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CPE for Government Auditors

Chapter 2: Types of Yellow Book Audits

As I revise my self-study book, “The Yellow Book Interpreted,” I will be sharing chapters with you.

Objectives: 

  • Conclude which standards should and must be applied to each type of audit 
  • Distinguish among the three types of Yellow Book engagements

Relationship to Other Standards

GAGAS is just one of the standards that exists to guide you as an auditor. You may also use or be subject to the IIA’s Professional Practices Framework, the AICPA’s Statements on Auditing Standards, the AICPA’s Statements on Standards for Attestation Engagements, the Public Corporation Accounting Oversight Board (PCAOB) standards, or even one of many international auditing standards. What can make compliance so difficult is that these standards sometimes conflict or even try to outdo each other.

The Yellow Book is considered the toughest standard of them all. In 2006, I had the chance to meet David Walker, the Federal Comptroller General and leader of the GAO at the time, and I asked him whether he thought the standard-setting boards would ever come to agreement on terminology and standards. He said he was working on it. Then I put my foot in my mouth and said that the PCAOB standards were the preeminent standard and that everyone was scrambling to be like them. He quickly corrected me and said that the Yellow Book was the toughest standard out there, and his goal was that the Yellow Book would remain the preeminent standard that all other standard-setting bodies would emulate.

For most of my audit career, the Yellow Book has been a superior document to the AICPA standards. But in the last ten years, the AICPA has been working to tighten up their standards. The AICPA audit standards regarding risk assessment significantly changed the way that audit planning is conducted. All revisions of the Yellow Book, all chapters, including the financial, attestation, and performance chapters, sync up with the language contained in these and all subsequent AICPA audit standards. It is important to note that the performance standards – which do not have to follow the AICPA standards – borrow heavily from and use the same language as the AICPA.

If you conduct a financial or attestation engagement under the Yellow Book standards, you also must follow the AICPA standards for audits and attestation engagements. The performance auditing standards do not adopt the AICPA standards, although they do use similar language and have similar requirements to the AICPA standards.

The Yellow Book goes on to mention other standards and says that these other standards are not incorporated into GAGAS but can be used in conjunction with GAGAS. In case of conflict, GAGAS should prevail.

2.12     Auditors may use GAGAS in conjunction with professional standards issued by other authoritative bodies.

2.13     The relationship between GAGAS and other professional standards for financial audits, attestation engagements, and reviews of financial statements is as follows:

a. The American Institute of Certified Public Accountants (AICPA) has established professional standards that apply to financial audits, attestation engagements, and reviews of financial statements for nonissuers (entities other than issuers under the Sarbanes-Oxley Act of 2002 such as privately held companies, nonprofit entities, and government entities) conducted by certified public accountants (CPA). For financial audits and attestation engagements, GAGAS incorporates by reference AICPA Statements on Auditing Standards and Statements on Standards for Attestation Engagements. For reviews of financial statements, GAGAS incorporates by reference AR-C, section 90, Review of Financial Statements.

b.The International Auditing and Assurance Standards Board (IAASB) has established professional standards that apply to financial audits and assurance engagements. Auditors may elect to use the IAASB standards and the related International Standards on Auditing and International Standards on Assurance Engagements in conjunction with GAGAS.

c.The Public Company Accounting Oversight Board (PCAOB) has established professional standards that apply to financial audits and attestation engagements for issuers. Auditors may elect to use the PCAOB standards in conjunction with GAGAS.

2.15     For performance audits, GAGAS does not incorporate other standards by reference, but recognizes that auditors may use or may be required to use other professional standards in conjunction with GAGAS, such as the following:

1.International Standards for the Professional Practice of Internal Auditing, Institute of Internal Auditors, Inc.;

2.International Standards of Supreme Audit Institutions, International Organization of Supreme Audit Institutions;

3.Guiding Principles for Evaluators, American Evaluation Association;

4. The Program Evaluation Standards, Joint Committee on Standards for Education Evaluation;

5. Standards for Educational and Psychological Testing, American Psychological Association; and

6. IT Standards, Guidelines, and Tools and Techniques for Audit and Assurance and Control Professionals, Information Systems Audit and Control Association.

Defining Government Audits and Attestation Engagements

Defining the type of audit engagement is sometimes a matter of professional judgment. In other words, it isn’t a black-and-white decision. Understanding your options and choosing well is an important step in a Yellow Book audit.

Determining which type of audit you are conducting has confused more than one auditor and the requesting client. For example, if you are tasked with ensuring compliance with state regulations regarding a state grant for a school lunch program, you could, as we will see in the audit type definitions below, do that audit as a performance audit or as an attestation engagement.

