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The AICPA's accounting and review services committee has proposed a new level of service. The battle lines are already being drawn.

The SSARS Exemption Controversy:
A Proposed Solution

By Patrick J. Brennan

Ever since SSARS came into existence, practitioners have requested exemption from its requirements for internal-use-only financial statements. Developments over recent years have only added to the problem. The AICPA has proposed a solution. There is by no means agreement among practitioners as to the benefits of the proposal.

There is a perception by certain accountants that practicing under the Statements on Standards for Accounting and Review Services (SSARS) is uneconomical, both for themselves and their clients. They feel the requirements of SSARS create unnecessary procedures and reports while putting unnecessary restrictions on providing services clients expect and find useful. Some of these unnecessary procedures include completing checklists to document work performed--to determine if all disclosures were made and accounting positions taken by the accountant are in accordance with standards. These practitioners feel there should be a way to prepare a financial statement that is to be used solely by the client and accountant to discuss certain aspects of the business without complying with current requirements of SSARS.

Since the SSARS statements were issued, there has been a constant movement by certain members of the accounting profession to obtain exemptions from their requirements. Before discussing the reasons for the requests for these exemptions, it may be helpful to review the background of nonaudit services rendered by accountants on the nonpublic financial statements of their clients.

Background

Prior to the issuance of SSARS there were two levels of service an accountant could render relating to historical financial statements of nonpublic entities‹audit and "unaudited."

The literature prescribed the type of report to be issued for unaudited financial statements but did not prescribe procedures, if any, that had to be performed. In fact, it stated the accountant had no responsibility to apply any procedures to unaudited financial statements. As a result, different accountants performed different procedures. These procedures ranged from the very extensive--the performance of cutoff work on sales and purchases, analytical procedures, and inventory price testing--to the very minimal-- looking at bank reconciliations or checking postings and footings--to doing nothing. These various procedures were performed either because the accountant wanted some comfort about the financial statements that he or she was associated with or the client desired some level of work to be performed. Even though the extent of procedures differed, the accountant's report issued with the financial statements was the same. This lack of procedure standards for unaudited financial statements was perceived as causing confusion on the part of users of financial statements. These users were asked to make various credit or other decisions on the financial statements without knowing how much reliance they should place on the financial statements.

Certain accountants may also have felt there was no obligation on their part to perform any procedures if they discovered what could be a potential irregularity. As an example, in 1136 Tenants Corp. v. Max Rothenberg & Co., which took place in 1967, the CPA firm was sued by the client co-op apartment house for negligent failure to discover an embezzlement by the managing agent who hired the firm to write up the books. The firm was held liable for failure to inquire or communicate concerning missing invoices despite a legend on the financial statements stating, "No independent verifications were undertaken thereon." The firm moved to dismiss the case but the court denied the motion and held that even if a CPA "acted as but a robot, merely doing copy work," there was an issue as to whether there were suspicious circumstances relating to missing invoices that imposed a duty on the firm to warn the client. When the case went to trial, the court found an engagement to audit and entered a judgment for more than $237,000 despite the firm's oral evidence that it was employed for $600 annually to "write up" the books.

The ARSC

As a result, the Accounting and Review Services Committee (ARSC) of the AICPA, a senior technical committee, was formed. The mandate of the committee was to formulate a set of standards to be followed by accountants who performed services on unaudited financial statements of nonpublic entities and to develop a report that was more positive in disclosing the work performed by the accountant. In 1978, the committee issued SSARS No.1 entitled Compilation and Review of Financial Statements. This statement contains standards for performing either of two levels of service on unaudited financial statements of nonpublic companies‹a compilation or a review. This statement also prescribes the wording for the accountant's report to be issued in each case. Although this standard contains guidance for the accountant, it also contains certain prohibitions. It prohibits the accountant from issuing any report on unaudited financial statements of a nonpublic entity or submitting such financial statements to the client or others unless the accountant complies with its provisions. This prohibition, in effect, does not permit the issuance of "plain paper" or "internal use only" financial statements by the accountant. Originally this standard also prohibited the accountant from merely typing or reproducing the financial statements as an accommodation to a client. The standard does allow the accountant to report on financial statements that are not in conformity with GAAP or do not contain all the necessary disclosures required by GAAP including omission of the statement of cash flows. The standard also permits the accountant to report on financial statements prepared on a comprehensive basis of accounting other than GAAP, such as the cash or income tax basis.

