WHITE PAPER

Here are the issues. It's time for a decision.

By Judith M. SherinskyIn Brief

Getting Ready for a Hearing

The issuance of an exposure draft of a proposed SSARS, Assembly of Financial Statements for Internal-Use Only, resulted in an analysis of the factors that appeared to increase the time and cost of performing compilation engagements. One factor was that CPAs are not aware of other services that could be performed. These include--

* compiling financial statements that omit substantially all disclosures.

* compiling financial statements using an OCBOA.

* compiling financial statements based on clients' needs.

* providing reports containing only selected information.

* submitting draft financial statements.

* compiling only one financial statement.

* providing a copy of the tax return.

Other factors include--

* making unessential cosmetic improvements to financial statements.

* misconceptions about stationery and signature requirements.

* performing more work than required because of concerns about peer review.

No action will be taken on the exposure draft until after a public hearing to be held in August 1997. One of the issues to be discussed at the hearing is whether SSARSs should be amended or interpreted to address the problem of the applicability of SSARSs. Although SSARS No. 1 defines the term submission of financial statements, there are many gray areas, particularly those involving financial statements in electronic form.

Another issue to be covered is the possibility of permitting CPAs to issue plain-paper financial statements. The pros and cons on this issue are included in an exhibit.

This article was adopted from a paper written to provide background for a public hearing to be held August 27-28, 1997 at the Rosemont Convention Center, Rosemont, IL. At the hearing, the Accounting and Review Services Committee (ARSC) will hear views on the following questions.

* Can the applicability section of Statement on Standards for Accounting and Review Services (SSARS) No. 1, Compilation and Review of Financial Statements, be clarified to enable CPAs to easily determine when they are required to compile financial statements, and when they are not?

* Should the applicability section of SSARS No. 1 be revised to exempt CPAs from the requirement to compile financial statements in certain situations?

* Should CPAs be permitted
to issue plain-paper financial statements?

More details on this hearing were provided in News and Views in the July 1997 issue.

Proposed Exemption from SSARSs

In September 1995, the ARSC issued an exposure draft of a proposed SSARS, entitled Assembly of Financial Statements for Internal-Use Only, that would permit CPAs to submit financial statements to their clients without having to comply with the requirements of SSARS No. 1, if distribution of the financial statements were restricted to internal personnel.

Proponents of the proposal believe many nonpublic entities do not need financial statements that comply in all material respects with GAAP or an OCBOA if the statements are for internal use only. They believe the requirement to report on financial statements and identify departures from the basis of accounting used adds unnecessary time and cost to engagements.

Opponents of the proposal believe the proposed SSARS would increase the incidence of material misstatements in financial statements resulting from these engagements because the proposal does not establish a minimum level of adherence to GAAP or an OCBOA. They agree that many nonpublic entities may not need financial statements that comply in all material respects with GAAP or an OCBOA. However, CPAs cannot control the distribution of financial statements they submit to their clients, and it is believed many of these statements may be passed on to banks and other creditors without a compilation report to inform readers of the limitations of the work performed on them and the deficiencies in the statements. Opponents of the proposal also believe the exemption is not needed because existing standards provide CPAs with various options for performing less complex and less time-consuming compilations.

The AICPA received over 500 comment letters on this highly controversial proposal, and when the ARSC met in February 1996 to discuss the comment letters they concluded they needed additional information about the kinds of problems CPAs encounter when performing compilation engagements under SSARSs. To obtain this information, the ARSC sent a questionnaire to all those who had written letters in support of the exposure draft, made phone calls to several proponents and opponents of the proposal, and invited members of the AICPA Small Firm Advocacy Committee to the May 1996 ARSC meeting to talk about the problems practitioners are experiencing.

The primary complaint expressed by supporters of the exposure draft was that performing compilation engagements is too time consuming and costly and clients are reluctant to pay for these services. A careful analysis of these practitioners' comments revealed that the following factors appear to increase the time and cost entailed in performing compilation engagements.

Overlooking Simpler Available Options

Many CPAs are unaware of the wide range of financial statement services they may provide to their clients, other than compiling full-disclosure GAAP financial statements. Existing standards enable practitioners to perform the following alternatives to the standard compilation service:

Compiling Financial Statements that Omit Substantially All Disclosures. In this type of engagement, the CPA need only be concerned with measurement departures and may omit all of the disclosures required by GAAP or an OCBOA, as long as the report is modified to alert financial-statement users to the omission of the disclosures. Paragraphs 19 through 21 of SSARS No. 1 provide performance and reporting guidance for such engagements.

