AUDITS OF SPECIAL PURPOSE FRAMEWORK FINANCIAL
STATEMENTS
(Illustrating the AICPA’s FRF for SMEs basis)
By Larry L. Perry, CPA
CPA Firm Support Services, LLC
LEARNING OBJECTIVES
 To understand the requirements of AU-C 800.
 To identify major accounting policies and principles for the FRF for SMEs.
 To design and perform appropriate auditing procedures for applications of FRF
for SMEs policies and principles.
 To be able to integrate required auditing procedures for special purpose
frameworks into a normal audit process.
INTRODUCTION
AU-C Section 800, Special Considerations—Audits of Financial Statements Prepared in
Accordance With Special Purpose Frameworks, was effective, along with other Clarified
Auditing Standards, for periods ending after December 15, 2012. This standard applies
to audit engagements for reporting entities preparing financial statements in accordance
with special purpose frameworks. These materials illustrate the audit procedures
applicable to financial statements prepared using the AICPA’s Financial Reporting
Framework for Small- and Medium-Sized Entities (FRF for SMEs).
These materials present an outline and summary of the typical procedures and activities
for an audit engagement with the requirements of AU-C 800 for auditing special purpose
frameworks interfaced into applicable sections of the outline. Key auditing issues in the
FRF for SMEs that differ from U.S. GAAP are discussed following the outline of the
audit process.
THE AUDIT PROCESS
A. Pre-planning Phase:
1. Obtain the prior year’s permanent, tax, correspondence and current files.
a. Become familiar with the prior period’s auditor’s report, financial statements
and footnotes.
b. Determine that the reporting framework is appropriate given the nature, size,
and complexity of the client.
c. If a change to a special purpose framework has been made or is planned, such
as the AICPA’s Financial Reporting Framework for Small- and Medium-
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d.
e.
f.
g.
h.
i.
j.
k.
Sized Entities, and it can save financial statement preparation and audit time,
consult with reporting entity management and the user of the financials to
determine if a special purpose framework can appropriately present financial
position and results of operations of the entity. Determine if comparative
statements will be required by management or financial statement users and, if
necessary, the degree of restatements that will be required for the prior period.
Review the prior year’s risk assessment procedures, levels of assessed risk,
audit strategy and audit plan (program) to determine if there are opportunities
for changes that will save audit time charges in the current year.
Review the key forms, practice aids, working papers, and other documentation
in last year’s current file to determine any client documents, unnecessary
working papers or correspondence that can be eliminated this year.
Determine if it is possible to use the prior year’s control risk assessment in the
current year and if doing so can reduce the current year’s risk assessment
procedures and other substantive tests.
Read the prior year’s internal control communication letter and investigate the
current status of significant deficiencies and material weaknesses and their
affects on the current year’s auditing procedures.
Prepare a list of procedures and activities that can be performed during interim
work, make staffing requests and schedule the interim work
Determine if specialists will be needed, e.g., IT persons, attorneys, valuation
experts, actuaries, etc.
Prepare a list of schedules and other assistance to request from client and
deliver at least 30 days before the reporting date.
Begin a Planning Document or prepare a separate memo documenting
procedures and findings.
Special Purpose Framework Audit Procedures
Auditors are responsible for evaluating the appropriateness of an entity’s applicable
financial reporting framework. The evaluation should take into account financial
statement users’ needs and whether or not the framework appropriately presents the
entity’s financial position and results of operations. Here are some general questions
management, users and auditors may ask when considering the appropriateness of using
the FRF for SMEs or another special purpose framework:
 Is U.S. GAAP required by financial statement users? Obviously, a “yes” answer
to this question would preclude the use of a special purpose framework.
 Are prescribed-format financial statements required by users? This also would
prevent the use of a special purpose framework.
 Does the current financial reporting framework meet the needs of users or would
another special purpose framework be more appropriate? This question will focus
attention on the accounting policies and principles of various special purpose
frameworks. A document entitled Financial Reporting Framework for Smalland Medium-Sized Entities containing accounting policies and principles is
available for free download from the AICPA (www.aicpa.org ).
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 Would a special purpose framework, such as the FRF for SMEs, be cost-efficient
for financial reporting? If the questions above indicate a special purpose
framework can appropriately present the financial position and results of
operations of a reporting entity, accounting and reporting under the special
purpose framework should also create efficiencies in the financial statement and
footnotes preparation process to be an appropriate choice by management.
A detailed Decision Tool, including additional questions for considering changes to the
FRF for SMEs, cash, modified cash and income tax bases of accounting, is also available
for free download from the AICPA. Management and auditors should document the
decision making for selecting a special purpose framework.
2. Hold pre-planning meeting with the in-charge accountant and engagement leader
(partner, shareholder, sole practitioner).
a. Discuss client changes in business, organization, accounting, financial
reporting framework, internal control, personnel and current events that may
affect this year’s audit.
b. Discuss any effects of the current economic climate, any going concern issues
and the need for management to develop plans to overcome potential threats
to the continuing existence of the entity.
c. Discuss findings, questions and other issues from the review of the prior
year’s working papers (outlined above).
d. Schedule due dates, interim and year-end fieldwork and assign staff personnel.
e. Discuss fees, billing policies, budgets and other administrative issues.
f. Begin engagement leader participation memo documenting involvement and
supervision or plan to describe involvement in more detail on electronic time
slips or timesheets.
Special Purpose Framework Audit Procedures
When U.S. GAAP or a special purpose framework is being used as the applicable
financial reporting framework, all engagement personnel must understand applicable
accounting principles. For the FRF for SMEs, toolkits have been made available by the
AICPA for statement preparers, users and CPA firms containing these documents:
 Introduction to the Financial Reporting Framework for Small- and Medium-Sized
Entities (a 200+ page documentation of framework policies)
 Illustrative Financial Statements
 Presentation and Disclosure Checklist for FRF for SMEs
 Numerous other aids to facilitate understanding of the framework and to
communicate it to clients and others, such as bankers and lawyers.
3. Schedule time for engagement leader to meet with the management or governance
person that engaged the firm to deliver the engagement letter.
a. Reach an understanding about the nature of the engagement, as well as client
and CPA firm responsibilities. Discuss management’s responsibility to select
the most appropriate financial reporting framework.
b. Discuss current client issues, including any affects of economic climate
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c.
d.
e.
f.
g.
h.
Make fraud inquiries.
Arrange for proper workspace.
Arrange for client assistance.
Finalize dates for interim and year end fieldwork.
Discuss target dates.
Discuss range of audit fees and affects of variables (problems, no client
assistance, etc.).
i. Document discussions in the leader participation memo, on electronic time
slips or in some other way.
4. If possible, prepare a rough draft or block out financial statements and footnotes.
Special Purpose Framework Audit Procedures
In addition to the items above that should be discussed in a meeting (or other means of
oral communication such as Skype, Face Time or telephone) between the engagement
leader and the client management and governance persons, financial statement users’
reporting requirements should be discussed. The pre-planning discussions and evaluation
of an applicable reporting framework should include discussions with financial statement
users. Their needs and preferences should be given priority in management’s decisions to
use a special purpose framework. As mentioned above, a special purpose framework will
not be acceptable when the user requires a U.S. GAAP or prescribed format financial
reporting framework.
B. Planning Phase:
1. Complete or update basic documentation necessary to demonstrate an
understanding of the client’s business and environment, financial reporting
framework and internal control.
a. Client Acceptance and Continuance Form
b. General Ledger Analysis Worksheet
c. Internal control flowcharts, Internal Control Questionnaire and systems
walk-through memo or other documentation
d. Documentation of any and all inquiries of management or client personnel
2. Assess control risk by financial statement classifications, combine with inherent
risk documentation, and assess level of risk of material misstatement.
3. Use assessed risk at financial statement level from Client Acceptance and
Continuance Form (illustration attached at the end of these materials) and other
documentation to establish planning materiality, tolerable misstatement, and the
lower limit for individually significant items at the financial statement level.
4. Use assessed risk of material misstatement at the assertion (financial statement
classification) level to establish tolerable misstatement and the lower limit for
individually significant items at the financial statement classification level.
5. Design a sampling or non-sampling plan using materiality levels for financial
statement classifications.
6. Document planning activities and decisions in a Planning Document (illustrated at
the end of the materials).
7. Hold meeting with in-charge accountant and engagement leader to discuss
planning results and finalize audit strategy.
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8. Tailor the audit program.
9. Make work assignments and provide necessary training for staff personnel.
10. Hold planning and brainstorming meeting with all engagement personnel.
11. Prepare planning communication with persons charged with governance.
Special Purpose Framework Audit Procedures
The accounting policies and procedures applicable to financial statements prepared under
a special purpose framework must be documented in engagement files. The
documentation should include both the basic policies and procedures of the framework
applicable to the entity’s financial statements, as well options management may have
elected under the applicable financial reporting framework.
All engagement personnel must be familiar with the general and specific policies and
procedures of the applicable reporting framework prior to the engagement team’s
brainstorming/planning meeting to properly identify and consider potential risks of
material misstatement due to error or fraud. Engagement files should contain
documentation of each engagement team member’s understanding of the applicable
reporting framework.
For the FRF for SMEs, the resource material made available by the AICPA that was
mentioned above should be read, discussed among team members and applied to the
financial reporting system of the entity subjected to audit. Documentation of an internal
CPA firm training meeting for special purpose frameworks is one way to evidence the
understanding of special purpose frameworks by engagement team members.
