1Chapter

25

Other Assurance Services and Nonassurance Services

Review Questions

25-1 Levels of assurance represent the degree of certainty the practitioner has attained, and wishes to convey, that the conclusions stated in his or her report are correct. Audits of historical financial statements prepared in accordance with generally accepted accounting principles are one type of examination. They are governed by auditing standards. An audit results in a conclusion that is in a positive form. In this type of report, the practitioner makes a direct statement as to whether the presentation of the assertions, taken as a whole, conforms to the applicable criteria. The level of assurance is high. In a review, the practitioner provides a conclusion in the form of a negative assurance. In this form, the practitioner s report states whether any information came to the practitioner s attention to indicate that the assertions are not presented in all material respects in conformity with the applicable criteria. The level of assurance is moderate. A compilation is defined in !!A"! as presenting, in the form of financial statements, information that is the representation of management without undertaking to express any assurance on the statements. 25-2 A negative assurance states, along with factual statements, that nothing came to the auditor s attention that would lead the auditor to believe that the financial statements were not prepared in accordance with #AA$ or other comprehensive basis of accounting. The reason for including such a statement in a review report is to provide financial statement users with some level of assurance that the financial statements are fairly stated. The level of assurance is less than that for an audit of historical financial statements, but more than the %ero&level assurance for a compilation. 25-3 'ompilation is defined in !!A"! (o. 1 as presenting in the form of financial statements information that is the representation of management, without undertaking to express any assurance on the statements. "eview is defined by !!A"! (o. 1 as performing in)uiry and analytical procedures that provide the accountant with a reasonable basis for expressing limited assurance that there are no material modifications that should be made to the statements in order for them to be in conformity with #AA$. There is no level of assurance provided by a compilation. "eviews provide limited assurance, but considerably less than a typical audit.

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25-4

,ne of three forms of compilation can be provided to clients

Compilation With Full Disclosure 'ompilation of this type re)uires disclosures in accordance with generally accepted accounting principles, the same as for audited statements. Compilation That Omits Substantially All Disclosures This type of compilation is acceptable if the report indicates the lack of disclosures and the absence of disclosures is not, to the '$A s knowledge, undertaken with the intent to mislead users. Compilation Without ndependence A '$A firm can issue a compilation report even if it is not independent with respect to the client, as defined by the Code of !rofessional Conduct. .owever, the '$A firm must state its lack of independence in the report.

25-5 The following five things are re)uired by !!A"! (o. 1 for compilation. The preparer of the statements must

/now something about the accounting principles and practices of the client s industry. /now the client, the nature of its business transactions, accounting records and employees, and the basis, form, and content of the financial statements. 0ake in)uiries to determine if the client s information is satisfactory. "ead the compiled financial statements and be alert for any obvious omissions or errors in arithmetic and generally accepted accounting principles. 1isclose in the report any omissions or departures from generally accepted accounting principles of which the accountant is aware. This re)uirement does not apply to a compilation that omits substantially all disclosures.

25-6 2or a compilation, the accountant does not have to make in)uiries or perform other procedures to verify information supplied by the entity beyond those identified in the answer to "eview 3uestion *+&+. 4ut if the accountant becomes aware that the statements are not fairly presented, he or she should obtain additional information. If the client refuses to provide the information, the accountant should withdraw from the compilation engagement.

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25-7

The following types of procedures are emphasi%ed for review services

,btain knowledge of the accounting principles and practices of the client s industry. The level of knowledge for reviews should be somewhat higher than that for compilation. ,btain knowledge of the client. The information should be about the nature of the client s business transactions, its accounting records and employees, and the basis, form, and content of the financial statements. The level of knowledge should be higher than that for compilation. 0ake in)uiries of management. The ob5ective of these in)uiries is to determine whether the financial statements are fairly presented, assuming that management does not intend to deceive the accountant. In)uiry is the most important of the review procedures. The following are illustrative in)uiries6 In)uire as to the company s procedures for recording, classifying, and summari%ing transactions, and disclosing information in the statements. 6 In)uire into actions taken at meetings of stockholders and board of directors. 6 In)uire of persons having responsibility for financial and accounting matters whether the financial statements have been prepared in conformity with generally accepted accounting principles consistently applied. $erform analytical procedures. The analytical procedures are meant to identify relationships and individual items that appear to be unusual. The appropriate analytical procedures are no different from the ones already studied in 'hapters 7 and 8 and in those chapters dealing with tests of details of balances.

