Chapter 19 - Additional Assurance Services: Historical Financial Information CHAPTER 19 Additional Assurance Services: Historical Financial Information Review Questions 19-1 This statement is incorrect. An audit can be a significant expense to a small company. The audit fee must be justified by the benefits received from the audit. The needs of the users of the financial statements of many small nonpublic companies are satisfied by financial statements that have been reviewed or compiled by the CPAs. 19-2 The term auditor is most frequently used when discussing CPAs' role of attesting to the annual historical financial statements and when they are performing an operational audit. The term accountant refers to CPAs when they are performing other attestation services and accounting services. Thus, while auditors do perform the attestation service of audits, the statement that auditors perform attestation services and accountants perform accounting services is incomplete. 19-3 In communications with clients, CPAs should refer to themselves as auditors only when the service they are rendering is an audit performed in accordance with auditing standards. When rendering other services, they should refer to themselves as "accountants," or as "CPAs." The purpose of this distinction is to avoid leading the client to believe that the CPAs are acting as auditors when they actually are rendering other attestation or accounting services. 19-1
Transcript
Chapter 19 - Additional Assurance Services: Historical Financial Information
CHAPTER 19
Additional Assurance Services:Historical Financial Information
Review Questions
19-1 This statement is incorrect. An audit can be a significant expense to a small company. The audit fee must be justified by the benefits received from the audit. The needs of the users of the financial statements of many small nonpublic companies are satisfied by financial statements that have been reviewed or compiled by the CPAs.
19-2 The term auditor is most frequently used when discussing CPAs' role of attesting to the annual historical financial statements and when they are performing an operational audit. The term accountant refers to CPAs when they are performing other attestation services and accounting services. Thus, while auditors do perform the attestation service of audits, the statement that auditors perform attestation services and accountants perform accounting services is incomplete.
19-3 In communications with clients, CPAs should refer to themselves as auditors only when the service they are rendering is an audit performed in accordance with auditing standards. When rendering other services, they should refer to themselves as "accountants," or as "CPAs." The purpose of this distinction is to avoid leading the client to believe that the CPAs are acting as auditors when they actually are rendering other attestation or accounting services.
19-4 Yes. Auditors may express opinions on financial statements that are presented in accordance with a financial reporting framework other than GAAP (e.g., a special purpose framework, such as the cash basis). Such auditors' reports state indicate the framework being used and that the framework is a basis of accounting other than GAAP.
19-5 Four types of special purpose financial reporting frameworks are:
Cash basis. The cash receipts and disbursements basis of accounting, and modifications of the cash basis having substantial support, such as recording depreciation on fixed assets or accruing income taxes.
Tax basis. The basis of accounting that the entity uses or expects to use to file its income tax return for the period covered by the financial statements.
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Contractual basis. A basis of accounting in accordance with an agreement between the entity and one or more third parties other than the auditor.
Regulatory basis. A basis of accounting in accordance with the requirements or financial reporting provisions of a regulatory agency to whose jurisdiction the entity is subject. An example is a basis of accounting that insurance companies use pursuant to the rules of a state insurance commission.
19-6 The statement is incorrect. Only contractual basis and some regulatory basis special purpose financial reporting frameworks result in a restricted use report. Also the report’s use is not restricted only to those within the entity—parties to the contract or agreement, or the regulatory agencies to whose jurisdiction the entity is subject also may use the report.
19-7 When the financial statements are intended for use only outside the United States the auditor should issue one report, using either A United States style form of report, but one which indicates that the financial statements
have been prepared in accordance with a financial reporting framework generally accepted in another country, or
The other country audit report.
19-8 No, generally accepted accounting principles for personal financial statements require the valuation of assets at estimated current values, not at historical cost. A qualified or adverse opinion would be appropriate.
19-9 The procedures applied during a review of the quarterly financial statements include: (1) procedures to obtain an understanding of the client’s business and internal control; (2) analytical procedures applied to the interim financial data to identify and provide a basis for inquiries about relationships that appear unusual and that may indicate a misstatement; (3) inquires of management about such matters as unusual analytical relationships, significant transactions occurring around period end, subsequent events, and the occurrence or allegations of fraud; (4) reading minutes of meetings of stockholders and directors and the interim financial information; (5) obtaining evidence that the interim financial information agrees to the accounting records, and (6) obtaining written representations from management regarding the presentation and completeness of the statements.
