preparation, compilation, and review engagements

Preparation, Compilation, and Review EngagementsUpdate and Review

Kimberly Burke, Ph.D., and Hugh Parker, Ph.D., CPA

AICPAStore.com | CIMAglobal.com

CPE/CPD = 4 credit hours

PREPARATION, COMPILATION, AND

REVIEW ENGAGEMENTS: UPDATE AND REVIEW

BY KIMBERLY BURKE, PH.D., AND HUGH PARKER, PH.D., CPA

Notice to readers

Preparation, Compilation, and Review Engagements: Update and Review is intended solely for

use in continuing professional education and not as a reference. It does not represent an official

position of the Association of International Certified Professional Accountants, and it is

distributed with the understanding that the author and publisher are not rendering legal,

accounting, or other professional services in the publication. This course is intended to be an

overview of the topics discussed within, and the author has made every attempt to verify the

completeness and accuracy of the information herein. However, neither the author nor publisher

can guarantee the applicability of the information found herein. If legal advice or other expert

assistance is required, the services of a competent professional should be sought.

Special note: COVID-19 resources

The Association, the global voice of the American Institute of CPAs and the Chartered Institute

of Management Accountants, is taking the Coronavirus (COVID-19) very seriously. We are

continually monitoring the virus’ impact on our members and the profession. For the most up-to-

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https://future.aicpa.org/resources/toolkit/aicpa-coronavirus-resource-center. For topic-specific

updates, please visit the following resource centers.

COVID-19 Resource Center Website

Audit and assurance https://future.aicpa.org/topic/audit-

assurance/covid-19-audit-assurance

Accounting & reporting https://future.aicpa.org/topic/accounting-

reporting/covid-19-accounting-reporting

Forensic services https://future.aicpa.org/topic/forensic-

services/covid-19-forensic-services

Valuation services https://future.aicpa.org/topic/valuation-

services/covid-19-valuation-services

Management accounting https://future.aicpa.org/topic/management-

accounting/covid-19-management-accounting

Personal financial planning https://future.aicpa.org/topic/financial-

planning/covid-19-personal-finance-planning

Small firm https://future.aicpa.org/topic/firm-practice-

management/covid-19-small-firms

Tax https://future.aicpa.org/topic/tax/covid-19-tax

Technology https://future.aicpa.org/topic/technology/covid-

19-technology

Government https://future.aicpa.org/topic/government/covid-

19-government

© 2021 Association of International Certified Professional Accountants, Inc. All rights reserved.

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CL4COMP GS-0421-0A Revised: February 2021

Use of materials

This course manual accompanies all formats in which the course is offered, including self-study

text, self-study online, group study, in-firm, and other formats, as applicable. Specific

instructions for users of the various formats are included in this section.

CPAs are required to participate in continuing professional education (CPE) to maintain their

professional competence and provide quality professional services. CPAs are responsible for

complying with all applicable CPE requirements, rules, and regulations of state licensing bodies,

other governmental entities, membership associations, and other professional organizations or

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Professional standards for CPE programs are issued jointly by the American Institute of Certified

Public Accountants (AICPA) and the National Association of State Boards of Accountancy

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provide feedback for both correct and incorrect responses. Note that these reviews are provided

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© 2021 Association of International Certified Professional Accountants. All rights reserved. Table of Contents 1

Table of Contents

Current Economic Environment 1

The U.S. business environment 2

Implications of the current economy 9

Summary 19

Solutions 21

Recent Statements on Standards for Accounting and Review Services Developments 23

SSARS No. 25, Materiality in a Review of Financial Statements and Adverse Conclusions – 2020 24

SSARS No. 24, Omnibus Statement on Standards for Accounting and Review Services – 2018 30

SSARS Nos. 22–23, Compiling pro forma and prospective financial information 41

Summary 47

Solutions 51

Current Practice Issues 57

AICPA resources 58

Current independence and ethics issues 62

Current issues from ARSC 72

QC section 10, A Firm’s System of Quality Control 76

Summary 79

Practice question — Quality control 80

Solutions 83

Current Accounting and Reporting Issues 89

Common deficiencies in peer reviews 90

Recent accounting standards overview 97

Other accounting frameworks 114

Summary 117

Practice questions 118

Solutions 119

© 2021 Association of International Certified Professional Accountants. All rights reserved. Table of Contents 2

On the Horizon 123

Resources 124

ARSC pipeline 126

FASB pipeline 127

Summary 131

Solutions 133

Glossary 135

© 2021 Association of International Certified Professional Accountants. All rights reserved. 1

Current Economic Environment

Learning objectives

Identify the key economic factors that may affect clients and their financial statements.

Identify financial reporting implications of the coronavirus pandemic.

Recall the accountant’s responsibility for going concern issues.

Recall the accountant’s responsibility for subsequent events.

Recall the accountant’s responsibility for fraud and recommendations for minimizing fraud-related risk.

Recognize the accountant’s responsibility for other engagement issues related to the coronavirus pandemic.


The U.S. business environment In performing a review engagement, accountants are required to have an understanding of the industry in

which the client operates. Economic factors, including interest rates, availability of credit, consumer

confidence, overall economic expansion or contraction, inflation, and labor market conditions are likely to

have an impact on clients and their financial statements. Specifically, adverse effects in these economic

factors may provide sufficient pressure or motivation for client managers to adopt more aggressive

accounting and financial reporting strategies. In the current year, accountants also must consider the

economic effects of the coronavirus pandemic on financial reporting decisions and the degree to which it

has left the economy vulnerable.

Globally, gross domestic product (GDP) growth is slowing down to an annual growth rate of around 3%,

with some countries, like the United States and Japan, offsetting weaker results in others’ advanced

economies such as Europe. Trade tensions, globally, are affecting business confidence and investment,

but these tensions are often offset by strong labor markets and consumer spending.

As described later, economic indicators such as GDP, unemployment, and the federal fund rate

demonstrate an economy that has not recovered from the coronavirus pandemic. There seems to be a

divergence, however, between the rallying stock market and the stumbling economy since April 2020.

Although the overall decline in the Dow Jones Industrial Average had a decline of 2.7% for 2020, as of the

third quarter, the average demonstrated a leap in the second quarter that increased it by about 10,000

points. The average grew another 7.6% in the third quarter. Overall, as of the third quarter of 2020, the

NASDAQ composite index is up 24.5%, gaining 11% in the third quarter, following a slight 5% decline in

September. As the government and Federal Reserve make great efforts to support the recovery in the

economy, stocks would be preferred option in a purchaser’s portfolio, especially when the interest rate is

expected to stay near zero. The Chicago Board Options Exchange Volatility Index (VIX) is considered an

indicator of investor sentiment, market volatility, and fear in the market. The VIX increased to above 66 in

March 2020, the highest level seen since the Great Recession of 2008. As of December 2020, the VIX has

dropped to 20.82. Although indicative of a relatively low risk environment, the VIX is still significantly

elevated when compared to the range of 15–17 during the previous decade.

One of the leading indicators of a country’s economic health is its GDP. GDP measures output of goods

and services by labor and property within the United States. It increases as the economy grows and

decreases as the economy slows and is a main indicator of a recessionary economy. The pandemic’s

effects are reflected in GDP during 2020, although it is not possible to isolate those effects. Generally

speaking, consumer and business spending both contributed to the decline as they followed government-

issued “stay at home” orders. Consumers reduced consumption of both goods and services, and

business spending declined or was redirected. In the first quarter of 2020, real GDP decreased at an

annual rate of 5%. The second quarter of 2020 continued to reflect the effects of the pandemic as real

GDP decreased at an annual rate of 31.7%. In the third quarter of 2020, real GDP increased at an annual

rate of 33.1% (second estimate). The increase reflects attempts of the economy to return to “normal”

following the shutdown in the previous quarters. More specifically, the increase has been attributed to

positive contributions from nonresidential fixed investment, residential investment, and exports. These


increases were partially offset by negative contributions from state and local government spending,

private inventory investment, and personal consumption expenditures. Imports that reduce the

calculation of GDP also increased.

The unemployment rate, reflecting the number of employable people who are actively seeking work, is

another indicator of economic health. The pandemic also contributed to significant changes in

unemployment rates during 2020 as captured by the Bureau of Labor Statistics. To offer some

perspective, the unemployment rate was 3.5% for December 2019, where a rate of between 4% and 6% is

generally considered to reflect a healthy economy. In April 2020, as government-issued “stay at home”

orders took effect, unemployment rose to 14.7%, representing 23.1 million people. Of those,

approximately 18.1 million were temporarily laid off. The unemployment rate increased steadily through

May, followed by steep reductions in unemployment in October 2020, when the unemployment rate fell to

6.9%, which represents approximately 11.1 million people. Of those, approximately 3.2 million people

were temporarily laid off. Although a significant improvement over the highest unemployment rate in May

of 2020, the October 2020 unemployment rate of 6.9% is almost twice the 3.5% rate of unemployment in

February 2020.

The federal funds rate is another important indicator of economic health in that it is used to manage

inflation, unemployment, and other interest rates, including the prime rate. During the financial crisis of

2008–2009, the Federal Reserve Board decreased the target rate for the federal funds rate more than 5.0

percentage points. From its high of 5.25% prior to the crisis, it was decreased to less than 0.25%, where it

remained through November 2015. In December 2015, the board raised the range of its benchmark

interest rate by a quarter of a percentage point to between 0.25% and 0.50%. The board noted that the

change resulted from considerable improvement in the labor market, citing an unemployment rate of

5.0%. After steadily raising the target rate throughout 2018, reaching a high of 2.5%, the Board of

Governors of the Federal Reserve System decreased the target for the federal funds rate in 2019 to

between 1.75% and 2.0%. During 2020, as the coronavirus pandemic continued to adversely affect the

economy, the Board of Governors reduced the target rate to between 0% and 0.25%. The Board of

Governors has indicated that they are likely to leave the rate at this level until 2023 when the labor market

conditions should reflect healthy employment and an inflation rate of 2%. In the meantime, the Federal

Reserve chairman reiterated that the Federal Reserve would use all the tools at its disposal to assist the

economy and market.

Although the U.S. economy is slowly coming back to life as businesses reopen, it may take years for the

economy to recover from the fallout due to the pandemic. Accountants should continue to monitor

economic factors such as interest rates, consumer confidence, overall economic expansion or

contraction, inflation, and the labor market. Accountants should also consider the effects of these

economic factors on their clients and the clients’ engagements this year.

Business confidence

The CPA Outlook Index (a measure of sentiment about the U.S. economy and key business performance

categories conducted by the AICPA) surveys members in business and industry holding executive


positions in both public and privately owned organizations of all sizes, and across a broad spectrum of

industries. The overall index reflects several measures, including optimism regarding (1) the U.S.

economy, (2) the respondent’s organization, and (3) prospects for expansion. Typically, an index of

greater than 50 indicates a generally positive outlook with increasing activity. The overall index decreased

from 76 in the first quarter of 2020 to 38 in the second quarter, rising to 54 in the third quarter of 2020.

Optimism about the U.S. economy decreased from 42% in the third quarter of 2019 to 24% in the third

quarter of 2020. Those respondents who were more optimistic about the U.S. economy cited low interest

rates, construction, consumer spending, and resilience of the economy. Those respondents who were more

pessimistic cited the pandemic’s effect on the economy, business closures, and unemployment.

Organizational optimism decreased from the third quarter of 2019 to the third quarter of 2020, from 58% to

41%, corresponding to decreases in expansion plan optimism 61% to 43%. Respondents noted that labor

costs remain the top concern influencing both organizational and expansion optimism.

