One of the many challenging issues in public accounting during the coronavirus pandemic is the question of how practitioners should handle compilations of financial statements in which clients have elected to omit substantially all disclosures.
Cost savings is just one of many reasons why reporting entities choose to distribute financial statements that omit substantially all disclosures. It may be too costly for a company to prepare financial statements with a full set of disclosures when the information is only being used by internal staff or banks that already are well informed about the company's financials.
But pandemic-related issues related to cash flow, liquidity, subsequent events, and going concern create a danger that financial statements that omit disclosures about such issues may mislead users. And a practitioner is not permitted to issue a compilation report if, in the practitioner's professional judgment, the financial statements would be misleading to users of such financial statements.
The Statements on Standards for Accounting and Review Services (SSARSs) are clear for engagements that substantially omit all disclosures. AR-C Section 80, Compilation of Financial Statements, does not preclude practitioners from adding additional paragraphs in their report to emphasize matters that the practitioner considers appropriate.
A CPA performing such an engagement who concludes that the financial statements are not misleading simply needs to make it clear in the compilation report that:
- Management has chosen to omit substantially all disclosures.
- If the omitted disclosures had been included, they might influence the user's conclusions about the reporting entity.
- The financial statements are not designed for those who are not informed about the entity's financial position, results of operations, and cash flows.
While the practitioner has no control over distribution, the practitioner may advise the client to limit the distribution of the financial statements to users for whom the financial statements were designed.
Difficult judgment
With many businesses struggling to remain solvent during the pandemic, the risk that financial statements that omit substantially all disclosures may be misleading is heightened. This creates a challenge for many practitioners engaged to perform a nondisclosure compilation, particularly around the issues of going concern and subsequent events.
"You get into this new world where events subsequent to year end may be less certain than in the past," said Mike Westervelt, CPA, a principal with CLA in Charlotte and a member of the AICPA Accounting and Review Services Committee. "Are you even operating? What's going on with your business? There's probably some benefit to including some selective disclosure to clarify these matters."
The process for a high-quality engagement in these circumstances starts with the practitioner gaining an understanding of the client's business and then making a judgment on whether the financial statements may be misleading with the omission of certain disclosures.
This is an easy judgment if the business is on sound footing and the financials reflect that. If the client has liquidity risks or there is substantial doubt about the client's ability to continue as a going concern, the judgment gets more difficult.
"This is going to be a judgment call at the end of the day with fairly limited actual requirements," said Danielle Supkis Cheek, CPA, director, Entrepreneurial Advisory Services for PKF Texas and chair of the AICPA Technical Issues Committee. "It's going to feel uncomfortable, and there are going to be a lot of uncomfortable conversations."
A CPA's options
If a CPA determines that the financial statements may be misleading without certain disclosures, Westervelt recommends having a discussion with the client. The client can choose to make selective disclosures about any troublesome matters (for example, going concern) so that risk that the financial statements may be misleading is lessened. In that case, Westervelt said, the CPA can add a separate paragraph to the compilation report referring to the disclosure.
Selective disclosures should be labeled in the financial statements as selective information, with language explaining that all the disclosures required by the applicable accounting framework are not included.
If the client decides not to make a disclosure that would lessen the risk that the financial statements may be misleading, Westervelt said, the CPA can add a separate paragraph to the compilation report that provides users with the necessary information.
Westervelt prefers the selective disclosure accompanied by the separate paragraph referencing such disclosure.
"But if the client determines that they don't want to say anything, it is in the professional's ability to say, 'I'm going to add a separate paragraph because I think it's important,'" Westervelt said "But you want to have that conversation with your client and say, 'I'm going to add this paragraph because it's important.'"
Supkis Cheek advocates having a good dialogue with a client on this topic, and said selective disclosures most often are the best option. She said she tries to explain to clients that selective disclosure can benefit the company because it gives management a chance to tell the story about its risks and challenges — and also its plans for addressing those issues — in the current environment.
"It's the client's financial statements, and it is their opportunity to provide context," she said.
The Center for Plain English Accounting (CPEA) is the AICPA's national A&A resource center and assists members with accounting, auditing, attest, review, and compilation needs by sharing technical advice and guidance in a straightforward manner. For more information on the benefits of membership, visit the CPEA webpage.
For more news and reporting on the coronavirus and how CPAs can handle challenges related to the outbreak, visit the JofA's coronavirus resources page or subscribe to our email alerts for breaking PPP news.
— Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA's editorial director.