252or review services, if a client fails to follow generally accepted accounting principles, a modification of the report is needed. The accountant is not re)uired to determine the effect of a departure if management has not done so, but that fact must also be disclosed in the report. 2or example, the use of replacement cost rather than 2I2, for inventory valuation would have to be disclosed, but the effect of the departure on net earnings does not re)uire disclosure. 25-! 'ompilations and reviews under !!A"! (o. 1 can only be issued for nonpublic companies for which an audit has not been performed. They may be for monthly, )uarterly, or annual statements. "eviews are issued on )uarterly information of publicly held companies as a part of the client s reporting re)uirements to the !9' and are sub5ect to $'A,4 standards. Although there are some minor differences in the wording on a review report for a nonpublic company and a public company review report, they are substantively the same.

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25-1" The review procedures are essentially the same for public company and !!A"! 1 reviews. !ome additional procedures are re)uired for public company reviews that are beyond the scope of !!A"! 1 as follows

The level of knowledge the accountant has about the client s internal control is likely to be higher for public company reviews. 4ecause an annual audit is done for public companies that have an interim review, the accountant must also obtain sufficient information about the client;s internal control for both annual and interim financial information. The auditor s knowledge of the results of the audit procedures performed during the annual audit will affect the scope of the procedures performed during the review of interim financial information. The accountant will also have a good idea whether the )uarterly statements were accurate after the annual audit is complete. This information will be useful in determining the review procedures in subse)uent years. <nder !!A"!, the auditor makes in)uiries about actions of directors and stockholder meetings= for public companies the auditor reads the minutes of those meetings. 2or public companies, the accountant must also obtain evidence that the interim financial information agrees or reconciles with the accounting records.

25-11 Attestation standards provide a general framework for and set reasonable boundaries around the attestation function. They provide guidance to AI'$A standard&setting bodies for establishing detailed standards and interpretations of standards for specific types of services. They also provide practitioners useful guidance in performing new and evolving attestation services where no specific guidance exists. The attestation standards, therefore, provide a conceptual framework for various types of services. #enerally accepted auditing standards do the same thing for the conduct of the ordinary audit of financial statements prepared in accordance with generally accepted accounting principles. 25-12 In a WebTrust assurance services engagement, a client engages a '$A to provide reasonable assurance that a company;s >eb site complies with one or more of the following fi"e Trust Ser"ices principles1. *. :. Security ? !ecurity practices ensuring that the system is protected against authori%ed access @both physical and logicalA. A"ailability ? Availability practices, ensuring that the system is available for operation and use as committed or agreed. !rocessing ntegrity # $rocessing integrity, ensuring that system processing is complete, accurate, timely, and authori%ed.

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25-12 #continued$ B. +. Online !ri"acy ? ,nline privacy practices, ensuring that personal information obtained as a result of e&commerce is collected, used, disclosed, and retained as committed or agreed. Confidentiality ? 'onfidentiality practices, ensuring that information designated as confidential is protected as committed or agreed.

A licensed '$A can issue a WebTrust opinion on an individual principle or on combinations of principles. 25-13 The purpose of a SysTrust engagement is for the licensed accountant to evaluate a company;s information technology system using Trust Ser"ices principles and criteria and to determine whether controls over the system exist. The accountant then performs tests to determine whether those controls were operating effectively during a specified period. !ee the solution to "eview 3uestion *+&1* for the five Trust Ser"ices principles. 25-14 A prospecti"e financial statement is a predicted or expected financial statement in some future period or at some future date. There are two general types of prospective financial statements- forecasts and pro5ections. A forecast is a prospective financial statement that presents an entity s expected financial position, results of operations, and cash flows for future periods, to the best of the responsible party s knowledge and belief. A pro$ection is a prospective financial statement that presents an entity s financial position, results of operations, and cash flows, to the best of the responsible party s knowledge and belief, given one or more hypothetical assumptions. An examination of prospective financial statements involves

9valuating the preparation of the prospective financial statements. 9valuating the support underlying assumptions. 9valuating the presentation of the prospective financial statements for conformity with AI'$A presentation guidelines. Issuing an examination report.

