Category Archives for "Preparation, Compilation & Review"

Perform compilation engagement
Jan 08

AR-C 80: How to Perform Compilation Engagements

By Charles Hall | Preparation, Compilation & Review

Knowing how to perform compilation engagements is important for CPAs. Below I provide an overview of the salient points of AR-C 80, Compilation Engagements. I also provide a sample compilation report.

Compilation Guidance

The guidance for compilations is located in AR-C 80, Compilation Engagements.

Applicability of AR-C 80

The accountant should perform a compilation engagement when he is engaged to do so.

A compilation engagement letter should be prepared and signed by the accountant or the accountant’s firm and management or those charged with governance. An engagement letter to only prepare financial statements is not a trigger for the performance of a compilation engagement.

Previously (in the SSARS 19 days), the preparation and submission of financial statements to a client triggered the performance of a compilation engagement. Now, compilation engagement guidance is applicable only when the accountant is engaged to (requested to) perform a compilation.

Objectives

The objectives of the accountant in a compilation engagement are to:

  • Assist management in the presentation of financial statements
  • Report on the financial statements in accordance with the compilation engagement section of the SSARSs

Reports

In a compilation engagement, a compilation report is always required. A compilation engagement is an attest, nonassurance service. Nonassurance means the accountant is not required to verify the accuracy or completeness of the information provided by management or otherwise gather evidence to express an opinion or a conclusion on the financial statements.

Compilation reports look distinctly different from audit or review reports (which include paragraph titles such as Management Responsibility and Accountant’s Responsibility). The standard compilation report is one paragraph with no paragraph titles. (See the Sample Compilation Report section below.)

Compilation Financial Statements

The accountant prepares financial statements as directed by management or those charged with governance. The financials should be prepared using an acceptable reporting framework including any of the following:

  • Cash basis
  • Tax basis
  • Regulatory basis
  • Contractual basis
  • Other basis (as long as the basis uses reasonable, logical criteria that are applied to all material items)
  • Generally accepted accounting principles (GAAP)

All of the above bases of accounting, with the exception of GAAP, are referred to as special purpose frameworks. The description of special purpose frameworks may be included in:

  • The financial statement titles
  • The notes to the financial statements, or
  • Otherwise on the face of the financial statements

Management specifies the financial statements to be prepared. The most common financial statements created include:

  • Balance sheet
  • Income statement
  • Cash flow statement

The accountant can, if directed by management, create and issue just one financial statement (e.g., income statement).

Some bases of accounting (e.g., tax-basis) do not require the issuance of a cash flow statement.

The financial statements can be for an annual period or for a shorter or longer period. So, financial statements can be for a fiscal year, quarterly, or monthly, for example.

Should a reference to the compilation report be included at the bottom of each financial statement page (including supplementary information)? While not required, it is acceptable to add a reference such as:

  • See Accountant’s Report
  • See Accountant’s Compilation Report, or
  • See Independent Accountant’s Compilation Report

Why add such references? The accountant’s report may become detached from the financial statements. The reference notifies the reader of the financial statement that a compilation report exists.

Compilation Documentation Requirements

The accountant should prepare and retain the following documentation:

  • The engagement letter
  • The financial statements, and
  • The accountant’s compilation report

The accountant should document any significant consultations or judgments.

If the accountant departs from a presumptively mandatory requirement, it is necessary to document the justification for the departure and how the alternative procedures performed are sufficient to achieve the intent of the requirement. (The SSARSs use the word should to indicate a presumptively mandatory requirement.)

Compilation Engagement Letter

compilation engagements

While it is possible for the accountant to perform only a compilation and not prepare the financial statements, most compilation engagement letters will state that the following will be performed by the accountant:

  1. Preparation of the financial statements (a nonattest service)
  2. A compilation service (an attest service)

Since a nonattest service and an attest service are being provided, the accountant will add language to the engagement letter describing the client’s responsibility for the nonattest service.

AICPA independence standards require the accountant to consider whether he is independent when he performs an attest service (e.g., compilation) and a nonattest service (e.g., preparation of financial statements) for the same client. If management does not possess the requisite skill, knowledge, and experience to oversee the preparation of the financial statements and accept responsibility, the accountant may not be independent.

Compilation Procedures

The accountant should:

  • Read the financial statements in light of the accountant’s understanding of the selected financial reporting framework and the significant accounting policies adopted by management
  • Consider whether the financial statements appear appropriate in form and free from obvious material misstatements

Here are examples of inappropriate form and obvious material misstatements:

  • An equity account is shown in the liability section of the balance sheet
  • The balance sheet does not reflect the accrual of receivables though the financial statements were supposedly prepared in accordance with GAAP
  • Total assets as reflected on the balance sheet do not equal the individual items on the statement (an addition error)
  • The financial statements omit a material debt disclosure, though the statements were prepared in accordance with GAAP and substantially all disclosures were to be included

Given that the focus of a compilation is the reading of the financial statements to determine if they are appropriate in form and free from obvious material misstatements, what are some procedures that are not required?

  • Confirmation of cash
  • Testing of subsequent receipts
  • Analytical comparisons with the prior year
  • Substantive analytics
  • Confirmation of debt
  • A search for unrecorded liabilities

Is it permissible to perform audit or review procedures while conducting a compilation engagement? While not required to do so, such procedures are allowed. If you perform audit or review procedures, be careful not to imply to the client or other parties that you are performing a service other than a compilation.

The accountant is not required to perform procedures to ensure the completeness of the client-supplied information, but what if the client provides information that is obviously not complete or contains material errors? If management-supplied information is not complete or appears incorrect, the accountant should request corrections.

Also, the accountant should request corrections if:

  • The financial statements do not appropriately refer to the applicable financial reporting framework
  • Revisions are necessary to comply with the selected reporting framework, or
  • The financial statements are otherwise misleading

If requested or corrected information is not received or if the financial statements are not corrected, the accountant should consider withdrawing from the engagement and may wish to consult with legal counsel.

If the accountant decides not to withdraw and a material departure from the reporting framework exists, he should modify the compilation report to disclose the departure. See the example below in Reporting Known Departures from the Applicable Financial Reporting Framework.