One internal audit shop I work for on a regular basis operates inside a large state agency. They are responsible for a multitude of auditing and monitoring functions. Sergio, their audit director, is not a CPA. He is a certified internal auditor (CIA), a designation awarded by the IIA. Besides being an audit director, Sergio is on the international planning committee for the IIA. And he knows nothing about AICPA standards, and he doesn’t want to know about AICPA standards!

Since he works for a Texas state agency, state law dictates that he must simultaneously use the Yellow Book and the Red Book (the IIA’s standards). He jokingly calls himself an “orange” shop (Get it? Red and yellow make orange.). He does not even factor the AICPA into his work or his thinking and, thus, calls everything he does a performance audit.

Is that okay? Yes, because the GAO says in 1.15 that some engagements may have objectives that could be met using more than one approach.

1.14      All GAGAS engagements begin with objectives, and those objectives determine the type of engagement to be conducted and the applicable standards to be followed. This document classifies financial audits, attestation engagements, reviews of financial statements, and performance audits, as defined by their objectives, as the types of engagements that are covered by GAGAS.

1.15      In some GAGAS engagements, the standards applicable to the specific objective will be apparent. For example, if the objective is to express an opinion on financial statements, the standards for financial audits apply. However, some engagements may have objectives that could be met using more than one approach. For example, if the objective is to determine the reliability of performance measures, auditors can perform this work in accordance with either the standards for attestation engagements or performance audits.

CPAs Also Have to Choose

And Sergio isn’t the only one faced with this decision. CPAs in public practice are regularly asked to help governmental entities with more than financial statement audits and single audits.

I had a long phone call with a partner from a national CPA firm who wanted to take on a project for one of her steady clients, but her technical advisors were prohibiting her from taking on the project. It seems that the client, a state agency, was unclear in their request for proposal. The request for proposal called for a performance audit of funds spent by their sub-recipients. But, to her, what she read in the request for proposal did not sound like a performance audit.

The state agency passed federal funds and state funds to not-for-profits. These not-for-profits reported their expenditures back to the state and asked for reimbursement. The state agency wanted to make sure the costs were valid but didn’t have the manpower to check for themselves. Instead, they sent out a request for proposal asking her firm and other firms to conduct a performance audit of these payments.

This simple project did not sound like a full-blown performance audit. It sounded more like a review or agreed-upon procedure to the partner and I agreed. The Yellow Book devotes two lengthy chapters to describe requirements for conducting a performance audit. A performance audit involves a lot of planning, including understanding internal controls and conducting a risk assessment.

A performance audit doesn’t simply stop at saying what is so; a good performance audit will also tell you why something is as it is. For instance, if the sub-recipient was not reporting the proper costs, the auditor would find out how this happened and then recommend something be done to keep it from happening in the future. It sounded from the request for proposal that the state agency only wanted to know if the amounts were correct, not why the amounts were not correct. What this project is called will make a huge difference in how much money is spent to get it done.

And it is not normal for a CPA firm to take on a performance audit. Not impossible, but not normal, either. Generally, legislative auditors or internal auditors, rather than CPA firms, perform performance audits because performance audit standards do not integrate or refer to AICPA requirements.

CPAs can choose among several engagement types and still apply AICPA standards. The AICPA rules the behavior of a CPA. But CPAs have a good amount of flexibility under the AICPA standards; they can perform their work under AICPA rules for financial audits, attestation engagements, or consulting engagements. It is very important for CPAs to call it the right type of engagement because the rules are different for each type of engagement. The CPAs’ choice will also impact their ability to perform other work for the government in the future.

The CPA firm partner was leaning toward calling this engagement an attestation engagement.
On an attestation engagement, a CPA would attest to the truth of a simple statement such as, “Costs reported by the sub-recipients are accurate and properly classified.” This will be a relatively inexpensive engagement. The CPA will not ask why the reports were inaccurate but will simply verify that they are or aren’t. If the reports are inaccurate, the state agency will have the responsibility to follow up to find out what happened.

How Much Is This Going to Cost?

I’m just ball-parking here (and I am sure I will get some emails on this!), but say that a performance audit costs $45,000, an attestation engagement costs $20,000, and it costs $6000 for some dude to simply check the numbers.

Who is this dude? He is so cheap! This dude is not a CPA and doesn’t follow any standards for his work. He will simply go out and verify that the numbers are OK and report back. And maybe in this case, that would be an appropriate thing for the state agency to pay for.

My CPA friend complained that these dudes are undercutting her and taking plenty of business. One dude even goes as far as to name his company using CPA-like words (like Assurance, Inc.) to imply that he does work similar to a CPA.

But my CPA friend wouldn’t touch a project without following standards with a ten-foot pole! Being a CPA, neither would I. The standards protect our clients and us by requiring that:

  • we remain independent of our subject matter,
  • we ensure professional competence regarding the subject matter,
  • we design methodologies that will yield sufficient and appropriate evidence,
  • our conclusions are based on documented fact,
  • our reports are thorough and free of exaggeration and error, and
  • our reports undergo quality review.

