19
Additional CHAPTER Assurance Services: Historical Financial Information
Review Questions 19-1 This statement is incorrect. An audit can be a significant expense to a small company. The audit fee must be justified by the benefits received from the audit. The needs of the users of the financial statements of many small nonpublic companies are satisfied by financial statements that have been reviewed or compiled by the CPAs. The term auditor is most frequently used when discussing CPAs' role of attesting to the annual historical financial statements and when they are performing an operational audit. The term accountant refers to CPAs when they are performing other attestation services and accounting services. Thus, while auditors do perform the attestation service of audits, the statement that auditors perform attestation services and accountants perform accounting services is incomplete. In communications with clients, CPAs should refer to themselves as auditors only when the service they are rendering is an audit performed in accordance with generally accepted auditing standards. When rendering other services, they should refer to themselves as "accountants," or as "CPAs." The purpose of this distinction is to avoid leading the client to believe that the CPAs are acting as auditors when they actually are rendering other attestation or accounting services. Yes. Auditors may express opinions on financial statements that are presented in accordance with the cash basis or any other comprehensive basis of accounting. Such auditors' reports are a type of special report and must state that the financial statements are not presented in conformity with generally accepted accounting principles, as well as indicate the accounting basis used. Neither. While the performance of an agreed-upon procedures engagement is considered an attestation service (as is an audit), the two attestation services differ. Because agreed-upon procedures engagements are attestation services they are not considered accounting services. Engagements to perform agreed-upon procedures are restricted because the specified parties have agreed to the nature and extent of the procedures to be performed to meet their needs. The nature and extent may not be appropriate for other parties.
19-2
19-3
19-4
19-5
19-6
19-7
When a report is for use primarily outside the United States the auditors may issue (1) a U.S. report, modified as appropriate to reflect the principles of the other country, or (2) the report of the other country, if the auditors understand the related responsibilities. No, generally accepted accounting principles for personal financial statements require the valuation of assets at estimated current values, not at historical cost. A CPA can issue an unqualified special report on Wilson's statements, however, because historical cost is a comprehensive basis of accounting even though it is not in accordance with GAAP. The procedures applied during a review of the quarterly financial statements of a public company include: (1) procedures to obtain an understanding of the client's business and internal control; (2) analytical procedures applied to the interim financial data to identify and provide a basis for inquiries about relationships that appear unusual and that may indicate a misstatement; (3) inquires of management about such matters as unusual analytical relationships, significant transactions occurring around period end, subsequent events, and the occurrence or allegations of fraud; (4) reading minutes of meetings of stockholders and directors and the interim financial information; (5) obtaining evidence that the interim financial information agrees to the accounting records, and (6) obtaining written representations from management regarding the presentation and completeness of the statements.
19-8
19-9
19-10 The most unique aspect of the required review of the quarterly financial information of public companies is the fact that the CPAs are not required to report on the engagements. Therefore, the CPAs must notify the SEC if the client files materially misstatement information. 19-11 The CPAs assist audit committees by communicating matters that assist them in performing their functions, including: Instances of fraud and illegal acts; Reportable conditions related to the preparation of interim financial statements; Significant review adjustments found by the CPAs; The quality of accounting principles and estimates; Disagreements with management over accounting principles or review procedures; and Any other difficulties encountered performing the review. 19-12 In recognition of the fact that many small nonpublic companies do not need audits of their financial statements, the AICPA established the Accounting and Review Services Committee. That committee establishes standards for the compilation and review of the financial statements of nonpublic companies. CPAs may perform a compilation, a review, agreed-upon procedures, or an audit of the financial statements of a nonpublic company. 19-13 A review of financial statements of a nonpublic company does not involve a consideration of internal control, tests of the accounting records, or obtaining corroborating evidence, which are performed during an audit. Therefore, a review does not provide a basis for an opinion as to whether the financial statements are fairly presented in accordance with generally accepted accounting principles. 19-14 The primary procedures for a review of financial statements include inquiry of client management, and analytical procedures performed on the financial information by reference to prior financial statements, budgets, and other operating data. The CPAs also inquire concerning the actions taken in meetings of stockholders, the board of directors, and committees of the board. The accountants' inquiries should focus on whether the financial statements conform to generally accepted accounting principles, changes