Sample Compilation Report

The following is a sample compilation report:

Management is responsible for the accompanying financial statements of XYZ Company, which comprise the balance sheets as of December 31, 20X2 and 20X1 and the related statements of income, changes in stockholder’s equity, and cash flows for the years then ended, and the related notes to the financial statements in accordance with accounting principles generally accepted in the United States of America. I (We) have performed a compilation engagement in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. I (we) did not audit or review the financial statements nor was (were) I (we) required to perform any procedures to verify the accuracy or completeness of the information provided by management. I (we) do not express an opinion, a conclusion, nor provide any assurance on these financial statements.

[Signature of accounting firm or accountant, as appropriate]

[Accountant’s city and state]

[Report Date]

Minimum Compilation Report Elements

The compilation report should:

  • Include a statement that management (owners) is (are) responsible for the financial statements
  • Identify the financial statements
  • Identify the entity
  • Specify the date or period covered
  • Include a statement that the compilation was performed in accordance with SSARS
  • Include a statement that the accountant did not audit or review the financial statements nor was the accountant required to perform any procedures to verify the accuracy or completeness of the information provided by management, and does not express an opinion, a conclusion, nor provide any assurance on the financial statements
  • Include the signature of the accountant or the accountant’s firm
  • Include the city and state where the accountant practices and
  • Include the date of the report (which should be the date the accountant completes the compilation procedures)

You may have noticed that a compilation title and salutation are not required. Can they be included? While AR-C 80 does not require a report title or a salutation, it is permissible to add them. Here’s a sample report title and salutation:

                        Accountant’s Compilation Report

To the Board of Directors and Management

XYZ Company

The signature on the compilation report can be manual, printed, or digital.

If the accountant’s letterhead includes the city and state where the accountant practices, then the city and state can be omitted from the bottom of the compilation report.

The date of the compilation report should be the date the accountant completes the compilation procedures.

Omission of Substantially All Disclosures

Can the accountant omit all disclosures (notes to the financial statements) in a compilation engagement? Yes. Alternatively, the accountant can provide selected disclosures or if needed, full disclosure. In short, the accountant can do any of the following:

The compilation report should disclose the omission of substantially all disclosures with language such as the following:

Management has elected to omit substantially all the disclosures ordinarily included in financial statements prepared in accordance with the tax-basis of accounting. If the omitted disclosures were included in the financial statements, they might influence the user’s conclusions about the company’s assets, liabilities, equity, revenue, and expenses. Accordingly, the financial statements are not designed for those who are not informed about such matters.

The engagement letter should describe the level of disclosure to be included in the financial statements.

Reporting Known Departures from the Reporting Framework

Compilation report

If the accountant becomes aware of a material departure from the basis of accounting that is not corrected, he should modify the compilation report to disclose the departure. For example:

Management is responsible for the accompanying financial statements of XYZ Company, which comprise the balance sheets as of December 31, 20X2 and 20X1 and the related statements of income, changes in stockholder’s equity, and cash flows for the years then ended, and the related notes to the financial statements in accordance with accounting principles generally accepted in the United States of America. I (We) have performed compilation engagements in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. I (we) did not audit or review the financial statements nor was (were) I (we) required to perform any procedures to verify the accuracy or completeness of the information provided by management. I (we) do not express an opinion, a conclusion, nor provide any assurance on these financial statements.

Accounting principles generally accepted in the United States of America require that material impairments in the fair value of owned property be recognized in the balance sheet. Management has informed us that a recent appraisal of its Fumbleton office reflected a fair value of $2.25 million less than carrying value. If accounting principles generally accepted in the United States of America were followed, the buildings and equity accounts would have decreased by $2.25 million.

[Signature of accounting firm or accountant, as appropriate]

[Accountant’s city and state]

[Report Date]

The effects of the departure, if known, should be disclosed in a separate paragraph of the compilation report. If the effects of the departure are not known and cannot be readily determined with the accountant’s procedures, the compilation report should include a statement that the determination has not been made by management.

The accountant may not issue a compilation report that states the financial statements (as a whole) are not presented in accordance with the applicable financial reporting framework. Doing so is considered, in effect, an adverse opinion. An adverse opinion can only be expressed in an audit engagement.

Reporting When There are Other Accountants

Other accountants might perform a compilation of a subsidiary. What is your reporting responsibility if you are performing a compilation of a consolidated entity that includes the subsidiary? The compilation report for the consolidated entity is not altered to make a reference to the other accountant. AR-C 80 is silent in regard to whether you are required to obtain a copy of the other accountant’s compilation report.

Going Concern in Compilations

If the accountant becomes aware of uncertainties with regard to an entity’s ability to continue as a going concern, he may suggest additional disclosures. Without the additional going concern disclosures, it is possible that the financial statements could be misleading.

If substantially all disclosures are omitted from the financial statements, disclosure of the going concern uncertainty is not required. Even so, the accountant should be careful not to issue financial statements that are misleading. If needed, ask management to include the requisite going concern disclosures.

If the necessary going concern disclosures are not added and the financial statements are misleading, the accountant should consider withdrawing from the engagement.

Is it permissible to include an emphasis-of-a-matter paragraph in a compilation report? Yes.

The following is an example of a going concern uncertainty paragraph that could be added to a compilation report:

Going Concern

As discussed in Note H, certain conditions indicate that the Company may be unable to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary should the Company be unable to continue as a going concern.

When Independence is Lacking

Where should an accountant’s lack of independence be noted in the compilation report? The accountant can disclose his lack of independence in the last paragraph of the compilation report with wording such as:

I am (We are) not independent with respect to XYZ Company.

The reason for the lack of independence need not be included, but if the accountant includes one reason for a lack of independence, then all such reasons should be included.

If independence is impaired and the accountant desires to provide the reason independence is impaired, the compilation report may include wording such as:

We are not independent with respect to XYZ Company as of and for the year ended June 30, 2019, because an engagement team member made management decisions on behalf of XYZ Company.

Special Purpose Frameworks and Compilations

compilation engagements

The compilation report should highlight the use of a special purpose framework when one is used.

If a special purpose framework is used and disclosures are included, then the compilation report should include a separate paragraph such as the following:

We draw attention to Note X in the financial statements, which describes the basis of accounting. The financial statements are prepared in accordance with the tax-basis of accounting, which is a basis of accounting other than accounting principles generally accepted in the United States of America.

