In the Year 2010....

Wasn't that the title of a song? Oh, I remember. It was "in the year 2525." Anyway, the year 2010 will be the beginning of a breath-taking trip into the future for accountants and auditors. In some ways, I feel like it's "backing into the future." Accounting standards are returning to a "principles based" set of rules, the way it was before we had the rules! Practiitoners and standards-setters are recognizing that risk drives the performance of all levels of accounting and auditing services, the common sense rule some of us "ancients" used back in the dark ages. Could it be we have come full circle and once again we're using our common sense to guide our work? If this is so, we need to make some changes to the ways we do things. Read on.

In the mid-1980s when the expectation-gap pronouncements nearly consumed us, common sense was covered up with all kinds of empirical studies, frameworks and formula approaches to their application. It took us a while to wade through the mire but most of us were able to recover our ability to think and reason. And then along came the flood tide of risk assessment standards in 2006, the beginning of accounting and auditing convergence projects and globalization of everything dear to us. I can still hear the sounds of CPA practiitioners gasping for air as they struggle not to go down for the third time!

You've probably heard the story of the man than went to the doctor with pain in his shoulder. As he extended his arm in a semi-circle over his head he complained, "This really makes my shoulder hurt." The doctor replied, "Well, don't do that anymore!" We've got to follow that doctor's advice and find ways to stop doing the things that are hurting our accounting and auditing practices! Here are some things that are causing CPA firms pain:

• Accounting standards overload--We are responsible for complying with accounting rules that no one wants, not our clients nor the users of their financial statements!
• Practice aids and forms dependency--Some CPA firms' staff personnel have been caught in the tsunami of auditing standards of the latter years and have grabbed the nearest practice aid to stay affloat. There is no time to understand, only paddle!
• Fear of peer review--Intended as a way to help CPA firms improve the quality of their practices, in some states it has become adversarial and punitive in its purpose. Afraid of the power of a peer reviewer, we may protest but meekly but crawl back into our cage when the lion roars.

The doctor said, "Don't do that anymore!" We need to begin planning ways to avoid the application of cumbersome GAAP rules. We've got to train our staff personnel to know when, and when not, to use standard practice aids from major publishers. We must train our people to know the requirements of auditing standards so they can do the minimum amount of work in each engagement's circumstances. Once again, firms of all sizes must begin to create proprietary auditing practice aids that meet the needs of their client engagements and challenge the peer reviewer to prove them wrong!

It's time to stick our heads out the window and shout, "We're mad as hell and we're not going to take it anymore!" I mean right now! Post your "shout" on this blog and tell the standard-setters why you are fed up!

Thinking Outside the Box--An Auditor's Greatest Gift!

For all audit engagements, documentation must evidence compliance with the requirements of applicable SASs. Because SASs are written to be applicable to audit engagements of all sizes, compliance for a small audit engagement will likely be different than for a large audit. Audit documentation of compliance, therefore, is also likely to be different.

As we begin to think outside the box in planning, performing and documenting small audits, a CPA firm's quality control document must give the engagement executive the authority to make modifications that are tailored to the nature, size and complexity of a small entity. Our next step is to develop alternative documentation for use on our small audits.

In a December, 2009 article in the Journal of Accountancy entitled "Risk-Based Audit Best Practices" by Michael Ramos, CPA (a must read for all auditors!), this statement stands out:

"Once thought to be the purview of only the largest firms, growing numbers of audit firms are developing a more customized, firm-specific set of audit practice aids by creating their own forms or checklists for highly judgmental areas such as the documentation of internal controls."

Particularly on small audits, auditors can no longer afford to simply use all the practice aids of a major publisher! There are many ways to comply with quality control and auditing standards. Common sense and analytical thinking has always been a key to performing high-quality, highly-efficient audits and it still is today! With the increasing standards overload, CPA firms must begin to plan and use key audit documentation relative to the nature, size and complexity of an entity.

On December 23, 2009 I'm presenting a webcast on CPE Link, co-sponsored by AccountingWEB, entitled "Using Only Key Forms and the Most Efficient Documentation." In this webcast, I'll present an illustrative small audits alternative documentation plan which can be integrated with practice aids of major publishers. Participants in this webcast will receive beta copies of forms under development for my Small Audits Handbook along with written suggestions for their use. This webcast could be an auditor's greatest gift this holiday season! You can register on my instructor's page at www.cpelink.com. I hope to see you there!

Training Outstanding Auditors

Having struggled through college with mediocre grades, it took me decades to realize that my grades didn’t matter much! I learned almost everything I know after college, on the job. Before you click your back arrow, let me correct myself a little. Grades do matter. Good grades demonstrate a student’s diligence, commitment and achievement, and they are necessary to get a good job. They are, however, only the beginning.

