Forty Mistakes Auditors Make

Here are 40 technology, planning, and execution deficiencies

Here are forty mistakes auditors make. While the list is (obviously) not comprehensive, you’ll see common technology, planning, and execution mistakes.

forty mistakes auditors make

  1. We aren’t paperless.
  2. We don’t link our trial balances to our work papers.
  3. We haven’t learned to use Adobe Acrobat.
  4. We don’t use optical character recognition (OCR), so we can’t electronically search our documents.
  5. We don’t use project management software such as Basecamp.
  6. We lose team communications (i.e., emails) because we aren’t using Slack.
  7. We use old (slow) computers.
  8. We don’t properly consider and document our independence.
  9. We don’t perform continuance procedures.
  10. We don’t assign appropriate personnel to risky engagements.
  11. We don’t appropriately price the engagement which leads to unattainable time budgets.
  12. We don’t focus our efforts on particular niches (thinking we can audit anything that comes our way).
  13. We keep doing the same thing year after year after year (and then complain we have too much time in the job).
  14. We assume we already know all the risks.
  15. We perform no (real) risk assessment.
  16. We don’t perform walkthroughs because we assume nothing has changed.
  17. We don’t perform walkthroughs because we are afraid of interacting with client personnel.
  18. We don’t consider internal control weaknesses in our risk assessment and audit program development.
  19. We create preliminary analytics in a perfunctory manner, not allowing them to inform us about risks.
  20. We ask perfunctory fraud questions without truly considering fraud risks.
  21. We don’t perform retrospective reviews of estimates.
  22. We don’t link identified risks to our audit plans.
  23. We don’t (really) have an engagement team discussion.
  24. We don’t tailor our audit programs.
  25. We don’t add purpose statements or conclusions on our work papers.
  26. We don’t define our tickmarks.
  27. We receive unnecessary documents from the client and leave them in the audit file.
  28. We leave review notes in the file.
  29. We don’t sign off on work papers, so no one knows who created the document.
  30. We don’t perform post-audit reviews to document the mistakes we made (so they won’t be repeated next year).
  31. We ask clients for certain documents without showing them the prior year example (and they provide the wrong document).
  32. We get on and off the same engagement too many times, losing momentum and wasting time.
  33. We send our audit team into the field even though the client hasn’t provided requested information.
  34. We don’t educate the client regarding the importance of timely information.
  35. We use staff that are not properly trained.
  36. We don’t plan our CPE to address upcoming audits.
  37. We don’t review staff work on a timely basis, so feedback is late (or not provided at all).
  38. We don’t report significant deficiencies or material weaknesses (because of client push-back).
  39. We fail to lock down our files.
  40. We don’t add value to our audits.

Sleeping with Your Decisions as a CPA

Are you struggling with an ethical issue?

Men are alike in their promises. It is only in their deeds that they differ. Molière

We’ve all been there.

Your client wants you to sign off on an issue, one that is in the land of gray–you know, that place where there is no black or white. And, of course, the issue has significant dollars attached to it, so it’s important.

Your anguish rises, so you try to see the Great Oz, but he’s not available. No trips to Kansas today.

You want to do the right thing, but what is it?

Sleeping with Your Decisions as a CPA

Picture courtesy of AdobeStock.com

Four Questions for Clarity

Here are four questions to ask:

  1. How would I feel if my choice was placed on the front-page of the local newspaper (or in the Journal of Accountancy)?
  2. What would my father do (or anyone else I greatly respect)?
  3. What would I advise my child to do? (If your child is three, pretend she is thirty.)
  4. What’s the worst thing that could happen

Four Actions for Clarity

Here are four actions to take:

  1. Call the AICPA Ethics Hotline or the AICPA Technical Hotline (877-242-7212). (They are independent of the issue, so they will give you a straight-up answer.)
  2. Call a CPA with knowledge in the area of concern, and ask his or her opinion.
  3. Create a memo supporting your proposed decision, and share it with a partner, quality control department, or whoever is in charge. (I find that writing creates clarity.)
  4. Sit on it (if you can). I gain clarity as I allow the issue to percolate, and as I pray about it. I try not to make a high-stakes decision quickly. A hurried decision is usually a poor one.

