The end of the year is coming, and for auditors, that means busy season is just around the corner. There never seem to be enough hours in the day to accomplish all that needs to be done, but putting off preparing for busy season only make things worse. In the words of Benjamin Franklin, “By failing to prepare, you are preparing to fail.”
Every firm should take the following five steps to prepare for busy season:
- Evaluate last year’s busy season
- Assess current authoritative literature
- Consider recent peer review and internal inspection findings
- Communicate early with clients
- Prepare staff and invest time in planning.
This article will address each of these steps, focusing on learning from recent peer review findings.
Evaluate Last Year’s Busy Season
When preparing for the future, there is no better place to start than the past. Accordingly, firms should begin by objectively evaluating the previous busy season to see what can be learned from it. One way to do that is to conduct a retrospective or postmortem on the prior year’s busy season. A firm should consider pulling together a group of its audit professionals to brainstorm what went well, what did not go well, and what the firm should do differently. For smaller firms, this could mean getting the entire audit staff together for a long lunch. For larger firms, it might mean getting some partners, managers, and in-charges for a brainstorming discussion.
Audit files often include suggestions for audit efficiencies, such as a comment to obtain an accounts receivable file in a certain electronic format that is better suited to data extraction techniques, which can serve as a starting point. In addition, the following topics might also be part of that discussion:
- Technology issues, either software or hardware, which negatively impacted auditor efficiency
- Improving client assistance
- The timeliness of meeting client deadlines and issuing reports
- Preparing staff for busy season, including keeping them motivated and feeling valued
- The scheduling process, including whether budgets were realistic, whether the schedule appropriately considered the competency of individuals, whether appropriate partner time was charged during planning, and how overtime was spread among the staff
- Whether appropriate professional skepticism was exhibited on engagements
- The interplay between quality versus efficiency and the “tone at the top” exhibited by firm management.
In addition, a retrospective in the area of client acceptance and continuance might also be helpful, especially when considering whether the firm should resign from certain difficult clients or the firm should no longer perform work in a particular industry. Some of those clients may have already been engaged for December 31, 2016, audits, so a more thorough evaluation of this particular topic may need to be done after next year’s busy season.
Assess Current Authoritative Literature
In the second step, a firm should assess whether there are significant new pronouncements that will affect this year’s audits. If the new standards will require significant additional audit time, firms will also need to consider the effect of those new pronouncements on engagement fee realization. Firms should consider not only pronouncements that have been issued recently, but also pronouncements issued in previous years that will now be effective for year-end audits. A year-end GAAP/GAAS update continuing professional education (CPE) course for key (or all) audit professionals is highly recommended.
Activity has been relatively quiet at the AICPA on the audit front, with only two Statements on Auditing Standards (SAS) issued in the last two years, and those having a narrow impact. Statement on Standards for Attestation Engagements (SSAE) 18, however, was issued in April and includes significant changes for non-traditional engagements, such as agreed-upon procedures engagements and examinations. These changes will be effective for reports dated on or after May 1, 2017 and will need to be considered when drafting the related engagement letters. In addition, FASB has more than made up for the slow pace of auditing standards changes, issuing approximately 30 new Accounting Standards Updates (ASU) covering rather specialized areas in the last 18 months alone. Several of these standards have delayed effective dates, the most far-reaching being the ASUs on revenue recognition and leases.
While these standards will not apply to audits this year (except for early adopters), auditors nevertheless need to educate themselves about the main provisions so that they can start assessing their effects and counsel their clients to be prepared for future retroactive applications. Firms should particularly consider those clients that will be most affected by the new standards, such as those with significant operating lease commitments (especially if they have debt covenants that might not be met if a large liability is recorded on the balance sheet) and those in industries with complex customer contracts that will be most affected by the revenue recognition standard.