in business activities, and significant subsequent events. The accountants are also required to obtain a representation letter from management of the company. 19-15 While not strictly required, engagement letters are important for accounting and review services. This importance is due to the fact that accounting and review services are quite different from audits and, therefore, the engagement letter should explain the nature of the services to be rendered and make clear to the client that the CPAs will not be performing an audit. 19-16 A comfort letter is designed to aid securities underwriters in the investigations of registration statements required under the Securities Act of 1933. In the letter, the CPAs provide assurances regarding various financial information included in the registration statement. 19-17 The auditors will normally provide an opinion on whether the condensed information is fairly stated in all material respects in relation to the basic financial statements. 19-18 The minimum procedures required include reading the compiled statements for appropriate format and obvious material misstatement. But, when performing this service CPAs generally are asked to prepare the financial statements. Also, prior to performing a compilation the CPAs must have knowledge of the accounting principles and practices used within the client's industry and must have a general understanding of the client's business transactions and accounting records. 19-19 Yes. When performing compilations, CPAs may issue a compilation report that indicates that management has elected to omit substantially all of the disclosures required by GAAP. When performing a review, the CPA who is aware of a departure from GAAP (including adequate disclosure) must consider modifying the report to be issued to reflect such information or, if the statements appear to be misleading, consider resignation. In the case of audits, omission of such disclosures leads to either a qualified or an adverse opinion based on the inadequate disclosure. 19-20 If the accountants discover a material departure from GAAP, they should request that management revise the financial statements. If management refuses to do so, the CPAs should modify their report to describe the departure and its effect on the financial statements, if known. 19-21 When compiled financial statements are not expected to be used by a third party, the CPAs must still perform the standard compilation procedures. However, they have the following two reporting options: (1) (2) Issue a compilation report, or Issue no report and document in an engagement letter the understanding with the client that the financial statements will not be used by a third party. Also, make sure that the financial statements include a restricting phrase, such as "Restricted for Management's Use Only."
19-22 If the CPA firm discovers that it is not independent, the firm cannot issue a review report. The CPA firm can either resign from the engagement or perform a compilation of the financial statements with a report that discloses that the firm is not independent.
Questions Requiring Analysis 19-23 (a) No. The AICPA Code of Professional Conduct prohibits direct interests by CPAs in audit clients during the period of the professional engagement. Since interests of an auditor's spouse and dependent children are attributed directly to the auditor, Bell & Davis are not independent with respect to Worthmore.
(b)
The report is deficient in the following three respects: (1) A CPA firm that is not independent cannot comply with the generally accepted auditing standard requiring an independence in mental attitude in all matters relating to the assignment. Therefore, the auditor must disclaim an opinion on the financial statements. The AICPA, in SAS No. 26 (AU 504), suggests the following form of report: We are not independent with respect to XYZ Company, and the accompanying balance sheet as of December 31, 20Xl, and the related statements of income, retained earnings, and cash flows for the year then ended were not audited by us and, accordingly, we do not express an opinion on them. (2) (3) The report should not indicate the reason for the lack of independence by the CPA firm. The report should indicate that the financial statements do not contain a statement of cash flows; the omission of this statement represents a departure from generally accepted accounting principles.
19-24 (a)
Since Ambassador Hardware Co. is a nonpublic company, its financial statements may be audited, reviewed, or compiled. A review of financial statements involves the performance of inquiry and analytical procedures to provide a basis for limited assurance that the financial statements are in accordance with generally accepted accounting principles. The accountants do not perform procedures to corroborate the financial statement information and they do not perform an assessment of internal control. A compilation of financial statements involves the preparation of financial statements from representations by management. The accountants provide no assurance regarding the "fairness" of the financial statements. In selecting the type of service, Ambassador's management should consider the needs of the users of the company's financial statements. For example, Ambassador's creditors may be willing to extend necessary capital to the company on the basis of compiled or reviewed financial statements. However, if the owners of the company are considering issuing shares of stock to the public in the near future, they should consider the need to obtain audited financial statements to comply with SEC regulations. Independent Auditors' Report
(b)
19-25 The General Partner Dale, Booster & Co.
