In this article, I provide information about various special purpose reporting frameworks (e.g., cash basis, modified-cash basis, and income tax basis) and how you can use them to create financial statements for your clients.
Suppose you’ve been contacted by your client to prepare their financial statements and issue a compilation report. At first, you think, I’ll create the financials in accordance with GAAP, but then you remember there are special purpose reporting frameworks. Maybe the cash basis or income tax basis is a better option.
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.
Preparation of Financial Statements
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-productof 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.
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:
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:
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
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
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:
On each financial statement page (including the related notes), indicate, at a minimum, that “no assurance is provided,” or
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]
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.
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 and issues a compilation report?
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. Providing the monthly preparation services and the December compilation service triggers a requirement to consider independence.
Just remember this for now: Independence is not required for preparation engagements, and there are no requirements to disclose a lack of independence in a preparation engagement.
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:
Omit all disclosures
Provide selected disclosures
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:
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:
Profit participation, or
Income tax provisions
Required supplementary information
Pro forma financial information
AR-C 70 Prospective Financial Information
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:
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
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)
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.
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.
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
Do you ever want to include justone disclosure in your financial statements without providing all the notes? Selected disclosures can be included in certain situations, including when you omit substantially all disclosures.
Do professional standards allow this? Yes. But only if you use AR-C 70 (the preparation guidance) or AR-C 80 (the compilation guidance).
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Selected Disclosures in Compilations
As you probably already know, a CPA can issue compiled financial statements without disclosures as long as the compilation report discloses the omission. An example follows.
Management has elected to omit substantially all of the disclosures required by accounting principles generally accepted in the United States of America. If the omitted disclosures were included in the financial statements, they might influence the user’s conclusions about the Company’s financial position, results of operations and cash flows. Accordingly, the financial statements are not designed for those who are not informed about such matters.
If the financial statements include one or two notes, then the financial statements still omit substantially all of the disclosures, so the accountant (still) uses the wording in the preceding paragraph.
Sample Selected Disclosure
An example of a selected disclosure follows:
Selected Information –
Substantially All Disclosures Required by Accounting Principles
Generally Accepted in the United States of America are Not Included
December 31, 2020
Note 1. Long-Term Debt.
ABC Company borrowed $450,000 on July 15, 2020, from XYZ Bank. The rate of interest is 5%, and the loan is collateralized by equipment of the Company. Payments are $10,000 per month plus interest for two years with a balloon payment for the balance of the amount owed.
Additionally, you can omit substantially all disclosures in a preparation engagement.
AR-C 70 says:
The accountant may prepare financial statements that include disclosures about only a few matters in the notes to the financial statements. Such disclosures may be labeled “Selected Information—Substantially All Disclosures Required by [the applicable financial reporting framework] Are Not Included.”
So, the selected-disclosure option is available in a Preparation of Financial Statements engagement. Include the required disclaimer at the bottom of the page such as “No assurance is provided on these financial statements.”
The accountant should consider whether management’s election to include only selected disclosures causes the financial statements to be misleading (for example, by omitting the disclosures that contain negative information). If so, the accountant should request that the financial statements be revised to include the omitted disclosures.
The selected-disclosure option is not available for financial statements subject to a review engagement. Such financial statements must be full disclosure.
What About You?
Do you ever use this selected-disclosure option? Any reservations about doing so?