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June 1992

Compilation and review: the standards, they are a changing. (proposed Statement on Standards for Accounting and Review Services)

by Rubin, Steven

    Abstract- The report and work program for CPAs' compilation and review (C/R) engagements is to be revised by the American Institute of Certified Public Accountants under a proposed Statement on Standards for Accounting and Review Services (SSARS). The Exposure Draft of the SSARS was released on Mar 18, 1992. The proposal is expected to be particularly significant to C/Rs conducted on financial statements of nonpublic companies. Among the aspects of C/R to undergo revision are review and compilation reports, engagement letters, letters for client representation in reviews, the relay of information to clients concerning irregularities and corrupt practices, the application of Good Accounting and Auditing Practices to C/Rs, the printing and recopying of financial statements, and outgoing CPA-incoming CPA communications.

For the first time in about seven years, the AICPA Accounting and Review Services Committee (ARSC) has issued an Exposure Draft (ED) of a proposed Statement on Standards for Accounting and Review Services (SSARS). And this one is a biggy ! Released on March 18, 1992, the ED contains many proposed amendments to the existing SSARS literature that- -beginning this year--would have a major impact on compilations and reviews (C/ Rs) performed on nonpublic companies' financial statements (financials).


The proposed amendments may be helpfully sorted into two categories: 1) those that would affect substantially all C/Rs and 2) those that would affect many C/Rs, but on an engagement-by- engagement basis.

Category one amendments would affect these C/R areas:

* Review reports;

* Compilation reports;

* Client representation letters for reviews;

* Communication of information about errors, irregularities, or illegal acts to clients; and

* Engagement letters.

Category two amendments would affect these C/R areas:

* Client's ability to continue as a going concern;

* Application of GAAP to C/Rs;

* Typing or reproduction of financials;

* Change in engagement from a review to a compilation; and

* Communication between successor and predecessor CPAs.

Figure 1 presents a summary of the proposed amendments, including the impact that the amendments would have on the affected C/R areas.


Though the proposed amendments are just that--proposed--it would be a grave mistake to ignore their potential impact, because the proposed amendments are so imminent and many are so sweeping. True, there is no guarantee that they will be adopted by ARSC exactly as exposed. No one will know the outcome until ARSC completes its due process and deliberations, including its consideration of letters received from all interested parties during the ED's comment period, which ends June 30, 1992.

Sharp CPAs, however, will want to start thinking now about how these proposed amendments would impact their practices, to enable them to maintain their competitive edge. Both clients and users will most certainly want to know how the proposed amendments affect them as well. This article is intended to help do just that. As an added benefit, this article gives the complete citations--keyed to AICPA Professional Standards Volumes 1 and 2--for the existing standards to which the proposed amendments relate. The purpose in doing so is not to be pedantic, but to help those interested to easily locate and consult those standards if they choose to.


Certain Language Revised Most pervasive among the proposed amendments is one that would revise certain language in the first paragraph of every SSARS review report and, as discussed below, every compilation report.

The current SSARS review report indicates that the review was performed "in accordance with standards established by the American Institute of Certified Public Accountants." That language would be revised to indicate that the review was performed "in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants." Figure 2 presents a sample SSARS review report that shows the proposed revision.

Why the Revision? The revision was deemed necessary due to apparent confusion between 1 ) a SSARS review report and 2) a report on a limited review performed under AU Sec. 722, Review of or Performing Procedures on Interim Financial Information, on interim financial information of a publicly-held company whose annual financials are audited. Figure 2 also presents a sample report on the latter type of review. And, as can been seen by comparing that report with the SSARS review report the two reports are indeed very similar.

That similarity has seemingly led some SSARS review report users to incorrectly conclude, in some cases, that SSARS reviews had been performed under the requirements of AU Sec. 722, which are more stringent than those for a SSARS review. An AU Sec. 722 review involves, for instance, the CPA's performing certain procedures relating to a client's internal control structure, while a SSARS review does not.

To avoid future confusion, the practical solution was for ARSC to revise certain language in SSARS review reports, to better differentiate such reports from AU Sec. 722 review reports.

SSARS Reviews for Publicly-Held Companies. In a related action, while not directly affecting C/Rs for nonpublic companies, AR Sec. 100.01, Footnote 1, Compilation and Review of Financial Statements, would be amended to recognize that AU Sec. 504.05, Footnote 4, Association with Financial Statements, permits CPAs to perform SSARS reviews on interim or annual financials of publicly-held companies whose annual financials are not audited. If their annual financials are audited, however, only Sec. AU 722 reviews may be performed on their interims, as discussed previously.