C. Performance Phase:
1. Perform the maximum amount of interim work that is practical before client’s
fiscal yearend.
a. Risk assessment procedures
b. Reading minutes of meetings of board of governance
c. Substantive tests for property, plant and equipment, debt and expenses
d. Interim analytical procedures—reading general ledger
e. Cycle counts of perpetual inventories
f. Receivables confirmations
g. Loan files exams--banks
h. Site inspections--contractors
i. Other planning activities
j. Oversee client working paper preparation
k. Block out or replicate audit documentation
l. Other work
2. Perform highly-effective analytical procedures whenever possible that can
generate evidence for evaluating all financial statement assertions for accounts
such as sales and revenues, certain salaries and wages, payroll taxes, depreciation,
interest income and expense, etc.
3. Complete audit program procedures and prepare supporting audit documentation.
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Special Purpose Framework Audit Procedures
Performance of auditing procedures for financial statement classifications and other
issues applicable to the FRF for SMEs is discussed after the following summary of
completion phase activities.
D. Completion (Wrap-Up) Phase:
1. Complete in-charge accountant’s review of assistant’s work as soon as it is
completed and clear review points as soon as possible.
2. Plan to clear open items early (do not leave items to last minute).
3. Draft audit report, financial statements and footnotes (finalize if client prepares).
4. Prepare a list to facilitate engagement leader’s final review.
a. Identify any significant issues not discussed with the leader and their
resolution.
b. Identify specific documentation prepared by the in-charge accountant that
needs the leader’s review.
5. Schedule leader’s review (and all other required reviews) in the field whenever
possible (otherwise schedule staff time to complete in-office wrap-up and
review).
6. Obtain leader’s final review of working papers, audit report and financial
statements and footnotes and clear review points and open items as soon as
possible.
7. Prepare internal control communication letter and obtain leader’s review.
8. Obtain client’s approval of a draft of the financial statements, present a draft of
the internal control communication letter and get management’s representation
letter signed.
9. Meet and communicate with persons charged with governance.
10. Perform the administrative wrap-up procedures.
a. Furnishing clients with proposed adjustments, discussing their content
and documenting client responses.
b. Obtaining all signed correspondence.
c. Making sure all review notes and open items lists are cleared and
destroyed.
d. Preparing a list of time savings issues for next year.
e. Preparing, reviewing and completing all necessary tax returns.
f. Completing final time accumulation schedules and comparing with
budgets (if required by firm policy).
11. Hold post-engagement training meeting with engagement personnel.
12. Complete final quality control procedures, document report release date and lock
or secure audit documentation.
13. Evaluate the CPA firm’s client service.
14. Identify, discuss, and communicate to the client any additional services that could
help the client accomplish its operational objectives.
KEY ISSUES RELATED TO AUDITING FINANCIAL STATEMENT
CLASSIFICATIONS UNDER THE FRF FOR SMEs
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CASH CLASSIFICATIONS
Accounting Standards
Demand and time deposits in banks, credit unions and other depositories, cash on hand
and cash equivalents are included in this classification. The accrual basis of accounting is
used for the FRF for SMEs. Cash equivalents are highly liquid investments that usually
have a maturity of less than three months from date of acquisition by an investor. Cash
and any cash equivalents should be classified together with the description of “Cash and
Cash Equivalents” in both the statement of financial position and statement of cash flows.
Cash balances that are restricted because of withdrawal restrictions should be classified
separately. Depending on the nature of the restrictions, these balances may be classified
as current or non-current.
Negative cash balances, i.e., bank overdrafts, should be classified as current liabilities
unless the legal right of offset relates to these and other accounts at the same financial
institution. Also, any material amounts of written and held checks should be reclassified
as current liabilities.
Auditing Standards
Audit strategies are based on the standards issued by the Auditing Standards Board of the
AICPA, specifically the clarified risk assessment standards which are referred to in the
Planning Section above. These standards indicate that all risk assessment procedures,
tests of controls, analytical procedures and tests of balances produce substantive evidence
that enables an auditor to design the most cost-beneficial audit strategy on every audit
engagement. Risk assessment, based on an auditor’s professional judgment and
professional skepticism, is required on all audits to indentify potential risks of material
misstatement due to error or fraud and to design audit responses that will prevent such
risks from causing the audited financial statements from becoming misleading. These
standards apply to audits of all financial reporting frameworks, including special purpose
frameworks such as the FRF for SMEs.
COMMON SUBSTANTIVE TESTS OF BALANCES PROCEDURES FOR CASH
Analytical Procedures
For all levels of risk of material misstatement, some specific analytical procedures
normally performed for cash would include:
 Compare account balances with the preceding year or years. Investigate
significant changes in amounts or deviations from trends.
 Investigate accounts opened or closed during the year.
 Investigate credit balances to determine if they represent actual bank overdrafts.
 Compute quick current ratio (cash and net receivables to current liabilities) and
compare among years.
Other Substantive Tests of Balances Procedures for Cash
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The nature, extent and timing of detailed tests of balances procedures should be
determined based on the assessed level of risk of material misstatement for each financial
statement classification (assertion level). The assessed level of risk should be determined
based on the documentation of the auditor’s risk assessment procedures. There are no
special issues in designing auditing procedures for cash under the FRF for SMEs. Basic
auditing procedures for the applicable assessed levels of risk of material misstatement
would include proving bank reconciliations, obtaining confirmation of bank balances and
determining interbank and intrabank transfers before and after the reporting date. The
Tests of Balances Procedures Schedule at the end of these materials illustrates the affects
of the assessed levels of risk of material misstatement on tests of balances auditing
procedures.
ACCOUNTS AND NOTES RECEIVABLE
Accounting Standards
Since the FRF for SMEs is based on the accrual basis of accounting, revenues and related
accounts receivable are recorded based on performance, i.e., delivery of a product or
performance of a service. Notes receivable would be recorded when they are issued and
signed by the counterparty. An allowance for uncollectible accounts is ordinarily
required, unless management elects the direct write-off method, and the results of that
method are comparable to the allowance method.
Auditing Procedures
For all levels of assessed risk of material misstatement, other analytical procedures
normally performed for accounts receivable would include:



Compare account balances in accounts, loans and notes receivable with the
preceding year or years. Investigate significant changes in amounts or deviations
from trends.
Investigate large and/or unusual balances classified as other accounts receivable.
Consider computing the following ratios and comparing to the prior year or years
to assist in evaluating the existence and valuation (collectability) assertions:
o Number of days net revenues in accounts receivable
o Yearend receivables as a percent of gross revenues
o Bad debts as percentage of gross revenues
o Allowance for doubtful accounts as a percentage of accounts receivable
o Aged categories as a percentage of total accounts receivable
o Interest income as a percentage of the average balance of notes receivable
outstanding
The nature, extent and timing of detailed tests of balances procedures should be
determined based on the assessed level of risk of misstatement for each financial
statement classification (assertion level) after considering the results of risk assessment
and analytical procedures. The assessed level of risk should be determined based on the
documentation of the auditor’s risk assessment procedures. These accompanying
illustrative practice aids for the Always Best Corporation contain an example of the
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documentation of risk assessment procedures and the assessment of the level of risk of
material misstatement by financial statement classification.
Common tests of balances auditing procedures, based on assessed levels of risk, include
confirmations of account balances, sales cutoff tests, inspecting subsequent collections
documentation and determining the appropriateness of the recorded allowance for
uncollectible accounts by reviewing and discussing the aged trial balance of accounts
receivable with management. When management elects the direct write-off method for
uncollectible accounts under the FRF for SMEs, the auditor will ordinarily make more
detailed inquiries and inspect more documentation of older accounts on the entity’s aged
trial balance of accounts receivable.
INVENTORIES
Accounting Principles
Inventories are valued at the lower of cost or net realizable value (selling price less
estimated costs of completion and disposal). General disclosures are:
 Accounting policies and costing method.
 Carrying amounts of inventories in total and by appropriate classifications, e.g.,
raw materials, work-in-progress, finished goods, merchandise, supplies, etc.
 Costs of goods sold for periods presented.
 Unusual or material losses resulting from costing methods.
 Material purchase commitments and any expected loss when the purchase price
exceeds market value.
 Any interest costs capitalized in inventories.
Auditing Procedures
Specific Auditing Standards for inventory are published in the AICPA Professional
Standards, AU Section 331 http://www.aicpa.org / Research / Standards / AuditAttest /
DownloadableDocuments / AU-00331.pdf . Some of the key issues in this section
include:
 Inventory observation is a generally accepted auditing procedure (before the
McKesson Robbins fraud in 1938 inventories could simply be confirmed by
auditors).
 For physical counts of inventory, the auditor must usually be present at the time
of the count to observe count procedures, make test counts and inquire about
potential risks of material misstatement.
 For accurate perpetual inventory records, the auditor’s observation procedures
may be performed on a cycle basis during the reporting period.
 For statistical methods of sampling inventory, the auditor must be satisfied that
the client’s methods produce reliable results that are substantially the same as a
count of all items. The auditor must be present for representative counts and must
evaluate the sampling plan and its application to determine results are reasonable
and statistically valid.
 For inventories held in public warehouses, quantities may be confirmed but
additional procedures are usually necessary, such as obtaining an audit report on
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the warehouseman’s internal control or applying appropriate procedures at the
warehouse to determine confirmed information is reliable.
Based on assessed levels of risk of material misstatement, common tests of balances
procedures include test counts made during observations of physical inventories counts,
tests of prices assigned to inventory quantities and clerical tests of the compilation of
dollar values of inventory components.
Slightly different from the U.S. GAAP method of determining the “lower of cost or
market,” as described above the FRF for SMEs requires net realizable value to be
calculated as the selling price less estimated costs of completion and disposal. Auditing
procedures should include tests of a reporting entity’s application of this pricing rule.
INVESTMENTS
Accounting Principles
Investments:
Investments in entities over which a company has significant influence are accounted for
under the equity method. All other investments are accounted for based on historical
cost; except for securities held for sale which are valued at market value (changes are
included in current income). Income from investments should be presented separately or
disclosed in the footnotes. Equity method investees should follow the same method of
accounting as the as the investor (or their financial statements should be adjusted to the
investor’s method before determining equity changes). An entity’s share of any
discontinued operations, changes in accounting policies or corrections of errors and
capital transactions of an equity method investee should be presented and disclosed
separately.