The dude doesn’t have to worry about standards or independence.

The dude doesn’t have to follow any of those standards. No wonder he is so cheap. And he doesn’t have to worry, as my CPA friend does, about compromising auditor and firm independence when it comes to future work.

It boils down to the question the client wants answered, whether they care about audit standards and cost.

Here is what the state agency hiring this help needs to consider:

  • Which is more important, cost or standards?
  • Is it important to the state agency that the auditor tell them that the numbers are accurate or why numbers are inaccurate or both?
  • Do they want to be sure that rigorous and thorough work was done to uncover the inaccuracies and reasons for the inaccuracies?

If the client answers yes to the second and third questions, they are right to call it a performance audit.

Is the state agency primarily interested in having a few simple questions answered about the numbers, such as accuracy or categorization of expenditures? If so, then they should choose to call this project an attestation engagement.

If the state agency doesn’t want any standards followed, then it can simply ask someone to verify the numbers for them and in this case, the dude can perform the work.

See how much more involved this decision is? I doubt the state agency really wants a performance audit, but they don’t want to take the time to think about and define what they really want. The term “performance audit” specifies what type of work is involved and selecting this term to describe a project in an RFP has its consequences. It means something specific and costly to the professionals responding to the RFP. And, in this case, it means that the state agency would spend more of the taxpayers’ money than necessary.

Four Types of Engagements

The GAO names four types of assurance engagements:

  1. financial audits
  2. attestation engagements
  3. reviews of financial statements
  4. performance audits.

The third type of engagement on this list is new to the Yellow Book as of 2018; reviews of financial statements.

1.  Financial Audit

The first type of audit is the financial audit. Financial audits are the most clearly defined type of audit.

1.17      Financial audits provide independent assessments of whether entities’ reported financial information (e.g., financial condition, results, and use of resources) is presented fairly, in all material respects, in accordance with recognized criteria. Financial audits conducted in accordance with GAGAS include financial statement audits and other related financial audits.

a.   Financial statement audits: The primary purpose of a financial statement audit is to provide financial statement users with an opinion by an auditor on whether an entity’s financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework. Reporting on financial statement audits conducted in accordance with GAGAS also includes reports on internal control over financial reporting and on compliance with provisions of laws, regulations, contracts, and grant agreements that have a material effect on the financial statements.

b.   Other types of financial audits: Other types of financial audits conducted in accordance with GAGAS entail various scopes of work, including

1. obtaining sufficient, appropriate evidence to form an opinion on a single financial statement or specified elements, accounts, or line items of a financial statement;

2.issuing letters (commonly referred to as comfort letters) for underwriters and certain other requesting parties

3.auditing applicable compliance and internal control requirements relating to one or more government programs; and

4.conducting an audit of internal control over financial reporting that is integrated with an audit of financial statements (integrated audit)

An audit concludes or opines on whether a subject matter meets criteria. In the case of a financial audit, the subject matter is either the financial statements or some component of the financial statements. And the criteria is generally accepted accounting principles (GAAP), or some other set of rules about what the financial statements should look like.

When finishing a financial audit, you conclude whether the financial statements met the criteria. This conclusion is called an opinion, and the financial auditor will say something like the following in their report: “In our opinion, the financial statements present fairly the results of operations … in accordance with generally accepted accounting principles (or GAAP).”

In order to express an opinion, a financial auditor has to do plenty of work to gather evidence that the information presented in the financial statements is valid. Opinions aren’t thrown around lightly, and these engagements take a lot of time and, therefore, cost the client a lot of money.

Why knowingly choose to have a financial audit performed when they are so costly? Because the users of financial statements cannot trust the creators of the financial statements to tell the full truth and follow rules on their own. Yes, it is a sad state of affairs that some people and organizations lie to make themselves look good. But you only have to remember the litany of corporate scandals our global economy has suffered due to those who have lied on their financial statements to see the need.

Some organizations are required to undergo financial audits by regulators or grantors. If the entity and trades stock on the US stock market, they must undergo a financial audit per SEC (Security and Exchange Commission) regulations. Or, if the entity receives federal grant funds and triggers a Single Audit, the federal government requires your auditor to express an opinion on the financial statements and verify compliance with the grant terms and conditions.

2. Attestation Engagements

But what if the client asks you to evaluate another subject matter against another criteria? Or what if the client doesn’t want to pay for an opinion? Instead, they would just like a CPA firm to check something for them because they want the CPA’s objective assessment of a situation.

