For many public accounting firms, the client acquisition decision often follows a common cost-benefit analysis; beyond the consideration of additional revenue generated, scheduling constraints, opportunity costs, and risks must be considered. To the extent that firms can generate revenue without foregoing other opportunities, new clients may be particularly appealing. For firms facing the opportunity to acquire government or nonprofit clients in need of a uniform guidance audit (also known as a single audit), the siren song may be strong. With many of these entities having a June 30 year-end, firms can generate additional revenue in the summer, when other client activity is at a lull. Increased staff utilization during this period may be attractive, as the costs associated with salaries and benefits remain fixed and the newly generated revenue translates mostly into profit.
The decision to pursue uniform guidance audits should, however, also consider two additional costs. First, developing adequate expertise to audit both the financial statements and compliance with laws, regulations, and federal grant requirements is costly. Second, the significance of uniform guidance audit results to subsequent federal grant award decisions shines a bright light on auditors’ findings, introducing risk associated with accepting uniform guidance audit clients.
The Detection Gap
Audit firms must recognize that their decision to pursue clients requiring uniform guidance audits may increase the firm’s business risk. Uniform guidance audits require firms to submit audit findings to the Federal Audit Clearinghouse (FAC) through Data Collection Form SF-SAC; the FAC then makes the information reported available to the public on an individual federal grantee basis or in the aggregate (i.e., the FAC database is available for download). In 2017, more than 28,000 governments and nonprofit organizations were subject to a uniform guidance audit and submitted reporting forms for such to the FAC. As depicted in Exhibit 1, the reported audit findings for these 28,000 audits are available for use in subsequent federal grant award decisions made by federal agencies. Ideally, the reported audit findings would provide an accurate representation of the degree to which an auditee’s internal controls are sufficient and the degree of compliance with federal requirements. Any deficiencies, including internal control deficiencies and noncompliance with federal grant awards, are reported to the FAC. Thus, federal agencies should have complete information in grant award decisions; however, flaws in the audit process may result in a detection gap, and reported findings may not include all actual deficiencies. In this case, federal agencies have imperfect information when making funding decisions.
Audit firms without a strong understanding of uniform guidance audit requirements and the financial reporting requirements for governments and nonprofit organizations face a potential detection gap, which may lead to ineffective grant funding allocation decisions, as government and nonprofit entities may in some cases receive funding when a more accurate evaluation of their internal controls and compliance would have revealed deficiencies. In these instances, firms may face consequences associated with their failure to detect or report audit findings.
Audit firm experience closes the detection gap and reduces the firm’s business risk. Alternatively, a lack of experience can widen the detection gap and increase a firm’s business risk. Firms accepting uniform guidance audits must comply with Generally Accepted Government Auditing Standards (GAGAS), also commonly referred to as the Yellow Book. Historically, and still true with the most recent Yellow Book revision in 2018, auditors conducting these audits must have training specific to governmental audits. Of the 80 hours of continuing professional education (CPE) every two years, 24 hours must be related to government auditing. Furthermore, ethical principles require that firms only accept engagements which they are competent to perform. Experience among firms conducting uniform guidance audits varies widely, however; among the firms represented in the 2017 FAC database, more than 25% of the submitted audits were conducted by firms responsible for fewer than 10 uniform guidance audits in that year. Even if the firms in this lowest category of experience comply with Yellow Book training requirements, the quality of their audit may be significantly lower than a uniform guidance audit conducted by firms conducting more than 100 such audits (present in approximately 25% of the 28,000 uniform guidance audits in 2017).
At the national level, concerns with the quality of these audits have been identified by federal government agencies and professional associations. The President’s Council on Integrity and Efficiency (PCIE 2007) conducted a National Sampling Project to determine the average level of single audit quality. Of the 208 audits sampled, 35.5% were deemed unacceptable, and an additional 16% were deemed of limited reliability. Although the National Sampling Project did not separately identify the experience of the firms in the lower quality audits, it did identify a greater concentration of low-quality audits among smaller government and nonprofit auditees. These auditees may be more likely to have an audit firm with less experience with these audits if the supply of qualified audit firms is constrained.