If disclosures are omitted, the separate paragraph could read as follows:

The financial statements are prepared in accordance with the tax-basis of accounting, which is a basis of accounting other than accounting principles generally accepted in the United States of America.

Unless the entity elects to omit substantially all disclosures, the compilation report should be modified to describe departures when the financial statements do not contain:

  1. A description of the special purpose framework
  2. A summary of significant accounting policies
  3. A description of how the special purpose framework differs from GAAP
  4. Disclosures similar to those of GAAP

The description of the special purpose framework can be included in the titles of the financial statements or the notes. If the financial statements omit notes, the financial statement titles should include the special purpose framework; for example, Statement of Revenues and Expenses—Tax Basis.

If substantially all disclosures are omitted, then 2, 3, and 4 above are not necessary. However, the accountant should include a separate paragraph in the accountant’s compilation report stating that management elected to omit substantially all disclosures. (See the preceding section titled Omission of Substantially All Disclosures.)

Click here for more information about which special purpose framework you should use.

Other Historical Information

In addition to historical financial statements, AR-C 80 may be applied to the following:

  • Specified elements, accounts, or items of a financial statement, including schedules of:
    • Rents
    • Royalties
    • Profit participation, or
    • Income tax provisions
  • Supplementary information
  • Required supplementary information
  • Pro forma financial information

Prospective Information and Compilations

AR-C 80 can be applied to prospective information.

Prospective financial information is defined as any financial information about the future.

Prospective financial information can be presented as:

  • A complete set of financial statements, or
  • One or more elements, items, or accounts

If you prepare prospective financial information, the summary of significant assumptions must be included Why? It is considered essential to the user’s understanding of such information.

If you prepare a financial projection, you should not exclude:

  • The identification of hypothetical assumptions, or
  • The description of the limitations on the usefulness of the presentation

The compilation report should include statements that:

  • The forecasted or projected results may not be achieved and
  • The accountant assumes no responsibility to update the report for events and circumstances occurring after the date of the report

AR-C 80 references the AICPA Guide Prospective Financial Information as suitable criteria for the preparation and presentation of prospective financial information.

Prescribed Forms and Compilations

Is it permissible to perform a compilation engagement with regard to prescribed forms?

Yes. There is nothing in the SSARSs that prohibits the accountant from performing a compilation engagement with regard to prescribed forms (e.g., bank personal financial statement).

When a bank, credit union, regulatory or governmental agency, or other similar entity designs a prescribed form to meet its needs, there is a presumption that the required information is sufficient. What should be done if the prescribed form conflicts with the applicable basis of accounting? For example, what if the prescribed form requires all numbers to be in compliance with GAAP with the exception of receivables? Follow the form, and no departure from the applicable reporting framework exists. In effect, the form and its related directions are treated as though they are the applicable reporting framework. The accountant must report departures from the prescribed form and related instructions as a departure from the applicable financial reporting framework. Include any significant departures in the compilation report. (See the preceding section titled Reporting Known Departures from the Applicable Financial Reporting Framework.)

If the prescribed form includes a compilation report not in conformity with AR-C 80, the report should not be signed. Append an appropriate compilation report to the prescribed form.

Compilation Engagements Conclusion

There you have it. Now you know how to perform a compilation engagement.

The main things to remember are (1) you need a signed engagement letter, (2) always include a compilation report with the financial statements, and (3) read the financial statements to determine if they are appropriate.

If you desire to issue financial statements without a compilation report, read my article about the use of AR-C 70, Preparation of Financial Statements.

If you desire to issue financial statements in conjunction with a review engagement, read my article about the use of AR-C 90, Review Engagements.

SSARS 25
Feb 19

SSARS 25: Materiality and Adverse Conclusions

By Charles Hall | Accounting and Auditing , Preparation, Compilation & Review

The AICPA has issued SSARS 25. It is titled Materiality in a Review of Financial Statements and Adverse Conclusions. Below I tell you how this standard affects your future review engagements.

Materiality in Review Engagements

Until SSARS 25, there was no requirement for you to document materiality in review engagements. Some firms, like my own, decided to do so any way. Others have not. Now, there's no choice. SSARS 25 explicitly requires that we determine and use materiality. 

Makes sense. The accountant's conclusion says we are not aware of any material modifications that should be made. The conclusion paragraph follows:

Accountant's Conclusion
Based on our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in accordance with accounting principles generally accepted in the United States of America. 

It would be difficult to plan or conclude a review engagement without knowing what materiality is. SSARS 25 requires that  we design and perform analytical procedures and inquiries to address all material items in the financial statements. This includes disclosures.

Next, you will see that the standard now permits adverse conclusions.

Adverse Conclusions in Review Engagements

In the past, adverse conclusions in a review engagement were not allowed. SSARS 25 changes this. If the financial statements are materially and pervasively misstated, you can issue an adverse conclusion.

SSARS 25 provides an illustrative accountant's review report with an adverse conclusion. (See illustration 7 on pages 85 and 86 of SSARS 25.) That example states the financial statements are not in accordance with accounting principles generally accepted in the United States of America.

Here's the adverse review report conclusion:

Adverse Conclusion
Based on my (our) review, due to the significance of the matter described in the Basis for Adverse Conclusion paragraph, the financial statements are not in accordance with accounting principles generally accepted in the United States of America.

One more thing, SSARS 25 requires a statement in the review report regarding independence.

SSARS 25

Independence in Review Reports

Independence is still required to perform a review engagement. What is different, however, is the accountant must include a statement in the review report saying he or she is independent. That phrase, to be included in the Accountant's Responsibility section of the report, reads as follows:

We are required to be independent of ABC Company and to meet our other ethical responsibilities, in accordance with the relevant ethical requirements related to our review.

See examples of the independence wording in the illustrative reports in SSARS 25. Those reports start on page 75 of the standard.

So when is SSARS 25 effective?

SSARS 25 Effective Date 

The effective date for SSARS 25 is for periods ending on or after December 15, 2021. Early implementation is permitted.