Consolidation and Subsidiaries:
Management can elect to consolidate more than 50%-owned subsidiaries or account for
them using the equity method (if it exercises significant influence over the entity). When
significant influence is not exercised over the subsidiary, the cost method should be used
to report the investment. Equity and debt securities that are available for sale, however,
should be recognized at market values with changes in such values included in periodic
net income.
Business Combinations:
This framework essentially requires the acquisition method of accounting using
acquisition-date market values. It permits, however, management to elect to account for
an intangible asset either separately or as a part of goodwill depending on circumstances.
General disclosures similar to U.S. GAAP are required for material and immaterial
business combinations.
Goodwill:
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Goodwill may be amortized using either the federal income tax amortization period or 15
years. No tests for impairment are required for long-lived assets, tangible or intangible,
unless a triggering event occurs that indicates an asset may be impaired.
Intangible Assets:
All intangible assets will be assigned estimated useful lives and amortized over that
period. In additional to any triggered tests for impairment, any long-term assets no longer
used should be written off. Management may elect either to expense development phase
intangibles or to capitalize their costs. Start-up costs and research expenses are expensed
as period costs.
Market Value Accounting:
The term “market value” is used instead of U.S. GAAP “fair value” requirements. The
definition is: “The amount of the consideration that would be agreed upon in an arm’s
length transaction between knowledgeable, willing parties who are under no compulsion
to act.” Since the FRF for SMEs uses a cost basis primarily, measurement using market
values is generally limited to business combinations, some non-monetary transactions
and marketable equity and debt securities that are available for sale.
Derivatives:
This framework requires a disclosure approach only with recognition at settlement on a
cash basis. Disclosures include:
 The face, contract or notional principal amount (upon which payments are
calculated).
 The nature, terms, cash requirements and credit and market risks
 The entity’s purposes in holding the derivatives.
 At the reporting date, the net settlement amounts of the derivatives.
Hedge accounting is not permitted.
Push-Down (New Basis) Accounting:
When an acquirer gains more than 50% control of an entity, the assets and liabilities of
the acquired entity may be comprehensively revalued in its financial statements,
assuming the new values are reasonably determinable. This results in similar values
being used in the acquired entity’s financial statements and the acquirer’s consolidated
statements.
Auditing Procedures
Goodwill and Intangibles:
Auditing goodwill and intangibles will include two significant steps:
 Determining any triggering events that could cause impairment of the assets.
 Evaluating the assets useful lives and amortization methods.
Determining events triggering impairment will likely occur as a result of performing
these and other auditing procedures:
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 Delivery and discussion of the engagement letter by the engagement leader. In
addition to other questions about the reporting entity’s overall business and
environment, the engagement leader will normally make inquiries about the
current operating results of acquired entities from which the intangibles were
acquired. Current financial statements of the acquired entities should be
reviewed during these discussions.
 Amortization rates and methods should be tested in accordance with the
engagement audit strategy.
 The accounting for any business combinations during the period should be
audited to determine that tangible assets, liabilities, goodwill and intangibles are
calculated and recorded properly in accordance with the principles of the FRF for
SMEs.
Investments:
Investments accounted for under the cost method are recorded at their purchase costs.
Dividends, interest or other income is recorded in income as received or accrued. As it
would be for any reporting framework, brokers’ statements, purchase receipts, contracts
or other documentation would be inspected by the auditor in the period of acquisition;
evidence of continuing ownership should be inspected in subsequent years. Income
received or receivable should be traced to appropriate support. Any dividends issued out
of investee capital should be recorded as reductions of the cost of the investment. The
auditor should also make inquiries of management and persons charged with governance
and perform appropriate research to determine there are no triggering events that could
cause the carrying amount of the investments to be permanently impaired.
For investments accounted for under the equity method, auditors should inspect
documentation supporting the purchase cost in the year of acquisition of the investment.
Since the equity method can only be used when the investor has significant influence
over the investee, the auditor should consider these and other matters:
 Representation on the board of directors of the investee.
 Participation in policy making processes.
 Material intercompany transactions.
 Interchange of managerial personnel.
 Technological dependency.
 Concentration of other shareholdings (like a larger number of smaller
shareholders).
When the investor has significant influence over the investee, normally an investment
interest of 20%-50%, the equity method may be used under the FRF for SMEs. Under
the equity method, the investor’s proportionate share of the investee’s periodic income
should be recognized in its statement of operations. Depending on the materiality of the
investor’s share of investee income reported in its statement of operations, the auditor
should perform appropriate procedures to audit the income amount.
For less material amounts of income, at a minimum, the auditor should read financial
statements of the investee to determine they are appropriate in accordance with the
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investee’s applicable financial reporting framework. For material amounts of investee
income recorded in the investor’s income, a review or audit of the financial statements
may be required.
The auditor should also determine that appropriate adjustments have been made to
income amounts, including eliminating intercompany gains and losses, amortizing any
difference between the investor’s cost and the underlying equity in the net assets of the
investee and adjustments of differences in the investee’s applicable reporting framework
for both the equity and consolidation methods if necessary. As under the cost method, the
auditor should also determine if any triggering events have occurred that could cause
impairment of the carrying amount of the equity method investment.
Consolidations:
When the entity elects the consolidation method for 50+% owned subsidiaries, the
requirements in AU-C 600, Audits of Group Financial Statements, are applicable. Under
this standard, the group audit partner has responsibility for either 1) re-performing or
reviewing component auditors’ work or 2) referring to component auditors in the group
audit report.
Business Combinations:
Since accounting principles are similar to those for U.S. GAAP, auditing procedures are
also similar. The determination of acquisition date market values assigned by
management should be evaluated by the auditor. Market values are considered to be
those which are most readily accessible and reliable and, as a last resort, estimates based
on some form of objective evidence may be used. As discussed above, intangibles can
only be recorded if they are separable, have a definite used life and have a determinable
value.
Derivatives:
Reviewing derivatives’ contracts or agreements and statements from investment brokers
or managers will be necessary to determine and support appropriate amounts for
disclosure. Confirmations of current settlement values or alternative procedures will also
be necessary.
PROPERTY AND EQUIPMENT
Accounting Principles
Property, plant and equipment is recorded under the FRF for SMEs similar to U.S.
GAAP, i.e., at acquisition costs. Acquisition costs gnerally include:
 Purchase prices.
 Shipping charges.
 Installation and testing costs.
 Real estate commissions and legal fees.
 Other costs related to acquiring and preparing fixed assets for use.
 Market values of assets received in non-monetary exchanges.
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For fixed assets constructed or developed by an entity, all direct costs, overhead costs and
interest or carrying costs related to the fixed asset are capitalized as its carrying amount.
Similar to the “improvement or betterment rule” used in practice under U.S. GAAP, costs
incurred to increase the life or capacity of a fixed asset are considered improvements and,
along with the remaining carrying amount of the asset, are depreciated over its extended
useful life; this change is accounted for prospectively as a change in accounting method.
Costs to maintain the service potential of a fixed asset are recorded as repairs and
maintenance in the period incurred.
Depreciation expense of the carrying amount is calculated in a systematic and rational
way over an asset’s useful life. The useful life of an asset is limited to the shortest of its
physical, technological, commercial or legal life. Straight-line and variable methods of
depreciation may be used, provided they are representative of a fixed asset’s economic
return or use in the operations of an entity. Depreciation methods and the lives of
property, plant and equipment should be reviewed periodically to determine any changes
in the use of an asset, changes in technology affecting productivity, impairments to the
operation or use of the asset and other events that could change the expected use of fixed
assets. Depreciation methods and useful lives should be adjusted prospectively.
Asset retirement obligations should be included in the carrying amounts of property,
plant and equipment in a business combination transaction, even though not recorded in
the financial statements of an acquired entity. For example, the cost of replacing
underground gasoline storage tanks as required by a state law, if probable and
estimatible, should be included in the acquisition costs of a convenience store.
Assets may be leased under operating or capital lease agreements. Leased assets meeting
the criteria for capital leases under the FRF for SMEs (which are similar to current U.S.
GAAP requirements) should be capitalized and carried at the discounted present value of
future minimum payments.
Auditing Procedures
The Clarified Auditing Standard specifically applicable to property and equipment is
included in AU-C 540, Auditing Accounting Estimates, including Fair Value Accounting
Estimates, and Related Disclosures, The principal issues in AU-C 540 affecting property
and equipment recorded under the FRF for SMEs would be connected with the valuation
of assets received in non-monetary exchanges and with the determination of market
values for comparison to carrying amounts when a triggering event occurs, such as a
technological change. The auditor must evaluate the reasonableness of management’s
determination of market values assigned to assets and determine any impairment loss in
these circumstances. Other principal audit issues for property and equipment relate to the
useful lives and residual values of depreciable assets and their depreciation and
amortization methods. The auditor must determine that these estimates are reasonable and
appropriate under the FRF for SMEs accounting principles adopted by a reporting entity.
Other customary auditing procedures for property and equipment include the following:
14
 Determining acquisition costs are recorded properly, including costs assigned to
internally-constructed fixed assets.
 Inspecting property and equipment to gather evidence for the existence assertion
and to identify any unrecorded equipment (completeness assertion).
 Determining if any repairs of assets meet the improvement or betterment rule and
should be capitalized.
 Analyzing repairs and maintenance, supplies, small tools and other related
accounts to determine capitalization limits have been met.
 Reviewing management’s depreciation methods and rates.
 Identifying any idle equipment, fully depreciated equipment or property related to
discontinued operations for separate accounting and reporting.
