While Taylor Swift is the music icon everyone is talking about these days, there’s another American singer-songwriter icon that inspired today’s blog: Stevie Nicks – specifically her song, “Stand Back”. Each time I read the stand-back requirement found in Statement on Auditing Standards (SAS) No. 145, I can’t help but start singing the song in my head! Even if you aren’t a Stevie Nicks fan, hopefully this post will help you remember to do the stand-back assessment on your audits!

Guidance

Statement on Auditing Standards (SAS) No. 145, Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement was issued in October 2021 by the AICPA Auditing Standards Board (ASB). The ASB specifically notes in their “At-a-glance” document overviewing SAS 145 that the SAS “does not fundamentally change the key concepts underpinning audit risk. Rather it clarifies and enhances certain aspects of the identification and assessment of the risks of material misstatement to drive better risk assessments and, therefore, enhance audit quality.” Within this 200+ page SAS, there is a new requirement that I want to discuss in more detail today: the stand-back requirement.

What is the stand-back assessment requirement?

Is the new stand-back assessment requirement going to be a concept that “knocks your socks off”? Absolutely not (or at least I hope not!), but it’s one not to be overlooked. Let’s take a look at the new requirement found within the SAS.

SAS 145, paragraph 40 states:

“For material classes of transactions, account balances, or disclosures that have not been determined to be significant classes of transactions, account balances, or disclosures, the auditor should evaluate whether the auditor’s determination remains appropriate.”

The stand-back requirement focuses on two key words: material and significant. Let’s clarify what those terms mean under U.S. Generally Accepted Auditing Standards (U.S. GAAS).

Material

Materiality is in the context of the financial statements. According to U.S. GAAS, classes of transactions, account balances or disclosures are material “if there is a substantial likelihood that omitting, misstating, or obscuring information about them would influence the judgment made by a reasonable user based on the financial statements." Keep in mind that materiality is not just a quantitative determination – qualitative factors must also be considered!

Significant

Classes of transactions, account balances or disclosures are determined to be significant when there is “one or more relevant assertions” identified. SAS 145 adds a bit more detail and explains that “significance can be described as the relative importance of a matter and is judged by the auditor in the context in which the matter is being considered. For inherent risk, significance may be considered in the context of how, and the degree to which, inherent risk factors affect the combination of the likelihood of a misstatement occurring and the magnitude of the potential misstatement should that misstatement occur. The determination of significant risks allows for the auditor to focus more attention on those risks that are close to the upper end of the spectrum of inherent risk through the performance of certain required responses.”

Said another way, the requirement involves looking at all of the material transactions, accounts and disclosures that have not been determined to be significant and evaluating if changes need to be made (i.e., if an account should have been determined as significant).

When does this requirement occur during an audit?

Auditors are required to identify and assess the risks of material misstatement to provide a basis for designing audit procedures to respond to these risks. We aren’t diving into the details of risk assessment procedures in this blog post, but in terms of timing, the stand-back assessment should occur after initial risk assessment procedures are performed but before the response procedures are conducted. 

Why was this requirement added?

The stand-back requirement was added to aid the auditor in evaluating if they have completely identified all of the significant classes of transactions, account balances, and disclosures. You can think of it as a “double-check” to make sure an account, transaction, or disclosure that is material isn’t overlooked. Remember, the whole point of risk assessment procedures (including the stand-back requirement) is to aid the auditor in the identification and assessment of risks. If risks aren’t properly identified and assessed, then the audit may be ineffective!

As with anything in the audit, documentation is key. Perhaps you have a material account that, in your professional judgement, isn’t significant? That’s fine! Your logic and reasoning must be documented.

What happens if the auditor identifies a transaction, account, or disclosure that is significant when performing the stand-back requirement?

No big deal! The risk assessment process is dynamic in an audit! Document the results of your stand-back assessment and adjust your risk assessment and planned audit response, as necessary.

Audit training resources

Do you or your team need a refresher of foundational audit concepts? Or perhaps you’d like to dive deeper into the world of internal controls. Either way, GAAP Dynamics has you covered. We’ve facilitated a series of webinars covering key audit concepts for firms and we are currently developing a library of CPE-eligible, eLearning courses that will be released soon. Reach out and let’s chat about audit training solutions!

Fun facts about Stevie Nicks and “Stand Back”

Stevie heard Prince’s “Little Red Corvette” while driving and liked the melody. She stopped and bought a tape recorder and recorded the song on the evening of her wedding day! After telling Prince how she wrote the song, he played synthesizers on it. According to Stevie, “Stand Back” is one of her favorite songs onstage!

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Disclaimer  

This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.