Sleeping Well

Remember, a clear conscience is a precious commodity. If you believe a particular course of action is going to keep you awake at night, then your conscience is speaking to you.

Do the right thing and sleep well. Good evening.

2017 OMB Compliance Supplement Issued on August 17, 2017

The Office of Management and Budget issued the 2017 Compliance Supplement today (August 17, 2017). You can see it here.

The 2017 Compliance Supplement applies to audits of fiscal years beginning after June 30, 2016.

2017 Compliance Supplement

Auditing Debt: The Why and How Guide

A key risk is that debt is classified as noncurrent when it should be current

What are the keys to auditing debt correctly?

While auditing debt can be simple, sometimes it gets tricky. You might even get eclipsed by the accounting! The violation of covenants can darken the sky. Also, some companies keep debt off the books by structuring leases to avoid capitalization. So, put on your shades and let’s take a look at how to audit debt.

auditing debt

Auditing Debt — An Overview

In many governments, nonprofits, and small businesses debt is a significant part of total liabilities. Consequently, it is often a significant transaction area. 

In this post, we will cover the following:

  • Primary debt assertions
  • Debt walkthroughs
  • Directional risk for debt
  • Primary risks for debt
  • Common debt control deficiencies
  • Risk of material misstatement for debt
  • Substantive procedures for debt
  • Common debt work papers

Primary Debt Assertions

The primary relevant debt assertions are:

  • Completeness
  • Classification

I believe—in general—completeness and classification are the most important debt assertions. When a company shows debt on its balance sheet, it is asserting that it is complete and classified correctly. By classification, we mean it is properly displayed as either short-term or long-term.

Keep these assertions in mind as you perform your transaction cycle walkthroughs.

Debt Walkthroughs

Early in your audit, perform a walkthrough of debt to see if there are any control weaknesses. As you perform this risk assessment procedure, what questions should you ask? What should you observe? What documents should you inspect? Here are a few suggestions.

Walkthrough Questions and Actions

As you perform your debt walkthrough ask or perform the following:

  • Are there any debt covenants?
  • Does the company have any covenant violations?
  • If the company has violations, is the debt classified appropriately (usually current)?
  • Is the company reconciling the balance sheet to a loan amortization schedule?
  • Inspect amortization schedules.
  • Does the company have any unused lines of credit or other credit available?
  • Inspect loan documents.
  • Has the company refinanced its debt with another institution? Why?
  • Who approves the borrowing of new money?
  • Inspect loan approvals.
  • How are debt service payments made (e.g., by check or wire)?
  • Are there any sinking funds? If yes, who is responsible for making deposits and how is this done?
  • Observe the segregation of duties for persons:
    • Approving new loans,
    • Receipting new loan proceeds, 
    • Recording debt in the general ledger, and 
    • Reconciling the debt on the balance sheet to the loan amortization schedules
  • Is the company required to file any periodic (e.g., quarterly) reports with the lender?
  • Inspect sample quarterly debt reports, if applicable.
  • Does the company have any capital leases?
  • Who is responsible for determining whether a lease should be capitalized?
  • What criteria is the company using to capitalize leases?
  • Has collateral been pledged? If yes, what?
  • What are the terms of the debt agreements?
  • Has all debt of the company been recorded in the general ledger?
  • Have debt issuance costs been netted against debt in the financial statements?
  • Has the company guaranteed the debt of another entity?

If control weaknesses exist, create audit procedures to respond to them. For example, if—during the walkthrough—we see that one person approves loans and deposits loan proceeds, then we will perform fraud-related substantive procedures. 

Debt-Related Fraud

Companies can intentionally omit debt from their balance sheets in order to inflate their equity total. (Since total assets equal liabilities plus equity, then equity goes up if debt is omitted.)

As we saw with Enron many years ago, some entities try to move their debt to other entities. So auditors need to consider that a company may intentionally omit debt from its balance sheet.

Another potential fraudulent presentation is showing short-term debt as long-term. When might this happen? When there is a debt covenant violation. The company may need to present the debt as current when such violations occur. Here’s how to report debt covenant violations.

