Auditing Notes - Chapter 2

Quality Control Standards I.

II.

Applicability: A. A CPA firm is required by the AICPA Code of Professional Conduct to adopt a system of quality control for its auditing, attestation, and accounting and review services. B. Statements on Quality Control Standards (SQCS) are issued by Auditing Standards Board and are applicable to both audit and non-audit engagements. Elements: The five interrelated elements of quality control are: • A – Acceptance and Continuance of Clients and Engagements • I – Independence, Integrity, and Objectivity • C – Continuous Monitoring • P – Personnel Management • A – Assurance Regarding Engagement Performance • AICPA is all about quality control standards. A. Acceptance and Continuance of Clients and Engagements 1. Policies to decide to accept or continue client relationship and to perform a specific engagement 2. Policies for the likelihood of association with a client whose management lacks integrity is

minimized and that the firm: a. Undertakes only those engagements that it can reasonably expect to complete with professional competence b. Appropriately considers the risks associated with providing professional services in the particular circumstances 3. Examples: a. Reviewing the FS and credit rating of the proposed client b. Inquiring of third parties as to the reputation of the proposed client c. Evaluating the firm’s ability to service the client properly d. Periodically re-evaluating clients for continuance B. Independence, Integrity, and Objectivity 1. Maintain public confidence in the profession 2. Policies that personnel maintain independence (in fact and appearance), perform all professional responsibilities with integrity, and maintain objectivity in discharging professional responsibilities 3. Qualities are defined and described as follows: a. Independence encompasses impartiality and freedom from any obligation to or interest in the client b. Integrity requires personnel to be honest and candid. Service and the public trust must not be subordinated to personal gain advantage c. Objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest 4. Examples include: a. Maintaining records showing which personnel were previously employed by clients or have relatives holding key positions with clients b. Notifying personnel as to the names of the audit clients publicly held c. Confirming with staff that prohibited relationships do not exist d. Emphasizing independence of mental attitude in training and supervision 5. The SOX of 2002 contains certain provisions that must be followed to maintain independence: a. Prohibits other services for audit clients (i.e. bookkeeping, financial information systems design/implementation, appraisals, actuarial services, internal audit outsourcing services, management/human resource functions, investment services, legal services) i. Other non-audit services may be performed if they are pre-approved by the audit committee and disclosed to investors in periodic report (i.e. tax services) ii. Tax service and related fees must be communicated to audit committee in writing. Potential effects of the services on the firm’s independence should be discussed with audit committee and documented

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b. Cannot audit public companies whose CEO, CFO, etc. if also a previous employee of the

accounting firm who worked on the audit during the preceding year. i. 1 year cool off period c. The lead partner and the reviewing partner must rotate off the audit every 5 years d. No contingent fee arrangements e. Not provide audit clients any tax services for confidential or aggressive tax transactions f. Not provide any tax services to corporate officers of audit clients, or family members of corporate officers. i. Officers personal tax return NOT allowed C. Continuous Monitoring 1. Establish policies to oversee that policies established by the firm for each of the other elements of quality control are suitably designed and are applied 2. Monitoring involves an ongoing consideration and evaluation of the: a. Relevance and adequacy of the firm’s policies and procedures b. Appropriateness of the firm’s guidance materials and any practice aids c. Effectiveness of professional development activities d. Compliance with the firm’s policies and procedures 3. Examples: a. Inspect audit documentation and administration files for selected clients b. Peer review conducted under AICPA standards c. A “wrap-up” or second partner “preissuance” review of audit documentation by a partner not involved in the audit. SOX 2002 requires such review for every public company audit report. Purpose of this review is to focus on the fair presentation of the FS in conformity with GAAP d. Performance of corrective actions and communication of weaknesses to firm personnel 4. Peer Review a. Self-Regulation: i. One CPA firm reviews another CPA firm’s compliance with quality control. CPA firm, that is member of the AICPA, must have a peer review every 3 years to maintain membership with AICPA. Firm can choose the firm to ask or ask AICPA to select a review team b. Purpose ii. Purpose of peer review is to determine and report whether the CPA firm has developed adequate policies and procedures for the elements of quality control and if following them in practice c. Results iii. A report is issued with conclusions and recommendations. If firm fails to take corrective actions, it is subject to sanctions D. Personnel Management 1. Criteria for hiring, assignment of the firm’s personnel to engagements, professional development, and advancement 2. Personnel management policies should be established: a. Those hired possess the appropriate characteristics to perform competently b. Work is assigned to personnel that have the degree of technical training and proficiency required in the circumstances c. Personnel participate in continuing education and professional development activities d. Personnel selected for advancement have the qualifications necessary to fulfill the responsibilities to be assumed 3. Examples: a. Requiring timely identification of staffing requirements b. Planning for the total personnel needs of all the professional engagements c. Requiring a background check on new personnel Becker Auditing – 2008 Edition

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Requiring supervisors to prepare performance evaluations Requiring personnel to attend training Consideration of continuity and periodic rotation of personnel Consideration of opportunities for on-the-job training E. Assurance Regarding Engagement Performance 1. Policies to check that the work performed by engagement personnel meets applicable professional standards, regulatory requirements, and the firm’s own standards of quality a. Such policies should encompass all phases of design and execution of the engagement – planning, performing, supervising, reviewing, documenting, communicating results, and consulting with individuals having appropriate knowledge, competence, judgment, and authority 2. Examples: a. Designating individuals with expertise in matters related to the SEC b. Referring questions to the appropriate group in the AICPA or state society c. Developing and using standard audit forms, checklists, and questionnaires d. Establishing procedures for reviewing engagement documentation and reports Other Considerations A. Policies: nature and extent of firm’s quality control policies depend on: 1. The firm’s size 2. Its organizational structure 3. The nature and complexity of its practice 4. The degree of operating autonomy allowed its personnel and its individual offices 5. Cost-benefit considerations B. Relationship Between Auditing Standards and Quality Control Standards 1. GAAS vs. Quality Control Standards a. GAAS relates to the conduct of each individual audit engagement b. Quality Control relates to the conduct of all professional activities of the firm’s practice as a whole c. The quality control standards of a firm affect both the performance of each audit and the performance of the audit practice as a whole 2. Quality Control Deficiencies: a. Deficiencies/noncompliance with quality control standards does NOT mean lack of GAAS compliance d. e. f. g.