Compiling Financial Statements Using an OCBOA. These financial statements generally are less complex and require less preparation time, especially if they also omit substantially all of the disclosures required by the OCBOA. If a CPA compiles monthly cash-basis financial statements with substantially all disclosures omitted, the compilation report generally will not change from month to month because only items representing measurement departures from the cash basis would have to be identified in the compilation report, and such departures are extremely rare. The report also would be modified to alert financial statement users to the omission of the disclosures.

Compiling GAAP Financial Statements Based on Clients' Needs. In this type of service, the CPA and the client would determine which adjustments would be made to the financial statement and which would be ommitted based on client needs. For example, it may be decided pension and bonus accruals will be made at year-end but not at interim periods. In those circumstances, the CPA may draft, in advance, pro forma interim compilation reports listing (but not quantifying) all planned GAAP departures. This option enables a CPA to compile less complex financial statements that are accompanied by a report alerting financial-statement users to the departures in the statements. In conjunction with this approach, a client may use the gross profit method of estimating the value of ending inventory at interim periods and other estimates provided for in Accounting Principles Board Opinion 28, Interim Financial Reporting.

Providing Reports Containing Only Selected Information. This information, based on clients' needs, may consist of selected account balances, such as cash or accounts receivable; operating information, such as the number of meals served during a particular month; or a combination of financial and operating information. Interpretation No. 8 of SSARS No. 1, Reports on Specified Elements, Accounts, or Items of a Financial Statement, excludes presentations of elements, accounts, or items of a financial statement from the applicability of SSARS No. 1 because that standard provides guidance on the compilation and review of financial statements, and presentations of specified elements, accounts, or items of a financial statement are not financial statements. Thus, the accountant is not required to report on such presentations unless the accountant is engaged to do so under Statement on Auditing Standards (SAS) No. 62, Special Reports, SAS No. 75, Engagements to Apply Agreed-Upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement, or Statement on Standards for Attestation Engagements (SSAE) No. 4, Agreed-Upon Procedures Engagements.

Submitting Draft Financial Statements. Interpretation No. 17 of SSARS No. 1, Submitting Draft Financial Statements, indicates that accountants frequently submit draft financial statements to their clients 1) because information needed to complete the compilation will not be available until a later date or 2) to provide a client with the opportunity to read and analyze the financial statements before they are finalized. The interpretation states that an accountant may submit draft financial statements to a client as long as the accountant 1) intends to submit final financial statements to the client with an appropriate compilation report after any additional work is completed, and 2) labels each page of the financial statements with words such as "Draft," "Preliminary Draft," "Draft-Subject to Change," or "Working Draft." Interpretation No. 17 indicates that in the rare circumstances where the accountant intended to but never submitted final financial statements, the accountant may want to document the reasons why he or she was unable to submit those financial statements.

Compiling Only One Financial Statement, such as the balance sheet, and not the other related financial statements, as provided for in paragraph 18 of SSARS No. 1.

Providing a Copy of the Tax Return. Interpretation No. 10 of SSARS No. 1, "Reporting on Tax Returns," states that SSARS No. 1 imposes no requirement on an accountant to report on financial information contained in a tax return. The fact a tax return is subsequently used for purposes other than submission to taxing authorities does not affect that exception.

Other Factors Increasing Time and Costs

Making Unessential Cosmetic Improvements to Financial Statements. Many CPAs generate financial statements at their clients' offices using their clients' software. In some cases, limitations of the software prevent the CPA from being able to make required changes to the statements. For example, the software might not allow the CPA to change the title of a financial statement from "Income Statement" to a title that would be appropriate for a cash-basis statement, such as "Statement of Revenue Collected and Expenses Paid." Also, the software might provide a limited amount of space for captions in the statements so that certain captions would have to be abbreviated. These limitations would require a CPA mark up the printed financial statements to delete inappropriate information, write in corrected information, or expand on abbreviated information. Some CPAs may find the resulting marked-up financial statements unprofessional-looking or believe the statements do not meet professional standards. Many of these CPAs go back to their offices to reenter the financial-statement data using more sophisticated software that produces a more polished statement. Other practitioners contend the marked-up statements produced in their clients' offices are "good enough" for their clients' use, and when the ARSC inspected some of these financial statements, they concurred. The additional work entailed in reentering data for processing by another software program or retyping financial statements to improve their cosmetic appearance delays the submission of financial statements to a client and makes the engagement more time-consuming and costly than it need be. SSARSs does not require this additional effort, and if a CPA has complied with the requirements of SSARSs and believes the financial statements are presented in accordance with the stated basis of accounting, there is no need for cosmetic improvements.

