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Oct 1989

Special reports: conforming changes and new engagements. (Statement of Auditing Standards)

by Munter, Paul

    Abstract- The auditing of special reports must now be done in accordance with Statement of Auditing Standard 62, Special Reports. Special reports are divided into five categories, including: financial statements prepared on a basis other than Generally Accepted Accounting Principles (GAAP), OCBOA; audits of specified elements of a financial statement; and compliance with contractural agreements. Under SAS 62, reports prepared under OCBOA include: government regulatory audits; income tax returns; and reports prepared with the cash receipts and disbursements basis of accounting. During the audit of OCBOA statements, there is no obligation to disclose discrepancies between GAAP and OCBOA. However, the auditor, though not following GAAP, should consider the need for disclosures in certain situations, including: transactions of related parties; assets and equity restrictions; and uncertainties.

Special reports can be divided into five categories (the first four were recognized in SAS 14):

9 Audits of financial statements prepared in conformity with a comprehensive basis of accounting other than GAAP(OCBOA);

* Audits of specified elements, accounts, or items of a financial statement;

* Compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements;

* Financial information presented in prescribed forms or schedules that require a prescribed form of report.

The fifth service, introduced by SAS 62 under the umbrella of special reports, is related to special-purpose financial statements prepared to comply with contractual agreements or regulatory provisions. As noted earlier, some changes were made to conform to the wording in SAS 58, while others were made to reflect reports on new services or changes in existing services. Exhibits 1 and 2 provide an overview of these changes.

SAS 62 is applicable only when one of the described services is provided. In other circumstances, the accountant is not necessarily precluded from issuing a report; however, the auditor should then look to the Attestation Standards for guidance on reporting. Financial Statements Prepared in Conformity with a Comprehensive Basis of Accounting Other than GAAP

The basic presumption of financial statements is that they are prepared in accordance with GAAP. However, in some situations, because of special circumstances, financial statements are prepared in accordance with a comprehensive basis of accounting other than GAAP; these are OCBOA statements. In accordance with SAS 62, OCBOA includes:

* A basis of accounting used to comply with the requirements or financial reporting provisions of a governmental regulatory agency to whose jurisdiction the entity is subject such as a Public Utility Commission for an electric utility company or the Comptroller of the Currency for a bank;

* A basis of accounting used or to be used for income tax returns;

* The cash receipts and disbursements basis of accounting, and modifications thereof having substantial support such as recording depreciation of fixed assets or accruing income taxes;

o A definite set of criteria have substantial support that is applied to all material items in financial statements such as general price-level accounting.

Although these descriptions of OCBOA are substantially the same as in SAS 14, the required auditor's report for such statements is significantly different. SAS 62 presumes that the statements are being audited. If not, the Compilation and Review Standards SSARSS) or the Attestation Standards, should be followed, as appropriate.

When the OCBOA statements are being audited, GAAS is applicable, although the first reporting standard is modified to reflect the basis of accounting being used. As a result, the auditor must first determine that the basis used qualifies as an OCBOA as defined by SAS 62. If the auditor believes otherwise, then he or she should follow the reporting guidance of SAS 58 and issue a report modified because of GAAP departures. If the auditor determines that the OCBOA used satisfies the requirements of SAS 62, he or she must assess the adequacy of the financial disclosures, including those in the notes, in a manner similar to auditing GAAP-basis statements. The auditor must carefully consider the adequacy of the summary of significant accounting policies, the disclosure of the basis used and how the OCBOA differs from GAAP. However, there is no requirement that the effects of the differences between GAAP and the OCBOA be disclosed. Even though GAAP is not being followed, the auditor also should consider the need for and the adequacy of disclosures about: 1) related party transactions; 2) restrictions on assets and equity-such as through debt covenant agreements; 3) subsequent events; and 4) uncertainties. Finally, the auditor should be satisfied that the statements' names reflect the basis of accounting and do not use terminology typical to GAAP-basis statements. Terms such as balance sheet and income statement should be avoided. When reporting on OCBOA statements the auditor's report will contain four paragraphs if an unqualified opinion is expressed, as illustrated in paragraph 8 of SAS 62. They are: an introductory paragraph, a scope paragraph, an explanatory paragraph, and an opinion paragraph. A fifth paragraph is mandated when the statements are prepared in conformity with the requirements of a governmental regulatory agency to restrict the distribution of the report solely to those within the entity and for filing with the regulatory agency.

