Compilation and review services: answers to questions old and new.by Winters, Alan J.
The AICPA's Accounting and Review Services Committee (ARSC) has dashed on to the standard setting playing field after having sat on the sidelines during the past several years. Many events convinced the committee that it was time to provide additional guidelines in the form of interpretations as to when SSARS applied. A number of these interpretations address long-standing complilation-service issues with guidance that is likely to produce substantial changes in many accountants' practices. Other interpretations will not have a pervasive an effect but will be significant to some CPAs' services.
The events that spurred this activity include:
* A reassessment of the plain paper service championed primarily by the AICPA's Private Companies Practice Section Executive Committee (PCPS) and its Technical Issues Committee.
* The Auditing Standards Board's issuance of the expectation gap SASs and SAS 62, Special Reports.
* The AICPA's adoption of a new Code of Professional Conduct extending Rule 203 to review services.
PLAIN PAPER SERVICE
During much of 1989 and early 1990, several individuals and groups renewed and accentuated a call for a level of accounting service below a compilation. The underlying reasong was that SSARS 1 compilation standars were too stringent and therefore crippled the accountants' ability to provide timely and cost-effective financial statements. The PCPS Executive Committee and its Technical Issues Committee asked that ARSC reconsider permitting plain paper service as a means of alleviating this problem. Their proposal was presented and discussed at a public forum held by the AICPA in September 1989. While traditionally referred to a s "plain paper," this label does not adequately convey the substance of the proposed service or the issues involved. The service proposed by the PCPS Groups contained the following elements.
* CPAs could provide an accounting service for interim financial statements without issuing a report.
* The financial statements would bear a legend or notation that they were for management use only and they contained departures from GAAP.
* No CPA name, logo, watermark, or other means of association would be on the financial statements nor could the statements be presented along with any other report by the CPA.
* An understanding would be established with the client that the financial statements would be used solely within the entity and the CPA could not have any knowledge that would cause a belief that the statements would be used by outside parties.
At the public forum, those advocating this proposal asserted that it would allow accountants to deliver timely and reasonably priced financial statements, would establish a means of legitimately avoiding the need to comply with "unnecessary" accounting and reporting standards, and would be consistent with the guidance pertaining to prospective financial statements where "internal use only" statements are permitted without an accountant's report. The advocates also contented that financial statement users are sufficiently sophisticated to avoid using such financial statements should they be made available.
During the forum, the proposal's opponents voiced several objections. Their major objection was that creating a lower level of accountant's service was not an appropriate response to a concern about accounting standards overload. They felt such a service ignored the accountant's obligation for due care and, as such, was not a professional service. They also stated that the proposed legend or notation would be an announcement of CPA association--managements would not use the legend except in such circumstances. In addition, opponents observed that a client could not be justifiably denied the right to state that the CPA was involved with the financial presentations.
At a meeting subsequent to the public forum, ARSC concluded that it should not amend SSARS to provide a lower service. Its major reasons were that such a service would lead to abuses, would result in lower quality service to the client, and was not in the public interest. In addition, the committee decided that compilation reporting standards are not onerous to comply with even when a substantial number of GAAP departures exist.
ARSC did, however, determine that additional guidance concerning the applicability of SSARS 1 would assist practitioners in dealing with several of the concerns that had prompted the plain paper proposal. The committee held a special conference in January 1990 at which past and present members of the committee, members of the PCPS groups, and other interested parties reviewed and analyzed a number of practice problems pertaining to SSARS 1 applicability.
The special conference deliberations identified three major questions where ARSC believed guidance was needed.
* When do financial presentations meet the definition of a financial statement as set forth in SSARS 1?
* What constitures "submitting" financial statements as that term is used in SSARS 1?
* What responsibilities do accountants have regarding draft financial statements submitted to clients?
What Is and Is Not a Financial
SSARS establishes standards for the compilation and review of financial statements of nonpublic entities--that its, it applies only to financial statements. As a result, determining whether a financial presentation is a financial statement is paramount in determining whether the accountant must follow those standards. SSARS 1 defines a financial statement as:
"A presentation of financial data, including accompanying notes, derived from accounting records and intended to communicate an entity's economic resources or obligations at a point in time, or the changes therein for a period of time, in accordance with generally accepted accounting principles or a comprehensive basis of accounting.