Consider Recent Peer Review and Internal Inspection Findings
Firms that perform audits and other attest engagements are required to have a peer review every three years. Accordingly, the third step in preparing for busy season is to consider the impact of the most recent peer review and internal quality control inspection findings and ensure that appropriate remedial actions have been taken. In addition, the AICPA publishes summaries of findings noted in recent peer reviews periodically, which firms should review and consider when planning next year’s audit engagements. The most recent examples, published in July 2016 (http://bit.ly/2fWbHEe), cover audit engagements with year-ends between December 31, 2014, and March 31, 2016. In addition, the authors frequently have discussions throughout the year with peer reviewers about deficiencies noted in peer reviews. This section discusses some of the examples that are applicable to most audit engagements. (The AICPA also publishes deficiencies unique to firms practicing in specialized industries, which are outside the scope of the article.)
When preparing for the future, there is no better place to start than the past.
Failing to document and perform planning procedures is a common deficiency noted in peer reviews. Audit planning covers a wide range of activities, and compliance with auditing standards related to planning can pose problems for auditors. Some of the related deficiencies are discussed below.
Preliminary analytical procedures.
Auditors may not adequately document preliminary analytical procedures. A simple sign-off of a program step is not enough; auditors need to include a work-paper in the engagement file documenting the procedures performed. Note that merely explaining fluctuations between the prior year and the current year final balances during detail testing does not meet the objective. Preliminary analytical procedures, and the related documentation, should focus on developing the audit scope to achieve a more effective and efficient audit plan.
When auditors perform nonattest services for attest clients, they have to comply with the requirements of ET 1.295 of the AICPA Code of Professional Conduct to remain independent. Auditors need to ensure that an understanding with the client is established and documented in writing and all requirements of ET 1.295 are met. This entails obtaining evidence of the competence of a client individual designated to oversee the nonattest services. Auditors also need to be careful that their audit documentation does not give the appearance of performing nonattest services when they have not been engaged to perform such services, especially when if performed they would impair independence. When performing multiple nonattest services for attest clients, auditors should evaluate whether the aggregate effect of those services results in a significant threat to independence that cannot be reduced to an acceptable level by the application of safeguards.
Group audit standard.
Peer reviewers often note that auditors fail to document consideration of and compliance with the group audit standard when a component unit is audited by either another audit firm or another audit team in the same firm. This is a complex area that requires careful consideration and documentation. Under the AICPA’s auditing standards (but not the PCAOB’s), consolidated financial statements are group financial statements, as are combined financial statements. Combined financial statements are often presented when companies are under common management. Frequently, auditors fail to identify that they are auditing component financial statements and need to comply with AU-C 600, Special Considerations—Audits of Group Financial Statements (Including the Work of Component Auditors).
Risk assessment and developing the detailed audit plan.
Common deficiencies relate to performing risk assessment procedures, identifying risks, and developing the detailed audit plan. These deficiencies include a failure to perform or document the engagement team discussion regarding the susceptibility of the entity’s financial statements to misstatement due to error or fraud; to document an understanding of internal control; and to document the assessment of risks, significant risks identified and the related controls, and the overall audit strategy in response to the assessed risks of material misstatement.
Besides a discussion by the engagement team about fraud risks, auditors need to perform and document inquiries with certain client personnel about the risks of fraud. To avoid a peer review matter when performing those inquiries, they should ensure that all of the required questions are covered and interviews are performed in a thoughtful manner to determine if there are any risks of material misstatement due to fraud. Care should be taken to ensure a link between the risks identified in planning, the documentation of the planned audit approach, and the procedures performed. For example, if the controller expresses concerns about pressures placed on operating personnel to meet sales goals, the auditor should design and perform additional audit procedures to address the risk of revenue overstatement.
Another common deficiency noted by peer reviewers is a failure to tailor audit programs for a specific client. Standard audit programs and practice aids are wonderful timesavers, but they need to be tailored to the client’s industry and other specific circumstances. In addition, auditors need to make sure that they perform adequate tests in key audit areas. The amount of testing that needs to be done is a matter of professional judgment; however, auditors would be expected to perform more extensive audit procedures in areas with larger balances and higher risks of material mis-statement. In addition, auditors should avoid “conversational” auditing and inadvertent reliance on client explanations or computer-generated reports.