Subsequently, the committee issued SSARSs No. 2 through No. 7. These subsequent statements give the accountant guidance in various situations such as the following:

* Association with comparative financial statements,

* Statements included in certain prescribed forms,

* Personal financial statements included in written personal financial plans,

* Communications between predecessor and successor accountants,

* Definition of submission of financial statements, and

* Management representation letters.

The original prohibition from merely typing or reproducing client-prepared financial statements by the accountant as an accommodation to a client, as noted earlier, was also revised by these latter statements.

Exceptions

Personal Financial Statements. SSARS No. 6, Reporting on Personal Financial Statements Included in Written Personal Financial Plans, issued in 1986, provides for an exemption from certain of the reporting requirements of SSARS No. 1. Essentially, this standard states an accountant under certain circumstances can report on personal financial statements that may be incomplete or not conform to GAAP and are not audited, reviewed, or compiled. The criteria for the special exemption include reaching an understanding with the client that these financial statements are to be included in a written personal financial plan and are not to be used for any purpose other than assisting the client and the client's advisors in developing the client's personal financial goals and objectives. These caveats must be included in the accountant's report that accompanies the financial statements. The ARSC allowed this exemption because the financial plan is the ultimate product and the personal financial statements included in written, personal financial plans are really incidental.

Litigation Services. An interpretation to SSARS indicates that financial statements submitted in conjunction with certain litigation services may also be excluded from the applicability of SSARS in limited circumstances. Examples under which this exemption operates include litigation services that involve pending or potential formal legal or regulatory proceedings before a "trier of fact" when‹

* the accountant acts as an expert witness,

* the accountant acts as a trier of facts or on behalf of one,

* the accountant's work is subject to detailed analysis and challenge by each party in the dispute, or

* the accountant is engaged by an attorney to do work protected by the attorney's work product privilege and such work is not intended to be used for other purposes.

An accountant is not required to issue a compilation or review report on these financial statements that are issued in accordance with these examples.

Internal Use Prospective Financial Statements. The Statement on Standards for Accountants' Services on Prospective Financial Information, issued by the Auditing Standards Board in 1985 and amended by Statement of Position 90-1, Accountants Services on Prospective Financial Statements for Internal Use Only and Partial Presentations, allows issuance of prospective financial statements for internal use only. These internal-use-only prospective financial statements consist solely of forecasts and projections. The accountant must attach his or her report that states such statements are restricted to internal use by management. Although these prospective statements can be compiled, this service is not covered under the SSARS.

Other Possible Exemptions. In the past, the ARSC has evaluated the question of providing additional exceptions to the standards. In 1982, there was a request to exempt computer generated interim financial statements. This prompted the issuance of an exposure draft entitled Computer-Prepared Interim Financial Statements. The majority of the responses to the exposure draft were not in favor of this exemption. The exposure draft was withdrawn and no exemption was given.

There was also a request in 1984 to permit the reporting on financial statements that were to be restricted to internal use only. No exemption was given by ARSC, and the only exemption for such statements is when the accountant is compiling or examining prospective financial statements.

Finally, there was a request in 1989 to permit the issuance of financial statements with which an accountant was associated without being accompanied by an accountants report, the so-called "plain paper" statements. This request also was rejected by the ARSC which reaffirmed its position that the existing SSARS must be complied with.

Why Has the Issue Been Raised Again?

There are a number of reasons for practitioners again to request an exemption from the requirements of SSARS. They are the advancement of technology as it relates to computers and to the development of financial statement preparation programs, the emergence of non-CPA owned firms who now render compilation and accounting services to clients, the onset of the peer review program, the increasing number and complexity of GAAP, and the change in the traditional type of engagement to more of a management services emphasis.

Technology. The advancement of technology has resulted in more and more clients acquiring computers and software to record transactions and prepare financial statements. As a result, some accountants feel there are other practitioners performing accounting and review services for their clients but not following the requirements of SSARS. They do this by either ignoring the standards altogether or trying to find methods or loopholes to circumvent the standards, such as preparing the financial statements on their client's computer but having the client "push the button" to generate the statements.