Compilation Reports

Language Revised Here, Too. Just as the first paragraph of every SSARS review report would be revised, as discussed, so would the first paragraph of every compilation report. Figure 2 presents a sample compilation report that shows the proposed revision.

Why the Revision Here, Too? The revision in the compilation report is more cosmetic than substantive. It is unlikely that any users would confuse compilation reports with reports on limited reviews of publicly- held companies' interim financial information. Nevertheless, the language of every compilation report also would be revised, so that the first paragraph of all C/R reports would continue to track each other to the furthest extent possible.

Client Representation Letters for Reviews

New Requirement. Obtaining client representation letters (rep letters) in C/R engagements, now an optional procedure under AR Sec. 100.31, would become a required procedure in every review engagement. Consequently, a SSARS review engagement would be considered incomplete-- and no type of SSARS review or compilation report could be issued--if a client refuses to sign a rep letter. Figure 3 presents a sample rep letter for a SSARS review engagement.

Such a letter would be obtained from--and signed by--the members of a SSARS review client's management who the CPA believes are responsible for, and knowledgeable about, matters covered in the rep letter. Normally the signators are the client's chief executive officer and chief financial officer. In theory, rep letters should be drafted and prepared by the clients since, after all, the letters consist of the clients' representations to their CPAs. As a practical matter, however, rep letters---or at least drafts of rep letters-ordinarily are prepared by the CPAs for client signature.

Why the New Requirement? The new requirement was deemed necessary because it was generally felt that a SSARS review client ought to acknowledge in writing, at an engagement's end, that 1) management is responsible for the financial statements' fair presentation, in conformity with GAAP, 2) all information included in the financials is the client's representations, and 3) all such representations, including representations given to the CPA orally, are true to the best of management's knowledge and belief.

Undoubtedly, some SSARS review clients will balk at this new requirement. Invariably, some of them--particularly clients served for many years--will raise the "what's-the-matter-don't-you-trust-me- anymore" argument or the "how-much-extra-is-this-going-to-cost-me" argument. In anticipation of these and other negative reactions by SSARS review clients, the AICPA is expected to develop materials that will explain the why's and wherefore's of the new requirement.

Interestingly, it was not generally felt that rep letters were needed in compilation engagements. So, for compilation engagements, obtaining rep letters is still a matter of choice for CPAs.

Communicating About Errors, Irregularities and Illegal Acts

A Softening. AR Sec. 100.08, as currently written: 1) acknowledges that C/Rs cannot be relied on to disclose errors, irregularities or illegal acts, because C/R engagements are not specifically designed for that purpose, and 2) requires CPAs to inform their clients of any such matters that come to the CPAs' attention during C/Rs.

That requirement would be somewhat softened, however, in that CPAs would not have to inform clients of such matters that are "clearly inconsequential."

Why the Softening? The softening was deemed necessary to make the requirement for communication of such matters in C/Rs no stricter than the requirement in audit engagements. In audits, "clearly inconsequential" errors, irregularities, or illegal acts do not have to be communicated to clients according to AU Secs. 316.28, The Auditor's Responsibility to Detect and Report Errors and Irregularities, and 317.17, Illegal Acts by Clients. Without the softening, CPAs could, conceivably, find themselves having to communicate to C/R clients matters that would not have to be communicated to audit clients.

Curiously, the term "clearly inconsequential" is not defined in either the auditing literature or the ED. Whether the term will be defined down the road is uncertain.

Engagement Letters

Use of engagement letters, while presently not required in C/Rs is, nevertheless, the SSARS-preferred manner of establishing with clients a required understanding about the services to be performed, the nature and limitations of those services, and the type of C/R report to be issued (AR Sec. 100.08).

Whatever amendments ARSC ultimately makes to SSARS as a result of the exposure process will obviously affect that understanding, and every C/R engagement letter that is used would have to be revised for 1992 and thereafter to reflect those amendments. Figure 4 presents relevant parts of sample C/R engagement letters.


Client's Ability to Continue as a Going Concern

New Guidance. Currently, CPAs normally do not have to modify C/R reports for uncertainties, as long as the financials appropriately disclose such matters (AR Sec. 100.40, Footnote 14).

However, Footnote 14 would be amended to 1) clarify that the same reporting principles hold true for an uncertainty about a client's ability to continue as a going concern and 2) steer CPAs to AU Secs. 341.10 and .11, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, for guidance on evaluating the adequacy of going-concern disclosures.

Why the New Guidance? The new guidance was deemed necessary to clarify the CPA's reporting responsibilities when the CPA decides that there is an uncertain about a client's ability to continue as a going concern and the type of information that should be disclosed about such a situation.