Legislative and regulatory developments

Tax Cuts and Jobs Act

On December 22, 2017, President Donald Trump signed into law H.R. 1, known as the Tax Cuts and Jobs

Act (TCJA), which makes widespread changes to the Internal Revenue Code. Almost all of its provisions,

including a lower corporate tax rate of 21% and lower individual income tax rates, went into effect

January 1, 2018.

Among the many changes to current tax law was one that permanently lowered the corporate income tax

rate from 35% to 21%, effective for 2018. The Senate version lowered the rate to 20% but delayed its

effective date until 2019; the House bill originally had a 20% rate that would have been effective in 2018.

The bill also lowered the individual income tax rates through 2025. The new top rate will be 37%, lowered

from 39.6%. The law keeps the same number of brackets as under current law. It also keeps the

individual alternative minimum tax (AMT), with a higher exemption than under current law, but eliminates

the corporate AMT.

CARES Act

The global pandemic continues to adversely affect the global economy, causing significant business

disruption. As a result, the U.S. government introduced the Coronavirus Aid, Relief, and Economic

Security (CARES) Act to prevent economic downturn in various ways. The CARES Act was an over $2

trillion relief package that Congress passed at the end of March 2020. This act provides prompt

economic assistance for American workers and families, small businesses, and state and local

governments.

The relief package will have a huge impact on state and local government budgets. The CARES Act

provides economic impact payments to American households of $1,200 per adult ($2,400 for joint filers)

for individuals whose income was less than $99,000 (or $198,000 for joint filers) and $500 per child. The


credit begins to phase out for taxpayers with adjusted gross income above $150,000 for joint filers,

$112,500 for heads of households, and $75,000 for other individuals. Stimulus rebates are being treated

as advance refunds of a 2020 tax credit. Taxpayers will reduce the amount of the credit available on their

2020 tax return by the amount of the advance refund they receive. The credit is not available to

nonresident aliens, individuals who can be claimed as a dependent by another taxpayer, and estates and

trusts.

Additionally, the IRS will use the information for Forms SSA-1099 and RRB-1099 to generate $1,200

economic impact payments to Social Security recipients who did not file tax returns in 2018 or 2019.

Recipients will receive these payments as a direct deposit or by paper check, just as they would normally

receive their benefits.

The small business Paycheck Protection Program (PPP) is providing small businesses with necessary

resources to cover applicable overhead and payroll costs. According to the PPP report (round 2), the

overall average loan size is $108,000, and the top loan size category is between $350,000 and $1 million.

The top industry sectors by the North American Industry Classification System are health care and social

assistance, professional, scientific and technical services, and construction.

As part of the Families First Coronavirus Response Act (HR 6201), employers of fewer than 500

employees are required to provide mandatory sick time and paid family leave, and are eligible for payroll

tax credits to offset the costs. Eligible self-employed individuals also qualify for the credits. Health care

providers and emergency responders are excluded; employers with fewer than 50 employers can be

exempted.

The CARES Act offers great support to businesses to help them get back to business quickly. Eligible

employers who suffer economic hardship and face closure orders due to the pandemic will get a

refundable tax credit of 50% of qualified wages (up to $10,000) for employees. Employers with gross

receipts below 50% of the comparable quarter in 2019 are also eligible, until their gross receipts exceed

80% of the comparable quarter in the prior year. Qualifying wages are based on the average number of

employees in 2019. For employers with more than 100 employees, the credit is allowed if the employer

pays employees who are not providing services due to the suspension of the business or a drop in gross

receipts. For employers with 100 or fewer employees, all wages paid qualify for the credit. Employers can

reimburse the credit immediately by reducing the deposits of payroll taxes that have been withheld from

employees’ wages.

There are also other changes, such as payroll tax deferral. Employers and self-employed individuals can

delay payment of the employer share of the Social Security tax. The deferred employment tax can be paid

in two years – payment is delayed by 50% for the 2020 employer’s share of Social Security payroll taxes

until December 31, 2021; the other 50% will not be due until December 31, 2022. The CARES Act includes

provisions that are directly related to the risk of material misstatement such as unrecorded transactions,

fraud, and noncompliance with laws and regulations.

The CARES Act offers significant and temporary relief on retirement funds. According to the act,

taxpayers can take up to $100,000 in coronavirus-related distributions from retirement plans without

being subject to the 10% additional tax for early distributions. Eligible distributions can be made between


January 1 and December 31, 2020. In addition, the distribution may be exempted from 20% mandatory

withholdings for certain retirement plan distributions. Coronavirus-related distributions may be repaid

within three years. Any resulting income inclusion would be subject to tax over three years. Existing loans

of up to $100,000 from qualified plans and repayment can be delayed for one year. The required

minimum distribution rules are temporarily suspended for 2020. The bill delays 2020 minimum required

contributions for single-employer plans until 2021. Note that the required contributions are not waived

and accordingly should be accrued in the appropriate period.

These are some interesting tax traits in the CARES Act that are particularly important to insurers or the

affiliates, stakeholders, or brokers, such as net operating losses (NOLs) and AMT credit refunds. For tax

years beginning before 2021, the 80% income limitation for NOL deductions is temporarily repealed.

For losses arising in tax years 2018, 2019, and 2020, a five-year carryback is allowed (taxpayers can elect

to forgo the carryback). This law also applies to pass-through businesses and sole proprietorships.

In terms of the AMT credit refunds acceleration, the CARES Act allows corporations to claim 100% of

AMT credits in 2019 as fully refundable and provides an election to claim the AMT credit refund in 2018.

That means the AMT credit for corporations is now a refundable credit for the 2018 and 2019 tax years.

However, attention to the process (for instance, the due date) should be paid in order to select the best

relief method.

The CARES Act established the Coronavirus Relief Fund of $150 billion for states and local and tribal

governments, and it also creates guidance on eligible uses of fund disbursements by the government.

COVID-19 relief bill (December 2020)

In late December 2020, legislation passed to provide $900 billion in additional relief due to the global

pandemic. The bill provides aid for small businesses, including $284 billion for the PPP as well as $20

billion in economic injury disaster loans and grants for smaller businesses in low-income communities.

Additional PPP funding is available to previous recipients of PPP loans, even if they have returned part or

all of a previous PPP loan. Previous recipients can apply for another loan up to $2 million if they have 300

or fewer employees, have used or will use the full amount of their first PPP loan, and can show 25% gross

revenue decline in any 2020 quarter compared to the same quarter in 2019. In addition, the new bill

makes forgivable loans available to 501(c)(6) businesses such as chambers of commerce, visitors’

bureaus, and other organizations with 300 or fewer employees that do not receive more than 15% of

receipts from lobbying.

The new round of funding is available to first-time borrowers, including the following:

Businesses with 500 or fewer employees that are eligible for other SBA 7(a) loans Sole proprietors, independent contractors, and eligible self-employed individuals Not-for-profits Accommodation and food services operations with fewer than 300 employees per physical location


The new bill provides an expanded list of potentially forgivable expenses, including, for example, personal

protective equipment and software and cloud computing services. In addition, the bill also specifies that

business expenses paid with forgiven PPP loans are tax-deductible, superseding previous IRS guidance.

The legislation also includes the following key provisions:

Aid for entertainment and cultural organizations, including access for shuttered live venues, independent movie theaters, and cultural institutions to $15 billion in dedicated funding, while $12 billion is set aside to help businesses in low-income and minority communities.

Aid for individuals, including $166 billion for economic impact payments of $600 for individuals making up to $75,000 per year, and $1,200 for married couples making up to $150,000 per year, as well as a $600 payment for each dependent child.

Extension of unemployment benefits, including $120 billion to provide workers receiving unemployment benefits an addition $300 per week supplement from December 26, 2020–March 14, 2021. The bill also expands coverage to self-employed gig workers and others in nontraditional employments, as well as additional weeks of federally funded unemployment benefits to individuals who exhaust their regular state benefits.

Rental aid and eviction protection, including $25 billion in rental aid and extension of the national eviction moratorium through January 31, 2021.

Other support, including $45 billion in transportation funding for airlines, transit systems, state highways, etc.; $82 billion in funding for colleges and schools; $22 billion for health-related expenses incurred by state and local governments; $13 billion in emergency food assistance; and $7 billion in broad band expansion.

In addition, the bill extends the employee retention tax credit and several expiring tax provisions, and

temporarily allows a 100% business expense deduction for meals (increased from the current 50%) as

long as the expense is for food or beverages provided by a restaurant, applicable to expenses incurred

after December 31, 2020, and before December 31, 2022.

Unrecorded sales tax liabilities

In 1992, the Supreme Court ruled in Quill vs. North Dakota that states were not allowed to collect sales

taxes on retail sales made by sellers who did not have a physical presence in the state. Over time, e-

commerce increased dramatically from mail order retailers like Quill to online-only businesses, and states

were foregoing the tax revenues associated with those sales. In 2018, the Supreme Court reversed the

Quill ruling in the case of South Dakota vs. Wayfair Inc. In the Wayfair case, the Supreme Court ruled that

a physical presence is no longer required in order for a state to require a retailer to collect sales or use

tax. The court also ruled that its decision excluded businesses with fewer than 200 transactions or

$100,000 of in-state sales collected in the state.

Since the Wayfair decision, some taxing authorities have set thresholds that exceed those set by the

Supreme Court. Although the Wayfair decision was made in 2018, taxing authorities also have set

different effective dates for implementing the decision. As a result, online retailers that make sales in

different states must become familiar and compliant with the statutes in effect in the relevant states.

These circumstances could affect financial statements of retailers with sales in multiple states. When

those financial statements are the subject of a review engagement, accountants should include


questions about the appropriate collection of sales tax and multistate compliance in their inquiry

procedures. Analytical procedures could also be performed to determine the reasonableness of the sales

tax liability.

Knowledge check

1. Which statement about economic indicators is not correct?

a. The federal funds rate is used to manage inflation and unemployment. b. GDP measures output of goods and services by labor and property within the United States,

increasing as the economy grows and decreasing as the economy slows. c. When considering the CPA Outlook Index, an index of greater than 50 indicates a generally

positive outlook with increasing activity. d. A 7% unemployment rate is inside the range of what is typically considered healthy.


Implications of the current economy In response to the global coronavirus pandemic, businesses are facing significant economic uncertainty

from which several operating, accounting and assurance issues have arisen. It is important for

accountants to be aware of the potential impact of the pandemic on the financial statements, going

concern, and subsequent events. Accountants should also remain aware of issues related to fraud or

illegal acts.

Financial reporting impact of the coronavirus pandemic

The global coronavirus pandemic has significantly impacted the U.S. economy as businesses struggle

with layoffs, furloughs, shifts in demand, supply chain interruption, employees working from home, and

lack of childcare options. As the landscape for business has changed, new challenges have been

introduced with regard to both financial reporting and the performance of attestation services. Although

a full exploration of potential financial reporting issues is beyond the scope of this course, some of the

broader areas that may be affected are presented in the following table.