III.

OTHER ENGAGEMENTS, REPORTS, AND ACCOUNTING SERVICES I.

Special Reports: Client does not necessarily have to comply with GAAP o Auditor has to comply with GAAS and obtain reasonable degree of assurance. o Auditing standards have restricted special reports to the following 5 areas: i. OCBOA – Other comprehensive basis of accounting financial statements • Ex: cash basis, tax basis ii. Specified elements, accounts, or items in a financial statement • Ex: audit accounts receivable only iii. Compliance with contractual or regulatory requirements related to audited financial statements iv. Financial presentations to comply with contractual agreements or regulatory provisions v. Financial information presented in prescribed forms or schedules that require a prescribed form of auditor’s report A. Financial Statements Prepared in Conformity with an OCBOA 1. OCBOA Financial Statements = Non-GAAP, considered comprehensive basis of accounting a. A cash receipts and disbursements system b. A basis of accounting that the entity uses to file its income tax returns c. A basis of accounting used to comply with the requirements of a governmental regulatory agency having jurisdiction over the reporting entity d. A definite set of criteria having substantial support that is applied to all material items, such as price-level adjusted financial statements

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The use of a non-GAAP method requires the auditor to modify the report to either a `qualified` or `adverse` opinion unless the non-GAAP method is an OCBOA, where the unqualified opinion on the OCBOA basis is appropriate. 2. Reports on OCBOA Financial Statements: Significant differences between the standard auditor`s report and OCBOA FS: a. Non-GAAP Titles (Introductory and Opinion Paragraphs) i. Don`t use GAAP terms ii. Examples:
Statement of assets and liabilities arising from cash transactions
Statement of revenue collected and expenses paid
Statement of income – statutory basis
Statement of increases or decreases in funds arising from cash transactions b. Scope paragraph: i. Same as standard report c. Explanatory paragraph: OCBOA is... i. The basis of presentation, and referring to the footnote describing it ii. That the basis of presentation is non-GAAP basis d. OCBOA Opinion Paragraph i. Expresses or disclaims auditor`s opinion whether FS are presented fairly, in all material respects, in conformity with the described basis. ii. If it is fair on OCBOA basis iii. Explanatory paragraph and modifying language should be used if the FS are not fair or if limited audit scope. 3. OCBOA Report: Financial Statements Prepared on the Cash Basis – See sample pg. A2-10 4. OCBOA Report: Prepared on a Basis to Comply with a Regulatory Agency = Restricted Use a. When FS is in conformity with requirements established by a governmental regulatory agency, a restrictive paragraph is included limiting the use of report to management, board of directors, and the regulatory agency. B. SPECIAL REPORTS: Specified Elements, Accounts, or Items of a FS 1. Audit of specified elements, accounts, or items on FS may be performed either: a. As a special engagement b. In conjunction with an audit of FS 2. Example: a. Rentals, royalties, profit sharing, income tax provisions, etc 3. Auditing Standards a. GAAS should be followed with possible exception of the first report standard (ACDO). This is applicable only when specified elements, accounts, or items of a FS are intended to be in conformity with GAAP 4. Piecemeal Opinions a. Expressions of opinion to certain identified line items in FS, when the items are a major portion of the FS b. Piecemeal opinions should not be expressed when the auditor has expressed an adverse opinion or disclaimed an opinion i. However, an opinion on specified elements may be expressed if it does not encompass so many items as to constitute a major portion of the FS. Such an opinion should not accompany the disclaimer or adverse opinion. 5. General Rule: a. Not allowed = Major item and adverse or disclaimer b. Allowed = Minor item and not accompany adverse or disclaimer 6. Possible Restricted Use Paragraph a. If element, account, or item is prepared to comply with a contract or agreement rather than GAAP or OCBOA, then use of the report must be restricted to only involved parties. 7. Special Report – Report Relating to Accounts Receivable: see sample – page A2-12 C. SPECIAL REPORTS: Compliance with Aspects of Contractual Agreements or Regulatory Requirements Related to Audited Financial Statements 1. Audit Requirement a. Auditor must have audited the client`s FS and may only issue negative assurance on this compliance b. However, such assurance should not be given if FS were given an adverse or disclaimer 2. Negative Assurance = We are NOT lawyers!!!

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D. E.

•

F.

G.

a. Negative assurance may be in a separate report or an additional paragraph after the opinion paragraph b. The report will include: i. A title using the word ``independent`` ii. Negative assurance no compliance iii. Reference to the specific agreement iv. A statement that the assurance is being given in connection with an audit of FS, which was not directed to obtaining knowledge about compliance matters v. Discussion of any significant interpretations made my management relating to the contractual or regulatory agreement vi. A restriction on the use of the report vii. Signature of the firm and date of report c. If the compliance report is issued as a separate report, the report would include: i. A statement that the FS where audited according to GAAS, the date of the report, and any departure from the standard report 3. Special Report – Issued as a Separate Report: see sample – pg A2-13 SPECIAL REPORT: Special-Purpose Financial Presentations to Comply with Contractual Agreements Or Regulatory Provisions 1. An auditor may be requested to report on: a. An incomplete financial presentation that is prepared in conformity with GAAP or OCBOA b. A special-purpose financial presentation that is not in conformity with GAAP or OCBOA 2. Incomplete Financial Presentation: If prepared with GAAP or OCBOA and is incomplete: a. Restricted Use: Generally it is only for use of involved parties b. Exception: Report filed with a regulatory agency and included in docs for general public c. Example: schedule of gross profit defined by a regulatory body excludes certain costs 3. Non-GAAP (non-OCBOA) Financial Presentation: a. Not in conformity with GAAP or OCBOA b. Restricted Use: only for involved parties c. Examples: i. Loan agreement requiring the borrower to prepare consolidated FS in which inventory is presented at a replacement cost, or an acquisition agreement requiring property, plant, and equipment to be reported at market value. General Rule: CPA`s report will be restricted when the FS are in compliance with a contract (as opposed to GAAP or OCBOA) 4. Example: Special Report – Incomplete FS that Otherwise Would Be in Conformity with GAAP or OCBOA: See sample – pg A2-14 Financial Information Presented in Prescribed Forms or Schedules 1. Auditor may attest to fairness of FS in prescribed forms (i.e. loan apps or regulatory filings) 2. Auditor must pay attention to type and wording if info requested 3. Form Deficiencies: forms often prescribe the wording of auditor`s report. It may be necessary to reword the form or attach separate report Modifications to Special Reports in General 1. Auditor may modify unqualified report by adding an explanatory paragraph after opinion paragraph. Reasons: lack of consistency, going concern uncertainties, other auditors, change of prior opinion on comparative FS, and emphasis of matter COMPILATION AND REVIEW OF FINANCIAL STATEMENTS = Unaudited/Disclaimer

