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July 1989

Documenting compliance with SAS 59. (Statement of Auditing Standards)

by Goldstein, Fred R.

    Abstract- A review of the Auditing Standards Board's Statement on Auditing Standards (SAS) No. 59, which developed guidance on an auditor's conduct during an audit, indicates many auditors have questions about how to implement the guidance in SAS 59. Specific areas of concern include how to document an evaluation of substantial doubt in the audit file, and how to document and report management's plans. Suggested steps for documenting an evaluation of substantial doubt in the audit file include: reviewing compliance with debt and loan agreements; reading minutes; and meeting with legal counsel. Suggested steps for documenting and reporting management's plans include: describing pertinent conditions and events related to assessment; discussing the possible effects of conditions and events; and developing a synopsis of management's evaluation.

Documenting Compliance with SAS 59

The ASB has issued Statement on Auditing Standards No. 59, The Auditor's Consideration of An Entity's Ability to Continue As a Going Concern, to replace SAS No. 34, its predecessor with a similar title. While the new standard goes a long way towards addressing concerns not dealt with adequately by the predecessor standard, questions have already begun to arise among practitioners about how to implement the guidance in SAS 59 and how to document that implementation. It may be worthwhile to review some of the issues raised and discuss their implications.

In order to understand why the average CPA is concerned about SAS 59, we should keep in mind why the ASB decided it was time for a new standard:

1. There were questions about whether auditors had been taking sufficient responsibility for evaluating a client's ability to continue in existence.

2. There were more than a few companies that had gone out of business shortly after the issuance of an auditor's statement that did not mention the possibility that the company might not continue.

Based on (1) and (2), it was decided that guidance on the auditor's conduct during the audit needed enhancement and that the CPA's reporting responsibility should be better defined when there may be doubts about continuity of the entity's existence.

Situations in Which Confusion Exists

Some practitioners remain confused about their responsibilities under SAS 59, versus its predecessor SAS 34. The new standard requires a mandatory evaluation of whether audit procedures have identified conditions or events that, in the aggregate, indicate that there could be substantial doubt concerning entity continuity. The standard goes on to specify procedures designed and performed to meet other audit objectives that are sufficient for making such an evaluation. SAS 59 also highlights conditions and events giving rise to a substantial doubt about such entity continuity. However, the new standard does not detail a new evaluation method.

Another source of confusion in SAS 59 concerns documentation in the audit file management's plans when doubt exists and evaluation of such plans is made by the CPA. While the new standard spells out elements of management's plans that might mitigat doubts, it is silent as to how to buttress the audit file.

Many accountants do not yet understand the circumstances under which a favorable evaluation of management's plans by the auditor, in accordance with SAS 59, should be spelled out in workpapers and in some cases, disclosed in notes to financial statements.

How to Document an Evaluation of Substantial Doubt in the Audit File

Some firms have had pre-planning checklists and audit programs which framed out continuity questions. Other firms wrote memos to the file only when such conditions were discovered and evaluated. Under the new standard, it would appear that preplanning checklists, audit programs and final review checklists would be deficient without a specific question under general matters, such as contingencies, subsequent events and related party transactions, asking whether the evaluation has taken place (see Example 1). A separate questionnaire on continuity may also be advisable. It should spell out critical questions and assessments detailed in SAS 59.

SAS 59 outlines some customary procedures designed and performed by CPAs to meet audit objectives that are sufficient for making the evaluation to identify events and conditions. These steps include the following:

1. Analytic procedures (SAS 56)

2. Review of subsequent events.

3. Review of compliance with debt

and loan agreements.

4. Reading minutes.

5. Inquiry of legal counsel.

6. Confirmation of arrangements

with third parties to provide

financial support.

Many of the aforementioned steps customarily are part of existing audit program questions and documentation, made before the expectation gap standards were promulgated by the ASB. It would appear that questions concerning these matters in final review checklists and audit programs should contain language suggestive of going concern considerations, no matter which sections the steps appear under in the checklists or programs. This will constantly remind all personnel of the implications involved.

