In July 1994, the Auditing Standards Board (ASB) of the AICPA issued Statement on Auditing Standards (SAS) No. 73, Using the Work of a Specialist. SAS No. 73 supersedes SAS No. 11, Using the Work of a Specialist, and provides guidance to independent auditors about the use of a specialist's work when such independent auditors perform audits of financial statements prepared in accordance with GAAP. SAS No. 73 expands on the guidance contained in SAS No. 11. It applies also to audits of financial statements performed under a comprehensive basis of accounting other than GAAP as well as to other engagements performed under SAS No. 62, Special Reports.

The scope of SAS No. 73 was expanded over that of SAS No. 11 in the following areas:

* the evaluation of representations made by a specialist;

* the use of a specialist that has a relationship with the independent auditor's client; and

* situations when the services of a specialist should be used.

Specifically, SAS No. 73 applies to situations where an independent auditor uses a specialist's work as evidential matter in performing substantive tests to evaluate material financial statement assertions, and -

* management has engaged or employed a specialist to prepare, or assist in the preparation of, material financial statement assertions;

* management has engaged a specialist employed by the independent auditor's firm to provide advisory services; or

* the independent auditor has engaged a specialist.

SAS No. 73 does not apply to situations covered by SAS No. 22, Planning and Supervision, where a specialist who is an employee of the independent auditor's firm, participates in the audit. In its deliberations, the ASB discussed situations where management engaged an employee of the independent auditor's firm to provide advisory services and the independent auditor intended to use that specialist's work as evidential matter. SAS No. 73 requires the independent auditor to consider whether using the work of the specialist employed by the Independent auditor's firm would affect his or her independence.

In addition, SAS No. 73 does not apply to those situations where the specialist's work is used for internal purposes, such as actuarial reports used to price insurance products or appraisals used by lending institutions in the loan origination process.

SAS No. 73 is effective for audits of financial statements for periods ending on or after December 15, 1994; however, early application is encouraged.

Background

The ASB decided to address several issues relating to a specialist's work that had been brought to its attention by the AICPA Quality Control Inquiry Committee (QCIC). Among other matters, member firms are required to report to the QCIC any litigation brought against the firm or its personnel. The issues considered by the ASB relate to whether there was sufficient auditing guidance available for independent auditors to -

* evaluate a specialist's competence and qualifications;

* determine what constitutes a specialist;

* consider ongoing specialist-client relationships;

* evaluate the methods and assumptions underlying a speciatist's findings; and

* apply appropriate procedures to special purpose inventories.

A primary concern of the QCIC was that the guidance contained in SAS No. 11 did not address the evaluation of representations made by specialists. Of particular concern was the acceptance of appraisals by auditors without a review for reasonableness in light of market conditions or consistency with regulatory standards. The QCIC believed a change in auditing standards was necessary to require auditors to evaluate appraisals for reasonableness.

Determining What Constitutes a Specialist

Specialists are defined in SAS No. 73 to Include persons or firms that possess special skills or knowledge in particular fields other than accounting or auditing. They Include actuaries, appraisers, engineers, environmental consultants, geologists, and others.

SAS No. 73 also applies to attorneys engaged by a client to provide services other than those concerning litigation, claims, or assessments that are addressed in SAS No. 12, Inquiry of a Client's Lawyer Concerning Litigation, Claims, and Assessments, (i.e., interpreting provisions of contractual agreements).

Deciding When to Use the Work Of a Specialist

SAS No. 73 notes that the independent auditor's education and experience enable him or her to be knowledgeable about business matters in general, but the independent auditor is not expected to have the expertise of a person trained for or qualified to engage in the practice of another profession or occupation. In its discussions concerning SAS No. 73, the ASB noted that the independent auditor may encounter complex or subjective matters during an audit that are potentially material to the financial statements. Such matters may require special knowledge and, in the independent auditor's judgment, require using the work of a specialist to obtain competent evidential matter.

SAS No. 73 provides several examples of the types of matters the independent auditor may decide require him or her to consider using a specialist's work. These include -

* valuation of special-purpose inventories, high-technology materials or equipment, pharmaceutical products, complex financial instruments, real estate, restricted securities, works of art, and other assets;

* matters pertaining to environmental contingencies;

* determination of physical characteristics relating to quantity on hand or condition of minerals, mineral reserves, or materials stored in stockpiles, and other assets;

* determination of amounts derived by using specialized techniques or methods including actuarial determinations for employee benefits obligations and discloses, and determinations for insurance loss reserves; and

* interpretation of technical requirements, regulations, or agreements including the potential significance of contracts or other legal documents, or legal title to property.

The ASB considered the issue of whether the requirement in SOP 92-4, Auditing Insurance Entities' Loss Reserves, to use an outside specialist was appropriate and consistent with the guidance in the statement. Even though no consensus was reached, the ASB decided that in the specific situation involving the audit of insurance entities' loss reserves, an outside loss-reserve specialist - that is, one who is not an employee or officer of the company - should be used. When the independent auditor has the requisite knowledge and experience, the SOP indicates the Independent auditor may serve as a loss-reserve specialist.

Evaluating a Specialist's Competence and Qualifications

SAS No. 73 requires the independent auditor to evaluate the professional qualifications of the specialist in determining that the specialist possesses the necessary skill or knowledge in the particular field. It suggests the independent auditor consider the following credentials of the specialist when making this determination:

* The professional certification, license, or other recognition of competence in the specialist's field, as appropriate;

* The reputation and standing in the views of the specialist's peers and others familiar with the specialist's capability or performance; and

* The specialist's experience in the type of work under consideration.

