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Dec 1993

1993 year-end accounting and auditing update. (includes related article)

by Primoff, Walter M.

    Abstract- About 43% of the 40,000-plus firms enrolled in the quality review program of the AICPA perform only compilation and review engagements. Results of an extensive off-site quality review of these firms shows that 2% operated adversely while 25% conducted significant departures from professional standards. Among these significant departures are deviations from measurement or disclosure standards set in generally accepted accounting principles, and issuance of misleading reviews or compilation reports. It has been found out that these deficiencies are mainly due to inadequate policies and procedures for the review of reports and financial statements, insufficient documentation requirements, unsatisfactory continuing professional education (CPE) and incomplete libraries. These problems can be remedied through the use of practice aids, expansion of CPE requirements and maintenance of adequate library.

The AICPA Quality Review Program has shown that 43% of the over 40,000 firms enrolled perform compilation and review engagements only (no audits). For the last two years these firms have been undergoing their first quality reviews. The reviews have identified common areas for improvement and are the principal focus of this year-end update article. In addition, SSARS No. 7 is effective for compilation and review reports issued on December 15, 1993.

The AICPA quality review program has provided a number of interesting statistics which shed a great deal of light about the kind of work the over 40,000 CPA practice units enrolled in the program are doing. Overall statistics as of July 1993 reveal that:

* Thirty-nine percent of the firms perform audit engagements as well as presumably compilations and reviews;

* Forty-three percent perform compilation and review engagements only (some of these may only perform one or the other service exclusively); and

* The remaining eighteen percent of the firms perform no auditing or accounting engagements (up from 16% in the prior year).

Assuming, as noted above, most firms that do audits also do compilations and reviews, there are approximately 33,000 firms in the quality review program that provide these services.

In addition, SSARS No. 7, Omnibus Statement on Standards for Accounting and Review Services--1992, was issued in late 1992 and is effective for compilation and review reports issued after December 15, 1993.

Accordingly the emphasis for this year's update is on compilation and review reports.

An additional impetus is provided by the results of the first full year of off-site reviews in the quality review program. Off-site reviews, consisting of a report review of selected compilation and review reports, are available to the 17,000 or so firms that perform compilation and review engagements only.

Off-site Quality Review Results

The quality review program was phased in over a period of years starting with larger firms with an auditing practice and working its way towards sole practitioners that do only compilations and reviews. Firms with an auditing practice are subject to an on-site review covering their entire system of quality control. Firms that do only compilations and reviews may have an off-site review of reports and financial statements of selected engagements only. Last year a significant number of off-site reviews were performed.

The results of one state society's statistics for last year disclose some interesting results. For off-site reviews, 2% were adverse and 25% were qualified for significant departures from professional standards. For on-site reviews, 2% were adverse and 16% were qualified for matters related to deficiencies in the firm's system of quality control. It should be noted that the bases for qualification are different for on- site and off-site reviews. For instance, the finding of a significant departure from professional standards in a set of financial statements for an on-site review might not lead to a qualified report. That would be the case if the reviewer considered the departure to be an isolated occurrence and not reflective of a weakness in the firm's system of quality control. On an off-site review, because the report only runs to the reports and financial statements reviewed and not the system of quality control, such a finding would automatically lead to a qualified report. Notwithstanding this, such a high incidence of qualified and adverse reports on off-site reviews indicates a need for greater care in performing compilation and review engagements.

What is a Significant Departure?

The instructions to reviewers contained in the quality review program manual cite two types of findings that are significant departures from professional standards. The first is "a departure from the measurement or disclosure requirements of generally accepted accounting principles or, where applicable, another comprehensive basis of accounting, that significantly affects the user's understanding of the financial information presented and that is not described in the accountant's report." Among the examples given are the use of an inappropriate method of revenue recognition and the failure to disclose significant related- party transactions. The other is "the issuance of a review or compilation report that is misleading in the circumstances." An example is the issuance of a compilation report that does not note that substantially all disclosures have been omitted. This example was found in a large number of off-site reviews.

Other Deficiencies Noted

The following are other findings noted in the quality review program on compilation and review engagements:

* Review reports are not modified with regard to financial statements that omitted substantially all disclosures;

* Compilation reports do not refer to the failure to include a cash- flows statement;

* Reports do not indicate the degree of responsibility for supplementary information;

* Reports on OCBOA financial statements refer to them as conforming with GAAP;

* OCBOA financial statements contain incorrect titles;

* Cash-flows statements are not prepared in accordance with SFAS No. 95;

* Reports do not refer to all periods presented;

* Report wording does not conform to professional standards; and

* Workpapers do not document work performed as required by SSARS.

Cause of Deficiencies

One of the limitations of the off-site review program is that a reviewer has little or no basis for knowing the probable cause of deficiencies found. He or she reviews financial statements off site and only through inquiry and discussion of deficiencies learns of the firm's policies and procedures for reviewing reports and financial statements. In an on-site review, because the emphasis is on procedures, the reviewer can make an assessment of the cause of the deficiency and can recommend specific procedures to prevent recurrence.