We have audited the accompanying statement of assets, liabilities, and capital on an income tax basis of Dale, Booster & Co., a partnership, as of December 31, 20X1, and the related statement of revenue and expenses--income tax basis, and the statement of changes in partners capital accounts for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance as to whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As described in Note X to the financial statements, the partnership's policy is to prepare its financial statements on the accounting basis used for income tax purposes, which is a comprehensive basis of accounting other than generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities, and capital of the Dale, Booster & Co. partnership as of December 31, 20X1, and its revenue and expenses and changes in its partners' capital accounts for the year then ended, on the income tax basis of accounting as described in Note X. As discussed in Note Y to the financial statements, the Company is involved in continuing litigation relating to patent infringement. The amount of damages, if any, resulting from this litigation cannot be determined at this time. Rose & Co., CPAs March 1, 20X2 19-26 (a) CPAs may report on specified elements, accounts, or items of a financial statement in the following ways: (1) An opinion may be expressed as to whether the information is fairly presented on the basis indicated. In such engagements, the auditors must apply auditing procedures and materiality must be judged in relation to the items presented. A report may be expressed on the application of agreed-upon procedures to the information. In such circumstances, the auditors must be assured that the parties involved understand the nature and extent of the procedures. The report should indicate the procedures performed, state the intended distribution of the report, the CPAs' findings, provide a disclaimer of an opinion on the information, and indicate that the report does not extend to the financial statements taken as a whole. A review of the information may be performed. In such a circumstance the auditors would apply the appropriate analytical review and inquiry procedures to allow them to provide limited assurance (e.g., "we are not aware of any material modifications") on the information.
(2)
(3)
(b)
Such reports must be restricted as to distribution because the reports could potentially mislead the general public. Only individuals that have a clear understanding of the nature and extent of the auditors' procedures should have access to the reports. The statement is incorrect because while no assurance is provided when accounting services are performed, they are not considered special reports. Five types of reports are referred to as "special reports": (1) (2) (3) Financial statements prepared in accordance with a comprehensive basis of accounting other than generally accepted accounting principles (e.g., cash-basis statements). Specific elements, accounts, or items of financial statements (e.g., a report on net sales). Compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements (e.g., client's compliance with restrictions of a debt agreement). Special-purpose financial presentations (e.g., a report on certain specified assets being sold).
19-27 (a)
(b)
(4)
(5)
Audited financial information presented in prescribed forms (e.g., filings with certain regulatory agencies).
(c)
Examples of accounting services include compilations of financial statements, compilations of prospective financial statements, and "unaudited" financial statement association with financial statements of a public company (only one required). The major procedures for a review of financial statements include: (1) (2) (3) Inquiries concerning the company's accounting principles and practices. Inquiries concerning the company's system of accounting. Analytical procedures to identify relationships and items that appear to be unusual. The procedures include comparisons of accounting data with prior financial statements and budgets and a study of relationships between accounts that can be expected to conform to predictable patterns. Inquiries concerning actions taken at meetings of stockholders, board of directors, and committees of the board. Reading the financial statements for conformity with generally accepted accounting principles. Obtaining reports from other accountants, if any, who have audited or reviewed the financial statements of components of the company. Inquiries of management concerning the conformity of the financial statements with generally accepted accounting principles and material subsequent events. Obtaining a representation letter from management.
19-28 (a)
(4) (5) (6) (7) (8) (b)
The report on a review of financial statements should indicate that: (1) (2) (3) (4) (5) A review was performed in accordance with AICPA standards. The financial statements are representations of management. A review consists of inquiries of management and analytical procedures. A review is substantially less in scope than an audit; therefore, no opinion is expressed regarding the financial statements taken as a whole. The accountants are not aware of any material modifications that should be made in the financial statements for them to be in conformity with generally accepted accounting principles.