Table – Financial reporting and relevant guidance

Economic activity

Potential implications for

reporting Relevant guidance

Cessation of operations, reductions in demand, decreased cash flow or liquidity

Impairment of financial

assets, including accounts

receivable, loans, leases

Inventory impairment

Fair value estimates of

investments

Allowance for expected

credit losses

ASC 310 (receivables and loans)

ASC 320-10 (debt securities when an entity has not adopted ASC 236)

ASC 321-10 (impairment)

ASC 326 (credit losses)

ASC 330 (inventory)

ASC 842 (net investment in leases)



Economic activity



Cessation of operations, decreased revenues, supply chain interruptions, decline in global equity markets

Change in circumstances

requiring impairment testing

of indefinite-lived assets

Triggering event for

recoverability test of long-

lived assets

Impairment of right-of-use

assets

Triggering event for testing

impairment of goodwill

ASC 350-20 (impairment of goodwill)

FASB Accounting Standards Codification (ASC) 350-30 (impairment of indefinite-lived assets

FASB ASC 360-10 (recoverability of long-lived assets)

FASB ASC 842-20 (impairment of leased assets)

Lease concessions, including reduced prices, deferral of payment terms, forgiveness of lease amounts

Contract no longer contains

a lease

Separate lease contract or a

modification of existing

contract

FASB ASC 842 (leases and lease modifications)

FASB Staff Q&A, Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the Covid-19 Pandemic

Liquidity issues affecting collectability of sales, contract concessions to encourage continued purchases, delays in delivery of goods

Lack of a contract due to

changes in enforceable rights

or collectability

Contract modification due to

concessions

Variable consideration from

price concessions or

incentives

Significant financing

component introduced with

extended payment terms

Timing of revenue

recognition due to delays in

delivery

FASB ASC 606-10



Economic activity



Reductions in workforce costs through voluntary and nonvoluntary employee furloughs, payment of voluntary or nonvoluntary termination benefits

Compensation expense

calculation and accrual

Estimation of related

compensation liability

FASB ASC 420-10 (involuntary termination benefits)

FASB ASC 710-10 (temporary layoff treated like compensated absences)

FASB ASC 712-10 (temporary layoff treated like postemployment benefit)

FASB ASC 715-30 (involuntary termination benefits

EITF Issue No. 01-10, Accounting for the Impact of the Terrorist Attacks of September 11, 2001

Business entities receive government assistance, as grants, loans, or tax credits

Consider whether the

transaction is an exchange or

contribution

Recognize revenue for

exchange transactions

Recognition of government

grants/contributions

FASB ASC 606 (accounting for exchange)

FASB ASC 958-605 (accounting for contribution) excludes for-profit businesses but may be used for purposes of analogy.

International Accounting Standards 20 (may be appropriate for accounting for contributions to businesses)

Reductions in revenues, incurrence of losses, reductions in forecasted cash flow

Realizability of deferred tax

assets

Need for valuation account

for deferred tax assets

FASB ASC 740 (income taxes)

CARES Act provisions related to income taxes for 2019 and 2020

5-year NOL carryback

provisions for losses created

in 2018–2020

Deferral of the 80% income

limitation for NOL carryovers

from 2018–2021

CARES Act



Economic activity



Overall economic volatility Increased need for

disclosures because the

assumptions and estimates

underlying the financial

statements are likely to

change in the near term

Increased need for

disclosure of current

vulnerabilities due to

concentrations of risk

FASB ASC 275-10 (risks and uncertainties)

Engagement issues related to the coronavirus pandemic

The disruption caused by the pandemic has already dramatically changed business operations

worldwide. For entities that have survived the coronavirus pandemic, their operations may look very

different from prior years, or they may struggle to maintain compliance with debt covenants. For other

businesses, closure has resulted from the effects of the pandemic, and it is likely these closures will

continue, presenting concerns about an entity’s ability to continue as a going concern. In addition, as the

economy and business operations continue to change quickly, there is an increasing need for

accountants to be aware of and prepared for addressing subsequent events in the performance of a

review engagement. Unfortunately, accountants may also encounter situations that indicate fraud or an

illegal act in this particularly volatile environment as many businesses struggle to survive.

Going concern

Accountants performing review engagements are required to consider whether, during the performance

of review procedures, evidence or information came to the accountant’s attention indicating that there

could be an uncertainty about the entity’s ability to continue for a reasonable period of time, which is

typically within one year after the date that the financial statements are issued or within one year after

the date the financial statements are available to be issued.

Some financial reporting frameworks, such as generally accepted accounting principles (GAAP), require

management to evaluate an entity’s ability to continue as a going concern for a reasonable period of

time. When the financial reporting framework requires management’s evaluation, the accountant

reviewing those financial statements should perform procedures to determine the following:


Whether the going concern basis of accounting is appropriate Management’s evaluation of whether there are conditions or events that raised substantial doubt

about the entity’s ability to continue as a going concern If there are conditions or events that raised substantial doubt about the entity’s ability to continue as

a going concern, and management’s plans to mitigate those matters The adequacy of the related disclosures in the financial statements

When a financial reporting framework does not include a requirement for management to evaluate the

entity’s ability to continue as a going concern for a reasonable period of time, the accountant may

become aware of conditions or events that raise substantial doubt about an entity’s ability to continue as

a going concern for a reasonable period of time. Under these circumstances, the accountant should do

the following:

Inquire of management whether the going concern basis of accounting is appropriate Inquire of management about its plans for dealing with the adverse effects of the conditions and events Consider the adequacy of the disclosure about such matters in the financial statements

With regard to the adequacy of disclosures, the guidance focuses on providing sufficient detail of the

origin, possible magnitude of effect, and management’s response, including management’s plans and

information about the recoverability of recorded asset or liability accounts.

Typically, going concerns will be reflected in the accountant’s report using an emphasis-of-matter

paragraph. When the accountant concludes that substantial doubt about the entity’s ability to continue

as a going concern for a reasonable period of time remains, the emphasis-of-matter paragraph should be

expressed through the use of terms consistent with those included in the applicable financial reporting

framework but should not use conditional language such as “subject to.” When the accountant concludes

that substantial doubt has been alleviated by management’s plans, the accountant may include an

emphasis-of-matter paragraph referring to management’s disclosures related to the conditions and

events and management’s plans related to those conditions or events. When an accountant becomes

aware of a failure to perform a going concern evaluation or provide adequate disclosure of going

concern, and the client decides not to change the financial statements, the only reporting option is to

note the departure from the applicable financial reporting framework in the compilation or review report.

Subsequent events

Given the volatility of the economy and the speed with which events have occurred during the

coronavirus pandemic, accountants performing a review engagement should be prepared to consider

information that comes to light during the period between the date of the balance sheet and the date the

financial statements are issued. Evidence of subsequent events that may have a material effect on

reviewed financial statements may come to the accountant’s attention either during the performance of

the review procedures or subsequent to the date of the review report, but prior to the release of the

report. In either case, the accountant should first request management to consider the possible effects

of the subsequent event on the financial statements and related notes.

If the accountant determines that the subsequent event has been adequately reflected in the financial

statements, the accountant may choose to include an emphasis-of-matter paragraph drawing the


financial statement reader’s attention to the event. If, however, the accountant determines that the

subsequent event has not been adequately reflected in the financial statements and associated notes,

the accountant should treat the situation as a departure from the applicable financial reporting

framework.

When new information about a fact in existence at the report date is discovered after the review report

has been released, and the review report would have been affected if the information had been known,

the requirements discussed in this section apply, even if the accountant has withdrawn or been

discharged from an engagement. The accountant should discuss the matter with management or those

charged with governance and determine whether the financial statements need revision. In determining

whether the financial statements need revision, the accountant should first consider the requirements of

the applicable financial reporting framework. In addition, the accountant may consider whether he or she

believes that users are likely to attach importance to the information; whether reviewed or audited

financial statements have been issued for a subsequent period; the time elapsed since the financial

statements were issued; and any legal implications.

Assuming the financial statements need revision and management agrees to revise the financial

statements, the accountant should obtain additional or revised information considered sufficient to

obtain limited assurance on the financial statements. If the reviewed financial statements were provided

to third parties, the accountant needs to assess the timeliness and appropriateness of steps taken by

management to inform those parties that the financial statements should not be used. Those steps may

include notification of specific third parties, issuance of revised financial statements and disclosures, or

issuance of subsequent period financial statements with appropriate disclosures of the matter. In

addition, if the accountant’s conclusion on the revised financial statements differs from the conclusion

on the original financial statements, the accountant should add an emphasis-of-matter paragraph that

includes (1) the date of the accountant’s previous report, (2) a description of the revisions, and

(3) substantive reasons for the revision.

If the client does not revise the financial statements and those statements have not been made available

to third parties, the accountant should notify management and those charged with governance not to

make the reviewed financial statements available to third parties before revisions are made and a new

report is provided. If the accountant learns that the reviewed financial statements have been made

available to third parties, he or she should follow the guidance in the following paragraph.

If the client does not revise the financial statements and they have been made available to third parties,

the accountant should assess the timeliness and appropriateness of steps taken by management to

inform those parties that the financial statements should not be used. Those steps may include

notification of specific third parties, issuance of revised financial statements and disclosures, or issuance

of subsequent period financial statements with appropriate disclosures of the matter. If the accountant

believes management’s procedures are appropriate and accurate, nothing more is required of the

accountant.


If not, the accountant should notify the appropriate personnel at the highest levels in the entity (such as

the owner or those charged with governance) that, in the absence of disclosure by the client, the

accountant will take steps to prevent further use of the financial statements and, if applicable, the

accountant’s report. The authors recommend that the accountant immediately contact legal counsel.

Unless otherwise counseled by the accountant’s attorney, the accountant should

notify the client that the accountant’s review report must no longer be used. notify the regulatory agencies that have jurisdiction over the client that the accountant’s report should

no longer be used, including a request that the agency take whatever steps it deems appropriate. notify each person known to the accountant to be using the financial statements that the financial

statements and the accountant’s report should no longer be used. In many instances, it will not be practicable for the accountant to give appropriate individual notification to stakeholders whose identities ordinarily are unknown to him or her; notifying a regulatory agency that has jurisdiction over the client will usually be the only practicable way for the accountant to provide appropriate disclosure. The accountant should request the regulatory agency to take whatever steps it may deem appropriate to accomplish the necessary disclosure.

Any notification to persons other than the client should include a description of the nature of the

subsequently acquired information and its effects on the financial statements. In addition, the

information disclosed should be as precise, factual, and concise as possible, providing no more

information than that which is reasonably necessary. If the client has not cooperated, the accountant’s

disclosure does not need to detail the specific information, but can merely indicate that information has

come to his or her attention that the client has not cooperated in attempting to substantiate, and that, if

the information is true, the accountant believes that the review report must no longer be used.

Accountant’s responsibility for fraud or illegal acts

Accountants performing engagements in accordance with Statements on Standards for Accounting and

Review Services (SSARSs) are under no obligation to search for fraud or illegal acts. The engagement

letter should inform the client that such engagements cannot be relied upon to discover fraud or illegal

acts.

If the accountant becomes aware that fraud (including misappropriation of assets) may have occurred,

the accountant should communicate the matter to the appropriate level of management (at a level above

those involved with the suspected fraud, if possible). If the accountant becomes aware of matters

involving identified or suspected noncompliance with laws and regulations whose effects should be

considered when preparing financial statements, the accountant should communicate the matters to

management, other than when matters are clearly inconsequential. If the fraud or noncompliance with

laws or regulations involves senior management or results in a material misstatement of the financial

statements, the accountant should communicate the matter directly to those charged with governance.

The accountant should consider the need to obtain legal advice and take appropriate action, including

potential withdrawal, if management or (as appropriate) those charged with governance do not provide

sufficient information that supports that


the financial statements are not materially misstated due to fraud, or the entity is in compliance with laws and regulations, and in the accountant’s professional judgment,

the effect of the suspected noncompliance may be material to the financial statements.

