Taxing Matters

For many years, the legal profession was the brunt of cocktail party humor. Now, in the aftermath of the scandals involving Enron, WorldCom, and Tyco, the accounting profession has taken its place. A typical jibe: “Why did the auditor cross the road?” Answer: “Because he looked in the work papers and that’s what he did last year.”

In many cases they were not far from the truth. The end result was the Sarbanes-Oxley Act of 2002, also known as the Public Company Accounting Reform and Investor Protection Act of 2002. The act established new enhanced standards for public companies, their management, and the accounting profession.

In an effort to police itself and tighten its standards, the American Institute of Public Accountants issued 11 new standards for auditing effective for accounting periods either beginning on or after December 15, 2006. They apply to both public and private companies.

How are co-ops and condos affected? The most significant area is risk assessment. That process has been expanded from simply identifying risk areas to employing a method relating each risk to what can go wrong and then considering the effect on the financial statement for each risk.

These enhanced procedures require that auditors evaluate your relevant controls and verify that they are in place. Based on that, they will ascertain what risks your building faces, meaning any significant risks will require special consideration. If a firm utilizes the audit approach previously used by many smaller accounting firms, this will lead to much more testing. Further, audit sample sizes can no longer be smaller than those required by statistical sampling, therefore significantly more transactions may be examined.

For the first time, the new standards require that internal controls actually be tested. (Internal controls are all of the processes used to assure the building is properly run and its assets are protected from theft.) Until now, external auditors were merely required to gain an understanding of a building’s safeguards and not to verify that they were actually being performed. That is no longer the case.

As a result, you should expect your accountant to perform more work up front in planning for such a risk-based audit. You should expect a variety of new questions and requests for information. An important benefit is your accountant’s increased knowledge of the details of how your building is run. This will allow the accountants to offer their insight, comments, and recommendations. However, the standards no longer allow for oral explanations by a client in and of themselves to be sufficient explanations and therefore these may need to be corroborated by other evidence.

There is also a new requirement that the auditor communicate in writing any significant internal control deficiencies and material weaknesses to management and those charged with governance. A significant deficiency occurs when the controls and/or their lack of application cannot reduce the risk of a misstatement in your financials to what would be considered less than a likely occurrence. A material weakness is when your building doesn’t have strong enough internal controls to detect or prevent any material misstatements.

Also, the standards indicate that the failure to correct issues identified in previous years will be considered a significant deficiency. If corrective action is not undertaken, the issue must continue to be reported and highlighted as unresolved.

What this all boils down to is that there is now a much greater burden on the accounting profession concerning the audit procedures and taxation considerations. However, this does not come without a cost. In August 2007, the Corporate Library issued a study of 3,139 companies and found that audit fees rose 64 percent from 2001 to 2006. The median audit fee rose 345.68 percent. Don’t be surprised if your audit fees go up. Nonetheless, the enhanced audit procedures offer better protection from scrutiny and more reliable financial statements.