The introductory paragraph parallels SAS 58. Key changes appear in Exhibit 1. Terminology that makes this paragraph unique to special reports is that the titles of the statements are modified to reflect that they are not intended to present financial position, results of operations, or cash flows in conformity with GAAP. For example, if the statements are being filed with a regulatory agency, the financial position is presented in a statement labeled Balance Sheet-Statutory Basis, (or similar wording). Or, if prepared on a cash basis, the statement might be titled Statement Of Assets and Liabilities Arising from Cash Transactions. The scope paragraph to be used now conforms to SAS 58 terminology and includes a complete description of the statements audited.

The second paragraph explains the nature of an audit under GAAS as required by SAS 58.

The third paragraph is unique to the special report. It states the basis of presentation and refers to the note in the statements that gives the full details thereof. SAS 62 states that while the note should describe how the presentation differs from GAAP, there is no requirement to quantify the effects of the differences between GAAP and the OCBOA. The paragraph should contain a positive statement that the basis is a comprehensive basis of accounting other than GAAP. This is different from the cautionary wording of SAS 14, which stated that the financials were not intended to be presentations in accordance with GAAP.

The fourth opinion paragraph likewise is adapted from SAS 58. Accordingly, it does not contain a reference to consistency when there has been no change from the prior year in the principles being applied. Specified Elements, Accounts, or items of a Financial Statement

The auditor may express an opinion on one or more specified elements, accounts, or items of a financial statement. For example, the auditor may report on rentals, royalties, profit participation, or a provision for income taxes.1

As before, these audits may be performed either as separate engagements or with an audit of financial statements. However, to express an opinion on a specified element, account, or item that is based upon an entity's net income or stockholders' equity, the auditor should have audited the complete financial statements.

In issuing a special report on specified elements, accounts, or items, the auditor must express an opinion on each element. In doing so, all of GAAS, except for the first reporting standard if the element is not in accordance with GAAP, should be applied. Additionally, since each element will be reported on, the auditor's materiality judgment is to be based on the individual element and not on the statements taken as a whole. Therefore, such an engagement is normally more extensive than if the specified element were being considered in conjunction with an audit of financial statements.

The auditor must be careful in these engagements since the report must be distinguished from a piecemeal opinion which, for many years, an auditor has been prohibited from issuing. Therefore, if the auditor has issued an adverse opinion or disclaimed an opinion on the statements taken as a whole, the auditor should carefully consider whether reporting on the specified element included in such statement is tantamount to a piecemeal opinion. If the auditor is satisfied that the report is not in effect a piecemeal opinion, then it may be issued. However it should be presented separately from the report on the financial statements.

The following should be included in the auditor's report on specified elements, accounts, or items: 1. A responsibility paragraph that:

a. states that the specified elements, accounts, or items

were audited;

b. if the financial statements which include the items






c. describes the basis on which the specified elements,

accounts, or items are presented (if other than

GAAP) and, if appropriate, any agreements specifying

that basis (this may be included as a separate,

third, paragraph in the report);

e. states the responsibilities of management and of the


2. A scope paragraph that:

a. states that GAAS were applied;

b. states the requirements of GAAS-namely to plan

and perform the audit to obtain reasonable assurance

about whether the specified elements, accounts, or

items are free from material misstatements;

c. describes the nature of an audit;

d. states that the auditor believes that the audit provides

a reasonable basis for the opinion rendered.



in a manner which is not GAAP or OCBOA, a

paragraph which restricts the distribution of the report

to those who are party to the agreement. Paragraph 18 of SAS 62 provides illustrations of such a report when no modifications of the opinion are needed. Modification of the opinion paragraph is illustrated later herein. Compliance With Aspects of Contractual Agreements or Regulatory Requirements Related to Audited Financial Statements

In today's business environment, auditors are increasingly asked to report whether an entity is in compliance with contractual or regulatory requirements.2 SAS 62 continues to allow auditors to provide negative assurance in certain instances.

