Case studies in compilation and review. (Auditing)by Carmichael, Douglas R.
The full set of 15 cases (which are short and to the point) are available upon request from The CPA Journal to be reproduced, shared, and discussed (primarily among practitioners) as a part of either formal programs of professional development or informal group study. Credit grantors, clients and other report users (as well as college students) may find the cases helpful in understanding the issues faced by practitioners.
Case A: Client Representation Letters
In connection with a review of Wee Co.'s financial statements, Yet & Yet, CPAs, request Wee's chief executive and chief financial officers to sign a representation letter. The two officers refuse.
Question. Under the circumstances, which of the following types of reports may Yet & Yet issue on Wee Co.'s financial statements?
a. standard review report b. modified review report c. standard compilation report d. no type of report
Suggested Solution. Under the circumstances, Yet & Yet would be unable to issue any type of report on Wee's financial statements, for the following reasons:
1. AR Sec. 100.28 makes the obtaining of a representation letter--once an optional procedure--a required procedure for a review to be considered complete and, therefore, for a review report to be issued, and
2. AR Sec. 100.47 states that a CPA whose review client refuses to sign a client representation letter--
a. may not issue a review report and b. ordinarily may not issue a compilation report.
Case B: Draft Financial Statements
In an attempt to save on its accounting fees, Moore Co. has asked Lee & Lee, CPAs, to prepare (as an end product for Moore's internal use only) "draft" financial statements without any accompanying report. If Lee & Lee accept this engagement, they fully intend to conspicuously mark the draft financial statements: "Draft--For Discussion Purposes Only."
Question. May Lee & Lee accept this engagement?
Suggested Solution. Lee & Lee may not accept this engagement because AR Secs. 9100.61-.62, prohibit CPAs from submitting to clients or others draft financial statements unless the CPAs--
1. intend to submit financial statements in final form accompanied by an appropriate compilation or review report, and
2. conspicuously mark the draft financial statements as such.
In this case, condition 2 would be met, but condition 1 would not be met.
Case C: Environmental Treatment Costs
In compiling Good Co.'s financial statements for calendar 1992, Hep & Hep, CPAs, become aware of the following matters:
1. gasoline tanks owned by Good, and located directly under its property, leaked during 1992,
2. the leakage caused contamination to Good's property,
3. the property was not, and is not, being held for sale, and
4. in connection with the leakage, Good incurred $310,000 in costs, as follows:
$100,000 to refine the soil 200,000 to encase tanks to prevent future leakage 10,000 fine to a regulatory agency
Questions. 1. How should each of those costs be accounted for (capitalized versus charged to expense) in Good's financial statements?
2. Would it matter whether the most appropriate guidance for answering question 1 was contained in a consensus of the FASB's Emerging Issues Task Force, rather than in a FASB Statement?
Suggested Solutions. 1. The costs should be accounted for in Good's financial statements as follows, based on the EITF consensus discussed below:
$100,000 to refine the soft should be charged to expense 200,000 to encase tanks to prevent future leakage may be capitalized 10,000 fine to a regulatory agency should be charged to expense
The consensus on EITF Issue No. 90-8 states that environmental contamination treatment costs--
a. should generally be charged to expense as incurred, but
b. may be capitalized if any one of the following criteria is met:
a. The costs extend the life, increase the capacity, or improve the safety or efficiency of the client's property. (For purposes of this criterion, the property's condition after the costs are incurred must be improved as compared with the property's condition when it was originally constructed or acquired, if later.)
b. The costs mitigate or prevent environmental contamination yet to occur and that otherwise might result from future operations or activities and the property's condition after the costs are incurred are improved as compared with the property's condition when it was originally constructed or acquired, if later.
c. The costs are incurred in preparing the property for sale.
2. No. It does not matter that the most appropriate guidance for answering question 1 is contained in a consensus of the FASB Emerging Issues Task Force, rather than in an FASB Statement, for the following reasons:
a. AR Sec. 100.04, footnote 3, states the definition of GAAP and the hierarchy of established accounting principles presented in AU Sec. 411 apply to compilations and reviews, as well as audits, and
b. AU Sec. 411 identifies consensuses of the EITF as a source of established accounting principles that CPAs should consider in determining whether financial statements are presented in conformity with GAAP.
Case D: Going-Concern Uncertainties
In reviewing Bear Co.'s financial statements, Ace & Ace, CPAs, become aware of uncertainties about Bear's ability to continue as a going concern. Ace & Ace believe these matters are important enough for Bear to disclose in the notes to its financial statements.
Questions. 1. What are Ace & Ace's reporting responsibilities if Bear either a) discloses the significant uncertainties? or b) refuses to disclose the significant uncertainties?
2. Would the answer to question 1 remain the same if Ace & Ace had been engaged to perform a compilation, rather than a review?
3. Would the answer to question 1 remain the same if Ace & Ace had been engaged to perform a compilation of financial statements that omitted substantially all disclosures, rather than a review or compilation?
Suggested Solutions. 1. Ace & Ace's reporting responsibilities for both parts of this question are set forth in AR Sec. 100.40, footnote 18. That footnote states the following:
a. An uncertainty, including an uncertainty about an entity's ability to continue as a going concern, normally would not cause a standard report to be modified, as long as the financial statements appropriately disclose such matters, and
b. CPAs should refer to the guidance in AU Sec. 341.10-.11 in evaluating the adequacy of disclosure of going-concern uncertainties.
As indicated in AU Sec. 341.11, some of the information that might be disclosed include the following:
* 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);
* Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.
* In addition, as to the second part of this question, if Bear refuses to disclose the significant uncertainties, Ace & Ace could decide to issue no report and to withdraw from the engagement, as discussed in AR Sec. 100.41.
2. Yes. The answer to question 1 would remain the same if Ace & Ace had been engaged to perform a compilation, rather than a review, because AR Secs. 100.40.41 apply to compilations, as well as reviews.
3. The answer to question 1 could change if Ace & Ace had been engaged to perform a compilation of financial statements that omitted substantially all disclosures, rather than a review or compilation. For instance, in its Compilation and Review Alert-1992, the AICPA staff, citing AR Sec. 9100.11, states that CPAs need not "feel uneasy" when financial statements that omit substantially all disclosures also omit disclosure about going-concern matters because the language in the compilation report accompanying such financial statements adequately warns users of their limitations. In contrast, the authors of this case believe CPAs should feel uneasy about the omission of a disclosure about going-concern matters for the following reasons:
a. A fundamental concept underlying financial reporting is that, in the absence of disclosure to the contrary, a user has the right to assume that there are no known going-concern problems, and
b. The omission of disclosure about certain known going-concern problems could be viewed as an attempt to mislead, a situation to be avoided according to AR Sec. 100.19
Note: The CPA Journal is interested in learning of practice issues and problems in the compilation and review area. Please write the Managing Editor describing the problem encountered and your solution. Such practice issues may become the subject of case studies for future publication.
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