AR-C 90 review engagements
Dec 25

AR-C 90: How to Perform Review Engagements

By Charles Hall | Preparation, Compilation & Review

Review engagements provide limited assurance using AR-C 90, Review of Financial Statements. And these engagements can be done with much less effort than audits.

So, what are the requirements of a review engagement? When might a review be preferable to an audit? Must the CPA be independent? Can the CPA prepare the financial statements and perform the review engagement? Can a special purpose reporting framework be used? Who might desire a review report (rather than an audit or a compilation report)?

I'll answer these questions below, but, first here's a quick video introduction to the post.

Review Engagement Guidance

The guidance for reviews can be found in AR-C 90, Review of Financial Statements. AR-C 90 is part of  the AICPA's Statements on Standards for Accounting and Reporting Services (SSARS)..

Though this article is long, it's not intended to be comprehensive. It's an overview.

Applicability of AR-C 90

You should perform a review engagement when engaged to do so. If your client asks for this service and you accept, you are engaged.

A review engagement letter should be prepared and signed by the accountant or the accountant’s firm and management or those charged with governance. See engagement letter guidance below.

AR-C 90 Objectives

The objective of the accountant in a review engagement is to provide limited assurance regarding the financial statements. Other historical information such as supplementary information can also be included.

So how does an accountant perform a review engagement? Primarily with inquiries and analytics.

So, how does the limited assurance in a review engagement compare with compilations and audits?

In a compilation engagement, no assurance is provided. What procedures are employed in a compilation? Primarily, the accountant reads the financial statements for appropriateness. Why perform a compilation rather than a review? Economy and cost. Since procedures are minimal, it's easier to perform a compilation and less costly to the client.

In an audit, the accountant provides a high level of assurance. The accountant performs procedures beyond inquires and analytics such as confirmations. Audit risk assessment and planning requirements are much more rigorous than that of a review. While audits provide a higher level of assurance, they are more time-consuming. Consequently, the additional time raises the cost for the client. This is why reviews are sometimes performed rather than an audit.

Prior to performing a review engagement, make sure all stakeholders will accept this product. Some lenders might require an audit.

Review Reports

A review report is always required in a review engagement. That report states that no material modifications are necessary for the financial statements to be in accordance with the reporting framework. (See a sample review report below.)

If a departure from the reporting framework is present, an other-matter paragraph is added to the review report. If the effects of the departure are determined, they are disclosed in the report. If not known, the paragraph states that the effects have not been determined.  

Review Financial Statements

The accountant prepares financial statements as directed by management or those charged with governance. The financials should be prepared using an acceptable reporting framework including any of the following:

All of the above bases of accounting, with the exception of GAAP, are referred to as special purpose frameworks. When such a framework is used, a description is required and can be included in:

  • The financial statement titles
  • The notes to the financial statements, or
  • Otherwise on the face of the financial statements

The financial statement should disclose how the special purpose framework differs from generally accepted accounting principles. If, for example, a company uses accelerated depreciation in tax-basis statements, the financial statements should disclose how this method differs from straight-line (the usual GAAP method). 

The review report language changes when a company uses a special purpose reporting framework. See Exhibit C, illustration 3 in AR-90 for a tax-basis review report. 

Which Financial Statements?

Management specifies the financial statements to be prepared. Normally a company desires a balance sheet, an income statement, and a cash flow statement. The accountant can, however, issue just one financial statement (e.g., income statement). 

Who prepares the financial statements? The company or the CPA firm can prepare them.

Can the cash flow statement be omitted? GAAP requires a cash flow statement when a statement of financial condition and an income statement are included. Compilation standards allow for the omission of the GAAP cash flow statement if the omission is noted in the compilation report. Not so in a review engagement. The cash flow statement must be included when GAAP is used.

But is the cash flow statement required when the tax-basis of accounting is used? No, the cash flow statement can be omitted when the financial statements are tax-basis.

Disclosures in Reviewed Financial Statements

What about disclosures? Are they required in a review engagement?

In compilation engagements, disclosures can be omitted. Not so in a review engagement. Full disclosure is required, regardless of the reporting framework..

References to Review Report and Notes

Should a reference to the review report and the notes be included at the bottom of each financial statement page? While not required by the SSARS, it is acceptable to add a reference such as:

  • See Accountant’s Report and accompanying notes
  • See Accountant’s Review Report and accompanying notes, or
  • See Independent Accountant’s Review Report and accompanying notes

Review Engagement Documentation Requirements

The accountant should prepare and retain the following documentation:

  • Engagement letter
  • Financial statements 
  • Accountant’s review report 
  • Communications with management or others regarding fraud or noncompliance with laws or regulations
  • Communications with other accountants that reviewed or audited financial statements of significant components 
  • Emphasis-of-matter or other-matter paragraph communications with management or others
  • The representation letter (see Exhibit B of AR-C 90 for sample wording)

The review documentation should be sufficient to enable an experienced accountant, having no previous connection to the engagement to understand:

  • the nature, timing, and extent of the review procedures,
  • the results of the review procedures and evidence obtained, and
  • significant findings or issues, and the related conclusions and judgments

Review Engagement Letter

AR-C 80

While it is possible for the accountant to perform only a review and not prepare the financial statements, most review engagement letters will state that the following will be performed by the accountant:

  1. Preparation of the financial statements (a nonattest service)
  2. A review engagement (an attest service)

Since a nonattest service and an attest service are being provided, the accountant will add language to the engagement letter describing the client’s responsibility for the nonattest service. 

See illustrative engagement letters in Exhibit A of AR-C 90.

AICPA independence standards require the accountant to consider whether he is independent when the CPA performs an attest service (e.g., review) and a nonattest service (e.g., preparation of financial statements) for the same client. If management does not possess the skill, knowledge, and experience to oversee the preparation of the financial statements and accept responsibility, the accountant may not be independent.

So, must the accountant be independent? Yes, independence is required in review engagements.

AR-C 90 Review Procedures

The accountant should:

  1. Make inquiries,
  2. Perform analytical procedures, and
  3. Perform other procedures, as appropriate

Direct your procedures to areas with increased risks of material misstatement. An understanding of the entity and the industry in which the entity operates will better enable you to identify potential misstatements.

