Auditing Governments and Not-For-Profit Organizations

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1 Chapter 16 Auditing Governments and Not-For-Profit Organizations Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 16 1 Learning Objectives Auditing Government & Not-for-Profit vs. Business Types of audits that governments conduct Standards of government audits Role of Yellow-Book in governmental auditing Single Audit Act (A-133) Auditor reports Characteristics and key elements of performance audits Ethical issues facing governmental and not-for-profit accountants and auditors. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

2 FACT U.S. Government Accountability Office (GAO) Audit of the U.S. Government For the past 17 YEARS, from 1997 to 2014, the GAO has Disclaimed an Opinion on the U.S. Government s Financial Statements _Final.pdf (page 225) Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 16 3 While significant progress has been made in improving federal financial management since the federal government began preparing consolidated financial statements 17 years ago, three major impediments continued to prevent us from rendering an opinion on the federal government's accrual-based consolidated financial statements over this period: (1) serious financial management problems at DOD that have prevented its financial statements from being auditable, (2) the federal government's inability to adequately account for and reconcile intra-governmental activity and balances between federal entities, and (3) the federal government's ineffective process for preparing the consolidated financial statements. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

3 Three major impediments (1) SERIOUS financial management problems at the Department of Defense (2) the federal government's INABILITY to adequately account for and reconcile intra-governmental activity and balances between federal agencies (3) the federal government's INEFFECTIVE process for preparing the consolidated financial statements. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 16 5 State and local governments are a substantial part of the U.S. economy Based on the 2012 census there are 90,106 local governments in the U.S. In 2013, federal and state governments account for 31% of 2013 U. S. GDP (2011, U.S. Bureau of Economic Analysis) In May 2013, federal and state governments account for 16.07% of paid employment (May 2013, U.S. Bureau of Economic Analysis) In 2013, expenditures of state and local governments were over $9.4 trillion (2014, U.S. Bureau of Economic Analysis) 14.1% of the 2013 U.S. GDP ($ trillion) Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

4 Important Concepts Understand very clearly what is meant by generally accepted government auditing standards (GAGAS), the source of GAGAS, and why GAGAS are much broader than GAAS, in particular for financial audits and performance audits Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 16 7 Audits of Governments & NFPs Vs. Business Audit: examination of records or accounts for accuracy. Business sector audits: characterized by attest function (i.e. to affirm to be correct, true, or genuine. ) Attest function adds credibility to the assertions of others Government/Not-for-Profit sector audits: Auditors not only attest BUT also independently evaluate. Auditors assess whether auditees have achieved the objectives. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

5 Types of Audits Government Auditing Standards (2011) characterize government audits into three categories: Financial Audits: determine if financial statements are in accordance with GAAP. Attestation engagements: Examine, review, perform agreed-upon procedures Performance Audits: o Effective usage of entity s resources (Efficiency) o Effectiveness of internal controls o Verifying that organization is complying with the terms of laws, grants, and contracts. o Provide guidance on how the organization can improve GAGAS standards place much more emphasis on compliance with laws and regulations than do GAAS Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter 16 9 GAGAS --Yellow Book Generally Accepted Government Auditing Standards (GAGAS) Issued by the Government Accountability Office (GAO). Prescribes accounting standards and practices for ALL federal agencies (as required by law, regulation, agreement, contract, or policy) Mirror GAAS in discussion of: Auditor s professional qualifications Quality of audit effort, Characteristics of professional/meaningful audit reports Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

6 Generally Accepted Government Auditing Standards (GAGAS) Contains a total of 32 standards for both financial and performance audits Required of auditors in a Single Audit Government auditing standards are divided into: General standards Field work standards Reporting standards Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Levels of Reporting in Governmental Single Audits Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

7 Generally Accepted Government Auditing Standards (GAGAS) Broader than GAAS: This gives an overview of the breadth and depth of GAGAS. Financial Audits Attestation Engagements Performance Audits General Standards Field Work Standards Reporting Standards GAAS GAGAS GAAS GAGAS GAAS GAGAS Totals Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter GAAS v/s GAGAS General -Training and Proficiency Independence Due Care General -Qualifications: Professional Proficiency Knowledge of government programs CPE requirements Independence Due Professional Care Quality Control Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

