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.
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.
The standard review 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 material misstatements are identified and relate to specific amounts in the financial statements, you will issue a review report with a basis for qualified conclusion paragraph and you'll have a qualified conclusion. See Exhibit C, illustration 5 in AR-C 90 for a sample review report with a departure from GAAP. 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.
If misstatements are material and pervasive, an adverse conclusion is appropriate. The review report will also have a basis for adverse conclusion paragraph. See Exhibit C, illustration 7 in AR-C 90 for a sample review report with an adverse conclusion.
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:
- 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. 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
- A copy of the reviewed financial statements
- Accountant’s review report
- Communications with management and those charged with governance about significant matters arising during the engagement
- 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)
- Information about how any inconsistencies were addressed when the accountant identified information that was inconsistent with the accountant's findings regarding significant matters affecting the financial statements
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 evidence obtained and the accountant's conclusions based on that evidence
- significant matters 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:
- Make inquiries,
- 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-90.29 provides a series of inquiries that should be made of management and others. Those questions include 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.
The accountant should remain alert for related party transactions outside the normal business course. Inquiries should be made about such transactions.
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's 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 before computing the numbers. AR-C 90 says that the expectations should enable you to identify material misstatements. So the expectations have to be precise enough to yield that result.
Here are the five steps I use:
- Develop expectations
- 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.
How do we develop expectations?
It is helpful to discuss current operations with management before 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 are familiar with their 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 expected them to be stable, you'll perform additional procedures to see why.
Interestingly (at least to me), AR-C 90.A45 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.
Materiality in Review Engagements
AR-C 90 requires accountants to determine and use materiality. This makes sense given the review report says the following:
Those standards require us to perform procedures to obtain limited assurance as a basis for reporting whether 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.
You can't know what a "material modification" is without knowing what materiality is. So, the accountant should use materiality in the planning and conduct of the review engagement. AR-C 90 says the determination of materiality is a matter of professional judgment.
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 before releasing the financial statements.)
Provide the draft of the financial statements to the client promptly 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.
We are required to be independent of XYZ Company and to meet our ethical responsibilities, in accordance with the relevant ethical requirements related to our reviews.
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 seven 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 refer to the other accountants in your review report. If reference is made, AR-C 90.122 states the accountant should clearly indicate in the accountant's review report that the accountant used the work of other accountants. The report should also 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 your conclusion, as it relates to the entity reviewed by the other accountants, is based solely on their report.
Third, regardless of whether you decide to refer to the other accountants, communicate with the other accountants. Determine the following:
- That the other accountants are familiar with the relevant reporting framework and review or auditing standards, as applicable.
- Advise them that you are including the subsidiary's financials in the consolidation and that their report will be relied upon, and when applicable, that the other accountant's report will be referred to in your review report.
- Communicate the ethical requirements of the engagement, mainly independence.
- And finally, advise them that you are reviewing matters affecting the intercompany eliminations.
Going Concern in Review Engagements
If the reporting framework requires that management evaluate going concern (FASB has such a requirement), then you should perform going concern review procedures. Those procedures include:
- Determining whether the going concern basis of accounting is appropriate
- Reviewing management's evaluation of whether substantial doubt exists
- When there is substantial doubt, reviewing management's plans to mitigate the conditions
- Reviewing going concern disclosures
See my article about going concern in relation to FASB standards.
If the applicable 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, do the following:
- Ask management if the going concern basis of accounting is appropriate
- Ask management about their plans to address the adverse effects of the conditions or events
- Review the going concern disclosures to see if they are appropriate
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:
- 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: