Annual year-end accounting and auditing update. (includes related article)by Primoff, Walter M.
In this calm before the year-end storm, CPAs should position themselves for a successful accounting and auditing season. In this second annual year-end tune up article, the editors have focused on the review process as an important element for efficient and effective completion of engagements. They present pronouncements that are effective for the first time for calendar year engagements or have been issued since last year. They also present the business reasons for doing the job right the first time.
Some of the most common deficiencies appearing in letters of comment of quality reviews of firms' accounting and auditing practices are--
* A lack of documentation of the planning and review phases of engagements;
* Disclosure and other GAAP deficiencies in financial statements; and
* Deviations from professional standards in the wording of accountants' reports.
A firm regardless of size, protects itself from deficiencies of this kind by a careful review of the reports and accompanying financial statements it issues and of the work papers supporting such reports and statements. The size of the firm may influence who performs the review, the tools used to assist in the review, and when the review is performed. But there is no substitute for a careful review by an experienced accountant of the work done.
In the January 1992 issue of The CPA Journal, in anticipation of the 1991 year-end financial statement crunch, the editors discussed the importance of proper planning of accounting and auditing engagements. This year, considering the deficiencies that continue to show in quality reviews, we have chosen the review phase of accounting and auditing engagements for discussion.
DUE PROFESSIONAL CARE MEANS CAREFUL REVIEW
The exercise of due professional care applies to all accounting and auditing engagements, and thorough and complete review of work done is part of exercising such care. Because of the differing levels of assurance given on audit, review, and compilation engagements, the review aspects also differ. In our discussion, we have attempted to generalize where we believe the concepts relate to all types of engagements. However, because of the additional assurances provided by audit engagements, many times during the discussion audit work is singled out for additional coverage.
Under professional standards, how and what work papers are reviewed and the methods of documentation of that review are left to the individual firm or practice unit to decide. It is up to the firm to determine what approach is appropriate based upon the nature of its practice and the experience and qualification of its personnel.
THE REVIEW PHASE
The review phase of accounting and auditing engagements is typically the last chance for a firm to determine whether its work is adequate and supports the report to be issued. Unfortunately, quality reviewers are finding that many firms are overlooking or not properly documenting the review. However, the consequences of an inadequate review could be more than a finding in a letter of comment from a quality review. Substandard reports and financial statements can lead to unhappy clients and a tarnished reputation, and may expose the accountant to the very severe consequences of legal liability.
Why Deficiencies in the Review Process Are Being Found
Deficiencies noted in the review stages of accounting and auditing engagements are frequently the result of the following:
* Time pressures that cause the review to be deferred until its too late ("I'll do it later") or inadequately performed ("I have confidence in my staff");
* Inadequate knowledge or training of the person performing the review;
* Perfunctory use of engagement review check lists;
* Tendency of some accountants to mechanically follow past practices or what was done last year; and
* Haste to complete the engagement and get on to other matters.
What Is Review?
The review phase of an engagement can be divided into three basic steps:
1. Analytical Review. SAS 56, Analytical Procedures, requires the use of analytical procedures in the review phase of all audits. In review engagements analytical procedures are an important step in providing limited assurance that the statements are free of material error. The purpose of applying analytical procedures during the review phase is to assist the auditor or accountant in determining whether the conclusions reached are appropriate.
2. Review of Workpapers. SAS 22, Planning and Supervision, establishes a broad requirement that work performed by each assistant should be reviewed. The purpose of the review is to determine whether the work is adequately performed and whether the results are consistent with the auditor's report to be issued. The concepts of planning and supervision carry over and apply equally to accounting engagements.
3. Review of Financial Statements and Accountant's Report Thereon. The final products of the typical accounting and auditing engagement are the financial statements and associated report. Typically the most experienced accountant working directly on the engagement prepares--or reviews the client-prepared--financial statements and prepares the report. Exercise of due professional care calls for a review of those documents to provide the appropriate level of assurance that they conform to professional standards.
