Detecting Material Misstatements Resulting from Violations of Contract Provisions or Grant Agreements, or from Abuse
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GAO-03-673G Government Auditing Standards > Chapter 4 Field Work Standards for Financial Audits > Detecting Material Misstatements Resulting from Violations of Contract Provisions or Grant Agreements, or from Abuse
4.17 The standard related to violations of contract provisions or grant agreements or abuse for financial audits performed in accordance with GAGAS is:
a. Auditors should design the audit to provide reasonable assurance of detecting material misstatements resulting from violations of provisions of contracts or grant agreements that have a direct and material effect on the determination of financial statement amounts or other financial data significant to the audit objectives. If specific information comes to the auditors’ attention that provides evidence concerning the existence of possible violations of provisions of contracts or grant agreements that could have a material indirect effect on the determination of financial statement amounts or other financial data significant to the audit objectives, auditors should apply audit procedures specifically directed to ascertain whether violations of provisions of contracts or grant agreements have occurred or are likely to have occurred.
b. Auditors should be alert to situations or transactions that could be indicative of abuse, and if indications of abuse exist that could significantly affect the financial statement amounts or other financial data, auditors should apply audit procedures specifically directed to ascertain whether abuse has occurred and the effect on the financial statement amounts or other financial data.
4.18 AICPA standards and GAGAS require auditors to assess the risk of material misstatements of financial statement amounts or other financial data significant 1 to the audit objectives due to fraud and to consider that assessment in designing the audit procedures to be performed. 2 Auditors are also required to design the audit to provide reasonable assurance of detecting material misstatements resulting from direct and material illegal acts (violations of laws and regulations) and to be aware of the possibility that indirect illegal acts 3 may have occurred.4 Under GAGAS, auditors have the same responsibilities for detecting material misstatements arising from violations of provisions of contracts or grant agreements as they do for detecting those arising from fraud and illegal acts. Auditors should design the audit to provide reasonable assurance of detecting material misstatements resulting from direct and material violations of provisions of contracts or grant agreements. If specific information comes to the auditors’ attention that provides evidence concerning the existence of possible violations of provisions of contracts or grant agreements that could have a material indirect effect on the financial statements or significant indirect effect on other financial data needed to achieve audit objectives, auditors should apply audit procedures specifically directed to ascertain whether violations have occurred or are likely to have occurred.
4.19 Abuse is distinct from fraud, illegal acts, and violations of provisions of contracts or grant agreements. When abuse occurs, no law, regulation, or provision of a contract or grant agreement is violated. Rather, abuse involves behavior that is deficient or improper when compared with behavior that a prudent person would consider reasonable and necessary business practice given the facts and circumstances. 5 Auditors should be alert to situations or transactions that could be indicative of abuse. When information comes to the auditors’ attention (through audit procedures, allegations received through a fraud hotline, or other means) indicating that abuse may have occurred, auditors should consider whether the possible abuse could affect the financial statement amounts or other financial data significantly. If indications of possible abuse exist that significantly affect the financial statement amounts or other financial data, the auditors should extend the audit steps and procedures, as necessary, to (1) determine whether the abuse occurred and, if so, (2) determine its effect on the financial statement amounts or other financial data. Auditors should consider both quantitative and qualitative factors in making judgments regarding the materiality of possible abuse and whether they need to extend the audit steps and procedures. However, because the determination of abuse is subjective, auditors are not expected to provide reasonable assurance of detecting abuse.
4.20 Auditors should exercise professional judgment in pursuing indications of possible fraud, illegal acts, violations of provisions of contracts or grant agreements, or abuse, in order not to interfere with potential investigations, legal proceedings, or both. Under some circumstances, laws, regulations, or policies require auditors to report indications of certain types of fraud, illegal acts, violations of provisions of contracts or grant agreements, and abuse to law enforcement or investigatory authorities before extending audit steps and procedures. Auditors may also be required to withdraw from or defer further work on the engagement or a portion of the engagement in order not to interfere with an investigation.
1The terms “material” and “significant” are synonymous under GAGAS. “Material” is used in the AICPA standards in relation to audits of financial statements. “Significant” is used in relation to other types of audits governed by GAGAS, such as performance audits, where the term “material” is generally not used.
2Two types of misstatements are relevant to the auditors’ consideration of fraud in an audit of financial statements--misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets. The primary factor that distinguishes fraud from error is whether the underlying action that results in the misstatement in the financial statements is intentional or unintentional.
3Indirect illegal acts are violations of laws and regulations having material but indirect effects on the financial statements.
4Whether a particular act is, in fact, illegal may have to await final determination by a court of law or other adjudicative body. Thus, when auditors disclose matters that have led them to conclude that an illegal act is likely to have occurred, they should not imply that they have made a determination of illegality.
5For example, in a financial statement audit, auditors might find abuse when examining sensitive payments such as travel of senior management officials to locations chosen for personal reasons rather than less costly locations which would have been appropriate to satisfy the business objectives of the travel. While auditors generally will not view travel expenses of senior management officials as quantitatively material to the financial statements, this expense generally would be considered qualitatively material to the financial statements.
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