1. Review Inquiries

AR-90.22 provides a series of inquiries that should be made of management and others. Those questions includes matters such as fraud, subsequent events, related party transactions, and litigation. Additionally, once you create your analytical procedures, you may have questions regarding unexpected changes.

2. Review Analytical Procedures

Apply analytical procedures to the numbers. What kind? Well that depends. What numbers are most important? What numbers are most likely to be misstated? What types of analytics illuminate the client's business? Consideration of such factors will lead you to the right analytics.

Here are examples:

  • Comparing the current year financial statement numbers with the prior year
  • Comparing the current year trial balance numbers with the prior year
  • Ratios such as debt/equity or current assets/current liabilities or depreciation/total depreciable assets
  • Computing numbers with nonfinancial information such as the number of units sold times the average price 
  • Comparing quarterly revenues by location

As you can see, judgment is required. Moreover, you need to develop expectations prior to computing the numbers. AR-C 90 states "Develop an expectation of recorded amounts or ratios that is precise enough to provide the accountant with limited assurance that a misstatement will be identified."

Here are the five steps I use:

  1. Develop expectations
  2. Compute the numbers
  3. See if the numbers align with expectations
  4. Follow up with additional inquiries if expectations are not met
  5. Develop a conclusion

I find that many accountants fail to document their expectations. Or if expectations are documented, a second problem occurs: The numbers don't align with the expectation, and there's no documented follow up. If the numbers don't align with expectations, make sure you determine why.

Expectations

One question I often receive is, "How do I develop my expectations?"

It is helpful to have a discussion with management prior to computing your numbers. You want to know, for example, if sales rose during the year or if there were reductions in the workforce. The conversation informs your expectations.

Also, if you've previously worked with the client, you have knowledge regarding the client such as profit margins or debt levels. This prior knowledge informs your expectations.

Finally, you might also read the minutes (if there are any) before computing your numbers.

3. Other Review Procedures

AR-C 90 states that procedures include inquiry, analytics, and other procedures. The third element--other procedures-- is a general category that encompasses reading the financial statements and responding to risks. You might, for example, identify potential misstatements as you perform analytical procedures. If revenues are up 25% but you expect them to be stable, you'll perform additional procedures to see why.

Interestingly (at least to me), AR-C 90.A34 states that you can perform audit procedures in a review engagement. Though your review engagement letter states you are not performing an audit, your review file can include audit procedures. Why would the AICPA provide this latitude? To give you the ability to reach beyond your typical review procedures (inquiry and analytics). You need a basis for the limited assurance you are providing. And in some situations, you may need audit procedures to get you there.

Review Representation Letter

AR-C 90
 
 
 
 

A signed representation letter is required in all review engagements.

The date of the representation letter will agree with the date of the review report. In no event should the date of the representation letter precede the date of the review report. (The accountant is not required to have physical possession of the letter on the date of the review report. But the accountant should have the signed letter prior to releasing the financial statements.)

So, provide the draft of the financial statements to the client in a timely manner so they can review them and assume responsibility. Thereafter, the client can sign the representation letter.

Additionally, the representation letter should cover all financial statements and all periods in the report.

Exhibit B of AR-90 provides a sample representation letter.

Sample Review Report

The following is a sample review report (Exhibit C of AR-C 90 provides six illustrative review reports):

Independent Accountant's Review Report

[Appropriate Addressee]

I (We) have reviewed the accompanying financial statements of XYZ Company, which comprise the balance sheets as of December 31, 20X2 and 20X1, and the related statements of income, changes in stockholders' equity, and cash flows for the years then ended, and the related notes to the financial statements. A review includes primarily applying analytical procedures to management's (owners') financial data and making inquiries of company management (owners). A review is substantially less in scope than an audit, the objective of which is the expression of an opinion regarding the financial statements as a whole. Accordingly, I (we) do not express such an opinion.

Management's Responsibility for the Financial Statements

Management (Owners) is (are) responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement whether due to fraud or error.

Accountant's Responsibility

My (Our) responsibility is to conduct the review engagements in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. Those standards require me (us) to perform procedures to obtain limited assurance as a basis for reporting whether I am (we are) aware of any material modifications that should be made to the financial statements for them to be in accordance with accounting principles generally accepted in the United States of America. I (We) believe that the results of my (our) procedures provide a reasonable basis for my (our) conclusion.

Accountant's Conclusion

Based on my (our) reviews, I am (we are) not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in accordance with accounting principles generally accepted in the United States of America.

[Signature of accounting firm or accountant, as appropriate]

[Accountant's city and state]

[Date of the accountant's review report]

Reporting When There are Other Accountants

What are your responsibilities if you are performing the review of a consolidated entity that includes a subsidiary audited or reviewed by another accountant? 

First, obtain and read the subsidiary report.

Second, decide whether to make reference to the other accountants in your review report. If reference is made, AR-C 90.79 states "the accountant should clearly indicate in the accountant's review report that the accountant used the work of other accountants and should include the magnitude of the portion of the financial statements audited or reviewed by the other accountants." See Illustration 6 in Appendix C of AR-C 90 for sample report language. If you refer to the other accountant, you will state that you did not review the subsidiary financial statements.

Third, regardless of whether you decide to make reference to the other accountants, communicate with the other accountants. This communication includes a statement that the other accountants understand the relevant reporting framework and review or auditing standards, as applicable. Advise them that you are including the subsidiary's financials in the consolidation. Additionally, communicate the ethical requirements of the engagement, mainly independence. And finally, advise that you are reviewing matters affecting the intercompany eliminations.

Going Concern in Review Engagements

If the reporting framework requires that management evaluate going concern, then you should perform review procedures in regard to that and other related information. 

If the reporting framework does not require management to evaluate going concern but you become aware of conditions or events that raise substantial doubt about the entity's ability to continue as a going concern, you should perform review procedures such as inquiries about whether the going concern basis of accounting is appropriate. 

See my article titled Going Concern in Compilation and Review Engagements.

Other Historical Information in Review Engagements

In addition to historical financial statements, AR-C 90 may be applied to the following:

  • Specified elements, accounts, or items of a financial statement, including schedules of:
    • Rents
    • Royalties
    • Profit participation, or
    • Income tax provisions
  • Supplementary information
  • Required supplementary information
  • Tax return information

Review Engagements Conclusion

There you have it. Now you know how to perform a review engagement.

