In April 1988 the ASB issued SASs 53 to 61. SAS 58 on audit reports is effective for reports issued on or after january 1, 1989. SAS 55 on internal control structure is effective for audits of financial statements for periods beginning on or after January 1, 1990. All other SASs are effective for audits of financial statements for periods beginning on or after January 1, 1989. Early application is permissible. Need to Educate Clients

In the short time given to digest the new SASS, many auditors realize that educating clients about the content of the SASs and the anticipated cost and difficulty of applying them to existing audit engagements is as important as educating themselves about the pronouncements. The auditor is finding it difficult to complete post-January 1, 1989, audit engagements within the framework of the pre-January 1, 1989, audit fee structure. Clients must be familiar with the new SASs in order to understand the SASS' impact on audit time and the need for increases in audit fees.

Auditors on small- to medium-sized engagements, have historically performed audits using standardized internal control questionnaires, audit programs, and disclosure check lists. In some cases, these practice aids may have been mechanically applied, and their use did not encourage or expand communication between auditor and client.

Because of inherent constraints on fees for small- to medium-sized engagements, the auditor implementing the new SASs will have to place a much greater emphasis on planning and supervision to maximize efficiency. The auditor will have to become more proficient in designing adequate audit programs and efficiently documenting evidence in work- papers to support audit conclusions.

This article focuses on SASs 55 and 56 because they both require additional audit work, but also have the potential for improving audit efficiency. SAS 56-Analytical Procedures

SAS 56 does not specify particular analytical procedures that should be performed in the various stages of an audit, but it gives the auditor freedom to choose procedures that best fit the particular circumstances. The use of analytical procedures is limited only by the availability of reliable data and the auditor's own creativity.

Analytical procedures should be applied as follows:

* In the initial planning stages of an audit;

* During the substantive phases of an audit in conjunction with other procedures; and

* When completing an audit.

The SAS states that it is expected that in all audits, analytical procedures would be performed in the planning and final review stages. Analytical procedures used in planning audits should focus on:

1. Enhancing the auditor's understanding of the client's business and the transactions and events that have occurred since the last audit; and

2. Identifying areas that may represent specific risks relevant to the audit.

The objective of the analytical procedures is to identify things such as the existence of unusual transactions and events, and amounts, ratios and trends that might indicate matters that have financial statement and audit planning ramifications.

For the small- or medium-sized business, the analytical procedures in the planning stage might consist of a comparison of unadjusted account balances to the prior year's audited trial balance amounts. It might consist of a review and discussion with the credit manager of the accounts receivable aging summary with a comparison to the prior year amounts. It could take the form of a month-by-month comparison, current year to prior, of sales and purchases. It should include a discussion with the owner/manager of his or her view of changes in operations during the year.

In the final review stages, the audited amounts of each account balance would again be compared to the audited amounts for last year. Then the ratios and percentage relationships could be calculated to assure that the final financial statements made sense. Why was the gross profit a percentage point different? Does the increase in number of days' sales in receivables make sense relative to the auditor's knowledge and understanding of the details of those receivables and the reserve for doubtful accounts? The concurring review partner, when reading the final statements, will also want to look at relationships and understand the reasons why they have changed.

Analytical procedures need not be performed as part of the substantive stages of all audits. Here it becomes a matter of efficiency and effectiveness. SAS 55 states that when using analytical procedures as a substantive test, the auditor must consider many factors. It does not suffice to accept the representations of the owner/manager. Explanations of exceptions must be corroborated with other competent evidential matter. Of particular note, the auditor must be concerned with the degree of precision obtainable from applying the procedure. Is it likely to detect a material misstatement? The guidance in the SAS must be carefully studied so as not to place undue reliance on the results of applying an analytical procedure in the substantive part of the audit.

Three common types of analytical procedures which can be used in the audit of a small- and medium-sized business are:

1. Trend analysis-analyzing changes in an account balance over past accounting periods. This tool helps the auditor develop an expected result for the current period.