19-10 A unique aspect of the required review of the quarterly financial information is the fact that the CPAs are not required to report on the engagement. Therefore, for a public company, the CPAs must notify the SEC if the client files materially misstatement information. Another unique aspect, as compared to a SSARS review is the required understanding of internal control that must be obtained.
19-11 The CPAs assist audit committees by communicating matters that assist them in performing their functions, including:
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Instances of fraud and illegal acts; Significant deficiencies related to the preparation of interim financial statements; Significant review adjustments found by the CPAs; The quality of accounting principles and estimates; Disagreements with management over accounting principles or review procedures; and Any other difficulties encountered performing the review.
19-12 In recognition of the fact that many small nonpublic companies do not need audits of their financial statements, the AICPA established the Accounting and Review Services Committee. That committee establishes standards for the compilation and review of the financial statements of nonpublic companies. CPAs may perform a compilation, a review, or an audit of the financial statements of a nonpublic company.
19-13 A review of financial statements of a nonpublic company does not involve a consideration of internal control, tests of the accounting records, or obtaining corroborating evidence, which are performed during an audit. Therefore, a review does not provide a basis for an opinion as to whether the financial statements are fairly presented in accordance with generally accepted accounting principles.
19-14 The primary procedures for a review of financial statements include inquiry of client management, and analytical procedures performed on the financial information by reference to prior financial statements, budgets, and other operating data. The CPAs also inquire concerning the actions taken in meetings of stockholders, the board of directors, and committees of the board. The accountants' inquiries should focus on whether the financial statements conform to generally accepted accounting principles, changes in business activities, and significant subsequent events. The accountants are also required to obtain a representation letter from management of the company.
19-15 Engagement letters (or some other written form of communication with management) are required for accounting and review services. Establishing an understanding with the client is of particular importance in this area since accounting and review services are quite different from audit.
19-16 A comfort letter is designed to aid securities underwriters in the investigations of registration statements required under the Securities Act of 1933. In the letter, the CPAs provide assurances regarding various financial information included in the registration statement.
19-17 The auditors will normally provide an opinion on whether the summary financial statements are fairly stated in all material respects in relation to the basic financial statements.
19-18 The minimum procedures required include reading the compiled statements for appropriate format and obvious material misstatement. But, when performing this service CPAs generally are asked to prepare the financial statements. Also, prior to performing a compilation the CPAs must have knowledge of the accounting principles and practices used within the client's industry and must have a general understanding of the client's business transactions and accounting records.
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19-19 Yes. When performing compilations, CPAs may issue a compilation report that indicates that management has elected to omit substantially all of the disclosures required by GAAP. When performing a review, the CPA who is aware of a departure from GAAP (including adequate disclosure) must consider modifying the report to be issued to reflect such information or, if the statements appear to be misleading, consider resignation. In the case of audits, omission of such disclosures leads to either a qualified or an adverse opinion based on the inadequate disclosure.
19-20 If the accountants discover a material departure from GAAP, they should request that management revise the financial statements. If management refuses to do so, the CPAs should modify their report to describe the departure and its effect on the financial statements, if known. If the CPAs do not believe that report modification is adequate, they should withdraw from the engagement.
19-21 When compiled financial statements are not expected to be used by a third party, the CPAs must still perform the standard compilation procedures. However, they have the following two reporting options:(1) Issue a compilation report, or(2) Issue no report and document in an engagement letter the understanding with the client
that the financial statements will not be used by a third party. Also, the accountants should make sure that the financial statements include a restricting phrase, such as “Restricted for Management’s Use Only.”
19-22 If the CPA firm discovers that it is not independent, the firm cannot issue a review report. The CPA firm can either resign from the engagement or perform a compilation of the financial statements with a report that discloses that the firm is not independent.
Questions Requiring Analysis
19-23 (a) Since Ambassador Hardware Co. is a nonpublic company, its financial statements may be audited, reviewed, or compiled. A review of financial statements involves the performance of inquiry and analytical procedures. The objective of a review is to express limited assurance that there are no material modifications for the financial statements to be accordance with generally accepted accounting principles (or some other comprehensive basis of accounting). The accountants do not perform procedures to corroborate the financial statement information and they do not perform an assessment of internal control. A compilation of financial statements involves the preparation of financial statements from representations by management. The accountants provide no assurance regarding the "fairness" of the financial statements.
