Viewpoints

Overview of New Auditing Standards

Kristen Clark

Originally Published In:
September 2007
Author: Kristen Clark, CPA

The post-Enron period continues to raise legitimate questions about corporate ethics and governance.  These questions include the role of a company’s board of directors and its audit and/or finance committees, internal controls, compliance with accounting and audit standards and other reporting requirements, financial reporting transparency, the adequacy of the current financial reporting model, and other issues. 

In response to this financial reporting environment, the Auditing Standards Board, working in concert with the International Auditing and Assurance Standards Board and the Public Companies Accounting Oversight Board has completed a project to develop stronger and more definitive auditing standards intended to enhance auditor performance and improve audit effectiveness.

First, I’d like to talk about Risk-Based Auditing

Traditionally, auditors have focused primarily on the accounts comprising the financial statements, and risk was assessed based on the accounts' size, characteristics, and related controls. During the 1990's, many auditors moved away from audit approaches that focused narrowly on financial statement accounts toward broader based audit approaches, which are sometimes referred to as "risk-based auditing".
Under these newer methodologies, auditors take a more holistic view of the business, including reviewing business strategies and processes, internal and external factors, and performance measurement practices to identify risks of material misstatement. Then, the auditors devote the most audit attention to higher risk areas.

Risk-based auditing is more effective because (a) auditors develop a greater understanding of the companies, their environments, and business processes and (b) their audit procedures are more targeted to the areas that are more likely prone to material misstatement.

To that end, the Auditing Standards Board has issued eleven amendments to existing auditing standards to improve the quality and effectiveness of audits and to enhance the auditors’ application of the risk-based audit model by requiring:

• More in-depth understanding of the entity and its environment, including 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.

In summary, these are the changes you will see in the next audit of your business.

Let’s turn for a moment to Internal Control

Misstatement, whether caused by fraud or error, usually occurs because of weaknesses in internal control.  The auditor’s understanding of the entity, its environment and internal controls should support risk assessment.

Auditors are now required to identify significant risks that need special audit consideration.  And we are now required to increase our knowledge of control activities that prevent and detect fraudulent and erroneous financial reporting. 

As we plan audit engagements, we will be requesting detailed documentation of your accounting systems.  We will be reviewing those systems for gaps in design and weaknesses in operation.  Additionally, we will be reporting on the design and operating effectiveness of internal control and will be making recommendations to management on the structure of internal controls.  

It is ultimately management’s responsibility to create controls that reduce the potential for misstatement due to error or fraud, and for fostering an institutional intolerance for fraudulent behavior, including the monitoring of management’s override of those controls.

Finally, I’d like to discuss Financial Disclosures

At the root of financial reporting is the availability of timely, reliable and meaningful information.  The success of our capital markets depends upon informative, reliable financial reporting – often referred to as “transparency.”

The new auditing standards emphasize that risks of material misstatement should be considered for financial statement disclosures and require the auditor to test these disclosures. Assertions about presentation and disclosure have been expanded to include completeness and understandability to users.

Auditors are now required to focus on the selection and application of accounting policies and whether they are appropriate for the business and consistent with generally accepted accounting principles and with those used in the relevant industry.

All of these changes will require significant increases in time spent on an audit, as well as having an impact on the timing of audit procedures.

I, along with our other audit partners, will be discussing how working together with our clients, we can control audit costs and efficiently implement the new standards.

Disclaimer: The Bonadio Group provides the information in Viewpoints for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in Viewpoints are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.