Sarah Beckett Ference, CPA, is a risk control director at CNA and oversees risk controls services provided

to CPA firms in the AICPA Professional Liability Insurance Program. In the article “Failure to Detect Theft

or Fraud: It’s not just an audit issue,” originally published in the February 2014 issue of the Journal of

Accountancy, Ference noted several techniques that CPAs could use to protect themselves against risk

exposures related to failure to detect theft and fraud. These recommendations have been modified to be

applicable to SSARSs engagements, and include the following:

Regularly evaluate the risk of the client and the engagement. Client and engagement acceptance and continuance protocols are not simply for audit engagements. Regularly screen clients and consider the risks associated with both the client and the services you are being engaged to perform. It should raise a red flag for the CPA when clients dismiss internal control weaknesses brought to their attention. Is this a situation where the client has an unreasonable service expectation, or is it possibly one of questionable integrity? Either way, the CPA should take precautions.

Use engagement letters on all engagements. Even though SSARS No. 21, Statement on Standards for Accounting and Review Services: Clarification and Recodification, now requires an engagement letter or other suitable form of written agreement for review, compilation, and preparation services, claim experiences of the AICPA Professional Liability Insurance Program have indicated there is room for improvement. A well-crafted engagement letter can help reduce expectation gaps and can serve as key evidence in the defense of a professional liability claim. The engagement letter should include an understandable description of the scope and limitation of services to be performed, a statement that the engagement is not designed to detect theft or fraud, and the responsibilities of both the client and the CPA. The engagement letter should also be renewed and signed by the client annually.

Stay within the scope of the engagement. An engagement letter is useful only if the CPA adheres to the defined scope in rendering the professional services. Additional services, or modifications to agreed-upon services, should be memorialized in writing with the client, whether it’s through email, a new engagement letter, or an amendment to the existing engagement letter.

Be fraud aware. Train all firm personnel, not only auditors, about potential fraud risk factors and the “fraud risk triangle” (opportunity, rationalization, and incentive/pressure). Learn about the risk factors associated with common frauds, such as embezzlement by an unmonitored bookkeeper or controller with excessive authority or access, or use of business credit cards for personal expenses. Firm personnel should be educated about common internal control weaknesses that create an opportunity for fraud to occur, such as a lack of segregation of duties, poor tone at the top, or infrequent vacations taken by key financial employees.

Apply professional skepticism to all engagements. This is particularly important with engagements with longtime clients, in which a level of established comfort could threaten objectivity. Trust your instincts and follow up on matters that don’t seem quite right.

If you see something, say something, and follow up in writing. Management letters with suggestions for control or process improvements are not designed solely for audit clients. If you observe a weakness in internal controls or believe management should follow up on an observation noted, inform your client orally and in writing. If the weakness persists year after year, keep telling the client both orally and in writing until the deficiency is addressed.

Document, document, document. Contemporaneous documentation represents critical evidence in the defense of professional liability claims. Strong documentation includes, at a minimum, a well-crafted and detailed engagement letter, documentation regarding client inquiries made and responses received, and communication of internal control matters or suspicious activities noted.


Without documentation, many juries are more sympathetic to the client. Documentation provides defense counsel with something to defend.

Other issues

One of the primary performance requirements for review engagements is the application of analytical

procedures to the financial statements. These procedures involve comparisons of recorded amounts, or

ratios, developed from recorded amounts to expectations developed by the accountant conducting the

review. The accountant develops expectations by identifying and using plausible relationships that are

reasonably expected to exist based on his or her understanding of the client and the industry in which the

client operates. These expectations are most often based on comparable financial information from prior

periods.

Given the effects of the coronavirus pandemic on entities across most industries, it may not be

reasonable to develop expectations for the current year based on prior years. Instead, the accountant

may need to consider other sources of information to develop expectations. These other sources might

include the following:

Anticipated results. For example, budgets or forecasts including extrapolations from interim or annual data.

Relationships among elements of financial information with the period. For example, ratio analysis of gross profit percentage.

Information regarding the industry in which the client operates. For example, gross margin information.

Relationships of financial information with relevant nonfinancial information. For example, estimated interest expense based on principal and average rate of return.

With the ongoing uncertainty, entities may face challenges including delays in financial statement

issuance and financial ramifications of the pandemic. Breaches of financial covenants based on

calculations of income, earnings before interest, taxes, depreciation, and amortization (or EBITDA), or

some similar measure of earnings, will become more scrutinized as borrowers face lower revenues and

increased costs in dealing with the pandemic. Borrowing base calculations, which are often based on

levels of accounts receivable, may reduce amounts available to borrowers under existing lines of credit.

A covenant default might require the reclassification of long-term debt to short-term debt, which in turn

might cause violations of additional financial covenants, such as liquidity ratios. Accountants may want

to discuss whether there would be a need for waivers or amendment of the relevant terms of the loan

agreement with their clients as part of the engagement.

Given the number of issues specific to the pandemic, the accountant should consider additional

appropriate representations in the management representation letter for review engagements. For

example, the accountant may include additional representations for matters such as going concern,

subsequent events, risk and uncertainties, fraud, significant estimates, and so on.

In addition, accountants conducting a review engagement may also want to consider adding an

emphasis-of-matter paragraph to the review report. For example, an emphasis paragraph might be

appropriate to draw attention to subsequent events, or major catastrophes related to the pandemic.


Recall that these paragraphs are used to draw attention to items that are appropriately accounted for

and disclosed in the financial statements. They are not appropriate for missing information or inadequate

disclosure.

Connected concepts – Advising clients

Assume you are supervising a review engagement for a long-standing client in the restaurant industry. The client has a significant loan and is required to provide reviewed financial statements to her lender annually. This year, the client’s business has been struggling due to the global pandemic. Her restaurants closed temporarily due to government mandates, and once they reopened, the restrictions on seating, masks, and customer behavior resulted in significantly fewer customers. Currently, customer demand is insufficient to support a full contingent of employees, many of whom have been with the company for several years, and the client is concerned about making her lease payments. In addition, shortly before the shutdown, the client had ordered significant product, leaving her with excess inventory. What options could you offer your client regarding cost savings for the review engagement? What practical advice would you give the client to help her manage her relationship with the lender and protect her income?

Knowledge check

2. Which of the following statements about the financial reporting implications of the pandemic is correct?

a. The standards for revenue recognition have been revised due to the coronavirus pandemic. b. Volatile economic activity may indicate the need to consider the impairment of assets. c. Lessees may postpone implementation of the new lease standard due to the pandemic. d. The CARES Act has no impact on the carryback or carryforward provisions for net operating

losses.

3. What should an accountant do when he or she becomes aware that adequate disclosure of going concern issues has not been made by the preparer of the financial statements being reviewed and the client decides not to change the financial statements?

a. No mention of the going concern issues is necessary. b. The accountant should include an emphasis-of-matter paragraph. c. The accountant should modify the review report noting the nature and dollar magnitude (if

known) of the omitted disclosure. d. The accountant must withdraw from the engagement.

4. Which is not a way to limit risk exposure related to fraud in a preparation, compilation, or review engagement?

a. Use engagement letters only on riskier engagements. b. Stay within the scope of the engagement. c. Apply professional skepticism to all engagements. d. Regularly evaluate the risk of the client and the engagement.


Summary We have just discussed the following points:

Outlook for the U.S. business economy Financial reporting implications of the coronavirus pandemic Review engagement implications of the pandemic Accountant’s responsibility for considering going concern Accountant’s resposnbility for considering subsequent events Accountant’s responsibility for fraud Accountant’s responsibility for other engagement issues related to the pandemic


Solutions

Current Economic Environment

Knowledge check solutions

1.

a. Incorrect. This statement is accurate. The federal funds rate is used to manage inflation, unemployment, and other interest rates.

b. Incorrect. This statement is accurate. GDP measures national output and has a direct relationship with economic growth.

c. Incorrect. This statement is accurate. The CPA Outlook Index is a measure of sentiment that is generally positive when above 50.

d. Correct. This statement is not accurate. An unemployment rate between 4% and 6% is generally considered healthy. A 7% unemployment rate is outside the range.

2.

a. Incorrect. Although the pandemic may have implications for revenue recognition, the requirements of the revenue recognition standard have not changed.

b. Correct. Changes such as short-term cessation of operations, reductions in demand, etc. may indicate that the value of either financial or nonfinancial assets may have changed in such a way that requires impairment.

c. Incorrect. Although the pandemic may have implications for lease accounting, the requirements of the leasing standard have not changed and implementation has not been delayed.

d. Incorrect. The CARES Act changes the requirements for accounting for NOLs. It allows for a 5-year carryback for losses generated between 2018 and 2020. The act also defers the 80% limitation in NOLs for 2018–2021.


3.

a. Incorrect. If the accountant is aware that the financial statements are inaccurate regarding going concern, and the preparer does not plan to change them, the accountant must make reference to this inadequacy in the compilation or review report.

b. Incorrect. An emphasis-of-matter paragraph is used to draw attention to issues appropriately accounted for in the financial statements. Failure to refer to going concern in these circumstances is not appropriate.

c. Correct. When going concern disclosure is inadequate, the accountant should describe the nature of that omission in the accountant’s report. If possible, the accountant should describe the magnitude of the omission also.

d. Incorrect. The accountant is not required to withdraw from the engagement when a going concern disclosure has been omitted.

4.

a. Correct. Engagement letters should be used on all SSARSs engagements to establish scope of work, clarify limitations, and strengthen communications and understanding between the accountant and client.

b. Incorrect. CNA recommends staying within the scope of the engagement.

c. Incorrect. CNA recommends applying professional skepticism to all engagements.

d. Incorrect. CNA recommends regularly evaluating the risk of each client and engagement.


Recent Statements on Standards for Accounting and Review Services Developments

Learning objectives

Identify the performance and reporting requirements for Statement on Standards for Accounting and Review Services (SSARSs) for SSARS No. 25.

Identify the reporting requirements for compilation and review engagements from SSARS No. 24.

Recall the performance and reporting requirements for compilation engagements of pro forma financial information from SSARS No. 22.

Recall the performance and reporting requirements for compilation engagements of prospective financial information from SSARS No. 23.


SSARS No. 25, Materiality in a Review of Financial Statements and Adverse Conclusions – 2020 In February 2020, the Accounting and Review Services Committee (ARSC) issued SSARS) No. 25,

Materiality in a Review of Financial Statements and Adverse Conclusions. SSARS No. 25 resulted in two

primary and significant changes to the guidance for review engagements. The standard requires

practitioners to determine materiality for the financial statements as a whole and apply this materiality in

designing the procedures and evaluating the results obtained from those procedures, making the

concept of materiality consistent regardless of the level of service performed on financial statements.

The standard also allows accountants to issue modified conclusions in a review engagement, and aligns

with international standards for review engagements as included in the International Standard on Review

Engagements (ISRE) 2400 (Revised), Engagements to Review Historical Financial Statements. ARSC

believes convergence between the two standards facilitates an accountant’s ability to perform and report

on engagements in accordance with both sets of standards and reduces confusion about the levels of

assurance provided by both. In addition, SSARS No. 25 includes some smaller changes to preparation,

compilation, and review engagements.

SSARS No. 25 is effective for preparation, compilation, and review engagements of financial statements

for periods ending on or after December 15, 2021. Early implementation is permitted.