(b) In selecting the type of service, Ambassador's management should consider the needs of the users of the company's financial statements. For example, Ambassador's creditors may be willing to extend necessary capital to the company on the basis of compiled or reviewed financial statements. However, if the owners of the company are considering issuing shares of stock to the public in the near future, they should consider the need to obtain audited financial statements to comply with SEC regulations.
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19-24 Independent Auditors' Report
Dale, Booster & Co.
We have audited the accompanying financial statements of Dale, Booster & Co., which comprise the statement of assets and liabilities arising from cash transactions as of December 31, 20X1 and the related statement of revenue collected and expenses paid for the year then ended.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with the cash receipts and disbursements basis of accounting described in Note X; this includes determining that the cash receipts and disbursements basis of accounting is an acceptable basis for the preparation of the financial statements in the circumstances. Management is also responsible for 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.
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the partnership’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the partnership’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and liabilities arising from cash transactions of Dale, Booster & Co. as of December 31, 20X1, and its revenue collected and expenses paid during the year then ended in accordance with the cash receipts and disbursements basis of accounting described in Note X.
Basis of Accounting
Without modifying our opinion, we draw attention to Note X to the financial statements, which describes the basis of accounting. The financial statements are prepared on the cash receipts and disbursements basis of accounting, which is a basis of accounting other than generally accepted accounting principles.
Emphasis of MatterAs discussed in Note Y to the financial statements, the Company is involved in continuing litigation relating to patent infringement. The amount of damages, if any, resulting from this litigation cannot be determined at this time.
Rose & Co., CPAsKansas City, Missouri
March 1, 20X2[
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19-25 (a) CPAs may report on specified elements, accounts, or items of a financial statement in the following ways:
(1) An audit may be performed, resulting in an opinion as to whether the information is fairly presented on the basis indicated. In such engagements, the auditors must apply auditing procedures and materiality must be judged in relation to the items presented.
(2) A report may be expressed on the application of agreed-upon procedures to the information. In such circumstances, the auditors must be assured that the parties involved understand the nature and extent of the procedures. The report should indicate the procedures performed, state the intended distribution of the report, the CPAs' findings, provide a disclaimer of an opinion on the information, and indicate that the report does not extend to the financial statements taken as a whole.
(3) A review of the information may be performed. In such a circumstance the auditors would apply the appropriate analytical review and inquiry procedures to allow them to provide limited assurance (e.g., “we are not aware of any material modifications”) on the information.
(b) Yes. Such reports should indicate that they are intended solely for the use of certain specific parties. Only individuals that have a clear understanding of the nature and extent of the auditors' procedures should have access to the reports.
19-26 (a) The major procedures for a review of financial statements include:
(1) Inquiries concerning the company's accounting principles and practices.(2) Inquiries concerning the company's system of accounting.(3) Analytical procedures to identify relationships and items that appear to be unusual.
The procedures include comparisons of accounting data with prior financial statements and budgets and a study of relationships between accounts that can be expected to conform to predictable patterns.
(4) Inquiries concerning actions taken at meetings of stockholders, board of directors, and committees of the board.
(5) Reading the financial statements for conformity with generally accepted accounting principles.
(6) Obtaining reports from other accountants, if any, who have audited or reviewed the financial statements of components of the company.
(7) Inquiries of management concerning the conformity of the financial statements with generally accepted accounting principles and material subsequent events.
(8) Obtaining a representation letter from management.
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(b) The report on a review of financial statements should indicate that:
(1) A review was performed in accordance with AICPA standards.(2) The financial statements are representations of management.(3) A review consists of inquiries of management and analytical procedures.(4) A review is substantially less in scope than an audit; therefore, no opinion is
expressed regarding the financial statements taken as a whole.(5) The accountants are not aware of any material modifications that should be made in
the financial statements for them to be in conformity with generally accepted accounting principles.
Note to Instructor: The above are the “big picture” items. Students will include varying other points.
(c) If the accountants discover a material departure from generally accepted accounting principles, they should request that the client revise the financial statements. If the financial statements are not revised, the departure should be disclosed in a separate paragraph of the accountants' report, including the effects of the departure on the financial statements, if known.