Based on experience with onsite reviews, the following procedural deficiencies are frequent causes of engagement findings of the type noted above for off-site reviews.

Inadequate Review. The firm does not have adequate policies and procedures for reviewing reports and financial statements. There are no requirements for the use of financial-statement checklists or for a second review by a person having no involvement with the engagement. As a result, it is easy for the report and statements to be read by the practitioner in a cursory manner after preparation. This deficiency is by no means limited to compilations and reviews and is quite common even for quality reviews involving audits. The incidence is higher for smaller practice units that limit their practices to accounting engagements.

Inadequate Documentation Requirements. SSARS does not specify the form or content of the working papers an accountant should prepare in connection with a review engagement and is silent regarding the working papers, if any, that would be prepared in a compilation engagement. While it doesn't specify the form or content, SSARS requires for review engagements that working papers describe a) the matters covered in the accountant's inquiry and analytical procedures and b) unusual matters that the accountant considered during the performance of the review, including theft disposition. Many firms do not have policies and procedures for meeting these minimum documentation requirements. As a result, the working papers of many review engagements for those firms do not comply with professional standards.

Inadequate CPE. Many firms only do a limited number of reviews and compilations. Their practices are essentially tax practices, and the financial statements they issue are often at the request of tax clients. Most, if not all of the CPE taken by individuals in the firm are taken in tax. This is particularly true in New York State, since yearly CPE requirements may be met by taking 24 hours rather than 40 hours by concentrating either in accounting, auditing, or tax. Many practitioners whose practice is primarily in the tax area take 24 hours in tax CPE to meet their state licensing requirements. Additional hours to meet the AICPA 40 hours might be taken in management-type courses that meet AICPA requirements but not those of the state. As a result, they may not be up to date in accounting matters. Even where a firm does have adequate checklists, this lack of up-to-date knowledge may lead to improper completion because of a misunderstanding of the meaning of items on the checklists.

Inadequate Libraries. For the same reason--concentration on tax--many firms do not have adequate libraries to support an accounting practice. In addition to not having basic FASB and AICPA materials, some firms do not have the current audit guides for the industries in which their clients operate. As a result, they are not in a position to research problems that arise in theft accounting practice and don't know where to go to find the solution.

Corrective Measures

Use Practice Aids. There is an abundant number of checklists and standardized review materials available from third-party vendors such as Practitioners Publishing Company and the AICPA for use in an accountIng and auditing practice. For a relatively modest cost these materials can significantly enhance the quality of the work product. For compilations and reviews, the number of checklists should be less than for audits. A financial statement and report checklist is the mainstay for a review and compilation practice. Work programs are also available to guide individuals in performing and documenting the procedures required by standards. It makes sense to obtain checklists and work guides from the same source to ensure all matters are covered in an efficient manner. They should be updated annually to make sure that new pronouncements are given proper consideration. The accompanying sidebar provides some additional guidance in the use of these practice aids.


Expand CPE Requirements. Many firms have CPE policies merely requiring individuals to meet state licensing requirements. However, if a firm has an accounting practice, it should require individuals involved in that aspect of practice to have a minimum number of hours each year in accounting matters. This should be a stated policy and monitored each year as part of the inspection process.

Maintain Adequate Library. Firms should establish a library containing an appropriate level of accounting literature for their practice. This month's accounting column contains guidance on the contents of an adequate accounting library, explains the literature, and provides advice on how to keep it up to date. Guidance on how to seek advice in researching and resolving accounting issues is also provided.


Omnibus Statement on Standards for Accounting and Review Services-1992 is effective for periods ending after December 15, 1993. Here are the highlights of the changes set forth in this statement.

Report Language. Both compilation and review report language was modified. The principal modification is to state in the accountant's report that the work performed, i.e., review or compilation, was in accordance with SSARS. Before this modification, the reports referred to standards established by the AICPA and made no mention of SSARS.

Management Representation Letters. A written representation from members of management of the client to confirm the oral representations made concerning a review engagement is now required. The letter "normally" would be signed by the chief executive officer and the chief financial officer. Previously SSARS used language that would have had the accountant give consideration to obtaining such a letter for review engagements.

Errors, Irregularities, or Illegal Acts. SSARS states that the "accountant should establish an understanding with the entity, preferably in writing, regarding the services to performed. The understanding should include a description of the nature and limitations of the services to be performed and a description of the report the accountant expects to render." SSARS goes on to say that the understanding should state the accountants responsibility for reporting errors, irregularities, and illegal acts that come to his or her attention. Prior to SSARS No. 7, the accountant was directed to inform the entity of any such matters that came to his or her attention. The new guidance provides some thresholds and states the accountant does not have to communicate to clients errors that are not material and irregularities or illegal acts that are clearly inconsequential.

Going Concern. SAS No. 59, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern, requires that the auditor include an explanatory paragraph in his or her report if the auditor concludes there is substantial doubt about the entity's ability to continue as a going concern and the disclosures about the going concern uncertainty in the financial statements and notes thereto are adequate. If the disclosures are not adequate, the statements are not in conformity with GAAP and a qualified or adverse opinion would be appropriate. SSARS No. 7 refers the accountant to SAS 59 in evaluating the adequacy of disclosures about going concern and states that accountants normally do not have to modify reports for going concern uncertainties if the financials appropriately disclose such matters. However, the accountant is not precluded from including an emphasis paragraph in his or her report about the going concern uncertainty.

