A summary annual report (SAR) is a condensed corporate annual report written in a style that enables management to communicate corporate financial information to its investors in a more flexible and understandable format. Beginning in 1987, a number of corporations issued SARs, and there is the possibility that, if the economic climate permits, many more may start issuing SARs.

The Evolution of the SAR

The first modern annual report containing audited financial statements was issued by U.S. Steel, (now USX Corp.), in 1902. The SEC does not have any specific requirements for issuance of a glossy annual report to stockholders. It only requires the distribution of audited financial statements and certain other information to the stockholders (proxy statement) at least 20 days before the company annual meeting. When in 1986, General Motors (GM) asked the SEC for permission to issue an SAR in lieu of the traditional glossy annual report, the Commission really had no basis to object.

The idea of the SAR received its true impetus when in 1983 the Financial Executives Research Foundation (FERF) published a two-volume study on summary annual reporting. Nineteen major corporations participated in the study's experiment by preparing mock SARS for fiscal 1981. The results of the FERF-sponsored study indicated that the mock SARs were shorter, more readable and less expensive. The study also found that there was a wide diversity in the manner in which the 19 participating companies reported the auditor's association with the SAR. As part of the FERF study's results, recommendations for minimum disclosure guidelines on the general content of the SAR as well as for other specific disclosures were made. Although there was no suggested format for the SAR, it was recommended that the SAR contain a narrative financial review, completed or condensed two-year comparative financial statements, and optional note disclosures accompanying the financial statements. The study also contained a recommendation that the SAR include a report of management and report of the independent auditor.

In 1986, GM proposed to the SEC that it issue an SAR to its stockholders. The stockholders would continue to receive a complete set of audited financial statements, prepared in accordance with both GAAP and Regulation S-X, in proxy materials mailed prior to the annual stockholders' meeting. Stockholders would also continue to receive a Form 10-K copy on request. The SEC approved the GM proposal, but emphasized that GM follow certain minimum guidelines, including incorporation of the auditor's report on the condensed financial statements in the SAR. GM quietly reneged on its proposal to issue an SAR, perhaps due to adverse investor reaction during the stock market decline of October 1987. However, McKesson Corporation apparently noted GM's correspondence with the SEC and issued its first SAR in 1987.

Auditor Association

Independent auditors have historically been associated with financial statements in corporate annual reports. The financial statements filed with the SEC on Form 10-K must carry an audit report from a CPA.

At present, SAS 42, Reporting on Condensed Financial Statements and Selected Financial Data, contains the only guidance for auditors associated with condensed financial statements appearing in an SAR. This SAS requires the inclusion of an audit report and prescribes its form in a document that contains condensed financial statements that have been derived from audited financial statements. SAS 42 was issued in 1982 and precedes the development of the SAR, but reporting on financial statements in an SAR seems to fit the SAS 42 framework.

The FERF study recommended that, at a minimum, an SAR should state that the audited financial statements, including the auditor's report, are available in Form 10-K. In addition, if the audit report is qualified for a matter other than consistency due to a change in accounting, such qualification should also be mentioned in the SAR. The FERF study suggested that if an audit report is included in an SAR, it could be patterned after the one given in SAS 42.

Analysis

Complete sets of annual reports and Form 10-K reports for fiscal 1987 and 1986 were obtained from 22 companies whose names are listed in the first column of Exhibit 1. The 22 SAR companies analyzed were located all over the country and were engaged in a variety of businesses: banking and financial services (5); food processing and sales (4); oil, gas, and energy (4); computers, drugs, and health care (2 each); and engineering, management information systems, office products, forest products and paper, and diversified business (1 each). There was no uniformity in the size of the companies preparing SARs.

Auditor Involvement

Of the 22 SARs, 17 included audit reports. From the group of five companies that did not (identified with an asterisk in the table), one company (Kroger) did name its auditor.

It is understandable that one of the five SARs did not include an audit report because it did not include any financial statements. The remaining four SARs included financial statements without an accompanying audit report.

