The Impact of SAS 112 on
Governmental Financial
Statement Audits
GAQC Member Conference Call
January 4, 2007
Presented by
Chuck Landes, CPA
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What We Will Cover
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The requirements of SAS No.112
How relates to changes being made in the
Yellow Book
Implication on single audits and other
compliance audits
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SAS No. 112
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In a Nutshell, SAS No. 112…
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Defines the terms significant deficiencies and
material weaknesses
Provides guidance on evaluating the severity
of control deficiencies
Requires the auditor to communicate, in
writing, to management and those charged
with governance
Effective date = audits of periods ending on
or after December 15, 2006
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SAS No. 112
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Those charged with governance = the persons
with responsibility for overseeing the strategic
direction of the entity and the entity’s financial
reporting and disclosure process.
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Recognizes that body to whom communication
is made may take different forms
• Board of Directors
• Committee of management
• Single owner
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Old Versus New
Old Definitions
Material weakness
New Definitions
Material weakness
Reportable condition
Significant deficiency
Management letter comment (under Yellow
Book only)
Other matters related to internal control
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Old Definitions
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Reportable conditions involve matters coming to the
auditors attention relating to significant deficiencies in the
design or operation of the internal control that, in our
judgment, could adversely affect the organization’s ability to
initiate, record, process, and report financial data consistent
with the assertions of management in the financial
statements.
A material weakness is a reportable condition in which the
design or operation of one or more of the internal control
components does not reduce to a relatively low level the risk
that misstatements caused by error or fraud in amounts that
would be material in relation to the financial statements
being audited may occur and not be detected within a timely
period by employees in the normal course of performing
their assigned functions.
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SAS No. 112
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Conforms definitions of control deficiency, significant
deficiency, and material weakness to those in
PCAOB AS#2 . The term significant deficiency
replaces the term reportable condition
Requires written communication of significant
deficiencies and material weaknesses to
management and those charged with governance.
• Should be communicated even if they were
communicated in connection with previous audits
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SAS No. 112
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A control deficiency exists when the
design or operation of a control does not
allow management or employees, in the
course of performing their assigned
functions, to prevent or detect
misstatements on a timely basis.
Control deficiencies may involve one or
more of the five interrelated components
of internal control
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SAS No. 112
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A significant deficiency is a control deficiency, or
combination of control deficiencies … such that there
is more than a remote likelihood that a misstatement
of the entity’s financial statements that is more than
inconsequential will not be prevented or detected.
A material weakness is a significant deficiency, or
combination of significant deficiencies, that results in
more than a remote likelihood that a material
misstatement of the financial statements will not be
prevented or detected.
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Remote Likelihood
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Remote likelihood has the same
meaning as in FASB Statement No. 5
Remote is defined such that the chance
of the future events or events occurring
is slight
Therefore, the likelihood of an event is
“more than remote” when it is at least
possible
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More Than Inconsequential
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More than inconsequential describes the magnitude of
potential misstatement that could occur as a result of a
significant deficiency
Misstatement is “inconsequential” if a reasonable person
would conclude would clearly be immaterial to the
financial statements
In determining whether potential misstatement would be
more than inconsequential, auditor should consider
qualitative and quantitative factors
A potential misstatement that is less than 20% of overall
financial statement materiality may be inconsequential
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Evaluating Deficiencies
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Provides guidance in evaluating:
•
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Deviations in the design or operation of controls and
whether those deviations constitute control deficiencies
The severity of control deficiencies
•
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Based on nature, likelihood, and magnitude
Whether misstatements or potential misstatements are “more
than inconsequential”
Examples of factors that may affect the likelihood
that a control could fail to prevent or detect a
misstatement
•
•
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Susceptibility to loss or fraud
Subjectivity and complexity of the amount involved
Cause and frequency of any known or detected exceptions
related to the operating effectiveness of a control
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Evaluating Deficiencies
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Several factors affect the magnitude of a
misstatement that could result from a
deficiency including the following:
• F/S amounts or total of transactions exposed to
•
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the deficiency
Volume of activity in the account balance or class
of transactions exposed to the deficiency
Auditor should also evaluate compensating
controls
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Evaluating Deficiencies
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SAS identifies control deficiencies that ordinarily
would be considered at least significant deficiencies
Also identifies circumstances that should be
regarded as at least a significant deficiency and a
strong indicator of a material weakness
After concluding on severity of deficiency (control
deficiency, significant deficiency, material weakness),
to consider whether “prudent individuals” having
knowledge of facts and circumstances would come
to same conclusion.
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SAS No. 112
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Written communication required no later than 60
days following issuance of audit report (including
deficiencies that were communicated in previous
audits)
Auditor may decide communicate certain
deficiencies during the audit
Provides illustrative written communications
Includes an appendix containing examples of
circumstances that may be control deficiencies,
significant deficiencies, or material weaknesses
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SAS No. 112
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Also states that nothing precludes the auditor
from communicating to management and
those charged with governance other matters
that the auditor:
•
•
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Believes to be of potential benefit to the entity
Has been requested to communicate
Such a communication can be done orally or
in writing
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SAS No. 112
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Management may wish to, or be required to, prepare a
written response to the auditor’s communication
Such response may include a description of corrective
actions, the entity’s plans to implement new controls, or a
statement indicating that the cost of correcting would
exceed the benefit
If such a response is included in a document with the
auditor’s written communication the auditor should add a
paragraph to the communication disclaiming an opinion
on such information
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What about Government Auditing
Standards?
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Proposed Yellow Book Changes
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Yellow Book is adopting new
terminology
• All significant deficiencies and material
•
weaknesses proposed to be included in the
Yellow Book report
Deficiencies in internal control that are not
significant deficiencies would go in
management letter unless clearly
inconsequential
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Other Yellow Book Requirements
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Audit findings relating to internal control
deficiencies would need to include the required
elements defined by the Yellow Book as:
•
•
•
•
•
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Criteria
Condition
Cause
Effect or potential effect
Recommendations for corrective action if able
Views of responsible officials, including planned
corrective action
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What About Single Audits and Other
Federal Compliance Audits?
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Single Audits
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The big question is what action OMB will take
with regard to single audits
• A-133 requires report to include reportable
•
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conditions and material weaknesses that relate to
federal programs
Type A program can not be considered low-risk if
it had a reportable condition
Entity is not able to be a low-risk auditee if it had
deficiencies in I/C over financial reporting that
would be considered material weaknesses or if
any of the federal programs had material
weaknesses (in either of the 2 preceding years)
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Single Audits
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Current Status - definitions
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ASB (working with a task force of practitioners that do
these audits) has developed a draft audit interpretation
that would provide updated definitions and terminology
for control deficiencies in a single audit environment
that are consistent with SAS No. 112
OMB has the interpretation for review
If approved, the plan would be for OMB to issue a
notice on its Web site in the near future pointing
auditors to the new auditing interpretation that would
be issued on the AICPA Web site concurrently with the
OMB notice
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Single Audits
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Current Status – Definitions
• Watch GAQC Web site for developments in
•
this area
GAQC will schedule a member conference
call to discuss SAS 112 implications on single
audits as soon as we have a final answer
(which should be in the near future)
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Single Audits
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Current Status – Scope issues
• OMB has yet to determine whether any
•
changes will be made to address the scope
issues (i.e., type A program determination
issues and low-risk auditees)
Likely would entail a formal revision to A-133
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Other Compliance Audits
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The other big question is what action the
numerous federal agencies with audit guides
(for example, HUD and Education) will take?
Will be a challenge!
GAQC staff will be working to encourage
federal agencies with Guides to address this
issue directly and soon
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Questions ?????
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