Friday, October 5, 2007

SAS No. 112 and Who Does Your Financial Statements

Lot of discussion this week at the Audit Risk Conference on Statement on Auditing Standards ("SAS") No. 112, Communicating Internal Control Related Matters Identified in an Audit. Most of the Risk Assessment standards become effective at the end of 2007, but SAS No. 112 was effective at the end of 2006.

A big issue that came out of SAS No. 112 related to preparation of an entity's financial statements. Historically, an entity's CPA firm would assist in drafting the financial statements, including the notes to the financial statements. Let's be realistic - most small businesses do not have the in house capability to do this themselves, or even if they do would prefer that the auditor, who has a lot of experience in this area, do it.

SAS No. 112 though makes it clear that an entity has the responsibility to do draft its financial statements, including the notes. If the auditor does it, then the entity has essentially included the auditor in its internal control structure. And SAS No. 112 says you can't include the auditor in your internal control structure.

This is a problem for many companies. If they keep the status quo, then the auditor has to issue a letter stating that the entity has a significant deficiency in internal control in this area. This can lead to problems in some instances.

Solutions:
  1. Demonstrate the capability to supervise the work done by the auditor. If possible, then there should be no significant weakness.
  2. Don't make a change. Many entities are fine with getting this as a significant weakness.
  3. Bring in a second accounting firm to specifically prepare the financial statements and notes prior to the auditors coming in.

The auditing theorists really like that 3rd idea, and think it will happen a lot as time goes forward. In theory it makes sense, but I'm sure there are CPAs out there who are afraid the second accounting firm will try to take over the entire account.

For my part, I'm doing audits where a second firm is involved. In both cases, I got brought in by the second firm. We've arrived at a situation where we respect what the other is doing and work well with each other to service the client. Which is what it is all about anyway.

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