Revised Yellow Book Standards – Are You Ready?

Wednesday, April 22, 2020

GAO logoAs you are likely aware, the GAO 2018 Revision of the Government Auditing Standards – also known as the Yellow Book – are in effect for the fiscal year ended June 30, 2020. We are not anticipating any delay in this standard as it is already in effect; therefore, the standard will be applicable for certain audits for units with a June 30, 2020 fiscal year end. What does that mean to you as a local government? Or to you as an auditor of local governments? 

When do the Yellow Book Standards apply to a local government audit?
Any unit of government that expends $100,000 or more in state or federal funds in a given fiscal year must have a Yellow Book audit. 

What has changed in the revised standards?
The GAO has implemented stronger standards regarding independence of the auditor from the governmental unit and given some very specific guidance on how those standards impact the auditors’ work, especially regarding non-attest services performed for the audit client, including writing the financial statements. While the revised standards do not prohibit the auditor from writing the financial statements of an audit client, they do require certain thresholds to be met and certain actions by the auditor if he or she will continue to write the financial statements of an audit client.

The thresholds consist of a two-part test. The first part that must be satisfied is that the unit of government must have someone on staff or under contract that possesses the suitable skills, knowledge, and experience (SKE) to oversee the non-attest service, in this case the writing of the financial statements. While this person does not have to be able to recreate the statements, the identified SKE person must be able to recognize if the statements are materially correct. Units please note this person can be a contracted vendor – it does not have to be an employee of the unit, and it does not have to be the finance officer. 

If the auditor and unit cannot identify an appropriate SKE person for the unit of government, the auditor cannot write the statements and perform the audit.  This distinction is clearly made in the revised standards. 

We consider a “lack of expertise” or a similar finding in a unit’s 2019 audit to be an indicator or a “red flag” that unit staff may not possess the appropriate SKE as required by the 2018 Yellow Book revision, unless there have been staff changes, significant staff training, or the procurement of a qualified vendor to provide the necessary SKE. We will be monitoring findings in the 2020 audits for inconsistencies with findings that were reported in 2019 audits and may have questions for auditors as a result.  

Once the unit and the auditor have identified an acceptable SKE person, the independence test advances to the second part. The auditor must be able to sufficiently overcome the threat to his or her independence that is caused by the auditor writing the financial statements. Again, the revised standards are very clear on this point – the writing of the financial statements is a threat to independence and must be overcome. The revised standard provides several examples of ways that auditors can overcome this threat:

  • The auditor can have certain individuals within their firm write the statements and other individuals conduct the audit, with no crossover between the two parts of the engagement;
  • The auditor can have another member of the audit firm that is knowledgeable in governmental accounting and auditing review the work of the audit team;
  • The audit firm can hire another audit firm to review the non-audit services performed, including the writing of the financials; or
  • The audit firm can hire another audit firm to recreate the financials.

Whatever approach the auditor decides to take, there must be clear and complete documentation of how the threat to independence was overcome. If the auditor cannot sufficiently overcome the threat to his or her independence, the auditor cannot write the financial statements and conduct the audit. 

There are other changes in the 2018 revision of the Yellow Book that mainly relate to the auditors’ responsibilities with regards to CPE, and identifying fraud, waste, and abuse. We encourage all governmental auditors to be familiar with these revised standards. 

Where can I learn more?
For more information, please see our Memorandum 2019-07 on the revised standards. You can access the memo here
You can find the revised standards here.