19-27 (a) The accountants can provide negative assurance that the unaudited financial statements comply with the 1933 Act and SEC pronouncements, and are fairly presented in accordance with generally accepted accounting principles on a basis consistent with that of the audited financial statements and schedules included therein.
(b) Comfort letters also typically contain the assurances as to:
(1) The independence of the accountants.
(2) Compliance of audited financial statements and schedules with the Securities Act and related rules and regulations.
(3) Changes in selected financial statement items during a specified period from the date of the latest financial statements included in the registration statement.
(4) Tables, statistics, and other financial information in the registration statement.
(5) Pro forma financial information, financial forecasts.
(6) Certain non-financial information included in the registration statement complies with SEC regulations.
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19-28 (a) When accountants are associated with the financial statements of a nonpublic company, they should look for guidance in the Statements on Standards for Accounting and Reviewer Services—particularly the compilation standards.
(c) Wilson is responsible for following the compilation standards. Included here are requirements to have knowledge of accounting principles used within the industry and a general understanding of the client’s business transactions and accounting records. If the information appears to be incorrect, incomplete or otherwise unsatisfactory, actions must be taken. A properly prepared compilation report must accompany the financial statements in circumstances in which it is likely that a third party might use them
Objective Questions
19-29 Multiple Choice
(a) (3) Audits of financial statements include confirmations of accounts receivable, reviews generally do not.
(b) (1) Both a representation letter and an engagement letter are required.
(c) (2) Independence is only required for attestation services. Since compilation is not an attestation service, independence is not required. Independence is required on a review engagement.
(d) (3) Inquiries of management ordinarily included those on subsequent events, significant journal entries and other adjustments, and unusual or complex situations affecting the financial statements. Inquiries about communications with related parties are not specifically required.
(e) (3) The auditors’ report on summarized financial statements includes an opinion on whether the summarized information is fairly stated in all material respects in relation to the basic financial statements.
(f) (2) Management of public companies must engage CPAs to review their company’s quarterly financial information.
(g) (3) The appropriate report on compiled financial statements that omit disclosures includes an indication that management has elected to omit the disclosures and the financial statements are not intended for individuals not informed of such matters.
(h) (4) Agreed-upon procedures engagements always result in a restricted use (limited distribution) report.
(i) (3) Completeness is generally the most difficult assertion with respect to personal financial statements due to poor internal control and motivation by some individuals to omit assets and income.
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(j) (4) The special purpose financial reporting frameworks include cash basis, tax basis, regulatory basis, and contractual basis.
(k) (1) A compilation report contains a disclaimer regarding the financial statements; it should not include the expression of negative assurance.
(l) (1) A comfort letter is issued by the independent auditors to the underwriters. Accordingly, such letters are normally signed by the independent auditors.
19-30
Statement Correct Incorrect1. A special purpose financial reporting
framework is any framework other than GAAP.X
2. Some, but not all, special purpose frameworks require an indication that the financial statements are intended solely for certain specified users.
X
3. An audit report on financial statements that are prepared using a special purpose framework must include an emphasis of a matter paragraph alerting users that the financial statements were prepared in accordance with the framework.
X
4. An audit report on financial statements that are prepared using a special purpose framework must in all circumstances include a description of the purposes for which the statements are prepared.
X
5. An audit opinion on financial statements that use a special purpose framework may be unmodified.
X
6. The Attestation Standards, not the Statements on Auditing Standards apply to engagements involving special purpose frameworks.
X
7. If a regulatory agency requires a particular layout for the audit report, the auditor may be able to use that layout rather than the suggested report included in the Professional Standards.
X
8. An audit report on financial statements that are prepared using a special purpose framework will indicate that the audit was conducted in accordance with the special purpose financial reporting framework auditing standards.
X
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19-31Question Yes No1. Is this considered an audit of financial
statements using a special purpose financial reporting framework?
X
2. In performing the audit, must your firm consider GAAS to the extent the standards are appropriate?
X
3. If the financial statements are intended for use only outside the United States, must an audit report include an opinion on whether US GAAP are followed?
X
4. If the financial statements are intended for use both in the US and in Laos, must an audit report include an opinion on whether US GAAP are followed?
X
5. When the financial statements are intended for use only outside the United States, if Laotian generally accepted auditing standards do not require the Laotian form of audit report may your firm use the US style form and modify it as necessary?