CPAs should understand that this amendment would not require them to apply any new procedures for evaluating whether there is an uncertainty about the C/R client's ability to continue as a going concern. Rather, AU Secs. 341.10 and .11 would apply to C/Rs only when the CPA's ordinary C/R procedures lead the CPA to determine that there is an uncertainty about the client's ability to continue as a going concern.

What AU 341 Says. AU Sec. 341.10 identifies the following information that might need to be disclosed for going concern situations:

* Pertinent conditions and events giving rise to the going-concern situations;

* The possible effects of such conditions and events;

* Management's evaluation of the significance of those conditions and events and any mitigating factors;

* Possible discontinuance of operations;

* Management's plans, including relevant prospective financial information; and

* Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

In addition, AU Sec. 341.11, identifies the following information that should be considered for disclosure when a goingconcern situation has been alleviated:

* Principal conditions and events that initially raised the uncertainty;

* Possible effects of such conditions and events; and

* Any mitigating factors, including management's plans. GAAP Applies to C/Rs

A Clarification. A footnote would be inserted in AR Sec. 100.04 to clarify that the definition of generally accepted accounting principles (GAAP) and the hierarchy of GAAP set forth in AU Sec. 411, The Meaning of '"Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, also apply to compiled and reviewed GAAP financials.

Why the Clarification? The clarification was deemed necessary to stem a mistaken notion. As ironic as it seems, some preparers, users, and even CPAs in practice apparently have the erroneous belief that 1) GAAP applies to audited GAAP financials, but not to compiled or reviewed GAAP financials, and 2) sources of GAAP beyond the so-called "authoritative accounting standards" (discussed below) have to be considered in audits of GAAP financials but not in C/Rs of GAAP financials.

Though GAAP is discussed in AU Sec. 411 in terms of the "auditor's consideration," the SSARS amendment would, in effect, make clear that GAAP is GAAP whether the CPA is expressing reasonable assurance (in an audit report), limited assurance (in a review report), or no assurance (in a compilation report) on financials prepared on a GAAP basis.

What AU Sec.. 411 Says. According to AU Sec. 411.02, GAAP "encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time."

Much of the remainder of AU Sec. 411 identifies sources of GAAP to be considered when a particular transaction's accounting treatment is not specified in the so-called "authoritative accounting standards" which, for non-governmental entities, consists of the following:

* Statements of Financial Accounting Standards and Interpretations of the FAS B;

* Opinions of the Accounting Principles Board; and

* Accounting Research Bulletins of the Committee on Accounting Procedure.

Some of the other sources identified in Sec. 411 include:

* FASB Technical Bulletins;

* AiCPA audit and accounting guides and statements of position;

* Minutes of the FASB's Emerging Issues Task Force; and

* Accounting handbooks.

To Illustrate. A CPA performing a SSARS review on an airline's financials should consider the accounting principles set forth in the AiCPA audit guide for airlines in determining that there are no material modifications that should be made to the airline's financials for the financials to be in conformity with GAAP.

Similarly, a CPA compiling the financials of a retailer that sells extended warranty.' or product maintenance contracts should consult FASB Technical Bulletin 90-1, on accounting for such contracts, when questions arise about the appropriate GAAP accounting for such contracts.

OCBOA Disclosures. Of course, not all financials are prepared on a GAAP basis; some are prepared on a comprehensive basis of accounting other than GAAP (OCBOA), for example, the income tax basis. While CPA's generally understand that GAAP recognition and measurement principles do not apply to OCBOA financials, some CPA's have raised questions about the types of disclosures that should be made in compiled or reviewed OCBOA financials.

A new footnote reference, to be inserted in AR Sec. 100.04, would steer CPAs to AU Secs. 623.09 and .10, Special Reports, for guidance on evaluating the adequacy of disclosures in OCBOA financials. That guidance holds that disclosures about items in, and matters relating to, OCBOA financials should parallel disclosures for comparable items in, and matters relating to, GAAP financials. Examples are disclosure about depreciation methods, interest expense on and maturities of long-term debt, commitments, related party transactions, and subsequent events.

Typing or Reproduction of Financials

A Prohibition Removed. Right now, the last sentence of AR Sec. 100.07 prohibits CPAs from merely typing or reproducing financials as an accommodation to clients. That prohibition, however, would be removed.

Why Remove the Prohibition? The removal of the prohibition was deemed necessary because the prohibition conflicts with the guidance in AR Secs. 9100.58 through .60 (a SSARS interpretation issued in September 1990), which 1) indicates that a CPA does not have to comply with SSARS unless the CPA has "submitted" financials and 2) defines submission as presenting to clients or others financials that the CPA has:

* Generated either manually or through the use of computer software; or

* Modified by materially changing account classifications, amounts, or disclosures directly on client-prepared financials.

