EXECUTIVE
SUMMARY |
SSARS NO. 12,
Omnibus Statement on
Standards for Accounting and Review
Services2005, amended SSARS no.
1, making specific changes regarding the
practitioners consideration of fraud and
illegal acts in compilation and review
engagements. ALTHOUGH
COMPILATION AND REVIEW
performance standards dont require CPAs
to assess the risk of fraud, they still
must inform the client of incorrect,
incomplete or otherwise unsatisfactory
information discovered during an
engagement. ACCOUNTANTS
NEED NOT REPORT illegal
acts that are clearly inconsequential
and may reach agreement in advance with
the entity regarding the nature of such
items to be communicated.
MISSTATEMENTS IN FINANCIAL STATEMENTS
may be intentional, thus
constituting fraud, or unintentional,
the result of error. Therefore, in a
review, CPAs must make specific
inquiries and obtain specific written
representations from management about
fraud. IN ADDITION
TO THE REVISIONS to SSARS
no. 1 related to fraud, SSARS no. 12
contains amendments to guidance on
updating management representation
letters, restricted-use reports and
restatement adjustments. |
J. RUSSELL
MADRAY, CPA, is president of the Madray
Group Inc., an accounting and auditing
technical consulting practice, and a
senior lecturer at Clemson Universitys
School of Accountancy and Legal Studies in
Clemson, S.C. His e-mail address is
russ@madray.com . |
new statement on
standards for accounting and review services
(SSARS) makes specific changes regarding an
accountants consideration of fraud and illegal
acts in compilation and review engagements. The
AICPA Accounting and Review Services Committee
(ARSC) amended SSARS no. 1, Compilation and
Review of Financial Statements by issuing
SSARS no. 12, Omnibus Statement on Standards
for Accounting and Review Services2005.
This article covers SSARS no. 12s changes, which
are generally effective for compilations and
reviews of financial statements for periods ending
after December 15, 2005. SSARS no. 12
does not change the objectives in such
engagements. You need not report illegal acts that
are clearly inconsequential and may reach
agreement in advance with the entity regarding the
nature of such items to be communicated. The
statement doesnt require you as the CPA to assess
the risk of fraud or to plan a compilation or
review engagement specifically to discover fraud.
However, this doesnt relieve you of
responsibility for informing the client if
incorrect, incomplete or otherwise unsatisfactory
information comes to your attention during the
engagement. In 2004 ARSC issued SSARS
no. 10, which required that the accountant in a
review engagement make specific inquiries and
obtain written representations from management
regarding fraud (see
An Update on Review Engagements,
JofA , Aug.04, page 69). At the same time
ARSC issued an interpretation to explain what
steps should be taken to communicate about fraud
or illegal acts when, during the performance of a
compilation or a review engagement, the accountant
suspects that fraud or an illegal act may have
occurred.
Trouble by the
Numbers
Compilation Engagements: Causes of
Malpractice Claims, 19942000
Errors on financial
statements | 33%
|
Failure to detect defalcation
| 25 |
Engagement scope
dispute | 18 |
Inadequate
disclosures | 9 |
Conflict of
interest | 7 |
Fraud |
6 |
Release of records |
2 |
Total | 100%
|
Source: AICPA,
Compilation and Review Alert 2004/05,
page 14. |
FIRST THINGS FIRST: THE UNDERSTANDING
SSARS no. 1 (as amendedin
this and all other references in this article)
says CPAs should establish an understanding with
the client, preferably in writing, regarding the
compilation or review services to be performed.
This should include a description of the nature
and limitations of the services to be performed
and of any report to be issued. It also should
provide that The engagement cannot
be relied upon to disclose errors, fraud or
illegal acts. The CPA will inform the
appropriate level of management of any material
errors and any evidence or information that comes
to his or her attention during the performance of
compilation or review procedures that fraud or
illegal acts may have occurred. In performing such
an engagement you need not report any matters
regarding illegal acts that are clearly
inconsequential and may reach agreement with the
entity in advance about which matters will be
communicated.
More SSARSs
The AICPA Accounting and Review
Services Committee (ARSC) also recently
issued SSARS nos. 13 and 14 (see Official
Releases, JofA, Nov.05, pages 109121).