Misconceptions About Stationery and Signature Requirements. Many of the CPAs who wrote letters in support of the assembly exposure draft indicated that an assembly service would be helpful to them because it would enable them to submit financial statements to their clients at their clients' offices without having to go back to their own offices to print the compilation report on firm letterhead and have the compilation report manually signed by a specified individual. SSARS No. 1 requires neither that a compilation or review report be printed on firm letterhead, nor that the report be manually signed. A compilation or review report may be printed on plain stationery, without any letterhead, and the signature on the report may be manually signed, typed, computer printed, or stamped with a signature facsimile.

Performing More Work than Required Because of Concerns About Peer Review. CPAs are concerned about the time and cost entailed in peer review, especially if they only perform compilation engagements for one or very few clients. Some practitioners perform more work than is required in a compilation engagement in anticipation of peer review. The ARSC has been meeting with representatives of the AICPA Peer Review Program in an effort to reconcile some of the differences that might exist between the expectations of some peer reviewers and the requirements of SSARSs for compilation engagements. As a result of these discussions, the AICPA Peer Review Board and the SEC Practice Section Peer Review Committee recently revised certain peer review checklists so they more closely parallel the requirements of SSARSs. Although many CPAs use procedural and disclosure checklists to assist them in performing compilation engagements, SSARSs does not require the use of checklists or any other working paper documentation in a compilation engagement.

Status of the Exposure Draft

An important problem identified in comment letters on the exposure draft is the difficulty many CPAs have in determining whether SSARSs is applicable to the services they perform for their clients. The ARSC has been considering this problem as well as various options for addressing it. At its March 1997 meeting, the ARSC decided to defer voting on the proposed SSARS until after the public hearing because comments at the hearing may provide new information for the ARSC to consider in making its decision about the proposal. If the ARSC decides not to issue the exposure draft as a final standard, it may need to amend or interpret SSARSs to address the problem of the applicability of SSARSs.

The Applicability of SSARSs

Submission of Financial Statements. An issue that many CPAs are concerned about and one that prompted the ARSC to conduct a public hearing is the difficulty some CPAs have in determining whether SSARSs is applicable to the engagements they perform. SSARS No. 1 states that if an accountant submits financial statements to a client or others, the CPA is required to at least compile those financial statements. The definition of the term submission of financial statements is very important in SSARS No. 1 because if a CPA has submitted financial statements, he or she is required to at least compile the financial statements; if the CPA has not submitted financial statements there is no requirement to compile. Paragraph 7 of SSARS No. 1 defines the submission of financial statements and specifies which acts trigger the requirement to compile. Submission of financial statements is currently defined as presenting to a client or others financial statements that the accountant has--

* Generated, either manually or through the use of computer software, or

* Modified by materially changing account classification, amounts, or disclosures directly on client-prepared financial
statements.

Paragraph 7 also states that the following services do not constitute a submission of financial statements and thus do not require that an accountant report on them.

* Reading client-prepared financial
statements

* Typing or reproducing client-prepared financial statements, without modification, as an accommodation to a client

* Proposing correcting journal entries or disclosures to the financial statements, either orally or in written form, that materially change client-prepared financial statements, as long as the accountant does not directly modify the client-prepared financial statements

* Preparing standard monthly journal entries (e.g., standard entries for depreciation and expiration of prepaid expenses)

* Providing a client with a financial statement format that does not include dollar amounts, to be used by the client to prepare financial statements

* Advising a client about the selection or use of computer software the client will use to generate statements

* Providing the client with the use of or access to computer hardware or software the client will use to generate statements

In most situations, the applicability of SSARSs is fairly clear; however, the applicability may become blurry in certain situations, especially those involving financial statements in an electronic format. For example, consider a situation in which a CPA prepares adjusting journal entries for a client and enters them (either at the client's office via keyboard or diskette, or remotely via modem) into the client's computer that contains software that automatically updates the client's database to produce revised financial statements. The CPA may not have intended to generate financial statements, but the computer automatically performs this function. Has the CPA generated financial statements if the statements exist in the computer's memory or does generation require that the statements be printed and given to the client by the CPA?

Engagement Driven. In addition to requiring clarification, some CPAs believe the applicability provisions of SSARSs should be revised so that a CPA would only be required to compile financial statements if he or she were engaged to do so. Under existing standards, if a CPA performs certain acts, the CPA is required to compile the financial statements, even though he or she has not been engaged to do so. A CPA who is not completely familiar with the applicability provisions of SSARS No. 1 would be obligated to compile financial statements if he or she inadvertently performed certain acts that triggered the requirement to compile. CPAs who are familiar with the applicability provisions of SSARSs, and know how to avoid the requirement to compile, believe the conduct of an engagement should not be dictated by the need to avoid the requirement to compile, especially if that approach does not meet client needs. For example, in the scenario cited above, the CPA could avoid the requirement to compile by 1) preparing adjusting journal entries on a sheet of paper and giving them to the client who could enter the adjustments into the client's computer or 2) electronically transmitting the journal entries to the client (but not directly into the client's database). However, many CPAs believe requiring a client to enter data into a computer that could be electronically transmitted from a CPA's office to a client's database via modem is an unnecessary and time-consuming requirement that is not in a client's best interest. They believe the standards should be changed to make such practices unnecessary.