 Reading lease agreements to identify any capitalizable leased assets and to
evaluate management’s applicable accounting policies.
 Analyzing rental income and expense for the existence of other leases and
subleases.
 Reviewing the calculations of gain or loss on any disposals of property and
equipment.
ACCOUNTS PAYABLE, ACCRUED EXPENSES, LONG-TERM DEBT AND
PENSION PLANS
Accounting Principles
Accounts Payable and Accrued Expenses:
The AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities is
based on the accrual basis of accounting. Expenses and related liability accounts,
therefore, are recorded as accounts payable or accrued expenses when the expenses are
incurred. Unless affected by other principles in the FRF for SMEs, such as accounting
for goodwill and intangibles discussed above, there are no significant differences from
U.S. GAAP.
Long-Term Debt:
Accounting for long-term debt and footnotes disclosures under the FRF for SMEs is also
similar to U.S. GAAP. Differences may arise in the future for capitalized lease
obligations, however, when the Financial Accounting Standards Board issues an
Accounting Standard Update changing the criteria for lease capitalization to “use of an
asset.” Currently, lease accounting principles under the FRF for SMEs are similar to the
principles that originated under SFAS No. 13 (ASC Topic 840).
Retirement and Postemployment Benefits:
Under U.S. GAAP, a projected benefit obligation model with accounting for the
aggregate of periodic pension costs and the overfunded and underfunded status of defined
benefit and post-retirement benefits plans is required. Defined contribution plans’ costs
are accounted for as period expenses.
15
For the FRF for SMEs, management may elect to account for defined benefit plans using
a current contribution payable method or one of the accrued benefit obligation methods
similar to U.S. GAAP. From paragraph 20.32 of the AICPA’s Financial Reporting
Framework for Small- and Medium-Sized Entities, “an entity should determine its
accrued benefit obligation using:
 the projected benefit method prorated on services, when future salary levels or
cost escalation affect the amount of the retirement and other postemployment
benefits or
 the accumulated benefit method, when future salary levels and cost escalation do
not affect the amount of the retirement and other postemployment benefits.”
Detailed guidance for application of these methods is included in the above-mentioned
publication.
Auditing Procedures
Accounts Payable, Accrued Expenses and Long-Term Debt:
Since there are no significant differences in accounting principles from U.S. GAAP,
auditing procedures for accounts payable, accrued expenses and long-term debt for the
FRF for SMEs will generally be the same. Since completeness of account balances and
related disclosures is the primary financial statement assertion for audit evaluation of
liabilities, searching subsequent disbursements for liabilities that should be recorded at
the reporting date will be the primary auditing procedure. Inquiries of management and
persons charged with governance, scanning general ledger account activity,
correspondence with financial institutions and Uniform Commercial Code confirmations
will guide the search of unrecorded debt obligations.
Retirement and Postemployment Benefits:
When management elects the contribution payable method for defined benefit plans, as it
is for defined contribution plans, inspection of plan statements will be necessary to
support the amounts payable and related pension expense for the reporting period. When
the accrued benefit obligation model is elected, basic auditing procedures will include
confirmations of plan details with actuaries, reviewing actuaries’ processes and their
computations of pension costs, and determining that over- and under-funded status of the
plans is properly recorded in the financial statements. Other specific accounting
principles and financial statement disclosures required by the FRF for SMEs should also
be considered when performing auditing procedures.
INCOME TAXES
Accounting Principles
The FRF for SMEs offers entities subject to income taxes a choice of two methods for
accounting for income taxes:
1. The taxes payable method.
2. The deferred income taxes method.
A brief summary of the two methods follows.
16
Taxes Payable Method:
An asset or liability will be recognized to the extent of refundable and unpaid income
taxes, which unpaid taxes should include any from prior years. Carrybacks of tax losses
should be recognized as a current asset and tax benefit in the period the tax loss occurs.
Income taxes refundable or payable are calculated in accordance with the applicable
capital gains or ordinary income tax rates and laws in effect at the date of the statement of
financial position.
Deferred Income Taxes Method:
Similar to U.S. GAAP, deferred tax assets and deferred tax liabilities are recognized for
future deductible amounts and future taxable amounts, respectively. Differences in the
tax bases of assets and liabilities and their carrying amounts for financial reporting
purposes are called temporary differences. Temporary differences may be future taxable
or deductible differences. Deferred tax assets result from amounts that will be deductible
for tax reporting in the future. Deferred tax liabilities result from amounts that will be
taxable in the future.
Deferred income tax calculations under the FRF for SMEs do not require consideration of
uncertainties in income tax positions, as does U.S. GAAP. Other than this exception,
deferred tax calculations are similar to those under U.S. GAAP.
Auditing Procedures
Auditors are responsible for evaluating the appropriateness of management’s calculations
of income taxes currently payable and, if the deferred taxes method is elected, deferred
tax calculations in accordance with the principles of the FRF for SMEs. For small- to
medium-sized entities, auditors often assist management with these calculations or, in
some cases, make the calculations. When this occurs, this becomes a non-attest service
subject to the provisions of ET 101-3 and management must assign a person with suitable
skill, knowledge or experience to review, accept and take responsibility for the non-attest
services.
AU-C 250, Consideration of Laws and Regulations in an Audit, requires an auditor to
collect evidence to evaluate management’s calculations under laws and regulations that
have a direct, material effect on the financial statements. Income taxes are classified as
direct effect laws and regulations. Engagement files should contain evidence of the
auditor’s knowledge of the laws and regulations, as well as tests of balances for affected
accounts, e.g., income taxes payable or refundable, current and non-current deferred
income taxes and current and non-current income tax provision or benefit.
COMMITMENTS AND CONTINGENCIES
Accounting Principles
Commitments:
17
Future material commitments should be disclosed in the footnotes. This may include
facilities or major assets’ purchase or construction, debt reduction or refinancing,
restrictive covenants in debt agreements and purchase commitments.
Contingencies:
Contingencies may arise in connection with guarantees of obligations of others,
threatened litigation or other matters. Accounting for contingencies, similar to U.S.
GAAP, depends on the probability of occurrence of an event causing the contingency and
whether the amount is determinable. Professional judgment should be used to determine
appropriate amounts. Uncertainties about an event are categorized as:
 Probable of occurrence—the event is likely to occur; a greater likelihood than
“more likely than not” (generally considered 50+%) but not absolutely certain.
 Remote—a slight chance of occurrence exists.
 Reasonably possible—the chance of occurrence is greater than remote and less
than probable or likely.
Contingent losses should be recorded when it is probable future events confirm that the
carrying amount of an asset has been impaired or a liability has been incurred the amount
of the loss is reasonably determinable. Contingent gains normally would not be recorded
because they do not meet the requirements for revenue recognition; namely, they may
never be realized.
When it is probable a future event will result in the acquisition of an asset or reduction of
a liability producing a contingent gain, a footnote should disclose the nature of the
contingency and an estimate of its amount or a statement an estimate is not determinable.
As CFO for ABC Corporation, assume you are evaluating the necessary disclosures for a
contingent loss. Your attorney has informed you that a settlement of $30,000 is probable
for a $100,000 lawsuit against your company, although certainty of the amount is about
60%. What is your suggested accounting treatment for this contingency?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
Guarantees:
Accounting treatment for guarantees should be the same as for contingent losses.
Disclosures, even for a remote likelihood the guarantor will become obligated, are as
follows:
 The nature and approximate term of the guarantee, how it arose and
circumstances triggering performance.
 The maximum, undiscounted amount of future payments that could be required or
a statement that the amount can not be determined.
 The amount of any currently existing recorded liability.
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

Recourse provisions that enable the guarantor to recover any amounts paid on
behalf of a guaranteed party.
Any assets held as collateral by third parties which can be liquidated by the
guarantor.
Auditing Procedures
Delivery and discussion of the engagement letter and the management representation
letter, reading and excerpting minutes of meetings of boards of governance and
committees, reading and excerpting loan agreements and other contracts and
communications with management and members of boards of governance, reviewing and
discussing lawyers’ letters and reviews of subsequent events, among other engagement
performance procedures, produces audit evidence regarding the existence of
commitments and contingencies. While proper presentation and disclosure of
commitments and contingencies is the primary responsibility of reporting entity
management, all such circumstances should be evaluated by the auditor.
STOCKHOLDERS’ EQUITY
Accounting Principles
When an entity redeems or acquires shares of its own stock, the transactions are recorded
as capital transactions. Management can elect one of two methods of accounting:
 Cost method.
 Constructive retirement method.
The cost method is similar to the treasury stock method under U.S. GAAP in that shares
are carried at cost and reported as a deduction from stockholders’ equity or as treasury
stock. When reacquired shares are sold, amounts received in excess of cost are treated as
paid-in capital. Any deficiency should be charged to additional paid-in capital related to
the previous issuance of the stock with any excess amounts charged to retained earnings.
If shares are retired or cancelled, their cost is allocated to the appropriate capital stock or
additional paid-in capital accounts.
Under the constructive retirement method, the aggregate par or stated value of the
acquired shares reduces the capital stock account with any excess amounts paid charged
against paid-in capital. Subsequent retirement or cancellation of the shares would require
no further accounting.
Dividends should be recognized when declared and should only be provided for
outstanding shares.
Accounting for Stock and Equity Compensation:
The FRF for SMEs does not recognize compensation expense when stock or other equity
compensation is issued. Certain disclosures are required however. When options are
exercised, they are recorded as a normal stock issuance, i.e., an equity transaction.
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Equity transactions with non-employees are recognized when goods or services are
received by an entity. Such transactions are measured based on either the value of the
goods or services received or the equity instruments exchanged, whichever valuation is
most appropriate.
