The AICPA’s Accounting and Review Services Committee (ARSC) has proposed the most significant changes to the professional literature for compilation and review engagements since the December 1978 issuance of SSARS no. 1, Compilation and Review of Financial Statements. The proposed Statements on Standards for Accounting and Review Services (SSARSs), issued in April for public comment, were developed to address concerns shared by smaller business owners, users of small business financial statements and CPAs that serve smaller entities and to provide more flexibility in a complex practice environment.
The primary change in the proposed standards for review engagements relates to allowing practitioners to perform review engagements when independence has been impaired due to the performance of a non-attest service designed to help management prepare higher quality or more reliable financial statements. The primary change in the proposed standards for compilation engagements is the ability for the accountant to disclose a general description of the reasons for a lack of independence in the compilation report.
The proposed SSARSs are:
- Framework and Objectives for Performing and Reporting on Compilation and Review Engagements
- Compilation of Financial Statements
- Review of Financial Statements
THE CURRENT ENVIRONMENT
Today, there are approximately 44,000 CPA firms in the United States, of which 31,000 are run by sole practitioners. Many CPAs in these smaller firms serve their small business clients by helping them work through the difficult maze of accounting standards. They help clients by compiling or reviewing their clients’ financial statements, in addition to performing other accounting services, where the client’s financial statements (monthly and annual) are used by management and third parties to secure financing or for other reasons.
Bankers and other third-party users of small business financial statements recognize that the business owner may be an expert at running a business; however, they do not expect the small business owner to be an expert in financial reporting. As a result, bankers have advised ARSC that they welcome the involvement of a CPA throughout the year because they believe the CPA’s involvement will improve the reliability of the financial information.
The involvement of the CPA in compiling or reviewing the financial statements works great until the CPA crosses the line of performing a service that would be part of the client’s system of internal control—the policies and procedures that prevent or detect and correct misstatements in the accounting books and financial statements.
As accounting standards become more complex and small business clients look to their CPAs to help them keep accurate accounting books and prepare quality financial statements, CPAs under existing independence standards are faced with a difficult dilemma. If CPAs perform or maintain internal controls for the benefit of their clients, they impair their independence and then are not able to perform a review.
On the other hand, if the client doesn’t have these controls in place, the client is most likely unable to keep their books or prepare monthly financial statements that are in accordance with appropriate accounting standards. As a result, management and users may not be receiving reliable monthly financial information. This puts the CPA in the difficult position of deciding whether to perform the internal control services (designed to prevent or detect and correct misstatements in the accounting records) or, to maintain independence, let clients struggle on their own.
In many cases, where the CPA’s independence has been impaired due to the performance of these services, clients have needed to engage another firm to perform a year-end review. Having two CPA firms involved increases costs and, from the client’s perspective, is an inefficient and awkward process. Clients (as well as their banks) are rightly confused about the logic behind having to engage a second firm to perform a year-end review engagement when the client’s longtime CPA is in a better position to understand the client and their business.
Faced with this situation in increasing numbers, CPAs who serve small businesses turned to the AICPA and ARSC and questioned whether the current framework for the performance of and reporting on compilation and review engagements was still appropriate. ARSC sought input from small business owners, third-party users of small business financial statements, and CPA practitioners who serve smaller businesses (see sidebar, “Why Tackle This Project Now?”) regarding whether they believed the current requirements for compilation and review engagements and their interplay with the independence rules were appropriate.
After studying the issue, including the alternative frameworks for the financial reporting process, ARSC has proposed repositioning the requirement to be independent in the performance of a review engagement. Under current standards, the accountant must be independent with respect to the client to perform a review (that is, it is a precondition). Since independence is a precondition related to performing a review engagement, practitioners are precluded from performing a review without regard to why independence is considered impaired.
The proposed review standard incorporates the recommendations of the AICPA Reliability Task Force and responds to the concerns touched on earlier by permitting an accountant to perform the review when the accountant’s independence is impaired by the performance of internal control services, which are designed to improve the quality or reliability of the client’s financial information and have no impact on a CPA’s objectivity.