Peer review findings related to accounting issues often include the following errors:
- Failure to correctly classify long-term debt
- Incorrect accounting for a transaction, such as treating a capital lease as operating (most likely if the client enters into significant new transactions or if there are new accounting standards effective)
- Improper application of the basis of accounting. When the client uses a special purpose framework, such as the income tax basis, auditors should ensure that the balances in the financial statements and note descriptions are consistent with the basis of accounting being used. To avoid improper application of the accounting basis, auditors should make sure that—
- accruals are included in GAAP-basis financial statements, but not in pure cash basis financial statements;
- the direct write-off method is used for losses on doubtful accounts in tax-basis financial statements, while an allowance is recorded in GAAP-basis statements; and
- deferred income taxes are provided for in GAAP-basis financial statements, but not in cash-basis statements.
Peer reviewers have also found errors in the cash flow statement. These errors include misclassification of cash flows as operating, investing, or financing; improper classification of items as cash equivalents; or captions in cash flow statements that do not tie to the balance sheet and income statement.
Peer reviewers have found that disclosures of related-party transactions, valuation allowances, debt terms and maturities, income tax matters, and significant concentrations are often omitted. In addition, financial statement disclosures required by GAAP are incorrect or incomplete, with issues such as a failure to disclose the date through which subsequent events were evaluated, to appropriately disclose fair value hierarchy information related to investments in marketable securities or to disclose significant estimates, to have audit documentation that supports disclosures or amounts in the statement of cash flows, to disclose significant accounting policies, and to disclose non-cash transactions or cash paid for interest and taxes.
To prevent disclosure errors, it is recommended that auditors use an up-to-date disclosure checklist. After going through the disclosure checklist, a final review of the financial statements will help determine if there is sufficient information for a user to understand important aspects of material amounts and transactions.
Common reporting deficiencies occur when the auditor’s report does not conform to the auditing standards or contains other mistakes:
- Reports dated incorrectly. The report date, the date of the management representation letter, and the date through which management evaluates subsequent events should all be the same, and no earlier than when sufficient appropriate audit evidence was obtained and all review procedures were completed.
- Incorrect financial statement titles. The titles of the financial statements should match the titles listed in the auditor’s report and be appropriate for the type of entity. For example, a nonprofit entity typically provides a statement of activities rather than an income statement. In addition, titles of financial statements prepared using a special-purpose framework should differ from GAAP basis titles, so there is no implication that the statements are prepared in accordance with GAAP.
- Missing or incorrect report elements. Auditors should not vary from the standard language of a report unless the report captures all of the required elements. In addition, the report should include the required headings and cover all of the periods presented by the financial statements.
- Failure to disclose GAAP departures. A GAAP departure requires a qualified or adverse opinion, and the auditor should disclose the departure in a separate paragraph of the report. Disclosure in the financial statements alone is not sufficient. Auditors should carefully draft the Basis for Qualified Opinion paragraph of the report to ensure that it correctly and completely states all the reasons for the opinion qualification.
- Failure to appropriately report on supplementary information. Auditors should report on supplementary information either in the auditor’s report on the financial statements or in a separate report, and the report should clearly state the degree of responsibility taken by the auditor, which is frequently less than that taken for the basic financial statements.
To prevent disclosure errors, it is recommended that auditors use an up-to-date disclosure checklist.
If an engagement quality control review is not performed on the audit as a whole, it is recommended that another auditor perform a cold review of the report and financial statements to check for common reporting mistakes, as well as grammatical errors. A reporting checklist may be used either to find reporting guidance relevant to a particular situation or as a quality control check before a draft report is issued.
Auditing deficiencies observed in peer reviews include a failure to observe inventory when the amount is material to the financial statements and a failure to perform sufficient procedures or adequately document those procedures to obtain assurance of fair value measurements. In addition, peer reviewers have found instances when accounts receivable were not confirmed and the reasons for not confirming were either not documented or did not qualify under the exceptions in the standard. Peer reviewers also noted that some auditors failed to communicate or document required communications with those charged with governance.
