In December 2008, the PCAOB issued Alert No. 3 Audit Considerations in the Current economic Environment that lays out broad guidelines for the auditor to consider while performing an audit in this economic environment.

The current economic environment may also trigger certain risk factors that may affect the risk of misstatement due to fraudulent financial reporting.
Incentives and pressures

• Financial stability or profitability is threatened by economic, industry, or Company operating conditions;
• Excessive pressure exists for management to meet the requirements or expectations of third parties;
• Information available indicates management or the board of directors’ personal financial situation is threatened by the Company’s financial performance;

Opportunities

• There is ineffective monitoring of management;
• There is a complex or unstable organizational structure;
• Internal control components are deficient

The auditor responds to risks of material misstatement due to fraud in the following three ways:

• Overall responses on how the audit will be conducted (engagement personnel assigned, review of managements selection and application of accounting policies);
• A response relating to the nature, timing and extent of procedures performed;
• Response involving performance of specific procedures (examine journal entries, review of accounting estimates)

The auditor should focus his attention on the following areas:

Special Audit Areas

1.    Auditing Fair Value Measurements

Certain kinds of investments such as auction rate securities, commercial paper, mortgage-backed or other asset-backed securities and other investments may present complexities in valuation because of the current conditions in the financial markets. Accordingly, difficulties surrounding the measurement of fair value and the adequacy of related disclosures have come under increased focus over the past year.

The following matters may be particularly important for auditors in considering fair value accounting estimates:

• The choice and complexity of valuation techniques and models;
• Judgments concerning significant assumptions that may be used by others such as specialists employed or engaged by the company or the auditor;
• The availability, or lack thereof, of information or evidence and its reliability; and
• The extent of disclosure in the financial statements about measurement methods and uncertainty.

2.    Company’s ability to continue as a going concern

In the current economic environment, some companies may face challenges in their ability to continue operating as a going concern.

Conditions or events that indicate substantial doubt about the company’s ability to continue as a going concern for a reasonable period of time include:

• Negative trends – for example, recurring operating losses, working capital deficiencies, negative cash flows from operating activities, adverse key financial ratios;
• Internal matters – for example, work stoppages or other labor difficulties, substantial dependence on the success of a particular project, uneconomic long-term commitments, need to significantly revise operations;
• External matters that have occurred - for example, legal proceedings, legislation, or similar matters that might jeopardize a company’s ability to operate;

The auditor’s considerations relating to management plans may include the following:

• Plans to dispose of assets;
• Plans to borrow money or restructure debt;
• Plans to reduce or delay expenditures;
• Plans to increase ownership equity.

3.    Deferred tax assets
Deferred tax assets are required to be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50 percent) that some portion or all of the deferred tax assets will not be realized.

Future realization of a deferred tax asset ultimately depends on the existence of sufficient taxable income within the carry forward period available under the tax law.
4.    Goodwill and Intangible assets
Market conditions during an economic downturn may result in an impairment of goodwill, other indefinite-lived intangible assets and other long-lived assets. The following are indicators of potential impairment:

• A significant decrease in the market price of a long-lived asset (asset group);
• A significant adverse change in legal factors or in the business climate;
• An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group);

The auditor should consider these factors among others like pension liabilities, debt obligations, other than temporary impairment, receivables and other areas that have a high inherent risk because of the estimates involved in the account.