Auditing 3

Becker Professional Education | CPA Exam Review

Illegal acts
The AICPA has stated that it will test both the Clarified SASs and the "old" SASs on the Auditing exam starting
on July 1, 2013. The AICPA has not given a definitive time period for this dual-testing, but has stated that
it will continue until the Clarified SASs fully replace the old SASs (most likely at the end of 2014). The good
news is that Becker is well-positioned to prepare you for the Auditing exam during this period of transition
from the old SASs to the Clarified SASs. This Audit B textbook (Clarified SASs), is essentially the Audit A
textbook (old SASs) with enhancements to cover the new/clarified provisions of the Clarified SASs. This new
section has been added to your Audit 3 lecture to cover illegal acts. The concept of illegal acts has been
replaced by the broader concept of compliance with laws and regulations in the Clarified SASs. However, you
may still see questions related to illegal acts on your Audit Exam. If you would like to print out this new topic,
please go to 2013 Edition course updates for the Audit B textbook available at http://beckerkb.custhelp.com.
Illegal Acts

I.

ILLEGAL ACTS BY CLIENTS

A.

Illegal Acts Defined

Illegal acts are violations of laws or governmental regulations committed by the entity or by
company personnel acting on behalf of the entity.

B.

Auditor's Responsibility to Detect Illegal Acts

1.

Direct Effect on Financial Statements

The auditor's responsibility to detect illegal acts that have a material and direct effect on
financial statements is the same as that for errors and fraud. In other words, the auditor
has a responsibility to plan and perform the audit to obtain reasonable assurance that the
financial statements are free of material misstatement.

2.

Indirect Effect on Financial Statements

The auditor is under no obligation to look for illegal acts having an indirect effect on the
financial statements. However, if specific information comes to the auditor's attention
concerning illegal acts, the auditor should apply appropriate audit procedures.

Generally, the less the act affects the financial statements, the less likely it is that the auditor
will discover it.
C.

Audit Procedures
The auditor generally does not include procedures specifically to detect illegal acts, but may
discover such acts through other procedures, such as reading minutes or making inquiries of
management or of legal counsel. Information that may be indicative of illegal acts includes:

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1.

Unauthorized or improperly recorded transactions;

2.

Payments of unusual fines or penalties;

3.

Payments that are unusually large or excessive, especially those made in cash;

4.

Unexplained payments, or payments for unspecified services;

5.

Investigations by governmental agencies, or known violations of laws or regulations; and

6.

Failure to file tax returns or pay other appropriate fees.

2012 DeVry/Becker Educational Development Corp. All rights reserved.

Becker Professional Education | CPA Exam Review

Auditing 3

U . S . A U D I T I N G STA N D A R D S v s . I N TE R N AT I O N AL STA N D A R D S O N A U D I T I N G

ISA 250 does not distinguish between laws and regulations that have a direct versus an indirect effect on the financial
statements, but instead states that the auditor should recognize that noncompliance with laws and regulations may
materially affect the financial statements. ISA 250 states that laws and regulations vary considerably in relation to the
financial statements and that the auditor is less likely to become aware of noncompliance that is far removed from
the financial statements.

D.

Auditor's Response to Illegal Acts

1.

Possible Illegal Acts

When the auditor becomes aware of information concerning a possible illegal act, the
auditor should:

2.

a.

Obtain an understanding of the nature of the act and its effect on the financial
statements;

b.

Inquire of management at a level above those involved;

c.

Consult the client's legal counsel about the application of relevant laws and
regulations to the circumstances; and

d.

Apply additional audit procedures, if necessary.

Detected Illegal Acts

When the auditor concludes that an illegal act has occurred, the auditor should:

E.

a.

Consider the effects of the illegal act on the financial statements;

b.

Evaluate the materiality of the illegal act, considering both quantitative and
qualitative factors;

c.

Evaluate the disclosure of loss contingencies, including possible fines, penalties,

and damages;

d.

Consider the implications for other areas of the audit; and

e.

Communicate the illegal act to those charged with governance.

Effect of Illegal Acts on the Auditor's Report

1.

Departure from GAAP

If the auditor concludes that a material illegal act exists and that it has not been properly
accounted for or disclosed, the auditor should insist that the financial statements be
revised. If the client refuses, a qualified opinion or adverse opinion should be issued
with full disclosure of the matter.

2.

Insufficient Evidence
If the auditor is precluded from obtaining sufficient appropriate audit evidence about the
illegal act, generally a disclaimer of opinion should be issued.

3.

Client Response
If the client refuses to accept the auditor's report as modified, the auditor should withdraw
from the engagement and notify those charged with governance in writing.

2012 DeVry/Becker Educational Development Corp. All rights reserved.

A3-77

Auditing 3

F.

Becker Professional Education | CPA Exam Review

Implications of Illegal Acts

The auditor should consider the effect of illegal acts on the evaluation of internal control and
on the planned degree of reliance on management representations. If the client fails to take
appropriate remedial action regarding any illegal act (including those that are not material),
the auditor may consider withdrawing from the engagement.

G.

Communication of Illegal Acts

1.

Those Charged with Governance

Those charged with governance should be adequately informed of illegal acts unless
they are clearly inconsequential. Such communication may be oral or written, but oral
communications should be documented.

2.

Parties Outside the Entity

Ordinarily, the disclosure of illegal acts to parties other than senior management and
those charged with governance is not part of the auditor's responsibility. However, in
certain circumstances, a duty to disclose outside the entity may exist.
a.

To comply with certain legal and regulatory requirements, such as on Form 8-K
and on reports required by the Private Securities Litigation Reform Act of 1995;
(1) Under the Private Securities Litigation Reform Act of 1995, if an auditor reports
an illegal act to the board of directors of a client, and if the client fails to take
appropriate remedial action and the board fails to inform the SEC of this fact,
then the auditor is required to deliver a report concerning the illegal act to the
SEC within one business day.

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b.

To a successor auditor when the successor makes inquiries of the predecessor

auditor, with specific permission of the client;

c.

In response to a subpoena; and

d.

To a funding agency or other specified agency in accordance with requirements

for audits of entities that receive governmental financial assistance.

2012 DeVry/Becker Educational Development Corp. All rights reserved.