Materiality in review engagements

Currently, there is no requirement for an accountant to consider materiality in the guidance for review

engagements. However, the concept of materiality is embedded throughout review engagements,

including (1) a conclusion that notes the accountant is not aware of any material modifications

necessary for the financial statements, (2) the design and performance of inquiry and analytical

procedures that reflects a focus on material items, and (3) the evaluation of uncorrected misstatements

and inadequate disclosures in which the accountant considers their effects both individually and in the

aggregate. SSARS No. 25 adds an explicit requirement that the accountant determine materiality for the

financial statements as a whole, including disclosures, and apply this materiality in designing the

procedures and evaluating results obtained from those procedures.

An accountant’s consideration of materiality is made in the context of the applicable financial reporting

framework. The standard notes that different financial reporting frameworks often discuss the concept

of materiality in the context of preparation and presentation of financial statements. Although the

specifics may differ, the discussions of materiality share some common elements, including the

following:


Reasonable user test. Misstatements, including omissions, are considered to be material if there is a substantial likelihood that, individually or in the aggregate, they would influence the judgment made by a reasonable user based on the financil statements.

Contextually driven. Judgments about materiality are made in light of surrounding circumstances and affected by the size or nature of a misstatement or a combination of both.

Number and nature. Judgments about materiality involve both qualitative and quantitative considerations. Qualititative factors are those that are material due to their nature, but the dollar amount alone would be considered immaterial. For example, a small misstatement that converted a net loss to net income could be considered qualitatively material.

Collective needs. Judgements about matters that are material to users of the financial statements are based on a consideration of the common financial information needs of users as a group. The possible effect of misstatements on specific individual users, whose needs may vary widely, is not considered.

In circumstances when a financial reporting framework does not include a discussion of materiality,

accountants should consider these characteristics as a frame of reference.

In addition, similarly to the auditing literature, the SSARS No. 25 notes that determination of materiality is

a matter of professional judgement and is affected by the accountant’s perception of the financial

information needs of users of the financial statements. For purposes of determining materiality, the

accountant may assume that reasonable users

have a reasonable knowledge of business and economic activities and accounting, and are willing to study the financial information with reasonable diligence;

understand that financial statements are prepared, presented, and reviewed to levels of materiality; recognize the uncertainties inherent in the measurement of amounts based on the use of estimates,

judgment, and the consideration of future events; and make reasonable judgments based on the information in the financial statements.

Although materiality should be determined and applied before designing procedures and evaluating

results, the accountant may become aware of information during the review that would have affected the

materiality determination had it been known at the time. The accountant may become aware of this

information due to a change in circumstances for the entity that occurs during the review (e.g. the

deicison to dispose of a major segment), or as a result of performing review procedures (e.g. actual

financial results are going to be signficantly different than the anticipated results used to determine

materiality). In these circumstances, accountants should revise materiality for the financial statements

taken as a whole.

ARSC does not believe an explicit requirement for the accountant to determine materiality will result in a

significant change in practice because the accountant has always had to have an understanding of

materiality in order to conclude that he or she is not aware of any material modifications that should be

made to the financial statements in order for them to be in accordance with the applicable financial

reporting framework. However, the requirement that the accountant design and perform analytical

procedures and inquiries to address all material items may result in a change in practice for some

accountants as it precludes waiving procedures on items that, while material, may be considered low

risk.


Modified conclusions in a review engagement

Currently, accountants are precluded from issuing a modified conclusion when financial statements

subject to a review engagement are materially misstated. ARSC questioned the appropriateness of this

prohibition and the degree to which it was in the public interest. ARSC also noted that under the

international equivalent, ISRE 2400, an accountant in similar circumstances would be required to issue an

adverse conclusion. SSARS No. 25 removes the prohibition on modifying the accountant’s report when

the financial statements are not in accordance with the applicable financial reporting framework,

effectively providing the option for an accountant to issue a qualified or adverse conclusion.

An unmodified conclusion in a review report indicates that the accountant has obtained limited

assurance sufficient to conclude that nothing has come to the accountant’s attention that causes him or

her to believe that the financial statements are not prepared, in all material respects, in accordance with

the applicable financial reporting framework. When the accountant determines, based on the procedures

performed and the review evidence obtained, that the financial statements are materially misstated, three

options are available to the accountant. First, the accountant may choose to withdraw from the review

engagement. Second, the accountant my choose to issue a qualified conclusion. Alternatively, the

accountant may issue an adverse conclusion.

The difference between a qualified conclusion and an adverse one is the difference between

misstatements that are pervasive and those that are not. SSARS No. 25 defines pervasive effects as

those that, in the accountant’s judgment

are not confined to specific elements, accounts, or items of the financial statements; if so confined, represent or could represent a substantial portion of the financial statements; or with regard to disclosures, are fundamental to users’ understanding of the financial statements.

Accordingly, a qualified conclusion is warranted when the accountant concludes that the effects of the

matter(s) giving rise to the modification are material, but not pervasive to the financial statements. An

adverse conclusion is warranted when the accountant concludes that the matter(s) giving rise to the

modification are both material and pervasive to the financial statements.

When the accountant modifies the conclusion, the conclusion paragraph should be labeled “Qualified

Conclusion” or “Adverse Conclusion.” In addition, a description of the matter giving rise to the

modification should be included under the appropriate heading in a separate paragraph in the

accountant’s review report in the basis for conclusion paragraph that immediately precedes the

conclusion paragraph.The descriptive basis for conclusion should be included under an appropriate

heading, such as “Basis for Qualified Conclusion” or “Basis for Adverse Conclusion.”

When the accountant expresses a qualified conclusion on the financial statements, the accountant

should, unless otherwise required by law or regulation, use the following language:

Based on my (our) review, except for the effects of the matter(s) described in the Basis for Qualified

Conclusion paragraph, I am (we are) not aware of any material modifications that should be made


to the accompanying financial statements in order for them to be in accordance with [the

applicable financial reporting framework].

When the accountant expresses an adverse conclusion on the financial statements, the accountant

should, unless otherwise required by law or regulation, use the following language:

Based on my (our) review, due to the significance of the matter(s) described in the Basis for

Adverse Conclusion paragraph, the financial statements are not in accordance with [the applicable

financial reporting framework].

When either a qualified or adverse conclusion is included in the review report, the accountant should

provide sufficient informaiton about material misstatement that gave rise to that conclusion. This

information should be included in the basis for conclusion paragraph. Specifically, the accountant should

describe and quantify the financial effects of the misstatement if the material misstatment relates to specific amounts in the financial statements (including qualitative disclosures) and the effects of the departure on the financial statements have been determined by management or are known to the accountant as a result of the accountant’s procedures. If the effects of the departure have not been determined by management or are not known to the accountant as a result of the accountant’s procedures, the accountant is not required to determine the effects of the departure. However, in such circumstances, the accountant should state in the report that such determination has not been made by management.

explain how the disclosures are misstated if the material misstatement relates to narrative disclosures.

describe the nature of omitted information if the material misstatement relates to the nondisclosure of informaiton required to be disclosed. The accountant should include the omitted disclosures when practicable to do so.

SSARS No. 25 provides the following example of a Basis for Adverse Conclusion paragraph:

As disclosed in Note X to these financial statements, the Company has not consolidated the

financial statements of subsidiary ABC Company it acquired during 20X1 because it has not yet

been able to ascertain the fair values of certain of the subsidiary’s material assets and liabilities at

the acquisition date. This investment is therefore accounted for on a cost basis by the Company.

Under accounting principles generally accepted in the United States of America, the subsidiary

should have been consolidated because it is controlled by the Company. Had XYZ Company been

consolidated, many elements in the accompanying consolidated financial statements would have

been materially affected. The effects on the consolidated financial statements of the failure to

consolidate have not been determined.

Other changes

In addition to the preceding changes, SSARS No. 25 also makes the following adjustments to the

guidance for preparation, compilation, and review engagements:


Preparation engagements (AR-C section 70, Preparation of Financial Statements)1 — Current standards require an accountant to withdraw from an engagement because either (1) the accountant is precluded from placing “no assurance provided” on the financial statements, or (2) management fails to provide additional or corrected information when the accountant becomes aware that information used to prepare the financial statements is incomplete, inaccurate or otherwise unsatisfactory. SSARS No. 25 maintains the requirement to withdraw from the engagement, but it adds a requirement that accountants should inform management of their reason(s) for withdrawing. The application guidance also suggests that accountants may want to consult with legal counsel before withdrawing from the engagement.

Financial statements prepared in accordance with a contractual basis of accounting that are compiled (AR-C section 80, Compilation Engagements) or reviewed (AR-C section 90, Review of Financial Statements) — SSARS No. 25 notes that there may be circumstances in which a regulatory or contractual basis of accounting is based on a general purpose framework (e.g. accounting principles generally accepted in the United States of America [GAAP]), but does not comply with all the requirements of that framework. An example is a contract that requires financial statements to be prepared in accordance with most, but not all, of GAAP. SSARS No. 25 notes that it is inappropriate for the description of the applicable financial reporting framework in the special purpose financial statements to imply that the special purpose framework includes all the requirements of, or is the same as, the financial reporting framework on which the special purpose framework is based. The requirement is designed to avoid misunderstandings about compliance with the general purpose framework.

Special purpose financial statements prepared in accordance with a contractual basis of accounting – SSARSs already require a separate paragraph in the accountant’s compilation or review report when financial statements are prepared in accordance with a special purpose framework. When the special purpose framework is a contractual basis of accounting, the accountant should consider whether the financial statements adequately describe any significant interpretations in of the contract on which the financial statements are based. In addition, accountants should include a statement that the financial statements may not be suitable for another purpose in the required separate paragraph in the accountant’s report.

Limited assurance for review engagements (AR-C section 90) — SSARS No. 25 provides the following new definition of limited assurance: — A level of assurance that is less than the reasonable assurance obtained in an audit engagement

but is at an acceptable level as the basis for the conclusion expressed in the accountant’s review report.

Professional skepticism in review engagements (AR-C section 90) — SSARS No. 25 adds an explicit requirement that the accountant plan and perform the review with professional skepticism, recognizing that circumstances may exist that cause the financial statements to be materially misstated. The standard notes that professional skepticism is necessary to the critical assessment of review evidence, and is exercised by neither assuming that management is dishonest or unquestionably honest. The exercise of professional skepticism includes being alert to items like review evidence that contradicts other review evidence obtained, or information that brings into question the reliability of responses to inquiries and other information or records to be used as review evidence.

Additional inquiries in review engagements (AR-C section 90) — SSARS No. 25 requires additional inquiries of management regarding material commitments, contractual obligations, or contingencies. It also requires additional inquiries regarding material nonmonetary transactions or transactions for which there is no consideration in the financial reporting period under consideration.

1 All AR-C sections can be found in AICPA Professional Standards,


Related parties in review engagements (AR-C section 90) — SSARS No. 25 requires accountants to remain alert for arrangements or information that may indicate the existence of related party relationships or related party transactions that have not previously been identified. In addition, for those transactions outside the normal course of business, SSARS No. 25 requires the accountant to inquire about the nature of those transactions and the involvement of any related parties.

Knowledge check

1. Which of the following is not a common element of materiality among different financial reporting frameworks?

a. Misstatements are material if there is a substantial likelihood they would influence the judgment made by a reasonable user of those financial statements.

b. The determination of materiality is not influenced by the nature or size of the misstatement. c. Material misstatements may be either qualitatively or quantitatively material, or both. d. The possible effects of misstatements on specific individuals is not considered in determining

materiality.

