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:
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:
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.
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.
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.
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.
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 frameworkis used, a description is required andcan 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:
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
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:
Preparation of the financial statements (a nonattest service)
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:
Perform analytical procedures, and
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:
Compute the numbers
See if the numbers align with expectations
Follow up with additional inquiries if expectations are not met
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.
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
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.
Review Report Sample
The following is a review report sample (sometimes referred to as an accounting review report):
Independent Accountant's Review Report
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.
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.
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]
Exhibit C of AR-C 90 provides six review report illustrations.
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.
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.
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.
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.
Peer reviewers continue to focus on independence documentation. Today I’ll provide you with examples of what peer reviewers are looking for and guidance to keep you out of hot water.
Documentation of Nonattest Services
Peer reviews focus upon nonattest services provided to attest clients. How do we know? Well, see the peer review checklist question below (for an attest engagement).
The big “no-no” is to assume management responsibilities and then perform an attest service. Why? Performing management responsibilities impairs your independence.
Preparing Financial Statements
Below is another question from the peer review checklists. Notice the first item below: Accepting responsibility for the preparation and fair presentation of the client’s financial statements. The client (not the auditor) must assume responsibility for the financial statements.
If the client can’t–or is unwilling to–assume responsibility for the financial statements, then we are not independent, and we cannot perform an audit or a review. This assumption of responsibility does not mean the client has the ability to create financial statements, but it does mean that:
that the client will oversee the nonattest service,
the client will evaluate the adequacy and results of the nonattest service, and
the client will accept responsibility for the nonattest service
If we prepare financial statements and perform an audit, review, or compilation, we have performed a nonattest service and an attest service. Why is this important? Because if we perform a nonattest service and an attest service for the same client, we must assess our independence. And if we are not independent, then we can’t perform an audit or review engagement. (It is permissible to perform the compilation engagement when independence is impaired, but the accountant must say–in the compilation report–that he is not independent.)
Other Peer Review Questions
The peer review checklists also ask for:
The name and title of the client personnel overseeing the nonattest service and
A description of the accountant’s “assessment and factors leading to your satisfaction that the client personnel overseeing the service had sufficient skills, knowledge and experience.”
Separate Form to Document Independence
So do we need a separate form in our file to document independence?
It certainly would not hurt, and I suggest that you do. PPC and CCH offer such forms (and I am sure other work paper providers do the same). These forms provide a place to document all nonattest services and to assess and document our client’s ability to assume responsibility for the nonattest services.
The PPC and CCH forms also address the cumulative effect of performing multiple nonattest services. The AICPA has stated that the performance of multiple nonattest services can impair independence. So you should document your consideration of whether the cumulative nonattest services create a problem. Peer review checklists ask if we documented this consideration.
Additionally, if significant threats are present, the accountant should document the safeguard(s) used to mitigate the risk. This documentation is particularly crucial in Yellow Book engagements. The PPC and CCH independence forms will assist you with this documentation. Below are peer review checklist questions:
Alignment in Independence Documentation
We should–in the engagement letter–specify the nonattest services and the responsibilities of management. If you are performing an audit or a review engagement, add additional language to the representation letter regarding the nonattest services performed and the client’s responsibility for those services.
So I am suggesting you document the nonattest services in three places:
Independence form, and
Representation letter (when relevant)
And when you do, please make sure the nonattest services listed in each document are the same.
Nonattest Services and Independence
Here’s a video that explains nonattest services and how to document your independence in regard to them.
Do you need to concern yourself with going concern in compilation and review engagements? Yes, if the financial statements are prepared in accordance with the FASB Codification. But is going concern relevant to special purpose frameworks such as the cash basis or tax basis financial statements. Yes, going concern is in play even with special purpose frameworks. This post provides an overview of what you need to know about going concern as it relates to compilation and review engagements.
But what about financial statements subject to a compilation engagement, especially when substantially all disclosures are omitted? Is it permissible for the CPA to ignore the going concern standard since it just requires disclosures? Yes, but be careful. Ask yourself whether the financial statements would be misleading (without the going concern disclosure). If they are misleading, then include a selected disclosure regarding going concern. Also, consider adding an emphasis-of-matter paragraph (regarding going concern) to your compilation report.
