Statement on Auditing Standards, Consideration of Fraud in a Financial Statement Audit (Redrafted)

1. The SAS

a) Supersedes SAS No. 99, Consideration of Fraud in a Financial Statement Audit (AICPA, Professional Standards, vol. 1, AU sec. 316).

b) Redrafting of SAS No. 99 to apply the ASB’s clarity drafting conventions and to converge with International Standards on Auditing (ISAs).

c) Convergence – Drafted using ISA 240 (Redrafted), The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, as a base.

d) Differences between SAS No. 99 and ISA 240 (Redrafted) for which the ASB believes no compelling reason to be different exists have been eliminated.

e) The ASB made various changes to the language of the ISA during the drafting process to use terms or phrases that are more commonly used in the United States, and to tailor examples and guidance to the U.S. environment. The ASB believes that such changes will not create differences between the application of ISA 240 and the application of the SAS.

2. Effective Date – Effective for audits of financial statements for periods ending on or after December 15, 2012.

3. Changes from Existing Standards

a) Does not change or expand SAS No. 99 in any significant respect.

b) To reflect a more principles-based approach to standard setting, certain requirements that are duplicative of broader requirements in SAS No. 99 have been moved to application and other explanatory material, consistent with ISA 240 (Redrafted). The ASB’s view is that this has not changed the overall effectiveness of the proposed SAS.

4. Additions to the SAS

a) The Clarity Project of the ASB has added some sections to the redrafted SAS’s. In this case Objectives are added. Objectives refer to the objectives of the auditor. In this proposed SAS Objectives are to:

(1) identify and assess the risks of material misstatement of the financial statements due to fraud;

(2) obtain sufficient appropriate audit evidence about the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses;

(3) respond appropriately to identified or suspected fraud.

Statement on Auditing Standards, Audit Considerations Relating to an Entity Using a Service Organization (Redrafted)

1. Introduction. This SAS

a) Supersedes SAS No. 70, Service Organizations (AICPA, Professional Standards, vol. 1, AU sec. 324), which contains guidance for auditors auditing the financial statements of entities that use a service organization (user auditors) and for auditors reporting on controls at a service organization (service auditors).

b) Contains guidance for user auditors. Guidance for service auditors will be contained in a new Statement on Standards for Attestation Engagements (SSAE), Reporting on Controls at a Service Organization, which is being exposed for comment concurrently with this SAS.

2. Affects Existing Standards

a) A user organization is known as a user entity.

b) In a type 2 report, the service auditor’s report would contain an opinion on the fairness of the description of the service organization’s system and on the suitability of the design of the controls for a period rather than as of a specified date, as it currently does.

c) A user auditor is permitted to make reference to the work of a service auditor in his or her report to explain a modification of the user auditor’s opinion. In those circumstances, the user auditor’s report would be required to indicate that such reference does not diminish the user auditor’s responsibility for that opinion. (As in extant AU section 324, the user auditor would be prohibited from making reference to the work of a service auditor in a user auditor’s report containing an unmodified opinion. The user auditor cannot divide responsibility for the audit of user’s financial statements by referring to the service auditor’s report.)

d) A user auditor is required to inquire of management of the user entity about whether the service organization has reported to the user entity any fraud, noncompliance with laws and regulations, or uncorrected misstatements. If so, the user auditor would be required to evaluate how such matters affect the nature, timing, and extent of the user auditor’s further audit procedures.

e) The SAS is applicable to situations in which an entity uses a shared service organization that provides services to a group of related entities.

3. Convergence

a) Drafted using the December 2007 exposure draft of International Standard on Auditing (ISA) 402 (Revised and Redrafted), Audit Considerations Relating to an Entity Using a Third Party Service Organization, as a base.

b) Differences between the SAS and the ISA 402 exposure draft, for which the ASB believes there is no compelling reason to be different, have been eliminated.

c) The ASB has made various changes to the language in the proposed ISA, including replacing terms or phrases used in the proposed ISA with those more commonly used in the United States, and tailoring examples and guidance so that they are more appropriate for the U.S. environment.

4. Effective Date

a) The SAS is effective for audits of financial statements for periods ending on or after December 15, 2012.

Statement on Auditing Standards Consideration of Laws and Regulations in an Audit of Financial Statements

SAS Consideration of Laws and Regulations in an Audit of Financial Statements supersedes SAS No. 54, Illegal Acts by Clients (AICPA, Professional Standards, vol. 1, AU sec. 317).

Effective for audits of financial statements for periods ending on or after December 15, 2012.

1. Scope

a) Addresses the auditor’s responsibility to consider laws and regulations in an audit of financial statements.

b) Does not apply to other assurance engagements in which the auditor is specifically engaged to test and report separately on compliance with specific laws or regulations.