ARSC found that some financial presentations have characteristics that make them difficult to classify clearly as either a financial statement or some other type of presentation--typically a trial balance. Exhibit 1 illustrates a presentation in which opinions as to whether it is a financial statement or a trial balance are likely to differ.
Interpretation 15. To help accountatnts who are involved with client financial presentations differentiate financial statements from a trial balance, ARSC issued Interpretation 15 setting forth various attributes or characteristics to be considered. Although this interpretation focuses specifically on differentiating a financial statement from a trial balance, the characteristics are useful for differentiating financial statements from other types of presentations as well. These attributes are discussed briefly below.
* Account Presentation. In a financial statement, similar accounts are combined to create classifications or groupings with corresponding subtotals. For example,
"current assets," "long-term debt," and "operating expenses." In contrast, a trial balance consists of a listing of all general ledger accounts and their corresponding debit or credit balances.
* Presentation Titles. Financial statements generally contain titles that identify the presentation as one intended to present financial position, results of operations, or cash flows. Examples of such titles are balance sheet, statement of income, and statement of cash receipts and disbursements. Titles for a trial balance are (or should be) substantially different--for example, "Working Trial Balance," "Adjusted Trial Balance," or "Listing of General Ledger Accounts."
* Accounting Equation Format. The balance sheet and income statement present financial information according to the fundamental concepts and relationships expressed in the following equations: Assets = Liabilities + Owners' Equity and Revenues - Expenses + Gains - Losses = Net Income. In a true trial balance, no attempt is made to present these mathematical or conceptual relationships.
* Net Income Captions. The income statement in a set of financial statements generally contains a caption such as "Net Income," or "Net Revenues over Expenses," to identify the net results of operations. Trial balance presentations usually do not contain similar captions.
* Order of Account Presentation. A balance sheet usually presents assets in the order of their liquidity and liabilities in the order of their maturity. In a trial balance, accounts are generally listed in account number order as they appear in the general ledger.
* Articulation. In a set of financial statements, the income statement articulates with the balance sheet because the net results from operations are added to or subtracted from opening retained earnings. In a trial balance, the net results of operations is normally not closed out to retained earnings.
An accountant must use his or her judgment when deciding whether a presentation is a financial statement or a trial balance. The judgment should be based on the preponderance of attributes, because the presence of one or two attributes may not be conclusive and, in fact, may create confusion about the nature of the presentation. Consequently, accountants should use these attributes to avoid producing and submitting presentations that are not clearly either a financial statement or a trial balance. That is, accountants should modify presentations as necessary to ensure that the type of presentation is clear.
For example, Exhibit 2 presents a modification of the ambiguous Exhibit 1 resulting in what is undeniably a financial statement presentation--the attributes of the modified presentation leave no doubt about its nature. Exhibit 3 is a recasting of Exhibit 1, creating a presentation that is unquestionably a trial balance by virtue of its characteristics.
When Has the Accountant
Submitted Financial Statements?
Another critical determinant of SSARS 1 applicability is the act of submitting financial statements. Paragraph .01 of SSARS 1 states that the accountant should not submit unaudited financial statements to a client or others unless he or she complies with the provisions of SSARS 1 (emphasis added). Therefore, the financial presentation must not only meet the definition of a financial statement, as discussed in the previous section, but also the accountant must submit the financial statement before SSARS can apply.
Unfortunately, SSARS 1 did not define or elaborate on the term "submit," and what constitutes submitting has been at the root of numerous practice questions for many years. The following scenario highlights the issues:
1. A CPA is engaged to review X Company's annual financial statements (December 31 year end).
2. In October, the CPA visits X Company to become familiar with its accounting system and talk with the controller. During this visit, the CPA scans the client-prepared quarterly financial statements and notices two questionable items:
--The inventory amount is the same on each statement.
--Purchased computer equipment is financed through an installment note. The monthly payment is being charged to an expense account, however, and the asset has not been capitalized.
3. The CPA suggests using the gross profit method of estimating inventory for the quarterly statements and explains the method to the controller. The CPA also explains the proper method of accounting for the purchased computer equipment.
4. The controller remains uncertain about the amounts to record for the purchased equipment so the CPA calculates the amounts to be capitalized, recorded as a liability, and charged to interest expense.