X
6. When the financial statements are intended for use only outside the United States, if Laotian generally accepted auditing standards do not require the Laotian form of audit report may your firm use the Laotian style form?
X
7. Must a paragraph be added to the audit report (or audit reports) indicating that the financial statements are solely for certain specified users?
X
19-32(a) Disagree (International Financial Reporting Standards are considered a general purpose
financial reporting framework).(b) Disagree (Cash basis financial statements use need not be restricted).(c) Agree.(d) Agree.(e) Agree.
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19-33 Simulation
ServiceMay provide, independence
is required
May provide, independence
is not required
May not
providea. Provide an opinion on whether financial statements are pre-
pared following the cash basis of accounting. Xb. Compile the financial statements for the past year and issue a
publicly available report. Xc. Apply certain agreed-upon procedures to accounts receivable
for purposes of obtaining a loan, and express a summary of findings relating to those procedures.
X
d. Review quarterly information and issue a report that includes limited assurance. X
e. Perform an audit of the financial statements on whether they are prepared following generally accepted accounting princi-ples.
X
f. Compile the financial statements for the past year, but not is-sue a report since the financial statements are only for the company’s use.
We have audited the accompanying financial statements of Jiffy Clerical Services, which comprise the statement of assets and liabilities arising from cash transactions as of December 31, 20X1 and the related statement of revenue collected and expenses paid for the year then ended.
Management’s Responsibility for the Financial Statements
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Management is responsible for the preparation and fair presentation of these financial statements in accordance with the cash receipts and disbursements basis of accounting described in Note X ; this includes determining that the cash receipts and disbursements basis of accounting is an acceptable basis for the preparation of the financial statements in the circumstances. Management is also responsible for 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.
Auditor’s Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the partnership’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the partnership’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and liabilities arising from cash transactions of Jiffy Clerical Services as of December 31, 20X1, and its revenue collected and expenses paid during the year then ended in accordance with the cash receipts and disbursements basis of accounting described in Note X.
Basis of Accounting
Without modifying our opinion, we draw attention to Note X to the financial statements, which describes the basis of accounting. The financial statements are prepared on the cash receipts and disbursements basis of accounting, which is a basis of accounting other than generally accepted accounting principles.
Blue, Gray & Co.City, State
February 23, 20X5
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(b) The report must be modified because the statements are not in conformity with the meaning of "generally accepted accounting principles" as used in the conventional standard report. No opinion is expressed as to the statements' conformity to generally accepted accounting principles because cash basis statements omitting assets or liabilities of material amount are not in accordance with such principles.
Further, the financial statements are not called balance sheet or income statement because of material differences from accrual statements. Special care must be taken to avoid leading the reader to incorrect inferences. Cash basis statements should be titled to reveal clearly what they represent and to avoid implying that they present financial position or operating results in accordance with generally accepted accounting principles.
(a) A review of interim financial statements does not provide a basis for the expression of an opinion because a review is not an audit performed in accordance with generally accepted auditing standards--that is, it does not include the collection of sufficient competent evidence to support an opinion.
(b) The procedures that Loman must perform consist primarily of inquiries and analytical procedures concerning significant accounting matters relating to the financial information to be reported. The procedures that Loman should apply ordinarily may be limited to the following:
Procedure Purpose of Procedure
Reviewing documentation of the most recent audit and financial statements, and considering the results of auditing procedures.
To update the understanding of the business and internal control.
Inquiry concerning any significant changes in the company’s business activities.
To update the understanding of the business and internal control.
Performing analytical procedures. To identify potential misstatements and provide a basis for inquiries to management and certain other procedures.
Making inquiries of management regarding unusual relationships.
To obtain assurance that unusual relationships are not the result of misstatements of the interim information.
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Performing additional procedures if the CPAs become aware that interim information may be incorrect, incomplete, or otherwise unsatisfactory.
To obtain assurance that the interim information is not materially misstated.
Inquiring of officers and other executives having responsibility for financial and accounting matters concerning:
(a) Whether the interim financial statements have been prepared in conformity with generally accepted accounting principles consistently applied.
(b) Unusual or complex situations affecting the interim financial information.
(c) Significant transactions occurring around the end of the period.