I.

Levels of Service: CPAs can perform 2 levels of service for unaudited financial statements of non-public company A. Compilation: NO ASSURANCE 1. CPA presents in the form of FS info that is representation of management. 2. Does not perform any audit or review procedures 3. Does not assume any attest responsibilities 4. Does not express any assurance on FS B. Review: LIMITED ASSURANCE 1. CPA may express limited (negative) assurance on unaudited FS 2. Limited assurance there are no material modifications needed to FS to conform with GAAP 3. Based on inquiry and analytical procedures by CPA C. Performance of More Than One Service 1. If accountant performs more than one service (i.e. compilation and audit), accountant generally should issue the report that is appropriate for the highest level of service

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II.

III.

IV.

Professional Standards A. Statements on Standards for Accounting and Review Services (SSARS) 1. Authoritative body of the AICPA designated to issue pronouncements with unaudited FS of nonpublic entity. Known as = ``Statements on Standards for Accounting and Review Services`` or ``SSARS`` 2. SSARS: Accountant should: a. Have sufficient knowledge to identify applicable SSARS b. Exercise professional judgment in applying SSARS c. Be able to justify departures from SSARS 3. Other Guidance: a. Accountant to consider other applicable interpretive publications and are recommendations to proposed standards. They are: i. SSARS interpretations and appendices ii. AICPA Accounting and Audit guides iii. AICPA Statements of Position b. Other compilation and review publications have NO authoritative status but may be helpful: i. AICPA Compilation and Review Alert ii. Articles in professional journals B. SSARS Applicability = Non-public entity 1. Applies when accountant ``submits`` unaudited FS of non-public co. a. Submission is presenting FS to client or third party that accountant has prepared (manually or computer) b. Preparation is that accountant has created FS that would otherwise not exist c. Non-public entity is: i. Not publicly traded, OR ii. Not filed with regulatory agency for going public, OR iii. Not a subsidiary, corporate joint venture, or controlled by an entity described in i. or ii. 2. Applies to engagements where accountant is engaged to compile or issue compilation report on specified elements, accounts, or items of a non-public entity`s FS, or pro-forma financials info on non-public companies. a. Issuance of report is not required if accountant prepares or assists in preparing information, unless specifically engaged to compile such information b. Accountant should consider whether it might be prudent to issue a compilation report to clarify that no assurance is being provided, even if report not required C. Financial Statement Association 1. Accountant should not consent to use of their name with unaudited FS unless they compiled or reviewed them or FS are indicated that accountant has not compiled or reviewed them and assumes no responsibility D. Other Accounting Services (SSARS do NOT apply) 1. SSARS do not apply to other services like preparing one or few adjusting/correcting entries, consulting on financial matters, preparing tax returns, rendering manual or automated bookkeeping or data processing services, and processing financial data for clients of other accounting firms. a. The auditor make many adjusting/correcting entries which is considered preparing for the FS, and therefore SSARS applies. The auditor must make judgement when determining this. Establishing an Understanding with the Client (Engagement Letter Recommended) – NOT required A. Requirements 1. Compilation and review standards do not require accountants to have written engagement letter. 2. If engagement is to compile FS not to be used by third party and compilation report is not issued then written engagement letter is required. B. Matters to Communicate – Required to establish an understanding with the client: 1. Description of specific services to be performed 2. Description of any report expected to be rendered 3. Explanation of any limitations of the services, including: a. Engagement cannot be relied upon to disclose errors, fraud, or illegal acts, AND b. AND, entity will be informed of any information indicating that fraud or illegal act may have occurred 4. Description of other accounting services, if any, to be performed Compilation of Financial Statements (Non-public Companies Only) – NO ASSURANCE • Compilation engagement may involve compiling and reporting on only one financial statement A. Compilation Requirements 1. Knowledge of Industry Accounting Principles and Practices

