Chapter 19 - Additional Assurance Services: Historical Financial Information

CHAPTER 19
Additional 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.

19-2

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.

19-3

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 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.

19-4

Yes. Auditors may express opinions on financial statements that are presented in accordance with a
financial reporting framework other than GAAP (e.g., a special purpose framework, such as the
cash basis). Such auditors' reports state indicate the framework being used and that the framework
is a basis of accounting other than GAAP.

19-5

Four types of special purpose financial reporting frameworks are:

Cash basis. The cash receipts and disbursements basis of accounting, and modifications of the
cash basis having substantial support, such as recording depreciation on fixed assets or
accruing income taxes.
Tax basis. The basis of accounting that the entity uses or expects to use to file its income tax
return for the period covered by the financial statements.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

Contractual basis. A basis of accounting in accordance with an agreement between the entity
and one or more third parties other than the auditor.
Regulatory basis. A basis of accounting in accordance with the requirements or financial
reporting provisions of a regulatory agency to whose jurisdiction the entity is subject. An
example is a basis of accounting that insurance companies use pursuant to the rules of a state
insurance commission.
19-6

The statement is incorrect. Only contractual basis and some regulatory basis special purpose
financial reporting frameworks result in a restricted use report. Also the reports use is not
restricted only to those within the entityparties to the contract or agreement, or the regulatory
agencies to whose jurisdiction the entity is subject also may use the report.

19-7

When the financial statements are intended for use only outside the United States the auditor
should issue one report, using either
A United States style form of report, but one which indicates that the financial statements have
been prepared in accordance with a financial reporting framework generally accepted in
another country, or
The other country audit report.

19-8

No, generally accepted accounting principles for personal financial statements require the valuation
of assets at estimated current values, not at historical cost. A qualified or adverse opinion would be
appropriate.

19-9

The procedures applied during a review of the quarterly financial statements include: (1)
procedures to obtain an understanding of the clients 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.

19-10 A unique aspect of the required review of the quarterly financial information is the fact that the
CPAs are not required to report on the engagement. Therefore, for a public company, the CPAs
must notify the SEC if the client files materially misstatement information. Another unique aspect,
as compared to a SSARS review is the required understanding of internal control that must be
obtained.
19-11 The CPAs assist audit committees by communicating matters that assist them in performing their
functions, including:

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Chapter 19 - Additional Assurance Services: Historical Financial Information

Instances of fraud and illegal acts;

Significant deficiencies 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, 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 Engagement letters (or some other written form of communication with management) are required
for accounting and review services. Establishing an understanding with the client is of particular
importance in this area since accounting and review services are quite different from 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 summary financial statements are
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.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

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. If the CPAs do
not believe that report modification is adequate, they should withdraw from the engagement.
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)
Issue a compilation report, or
(2)
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, the accountants should
make sure that the financial statements include a restricting phrase, such as Restricted for
Managements 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)
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. The objective of a review is to express
limited assurance that there are no material modifications for the financial statements to be
accordance with generally accepted accounting principles (or some other comprehensive
basis of accounting). 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.
(b)

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.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

19-24

Independent Auditors' Report

Dale, Booster & Co.
We have audited the accompanying financial statements of Dale, Booster & Co., which comprise the statement of
assets and liabilities arising from cash transactions as of December 31, 20X1 and the related statement of revenue
collected and expenses paid for the year then ended.
Managements Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with
the cash receipts and disbursements basis of accounting described in Note X; this includes determining that the cash
receipts and disbursements basis of accounting is an acceptable basis for the preparation of the financial statements in
the circumstances. Management is also responsible for the design, implementation, and maintenance of internal
control relevant to the preparation and fair presentation of financial statements that are free from material
misstatement, whether due to fraud or error.
Auditors Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit
in accordance with auditing standards generally accepted in the United States of America. Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial
statements. The procedures selected depend on the auditors judgment, including the assessment of the risks of
material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the
auditor considers internal control relevant to the partnerships preparation and fair presentation of the financial
statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the partnerships internal control. An audit also includes evaluating the
appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by
management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit
opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and
liabilities arising from cash transactions of Dale, Booster & Co. as of December 31, 20X1, and its revenue collected
and expenses paid during the year then ended in accordance with the cash receipts and disbursements basis of
accounting described in Note X.
Basis of Accounting
Without modifying our opinion, we draw attention to Note X to the financial statements, which describes the basis of
accounting. The financial statements are prepared on the cash receipts and disbursements basis of accounting, which is
a basis of accounting other than generally accepted accounting principles.
Emphasis of Matter

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

Kansas City, Missouri
March 1, 20X2
[

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Chapter 19 - Additional Assurance Services: Historical Financial Information

19-25

(a)
CPAs may report on specified elements, accounts, or items of a financial statement
in the following ways:
(1)

(2)

(3)

(b)

19-26

An audit may be performed, resulting in an opinion 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.

