NATIONAL INTERGOVERNMENTAL AUDIT FORUM

HOW TO AVOID A
SUBSTANDARD AUDIT:
SUGGESTIONS FOR
PROCURING AN AUDIT

Intergovernmental Audit Forum
 (Federal * State * Local)

May 1988

Executive
Committee

Charles A. Bowsher   Chairman, Comptroller General of the
                     United States

Frederick D. Wolf    GAO Representative, Director, Account-
                     ing and Financial Management Divi-
                     sion, U.S. General Accounting Office

Anthony Piccirilli   Vice-Chairman and State Representa-
                     tive, Auditor General, Rhode Island

Gerald R. Riso       OMB Representative, Associate Director
                     for Management, Office of Management
                     and Budget

Richard P. Kusserow  Federal Representative, Inspector
                     General, U.S. Department of Health
                     and Human Services

Daniel Paul          Local Representative, City Auditor,
                     Dallas, Texas

Edward Renfrow       Chairperson Representative for
                     Regional Forums, State Auditor, North
                     Carolina

NIAF
Executive
Director

Joseph D. Comtols    U.S. General Accounting Office

PROCUREMENT HANDBOOD TASK FORCE

John J. Cronin, Jr.  Task Force Director, U.S. General
                     Accounting Office

Sefton Boyars        Regional Inspector General, U.S.
                     Department of Education

John Crossley        Legislative Auditor, State of Nevada

Harvey Eckert        Deputy Secretary for Comptroller
                     Operations. Cornmonwealth Of
                     Pennsylvania

Alan Erickson        Finance Director, City of Brooklyn
                     Park, Minnesota

Ken Foster           Audit Manager, U.S. General Accounting
                     Office

Roland Malan         Assistant Deputy Comptroller, State of
                     New York

Dick Mangione        Office of Inspector General. U.S.
                     Department of Health and Human
                     Services

Terry Mllrany        Audit Supervisor, Office of the City
                     Auditor, Dallas, Texas

Hal Steinberg        Peat Marwick Main & Company

Nancy Crothers,      Manager, Writing Resources Branch,
Editor               U.S. General Accounting Office

In recent years, much attention has been focused on the quality of audits
of entities that receive federal assistance. This has been particularly true
since the passage of the Single Audit Act of 1984, which requires a single,
comprehensive financial and compliance audit of many entities receiving
federal funds. The Congress, the General Accounting Office, federal inspec-
tors general, state and local governments, and the accounting profession 
itself have all expressed concern about the quality of these audits.
These groups have undertaken a number of significant actions during the past 
year to address these concerns.

This handbook was prepared by the National Intergovernmental Audit Forum to 
help public entities that are planning an external audit ensure that they 
engage a qualified auditor and receive a quality audit. Because we believe 
that approaching procurement systematically is the best way to ensure a 
quality audit, regardless of the size or complexity of the entity, this 
handbook suggests such an approach. While the guidance this handbook presents 
is in no way mandatory, we hope that using it will enable you to receive the 
best audit possible.

Charles A. Bowsher
Comptroller General
of the United States

Contents

Foreword

Introduction............................ 1

Planning: An............................ 4
Essential First
Step

Competition............................. 8
and Solicitation:
Communicating
Audit
Requirements

Technical.............................. 14
Evaluation:
Selecting a
Qualified
Auditor

The Written............................ 19
Agreement:
Documenting
Expectations

Audit.................................. 22
Monitoring:
Ensuring a
Quality Audit

Bibliography........................... 24

ABBREVIATIONS

AICPA    American Institute of
         Certified Public
         Accountants

CPA      certified public accountant

GAAS     generally accepted auditing
         standards

GAGAS    generally accepted government 
         auditing standards

GAO      General Accounting Office

NIAF     National intergovernmental
         Audit Forum

0MB      Office of Management and
         Budget

RFP      Request for proposal

INTRODUCTION

Regardless of the type or size of public entity you are affIliated with-from
the smallest town or local entity to the largest state or federal agency, 
from a neighborhood health clinic to a major hospital, from a grade school 
to a university-an effective audit can improve management operations and
yield significant dollar savings. It can also help you avoid wasting your
entity's resources on a substandard audit. If your responsibilities include
hiring a certified public accountant (CPA) or any other independent auditor,
this handbook can help you get the most for your money.

