Successfully Preparing For Year-End Audits of Privately-Held Clients
Year-end is typically a busy time for external auditors, even without the added stress of the COVID-19 pandemic. But as most CPA firms know, the hectic atmosphere is not a reason to neglect a highly-developed, measured, methodical year-end audit strategy plan.
In addition to meeting a CPA firm’s quality control standards, audit engagements are subject to a peer review or outside monitoring process — and a peer review report with a rating of pass with deficiencies, or fail, may shake the core confidence of a CPA firm’s leadership, clients and the public interest. Collemi Consulting professionals have been called in when CPA firms have encountered negative peer review results, and we’ve been asked to address some commonly cited matters.
To begin with, a well-crafted audit will address and satisfy the following issues:
- Common peer review challenges
- Audit planning and supervision
- Audit risk and risk assessment procedures
- Obtaining and documenting an understanding of the audit client and its environment, including its internal controls
- Materiality considerations
- Linking audit procedures to mitigate the risks identified and reach audit conclusions
- Required auditor communications
The auditor’s overall objective when conducting a risk-based approach to audits of financial statements is to provide reasonable assurance that the financial statements, as a whole, are free from material misstatement, enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP).
Avoidance of Common Peer Review Issues
Frequently cited mishaps with respect to risk assessment include:
- Failure to link the substantive procedures performed to the results of the risk assessment
- Audit procedures not linked to the client’s financial statement and relevant assertion-level risks for significant classes of transactions, account balances, or disclosures
- Designing audit procedures with little regard for the results of that assessment as required by AU-C 315, Understanding the Entity and its Environment and Assessing Risks of Material Misstatements.
Risk Assessment Shortcomings
Peer reviewers often cite shortcomings in auditors’ understanding of the entity and its control environment. This includes a failure to understand the entity’s internal controls. When conducting your risk assessment, it’s useful to remember that your assessment will generally be more effective at the start of the engagement, and that internal control procedures may be performed before the risk assessment document is completed. The auditor, however, is not required to test internal controls unless mandated under certain circumstances.
Other critical points to keep in mind include the importance of having strong audit workpaper documentation; and that the risk assessment process is an iterative one: repetition in order to generate a sequence of outcomes. Also, the AICPA Professional Standards have changed over the last decade due to the issuance of the suite of risk assessment standards and Clarity requirements.
Please note that practice aids are no substitute for understanding the Professional Standards. Although auditors are only required to document their understanding of the factors that help them draw conclusions, auditors are still responsible for maintaining adequate documentation, and it’s their responsibility to meet Professional Standards.
Audit Documentation Dilemmas
Audit documentation is defined as “the record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached.” Audit documentation should be sufficient to enable an “experienced auditor” — one who is independent and competent enough to challenge the engagement team’s procedures and conclusions — to understand such characteristics as the nature, timing, and extent of the audit, the results of the audit procedures performed, and any significant findings or issues.
Properly executed, audit workpaper documentation can stand on its own without any verbal explanation by the auditor if it answers the 5 “W” and 1 “H” questions: Who?, What?, When?, Where?, Why?, How?
Audit documentation serves as:
- Evidence that the audit was properly planned and performed in accordance with auditing standards generally accepted in the United States of America (U.S. GAAS) and Evidence of the auditor’s basis for a conclusion
To further increase audit quality, audit documentation should provide sufficient and appropriate evidence that:
- Risk assessment procedures were performed
- There was appropriate response to address the risk of misstatement at the financial statement level
- The nature, timing and extent of audit procedures performed were adequate for the engagement
- There was linkage of those procedures with the assessed risks
- The results of the audit procedures
- Conclusions reached
- Significant risks were reasonably considered
Audit workpapers should also reflect justification for any departures from presumptively mandatory requirements. They should also identify individuals who performed the work, when it was completed, the person who reviewed the work, and the date and extent of the review.
Audit workpaper documentation should also identify characteristics of the specific items tested, and discuss significant findings or issues with management or those charged with governance. Any information that contradicted or was inconsistent with the final conclusion on a significant audit finding or issue that was addressed should also be documented.
Don’t Forget About Litigation Attorneys
Over the years we’ve worked with litigation attorneys who have shared some “flash points” with us about notes and other workpaper matters that can come back and haunt the auditor. To be on the safe side, these are some real-life phrases and other items that should not make an appearance in your audit workpaper files:
- Extraneous remarks or irrelevant memoranda, like “the client’s books are a complete mess” or “these expenses seem questionable”
- Auditor statements that discredit their own work: “close enough for government work”
- Personal files containing memos, schedules, and other matters related to an engagement
- Superseded or outdated workpapers
Elements of properly prepared workpaper files include: initialing and dating each audit program step, signing off any audit program step as not applicable “N/A,” or as not considered necessary “N/C/N”, followed by an explanation. Any “Open Items Lists” should be reviewed and any conclusions regarding unique issues should be thoroughly documented. Additionally, time budgets explaining any overages and underages should be maintained, and the completion date should be documented. Professional Standards require that workpapers should be retained for a minimum of five years from the report release date — although practice, legal, regulatory, or other factors may dictate a longer retention period.
If something questionable is in writing, it may be used against the auditor. Consequently, consider whether certain conversations should be kept verbal or committed to writing. These matters include your correspondence files, email communications, voicemail messages, and time sheets.
“Properly executed, audit workpaper documentation can stand on its own without any verbal explanation by the auditor if it answers 6 questions: Who?, What?, When?, Where?, Why?, How?”
-Salvatore A. Collemi, CPA, Collemi Consulting & Advisory Services, LLC
Don’t Forget Your Independence
The AICPA Code of Professional Conduct requires auditors to be independent in both fact and appearance. Auditor independence issues can be classified into four high-level areas:
- Financial interests
- Family relationships
- Management functions
- Management decision making
In order to perform permissible non-attest services, the audit client must first agree to:
- Make all management decisions and perform all management responsibilities
- Designate an individual with suitable skills, knowledge, and/or experience, preferably within senior-level of management, to oversee the performance of the non-attest services
- Evaluate the adequacy and results of the non-attest services
- Accept responsibility for the results of the non-attest services
- Establish and maintain internal controls, including monitoring ongoing activities
Auditors should exercise caution when it comes to certain “independence” matters that can raise red flags about their independence in a peer review or litigation matter. Some areas include:
- Providing multiple non-attest work products
- Significant concentration of revenue coming from one audit client
- Taking on management responsibilities
- Providing consultation that goes beyond routine advice
- Inadvertently engaging in other non-compliance activities like performing non-attest services for a company before it becomes an attest client; loaning staff members to an attest client; certain mergers or purchase of a CPA firm; employment of, or association with, an attest client; performing attest services for a client with unpaid fees; and engaging a client employee.
Other red-flag issues include financial interests in an attest client and their affiliates, the adequacy of fees being charged, and the existence of group audits.
Audit engagement teams who put in the proper strategic planning up front — which may be 25% to 30% of the total time budgeted for the year-end audit — will greatly enhance the chance of a successful engagement. We recommend an inclusive approach that involves the partner, manager, in-charge as well as quality control professionals and technical advisors like Collemi Consulting. Together, this team approach can identify issues ahead of the audit while planning strategies in a proactive manner. Year-end audits are never simple, and the COVID-19 pandemic makes them even more challenging.
Collemi Consulting & Advisory Services, LLC strives to promote and enhance audit quality to U.S. and international public accounting firms, private sector, attorneys, valuation specialists, standard-setters, regulators and other organizations that influence the public accounting profession.