Analytical Procedures in the Review Phase
The analytical review consists of applying analytical procedures to determine whether the conclusions reached during an audit are valid or, in the case of a review that the financial statements do not appear to contain material misstatement. It is at this point that the accountant takes a step back to see that the financial statements as a whole make sense. That determination is based on the auditor's knowledge of the client and its operations and industry. For audits, SAS 56 states that the analytical procedures should include consideration of:
* The adequacy of data gathered in response to unusual or unexpected balances that were identified either in planning or performing the audit; and
* Unusual or unexpected balances or relationships that were not previously identified.
In other words, the auditor should consider whether the data gathered during the audit provides an adequate understanding of any unusual or unexpected financial relationships. If an adequate understanding is not reached, additional audit procedures are typically needed.
SAS 56 does not specify analytical procedures that must be applied. In most small business audits, a simple comparison of current year financial statements with prior year's is an effective and adequate analytical procedure. Documentation of the analytical review may consist of descriptions of the resolutions of any unusual relationships noted and a simple sign off on a work program step or a memo describing the review.
Review of Workpapers
SAS 22 does not mandate any particular type of workpaper review, but it implies that there must be some procedure for bringing significant accounting or auditing problems to the attention of the engagement partner or other senior person. For most audits and reviews, the review of workpapers has two stages:
* A detailed review of the work performed by staff.
* A higher level supervisory review.
Detailed Review of Workpapers. The purposes of performing a detailed review of work performed by staff is to ensure:
1. Professional standards and firm policies were followed.
2. Work on individual financial statement components is integrated into the overall audit or review conclusions.
3. The supervisory reviewer is made aware of the results of the audit tests or inquiry and analytical procedures. The detailed review of workpapers depending on the nature of the engagement, usually includes steps to determine that:
1. The workpaper is complete and satisfactory in form (properly headed, dated, initialed, indexed, and cross-referenced to the working trial balance).
2. Amounts agree with the working trial balance.
3. The related work program steps have been completed and are initialed and indexed.
4. Conclusions are supported.
5. Misstatements are identified and adequately summarized and considered for their impact on the financial statements.
6. Information relevant to other accounts is properly cross-referenced.
7. Relevant information in the permanent or other files is incorporated and cross-referenced.
8. Matters for the client representation letter or management letter have been identified.
The detailed workpaper review generally can be performed by an experienced staff person. It is not necessary for a partner to perform the review. The experience level of the reviewer, however, should be sufficient to provide an effective, reliable review.
While doing the detailed workpaper review, it is a good practice for the staff to accumulate points that should be brought to the attention of the partner. This can be done through an issues memo or some other form. The intent is to highlight accounting, disclosure, audit, or review issues as appropriate for the benefit of the supervisory reviewer-- partner or other professional--so that they are not left to the supervisory reviewer to pick up or perhaps miss in the process of his or her review.
Generally, the easiest and most effective way to document the detailed workpaper review is to have the reviewer initial each workpaper that is reviewed in a prescribed place.
Supervisory Review. The supervisory review should focus more on summaries and evaluations and less on detailed workpapers. The purpose of the summary review is to serve as a last look at whether the work supports the report to be issued.
The supervisory review usually consists of steps to determine that:
1. All workpapers prepared by the detailed reviewer have been reviewed by the supervisory reviewer.
2. The work program is complete and properly initialed and signed-off.
3. The work and conclusions support the report to be issued.
4. The client representation, legal, and management letters, as appropriate, address all important items.
5. The report and financial statements are in accordance with applicable professional standards.
6. Any significant unusual matters, complications, consultations, technical issues, or disagreements are appropriately resolved.
The supervisory reviewer should be a partner or experienced senior staff person. In many firm's the supervisory TABULAR DATA OMITTED review is the responsibility of the engagement partner. Portion's of the supervisory review can be delegated to other senior staff persons, but the overall responsibility remains with the partner. The judgment necessary for this level of review is significant and the consequences of mistakes can be great.