(c)
If the accountants discover a material departure from generally accepted accounting principles, they should request that the client revise the financial statements. If the financial statements are not revised, the departure should be disclosed in a separate paragraph of the accountants' report, including the effects of the departure on the financial statements, if known. The accountants can provide negative assurance that the unaudited financial statements comply with the 1933 Act and SEC pronouncements, and are fairly presented in accordance with generally accepted accounting principles on a basis consistent with that of the audited financial statements and schedules included therein. Comfort letters also typically contain the assurances as to: (1) The independence of the accountants.
19-29 (a)
(b)
(2)
Compliance of audited financial statements and schedules with the Securities Act and related rules and regulations. Changes in selected financial statement items during a specified period from the date of the latest financial statements included in the registration statement. Tables, statistics, and other financial information in the registration statement. Pro forma financial information, financial forecasts. Certain non-financial information included in the registration statement complies with SEC regulations.
(3)
(4) (5) (6)
19-30 (a)
When accountants are associated with the financial statements of a public company, they should look for guidance in Statements on Auditing Standards issued by the Auditing Standards Board. In particular, SAS No. 26 (AU 504) applies to such engagements. When accountants are associated with the financial statements of a public company, but have not audited or reviewed such statements, the financial statements should be accompanied by a clearly written disclaimer of opinion. The accountants are associated with financial statements when they consent to the use of their name in a document containing the statements, or they submit to the client or others financial statements that they have prepared or assisted in preparing. Accountants have no responsibility to apply any auditing or review procedures to unaudited financial statements, except to read the statements for obvious material errors. If the accountants discover that the financial statements contain a material departure from generally accepted accounting principles, they should insist on appropriate revision, or explain their reservations in their report.
(b)
(c)
Multiple Choice Questions 19-31 (a) (3) Audits of financial statements include confirmations of accounts receivable, reviews generally do not. A representation letter, but not an engagement letter, is required when a review of a nonpublic company is being performed. Independence is only required for attestation services. Since compilation is not an attestation service, independence is not required. Independence is required on a review engagement. Inquiries of management ordinarily included those on subsequent events, significant journal entries and other adjustments, and unusual or complex situations affecting the financial statements. Inquiries about communications with related parties not are specifically required. The auditors' report on condensed financial statements includes an opinion on whether the condensed information is fairly stated in all material respects in relation to the basic financial statements.
(b)
(3)
(c)
(2)
(d)
(3)
(e)
(3)
(f)
(2)
Management of public companies must engage CPAs to review their company's quarterly financial information. The appropriate report on compiled financial statements that omit disclosures includes an indication that management has elected to omit the disclosures and the financial statements are not intended for individuals not informed of such matters. Agreed-upon procedures engagements always result in a restricted use (limited distribution) report. Completeness is generally the most difficult assertion with respect to personal financial statements due to poor internal control and motivation by some individuals to omit assets and income. Special reports are appropriate for attesting to compliance with contractual agreements related to audited financial statements. A compilation report contains a disclaimer regarding the financial statements; it should not include the expression of negative assurance. A comfort letter is issued by the independent auditors to the underwriters. Accordingly, such letters are normally signed by the independent auditors.
(g)
(3)
(h)
(4)
(i)
(3)
(j)
(2)
(k)
(1)
(l)
(1)
Problems 19-32 SOLUTION: Jiffy Clerical Services (Estimated time: 30 minutes) (a) Audit report Independent Auditors' Report The Board of Directors Jiffy Clerical Services We have audited the accompanying statement of assets and liabilities arising from cash transactions of Jiffy Clerical Services as of December 31, 20X4, and the related statement of revenue collected and expenses paid for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance as to whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As more fully described in Note 1, the Company's policy is to prepare its financial statements on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and liabilities arising from cash transactions of Jiffy Clerical Services as of December 31, 20X4, and the revenue collected and expenses paid during the year then ended, on the basis of accounting described in Note 1. Blue, Gray & Co. February 23, 20X5 (b) The report must be modified because the statements are not in conformity with the meaning of "generally accepted accounting principles" as used in the conventional standard report. No opinion is expressed as to the statements' conformity to generally accepted accounting principles because cash basis statements omitting assets or liabilities of material amount are not in accordance with such principles. Further, the financial statements are not called balance sheet or income statement because of material differences from accrual statements. Special care must be taken to avoid leading the reader to incorrect inferences. Cash basis statements should be titled to reveal clearly what they represent and to avoid implying that they present financial position or operating results in accordance with generally accepted accounting principles.
