Testing compliance for major programs and sampling for compliance

In this lesson you will

Set compliance materiality at the level of each major program and type of compliance requirement
Design samples that test compliance and controls together where the population is the same
Project sample exceptions into likely questioned costs
Document testing that supports an opinion on each major program

What the opinion has to cover

2 CFR 200.514(d) requires the auditor to determine whether the auditee complied with federal statutes, regulations and award terms that may have a direct and material effect on each major program. Compliance testing must include tests of transactions or other procedures that give sufficient appropriate audit evidence to support an opinion on compliance (200.514(d)(4)). AU-C 935, the AICPA standard for compliance audits, supplies the framework: understand the compliance requirements, assess the risks of material noncompliance for each, respond with further procedures and form the opinion.

Materiality is per program

The opinion is on each major program, so materiality is too. Under AU-C 935 the auditor establishes materiality for the compliance audit based on the governmental audit requirement, and Subpart F frames it at the program level: findings are evaluated in relation to a type of compliance requirement for a major program (200.516(a)(1) and (2)). Financial statement materiality has no role. A $40,000 exception can be immaterial to a $30 million program and material to a $600,000 program.

Practitioners set two judgments for each major program: what amount of noncompliance would be material to the program as a whole, and what amount would be material for a single type of compliance requirement. Both are qualitative as well as quantitative. Noncompliance with eligibility or with a special test that the federal agency treats as critical can be material at small dollar amounts.

Sampling for compliance

Most compliance tests are attribute tests: was this cost allowable, was this participant eligible, was this report accurate and timely. AU-C 530 governs sampling design, selection and evaluation. In practice:

Define the population per requirement. Allowable cost testing samples program expenditures; eligibility testing samples participants or eligibility determinations; reporting testing samples reports filed.
Use dual-purpose samples. When the control and the compliance requirement act on the same transactions, one sample can test the control attribute and the compliance attribute. This is common for allowable costs and eligibility.
Size the sample from your methodology. Sample size rises with lower tolerable deviation and higher assessed risk. When controls over a requirement are ineffective, control risk is at the maximum and compliance samples grow. The audit sample size calculator and AU-C 530 page cover the inputs.
Test the full period and every location that administers the program, or document why a subset represents the population.

Non-sampling procedures matter too. Period of performance is often tested by scanning costs posted near award start and end dates. Reporting is tested by reconciling each federal report to the ledger. Cash management is tested by comparing draw dates to disbursement dates.

Projecting exceptions

The Uniform Guidance distinguishes known questioned costs (specifically identified) from likely questioned costs (the auditor's best estimate of the total, developed by projecting sample results to the population). In evaluating the effect on the compliance opinion, the auditor considers likely questioned costs, not only known questioned costs (2 CFR 200.1). The reporting threshold in 200.516(a)(3) also looks at likely questioned costs. When you report a finding, include the information that puts it in perspective: the sample size, the population, the number of exceptions and whether the sample was statistically valid (200.516(b)(8)).

Documentation that holds up

For each major program and each direct and material requirement, the file shows: the requirement and its source; the controls tested and the conclusion; the compliance procedures, population, sample size and selection method; the exceptions; the projection; and the conclusion against program-level materiality. The single audit walkthrough shows how these pieces fit in a program-level workpaper.

Common peer review findings

Samples sized for the financial statement audit reused for compliance without considering program materiality.
Exceptions treated as isolated with no projection.
Requirements marked direct and material in planning with no test performed.
Only one site tested for a program administered at several sites.

Worked example

Harbor Point Transit: allowable cost testing on a $2.4 million program

Harbor Point Transit's major program has $2,400,000 of payroll charges. Allowable costs and the payroll certification control act on the same transactions, so the team draws one random dual-purpose sample of 60 payroll charges totaling $180,000.

Results:

Control attribute: 3 charges lack the supervisor's certification of time worked on the program.
Compliance attribute: 2 of those 3 charges, totaling $6,000, are for an employee who worked on a non-federal project that month. The costs are unallowable.

Known questioned costs = $6,000. Questioned cost rate in the sample = $6,000 / $180,000 = 3.33 percent. Likely questioned costs = $6,000 / $180,000 x $2,400,000 = $80,000.

Likely questioned costs exceed $25,000, so the $6,000 of known questioned costs must be reported as a finding (200.516(a)(3)). The team had set program-level materiality for allowable costs at $120,000. Likely questioned costs of $80,000 are below it, so the opinion on allowable costs can stay unmodified, but the control deviations go into the evaluation of a significant deficiency over compliance. The finding states: 60 items tested from a population of $2,400,000, 2 exceptions, statistically valid random sample.

Self-check

Answer each question before you open the answer.

Why can a $40,000 exception be material in a single audit even when it is trivial to the financial statements?
Show answer
Because compliance materiality is set for each major program and type of compliance requirement, not for the financial statements. A $40,000 exception can be material to a small program.
Which questioned cost amount does the auditor consider when evaluating the effect on the compliance opinion?
Show answer
Likely questioned costs, the best estimate of the total including projected amounts, not just known questioned costs (2 CFR 200.1, definition of questioned cost).
When is a single dual-purpose sample appropriate for allowable costs?
Show answer
When the control and the compliance attribute operate on the same population of transactions, such as program expenditures that each require an approval. The sample is sized for the more demanding of the two objectives.

Sources

Back to the syllabus

Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error