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a. Knowledge of accounting principles and practices of client’s industry b. If accountants don’t have experience in that industry, they should gain required knowledge 2. Understanding of Client’s Business a. S – Staff qualifications b. T – Transaction types and frequency c. A – Accounting basis used to prepare the financial statements d. F – Form of the accounting records e. F – Financial statements’ form and content 3. Reading the Financial Statements a. Never associated with false, fraudulent, or misleading FS b. Before issuing report, accountant should read the compiled FS to see if: i. Appropriate in form ii. Free from material errors (arithmetic, clerical, GAAP related) 4. Fraud and Illegal Acts a. If fraud/illegal act occurred, accountant should consider effect of the matter on compilation report, and request management to consider the effect on FS B. Financial Statements that may be Inaccurate or Incomplete 1. Accountants are not required, but may, make inquiries to verify info given by client. If they discover info is incorrect, they should obtain revised info from client. If client refuses, then withdraw. C. Reporting on a Compilation 1. Overview: Independence not required – NO ASSURANCE: Report should include: a. A – statement that compilation has been performed according to SSARS issued by AICPA b. L – statement that compilation is limited to presenting info that management represents c. A – statement that accountant has not audited the FS d. R – statement that accountant has not reviewed the FS e. D – disclaimer of opinion and statement that accountant gives no assurance on FS f. Signature (manual, stamped, electronic, or typed) and a date (usually date of compiled) • You are “A LARD” when all you do is compile the financial statements. 2. Additional Requirements a. Mark each page with “See Accountant’s Compilation Report” b. SSARS does not require that compilation report be printed on accountant’s letterhead 3. Sample Report – Standard Compilation Report: see sample – page A2-19 4. Prescribed Forms that call for a GAAP Departure a. Use alternative form of standard report b. Additional paragraph added departing from GAAP and stating FS are not designed for those who are not informed about the resulting differences 5. Reporting on Financial Statements that Omit Substantially all Disclosures a. Compilation with Omission of All disclosures per client’s request. Accountant may compile if: i. The accountant’s report indicates the omission by adding the middle paragraph, AND ii. AND, reason for omission is not intended to mislead the FS • Compiled FS that omit GAAP disclosures are acceptable if:  Reason for omission was not to deceive user  Compilation report warns user of missing disclosures  “Restricted Use” NOT required b. Example: Compilation w/ Additional Paragraph Omit Disclosures – see sample – pg A2-20 c. Compilation with Limited Disclosure – notes should indicate “Selected Info – GAAP departure 6. OCBOA Financial Statements – If compilation is on OCBOA basis, must disclose 7. Departures from GAAP – must disclose or withdraw 8. Reporting When Not Independent – Disclosure Required in last paragraph 9. Compilations of Personal Financial Statements: accountant may submit unaudited FS that are GAAP departures, and will be exempt from SSARS if: a. Client agrees, accountant states in report that personal FS will only be used to develop financial plan, and not to obtain credit. b. Accountant believes that client would not use report to obtain credit D. Exception to Reporting Requirement 1. Unaudited Compiled Financial Statements Reasonably Expected to be Used by Third Parties a. Compilation report required b. Reporting requirements discussed above in IV.C. 2. Unaudited Compiled Financial Statements Not Expected to be Used by Third Parties a. Accountant may use engagement letter instead of compilation report = Plain Paper Report

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V.

b. Written communication required, compilation report or engagement letter (preferably signed by management) stating services to be performed and limited use of FS c. Engagement letter issued = accountant should reference each page of FS “Restricted Use” Review of Financial Statements: Non-public Companies = LIMITED ASSURANCE A. Review Procedures should be Tailored (to specific engagement). Following factors may affect procedures: 1. The nature and materiality of financial statement items 2. The likelihood of misstatement 3. Knowledge form current and previous engagements 4. Qualifications of the entity’s accounting personnel 5. The extent to which an item is affected by management’s judgment 6. Inadequacies in the entity’s underlying financial data B. Review Requirements: performance requirements:  U – Understanding with client must be established  L – Learn and/or obtain sufficient knowledge of the entity’s business  I – Inquiries should be addressed to appropriate individuals************************  A – Analytical procedures should be performed**************************************  R – Review -- other procedures should be performed  C – Client representation letter should be obtained from management*************  P – Professional judgment should be used to evaluate results  A – Accountant (CPA) should communicate results 1. Understanding with the Client Must be Established a. Engagement letter recommended b. Objectives of the engagement: to determine material modifications are necessary for conformity with GAAP. Inquiries and analytical procedures provide support. c. Management’s Responsibilities: should be similar for financial info and financial statements 2. Learn and/or Obtain Sufficient Knowledge of the Entity’s Business a. Knowledge of Accounting Principles and Practices of the Industry b. Understanding of Client’s Business (i.e. organization, operating characteristics, nature of its assets, liabilities, equity, revenues, and expenses) c. Not Required for Reviews: i. Test of Internal Control – Not Required ii. Perform Audit Tests – Not Required iii. Assess Fraud Risk – Not Required d. Communicate with the Predecessor Accountant – Successor auditor may, but not required to. 3. Inquiries should be Addressed to Appropriate Individuals: Accountant should inquire within (inside, not outside) the organization directed to members of management with financial/accounting responsibilities, to assure that adequate responses are obtained.  Inquiries are of internal personnel, not external personnel. 4. Analytical Procedures should be Performed a. Develop expectation and compare recorded amounts to that expectation b. Analytical procedures in a review should detect unusual relationships and individual items c. Procedures are: i. Compare the current statements with prior period statements, or current ratios with prior period ratios ii. Compare actual statements with budgets or forecasts iii. Compare financial and relevant nonfinancial information iv. Compare ratios and indicators with those of other entities in industry v. Compare relationships amount elements in the FS with corresponding prior period relationships 5. Review – Other Procedures a. Accountant should read FS for conformity with GAAP (or OCBOA) b. Obtain reports of other accountants who have audited/reviewed major components of entity 6. Client Representation Letter from Management Must be Obtained – Required a. Letter should not be dated before the date of accountant’s report b. Management’s failure to provide representation letter = incomplete review c. Contents of Letter – Management should include: i. Management’s responsibility for FS and that they are fairly stated ii. Management’s full and truthful response to all inquiries iii. Representations about the completeness of information iv. Information concerning subsequent events v. Acknowledgement of management’s responsibility to prevent/detect fraud

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VI.

VII.

VIII.

