2018 Yellow Book and New Independence Rules for Auditors
Many organizations are subject to reporting under generally accepted government auditing standards, also known as the Yellow Book. This reporting applies to all organizations that are subject to Single Audit reporting, HUD audits, most charter/contract schools and many social service agencies that receive state funding.
The 2018 Yellow Book was recently updated and includes a significant change regarding auditor independence. In essence, auditors are no longer considered independent with respect to the audit if auditors prepare an organization’s financial statements without having one or more safeguards in place. Safeguards may include: A separate and independent engagement quality control review or separate and independent team members who are responsible for preparing the financial statements. Either safeguard will likely result in an increase in audit time and cost.
The best and most cost effective solution is to have the organization prepare its own financial statements, which would avoid the need for any additional safeguard as noted above. The preparation may be performed by the organization’s CFO or similar position, an outsourced accounting service provider, a board member who may be a CPA or work for a CPA firm or other options. The individual or firm preparing the financial statements should possess the technical experience and background necessary to understand the organization, as well as how to prepare financial statements in accordance with accounting principles generally accepted in the United States. The financial statements must be complete, including a statement of cash flows and all necessary footnote disclosures.
If the organization chooses to prepare its own financial statements, the audit firm may assist the organization by sending a copy of the prior year financial statement groupings and templates as well as a disclosure checklist that the organization can use as a resource to make sure all necessary footnote disclosures are included.
Although the 2018 Yellow Book changed the rules regarding auditor independence, it did not change the responsibility of management with respect to all nonaudit services, including financial statements prepared by the audit firm. In all cases involving non-audit services, management must:
- Assume all management responsibilities;
- Assign an individual with the necessary skills, knowledge and experience (SKE) to oversee the performance of the nonaudit services;
- Evaluate the adequacy and results of the non-audit services; and
- Accept responsibility for the results of the non-audit services.
The Yellow Book defines SKE as management being able to determine the reasonableness of the results of the nonaudit services, as well as being able to recognize a material error, omission or misstatement in the results of the nonaudit services.
Although the 2018 Yellow Book is effective for audits of financial statements for periods ending on or after June 30, 2020, the requirements are in effect for the entire fiscal year June 30, 2020. This means auditors must be independent as of July 1, 2019 and applies now to the preparation of financial statements for the year ending June 30, 2019 and forward.
We encourage you to discuss this new requirement, and the options available to you, with your respective audit firm engagement team.
For more information, contact Jim Quaid at email@example.com or 312.670.7444. Visit ORBA.com to learn more about our Not-For-Profit Group.