Form of Audit Report

Title and Addressee. Fifteen of the 17 audit reports were variously titled Auditor's Report, Report of Independent Accountants or Public Accountants, Report of Certified Public Accountants, Opinion of Independent Auditors, Accountant's Opinion, etc. Since SAS 58 now requires a title that includes the word "Independent" to be placed on the auditor's report, such diversity will no doubt be reduced in future audit reports.

Fourteen reports were addressed to the shareholders/stockholders and to the board of directors, while two reports were addressed only to shareholders/stockholders. One audit report was not addressed to anyone.

General Form. SAS 42 recommends a one-paragraph audit report on condensed financial statements. In the absence of any specific auditing standards on SARs, the FERF study also adopted the same one-paragraph report form. In this report, the auditor expresses both the scope of the audit engagement and the opinion on the condensed financial statements. For purposes of this example, the wording has been changed slightly from that recommended by FERF to reflect the guidance in SAS 58.

"We have audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of X Company and subsidiaries as of December 31, 19X0, and the related consolidated statements of income, retained earnings, and changes in financial position for the year then ended (not presented herein); and in our report dated February 15, 19X1, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated financial statement is fairly stated in all material respects in relation to the consolidated financial statements from which it has been derived."

Only four (American Fructose, American Maize, Becton Dickinson, and Marine Midland) of the 17 audit reports followed this general one- paragraph form. Twelve audit reports followed a two paragraph report form in which the report was explicitly divided into a scope paragraph and an opinion paragraph. One company (American Management Systems) included a three-paragraph audit report in its SAR.

Signature and Date. All of the audit reports were signed and dated by the auditors. In each case, the date of the auditor's report on either Form 10-K or proxy statement corresponded with the date on the SAR audit report.

Referencing Other Information in

Scope Paragraph

According to SAS 42, a client's condensed financial statements should be read in conjunction with the complete financial statements that include all the disclosures required by GAAP. To avoid the risk that users might assume that the condensed statements include all the disclosures, the auditor is required to report both that an audit of the complete set of statements was performed and the type of opinion rendered as a result of that examination. SAS 42 does not require the auditor to report that the complete set of financial statements are shown in the client's Form 10-K and proxy statement.

The scope paragraphs of the 17 audit reports revealed some diversity in the ways that auditors chose to refer to the: 1) client's complete set of financial statements appearing in either Form 10-K or proxy statement; 2) auditor's report on the complete set of financial statements; and 3) type of audit report appearing in either Form 10-K or proxy statement.

Reference to Financial Statements. Section A of the table in Exhibit 1 summarizes the results as to whether the auditors, in the scope paragraph, chose to reference the client's complete set of financial statements contained in either Form 10-K or proxy statement, or both. It is interesting to note that five audit reports made no reference at all to the complete set of financial statements incorporated in other documents.

SAS 42 does not require the auditor to refer users to the documents containing the complete set of financial statements. It seems that such a reference would improve the usefulness of the report in the SAR.

Reference to the Audit Report. Although not required to do so by SAS 42, 12 auditors reported in the scope paragraph a reference to their audit report on the complete set of financial statements. Section B of the table shows these results. You can see the variety of ways in which auditors referred to their reports on the complete financial statements.

Reference to the Type of Report. Each scope paragraph in the 17 audit reports appeared to follow SAS 42 guidance with respect to stating the type of audit report rendered on the client's complete set of financial statements; 13 reports referred users to unqualified audit reports, three reports made reference to qualified reports, and one report (American Management Systems) referred users to a report that was unqualified for each of three past years and qualified for each of two most recent years.

Content of the Opinion Paragraph. All 17 auditors appeared to follow SAS 42 with respect to reporting in the opinion paragraph as to whether the condensed financial statements were fairly stated in all material respects in relation to the complete set of financial statements from which they were derived. However, 12 audit reports referred to the client's "condensed" financial statements and 5 other reports referenced either "consolidated" or "summary" financial statements.

Gyan Chandra, PhD, Miami University, Oxford, OH, and Larry Rankin, PhD, CPA, Miami University, Oxford, OH