Proposed Omnibus SAS Encourages Managers to Report Errors
In response to SEC concerns and to encourage more transparent financial reporting by companies, the auditing standards board (ASB) issued for exposure guidance that will require corporate managers to inform auditors of the nature of any financial statement adjustments.
The omnibus exposure draft, Audit Adjustments, Reporting on Consistency, and Service Organizations (Omnibus Statement on Auditing Standards—1999) , adds to a list of matters addressed in the audit engagement letter an item reminding management it is responsible for correcting material misstatements and for informing the auditor of any uncorrected, nonmaterial misstatements. A summary of uncorrected misstatements must be included in the financial statement representation letter. The auditor is required to inform the audit committee about any uncorrected misstatements.
"We can't mandate that managers record immaterial adjustments," said Richard Dieter, a partner of Arthur Andersen, LLP in Boston and a member of the ASB. "However, we want to ensure management informs the audit committee of the nature of such misstatements." The guidance on audit adjustments will amend SAS no. 61, Communication With Audit Committees .
In another part of the ED, the ASB proposed amending SAS no. 70, Reports on the Processing of Transactions by Service Organizations, to be applicable when an audited entity receives services from another organization, such as a bank or a securities broker. Under "Service Organizations," the exposure draft clarifies the factors an auditor must consider when determining the significance of a third-party service organization's internal controls.
"Companies often outsource securities transactions to a financial institution and make banks custodians of their pension plans," said Dieter. According to the proposed SAS, every auditor must obtain an understanding of that service organization's internal controls to prevent misstatements from appearing in the audited company's financial statements.
Reporting on consistency
Yet another part of the proposed SAS clarifies when an auditor must add to the audit report an explanatory paragraph addressing consistency. It amends AU section 420, "Consistency of Application of Generally Accepted Accounting Principles (AICPA, Professional Standards ).
Copies of the ED are available from the AICPA order department by phone at 888-777-7077 (product no. 800128) or online at www.aicpa.org. The comment period for the draft ended June 22, 1999.
AICPA Clarifies Concurring Partner Role
"Right now, we'll live with it," said Richard Miller, AICPA general counsel and secretary of the board of directors, when asked about the Supreme Court's denial of Robert D. Potts' petition for review of a federal appeals court's decision. The court upheld an SEC sanction against Potts for recklessness as a concurring partner. (See "CPA Sanctioned on Concurring Review," JofA, Dec.98, page 20.) Even though Miller was disappointed by the May 3 decision, he was not surprised. "The Supreme Court gets a lot of cases and hears only a small percentage of them. On another day, it may take on a case like Potts."
Despite this setback, the profession can at least look forward to clearer guidance in the future. The auditing standards board (ASB) and the SEC practice section (SECPS) of the AICPA division for CPA firms have been working on new procedures for concurring partner reviews with the SEC's blessing. With general agreement on a concurring partner's review responsibilities, an issue such as that raised by the Potts case is not likely to recur.
The AICPA had filed an amicus curiae brief supporting Potts, who was given a nine-month suspension by the SEC for his role in the 1988 and 1989 audits of Kahler Corp., a hotel operator. Potts, who at the time was a partner at Touche Ross and its successor Deloitte & Touche, signed off on the audits. His "improper professional conduct" stemmed from the accounting treatment of University Park Hotel (a 1987 acquisition of Kahler's), which resulted in incorrect net gain and loss realization, erroneous classification of the interest as an asset for sale and improper application of accounting method dates. The SEC determined that Potts had deviated from GAAP and GAAS and was negligent in his duties as an independent auditor.
Potts argued in his appeals statement that the SEC had erred in attributing GAAS status to SECPS guidelines, in applying GAAS requirements to his conduct and in failing to consider whether such conduct in fact presented a threat to SEC processes.
Potts is significant to the accounting profession because it paves the way for broad interpretation and censorship by the SEC of accountants' performance. The case also infringes on the profession's self-regulatory status (which it steadily defends) and restricts auditors in their ability to respond to the natural ebb and flow of audit engagements without fear of a SEC disciplinary action.
David Brumbeloe, director of the AICPA's SEC practice section, noted there have been at least three instances since Potts in which the SEC charged concurring partners with negligence. This prompted the SECPS to revisit its guidelines for concurring partner reviews. While providing guidance is within the profession's domain, the SECPS welcomed SEC input and invited commission representatives to participate on a task force addressing concurring partner reviews.
ASB and SECPS make revisions
The SEC wanted professional standards to specifically address concurring partner responsibilities. In response, the ASB prepared an exposure draft that amends Statement on Quality Control Standards (SQCS) no. 2, System of Quality Control for a CPA Firm's Accounting and Auditing Practice. The new language calls for firms to establish engagement performance policies and procedures—encompassing all phases of the design and execution of the engagement—that address concurring partner review requirements (applicable to SEC engagements) as set forth in the SECPS membership requirements. When issued as final, the standard will be effective as of January 1, 2000. To further refine the audit review process, the SECPS revised Appendix E, "Concurring Partner Review Requirement," of its membership requirements, establishing minimum qualifications for concurring partners and addressing the nature, extent and timing of the review and the required documentation. Although a concurring partner's review responsibility is not equivalent to that of an audit engagement partner, the concurring partner is expected to
- Discuss significant accounting, auditing and financial reporting matters with the audit engagement partner.
- Discuss the audit engagement team's identification and audit of high-risk transaction and account balances.
- Review documentation of the resolution of significant accounting, auditing and financial reporting matters, including those pertaining to consultation with firm personnel or external resources.
- Review a summary of unadjusted audit differences.
- Read the financial statements and auditors' report.
- Confirm with the audit engagement partner that no unresolved matters are likely to have a material effect on the financial statements or auditors' report.
The revision includes a "cooling-off period" provision affecting partner rotation: an audit engagement partner may not serve as a concurring partner for at least two years after his or her last year as the lead engagement partner. This provision could have a negative impact on small firms, whose rotation capacity may be limited. However, firms that would experience undue hardship as a result may request a waiver from the SECPS peer review committee. The revised SECPS membership requirements will be effective as of October 1, 1999. The ASB exposure draft and the SECPS concurring partner review membership requirements and related appendix are available on the AICPA Web site at www.aicpa.org .