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By John F. Burke, CPA,
The CPA Journal

On March 7, 1997, the Auditing Standards Board (ASB) issued three exposure drafts of proposed statements on standards. The comment period for the three exposure drafts ends June 16, 1997.

The proposed statement on auditing standards, Communications Between Predecessor and Successor Auditors, would supersede SAS No. 7 and its interpretations. The latter will be incorporated into the new statement. The new standard will change the present literature by--

* revising the definition of both predecessor and successor auditors.

* expanding the list of required inquiries of predecessor auditors to include communications to audit committees or others with equivalent authority and responsibility regarding fraud, illegal acts by clients, and internal control related matters.

* adding a section, "Successor Auditor's Use of Communications." This section provides guidance on the use of the review of predecessor working papers with respect to the opening balances and consistency of accounting principles. Ultimately, however, the adequacy of the work in these areas is solely the responsibility of the successor auditor.

* expanding the working papers the predecessor auditor should permit being reviewed to include those relating to documentation of planning, internal control, and audit results.

* including appendixes for both an illustrative client consent and acknowledgment letter and a illustrative successor auditor acknowledgment letter.

The statement would be effective with respect to acceptance of an engagement after December 31, 1997, with early application encouraged.

The proposed statements on auditing standards and standards for attestation engagements, Establishing an Understanding with the Client, would amend SAS No. 1 and SSAE No. 1. These proposed statements are a response to Statement on Quality Control Standards No. 2, System of Quality Control for a CPA Firm's Accounting and Auditing Practice, which requires CPA firms to provide policies and procedures for obtaining an understanding with a client regarding services to be performed. The proposed statements would require the auditor (practitioner) to establish an understanding with the client that includes the objective of the engagement, the responsibilities of management and the auditor (practitioner) , and any limitations of the engagement. Such understanding with the client must be documented in the working papers, preferably through a written communication with the client.

The statements would be effective for engagements beginning after December 15, 1997, with earlier application encouraged.

The proposed statement on standards for attestation engagements, Management's Discussion and Analysis, is the second such exposure draft on the subject. The first exposure draft was issued in 1987 and ultimately deferred. The proposed statement would require amending various sections of SAS No. 72, Letters for Underwriters and Certain Other Requesting Parties, and the proposed amendments are included as an appendix.

The MD&A project was revisited as a result of the recommendations of the Special Committee on Financial Reporting. The service is entirely voluntary at the present time. However, the ASB is attempting to anticipate changes in the existing financial reporting model as a result of proposals by that committee and to respond to their research that indicated some users desired more auditor involvement in the financial information they receive.

The proposed statement provides two levels of service for such engagements, an examination and a review. An examination would lead to the issuance of an opinion while a review would provide negative assurance.

The proposed statement provides guidance in the following:

* Accepting an engagement

* Planning the engagement

* Considering internal control applicable to the preparation of MD&A

* Obtaining sufficient evidence for an examination

* Applying analytical procedures and inquiries for a review

* Considering events subsequent to the balance-sheet date

* Reporting

The forward section of the exposure draft acknowledges that an examination or review of an MD&A presentation may be performed under SSAE No. 1, Attestation Standards. The proposed standard expands on the guidance in that standard by providing specific guidance on engagement acceptance, performance issues, and reporting matters. The following is a discussion of some of the matters on which the proposed statement provides such guidance.

Engagement Acceptance. To accept an engagement to examine MD&A, the practitioner must have audited the financial statements for at least the latest period addressed by the MD&A. To accept an engagement to review MD&A, the practitioner must have performed either an audit of the annual financial statements or a review of interim financial statements for at least the latest period to which the MD&A presentation relates.

Internal Control Considerations. In an examination, the practitioner must obtain an understanding of internal control applicable to the preparation of MD&A sufficient to plan the engagement and assess control risk. Controls may be tested by performing inquiries of client personnel, inspection of documents, and observation. In a review, the practitioner must consider relevant portions of the entity's internal control applicable to the preparation of MD&A to identify types of potential misstatements and to select the inquiries and analytical procedures. No testing of controls would be done.

Materiality. Practitioners should consider materiality in planning and performing the engagement. The omission or misstatement of an individual assertion is material if the magnitude of the omission or misstatement--individually or when aggregated with other omissions or misstatements--is such that a reasonable person relying on the MD&A presentation would be influenced by the inclusion or correction of the individual assertion.

The statement would be applicable to engagements for public companies required to follow Item 303 of Regulation S-K and nonpublic companies that choose to prepare MD&A using published SEC rules and regulations.

The effective date for the statement would be for engagements to examine or review MD&A presentations for periods ending on or after December 31, 1997, with earlier application encouraged. *

Douglas R. Carmichael, PhD, CPA
Baruch College

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