Therefore, as long as a CPA does not do either of the above, any other services that the CPA performs, including merely typing or reproducing financials, would not be prohibited under SSARS.

Incidentally, AR Sec. 9100.60 identifies the following services, among others, that CPAs can perform and still not be considered as having submitted financials:

* Preparing journal entries;

* Providing clients with financial statement formats without dollar amounts (a pro forma) that clients can use to prepare their financials;

* Reading client-prepared financials; and

* Proposing correcting journal entries or disclosures.

Change in Engagement from a Review to a Compilation

An Amendment. As currently written, AR Secs. 100.44 through .49 discuss CPAs' responsibilities when CPAs have been engaged to perform an audit but are requested by the client to change to either a review or a compilation before the audit report is issued (commonly called a step- down or drop-down). Those sections, however, overlook another similar situation: When CPAs have been engaged to perform a review but are requested to change to a compilation before the review report is issued.

AR Secs. 100.44 through .49 would be amended to also apply to a drop- down from a review to a compilation.

Why the Amendment? The amendment was deemed necessary to narrow diversity in practice. Some CPAs do not apply the provisions of AR Secs. 100.44 to .49 in a drop-down from a review to a compilation because there is no requirement to do so. Other CPAs, however, apply those provisions because those CPAs believe that those provisions represent the best guidance available. Apparently, ARSC had intended that the provisions ofAR Secs. 100.44 through .49 should apply to all drop-downs all along.

What AR Secs 100.44 through .49 Say. The provisions of AR Secs. 100.44 through .49 are summarized as follows: 1. A request for a drop-down may result from:

* A change in circumstances affecting the client's requirement for a particular type of engagement. A change in circumstances ordinarily is considered to be a reasonable basis for a client's requesting a drop- down;

* A misunderstanding about the nature of an audit, review or compilation; or

* A restriction on the original engagement's scope, whether imposed by the client or caused by other circumstances. In this case, CPAs should evaluate the possibility that information affected by the scope restriction may be incorrect, incomplete or otherwise unsatisfactory, and therefore affect the dropped-down engagement as well. 2. CPAs should consider the following information before agreeing to a client's request for a drop-down:

* Reason given for the request, particularly the implications of a restriction on the original engagement's scope. A CPA prohibited by the client from corresponding with the client's legal counsel ordinarily would be precluded from issuing any C/R report, and a CPA whose review client has refused to sign a representation letter would always be precluded from issuing any C/R report; and

* Amount of additional effort and cost required to complete the original engagement. CPAs should carefully consider a drop-down's propriety if the original engagement's procedures are substantially complete or the cost to complete such procedures is insignificant.

3. CPAs who conclude, based on professional judgment, that there is reasonable justification to agree to a dropdown should:

* Comply with the standards applicable to the new engagement; and

* Issue an appropriate C/R report, but should not refer to the original engagement, any procedures performed, or scope limitations that resulted in the drop-down.

Communications Between Predecessor and Successor CPAS

A Modification. During a C/R engagement, a CPA might become aware of information that leads the CPA to believe that financials on which a predecessor CPA reported might require revision. In such a case, AR Sec. 400.10, Communications Between Predecessor and Successor Accountants, requires the successor to request the client to communicate this information to the predecessor.

AR Sec. 400.01 (the introductory paragraph of that section) would be modified to include a reference to the AR Sec. 400.10 requirement.

Why the Modification? The modification was deemed necessary because the requirement, though having existed since 1981, apparently has gone unnoticed by some successors. That oversight probably was due to the requirement's unfortunate location, the tenth and final paragraph of AR Sec. 400.

A Deletion. In a related amendment, AR Sec. 400.03, Footnote 2, would be deleted because that footnote incorrectly implies that AU Sec. 315, Communications Between Predecessor and Successor Auditors, applies when there has been--or there is expected to be--a change in service from a C/R to an audit or from an audit to a C/R. In fact, AU Sec. 315 was intended to apply only to changes in auditors.

DON'T DELAY, START THINKING TODAY ! As stated at the outset, many of the proposed amendments would affect substantially all C/Rs beginning this year. Sharp CPAs, who start thinking now about how these proposed amendments would impact their practices, will clearly have the competitive edge over CPAs who procrastinate, and clients and users will want to determine now how the proposed amendments affect them, to avoid year-end surprises.

Steven Rubin, CPA, is Director of Quality Control at Weissbarth. AIrman & Michaelson, New York, NY; chairman of the NYSSCPA Accounting and Review Services Committee; and a frequent writer and lecturer on accounting and auditing matters.

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