Taking steps to ensure a quality audit is especially important in light of a
Oeneral Accounting Office (GAO) report 1_/ that identified 34 percent of CPA
audits it reviewed as substandard.  Another GAO report 2_/ disclosed that
entities with ineffective procurement systems stood a 46-percent chance of
receiving a substandard audit; that figure dropped dramatically to 17 percent 
for entities that followed systematic audit procurement practices.

Public entities should never select auditors without considering five

1_/ CPA Audit Quality: Many Governmental Audits Do Not Comply with Professional 
    Standards (GAO/AFMD-86-33. Mar. 19, 1986).

2_/ CPA Audit Quality: A Framework for Procuring Audit Services (GAO/AFMD-
    86-34, Aug. 18, 1987).

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 basic elements of an effective audit procurement process:

* planning (determining what needs to  be done and when),
* fostering competition by soliciting proposals (writing a clear and direct 
  solicitation document and disseminating it widely),
* technically evaluating proposals and qualifications (authorizing a 
  committee of imowledgeable persons to evaluate the ability of prospective 
  auditors to effectively carry out the audit),
* preparing a written agreement (documenting the expectations of both the
  entity and the auditor), and *monitoring the auditor's performance
  (periodically reviewing the progress of that performance).

This handbook discusses these five elements of audit procurement. It also
addresses the use of audit committees-independent committees composed of 
persons with kmowledge of accounting, auditing, finance, or management-
which, among other things, can assist entities in procuring audit
seivices and overseeing the audit process. In addition, because many small
entities-in this context. those that contract for audits costing less than
$10,0OO-do not have procurement systems that are as formal as those of
large states or local governments, we present information at the end of 
each section on how the critical elements of a procurement system can be 
applied to the special needs of small entities.

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Finally, we have included a short bibliography of procurement guidelines.
keep in mind, however, that if the guidance that this handbook provides
conflicts with applicable laws or regulations or relevant grant conditions,
the laws. regulations, or conditions are controlling.

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PLANNING  AN ESSENTIAL FIRST STEP

Planning to procure a quality audit requires time and attention. But the
resources an entity spends on planning are likely to be rewarded by a
smoother, more timely, and often less expensive audit.

Matters to    
Consider

* Defining the entity to be audited. Governments and other public 
  organizations are often composed of numerous smaller, sometimes legally 
  separate entities. You should decide which of These units to include in 
  the scope of your audit, talcing into account any legal requirements and 
  generally accepted accounting principles.

* Delineating the scope of the financial audit. For audits of financial 
  statements, you need to determine whether you want the auditor to limit 
  the examination to the general-purpose financial statements, the minimum
  allowable audit scope, or to extend the examination to cover additional 
  statements, such as the combined, individual fund, and account-group 
  financial statements.

* Determining the specific audit requirements. To determine your audit
  requirements-a sometimes difficult task-you may want to seek the assis-
  tance of knowledgeable persons. This assistance is ideally provided by an
  audit committee composed of people with backgrounds in accounting, 
  auditing, finance, or management. Entities without audit committees may
  want to seek the assistance of other government personnel with specialized
  knowledge of accounting and auditing.

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* Deciding on the appropriate auditing standards. While generally accepted
  auditing standards (GAAS) are typically used for both private and public 
  sector audits, your organization may be subject to grant terms, state 
  statutes, federal regulations, or The Single Audit Act and thus may be 
  required to use generally accepted government auditing standards (GAGAS), 
  which are issued by The Comptroller General of the United States. GAGAS 
  incorporate GAAS but involve additional auditor responsibilities, including 
  special reporting on internal controls and on compliance with applicable 
  laws and regulations. You will need to determine and specify the 
  appropriate standards for your auditor to follow.
 
* Determining whether the Single Audit Act applies to your organization. The
  Single Audit Act of 1984 established supplemental audit requirements in
  the areas of internal control and compliance reviews. You should find out 
  if your organization is affected by this legislation. A good reference 
  document is the American Institute of Certified Public Accountants' (AICPA) 
  guide for audits of state and local governmental units. 3_/

* Identifying the attributes necessary in an auditor. We suggest that the 
  personnel performing the audit have 
  
  3_/ Audit and Accounting Guide: Audits of State and Local Governmental 
      Units, revised edition (AICPA, Jan 1986)

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  experience with audits or sinuiar entities as well as continuing 
  professional education in governmental accounting and auditing. Moreover, 
  they should comply with applicable requirements for peer review and 
  continuing professional education.