In these cases, the CPA firm can perform an attestation engagement. The CPA attests to the veracity of a statement made by the client. For example, the client might assert, “We are in compliance with loan covenants.” Or, “We counted and included all inventory in our report to headquarters.” Or, “All expenditures are supported by documentation.”

In order to conduct an attestation engagement, the auditor must also apply the AICPA’s SSAEs or Statements on Standards for Attestation Engagements.

1.18      Attestation engagements can cover a broad range of financial or nonfinancial objectives about the subject matter or assertion depending on the users’ needs. In an attestation engagement, the subject matter or an assertion by a party other than the auditors is measured or evaluated in accordance with suitable criteria. The work the auditors perform and the level of assurance associated with the report vary based on the type of attestation engagement. 

Attestation engagements are divided into three subcategories depending on how much assurance the auditor provides: examinations, reviews, and agreed-upon procedures. Examinations are the most intense, reviews are less so, and agreed-upon engagements are the least intense of all three. Check out the description from the Yellow Book of these three types of engagements:

1.18a    Examination: An auditor obtains reasonable assurance by obtaining sufficient, appropriate evidence about the measurement or evaluation of subject matter against criteria in order to be able to draw reasonable conclusions on which to base the auditor’s opinion about whether the subject matter is in accordance with (or based on) the criteria or the assertion is fairly stated, in all material respects. The auditor obtains the same level of assurance in an examination as in a financial statement audit.

b.         Review: An auditor obtains limited assurance by obtaining sufficient, appropriate review evidence about the measurement or evaluation of subject matter against criteria in order to express a conclusion about whether any material modification should be made to the subject matter in order for it to be in accordance with (or based on) the criteria or to the assertion in order for it to be fairly stated. Review-level work does not include reporting on internal control or compliance with provisions of laws, regulations, contracts, and grant agreements. The auditor obtains the same level of assurance in a review engagement as in a review of financial statements.

c.         Agreed-upon procedures engagement: An auditor performs specific procedures on subject matter or an assertion and reports the findings without providing an opinion or a conclusion on it. The specified parties to the engagement agree upon and are responsible for the sufficiency of the procedures for their purposes. The specified parties are the intended users to whom use of the report is limited.

When would a client ask for an examination? When they have a subject matter on which they want an opinion that doesn’t qualify as a financial audit.

When would a client ask for a review? When they don’t want to pay for a full-blown audit but do want some sort of assurance that the subject matter is OK. Notice that you do not express an opinion on a review. Instead you say, “Nothing came to our attention that leads us to believe the subject matter does not meet the criteria.”

And when would a client ask you to perform an agreed-upon procedure? When they want to hire someone they can trust to be objective and independent to do something for them that they don’t trust themselves or those for whom they are responsible to do themselves. Please realize I am generalizing …

Levels of Assurance

Audit literature frequently uses the term “levels of assurance.” If the client wants a high level of assurance that the subject matter meets the criteria, the auditor has to do an awful lot of work. In other words, in order for the auditor to pinky-swear that the subject matter meets the criteria, the auditor must gather a lot of evidence, and gathering and documenting evidence takes a lot of work. High assurance generally equates to an opinion in CPA-land. In recent audit literature, the term ‘high assurance’ has been replaced with ‘reasonable assurance’ because the AICPA has become uncomfortable promising a high-level assurance!

chart

If the client can tolerate a moderate amount of assurance – if they are OK with the CPA telling them that “nothing came to their attention” that needs adjustment – then they can ask for a review.

If they want no assurance that something is true, the client can ask the auditor to perform an agreed-upon procedure engagement. In that case, a CPA simply says, “I did this and here is what resulted” – no opinion, no consideration of anything outside of the agreed-upon procedure itself.

For example, my church undergoes a financial audit every two years that costs them around $13,000. In the off years, they ask the CPA firm to conduct a review of controls over cash receipts, which costs them only $5,000. While it costs less, the church also receives less assurance over a more limited subject matter.

To recap the difference between a financial audit and an attestation engagement:

  • A financial audit provides the client with a reasonable (high) level of assurance that the financial statements meet GAAP.
  • An attestation engagement can provide the client with a reasonable (high) level of assurance, a moderate level of assurance, or no assurance about a wide variety of subject matters evaluated against a wide variety of criteria.

3. Performance Audits

Performance audits are wide open! The only thing a performance auditor cannot do is opine on whether the financial statements are presented in accordance with GAAP. Every other audit objective is fair game in this category.

Performance audits are generally conducted at a reasonable (high) level of assurance although technically, performance auditors can also offer a moderate level of assurance.

The GAO defines performance audits as engagements that provide assurance or conclusions based on an evaluation of sufficient, appropriate evidence against stated criteria, such as specific requirements, measures, or defined business practices.  Performance audits can include any subject that can be assessed against criteria.

