Proposed revisions to SSARS no. 1 make some bold changes.
A New Approach to
BY DIANE S. CONANT AND J. RUSSELL MADRAY
|EXECUTIVE SUMMARY |
- THE AICPA ACCOUNTING AND REVIEW SERVICES committee issued a proposed revision of SSARS no. 1, Compilation and Review of Financial Statements, in December 1999. It gives accountants new communications alternatives they can use when compiled financial statements will be restricted to management use only.
- THE PROPOSAL DOES NOT PROVIDE AN EXEMPTION from SSARS no. 1 or create another level of service. An accountant would still have to compile the financial statements restricted to management’s use under existing SSARS no. 1 performance standards.
- A NEW DEFINITION OF “SUBMISSION OF FINANCIAL statements” would exclude the modification concept and instead focus only on the generation of financial statements. The new communication options the revision provides would be appropriate only when the accountant does not expect third parties to use the financial statements.
- ACCOUNTANTS WOULD HAVE TWO NEW COMMUNICATION options available to them: an engagement letter agreed to and signed by management or a letter addressed directly to management. These letters would include much of the same information currently contained in the standard compilation report.
- THE ED DEFINES THIRD PARTIES AS ALL PARTIES except members of management who are knowledgeable about the nature of the procedures applied and the basis of accounting or assumptions used in presenting the financial statements. This means some members of management—those not knowledgeable about the entity’s accounting matters—could be considered third parties.
|DIANE S. CONANT, CPA, is a partner of Conant, Nelson & Conant, Ltd., in Las Vegas and chairwoman of the AICPA accounting and review services committee. Her e-mail address is firstname.lastname@example.org . J. RUSSELL MADRAY, CPA, is a lecturer at Clemson University School of Accountancy and Legal Studies, in Clemson, South Carolina. He is a member of the ARSC. His e-mail address is email@example.com . |
fter years of attempts to alter the requirements or exempt certain services, the AICPA accounting and review services committee (ARSC) has issued an exposure draft that seeks to make fundamental changes in compilation engagements. The December 31, 1999, ED would revise Statement on Standards for Accounting and Review Services (SSARS) no. 1, Compilation and Review of Financial Statements, which established performance and reporting standards for compilation and review engagements. Previous auditing standards required accountants to add a disclaimer to the unaudited financial statements they were associated with. Exhibit 1 provides an overview of the changes the new ED proposes.
SSARS no. 1 was supposed to establish a minimum level of service for unaudited financial statements of nonpublic entities. To accomplish this, there is a trigger in paragraph 7 that says that, “The accountant should not submit unaudited financial statements of a nonpublic entity to his or her client or others unless, as a minimum, he or she complies with the provisions of this statement applicable to a compilation engagement. Submission of financial statements is defined as presenting to a client or others financial statements that the accountant has (a) generated , either manually or through the use of computer software, or (b) modified , by materially changing account classification, amounts, or disclosures directly on client-prepared financial statements.” (Italics have been added for emphasis.) This means that if the accountant generates a financial statement or modifies a client-generated financial statement, he or she has “submitted” a financial statement, triggering the need to comply with the performance and reporting standards in SSARS no. 1.
Although this trigger effectively established a minimum level of service, in the years since SSARS no. 1 was issued, the accounting profession, the competitive environment and technology have all changed. These progressive changes have led to problems for practitioners, including deciding whether or not SSARS applies (see case study 1). Many times an accountant is forced either to compile financial statements or violate the SSARS professional standards.
|Case Study 1 |
To Apply SSARS or Not, That Is the Question
A client asks for help finding a problem in an income statement that he or she has just printed—net income just doesn’t “look right.” You sit down and begin to review the prior month’s entries in the client’s computerized accounting database and notice that four checks totaling $15,000—a material amount—were coded incorrectly as “repairs and maintenance.” Based on your close association with the client and your knowledge of the prior month’s activities, you know the checks should have been coded as “leasehold improvements.” To solve the problem you simply change the account classifications and log out of the software.
Did you just “submit” financial statements? In our opinion, you did, because you materially modified the client’s financial statement by changing account classifications (paragraph 7 of SSARS no. 1). Did you intend to compile the financial statements? Probably not. Must you now compile the client’s financial statements? According to SSARS no. 1, you must.
What if, instead of going to the client’s office, you made the same modifications on a disk in your office or by modem? In our opinion, the answer would be the same; you submitted financial statements and now you must compile those statements.
The other problem accountants face derives from market influences. As client relationships change, many practitioners feel constrained by the requirements of SSARS no. 1. There are instances when a client needs financial statements solely for management purposes. Yet SSARS no. 1 requires accountants to perform a compilation engagement and issue a report on the financial statements even if neither the client nor the accountant believes it is necessary.