* Deciding how to evaluate prospective audit firms. Developing a systematic
  procedure for evaluating firms' qualifications is essential. Although 
  price is important, technical qualifications should be a critical 
  criterion in selecting an auditor.

* Reviewing legal requirements. You should review applicable laws, regula-
  tions, and grant conditions to ensure that both the procurement process 
  and the audit itself will meet legal requirements.

* Considering a multiyear agreement.  The first year of an audit engagement
  usually involves significant start-up costs as auditors devote considerable
  time to learning about the entity and its internal control systems. Halving
  completed this groundwork, the auditor usually is able to work at less cost
  in the succeeding years. If authorized by law, a multiyear agreement-perhaps 
  a 1-year agreement with the option to extend the agreement for up to 5 
  years-has a dual advantage: It enables an auditor to propose a price that 
  takes into account the savings to be realized in subsequent years and saves 
  the entity the Costs associated with repeating the selection process.

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* Evaluating the auditor rotation option.  Some people argue that changing 
  auditors at the end of a multiyear contract infuses the audit process with 
  fresh views and new perspectives. Others contend that these benefits can 
  be achieved through internal rotation of audit staff and that malataining 
  a long-term, ongoing relationship with a particular auditor is more 
  advantageous. A long-term relationship with a firm. however, will not 
  necessarily enable the entity to seek out and take advantage of lower 
  priced audits. It makes sense to carefully consider the advantages and 
  disadvantages of auditor rotation as well as applicable legal requirements 
  before setting a policy.

* Establishing a work schedule. You should develop a schedule both for
  yourself and for the auditor you eventually select that sets forth dates by
  which certala milestones in the audit process must be reached. The only
  way to ensure the timely preparation and issuance of financial statements
  and related reports is to develop and adhere to such a schedule.

Small Entities      

All of the foregoing suggestions-especially creating and using an audit
committee-can help a small entity achieve a quality audit. Even the
smallest organization can appoint a two- or Three-person audit committee
that understands what is to be audited and how the audit should be performed.

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COMPETITION AND SOLICITATION:
COMMUNICATING AUDIT REQUIREMENTS

Full and open competition is basic to government procurement. Encouraging 
as many qualified audit firms as possible to submit their proposals for
auditing your organization increases the likelihood that you will receive a
quality audit at a falr price. The next step, Then, is to communicate your
audit needs to potential bidders.4_/  This step is critical, because bidders 
who do not clearly understand exactly what services you want might not 
respond. 

How to Solicit an   
Audit

There are many ways to solicit bids for your audit, but the most reliable
method-and the one we suggest-is a written request for proposal, or RFP.
RFPs should be clearly written; set forth all terms, conditions, and 
evaluation criteria as well as the scope of the work required; and be 
sufficientiy well distributed and publicized to ensure full and open 
competition.

Using your audit committee to advise you when writing your RFP is a good
idea. Committee members should have a clear understanding of both the
audit function and what your organization requires of the audit.

You may want to consider compiling a list of potential auditors from general
and professional directories and from your past experiences with audit
firms. Malntaining an updated list 

4_/ This handbook uses the term "bidder" to mean "proposer" or "offeror"

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makes it easy to distribute your RFP to the firms that are most likely to be
interested in bidding on your audit.

What to Include in 
Your RFP

The prime consideration in preparing your RFP is that it contain enough
information to provide bidders with a common basis by which to prepare
proposals that address all your audit needs. It is also important, however,
that you consult with your purchasing office and/or legal counsel to ensure
that your RFP conforms with the laws, regulations, and grant terms applica-
ble to your organization. At a minimum, your RFP should contain the following:

* the name and address of your organization;

* the entity to be audited, scope of services to be provided, and specific
  reports, etc., to be delivered;

* the period to be audited (with an explanation if the RFP calls for a 
  multi-year procurement);

* the name and telephone number of a contact person at your organization;

* the format in which you want proposals to be prepared;

* the address to which proposals should be delivered or sent;

* the date and time proposals are due;

* the number of proposal copies to be submitted;

* the criteria to be used in evaluating the bid and their relative 
  importance to each other;

* the method and timing of payment; and

* any other important points, including the consequences if due dates are
  missed or work does not meet audit standards.