SSARS no. 13, Compilation of
Specified Elements, Accounts, or Items
of a Financial Statement, expands
the applicability of the SSARSs to
situations in which an accountant is
engaged to compile, or issues a
compilation report on, specified elements,
accounts or items of a financial
statement. SSARS no. 14, Compilation
of Pro Forma Financial Information,
expands the applicability of SSARSs
to situations in which an accountant is
engaged to compile, or issues a
compilation report on, pro forma financial
information. |
COMPILATIONS The
objective of a compilation is to present
informationin the form of financial
statementsthat is the representation of
management, without undertaking to express any
assurance on the statements. You are not required
to perform any additional procedures or search for
fraud or illegal acts. However, during the
performance of compilation or review procedures,
such as inquiries or analytical procedures
in a review or reading the financial statements in
a compilation, if any evidence or information
comes to your attention regarding fraud or an
illegal act, you should request that management
consider the effect of the matter on the financial
statements and you should consider its effect on
the compilation report. If you believe the
financial statements are materially misstated, you
should obtain additional or revised information.
REVIEWS
A review engagement provides limited
assurance that the financial statements require no
material modifications in order to conform to
generally accepted accounting principles (GAAP) or
an other comprehensive basis of accounting
(OCBOA). Misstatements can be intentional, thus
constituting fraud, or unintentional, the result
of error. SSARS no. 1, issued in 1978, established
that the objective of a review engagement is to
provide a CPA with a reasonable basis for
expressing such limited assurance. The
SSARS requires the accountant to obtain from
management specific written representations for
all financial statements and periods covered by
the accountants review report. The contents will
depend on the circumstances of the engagement and
the nature and basis of the presentation of the
financial statements, but management must
specifically acknowledge Its responsibility to
prevent and detect fraud. Any awarenessincluding
communications received from employees, former
employees or othersof any fraud or suspected
fraud affecting the entity that could have a
material effect on financial statements.
COMMUNICATION IS THE KEY
When fraud or an illegal act involves
senior management, you should report it to an
individual or group at a higher level, such as the
manager, owner or board of directors. The
communication may be oral or written; if its
oral, you should document it. When an owner of the
business is involved, you should consider
resigning from the engagement. You also
should consider consulting with your counsel and
insurance provider whenever any information comes
to your attention that fraud or an illegal act may
have occurred, unless its clearly
inconsequential. Its not ordinarily
part of the CPAs job to disclose any evidence or
informationabout fraud or illegal acts that may
have occurredto parties other than the clients
senior management or board of directors. In fact,
doing so would be precluded by your ethical or
legal obligations of confidentiality unless its
To comply with certain
legal and regulatory requirements. To respond to a
successor accountant who is communicating with you
in accordance with SSARS no. 4,
Communications Between Predecessor and Successor
Accountants (AICPA, Professional
Standards, volume 2, AR section 400), as
amended, regarding acceptance of an engagement to
compile or review the financial statements of a
nonpublic entity. In response to a
subpoena. Its a good idea to consult
with legal counsel before discussing matters with
outside parties.
Litigation Risk in
Compilation Engagements
Y ouve
likely heard about the growing trend of
lawsuits filed against CPAs who perform
compilations and bookkeeping services that
fail to detect employee embezzlement. As
CPAs, you should be aware that the risk of
a costly lawsuit is present in all
engagementseven compilation engagements.
Here are some steps to take. Perform all
compilation engagements in accordance
with statements on standards for
accounting and review services (SSARSs).
Many clients do not understand or
appreciate the fact that a compilation
or bookkeeping service does not include
the examination of cancelled checks or
bank images. Some clients presume that
when you ask for their bank statement or
reconciliation, you are examining the
cancelled checks for fraudulent payees
and/or endorsementsthough clearly,
compilation standards do not require
that. Its important to have a
meaningful discussion with each client
about the compilation procedures you
will perform and to tailor the
engagement letter to reflect what will
and wont be done. Reassess your
firms client acceptance and continuance
procedures. Practice Alert 2003-03,
Acceptance and Continuance of
Clients and Engagements,
provides guidance with respect to such
procedures (
www.aicpa.org/download/secps/pralert_03_03.pdf
). Talk to your
clients who own businesses about the
risk of fraud and their
responsibilities. Since it is not your
responsibility to examine cancelled
checks when performing a compilation
engagement, stress that its important
for the business owner (or someone else
unrelated to the cash function) to
perform this procedure as part of
internal control over financial
reporting. Avoid clients
that operate in industries outside your
firms expertise. SSARSs do not prevent
your accepting such engagements, but
they do require that you obtain the
necessary level of knowledge to properly
serve those clients. Use clearly
worded engagement letters that outline
both your responsibilities and the
clients. (For examples, go to
www.aicpa.org/members/div/auditstd/technic_arsc.asp
.) Stress that a compilation does
not involve obtaining an understanding
of internal control or assessing control
risk; testing accounting records by
obtaining corroborating evidential
matter through inspection, observation
or confirmation (for example, by
examining cancelled checks); or
performing inquiries, analyses or
certain other procedures ordinarily
performed in audits or reviews.