2. Effect of Laws and Regulations

a) The impact of laws and regulations on financial statements varies considerably.

b) The applicable laws and regulations constitute the legal and regulatory framework of the entity.

c) Some laws or regulations have provisions with a direct effect on the financial statements because they determine the reported amounts and disclosures required in an entity’s financial statements.

d) Other laws or regulations are to be complied with by management, or set the provisions under which the entity is allowed to conduct its business, but do not have a direct effect on an entity’s financial statements.

e) Some entities operate in heavily regulated industries (such as banks and chemical companies) while others are subject only to the many laws and regulations that relate generally to the operating aspects of the business (such as those related to occupational safety and health and equal employment opportunity).

f) Noncompliance with laws and regulations may result in fines, litigation, or other consequences for the entity that may have a material effect on the financial statements.

3. Responsibility for Compliance with Laws and Regulations

a) Responsibility of Management– Management’s responsibility, with the oversight of those charged with governance, is

(1) to ensure that the entity’s operations are conducted in accordance with the provisions of laws and regulations, including compliance with the provisions of laws and regulations that determine the reported amounts and disclosures in an entity’s financial statements.

b) Responsibility of the Auditor

(1) The requirements in this SAS are designed to assist the auditor in identifying material misstatement of the financial statements due to noncompliance with laws and regulations.

(2) The auditor is not responsible for preventing noncompliance and cannot be expected to detect noncompliance with all laws and regulations.

(3) The auditor is responsible for obtaining reasonable assurance that the financial statements as a whole are free from material misstatement, whether caused by fraud or error.

(4) The auditor is responsible for taking into account the applicable legal and regulatory framework during the planning and execution of the audit procedures.

(5) In the context of laws and regulations, the potential effects of inherent limitations on the auditor’s ability to detect material misstatements are greater for the following reasons:

(a) Many laws and regulations (relating principally to the operating aspects of an entity) typically do not affect the financial statements and are not captured by the entity’s information systems relevant to financial reporting.

(b) Noncompliance may involve acts designed to conceal it, such as collusion, forgery, deliberate failure to record transactions, management override of controls, or intentional misrepresentations made to the auditor.

(c) Whether an act constitutes noncompliance is ultimately a matter for legal determination, such as by a court of law.

(6) This SAS distinguishes the auditor’s responsibilities in relation to compliance with the following two categories of laws and regulations that may have a material effect on the financial statements of the company:

(a) The provisions of those laws and regulations generally recognized to have a direct effect on the determination of material amounts and disclosures in the financial statements, such as tax and pension laws and regulations.

(b) The provisions of other laws and regulations that do not have a direct effect on the determination of the amounts and disclosures in the financial statements but compliance with which may be:

(i) fundamental to the operating aspects of the business,

(ii) fundamental to an entity’s ability to continue its business, or necessary for the entity to avoid material penalties (for example, compliance with the terms of an operating license, regulatory solvency requirements, or environmental regulations).

c) Differing requirements are specified for each of the previously mentioned categories of laws and regulations.

(1) Auditor’s responsibility for the category referred to in (6) (a) is to obtain sufficient appropriate audit evidence regarding material amounts and disclosures in the financial statements that are determined by the provisions of those laws and regulations.

(2) Auditor’s responsibility for the category referred to in (6) (b) is limited to performing specified audit procedures that may identify noncompliance with those laws and regulations that may have a material effect on the financial statements.

d) The auditor is required to remain alert to the possibility that other audit procedures applied for the purpose of forming an opinion on financial statements may bring instances of identified or suspected noncompliance with laws and regulations to the auditor’s attention.

The Principles and Objectives for Redrafted SASs

Here is a summary of the first redrafted and clarified SAS issued by the Auditing Standards Board which will become effective for periods ending after December 15, 2012:

Preface to Codification of Statements on Auditing Standards, Principles Underlying an Audit Conducted in Accordance With Generally Accepted Auditing Standards and Statement on Auditing Standards, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards

This released document contains two elements:

· Preface to Codification of Statements on Auditing Standards, Principles Underlying an Audit Conducted in Accordance With Generally Accepted Auditing Standards, and

· Statement on Auditing Standards, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards.

Changes from Existing Standards

Will supersede SAS No. 95, as amended, which contains the general, field work, and reporting standards (the 10 standards).

Consideration by the ASB of the 10 standards

· SASs are codified within the framework of the 10 standards, viewed as the historical basis for generally accepted auditing standards (GAAS). The clarity drafting conventions adopted by the ASB include establishing an objective or objectives for each SAS.

· The SAS establishes the overall objectives of the auditor, which are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thus, enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and to report on the financial statements, or otherwise as required by the SASs, in accordance with the auditor’s findings.

· Each SAS contains an objective, or objectives that provide a link between the requirements and the overall objectives of the auditor. The SASs taken together provide the standards for the auditor’s work in fulfilling the overall objectives of the auditor.

· If an auditor fulfills the overall objective of the audit and meets applicable ethical requirements, such as the AICPA Code of Professional Conduct, the ASB believes that the auditor will have fulfilled the requirements currently stated in the 10 standards. Accordingly, the proposed SAS does not contain 10 unconditional requirements that are the direct equivalent of the 10 standards.