Additionally, mistakes can lead to errors in debt accounting.

Debt Mistakes

Debt errors may occur when accounting personnel misclassify debt service payments. Also, debt can be mistakenly presented as long-term when it is current.

We also need to consider the directional risk for debt. 

Directional Risk for Debt

The directional risk for debt is that it is understated. So, audit for completeness (and determine that all debt is recorded).

Primary Risks for Debt

The primary risks for debt are:

  1. Debt is intentionally understated (or omitted)
  2. Debt is not classified as current though there is a covenant default that requires such treatment

As you think about these risks, consider the control deficiencies that allow debt misstatements.

Common Debt Control Deficiencies

In smaller entities, it is common to have the following control deficiencies:

  • One person performs two or more of the following: 
    • Approves the borrowing of new funds,
    • Enters the new debt in the accounting system, 
    • Deposits funds from the new debt
  • Funds are borrowed without appropriate approval
  • Debt postings are not agreed to an amortization schedule
  • The accounting personnel don’t understand the accounting standards for debt covenant violations and lease capitalization

Another key to auditing debt is understanding the risks of material misstatement.

Risk of Material Misstatement for Debt

In auditing debt, the assertions that concern me the most are classification and completeness. So my risk of material misstatement for these assertions is usually moderate to high. 

My response to the higher risk assessments is to perform certain substantive procedures: namely, a review of debt covenant compliance and a review of lease accounting. Why?

A company desires to display debt as long-term (even though it is short-term). Doing so makes working capital (current assets minus current liabilities) stronger. If a debt covenant violation causes debt to be current, working capital can tank quickly. So, the temptation is to show debt as long-term even though it is technically current.

Additionally, debt issuance costs are a deduction from debt. Review the classification of these costs which prior to ASU 2015-03 were assets. See this post for more information.

And one more thing. If capital leases are not capitalized (though they should be), the debt does not appear on the balance sheet, making the company look healthier than it is. (FASB has issued a new lease standard that will require the capitalization of all leases of more than one year, but it’s not presently effective. You can see ASU 2016-02, Leases here.)

Once your risk assessment is complete, you’ll decide what substantive procedures to perform.

Substantive Procedures for Debt

My customary tests for auditing debt are as follows:

  1. Summarize and review all debt covenants
  2. Review all leases for correct classification as capital or operating
  3. Confirm all significant debt with the lender
  4. Determine if all debt is classified appropriately (as current or noncurrent)
  5. Agree the end-of-period balances on the balance sheet to the amortization schedule
  6. Review any significant accrued interest at period-end

In light of my risk assessment and substantive procedures, what debt work papers do I normally include in my audit files?

Common Debt Work Papers

My debt work papers normally include the following:

  • An understanding of debt-related internal controls 
  • Documentation of any debt internal control deficiencies
  • Risk assessment of debt at the assertion level
  • Debt audit program
  • A copy of all significant debt agreements (including leases and line-of-credit agreements)
  • Minutes reflecting the approval of new debt
  • A summary of debt activity (beginning balance plus new debt minus principal payments and ending balance)
  • Amortization schedules for each debt

If there’s any question about debt agreements and their presentation, I include additional representation letter language to address the issue.

In Summary

In summary, today we looked at the keys to auditing debt. Those keys include risk assessment procedures, determining relevant assertions, creating risk assessments, and developing substantive procedures. The most important issues to address are usually (1) the classification of debt (especially if debt covenant violations exist) and (2) lease accounting.

Look for my next post in The Why and How of Auditing. Next week we’ll look at how to audit equity.

If you’ve missed my prior posts in this audit series, click here.

Going Concern in Compilation and Review Engagements

If your compilation and review engagement clients have financial difficulties, then think about going concern disclosures

Do you need to concern yourself with going concern in compilation and review engagements? Yes, if the financial statements are prepared in accordance with the FASB Codification. But is going concern relevant to special purpose frameworks such as the cash basis or tax basis financial statements. Yes, going concern is in play even with special purpose frameworks. This post provides an overview of what you need to know about going concern as it relates to compilation and review engagements.

