What Else Is There to Know About External Audits?

Transcription

1 What Else Is There to Know About External Audits? July 2018 Auditors On The Road Area Training (OTRAT) Today s Roadmap External Audit Purpose Roles of Those Involved in the Process Why Only Reasonable Assurance? 10 Common Points of Misunderstanding 10 Steps to a Successful External Audit 1

2 External Audit Purpose Accounting of Your Stewardship Comprehensive Annual Financial Report (CAFR) or Annual Financial Statements Third Party Assurance External Auditor Independent Provides Reasonable Assurance Fair Presentation of Financial Statements Audit Process Gather evidence (i.e. source documents) Generally Accepted Auditing Standards (GAAS) How we audit Governmental GAAP Format of reporting Reportable conditions (i.e. findings) External Audit Role of County Auditor Responsible for Stewardship of County s Resources Responsible for Financial Statement Preparation External auditor assistance is allowable County Auditors responsible for contents Possesses Skills, Knowledge, and Experience (SKE) Management Representation Letter GAAS Requirement Stated in Engagement Letter, as a condition of the engagement 2

3 External Audit Role of Internal Control System of Internal Control Accounted for properly Reported properly System of Internal Control External Audit System of Internal Control Authority to Initiate transactions Authority to Approve transactions Responsibility, and access, to Record transactions Consider IT credentials of employees Which clerks responsible, and access only their respective modules Decentralized collection points and accounting (e.g. JP s offices) Monitoring Financial Information Being Recorded GOAL: Prevent, Detect, and Correct Timely 3

4 External Audit Role of Governing Body (Commissioner s Court) County Auditor primarily responsible Governing Body is ultimately responsible for ensuring County Auditor meets these responsibilities Audit Committee External Audit Reasonable Assurance Role of an External Auditor To gather evidence to support the financial statements presented in order to provide reasonable assurance that the financial statements are a fair presentation of the government s financial activity. ABSOLUTE ASSURANCE 4

5 External Audit Fair Presentation Objective Financial Statements that are materially correct Free of significant errors that could affect decisions based on them 10 Common Misunderstandings About External Audits 5

6 # 1: Fair presentation of financial statements is not the equivalent to financial health. Often independent auditors are criticized when people find out that they issued an unmodified ( clean ) opinion on the fair presentation of financial statements when the County is not in a good financial position. The reality is that the two are not connected. The financial statement audit is designed to determine whether the financial statements are presented fairly, in all material respects, not to determine the soundness of the entity s financial position. # 2: Financial statement audits are not designed to detect all instances of fraud, abuse, and program noncompliance. Many people assume the principal goal of a financial statement audit is to uncover fraud, abuse, and instance of program noncompliance. However, as discussed earlier the financial statement audit is designed to determine whether the financial statements are presented fairly, in all material respects. Many instances of fraud, abuse, and program noncompliance fail to reach the materiality threshold that is used during an audit and will not be detected by audit procedures. Independent auditors will report any instance encountered (unless it is clearly inconsequential), regardless of materiality. However, it is important to keep in mind that the financial statement audit is not designed to identify immaterial instances of fraud, abuse, and program noncompliance, nor is it likely to do so. 6

7 # 3: Size is not the sole consideration in judging materiality. Quantitative Factors Materiality Qualitative Factors The quantitative base for materiality is a formula that is generally based off of: Total assets or Total revenue The quantitative amounts may be adjusted for qualitative factors such as: Relationships i.e. related parties, key management personnel, etc. Circumstances first-year engagement, turnover, etc. Nature regulatory requirements related to grant compliance, etc. # 4: Quantitative materiality needs to be assessed in relation to individual major funds and to each of the government-wide activity columns. There are multiple opinions expressed which requires the need for multiple materiality amounts. Example County Financial Reporting Opinion Units: Government-Wide Governmental Activities separate materiality Governmental Funds General Fund separate materiality Road and Bridge Fund separate materiality County Clerk Records Preservation Fund separate materiality Other Nonmajor Governmental Funds separate materiality (aggregated) Proprietary Funds Internal Service Funds separate materiality Fiduciary Funds Agency Funds separate materiality An amount may not be material from the perspective of the government taken as a whole (government-wide level), but it may be material from the narrower vantage point of an individual major fund. 7

8 # 5: You cannot assess the reliability of data yet ignore the system that generates the data. There are two fundamental approaches an independent auditor can take to determine the reliability of data presented in financial statements. One approach is to directly test a given item (e.g., confirm the amount reported as cash on deposit with the bank). The other approach is to test the reliability of the underlying system that generates the data (e.g., validate the amount reported as vendor payables by testing the reliability of the processing of transactions in the purchasing system). Auditors describe the first approach as substantive testing and the second as the testing of controls. Independent auditors are required to obtain an understanding of internal controls. This must be done to get an understanding of how the County processes transactions through the system. From that point, the independent auditor designs their audit procedures and decides to proceed with substantive testing only or a combination of substantive testing and testing of controls. # 6: Auditors must report significant deficiencies and material weaknesses even if those deficiencies had no effect on the fair presentation of the financial statements. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. A material weakness is a deficiency, or a combination of deficiencies in internal control, such that there is a reasonable possibility that a material misstatement of the entity s financial statements will not be prevented, or detected and corrected, on a timely basis. 8