If CPAs chose to perform a review when their independence is impaired because of the performance of these services, the proposed standard would still require them to obtain the same level of objective evidence (as if they were independent) and to disclose in the review report that certain services were performed and that those services impaired their independence. An accountant would still be precluded from reviewing the financial statements for a client when the accountant’s independence is impaired for any other reason.
OTHER KEY CHANGES: REVIEW ENGAGEMENTS
Additional changes proposed in the exposure draft relate to incorporating concepts into the standards that are intended to harmonize the U.S. review standards with both the international review standard and also with review guidance in the existing attestation standards.
1. Moderate assurance and review evidence
Current authoritative literature for review engagements includes the stipulation that, to obtain a reasonable basis for the expression of limited assurance, the accountant must:
- Apply analytical procedures to the financial statements.
- Make inquiries of management and, when deemed appropriate, other company personnel.
- Obtain representations from management for all financial statements and periods covered by the accountant’s review report.
However, nothing in the existing standards provides a framework for the level of assurance that the practitioner is seeking to obtain or explains conceptually how the practitioner should tailor review procedures to accomplish the objective of a review. As a result, some review engagements are performed by blindly using an illustrative checklist rather than having the CPA apply professional judgment to tailoring the nature and extent of review procedures to the client’s situation. When this is done, the review engagement is more akin to an agreed-upon procedures engagement than an assurance engagement. The proposal attempts to make clear the level of assurance that the CPA is seeking to obtain as well as to provide a conceptual framework on how to accomplish that level of assurance.
The proposal uses the term moderate assurance in place of the term limited assurance in the existing literature. Moderate assurance is the term used in the international review standards as well as in existing U.S. technical literature related to attestation engagements. The levels of assurance obtained in an SSARSs review, a review performed in accordance with the international standards, and a review performed in accordance with the attestation standards are intended to be equivalent. Because limited assurance may mean any level of assurance on a spectrum from zero to something just less than 100%, the use of the term moderate assurance better articulates the concept that the level of assurance the CPA is attempting to attain is approximately in the middle of that spectrum.
ARSC also determined that, to harmonize with the concept of evidence included in international review engagement requirements, the term review evidence should be introduced to the review literature. It is defined in the proposed standard as the “information used by the accountant to provide a reasonable basis for the obtaining of moderate assurance.” Review evidence necessary to restrict review risk to a moderate level ordinarily can be obtained through analytical procedures and inquiries.
ARSC members believe that practitioners appropriately performing review engagements under the existing standards should see minimal impact on the performance of their engagements with the introduction of the terms moderate assurance or review evidence. They believe these proposed changes will help practitioners understand that a review engagement is an assurance engagement and to understand the consideration of evidence that is required in order to conclude on the financial statements.
2. Review risk
The proposal introduces the term review risk and defines it as “the risk that the accountant may unknowingly fail to modify his or her review report on financial statements that are materially misstated.” ARSC determined that the risk should be acknowledged in the proposed guidance so practitioners can understand the concept of review evidence. The proposed guidance does not require the accountant to perform risk assessment procedures as would be performed in an audit engagement. Practitioners should see minimal impact on the performance of their engagements with the introduction of the concept of review risk.
3. Requirement to obtain an engagement letter
Current review standards state that the accountant should establish an understanding with the entity, preferably in writing, regarding the services to be performed. Many practitioners have determined that best practice dictates that the understanding should be documented through the use of an engagement letter.
The proposal makes establishing an understanding with management regarding the services to be performed for each engagement through an engagement letter a requirement. The requirement is designed to align review engagements performed in the U.S. with engagements performed internationally and with requirements for U.S. audit engagements. Although this may constitute an additional procedure for some accountants, ARSC determined that it is an improvement in practice.
4. Enhanced documentation requirements
The proposal includes the stipulation that the review documentation should include the matters covered in the accountant’s inquiry procedures. The proposed review standard establishes a requirement that the accountant document management’s responses to the accountant’s inquiries regarding fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. Additionally, there is a proposed requirement that the accountant document management’s responses to the significant matters covered in the accountant’s inquiry procedures.
The documentation may result in additional procedures for some accountants. ARSC determined that the additional documentation requirement is appropriate since it supports the accountant’s conclusion that he or she obtained sufficient review evidence to support his or her conclusion on the financial statements.