Peer reviewers have also noticed deficiencies related to management representation letters, including a failure to—
- date (or update) the letter as required,
- include appropriate financial statement periods, or
- include the required representations.
In connection with substantive analytical procedures, auditors should be careful when comparing balances to prior-year amounts. The basis for an expectation should be audited and documented. If the expectation is that the current amount will be similar to the prior year, such an expectation should be justified in the audit documentation. If the expectation is that the amounts will not be similar because of some known event, however, then the prior year’s balance should be adjusted for the known event before making the comparison. Auditing standards require that the effects of such known events be built into the expectation, rather than merely used to explain variances from an unreasonable expectation that fails to consider facts and circumstances.
Finally, peer reviewers have noted failures to include audit documentation that contains sufficient competent evidence to support the auditor’s opinion on the financial statements. Auditors need to make sure that such documentation is included in the workpapers. As a reminder, all of the documentation needs to be wrapped up by the document completion date. The standard requires that this process be completed no later than 60 days after releasing an audit report, after which all extraneous material must be retained for five years (or longer if required by state law). In an electronic environment, that includes making sure that the trash folder is emptied and unfiled workpapers are either filed or deleted.
Based on a new question included in AICPA peer review checklists, peer reviewers will be focusing more intently on the quality control policies and procedures that firms use to ensure that their guidance and quality control materials, whether developed in-house or obtained from a third-party provider, remain reliable, relevant, and current based upon new professional pronouncements and whether those materials are suitable for the firm’s practice. The focus will include whether those materials are appropriately tailored for an industry and, if purchased from a third-party vendor, whether the latest edition is being used.
Communicate Early with Clients
The last quarter of the year is often a busy time for auditors. They must contact clients to finalize plans for year-end audits; this includes discussing the scope of engagements, any nonattest services that will be performed, fee issues, and plans for observing any year-end inventory counts, as well as finalizing engagement letters. Auditors should take advantage of these discussions to communicate early with clients about other matters, such as new accounting standards.
Auditors should also provide clients with a listing of audit schedules that they will need and when they will need them. It is most efficient if the auditors provide example schedules in an electronic format so that clients can simply fill in the needed information. Auditors should also provide information on why they are requesting a particular schedule and how it will be used, since clients can sometimes suggest a quicker way to achieve the objective.
Prepare Staff and Invest Time in Planning
After all of the information above has been considered, the final step is to prepare the audit staff and then to invest time in preparing for and planning the audit engagements.
Firms should ensure that auditors have the necessary training on new standards, even if only through short webinars, so they will feel prepared to have initial discussions with clients. In addition, technology and other issues should be addressed with staff before year-end. Finally, firms should remind auditors of peer review comments or deficiencies noted by the AICPA to ensure that auditing standards are correctly followed during busy season and that workpaper documentation is appropriate.
Investing time in planning.
Firms should ensure that an appropriate amount of time is set aside to plan audit engagements. Planning audits involves establishing the overall strategy for engagements and developing audit plans. The nature, timing, and extent of audit planning vary with the size and complexity of the entity and with the auditor’s understanding of the entity and its environment, including internal control and a risk assessment process. Some of the risk assessment procedures performed as part of planning, such as inquiries and nonsubstantive analytical procedures, may provide audit evidence about relevant assertions related to account balances, transaction classes, or disclosures.
The risk assessment and audit plan should drive audit procedures. In many cases, however, planning is out of sync with the actual work performed during the audit engagement. For example, risks are identified in planning, but the procedures are not modified to respond to those risks, or no risks are identified and the auditor performs unnecessarily detailed testing in an area because that is what was done in the prior year. This is inefficient. If sufficient time is not invested in the planning part of an audit engagement, the audit team is destined to make the same mistakes as the prior year.
While auditors cannot spend all of their time planning, planning needs to be done at an appropriate level to drive the engagement procedures.
Firms should consider scheduling another retrospective on the upcoming busy season once it is completed.
A retrospective on a busy season is better performed right after it is finished. Therefore, firms should consider scheduling another retrospective on the upcoming busy season once it is completed, thereby ensuring that the planning for 2018 gets off on the right foot.