Your nonprofit organization will soon feel the impact of new auditing requirements. A new Statement of Auditing Standards, SAS #112, issued by the Auditing Standards Board of the American Institute of Certified Public Accountants, is effective for audits of financial statements for periods ending on or after December 15, 2006.

SAS #112 establishes standards, responsibilities and guidance for auditors during an engagement for identifying and evaluating a client’s internal control over financial reporting. This new standard requires the auditor to report in writing to management and the Board on any control deficiencies found during the audit that are considered significant deficiencies or material weaknesses.

A control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis.

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

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 financial statements will not be prevented or detected.

The new standard focuses increased auditor attention on the controls that relate to the organization’s objective of reliable financial reporting, such as management’s ability to produce accurate external financial reports. The new definitions have a lower reporting threshold so that more control deficiencies will be considered significant.

SAS #112 does not require the auditor to search for control deficiencies, but rather to evaluate them if they have been identified. The auditor is required to consider both the quantitative and qualitative perspective in determining whether a deficiency is significant. The significance of a control deficiency depends on the potential for a misstatement, not on whether a misstatement actually has occurred. The auditor will have considerably less room for judgment as to the severity of a control deficiency.

SAS #112 includes a listing of situations that are, at minimum, significant deficiencies, as well as those that are strong indicators of material weaknesses (MW). These include:

• Lack of controls over non-routine and non-systematic transactions.
• Lack of controls over period-end financial reporting process.
• Ineffective oversight of the organization’s financial reporting and internal control by the Board (MW).
• Restatement of previously issued financial statements (MW).
• Identification by the auditor of a material misstatement in the financial statements for the period under audit that was not initially identified by the organization’s internal control, i.e. audit adjustments (MW).
• Failure by management, or the Board, to assess the effect of a significant deficiency previously communicated to them and either correct it, or decide that it will not be corrected (MW).

What does this mean to your organization? Because of the more stringent examination and reporting standards, the terms “significant deficiency” and/or “material weakness” may well be appearing in a letter from the auditor to the Board of Directors (the management letter).

Preparing your organization for the new world of SAS #112 standards involves several steps:

1. Educate yourself –

• Learn the key components of strong internal controls.
• Understand your financial statements and the required disclosures.
• Build a resource network to assist you as questions arise.

2. Eliminate all audit adjustments -

• Talk to your auditor about the nature of any prior year audit adjustments.
• Identify and record all potential adjustments prior to the audit.
• Maintain a file of issues and/or transactions occurring during the year that might have GAAP accounting issues.
• Seek advice from your auditor, or others, regarding these items prior to the audit.
• Consider the need to hire external assistance prior to the audit.

3. Educate your Board -

• Don’t let your Board be blind-sided.
• Educate them so that they might assist in evaluating and improving controls.

4. Inventory your system -

• Identify significant accounts, disclosures, processes and cycles that are used by, or take place in, your organization.

5. Prioritize -

• Do not try to fix or improve everything at once.
• Consider making improvements over three years.
• Identify the areas of greatest weakness and improve those first.

Be prepared to respond positively to a significant deficiency or material weakness. Having an improvement plan and acting on it will put any deficiencies in a much more positive light, especially to donors and funders.

Above all, be realistic - internal control is an ongoing process. All improvements to your system will have a cost and if the cost of completely eliminating significant deficiencies is high, be prepared to accept it. If you can’t afford to be perfect today, set a goal to improve over time.

About the Author Audit Partner, Julleen Snyder, has been with Jacobson Jarvis since 1995. She has previous experience working within a not-for-profit organization, which has given her a unique perspective on client issues in addition to the ability to implement timely and appropriate solutions. Julleen spent four years with Ernst & Young as an auditor where she had the privilege of specializing in planning, supervising, and coordinating fieldwork for the firm’s not-for-profit clients. Julleen joined Jacobson Jarvis from The Hope Heart Institute where she served as the organization’s controller. Julleen is the 2002 co-author of QuickBooks® Solutions for Nonprofit Organizations: A Problem-Solving Guide for Accounting Professionals by Practitioners Publishing Company. She has been a member of the YMCA finance committee and is currently serving as Treasurer on the Board of Directors of the Washington Society of Certified Public Accountants. You may reach Julleen by phone at 206-628-8990, or by email at julleen@jjco.com.

Julleen Snyder, CPA

Upcoming Program

Internal Controls
Five control components & how they work together

Date: February 21, 2007
Time: 11:55 AM - 1:30 PM
Fee: $35
Presenter: Leah Kosik, CPA, Jacobson Jarvis Special Projects Manager

Properly working internal controls provide great value to your organization, especially in light of SAS #112. They are a way of assuring that the systems behind the financial reporting are reliable. An internal control system is composed of checks and balances and is about risk management across the entire organization. Coordinating efficient financial reporting and effective controls is challenging. To assure continued effectiveness, the system must be regularly updated and evaluated. If reliable, it’s highly likely that your organization’s financial reports are reliable.

Join Leah Kosik as she provides an in-depth examination of the five internal control components and how they work together to form a reliable internal control system.

Wednesday Club is held in the Plaza 600 Building at 600 Stewart Street (at 6th Avenue) in Seattle. The $35 program includes materials and a gourmet box lunch. Attendees receive 1.5 units of CPE credit.
Register at 206-628-8990

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