The main purpose of a review is to provide limited assurance in regard to the information. Inquiries and analytics are required. A signed representation letter is also required.

If you desire to issue financial statements without a compilation or review report, consider the use of AR-C 70, Preparation of Financial Statements.

If you desire to issue financial statements without a review report, consider using AR-C 80, Compilation Engagements.

The AICPA provides the full text of AR-C 90 online. You can download the PDF if you like. Once you download the document, you can use control-f to find particular words. I find this useful.

For additional SSARS-related articles see:

financial statement references
Nov 03

Financial Statement References (at the Bottom of the Page)

By Charles Hall | Accounting , Preparation, Compilation & Review

What financial statement references are required at the bottom of financial statement pages? Is there a difference in the references in audited statements and those in compilations or reviews? What wording should be placed at the bottom of supplementary pages? Below I answer these questions.

financial statement references

Audited Financial Statements and Supplementary Information

First, let’s look at financial statement references in audit reports.

While generally accepted accounting principles do not require financial page references to the notes, it is a common practice to do so. Here are examples:

  • See notes to the financial statements.
  • The accompanying notes are an integral part of these financial statements.
  • See accompanying notes.

Accountants can also–though not required–reference specific disclosures on a financial statement page. For example, See Note 6 (next to the Inventory line on a balance sheet). It is my preference to use general references such as See accompanying notes.

Audit standards do not require financial statement page references to the audit opinion.

Supplementary pages should not include a reference to the notes or the opinion.

Preparation, Compilation, and Review Engagements

Now, let’s discuss references in preparation, compilation, and review engagements. 

Compilation and Review Engagements

The Statements on Standards for Accounting and Review Services (SSARS) do not require a reference (on financial statement pages) to the compilation or review report; however, it is permissible to do so. What do I do? I do not refer to the accountant’s report. I include See accompanying notes at the bottom of each financial statement page (when notes are included). This reference to notes, however, is not required, even when notes are included. (Notes can be omitted in compilation engagements.)

You are not required to include a reference to the accountant’s report on the supplementary information pages. Examples include:

  • See Accountant’s Compilation Report.
  • See Independent Accountant’s Review Report.

What do I do? I include a reference to the accountant’s report on each supplementary page. But, again, it’s fine to not include a reference to the report.

Preparation of Financial Statement Engagements

Additionally, SSARS provides a nonattest option called the preparation of financial statements (AR-C 70). This option is used by the CPA to issue financial statements that are not subject to the compilation standards. No compilation report is issued. AR-C 70 requires that the accountant either state on each page that “no assurance is provided” or provide a disclaimer that precedes the financial statements. AR-C 70 does not require that the financial statement pages refer to the disclaimer (if provided), but it is permissible to do so. Such a reference might read See Accountant’s Disclaimer.

If your AR-C 70 work product has supplementary information, consider including this same reference (See Accountant’s Disclaimer) on the supplementary pages.

AR-C 70
Aug 11

AR-C 70: Preparation of Financial Statements Engagement

By Charles Hall | Preparation, Compilation & Review

Are you aware of the option in the SSARS titled Preparation of Financial Statements (AR-C 70)? Many CPAs still believe the lowest level of service in the SSARS is a compilation, but this is not true. CPAs can and do issue financial statements without a compilation report. Today I provide an in-depth look at AR-70, Preparation of Financial Statements.

But before I do, here’s video explaining the differences in preparation and compilation engagements.

Preparation of Financial Statements

Guidance

AR-C 70, Preparation of Financial Statements, is the guidance for the preparation of financial statements.

Applicability – AR-C Section 70

AR-C section 70, Preparation of Financial Statements, is applicable when a public accountant is engaged to prepare financial statements or prospective financial information.

This section can also be applied to the preparation of other historical financial information (e.g., schedule of rents).

AR-C 70 does not apply when the accountant prepares financial statements or prospective financial information:

  • And is engaged to perform an audit, review, or compilation of financial statements
  • Solely for submission to taxing authorities
  • For inclusion in written personal financial plans
  • In conjunction with litigation services that involve pending or potential legal or regulatory proceedings, or
  • In conjunction with business valuation services

Are there other times when AR-C 70 is not applicable? Yes. The preparation guidance does not apply when the accountant is merely assisting in the preparation of financial statements; such services are considered bookkeeping.

Examples of bookkeeping services include:

  • Preparing or proposing certain adjustments, such as those applicable to deferred income taxes or depreciation
  • Drafting financial statement notes
  • Entering general ledger transactions or processing payments in the client’s accounting software

When AR-C 70 is applicable, certain compliance actions—such as the creation of a signed engagement letter—are required. If the accountant is merely assisting with bookkeeping services, AR-C 70 is not triggered, and compliance with the standard is not necessary.

If the accountant is only entering transactions into a general ledger and making journal entries, he is merely assisting with bookkeeping. Such assistance is often provided in an online bookkeeping software such as QuickBooks. If this is the only service provided, AR-C 70 is not applicable.

If the accountant is engaged to prepare financial statements and performs any of the following, then AR-C 70 applies.

  • The accountant prepares financial statements that are provided to another accountant (another firm) for audit purposes
  • The accountant prepares financial statements separately from a tax return (e.g., the accountant might prepare a tax return that includes financial statements and then—at the client’s request—creates financial statements separately from the return)
  • The accountant uses the client’s general ledger information to prepare financial statements outside of the accounting software (e.g., the accountant places information from a Quickbooks general ledger into Excel and creates financial statements)

As you can see, the preparation standard makes a distinction between:

  • Preparing financial statements (which triggers AR-C 70) and
  • Merely assisting (which does not trigger AR-C 70)

Are there any other situations where AR-C 70 does not apply? Yes. The AICPA’s Center for Plain English Accounting addressed this question in the following question and answer:

Q: If financial statements are prepared by the accountant as a by-product of another engagement (for example, an engagement to prepare a tax return), is the accountant required to follow section 70 of SSARS No. 21 and include any special disclaimer or “no assurance” statement on those financial statements?

