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.
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.
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.
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.
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 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.
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.
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..
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:
The accountant should prepare and retain the following documentation:
The review documentation should be sufficient to enable an experienced accountant, having no previous connection to the engagement to understand:
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:
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.
The accountant should:
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.
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.
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:
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:
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.
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.
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.
The following is a sample review report (Exhibit C of AR-C 90 provides six illustrative review reports):
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]
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.
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.
In addition to historical financial statements, AR-C 90 may be applied to the following:
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:
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Charles Hall is a practicing CPA and Certified Fraud Examiner. For the last thirty years, he has primarily audited governments, nonprofits, and small businesses. He is the author of The Little Book of Local Government Fraud Prevention and Preparation of Financial Statements & Compilation Engagements. He frequently speaks at continuing education events. Charles is the quality control partner for McNair, McLemore, Middlebrooks & Co. where he provides daily audit and accounting assistance to over 65 CPAs. In addition, he consults with other CPA firms, assisting them with auditing and accounting issues.
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