vi. Knowledge of any material fraud or suspected fraud d. Updating the Management Representation Letter. Accountant may request update when: i. Significant amount of time passed between procedures and issuance of report ii. A material subsequent event between completion of procedures and report issuance iii. Former client requests that accountant reissue a prior period report iv. Updated letter should state: a) Whether any previous representations should be modified b) Whether any subsequent events requiring adjustments to or disclosure in FS have occurred 7. Professional judgement to Evaluate Results a. Incomplete Review i. If review is incomplete, it prevents the issuance of a review report b. Form and Content of Documentation i. Designed to meet needs of that particular engagement ii. Written documentation from other types of engagement may be used for support iii. Oral explanations may be used to clarify documentation iv. Documentation should include: a) Significant findings, actions taken, and basis for conclusions b) Inquiries made c) Analytical procedures performed d) Unusual matters and their disposition e) Communications f) Management representation letter  NOT Included in review: Test of Internal Control and Audit Test Work 8. Accountant (CPA) Communicates Results a. Reporting on a Review. Report should include: i. A – Statement that review is performed in accordance to AICPA ii. M – Statement that financial statement information is representation of management iii. I – Statement that review consists principally of inquiries of company personnel iv. A – Statement that review consists of analytical procedures applied to financial data v. S – Statement that review is substantially less in scope than audit vi. A D – statement that no opinion is expressed: disclaimer of opinion is issued vii. Statement that accountant is not aware of any material modifications to be in conformity with GAAP (other than those indicated in report) = LIMITED ASSURANCE viii. Signature (manual, stamped, electronic, or typed) and date (when review procedures were completed) b. Miscellaneous i. Each page of statements be marked “See Accountant’s Review Report” ii. Date of report should be same as date the review was completed iii. Uncertainties/Inconsistencies don’t require modification if adequately disclosed in notes c. Sample report – Standard Review Report – See sample – pg A2-27 d. Accountant’s Independence= REQUIRED = Limited Assurance Reporting on Departures from GAAP A. Accountant should recommend to revise FS to conform with GAAP B. If not revised, accountant should either modify report or withdraw. C. Report Modification 1. Add separate paragraph to end of report to disclose the GAAP departure 2. Third paragraph would refer to explanatory paragraph. D. Report Modification not Adequate 1. If disclosing GAAP departure is not adequate, accountant should withdraw. • An opinion, even if qualified or adverse, requires an audit. When compiling or reviewing and it is a GAAP departure, report would be modified or accountant would withdraw. No opinions expressed! Reporting Fraud and Illegal Acts: if accountant becomes aware of such, report to appropriate level of management A. Inconsequential Matters: don’t need to be communicated B. Documentation: Oral or written communication. Oral communication must be documented. C. Other Options: Withdraw or consult legal counsel if fraud or illegal acts involve owner of business D. Confidentiality: Not disclose to third party except in limited circumstances (legal requirements, subpoena, etc) Restricted Use Reports A. When FS based on criteria other than GAAP or OCBOA, report should be restricted B. Report should clearly state its “Restricted Use”

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IX.

I.

II.

III.

Change in Engagement From Audit to Compilation or Review: Change Must be Justified A. Considerations: Before agreeing to change, accountant should: 1. Reason for the request, especially if scope limitations 2. Effort required to complete the audit 3. Estimated additional cost to complete the audit 4. If changed, report should not refer to original engagement, any auditing procedures performed, or any scope limitation B. Reasons for Change 1. Acceptable Reasons a. Change in client requirements b. Misunderstanding as to nature of the service to be rendered c. Don’t have to, but consider withdrawing for any of these reasons 2. Unacceptable Reasons a. Audit would uncover errors or fraud b. Client is attempting to have the FS mislead or deceive 3. Scope Limitations. The following are unacceptable reasons: a. Client refuses to allow correspondence with legal counsel b. Client refuses to provide a signed representation letter c. Don’t have to, but consider withdrawing for any of these reasons REPORTING ON COMPARATIVE FINANCIAL STATEMENTS Period(s) in Question A. All Periods Compiled Or Reviewed 1. Continuing accountant should update report on prior period and issue it as part of current period B. Current Period is Reviewed and Prior Period Compiled (Service Upgrade) 1. Prior period report should be updated and issued as the last paragraph of current period’s report C. Current Period Compiled and Prior Period Reviewed (Service Downgrade) 1. Issue a compilation report and add a paragraph, describing limited responsibility assumed for prior period. Description include: date of original report and a statement that no review procedures performed after the original date. OR 2. OR, Reissue the prior period review report: a. Combined with current period compilation report, OR b. OR, presented separately Other Requirements A. Columnar Form: FS that have not been audited, reviewed, or compiled, should not be audited B. Omission of Required Disclosures: FS that omit all GAAP disclosures are not comparable. Not issue report. C. Information Affecting Previous Reports 1. Previous modification to disclose GAAP departure may not be needed or new modification to disclose GAAP departure may be required 2. Add paragraph to prior period reports, including: a. Date of the original report b. Statements of prior period have been changed c. Reason for the change in original report Other Accountants Involved in Prior Periods A. Predecessor Accountant’s Compilation or Review Report Reissued Unchanged 1. Predecessor accountant not required to reissue report. If decide to reissue, they should consider: a. Current presentation of statements of prior period b. Based on subsequent events c. In light of required modifications that may be necessary in their report 2. Old CPA should perform the following procedures: a. Read the statements and report of current period b. Compare the prior period statements with those issued previously and currently c. Obtain a representation letter from successor accountants stating FS are free from material misstatements • Whenever prior accountants are asked to reissue their prior report (audit, review, or compilation), they should read the new FS and obtain representation letter from new accountant. B. Predecessor’s Report Not Reissued 1. Successor’s Responsibility a. Make reference to the report of the predecessor in current report, OR b. OR, perform that level of service themselves 2. Expanded Report: When making reference to report of the predecessor in current report, include:

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a. Statement that prior periods were compiled/reviewed by other accountants (no names unless old and new CPA have combined practices b. Date of their report c. Description of the standard form of disclaimer or limited assurance given in prior report d. Description of any modifications contained in report C. Restated Prior-Period Financial Statements 1. Predecessor or successor accountant may report on changed prior-period FS as restated 2. Alternatively, successor accountant may report only on the restatement adjustment Reporting When One Period is Audited: Unaudited FS should be marked, and accountant should either: A. Reissue the prior period report, OR B. OR, include additional paragraph in current report describing responsibility assumed for prior period. 1. Current period unaudited and prior period audited (Service Downgrade): Add Paragraph, include: a. That prior period statements were audited b. Date of the previous report c. Opinions expressed, and if other than unqualified, reasons for modification d. That no auditing procedures have been performed since the previous report date 2. Current period audited and prior period unaudited (Service Upgrade): Add paragraph, include: a. Statement of service performed in prior period b. Date of previous report c. Description of any modification noted in that report d. Statement that service was less in scope than an audit and did not provide basis for opinion e. For public entities, disclaimer or description of a review f. For non-public entities, description of the compilation or review

IV.

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III.

IV.