2. Assume an accountant performing a review engagement determines, based on the procedures performed and the review evidence obtained, that the financial statements are materially misstated. Which of the following responses is not an option?

a. Include a disclaimer of conclusion in the review report. b. Withdraw from the engagement. c. Include a qualified conclusion in the review report. d. Include an adverse conclusion in the review report.


SSARS No. 24, Omnibus Statement on Standards for Accounting and Review Services – 2018 In May of 2018, ARSC issued SSARS No. 24, Omnibus Statement on Standards for Accounting and Review

Services – 2018. The standard addresses three separate issues — international reporting issues, going

concern in review engagements, and references in the review report to the review or audit of other

accountants — all of which are effective for compilations and reviews of financial statements for periods

ending on or after June 15, 2019. Early application is permitted. In addition, the standard proposes some

revisions to the review report that were effective upon issuance.

International reporting issues

SSARS No. 24 is codified in AICPA Professional Standards as AR-C section 100, Special Considerations—

International Reporting Issues, and provides the performance and reporting requirements when an

accountant is engaged to perform compilation or review when either

the financial statements have been prepared in accordance with a financial reporting framework generally accepted in another country, or

the compilation or review is to be performed in accordance with both SSARSs and another set of compilation or review standards.

Existing standards apply to compilation or review engagement for financial statements that have been

prepared in accordance with financial reporting frameworks established by bodies designated by the

AICPA as standard setters. As such, AR-C sections 80 and 90 apply to financial statements prepared in

accordance GAAP, International Financial Reporting Standards (IFRS) promulgated by the International

Accounting Standards Board (IASB), or a special purpose framework such as the cash- or tax-bases of

accounting. This new section applies to compilations and reviews of financial statements prepared in

accordance with a jurisdictional variation of IFRS such that the entity’s financial statements do not

contain an explicit or unreserved statement that the financial statements are in compliance with IFRS as

promulgated by the IASB.

Considerations when accepting the engagement

Existing standards contained in AR-C section 60, General Principles for Engagements Performed in

Accordance with Statements on Standards for Accounting and Review Services, already require the

accountant to determine whether the financial reporting framework is acceptable prior to accepting an

engagement to compile or review financial statements. To comply with these standards, accountants

should consider the purpose of the financial statements and whether law or regulation prescribes the

financial reporting framework. SSARS No. 24 expands these requirements when the financial statements

have been prepared in accordance with the financial reporting framework generally accepted in another


country (“other country financials”). Under these circumstances, the accountant should also obtain an

understanding of

the purpose of the financial statements and whether the financial reporting framework applied is a fair presentation framework,

the intended users, and the steps taken by management to determine that the applicable financial reporting framework is

acceptable in the circumstances.

In considering these issues, the accountant may consider whether the intended users are likely to be

familiar with the applicable financial reporting framework. SSARS No. 24 notes that when other country

financials are to be used in the United States in addition to another country, the accountant may consider

whether the financial statements are to be used in a manner that allows users in the U.S. to understand

the differences from accounting and reporting practices in the United States. If not, the accountant may

conclude that the other country financials are not appropriate for wide distribution in the United States.

When considering an engagement performed in accordance with SSARSs and another set of compilation

and review standards, the accountant should obtain an understanding of the applicable legal

responsibilities involved when both of the following are true:

The financial statements are intended for use only outside of the United States The accountant plans to use the form and content of the accountant’s compilation or review report of

the other set of compilation or review standards

Even when the form and content of the report are similar to that required by SSARSs, ARSC expressed

concern that the report may convey a different meaning or entail different legal responsibilities for the

accountant due to custom or culture. Accountants may be required to report on statutory compliance or

otherwise require an understanding of local laws and regulations. Depending on the nature and extent

of the accountant’s knowledge and experience, the accountant may find it necessary or useful to

consult with persons having appropriate expertise in the other set of compilation or review

standards and legal responsibilities.

Other country financials

The performance requirements of an engagement to compile or review other country financials are very

similar to a typical compilation or review engagement with a few added requirements. For engagements

involving other country financials, the accountant is required to obtain an understanding of the

framework being applied. The accountant may obtain this understanding by reading the statutes or

professional literature, or their codifications, which establish or describe the financial reporting

framework generally accepted in the other country. Often, the application of accounting principles to a

particular situation requires practical experience and, accordingly, the accountant may consult with

persons having expertise in applying the financial reporting framework of the other country. SSARS No.

24 also notes that when the other country financials are intended for use outside of the United States, the

accountant may use the report form and content of the other country as described in the section on

reporting, which follows.


Application of another set of compilation or review standards

Accountants may be engaged to perform a compilation or review in accordance with a set of standards

other than SSARSs. In these circumstances, though, the accountant must also apply the procedures

required by SSARSs. Accountants who undertake an engagement that involves both SSARSs and an

other set of standards should recognize they may be required to perform additional procedures beyond

those required by SSARSs. In addition, accountants must obtain an understanding of the other

standards. This understanding may be obtained by reading the statutes or professional literature, or their

codifications, which establish or describe the standards. Accountants may also consult with persons

having expertise, including practical experience, in applying the other standards.

Reporting – Only for use outside the United States

When the accountant’s compilation or review report on financial statements are intended only for use

outside of the United States, the accountant may either issue a report in accordance with SSARSs or in

accordance with the other set of compilation or review standards. If the accountant issues a report in

accordance with SSARSs, the content must include the following:

The elements required by SSARSs, excluding a paragraph regarding financial statements prepared in accordance with a special purpose framework

A statement that refers to the note in the financial statements, if applicable, that describes the basis of presentation of the financial statements, including identification of the country of origin of the accounting principles if the statements are prepared in accordance with a financial reporting framework generally accepted in another country

The accountant may issue a report in accordance with another set of compilation or review standards,

provided the following are true:

Such a report would be issued by accountants in the other country under similar circumstances If a review engagement is performed, the accountant has obtained sufficient appropriate review

evidence to support the conclusion expressed in the review report The accountant has complied with the reporting standards of the other set of compilation or review

standards and identifies such standards in the report

Recall, that when issuing a report in accordance with another set of compilation or review standards, the

accountant must obtain an understanding of applicable legal responsibilities as discussed in a preceding

section.

Reporting — Use in the United States

If the financial statements will be used in the United States, the accountant should report in accordance

with SSARSs, including the requirements related to financial statements prepared in accordance with a

special purpose framework included in AR-C sections 80 and 90 for compilations and reviews,

respectively.

Reporting — Use in and outside the United States

The accountant that prepares financial statements in accordance with GAAP may also prepare other

country financials for use outside the United States. The accountant may report on the other country


financial by preparing a report in accordance with another set of compilation or review standards as

described above. The accountant may include in the reports that another report has been issued on the

entity’s financial statements that have been prepared in accordance with a financial reporting framework

generally accepted in another country. The accountant’s statement may also reference any note

disclosure in the financial statements that describes significant differences between the accounting

principles used and GAAP. Such a statement may be included in a separate paragraph to the

accountant’s compilation or review report (this paragraph would be an emphasis-of-matter paragraph in

an accountant’s review report). The following is an example:

We also have reported separately on the financial statements of ABC Company for the same

period presented in accordance with [specify the financial reporting framework generally accepted]

in [name of country]. (Note X summarizes the significant differences between the [specify the

financial reporting framework generally accepted] in [name of country] and accounting principles

generally accepted in the United States of America.)

Other reporting issues for engagements conducted under SSARSs and other standards

As noted, accountants may conduct compilation or review engagements in accordance with the

standards of another country as long as they also comply with SSARSs. Under those circumstances, the

accountant should not refer to having conducted a compilation or review in accordance with another set

of compilation or review standards in addition to SSARSs unless the compilation or review was

conducted in accordance with both sets of standards in their entirety. When the accountant’s

compilation or review report refers to both SSARSs and another set of compilation or review standards,

the accountant’s compilation or review report should identify the other set of compilation or review

standards, as well as its origin.

SSARS No. 24 provides several examples of accountant’s compilation and review reports to accompany

the performance and reporting requirements for engagements involving financial statements prepared in

accordance with accounting principles generally accepted in another country as well as for compilation

and review engagements conducted in accordance with standards of another country.

Going concern issues in review engagements

Another section of SSARS No. 24 revises AR-C section 90 to harmonize the requirements and guidance

regarding an accountant’s consideration of going concern in review of financial statements with the

corresponding audit requirements. Fundamental to this standard is the requirement that accountants

performing review engagements are required to consider whether, during the performance of review

procedures, evidence or information came to the accountant’s attention indicating that there could be an

uncertainty about the entity’s ability to continue for a reasonable period of time. The following section

highlights some of the more important of the revisions that result from the new requirements.


Definition of a reasonable period of time

When considering going concern, there is a presumption that the consideration must be limited to a

reasonable period of time. Most financial reporting frameworks specify what constitutes a reasonable

period of time. For example, FASB defines a reasonable period of time to be within one year after the date

that the financial statements are issued (or within one year after the date the financial statements are

available to be issued, when applicable. Similarly, GASB specifies 12 months beyond the date of the

financial statements with a further requirement that, if a governmental entity currently knows information

that may raise substantial doubt shortly thereafter (for example within an additional three months), such

information should be considered. IASB specifies a period of at least, but not limited to, one year from the

end of the reporting period.

For those financial reporting frameworks that do not specify a reasonable period of time, SSARS No. 24

provides the following definition:

The period of time required by the applicable financial reporting framework or, if no such

requirement exists, within one year after the date that the financial statements are issued (or within

one year after the date that the financial statements are available to be issued, when applicable.

Performance requirements

The accountant’s specific responsibilities for going concern issues in review engagements was ill-defined

in previous standards. In addition, different financial reporting frameworks have different requirements

for addressing going concern.

Some financial reporting frameworks, such as GAAP, require management to evaluate an entity’s ability

to continue as a going concern for a reasonable period of time. When the financial reporting framework

requires management’s evaluation, the accountant reviewing those financial statements should perform

procedures to determine the following:

Whether the going concern basis of accounting is appropriate Management’s evaluation of whether there are conditions or events that raised substantial doubt

about the entity’s ability to continue as a going concern If there are conditions or events that raised substantial doubt about the entity’s ability to continue as

a going concern, and management’s plans to mitigate those matters The adequacy of the related disclosures in the financial statements

The nature and extent of the accountant’s review procedures are matters of the accountant’s

professional judgment. For example, when a history of profitable operations and ready access to

financing exists, inquiry alone might be sufficient to review the entity’s ability to continue as a going

concern for a reasonable period of time.

Some financial reporting frameworks do not include a requirement for management to evaluate the

entity’s ability to continue as a going concern for a reasonable period of time. When reviewing financial

statements prepared in accordance with one of these financial reporting frameworks the accountant

may become aware of conditions or events that raise substantial doubt about an entity’s ability to

continue as a going concern for a reasonable period of time. Those events may have existed at the date


of the prior period financial statements (regardless of whether the substantial doubt was alleviated by the

accountant’s consideration of management’s plans) or, the accountant may encounter them in the

course of performing review procedures on the current period financial statements. Either way, if the

accountant becomes aware of conditions or events that raise substantial doubt about the entity's ability

to continue as a going concern, the accountant should do the following:

Inquire of management whether the going concern basis of accounting is appropriate Inquire of management about its plans for dealing with the adverse effects of the conditions and events Consider the adequacy of the disclosure about such matters in the financial statements.

