The Effects of the New Risk Assessment Auditing Standards and Proposed Changes to IRS Form 990

We would like to make you aware of recent developments in the auditing profession that may affect your next audit engagement. In March 2006, the American Institute of Certified Public Accountants (AICPA) issued eight new auditing standards, collectively referred to as the risk assessment standards. The risk assessment standards are effective for audits of financial statements for periods beginning on or after December 15, 2006. Thus, auditors will be required to apply the standards in their audits of 2007 calendar year-end financial statements. Most auditors believe that the changes caused by the risk assessment standards are the most significant in recent history.

Overall, the new standards should increase the effectiveness of financial statement audits. In applying the risk assessment standards, auditors explicitly consider higher risk areas by focusing on what is most likely to go wrong that could affect the financial statements. Auditors assess the risk that the financial statements are materially misstated and design and perform audit procedures to respond to those identified risks. In performing audits under the new standards, auditors may find that they may need to spend more time documenting their understanding of clients' internal control systems and determining if those systems have been implemented.

The risk assessment standards incorporate many of the underlying concepts and detailed performance requirements that exist in current auditing standards. However, they also create significant new requirements for auditors. In most cases, implementation of the new standards will result in an overall increased work effort by the auditors. For example, under a traditional audit approach, the auditor could plan to assess control risk at the maximum and test an entity's year-end cash balances using only substantive procedures such as confirming account balances with financial institutions and reviewing reconciling items on the bank reconciliation. Under the risk assessment standards, the auditor is required to have, and document, the basis for his or her risk assessment rather than just defaulting to high control risk. Thus, obtaining an understanding that is sufficient to assess the risks of material misstatement requires the auditor to develop a fairly thorough and robust knowledge of the components of internal control. This understanding for the audit of an entity's year-end cash balances may need to be obtained through a review of year-end and interim bank reconcilations, review of documentation supporting cash receipts and disbursements transactions, and inquiries of management and other employees.

The key to performing a successful audit under the risk assessment standards is planning. In general, an audit under the risk assessment standards requires more time spent in up-front planning than audits performed under a traditional audit approach. During the planning process, the auditor gains sufficient knowledge of the client to identify risky audit areas and determine the procedures necessary to address identified risks. For lower-risk areas, the auditor determines what limited procedures will be necessary in light of the assessed level or risk. The additional time spent during the planning process when applying risk assessment may be offset by efficiencies gained from limiting procedures in lower-risk areas.

We would be pleased to discuss the effects of the risk assessment standards on your audit and answer any questions you may have. If you would like to schedule a meeting to discuss these new standards, please feel free to contact us.

In addition, the Internal Revenue Service (IRS) recently released a draft version of a revised Form 990, Return of Organization Exempt From Income Tax. The draft version is not final and is still subject to change. In fact, the IRS is accepting comments on the new form until September 14, 2007. The revised form would substantially expand the information reported on Form 990 and increase the disclosure of an exempt organization's activities. The draft Form 990 and related supporting schedules can be viewed at http://www.irs.gov/charities.

Again, as with the new auditing standards, please feel free to contact us with any questions you may have about the proposed revisions to Form 990.