REPORTING ON COMPARATIVE FINANCIAL STATEMENTS = Public Entities Background A. Definition 1. Period less than a full year, OR 2. OR, twelve-month period ending on a date other than the entity’s fiscal year end B. Situations Requiring a Review of Interim Financial Information 1. If SEC requires entity to file quarterly reports, SEC requires for accountant to review before filing. 2. SEC may require to include quarterly financial data in annual filings, such info must be reviewed. 3. Accountant performing initial audit of FS including quarterly data, should review that quarterly data. C. Written Report: GAAS does not require written report on review of interim financial info, but if client states in the document filed that accountant has reviewed them, then written report is required with that document. D. Applicability: May conduct review of interim financial info of: 1. Public companies 2. Companies anticipating going public, if latest annual FS have been audited Procedures (same as privately held company) • U – Understanding with client must be established • L – Learn and/or obtain sufficient knowledge of the entity’s business/internal control • I – Inquiries should be addressed to appropriate individuals************************ • A – Analytical procedures should be performed************************************** • R – Review -- other procedures should be performed • C – Client representation letter should be obtained from management************* • P – Professional judgment should be used to evaluate results • A – Accountant (CPA) should communicate results Understanding with the Client Must be Established A. Objectives of the Engagement 1. Objective of review if interim financial info: to determine material modifications are necessary for conformity with GAAP. B. Management’s Responsibilities = FS: should be similar for financial info and financial statements C. Accountant’s Responsibilities = Review report. 1. Auditing standards: responsible for conducting review in accordance to PCAOB standards, which encompass Statements on Auditing Standards in this area. 2. Scope of Review: consists of analytical procedures and inquires, less in scope than audit, so no opinion expressed. D. Limitations of the Engagement of review engagement are similar to an audit. No assurance on internal control Learn and/or Obtain Sufficient Knowledge of the Entity’s Business and Its Internal Control A. Purpose

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V.

VI.

VII.

VIII.

IX.

X.

1. Determine what types of material misstatements may occur 2. Evaluate the likelihood of such misstatements will occur 3. Select appropriate inquiries and analytical procedures B. Planning: Accountant update his knowledge by performing: 1. Read documentation of prior audit and review 2. Read most recent annual financial info and financial info from recent comparable interim periods 3. Inquire of management regarding changes in business activities or internal control C. Obtaining Knowledge 1. Initial Review a. Inquire of the predecessor accountant and may review the predecessor’s documentation b. Successor accountant remains solely responsible for review procedures and conclusions 2. Continuing Client a. Perform procedures to obtain knowledge about five components of internal control b. Internal control over interim financial information may differ from internal control over annual financial statements 3. Scope Restriction: a. Significant deficiencies in internal control may make it impracticable for accountant to perform a review Inquiries Should be Addressed to Appropriate Individuals A. Required Inquiries (of inside the organization, not outside) B. Not Required 1. Inquiry of Client’s Lawyer 2. Going Concern Analytical Procedures Should be Performed A. Analytical procedures in a review should detect unusual relationships and individual items 1. Comparisons over time of interim financial information for trends: a. Current quarter vs. Immediately preceding interim period b. Current quarter vs. Comparable quarter from prior year c. Current year-to-date vs. Corresponding period from prior year 2. Consideration of plausible relationships among both financial and relevant nonfinancial information = ratios. 3. Comparison of recorded amounts (or ratios) to accountant’s expectations = budget to actual. 4. Comparison of disaggregated revenue data for current interim period with comparable prior periods Review: Other Procedures = Read “stuff” A. Read minutes of stockholder meetings B. Obtain reports from other accountants engaged to review the interim financial information of subsidiaries, investees, etc. C. Obtain evidence that the interim financial information agrees/reconciles with accounting records D. Read the interim financial information for conformity with GAAP E. Read other information accompanying the interim financial information for material inconsistencies or material misstatements of fact F. Extend review procedures to resolve any outstanding questions G. Timing and Coordination 1. Review procedures may be performed before or simultaneously with entity’s preparation of interim financial information 2. Certain audit procedures related to annual FS may be performed with review Client Written Representation Letter from Management Should be Obtained A. Representations to be obtained from management related to FS, the completeness of information, recognition, measurement, disclosure, and subsequent events B. Additional Representations regarding internal controls to be obtained: 1. Disclosures of all significant deficiencies in internal controls 2. Management’s responsibility for the design and implementation of controls 3. Knowledge of fraud or allegations of fraud Professional Judgement to Evaluate Results A. Likely Misstatements 1. Accumulate all such estimates for further evaluation 2. Consider the aggregated effect of several immaterial misstatements 3. Evaluate likely misstatements in terms of nature, cause, amount, timing, and effect on FS B. Scope Limitations = No Review Report to be issued Accountant (CPA) Communicates Results A. Communications to Management

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1. 2. 3.

XI.

Prompt communication required if: material modifications or entity filed SEC report prior to review If management does not respond, contact those charged with governance Of those charged with governance don’t respond, then resign, and may consult legal counsel • Problem: Management – Those charged with governance – Withdraw and legal advice B. Required Communications with Those Charged with Governance in regards to: 1. Fraud, illegal acts, and reportable conditions 2. Other items as described in auditing standards if significant enough to conduct a review 3. Made before entity files its interims with SEC C. Review Report on Interim Financial Information 1. Required Elements: Each page on interim to be marked “Unaudited”. Report should include: a. Title including “Independent” b. Statement that interim financial information identified in the report was reviewed c. Statement that interim financial information is management’s responsibility d. Statement that review was conduction in accordance to PCAOB (NOT SSARS AICPA) e. Description of procedures used f. Statement that review is less in scope than audit and no opinion expressed g. Statement about whether the accountant is aware of material modifications to conform GAAP h. Identify the country of accounting principles i. Signature (manual or printed) and date (completion of review procedures) 2. Sample Report – see sample – page A2-40 3. GAAP Departures a. Accountant should modify report b. Add explanatory, middle paragraph (before concluding paragraph), and modify concluding paragraph. 4. Going Concern: Disclose in F/S is okay, but no modification required if adequately disclosed 5. Lack of Consistency: Disclose in F/S is okay, but no modification required if adequately disclosed Other Uses of Interim Financial Information A. Interim Financial Information Accompanying Audited Financial Statements 1. Such info should be marked “unaudited” 2. No need to refer to review in audit report, but is required when: a. If not marked “unaudited” b. Quarterly info required by SEC is not reviewed c. Quarterly info required by SEC is omitted B. Interim Financial Information Presented in a Registration Statement 1. Clarify that report is not considered to be a “report” or “part” of registration statement LETTERS FOR UNDERWRITERS

I.

