New Guidance for Compilation and Review Engagements

By Thomas A. Ratcliffe

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• Sample wording addresses the situation where a CPA is associated with unaudited financial statements of a nonpublic entity and the CPA has not reviewed or compiled the financial statements.
• The SSARS reporting provisions now clarify that a statement of retained earnings is not a required financial statement.
• Additional guidance updates the content of management representation letters required in review engagements.
• The authoritative guidance now allows reporting on compiled supplementary information to the basic financial statements by issuing a separate report.
• SSARS 4, Communications Between Predecessor and Successor Accountants, now parallels changes in the auditing literature.

Each of the SSARS 9 changes became effective upon issuance of the document, with the exception of the new guidance related to management representation letters, which became effective for review engagements for reports dated on or after January 1, 2003.

Association with Financial Statements That Have Not Been Reviewed or Compiled

The auditing literature allows a CPA associated with the financial statements of a public company, but who has not audited or reviewed those financial statements, to state that he has not audited this unaudited information; furthermore, the auditing literature contains sample wording for this situation. SSARS 9 provides sample wording when this situation occurs in compilation and review engagements:

The accompanying balance sheet of X Company as of December 31, 20X1, the related statements of income, and cash flows for the year then ended were not audited, reviewed, or compiled by us and, accordingly, we do not express an opinion or any other form of assurance on them.

CPAs encounter such situations when they are engaged to perform a business valuation and they derive information from a client’s tax return; from another accountant’s audited, reviewed, or compiled financial statements; or from client-prepared financial statements. In June 2003, the ARSC staff issued SSARS 1/Interpretation 23, Applicability of Statements on Standards for Accounting and Review Services When an Accountant Engaged to Perform a Business Valuation Derives Information from an Entity’s Tax Return. As discussed in Interpretation 23, when a CPA derives information from another source and has not “submitted” financial statements as contemplated in SSARS, the CPA should refer to the source of the financial information and indicate in the report that she has not audited, reviewed, or compiled the financial information and that she assumes no responsibility for the information. Essentially, Interpretation 23 covers a special case of SSARS 9’s general guidance related to special reports. The following is an example of the appropriate SSARS 9 wording for such situations:

In preparing our business valuation report, we have relied upon historical financial information provided to us by management and derived from [refer to the source of the information, such as a tax return, an audit report issued by another auditor, etc.].

This financial information has not been audited, reviewed, or compiled by us and accordingly we do not express an opinion or any form of assurance of this financial information.

If the CPA becomes aware that the client has improperly associated her name with a client-prepared document containing unaudited financial statements, she should advise the client that such use of her name is inappropriate, and consider what other actions might be appropriate, including consultation with an attorney.

The Statement of Retained Earnings

The accounting literature does not require the statement of retained earnings as a basic financial statement. Accounting Principles Board (APB) Opinion 12, Omnibus Opinion–1967, requires disclosure of changes in equity during a reporting period. This disclosure requirement can be accomplished by preparing a separate financial statement (e.g., a statement of changes in equity or a statement of retained earnings), by combining these disclosures within the body of another financial statement (e.g., a combined statement of income and retained earnings), or by presenting these disclosures in the notes to the financial statements. SSARS 9 stipulates that there is no requirement for a statement of retained earnings in GAAP-based financial statements, nor in financial statements prepared under some other comprehensive basis of accounting (OCBOA).

This clarification addresses the situation where a CPA has compiled financial statements in which management has omitted substantially all disclosures required by GAAP or OCBOA. Compilation reports need not refer to an omitted statement of retained earnings, because the statement of retained earnings is not a required financial statement. In compiling an OCBOA financial statement, there should be no reference to the omission of either the statement of cash flows or the statement of retained earnings, because neither is required.

Management Representation Letters

SSARS 9 identifies the content of these representation letters, their dating, and the reporting periods covered by management representations. Written representations are required from management for all financial statements and reporting periods covered by a review report. For example, for comparative financial statements, representations obtained at the completion of the most recent review engagement should address all periods covered by the report. The specific representations will depend on the circumstances of the engagement, and the nature and basis of presentation (i.e., GAAP or OCBOA). Management’s representation letter should include the following:

• Management’s acknowledgment of responsibility for fair presentation in the financial statements.
• Management’s belief that the financial statements are fairly presented in conformity with GAAP or OCBOA.
• Management’s acknowledgment of full and truthful responses to all inquiries.
• Management’s acknowledgment of responsibility for the completeness of the information within the financial statements.
• Management’s acknowledgment that the CPA has been made aware of any subsequent events that could affect measurements or disclosures in the financial statements.

The management representation letter should be addressed to the CPA. Because events occurring through the date of the review report may require adjustment to, or disclosure in, the financial statements, the representation letter should be dated no earlier than the review report. Those members of management responsible for and knowledgeable about the matters in the representation letter, normally the CEO and CFO, should sign it. Current management should sign written representations for all periods covered by the report, even if it was not present during them all. An example of a review engagement representation letter updated for SSARS 9 appears in Exhibit 1.

Reporting on Compiled Supplementary Information

Before SSARS 9, it was unclear whether a separate report could be issued on compiled supplementary information if that information accompanies compiled financial statements. The review engagement literature allows the issuance of a separate report on supplementary information that accompanies reviewed financial statements. The compilation engagement literature now accepts a separate compilation for supplementary information that accompanies compiled financial statements.

