Prepared by Craig L. Greene, CPA/CFF, CFE, MCJ

 

Purpose of Governmental Auditing Standards

Governmental Auditing Standards are currently contained in the publication referred to as the "Yellow Book." The Yellow Book contains standards for audits of government organizations, programs, activities, and functions, and of government assistance received by contractors, non-profit organizations, and other non-government organizations. These standards often referred to as generally accepted government auditing standards ("GAGAS"), are to be followed by auditors and audit organizations when required by law, regulation, agreement, contract, or policy. The standards pertain to auditor's professional qualifications, the quality of audit effort, and the characteristics of professional and meaningful audit reports.

 

Field Work Standards for Financial Audits

The field work standards discussing fraud are similar to those promulgated by the AICPA prior to the release of SAS No. 82, Consideration of Fraud in a Financial Statement Audit.

Irregularities, Illegal Acts, and Other Noncompliance

GAGAS require the following:

• Auditors should design the audit to provide reasonable assurance of detecting irregularities that are material to the financial statements.

• Auditors should design the audit to provide reasonable assurance of detecting material misstatements resulting from direct and material illegal acts.

• Auditors should be aware of the possibility that indirect illegal acts may have occurred. If specific information comes to the auditor's attention that provides evidence concerning the existence of possible illegal acts that could have a material indirect effect on the financial statements, the auditors should apply audit procedures specifically directed to ascertaining whether an illegal act has occurred.

 

An additional compliance standard for financial statement audits is:

•Auditors should design the audit to provide reasonable assurance of detecting material misstatements resulting from noncompliance with provisions of contracts or grant agreements that have a material effect on the determination of financial statement amounts. If specific information comes to the auditor's attention that provides evidence concerning the existence of possible noncompliance that could have a material indirect effect on the financial statements, auditors should apply audit procedures specifically directed to ascertaining whether that noncompliance has occurred.

 

Auditors' Understanding of Possible Irregularities and of Laws and Regulations

GAGAS states that auditors are responsible for being aware of the characteristics and types of potentially material irregularities that could be associated with the area being audited so they can plan the audit to provide reasonable assurance of detecting material irregularities. 

Due Care Concerning Possible Irregularities and Illegal Acts

Auditors should exercise due professional care in pursuing indications of possible irregularities and illegal acts so as not to interfere with potential future investigations, legal proceedings, or both. Under some circumstances, laws, regulations, or policies may require auditors to report indications of certain types of irregularities to law enforcement or investigatory authorities before extending audit steps and procedures. Auditors may withdraw or defer further work on the audit or a portion of the audit in order not to interfere with an investigation.

An audit made in accordance with GAGAS will not guarantee the discovery of illegal acts or contingent liabilities resulting from them. Nor does the subsequent discovery of illegal acts committed during the audit period necessarily mean that the auditor's performance was inadequate, provided the audit was made in accordance with these standards.

 

Reporting Standards for Financial Audits

Irregularities, Illegal Acts and Other Noncompliance

When auditors conclude, based on evidence obtain, that an irregularity or illegal act either has occurred or is likely to have occurred, they should report relevant information. Auditors need not report information about an irregularity or illegal act that is clearly inconsequential. Thus, auditors should present in a report the same irregularities and illegal acts that they report to audit committees under AICPA standards.

In reporting material irregularities, illegal acts, or other noncompliance, the auditors should place their findings in proper perspective. To give the reader a basis for judging the prevalence and consequences of these conditions, the instances identified should be related to the universe or the number of cases examined and is quantified in terms of dollar value, if appropriate. In presenting material irregularities, illegal acts, or other noncompliance auditors should look to Chapter 7 of Government Auditing Standards' report contents standards for objectives, scope, and methodology; audit results; views of responsible officials; and its report presentation standards, as appropriate. Auditors may provide less extensive disclosure of irregularities that are not material in either quantitative or qualitative sense.

When auditors' detect irregularities, illegal acts, or other noncompliance that do not meet the criteria above for reporting, they should communicate those findings to the auditee, preferably in writing. If auditors have communicated those findings in a management letter to top management, they should refer to that management letter when they report on compliance. Auditors should document in their working papers all communications to the auditee about irregularities, illegal acts, and other noncompliance.

Direct Reporting of Irregularities and Illegal Acts

GAGAS require auditors to report irregularities or illegal acts directly to parties outside the auditee in two circumstances, as discussed below. These requirements are in addition to any legal requirements for direct reporting of irregularities or illegal acts. Auditors should meet these requirements even if they have resigned or been dismissed from the audit.

The auditee may be required by law or regulation to report certain irregularities or illegal acts to specified external parties (for example, to a federal inspector general or a state attorney general). If auditors have communicated such irregularities or illegal acts to the auditee, and it fails to report them, then the auditors should communicate their awareness of that failure to the auditee's governing body. If the auditee does not make the required report as soon as practicable after the auditor's communication with its governing body, then the auditors should report the irregularities or illegal acts directly to the external party specified in the law or regulation.

Management is responsible for taking timely and appropriate steps to remedy irregularities or illegal acts that the auditors report to it. When an irregularity or illegal act involves assistance received directly or indirectly from a governmental agency, auditors may have a duty to report it directly if management fails to take remedial steps. If auditors conclude that such failure is likely to cause them to depart from the standard report on the financial statements or resign from the audit, then they should communicate that conclusion to the auditee's governing body. Then, if the auditee does not report the irregularity or illegal act as soon as practicable to the entity that provided the government assistance, the auditors should report the irregularity or illegal act directly to that entity.

In both of these situations, auditors should obtain sufficient, competent, and relevant evidence (for example, by confirmation with outside parties) to corroborate assertions by management that it has unable to do so, then the auditors should report the irregularities or illegal acts directly as discussed above.

Finally, GAS reminds auditors that under some circumstances, laws, regulations, or policies may require them to report promptly indications of certain types of irregularities or illegal acts to law enforcement or investigatory authorities. When auditors conclude that this type of irregularity or illegal act either has occurred or is likely to have occurred, they should ask those authorities and/or legal counsel if reporting certain information about that irregularity or illegal act would compromise investigative or legal proceedings. Auditors should limit their reporting to matters that would not compromise those proceedings, such as information that is already part of the public record.