First, the assurance can be given only in conjunction with an audit of financial statements. Thus, in giving negative assurance, the auditor can only provide assurance on matters which have been subjected to audit procedures in the audit of the financial statements.3 Finally, negative assurance cannot be given if an adverse opinion or a disclaimer on the statements taken as a whole has been given.

The report on compliance with contractual or regulatory requirements can be either a separate report or part of the audit report. If negative assurance is provided separately, the following information should be provided in the report:

1. A paragraph stating that the financial statements were audited in accordance with GAAS, the audit report date, and any departures from the standard audit report.

2. A paragraph that refers to the applicable portion of the agreement or regulatory requirement, provides negative assurance, and states that the negative assurance is given in conjunction with the audited financial statements. The auditor typically would state that the audit was not directed primarily at obtaining knowledge of compliance.

3. A paragraph that provides a description and source of significant interpretations made by management.

4. A paragraph that restricts the distribution of the report; this paragraph satisfies the reporting requirements of Attestation Standards when negative assurance is given.

If the negative assurance is being provided as an addition to the report on the financial statements, negative assurance should be provided after the opinion paragraph. In so doing, the information required in (3) should be included in that paragraph. information Presented in Prescribed Form

In many situations, the auditor may be asked to provide information in accordance with a format specified by the entity that will use the information. SAS 62 continues the requirements of SAS 14. If the prescribed report is not consistent with the assurances to be provided, a report should be attached which complies with applicable reporting requirements. Special-Purpose Financial Presentation to Comply with Contractual Agreements or Regulatory Provisions

As noted earlier, SAS 62, in addition to providing conforming changes, also allows auditors to perform new services not previously covered by special report literature. The types of engagements contemplated are those in which the auditor is asked to report on "special-purpose" statements prepared to comply with contractual agreements or regulatory provisions. Typically, the information is intended solely for the parties to the agreement or a regulatory body or, perhaps, other specified parties.

SAS 62 divides the financial information into two categories:

1. A financial presentation which is in conformity with GAAP or OCBOA, but does not constitute a complete set of financial statements; and

2. A financial presentation, which may be a complete set of financial statements or an individual financial statement but which is prepared on the basis of accounting prescribed by the agreement and not in accordance with GAAP or OCBOA. incomplete Financial Presentation Otherwise in Conformity with GAAP or OCBOA

As contemplated by SAS 62, such information might include those assets and liabilities, presented in accordance with GAAP, which will be sold and transferred under an agreement, rather than all the entity's assets and liabilities. A similar situation might be a statement of assets and liabilities in accordance with GAAP, but only the assets that can be used as collateral under a debt agreement are included. SAS 62 specifies that such a financial presentation should generally be regarded as a financial statement, even though certain items may be excluded.

When reporting on these presentations, the auditor's materiality judgment would be in relation to the presentation taken as a whole.4 Additionally, since such presentations often include items which are the same as or similar to information provided in financial statements prepared in accordance with GAAP, similar disclosure requirements should be met. Thus, as when reporting on full OCBOA financial statements, the auditor should be satisfied as to the adequacy of both the disclosures and the information contained in the presentation. Further, the presentation should be appropriately titled such that the special- purpose nature is clear; again terms such as balance sheet," "income statement" or "statement of cash flows" should not be used.

In these situations, the auditors' report will parallel the standard audit report. However, there will be changes, since the presentation does not constitute a complete set of financial statements prepared in accordance with GAAP. Thus, the audit report should include: 1. A responsibility paragraph that:

a. identifies the financial statement reported on;

b. states the responsibilities of management and of the

auditor. 2. A scope paragraph. 3. An explanatory paragraph that:

a. explains what the presentation is intended to present

and refers the reader to a note that describes the


b. states that the presentation is not intended to be a

complete set of financial statements of the entity in

accordance with GAAP. 4. An opinion paragraph relating to the fair presentation,

in all material respects, of the information the presentation

is intended to present, in accordance with GAAP or

OCBOA. 5. A paragraph restricting the distribution of the report.