When
performing bookkeeping services,
especially as part of an engagement to
perform management services, take
special care to have a detailed
engagement letter that spells out the
procedures you will perform relative to
any cash account. When performing a bank
reconciliation, specify what procedures
will be performed, especially with
respect to the payee and the endorsement
of cancelled checks. Be aware of
three key facts about your risk in
compilation engagements:
The potential
for fraud exists on all engagements.
Although
SSARSs clearly state that a compilation
cannot be relied upon to disclose fraud
and that it is not your responsibility,
the publics perception often is
different. Theres a
growing trend of litigation against
accounting firms. A few
minutes of care and explanation can
protect your firm from litigation and
damage to its reputation. |
FRAUD OR ILLEGAL ACT?
Fraud is a broad legal concept, and
accountants do not make legal determinations of
whether an act is, in fact, fraudulent. Rather,
the accountants interest specifically relates to
acts that result in a material misstatement of the
financial statements. The primary factor that
distinguishes fraud from error is whether the
underlying action is intentional. If it is, its
fraud. Intent often is difficult to
determine, particularly in matters involving
accounting estimates and the application of
accounting principles. Two types of misstatements
are relevant to consideration of fraudthose
arising from fraudulent financial reporting and
those from misappropriation of assets.
Misstatements arising from fraudulent
financial reporting are
intentional misstatements or omissions of amounts
or disclosures in financial statements designed to
deceive financial statement users where the effect
causes the financial statements not to be
presented, in all material respects, in conformity
with GAAP or OCBOA.
Misstatements arising from misappropriation of
assets (sometimes referred to
as theft or defalcation) involve the theft of an
entitys assets that causes the financial
statements not to be presented in all material
respects in conformity with GAAP or OCBOA.
The term illegal acts refers to violations of
laws or governmental regulations other than fraud.
Illegal acts by clients, management or employees
acting on behalf of an entity are attributable to
the entity. Such acts cover a broad range of
issues, including occupational safety and health,
employment practices, environmental protection and
antitrust laws but not personal misconduct by the
entitys personnel unrelated to their business
activities. Illegal acts may not always be
intentional and may not always have an effect on
financial statements. Determining
whether an act is fraudulent or illegal is
normally beyond accountants professional
competence. It would generally be based on the
advice of an informed expert qualified to practice
law or final determination by a court of law.
However, an accountants training, experience and
understanding of the client and its industry may
provide a basis for recognizing that some client
acts may be fraudulent or illegal.
PUT IT IN WRITING
Although there are no specific
documentation requirements in a compilation
engagement, any information about suspected fraud
that you communicate to management or others
should be documented in the engagement workpapers.
In a review engagement, any
communications, whether oral or written, to
management or others regarding fraud or illegal
acts that come to your attention must be
documented in the workpapers.
UPDATE, RESTRICT, RESTATE
In addition to the revisions
to SSARS no. 1 related to fraud, SSARS no. 12
contains amendments to guidance on updating
management representation letters, restricted-use
reports and restatement adjustments.
The new guidance discusses the circumstances in
which you should consider obtaining an updating
representation letter from management. Examples
include situations in which You do not issue your
review report for a significant period of time
after obtaining a management representation letter
upon completion of inquiry and analytical review
procedures. A material event occurs
after the completion of inquiry and analytical
review procedures, including obtaining the
original management representation letter, but
before issuance of the report on the reviewed
financial statements. In cases where a
former client asks a predecessor accountant to
reissue his or her report on the financial
statements of a prior periodand those statements
are to be presented on a comparative basis with
reviewed financial statements of a subsequent
periodthe predecessor accountant should obtain an
updating representation letter from the management
of the former client.
AICPA RESOURCES
|
Publications SSARS No. 12,
Omnibus Statement on Standards for
Accounting and Review Services2005
(paperback, # 060650JA). SSARS no. 13,
Compilation of Specified
Elements, Accounts, or Items of a
Financial Statement (paperback,
# 060651JA). SSARS no. 14,
Compilation of Pro Forma
Financial Information
(paperback, # 060652JA).
Compilation and Review Alert2005/06
(paperback, # 022306JA).
