The following auditing interpretation is not the current version and does not reflect any amendments effective on or after December 31, 2016. The current version of the auditing interpretations can be found here.
Communication of Internal Control Related Matters Noted in an Audit: Auditing Interpretations of Section 325
- (.01 - .07) Reporting on the Existence of Material Weaknesses
- [.08 - .17] Audit Considerations for the Year 2000 Issue
Note: In an audit of financial statements only, auditing interpretation 1 to AU sec. 325, "Reporting on the Existence of Material Weaknesses," continues to apply except that the term "reportable condition" means "significant deficiency" as defined in paragraph 2 of this standard. Within the example report within paragraph 4 of the interpretation, the third sentence is replaced with the definition of a material weakness in paragraph A7 of Appendix A, Definitions, of PCAOB Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting That Is Integrated with An Audit of Financial Statements.
1. Reporting on the Existence of Material Weaknesses
Question—Section 325 requires the auditor to report to the audit committee or to individuals with equivalent authority and responsibility significant deficiencies noted during an audit of financial statements. It permits the issuance of reports that include a statement about whether any of the significant deficiencies identified are material weaknesses. In connection with an audit, may the auditor issue a written report on material weaknesses separate from the report on significant deficiencies?
Interpretation—Yes. Section 325 does not preclude the auditor from issuing a separate report stating whether he or she noted any material weaknesses during the audit. Reports on material weaknesses should—
- Indicate that the purpose of the audit was to report on the financial statements and not to provide assurance on internal control.
- Include the definition of a material weakness.
- State that the communication is intended solely for the information and the use of the audit committee, management, and others within the organization and is not intended to be and should not be used by anyone other than these specified parties. When there are requirements established by governmental agencies to furnish such reports, specific reference to such regulatory authorities may be made.
Section 325 prohibits the auditor from issuing a written report representing that no significant deficiencies were noted during the audit. Therefore, in issuing a report stating that no material weaknesses were noted, the auditor should not imply that no significant deficiencies were noted.
The following is an illustration of a report encompassing the above requirements:
In planning and performing our audit of the financial statements of ABC Corporation for the year ended December 31, 19XX, we considered its internal control in order to determine our auditing procedures for the purpose of expressing our opinion on the financial statements and not to provide assurance on the internal control. Our consideration of the internal control would not necessarily disclose all matters in the internal control that might be material weaknesses under standards established by the American Institute of Certified Public Accountants. A material weakness is a condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements caused by error or fraud in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. However, we noted no matters involving the internal control and its operation that we consider to be material weaknesses as defined above.
This report is intended solely for the information and use of the audit committee (board of directors, board of trustees, or owners in owner-managed enterprises), management, and others within the organization (or specified regulatory agency) and is not intended to be and should not be used by anyone other than these specified parties.
If conditions believed to be material weaknesses are disclosed, the report should describe the weaknesses that have come to the auditor's attention. The last sentence of the first paragraph of the report illustrated in paragraph .04 should be modified as follows and paragraphs describing the material weaknesses should follow the first paragraph:
However, we noted the following matters involving internal control and its operation that we consider to be material weaknesses as defined above.
In some cases reports on material weaknesses may include comments on specific aspects of internal control or on additional matters. For example, a regulatory agency may require comments on the accounting system and controls (but not on the control environment) or on compliance with certain provisions in contracts or regulations. In such cases the language in paragraph .04 should be modified to:
- identify clearly the specific aspects of internal controls or the additional matters covered by the report
- distinguish any additional matters from internal control
- describe in reasonable detail the scope of the review and tests concerning the additional matters
- express conclusions in language comparable to that in paragraph .04 or .05, as appropriate
The identification of the specific aspects of internal control or additional matters covered in the report should be as specific as the auditor considers necessary to prevent misunderstanding in this respect. Such identification can be made in some cases by reference to specific portions of other documents such as contracts or regulations.
[Issue Date: February, 1989; Revised: February, 1999.]
[2.] Audit Considerations for the Year 2000 Issue
[Withdrawn July, 2000 by the Audit Issues Task Force.]