Auditing Procedures
Auditing equity transactions under the FRF for SMEs will be similar to auditing equity
under other financial reporting frameworks. Beginning with confirmations with
registrars or inspections of stock record books, support for all transactions will be
inspected (sampled if they are numerous) to determine either the cost method or
constructive retirement method has been accounted for properly. Reading and excerpting
minutes of directors’ meeting and reading other correspondence with shareholders and
employees may identify equity transactions that have not been recognized in the
accounting records. Reading any stock compensation agreements will provide
information for disclosure of these arrangements.
REVENUES
Recognizing Revenues
Recognizing revenue under the FRF for SMEs requires completion of performance of a
transaction and reasonable assurance of collection of invoices and billings. Similar to
U.S. GAAP, revenue must be earned or realizable to be recognized.
Specifically for the sale of goods, performance is achieved when the seller has transferred
ownership of the goods to the buyer and the seller retains no continuing involvement in
the goods transferred.
When services are provided under long-term contracts, performance should be
determined under the percentage of completion method or the completed contract
method. The method that best relates the revenue to the work performed should be used.
Achievement of performance occurs when:



There is persuasive evidence of an arrangement.
Goods have been delivered or services have been provided.
The seller’s price is fixed or determinable.
Evidence of an arrangement: Business practices or prior transactions with a customer,
side agreements, consignment sales, the right to return a product or requirements to
repurchase a product may be indicators of whether an arrangement exists.
Delivery: Delivery generally occurs when a product is delivered to a customer’s facility
or another specified site. As it is when recognizing revenue under other reporting
frameworks, consideration of several factors may be necessary. Such factors include bill
and hold agreements, required customer acceptance, layaway sales, non-refundable fees,
licensing and other fees and who bears the risk of loss.
20
Seller’s price: Factors that should be considered to determine if a price if fixed or
determinable include cancellable provisions, the right of return of a product, price
protections or inventory credit arrangements and refundable fees for service agreements.
Generally, performance of a transaction determines when revenue is earned and
recognized. For the sale of goods or providing services, performance is considered
achieved when a seller has transferred goods to a buyer or provided services, i.e., a point
of sale or delivery has occurred, when the buyer assumes the risks and rewards of
ownership of a product or accepts the services, when there is reasonable assurance a
specified amount of consideration will be received (collectability) in return and when an
appropriate allowance for returns of products has been determined. A sale would not be
recorded when the seller retains significant risks of ownership, such as in the case of
consignment sales. An appropriate allowance for uncollectible accounts should be
provided based on the evaluation of collectability.
For long-term contracts or rendering services, performance should be determined under
either the percentage of completion method or the completed contract method, whichever
best presents revenues in relationship to the work that has been accomplished. Revenue
should be recognized under the percentage of completion method base on some
systematic, rational and consistent basis such as sales value, related costs, and extent of
progress or number of acts. Amounts billed are an appropriate basis only if they are
indicative of work completed.
The completed contract method normally should be used when the extent of progress
cannot be reasonably estimated. Management may elect to use the completed contract
method when it is used for income tax reporting or when the financial position and results
of operations are similar to the percentage of completion method. This may occur when
an entity performs numerous short-term contracts or in other situations.
Contract claims may be recorded when amounts have been awarded or received or at
times when it becomes probable the claims will result in additional contract revenue (if
amounts can be reasonably estimated). In the latter case, revenue should be recorded
only to the extent related costs are incurred.
Multiple Deliverable Arrangements:
For multiple deliverable arrangements, performance of transactions should be considered
separately in accordance with the recognition criteria above. An example would be the
sale of software with separately priced installation, training, maintenance and warranty
agreements. Revenue from elements such as maintenance and warranty agreements will
normally be recognized on a straight-line basis over the term of the agreement unless the
services are provided in an identifiable, significantly different pattern.
U.S. GAAP includes provisions for recognizing revenues in connection with
arrangements that have multi-deliverables. ASU 2009-13 clarified those requirements by
requiring a sales price to be assigned to each of the deliverables at the inception of an
arrangement.
21
Under the FRF for SMEs, similar provisions will apply. When a sales transaction
includes the delivery or performance of multiple products, services or rights to use assets,
and the delivery or performance occurs at different times, revenue recognition criteria
will be applied to each of the deliverables. A vendor of large appliances, for example,
will ordinarily sell the product, charge additionally for delivery, and make warranty
and/or maintenance agreements available for separate purchase. Separate revenue
recognition criteria would be applied to each of these deliverables. For fixed fee
warranty or maintenance agreements, revenue would be recognized over the term of the
agreement, ordinarily on a straight line basis.
Other Income
Investment income is recognized similar to U.S. GAAP. Interest is recognized over time,
royalties are recognized as they accrue under an agreement and dividends are recognized
when a shareholder has the right to receive payment.
Principal vs. Agent
Also like U.S. GAAP, an agent in a transaction will report only commissions as revenues.
Companies that conduct business as agents rather than as principals sometimes face a
dilemma as to how to record revenues, gross amount of billings or net amounts of
commissions. Judgment based on facts and circumstances should guide resolution.
Indicators of gross revenue reporting by principals include whether the entity:
 Is the primary obligor in the arrangement.
 Has general inventory risk.
 Has latitude in establishing price.
 Changes the product or performs part of the service.
 Has discretion in supplier selection.
 Is involved in the determination of product or service specifications.
 Has physical loss inventory risk.
 Has credit risk.
Indicators of net commission reporting include:
 The supplier, not the entity, is the primary obligor in the arrangement.
 The amount the company earns is fixed.
 The supplier has credit risk.
Improper Revenue Recognition
For the FRF for SMEs, improper revenue recognition may occur in any of these and other
situations:
 Letters of intent are used in lieu of signed contracts.
22
 Products are shipped before the scheduled shipment date without the customer’s
approval.
 Products can be returned without obligation after a free “tryout” period.
 Customers can unilaterally cancel a sale.
 Obligations to pay for products are contingent on a customer’s resale to a third
party or on financing from a third party.
 Sales are billed for products being held by the seller before delivery.
 Products are shipped after the end of the period.
 Products are shipped to a warehouse (or other intermediate location) without the
customer’s approval.
 Sales are invoiced before products are shipped.
 Part of a product is shipped and the part not shipped is a critical component of the
product.
 Sales are recorded based on purchase orders.
 Obligations to pay for the product depend on the seller fulfilling material
unsatisfied conditions.
 Products still to be assembled are invoiced.
 Products are sent to and held by freight companies pending return to the seller for
required customer modifications.
 Products require significant continuing vendor involvement (such as installation
or debugging) after delivery.
Auditing Procedures
Common Sense Questions about Assertions for Revenues
For revenues to be recognized properly in financial statements, all financial statement
assertions will be considered by management and auditors. Here are some common sense
questions that auditors should ask about the assertions for revenues:
 Were sales of products or services made to valid customers, do they meet the
criteria for valid sales, and did they actually occur in the reporting period?
 Do other revenues represent legitimate income of the entity received or
earned in the reporting period?
 Have all revenues of the entity been reflected in the financial statements?
 Are the sales or other revenues valued properly, i.e., do they reflect armslength valuation for products, services or transactions recorded during the
reporting period?
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 Are the revenues presented in the proper account classifications and are all
necessary disclosures included?
 Are revenues consistently recorded to reflect FRF for SMEs’ principles or
principles for another special purpose framework?
 Are only revenues applicable to the reporting period presented in the
financial statements?
AU-C 500 and AU-C 315 make clear that auditors must gather sufficient evidence to
evaluate relevant assertions for all material financial statement classifications. The
auditing standards also make it clear that some assertions, particularly the completeness
assertion for revenues, may require procedures other than detailed tests of balances to
reduce detection risk to an acceptably low level.
Evaluating the Completeness Assertion for Sales
When tests of balances or analytical procedures can be performed to efficiently evaluate
the completeness assertion, tests of controls are not necessary for this purpose.
Evaluating the completeness of sales and revenues through tests of balances, however, is
difficult at best.
Examples of substantive tests that can be used to evaluate the completeness assertion for
sales and revenues include examining contracts to determine all revenues that should be
recorded are recorded (for the construction industry) or using predictive analytical
procedures to determine the accuracy of recorded revenues or expenses, e.g., using copy
machine meter readings for a copying business to compute copying revenues and copy
machine rental expense. In other instances, limited tests of controls may be necessary to
properly evaluate the completeness of revenues. Tracing, say, 10 to 15 or more
documents originating sales transactions, e.g. customer orders or shipping reports, to the
sales journal is an example of a limited test of control procedure for completeness. A
systems walk-through procedure for the sales and collections cycle using 10-15
transactions may also provide sufficient evidence.
Matching Procedures with Financial Statement Assertions:
Recognizing that risk assessment procedures and analytical procedures are being
performed for revenues, and that cash and accounts receivable tests of balances
procedures contribute evidence for evaluating financial statement assertions for revenues,
the question at this point is “What additional tests of balances are necessary for
revenues?” The following table presents an analysis of evidence collected in carrying out
the audit strategy.
Here’s how the evidence collected under an audit strategy will impact the financial
statement assertions (x=a small contribution; X=a large contribution):
24
AUDIT STRATEGY AND
PROCEDURES
Risk Assessment Procedures
1. Completing Client Acceptance and
Continuance Form
2. Reading the general ledger.
3. Internal control flowchart for sales and
collections cycle.
4. Systems walk-through procedure with 10
sales transactions selected from shipping
reports without bias.
Analytical Procedures
1. Number of days sales in accounts
receivable.
2. Gross margin by product line.
3. Inventory turnover by product line.
4. Dollar balances of sales by product line
trend comparison for three years.