Compilation and Review
EngagementsEssential Questions and
Answers (paperback, #
006622JA). Review
Engagements: New and Expanded Guidance
on Analytical Procedures, Inquiries
and Other Procedures
(paperback, #006618JA).
CPE
Advanced Update for Compilation and
Review Engagements (text, #
731505JA). Also available as a public
seminar or on-site training (
www.aicpalearning.org/public_seminars.asp
). Conferences
National Advanced
Accounting and Auditing Technical
Symposium Chicago July
1921, 2006 For more
information about these resources, to
place an order or to register, go to
www.cpa2biz.com or call
888-777-7077. |
SSARS no. 12 also
revises SSARS no. 1 to provide guidance on
restricting the use of reports issued pursuant to
SSARSs. The term general use applies
to compilation and review reports that are not
restricted to specified parties, while
restricted use applies to reports that
are intended only for specified third parties.
Restrictions on the use of a report may arise, for
example, from the purpose of the report and the
potential for it to be misunderstood when taken
out of context. Restrict the use of a report when
its subject matter, or the presentation being
reported on, is based on measurement or disclosure
criteria contained in contractual agreements or
regulatory provisions not in conformity with GAAP
or OCBOA. Also consider informing your client that
restricted-use reports are not intended for
distribution to nonspecified parties, even when
they are included in a document containing a
separate general-use report. In establishing the
terms of the engagement, the new guidance does not
preclude your reaching an understanding with the
client that the client and the specified parties
will distribute it only to parties identified in
the report. You are not responsible for
controlling a clients distribution of a
restricted-use report, though the report should be
worded to alert readers to the restriction on its
use. SSARS no. 12 revises SSARS no. 2,
Reporting on Comparative Financial
Statements (AICPA, Professional
Standards, volume 2, AR section
200.25.26), to allow a successor accountant to
report on the restatement adjustment of
prior-period financial statements while indicating
that a predecessor accountant reported on the
financial statements of the prior period before
restatement. The previous guidance precluded the
successor accountants reporting on the
restatement adjustment only.
Requirements for
Consideration of Fraud and Illegal
Acts
Requirement
|
Compilation |
Review
| Audit
|
Establish required
understanding with the
entity. |
The engagement cannot be
relied upon to disclose errors,
fraud or illegal acts, but you
must inform the appropriate
level of management
of any material errors, or any
evidence or information that
comes to your attention during
the performance of compilation
procedures that fraud
or an illegal act may
have occurred. You need not
report any matters regarding
clearly inconsequential
illegal acts that may have
occurred and may reach
agreement in advance with the
entity on the nature of any
such matters to be
communicated. |
The engagement cannot be
relied upon to disclose errors,
fraud or illegal acts, but you
must inform the appropriate
level of management
of any material errors, or any
evidence or information that
comes to your attention during
the performance of review
procedures that fraud
or an illegal act may
have occurred. You need not
report any matters regarding
clearly inconsequential
illegal acts that may have
occurred and may reach
agreement in advance with the
entity on the nature of any
such matters to be
communicated. |
GAAS requires that you
obtain reasonable, rather than
absolute, assurance about
whether the financial statements
are free of material
misstatement, whether caused by
error or by fraud. Accordingly,
a material misstatement may
remain undetected. Also an
audit is not designed to
detect error or fraud that is
immaterial to the financial
statements. |
Conduct brainstorming
session among engagement
personnel regarding the
risks of material
misstatement due to fraud.
| No
| No | Yes
|
Gather information
necessary to identify risks
of material misstatement due
to fraud. |
No | No |
Yes |
Identify risks that may
result in a material
misstatement due to fraud.
| No
| No | Yes
|
Evaluate the entity's
programs and controls that
address the identified risks
of material misstatement due
to fraud, and assess the
risks, taking into account
this evaluation.
| No | No
| Yes |
Respond to the results
of the assessment.
| No | No
| Yes |
Evaluate evidence.
| No |
No | Yes |
Communicate information
about fraud to management.
| Only
evidence or information that
fraud or an illegal act may have
occurred that comes to your
attention during the performance
of compilation procedures need
be communicated. |
Only evidence or information
that fraud or an illegal act may
have occurred that comes to your
attention during the performance
of review procedures need be
communicated. | Yes
|
Document any
communications, whether oral
or written, to management or
others regarding fraud or
illegal acts.
| Recommended |
Required |
Required |
Document the
consideration of fraud.
| No |
No | Yes |
|
|