A: No. The accountant is only required to perform the preparation engagement in accordance with section 70 of SSARS No. 21 when engaged to prepare financial statements. Therefore, because the accountant was not engaged to prepare the financial statements, there is no requirement to include a statement on each page of the financial statements indicating that no assurance is provided on the financial statements.

The author requested that the AICPA define the word engaged. They responded that a client’s request for the preparation of financial statements service is the trigger for being “engaged.” In other words, a client’s request for the preparation of financial statements means we are “engaged,” provided we accept the work. Once the client makes the request, the accountant will create an engagement letter in compliance with AR-C 70.

If the client does not request the preparation of financial statements and the accountant creates the statements as a byproduct of another service (e.g., tax return), he is not subject to the requirements of AR-C 70.

So when is AR-C 70 applicable? When a public accountant is engagedtoprepare financial statements.

AR-C 70 Objective

The objective of the accountant is to prepare financial statements in accordance with the chosen reporting framework.

AR-C 70 Reports

A compilation report from the accountant is not required (and should not be provided) when preparing financial statements under AR-C 70.

Financial Statements

The accountant can prepare financial statements as directed by management or those charged with governance. The financials should be prepared using an acceptable reporting framework such as the following:

  • Cash basis
  • Tax basis
  • Regulatory basis
  • Contractual basis
  • Other basis (as long as the basis uses reasonable, logical criteria that are applied to all material items)
  • Generally accepted accounting principles (GAAP)

When preparing financial statements in accordance with a special purpose framework (e.g., tax basis), the accountant is required to include a description of the financial reporting framework either on the face of the financial statements or in a note. Here’s a sample disclosure in a financial statement title: Statement of Assets, Liabilities, and Equity—Tax Basis.

Management determines the financial statements to be prepared. Financial statements normally include the following:

  • Balance sheet
  • Income statement
  • Cash flow statement

The accountant can, if so directed by management, create and issue just one financial statement (e.g., income statement).

The financial statements can be for an annual period or for a shorter or longer period. So, financial statements can be for a fiscal year, quarterly, or monthly, for example.

The accountant should also obtain an understanding of the significant accounting policies to be used in the preparation of the financial statements.

In preparing the financial statement, the accountant may need to assist management with judgements regarding amounts or disclosures. The accountant should discuss these judgments with management. Why? So management can understand and accept responsibility for the financial statements.

Documentation Requirements – AR-C 70

preparation of financial statements

The accountant should prepare and retain the following documentation:

  • Engagement letter (or contract)
  • The financial statements

Documentation related to significant consultations or professional judgments are to be included in the engagement file. Also, if the accountant departs from a relevant presumptively mandatory requirement, he should document the justification for the departure and how the alternative procedures performed were sufficient to achieve the intent of the requirement. (The SSARSs use the word should to indicate a presumptively mandatory requirement.)

AR-C 70 Engagement Letter

Is an engagement letter required for a preparation service? Yes. Moreover, the letter should be signed by the accountant or the firm and management or those charged with governance. A verbal understanding is not sufficient. Though AR-C 70 does not specify how often the engagement letter should be updated, it is best to do so annually.

The engagement letter should specify:

  • The objectives of the engagement
  • The responsibilities of management
  • The responsibilities of the accountant
  • The limitations of the preparation engagement
  • Identification of the applicable financial reporting framework
  • The agreement of management that:
    • Each page of the financial statements will include a statement that no assurance is provided, or
    • The accountant will issue a disclaimer stating that no assurance is provided
  • Whether the financial statements will:
    • Contain known departures from the applicable reporting framework, and
    • Whether substantially all disclosures will be omitted

No Report

As noted above, no compilation report will be issued for a preparation service. The preparation service is considered a nonattest, nonassurance service, and no compilation, review, or audit procedures are required.

The accountant will do one of the following:

  1. On each financial statement page (including the related notes), indicate, at a minimum, that “no assurance is provided,” or
  2. Provide a disclaimer (see example below)

If the accountant uses the first option, wording such as the following should be included on each page of the financial statements (including the related notes):

  • No assurance is provided on these financial statements
  • These financial statements have not been subjected to an audit or review or compilation engagement, and no assurance is provided on them, or
  • ABC CPAs prepared these financial statements in accordance with professional standards of the AICPA, and no assurance is provided

Other statements can be used to communicate that no assurance is provided, but the minimum wording must include “No assurance is provided.” The “no assurance” wording is made at management’s discretion, and the accountant’s firm name is notrequired to be included. The wording is normally placed at the bottom of each page. If the client does not allow the accountant to include such a statement on each page of the financial statements, the accountant should:

  • Issue a disclaimer (see below)
  • Perform a compilation in accordance with AR-C 80, or
  • Withdraw from the engagement

Preparation of Financial Statements Disclaimer

If the disclaimer option is used, AR-C 70 provides the following language:

The accompanying financial statements of XYZ Company as of and for the year ended December 31, 20XX, were not subjected to an audit, review, or compilation engagement by me (us) and I (we) do not express an opinion, a conclusion, nor provide any assurance on them.

[Signature of accounting firm or accountant, as appropriate] 

[Accountant’s city and state]

[Date] 

Though not required, the disclaimer can be placed on firm letterhead. Notice that the disclaimer language above has no disclaimer title. While the standard is silent about providing a title, the accountant may add one. For example, Accountant’s Disclaimer. A salutation is not required, but may be added.

Some accountants prefer to provide a disclaimer on letterhead. Why? Any third party reader can see that the accounting firm is involved in the preparation of the statements and that no assurance is provided.

A third party may not know that an external accountant was involved in preparing the statements if the “no assurance is provided” legend is used and the firm’s name is not included. Remember, however, it is the client’s decision as to whether the “no assurance” legend is added or a disclaimer is provided.

Independence

Preparation of financial statements is a nonattest, nonassurance service. When an accountant performs only a preparation engagement, consideration of independence is not necessary.

If an accountant signs client checks and performs bookkeeping services, independence is not required. Moreover, if the accountant prepares financial statements for the same client, independence is not required. Signing checks, bookkeeping, and the preparation of financial statements are all nonattest services.

But what happens if the accountant prepares financial statements using AR-C 70 (a nonattest service) and later issues a compilation report using AR-C 80? Suppose an accountant issues monthly financial statements for January through November with no compilation report (using the preparation option), but in December issues financial statements with a compilation report. The December compilation service triggers a requirement to consider independence.