1.21      Performance audits provide objective analysis, findings, and conclusions to assist management and those charged with governance and oversight with, among other things, improving program performance and operations, reducing costs, facilitating decision making by parties responsible for overseeing or initiating corrective action, and contributing to public accountability. 

The performance auditor and the auditee need to agree on several important matters. The auditor and the client must need to agree on the criteria, the objective, the level of assurance, and whether the auditor should follow any audit standard other than the Yellow Book.

This level of flexibility makes CPA firms quite nervous. They don’t like to be non-commital when comes to the promises they make; they’ve got to worry about that liability, you know.  So, AICPA standards require CPAs to get the client to agree to the audit criteria, objective, level of assurance and audit standards in writing before they begin the engagement. Performance auditors are not held to this requirement.

To summarize, financial audits express an opinion on the financial statements – some component of the financial statements – and/or add a bit of compliance work (as in the case of the single audit). Any other type of assurance engagement can either be classified as an attestation engagement or a performance audit. Performance audits can be just about anything EXCEPT opinion audits of the financial statements. And performance audits, like financial audits, require a lot of work because they usually involve working at a reasonable (high) level of assurance.

4. Reviews of Financial Statements: A New Type of Engagement

For the first time in the 2018 version of the Yellow Book, the GAO mentions a new type of engagement – a review of financial statements. The level of assurance is similar to a review conducted under the AICPA attestation standards (SSAEs), but the applicable standards are not the SSAEs but instead the SSARS. SSARS stands for Statement on Standards for Accounting and Review Services and specifically the GAO addresses SSARS No. 21, Section 90, Review of Financial Statements

SSARS 21: 90.04 The objective of the accountant when performing a review of financial statements is to obtain limited assurance as a basis for reporting whether the accountant is aware of any material modifications that should be made to the financial statements for them to be in accordance with the applicable non-financial reporting framework, primarily through the performance of inquiry and analytical procedures

The Yellow Book addresses these sorts of engagements in the attestation standards, chapter 7.

Using the Name GAGAS in Vain

The GAO has felt it necessary to spell out which standards are optional and which are mandatory because the GAO doesn’t want you following GAGAS in spirit only.  In chapter 2, the GAO defines the terms “must” and “should.” In general, “must” means mandatory and “should” means mandatory unless you have a compelling reason to deviate.

The GAO emphasizes that not every paragraph of the Yellow Book contains mandatory requirements. Here is how the differences are explained:

2.02     GAGAS uses two categories of requirements, identified by specific terms, to describe the degree of responsibility they impose on auditors and audit organizations:

1.Unconditional requirements: Auditors and audit organizations must comply with an unconditional requirement in all cases where such requirement is relevant. GAGAS uses must to indicate an unconditional requirement.

2.Presumptively mandatory requirements: Auditors and audit organizations must comply with a presumptively mandatory requirement in all cases where such a requirement is relevant except in rare circumstances discussed in paragraphs 2.03, 2.04, and 2.08. GAGAS uses should to indicate a presumptively mandatory requirement

Unconditional requirements mean that you do not have an option to follow the requirement. You must comply with these requirements. When you see the word “must,” you will have a hard time justifying a departure and will not be able refer to the GAO in your report. If you see the word “should,” then you have a little more wiggle room. You can choose not to comply with a “should” statement, but you will need to justify the departure in your working papers and disclose your non-compliance in your audit report. Ouch!

2.03     In rare circumstances, auditors and audit organizations may determine it necessary to depart from a relevant presumptively mandatory requirement. In such rare circumstances, auditors should perform alternative procedures to achieve the intent of that requirement.

2.04     If, in rare circumstances, auditors judge it necessary to depart from a relevant presumptively mandatory requirement, they must document their justification for the departure and how the alternative procedures performed in the circumstances were sufficient to achieve the intent of that requirement.

In the 2018 Yellow Book, the must and should statements appear in a box.

The GAO goes on to explain a third category of discussion in the standards – explanatory material. Explanatory material is introduced with the words “may,” “might,” or “could.” In the 2018 Yellow Book, the explanatory material sits outside the box.

2.07     GAGAS contains requirements together with related explanatory material in the form of application guidance. Not every paragraph of GAGAS carries a requirement. Rather, GAGAS identifies the requirements through use of specific language. GAGAS also contains introductory material that provides context relevant to a proper understanding of a GAGAS chapter or section. Having an understanding of the entire text of applicable GAGAS includes an understanding of any financial audit, attestation, and reviews of financial statement standards incorporated by reference. 

Say “GAGAS” only if you mean it!

After explaining that you need to follow every “must” and “should,” the GAO goes on to say that you can’t claim to follow the Yellow Book if you didn’t follow every “must.” If you do not follow a “should” statement, you can claim to have followed the Yellow Book in your report, but you are going to have to disclose which should statement you did not follow. The GAO calls these “modified compliance statements.”