 Your chances of receiving high quality proposals will be enhanced if you

* explain the work that your organization does;

* explain what is to be audited, e.g., general-purpose financial statements, 
  specific funds, or both;

* describe in some detail your organization's accounting system, administra-
  tive controls, records, and procedures;

* inform prospective bidders whether the Single Audit Act applies to this
  audit;

* identify the appropriate auditing standards;

* inform prospective bidders if data from prior years (audit reports, 
  management letters, etc.) will be available, whether major audit findings 
  remain open from prior years, and whether any audits of subrecipients are
  required;

* notify prospective bidders of requirements for worirpaper retention and 
  for making the workpapers available to the entity as well as governmental
  auditors if they request them;

* describe expected audit products, the required format of the audit report,
  and the format of any required progress reports;

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* explain any assistance that your organization will offer. such as staff
  support to assist the auditor (which could materially reduce your audit
  costs); and

* outline the expected schedule of work (completing field work. issuing
  reports. etc.).

  Finally. a well-prepared RFP will elicit certain information from 
  prospective bidders. For example, it will ask bidding firms to state

* how they would conduct the audit and. if it were a multiyear contract.
  how they would approach the work efforts of the subsequent year(s);

* their qualifications, those of their local office. if applicable. and 
  those of the proposed audit staff. including their prior government 
  auditing experience;

* their policies on notification of changes in key personnel;

* whether the proposed staff have received continuing professional education 
  in governmental accounting and auditing during the last 2 years;

* whether they are independent, as defined by applicable auditing standards;

* whether they have received a positive peer review within the last 3 years;

* whether they have been the object of any disciplinary action durtng the 
  past 3 years; and their fee.

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Bidders'
Conference

Although you will have been as thorough as possible in preparing your RFP,
you may overlook some information that prospective bidders will find useful. 
One effective way of communicating additional information to bidders is to 
invite them to a bidders' conference, where you can provide additional 
information and they can ask any unanswered questions. Although these 
purposes could be served by letters and individual conversations, bringing 
all bidders together at the same time to hear the same information is 
efficient and helps ensure that all bidders are treated equally. This is
especially important, smce unsuccessful bidders may challenge the procurement
if their competitors were given significantly different or more information.

Small Entities

Obtaining an extensive list of potential bidders may be difficult for small 
entities in rural areas. Soliciting lists from nearby, larger entities and 
from CPA's in your region that have experience with governmental audits often 
is helpful.

Furthermore, preparing a detailed RFP for a small engagement may be 
economically impractical in many cases. Abbreviated RFPs, designed for 
small engagements and requiring only a little tailoring to meet individual 
needs, may be available through state and regional government organizations. 

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At a minimum, such RFPs should clearly define the work to be done, including
the reports and opinIons to be delivered.

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TECHNICAL EVALUATION: SELECTING A
QUALIFIED AUDITOR

Once the due date for proposals has passed, you can begin evaluating the
bidders' qualifications. The technical evaluation is important for two
reasons:

* it provides a systematic framework for selecting an auditor on the basis 
  of the entity's established RFP criteria and

* it documents that the auditor was selected fairly.

By comparing your entity's requirements with the auditors' plans, skills
experience, commitment, and understanding of the audit requirements and then 
reviewing bidders' price proposals, you will be able to select the firm that 
can provide the best audit at the fairest price.

The Role of        
Committees

To limit errors in judgment and to bring varied perspectives to the technical 
evaluation of the proposals, you will probably want to establish an 
evaluation committee. The committee should be composed of people with 
experience in accounting, auditing, budgeting, or another specialty field
pertinent to the required audit work. Your audit committee can also play an
important advisory role in this process.

The Evaluation    
Process

We suggest separate evaluations of technical ability and price. The technical 
evaluation addresses the firms' technical quallilcations and ability to

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perform the audit. Although the price for the work to be performed Is a sig-
nificant factor in the selection of a qualified audit firm, you will be more
likely to get a high quality audit at a fair price if both price and 
technical ability are taken Into account in selecting the successful bidder.