This restrictive paragraph cannot be used when the

information will be distributed to the public, such as in

a prospectus filed with the SEC. Financial Statement(s) Prepared an a Basis Prescribed by Agreement which is Not in Conformity with GAAP

Unlike the previous situation, other engagements may call for the auditor to report on a financial statement not prepared in accordance with GAAP or OCBOA. For example, a loan application may call for financial statements, wherein the inventory is to be valued at sales price; or in an acquisition agreement providing that fixed assets and inventories be measured at liquidation values.

While an auditor can be associated with such information, it does not constitute either GAAP basis or OCBOA financial statements since the GAAP departures do not have "substantial support." Again, the auditor would need to consider the adequacy of the disclosures associated therewith; in rendering an opinion, materiality is considered at the financial statement level. The auditor's report will include the following: 1. A responsibility paragraph. 2. A scope paragraph. 3. An explanatory paragraph that:

a. describes what the financial statement(s) is intended

to present and refers to the note which describes the

basis of presentation;

b. states that the financial statement(s) is not intended

to be a presentation in conformity with GAAP. 4. A paragraph that includes a description and the source

of significant interpretations made by management. 5. An opinion paragraph related to the fair presentation, in

all material respects, of the information intended to be

presented on the basis of accounting specified. 6. A paragraph that restricts the distribution of the report. Circumstances Calling for Explanatory Language in the Auditor's Report

In some situations, the auditor's report will need modification. Some of the modifications will result in an opinion which is qualified; others will result in a report modification, but still yield an unqualified opinion. In addition to being aware of when the auditor's report needs modification, it is also important to understand how that report is to be modified.

Exhibit 3 provides an overview of circumstances that may lead to a modified report. It differentiates between modifications which result in an unqualified opinion and those where the opinion is other than unqualified. The exhibit also shows where the modifying language should be placed in the report. As can be seen, in all situations where the opinion is affected, (i.e., a qualified or adverse opinion is rendered or the auditor disclaims an opinion), the explanatory paragraph precedes the opinion paragraph. Conversely, for lack of consistency, uncertainties, and going concern uncertainties, the explanatory paragraph is presented after the opinion paragraph and the opinion is still unqualified. When other auditors are involved, both the introductory paragraph and the opinion paragraph are modified to refer to the other auditor as is the case in an audit report for GAAP basis financial statements. Finally, when the auditor is issuing a report with a changed opinion on prior period information, an explanatory paragraph must precede the opinion paragraph.

In addition to the overview provided by Exhibit 3, Exhibit 4 presents illustrative reports for certain situations. Summary

The changes made to the "Special Reports" literature fall into two categories: 1) conforming changes; and 2) new engagement services. For conforming changes, the substance of the auditors work is not altered. Rather, the form of the report has been conformed to the new standard report in SAS 58. While much of SAS 62 is devoted to these types of changes, some of its provisions do require or allow the auditor to perform additional services.

I SAS 62 does not alter the provisions of SAS 35, "Special Reports-Applying Agreed-Upon Procedures to Specified Elements, Accounts, or Items of a Financial Statement." Thus, agreed-upon procedures may still be applied to elements, accounts, or items and the previous reporting requirements remain unchanged. For a discussion of these requirements, see Munter and Ratchlife, "Special Reports," The CPA Journal, February 1982.

2 Examples include loan agreements which have sinking fund requirements, restrictions of dividend payments, and/or maintenance of current ratio, debt-to-equity ratio or other leverage and coverage ratios.

3 If the auditor is asked to provide assurance on other matters, the Attestation Standards or SAS 35, as appropriate, should be followed.

4 The auditor would need to consider SAS 47, "Audit Risk and Materiality in Conducting an Audit." Munter and McCaslin, "Risk and Materiality in an Audit," The CPA Journal, November 1984, provides additional discussion of these requirements.

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