The supervisory reviewer can document specific workpapers reviewed by initialing those workpapers below the detailed workpaper reviewer's initials. Generally, it is neither necessary nor advisable for the supervisory reviewer to review every workpaper. Only workpapers prepared by the detailed reviewer and, if considered necessary, selected other workpapers should be reviewed by the supervisory reviewer.
Documenting the overall supervisory review is usually done by completing and initialing a reviewer's checklist. The advantage of using a standard reviewer checklist lies in making the reviewer follow predetermined review steps and firm policies.
In firms where the partner delegates portions of the supervisory review to others, the partner would be required to initial the reviewer checklist thereby approving the supervisor review and assuming responsibility for it. In any event the partner would be expected to be familiar with the key issues of the engagement and their satisfactory resolution.
Some firms feel that retaining the partner review notes in the work papers is an adequate method of documenting his or her supervisory review. It is probably the worst thing that could be done. If the engagement is ever subject to litigation, these notes become a road map for plaintiffs' lawyers and their CPA experts. At the completion of the engagement, the partner should review any notes developed during the review to see they have been cleared and go back to the papers to verify that the requested work has been properly documented. The notes should then be discarded.
Tax Specialist Review
Firms with separate tax departments or designated tax specialists may require for audits that a tax specialist review applicable tax areas of the workpapers. The tax specialist review can be documented by initialing the workpapers and preparing a memo to describe the consequences and ramifications of any issues identified and their resolution.
Many firms require someone with no involvement in the engagement to review the financial statements, report, and important issues identified during the engagement. The independent reviewer is free to review selected workpapers, ask questions, and consult with others, as necessary, to satisfy him or herself that all significant matters have been properly handled. That independent review can be documented by a sign-off on the standard reviewer's checklist or by a separate independent reviewer checklist.
Financial Statement and Report Review
The supervisory review in all types of engagements includes a review of the completed financial statements and report of independent auditor or accountant.
As part of the preparation of statements and reports or the initial review of client-prepared statements, many firms use standard checklists to assist in evaluating the completeness of financial statement disclosures and the appropriateness of the report being issued. In today's standards overload environment, an accountant proceeds at his or her own risk without the use of a comprehensive, up-to-date disclosure checklist. Similarly, a reporting guidance check list of some kind can be extremely helpful in assuring that all reporting matters have been considered.
In firms using them, the checklists are usually prepared by the preparer or initial reviewer of the statements and report, and are reviewed and initialed by the supervisory reviewer.
SPECIAL CONSIDERATIONS FOR SOLE PRACTITIONERS
Sole practitioners, even though they may have performed all the work themselves, still should perform and document an engagement review. Performing an effective review, however, requires the sole practitioner to step back from his or her work and assume the role of a reviewer.
The analytical review poses no significant problem for a sole practitioner. He or she should perform the same analytical procedures that any firm would apply. However, the detailed and supervisory review pose unique problems for the sole practitioner. In essence, the sole practitioner must combine the detailed workpaper review and the supervisory review into a single review. That requires the sole practitioner to perform a critical review of the completed work and evaluate whether the work adequately supports the report to be issued. The sole practitioner should keep in mind the importance of critically looking at his or her audit work and whether that work supports the conclusions. The use of a standard review checklist can increase the effectiveness of a sole practitioner's review.
Another possibility for the sole proprietor seeking an independent review is to engage another firm to assist on a fee basis. Other possibilities are the employment of retired partners or accounting professors on a part time basis. These part time professionals also can assist the firm in their quality review inspections. Still another method is to work out a swap arrangement with another sole practitioner of comparable size. This can be done on a time basis only with no fees involved. Whatever method is selected, the review should be documented in a manner similar to that of an independent partner review.