Yes. Such reports should indicate that they are intended solely for the use of certain
specific parties. Only individuals that have a clear understanding of the nature and extent
of the auditors' procedures should have access to the reports.
(a)

The major procedures for a review of financial statements include:

(1)
Inquiries concerning the company's accounting principles and practices.
(2)
Inquiries concerning the company's system of accounting.
(3) 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.
(4) Inquiries concerning actions taken at meetings of stockholders, board of directors, and
committees of the board.
(5) Reading the financial statements for conformity with generally accepted accounting
principles.
(6) Obtaining reports from other accountants, if any, who have audited or reviewed the
financial statements of components of the company.
(7) Inquiries of management concerning the conformity of the financial statements with
generally accepted accounting principles and material subsequent events.
(8)
Obtaining a representation letter from management.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

(b)

The report on a review of financial statements should indicate that:

(1)
A review was performed in accordance with AICPA standards.
(2)
The financial statements are representations of management.
(3)
A review consists of inquiries of management and analytical procedures.
(4) A review is substantially less in scope than an audit; therefore, no opinion is expressed
regarding the financial statements taken as a whole.
(5) 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.
Note to Instructor: The above are the big picture items. Students will include varying
other points.

(c)

19-27

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.
(a)
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.

(b)

Comfort letters also typically contain the assurances as to:

(1)

The independence of the accountants.

(2) Compliance of audited financial statements and schedules with the Securities Act and
related rules and regulations.
(3) Changes in selected financial statement items during a specified period from the date
of the latest financial statements included in the registration statement.
(4)

Tables, statistics, and other financial information in the registration statement.

(5)

Pro forma financial information, financial forecasts.

(6) Certain non-financial information included in the registration statement complies with
SEC regulations.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

19-28

(a)
When accountants are associated with the financial statements of a nonpublic
company, they should look for guidance in the Statements on Standards for Accounting
and Reviewer Servicesparticularly the compilation standards.
(c)

Wilson is responsible for following the compilation standards. Included here are
requirements to have knowledge of accounting principles used within the industry and a
general understanding of the clients business transactions and accounting records. If the
information appears to be incorrect, incomplete or otherwise unsatisfactory, actions must
be taken. A properly prepared compilation report must accompany the financial statements
in circumstances in which it is likely that a third party might use them

Objective Questions
19-29

Multiple Choice
(a) (3) Audits of financial statements include confirmations of accounts receivable,
reviews generally do not.
(b) (1) Both a representation letter and an engagement letter are required.
(c) (2) 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.
(d) (3) 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 are
not specifically required.
(e)

(3) The auditors report on summarized financial statements includes an opinion on

whether the summarized information is fairly stated in all material respects in relation to
the basic financial statements.

(f)

(2) Management of public companies must engage CPAs to review their companys
quarterly financial information.

(g)

(3) 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.

(h)

(4) Agreed-upon procedures engagements always result in a restricted use (limited

distribution) report.

(i)

(3) 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.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

(j)

(4) The special purpose financial reporting frameworks include cash basis, tax basis,
regulatory basis, and contractual basis.

(k)

(1) A compilation report contains a disclaimer regarding the financial statements; it should
not include the expression of negative assurance.

(l)

(1) A comfort letter is issued by the independent auditors to the underwriters.

Accordingly, such letters are normally signed by the independent auditors.

19-30
Statement
1. A special purpose financial reporting
framework is any framework other than GAAP.
2. Some, but not all, special purpose frameworks
require an indication that the financial
statements are intended solely for certain
specified users.
3. An audit report on financial statements that are
prepared using a special purpose framework
must include an emphasis of a matter paragraph
alerting users that the financial statements were
prepared in accordance with the framework.
4. An audit report on financial statements that are
prepared using a special purpose framework
must in all circumstances include a description
of the purposes for which the statements are
prepared.
5. An audit opinion on financial statements that
use a special purpose framework may be
unmodified.
6. The Attestation Standards, not the Statements
on Auditing Standards apply to engagements
involving special purpose frameworks.
7. If a regulatory agency requires a particular
layout for the audit report, the auditor may be
able to use that layout rather than the suggested
report included in the Professional Standards.
8. An audit report on financial statements that are
prepared using a special purpose framework
will indicate that the audit was conducted in
accordance with the special purpose financial
reporting framework auditing standards.

