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Jan 1992

Auditors as business advisors: logical extension of SAS 55. (Auditing)

by Temple, Raymond M.

    Abstract- SAS 55 (Consideration of the Internal Control Structure in a Financial Statement Audit) requires auditors to understand the control environment, the accounting system, and control procedures. It was first considered tedious and complex, but has been found to enhance audit effectiveness as well as provide information that can lead to expanded services to audit clients and to additional marketing opportunities. By drawing the attention of auditors back to the clients' business, SAS 55 has put these auditors in a better position to offer sound financial advice to their clients.

This article shares some of the experiences auditors have obtained by implementing the new standard and in spotting additional services as a result of leveraging off the audit work completed to comply with the requirements of SAS 55, namely to obtain an understanding of the control environment, the accounting system, and control procedures.

A seasoned auditor brings to the table many technical skill sets that come into play during the audit process and provide a natural link to business advisory services. Conducting walk-throughs and preparing flow charts and systems narratives are the same tools used by many MAS consultants in conducting fullblown operational reviews.

Clients expect auditors to detect weaknesses in internal controls even if such weaknesses do not directly affect the financial statements. For example, if a weakness in the credit sales system results in underpricing invoices, the financial statements may not be directly affected. In effect, that client has sold its product at a discount. Clients look to their auditors to provide them with necessary feedback on such matters.

SAS 55 requires the auditor to understand what the relevant policies and procedures are for each control structure component and whether they have been placed in operation. An effective method for obtaining this understanding is the cycle review or "walk-through" approach, generally consisting of:

* Inquiry of entity employees;

* Observation of the application of each policy and procedure;

* Inspection of entity-produced records; and

* Re-performance of the procedure.

As business advisors, auditors using this approach obtain a unique perspective on a client's business that gives them insights into a business rarely seen by others. Audit questionnaires now include business advisory check-off items that blend into each area of the engagement. As a result, this insight can provide many practice development opportunities for the CPA firm.

Control Environment

The auditor must obtain sufficient knowledge to understand management's attitude, awareness, and sensitivity concerning the control environment. As a result, auditors consider management's philosophy and operating style by reviewing a broad range of characteristics, including management's attitude toward financial reporting. In this process, the auditor may discover the company lacks a budget or profit planning structure necessary for planning and controlling operations. In addition to considering the audit implications, the auditor could discuss the fundamentals of budgeting with appropriate client personnel. Budgets, often viewed as "straightjackets" by management, are crucial in today's economy for all businesses. A simple illustration of the break- even concept is often enlightening to the non-financial-oriented owner of a small business. An effective presentation could lead to expanded services for the auditors by allowing them to assist in developing strategic business plans, creating responsibility accounting systems and procedures encompassing budgeting and variance analysis. Many such clients respond favorably to the cash forecasting suggestions made by auditors after their review of cash management techniques.

SAS 55 places additional requirements on the auditor to review the organizational structure of an enterprise and consider the form and nature of an entity's organizational units, and related management functions and reporting relationships. SAS 45, "Related Parties," requires the auditor to obtain an understanding of the business purpose of such transactions. In fulfilling this responsibility, auditors may in some cases expend considerable effort analyzing the transactions. Some auditors, by diagramming related party relationships and obtaining an understanding of their buisness purpose, have noticed outdated organizational structures as a result of either changes in federal and state tax laws, an unsettled legal environment, or general economic conditions.

Auditors today are much more tax focused than in the past, since many firms provide tax awareness programs that alert auditors to instances when clients can benefit from adopting new tax strategies. For instance, during the auditor's review of the organizational structure and related parties, the auditor might consider the possibility of merging multiple C corporations into one S corporation; adopting an employee stock ownership plan (ESOP) which offers numerous financial and tax advantages; or reconsidering the client's plans for succession and related estate and gift tax concerns.

The legal form and organization of doing business take on additional meaning in today's litigious environment. Some companies continue to expose their major operating assets to the claims of creditors stemming from unrelated speculative ventures. Often auditors alert their clients when such exposure exists and work with legal representatives on methods of restructuring operations to best protect client investments.

Auditors of small businesses have noted that many internal control structure policies and procedures are not documented in the form of policy and procedure manuals, flow charts, or other means. When clients experience employee turnover, the lack of such documentation results in excessive time training new employees and, in situations where key personnel leave, may cause major delays in meeting company objectives. Having obtained substantial knowledge about company policy and procedures while interviewing key personnel, the auditor is able to offer additional services--in this case, the preparation of the desired manuals. Considering the availability of desktop publishing technology, a firm could produce a professionally designed policy and procedure manual, and successfully market this service to other clients as well.

Accounting System Computer


Resistance to computers has all but vanished with the proliferation of micros. While obtaining an understanding of a client's accounting system and control procedures, the auditor obtains enough information to allow the engagement team to develop and influence the audit strategy. Studying the critical information flows of a business, the astute auditor often discovers many costly inefficiencies that are clearly inconsistent with client objectives. Examples include:

* Flaws in the organizational structure;

* Fragmented computer systems;

* Inadequate documentation; and

* Archaic internal control procedures.

In addition, auditors are able to observe current systems requirements as well as client understanding of the hardware and software configurations designed for them. While observing a client's computer operations, auditors may spot situations where clients still use independent workstations that result in a fragmented information system. Auditors can recommend linking such workstations with a LAN (local area network) and take an active role in designing such a system.

Auditors frequently detect a need for microcomputer training of client personnel in areas such as wordprocessing, spreadsheet applications, DOS training, database management, and software integration. Since today's computers no longer require a rocket scientist to understand and operate, CPA firms can offer training classes as part of a managerial advisory services function.

Control Procedures

CFOs from large organizations are under unrelenting pressure to reduce costs during recessions. Auditors obtaining an understanding of the internal control structure are often able to spot many non-value added activities of employees, such as:

* Redundant or excessive approval processes;

* Obsolete re-edits and rechecking procedures left over from manual systems prior to computerization; and

* Excessive layers of clerical and supervisory personnel.

As result, the auditor can advise management on matters such as headcount reduction and resource reallocation programs.

Attention to the Client's Business

For many smaller businesses, the only objective assessment of their internal controls comes from the annual audit. For larger companies, outside auditors have proven to be a valuable sounding board for management regarding the efficiency and effectiveness of existing internal control structures. SAS 55 has re-focused the auditors' attention on the clients' business. As a result, auditors can provide clients with constructive advice on financial matters affecting their businesses.

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