Most of the ideas proposed during the past 22 years involved an exemption from SSARS no. 1, including exemptions for management-use-only financial statements, interim financial statements and computer-generated financial statements. Each of these ideas met opposition from most of the accounting profession. In the new ED, ARSC has taken a different approach: Rather than create an exemption from SSARS no. 1, the committee rewrote the statement to recognize the realities of the accounting profession today.
SSARS no. 1 has always contained performance and reporting standards for compilation engagements. The ED does not change the performance standards. The accountant must still
- Have or obtain a general understanding of the accounting principles and practices of the industry in which the client operates.
- Have or obtain a general understanding of the client’s business.
- Obtain more information if the data the client supplies appear to be incorrect, incomplete or otherwise unsatisfactory to compile the financial statements.
- Read the compiled financial statements and consider whether they are appropriate in form and free of obvious material error.
The reporting standards also have not changed. They provide rules for
- The form of a standard compilation report.
- Reporting on financial statements that omit substantially all disclosures.
- Reporting when the accountant is not independent.
- Reporting when there are departures from GAAP or an other comprehensive basis of accounting (OCBOA).
The ED does make two modifications that
- Change the definition of “submission of financial statements.”
- Add communication options in certain circumstances.
ARSC decided that although the trigger could be confusing, it still served the valuable purpose of ensuring a minimum level of service on financial statements the accountant generated and presented to the client and should remain. However, the committee thought modifying the definition of submission would solve most applicability problems. It now defines submission of financial statements as “presenting to a client or third parties financial statements that the accountant has generated either manually or through the use of computer software.” Although the revised definition may create a loophole for accountants who want to avoid doing a compilation, ARSC decided the change was the best way to address today’s technological environment and still retain the trigger.
The second change involves communication options. The compilation report has long been the vehicle an accountant uses to express his or her degree of responsibility for the financial statements to the statement user. ARSC thought there should be other ways of communicating the same information under limited circumstances—for example, an engagement in which the client and accountant do not expect third parties to use the financial statements.
In such an engagement, the accountant could compile the financial statements and have three different ways to explain the accountant’s role in the engagement:
- The standard compilation report.
- An engagement letter signed by management.
- A letter addressed directly to management.
The two new options—the two letters—would contain much the same information as a standard compilation report but would simply be in a different format (see the sample engagement letter in exhibit 2 ). To learn how accountants might use these options in practice, see case study 2.
|Case Study 2 |
There Is No Longer a Question
Assume the same scenario as in case study 1, except you are now practicing under the new SSARS no. 1 and have a signed engagement letter with the client. Each month you go to the client’s office and make certain “corrections and adjustments” similar to those in case study 1 to produce financial statements for management’s use only. (Per your understanding with the client, the client will not make these financial statements available to third parties.)
Since you are complying with the performance standards (understanding the client’s industry, understanding the client’s business, taking certain actions if the information appears to be incorrect and reading the compiled financial statements) and you have already communicated with the client via an engagement letter, you are in full conformity with professional standards and are providing exactly what the client has requested in an effective and efficient manner.
You are no longer required to attach a compilation report to the financial statements, although that option is still available. You have instead communicated much of the same information in the engagement letter. Had you attached a compilation report, you would have had to identify all known departures—measurement and disclosure—from GAAP or OCBOA. Through the engagement letter you have indicated that material departures may exist without having to specifically identify them. Because the financial statements are intended for use only by those who can put the information in the proper context (nonthird parties) specific identification is not necessary.
The ED does not create a new type of engagement. According to SSARS no. 1, compilation of financial statements is defined as “presenting in the form of financial statements information that is the representation of management (owners) without undertaking to express any assurance on the statements.” ARSC did not change this definition—the financial statements are compiled in accordance with the performance standards whether they are accompanied by the standard report or by one of the new atlernatives described above.
The ED defines third parties as “all parties except for members of management who are knowledgeable about the nature of the procedures applied and the basis of accounting or assumptions used in the presentation of the financial statements.” Note that this is a definition by exception—it starts by assuming that third parties includes everyone, except certain members of management. Under this definition, some members of management could be considered third parties (those who are not knowledgeable about the entity’s accounting matters).
Some who read this proposal will say that all such financial statements will end up in the hands of third parties. While this could happen, ARSC thought this was an issue between the practitioner and his or her client. If the client represents to the accountant that he or she will not make the financial statements available to third parties yet does just that, the practitioner has a larger problem to deal with than complying with SSARS. ARSC recommends that accountants exercise some caution in selecting and retaining clients and recognize that restricted-use compilation engagements may not be appropriate for all clients.
|Exposure Draft on Business Valuations
ARSC also issued another exposure draft on December 31, 1999, Financial Statements Included in Written Business Valuations. Financial statements an accountant includes in written business valuations frequently contain departures from GAAP or an other comprehensive basis of accounting (OCBOA) because the purpose of such financial statements is solely to help develop and present the value of an entity. ARSC issued this ED to exempt financial statements included in written business valuations from SSARS no. 1 because users of these statements do not require the statements to conform with GAAP or an OCBOA.