19-9

Correct

Incorrect
X

X
X

Chapter 19 - Additional Assurance Services: Historical Financial Information

19-31
Question
1. Is this considered an audit of financial
statements using a special purpose financial
reporting framework?
2. In performing the audit, must your firm
consider GAAS to the extent the standards
are appropriate?
3. If the financial statements are intended for
use only outside the United States, must an
audit report include an opinion on whether
US GAAP are followed?
4. If the financial statements are intended for
use both in the US and in Laos, must an
audit report include an opinion on whether
US GAAP are followed?
5. When the financial statements are intended
for use only outside the United States, if
Laotian generally accepted auditing
standards do not require the Laotian form
of audit report may your firm use the US
style form and modify it as necessary?
6. When the financial statements are intended
for use only outside the United States, if
Laotian generally accepted auditing
standards do not require the Laotian form
of audit report may your firm use the
Laotian style form?
7. Must a paragraph be added to the audit
report (or audit reports) indicating that the
financial statements are solely for certain
specified users?
19-32
(a)
(b)
(c)
(d)
(e)

Yes

No
X

Disagree (International Financial Reporting Standards are considered a general purpose

financial reporting framework).
Disagree (Cash basis financial statements use need not be restricted).
Agree.
Agree.
Agree.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

19-33 Simulation
May provide,
independence
is required

Service
a.
b.
c.
d.
e.
f.

Provide an opinion on whether financial statements are prepared following the cash basis of accounting.
Compile the financial statements for the past year and issue a
publicly available report.
Apply certain agreed-upon procedures to accounts receivable
for purposes of obtaining a loan, and express a summary of
findings relating to those procedures.
Review quarterly information and issue a report that includes
limited assurance.
Perform an audit of the financial statements on whether they
are prepared following generally accepted accounting principles.
Compile the financial statements for the past year, but not issue a report since the financial statements are only for the
companys use.

May provide,
independence
is not
required

May
not
provide

X
X
X
X
X
X

19-34 Simulation
(a)
1
(b)
2
(c)
3
(d)
2
(e)
1
(f)
1
(g)
3
(h)
2
(i)
3
Problems
19-35 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 financial statements of Jiffy Clerical Services, which
comprise the statement of assets and liabilities arising from cash transactions as of December
31, 20X1 and the related statement of revenue collected and expenses paid for the year then
ended.
Managements Responsibility for the Financial Statements

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Chapter 19 - Additional Assurance Services: Historical Financial Information

Management is responsible for the preparation and fair presentation of these financial statements
in accordance with the cash receipts and disbursements basis of accounting described in Note X;
this includes determining that the cash receipts and disbursements basis of accounting is an
acceptable basis for the preparation of the financial statements in the circumstances. Management
is also responsible for the design, implementation, and maintenance of internal control relevant
to the preparation and fair presentation of financial statements that are free from material
misstatement, whether due to fraud or error.
Auditors Responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We
conducted our audit in accordance with auditing standards generally accepted in the United
States of America. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statements. The procedures selected depend on the auditors
judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditor considers
internal control relevant to the partnerships preparation and fair presentation of the financial
statements in order to design audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the partnerships internal control.
An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of significant accounting estimates made by management, as well as evaluating
the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.
Opinion
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, 20X1, and its revenue collected and expenses paid during the year then ended in accordance
with the cash receipts and disbursements basis of accounting described in Note X.
Basis of Accounting
Without modifying our opinion, we draw attention to Note X to the financial statements, which
describes the basis of accounting. The financial statements are prepared on the cash receipts and
disbursements basis of accounting, which is a basis of accounting other than generally accepted
accounting principles.

Blue, Gray & Co.

City, State
February 23, 20X5

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Chapter 19 - Additional Assurance Services: Historical Financial Information

(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.

19-36 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.

(b)

The procedures that Loman must perform consist primarily of inquiries and analytical
procedures concerning significant accounting matters relating to the financial information
to
be reported. The procedures that Loman should apply ordinarily may be limited to the
following:
Procedure

Purpose of Procedure

Reviewing documentation of the most recent

audit and financial statements, and considering
the results of auditing procedures.

To update the understanding of the

business and internal control.

Inquiry concerning any significant changes in

the companys business activities.

To update the understanding of the

business and internal control.

Performing analytical procedures.

