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In the wake of emerging developments
in corporate governance and in light of increasing expectations by
those who rely on audited financial statements the Auditing
Standards Board recently published new standards associated with
auditor communications. Among other things, Statement on Auditing
Standards No.114 establishes a requirement for the auditor of
financial statements to communicate certain significant matters
related to the audit to those charged with governance. The matters
include items that have been addressed in prior standards, as well
as certain new requirements. The Statement also provides additional
guidance on the communication process including, for example (this
list is not all inclusive):
-
the importance of effective
two-way communication
-
situations where management is
involved with governance, especially in small organizations
-
the adequacy of communications
between the auditor and those charged with governance
Our purpose with respect to this
article is to outline some of the new standards and how they affect
those charged with governance. We believe it is important for each
member of an organization’s governing body to recognize his/her
responsibilities as well as the responsibilities of the independent
auditor.
Definitions
The new standard clearly draws a
distinction between those charged with governance and the
management of the organization. The following definitions are
outlined in the new standard:
-
Those charged with governance
means the person(s) with responsibility for overseeing the
strategic direction of the entity and obligations related to the
accountability of the entity. For entities with a board of
directors, this term includes the audit committee or
similar subgroup.
-
Management
means the person(s) responsible for achieving the objectives of
the entity and who have the authority to establish policies and
make decisions by which those objectives are to be pursued.
Communication principles
With regard to communication, the
new standard points to three principle purposes. It indicates that
the auditor:
1.
Communicate clearly with those charged with governance the
responsibilities of the auditor in relation to the financial
statement audit, and an overview of the scope and timing of the
audit.
2.
Obtain from those charged with governance information
relevant to the audit.
3.
Provide those charged with governance with timely
observations.
Importance of two-way communications
While the standard is primarily
focused on communication from the auditor to those charged with
governance, it also indicates the importance of effective two-way
communications. The new standard indicates that two-way
communication assists those charged with governance in understanding
matters related to the audit, important transactions, sources of
supportive documentation, and in satisfying their obligation to
oversee the financial reporting activities. The standard goes on to
point out that poor two-way communication might be an indication of
the lack of an adequate control environment, which might influence
the auditor’s assessment of risk, and consequently the scope of the
audit procedures.
According to the new
standard, the auditor must assess the effectiveness of such
communications and whether it adequately fulfills the auditor’s
responsibilities. Based upon that assessment, the auditor may
determine that to fulfill his/her responsibility he/she must
communicate directly to the governing body, a right the auditor
always maintains.
To assess the effectiveness
of communications with those charged with governance the standard
indicates that the auditor may look to numerous indicators. For
example the auditor may:
·
Evaluate the
appropriateness and timeliness of action taken by those charged with
governance in response to matters communicated by the auditor.
·
Consider the openness
of those charged with governance in their communications with the
auditor.
·
Assess the apparent
ability of those charged with governance to meet without the
presence of management.
·
With regard to
situations in smaller organizations where management may also be
involved with governance, evaluate the awareness of how matters
discussed with the auditor affect their broader governance
responsibilities, along with their responsibilities as managers.
The standard points out that
good governance implies that the auditor should have access to the
audit committee or its subgroup, that the auditor actually meet with
the committee periodically, and the committee should meet with the
auditor without the presence of management at least
annually.
If, in the judgment of the
auditor, the two-way communication is not adequate, the standard
indicates that the auditor may have to ultimately withdraw from the
engagement. The position makes it clear that the Auditing Standards
Board views two-way communication as a very component of the audit.
Effective date
Statement on Auditing
Standards No.114 is effective for audits of financial statements for
periods beginning on or after December 15, 2006.
We encourage you to share
this article with your associates, especially those who are charged
with governance. Organizations, whether for-profit or nonprofit,
are better served if management as well as those charged with
governance have a clear understanding of the auditor’s
responsibilities.
Questions about this article
may be directed to Vincent Ruocco, LLC, CPA at 203.932.2931.
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