ASSERTIONS AFFECTED BY
EVIDENCE FROM PROCEDURES
Complete/Occur/Value/Exist
x
X
X
X
X
X
X
X
X
X
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
x
After assessing the contributions of substantive evidence from the risk assessment and
analytical procedures, the question at this point is “What other substantive tests of sales
and revenues are necessary?” Assuming no significant misstatements were found as a
result of the procedures above, at the moderate risk level the answer to the question is
likely “none” other than customary tests of balances for related receivables accounts,
such as confirmation procedures, sales cut-off tests and tests of the allowance for
uncollectible accounts at the beginning and end of the year.
If the auditor can perform a predictive analytical procedure for sales (such as the number
of units sold times sale price) for comparison to recorded sales and results are as
expected, and the results of other procedures for accounts receivable and cash accounts
are acceptable, the substantive evidence will likely be more than sufficient, even for high
risk! In other words, no other tests of balances for the sales account would ordinarily be
necessary.
When significant misstatements are found in the risk assessment and/or analytical
procedures, other tests of balances will be necessary. For the completeness assertion as
an example, the auditor may need to select a sample of 25-40 shipping reports and trace
them to their entry in the sales journal. It also may be necessary to compare sales by
month with preceding years to identify any material variations. If material variations are
identified, performing detailed support tests for a sample of recorded sales invoices may
be necessary to further evaluate the existence assertion.
OPERATING EXPENSES
The matching of costs with revenues in the same reporting period is a basic principle for
the accrual basis of accounting underlying the presentation of operating expenses. Costs
25
of goods sold and other operating expenses should be recorded in the same period related
revenues are recognized.
Generally, operating expenses are recognized on an accrual basis, when an expense is
incurred. Fixed assets are depreciated over their useful lives. Intangible assets are
amortized over their useful lives (or contractual periods as in the case of asset retirement
obligations) or periods specified in the FRF for SMEs (goodwill is amortized over the
period specified by the Internal Revenue Code or 15 years).
Lease Accounting
The FRF provides guidance for lessees’ accounting for capital and operating leases, and
for lessors’ accounting for sales-type, direct financing and operating leases. The
principles are based on the view that property has benefits and risks related to ownership.
Further, the FRF takes the position that when a lease transfers substantially all the
ownership benefits and risks it is essentially an acquisition of an asset and the incurrence
of an obligation and should be accounted for as a capital lease by the lessee and either a
sales-type or direct financing lease by the lessor.
This guidance does not apply to copyrights, patents and other licensing agreements which
are accounted for as intangible assets. Following is a discussion of basic lease
accounting principles under the FRF.
One or more criteria in a lease agreement indicating transfers of substantially all the
benefits and risks of ownership to lessees, similar to currently applicable U.S. GAAP,
include:
1. Transfer of ownership at the end of the lease term or a bargain purchase option
(that would cause the lessee to purchase).
2. A lease term that will enable the lessee to receive substantially all the economic
benefit from the asset. This would normally be a term that is 75% or more of the
remaining useful life of the asset. This criteria normally would not apply to land
unless there is reasonable assurance ownership will transfer at the end of the lease
term.
3. The lessor has some assurance of recovering the cost of the assets and earning a
return on that investment. This assurance exists if, at the inception of the lease,
the present value of the minimum lease payments excluding executory costs is
90% or more of the market value of the asset. The discount rate that should be
used to determine present value is the lower of the lessee’s incremental borrowing
rate or the interest rate implicit in the lease if it can be obtained or estimated (the
implicit rate will be used by a lessor).
For lessors, the benefits and risks of ownership normally are transferred when:
1. Any one of the criteria above is met.
2. Credit risk is similar to other receivables.
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3. Non-reimbursable costs likely to be incurred by the lessor can be estimated to
determine if substantial risks are retained, thereby preventing capitalization of the
lease
Again, a lease of an asset that transfers substantially all the benefits and risks of
ownership should be accounted for as a capital lease by the lessee and a sales-type or
direct financing lease by the lessor.
Auditing Procedures
Upon completion of risk assessment procedures, analytical procedures and tests of
balances procedures in major audit areas, most tests of balances for payroll and expense
accounts should have been completed.
Analytical Procedures that Reduce Tests of Balances Procedures for Operating
Expenses
The Clarified Auditing Standards require analytical procedures to be used as risk
assessment procedures during the planning phase of an audit engagement, as well as
during its completion phase. These and other analytical procedures performed during
engagement performance contribute substantive evidence for evaluating financial
statement assertions for revenues and expenses.
The following table illustrates the payroll and expense accounts affected by the analytical
procedures in other major audit areas.
SUBSTANTIVE EVIDENCE
PRODUCED FOR EXPENSES
1. Reasonableness tests may be performed
for depreciation, interest expense and
payroll taxes. Comparison of all expense
account balances with prior years.
2. Bad debt expense.
3. Purchases and costs of goods sold.
4. Impairment losses.
5. Insurance expense.
6. Depreciation, amortization, repairs and
maintenance, rents, supplies, small tools.
7. Purchases and all expense accounts.
8. Payroll and sales tax expenses.
9. Interest expense.
ANALYTICAL PROCEDURE
1. Highly effective predictive and
corroborative analytical procedures during
planning.
2. Allowance for doubtful accounts.
3. Inventories.
4. Investments.
5. Prepaid insurance.
6. Fixed assets.
7. Accounts payable.
8. Payroll and sales tax liabilities.
9. Notes payable and long-term debt.
Substantive Evidence from Tests of Balances in Other Audit Areas Affecting
Operating Expenses
As auditing procedures are performed in other major audit areas, substantive evidence is
produced that contributes to evaluating assertions for operating expenses. The following
table illustrates the accounts that are affected.
27
EXPENSES SUBSTANTIVE EVIDENCE
RISK ASSESSMENT, ANALYTICAL
AND TESTS OF BALANCES
PROCEDURES
1. Cash.
SUBSTANTIVE EVIDENCE
PRODUCED FOR EXPENSES
1. Proving cash balances at the beginning
and end of a year affects the completeness,
occurrence and cutoff and existence
assertions for expenses.
2. All assertions for bad debt expense are
affected.
3. All assertions for purchases and costs of
good sold are affected.
4. All assertions for insurance expense are
affected.
5. Support tests for repairs and
maintenance, rents, supplies, small tools,
etc. evaluate all applicable assertions.
Tests of depreciation and amortization
evaluate all applicable assertions.
6. Adjusted balances at the beginning and
end of a year contribute evidence for the
completeness, occurrence and cutoff and
existence assertions for all affected
accounts.
7. All assertions for interest expense are
verified.
2. Allowance for doubtful accounts.
3. Inventories.
4. Prepaid insurance.
5. Fixed assets.
6. Accounts payable, accrued expenses and
other liabilities.
7. Note payable and long-term debt.
From the risk assessment procedures, analytical procedures and tests of balances
procedures illustrated above, it is apparent that sufficient evidence for evaluating
financial statement assertions for operating expenses may have already been obtained.
Specific differences under the FRF for SMEs accounting principles for pension and
postretirement plans and income taxes were discussed in the liabilities section above.
DISCLOSURES
Management has primary responsibility for preparation of financial statements and
footnotes. Auditors must evaluate the management’s presentation and disclosures to
determine the requirements of AU-C 315 are met and assertions in financial statements
and footnotes are appropriate and reasonable. The assertions pertaining to presentation
and disclosure are:
 Occurrence and rights and obligations
Disclosed events, transactions, and other matters have occurred and pertain
to the entity.
 Completeness
28
All disclosures that should have been included in the financial statements have
been included.
 Classification and understandability
Financial information is appropriately presented and described, and disclosures
are clearly expressed.
 Accuracy and valuation
Financial and other information is disclosed fairly and in appropriate amounts.
The AICPA has provided a disclosure checklist among the downloadable materials for
the FRF for SMEs. Among other documentation in its Toolkits, the Presentation and
Disclosure Checklist for the FRF for SMEs provides detailed presentation and disclosure
requirements. The free checklist can be downloaded at:
http://www.aicpa.org/InterestAreas/FRC/AccountingFinancialReporting/PCFR/Downloa
dableDocuments/FRF-SME/FRFforSMEs_Presentation_Disclosure_Checklist.pdf .
CONCLUSION
As it is for audits of a U.S. GAAP financial reporting framework, audits of special
purpose frameworks begin with an understanding of the accounting principles and their
appropriate presentation in financial statements. This understanding and the auditor’s
knowledge of an entity’s business, environment and internal control provides the
foundation for development of a cost-beneficial audit strategy and audit plan (program).
Performing procedures in the audit plan, analyzing results and performing any additional
substantive procedures provides evidence for an engagement leader’s final determination
that detection risk is a an acceptably low level, thereby enabling the expression of an
unqualified or qualified audit opinion.
29
CPA PRACTICE AIDS, LLC
ILLUSTRATIVE TESTS OF BALANCES PROCEDURES
30
Reliance on TOB Procedures/RMM Result
Major Audit Area
1. Cash
2. Trade accounts
receivable and sales.
3. Inventories and cost of
sales.
Slightly Less than High
RMM
High RMM
Low to Medium RMM
1. Prove all major bank
reconcliations at the
engagement date. Trace most
reconciling items to cutoff
statements. Confirm all
accounts. Search for
unrecorded transfers.
1. Reduce the number of
reconciling items traced to
subsequent month’s statement. No cutoff statement.
Search for unrecorded
transfers. Confirm all
accounts,
1. Prove only major
reconciliations at engagement
date. No cutoff statements;
use next month statement.
Search for unrecorded
transfers. Confirm all
accounts.
2a. Send positive
confirmations, and/or perform
alternative procedures, for
individually significant
accounts comprising a
substantial portion of the
account balances as of the
engagement date. Confirm as
of the engagement date.
Support non-replies and
exceptions by reference to
sales and cash receipts
documents. Consider sending
positive confirmations on a
few representative remaining
accounts.