To identify potential misstatements and

provide a basis for inquiries to
management and certain other procedures.

Making inquiries of management regarding

unusual relationships.

To obtain assurance that unusual

relationships are not the result of
misstatements of the interim information.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

Performing additional procedures if the CPAs

become aware that interim information may be
incorrect, incomplete, or otherwise
unsatisfactory.

To obtain assurance that the interim

information is not materially misstated.

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.

To identify actions that may affect the

interim financial statements.

Reading the interim financial statements.

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.

As a basis, in part, for the report.

Obtaining evidence that the interim financial

information reconciles with the accounting
records.

To obtain assurance that the interim

information is not materially misstated.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

19-37 SOLUTION: Norman Lewis (Estimated time: 25 minutes)

Deficiency

Reason

Correction

(1)

The report does not

identify the
financial statements
that were compiled.

To avoid reader misunderstanding as to which

financial statements were
compiled.

The report should clearly

identify the compiled
statements, including the
company name, the individual
statements, and their dates.

(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.

Reference to the performance

of analytical review
procedures should be deleted
from the report

.
(3)

The report does The reader should be clearly

not indicate the
informed as to the nature of the
nature of a
accountants' service.
compilation of
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.

(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.

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.

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.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

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.

(b)

Even a regular audit engagement cannot provide absolute assurance of detecting fraud, 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.

(c)

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.

(d)

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.

(e)

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.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

19-39 SOLUTION: Calhoun (Estimated time: 35 minutes)

What Brown Should Have Done
to Avoid Inappropriate Action

Inappropriate Action
(1)

Brown was aware that the client

misunderstood the nature of the
engagement.

Brown should have established a clear

understanding with the client, preferably in writing,
through an engagement letter.

(2)

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.

The fee arrangement should have been based on the

nature and difficulty of the engagement

(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 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 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 should have investigated the possibility of

irregularities as indicated by the missing invoices.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

(5)

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.

The notes should have been drafted to clearly

indicate the method of valuation of the fixed assets.

What Brown Should Have Done

to Avoid Inappropriate Action

Inappropriate Action
(6)

Brown did not disclose the

departure from generally accepted
accounting principles in accounting
for fixed assets.

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.

(7)

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.

A report should have been drafted with a separate

paragraph referring to the departure from generally
accepted accounting principles.

(8)

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.

Each page of the financial statements should have

been labeled "See Accountants' Compilation
Report."

(9)

The financial statements were not

accompanied by a properly drafted
accountants' report.

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.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

In-Class Team Case

19-40 SOLUTION: Webstar (Estimated Time: 60 minutes)
a. Review of financial statements
(1)
(2)

(3)
(4)

(5)

Yes.
The procedures applied during a review of the quarterly financial statements of a
public company include: procedures to obtain an understanding of internal control;
analytical procedures applied to the interim financial data by reference to prior
interim information, budgets, and other data; reading minutes of meetings of
stockholders and directors; and obtaining written representations from
management regarding the presentation and completeness of the statements.
Limited (negative) assurance.
Departures from generally accepted accounting principles. Review reports are not
required to be altered in cases involving consistency or uncertainties, including
going concern. In addition, when a scope limitation is involved, the review is
considered incomplete and no review report should be issued.
Williams has confused the public company requirement of a review of interim
information with a review of a nonpublic company's annual statements. Webstar
is not required to have a review of its financial statements.

b. Compilation of financial statements

(1)
(2)

(3)

(4)
(5)

Yes.
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.
A compilation report need not be issued if the financial statements are not intended
to be used by a third party. In such case, the CPAs must document in an
engagement letter this fact, and the financial statements should be labeled as being
restricted to managements use.
A compilation report includes a disclaimer with no explicit assurance.
Compilation reports are modified for (a) departures from generally accepted
accounting principles, (b) lack of all disclosures, and (c) a lack of independence.

c. Financial Statements
(1)
(2)
(3)

Yes.
This is considered a report on a special purpose financial reporting framework.
The titles to the financial statements will be modified and a paragraph will be
added to the report indicating that a comprehensive basis of accounting other than
generally accepted accounting principles has been used.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

d. Auditing a Small Portion of the Financial Statements

(1)
(2)
(3)

Yes.
This is a "report on specified elements, accounts or items. Audits, agreed upon
procedures, and review are possible.
When expressing an opinion as a result of an audit on specified elements,
accounts, or items, positive assurance may be provided. An agreed-upon
procedures report includes a summary of findings. A review provides limited
(negative) assurance.