GAAP Hierarchy. Auditing literature hierarchy also applies to compiled and reviewed financial statements.

Typing and Reproduction. The prohibition against typing or reproducing financial statements as an accommodation to clients has been removed as long as the accountant does not "submit" the financials. SSARS No. 7 goes on to define what constitutes a submission of financial statements- -statements the accountant has generated or materially modified--and then goes on to say what is not a submission.

Change From a Review to Compilation. Prior guidance on a request by a client to change from an audit to a review or compilation is also applicable to a change from a review to a compilation. However, if for a review engagement, the accountant is unable to obtain a management letter, not only would the accountant be precluded from issuing a review report, but also he or she would ordinarily be precluded from issuing a compilation report.

Communication Between Successor and Predecessor Accountant. The successor accountant is now required to request the client communicate information to the predecessor accountant where the successor becomes aware of information that leads him or her to believe the financial statements reported on by predecessor may require revision.

Review of a Public Company. When a public entity does not have its annual financial statements audited, an accountant may review the entity's annual or interim financial statements.

Professional Standards Watch

Presented as a sidebar on page 24 is the yearly update of pronouncements issued since last year and those issued in prior years that have effective dates in 1993. Practitioners should also look for the 1993 Audit Risk Alert and 1993 Compilation and Review Alert published by the AICPA. In addition to these general alerts, many of the industry audit guides have yearly audit risk alerts. Alerts have been prepared in association with the following guides:

* Agribusinesses

* Airlines

* Casinos

* Common Interest Realty Associations

* Construction Contractors

* Credit Unions

* Depository Institutions

* Federal Government Contractors

* Health Care

* Investment Companies

* Not-for-Profit

* Oil and Gas Producers

* Securities

* State and Local Government

Staying Current is Essential

At the risk of oversimplification, many of the deficiencies noted in reports and financial statements issued by firms whose practice is limited to compilation and review engagements seem to arise from the failure of the practitioner to keep current. Examples are failure to reflect changes to report language set forth in SSARS and failure to recognize recent accounting pronouncements (e.g., cash flows statement versus changes in financial position and disclosures of concentrations of credit risk).

The same practitioner who fails to recognize the changing world of professional standards would never dream of not keeping current on tax matters. Imagine a CPA filing a 1993 tax return following the 1954 IRC. Obviously, the practitioner who fails to keep current doesn't think it matters. He or she feels the client doesn't care, nor do the other users of the accountant's report and the accompanying financial statements.

Professional standards are dynamic and responsive to the changing needs of users of financial information. No one is served by CPAs and accountants who fail to keep up and respond to changes occurring in professional standards.


Statements on Standards for Accounting and Review Services (SSARS) contain no specific documentation requirements for compilation engagements and only minimal documentation requirements for review engagements. At least a basic level of documentation is generally recommended, however, so that the firm can provide evidence that it has complied with the applicable standards. As a general rule, good practice suggests that workpapers for compilation and review engagements include at least the following:

* An engagement letter.

* A compilation or review procedures checklist. (The materials provided by some vendors include summarized checklists for interim engagements).

* An inquiry and analytical procedures program (needed only in review engagements).

* Documentation of unusual matters encountered and their resolution.

* A disclosure checklist (when the financial statements include disclosures).

* A reviewer's checklist.

* A client representation letter (required only in review engagements).

Practitioners should consider use of other optional workpapers such as:

* A new client acceptance form documenting the firm's basis for accepting the client.

* A client information form documenting the CPA's knowledge of the client's business and industry.

While firms may develop their own systems of forms and checklists, many look to outside vendors instead. Providers of quality control (QC) materials include the following:

* Practitioners Publishing Company - Fort Worth, Texas (800) 323-8724

* Grant Thornton - Chicago, Illinois (312) 616-7058

* McGladrey & Pullen - Minneapolis, Minnesota (612) 332-4300

* The American institute of Certified Public Accountants - New York, New York (800) 862-4272

* Harcourt Brace Professional Publishing - Orlando, Florida (800) 831- 7799

Whether the firm develops its own QC materials or purchases those of an outside vendor, certain basics should be considered:

* The QC system should be tailored to the firm's practice. For example, if a small firm does not have the many levels of staff found in larger firms, an elaborate review and supervision system is both unnecessary and inefficient.

* The QC system should cover all types of services provided by the firm (e.g., compilation, review, audit, forecast, and projection engagements). The system should also cover engagements to compile or review OCBOA financial statements as well as GAAP statements.

* The QC system should interface with all of the accounting and auditing manuals used by the firm. For that reason, it is often more efficient for the firm to purchase QC materials from a vendor that provides a complete QC system rather than only selected products.

* If QC materials purchased from a vendor have been peer reviewed, the firm's peer or quality reviewer need not evaluate the adequacy of the materials. That can reduce both the time and cost of the firm's review.

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