ASB ISSUES INTERPRETATION OF AU SECTION 623, SPECIAL REPORTS

By John F. Burke, CPA,
The CPA Journal

The Audit Issues Task Force of the Auditing Standards Board (ASB) has recently issued an interpretation of AU Section 623, Special Reports, relating to disclosures in OCBOA financial statements. This interpretation is a response to one of the recommendations of the PCPS Special Task Force on Standards Overload. The task force had concluded that the guidance in Section 623 (SAS No. 62) on disclosures in OCBOA financial statements was too broad and recommended that standard setters issue more specific guidance on appropriate disclosures in such statements.

The guidance in Section 623 on OCBOA financial statements is contained in a mere two paragraphs, which is why practitioners had problems and the task force wanted more guidance. The essence of the first paragraph is that such financial statements should "include all informative disclosures that are appropriate for the basis of accounting used." Then, like all Gaul, the second paragraph divides the disclosure requirements into three parts. The first is the summary of significant accounting policies, which discusses the basis of presentation and describes how that basis differs from GAAP. The differences need not be quantified. The second group of disclosures is that required when the OCBOA statements contain items that are the same as, or similar to, those contained in GAAP financial statements. The last area covered relates to disclosures for matters that are not specifically identified on the face of the financial statements. Related party transactions, restrictions on assets and owner's equity, subsequent events, and uncertainties are the examples given.

The interpretation does not address all OCBOA financial statements. It specifically deals with the requirements insofar as they relate to cash, modified cash, or the income tax basis of accounting.

The basis of presentation disclosure according to the interpretation may be brief and only the primary differences from GAAP need be described. For GAAP-like items, preparers would have the option of providing a GAAP-like disclosure or information that provides the substance of the disclosure. This could involve providing qualitative information for the specific quantitative information provided under GAAP. An example would be providing the repayment terms of long-term debt in lieu of the schedule of repayments over the next five years. Using percentages of revenues for sales to related parties is another example given.

For disclosures of other matters such as contingent liabilities, the interpretation again states that disclosure of the substance of the matter would be sufficient. It goes on to advise that it is not necessary to present information that is not relevant to the basis of accounting, e.g., the general caveat about estimates is not relevant in a cash basis statement. The same rule applies to the measurement of an element, account, or item. Information about actuarial calculations for pensions under SFAS No. 87 are not relevant in income tax or cash basis financial statements.

The concept of providing the substance of a GAAP presentation in notes to financial statements to avoid modifying financial statement format is stressed. This could be done for disclosures about accounting changes, discontinued operations, and extraordinary items. Specific disclosures for not-for-profit organizations that could be handled in this fashion are provided.

The interpretation codifies what most practitioners already know. Cash flow statements are not required when cash basis or modified cash basis statements are presented. They may also be omitted for those statements prepared on the accrual basis of accounting used for Federal income taxes. However, if an entity chooses to present a statement in a cash flow format, such statement should conform to GAAP or its substance.

The interpretation will not put an end to all the questions on OCBOA financial statements, but its emphasis on disclosure of the substance of matters should be helpful. *

ESTABLISHING AN UNDERSTANDING WITH THE CLIENT

By John F. Burke, CPA,
The CPA Journal

A number of years ago, the Auditing Standards Board (ASB) established a task force to consider issuing a standard requiring the use of engagement letters. The board eventually abandoned the project because it was considered an administrative matter and not one to be covered by standards. Interesting enough, if memory serves me correctly, the first auditing standard issued by the International Federation of Accountants' auditing procedures committee was on engagement letters, apparently because it was easy to get out. Well, times in the U.S. have changed.

The ASB has issued SAS No. 83 and SSAE No. 7, both entitled Establishing an Understanding with the Client. These statements were issued in response to Statement on Quality Control Standards (SQCS) No. 2, System of Quality Control for a CPA Firm's Accounting and Auditing Practice, which requires that CPA firms provide policies and procedures for obtaining an understanding with clients regarding services to be performed. In many respects, the requirements are similar to those contained in SSARS.

SAS Requirements

SAS No. 83 requires the auditor to establish an understanding with the client covering four specific areas: the objectives of the engagement, the responsibilities of management, the responsibilities of the auditor, and any limitations of the engagement. A footnote points out that certain engagements, e.g., agreed upon procedures, may involve different objectives that impact these areas. It also requires the auditor to document the understanding with the client in the working papers, preferably through a written communication with the client. If an understanding has not been reached, an auditor should ordinarily decline to accept or perform the engagement.

In addition to not requiring an engagement letter, the new SAS also provides some wiggle room as to what specific matters should be covered in the areas required to be addressed in the understanding. The following is a summary of the matters that ordinarily or generally are included.

Objectives. The objective of an audit is the expression of an opinion on the financial statements. (Not much wiggle room here.)

Management Responsibilities

* The entity's financial statements

* Establishing and maintaining effective internal control over financial reporting

* Identifying and ensuring compliance with applicable laws and regulations

* Making all financial records and relating information available to the auditor

* Providing a representation letter

Auditor Responsibilities

* Conducting the audit in accordance with generally accepted auditing standards

* Communicating reportable conditions that come to the auditor's attention

Limitations of the Engagement

* Because of the nature of an audit, a material misstatement may remain
undetected.

* An audit is not designed to detect immaterial errors or fraud.

* Conditions may force the auditor
to decline to express an opinion or issue a report.

* An audit is not designed to provide assurance on internal control or identify reportable conditions.

Optional Matters

The SAS indicates that the above matters may be communicated in the form of an engagement letter. It also indicates that the following matters may be included in the communication. (Read this to mean strongly suggested.)

* Arrangements for the conduct of the engagement (including client assistance, timing etc.), involvement of specialists or internal auditors, communicating with predecessor auditor, and/or billings and fees

* Any limitation regarding the liability of the auditor or client

* Access to audit working papers

* Additional services relating to regulatory requirements

* Other services

SSAE Requirements

The SSAE No. 7 requirements are basically the same as those for SAS No. 83. Because of the wide variety of attestation engagements, there are no suggested matters that ordinarily would be covered.

Effective Date

The statements are effective for engagements beginning after June 15, 1998, with earlier application encouraged. *

Editors:
Douglas R. Carmichael, PhD, CPA
Baruch College