25-15 The purpose of an engagement of specified elements, accounts, or items is like that of an ordinary audit, but it is limited only to certain accounts or parts of the financial statements. An example is the audit of the sales account for a retail store in a shopping mall. The following are four specific re)uirements for reports on specified elements, accounts, or items

The specified elements, accounts, or items must be identified. The basis on which the specified elements, accounts, or items are presented and the agreements specifying the basis must be described.

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25-15 #continued$

The source of significant interpretations made by the client about the provisions of a relevant agreement must be indicated and described. If the specified element, account, or item is presented on a basis that is not in conformity with #AA$ or another comprehensive basis of accounting, a paragraph that restricts the distribution of the report to those within the entity and the parties to the contract or agreement must be added.

25-16 The reporting re)uirements for statements prepared on a basis other than #AA$ include the following paragraphs- introductory, scope, middle, opinion, and restriction of distribution paragraph. The introductory, scope, and opinion paragraphs are essentially the same as for statements prepared in conformity with #AA$. The middle paragraph states the basis of presentation and refers to a note to the financial statements that describes the basis of accounting followed. The restriction of distribution @finalA paragraph is used when the financial statements are prepared in conformity with re)uirements of a governmental regulatory agency. 1istribution of the report is then restricted to those within the entity and for filing with the regulatory agency. 25-17 It would be appropriate for #ermany to provide a report to (orthern !tate 4ank on all of the conditions except the competency of management. "eports on the working capital ratio, dividends paid on preferred stock, and aging of accounts receivable are factual matters within a normal auditor s competence. "eporting on the competence of management is highly sub5ective and should not ordinarily be in a debt compliance letter. %u&tip&e Choice Questions 'ro( C)A *+a(inations a. a. a. @BA @:A @1A b. b. b. @*A @*A @*A c. @1A c. @*A d. @BA

25-1 25-1! 25-2"

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,iscussion Questions and )ro-&e(s

25-21 The accountant is responsible for the care in the preparation of compiled financial statements. The accountant must perform all five steps identified in the answer in "eview 3uestion *+&+ with due care. The report must also be properly prepared and reflect the findings of the accountant. <sers other than management are not prohibited from using compiled financial statements. They can expect the accountant to meet the standards set by the profession. The courts have not established the responsibilities of accountants for compilations. $resumably, the responsibilities should be far less than for audits and somewhat less than for reviews. "esponsibilities exist, but the level has yet to be finali%ed. 25-22 a/ R*Q.0R*, ON A R*10*2 *N3A3*%*N4
D D D D -/ R*Q.0R*, ON A CO%)05A40ON *N3A3*%*N4 D

)ROC*,.R* 1. *. :. B. +. C. 7. 8. E.

D D

D F "e)uired procedure

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25-23

a.

The primary procedures performed in a review engagement consist of performing analytical procedures and in)uiries of management. 4ut, in addition to those procedures, the accountant should also perform the following

,btain knowledge of the accounting principles and practices of the client;s industry. ,btain knowledge of the client;s business ,btain a letter of representation $erform additional procedures if the accountant becomes concerned that information is incorrect, incomplete or otherwise unsatisfactory. Issue the review report. In)uire about the nature of repairs made to determine if any represent expenses that should be capitali%ed. Ask about whether any of the related property, plant, and e)uipment should be ad5usted to reflect permanent impairment and in)uire if any e)uipment that is currently included in the financial statements has been disposed of during the year. In)uire about whether management has documentation in the contract of the real estate taxes not being the responsibility of the client until next year and ask to review that contract. $erhaps examine any public records of tax obligations for the county or municipality to determine the status of outstanding taxes due. Ask management to provide invoices from most recent purchases of pipes for construction and estimate the inventory values based on the most recent prices to determine the impact of changes in market conditions on the ending inventory balance. 'alculate days sales in inventory and compare trends to prior years to determine whether collections are slowing. Analy%e aging categories of accounts receivable relative to prior years to evaluate whether receivables are older. 0ake in)uiries of the client;s legal counsel to obtain their views of the likely outcome of the lawsuit.

b.

