Chapter 16

Auditing Governments and Not-For-Profit Organizations

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Learning Objectives

• Auditing Government & Not-for-Profit vs. Business • Types of audits that governments conduct• Standards of government audits• Role of “Yellow-Book” in governmental auditing• Single Audit Act (A-133)• Auditor reports• Performance audits

-Characteristics-Key elements

• Ethical issues facing governmental and not-for-profit accountants and auditors.

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Why are Audits of Governments Important?

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GOVERNMENT ACCOUNTABILITY

For the COLLECTION and EXPENDITURES of:

OTHER PEOPLE’S MONEY (TAXES)

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State and local governments are a substantial part of the U.S. economy

• Based on the 2012 census there are 89,004 local governments in the U.S.

• In 2011, federal and state governments account foro 13.6% of 2011 U. S. GDP (2011, U.S. Bureau of Economic

Analysis)o 16.8% of paid employment (2011,U.S. Bureau of Labor

Statistics)

• Expenditures of state and local governments were over $2.1 trillion (2011, U.S. Bureau of Economic Analysis) – 14.1% of the 2011 U.S. GDP ($ 15.094 trillion)

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Important Concepts

Understand very clearly what is meant by • generally accepted government auditing

standards (GAGAS), • the source of GAGAS, and • why GAGAS are much broader than GAAS,

in particular for financial audits and performance audits

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Overview: AuditsGovernments & Not-For-Profits Vs. Business• Audit:

-“examination of records or accounts for accuracy.”

• Business sector audits: -characterized by attest function (i.e. “to affirm to be correct, true, or genuine.”)

• Government/Not-for-Profit sector audits: -Auditors not only “attest” BUT also independently

evaluate. -Auditors assess whether auditees have achieved the

objectives.

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Types of Audits

Government Auditing Standards (2011) characterize government audits into three categories:

• Financial Audits: determines if financial statements are in accordance with GAAP.

• Attestation engagements: Examine, review, perform agreed-upon procedures

• Performance Audits: o Effectiveness of internal controlso Effective usage of entity’s resources (Efficiency)o Verifying that organization is complying with the terms of

laws, grants, and contracts. o Provide guidance on how the organization can improve

GAGAS standards place much more emphasis on compliance with laws and regulations than do GAAS

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GAGAS --Yellow Book

Generally Accepted Government Auditing Standards (GAGAS)

Issued by the Government Accountability Office (GAO).• Prescribes accounting standards and practices for ALL

federal agencies (as required by law, regulation, agreement, contract, or policy)

• Mirror GAAS in discussion of:oAuditor’s professional qualificationsoQuality of audit effort,oCharacteristics of

professional/meaningful

audit reports

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Generally Accepted Government Auditing Standards (GAGAS)

• Contains a total of 32 standards for both financial and performance audits

• Required of auditors in a Single Audit

• Government auditing standards are divided into:

oGeneral standards

oField work standards

oReporting standards Gra

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Generally Accepted Government Auditing Standards (GAGAS) Broader than GAAS:

This gives an overview of the breadth and depth of GAGAS.

Financial Audits

AttestationEngagements

Performance Audits

GAAS GAGAS GAAS GAGAS GAAS GAGAS

General Standards

3 4 5 5 0 4

Field Work Standards

3 5 2 7 0 4

Reporting Standards

4 11 4 9 0 4

Totals 10 20 11 21 0 12

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GAAS v/s GAGAS

• General

-Training and Proficiency

• Independence• Due Care

• General

-Qualifications:o Professional Proficiencyo Knowledge of

government programso CPE requirements

• Independence• Due Professional Care• Quality Control G

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Generally Accepted Government Auditing Standards (GAGAS)

• Professional competence requires auditors to have:

o A thorough knowledge of governmental auditing and the specific or unique environment in which the audited entity operates

o At least 80 hours of CE (CPE) every two years, of which at least 20 hours must be completed in each of the two years and at least 24 hours of which must be related directly to the audit environment

• Peer Review: has to be done at least once in 3 years.

• Compliance and Internal Controls: reasonable assurance in detecting fraud or misstatements (required by AICPA and GAO)

• Public Availability: audit reports are available for public inspection

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GAAS v/s GAGAS

Field Work• Adequate planning and

supervision• Evaluate internal control• Obtain competent

evidence

Field Work• Adequate planning and

supervision• Evaluate internal control• Obtain competent

evidence• Supplemental Standards:o Planning – consideration of

government programso Compliance testing G

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GAAS v/s GAGAS

Reporting• Adherence to GAAP• Consistent application• Adequate disclosure• Expression of opinion

Reporting• Adherence to GAAP• Consistent application• Adequate disclosure• Expression of opinion• Report distribution not

restricted• “In accordance with

GAAS and GAGAS”• Report on compliance

and internal control

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Reporting Requirements

• Must state compliance with GAGAS in the report when required to follow GAGAS, or representing to others that the audit followed GAGAS requirements.

