Auditing Governments and Not-For-Profit Organizations Chapter 16 Auditing Governments and Not-For-Profit Organizations Granof & Khumawala-6e Chapter 16

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. Granof & Khumawala-6e Chapter 16

Why are Audits of Governments Important? Granof & Khumawala-6e Chapter 16

GOVERNMENT ACCOUNTABILITY For the COLLECTION and EXPENDITURES of: OTHER PEOPLE’S MONEY (TAXES) Granof & Khumawala-6e Chapter 16

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 for 13.6% of 2011 U. S. GDP (2011, U.S. Bureau of Economic Analysis) 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) Granof & Khumawala-6e Chapter 16 2010 census is the latest version for U.S. local government 2011 U.S. GDP http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm 2011, U.S. Bureau of Economic Analysis http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=88&Freq=Qtr&FirstYear=2009&LastYear=2011 2011, U.S. Bureau of Labor Statistics- Federal and state government employment http://www.bls.gov/oes/current/999001.htm#00-0000 May 2011 U.S. total employment http://www.bls.gov/opub/ted/2012/ted_20120329.htm

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 Granof & Khumawala-6e Chapter 16

Overview: Audits Governments & Not-For-Profits Vs. Business -“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. Granof & Khumawala-6e Chapter 16

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: Effectiveness of internal controls Effective usage of entity’s resources (Efficiency) Verifying that organization is complying with the terms of laws, grants, and contracts. Provide guidance on how the organization can improve GAGAS standards place much more emphasis on compliance with laws and regulations than do GAAS Granof & Khumawala-6e Chapter 16

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: Auditor’s professional qualifications Quality of audit effort, Characteristics of professional/meaningful audit reports Granof & Khumawala-6e Chapter 16

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: General standards Field work standards Reporting standards Granof & Khumawala-6e Chapter 16

Generally Accepted Government Auditing Standards (GAGAS) Broader than GAAS: This gives an overview of the breadth and depth of GAGAS. Financial Audits Attestation Engagements Performance GAAS GAGAS General Standards 3 4 5 Field Work Standards 2 7 Reporting Standards 11 9 Totals 10 20 21 12 Granof & Khumawala-6e Chapter 16

GAAS v/s GAGAS General General -Qualifications: Professional Proficiency Knowledge of government programs CPE requirements Independence Due Professional Care Quality Control General -Training and Proficiency Independence Due Care Granof & Khumawala-6e Chapter 16

Generally Accepted Government Auditing Standards (GAGAS) Professional competence requires auditors to have: A thorough knowledge of governmental auditing and the specific or unique environment in which the audited entity operates 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 Granof & Khumawala-6e Chapter 16

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: Planning – consideration of government programs Compliance testing Granof & Khumawala-6e Chapter 16

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 Granof & Khumawala-6e Chapter 16

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.” Granof & Khumawala-6e Chapter 16

Total grant awards 2011 - $607 Billion Granof & Khumawala-6e Chapter 16 Fiscal Year 2010 U.S. Overseas Loans and Grants http://gbk.eads.usaidallnet.gov/about/program_summary.pdf GAO’S WEBSITE www.gao.gov Total grant awards 2011 - $607 Billion http://www.cbo.gov/publication/43967

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. 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) Granof & Khumawala-6e Chapter 16

Single Audit (Cont’d) Two main components: Audit conducted under GAGAS Compliance Audit of federal financial awards/major programs (Single Audit component) Understand the characteristics of a single audit, including: the purpose which entities must have a single audit what auditing work is required how major programs are selected for audit what reports must be rendered, when, and to whom Granof & Khumawala-6e Chapter 16

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 Granof & Khumawala-6e Chapter 16

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. Financial component of audit - basically the same as non-federal audit; includes the financial statements and accompanying notes. Compliance component – tests of compliance with applicable laws and regulations. Granof & Khumawala-6e Chapter 16

Federal Programs: Compliance Requirements Fourteen compliance requirements: Activities allowed or unallowed Allowable costs/cost principles Cash management Davis-Bacon Act Eligibility Equipment and real property management Matching, level of effort, earmarking Period of availability of funds Procurement and suspension and debarment Program income Real property acquisition and relocation assistance Reporting Sub-recipient monitoring Special tests and provisions Source: Adapted from OMB Circular A-133 Compliance Supplement, 2012. Granof & Khumawala-6e Chapter 16

GAAS - GAGAS Single Audit Relationships 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 Granof & Khumawala-6e Chapter 16 GAGAS Incorporates GAAS – and includes additional requirements Single 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: When the federal agency has become at risk, and 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. Granof & Khumawala-6e Chapter 16

Single Audit Act and OMB Circular A-133 No Single Audit or Program Specific Audit required--only GAAS and GAGAS Audit required. Did the nonfederal entity expend $500,000 or more of federal awards? No Yes Did the nonfederal entity 1) 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? Yes A program-specific audit is required. Granof & Khumawala-6e Chapter 16 No A Single Audit is required.

Single Audits: Four Reports Produced 1) 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 Granof & Khumawala-6e Chapter 16

Granof & Khumawala-6e Chapter 16

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: internal control compliance with laws and regulations, and the terms and provisions of contracts/grants Granof & Khumawala-6e Chapter 16

Internal Control Audit Assess internal control system components for adequacy and effectiveness – can it provide reasonable assurance of: Achieving effective and efficient operations; Reliable financial and performance reporting; and Compliance with laws and regulations. Extremely relevant to government procurement officials for determining organizational capability for successful performance of government contract effort. Granof & Khumawala-6e Chapter 16

Compliance Audits Assess compliance with established laws; regulations; contract provisions; grant agreements; and other requirements To assess the direct or indirect impact on the acquisition; protection; use; and disposition of the entity’s resources or quantity; quality; timeliness; and cost of services that the entity produces and delivers. Granof & Khumawala-6e Chapter 16

Single Audit: Compliance Component for “Major Programs” Granof & Khumawala-6e Chapter 16

Compliance Audits of Federal 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. Granof & Khumawala-6e Chapter 16

Selection of “Major Programs” 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 Granof & Khumawala-6e Chapter 16 3

Risk-Based Approach Step 1: Identify (larger) Type A Programs Step 2: Identify “low-risk” Type A programs Step 3: Identify “high-risk” Type B programs Granof & Khumawala-6e Chapter 16 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.

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 Granof & Khumawala-6e Chapter 16

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 Granof & Khumawala-6e Chapter 16

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 Granof & Khumawala-6e Chapter 16

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 Granof & Khumawala-6e Chapter 16

Summary 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. Granof & Khumawala-6e Chapter 16 3