USING A STANDARD REVIEWER'S CHECKLIST
The use of standard reviewer's checklists helps to ensure that the reviewer follows firm policy when performing the review. It also serves as documentation of the items considered by the reviewer. Firms usually adopt a suitable standard reviewer's checklist by either:
1. Purchasing a documentation system from a third party;
2. Joining an association of firms that provides a documentation system;
3. Creating their own documentation system.
Since most firms find it too time consuming and costly to create their own integrated documentation system, they look to outside providers and associations. Also, more and more associations are moving away from the task of creating and updating documentation systems, leaving outside providers as the primary source. When choosing a documentation system from an outside provider, a firm should carefully consider:
1. The reputation of the provider as a supplier of documentation systems for local firms.
2. The resources committed by the provider to updating the documentation system, keeping it technically current, and tailoring it to the needs of the local firm.
3. Whether the provider has undergone and passed an independent review of its own quality control system, which allows the firm's quality or peer reviewer to rely on the independent review.
The major providers of documentation systems to local CPA firms are:
1. The AICPA;
2. National or regional CPA firms;
3. Local firms active in quality control and quality review matters; or
4. Third party vendors such as Practitioners Publishing Company.
Integration of Forms. It is important that a firm use a fully integrated system of forms. The danger in not doing so is the possibility that required documentation will not get incorporated into the system. For example, some documentation systems may include review documentation in a work program, others in a report checklist, and still others in a separate reviewer's checklist. Unless the documentation system is fully integrated, it may result in the omission of required documentation.
BECOMING A MORE KNOWLEDGEABLE REVIEWER
Practitioners with review responsibilities should be concerned with maintaining their technical skills at an appropriate level. Performing analytical reviews, workpaper reviews, or independent reviews requires an up-to-date knowledge of accounting and auditing pronouncements. Also, resolutions of complex issues are often the responsibility of the reviewer.
Continuing Professional Education
Practitioners involved in the review phase of audits should carefully choose the subjects for satisfying his or her CPE requirements. Some of the major considerations should include:
1. Is additional training needed in specific areas (such as risk assessment or sampling) or industries (such as nonprofits or real estate)?
2. Is updating for recently issued professional standards needed?
3. Is additional training available from the provider of the documentation system?
4. Is there a need to provide additional training to the audit staff?
As is the case with documentation systems, there are a number of CPE courses that are suitable to meet the reviewer's needs. Major sources of accounting and auditing CPE are the AICPA, state societies, and third party vendors such as Practitioners Publishing Company.
Firm's using standard checklists or an integrated system purchased from a third-party vendor should hold training sessions explaining the use of the checklists. This is important when first adopted but should be done yearly to cover changes in checklists required by changes in the literature and to train new staff.
WHAT FIRMS SHOULD DO
To be ready for the upcoming busy season, firms should review their policies and procedures covering the review phase to determine whether a) they ensure compliance with professional standards and b) they fit the needs of the firm. Firms that do not have their policies and procedures in writing should strongly consider doing so. Written policies and procedures lessen the chance of misunderstanding and help ensure a more consistent approach to reviewing audit work. The written procedures need not be elaborate. They should fit the nature of the practice and the people doing the work. Probably the three most important considerations in establishing the policies and procedures are:
1. Do not adopt policies and procedures that are not practicable based upon the personnel and client base of the firm (for example, if a sole proprietor does not have the senior staff available to perform an independent review of engagements, do not require it in the policies and procedures).
2. Identify the qualifications of the staff or partners who can perform reviews.
3. Adopt a standard reviewer's checklist that integrates the firms overall documentation system.
TIMING OF REVIEW
Just as planning is an ongoing process, the review process should not be left to the end of the engagement. In fact, timely review in the field may lead to changes in the audit plan. Where several professionals work on an engagement, there should be a timely detailed review of each individuals' work by the next highest level of staff. This in-the-field review is essential for both the effectiveness and efficiency of the audit and is also part of on-the-job training. It also means that questions and additional work can be answered and accomplished on the spot, in the client's office. There is nothing more frustrating and wasteful than to have to send a staff member back to a client's office to answer questions raised by a reviewer after the field work is completed.