The AICPA’s Governmental Audit Quality Center (GAQC) investigated the quality of 87 single audits in 2014–2015, just prior to the implementation of uniform guidance. The GAQC reported 48% of the audits as nonconforming, meaning applicable professional standards were not followed. The GAQC also noted that firm size of the single audit practice was associated with higher-quality audits. Academic research has yielded similar findings. Among a sample of more than 24,000 single audits (also in the pre–uniform guidance period), the authors reported evidence that extremely low audit firm experience in the single audit domain (10 or fewer single audits in a given year) leads to fewer findings, controlling for organization type, funding sources, and other auditee demographics (“A Comprehensive Analysis of Findings from Single Audits: The Implications of Auditee Type and Auditor Expertise,” Journal of Governmental and Nonprofit Accounting, June 2018 http://bit.ly/2OjJzO0). They also noted that the lower rate of audit findings by low-experience audit firms was particularly pronounced for the compliance aspects of the engagement. For example, firms conducting 10 or fewer single audits in a given year were less likely, controlling for other factors, to report internal control deficiencies associated with major programs and less likely to report findings that affected direct federal funds. Audit firms with experience in other domains may therefore be able to transfer their knowledge to uniform guidance audits reasonably well for the financial statement assurance component of the engagement; however, the compliance aspects of these specialized audits may pose barriers to knowledge transfer from other types of audits.
Lower audit quality from firms lacking experience will likely persist in the post–uniform guidance period. Exhibit 2 presents the rate of uniform guidance findings (i.e., the percentage of time that findings affecting direct federal funds was reported) in 2017 using FAC data. Among the 28,000 audits submitted, approximately 20,000 (70%) are categorized as low risk, based on specific Office of Management and Budget (OMB) criteria (generally that the auditee has been subject to a uniform guidance audit for the preceding two fiscal years with favorable results). The remaining 8,000 (30%) are not low risk, which increases the scope of required audit procedures. The two categories of auditees based on risk are separately identified, and the experience of the audit firms responsible for the uniform guidance audits is categorized as lowest experience (fewer than 10 uniform guidance audits), low experience (10 to 28), medium experience (29 to 111), and high experience (more than 111). In either category of auditee risk—low or non-low—audit firm experience is associated with more findings. Among non–low risk auditees, those with a high-experience audit firm had a 33% rate of compliance findings, while those with a lowest-experience audit firm had a 26% rate of compliance findings. With a similar spread among low-risk auditees, those with a high-experience audit firm had a rate of 14.3% compliance findings, compared with 8.8% for those with a lowest-experience audit firm.
Ultimately, audit firm experience remains critical to identifying and reporting deficiencies following uniform guidance. Although an audit firm lacking experience may foreseeably be able to conduct a quality audit, Exhibit 2suggests differently in the aggregate. The differential findings in Exhibit 2 support the detection gap depicted in Exhibit 1, which has negative implications for the effectiveness of federal agency grant award decisions. The significance of these audit results to federal funding decisions should provide a cautionary tale to audit firms viewing this market as a remedy for the summer vacuum. Firms that have already developed experience in this area are more likely to obtain the more desirable uniform guidance audits (i.e., larger engagements with lower risk).
The following five questions can assist firms considering whether to enter this audit market:
- Does the firm have enough in-house uniform guidance experience?
- Does the firm have a plan for ongoing training and development related to uniform guidance audits?
- Can the firm consistently report uniform guidance audit findings that inform the federal grant-making process?
- Does the firm possess a long-term commitment to uniform guidance audit clients?
- Can the firm acquire and retain the personnel/resources needed for uniform guidance audits?
Firms answering these questions should avoid overconfidence when assessing expertise. Recognize uniform guidance audits require CPE-based and on-the-job training. Assess whether the firm recognizes the additional scrutiny associated with federal reporting requirements. Establish a long-term commitment to serving uniform guidance clients. Finally, invest in the people and resources necessary to provide consistent high-quality audits. In the end, firms must assess their willingness to develop the audit expertise and maintain the resources necessary to provide quality uniform guidance audits.