• “We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our finding and conclusions based on our audit objectives.”

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GAO’S WEBSITEwww.gao.gov

Total grant awards 2011 - $607 Billion

http://www.cbo.gov/publication/43967

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Single Audit Act of 1984• Administered by the Office of Management and Budget

(OMB).• Replaces a multitude of grant-by-grant audits with a single,

comprehensive, entity-wide audit.

o Intended (among other purposes) to improve the efficiency and effectiveness of governmental audit effort

• OMB Circular A-133 and the related Compliance Supplement provide implementing guidance.

• Federal agencies must agree to this process.

• Applies to both direct and indirect recipients of federal $$$

• $500,000 (1996 amendment) initiation threshold (multiple awards).

• Higher education, state/local governments, and other not-for-profit entities (1996 amendment)

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Single Audit (Cont’d)

• Two main components: o Audit conducted under GAGASo Compliance Audit of federal financial awards/major programs

(Single Audit component)

• Understand the characteristics of a single audit, including:o the purposeowhich entities must have a single auditowhat auditing work is requiredohow major programs are selected for auditowhat reports must be rendered, when, and to whom

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Single Audit: Key Requirements

• Annual audit of financial statements conducted by an independent auditor encompassing the entity’s financial statements and schedule of expenditures of federal awards.

• Fair presentation of financial statements and the schedule of federal financial awards is presented fairly in relation to the financial statements.

• Study and evaluation of internal controls --understanding of compliance requirements by major program.

• Assess control risk and structure control tests accordingly.

• Federal and nonfederal “Pass-through” agencies are assigned certain responsibilities for compliance

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Federal Single Audit• Entity receives funding under a federal grant or

allocation (CDBG, Student Financial Aid, etc.)• Greater than $500,000 must have “single audit” or

program-specific audit.• Implemented in 1984 – “Single Audit Act” ; OMB

Circular A-133 contains requirements.• Standardized audit requirements pertaining to the

federal assistance.• Organization-wide financial and compliance audit.o Financial component of audit - basically the same as non-

federal audit; includes the financial statements and accompanying notes.

o Compliance component – tests of compliance with applicable laws and regulations.

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Federal Programs: Compliance RequirementsFourteen compliance requirements:

1. Activities allowed or unallowed

2. Allowable costs/cost principles

3. Cash management

4. Davis-Bacon Act

5. Eligibility

6. Equipment and real property management

7. Matching, level of effort, earmarking

8. Period of availability of funds

9. Procurement and suspension and debarment

10. Program income

11. Real property acquisition and relocation assistance

12. Reporting

13. Sub-recipient monitoring

14. Special tests and provisionsSource: Adapted from OMB Circular A-133 Compliance Supplement, 2012.

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GAAS - GAGAS Single Audit Relationships

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FOR “MAJOR PROGRAMS”

-Internal Control Audit-Compliance Audit with Laws and Regulations

-Schedule of Questioned Costs

Single Audit

-General Internal Control Audit-General Compliance Audit with Laws and Regulations

GAGAS

-Financial Audits

GAAS

GAGAS Incorporates GAAS – and includes additional requirementsSingle Audit Incorporates GAGAS – and includes additional requirements

Single Audit Act – “Expended”• Requires organizations expending more than

$500,000 in federal assistance under more than one program be subject to single audit.

• Key task is determining when funds were expended.• Federal award is expended - Basic rule is:

o When the federal agency has become at risk, ando The nonfederal recipient has a duty of accountability.

• Recipient of funds has to deal only with a single agency (referred to as Cognizant Agency).

--All federal awarding agencies are required to accept the single audit reports as satisfying their program’s audit requirements

• Complex, as it isn’t a simple reflection of grants awarded in a fiscal year.

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Single Audit Act and OMB Circular A-133

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Did the nonfederal entity expend $500,000 or more of federal awards?

No Single Audit or Program Specific Audit required--only GAAS and GAGAS Audit required.

A program-specific audit is required.

Did the nonfederal entity1) expend federal awards under only one federal program--which did not require a financial statement audit,2) meet other requirements, and 3) properly elect a program specific audit?

A Single Audit is required.