1.

*.

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B.

+. 25-24 a.

In addition to the in)uiries listed, the accountant must understand the client s business to facilitate evaluating whether the statements are reasonable. Analytical procedures must also be performed. It may also be appropriate to in)uire about such things as the possibility of unbilled sales, authori%ation procedures for sales, whether the accounts receivable control account has been reconciled with the master file records, and the possible inclusion of consignment shipments as sales.

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25-24 #continued$ b. In reviews, no procedures such as tests of controls, substantive tests of transactions, cutoff tests, or confirmation re)uests are done. The only things that are done are in)uiries and analytical tests. An examination of the procedures for sales and receivables discussed in 'hapters 1B and 1C shows that there is considerable difference between an audit and those review procedures listed in this problem. In)uiries would ordinarily be made of the chief financial officer in a small or large business. ,rdinarily the chief financial officer in a small business is the owner, but it may also be a controller or vice& president. Additional procedures should be performed when the accountant believes, based on the information obtained through in)uiry and analytical procedures, that the financial statements may be materially misstated. 9xamples where this could be the case areG G G A material increase in the gross margin percent A material decrease in allowance for uncollectible accounts divided by accounts receivable A statement by a bookkeeper that leads the accountant to believe the client s personnel do not fully understand correct sales cutoff procedures

c.

d.

e.

The achieved level of assurance for audits is ordinarily much higher than for reviews. The differences in the procedures identified in this problem and those studied in 'hapters 1B and 1C are significant and result in large differences in the achieved levels of assurance. It is not appropriate to do a !!A"! review service for a publicly held company. !!A"! engagements are restricted to nonpublic companies. Annual statements of public companies must either be audited or unaudited in accordance with generally accepted auditing standards and re)uirements of the !ecurities and 9xchange 'ommission. This provides a clearer definition in the level of assurance for the financial statements of public companies. .owever, a review&type service can be provided for interim financial statements of public companies.

25-25

a.

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25-25 #continued$ b. There are some deficiencies in the approach taken

4ecause Tidwell is a high risk client, indicating a high likelihood of misstatement, and because the re)uired review procedures include in)uiries and analytical procedure, the review should, at least in part, be performed by the more experienced member of the engagement team, and not be so completely delegated. 4ecause there are some differences between an !!A"! 1 review and a public company review, use of the firm s standard procedures for !!A"! reviews without modification is inappropriate. Additional procedures to be performed include @at a minimumA "elating in)uiries to findings in the recent audit "eading minutes

c.

The following problems exist with regard to the report

$ages should be marked HunauditedH not Hreviewed.H The report should be addressed to the client, not the !ecurities and 9xchange 'ommission. The wording of the report should be changed from the !!A"! review to the re)uired wording for public companies, including reference to $'A,4 standards.

25-26 a. A client may re)uest a SysTrust engagement for a system that is in the pre&implementation phase. In this engagement, the '$A would report on the suitability of the design of the controls and the report would be as of a point in time rather than for a period of time. The '$A cannot perform WebTrust assurance services without being licensed by the AI'$A to provide such services. '$As seeking to provide WebTrust services must attend training, apply for the WebTrust license, and satisfy other )uality control re)uirements. The '$A can perform the re)uested SysTrust assurance service on compliance with the Availability principle. '$As can provide assurance about an entity;s compliance with a single Trust Ser"ices principle or a combination of two or more principles. The WebTrust seal cannot remain on the company;s >eb site through 0ay :1, *I1I without the '$A updating his or her work to support the seal. The WebTrust service re)uires the '$A to update his or her testing once every twelve months to ensure the entity continues to comply with Trust Ser"ices principles and criteria. *+&1I

b.

c.

d.

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a.

It would be acceptable to undertake the engagement only if all of the following conditions exist

The accountant has sufficient competence to properly complete an examination of the forecasted financial statements. The client is willing to take responsibility for preparation @with the accountant s assistanceA of the forecast in accordance with guidelines, established by the AI'$A in Statements on Standards for Accountant%s Ser"ices on !rospecti"e Financial Statements. The accountant believes a reasonably accurate forecast is practicable in the circumstances. The client understands and agrees to the examination procedures and reporting re)uirements the accountant must comply with.

b.

