Chapter 1 -
Introduction and Overview of
SAS No. 99
Learning Objectives
After completing this chapter, you should be
• Familiar with major requirements relating to an auditor’s responsibilities for detecting
material misstatements due to fraud during a GAAS audit.
• Able to identify ways in which SAS No. 99 changes existing audit practice.
• Familiar with the organization of the remainder of the course.
Introduction
Background and Overview of SAS No. 99
The accounting profession was under fire. Throughout the long, hot summer, newspapers were
filled with new details of a corporate accounting scandal. One of the largest, most respected
companies in the United States had been caught inflating earnings and assets through blatant
manipulation of the accounting rules. Thousands of investors and employees had suffered.
Congressional hearings were called to examine and understand the fraud, and everyone asked,
“Where were the auditors?” The accounting profession was under immense political pressure
from reform-minded lawmakers, and the negative publicity surrounding the perceived audit
failure cast all CPAs in the most unfavorable light.
Sound familiar? The year was 1938.
The corporate accounting scandal was McKesson-Robbins, in which the company inflated assets
and earnings by $19 million through the reporting of nonexistent inventory and fictitious sales.
In the wake of the scandal, the auditing profession responded by setting the first formal standards
for auditing procedures, including guidance on the auditor’s responsibilities for detecting fraud.
In the years since McKesson-Robbins, the business world has been rocked by even bigger
corporate frauds, and each time the profession has come under criticism – some of which is
justified and some of which is not. Once again we have witnessed the quick, spectacular failure
of some of this country’s largest companies, amid a series of indictments, arrests, and allegations
of financial fraud. As CPAs, we find ourselves in the uncomfortable position of having to
defend our work and our credibility. We are now at the beginning of the post-Enron world.
In the summer of 2002, the Sarbanes-Oxley Act was signed into law, and by all accounts it has
the potential to dramatically change the auditing profession. SAS No. 99,
Consideration of Fraud in a Financial Statement Audit, was the first major audit standard to be released after the
passage of Sarbanes-Oxley. No one ever intended these events to converge like this, but they did
– a new fraud standard delivered in the midst of endless revelations of corporate malfeasance.
The timing is fortuitous because this standard provides us with an excellent opportunity to repair
some of the recent damage to our reputation – one auditor, one engagement at a time.
SAS No. 99 has the potential to significantly improve audit quality, not just in detecting fraud,
but also in detecting all material misstatements and improving the quality of the financial
reporting process. This is why.
Integrity of the Standards-Setting Process
High-quality processes lead to high-quality results. Suppose you are building a house and you
want it to be beautiful and functional and stand the test of time. Everything you do – from the
drafting of the plans to the selection of materials and on through the actual construction itself –
must be designed to produce that type of quality. Because of that direct relationship between
process and product, we can judge the quality of a finished product before it is used by looking at
the quality of the process. Thinking of buying a home but having questions about its quality?
Examine the quality of the building process.
Auditors would have been skeptical if SAS No. 99 had been the product of a hasty process
designed solely as a response to the criticism the profession has received in the wake of highprofile
business failures.
For that reason, it is important to recognize that SAS No. 99 was
not a knee-jerk reaction to
recent events. This standard was four years in the making. It is the product of a thoughtful,
thorough, and open standards-setting process that constantly seeks to improve audit quality. The
standard incorporates
• Results of academic research on how auditors implemented previous standards on fraud
and how those standards might be improved.
• Recommendations of the Public Oversight Board’s Panel on Audit Effectiveness, who
conducted their own detailed study on audit effectiveness.
• Comments from over 50 groups and individuals representing a wide variety of
stakeholders in the financial reporting process.
Because of the care exercised in the development of the standard, it is a high-quality standard
that is likely to improve the ability of auditors to respond effectively to the potential for fraud.
Audit Smarter
If you are familiar with the previous auditing standard on fraud, you know that a cornerstone of
that standard was a list of “fraud risk factors,” which, though they do not necessarily indicate the
existence of fraud, often have been observed when frauds have occurred. This list of fraud risk
factors was intended to help auditors discover indicators of fraud while performing their
engagements. In practice, this list usually was reduced to a checklist that auditors completed and
included in their workpapers.
The academic research that examined the implementation of the previous standard resulted in
several key findings:
• Auditors did a good job of identifying indicators of fraud. However, once those
indicators were identified, they did a relatively poor job of responding appropriately to
the perceived risk of fraud.
• Auditors who rely exclusively on checklists to identify fraud risk factors are less effective
than those who supplement checklists with other procedures.
SAS No. 99 is extremely comprehensive and touches on many elements of the audit process. It
cannot be reduced to a checklist or form. The effective implementation of SAS No. 99 requires
auditors to
audit smarter and think when they audit. Engagement teams who implement the
standard by obtaining an updated version of a generic audit program will be doing themselves
and their clients an injustice. The effective implementation of SAS No. 99 will force you to
rethink how you plan and perform your audits.
Standard Will Result in Better Audits, Not Just Fraud Detection
As an example of the ways in which SAS No. 99 will result in better audits, consider the
effectiveness of analytical procedures. If you attend a training session on improving the
effectiveness of analytical procedures, one sure-fire way for the instructor to get a laugh (and
make an important point) is to describe some of the analytical review comments he or she has
read on workpapers over the years. “Revenues increased because the client sold more.” Or
“Change in account balance from prior year is reasonable per discussion with controller.”
What makes these types of comments scary is that they illustrate how an otherwise effective
audit procedure can be rendered ineffective. And analytical procedures are just one of several
areas where the performance of audit procedures is less than optimal. To reduce audit risk to an
acceptable level, others on the engagement team must revisit the audit area and do additional
work, which makes the engagement less efficient.
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