I recently wrote a post about ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which is effective for years ending after December 15, 2016. This standard requires companies to include certain disclosures when substantial doubt is present. So, we know that financial statements prepared in accordance with GAAP must include these disclosures. Otherwise, there is a GAAP departure. And in an audit, we modify our opinion when there is a departure.

Going Concern

Going Concern in Compilation Engagements

But what about financial statements subject to a compilation engagement, especially when substantially all disclosures are omitted? Is it not permissible for the CPA to ignore the going concern standard since it just requires disclosures? Yes, but be careful. Ask yourself whether the financial statements would be misleading (without the going concern disclosure). If they are misleading, then include a selected disclosure regarding going concern. Also, consider adding an emphasis of matter paragraph (regarding going concern) to your compilation report.

Consider the alternative. Your client (who has significant going concern issues) takes your compilation report and their financial statements (that has no disclosures) to a local bank. It’s obvious that the company is in poor shape. But the bank makes a large loan anyway, and later, the company defaults. Then the bank files suit against you (the CPA) asserting that you issued the compilation report without the emphasis of matter and financial statements without the going concern disclosure–knowing the statements were misleading.

Sample Compilation Report with a Going Concern Paragraph

An emphasis of a matter paragraph (concerning the going concern issue) is not required but may be necessary to ensure clarity. Below is a sample compilation report–with a going concern emphasis of matter–from the AICPA’s Preparation, Compilation and Review Audit Guide.

Management is responsible for the accompanying financial statements of XYZ Company, which comprise the balance sheets as of December 31, 20X2 and 20X1 and the related statements of income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes to the financial statements in accordance with accounting principles generally accepted in the United States of America. I (We) have performed compilation engagements in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. I (We) did not audit or review the financial statements nor was (were) I (we) required to perform any procedures to verify the accuracy or completeness of the information provided by management. Accordingly, I (we) do not express an opinion, a conclusion, nor provide any form of assurance on these financial statements.

As discussed in Note X, certain conditions indicate that the Company may be unable to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

[Signature of accounting firm or accountant, as appropriate]
[Accountant’s city and state]
[Date of the accountant’s report]

Going Concern in Review Engagements

Since review engagements require full disclosure, going concern disclosures–when substantial doubt exists in GAAP financial statements–are not optional. They must be provided. If not, then a GAAP departure exists.

AR-C 90.65 states “The accountant should consider whether, during the performance of review procedures, evidence or information came to the accountant’s attention indicating that there could be an uncertainty about the entity’s ability to continue as a going concern for a reasonable period of time.” So what’s a reasonable period of time? GAAP specifies the period as one year after the date the financial statements are available to be issued. If a financial reporting framework does not specify a period (such as the cash basis of accounting), then use one year from the date of the financial statements being reviewed.

The Accounting and Review Services Committee (ARSC) is presently reviewing AR-C 90 in light of FASB’s going concern standard, ASU 2014-15. ARSC is working to align the review standards with FASB’s going concern standards. Also, expect to see a requirement that an emphasis of matter paragraph be added to the review report when substantial doubt is present. 

Sample Going Concern Paragraph in a Review Report

Here’s a sample emphasis of matter paragraph for a review report.

Emphasis of Matter

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raises an uncertainty about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our conclusion is not modified with respect to this matter.

Special Purpose Frameworks

While the cash, modified cash, or tax bases of accounting do not address going concern, accountants still need to consider the effects of negative financial conditions and trends. Why? When using a special purpose framework (like the tax basis), the accountant should follow the guidance in GAAP. No, that doesn’t mean your disclosures are just like GAAP, but it does mean they are similar to GAAP.

Since GAAP tells the financial statement preparer to consider whether substantial doubt exists, then persons creating cash basis, modified cash basis or tax basis financial statements should do the same. If substantial doubt is present, going concern disclosures are necessary. Follow FASB’s guidance in my going concern post to create your special purpose framework disclosures.

So, what is substantial doubt? The FASB Codification defines it this way:

Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.

If substantial doubt is present and going concern disclosures are not included in full disclosure compilations or reviews, then modify your accountant’s report (for the departure).