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March 1992

You ARSCed for it! (Accounting and Review Services Committee of the American Institute of Certified Public Accountants)

by Rubin, Steven

    Abstract- The Accounting and Review Services Committee of the American Institute of Certified Public Accountants (AICPA) provides clarification of specific aspects of limited auditing. The application of compilation and review engagements to the submission of financial statements, particularly of unaudited versions, is given a substantial discussion using a case scenario. Trial balances are differentiated from financial statements and as such are not covered by limited auditing standards. The applicability of the practice of issuing draft forms, instead of final forms, of financial statements to clients is shown for specific scenarios. The applicability of the compilation report to financial statements based on specified elements, items or accounts is expounded on. Th financial and ethical aspects of unpaid fees as contained in financial statements is also examined.

Submission of Financial Statements

Practitioners generally understand that standards for compilation and review engagements apply when practitioners "submit" unaudited financial statements of nonpublic companies, even if they were not specifically engaged to compile or review such statements. What becomes important, then, is what constitutes "submission."

Question: Dee, CPA, has been asked by Fog Co., a nonpublic client, to provide it with a financial statement format that Fog can use to generate its 1990 financial statements. (Such a format is commonly called a pro forma. ) The pro forma won't contain any dollar amounts but will contain proposed footnote disclosures. Does Dee's compliance with Fog's request constitute "submission" of financial statements?

Answer: No, Dee's compliance with Fog's request does not constitute submission of financial statements. Accounting and Review Services (ARS) Interpretation 16 defines submission as presenting to a client, or others, financial statements that the practitioner has generated either manually or through use of computer software or modified by materially changing account classifications, amounts, or disclosures directly on client-prepared financial statements.

The interpretation goes on to state, however, that none of the following services constitutes submission as long as the practitioner does not directly modify client-generated financial statements:

* Preparing journal entries;

* Providing a client with a financial statement format without dollar amounts (aproforma) that the client can use to prepare its financial statements;

* Reading client-prepared financial statements; and

* Proposing correcting journal entries or disclosures.

Therefore, if Dee merely provides a pro forma as requested, Dee isn't deemed to have submitted financial statements and needn't comply with standards for a compilation or review engagement.

Financial Statement versus Trial Balance

Unlike financial statements, trial balances are not covered by standards for compilation and review engagements. The distinction, however, between a financial statement and a trial balance is not always clear, regardless of how a financial presentation is labeled. As a result, some presentations labeled trial balances are, in substance, financial statements. This confusion can only dilute the public's confidence in the financial reporting process and the services that practitioners provide. Consequently, guidance has been developed on what distinguishes a financial statement from a trial balance.

Question. Bar, CPA, plans to furnish Jax Co., a nonpublic client, with a financial presentation with the following attributes:

* Items are listed in order of liquidity rather than the order in which they appear in Jax's general ledger;

* Net income is identified as such;

* The allowance for doubtful accounts

is offset against accounts receivable to

arrive at a net amount; and

* The presentation is labelled trial balance.

Is Jax's financial presentation more likely a financial statement or a trial balance?

Answer: Jax's financial presentation is more likely a financial statement than a trial balance. ARS Interpretation 15 identifies certain attributes that should be considered in determining whether a financial presentation is more likely a financial statement or a trial balance. Those attributes are summarized in Figure 1. The interpretation holds that a "preponderance" of attributes should be used in making the determination.

Based on a "preponderance" determination, Jax's financial presentation is more likely a financial statement than a trial balance, because the presentation has more attributes of a financial statement than of a trial balance.

Draft Financial Statements

For years, practitioners have given draft financial statements and accompanying reports to clients to look at before the documents were issued in final form. However, considerable concern was expressed that some practitioners were furnishing their clients with drafts as final products (a throwback to the era of "plain paper" statements).

Question: Fox, CPA, plans to furnish Gad, a nonpublic client, with draft 1990 financial statements and an accompanying review report. Before the drafts are released, Gad informs Fox that the drafts are sufficient for Gad's needs and that final statements won't be needed. The drafts will be conspicuously marked as drafts. Should Fox furnish the drafts to Gad?

Answer: No, Fox shouldn't furnish the drafts to Gad. ARS Interpretation No. 17 permits practitioners to furnish draft financial statements to clients only if the practitioners do both of the following:

1. Conspicuously mark the statements as such; and

2. Intend to submit those financial statements in final form accompanied by the appropriate compilation or review report.