Unfortunately, much of our college learning was lost after we took our exams. Most of us had little practical experience in accounting or auditing and we didn’t have many instructors that had any either. Our lack of experience made retention more difficult. When I started my first day on the job in public accounting, a partner told me to use the records he dumped on my desk to perform a “proof of cash.” I sat there for hours, afraid to ask what a proof of cash was! He should have explained but I should have known!

Two years ago I accepted an adjunct professor position at a technical college to teach management accounting. Since the prerequisites were two basic-level accounting courses, I assumed the students knew and understood basic principles of accounting. When they couldn’t define terms like depreciation, accrual-basis, conservatism, and others, I quickly realized my assumption was faulty! These were good students at a good school, most of which had earned and A or B in basic accounting classes! Because of huge volumes of required reading, piles of homework and frequent exams, learning was mostly short-term. Their grades mattered, but not really.

While this scenario is not descriptive of all secondary education, it is similar to many colleges and universities. Practitioners are realizing that most accounting and auditing training for staff personnel has to occur on the job. Since staff persons with as little as six months experience are functioning as in-charge accountant on some small audits, they must be adequately trained and supervised. In my next blog, I’ll discuss some CPA firms’ approaches to training staff personnel. What is your firm doing?

Can Owner/Manager Controls Be Audited?

Many auditors believe that owner or manager controls are unauditable because their performance is usually not documented. Interestingly, new risk assessment standards in 2007 identified inquiries and observations as acceptable procedures for testing controls. For example, obtaining a copy of a bank statement and asking a business owner how she approaches its preliminary review before reconciliation may provide evidence that the assessed level of risk of material misstatements for cash is less than high. This procedure will produce reliable evidence when the integrity of management is high.

An auditor’s evaluation of management’s integrity as high has at least two significant affects on small audits. First, a strong control environment reduces risk at the financial statement level. Lower risk mean less evidence is required to reach a conclusion on the financial statements as whole. Second, high management integrity means higher reliance can be placed on responses to inquiries in tests of key controls, thereby reducing the amount of other substantive evidence necessary at the assertion level.

The answer to the headline question above is yes, owner/manager controls can be audited. Not only are they auditable, selecting and serving clients employing management personnel with good character and high integrity can increase both engagement and firm profits! What has been your experience? Post your comments and questions below.

How Does Management Integrity Affect Audits?

We’ve heard it referred to as the “tone at the top.” The character and behavior of an entity’s management sets the standard for other personnel. Despite elaborate codes of conduct, sanctions and whistle-blowing provisions, employees will follow their leaders. Even when leaders use the “do as I say, not do as I do” philosophy of management, subordinates will do as their leaders do.

From the five elements of internal control developed by the Treadway Commission in the late 1970s, we recognize management’s role as the “control environment.” The control environment of an entity is the backbone of its internal control. The smaller the entity, the more directly management’s practices affect control risk. The existence of key, or entity level, controls performed diligently by an owner or manager can reduce control risk, even when there is limited segregation of duties.

Key controls, like inspecting supporting documents when signing checks, or receiving and reviewing bank statements before a bookkeeper reconciles an account, can provide assurance that misstatements due to error or fraud will not go undetected. In other words, control risk can be less than high!

Based on the assumption management’s integrity is high, the following table demonstrates a good system of internal control for a small entity.

BOOKKEEPER	OFFICE MANAGER	OWNER/MANAGER
RECORDS ACCTS. RECEIVABLE	RECEIVES VENDOR INVOICES	SIGNS CHECKS
RECONCILES PETTY CASH	RECEIVES CASH AND MAIL	PREPARES/REVIEWS DEPOSITS
PRINTS CHECKS	MAILS CHECKS	MAKES BANK TRANSFERS
MAKES GENERAL LEDGER ENTRIES	APPROVES INVOICES	RECEIVES BANK STMT. BEFORE REC.
RECONCILES BANK STATEMENTS	APPROVES PURCHASE ORDERS	APPROVES BANK RECONCILIATIONS
	APPROVES PAYROLL	REVIEWS SALES INVOICES./AGINGS
	DISTRIBUTES PAYROLL	MAKES DEPOSITS
	DISBURSES PETTY CASH

Do you think these controls can be audited? Why or why not? If so, what affect can management's integrity have on a small audit? Post your comments below.

Client Acceptance and Retention Evaluations--the Good, Bad and the Ugly

Over the past year or so, the AICPA has alerted CPA firms to the importance of client acceptance and retention evaluation. As a defense for preventing association with less-than reputable clients and potentially erroneous or fraudulent financial statements, these evaluations are an integral part of the financial statement audit process.