19-33 SOLUTION: Brown & Brown (Estimated Time: 45 Minutes) Independent Auditors' Report To the Board of Trustees of Modern Museum, Inc. We have audited the accompanying statements of assets, liabilities and fund balances (modified cash basis) of Modern Museum, Inc., as of December 31, 20X4 and 20X3, and the related statements of support, revenues, and expenses and of changes in fund balances (modified cash basis) and changes in financial resources (modified cash basis) for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosure in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinions. As described in Note X, the organization's policy is to prepare its financial statements on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles. In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities, and fund balances of Modern Museum, Inc., at December 31, 20X4 and 20X3, and its support, revenues, and expenses and the changes in its fund balances and changes in financial resources for the years then ended, on the basis of accounting described in Note X. Brown & Brown CPAs March 12, 20X5 19-34 SOLUTION: Broadwall Corporation (Estimated time: 25 minutes) (a) A review of interim financial statements does not provide a basis for the expression of an opinion because a review is not an audit performed in accordance with generally accepted auditing standards--that is, it does not include the collection of sufficient competent evidence to support an opinion. The procedures that Loman must perform consist primarily of inquiries and analytical procedures concerning significant accounting matters relating to the financial information to
(b)
be reported. The procedures that Loman should apply ordinarily may be limited to the following: Procedure Reviewing documentation of the most recent audit and financial statements, and considering the results of auditing procedures. Inquiry concerning any significant changes in the company's business activities. Performing analytical procedures. Purpose of Procedure To update the understanding of the business and internal control.
To update the understanding of the business and internal control. To identify and provide a basis for inquiries to management and certain other procedures. To obtain assurance that unusual relationships are not the result of misstatements of the interim information. To obtain assurance that the interim information is not materially misstated.
Making inquiries of management regarding unusual relationships.
Performing additional procedures if the CPAs become aware that interim information may be incorrect, incomplete, or otherwise unsatisfactory. Inquiring of officers and other executives having responsibility for financial and accounting matters concerning: (a) Whether the interim financial statements have been prepared in conformity with generally accepted accounting principles consistently applied. (b) Unusual or complex situations affecting the interim financial information. (c) Significant transactions occurring around the end of the period. (d) Subsequent events. (e) Whether management has knowledge of fraud having been committed. (f) Whether allegations of fraudulent financial reporting have been made by employees, former employees, or other individuals.
In order to become aware of significant matters affecting the interim financial statements.
Reading the minutes of meetings of stockholders, board of directors, and committees of the board of directors. Procedure Reading the interim financial statements.
To identify actions that may affect the interim financial statements. Purpose of Procedure To consider, on the basis of information
coming the accountants' attention, whether the information to be reported conforms with generally accepted accounting principles. Obtaining reports from other accountants who may have been engaged to make a review of the interim financial information of significant components of the company. Obtaining evidence that the interim financial information reconciles with the accounting records. As a basis, in part, for the report.
To obtain assurance that the interim information is not materially misstated.
19-35 SOLUTION: Delano Company (Estimated Time: 20 minutes) Deficiencies in the staff assistant's draft are as follows: First paragraph: The statement of cash flows is not identified. Standards established by the AICPA, not generally accepted auditing standards, should be referred to. The financial statements are not stated to be the representations of management. The phrase "our review included such tests of the accounting records as we considered necessary in the circumstances" is inappropriate. Second paragraph: The phrase "analytical procedures applied to financial data" is omitted. The phrase "more in scope than a compilation" is inappropriate. An opinion should be disclaimed. An indication that "limited assurance" is expressed is not appropriate. Third paragraph: Reference to consistency is inappropriate.
