Agenda - 10-18-2007-1 - Laserfiche WebLink

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Memorandum No. 1077 August 1, 2007 Page 2 of 7 Discussion Last year, the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA) issued the Statement on Auditing Standards (SAS) No. 112 Communicating Internal Control Related Matters Identified in an Audit. This statement establishes standards and provides guidance on the auditor's responsibilities for identifying, evaluating, and communicating matters related to an entity's internal control over financial reporting identified in the audit of the financial statements. The new standard replaces SAS No. 60, Communication of Internal Control Related Matters Noted in an Audit. SAS No. 112 is effective for audits of financial statements for periods ended on or after December 15, 2006, which is for fiscal year ended June 30, 2007 for most local governments and public authorities in North Carolina. Under this new Statement, auditors are required, as part of each audit, to report in writing all control deficiencies identified during the audit that are considered significant deficiencies or material weaknesses (see Appendix A for definitions) to management and those in charge of governance. Please note that the term `reportable condition', which was used in prior years' audits, will no longer be used. It has been replaced with `significant deficiency,' which covers a wider range of findings than `reportable condition' covered. The scope of what is deemed to be a `material weakness' also has been expanded. In addition, any significant deficiencies and material weaknesses that were communicated to management and the governing board in previous audits that have yet to be eliminated must continue to be communicated in writing to those charged with governance. Based on this increased scope, the LGC is expecting an increase in findings on internal controls and an increase in the written communications from auditors to North Carolina governments (e.g., letters may be issued to governments this year that did not receive management letters in the previous years). The auditor will evaluate control deficiencies identified during the course of the audit. The auditor's awareness of control deficiencies will vary with each audit and will be influenced by the nature, timing, and extent of audit procedures performed, as well as other factors. The significance of a control deficiency will depend on whether there is potential for a misstatement in financial reporting, not on whether a misstatement actually occurred. In addition, the auditor will consider both qualitative and quantitative factors. If the auditor determines that a control deficiency is not significant or material, it may still be communicated to the unit in writing. We believe that SAS No. 112 will improve the qualify of communications between the auditor, the governing board, and management. Most experts in this field agree that the new standard will result in more control deficiencies being reported as significant deficiencies or material weaknesses. In turn, the auditors may need to gather more information to make the SAS No. 112 determinations. Based on this and other factors, the LGC believes that SAS No. 112 may increase the audit engagement fees because of these new requirements. The LGC staff expects that auditors of smaller units of governments may issue a SAS No. 112 report that includes deficiencies in the areas of lack of segregation of duties and, perhaps, the lack of expertise in financial accounting and reporting. Our office is aware that the existence of these deficiencies and others may already be known to management, may have existed for some time, and may represent a conscious decision by management or the board to accept that degree of risk due to the cost of mitigating the deficiency or other considerations. Management and the board should