2. Ratio analysis-comparing relationships among account balances. While trend analysis focuses on a single balance and does not incorporate knowledge about the relationship among account balances, ratio analysis uses the auditor's knowledge of relationships among accounts. Ratio analysis is useful for auditing both income statement and balance sheet account balances, while trend analysis is less useful in the audit of balance sheet accounts.

3. Reasonableness tests-computing an expected amount by using operating data as independent variables. A reasonableness test requires the auditor to develop a model that explains changes in a dependent variable by analyzing changes in independent variables. The approach can be mathematical (regression analysis) or judgmental.

An increase in time on the audit may result from the need to document the use of the analytical procedures. However, the benefit should be obvious to the auditor and the client. SAS 55-internal Control Structure

SAS 55, on consideration of the internal control structure in a financial statement audit, states that in obtaining an understanding of the internal control structure, the auditor should perform procedures that would provide a basis for sufficient knowledge of the design of the relevant policies, procedures and records about each of the three internal control structure elements, and whether they have been placed in operation. Thus, it requires more than a conversation with the owner/manager.

The three elements of an entity's internal control structure are:

1. The control environment;

2. The accounting system; and

3. Control procedures.

This knowledge is ordinarily obtained through previous experience with the entity and by applying procedures such as inquiries of appropriate management, supervisory and staff personnel; inspection of entity documents and records; and observation of entity activities and operations.

In the small- and medium-sized business, the control environment will be a direct function of the owner/ manager. Does he or she demonstrate a concern for the integrity and accuracy of accounting information? Is appropriate attention given to the hiring of employees to see that persons at appropriate skill levels are filling critical positions? Is there sufficient staffing to enable employees to devote the time necessary to produce accurate, reliable information? The "tone at the top" sets the standard for the total organization. The auditor's consideration of the control environment should be documented, probably in the form of a narrative, in the working papers.

Knowledge of the accounting system in the smaller entity should be well established from prior dealings. Making the many audit adjustments common in these audits win have provided a thorough understanding. All that may be needed is the documentation and walk through of that system, recorded either in narrative form or in simple flow charts. It would be a cradle to grave" analysis of the essential transaction streams, including the preparation of financial statements.

The auditor's consideration of the control procedures in a small- or medium-sized business could very well be accomplished as part of the first two steps. No doubt the owner/manager will be an essential ingredient in reviewing and authorizing transactions. What he or she does to detect errors or insure accuracy should be established as part of the review of the control environment. Examination of a few documents on a walk through basis should establish that the procedures are in place. Further, when describing the flow of transactions through the accounting system, points of control should be established, observed and described.

Having reviewed and documented the internal control structure, the auditor of a small- and medium-sized business must decide in the planning process how to proceed. The auditor may decide, for efficiency, to assess control risk at the maximum and basically do an all substantive audit. Or, the auditor may decide in some areas that the control structure policies and procedures that should enable the lowering of that control risk appear to be in place. If the auditor decides to lower control risk, he or she must test the controls to evaluate the effectiveness of such policies and procedures to prevent and detect material misstatements. This latter approach would be taken where the auditor thinks the effort to test the controls will be offset by a reduction in the substantive tests needed to keep the overall audit risk at an acceptable level.

One of the major causes of increased audit time in the implementation of the new SASs will relate to the first time requirement that the auditor document his or her understanding of the internal control structure and perform sufficient procedures to see it is in place. It is here that the education of the client will be important. The client will need to be convinced that both the client and the auditor gain from the process. For example, how many clients will eagerly await a discussion on the interrelationship of inherent, control and detection risk?

This article focused on the n w SASs, but the auditor in a medium- sized business should recognize that new FASB statements will also have significant impact on time budgets for 1989 audits. The additional time required to comply with new requirements on the statement of cash flows, accounting for income taxes (if adopted early) and required pension disclosures, should be considered in planning and determining their effects on the fee structure of future audit engagements. Conclusion

The anticipated communication between auditor and client coupled with the documentation of auditing procedures and new accounting requirements will place added burdens on the fee structure of many existing audit engagements. The auditor should anticipate the effort that will be needed both to implement the new pronouncements and to introduce clients to the implications for their financial statements and audit fees.

Robert S. Manzella