In this scenario, condition 1 is met but condition 2 isn't (because Fox has been put on notice that final statements aren't intended to be submitted). Therefore, Fox shouldn't furnish Gad with the drafts.

Interestingly, the interpretation doesn't directly address what is, perhaps, the more common occurrence: Gad telling Fox after the drafts are issued that Gad doesn't want final statements. However, the interpretation does state that, in the rare circumstance in which submitted draft financial statements are not submitted in final form, the work papers should document the reasons. Compiling Specified Elements, Accounts, or Items

Practitioners are frequently asked to report on presentations consisting of specified elements, accounts or items of financial statements (SE, A, or I). This is so regardless of whether the practitioners are associated with the financial statements. The professional literature provides guidance on engagements to issue reports that express assurance on SE, A, or 1. (Figure 2 identifies the relevant pronouncements.) However, the literature is silent on whether a practitioner may issue a report on SE, A, or I that doesn't express any assurance (a compilation report).

Question: Hep & Hep, CPAs, have been asked by Ice Co., a nonpublic client, to a) assist in preparing Ice's schedule of accounts receivable as of December 31, 1990, and b) issue a report on that schedule. The report needn't express any assurance. Hep & Hep didn't report on Ice's 1990 financial statements. What is the lowest level of report that Hep & Hep may issue on the schedule as a result of this engagement? Possible answers:

* No report may be issued;

* A report on the application of agreed upon procedures;

* A review report; or

* A compilation report.

Answer. The answer is that Hep & Hep may issue a compilation report. The AICPA staff, in a draft of a technical practice aid, has indicated that a compilation report would be permitted because the literature does not explicitly prohibit the case of SE, A, or 1. But, the compilation report would not be the same as a SSARS 1 compilation report, which applies to financial statements only.

The AICPA staff, while emphasizing that SSARS 1 was not intended to apply to SE, A, or 1, advises that a practitioner may wish to use the guidance in SSARS 1 to structure an engagement to compile such presentations and to design an appropriate compilation report similar to that for financial statements. Figure 3 compares and contrasts the two compilation reports. The main difference is that a compilation report on SE, A, or I wouldn't refer to standards established by the AICPA. This is so because such standards don't exist for engagements to compile SE, A, or 1. Though standards have not been established for compilations of SE, A, or 1, there is clearly no prohibition of this type of engagement and in practice, this type of engagement is occurring more frequently.

Effect of Unpaid Fees on Engagement

A client may owe fees to a practitioner for professional services rendered in prior years. The impact of those unpaid fees is a serious business consideration for practitioners, but it is an ethical consideration as well, one that could affect the ,type of report that the practitioner may issue.

Question: Able, CPA, the continuing accountant for Baker Co., a nonpublic client, has completed its review of Baker's 1990 financial statements, and Able plans to issue a review report on September 10, 1991. On that date, Able determines that Baker owes Able $1,000, relating to Able's preparation of Baker's 1988 income tax returns. The $1,000 isn't significant to either Able or Baker. Assuming fees remain unpaid, may Able issue a review report on those financial statements on September 10, 1991?

Answer. Asssuming the fees remain unpaid, Able may not issue a review report on September 10, 1991. Able may, however, issue a compilation report that discloses a lack of independence. This answer involves several issues.

Independence. Until recently, independence was not considered impaired when a client owed a practitioner more than the current year's fees for any work the practitioner previously did, because those unpaid amounts were deemed to take on the characteristics of a loan. There was, however, one exception: independence wasn't considered impaired when those unpaid amounts were clearly insignificant to both the client and the practitioner.

Ethics Ruling 52 recently eliminated the one exception. That ruling says that independence is considered impaired if, when the report on the client's current year is issued, any fees remain unpaid for any professional services provided more than one year before the date of the report. Therefore, on September 10, 1991, Able isn't independent with respect to Baker.

Type of Report. The next issue is the type of report Able may issue on that date. SSARS 1, paragraph 38, precludes a practitioner from issuing a review report on the financial statements of a nonpublic company with respect to which the practitioner isn't independent.

However, SSARS 1, paragraph 22, permits a practitioner to issue a compilation report on such financial statements if a) the practitioner has complied with the standards for a compilation engagement and b) the report discloses a lack of independence.

Able may, of course, issue no report at all. But that decision would stem from business, and not necessarily ethical, considerations.

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