Consider the following scenario. Your client (who has significant going concern issues) takes your compilation report (which has no emphasis of a matter paragraph) and their financial statements (that has no disclosures) to a local bank. It’s obvious that the company is not doing well. But the bank makes a large loan anyway, and later, the company defaults on the loan. Then the bank files suit against you (the CPA) asserting that you issued the compilation report without the emphasis-of-matter paragraph and that you knew the financial statements had no going concern disclosure. The bank says the financial statements were misleading.
While the emphasis-of-matter paragraph is not required, consider adding one anyway.
Going Concern in Review Engagements
Since review engagements require full disclosure, going concern disclosures are not optional when substantial doubt exists in GAAP financial statements. They must be provided. If they are not, a GAAP departure exists.
So what going concern procedures should you perform in a review engagement?
In regard to going concern when the financial reporting framework includes going concern requirements (e.g. GAAP), AR-C 90.65 states:
If the applicable financial reporting framework includes requirements for management to evaluate the entity’s ability to continue as a goingconcern for a reasonable period of time in preparing financial statements, the accountant should perform review procedures related to the following:
Whether the going concern basis of accounting is appropriate
Management’s evaluation of whether there are conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern
If there are conditions or events that raised substantial doubt about the entity’s ability to continue as a goingconcern, management’s plans to mitigate those matters
The adequacy of the related disclosures in the financial statements
In regard to going concern when the applicable financial reporting framework does not address going concern (e.g., tax basis), AR-C 90.66 states:
If the applicable financial reporting framework does not include a requirement for management to evaluate the entity’s ability to continue as a going concern for a reasonable period of time in preparing financial statements and conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time existed at the date of the prior period financial statements (regardless of whether the substantial doubt was alleviated by the accountant’s consideration of management’s plans) or, in the course of performing review procedures on the current period financial statements, the accountant becomes aware of conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern, the accountant should do the following:
Inquire of management whether the going concern basis of accounting is appropriate.
Inquire of management about its plans for dealing with the adverse effects of the conditions and events.
Consider the adequacy of the disclosure about such matters in the financial statements.
SSARS 24 does say that the nature and extent of procedures performed regarding going concern are a matter of professional judgment. If the audited entity has a history of profitable operations and access to financing, inquiry alone might be sufficient in a review engagement.
Going Concern Paragraph in a Review Report
If the accountant concludes that substantial doubt will remain for a reasonable period of time, an emphasis-of-matter paragraph is required in the review report. (Some reporting frameworks specify a “reasonable period of time.” For GAAP, it is one year from the date the financial statements are issued or are available to be issued.)
AR-C 90.A123 provides the following example of a going concern paragraph in a review engagement when (1) substantial doubt exists for a reasonable period of time, (2) management’s plans don’t alleviate the substantial doubt, and (3) the reporting framework requires a note disclosure.
Emphasis of Matter
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note X to the financial statements, the Company has suffered recurring losses from operations, has a net capital deficiency, and has stated that substantial doubt exists about the Company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are also described in Note X. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our conclusion is not modified with respect to this matter.
Representation Letter in Review Engagements
Be sure to update your representation letter when performing review engagements. SSARS 24 tweaked some language in the letter and added additional wording such as the following:
Management has disclosed to the accountant all information relevant to use of the going concern assumption in the financial statements.
Special Purpose Frameworks and Going Concern
While the cash, modified cash, or tax bases of accounting do not address going concern, accountants still need to consider the effects of negative financial conditions and trends. Why? When using a special purpose framework (like the tax basis), the accountant should follow the guidance in GAAP. No, that doesn’t mean your disclosures are just like GAAP, but it does mean they are similar to GAAP.
Since GAAP tells the financial statement preparer to consider whether substantial doubt exists, then persons creating cash basis, modified cash basis or tax basis financial statements should do the same. If substantial doubt is present, going concern disclosures are necessary.
So, what is substantial doubt? The FASB Codification defines it this way:
Substantial doubt about the entity’s ability to continue as a going concern is considered to exist when aggregate conditions and events indicate that it is probable that the entity will be unable to meet obligations when due within one year of the date that the financial statements are issued or are available to be issued.
If substantial doubt is present and going concern disclosures are not included in full disclosure compilations or reviews, then modify your accountant’s report (for the departure).