Requiring         
Minimum 
Standards

As a first step, we suggest that you require all bidders to meet certain
minimum standards before evaluating either theft technical qualifications 
or theft price proposals. By doing so, you can spare your entity the 
needless and timeconsuming technical evaluation of firms that do not meet 
your requiredments. These minimum standards can be determined by the laws 
governing your entity, its general Internal policies, and its policies 
regarding specific audit engagements. However you delineate them, we suggest 
that your minimum standards include that firms

* meet the appropriate state licensing requirements,

* meet the applicable independence standard,

* have a record of responsible work, and

* comply with applicable requirements for peer review and continuing profes-
  sional education.

Technical Criteria  

The technical criteria set out in the RFP and used in the evaluation process 
can vary. At a minimum, however, the evaluation committee should be able to

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answer "yes" to the foliowing questions.

Understanding    
the Audit
Requirements

* Does the proposal, both in the statement of the audit requirements and
  elsewhere demonsrrate that the firm has an understanding of the audit's
  objective(s), your organization's needs, and the fital products to be 
  delivered?

Soundness of      
Technical Approach 

* Does the proposal contain a sound technical plan and a realistic estimate
  of time required to complete the audit?

* Does the proposal show the bidder's intention to start the audit when
  required and complete the audit in a timely fashion?

* Does the technical plan show a practical approach to meeting benchmarks
  and specific deadlines?

* Does the proposal indicate that the firm will use (1) a systematic
  approach to examining systems and internal controls and (2) effective 
  procedures, including consideration of risk and materiality, to determine 
  the exent of audit testing and review necessary?

* Does the proposal indicate the bidder's willingness to use other auditors'
  work, to the extent possible, to avoid duplication of effort?

Qualifications of the 
Audit Firm

* Does the firm have experience In performing the required work for entities
  of your type and size?

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* Do prior clients have a positive opinion of the firm?

Qualifications of the 
Audit Team

* Does the proposal dearly show the collective experience of the team to be
  assigned to the project?

* Does The proposal specify, in concrete language, that key personnel have
  education and experience in the type of work that the audit entails?

* Is the experience explained in terms of specific audit engagements? 

* Is the continuing professional education of key personnel explained in
  detail?

* Does the proposal indicate the extent to which your entity's personnel
  would be expected to contribute to the work effort?

* Does the proposal specify that you must be notifIed in writing of changes
  in key personnel?

* If the proposal is for a multlyear contract, does it provide an approach 
  for plannIng and conducting the work efforts of the subsequent year(s)?

Rating the         
Proposals

Initial evaluations should be based on the bidders' proposals as submitted.
As you evaluate the proposals, make a list of strengths and weaknesses for
each to support its technical rating. After you complete the technical 
evaluation and review the prices offered by the bidders, you may be prepared
to select the proposal that is most advantageous to your entity.

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If, however, you feel you need more information before selecting a proposal, 
you should hold individual discussions with bidders who have a reasonable 
chance of being selected to allow them to respond to your concerns and 
submit revised proposals by a specified date. Care should be taken during 
these discussions not to reveal proprietary information submitted by other 
bidders. You should then evaluate the revised proposals as described above 
and award the contract on the basis of both technical competence and 
reasonable price.

Small Entities

Using a committee to carry out the evaluation process is especially important 
for small entities with limited resources. A more comprehensive analysis of 
the bids is likely to be achieved by having more people involved In the 
evaluation process.

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THE WRITTEN AGREEMENT:
DOCUMENTING EXPECTATIONS

The lack of a written agreement between the entity contracting for the audit 
and the audit firm can contribute to substandard audits performed by public 
accountants. To foster sound and productive communication and to avoid 
misunderstandings, both parties should agree in writing on important audit-
related matters. Make clear at the start-before bidders spend time assessing 
the nature of the job and estimating its costs-that you expect to sign a 
formal document as the culmination of the proposal process.  Audit firms 
unwilling to commit themselves to signing such a document are better avoided.

A signed agreement represents a contract and is binding upon both parties.
For that reason, when drafting the agreement, seeking the advice of your
purchasing office or legal counsel on the agreement's form and substance is
important.

