Illegal Act

8/20/2019 Illegal Act

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Auditing 3 Becker Professional Education | CPA Exam Review

I L L E G A L A C T S

The AICPA has stated that it will test both the Clarified SASs and the "old" SASs on the Auditing exam starting

on July 1, 2013. The AICPA has not given a definitive time period for this dual-testing, but has stated that

it will continue until the Clarified SASs fully replace the old SASs (most likely at the end of 2014). The good

news is that Becker is well-positioned to prepare you for the Auditing exam during this period of transition

from the old SASs to the Clarified SASs. This Audit B textbook (Clarified SASs), is essentially the Audit A

textbook (old SASs) with enhancements to cover the new/clarified provisions of the Clarified SASs. This new

section has been added to your Audit 3 lecture to cover illegal acts. The concept of illegal acts has been

replaced by the broader concept of compliance with laws and regulations in the Clarified SASs. However, you

may still see questions related to illegal acts on your Audit Exam. If you would like to print out this new topic,

please go to 2013 Edition course updates for the Audit B textbook available at http://beckerkb.custhelp.com.

I. ILLEGAL ACTS BY CLIENTS

A. Illegal Acts Defined

Illegal acts are violations of laws or governmental regulations committed by the entity or by

company personnel acting on behalf of the entity.

B. Auditor's Responsibility to Detect Illegal Acts

1. Direct Effect on Financial Statements

The auditor's responsibility to detect illegal acts that have a material and direct effect on

financial statements is the same as that for errors and fraud. In other words, the auditor

has a responsibility to plan and perform the audit to obtain reasonable assurance that the

financial statements are free of material misstatement.

2. Indirect Effect on Financial Statements

The auditor is under no obligation to look for illegal acts having an indirect effect on the

financial statements. However, if specific information comes to the auditor's attention

concerning illegal acts, the auditor should apply appropriate audit procedures.

Generally, the less the act affects the financial statements, the less likely it is that the auditor

will discover it.

C. Audit Procedures

The auditor generally does not include procedures specifically to detect illegal acts, but may

discover such acts through other procedures, such as reading minutes or making inquiries of

management or of legal counsel. Information that may be indicative of illegal acts includes:

1. Unauthorized or improperly recorded transactions;

2. Payments of unusual fines or penalties;

3. Payments that are unusually large or excessive, especially those made in cash;

4. Unexplained payments, or payments for unspecified services;

5. Investigations by governmental agencies, or known violations of laws or regulations; and

6. Failure to file tax returns or pay other appropriate fees.

Illegal Acts


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U . S . A U D I T I N G S T A N D A R D S V S . I N T E R N A T I O N A L S T A N D A R D S O N A U D I T I N G

ISA 250 does not distinguish between laws and regulations that have a direct versus an indirect effect on the financial

statements, but instead states that the auditor should recognize that noncompliance with laws and regulations may

materially affect the financial statements. ISA 250 states that laws and regulations vary considerably in relation to the

financial statements and that the auditor is less likely to become aware of noncompliance that is far removed from

the financial statements.

D. Auditor's Response to Illegal Acts

1. Possible Illegal Acts

When the auditor becomes aware of information concerning a possible illegal act, the

auditor should:

a. Obtain an understanding of the nature of the act and its effect on the financial

statements;

b. Inquire of management at a level above those involved;

c. Consult the client's legal counsel about the application of relevant laws andregulations to the circumstances; and

d. Apply additional audit procedures, if necessary.

2. Detected Illegal Acts

When the auditor concludes that an illegal act has occurred, the auditor should:

a. Consider the effects of the illegal act on the financial statements;

b. Evaluate the materiality of the illegal act, considering both quantitative and

qualitative factors;

c. Evaluate the disclosure of loss contingencies, including possible fines, penalties,

and damages;

d. Consider the implications for other areas of the audit; and

e. Communicate the illegal act to those charged with governance.

E. Effect of Illegal Acts on the Auditor's Report

1. Departure from GAAP

If the auditor concludes that a material illegal act exists and that it has not been properly

accounted for or disclosed, the auditor should insist that the financial statements be

revised. If the client refuses, a qualified opinion or adverse opinion should be issued

with full disclosure of the matter.

2. Insufficient Evidence

If the auditor is precluded from obtaining sufficient appropriate audit evidence about the

illegal act, generally a disclaimer of opinion should be issued.

3. Client Response

If the client refuses to accept the auditor's report as modified, the auditor should withdraw

from the engagement and notify those charged with governance in writing.


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Auditing 3 Becker Professional Education | CPA Exam Review

F. Implications of Illegal Acts

The auditor should consider the effect of illegal acts on the evaluation of internal control and

on the planned degree of reliance on management representations. If the client fails to take

appropriate remedial action regarding any illegal act (including those that are not material),

the auditor may consider withdrawing from the engagement.

G. Communication of Illegal Acts

1. Those Charged with Governance

Those charged with governance should be adequately informed of illegal acts unless

they are clearly inconsequential. Such communication may be oral or written, but oral

communications should be documented.

2. Parties Outside the Entity

Ordinarily, the disclosure of illegal acts to parties other than senior management and

those charged with governance is not part of the auditor's responsibility. However, in

certain circumstances, a duty to disclose outside the entity may exist.

a. To comply with certain legal and regulatory requirements, such as on Form 8-Kand on reports required by the Private Securities Litigation Reform Act of 1995;

(1) Under the Private Securities Litigation Reform Act of 1995, if an auditor reports

an illegal act to the board of directors of a client, and if the client fails to take

appropriate remedial action and the board fails to inform the SEC of this fact,

then the auditor is required to deliver a report concerning the illegal act to the

SEC within one business day.

b. To a successor auditor when the successor makes inquiries of the predecessor

auditor, with specific permission of the client;

c. In response to a subpoena; and

d. To a funding agency or other specified agency in accordance with requirementsfor audits of entities that receive governmental financial assistance.

Documents

Illegal Act