One of the first quality standards formulated by the AICPA, these evaluations were treated as a compliance function by many CPA firms. Practice aids were filled out and signed as a matter of routine, only to be initialed and carried forward for many years simply to comply with the quality control standards. Intended to help CPA firms cull their client portfolio to separate out the bad and the ugly, the process resulted in little more than a few extra pieces of paper in working paper files.

One of my business partners decades ago, Don Istvan, was a practice management consultant for hundreds of smaller CPA firms. The starting place for most of his consulting engagements was a required evaluation of a CPA firm’s clients. After completing a questionnaire evaluating client quality, CPA firm partners and managers assigned points to favorable attributes of each of their clients. The point awards were placed on a spreadsheet in descending order to help identify the bad and the ugly. One of Don’s first recommendations was to terminate 10% of the clients ranking the lowest. His second recommendation was usually to complete a similar evaluation for prospective clients and to accept only those with point awards higher than the previous year’s terminations. The results of this process over the years produced client portfolios of the highest quality for Don’s clients.

AICPA quality control standards were intended to accomplish the same end. In our current unstable economic environment, the client acceptance and retention evaluation is still the key to producing a high-quality client portfolio. It may also be the key to our survival!

What do you think about these required evaluations? Are they serving their purpose in your CPA firm or do they simply add more paper to engagements? Please post your comments.

How Do Ethics Rules Affect Our Audits?

I’m sure most of us would answer that we must comply with the AICPA Code of Professional Conduct and the rules of applicable state boards of accountancy in all functional areas of practice. A quick read of the disciplinary actions reported at www.aicpa.org, however, indicates not everyone understands the rules!

Some practitioners forgot requirements like we have to know what we’re doing when we engage to audit, we have to understand accounting principles and we can’t audit our own non-attest services. In the current economic environment, threats to our noncompliance with ethical requirements increase exponentially.

In 2008, the AICPA issued a Conceptual Framework for AICPA Independence Standards and a Guide for Complying with Rules 102-505. These pronouncements establish a framework for evaluating noncompliance with ethical rules. Among seven threats to impairment of independence, and to noncompliance with other ethical rules, is the familiarity threat. Members having a close or longstanding relationship with a client, the pronouncements indicate, may have an increased threat to violation of ethical rules.

While there are professional, client and CPA firm safeguards that may be implemented to eliminate or mitigate the threats, CPAs auditing smaller entities may be more at risk. The Framework and Guide will not only be used to evaluate our compliance with ethical rules, they will be the tools plaintiff’s attorneys use against us in adversarial actions! Discussions of the risk of potential violations of ethical standards due to client familiarity should be part of ongoing engagement planning on every audit.

The Foundation for Audit Documentation

Underpinning the small audit documentation outlined in my last blog, a CPA firm’s operating philosophies can contribute significantly to engagement efficiency. First on the list is the involvement of leadership on engagements.

Involvement on audit engagements for many CPA firm partners or sole proprietors is often limited to a brief meeting with staff personnel before the engagement begins and a review of the working papers and report after the engagement is finished. While this may limit the executive’s time charges on an audit, it also limits the opportunities to train personnel, to set the tone at the top, to ensure audit quality and to deal with engagement problems throughout the job. Limited executive participation usually results in increased time charges during the wrap-up phase to clean up review points and resolve problems after the fieldwork is finished.

Auditing standards now require participation of the top line authority in planning meetings on all audit engagements. Many executives also require in-charge accountants to communicate the status and problems of engagements throughout the performance phase. Some executives perform their engagement reviews in stages to avoid last minute problems. The result of all these practices is that engagement problems are dealt with early and engagement procedures are done correctly the first time! On large or small audits, much wasted time is eliminated and higher profitability is achieved when executives are involved in all phases of engagements.

Small Audit Documentation that Satisfies SASs

For all audit engagements, documentation must evidence compliance with the requirements of applicable SASs. Because SASs are written to be applicable audit engagements of all sizes, compliance for a small audit will likely be different than for a large audit. Audit documentation of compliance, therefore, is also likely to be different.

Here is a list of annual “key” documentation that will support most small audit strategies:

• Client acceptance and retention evaluations
• General ledger analysis worksheet
• Small audit internal control questionnaire, flowcharts or memos by financial statement classification
• Systems walk-through memo or other documentation
• Analytical procedures worksheets for engagement planning and review
• Risk of material misstatements evaluation by financial statements classification
• Linking working paper to guide the selection of tests of controls and tests of balances procedures based on risk
• Tolerable misstatements calculation by financial statements classification
• Sampling and non-sampling decisions worksheet
• Audit planning document summarizing audit strategies
• Small audit programs tailored for audit risk

Future blogs will discuss the impact of a CPA firm’s quality control, preparation of this documentation, formulation of audit strategies and related opportunities for efficiencies. Visit us often!