Practitioners have always been aware of the need to review compliance with debt and loan agreements. It is imperative to stay abreast of revised terms of the aforementioned agreements. Accordingly, continual updates of permanent file copies and attention to confirm response details is needed. It should also be obvious that loan compliance worksheets should be prepared regularly by the CPA (see Example 2). In addition, sluggish or slow payment of long-term debt, accounts payable and other accrued liabilities requires inquiry by audit personnel.

Analytic procedures are mandatory in the planning and final review stages of the audit, according to SAS 56. Statistics generated by such procedures take many forms and can appear in various places in the workfile. For procedures that suggest trends or difficulties, the audit program and reviewer's checklist should suggest positive evaluations by audit personnel and requisite forwarding to engagement management for final assessment. Some of the trends that may be regularly and easily documented in specific audit sections include:

Accounts receivable:

* Comparative aging, write-off

and collections days trends.

* Sales volume and discounts and

returns and allowances trends.


* Composition between raw,

work-in-progress and finished

goods categories.

* Gross profit and turnover of

inventory comparisons.

How to Document and Report Management's Plans

SAS 59 reiterates a variety of management's plans which might mitigate doubts concerning the entity's going-concern status. Such plans may include:

1. Plans to dispose of assets.

2. Plans for new borrowing or debt


3. Plans to increase ownership.

4. Prospective financial

information in the form of forecasts and

projections or operational

restructuring plans.

Many practitioners do not think SAS 59 is any clearer on how such plans can be documented in the file than SAS 34. Those CPAs expressing concern indicate that the basis for evaluating client plants is extremely difficult because the data underlying such plans is frequently sketchy. It appears that practitioners would be well advised to know the range of plans that are discussed in the new standard. Some aspects of management's plans may be difficult to evaluate, but many do lend themselves to inspection of corroborative evidence which belongs in the audit file. A little bit of ingenuity, as well as skepticism, can fulfill the objectives of SAS 59. Below are some examples of when documentation might be obtainable:

1. Ability and intent of a related party or entity can be documented by financial statements from that party, filing of subordination agreements by that party, and confirmation by the auditor from that party.

2. Cost reduction programs can be documented by payroll record inspections if related to labor reduction programs. Other cost reductions can also frequently be assessed in a manner similar to labor costs.

3. An improved sales climate or pricing changes by the client, embodied in forecasts or client assertions, can frequently be corroborated by inspection of order backlogs or recent customer orders.

4. Client asset sales are frequently preceded by correspondence, such as letters of intent or informal third-party memos.

The new standard suggests what information might be disclosed when substantial doubt exists. Constructing a memo concerning the going concern evaluation, which keys in on some of the suggested information one would disclose if reporting were appropriate, would also help document the evaluation. This type of memo should include the following:

1. Describe pertinent conditions and events giving rise to the assessment.

2. Discuss the possible effects of these conditions and events.

3. A synopsis of management's evaluation and summarization of any mitigating factors.

4. Highlight discontinuances of operations.

5. Describe management's plans.

6. Discuss information about the recoverability and classification of assets and liabilities.

Documenting the aforementioned evaluation is useful when assessing the seriousness of the going concern question, and whether plans by management to alleviate the problem are likely to succeed.

SAS 58, Reports on Audited Financial Statements, has been issued by the ASB to simplify report language so users can understand what the auditor does and does not do. In this regard, the practitioner should think of a continuity question as a piece of information to which the reader is entitled, a matter requiring emphasis but on which the auditor does not pass judgement. SAS 59 auditors' opinions are no longer phrased "subject to" and the reader of the statement is obliged to form his or her own conclusions. It is only when the auditor believes the disclosures are inadequate that there should be an adverse or qualified opinion in the auditor's report. Consequently, the auditor should decide, in situations where the condition is mitigated, whether the reader should be informed about the conditions by a disclosure in the notes to the financial statements. Example 1 and 2 Omitted

Fred R. Goldstein, CPA Putterman, Rush & Shapiro CPAs New York, NY

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