(d) Subsequent events.(e) Whether management has knowledge
of fraud having been committed.(f) Whether allegations of fraudulent
financial reporting have been made by employees, former employees, or other individuals.
In order to become aware of significant matters affecting the interim financial statements.
Reading the minutes of meetings of stockholders, board of directors, and committees of the board of directors.
To identify actions that may affect the interim financial statements.
Reading the interim financial statements. To consider, on the basis of information coming the accountants' attention, whether the information to be reported conforms with generally accepted accounting principles.
Obtaining reports from other accountants who may have been engaged to make a review of the interim financial information of significant components of the company.
As a basis, in part, for the report.
Obtaining evidence that the interim financial information reconciles with the accounting records.
To obtain assurance that the interim information is not materially misstated.
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19-37 SOLUTION: Norman Lewis (Estimated time: 25 minutes)
Deficiency Reason Correction
(1) The report does not identify the financial statements that were compiled.
(2) A compilation report should not indicate that analytical procedures were applied to the financial statements.
To avoid reader mis-understanding as to which financial statements were compiled.
A compilation involves the preparation of financial statements from representations of management, without performing procedures to audit or review the information. To indicate that procedures were applied to the financial statements could confuse the readers to the nature of the accountant's service.
The report should clearly identify the compiled statements, including the company name, the individual statements, and their dates.
Reference to the performance of analytical review procedures should be deleted from the report
.
(3) The report does not indicate the nature of a compilation of financial statements.
The reader should be clearly informed as to the nature of the accountants' service.
The report should indicate that a compilation is limited to presenting in the form of financial statement information that is the representation of management.
(4) The report provides negative assurance regarding the financial statements; it states that nothing came to the accountants' attention to indicate the financial statements are in error.
A compilation of financial statements does not provide a basis for the expression of negative assurance regarding the statements. The accountants report on the compilation should disclaim an opinion on the financial statements.
The statement of negative assurance should be altered to indicate that the accountants do not express an opinion or any other form of assurance on the financial statements.
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(a) Write-up work and compilation of financial statements represent an accounting service and not an audit of the financial statements. It is important that the client understand this distinction and more important that there be a clear understanding between the client and the CPAs of the nature of each engagement.
Verbal commitments, such as a telephone conversation, can often be misunderstood and therefore should be followed up with an engagement letter that spells out the terms, nature, and limitations of the services to be performed. A copy of this letter should be signed and returned by the client to acknowledge its understanding and approval of the scope of the engagement.
(b) Even a regular audit engagement cannot provide absolute assurance of detecting fraud, and in an engagement to compile financial statements the CPAs have no responsibility to apply any auditing or review procedures. However, as professionals, the CPAs do have a responsibility to exercise due care in carrying out their engagements, to apply professional judgment in the preparation of financial statements, and to bring to the client's attention any unusual or suspicious matters they note during their work. The CPAs have an obligation to investigate information that appears to be in error, incomplete, or otherwise inadequate.
(c) The word "audit" should be avoided in non-audit engagements. The CPAs should persuade their client to change the account title to "Accounting Services," and should be certain their client understands the difference between an accounting service and an engagement to examine the financial statements in accordance with generally accepted auditing standards.
(d) While the CPAs do not have a responsibility to perform any auditing or review procedures in a compilation engagement, they do have responsibility to perform all services with reasonable skill and care.
A situation involving missing invoices should have caused the CPAs to question the accuracy and completeness of the financial information submitted to them. They should have rejected the information and investigated the situation. If it appeared that irregularities existed, the CPAs should have advised the client of the missing invoices and suggested that the client follow up on the matter or, if the client so desired, the CPAs could pursue it further as an additional accounting service.
(e) Financial statements may be compiled that omit substantially all the disclosures required by generally accepted accounting principles. CPAs may compile them as long as they have no reason to believe that the financial statements are intended to mislead, and their compilation report clearly indicates that the financial statements omit the necessary disclosures.
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Inappropriate ActionWhat Brown Should Have Doneto Avoid Inappropriate Action
(1) Brown was aware that the client misunderstood the nature of the engagement.
(2) Brown's agreement with Calhoun provided for the payment of a contingent fee; specifically, the understanding called for the payment of a substantial fee if the work was completed in two weeks. Contingent fees for such clients are prohibited by the AICPA Code of Professional Conduct.