5. Revised reporting requirements
In addition to the revisions to the reporting requirements to disclose an independence impairment caused by the performance of internal control services, the proposed review standard further revises the reporting requirements for a review engagement to provide more transparency as to the procedures that the accountant performed, the level of assurance that those procedures are designed to obtain, and the conclusion reached. See Exhibit 1 for a comparison of current and proposed reporting requirements.
KEY CHANGES: COMPILATION ENGAGEMENTS
The primary change in the proposed guidance for compilation engagements relates to circumstances where practitioner independence with respect to the client has been impaired (see Exhibit 2 for a comparison of current and proposed reporting requirements). As proposed, practitioners would be allowed to report the reasons for the lack of independence, where current literature precludes disclosure of those reasons. Additionally, documentation requirements for compilation engagements would be slightly enhanced.
1. Requirement to obtain an engagement letter
Consistent with the decision to require a signed engagement letter from the client in a review engagement, an accountant would obtain an engagement letter in a compilation engagement as well. Doing so for any type of engagement helps reduce the likelihood that clients could misunderstand the nature of the services being performed.
2. Clarifying documentation requirements
In the current technical literature, the accountant has minimal documentation requirements in a compilation engagement. When an accountant compiles financial statements that are not intended to be used by third parties and the accountant uses the nonreporting exception for those engagements, the accountant is required to document the understanding of the engagement through an engagement letter. The only other required documentation in a compilation engagement relates to when the accountant communicates to management regarding fraud or illegal acts and when the accountant determines to perform alternative procedures instead of a presumptively mandatory procedure.
The proposed compilation standard would require that the accountant’s documentation include:
- The engagement letter.
- The communications to management regarding fraud and illegal acts, if any communication was made.
- Any findings or issues relating to the financial statements that came to the accountant’s attention that, in the accountant’s judgment, are significant, as well as actions taken to address such findings, and to the extent that the accountant had any questions or concerns, how those issues were resolved.
ARSC believes that the documentation of any findings and issues in a compilation engagement will enhance the performance of compilation engagements.
3. Disclosure of the reasons for a lack of independence in a compilation engagement
Current compilation standards prohibit accountants from disclosing the reasons for a lack of independence in a compilation report. However, third-party users of compiled financial statements have advised ARSC that they would find knowing the reasons that independence has been impaired useful in considering the accountant’s compilation report. Under the proposed standard, the accountant would be permitted, but not required, to disclose a general description of the reasons for the lack of independence.
WHAT CAN YOU DO?
ARSC is mindful of the need for the professional literature to drive the performance of engagements to serve the public interest. Also there always is the need to provide practitioners with the guidance necessary to appropriately perform and report on both compilation and review engagements. ARSC believes the proposed standards are responsive to the needs of the marketplace and represent a significant improvement of the professional literature for compilation and review engagements.
However, the work is not done. Stakeholders can provide input related to finalizing the new standards. The comment period on the proposed SSARSs ends on July 31. ARSC urges all interested parties to read the proposed standards and submit comment letters, whether they support the standards or suggest revisions to the proposed literature. ARSC will consider all of the comments at its September meeting.
The AICPA’s Accounting and Review Services Committee has proposed the most significant changes to the professional literature for compilation and review engagements in more than 30 years.
The primary change in the proposed standards for review engagements relates to allowing practitioners to perform review engagements when independence has been impaired due to the performance of a nonattest service designed to help management prepare higher quality or more reliable financial statements.
The proposal makes establishing an understanding with management regarding the services to be performed for each engagement through an engagement letter a requirement and includes enhanced documentation and reporting requirements.
The most significant change in the proposed standards for compilation engagements is the ability for the accountant to disclose a general description of the reasons for a lack of independence in the compilation report.
Thomas A. Ratcliffe , CPA, Ph.D., is director of accounting and auditing at Wilson Price in Montgomery, Ala. Charles E. Landes, CPA, is vice president–Professional Standards and Services Group for the AICPA. Michael P. Glynn, CPA, is a technical manager for the AICPA Audit and Attest Standards Team. Their e-mail addresses are, respectively, firstname.lastname@example.org, email@example.com and firstname.lastname@example.org.
“Refocusing on Reliability,” Oct. 08, page 74
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