For many firms, the review by the partner is the end of process. Other firms, including those in the Division for Firms of the AICPA, require a second concurring review. This review is similar to the independent review discussed earlier.
This review can be done by a second partner having no involvement with the engagement or by a review department. Review departments are common among medium-sized firms where the volume of reports justifies the cost. Small firms that do not have enough reports, and large firms that may have too many, use another partner or experienced manager.
DO IT RIGHT THE FIRST TIME
The increasing need to be cost effective is directly proportionate to the lingering unfavorable economy. Doing it right the first time, while obviously appropriate, may in our present economy be necessary for survival. Doing it right the first time, an important key to profitability, requires meaningful supervision. Inadequate supervision in any production situation can mean work has to be redone--sometimes by currently available but different personnel; blown budgets; lost time and/or material; unhappy management; lost customers or clients; and confused, undirected, and disgruntled employees who, at the first opportunity will add to turnover and the increasing costs of training new personnel.
When service and product quality are paramount, the costs of correction to finally get it right can be the difference between a viable and an insolvent business or professional practice. Whether you are in an industrial, commercial, or professional practice environment, getting it right the second or third time, even using less expensive labor, will generally prove to be the more costly route. If the result is to be a quality work product, floundering, unsupervised personnel must be brought under control and properly supervised.
The Cost of Quick Fixes
When time pressures demand a quick fix, the staff doing the initial work may have to be replaced by higher paid, better trained personnel to make the repairs.
Either way you lose, not only the more obvious dollar expenditures, but also employee training and morale. The supervisor who tries to rationalize that at the very least the loss on rework resulting from poor supervision, was a learning process for the lower levels of personnel, is probably wrong again. The lower level original players may have gone on to another assignment, unaware of anything wrong, perhaps even prepared to repeat the same errors.
Why is it that even when competent supervision is available in an organization, we frequently still don't get it right the first time? Whether the competent supervisor is a financial executive in industry or a partner in public practice, he or she must be given the time to supervise and the recognition for a job well done. How often do time and recognition go by the boards because the real-life culture of a company flies right in the face of its announced commitment to service and quality?
The Importance of the Right "Thy Shalts"
Let's look at a not necessarily atypical CPA firm whose first priority is "Thou shalt deliver quality service in a timely fashion," and whose other first priority is, "Thou shalt bring forth new clients in abundance." The overriding priority for partners and others in top supervisory positions become obvious because that priority is rewarded by handsomely recognizing the rainmakers, and sometimes even ignoring clients lost because of poor supervision. Nobody can diminish the need for a continual flow of new business, but everything has its season. If the reward for new business is so unbalanced in relation to performing as a supervisor, the result may be a distraction from supervising or that which is most important at the moment; doing it right the first time to deliver a timely, quality service, in a cost-effective fashion. This is not to say the engagement won't ultimately result in a quality piece of work, technically. It means the service rendered will probably: need rework; result in unbillable time and out-of-pocket expenses; not be timely; confuse and upset the staff and staff scheduling; and reduce the opportunity for possible future referrals from a-not-too happy client. Consider what this may do to client retention and the profitability of well supervised, repetitive engagements vs. what may be the remote possibility of a new client.
Active involved supervision is unquestionably a major key element to doing it right the first time. Solutions to problems from in-the-field supervisors are more easily accepted than those coming from a distance. They can prevent crises because of their on-site observations and by their availability for questions. They can sort out facts and explore alternatives, as well as better manage any downtime. Customer or client and employee retention are enhanced. Profits go up and costs go down.
Michael Goldstein, CPA, is a feature article editor of The CPA Journal and retired partner of a national CPA firm.
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