5. To further assist the controller, the CPA enters these calculated amounts along with the appropriate captions on the client-prepared quarterly statements.
6. Has the CPA submitted quarterly financial statements? If so, at what point did submission occur? That is, at what point did the CPA become subject to SSARS?
Interpretation 16. In providing guidance about what constitutes submission, ARSC decided to develop a precise boundary at which submission occurs. Although the committee would have preferred to allow greater use of the accountant's judgment, it concluded that a specific definition of "submit" was the only feasible means of eliminating confusion. Consequently, ARSC issued Interpretation 16 which states that the accountant submits financial statements by either:
* Generating financial statements, either manually or by using a computer; or
* Making material changes in account classification, amounts, or disclosures directly on client-prepared financial statements.
ARSC has defined generating financial statements very specifically. It includes only the act of putting financial information in financial statement format and does not include any preceding steps or services the accountant may perform. In addition, materially modifying client- generated financial statements is also strictly defined--the modifications must be made directly on the face of the financial statements. Modifications rendered in any other form do not result in submitting financial statements.
The precision of ARSC's definition of "submit" is best illustrated by considering the services listed in the interpretation as not constituting submission of financial statements.
* Reading client-prepared financial statements.
* Proposing material adjusting or correcting journal entries or disclosures to client-prepared statements, either orally or in written form, as long as the accountant does not enter such modifications directly on the face of the financial statements.
* Preparing standard monthly journal entries.
* Providing the client with a financial statement format to use in preparing financial statements as long as the format does not contain dollar amounts.
* Advising the client about the selection or use of computer software that the client will use to generate financial statements.
* Providing the use of or access to computer hardware or software that the client will use to generate financial statements.
Using this interpretation to address the questions posed in the scenario presented earlier would lead to the conclusion that not until making material modifications directly on X Company's quarterly financial statements did the CPA meet the definition of submitting and become subject to SSARS. Providing accounting advice and calculating adjusted amounts for the client do not result in submitting financial statements. The CPA must place the amounts directly on the face of the financial statements to meet ARSC's definition.
Computer-generated financial statements have, for years, fostered questions concerning SSARS applicability. How the submission definition applies to such statements warrants additional discussion. Technically, under ARSC's interpretation, generating financial statements with a computer occurs by executing the print command. Thus, unless the accountant "pushes the button," he or she is not submitting financial statements. Any accounting services preceding printing the financial statements, such as providing accounting software neven timesharing the accountant's software), providing the client with adjusting data, or entering source data or adjusting data directly into the computer, falls short of the act of generating (printing) computer-produced financial statements. In other words, if the accountant does everything except execute the print command and the client does that, the financial statements are client-generated not accountant submitted.
Although the interpretation's definition of submission is so precise that accountants are not submitting computer-generated financial statements unless they hit the print button, practitioners should avoid such situations. In the authors' opinion, if an accountant provides all of the accounting services prefatory to generating financial statements except printing them, those services are sufficient to require compliance with the SSARS requirements. For example, accountants should refrain from providing clients with statements in magnetic form, such as on a floppy disk, simply to avoid being subject to the standards.
What About Submitting Draft
ARSC also decided to address another question concerning the applicability of SSARS 1--the practice of issuing draft financial statements. Accountants sometimes issue statements in draft form, without a compilation report, because all of the information necessary to complete the compilation is not yet available or to provide the client with the opportunity to read and analyze the financial statements prior to putting them in final form.
Interpretation 17. ARSC also realized, however, that draft financial statements might result in abuses. Such financial statements might be issued to evade the performance and reporting requirements of SSARS 1. Thus, ARSC issued Interpretation 17 addressing the question, "Is it permissible for an accountant to submit draft financial statements without intending to comply with the reporting provisions of SSARS 1?"
The answer, of course, is "no." However, the interpretation recognizes that draft financial statements are appropriate when the accountant intends to submit final financial statements, accompanied by the appropriate report, and labels each page of the draft financial statements with language such as "draft," "preliminary draft," or "working draft." The interpretation also suggests, but does not require, that in the rare circumstance where final financial statements are not submitted, the accountant may want to document the reasons why.