What to Include in 
a Written Agreement

When an RFP has been used, the written agreement should incorporate by 
reference the terms of the RFP and those of the successful bidder's last
proposal. The letter should be signed by the entity and the audit firm. The
written agreement will then clearly specify the 

* audit scope, objective, and purpose;

* deadlines for work to be performed;

* audit cost;

* report format;

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* type and tinting of support to be provided to the auditor by the entity; and

* professional auditing standards to be followed in performing the audit.

Furthermore, the agreement should make the following points about the 
auditor/entity relationship, changes in the kind or amount of work required,
and access to and ownership of audit products.

* The relationship of the auditing firm to the entity is that of an 
  independent contractor.

* At any time, the entity may, by written notice, make changes In or 
  additions to work or services within the general scope of the agreement. 
  If suct changes are made, an equitable adjustment wili be made In the cost 
  of the audit using the rates specified in the agreement.

* If the contractor believes that a change In or addition to work is beyond 
  the general scope of the agreement, it must notify the entity in writing 
  within a specified time and before beginning that work. The agreement 
  should indicate where the final administrative authority rests in deciding
  disputes.

* The workpapers prepared by the contracting auditor during the audit are
  its own property. These documents should be retained for a period to be
  designated in this agreement and made available to the entity and 
  governmental auditors upon request.

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* All reports rendered to the entity by the contracting auditor are the 
  exclusive property of the entity and subject to its use and control, 
  according to applicable laws and regulations.

Small Entities      

In the absence of an RFP, many small engagements are documented only by
an engagement letter prepared by the CPA that protects the CPA more than 
the entity being audited. If you decide to use an engagement letter as 
your written agreement, we advise including the information listed above 
and ensuring that the document is signed by both parties.

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AUDIT MONITORING: ENSURING A
QUALITY AUDIT

Monitoring the progress of the audit is the most effective way to ensure that
your organization receives both the type and quality of audit services
specified in the written agreement.  This is a role that your audit committee
can carry out most effectively.  This group of experts can evaluate the audit 
while it is taking place, thereby addressing and resolving problems before 
the audit is completed. It can also review audit results and assist in post-
audit quality evaluation. Thus, not only does the audit product improve but 
worldng relationships between the audited entity and auditor are enhanced,

Monitoring is especially beneficial during the first year of a new auditor's
contract and during the audit of a particular unit or serment(s) of an 
organization that is unique or complex.  Furthermore, monitoring is 
beneficial throughout the term of a multiyear contract: It provides status 
reports and helps coordinate the auditing firm's activities with the audit's
requirements. While the responsibility for a quality audit rests ultimately
with the auditor, monitoring the work being performed as a quality assurance 
measure is a good idea.

Monitoring can be accomplished by requiring periodic progress reports as
well as by holding regular meetings to discuss issues that need to be 
resolved.  Furthermore, meeting after the completion of the audit to discuss

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the draft report can help ensure a clear understanding of the report and its
findings.

Small Entities 

Few small entities have the resources to thoroughly monitor the work of an
auditor. When audit committee members are unavailable within an organization, 
composing a committee from people outside the organization may be the answer.

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BIBLIOGRAPHY

Audit and Accounting Guide: Audits of
State and Local Governmental Units,
revised edition. AiCIA. January 1986.

A Finance Officers' Guide to the Audit
Selection Process. Government
Finance Officers Association. Special
Bulletin 1982b. November 1982.

Buying Professional and General Ser-
vices-A Guide. The Council of State
Governments. 1986.

CPA Audit Quality-A Framework for
Procuring Audit Services. GA0/AFMD-87-34.
August 1987.

Guldelines for Preparation of Requests
for Audit Proposals. Western Intergov-
ernmental Audit Forum. April 1958.

Study of Professional Services Con-
tracting. Office of Federal Procure-
ment Policy. January 1985.

Uniform Adinlistrative aequrements
for Grants and Cooperative Agree-
ments to State and Local Govern-
ments. (24 Federal Agency Common
Rule). March 11, 1988.

For further information, write the
National Intergovernmental Audit
Forum, 441 G Street, N.W.,
Washington, D.C. 20548.

Requests for copies of this pamphlet
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U.S. General Accounting Office
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