Competition. The emergence of non-CPA firms such as American Express Business and Tax Services has caused various competitive problems for the CPA. These firms and unlicensed accountants provide accounting services and perform compilations. They provide these compilation services more economically since they are not governed by the same set of standards as CPAs. Some practitioners feel they could perform more competitively in the marketplace if there was an exemption to certain of the standards imposed by SSARS.

Peer Review. Some practitioners have increased the extent of procedures when compiling financial statements to the point the procedures now approach those prescribed for reviews. These practitioners point to the peer review monitoring program, saying reviewers have imposed a higher standard for documentation and performance than contemplated when the standards were established.

GAAP. Many practitioners believe the proliferation of GAAP has caused financial statements to no longer have meaning to the managements of small, closely held companies. The FASB has issued approximately 100 standards since the inception of SSARS. Many practitioners feel a number of these standards are meaningful only in financial statements of public or very large and complex privately owned companies. Clients question the need for certain disclosures such as cash concentrations or for certain measurement adjustments such as are required for defined benefit pension plans. Practitioners argue that if users of financial statements are not receiving information pertinent to them, the standards should be changed to allow them to assist in preparing statements that are meaningful to users. Unlike shareholders in publicly held companies, most users of the financial statements of small businesses have an intimate knowledge of the business. Measurement and disclosure requirements are less useful to them than for investors and creditors of large publicly traded companies. This type of exemption has been granted in the past. For example, exemptions from computing earnings per share and disclosing business segment information apply to the financial statements of nonpublic companies.

Management Advisory Services. Another argument in support of relief is based on the performance of management advisory services. These advisory services may include recommending journal entries, reading client prepared financial statements, or proposing a financial statement format. The main purpose of this type of engagement is not to issue a financial statement but to give advice designed to help the client run the business. SSARS does not preclude the practitioner from performing these services without reporting on the client's financial statements. Some practitioners may, however, after reading the client prepared financial statements and analyzing the reasons for variations in income, gross profit, or expenses, make adjustments to the financial statements. The type and extent of procedures performed may end up crossing the threshold and be a submission of financial statements under SSARS.

Another View

On the other hand, there are practitioners who feel there is no need for any additional exemptions to the standards. They feel there is a risk that any exemptions to SSARS or the issuance of another set of standards for a level of service below a compilation will demean the profession. They feel that instead of increasing the ability of the licensed accountant to compete with non-CPA owned firms, it will lower the whole playing field and reduce the perceived added value the licensed accountant brings. Such practitioners also question whether a level of service below a compilation might cause the accountant to be connected with financial statements that are meaningless or even misleading.

Other practitioners feel compliance with existing standards is not onerous. Practitioners in this group feel the standards already allow alternatives for reporting on financial statements not in conformity with GAAP, for example, by compiling financial statements that are not accompanied by any disclosures or compiling or reviewing financial statements prepared on a comprehensive basis of accounting other than GAAP, such as cash or income tax basis. These practitioners feel SSARS also gives them the ability to report on financial statements that may also contain exceptions to GAAP by disclosing that fact in their accountants' reports. Even though such GAAP exceptions have to be disclosed, they do not have to be quantified. These practitioners do not see the necessity for any additional standards or an exemption from current standards. Even if engaged to perform management services, such as giving business advice, they feel this service can be accomplished under existing standards.

What About the Client?

Assume the only user of a financial statement is the management of a nonpublic company that, on an interim basis, needs information the accountant obtains from the company's unadjusted trial balance and puts into the form of a financial statement. The accountant knows this financial statement is not in conformity with either GAAP or OCBOA. Further assume the departures from GAAP or OCBOA are too numerous to mention in the accountant's report and the client has no interest in footnotes to the financial statement. In the current literature, there is no methodology for the accountant to report on and submit these statements. But since this type of statement would satisfy the intended user, shouldn't there be a method to be able to submit this type of statement?

Many practitioners would not want to perform this type of service since they feel a financial statement that does not contain all material adjustments to conform to GAAP or OCBOA could not possibly be of use to anyone. These same practitioners may be concerned other practitioners would use this internal use exemption to prepare substandard financial statements.