2.17     Auditors should include one of the following types of GAGAS compliance statements in reports on GAGAS engagements, as appropriate.

1.Unmodified GAGAS compliance statement: Stating that the auditors conducted the engagement in accordance with GAGAS. Auditors should include an unmodified GAGAS compliance statement in the audit report when they have

(1) followed unconditional and applicable presumptively mandatory GAGAS requirements or (2) followed unconditional requirements, documented justification for any departures from applicable presumptively mandatory requirements, and achieved the objectives of those requirements through other means.

2.Modified GAGAS compliance statement: Stating either that (1) the auditors conducted the engagement in accordance with GAGAS, except for specific applicable requirements that were not followed, or (2) because of the significance of the departure(s) from the requirements, the auditors were unable to and did not conduct the engagement in accordance with GAGAS.

 2.18    When auditors use a modified GAGAS statement, they should disclose in the report the applicable requirement(s) not followed, the reasons for not following the requirement(s), and how not following the requirement(s) affected or could have affected the engagement and the assurance provided. 

One team of monitors who was not required under any statute, law, or policy to follow the Yellow Book decided to brag that they followed Yellow Book standards in their audit reports. It was a point of pride with the team, and the client was duly impressed with their extra professionalism. However, the monitoring team had never undergone a peer review and had no plans to suffer one. Also, the management of the team didn’t want to pay for everyone on the team to be current with the 80-hour CPE requirements. At best, the team members got 20 or so hours of education every two years. The management team reasoned that they were following the Yellow Book in spirit.

In light of the definitions of “must” and “should,” they had a choice to make. They needed to either (1) explain in their audit reports that they were following most governmental standards but were uneducated or unwilling to undergo the scrutiny that they put their clients to, or (2) drop reference to the Yellow Book in their audit reports all together. They chose the latter.

In a roundabout way, the GAO has emphasized the significance of their standards by requiring us to tell on ourselves when we do not take the standards seriously. The concepts of transparency and accountability are now being applied to us!

I should mention here that performance auditors have whole paragraph that they must add to their report.

9.03     When auditors comply with all applicable GAGAS requirements, they should use the following language, which represents an unmodified GAGAS compliance statement, in the audit report to indicate that they conducted the audit in accordance with GAGAS:

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 findings and conclusions based on our audit objectives.

Introduction to the Yellow Book Interpreted

Objectives: 

  • Differentiate between the Yellow Book and other auditing standards
  • Assess whether an engagement requires the use of the Yellow Book
  • Identify the way the Yellow Book is organized

Why do they call it the “Yellow Book”?

The Yellow Book goes by many names:

  • Government Auditing Standards,
  • Generally Accepted Government Audit Standards (GAGAS – I love that one… pronounced “gag us”), and, of course,
  • The Yellow Book.

Legend has it that the original title of the Yellow Book was the “Golden Rule of Government Auditing,” and the cover was supposed to be gold. But when it came back from the printer, the cover was yellow. Whoops! Bye-bye catchy title, hello kitschy title – the Yellow Book. If you ever run across a hard copy, the cover is indeed a sunny yellow. Whether the inside is full of sun will be yours to judge as you read this text!

Why Does the Yellow Book Exist?

The Government Accountability Office (GAO) is the legislative auditor for the federal government. They first published the Yellow Book back in the 1970s as a guide for their own auditors. This is why the Yellow Book exists because the GAO wanted to set an audit standard for itself.

But in 1984, Congress passed a law called the Single Audit Act that made the Yellow Book relevant to a different set of auditors, CPAs in public practice. The Single Audit Act addresses audits of federal grants and requires that the audit be conducted in accordance with Government Auditing Standards. I don’t think the GAO intended to be involved in setting standards for CPAs in public practice. But through the passage of the Act, they were burdened with that responsibility. Subsequent to the Act, several state legislatures passed laws requiring the use of the Yellow Book for audits of governmental entities.

Who might use the Yellow Book on an Audit?

For the first time in 2018, the GAO lists users of the Yellow Book. This list is not comprehensive as it leaves out some of my clients including internal auditors working inside of state agencies and universities, but it is still interesting to see who the GAO thinks it is writing for:

1.12      GAGAS provides standards that are used by a wide range of auditors and audit organizations that audit government entities, entities that receive government awards, and other entities. These auditors and audit organizations may also be subject to additional requirements unique to their environments. Examples of the various types of users who may be required or may elect to use GAGAS include the following: 

Contract auditors: audit organizations that specialize in conducting engagements pertaining to government acquisitions and contract administration 

Certified public accounting firms: public accounting organizations in the private sector that provide audit, attestation, or review services under contract to government entities or recipients of government funds 