If 0onson believes the accountant can issue an opinion about the achievability of the forecast, but later finds that such an opinion cannot be given, 0onson is likely to be unhappy. The result would be a loss of fee, loss of a client for other services, and perhaps even a lawsuit. !imilarly, 0onson must understand his responsibilities concerning the forecast of the assumptions and other aspects of the report, again to avoid a misunderstanding later. The primary information the '$A firm will need to help in completing the forecast are the following

c.

Audited financial statements for the past several years. @9asily available because 0onson is an audit client.A Information about the economic conditions of the industry. The '$A firm will likely need knowledge beyond that re)uired for performing the audits. Information about the offer he has made for the new business and the offer he has received for the existing assets. 4ecause the financial statements will be a forecast, and not a pro5ection, it is necessary to determine that there is a reasonable likelihood of the transaction being completed and the forecasted result, assuming both transactions are finali%ed.

d.

The report will be a report on a forecast and will include the following components

An identification of the prospective financial statements presented. A statement that the examination of the prospective financial statements was made in accordance with AI'$A standards and a brief description of the nature of such examination. *+&11

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The accountant s opinion that the prospective financial state& ments are presented in conformity with AI'$A presentation guidelines and that the underlying assumptions provide a reasonable basis for the forecast. A caveat that the prospective results may not be achieved. A statement that the accountant assumes no responsibility to update the report for events and circumstances occurring after the date of the report.

25-2

a.

The purpose of a debt compliance letter is to provide the lender with an independent opinion of the existence or nonexistence of some condition. The lender usually will re)uest a '$A to determine whether certain loan covenants are being adhered to by the debtor. An audit of the company is necessary before a debt compliance letter is issued because a compliance letter would be difficult to prepare without an audit. This stems from the fact that the '$A is usually concerned with financial balances and ratios of the company when preparing a debt compliance letter. An audit is virtually re)uired in order to verify these amounts. A '$A firm could issue a debt compliance letter on the amount of the current ratio and the owner s e)uity. The firm may report on these two aspects because it is )ualified to evaluate such matters. .owever, the other three re)uests re)uire legal expertise and sub5ective 5udgment that a '$A firm does not claim to possess. Therefore, the '$A should restrict the debt compliance letter to the two )uantitative re)uests. We ha"e audited& in accordance with generally accepted auditing standards& the balance sheet of !ollution Control De"ices& nc' as of and the related statements of income& retained earnings& and cash flows for the year then ended& and ha"e issued our report thereon dated ' n connection with our audit& nothing came to our attention that caused us to belie"e that the Company failed to comply with any of the pro"isions of the indenture dated with (lender) insofar as they relate to accounting matters' *owe"er& our audit was not directed primarily toward obtaining knowledge of such noncompliance' This report is intended solely for the information of the boards of directors and management of !ollution Control De"ices& nc' and (lender) and should not be used for any other purpose'

b.

c.

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a.

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25-2! #continued$ b. The supplemental report would have to state that the company was not in compliance with the provisions of the indenture because net earnings did not exceed dividends by at least J1,III,III. The supplemental report would be the same as discussed in b. Assuming that a default in the provisions of the indenture results in the loan becoming due immediately, the auditor s report would have to include either an adverse or )ualified opinion depending upon the materiality of the misstatement. 4ecause the mortgage is for JB million, which is material to the client, violation of the indenture and potential default cannot be dismissed as being immaterial. 'ontingencies due to a lawsuit may affect the liabilities of the client that will affect the indenture provisions. The auditor will be unable to express an opinion in the debt compliance letter because of this uncertainty. This should be disclosed in the supplemental report. Kones will probably have to conduct additional audit tests in order to report on these items individually. It will be necessary for Kones to accumulate additional evidence because the materiality of the individual items is much lower than for the overall financial statements. The additional evidence will enable the auditor to obtain a higher level of assurance regarding the items than is attained without expanding the audit procedures. The individual items have a lower level of materiality because their magnitude is less than the overall financial statements. Therefore, an amount that is not considered material to the financial statements as a whole may be material when applied to the three accounts being considered. The following additional tests are likely to be needed before the special report can be issuedSales

c.

d.

