GAGAS audit was performed the report should also include an internal control report on financial reporting and compliance with law, regulation, and provisions of contracts and grants, or a statement indicating that the report has been separately issued (GAGAS reporting standard 2). 12-12 ...
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This note was uploaded on 05/20/2010 for the course ACCOUNTING 580 taught by Professor Waymire during the Spring '10 term at Northern Virginia.

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