9 # 7: Auditors are not allowed to perform any task that would compromise their independence. Independent auditors must refrain from placing themselves in the position of having to audit their own work, which could occur if they were to perform tasks that would put them in a management role. Certain nonaudit services are allowed, such as preparing financial statements, however an individual at the County must assume all management responsibilities, oversee the financial statement preparation services, and have adequate skills, knowledge, and/or experience for oversight of the services. In addition the independent audit firm must implement safeguards to eliminate any threat to independence. # 8: Audit fees cannot be the principal factor in selecting an audit firm (you often get what you pay for). The quality of professional services will naturally vary with the professional that perform them. Government accounting is substantially different from private sector accounting, as you know. Likewise, government AUDITING requires a specific expertise also. Therefore, in the audit procurement process, it is essential to determine if the audit firm, AND ITS GOVERNMENT AUDIT TEAM AS A WHOLE, have the requisite expertise and experience to perform a quality audit. Experience and expertise can be measured in a variety of ways. 9

10 # 9: It is in the County s best interest to sign a multi-year audit contract? First year costs are substantial Developing and documenting government s environment Developing and documenting IC framework Set up all funds and grouping accounts Drafting financial statements and footnotes Multi-year contracts allow for smoothing over contract period GFOA recommends governments contract for a minimum of 5 yrs # 10: Mandatory auditor rotation may pose special risks in the public sector (do not force yourself into a bad decision). Rotating auditors too frequently can increase the risk of fraud or errors going undetected. Rotating audit partners/audit teams with the same firm is a way to get a fresh set of eyes. Rather than requiring audit rotation, it s better to require an aggressive procurement effort to maximize the number of qualified firms in the selection pool 10

11 HOW DO I HANDLE EXTERNAL AUDITORS? 11

12 # 1: Plan Ahead Proper planning and clear expectations will help minimize anxiety and frustration. Maintain an open line of communication Keep schedules and reconciliations up-to-date throughout the year Fixed assets Debt rollforwards Grant activity recaps/reconciliations Reconciliation of interfund transfers and due to/from balances # 2: Update yourself on accounting standards Not only is it ideal to keep up with industry updates as a best practice, but practically speaking, you may need to be managing or tracking data in a different way in order to be able to provide the needed information for new reporting requirements. There is likely a cheat sheet in footnote 1 of your CAFR or Annual Report titled New Accounting Pronouncements. 12

13 # 3: Assess changes in activities Changes in your activities should be communicated to the external auditor during the planning stages of the audit Did you receive a new grant or another special funding source? Did you issue new debt? Were any of your activities discontinued or do you have any new segments? Were there any asset impairments or insurance recoveries? Were there any significant changes in internal control systems, such as software changes, personnel changes, added controls, weaknesses identified, suspected fraud? # 4: Learn from the past A starting point for self-review or a memory-jogger would be to review prior audit adjustments, review internal control recommendations, review your response to prior year controls findings and assess whether you ve responded accordingly, and think back (and inquire of your staff) on struggles you encountered during prior audits. During the planning meeting with the external auditor, discuss what went well during last year s audit, AND where there may be opportunities for improvement or more effective communication between you and the external auditor. 13

14 # 5: Develop a timeline and assign responsibility Make sure to get clarification on information requested by the external auditor when necessary. It s very possible that the auditor may have a copy of the document from the prior year that they can send you as an example. Delegate items on the request list to appropriate staff members and include a due date. Although it s against human nature tackle the most difficult, complex, or time-consuming area first. If you re the person responsible for gathering the information requested, and you ve delegated pieces to others, make sure to review what they ve given you to ensure it s what the external auditor requested and it s complete. And this is one of the most important suggestions we can offer: make sure ALL of the requested information is available before or on the first day of fieldwork. # 6: Organize data Create a repository of audit schedules that can be accessed in future years by the appropriate staff. Organize the data in folders and subfolders in a logical manner either by transaction cycle (cash, AP, receivables), or by county departments (JP, Sherriff), or by staff person assigned to gather that information, or by the order of the information request. Whatever is logical and works best in your organization is how you ll want to design it. A well-organized repository of audit information can: serve as reminders of exactly what you provided to the auditors in the prior year allow for auditor access to a specific network drive to allow each member of the audit team to access the specific information they need for their assigned testwork allow for additional requests during fieldwork to be added to the respective folders for the auditors to access (which will also help with creating a complete request list the next year) 14

15 # 7: Ask questions We touched on this a little bit in suggestion #5, but ask questions if you re not clear on what the external auditor is requesting. Most are happy to further explain their request, or provide an example of what they re looking for. Ask questions within your organization to gather necessary information for footnote disclosures such as pending or threatened litigation, related party transactions, commitments and contingencies, etc. # 8: Perform a self-review Take a step back and look at your financial statements, or trial balance, to assess the overall reasonableness. Do you see anything that looks unusual or that would require additional explanation? Go ahead and take a look at your revenue and expense accounts yearover-year and prepare yourself to explain variances in the amounts year to year. Most revenue and expense items are going to trend similarly year-toyear, so if you see a significant variance, investigate the reason. You may find that it s an adjustment you need to make, or at the very least, you ll already have an explanation ready when the auditor asks the question. **This is also an area that you could look at more frequently than annually, such as quarterly or at least mid-year to already be familiar with accounts trending differently than expected** 15

16 # 9: Be available during fieldwork If you ve scheduled mutually agreeable time for fieldwork, make every effort to be available and avoid key staff members taking unnecessary time off during the audit fieldwork. If all the previously requested information is available, in good order, and you and your staff are available to answer follow up questions and provide additional information as needed, then the auditors will be able to wrap up much quicker. At a minimum, communicate up front with your In-charge External auditor if you or key staff members will be out of the office so they can plan their work around those times. Request status update meetings, or at least an updated open items list from the external auditor at logical intervals during the audit. # 10: Evaluate results Maintain communication with your external auditor during the time between fieldwork and the issuance of the audit report. If there are open items at the end of fieldwork, establish agreed upon dates for the information to be provided. Request a Closing Meeting or an Exit Meeting with your external auditor to communicate results of the audit and to solicit feedback. 16

17 Q&A WITH EXTERNAL AUDITORS CONTACT INFORMATION: 17