The Root of Audit Requirements and Documentation

There is good news and bad news. First, the good news: for over two decades, publishers of auditing practice aids have supplied us with forms, checklists and programs to comply with existing professional standards. The bad news: the volumes of accounting and auditing pronouncements have increased exponentially causing huge stacks of paper or long lists of electronic forms for even the smallest audits.

When the new audit risk assessment standards were effective in 2007, the length and number of audit practice aids from most publishers increased substantially. Because it became very difficult to determine which documentation was required to comply with the new standards, conservatism ruled and many auditors used all the practice aids available. Audit quality was good but budget overrun was high!

Here is a foundational principle of audit efficiency. The root of audit requirements is not the practice aids purchased from a provider. Audit requirements for non-public and non-profit entities are rooted in the Statements on Auditing Standards (SASs) published by the Auditing Standards Board of the AICPA. Audit efficiency begins with choosing documentation that, first, satisfies the applicable requirements in SASs and, second, is the most efficient considering engagement circumstances. Watch for examples in future blogs on this site.

Achieving Small Audit Efficiency

Welcome to the first of many practical blogs dedicated to maximizing profitability on small audits. Normally you’ll find one or two blogs here each week which will be progressive in their order. In other words, foundational subjects will be presented first with applications discussed later in the series. If you miss a few days, be sure to catch up before reading the most current blogs. Plan to visit often.

It may seem that putting the word “efficiency” in the same sentence as the word “audit” seems like an oxymoron. Given the costly explosion of professional standards’ in recent years, it’s not surprising that many smaller CPA firms have given up their audit practices. The truth is, however, we can still make money on small audits!

Here’s the key: To maximize efficiency on small audits, every planning and performance decision must emphasize efficiency. I call this the “Ten-Minute Rule.” Taking advantage of every opportunity to save 5 or 10 minutes can result in huge overall engagement time savings! Read this blog often to accumulate your list of time savers!

For questions and consultations regarding all accounting and auditing issues, please visit our website, www.cpafirmsupport.com and check out our Subscription Plan.

Strategies for Small Audits

Many firms are realizing that profitability on small audits can’t always be obtained by utilizing the “one-size-fits-all” practice aids purchased from major publishers. Profitable small audits require unique engagement strategies.

An audit strategy for small audits that includes compliance with generally accepted auditing standards and that, at the same time, maximizes engagement profitability will normally include the following components:

• Making and responding to client acceptance and retention evaluations.
• Completing only core planning practice aids.
• Reading the client’s general ledger account activity to provide low-cost substantive evidence and risk-assessment procedures.
• Preparing internal control flowcharts and memos that can be carried forward.
• Performing systems walk-procedures to reduce the assessed risk of material misstatement.
• Performing maximum analytical procedures during planning, engagement performance and engagement review to reduce detailed tests of balances.
• Performing only necessary tests of control and tests of balances procedures.
• Determining tolerable misstatement by financial statement classification to minimize auditing procedures.
• Making decisions not to sample to save time.
• Completing a planning document to facilitate planning meetings and the audit team leader’s involvement.
  
  

My Small Audits Documentation Manual is being built around these strategies and should be available later this fall. In the intervening months, I’ll be sharing the contents of the Manual with our subscribers. Please visit our website, www.cpafirmsupport.com, to learn more about our Subscription Plan.

Larry Perry, CPA

Small Audits Made Easy and Profitable

Can small audits be profitable? Some practitioners think this question is an oxymoron, i.e., that the word profitable can’t be applied to small audits! My experience has shown otherwise.

Over 20 years ago I authored a Small Business Audit Manual that was designed to comply with the requirements of existing professional standards and, at the same time, minimize engagement time charges. Many smaller CPA firms have used the operating philosophies in that manual to achieve profitability on small audits for decades. Here, in a nutshell, are some of those operating philosophies:

• Involving leadership throughout engagements to establish and communicate the “tone at the top.”
• Meeting personal and firm ethical requirements.
• Accepting and serving high-quality clients.
• Hiring outstanding staff persons.
• Maximizing the benefits of CPE and on-the-job training for staff personnel.
• Assigning the right people to engagements.
• Providing the right level of supervision for engagement personnel.
• Planning, assessing risk and performing engagement procedures to produce the optimum mix of quality and profitability.
• Monitoring quality control for engagements and firm administration.
  
  

Over the next few months, our subscribers at www.cpafirmsupport.com will received detailed information on each of these operating philosophies.