19-36 SOLUTION: Norman Lewis (Estimated time: 25 minutes) Deficiency (1) The report does not identify the financial statements that were compiled. Reason To avoid reader misunderstanding as to which financial statements were compiled. Correction The report should clearly identify the compiled statements, including the company name, the individual statements, and their dates. Reference to the performance of analytical review procedures should be deleted from the report
(2)
A compilation report should not indicate that analytical procedures were applied to the financial statements.
A compilation involves the preparation of financial statements from representations of management, without performing procedures to audit or review the information. To indicate that procedures were applied to the financial statements could confuse the readers to the nature of the accountant's service.
. (3) The report does not The reader should be clearly indicate the nature of informed as to the nature of the a compilation of accountants' service. financial statements. The report should indicate that a compilation is limited to presenting in the form of financial statement information that is the representation of management. The statement of negative assurance should be altered to indicate that the accountants do not express an opinion or any other form of assurance on the financial statements.
(4)
The report provides negative assurance regarding the financial statements; it states that nothing came to the accountants' attention to indicate the financial statements are in error.
A compilation of financial statements does not provide a basis for the expression of negative assurance regarding the statements. The accountants report on the compilation should disclaim an opinion on the financial statements.
19-37 SOLUTION: Ajax Company (Estimated time: 25 minutes) Deficiencies in the report on the compiled financial statements are as follow: Within the first Paragraph (1) The financial statements are not properly identified. (2) Standards established by the AICPA should be referred to. (3) The expression "to obtain limited assurance" should not be used. Within the second paragraph (4) The information is not stated to be the representations of management. (5) The phrase "less in scope than an audit" is inappropriate. (6) Reference to the financial statements not being reviewed is omitted. (7) Reference to "any other form of assurance" is omitted. Within the third paragraph (8) Reference to the omission of the statement of cash flows is omitted. (9) There should be a statement that the financial statements are not designed for those uninformed about the omitted disclosures. (10) It is inappropriate to refer to changes in financial position. Within the fourth paragraph (11) The reason for the accountant's lack of independence should not be described. (12) Inclusion of the fifth paragraph is inappropriate. (13) The accountant's compilation report is not dated October 25, 20X8.
19-38 SOLUTION: Unaudited Financial Statements (Estimated time: 35 minutes) (a) Write-up work and compilation of financial statements represent an accounting service and not an audit of the financial statements. It is important that the client understand this distinction and more important that there be a clear understanding between the client and the CPAs of the nature of each engagement. Verbal commitments, such as a telephone conversation, can often be misunderstood and therefore should be followed up with an engagement letter that spells out the terms, nature, and limitations of the services to be performed. A copy of this letter should be signed and returned by the client to acknowledge its understanding and approval of the scope of the engagement. Even a regular audit engagement cannot provide absolute assurance of detecting irregularities, and in an engagement to compile financial statements the CPAs have no responsibility to apply any auditing or review procedures. However, as professionals, the CPAs do have a responsibility to exercise due care in carrying out their engagements, to apply professional judgment in the preparation of financial statements, and to bring to the client's attention any unusual or suspicious matters they note during their work. The CPAs have an obligation to investigate information that appears to be in error, incomplete, or otherwise inadequate. The word "audit" should be avoided in non-audit engagements. The CPAs should persuade their client to change the account title to "Accounting Services," and should be certain their client understands the difference between an accounting service and an engagement to examine the financial statements in accordance with generally accepted auditing standards.
(b)
(c)
(d)
Using language in a cover letter such as "... to which we have performed certain auditing procedures" can imply that an attest engagement of some type was made and the CPAs may find that they have assumed more responsibility than they intended. A short, concise disclaimer of opinion should always accompany unaudited financial statements with which the CPAs are associated, and each page should be clearly and conspicuously marked as unaudited. If a separate covering letter is used it should contain no language that would expand upon the simple disclaimer of opinion. The recommended disclaimer in Statement on Auditing Standards No. 26 (AU 504) is as follows: "The accompanying balance sheet of X Company as of December 31, 20X1, and the related statements of income, retained earnings, and changes in financial position for the year then ended were not audited by us and accordingly we do not express an opinion on them."