8 Generally Accepted Government Auditing Standards (GAGAS) Professional competence requires auditors to have: o A thorough knowledge of governmental auditing and the specific or unique environment in which the audited entity operates o 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 government environment and government audit Peer Review: has to be done at least once in 3 years. Compliance and Internal Controls: reasonable assurance in detecting fraud or misstatements (required by AICPA and GAO) Public Availability: audit reports are available for public inspection Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter GAAS v/s GAGAS Field Work Adequate planning and supervision Evaluate internal control Obtain competent evidence Field Work Adequate planning and supervision Evaluate internal control Obtain competent evidence Supplemental Standards: Planning consideration of government programs Compliance testing Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

9 GAAS v/s GAGAS Reporting Adherence to GAAP Consistent application Adequate disclosure Expression of opinion Reporting Adherence to GAAP Consistent application Adequate disclosure Expression of opinion Report distribution not restricted In accordance with GAAS and GAGAS Report on compliance and internal control Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Reporting Requirements Must state compliance with GAGAS in the report when required to follow GAGAS, or representing to others that the audit followed GAGAS requirements. We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our finding and conclusions based on our audit objectives. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

10 Single Audit Act of 1984 Administered by the Office of Management and Budget (OMB). Replaces a multitude of grant-by-grant audits with a single, comprehensive, entity-wide audit. Intended (among other purposes) to improve the efficiency and effectiveness of governmental audit effort Federal agencies must agree to this process. Applies to both direct and indirect recipients of federal money $750,000 (1996 amendment) initiation threshold (multiple awards). Higher education, state/local governments, and other not-for-profit entities (1996 amendment) OMB Circular A-133 and the related Compliance Supplement provide implementing guidance. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Single Audit (Cont d) Two main components: Audit conducted under GAGAS Compliance Audit of federal financial awards/major programs (Single Audit component) Understand the characteristics of a single audit, including: the purpose which entities must have a single audit what auditing work is required how major programs are selected for audit what reports must be rendered, when, and to whom Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

11 Single Audit: Key Requirements Annual audit of financial statements conducted by an independent auditor encompassing the entity s financial statements and schedule of expenditures of federal awards. Fair presentation of financial statements and the schedule of federal financial awards is presented fairly in relation to the financial statements. Study and evaluation of internal controls --understanding of compliance requirements by major program. Assess control risk and structure control tests accordingly. Federal and nonfederal Pass-through agencies are assigned certain responsibilities for compliance Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Federal Single Audit Entity receives funding under a federal grant or allocation (CDBG, Student Financial Aid, etc.) Greater than $750,000 must have single audit or program-specific audit. Implemented in 1984 Single Audit Act ; OMB Circular A-133 contains requirements. Standardized audit requirements pertaining to the federal assistance. Organization-wide financial and compliance audit. Financial component of audit - basically the same as non-federal audit; includes the financial statements and accompanying notes. Compliance component tests of compliance with applicable laws and regulations. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

12 Federal Programs: Compliance Requirements Fourteen compliance requirements: 1. Activities allowed or unallowed 2. Allowable costs/cost principles 3. Cash management 4. Davis-Bacon Act 5. Eligibility 6. Equipment and real property management 7. Matching level of effort earmarking 8. Period of availability of funds 9. Procurement, suspension and debarment 10. Program income 11. Real property acquisition and relocation assistance 12. Reporting 13. Subrecipient monitoring 14. Special tests and provisions Source: Adapted from OMB Circular A-133 Compliance Supplement, Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter GAAS - GAGAS Single Audit Relationships -Financial Audits GAAS -General Internal Control Audit -General Compliance Audit with Laws and Regulations GAGAS FOR MAJOR PROGRAMS -Internal Control Audit -Compliance Audit with Laws and Regulations -Schedule of Questioned Costs Single Audit GAGAS Incorporates GAAS and includes additional requirements Single Audit Incorporates GAGAS and includes additional requirements Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

13 Single Audit Act Expended Requires organizations expending more than $750,000 in federal assistance under more than one program be subject to single audit. Key task is determining when funds were expended. Federal award is expended When the federal agency has become at risk, and The nonfederal recipient has a duty of accountability. Recipient of funds has to deal only with a single agency (referred to as Cognizant Agency). All federal awarding agencies are required to accept the single audit reports as satisfying their program s audit requirements Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Single Audit Act and OMB Circular A-133 Did the nonfederal entity expend $750,000 or more of federal awards? Yes No No Single Audit or Program Specific Audit required--only GAAS and GAGAS Audit required. Did the nonfederal entity 1) expend federal awards under only one federal program--which did not require a financial statement audit, 2) meet other requirements, and 3) properly elect a program specific audit? No A Single Audit is required. Yes A program-specific audit is required. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