II.

III.

IV.

V.

Comfort Letter = Negative Assurance on unaudited interim FS) A. Due Diligence 1. A “due diligence defense” may be used by the underwriter 2. Underwriters request comfort letters for reasonable investigation B. Review Engagement Required: when comfort letter issued, CPA required to perform interim review per GAAS C. Attorney’s Opinion or Representation Letter Required D. Limitations – Comments in comfort letter are limited to: 1. Financial information expressed in dollars, AND 2. AND, financial information derived from the accounting records E. Restricted Use Positive Assurance is Provided with Respect to: A. CPA’s independence B. Compliance of FS with SEC Act, if FS are audited. (if not audited, give negative assurance) Negative Assurance if Proved with Respect to: A. Unaudited FS, unaudited condensed interim FS, and capsule financial info, assuming a review was performed 1. If review not performed, procedures performed and findings should be listed B. Changes in selected FS C. Whether certain non-financial statement information included in registration statement complies to form in all material respects with regulation S-K A List of Procedures Performed and Findings Obtained is Provided with Respect To: A. Pro forma info and forecasts B. Tables, statistics, and other financial info The Auditor Should Not Comment or Provide Assurance on:

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A. Market risk sensitive instruments B. Qualitative disclosures ATTEST ENGAGEMENTS (Auditing/Examining something other than historical FS) I.

Introduction A. Definition 1. Attest engagements may result in reports related to: a. Compliance with laws and regulations b. Compliance with contracts c. Internal control d. Computer systems and software e. Information supplemental to financial statements f. Prospective information g. Performance, physical characteristics, historical events, analyses, etc. 2. Trust Services: address risks and opportunities related to information technology. Five principles guide performance: security, availability, processing integrity, online privacy, and confidentiality. a. Web Trust Engagements i. Assurance related to e-commerce ii. CPA assesses client’s website for integrity, information protection, and disclosure b. SysTrust Engagements i. Assurance with reliability of any defined electronic system B. Statements on Standards for Attestation Engagements (SSAE) by AICPA address major attestation services: 1. Agreed-upon procedures 2. Financial forecasts and projections 3. Pro forma financial statements 4. Internal control over financial reporting 5. Compliance 6. Management’s Discussion and Analysis • The following standards apply to services a CPA may provide: o Audit engagements: SAS (Statements on Auditing Standards); PCAOB standards for issuers o Compilation and review engagements: SSARS (Statements on Standards for Accounting and Review Services) o Attest engagements: SSAE (Statements on Standards for Attestation Engagements) C. Statements on Standards for Attestation Engagements Do Not Apply to: 1. Audits 2. Compilations and reviews of non-public companies under SSARS 3. Return preparation (income tax, franchise, other) 4. Advocating for the client (litigation services) 5. Providing consulting/advisory services 6. Operational audits, normally performed by internal auditors. D. Attestation Standards 1. Broader in scope than GAAS, and don’t supersede any existing standards (SAS, SSARS) 2. Natural extension of GAAS, but differ conceptually in 3 ways:\ a. No reference is made to financial statements b. No reference is made to GAAP c. Attestation standards provide levels of assurance below that provided by a GAAS audit 3. Include hierarchy similar to GAAS hierarchy: a. Departures from presumptively mandatory requirements must be justified b. Interpretive publications should be considered c. Other attestation publications have no authoritative status, but may be helpful 4. The eleven attestation standards include: a. Five general standards:  T – Training and Proficiency  I – Independence  P – Performance/due professional care in planning and performance  P – Professional, adequate knowledge of subject matter  Y – Your belief that subject matter is capable of evaluation against suitable criteria b. Two fieldwork standards (note: internal control omitted)  P – Planning and supervision  A – Appropriate, sufficient evidence to provide a reasonable basis for conclusion

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c.

Four reporting standards:  S – Identify the Subject matter and character of engagement  S – Disclose Significant reservations  E – Express conclusions about subject matter  R – Restrict use of the report to specified parties when: i. The criteria are appropriate for only limited number of parties ii. Reporting on subject matter and written assertion has not been provided iii. Reporting on an agreed-upon procedures engagement • An easy way to remember the attestation standards is “TIPPY-PASSER” E. Additional Reporting Requirements 1. The report may be issued on the assertion itself or on subject matter to which the assertion relates a. A written assertion is generally obtained b. If material misstatements or deviations from criteria, modify the report 2. If reporting on the assertion, it should accompany the practitioner’s report or the assertion should be clearly stated in the report. 3. No restriction on use required. 4. Scope Restrictions = Consider withdrawing a. Examinations: Restrictions on scope of examination engagement may result in qualified,

disclaimer, or withdrawal

II.