Yes

Yes

No

No

Single Audits: Four Reports Produced1) Opinion on the Financial Statements and on the Schedule of

Expenditures of Federal Awards• The schedule includes a list of total expenditures of the organization• Proper categorization of expenses

2) Report on Compliance and on Internal Control over Financial Reporting• Directed towards the basic financial statements• Based on audit requirements of Governmental Auditing Standards• Include any material weaknesses in the controls

3) Report on Compliance with Requirements of “Major Programs”• Explain the nature of the examination • Auditors express an opinion • Include any “ reportable conditions”

4) Schedule of Findings and Questionable Costs• Most distinctive and informative• Summary of the results• Describe reportable conditions• Include findings pertaining to major programs

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Types of Audits: Financial

• The purpose is to perform an independent assessment of and to provide reasonable assurance about whether an entity’s reported financial condition, results, and use of resources are presented fairly (in accordance with recognized criteria)

• GAGAS financial reports include reports on:o internal controlocompliance with laws and regulations, and the

terms and provisions of contracts/grants

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Internal Control Audit• Assess internal control system components for

adequacy and effectiveness – can it provide reasonable assurance of:o Achieving effective and efficient operations;o Reliable financial and performance reporting; ando Compliance with laws and regulations.

• Extremely relevant to government procurement officials for determining organizational capability for successful performance of government contract effort.

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Compliance Audits• Assess compliance with

o established laws;o regulations;o contract provisions;o grant agreements; ando other requirements

• To assess the direct or indirect impact on theo acquisition;o protection;o use; ando disposition of the entity’s resources oro quantity;o quality;o timeliness; ando cost of services that the entity produces and delivers.

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Single Audit:Compliance Component for “Major Programs”

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Compliance Audits ofFederal Financial Awards/Major Programs

For each “Major Program” the auditor must test whether the program:

• was administered in conformity with the appropriate OMB Circular (A-102 or A-110)

• complied with detailed requirements in the A-133 Compliance Circular and other specified requirements.

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• Using a sliding scale identify “Type A” and “Type B” programs

• Identify low-risk programs (based on no audit findings in most recent audit and absence of certain risk factors)

• Assess risk of Type B programs (major programs that are not Type A programs)

• At a minimum, audit all high risk Type A programs and either

(1) half of the high-risk Type B programs or

(2) one high-risk Type B program for each low-risk Type A program

• Audit at least enough major programs to ensure that at least 50% of total federal award expenditures are audited

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Selection of “Major Programs”

Risk-Based ApproachStep 1:Identify (larger) Type A Programs

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Step 4:Select for audit as major programs a minimum of all Type ‘A programs not identified as “low-risk” in Step 2, plus certain “high-risk” Type B programs.

Step 3:Identify “high-risk” Type B programs

Step 2:Identify “low-risk” Type A programs

Key Audit Procedures

• Identify compliance requirements

• Plan the engagement

• Assess internal control

• Obtain sufficient evidence

• Consider subsequent events

• Evaluate and report on noncompliance

• Follow-up procedure

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Performance Audits• NOT required by Single Audit• Performance audits carried out on specific programs• Carried out by “internal” audit departments• Focus on organizational accomplishments• General standards are common to both financial and performance audits• Auditors make independent assessments• Conducted irregularly• Broader range of evidence• Each performance audit is unique• Requires more program-specific knowledge

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Steps in Conducting Performance Audit

• Selecting the audit target

• Establishing scope and purpose

• Discerning the objectives

• Scheduling disbursements

• Assessing management controls

• Preparing a written audit plan

• Gathering evidence

• Reporting the results

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Additional Topics: Ethical Issues

Governments and to a lesser extent not-for-profits have characteristics that present their employees with ethical decisions that are different from those faced by employees of businesses. These are:• Public expectations• Guardians of public funds (OPM)• Activities carried out in open view• Special powers• Conflicting loyalties

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• Auditors add value to information by being independent and conforming to professional auditing standards (GAAS or GAGAS)

• GAGAS are broader than GAAS in that they include standards for financial and performance audits established by the government through the GAO’s Yellow book.

• Under the Single Audit Act, GAGAS has to be adhered to in all audits of both governments and not-for-profit organizations. However, the Single audit requires only financial audits.

• Single audits comprise of 2 elements: an audit of financial statements and an audit of federal financial awards that follows the provisions of OMB Circular A-133.

• The single audit improves both the efficiency and effectiveness of audits of nonfederal entities with significant expenditures of federal award.

• Performance audits differ in concept from financial audits. It makes assessments about an entity’s programs. They are an important supplement to conventional financial audits.

• Government accountants and auditors face ethical dilemmas similar to those in the private sector which they must resolve in the face of public expectations and as guardians of public funds.

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Summary