The proposed statement
- Exempts from SSARS no. 1 historical financial statements and “normalized” financial statements included in a written business valuation.
- Defines normalized financial statements as historical financial statements that have been adjusted to make the financial information meaningful so an accountant can present and compare the financial results of one entity with those of a comparable entity as part of a business valuation engagement.
The proposal was modeled after SSARS no. 6, Reporting on Personal Financial Statements Included in Written Personal Financial Plans, which exempts personal financial statements from SSARS no. 1 if the client or accountant does not use the statements to obtain credit or for any purpose other than preparing a written personal financial plan.
A copy of the ED is available on the AICPA Web site (www.aicpa.org). Comments on any aspect of the ED are encouraged and can be sent to Sherry Boothe, Audit and Attest Standards, File 2000, AICPA, 1211 Avenue of the Americas, New York, New York 10036-8775 or e-mailed to Sboothe@aicpa.org . The deadline for comments is June 9, 2000. The statement would be effective upon issuance.
There have been several attempts to bring SSARS into conformity with today’s accounting profession. Exhibit 3 compares the current ED to one ARSC issued in 1995 to address the problem. Although the 1999 proposal makes changes in SSARS no. 1, it retains the best of what has always existed. SSARS no. 1 still embodies the traditional compilation, but ARSC believes that the proposed changes align the standard with the CPA Vision and equip practitioners to serve their clients well into the twenty-first century. An accountant now will be able to use his or her professional judgment about how to communicate with the client and provide quality service accordingly.
A copy of the ED is available on the AICPA Web site (www.aicpa.org). Comments on any aspect of the ED are encouraged and can be sent to Sherry Boothe, Audit and Attest Standards, File 2000, AICPA, 1211 Avenue of the Americas, New York, New York 10036-8775 or e-mailed to Sboothe@aicpa.org . The deadline for comments is June 9, 2000. The proposed effective date of the revision is for financial statements submitted on or after September 30, 2000.
|Plain Paper Revisited
For more than two decades the accounting profession has debated whether to allow CPAs to prepare so-called plain-paper financial statements for management-only use. The term “plain paper” meant CPAs would not have to put their name on bare-bones statements that were intended only for internal use.
To allow CPAs to issue plain-paper financial statements would have required major revisions to SSARS no. 1, Compilation and Review of Financial Statements. The AICPA issued SSARS no. 1 in 1978 at a time when the profession was concerned about shielding members from legal action. The statement set compilation as the lowest level of service for financial statements in the belief that there was no way CPAs could be certain their clients would not show internal-use-only financial statements to third parties.
In September 1995 the plain-paper debate led to the exposure draft Assembly of Financial Statements for Internal Use Only. It provided an exemption from SSARS no. 1 for internal-use-only financial statements and would have created a fourth level of service—assembly—in addition to audit, review and compilation. In issuing the ED, the AICPA accounting and review services committee (ARSC) acknowledged that SSARS no. 1 made it difficult for CPAs to provide nonpublic clients with needed services in a timely, cost-effective manner. ARSC said many such clients do not need financial statements that comply in all material respects with GAAP—or an other comprehensive basis of accounting—to manage their businesses.
In August 1997 the profession was still holding public hearings to debate whether SSARS no. 1 should be revised to exempt CPAs from having to compile financial statements in certain situations and instead permit them to issue plain-paper financial statements. Plain-paper supporters argued that requiring a compilation ignored client needs at a time of rapid technological advancement. Many clients did not want to pay for a compilation when management-only financial statements could do the job. In addition, many practitioners were already violating the spirit, if not the letter, of SSARS no. 1 by putting together computer-generated financial statements and having the clients push the buttons that printed them. Others argued that changes were not necessary because CPAs already had—but did not understand—the options under existing standards that would allow them to provide clients with timely and cost-effective compilation services.
The 1995 ED never reached final form. In issuing its latest ED in December 1999 to amend SSARS no. 1, ARSC acknowledged the last five years have brought changes to the services clients ask CPAs to perform. Low-cost software means even the smallest entity can prepare its own financial statements. Despite this, many nonpublic companies ask their CPAs to prepare management-only financial statements. The 1999 ED adds communication options to SSARS no. 1 to enable CPAs to use their professional judgment in responding to client needs.
—Peter D. Fleming