When a CPA has compiled both the basic financial statements and the supplementary information (presented only for supplementary analysis purposes), the compilation report on the basic financial statements can include a reference to the supplementary information, or there can be a separate report on this information. If a separate report is issued, it should state that this information is presented only for supplementary analysis purposes, that it has been compiled from information that is the representation of management without audit or review, and that the CPA does not express an opinion or any other form of assurance on the information. Exhibit 2 provides an example of a model compilation report with a reference to compiled supplementary information. A separate report would use the following wording:

Our report on our compilation of the basic financial statements of X Company appears on page 1. A compilation is limited to presenting in the form of financial statements information that is the representation of management [the owners]. We have not audited or reviewed the financial statements and, accordingly, do not express an opinion or any other form of assurance on them. The information included in the accompanying [identify the supplementary schedules] is presented only for supplementary analysis purposes. Such information has been compiled from information that is the representation of management [the owners], without audit or review. Accordingly, we do not express an opinion or any other form of assurance on the supplementary information.

Communications Between Predecessor and Successor Accountants

SSARS 9 amends SSARS 4 to provide guidance on communications when the successor accountant decides to communicate with the predecessor accountant regarding the acceptance of a compilation or review engagement. SSARS 9 does not require a successor to communicate with the predecessor, nor does it require a response from the predecessor when the successor initiates communications. SSARS 9 modifies the definition of predecessor and successor accountant, provides guidance regarding acceptance of an engagement, provides suggested inquiries that the successor accountant may decide to ask, and includes a sample successor accountant acknowledgment letter that the predecessor may use when granting access to workpapers.

A successor accountant is one who is considering accepting or has accepted a compilation or review engagement. A predecessor accountant is one who has reported on the most recent compiled or reviewed financial statements or resigned from the engagement, declined to stand for reappointment, or otherwise will not complete such an engagement.

The successor accountant may decide to communicate with a predecessor accountant in the following circumstances, among others:

• Information obtained about the prospective client or management is limited or appears to require special attention.
• The change in accountants takes place substantially after the end of the reporting period for which the financial statements are to be compiled or reviewed.
• There have been frequent changes in accountants.

The successor accountant should remember that the predecessor accountant and the client may have disagreed about accounting principles, procedures applied by the predecessor accountant, or other significant matters. Before communicating with a predecessor, the successor accountant should request permission from the prospective client to make such inquiries and to authorize the predecessor to respond fully.

A successor’s inquiries may be verbal or written. The inquiries should be specific, regarding matters that will assist the successor in determining whether to accept the engagement. Typical inquiries would include:

• Information that might bear on the integrity of management.
• Disagreements with management about accounting principles or the need to perform certain procedures.
• The cooperation of management in providing additional or revised information.
• The predecessor’s knowledge of any fraud or illegal acts.
• The predecessor’s understanding of the reason for the change in accountants.

If the successor accountant wants to review the predecessor’s workpapers, he should request that the client authorize access to them. Customarily, the predecessor will make certain workpapers available for review. The predecessor accountant may want an understanding with the successor accountant about the use of the workpapers, and request a written communication from the successor accountant about their use. An illustrative successor accountant acknowledgement letter appears in SSARS 9, Appendix A. An example of a successor accountant acknowledgment letter is shown in Exhibit 3.

Other Issues

SSARS 9 addresses two other issues:

• Before SSARS 9, the compilation and review engagement literature did not require a CPA’s signature on compilation and review reports. SSARS 9 requires a signature (manual, stamped, electronic, or typed) on these reports. As a practical expedient, ARSC allows a typed signature on compilation and review reports.
• Before SSARS 9, the compilation and review engagement literature did not cross-reference the AICPA’s Statements on Quality Control Standards (SQCS). The SQCSs include compilation and review engagements among those subject to quality control standards. SSARS 9 cross-references the SQCSs. Importantly, deficiencies in, or noncompliance with, a firm’s quality control policies and procedures do not, in and of themselves, indicate that a particular compilation or review engagement was not performed in accordance with SSARS.

In July 2002, the staff of the ARSC released SSARS 1/Interpretation 21, Applicability of SSARS 1 When Performing Controllership or Other Management Services. When a CPA in the practice of public accounting provides an entity with controllership or other management services involving the submission of financial statements, and the CPA is not a stockholder, partner, director, officer, or employee of the entity, he must follow the performance and communication requirements in SSARS, including the requirement to disclose lack of independence.

When a CPA in public accounting practice is a stockholder, partner, director, officer, or employee of the entity, she may either comply with the SSARS requirements or communicate, preferably in writing, her relationship to the entity (e.g., stockholder, partner, director, officer, or employee of the entity). An example of this type of communication follows:

The accompanying balance sheet of Company X as of December 31, 20XX, and the related statements of income and cash flows for the year then ended have been prepared by [name of accountant], CPA. I have prepared such financial statements in my capacity [describe capacity; for example, as a director] of Company X.

CPAs not in public accounting practice cannot issue reports under SSARS.

In December 2002, the staff of the ARSC issued SSARS 1/Interpretation 22, Use of Selected Information–Substantially All Disclosures Required by Generally Accepted Accounting Principles Are Not Included. It reiterates that using the “selected information” label for financial statement notes when the financial statements include more than a few disclosures is not appropriate. The omission of one or more financial statement notes or disclosures when substantially all other notes and disclosures are presented should be treated like any other departure from GAAP or OCBOA, by disclosing the nature of the departure, along with its effects.

More Changes Coming

The ARSC staff plans to issue additional interpretations (e.g., the comprehensive income display issue; the reference to the country of origin associated with accounting principles or auditing standards). Furthermore, the ARSC is finalizing new SSARS. One of the primary substantive issues for the relatively near future involves more extensive performance guidelines for review engagements performed under SSARS.