Federal inspectors general: government audit organizations within federal agencies that conduct engagements and investigations relating to the programs and operations of their agencies and issue reports both to agency management and to third parties external to the audited entity 

Federal agency internal auditors: internal government audit organizations associated with federal agencies that conduct engagements and investigations relating to the programs and operations of their agencies 

Municipal auditors: elected or appointed officials in government audit organizations in the United States at the city, county, and other local government levels 

State auditors: elected or appointed officials in audit organizations in the governments of the 50 states, the District of Columbia, and the U.S. territories 

Supreme audit institutions: national government audit organizations, in the United States or elsewhere, typically headed by a comptroller general or auditor general 

The Yellow Book has to be called into play by someone else.

Just because the Yellow Book exists does not mean you have to follow it in conducting a governmental audit. The Yellow Book has to be called forth by something or someone external to it:

1.08     Laws, regulations, contracts, grant agreements, and policies frequently require that engagements be conducted in accordance with GAGAS. In addition, many auditors and audit organizations voluntarily choose to conduct their work in accordance with GAGAS. The requirements and guidance in GAGAS in totality apply to engagements pertaining to government entities, programs, activities, and functions, and to government assistance administered by contractors, nonprofit entities, and other nongovernmental entities when the use of GAGAS is required or voluntarily adopted. 

The Yellow Book may be called forth by law or policy. The Single Audit Act is just one of many laws that call the Yellow Book into play. For instance, the State of Texas passed a law that all audits conducted by internal audit shops in the state will be conducted using government auditing standards.

If you conduct an audit of a city, the city may have a policy requiring that all audits be conducted in accordance with government auditing standards. Or, the request for proposal for the audit may request that the audit be conducted in accordance with government auditing standards. But it wouldn’t be surprising if the city does not have a policy or a law that mentions the Yellow Book. In this case, the internal auditor for the city would likely follow Institute of Internal Auditors (IIA) Standards and the external auditor would follow American Institute of Certified Public Accountants (AICPA) auditing standards.

The bottom line is that just because you audit a government does not mean you have to use the Yellow Book. If you cannot find any law or policy requiring it, you do not have to follow it. The Yellow Book is not like the AICPA’s audit standards, which, just because they exist, must be followed when expressing an opinion on the financial statements.

For instance, let’s say you are engaged to express an opinion on the financial statements of a small town in Georgia that does not receive any federal funds. Are you required to follow the Yellow Book on this engagement? To figure this out, you need to do more research. You need to determine whether the state of Georgia has a law or regulation requiring the use of GAGAS on audits of towns and cities in the state. You must also find out whether the town has a rule or regulation in its city charter that requires the use of GAGAS. The request for proposal may include a request that the audit be conducted in accordance with Yellow Book. You need to look at all these rules, regulations, and policies to find the answer.

You don’t necessarily have to use the Yellow Book when working as an internal auditor of a government or as a monitor of governmental funds.Obviously, if you work for the federal government and conduct an audit of federal funds, you probably use the Yellow Book in your work because the Inspector General Act or the CFO Act requires it. But if you are a county auditor, you probably are not required to use it to guide your work.

Here is an example. Many state agencies have set up monitoring teams to ensure that federal and state pass-through funds are being spent properly, and they usually look at a finite set of compliance requirements. Nowhere do state regulations or laws require that the state agencies follow the Yellow Book. And, the agencies do not conduct or contribute to the Single Audit of the sub-recipients. Therefore, these monitoring teams do not conduct their work to comply with the Yellow Book, even though they audit governmental funds of governmental entities.

The GAO lists several laws or regulations that may require the use of the Yellow Book:

1.09     The following are some of the laws, regulations, and or other authoritative sources that require the use of GAGAS:

  1. The Inspector General Act of 1978, as amended, 5 U.S.C. App. requires that the statutorily appointed federal inspectors general comply with GAGAS for audits of federal establishments, organizations, programs, activities, and functions. The act further states that the inspectors general shall take appropriate steps to assure that any work performed by nonfederal auditors complies with GAGAS.
  2. The Chief Financial Officers Act of 1990 (Public Law 101-576), as expanded by the Government Management Reform Act of 1994 (Public Law 103-356), requires that GAGAS be followed in audits of executive branch departments’ and agencies’ financial statements. The Accountability of Tax Dollars Act of 2002 (Public Law 107-289) generally extends this requirement to most executive agencies not subject to the Chief Financial Officers Act unless they are exempted for a given year by the Office of Management and Budget (OMB).
  3. The Single Audit Act Amendments of 1996 (Public Law 104-156) require that GAGAS be followed in audits of state and local governments and nonprofit entities that receive federal awards. OMB Circular No. A-133, Audits of States, Local Governments, and Non- Profit Organizations, which provides the government wide guidelines and policies on performing audits to comply with the Single Audit Act, also requires the use of GAGAS.