25-3"

a.

b.

'utoff tests of sales may be expanded 1epending upon the previous results, tests of controls and substantive tests of transactions for sales may be increased 9xamine physical existence of a sample of fixed assets 1etermine if fixed assets are still on the books but not being used "ecalculate depreciation Increase vouching of additions in the current year *+&1:

+et fixed assets

25-3" #continued$ n"entory

Increase the price test coverage of inventory value

It should be noted that the extent of these tests depends on the results attained in these areas in the audit, the amount of evidence gathered in the audit, and the client s internal controls. The audit procedures above are vague because of this and are intended to be illustrative of the type of procedures that should be considered. After&the&fact auditing has limitations in that some information cannot feasibly be recreated. 2or instance, the auditor cannot extend test counts of inventory in order to verify the )uantity of inventory. In these cases the auditor must attempt to satisfy the ob5ective by alternative methods. c. We ha"e audited the schedules of sales& net fixed assets& and in"entory "alued at F FO (as defined in the lease agreement dated between (lessor) and Sarack ,umber Supply Co') of Sarack ,umber Supply Co' for the year-ended ' These schedules are the responsibility of Sarack ,umber Supply Co%s' management' Our responsibility is to express an opinion on the schedules based on our audit' We conducted our audit in accordance with auditing standards generally accepted in the .nited States' Those standards re/uire that we plan and perform the audit to obtain reasonable assurance about whether the schedules of sales& net fixed assets& and in"entory "alued at F FO are free of material misstatement' An audit includes examining& on a test basis& e"idence supporting the amounts and disclosures in the schedules' An audit also includes assessing the accounting principles used and significant estimates made by management& as well as e"aluating the o"erall schedule presentation' We belie"e that our audit pro"ides a reasonable basis for our opinion' n our opinion& the schedules of sales& net fixed assets& and in"entory "alued at F FO present fairly& in all material respects& the sales& net fixed assets& and in"entory "alued at F FO of Sarack ,umber Supply Co' for the year-ended & on the basis specified in the lease agreement referred to abo"e' This report is intended solely for the information and use of the boards of directors and management of Sarack ,umber Supply Co' and (lessor) and should not be used for any other purpose'

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0nternet )ro-&e( So&ution6 Accountin7 and Review Services Co((ittee

25-1 The Accounting and "eview !ervices 'ommittee @A"!'A is responsible for issuing standards for compilations and reviews of financial statement issued by nonpublic companies. Lisit the AI'$A website Mhttp-NNwww.aicpa.orgO and answer the following )uestions about the operations of this committee1. .ow are individuals chosen to serve on the A"!'P Answer6 According to the website- QThe A"!' is a committee of seven members, all of whom are AI'$A members. 0embers are appointed to achieve an appropriate representation among small and medium firms actively involved in the provision of compilation and review services. The 1irector, AI'$A Audit and Attest !tandards @the Q1irectorRA, in consultation with the A"!' 'hair, nominates members of the A"!'. The AI'$A 4oard of 1irectors approves nominations for members of the A"!'.R *. .ow long must an exposure draft of a new standard @i.e., a new !!A"!A be made available for public commentP Answer6 According to the website- QIn determining an appropriate public exposure period of a proposed !!A"!, including the comment due date, the A"!' will take into consideration that the period from 2ebruary 1 through April :I of any calendar year represents the traditional Qbusy seasonR for many practitioners. Although the A"!' will attempt to limit having a comment period for a proposed !!A"! end during the traditional Qbusy seasonR, the decision regarding the comment due date will take into account the complexity of the sub5ect matter in the proposed !!A"! as well as the circumstances surrounding the need for a new standard.R :. 0ust meetings of the A"!' be open to the publicP Answer6 In short the answer is Qno.R The A"!' may find it necessary to hold private meetings to discuss matters of an administrative or confidential nature. ,n the other hand, the A"!' may hold open meetings to discuss the issuance of a new !!A"! or other matters that the committee believes are of interest to the public.
@Note- Internet problems address current issues using Internet sources. 4ecause Internet sites are sub5ect to change, Internet problems and solutions may change. 'urrent information on Internet problems is available at www.pearsonhighered.comNarens.A

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