Auditing Special Purpose Frameworks—Part 2

Planning an Audit

AU-C Section 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards, paragraph 20, http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-00200.pdf, requires an auditor to comply with all applicable AU-C sections when performing an audit.  AU-C Section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatements, paragraph 12c, http://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AU-C-00315.pdf, requires the auditor to obtain an understanding of an entity’s selection and application of accounting policies.  These requirements apply to all financial reporting frameworks, including special purpose frameworks.

This series of blogs will focus both on general audit requirements applicable to all financial reporting frameworks, as well as specific requirements relevant to two special purpose frameworks, the income tax basis and the AICPA’s FRF for SMEs basis.  Because an auditor is required to understand the applicable financial reporting framework used by an entity as part of engagement planning, summaries of the basic accounting policies for these two special purpose frameworks will be presented to illustrate the first step of the planning process.  These part includes some of the significant tax basis policies which are summarized below.

Summary of Some Basic Principles for the Tax Basis of Accounting

Account classification	aCCOUNTING POLICIES
1. Accounts Receivable	1. The specific charge-off method is required uncollectible trade and notes receivable.  Uncollectible balances are charged to bad debt expense when they are considered worthless, ordinarily when no more collection efforts are possible.
2. Inventories	2. Inventories are generally valued at cost using the lower of cost or market method or the retail method.  Most cost flow methods can be used with a reasonable allocation of manufacturing overhead to inventories.  Losses are recognized when incurred.
3. Investments	3. The cost basis is used for investments in equity and debt securities.  Dividends are included in income when received and the equity method is not permitted.
4. Prepaid expenses	4. Advance payments of expenses generally are deductible in the period to which they apply unless the related services will be consumed within 12 months of the date of payment or within the next tax year.

More accounting policies for the income tax basis of accounting will be presented in the next part.  Since this series will cover all commonly applicable requirements of the auditing standards applicable to all financial reporting frameworks, with emphasis on special purpose frameworks, the materials will be useful for reference.  Storing each of the blogs in electronic or hardcopy format will facilitate their use as non-authoritative, practical guidance for auditing engagements.  Some practitioners may also find them useful for internal discussions or training within their CPA firms. As you read along with me through this series, I invite your questions and comments, either in the comment box or directed to my personal email address, larry@cpafirmsupport.com.  Thank you for joining me in this blog experience!

Auditing Special Purpose Frameworks--Part 1

Section AU-C 800 of the AICPA Professional Standards includes the Clarified Auditing Standard, Special Consideration—Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks.  Special purpose frameworks (SPF) include:

• Cash or modified cash basis
• Tax basis
• Regulatory basis
• Contractual basis
• AICPA’s FRF for SMEs
• Other commonly accepted basis of accounting

 This series of blogs will discuss special considerations concerning:

• Engagement acceptance.
• The planning and performance phase of this type of engagement.
• Determining an opinion and reporting on the audit.

 Engagement Acceptance

This standard references the clarified SAS, Terms of Engagement, which requires and auditor to evaluate the appropriateness of an entity’s applicable financial reporting framework.  For special purpose frameworks, this requires an auditor to consider the purpose for which the financial statements are prepared, the known users of the financial statements and what management has done to determine the applicable reporting framework is appropriate for these circumstances.

In an engagement letter, the auditor should obtain management’s agreement that it is responsible for all providing all informative disclosures (a fair presentation framework) in the financial statements and footnotes applicable to the financial reporting framework it has decided to use (its applicable reporting framework).  Among those disclosures are:

• A description of the SPF, its significant accounting policies and the main differences from U.S. GAAP.
• Informative disclosures similar to those required by U.S. GAAP.
• Contractual frameworks, in addition, would include any significant interpretations of the contract used in preparing the financial statements.
• Any additional disclosures necessary to comply with the requirements for a fair presentation framework in the clarified auditing standards.

 The client acceptance and continuance decision-making requirements originated in the quality control standards first published in the 1980’s and are now required by current auditing standards.  Obtaining and documenting relevant organizational, environmental and operating information as a part of engagement acceptance or continuance is, of course, a condition precedent to obtaining an engagement letter and planning an engagement.  

As for audits of any framework, the engagement leader (sole practitioner or partner) should deliver and discuss the engagement letter contents, along with other engagement planning subjects, with the management or governance person of the reporting entity that has engaged the CPA firm.  Performing a client acceptance and continuance evaluation and delivering an engagement letter are often the first steps for compliance with the leadership involvement requirements of the AICPA’s Statement of Quality Control Standards No. 8.

My next blog will begin discussing considerations for planning and performing an audit of a special purpose framework.