April 2007 Newsletter

Auditor Communication

Source: www.aicpa.org—Statement of Auditing Standards No. 114, The Auditor’s Communication With Those Charged With Governance

Statement on Auditing Standards (SAS) No. 114 updates SAS No. 61 regarding communicating with those charged with governance for non-issuer financial statements. Among the changes, SAS No. 114 requires auditor to determine those appropriate people charged with governance. Auditors are now required to communicate both an overview of the planned scope and timing of the audit and representations the auditor is requesting from management. Auditors must document required communications, whether oral or written.

Comfort Letter Compliance

Source: The CPA Letter—How CPAs Should Handle “Comfort Letter” Requests from Lenders, Mortgage Brokers

Lenders and mortgage brokers often ask CPAs to provide “comfort letters” relating to borrowers’ claims. However, CPAs often put themselves at risk with these engagements by not understanding Attestation Interpretation No. 2, “Responding to Requests for Reports on Matters Relating to Solvency”. This interpretation states that auditors should not provide any form of assurance relating to matters of solvency. However, auditors may provide an attest report supporting their audit, review, or compilation. Pro forma and prospective financial information and agreed-upon procedures are also permissible.

Top 12 Tax Scams for 2007

Source: Clients Seek 2007’s ‘Dirty Dozen’ Scams

The IRS has coined 12 of the most common and blatant tax scams for 2007 as the “Dirty Dozen”. These scams include:

      1. Telephone Excise Tax Refund Abuses—Requesting large amounts for the special telephone tax refund. Some taxpayers request a refund of their entire phone bill, rather than the entitled three percent tax.
      2. Abusive Roth IRAs—Shifting under-valued property to Roth IRAs to allow otherwise taxable income to go untaxed.
      3. Phishing—Identity thieves posing as IRS employees by requesting credit card numbers from taxpayers to issue taxpayers a special tax refund.   
      4. Disguised corporate ownership—Domestic shell entities disguising the ownership of the business for underreporting income and committing financial crimes.
      5. Zero wages—An incorrect Substitute Form W-2 showing significantly reduced income to refute an employer’s W-2.
      6. Return Preparer Fraud—Tax preparers skimming a portion of refunds and charging inflated fees
      7. American Indian Employment Credit—Reducing taxable income by falsely citing an American Indian employment or treaty credit.
      8. Trust Misuse—Transferring assets to trusts with a tax preparer’s unfounded promise to reduce tax liability.
      9. Structured Entity Credits—Setting up partnerships to own and sell state conservation easement credits and other credits. The entity uses up its credits and wrongfully deducts the value as a total loss.
      10. Abuse of Charitable Organizations and Deductions—Moving assets to tax-exempt organizations, but maintaining control of the assets.
      11. Form 843 Tax Abatement—Falsely requesting abatement of previously assessed tax using Form 843.
      12. Frivolous Arguments—Unfounded arguments such as ‘wages are not income’ and ‘Congress never ratified the Sixteenth Amendment allowing congressional power to lay and collect income taxes’.


IRS Commissioner Mark W. Everson offers sound advice to avoid the Dirty Dozen; “If you use a tax professional, pick someone who is reputable”.

Risks in a Financial Statement Audit, Part I

Source: Journal of Accountancy - Assessing and Responding to Risks in a Financial Statement Audit.

New audit risk standards are found in the Statement on Auditing Standards No. 104-111.

The highlights from each new standard include:

SAS No. 104:

SAS No. 105:

SAS No. 106: Lists specific assertions the auditor should test.

SAS No. 107: Clarifies that reasonable assurance means “a high, but not absolute level of audit assurance”.

SAS No. 108: States that the auditor should have a written understanding with the client regarding the terms of the engagement.

SAS No. 109: Risk assessment procedures alone are not a sufficient basis for rendering the audit opinion.

SAS No. 110:

SAS No. 111:

Risks in a Financial Statement Audit, Part II

Journal of Accountancy.- Assessing and Responding to Risks in a Financial Statement Audit Part II

The new Statements on Auditing Standards (SAS) 104-111 define audit risk standards. As noted in these standards, “auditors must consider audit risk and must determine a materiality level for the financial statements taken as a whole.” How should auditors respond to the risk of material misstatement in designing and performing audit procedures? In designing audit procedures, auditors test management’s assertions that financial statements are free of material misstatements. Auditors only test internal controls if the control’s design is effective. However, substantive tests (analytics and/or tests of details) are always performed on management’s assertions. It is not appropriate for auditors to apply a “standard” audit program of procedures to all engagements.

Auditors are required to communicate significant deficiencies or material weaknesses in writing to management and those charged with governance. These findings can include inadequate documentation of the components of internal control or failure to make the required GAAP accounting computations, accruals, or estimates.

Definitions of material weakness, significant deficiency, and materiality

Source: Public Company Accounting Oversight Board Bylaws and Rules – Standards – AS2. PCAOB website. Accessed March 29, 2007.


Definition of material weakness in PCAOB AS 2

10. A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. (pg. 155)

Remote. The chance of the future events or events occurring is slight. (pg. 154)

Definition of significant deficiency in PCAOB AS 2

9. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects the company's ability to initiate, authorize, record, process, or report external financial data reliably in accordance with generally accepted accounting principles such that there is more than a remote likelihood that a misstatement of the company's annual or interim financial statements that is more than inconsequential will not be prevented or detected. (pg. 154)

Discussion of materiality in PCAOB AS 2

22. The auditor should apply the concept of materiality in an audit of internal control over financial reporting at both the financial-statement level and at the individual account-balance level. The auditor uses materiality at the financial-statement level in evaluating whether a deficiency, or combination of deficiencies, in controls is a significant deficiency or a material weakness. Materiality at both the financial-statement level and the individual account-balance level is relevant to planning the audit and designing procedures. Materiality at the account-balance level is necessarily lower than materiality at the financial-statement level.

23. The same conceptual definition of materiality that applies to financial reporting applies to information on internal control over financial reporting, including the relevance of both quantitative and qualitative considerations. (pg. 159)

Discussion of materiality in Implementation of PCAOB AS 2



Further, the standard does not re-define materiality for the purposes of auditing internal control. Rather, the standard provides that the same conceptual definition of materiality that applies under the federal securities laws to financial reporting applies to information on internal control.16/ This means that the auditor should plan and perform the audit of internal control using the same materiality measures as the auditor uses to plan and perform the annual audit of the financial statements. (pg. 16)

16/ See Auditing Standard No. 2, paragraphs 22 and 23. The federal courts and the SEC have defined materiality for purposes of the federal securities laws. See, e.g., Staff Accounting Bulletin No. 99, Materiality (Aug. 12, 1999).

Source: Statement of Financial Accounting Concepts No. 2. Accessed March 29, 2007. http://www.fasb.org/pdf/con2.pdf

Definition of materiality in GAAP

"…the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement." (pg. 10)

Definition of materiality in SEC. Accessed March 29, 2007. http://www.sec.gov/interps/account/sabcodet1.htm#1m

“is in substance identical to the formulation used by the courts in interpreting the federal securities laws. The Supreme Court has held that a fact is material if there is - a substantial likelihood that the...fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.”

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