1. Chapter 11 Auditing of Governmental and Not-for-Profit Organizations McGraw-Hill © 2003 The McGraw-Hill Companies, Inc. All rights reserved.

2. ` Learning Objectives After studying Chapter 11, you should be able to:  Explain the essential characteristics of financial audits by independent CPAs, including: othe objective(s) of financial audits othe source and content of generally accepted auditing standards (GAAS) othe types of audit reports that can be rendered othe contents of an unqualified and a qualified audit report omateriality orequired supplementary information

3. ` Learning Objectives (Cont’d )  Explain what is meant by ogenerally accepted government auditing standards (GAGAS) othe source of GAGAS owhy GAGAS are much broader than GAAS  Explain the types of audits performed under GAGAS, including oFinancial audits oAttestation engagements oPerformance audits

4. ` Learning Objectives (Cont’d)  Explain the characteristics of a single audit, including: o the purpose o which entities must have a single audit o what auditing work is required o how major programs are selected for audit o what reports must be rendered, when, and to whom  Describe the role of audit committees.

5. ` Key Terms Attestation engagementsNonaudit work Audit committeeOpinion units Audit findingsOversight agency Cognizant agencyPerformance audits Compliance auditProgram-specific audit Engagement letterQuestioned cost Financial auditsReportable condition GAAP hierarchyRisk-based approach GAASSingle audit GAGAS Major programs Materiality Material weakness

6. Financial — An opinion as to whether financial statements are fairly stated in conformity with GAAP and all material facts are disclosed Attestation engagement — Examinations or procedures that lead to a report and assertion about subject matter that is the responsibility of another party, e.g., internal controls, compliance, MD&A, contract amounts, performance measures Performance — A determination of whether managers are using resources efficiently and effectively in accomplishing organizational goals. Types of Governmental Audits

7.  Unqualified (clean) Explanatory language can be added but still unqualified. See Ill. 11-2  Qualified opinion Except for matter noted, financial statements still present fairly in conformity with GAAP. See Ill. 11-3  Adverse opinion - Financial statements do not present fairly in conformity with GAAP  Disclaimer of opinion - Often due to inability records or non-existence of records Types of Auditor’s Opinions

8. Paragraphs in a standard audit report:  Opening Identifies the financial statements being audited  Scope Describes the nature of the audit  Opinion Expresses the auditor’s opinion about the fairness of the financial statements  Explanatory Used in most governmental audits but seldom used in corporate audits Auditor’s Standard Report

9. GAAP Hierarchy SAS No. 69, as amended by SAS No. 91 Category Nongovernmen- tal Entities State and Local Governments Federal Governmental Entities aFASB statements…GASB statements… FASAB statements… bAICPA Audit and Accounting Guide… AICPA Audit and Accounting Guides… FASAB Technical Bulletins… cFASB Emerging Issues Task Force… AICPA Practice Bulletins AICPA AcSec Bulletins… dAICPA Q&As…GASB Q&As…FASAB Implementation Guides…

10. Materiality  DEFINITION: In the auditor’s judgment, the level at which the quantitative or qualitative effects of misstatements will have a significant impact on users’ evaluations  AICPA Audits of State and Local Governmental Units (2002) requires auditors to make separate materiality determinations for each opinion unit. Under GASBS 34, these are  governmental activities  business-type activities  aggregate discretely presented component units  each major governmental and enterprise fund  the aggregate remaining fund information

11. Auditing RSI  RSI, such as MD&A and budgetary comparison schedules, are outside the scope of the financial statement audit.  Auditors apply certain limited procedures in connection to RSI to provide assurance that they are fairly presented in relation to the basic financial statements.

12.  Standards issued by the AICPA.  10 standards (expanded on by about 100 SASs.)  3 general standards  3 field work standards  4 reporting standards  Applicable to financial audits only. Generally Accepted Auditing Standards (GAAS)

13.  Standards issued by the U.S. General Accounting Office in its “yellow book.”  Required of auditors in a Single Audit of organizations that expend more than $300,000 in federal sources in any year. Generally Accepted Government Auditing Standards (GAGAS)

14. Generally Accepted Government Auditing Standards (GAGAS) are Broader than GAAS GAASGAGASGAASGAGASGAASGAGAS General Standards 345504 Field Work Standards 372704 Reporting Standards 4114904 Totals10221121012

15.  Standard on adequacy of professional proficiency requires auditors to have:  A thorough knowledge of governmental auditing and the specific or unique environment in which the audited entity operate  At least 80 hours of CE (CPE) every two years, of which at least 20 hours must be completed in each of the two years and at least 24 hours of which must be related directly to the audit environment Unique Aspects of GAGAS

16.  GAGAS standards place much more emphasis on compliance with laws and regulations than do GAAS Unique Aspects of GAGAS (Cont’d)

17. Independence Standards  Independence is the cornerstone of the auditing profession and the second general standards in both the AICPA’s GAAS and GAO’s GAGAS.  GAO issued Amendment No. 3 to Government Auditing Standards in 1999 to address independence when nonaudit work is performed for audit clients, effective for audits performed after January 1, 2003.

18. GAO Independence Standards– Nonaudit Work  DEFINITION: That solely performed for the benefit of the entity requesting the work and does not provide for a basis for conclusions, recommendations, or opinions as would a financial audit, attestation engagement, or performance audit.  Two overarching principles: (1) Auditors should not perform management functions or make management decision. (2) Auditors should not audit their own work or provide nonaudit services in situations when the nonaudit services are significant to the audit subject matter.