REPORTING ON SPECIAL-PURPOSE
SAS 62, Special Reports, introduced a new category of special reports- -reports on special purpose financial presentations prepared to comply with a contractual agreement or regulatory provision. This category includes:
* Incomplete presentations of an entity's assets, liabilities, revenues, and expenses that are otherwise prepared in conformity with GAAP or OCBOA.
* Presentations prepared in accordance with a prescribed basis of accounting that
do not result in a presentation in conformity with GAAP or OCBOA.
Interpretation 18. SSARS does not specifically address these types of special purpose presentations and nonpublic entities may engage accountants to compile or review such presentations. To address this void in SSARS, ARSC issued Interpretation 18 stating that accountants may compile or review such presentations and provide guidance for such engagements. The guidance in the interpretation is quite detailed and parallels that in SAS 62. The basic provisions in the interpretation are summarized below.
A client's need for an incomplete presentation can arise from a variety of circumstances. For example, a loan agreement may require a real estate entity to prepare a schedule of gross income and expenses other than interest and depreciation. Similarly, a buy-sell agreement may specify a schedule of gross assets and liabilities that includes only assets to be sold and liabilities to be transferred. Both presentations are considered financial statements and, except for the items omitted, would be prepared in conformity with GAAP or OCBOA.
Contractual Presentation Not in
Conformity with GAAP or
Some contractual agreements require that a presentation be prepared in accordance with a basis of accounting other than GAAP or OCBOA. For example, an acquisition agreement may require the financial statements of the acquired entity to be prepared in conformity with GAAP except for certain assets, such as inventories and properties, for which the valuation basis is specified in the agreement. Such a presentation is not considered to be prepared in conformity with either GAAP or OCBOA, but for purposes of the application of SSARS are considered financial statements.
Standard Report Modifications
The interpretation requires the accountant to add two paragraphs to the compilation or review report on either type of presentation. The purpose of the paragraphs is essentially the same in either compilation or review reports on both types of presentations. Generally, the added paragraphs accomplish the following objectives: 1) indicate what the presentation is intended to present; 2) refer to a note in the financial statements that describes the basis of accounting; 3) state either that the presentation is not intended to be complete or in conformity with GAAP; and 4) state that the report distribution is restricted to specific parties. Exhibits 4 and 5 present examples of review and compilation reports based upon the interpretation.
For many years the CPA's ethical standards (Rule 203) have permitted auditors to express an unqualified opinion on an entity's financial statements when those statements contained a material departure from a promulgated accounting principle. Of course, the auditor had to be satisfied that such a departure was justified to keep the statements from being misleading. In practice these circumstances are rare.
When the AICPA's Code of Professional Conduct was revised, Rule 203 was expanded to apply to review services as well as audits. ARSC decided that an interpretation recognizing the extension of Rule 203 to review services would be appropriate and would provide a reference source for accountants if they encountered the rare situations where the rule would apply.
Interpretation 19. Interpretation 19 reiterates the guidance in Rule 203 and focuses the accountant's attention on the review report modifications necessary when Rule 203 applies to a review engagement. These report modifications require the accountant to describe the departure and, if practicable, its approximate effects, along with the reasons why conformance with the promulgated principle would result in a misleading statement.
HAVE ALL THE QUESTIONS
Compilation and review of financial statements are an important part of accountants' services. Clients do not always appreciate or understand the necessity for accountants to attach their reports to compiled statements. The clients often believe such reports carry negative connotations. While clients will continue to question "why the fuss? Just give me what I need," the recently issued interpretation will be of help in clarifying and providing uniformity in practice.
Kay W. Tatum, PhD, CPA, is Assistant Professor of Accounting at the University of Miami. She is a member of the AICPA and Florida Institute of CPAs. Dr. Tatum has published articles in accounting journals including The CPA Journal.
Alan J. Winters, PhD, CPA, is Friends of Accounting--Donald H. Cramer Professor of Accounting at the University of South Carolina. He was formerly Director of Auditing Research at the AICPA; is currently a member of its Accounting and Review Services Committee; and has served on a number of AICPA committee and task forces. Dr. Winters is a member of the AICPA, South Carolina Association of CPAs, and the Society of Louisiana CPAs.
The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.
©2009 The New York State Society of CPAs. Legal Notices
Visit the new cpajournal.com.