14 Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Single Audits: Four Reports Produced 1) Opinion on the Financial Statements and on the Schedule of Expenditures of Federal Awards The schedule includes a list of total expenditures of the organization Proper categorization of expenses 2) Report on Compliance and on Internal Control over Financial Reporting Directed towards the basic financial statements Based on audit requirements of Governmental Auditing Standards Include any material weaknesses in the controls 3) Report on Compliance with Requirements of Major Programs Explain the nature of the examination Auditors express an opinion Include any reportable conditions 4) Schedule of Findings and Questionable Costs Most distinctive and informative Summary of the results Describe reportable conditions Include findings pertaining to major programs Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

15 Types of Audits: Financial The purpose is to perform an independent assessment of and to provide reasonable assurance about whether an entity s reported financial condition, results, and use of resources are presented fairly (in accordance with recognized criteria) GAGAS financial reports include reports on: internal control compliance with laws and regulations, and the terms and provisions of contracts/grants Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Internal Control Audit Assess internal control system components for adequacy and effectiveness can it provide reasonable assurance of: Achieving effective and efficient operations; Reliable financial and performance reporting; and Compliance with laws and regulations. Extremely relevant to government procurement officials for determining organizational capability for successful performance of government contract effort. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

16 Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

17 Compliance Audits Assess compliance with established laws regulations contract provisions grant agreements other requirements To assess the direct or indirect impact on the acquisition; protection; use; and disposition of the entity s resources or quantity; quality; timeliness; and cost of services that the entity produces and delivers. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

18 Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

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21 Compliance Audits of Federal Financial Awards/Major Programs 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. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

22 Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Selection of Major Programs Using a sliding scale identify Type A and Type B 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) 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 Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

23 Risk-Based Approach Step 1: Identify (larger) Type A Programs Step 2: Identify low-risk Type A programs Step 3: Identify high-risk Type B programs Step 4: Select for audit as major programs a minimum of all Type A programs not identified as lowrisk in Step 2, plus certain high-risk Type B programs. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Key Audit Procedures Identify compliance requirements Plan the engagement Assess internal control Obtain sufficient evidence Consider subsequent events Evaluate and report on noncompliance Follow-up procedure Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

24 Performance Audits NOT required by Single Audit Performance audits carried out on specific programs Carried out by internal audit departments Focus on organizational accomplishments General standards are common to both financial and performance audits Auditors make independent assessments Conducted irregularly Broader range of evidence Each performance audit is unique Requires more program-specific knowledge Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Steps in Conducting Performance Audit Selecting the audit target Establishing scope and purpose Discerning the objectives Scheduling disbursements or other population Assessing management controls Preparing a written audit plan Gathering evidence Reporting the results of the audit Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter

25 Additional Topics: Ethical Issues Governments and to a lesser extent not-for-profits have characteristics that present their employees with ethical decisions that are different from those faced by employees of businesses. These are: Public expectations Guardians of public funds (OPM) Activities carried out in open view Special powers Conflicting loyalties Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter Summary Auditors add value to information by being independent and conforming to professional auditing standards (GAAS or GAGAS) GAGAS are broader than GAAS in that they include standards for financial and performance audits established by the government through the GAO s Yellow book. Under the Single Audit Act, GAGAS has to be adhered to in all audits of both governments and not-forprofit organizations. However, the Single audit requires only financial audits. Single audits comprise of 2 elements: an audit of financial statements and an audit of federal financial awards that follows the provisions of OMB Circular A-133. The single audit improves both the efficiency and effectiveness of audits of nonfederal entities with significant expenditures of federal award. Performance audits differ in concept from financial audits. It makes assessments about an entity s programs. They are an important supplement to conventional financial audits. Government accountants and auditors face ethical dilemmas similar to those in the private sector which they must resolve in the face of public expectations and as guardians of public funds. Granof, et al. 7th edition 2016 John Wiley & Sons, Inc. All rights reserved. Chapter