Here’s a related question: Which of the following services, if any, may an accountant who is not independent provide?

  1. Preparation
  2. Compilation
  3. Review

The answer is a preparation or compilation service. But if you are not independent in a compilation engagement, you must say so in the compilation report. Independence is required for review engagements.

Omission of Substantially All Disclosures

Can the accountant omit all disclosures (notes to the financial statements) in a preparation engagement? Yes. Alternatively, the accountant can provide selected disclosures or if needed, full disclosure. In short, the accountant can do any of the following:

  1. Omit all disclosures
  2. Provide selected disclosures
  3. Provide full disclosure

Regardless, the engagement letter should describe the level of disclosure to be provided in the financial statements. Also, the omission of substantially all disclosures should be communicated either on the face of the financial statements or in a selected note. There is no provision in the preparation standard to report the omission of disclosures in the accountant’s disclaimer that precedes the financial statements.

The accountant can communicate the omission of disclosures by including wording such as the following at the bottom of each financial statement page or in a note:

  • Substantially all disclosures required by accounting principles generally accepted in the United States are not included.
  • Substantially all disclosures ordinarily included in financial statements prepared in accordance with the tax-basis of accounting are not included.

The accountant can also communicate the omission of disclosures in the title of the financial statements. For example:

ABC Company

Statement of Income

Substantially All Disclosures Omitted

December 31, 2020

Information Provided is Incomplete or Inaccurate

Deficiencies in the information provided to the accountant should be communicated to management, and the inaccuracy or incompleteness of such information should be corrected. Deficiencies in the information include insufficient records, documents, explanations, and judgments.

Reporting Known Departures from the Applicable Financial Reporting Framework

How should a departure from the applicable financial reporting framework be reported? Discuss the departure with management to see if it can be corrected. If it is not corrected, disclose the departure. How?

A departure from the applicable financial reporting framework should be disclosed either on the face of the financial statements or in a note. If it takes more than a few words to describe the departure, note disclosure may be the better option—you’ll have more room there. There is no provision in the preparation standard to disclose departures in the accountant’s disclaimer that precedes the financial statements.

AR-C 70 Other Historical or Financial Information

In addition to historical financial statements, AR-C 70 may be applied to the following:

  • Specified elements, accounts, or items of a financial statement, including schedules of:
    • Rents
    • Royalties
    • Profit participation, or
    • Income tax provisions
  • Supplementary information
  • Required supplementary information
  • Pro forma financial information

AR-C 70 Prospective Financial Information

prospective financial statements

AR-C 70 can be applied to prospective information.

Prospective financial information is defined as any financial information about the future.

Prospective financial information can be presented as:

  • A complete set of financial statements, or
  • One or more elements, items, or accounts

If you prepare prospective financial information, the summary of significant assumptions must be included Why? It is considered essential to the user’s understanding of such information.

If you prepare a financial projection, you should not exclude:

  • The identification of hypothetical assumptions, or
  • The description of the limitations on the usefulness of the presentation

AR-C 70 references the AICPA Guide Prospective Financial Information as suitable criteria for the preparation and presentation of prospective financial information.

AR-C 70 Prescribed Forms

Is it permissible to perform a preparation of financial statement engagement with regard to prescribed forms?

Yes. There is nothing in AR-C 70 that prohibits the accountant from performing a preparation engagement with regard to prescribed forms (e.g., bank personal financial statement). However, the accountant is required to follow all of the preparation guidance. Clients may not want to add wording to the prescribed forms such as “no assurance is provided” or “substantially all disclosures are omitted.” As an alternative to adding such wording, the accountant can provide a disclaimer before the prescribed form.

Selected notes can follow the form if needed. If this option is used, the order of the deliverable is as follows:

  • Disclaimer
  • Prescribed form
  • Selected notes

When a bank, credit union, regulatory or governmental agency, or other similar entity designs a prescribed form to meet its needs, there is a presumption that the required information is sufficient. What should be done if the prescribed form conflicts with the applicable basis of accounting? For example, what if the prescribed form requires all numbers to be in compliance with GAAP with the exception of receivables? Follow the form. In effect, the prescribed form is the reporting framework. Report departures from the prescribed form and its related instructions on the face of the financial statements (the form) or in a note.

Draft Financial Statements

The client may request a draft copy of the financial statements prior to final issuance. To avoid confusion, mark statements with words like:

  • Draft Financial Statements
  • Working Draft
  • Draft – Subject to Change

Preparation of Financial Statements – A Simple Summary

  • AR-C 70 is applicable when the accountant is engaged to prepare financial statements and is not applicable when the accountant is engaged to perform a compilation or if the accountant is merely assisting with bookkeeping
  • The objective of the accountant is to prepare financial statements in accordance with the chosen reporting framework
  • The financial statements can be prepared in accordance with GAAP or a special purpose reporting framework
  • The financial statements can be distributed to third parties (and not just management)
  • The accountant must either:
    • State on each financial statement page that “no assurance is provided,” or
    • Provide a disclaimer
  • Documentation requirements include:
    • The engagement letter, and
    • The financial statements
  • An engagement letter must be signed by:
    • The accountant or the accountant’s firm, and
    • Management or those charged with governance
  • No report (e.g., compilation report) is attached to the financial statements
  • Consideration of independence is not required
  • Substantially all disclosures can be omitted
  • The omission of substantially all disclosures should be:
    • Disclosed on the face of the financial statements, or
    • In a note
  • Selected disclosures can be provided
  • Departures from the applicable financial reporting framework should be:
    • Disclosed on the face of the financial statements, or
    • In a note
  • A preparation engagement can be applied to historical financial statements and historical information (e.g., specified items of a financial statement).
  • A preparation engagement can be applied to prospective financial information. The summary of significant assumptions must be included.
  • A preparation engagement can be performed in relation to prescribed forms (e.g., bank personal financial statements)
  • Mark draft financial statements with appropriate wording (e.g., Draft Financial Statements)

Also, see my article Compilation Engagements: The SSARS Guidance.

Differences in Preparation and Compilation Engagements

How do preparation engagements compare to compilations? Here’s a video that explains the differences.

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