1.10      Other laws, regulations, or authoritative sources may require the use of GAGAS. For example, auditors at the state and local levels of government may be required by state and local laws and regulations to follow GAGAS. Also, auditors may be required by the terms of an agreement or contract to follow GAGAS. Auditors may also be required to follow GAGAS by federal audit guidelines pertaining to program requirements, such as those issued for Housing and Urban Development programs and Student Financial Aid programs. Being alert to such other laws, regulations, or authoritative sources may assist auditors in performing their work in accordance with the required standards.

1.11      Even if not required to do so, auditors may find it useful to follow GAGAS in performing audits of federal, state, and local government programs as well as audits of government awards administered by contractors, nonprofit entities, and other nongovernment entities. Many audit organizations not formally required to do so, both in the United States of America and in other countries, voluntarily follow GAGAS.

When the AICPA gets involved

The Yellow Book covers several different categories of engagements: financial audits, attestation engagements, reviews of financial statements, and performance audits. If you conduct a financial audit, you must also follow the AICPA audit standards. If you conduct an attestation engagement, you must also follow the AICPA attestation standards. If you conduct a review of the financial statements, you must follow the AICPA’s review standards. However, if you conduct a performance audit, you don’t have to follow the AICPA standards or any other standards for that matter!

The Yellow Book states, in the sections dealing with financial audits and attestation engagements, that the AICPA standards are to be applied. Then the Yellow Book adds a few additional requirements of its own. For example, the AICPA does not require that the findings contain the five distinct elements of a persuasive argument, but the Yellow Book does.

Periodically, the GAO revises the Yellow Book. When the GAO revises, they seek to match the language in the Yellow Book to the language in the AICPA standards. This is true even in the performance standards because the GAO wants the Yellow Book to use consistent terms and concepts throughout. Why do I mention this? If you are a performance auditor, you can’t entirely ignore the AICPA because when the AICPA moves and updates, the GAO matches their move and updates the financial AND performance audit chapters accordingly.

The Single Audit Layers

If you are one of the lucky souls who conduct Single Audits, you must pay attention to several layers of standards.

In addition to requiring that its instruction be followed, Single Audit requirements demand that the audit be conducted in accordance with government auditing standards. Upon opening the Yellow Book, you discover that a Single Audit qualifies as a financial audit. The financial audit chapters inside the Yellow Book then say that you must also follow the AICPA audit standards.

So, the layering looks like this:

Single Audit requirements
Yellow Book
AICPA audit standards (AU-C)

More often than not, if you audit a federal program, you must look at other requirements generated by the federal grantors that exceed the Single Audit requirements in the Uniform Guidance. For instance, in auditing HUD programs, you must follow the HUD audit guide as well as the Single Audit requirements (and hence the Yellow Book and the AICPA standards). Instead of three layers, you must be apply four layers of audit requirements. Does anybody want out of governmental auditing yet?

The Focus of This Manual

The focus of this manual is to cover onlythe government auditing standards, the Yellow Book. The manual will not delve into the AICPA standards, the IIA standards, or the Single Audit requirements in detail, although I may refer to them from time to time. The Yellow Book provides plenty of fodder for discussion on its own.

How the Yellow Book Is Organized

One key to understanding the Yellow Book standards is to get comfortable with the way they are organized. The standards are conveniently organized by introductory material and general standards as well as financial, attestation, and performance standards.

CHAPTER 1: Foundation and Principles for the Use and Application of Government Auditing Standards: This chapter introduces the types of audits and meaning of must, should, and may
CHAPTER 2: General Requirements for Complying with Government Auditing Standards
CHAPTER 3: Ethics, Independence, and Professional Judgment
CHAPTER 4: Competence and Continuing Professional Education
CHAPTER 5: Quality Control and Peer Review
CHAPTER 6: Standards for Financial Audits: This chapter is applicable to financial audits only and discusses fieldwork standards, including documentation and client communications during planning. This chapter also discusses reporting standards, including the need to garner client responses to findings. This chapter builds on top of AICPA audit standards.
CHAPTER 7: Standards for Attestation Engagements and Reviews of Financial Statements. This chapter is applicable to attestation engagements and reviews of financial statements only and is very redundant of financial auditing standards. This chapter builds on the AICPA’s Statements on Standards for Attestation Engagements (SSAEs) and the Statement on Standards for Accounting and Review Services (SSARS).
CHAPTER 8: Fieldwork Standards for Performance Audits. This chapter is applicable to performance audits only and does not layer on top of any other standards.
CHAPTER 9: Reporting Standards for Performance Audits. This chapter is applicable to performance audits only and does not layer on top of any other standards.

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