Brown should have established a clear understanding with the client, preferably in writing, through an engagement letter.
The fee arrangement should have been based on the nature and difficulty of the engagement
(3) Brown should not have suggested that his fees be recorded in an account entitled "Fees for Limited Audit Engagement." This action contributed further to the misunderstanding with the client concerning the nature of his services.
Brown should have insisted that his fee be recorded in an account that clearly indicated the nature of his services, such as "Fees for Accounting Services."
(4) Brown should have performed a further investigation of the situation indicated by the missing invoices. Even though a compilation does not involve the performance of procedures to substantiate the financial statement information, the accountants should investigate any situation that indicates that the information is incorrect, incomplete, or otherwise unsatisfactory.
Brown should have investigated the possibility of irregularities as indicated by the missing invoices.
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(5) Brown did not insist upon disclosure of the method of valuation of fixed assets in the notes to the financial statements. A separate letter is not an appropriate means to disclose and explain the effects of accounting principles.
The notes should have been drafted to clearly indicate the method of valuation of the fixed assets.
Inappropriate ActionWhat Brown Should Have Doneto Avoid Inappropriate Action
(6) Brown did not disclose the departure from generally accepted accounting principles in accounting for fixed assets.
A report should have been drafted to include a separate paragraph referring to the departure from generally accepted accounting principles, including the effect of the departure, if known.
(7) The financial statements did not include a statement of cash flows, and Brown did not disclose this departure from generally accepted accounting principles in a properly drafted compilation report.
A report should have been drafted with a separate paragraph referring to the departure from generally accepted accounting principles.
(8) Brown marked each page with a note indicating that the financial statements were submitted without complete audit verification. The financial statement reader cannot determine the type of service performed by Brown or the responsibility he was assuming.
Each page of the financial statements should have been labeled "See Accountants' Compilation Report."
(9) The financial statements were not accompanied by a properly drafted accountants' report.
The financial statements should have been accompanied with a compilation report, which included the paragraphs discussed above referring to the departures from generally accepted accounting principles.
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Chapter 19 - Additional Assurance Services: Historical Financial Information
(1) Yes.(2) The procedures applied during a review of the quarterly financial statements of a
public company include: procedures to obtain an understanding of internal control; analytical procedures applied to the interim financial data by reference to prior interim information, budgets, and other data; reading minutes of meetings of stockholders and directors; and obtaining written representations from management regarding the presentation and completeness of the statements.
(3) Limited (negative) assurance.(4) Departures from generally accepted accounting principles. Review reports are
not required to be altered in cases involving consistency or uncertainties, including going concern. In addition, when a scope limitation is involved, the review is considered incomplete and no review report should be issued.
(5) Williams has confused the public company requirement of a review of interim information with a review of a nonpublic company's annual statements. Webstar is not required to have a review of its financial statements.
b. Compilation of financial statements
(1) Yes.(2) The minimum procedures required include reading the compiled statements for
appropriate format and obvious material misstatement. But, when performing this service CPAs generally are asked to prepare the financial statements. Also, prior to performing a compilation the CPAs must have knowledge of the accounting principles and practices used within the client's industry, and must have a general understanding of the client's business transactions and accounting records.
(3) A compilation report need not be issued if the financial statements are not intended to be used by a third party. In such case, the CPAs must document in an engagement letter this fact, and the financial statements should be labeled as being restricted to management’s use.
(4) A compilation report includes a disclaimer with no explicit assurance.(5) Compilation reports are modified for (a) departures from generally accepted
accounting principles, (b) lack of all disclosures, and (c) a lack of independence.
c. Financial Statements
(1) Yes.(2) This is considered a report on a special purpose financial reporting framework.(3) The titles to the financial statements will be modified and a paragraph will be
added to the report indicating that a comprehensive basis of accounting other than generally accepted accounting principles has been used.
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Chapter 19 - Additional Assurance Services: Historical Financial Information
d. Auditing a Small Portion of the Financial Statements
(1) Yes.(2) This is a "report on specified elements, accounts or items. Audits, agreed upon
procedures, and review are possible. (3) When expressing an opinion as a result of an audit on specified elements,
accounts, or items, positive assurance may be provided. An agreed-upon procedures report includes a summary of findings. A review provides limited (negative) assurance.