2a. Select fewer items as
individually significant items
for positive confirmation.
Send some negatives on
smaller balances. Consider
sending confirmations one
month before engagement
date.
2a. Send positive
confirmations on ISI’s before
engagement date. Send some
negatives on smaller balances.
2b. Perform extensive sales
cutoff test by reference to
sales and shipping documents
for a large period before and
after engagement date.
2b. Shorten test period or
raise lower limit of items
tested.
2c. Compare sales by month,
by product, to preceding year.
Follow up on significant
fluctuations by reviews of
underlying records.
2c. Sales procedures
basically the same.
3a. Consider observing
inventory from start to finish.
Make test counts of all
individually significant items.
3a. Depending on client’s
controls over count, raise the
lower limit of
individually significant items
for test counts.
3b. Depending on client’s
double-check procedures for
pricing, extending and footing
the inventory sheet, consider
reducing the no. of
individually significant items
tested from 100%.
3b. Perform inventory pricing
and clerical tests for all
individually signi- ficant
items
2b. Select a few sales before
and after year end and trace to
support.
2c. None. Analytical
procedure only.
3a. Count fewer ISI’s.
3b. Reduce the number of
ISI’s price tests and clerical
tests.
Reliance on Tests of Balances/ RMM Result
31
Major Audit Area
4. Fixed assets.
5. Accounts payable.
High RMM
4. Perform extensive
vouching and inspections.
A significant portion of the
additions should be
subjected to support tests.
5a. Perform an extensive
search for unrecorded
liabilities including
subsequently recorded
transactions, open invoices,
receiving report and purchase
order files. Lower limits for
individually significant items
should be used. Consider
confirming major suppliers,
including zero balances.
Slightly Less than High
RMM
4. Raise the lower limit of
individually significant
items subjected to vouching
and inspection, i.e., vouch
fewer items.
5a. Same due to high
inherent risk of unrecorded
payables.
Low to Medium RMM
4. Reduce the number of
ISI’s vouched.
5a. Reduce the extent of the
search. No confirmations.
5b. Perform extensive
purchases cutoff tests by
reference to vendor invoices
for a large period before and
after engagement date.
5b. Shorten test period or
raise lower limit of
individually significant
items tested.
5b. Select a few purchases
before and after the yearend
and trace to support.
6. Expense accounts.
6. Perform extensive
vouching tests for all
significant account balances
by examining canceled
checks and supporting
documents.
6. Raise lower limit of
individually significant
items tested, i.e., support
fewer items. Consider
omitting inspection of
canceled checks.
6. None except for tax and
reporting purposes.
7. Payroll accounts.
7. Compare monthly payroll
by labor category and follow
up on variations by reference
to underlying records.
Consider reconciling gross
wages to payroll tax returns
and , if necessary, detailed
testing a few selected
disbursements.
7. Basically the same
procedures, except detailed
tests can be eliminated.
CPA PRACTICE AIDS, LLC
CLIENT ACCEPTANCE AND CONTINUANCE FORM
Name of Client: ALWAYS BEST CORPORATION
32
Engagement Date: DECEMBER 31, 2014
7. None except for analytical
procedures.
INSTRUCTIONS:
This form should be prepared by the in-charge accountant or engagement leader for new
clients and updated each year thereafter. The engagement partner should review the data
each year prior to the planning phase of the engagment.
CLIENT'S LEGAL NAME: ALWAYS BEST CORPORATION
ADDRESS: 123 ANYWHERE STREET, HOMETOWN, USA 99999
_____________________________________________________________________________
PHONE: 999-123-4567
FAX: 999-012-3456
WEBSITE: www.abcanywhere.com
FEDERAL EIN: 99-999999
STATE AND ACCOUNT NUMBER: 00-000000
1. Nature of business:
Manufactures precast concrete products (blocks, patio an yard decorations). Business
was started in 1987. Sales have been approximately $3,900,000 for the two preceeding
years. The Company is the only producer of yard products in a 300 mile radius.
2. Form of client organization:
Closely-held corporation, operated by a manger/vice-president.
_____________________________________________________________________________
3. Names of owners:
Don West--100%; President
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
4. Affiliated or related organizations or individuals:
Name
Relationship
Big Mountain Paving
Don West owns 100%
Pine Tree Lumber Co.
Don West owns 100%
Open Space Development Co.
Don West owns 50%
33
5. Officers and directors:
Name and relationship
Don West
Wilbur Smith
Hanna Smith (wife of Wilbur)
Sandy Smith (daughter of Wilbur)
Position
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
President
Vice-President/Manager
Office Manager/Secretary of Corp.
Office clerk
___________________________
___________________________
___________________________
___________________________
___________________________
___________________________
6. Client's attorneys:
Firm Name: McMann and McCallister
Address: 1108 Downtown Center, Anywhere, USA
__________________________________________________
Phone :999-111-2222
Contact person: John McMann
___________________________
___________________________
___________________________
___________________________
___________________________
7. Client's banking relationships:
Name and location
Contact Person
First National Bank of Anywhere, USA
Larry Lender
(Regular checking, imprest payroll checking, mortgage)
___________________________
__________________________________________________ ___________________________
8. Annual client services (delivery deadlines):
2014
20____
20____
Audit:
X
________ ________
Compilation:
________ ________ ________
Review:
________ ________ ________
Bookkeeping: (Predecessor auditor oversees)
________ ________ ________
Income tax return preparation:(Prepared by predecessor auditor)________ ________ ________
Tax planning:
________ ________ ________
Other services:
________ ________ ________
Annual business planning meeting with Don West
X
________ ________
__________________________________________________ ________ ________ ________
__________________________________________________ ________ ________ ________
__________________________________________________ ________ ________ ________
Describe use of statements: The audit has been an annual bank requirement since the
mortgage on the Company's facility was obtained 10 years ago. Owner wants annual audit
for his information and control.
34
9. List all the client's business locations:
123 ANYWHERE STREET, HOMETOWN, USA 99999
__________________________________________________
__________________________________________________
__________________________________________________
Nature of Activity
# Employees
Manufacturing
12
_________________ ____________
_________________ ____________
_________________ ____________
10. Describe the company's sources of revenue and revenue recognition methods:
Sales of precast concrete blocks, patio and yard decorations. Sales are made direct to customers.
Most advertising is word of mouth by manager. There are no major customers.
_________________________________________________________________________________
_________________________________________________________________________________
11. List the names of major sources of financing:
Mortgage at FNB of Anywhere. Small credit line available but rarely used.
_________________________________________________________________________________
_________________________________________________________________________________
_________________________________________________________________________________
12. Describe briefly compensation methods and employee benefit plans for all employee classes:
No benefit plans other than health insurance provided for all employees. All employees except for
the manager are paid by the hour. The manager's compensation is 50% of net income after tax.
_________________________________________________________________________________
_________________________________________________________________________________
13. Describe any significant engagement performance, accounting, reporting or tax problems you
of which you are currently aware: (Attach memo if additional space is needed.)
The Company uses the AICPA's Financial Reporting Framework for Small and Medium Sized Cos.
Inventories are a significant part of the Company's assets; raw materials are store in piles and
finished goods are store in a fenced and locked yard. Physical inventories are taken once a year:
bulk raw materials measurement require volume computations.
14. List available client assistance (refer to attached list of possible assistance):
Predecessor auditor prepares all requested working papers, financial statements and footnotes.
Predecessor auditor also assembles requested supporting documents, provides documentation of
various non-attest services he performs and prepares various confirmations under our supervision.
_________________________________________________________________________________
15. Are there any relationships such as famial, managerial involvement, or financial that could
appear to impair the firm's independence? List them below:
None per annual independence review according to our firm policy.
_________________________________________________________________________________
35
16. Describe any laws, statutes, regulations or ordinances that could have a direct effect on
the company's financial statements:
DOL wage and hour laws, OSHA regulations.
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
17. List any other events, circumstances or information that may affect the performance or
reporting for this engagement:
Performance of control activities by the predecessor auditor and by the owner are necessary
for financial statements to be auditable.
_____________________________________________________________________________
_____________________________________________________________________________
18. Assessment of risk at the financial statement level (include a discussion of any high
risk issues in the Planning Document):
No
Yes
a. Evaluate the integrity of management:
i. For small entities, are owners or managers absentee?
ii. Are there any significant disagreements (lawsuits,
etc.) among the owners?
iii. Is there high turn-over in key financial and management
positions?
iv. Does management and/or majority ownership lack
necessary experience to run the company?
v. Has any information come to your attention that could
impair the personal or business reputation of
management and/or majority owners?
vi. Is there any reason to believe management and/or
majority owners are less than honest?
vii. Are there any events or circumstances, such as the
current economic environment, loan renewals,
decreasing sales or market, loss of major suppliers,
or increasing costs of operations that could cause
management and/or majority owners to maintain less
than high standards of integrity?
b. Information contrary to the going concern assumption:
i. Is cash flow sufficient to meet current obligations?
ii. Have any sales, gross profit, earnings or other trends
deteriorated significantly before or after year end?
36
N/A
X
X
X
X
X
X
X
X
X
iii. Is there a large amount of debt or a deficiency in
operating capital?
iv. Are there any violations or waivers of debt covenants?
v. Is there any significant pending litigation against the
entity?
vi. Are there unfavorable changes, economic conditions or
legal actions that could impact the entity's industry?
vii. Are there any events or circumstances, such as
current economic conditions, loan renewals, decreasing
sales or market, loss of major customers, or increasing
costs of operations that could cause substantial doubt
about the continued existence of the entity?
X
X
X
X
X
c. Use of financial statements:
i. Are statements being used for high risk purposes,
such as obtaining credit, bonding, divorce proceedings,
merger or acquisition, etc.?