The AICPA Proposes a Solution

Following a 6-to-1 vote in favor, ARSC issued an exposure draft for a proposed SSARS titled Assembly of Financial Statements for Internal Use Only. This proposed Statement would provide an exemption from SSARS No. 1 for financial statements assembled for internal use only. The proposed statement defines assembly of financial statements as "providing various manual or automated bookkeeping or data processing services, the output of which is in the form of financial statements intended for internal use only. The function of assembling financial statements may include preparing a working trial balance, assisting in adjusting the books of account, and consulting on accounting matters. Assembly does not refer to the mere typing or reproduction of client-prepared financial statements."

The proposed statement indicates that whenever an accountant a) submits to a client that is a nonpublic entity, unaudited financial statements of that entity that are, or reasonably might be, expected to be used by another (third) party or b) reports on the unaudited financial statements of a nonpublic entity, the accountant should perform a compilation or review of financial statements and should issue a report prepared in accordance with the applicable standards of SSARS No. 1. The proposed statement goes on to say that the accountant, in deciding whether the financial statements are to be used by a third party, can rely on management's written representation without further inquiry, unless information comes to his or her attention that contradicts management's representation.

New Questions are Raised

The proposed statement indicates that the accountant who assembles unaudited financial statements pursuant to the exemption should establish a written understanding with the entity regarding the services to be performed. This written understanding should include a description of the nature and limitations of the services to be performed and a confirmation of management's representation and agreement that the financial statements are for internal use only. This written understanding should also state that the engagement cannot be relied upon to disclose errors, irregularities, or illegal acts.

The proposed statement will allow, but not require, the accountant to include a reference on each page of the financial statements such as "Restricted to Internal Use Only‹See Engagement Letter Dated [Date]."

Under the proposed statement, if the accountant becomes aware that financial statements assembled for internal use only are in the hands of third parties, the accountant should advise the client of that fact and should consider notifying the third parties and other appropriate actions, preferably in consultation with his or her attorney.

Finally the proposed statement indicates that if the accountant encloses a transmittal letter to the client with the assembled financial statements, the letter should be limited to a) an identification of the financial statements enclosed, b) a reference to the fact that they are for internal use only pursuant to the terms of the engagement letter, and c) comments of a business advisory nature to which the accountant wishes to draw the client's attention.

It appears that services provided by an accountant under this proposed statement would be exempt from the peer review program. It also appears this statement does not require the accountant to even read the financial statements nor adhere to any of the other requirements in the SSARS, such as obtaining an understanding of the industry in which the client operates. The proposed statement also does not appear to restrict this service to interim statements but allows it to be performed for year-end statements as well. Nor does it seem to require the accountant to be independent with respect to the client, nor to disclose a lack of independence.

Appendix A to the proposed statement is an illustrative engagement letter that suggests using an optional paragraph whereby the client agrees not to sue the accountant and to indemnify and hold the accountant harmless from any liability and legal costs arising from third party use of the assembled financial statements.

The proposed statement will please those who have advocated change from the beginning. Others will be vehemently opposed. Among other matters, the statement raises new questions on‹

* liability risk in the event a client‹using the assembled financial statements‹makes a decision that leads to financial loss,

* whether the service will be included as part of the AICPA's peer review program,

* whether the service will be considered part of the practice of public accounting and subject to regulation by licensing authorities (i.e., state boards of accountancy),

* the advisability of permitting an unmarked or unlegended version (plain paper, if you will) of an assembled statement to be issued. A copy could inadvertently reach the hands of a third party who might recognize that it had to be the work product of a knowledgeable accountant and accordingly useit for some unintended purpose.

The deadline for comments on the proposal is December 31, 1995. Comments received after that date are likely to receive consideration to the extent other comments are still being evaluated.

Practitioners and users of their services are encouraged to let their views be known. *

Patrick J. Brennan, CPA, is a partner with Putterman, Rush & Shapiro, LLP in charge of quality review, and was an adjunct professor at SUNY/College at Old Westbury. An active member of the NYSSCPA, Mr. Brennan is currently serving on the board of directors and various committees and task forces. He is a past president of the Nassau Chapter. Mr. Brennan is a frequent lecturer for the Foundation for Accounting Education and a recipient of its Distingushed Discussion Leader Award. In addition, Mr. Brennan is a member of the AICPA and the Institute of Management Accountants.

DECEMBER 1995 / THE CPA JOURNAL



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