Research and Discussion Case
19-41 Dallas McBain (Estimated time: 45 minutes)
(a) The undocumented disbursements should be of concern to the auditor even though this engagement is a "balance sheet only" audit. Forbes appears to have complete personal control over McBain's assets, including access to large amounts of cash. This constitutes an internal control significant deficiency, which an auditor should communicate to his or her client (McBain). Furthermore, Forbes is not properly executing his fiduciary responsibilities as he is disbursing McBain's funds without either direct authorization or proper documentation. Some risk exists that Forbes is embezzling assets from McBain. The 1136 Tenants Case illustrates the problems that an accountant (or an auditor) may encounter as a result of failing to advise a client of undocumented disbursements made by a managing agent.
There is a possibility that the undocumented disbursements are related to material misstatements in McBain's statement of assets and liabilities. For example, the disbursements could be for payments on material unrecorded liabilities. Also, the approximately $365,000 represents only the funds accounted for during the current year. If McBain is accumulating hidden assets, the amount of these assets might be quite material if the practice has been going on for a number of years. Therefore, the auditor has reason to be concerned about the completeness of the statement of assets and liabilities.
(b) The auditor should give consideration to the following courses of action:
(1) Advise McBain in writing of the weaknesses in internal control over the star's assets. This action is required by AICPA AU 265, and by the concept of due professional care. McBain should sign a copy of this communication to acknowledge receipt; this copy should be retained in the auditor's working papers.
(2) Request that McBain sign a representation letter regarding the completeness of the financial statement and acknowledging awareness and approval of the undocumented disbursements and the diversion of the proceeds of the sale of securities. This letter is necessary to assist the auditor in forming an opinion as to the completeness of the statement of assets and liabilities and also to prevent the auditor from being personally liable in the event that Forbes is perpetrating a fraud against McBain.
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Chapter 19 - Additional Assurance Services: Historical Financial Information
(3) Issue an unmodified auditor's report. This action would be appropriate only if the auditor was satisfied that the undocumented disbursements were personal expenditures, not related to unrecorded assets or liabilities. Whether the auditor personally approves of the way in which McBain spends money is not relevant to the auditor's report on McBain's financial statements.
(4) Issue a qualified opinion or a disclaimer of opinion. The argument for this course of action is that the weak internal control and the lack of documentation in the accounting records may be viewed as a scope limitation that prevents the auditor from being satisfied as to the completeness of the statement of assets and liabilities.
(5) Withdraw from the engagement. The argument for this course of action would depend upon whether the auditor concluded that Forbes and/or McBain appeared so lacking in integrity that the auditor should not be associated with them. Withdrawing from the engagement, however, would not eliminate the auditor's responsibilities to advise McBain of the undocumented disbursements, unaccounted for proceeds of the sale of securities, and weaknesses in internal control.
(c) Our recommendation:
We would definitely advise McBain in writing of the weakness in internal control and request that McBain sign a letter representing the awareness and approval of the undocumented disbursements. We would then have to make a judgment call as to whether to issue an unmodified or a qualified (scope limitation) auditors' report. Barring any other indications of unrecorded assets or liabilities, we lean toward the unmodified opinion. We recognize that individuals generally do not maintain strong internal control or accounting records comparable to those found in business entities. Also, we do not consider it highly unusual for an individual in McBain's position to spend money lavishly, often with little or no documentation. Our principal concern is that our auditors' report not be used to assist Forbes in concealing the misuse of assets from McBain. This concern, however, can better be resolved by written communication with McBain than by qualification of the auditors' report.
(d) The purpose in posing this last question is to spark a discussion of the "real-world" pressures upon a CPA to retain important clients. As the case was originally stated, the CPA was young and just starting a practice. Under these circumstances, the auditor might feel very uncomfortable in antagonizing either Forbes or McBain. Either of these individuals might be so influential in the community as to prevent the CPA's practice from getting off the ground.
By making the CPA well established and independently wealthy, and by making this engagement only a small part of the CPA's total practice, we remove much of this pressure. Theoretically, this should make no difference in the way that a CPA resolves a professional judgmental decision. In reality, however, such factors may exert great pressure on a sole practitioner or on an individual partner within a CPA firm. Such pressure to keep an important client is one reason that large CPA firms often require a "second partner review" of the working papers of each audit by a partner who has no responsibilities with respect to that client.