Research and Discussion Case

19-41 Dallas McBain (Estimated time: 45 minutes)
(a)

The undocumented disbursements should be of concern to the auditor even though this
engagement is a "balance sheet only" audit. Forbes appears to have complete personal
control over McBain's assets, including access to large amounts of cash. This constitutes
an internal control significant deficiency, which an auditor should communicate to his or
her client (McBain). Furthermore, Forbes is not properly executing his fiduciary
responsibilities as he is disbursing McBain's funds without either direct authorization or
proper documentation. Some risk exists that Forbes is embezzling assets from McBain.
The 1136 Tenants Case illustrates the problems that an accountant (or an auditor) may
encounter as a result of failing to advise a client of undocumented disbursements made by
a managing agent.
There is a possibility that the undocumented disbursements are related to material
misstatements in McBain's statement of assets and liabilities. For example, the
disbursements could be for payments on material unrecorded liabilities. Also, the
approximately $365,000 represents only the funds accounted for during the current year.
If McBain is accumulating hidden assets, the amount of these assets might be quite
material if the practice has been going on for a number of years. Therefore, the auditor
has reason to be concerned about the completeness of the statement of assets and
liabilities.

(b)

The auditor should give consideration to the following courses of action:

(1)

(2)

Advise McBain in writing of the weaknesses in internal control over the star's
assets. This action is required by AICPA AU 265, and by the concept of due
professional care. McBain should sign a copy of this communication to
acknowledge receipt; this copy should be retained in the auditor's working papers.
Request that McBain sign a representation letter regarding the completeness of
the financial statement and acknowledging awareness and approval of the
undocumented disbursements and the diversion of the proceeds of the sale of
securities. This letter is necessary to assist the auditor in forming an opinion as to
the completeness of the statement of assets and liabilities and also to prevent the
auditor from being personally liable in the event that Forbes is perpetrating a fraud
against McBain.

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Chapter 19 - Additional Assurance Services: Historical Financial Information

(3)

(4)

(5)

Issue an unmodified auditor's report. This action would be appropriate only if

the auditor was satisfied that the undocumented disbursements were personal
expenditures, not related to unrecorded assets or liabilities. Whether the auditor
personally approves of the way in which McBain spends money is not relevant to
the auditor's report on McBain's financial statements.
Issue a qualified opinion or a disclaimer of opinion. The argument for this
course of action is that the weak internal control and the lack of documentation in
the accounting records may be viewed as a scope limitation that prevents the
auditor from being satisfied as to the completeness of the statement of assets and
liabilities.
Withdraw from the engagement. The argument for this course of action would
depend upon whether the auditor concluded that Forbes and/or McBain appeared
so lacking in integrity that the auditor should not be associated with them.
Withdrawing from the engagement, however, would not eliminate the auditor's
responsibilities to advise McBain of the undocumented disbursements,
unaccounted for proceeds of the sale of securities, and weaknesses in internal
control.

(c) Our recommendation:

We would definitely advise McBain in writing of the weakness in internal control and
request that McBain sign a letter representing the awareness and approval of the
undocumented disbursements. We would then have to make a judgment call as to whether
to issue an unmodified or a qualified (scope limitation) auditors' report. Barring any other
indications of unrecorded assets or liabilities, we lean toward the unmodified opinion. We
recognize that individuals generally do not maintain strong internal control or accounting
records comparable to those found in business entities. Also, we do not consider it highly
unusual for an individual in McBain's position to spend money lavishly, often with little or
no documentation. Our principal concern is that our auditors' report not be used to assist
Forbes in concealing the misuse of assets from McBain. This concern, however, can better
be resolved by written communication with McBain than by qualification of the auditors'
report.
(d)

The purpose in posing this last question is to spark a discussion of the "real-world"
pressures upon a CPA to retain important clients. As the case was originally stated, the
CPA was young and just starting a practice. Under these circumstances, the auditor might
feel very uncomfortable in antagonizing either Forbes or McBain. Either of these
individuals might be so influential in the community as to prevent the CPA's practice from
getting off the ground.
By making the CPA well established and independently wealthy, and by making this
engagement only a small part of the CPA's total practice, we remove much of this pressure.
Theoretically, this should make no difference in the way that a CPA resolves a professional
judgmental decision. In reality, however, such factors may exert great pressure on a sole
practitioner or on an individual partner within a CPA firm. Such pressure to keep an
important client is one reason that large CPA firms often require a "second partner review"
of the working papers of each audit by a partner who has no responsibilities with respect
to that client.

19-21