X
d. Other matters:
i. Are there any other matters that could increase the
assessement of risk of misstatement at the financial
statement level? (Describe in the Planning Document)
X
Prepared or updated by: Frank Lee, (in-charge accountant)
Reviewed by: Harry Knose (engagement leader)
2014
20___
20___
9/30/14
09/30/14 ________ ________
10/5/14
10/05/14 ________ ________
Other notes and comments:
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
_____________________________________________________________________________
37
POSSIBLE CLIENT ASSISTANCE:
1.
2.
3.
4.
5.
6.
7.
8.
9.
General ledger activity printout and trial balance
Schedule of petty cash and other cash on hand
Bank reconciliations for all accounts
Aged trial balance of accounts receivable
Schedule of related party's receivables and payables
Schedule of notes receivable
Prepaid insurance shedule with copies of policies
Cash surrender value of life insurance schedules/confirms
Inventories physical count summaries and sheets with
prices, extentions and totals
10. Schedule of marketable securites
11. Schedule of investments
12. Schedules of fixed asset addions and disposals
13. Depreciation schedule
14. Schedule of accounts payable with current statements
15. Schedule of accrued expenses
16. Schedule of notes payable and long-term debt
17. Account analysis for:
a. Investment income
b. Miscellaneous income
c. Maintenance, repairs and supplies
d. Taxes paid
e. Contributions
f. Miscellaneous expense
g. Rental income and expense schedules with copies
of rental agreements
h. Bad debts expense
i. Professional fees
j. Reconciliation of salaries and wages to Forms W-3
k. Other accounts as considered necessary:
__________________________________________________
__________________________________________________
__________________________________________________
__________________________________________________
18. Typing assistance for audit correspondence:
a. Bank confirmations and letters
b. Attorney's letters
c. Securities held by brokers and others
d. Accounts and notes receivable confirmations
e. Accounts and notes payable confirmations
38
2014
20___
20___
X
________
X
X
X
X
X
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
X
________
X
X
X
X
X
X
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
X
X
X
X
X
________
________
________
________
________
________
________
________
________
________
________
________
________
X
X
X
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
________
X
X
________
X
X
________
________
________
________
________
________
________
________
________
________
Planning Document for a Group Audit
Client: _________________________________________________________________
Engagement Date: _______________________________________________________
Instructions:
This document should be completed by the group engagement in-charge accountant and
reviewed by the group engagement leader (partner, sole proprietor) before engagement
personnel begin fieldwork. It should describe engagement procedures accomplished
and/or planned for both the group and component audits. It may contain cross-references
to other planning documentation as applicable.
I.
Group Engagement Administration:
A. Delivery of Group Engagement Letter:
The engagement letter is one of the primary tools for obtaining client
understanding of their responsibilities and auditors’ responsibilities. A
good understanding before the engagement begins will prevent
misunderstandings from arising later. To accomplish this, the group
engagement leader should deliver the letter and discuss its contents with
the group CEO and/or representative member of the board of group
governance. The letter should indicate the components for which the
group auditor is taking audit responsibility and the component auditors’
reports to which it will refer in the group audit report.
Discussion of the letter with the party or parties engaging the CPA firm
should be one of the primary sources for discovering potential
misstatements, fraud or illegal acts, as well as other information relevant
to the group audit. The group audit partner should determine that
component auditor partners have delivered and discussed their
engagement letters with responsible management persons, even if the
group auditor is not taking responsibility for the component auditor’s
work.
B. Use of Client Assistance or Paraprofessionals:
Client assistance should be used to the maximum extent possible on every
engagement. When client personnel are unavailable, consider using firm
paraprofessionals to perform accounting services and clerical work in
connection with the engagement.
C. Planning for Proper Workspace:
39
The group engagement leader has the responsibility to arrange adequate
workspace before the fieldwork begins. Poor lighting, lack of adequate
heat or air conditioning, desks or tables that are too small, or work
locations that are not near client accounting personnel are examples of
situations that hinder the efficient completion of an engagement.
D. Assignment of Staff Personnel:
Assigning the right people to engagements ensures high quality and helps
complete the engagements in the minimum amount of time. SQCS No. 8,
effective January 1, 2012, requires CPA firm documentation of this
element of quality control. Personnel should be assigned to engagements
and tasks that are commensurate with their experience and capabilities.
When persons assigned don’t have experience and capabilities
commensurate with engagement risks, more and more frequent
supervision is required from the engagement leader. A primary audit
response to risk at the financial statement level required by audit and
quality control standards is to assign experienced staff persons to the highrisk area or provide more supervision to lesser experienced persons.
When the group auditor is taking responsibility for component auditor’s
work, the component auditor should confirm compliance with this element
of quality control and required audit standard, and that appropriate
documentation has been included in its engagement documentation files.
E. Target Dates:
Timely engagement completion involves setting target dates during
planning. These target dates should be entered in the firm’s staff
scheduling system.
Communications to component auditors should include target dates for the
group auditor’s involvement when taking responsibility for the component
auditor’s work, as well as dates financial information is required by the
group auditor from all components
F. Use of Specialists:
Consider using outside specialists whenever any auditing procedures
outside the firm’s expertise are expected to be performed. Such
circumstances may include actuarial computations for pension funds,
questions of law, observations of inventories of products or materials,
required tests of client accounting software, and complex accounting and
auditing problem situations.
40
When the auditor outsources any services in connection with an
engagement, the engagement letter should contain a paragraph notifying
the client. The auditor is also required to obtain a confidentiality
agreement from the person or organization performing outsourced
services.
When group audit specialists are engaged to perform work that will also
be applicable to components, the group auditor’s communication to
component auditors should discuss the selection of the specialists and their
processes.
G. Electronic Auditing Opportunities:
Trial balance and financial statement preparation software, electronic
practice aids, file container software, spreadsheets, word processing
software, document scanners, data extraction software (such as Idea,
Monarch or ACL) and “cloud” services should be used to create
efficiencies on the group and component audit engagements. List the
specific, planned applications for discussion among the group engagement
team and for communication to component auditors.
H Audit Budgets:
Prepare a group audit budget based on circumstances, not fees, during
engagement planning. Summarize the budget here for discussion among
the group engagement team. Include a separate section for involvement in
the work of component auditors.
II.
Group Technical Audit Planning Decisions:
A. Describe the process for selecting significant components.
Cross-reference this section to a separate memorandum or other
documentation summarizing organizational, operational and financial
information for all components. Summarize the components determined
to be significant and whether the group engagement team will take
responsibility for component auditors’ work or, instead, refer to
component auditors in the group audit report.
B. Risk of misstatement at the group financial statement level:
Use of Group Statements:
Describe high-risk uses of statements.
Potential for Group Going-Concern Problems:
41
Describe continued losses, high debt and external situations that
threaten the continued existence of the group or any of its
components.
Integrity of Group Management:
Discuss specific information that could cast doubt on group or
component management’s integrity.
Evaluate the risk of material misstatement at the group and component
financial statement levels and document the subjective impact on audit
responses and engagement procedures.
C. Document the group and components’ risk of misstatements evaluation at
the assertion level (financial statement classification level for smaller
entities), and the impact on the group and components’ audit strategy by
major financial statement classification. This and other sections may be
cross-referenced to other documentation.
D. Group Materiality Judgments:
Present a summary of the tolerable misstatement (performance materiality)
and lower limit for individually significant items calculations and
document group engagement team reasoning for group and component
financial statements materiality levels.
E. Group Sampling and Non-Sampling Decisions:
Describe the reasons for making decisions to sample or not sample at the
group and component levels. If decisions are made to sample, explain the
rationale for sample size calculations.
F. Group Audit Strategies:
Describe the general group audit strategy including detailed substantive
tests of balances, risk assessment procedures, tests of controls and/or
extensive analytical procedures. Cross-reference this section to other
group audit documentation for specific audit strategies at the group and
component financial statement classification levels.
G. Nature of Group Audit Procedures:
Summarize the nature and extent of work for significant components and
components to be referred to in the group audit report. Describe the nature,
extent and timing of tests of balances procedures and analytical procedures
42
for material financial statement classifications or cross-reference to other
documentation describing planned procedures for material financial
statement classifications at the group and component levels.
H. Significant Time-Savings Opportunities:
Describe here the opportunities to save time on the group and/or
component audits not discussed elsewhere.
I.
Group Engagement Team Meeting:
Summarize the significant potential risks of misstatement at the group and
component levels due to error or fraud, planned audit responses and other
matters discussed at the group engagement team meeting. All group
engagement personnel, including partners or sole practitioners, are
required to attend this meeting. Matters discussed affecting the work of
component auditors should be communicated to them.
J. Planned Involvement with Component Auditors
Summarize here, if not present above, the extent of involvement in the
work of component auditors when the group engagement team plans to
take responsibility for their work and/or when component auditors reports
will be referred to in the group audit report. This should include both
administrative and technical activities similar to those summarized above
for the group audit. This planned involvement should be part of the group
engagement team’s communication to component auditors.
I. Potential Risks of Misstatement due to Errors or Fraud and Audit
Responses—Group Audit:
From risk assessment procedures:
Document potential risks of misstatement discovered during the risk
assessment procedures and the planned audit responses.
From scanning the general ledger account activity and performing
other analytical procedures:
Document unusual matters, variances or other potential risks, and record
the planned audit responses here.
Factors discovered throughout the engagement, along with audit
responses and their results:
From inquiries of management personnel:
From inquiries of staff personnel:
43
From communication with persons charged with governance:
From performing fieldwork and other auditing procedures:
From performing subsequent events procedures:
J. Potential Risks of Misstatement due to Errors or Fraud and Audit
Responses—Component Audits
Summarize the same information from involvement with the work of
component auditors as presented above for group audits.
Prepared by:________________________________Date:_________________________
Reviewed by:_______________________________ Date:_________________________
44