(e)
While the CPAs do not have a responsibility to perform any auditing or review procedures in a compilation engagement, they do have responsibility to perform all services with reasonable skill and care. A situation involving missing invoices should have caused the CPAs to question the accuracy and completeness of the financial information submitted to them. They should have rejected the information and investigated the situation. If it appeared that irregularities existed, the CPAs should have advised the client of the missing invoices and suggested that the client follow up on the matter or, if the client so desired, the CPAs could pursue it further as an additional accounting service. By definition, unaudited financial statements have not been audited and the CPAs cannot be expected to have an opinion as to whether they are prepared in conformity with generally accepted accounting principles. However, they do have a responsibility to complete a compilation engagement in a professional manner, and if they conclude on the basis of facts known to them that the unaudited financial statements are not in conformity with generally accepted accounting principles, they should insist upon appropriate revisions. In this situation the land and building should be adjusted to historical cost less depreciation. If the CPAs cannot persuade their client to adjust the land and building, they should set forth clearly in their compilation report the departure from generally accepted accounting principles and the effect, if known to them, on the financial statements. Further, if the client refuses to accept the CPAs' report with their reservations clearly set forth, the CPAs should refuse to be associated with the financial statements and formally withdraw from the engagement. Financial statements may be compiled that omit substantially all the disclosures required by generally accepted accounting principles. CPAs may compile them as long as they have no reason to believe that the financial statements are intended to mislead, and their compilation report clearly indicates that the financial statements omit the necessary disclosures.
(f)
(g)
19-39 SOLUTION: Calhoun (Estimated time: 35 minutes) What Brown Should Have Done to Avoid Inappropriate Action Brown should have established a clear understanding with the client, preferably in writing, through an engagement letter. The fee arrangement should have been based on the nature and difficulty of the engagement
Inappropriate Action (1) Brown was aware that the client misunderstood the nature of the engagement. Brown's agreement with Calhoun provided for the payment of a contingent fee; specifically, the understanding called for the payment of a substantial fee if the work was completed in two weeks. Contingent fees for such clients are prohibited by the AICPA Code of Professional Conduct.
(2)
(3)
Brown should not have suggested that his fees be recorded in an account entitled "Fees for Limited Audit Engagement." This action contributed further to the misunderstanding with the client concerning the nature of his services. Brown should have performed a further investigation of the situation indicated by the missing invoices. Even though a compilation does not involve the performance of procedures to substantiate the financial statement information, the accountants should investigate any situation that indicates that the information is incorrect, incomplete, or otherwise unsatisfactory. Brown did not insist upon disclosure of the method of valuation of fixed assets in the notes to the financial statements. A separate letter is not an appropriate means to disclose and explain the effects of accounting principles.
Brown should have insisted that his fee be recorded in an account that clearly indicated the nature of his services, such as "Fees for Accounting Services."
(4)
Brown should have investigated the possibility of irregularities as indicated by the missing invoices.
(5)
The notes should have been drafted to clearly indicate the method of valuation of the fixed assets.
Inappropriate Action (6) Brown did not disclose the departure from generally accepted accounting principles in accounting for fixed assets. The financial statements did not include a statement of cash flows, and Brown did not disclose this departure from generally accepted accounting principles in a properly drafted compilation report. Brown marked each page with a note indicating that the financial statements were submitted without complete audit verification. The financial statement reader cannot determine the type of service performed by Brown or the responsibility he was assuming. The financial statements were not accompanied by a properly drafted accountants' report.
What Brown Should Have Done to Avoid Inappropriate Action A report should have been drafted to include a separate paragraph referring to the departure from generally accepted accounting principles, including the effect of the departure, if known. A report should have been drafted with a separate paragraph referring to the departure from generally accepted accounting principles.
(7)
(8)
Each page of the financial statements should have been labeled "See Accountants' Compilation Report."
(9)
The financial statements should have been accompanied with a compilation report, which included the paragraphs discussed above referring to the departures from generally accepted accounting principles.