b. Review: restrictions on scope of review engagement result in withdrawal F. Conclusion: fall into three groups: 1. Examination: a positive opinion, high level of assurance based on variety of procedures, like search, verification, inquiry, and analysis 2. Review (“Negative Assurance”): Moderate level of assurance based on inquiry and analytical procedures 3. Agreed-Upon Procedures: No assurance, but procedures and findings are listed G. Written Assertion 1. Generally obtained in examination and review engagements. If no written assertion is provided by management, outcome depends on whether the client is the responsible party a. If client is responsible: failure to provide a written assertion constitutes a scope limitation i. Modify report based on scope limitation and restrict use. ii. Review engagement with scope limitation is incomplete, practitioner should withdraw 2. Client is not responsible: report may be issued if procedures are performed and evidence obtained. Form of report may vary, and should be restricted H. Other Requirements 1. Documentation requirements for attestation similar to audit or review engagement 2. Understanding with client should be established, preferably through written communication 3. Obtain representation letter from responsible party 4. Inquire regarding subsequent events Agreed-Upon Procedures Engagements (mutual fund performance) A. Practitioner is engaged to issue a report of findings based on specific agreed-upon procedures B. Attestation standards apply to all agreed-upon procedures C. Written assertion generally is not required D. Conditions: procedures may be performed if the following conditions exist: • I – Independence of the Practitioner • A – Agreement of the Parties (agree on procedures, criteria, and limitations) • M – Measurability and Consistency • S – Sufficiency of the Procedures • U – Use of the report is restricted to the specified parties • R – Responsibility for the subject matter is one of the following: o Client is responsible o Client is able to provide evidence that a third party is responsible • “I-AM-SURE” you can perform these agreed-upon procedures. E. Reporting: Required Elements 1. Title including “Independent”, signature, and date 2. Identification of specified parties, subject matter, character of engagement, and responsible party 3. Subject matter is the responsibility of responsible party 4. Procedures performed were agreed to by specific parties identified 5. Sufficiency of procedures is solely the responsibility of specified parties 6. Engagement was conducted according to attestation standards by AICPA

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III.

7. List of procedures performed and findings 8. Practitioner was not engaged to conduct an examination of the subject matter, disclaim opinion 9. Restricted use F. Sample Report – Agreed-Upon Procedures: see sample: page A2-54 G. Explanatory Language 1. Disclose stipulated facts, assumptions, or interpretations 2. Description of records, controls, or data 3. Explain practitioner has no responsibility to update report 4. Explain sampling risk Financial Forecasts and Projections A. Financial Forecast: General and limited – based on expected conditions and expected courses of action B. Financial Projection: Limited use only – based on hypothetical assumptions; the “what if” type of scenario C. Uses of Prospective Financial Statements 1. General use- Financial forecast 2. Limited use- Financial projection D. Association with Prospective Financial Statements – Practitioner is associated in one of three ways: i) Compilation engagement, ii) Examination engagement (the report is generally to be used by a third party), iii) Agree-Upon procedures engagement • Note that a review of prospective FS is not allowed. 1. Compilation of Prospective Financial Statements a. Purpose: proper assembling of financial data based on responsible party’s assumptions: i. There is no assurance of any kind that statements are according to AICPA ii. The practitioner is not required to gather supporting evidence iii. Practitioner may not issue a compilation report if the entity fails to disclose a summary of significant assumptions b. Contents of Compilation Report (will appear in practitioner’s compilation report:) i. Indentify the responsible party and the FS ii. Practitioner has compiled the prospective FS with attestation guideline by AICPA iii. Compilation is limited in scope and not express opinion iv. Caveat that the prospective results may not be achieved v. Practitioner assumes no responsibility to update the report vi. Signature of practitioner’s firm and date of report • Note: no statement that prospective FS are in conformity with AICPA guidelines c. Sample Report – Compilation of a Financial Forecast – See sample: page A2-56 d. Compilation of a Financial Projection = LIMITED USE. The standard report slightly change: i. Description of the purpose of projection at the end of first paragraph ii. Reference to hypothetical assumption in second paragraph iii. Paragraph restricting use of report 2. Examination of Prospective Financial Statements (more substantial in scope than compilation) a. Purpose: express an opinion as to whether: i. The statements are in conformity with AICPA guidelines ii. Underlying assumptions provide reasonable basis for prospective statements b. Independence Required for examination engagements c. Evidence Required d. Content of Report Based on Examination i. Title including “Independent”, signature, and date of report ii. Identification of prospective FS iii. Identification of responsible party iv. Practitioner’s responsibility is to express opinion based on examination v. Examination was conducted according to attestation standards by AICPA vi. Practitioner believes that examination provides a reasonable basis for opinion vii. Opinion that prospective FS are in conformity with AICPA and underlying assumptions provide reasonable basis for the forecast or projection viii. Caveat that prospective results may not be achieved ix. Practitioner assumes no responsibility to update report x. Forecast= General & Limited Use; Projection= Limited Use Only e. Modifications to the Opinion – Following issues require modifications: i. AICPA guidelines are not followed (qualified “except for” or adverse) ii. Significant assumptions not disclosed (adverse) iii. Basis not reasonable (adverse) iv. Scope limitation (disclaimer)

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IV.

V. VI.

VII.

f. Sample Report – Examination of a Financial Forecast – see page A2-58 g. Examination of a Financial Projection – standard report would change to include: i. Description of purpose of projection in first paragraph ii. Reference to hypothetical assumption in third paragraph iii. Paragraph restricting the use of report 3. Agreed-Upon Procedures Applied to Prospective Financial Statements a. Procedures discussed above in II.A. and II.B. applied to agreed-upon procedures and to prospective financial statements. a. Additional condition is prospective FS must include a summary of significant assumptions b. A disclaimer on whether statements are in conformity with AICPA and assumptions provide reasonable basis E. Partial Presentations 1. Considered partial if prospective FS exclude certain essential elements 2. Not appropriate for general use F. Prospective Financial Statement Summary – see page A2-60 Pro Forma Financial statements A. Are NOT prospective financial statements! B. May demonstrate the effect of future or hypothetical event by showing how it might have affected the historical FS if it had occurred during that period C. May be examined or reviewed: 1. Do not re-evaluate internal control 2. Determine math/computation are correct D. Obtain understanding of even and evaluate pro forma adjustments E. May make reference to FS Reporting on an Entity’s Control Over Financial Reporting A. Practitioner may be engaged to report on effectiveness of entity’s internal control Compliance Attestations: practioner may be engaged to report on compliance – will generally perform an agreed-upon procedure, but may perform an examination. Review should not be performed. Reporting requirements are similar to those just discussed, with following additions: A. Agreed-Upon Procedures: report to include that procedures were performed to assist the specified parties B. Examination: examination does not provide a legal determination on entity’s compliance Management’s Discussion and Analysis A. CPA’s attest function may include examining or reviewing Management’s Discussion and Analysis (MD&A) report that public companies issue with audited FS B. MD&A requirements are by SEC C. CPA must obtain an understanding of these requirements before undertaking examination or review of MD&A

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