SSARS No. 24 emphasizes that a review of financial statements is not designed to identify conditions or

events that raise substantial doubt about the entity’s ability to continue as a going concern for a

reasonable period of time. However, the accountant may become aware of these conditions or events

and be faced with assessing their significance. The guidance provides examples of conditions or events

that might give rise to substantial doubt, including negative trends, indications of possible financial

difficulties, internal and external matters. In addition, SSARS No. 24 notes that the significance of these

conditions and events may be mitigated by management plans and information the accountant might

consider in evaluating the feasibility of those plans, including the following:

Plans to dispose of an asset or business — Restrictions on disposal of an asset or business, such as covenants that limit those transactions

in loan or similar agreements, or encumbrances against the asset or business — Marketability of the asset or business that management plans to sell — Possible direct or indirect effects of disposal of the asset or business

Plans to borrow money or restructure debt — Availability and terms of new debt financing or availability or terms of existing debt refinancing,

such as term debt, lines of credit, or arrangements for factoring receivables or sale-leaseback of assets

— Existing or committed arrangements to restructure or subordinate debt or to guarantee loans to the entity

— Possible effects on management’s borrowing plans of existing restrictions on additional borrowing or the sufficiency of available collateral

Plans to reduce or delay expenditures — Feasibility of plans to reduce overhead or administrative expenditures, to postpone maintenance

or research and development projects, or to lease rather than purchase assets — Possible direct or indirect effects on the entity and its cash flows of reduced or delayed

expenditures Plans to increase ownership equity

— Feasibility of plans to increase ownership equity, including existing or committed arrangements to raise additional capital

— Existing or committed arrangements to reduce current dividend requirements or to accelerate cash infusions from affiliates or other investors

With regard to the adequacy of disclosures, the guidance focuses on providing sufficient detail of the

origin, possible magnitude of effect, and management’s responses. Specifically, the disclosures should

describe the conditions and events that raise substantial doubt, their possible effects and management’s

evaluation of their significance relative to the entity’s ability to meet its obligations. In addition, the


disclosures should address any mitigating factors, including management’s plans and information about

the recoverability of recorded asset or liability accounts.

Written representations

For all financial statements presented and all periods covered by the review, the accountant should

request management to provide written representations that are dated as of the date of the accountant’s

review report. SSARS No. 24 adds the following written representations to the existing list of required

representations:

Management has disclosed to the accountant whether it believes that the effects of uncorrected misstatements are immaterial, individually and in the aggregate, to the financial statements as a whole. A summary of such items should be included in, or attached to, the written representation.

Management has disclosed to the accountant all known actual or possible litigation and claims whose effects should be considered when preparing the financial statements, and it has appropriately accounted for and disclosed such litigation and claims in accordance with the applicable financial reporting framework.

Management has disclosed to the accountant whether it believes that significant assumptions used in making accounting estimates are reasonable.

Management has disclosed to the accountant the identity of the entity’s related parties and all of the related party relationships and transactions of which it is aware, and it has appropriately accounted for and disclosed such relationships and transactions.

Management has disclosed to the accountant all information relevant to use of the going concern assumption in the financial statements.

Management has properly accounted for all events occurring subsequent to the date of the financial statements and for which the applicable financial reporting framework requires adjustment or disclosure.

Reporting requirements

If, after considering conditions or events and management’s plans, the accountant concludes that

substantial doubt about the entity’s ability to continue as a going concern for a reasonable period of time

remains, the accountant should include an emphasis of-matter paragraph in the accountant’s review

report. The emphasis-of-matter paragraph should be expressed through the use of terms consistent with

those included in the applicable financial reporting framework but should not use conditional language

such as “subject to.”

The following is an example of an emphasis paragraph when (1) the accountant concludes that

substantial doubt exists about the entity’s ability to continue as a going concern for a reasonable period

of time, (2) management’s plans do not alleviate the substantial doubt, and (3) the entity is required under

the applicable financial reporting framework to include a statement in the notes to the financial

statements that substantial doubt exists.

The accompanying financial statements have been prepared assuming that the Company will

continue as a going concern. As discussed in Note X to the financial statements, the Company has

suffered recurring losses from operations, and has a net capital deficiency, and has stated that

substantial doubt exists about the Company’s ability to continue as a going concern.

Management's evaluation of the events and conditions and management’s plans regarding to these


matters are also described in Note X. The financial statements do not include any adjustments that

might result from the outcome of this uncertainty. Our conclusion is not modified with respect to

this matter.

The following is an example of an emphasis paragraph when (1) the accountant concludes that

substantial doubt exists about the entity’s ability to continue as a going concern for a reasonable period

of time, (2) management’s plans do not alleviate the substantial doubt, and (3) the entity is not required

under the applicable financial reporting framework to include a statement in the notes to the financial

statements that substantial doubt exists.

The accompanying financial statements have been prepared assuming that the Company will

continue as a going concern. As discussed in Note X to the financial statements, the Company has

suffered recurring losses from operations and has a net capital deficiency, which raises substantial

doubt about its ability to continue as a going concern. Management's evaluation of the events and

conditions and management's plans regarding these matters are also described in Note X. The

financial statements do not include any adjustments that might result from the outcome of this

uncertainty. Our conclusion is not modified with respect to this matter.

If conditions or events, considered in the aggregate, have been identified that raise substantial doubt

about the entity’s ability to continue as a going concern for a reasonable period of time but, based on the

review evidence obtained, the accountant concludes that substantial doubt has been alleviated by

management’s plans, the accountant may include an emphasis-of-matter paragraph making reference to

management’s disclosures related to the conditions and events and management’s plans related to

those conditions or events. The following is an illustration of an emphasis-of-matter paragraph when

management has disclosed (a) conditions or events, considered in the aggregate, that raised substantial

doubt about the entity's ability to continue as a going concern for a reasonable period of time; (b) its

evaluation of the significance of those conditions or events, considered in the aggregate, in relation to the

entity's ability to meet its obligations; and (c) that the substantial doubt about the entity's ability to

continue as a going concern for a reasonable period of time has been alleviated by management's plans.

As discussed in Note X to the financial statements, the Company has suffered recurring losses

from operations and has a net capital deficiency. Management’s evaluation of the events and

conditions and management’s plans to mitigate these matters are also described in Note X. Our

conclusion is not modified with respect to this matter.

When an accountant becomes aware of a failure to perform a going concern evaluation or provide

adequate disclosure of going concern, the accountant should first encourage the client to consider the

implications of the current reporting and revise the financial statements prior to their issuance. In either

engagement, if the client decides not to change the financial statements, the only reporting option is to

note the departure from the applicable financial reporting framework in the compilation or review report.

When the accountant’s report should be modified, the nature of the departure from the financial reporting

framework should be disclosed in a separate paragraph, and


if the dollar effects of the departure have been determined by management, they should be disclosed; or

if the dollar effects of the departure have not been determined by management or are not readily known to the accountant as a result of his or her procedures, the accountant is not required to determine the effects of the departure. The report should indicate that no determination of the effects of the departure has been made.

In a review engagement, this paragraph should be presented under the heading “Known Departures from

the [identify the applicable financial reporting framework].”

References to the work of other accountants

Another component of SSARS No. 24 addresses the reference to the work of other accountants in a

review report. This section addresses when and how to make such a reference and additional

performance requirements when referencing the work of other accountants.

When to reference the work of other accountants

If other accountants audited or reviewed the financial statements of significant components of an entity,

the accountant of the reporting entity may decide not to assume responsibility for the work performed by

the other accountants. In that case, the accountant of the reporting entity should make reference to the

review or audit of such other accountants in the accountant’s review report. Such a reference should

clearly indicate that the accountant used the work of other accountants and should include the

magnitude of the portion of the financial statements audited or reviewed by the other accountants.

Reference to the audit or review of other accountants in the accountant’s review report on the reporting

entity should not be made if the other accountants issued an auditor’s or an accountant’s review report

that includes an alert that restricts the use of such report.

Note that the accountant of the reporting entity may make reference to any or all other accountants who

audited or reviewed significant components. For example, if a significant component is audited or

reviewed by an other accountant and a second significant component is audited or reviewed by a

different other accountant, the accountant of the reporting entity may decide to make reference to one of

the other accountants, both of the other accountants, or neither. The decision is solely at the discretion

and judgment of the accountant of the reporting entity.

In addition, the disclosure of the magnitude of the portion of the financial statements audited or reviewed

by other accountants may be achieved by stating the dollar amounts or percentages of total assets, total

revenues, other appropriate criteria, or a combination of these, whichever most clearly describes the

portion of the financial statements audited or reviewed by other accountants. When two or more other

accountants participate in the audit or review, the dollar amounts or the percentages covered by the

other accountants may be stated in the aggregate.

If the component’s financial statements are prepared using a different financial reporting framework

from that used for the financial statements of the reporting entity, the accountant should not make

reference to the review or audit of the other accountants in the review report unless the following apply:


The accountant has determined that the measurement, recognition, presentation, and disclosure criteria that are applicable to all material items in the component’s financial statements in accordance with the financial reporting framework used by the component are similar to the criteria that are applicable to all material items in the reporting entity’s financial statements in accordance with the financial reporting framework used by the reporting entity.

The accountant of the reporting entity has obtained sufficient appropriate review evidence for purposes of evaluating the appropriateness of the adjustments to convert the component’s financial statements to the financial reporting framework used by the reporting entity without the need to assume responsibility for, and thus be involved in, the work of the other accountants.

The greater the number of differences or the greater the significance of the differences between the

criteria used for measurement, recognition, presentation, and disclosure of all material items in the

component’s financial statements in accordance with the financial reporting framework used by the

component and the financial reporting framework used by the reporting entity, the less similar the

financial reporting frameworks. Financial statements prepared and presented in accordance with IFRS

and International Financial Reporting Standards for Small- and Medium-Sized Entities, as issued by the

International Accounting Standards Board, are generally viewed as similar to financial statements

prepared in accordance with GAAP. In most cases, special purpose frameworks are not similar to GAAP.


Regardless of whether the accountant of the reporting entity decides to make reference to the review or

audit of other accountants, the accountant of the reporting entity should communicate with the other

accountants and determine the following:

The other accountants are aware that the financial statements of the component that the other accountants have audited or reviewed are to be included in the financial statements on which the accountant of the reporting entity will report and that the other accountants’ report thereon will be relied upon and, where applicable, referred to by the accountant of the reporting entity.

The other accountants are familiar with the applicable financial reporting framework and with SSARSs or auditing standards generally accepted in the United States of America (GAAS), as applicable, and will conduct the review or audit in accordance therewith. Note that a report stating that a review was conducted in accordance with SSARSs or an audit in accordance in GAAS is sufficient. When the accountant has complied with other standards, the accountant of the reporting entity may evaluate professional judgment whether the engagement meets the relevant requirements of SSARSs or GAAS.

The other accountants understand the ethical requirements that are relevant to the engagement and, in particular, are independent. Note that when the other accountants are not subject to the AICPA Code of Professional Conduct, compliance by the other accountants with the ethics and independence requirements set forth in the International Ethics Standards Board Code of Ethics for Professional Accountants is sufficient to fulfill the other accountants’ ethical responsibilities.

A review will be made of matters affecting elimination of intercompany transactions and accounts and, if appropriate in the circumstances, the uniformity of accounting practices among the components included in the financial statements.


Other issues

Existing guidance in SSARSs provides a definition of the term “financial reporting framework.” SSARS No.