SAS No. 73 also requires the independent auditor to obtain an understanding of the nature of the work performed or to be performed by the specialist. This requirement is apparently intended to address an SEC concern that the independent auditor should obtain an understanding from the specialist that he or she (the specialist) is aware of the independent auditor's intended use of the specialist's work. The SEC believes this may, in some cases, require the independent auditor to contact the specialist for the required information.

The ASB also considered an issue as to the documentation the independent auditor needs to obtain concerning the understanding among himself or herself, the client, and the specialist as to the nature of the work performed or to be performed by the specialist. It was decided that the documentation guidance contained in SAS No. 41, Working Papers, is sufficient.

SAS No. 73 recommends that the independent auditor's understanding of the specialist's work performed or to be performed cover -

* the objectives and scope of the specialist's work;

* the specialist's relationship to the client;

* the assumptions or methods used by the specialist and, if appropriate, the consistency of the assumptions or methods with prior periods;

* the appropriateness of using the specialists' work for the intended purpose; and

* the form and content of the specialist's findings that will enable the independent auditor to make the evaluation as to whether the findings support the related assertions in the financial statements.

The accompanying exhibit contains an illustrative engagement letter from a client to a specialist that would assist in documenting these points.

Ongoing Specialist-Client Relationships

SAS No. 73 notes that in situations where a specialist does not have a relationship with the client, the specialist's work usually will provide the independent auditor with greater assurance of reliability than in situations where there is a specialist-client relationship.

SAS No. 73 requires independent auditors to evaluate the specialist- client relationship, including circumstances that might impair the objectivity of the specialist. Such circumstances include situations in which the client has the ability to directly or indirectly control or significantly influence the specialist. This might occur through employment, ownership, contractual right, or family relationship.

The SEC staff raised concerns about the use of a specialist who has a relationship with the client, and believes that in such situations the independent auditor should perform additional procedures. The ASB concluded that when an independent auditor uses the work of a specialist who has a relationship with the client, such work may be acceptable under certain circumstances; however, the independent auditor should always assess the risk that the specialist's objectivity might be impaired. If the independent auditor believes the relationship might impair the specialist's objectivity, the independent auditor should perform additional procedures with respect to some or all of the specialist's assumptions, methods, or findings to determine that the findings are not unreasonable or should engage another specialist for that purpose.

Evaluating the Specialist's Findings

Even though a specialist is responsible for determining the appropriateness and reasonableness of the methods and assumptions used and their application, according to SAS No. 73, the independent auditor is responsible for -

* obtaining an understanding of the methods and assumptions used by the specialist to determine whether the findings are suitable for corroborating the representations in the financial statements;

* making appropriate tests of all data (not just accounting data) provided to the specialist taking into account the independent auditor's assessment of control risk; and

* evaluating the specialist's findings to determine whether they support the related assertions in the financial statements.

Generally, independent auditors will use the specialist's work unless the independent auditor's procedures lead to a conclusion that the findings are unreasonable in the circumstances. If the independent auditor concludes the findings are unreasonable, he or she should perform additional procedures including obtaining another specialist's opinion.

Effect of the Specialist's Work on The Independent Auditor's Report

Reporting requirements under SAS No. 73 do not differ dramatically from those of SAS No. 11. SAS No. 73 concludes that if -

* the independent auditor determines the specialist's findings support the related assertions in the financial statements, he or she may reasonably conclude that sufficient competent evidential matter has been obtained.

* the independent auditor determines there is a material difference between the specialist's findings and the assertions in the financial statements, he or she should apply additional procedures.

* after applying any additional procedures that might be appropriate, the independent auditor is unable to resolve the matter, he or she should obtain the opinion of another specialist, unless it appears to the independent auditor that the matter cannot be resolved.

SAS No. 73 concludes the independent auditor should qualify his or her opinion or disclaim an opinion if the matter remains unresolved because of the inability to obtain sufficient competent evidential matter as to an assertion of material significance in the financial statements. In such situations, the unresolved matter would constitute a scope limitation. However, if the independent auditor concludes after performing additional procedures (including obtaining another specialist's opinion) that the assertions in the financial statements are not in conformity with GAAP, then he or she should express a qualified or adverse opinion.

Referring to the Specialist in the Independent Auditor's Report

Generally, SAS No. 73 continues the guidance of SAS No. 11, recommending that an independent auditor refrain from referring to a specialist's work or findings in an unqualified report. It is believed such a reference might be misunderstood to -

* be considered a qualification of the independent auditor's opinion;

* be a division of responsibility between the independent auditor and the specialist; or

* infer that the independent auditor making such reference performed a more thorough audit than an independent auditor not making such reference.

However, SAS No. 73 allows the independent auditor, as a result of the specialist's report or findings, to add explanatory language to his or her standard report or depart from an unqualified opinion. Reference to and identification of the specialist may be made in the independent auditor's report if the independent auditor believes such reference will facilitate an understanding of the reason for the explanatory paragraph or the departure from the unqualified opinion.

Adrian P. Fitzimons, PhD, CPA, CMA, CFA, is an associate professor at St. John's University. Marc H. Levine, PhD, CPA, and Joel G. Siegel, PhD, CPA, are professors at Queens College, CUNY.