Replacement of the 10 standards with principles

· To preserve the functions of the 10 standards, the ASB has developed the Principles Governing the Conduct of an Audit in Accordance With Generally Accepted Auditing Standards (referred to as the principles).

· The principles identified in the preface:

§ have been drafted in the present tense.

§ are not requirements and

§ do not carry any authority.

§ are the fundamental principles that govern an audit and are supported by the objectives and requirements of the individual SASs.

Structure of the Principles

· The purpose of an audit (purpose). To provide financial statement users with an opinion by the auditor on whether the statements are presented fairly, in all material respects, in a manner that conforms to an applicable financial reporting framework

· Personal responsibilities of the auditor (responsibilities). These include competence and capabilities, compliance with appropriate ethical standards and approaching the work with appropriate professional skepticism and judgment.

· Auditor actions in performing the audit (performance). Perform the work necessary to be reasonably, but not absolutely, sure that the financial statements are free from material misstatement due to fraud or error.

· Reporting (reporting). Based on the results of the performance of the audit, express an opinion or state that an opinion cannot be expressed on the financial statements.

Applicable Financial Reporting Frameworks

The SAS introduces the following terms:

Financial reporting framework. A set of accounting principles that are used to determine measurement, recognition, presentation, and disclosure of all material items for preparing financial statements in accordance with principles generally accepted in the U.S.(GAAP), International Financial Reporting Standards (IFRSs), issued by the International Accounting Standards Board (IASB), or a special purpose framework prepared on a comprehensive basis of accounting other than GAAP (OCBOA– now referred as Special Purpose Framework).

Applicable financial reporting framework— The financial reporting framework adopted by management in the preparation and presentation of the financial statements.

Fair-presentation framework— Refers to a financial reporting framework that requires compliance with the requirements of the framework and acknowledges explicitly or implicitly that, to achieve fair presentation of the financial statements, it may be necessary for management to provide disclosures beyond those specifically required by the framework; or acknowledges explicitly that it may be necessary for management to depart from a requirement of the framework to achieve fair presentation of the financial statements. Such departures are expected to be necessary only in extremely rare circumstances. Current reporting requirements do not permit. departures from GAAP.

Regulatory and contractual-based framework—Refers to a financial reporting framework that requires compliance with the requirements of the framework, but does not contain the acknowledgments in (c) above This type of framework is referred to in the ISAs as a compliance framework; the term was changed for purposes of GAAS to regulatory or contractual-based framework to avoid confusion with the term compliance audit.

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ASB Clarity and Convergence Projects Produce 30+ New SASs

The AICPA Auditing Standards Board (ASB) is involved in a project that is designed to make U.S. generally accepted auditing standards (GAAS) easier to read, understand, and apply. Since the creation of the Public Company Accounting Oversight Board (PCAOB) in 2004 the ASB has gone through a reorganization and has considered how best to meet its mission. In addition it has been cognizant of the increasingly widespread acceptance of International Standards on Auditing (ISAs).

The Board subsequently developed a plan to converge U.S. GAAS with the ISAs while, at the same time, avoiding unnecessary conflict with PCAOB standards. In order to converge SASs with ISAs the Board aligned its agenda with that of the IAASB and began to develop its standards based on the ISAs. This allows the ASB to consider projects simultaneously with the IAASB.

Clarity Project

The foundation of the Clarity Project is the establishment of an objective for each auditing standard to better reflect a principles-based approach to standard-setting. In March 2007 the ASB issued a discussion paper, Improving the Clarity of ASB Standards. As a result of the feedback the Board received on this discussion paper, the ASB established “clarity drafting conventions” that will be applied to all standards issued by the ASB after January, 2008.

The clarity drafting conventions are:

a) Establishing objectives for each of the standards
b) Including a definitions section, where relevant, in each standard
c) Separating requirements from application and other explanatory material
d) Numbering application and other explanatory material paragraphs using an A prefix and presenting them in a separate section (following the requirements section)
e) Using formatting techniques, such as bulleted lists, to enhance readability
f) Special considerations relevant to audits of smaller, less complex entities
g) Special considerations relevant to audits of governmental audits

The ASB currently is in the process of:

a) Redrafting all of the auditing sections in Codification of Statements on Auditing Standards,
b) Applying the clarity drafting conventions, and
c) Converging the material with the international auditing standards.

This process includes exposing clarity redrafts, considering comments, making changes, and finalizing the standards. The ASB has directed that all clarified and redrafted standards will be effective on the same date, (Standards that address current issues will have earlier effective dates.), for audits of financial statements for periods ending on or after December 15, 2012.

Currently, there are more than 20 finalized standards plus other proposed standards. While changes in the standards are for most subjects not consequential, auditors will need an understanding of the new standards when auditing entities for the year ending December 31, 2012. In future blogs, we plan to discuss and dissect each of the new finalized standards that are posted on the ASB's Clarity Project page of the AICPA website.