19. GAO Independence Standards Nonaudit Work (Cont’d)  Acceptable, no safeguards need to be in place  Providing routine advice or methodologies, serving on advisory committees, answering technical questions, providing training  Prohibited  Maintaining the accounting records, posting transactions to the records, recommending a single person for a position. supervising the information technology system  Permitted, if safeguards are in place  Preparing draft financial statements based on management’s trial balance, maintaining depreciation schedules for which management has determined the key elements in the calculations, proposing adjusting and correction entries that management accepts

20. Safeguards (1) Preclude nonaudit personnel from planning… the audit (2) Do not reduce the scope of the audit (3) Document consideration of nonaudit work (4) Document an understanding with the client of the objectives and scope of the audit work (5) Include policies to ensure compliance with independence standards (6) Avoid certain nonaudit work such as operating the client’s accounting system (7) Make all documentation available for peer review

21.  Intended (among other purposes) to improve the efficiency and effectiveness of governmental audit effort  Replaces a multitude of grant-by-grant audits with a single, comprehensive, entity-wide audit  All federal awarding agencies are required to accept the single audit reports as satisfying their program’s audit requirements Single Audit

22.  1996 Single Audit Act Amendments:  Raises the threshold for a single audit from $100,000 received to $300,000 expended  Extends statutory requirement for single audit coverage to not-for-profit organizations as well as state and local governments  Establishes a risk-based approach for audit testing, thus placing greater audit coverage on high risk programs Single Audit (Cont’d)

23.  1996 Single Audit Act Amendments:  Improves the contents and timeliness of single audit reporting  Permits the Office of Management and Budgeting (OMB) to administratively revise Single Audit requirements without requiring additional legislation  OMB Circular A-133 and the related Compliance Supplement provide implementing guidance for conducting the single audit Single Audit (Cont’d)

24. Q: Who has to have an audit under GAGAS? see Illustration 11-7 A: Any state or local government or not-for-profit organization that expends at least $300,000 in federal awards during a year must have an audit in conformity with GAGAS.  If expended only for one program or one program cluster, the entity can have a program audit, otherwise the audit must be a single audit. Single Audit (Cont’d)

25.  Calculation of amount of federal awards expended  Calculation can be complex  Basic rule is that a federal award has been expended when the federal agency has become at risk and the nonfederal recipient has a duty of accountability  Recommend working Case 11-1 to understand nuances of calculation Single Audit (Cont’d)

26.  Annual audit encompassing the entity’s financial statements and schedule of expenditures of federal awards  Audit must be conducted by an independent auditor  Auditor must determine whether financial statements present fairly in conformity with GAAP and the schedule of federal financial awards is presented fairly in relation to the financial statements. Single Audit Requirements

27.  Auditor must obtain an understanding of internal controls pertaining to the compliance requirements for each major program, and assess control risk and perform tests of control.  Federal and nonfederal “Pass-through” agencies are assigned certain responsibilities for compliance Single Audit Requirements (Cont’d)

28.  For each major program the auditor must test whether the program:  was administered in conformity with the appropriate OMB Circular (A-102 or A-110)  complied with detailed requirements in the A-133 Compliance Circular and other specified requirements Compliance Audits (as part of single audit)

29.  Using sliding scale shown in CH 11, identify “Type A” programs  Identify low-risk programs (based on no audit findings in most recent audit and absence of certain risk factors)  Assess risk of Type B programs (major programs that are not Type A programs) Selection of Programs for Single Audit

30.  At a minimum, audit all high risk Type A programs and either (1) half of the high-risk Type B programs or (2) one high-risk Type B program for each low- risk Type A program  Audit at least enough major programs to ensure that at least 50% of total federal award expenditures are audited Selection of Programs for Single Audit (Cont’d )

31.  Both auditee and auditor have responsibilities for the “reporting package” that must be sent to the single audit clearinghouse in Indiana  Reporting package consists of:  Financial statements and schedule of expenditures of federal awards  Summary schedule of prior audit findings  Auditor’s reports (see Ill. 11-10; now condensed to three reports by AICPA SOP 98-3)  Corrective action plan Required Reporting Under Single Audit

32.  Schedule of findings and questioned cost  Describes such matters as internal control weaknesses, instances of noncompliance, questioned costs, fraud, and material misrepresentations by the auditee  Internal control weaknesses are reported as either: reportable conditions (significant internal control deficiencies that could adversely affect compliance), or material weaknesses (severe reportable conditions that render internal controls ineffective in reducing risk of noncompliance to an acceptably low level) Required Reporting Under Single Audit

33.  A questioned cost usually involves an instance of noncompliance with a law or regulation where the costs are either not allowable, are unreasonable, or are not supported by adequate documentation  Known questioned costs greater than $10,000 or likely costs greater than $10,000 must be reported in the schedule of findings and questioned costs Schedule of Findings and Questioned Costs (Cont’d)

34.  To promote quality control, nonfederal entities expending more than $25 million in federal awards are assigned a cognizant agency—usually the agency providing the predominant amount of support.  Cognizant agency provides technical advice and liaison, conducts quality control reviews, refers substandard audits for disciplinary action, and facilitates communication Cognizant Agencies and Oversight Agencies

35.  Nonfederal entities expending less than $25 million are assigned an oversight agency rather than a cognizant agency  Oversight agencies have similar but less extensive responsibilities than oversight agencies Cognizant Agencies and Oversight Agencies (Cont’d)

36.  Auditors add value to information by being independent and conforming to professional auditing standards (GAAS or GAGAS)  GAGAS applies to audits of nonfederal entities that expend at least $300,000 of federal awards  GAGAS are broader than GAAS in that they include standards for financial and performance audits.  The single audit improves both the efficiency and effectiveness of audits of nonfederal entities with significant expenditures of federal award. End Concluding Comments