Communication with management and those charged with governance

Welcome to Your Guide on Audit Communications!

In the world of auditing, you aren't just a "numbers person" hiding in a back room. You are a communicator! To perform a high-quality audit, you must stay in constant contact with the people running the show. This chapter focuses on how you talk to Management and Those Charged with Governance (TCWG). Think of this as the "rules of engagement" for professional conversations. Don't worry if this seems like a lot of technical jargon at first—we’re going to break it down into simple, real-world pieces!

Who are "Those Charged with Governance" (TCWG)?

Before we learn what to say, we need to know who we are talking to. In a company, there are two main groups:

1. Management: These are the people running the day-to-day operations (like the CEO or CFO). Think of them as the drivers of the car.
2. Those Charged with Governance (TCWG): These are the people who oversee the strategic direction and accountability of the company. Usually, this is the Board of Directors or the Audit Committee. Think of them as the owners of the car who make sure the driver is following the rules.

Quick Tip: In the CPA exam, if you see "Audit Committee," they are almost always the primary group representing TCWG.

Why Do We Communicate?

We don't just talk to be friendly! We communicate to:
- Help TCWG understand their oversight responsibilities.
- Give TCWG a heads-up on how the audit is going.
- Get information from TCWG that might help us with the audit (they might know about risks we haven't seen yet).

What Matters Must Be Communicated?

You can't tell TCWG every single tiny thing you did. You need to focus on significant findings. Here is a helpful mnemonic to remember the key items we must discuss with TCWG: "SPAM PODIUM"

S – Selection of accounting policies (did they change how they count inventory?).
P – Processes used by management to make estimates (like how they guess how many customers won't pay their bills).
A – Adequacy of financial statement disclosures.
M – Management judgments that were significant.
P – Planned scope and timing of the audit (the "game plan").
O – Other significant issues.
D – Difficulties encountered during the audit (like if management was uncooperative).
I – Impaired independence (anything that makes it look like the auditor isn't neutral).
U – Uncorrected misstatements (errors the auditor found that management refused to fix).
M – Management disagreements (even if they were eventually resolved!).

Did you know?

If the auditor and management have a big argument about an accounting principle, the auditor MUST tell the Audit Committee, even if management eventually gives in and does it the auditor's way!

Timing and Format: How and When to Talk

Auditors need to be timely. You shouldn't wait until three months after the audit is finished to mention a huge problem!

1. Timing: Communication should happen on a timely basis. For some specific entities (like public companies/issuers), certain communications must happen before the audit report is issued.

2. Oral vs. Written:
- Some things can be oral (a conversation or meeting). If you speak it, you must document the conversation in your workpapers.
- Significant findings should be in writing if the auditor believes oral communication wouldn't be adequate.
- Independence communications (for issuers/public companies) must be in writing.

Quick Review Box:
- Oral: Okay for many general topics, but must be documented.
- Written: Required for certain independence issues and strongly recommended for significant findings.

Communicating Internal Control Deficiencies

This is a "hot topic" for the CPA exam. If you find problems with the company’s internal controls, you have to report them.

The "Severity Scale"

1. Control Deficiency: A small hiccup. You usually just tell management.
2. Significant Deficiency: More serious than a hiccup, but not a total disaster. This must be communicated in writing to TCWG.
3. Material Weakness: The "Red Alert." There is a reasonable possibility that a material misstatement will not be prevented or detected. This must be communicated in writing to TCWG and management.

Analogy:
- Control Deficiency: Your front door lock is a bit sticky.
- Significant Deficiency: Your front door lock is broken, but you have a security guard at the gate.
- Material Weakness: You have no front door and no security guard. Anyone can walk in!

Key Takeaway:

Significant Deficiencies and Material Weaknesses must be communicated in writing to management and TCWG no later than 60 days after the report release date (for non-issuers).

Common Mistakes to Avoid

Mistake #1: Thinking you only talk to Management.
Remember, the Audit Committee (TCWG) is your "client" in many ways. They are the ones who hire you to keep an eye on management. If management is doing something wrong, you go to TCWG!

Mistake #2: Not documenting oral communications.
If it isn't documented, it didn't happen. If you have a phone call with the Board Chairman about the audit scope, you must write a memo in your files about what was said.

Mistake #3: Missing the "independence" rule.
For public companies, auditors must confirm their independence to the Audit Committee in writing at least annually.

Summary Checklist for Students

Before moving on, make sure you can answer these:
- Can I define the difference between Management and TCWG?
- Do I remember the "SPAM PODIUM" mnemonic for what to communicate?
- Do I know which internal control issues require a written letter? (Answer: Significant Deficiencies and Material Weaknesses).
- Do I understand that disagreements with management must be reported, even if they are resolved?

You're doing great! Auditing is all about the "checks and balances" between these groups. Keep this structure in mind, and you'll ace the questions on Area I!