Tax Returns. Another scenario that reflects the applicability problem is one in which a client engages a CPA to prepare its tax return based on financial statements prepared by the client. The CPA posts adjustments to the client-prepared financial statements, and the adjusted statements become a worksheet for the preparation of the tax return. The client's bookkeeper wishes to adjust the company's books to reflect the tax closing and asks the CPA to send the adjustments to him. The CPA does so; however, the bookkeeper has difficulty reconciling the balances in certain accounts to the balances in the tax return. The CPA's worksheet would provide the bookkeeper with sufficient detail to reconcile the balances. However, if the CPA sends the worksheet to the bookkeeper, the CPA will be required to compile the financial statements because the CPA has "modified [the client's financial statements] by materially changing account classifications [and] amounts.... directly on client-prepared financial statements." Many CPAs believe a CPA should not be required to compile these financial statements because the objective of the engagement was to prepare a tax return and not to provide the client with financial statements. The CPA could avoid the requirement to compile by only sending the bookkeeper the adjustments and not the financial-statement worksheet; however, this approach would not meet the client's needs in these circumstances.

Support for Status Quo

Those who support retaining the existing applicability provisions of SSARSs believe the provisions have merit because they identify acts that a CPA might perform 1) that have a significant effect on a client's financial statements and 2) that "associate" a CPA with financial statements and therefore should trigger the requirement to compile. They believe the applicability provisions of SSARSs are not difficult to apply and the concerns that have been raised come from CPAs seeking loopholes in the standards that will enable them to avoid the requirement to compile. Some of those CPAs have developed questionable techniques to circumvent the applicability provisions of SSARSs, such as performing all the work entailed in preparing a client's financial statements and having the client press the ENTER button on the computer that causes the financial statements to be generated. Those practitioners contend that the client, not the CPA, has "generated" the financial statements; therefore, the CPA is not required to compile.

Support with Change. Some supporters of the existing applicability provisions concede that SSARSs may need to be revised to make them easier to apply, however, they might recommend that the standards be amended to require a CPA to compile financial statements if the CPA proposes material adjustments to a client's financial statements that ultimately are incorporated into those statements. That kind of revision would make the form in which the adjustments are communicated to a client (orally, on paper, via diskette or modem) or the manner in which the financial statements are generated (the client or the CPA presses the ENTER button on the computer) irrelevant.

CPAs Providing Controllership
Services to Clients

Many CPAs are engaged to provide part-time or full-time controllership services to their clients. They maintain the accounting books and records, prepare financial statements, and perform significant management functions for their clients, such as hiring employees, authorizing purchases, investing idle cash, and signing checks. They contend the services they perform are the same as those performed by management and they are well beyond being nonindependent. They believe SSARSs should not be applicable to the financial statements they prepare because a compilation report is issued by an outside accountant to report on financial statements that are the representations of another party. Under existing standards, an accountant whose independence is impaired may compile financial statements for a client as long as the accountant indicates his or her lack of independence in the compilation report. At its March 1997 meeting, the ARSC voted to expose for comment a proposed amendment to SSARS No. 1 that would preclude a CPA from compiling financial statements for a client if the CPA performs services for that client that are equivalent to those performed by management. One problem entailed in this proposal is differentiating between services that impair an accountant's independence and those that are equivalent to the services performed by
management.

Plain-Paper Financial Statements

The ARSC has been wrestling with the submission issue and trying, with little success, to clarify the guidance on submission in SSARS No. 1. As noted previously, one suggestion has been to make the requirement to compile financial statements "engagement driven" so that if a CPA were engaged to compile financial statements he or she would do so, and if a CPA were not engaged to compile the financial statements there would be no requirement to compile.

Although the literature does not define plain-paper financial statements, they generally are understood to be financial statements that do not disclose the identity of the CPA who has prepared them or the fact they have been prepared by a CPA. Practitioners generally agree that plain-paper financial statements have the following attributes.

* The statements are presented on stationery or in an electronic format that does not bear the CPA's name, letterhead, watermark, or insignia.

* The CPA's name is not included in
the document containing the financial statements.

At its January 16-17, 1997 meeting, the ARSC discussed plain-paper financial statements and identified the pros and cons of plain-paper engagements shown in the exhibit. *

Judith M. Sherinsky, CPA, is a technical manager, audit and attest standards, at the AICPA.