24 adds a paragraph to that definition describing what is meant in the literature by the term, fair

presentation framework. It is defined as referring to a financial reporting framework that requires

compliance with the requirements of the framework and does one of the following:

a. Acknowledges explicitly or implicitly that, to achieve fair presentation of the financial statements, it may be necessary for management to provide disclosures beyond those specifically required by the framework.

b. Acknowledges explicitly that it may be necessary for management to depart from a requirement of the framework to achieve fair presentation of the financial statements. Such departures are expected to be necessary only in rare circumstances.

A financial reporting framework that requires compliance with the requirements of the framework but

does not contain the acknowledgment in items a. or b. is not considered a fair presentation framework.

The accountant’s review report is also changed slightly in the section “Management’s Responsibility for

the Financial Statements.” That section of the report includes an explanation that management’s

responsibilities include the design, implementation, and maintenance of internal control. SSARS No. 24

provides clarifying language that limits that responsibility to internal controls “relevant to the preparation

and fair presentation of financial statements that are free from material misstatement whether due to

error or fraud.”

Knowledge check

3. SSARS No. 24, Omnibus Statement on Standards for Accounting and Review Services – 2018, does not apply to:

a. Fraud or illegal acts in review engagements. b. Referencing the work of other accountants. c. International reporting issues. d. Going concern considerations in review engagements.

4. Accountants may perform:

a. A compilation engagement in accordance with another country’s standards for compilations without complying with SSARSs.

b. Review engagements in accordance with another country’s standards for review engagements without obtaining sufficient appropriate review evidence.

c. Compilation or review engagements on financial statements that have been prepared in accordance with accounting principles generally accepted in another country.

d. Compilation, but not review, engagements in accordance with another country’s standards for compilation and review and SSARSs.


SSARS Nos. 22–23, Compiling pro forma and prospective financial information One of the last pieces of the ARSC Clarity Project, SSARS No. 22, Compilation of Pro Forma Financial

Information, and SSARS No. 23, Omnibus Statement on Standards for Accounting and Review Services—

2016, were issued in September 2016 and became effective for compilation reports on pro forma

financial and prospective information dated on or after May 1, 2017. The standards provide performance

and reporting requirements as well as application guidance for these engagements involving pro forma

information. The clarified standards are codified in AICPA Professional Standards as AR-C section 120 for

pro forma financial information and in AR-C section 80 for prospective financial information.

Defining pro forma and prospective financial information

Pro forma financial information

Pro forma financial information is historical information to which the anticipated effects of a future

transaction or event have been applied. In other words, pro forma financial information demonstrates

what would have happened to the historical financial statements if specific events had occurred at an

earlier date.

Pro forma financial information is commonly used to show the effects of transactions such as business

combinations, change in capitalization, disposition of a significant portion of the business, change in the

form of business organization, or proposed sale of securities and application of proceeds.

Accountants may undertake a preparation or compilation engagement for pro forma financial

information. This engagement may be separate from or in conjunction with a compilation, a review, or an

audit of financial statements. Note, however, that pro forma financial information cannot be the subject

of a review engagement.

Prospective financial information

Prospective financial information includes any financial information about the future. The financial

information may be in the form of a complete set of financial statements or elements, items, or

accounts. Prospective financial information includes financial forecasts and financial projections

(defined in the next two paragraphs) but may also be referred to as feasibility studies, break-even

analyses, and budgets. Partial presentations that exclude one or more relevant elements are also

allowed.

Financial forecasts are prospective financial statements that present, to the best of the responsible

party’s knowledge and belief, an entity’s expected financial position, results of operations, and cash

flows. The financial forecast is based on the responsible party’s assumptions reflecting conditions it

expects to exist and the actions it expects to take. A financial forecast may be expressed as a


single-point estimate or as a range. Because recipients of prospective financial statements distributed

for general use are unable to ask the responsible party directly about the statements, the presentation

most useful to them is the one that portrays the expected results. As a result, only a financial forecast is

appropriate for general use.

A financial projection is very similar to a financial forecast in that these prospective financial statements

present, to the best of the responsible party’s knowledge and belief, an entity’s expected financial

position, results of operations, and cash flows. However, the financial projection also takes into

consideration one or more hypothetical assumptions, answering the question, “What would happen

if . . .” Note that the hypothetical assumptions are not necessarily those that are expected to occur; nor

does the responsible party need to have a reasonably objective basis for the assumption. Generally,

though these assumptions are consistent with the purpose of the projection and limited in number and

significance. As the number or significance of the assumptions increases and the “what ifs” become

more variable, it is less likely that it is appropriate for the responsible party to present prospective

financial information.

Compiling pro forma financial information

In order to distinguish pro forma from other historical financial information, appropriate labels and

adequate disclosures are required for pro forma financial information. Adequate disclosure will include

the following:

A description of the transaction or event that is reflected in the pro forma financial information The date on which the transaction or event is assumed to occur The financial reporting framework of the financial statements The source of the historical financial information on which the pro forma financial information is based Significant assumptions used to develop the pro forma adjustments Any significant uncertainties about those assumptions

The pro forma financial information should also indicate that it should be read in conjunction with the related

historical financial information, and that the pro forma financial information is not necessarily indicative of

the results that would have been attained had the transaction or event actually taken place earlier.


The performance requirements of an engagement to compile pro forma financial information are very

similar to a typical compilation engagement, with a few added requirements specific to pro forma

information. The specific performance requirements are as follows:

Establish an understanding with the client. Have appropriate knowledge and understanding of the entity’s financial reporting framework. Obtain an understanding of the underlying transaction or event. Read the financial information, considering the underlying transaction or event and the source of the

historical financial statements. Ascertain that management has fulfilled its agreements.


In establishing an understanding with the client, the accountant must follow all of the general procedures

related to acceptance and continuance of a client applicable to any compilation engagement. In addition,

as a condition of accepting an engagement, the accountant should (1) determine whether preliminary

knowledge of the engagement circumstances indicate that ethical requirements regarding professional

competence will be satisfied, (2) determine whether the financial reporting framework selected by

management to be applied in the preparation of the financial statements is acceptable, and (3) obtain the

agreement of management that it acknowledges and understands its responsibilities.

For engagements to compile pro forma financial information, management should acknowledge and

understand its responsibilities for the following:

Prepare and fairly present pro forma financial information in accordance with the applicable financial reporting framework.

Include the financial statements (or interim statements) that have been compiled, reviewed, or audited, as well as their associated compilation, review, or audit report in any document containing the pro forma financial information.

Present a summary of significant assumptions with the pro forma financial information. Obtain the accountant’s permission prior to including the accountant’s compilation report in any

document containing the pro forma financial information that indicates that the entity’s accountant has performed a compilation on the pro forma financial information.

Once management has agreed to its responsibilities, the accountant should document the terms of the

engagement in an engagement letter or other written agreement. The engagement letter should be

signed by both the accountant and management or those charged with governance.

One of the performance requirements of all compilation engagements is that the accountant should read

the financial statements and consider whether they appear to be appropriate in form and free from

obvious material misstatements. On an engagement to compile pro forma financial information, the

accountant must understand the underlying transaction or event in order to complete this step. With an

understanding of the transaction or event, the accountant must read the pro forma financial information

and consider the following:

Whether the underlying transaction or event, the pro forma adjustments, the significant assumptions, and the significant uncertainties, if any, about those assumptions have been appropriately described

Whether the source of the historical financial information on which the pro forma financial information is based has been appropriately identified

The final performance requirement is for the accountant to ascertain that management has fulfilled what

it agreed to in the client acceptance and continuance discussion of the engagement, as reiterated in the

engagement letter. Specifically, the accountant should ensure that management has fulfilled its

obligations to do the following:

Include the most recent financial statements or interim financial statements in any document containing the pro forma financial information. If the engagement involves a business combination, the relevant financial information for the significant constituent parts of the combined entity.

Ensure that the financial statements on which the pro forma financial information is based have been subjected to compilation, review, or audit.


Include the compilation report, review report, or audit opinion in any document containing the pro forma financial information.

Reporting on pro forma information

Generally, the report on compiled pro forma financial information follows the same guidelines as a report

on a typical compilation. In addition to the elements of the standard compilation report, a compilation

report on pro forma financial information should include the following:

A reference to the financial statements from which the historical financial information is derived and a statement about whether such financial statements were subjected to an audit, review, or compilation engagement

A reference to any modification of the audit, review, or compilation report on the historical financial information

A description of the nature and limitations of pro forma financial information

The compilation report on pro forma financial information may be presented separately from the

accountant’s report on financial statements, or it may be added to that report. An uncertainty about

whether the underlying transaction or event will be consummated does not require a report modification.

The appendix to this course presents a sample compilation report on pro forma financial information.

Practitioners performing compilation engagements on pro forma financial statements are required to

consider their independence because compilation is an attestation service. They are not, however,

required to be independent of their clients because no assurance is provided by the compilation report.

Practitioners who lack independence are required to disclose that information in a final paragraph of the

compilation report. The accountant is neither required to, nor precluded from, disclosing a description of

the reasons that independence is impaired. If the accountant elects to disclose a description of the

reasons independence is impaired, that description should be complete, including all reasons.

Documentation

According to AR-C section 120, documentation for compilation engagements on pro forma financial

information should include the following:

The signed, written engagement letter documenting the understanding with the client. This letter is required to be signed by both management and the accountant.

The results of procedures performed. A copy of the pro forma financial information. A copy of the accountant’s compilation report.

The authors recommend additional documentation they believe are necessary to support compliance

with standards for compilation engagements. These include documentation of the appropriate

knowledge and understanding of the entity’s financial reporting framework, documentation of the

understanding of the underlying transaction or event, and a work program. The authors also recommend

that accountants document any findings or issues that, in their judgment, are significant.


Compiling prospective financial information

Accountants may undertake a preparation or compilation engagement for prospective financial

information. This engagement may be separate from or in conjunction with a compilation engagement

for financial statements.

There are very few differences between the performance and reporting requirements of a compilation of

historical financial statements and a compilation of prospective financial information. The remainder of

this section describes any additional procedures specific to prospective financial information.

With regard to performance requirements, there are no specific additions for compilations of prospective

financial information. The accountant must still (1) establish an understanding with the client in writing,

and typically in the form of an engagement letter, (2) obtain an understanding of the client and its

industry, (3) read the financial statements or information, and (4) obtain additional information if the

accountant becomes aware that information supplied by the entity may be incorrect, incomplete, or

otherwise unsatisfactory or if a fraud or illegal act has occurred.

Reporting requirements are slightly expanded for compilation engagements involving prospective

financial information. These compilation reports should include all of the elements of a typical

compilation engagement, including identification of the financial information that was compiled, a

statement that the engagement was performed in accordance with SSARSs, a statement that the

information was not reviewed or audited, and that no conclusion or opinion is provided. Because

prospective financial statements are based on assumptions about the future, the summary of significant

assumptions is essential to the user’s understanding of prospective financial information. As a result, an

accountant should not issue a compilation report on prospective financial information that excludes

disclosure of the summary of significant assumptions. Similarly, the accountant should not issue a

compilation report on a financial projection that excludes either (1) an identification of the hypothetical

assumptions or (2) a description of the limitations on the usefulness of the presentation.

In addition, the accountant must modify the compilation report when the subject matter is prospective

financial information. Specifically, the compilation report should include the following statements:

The forecasted or projected results may not be achieved. The accountant assumes no responsibility to update the report for events and circumstances

occurring after the date of the report.


Knowledge check

5. In an engagement to compile pro forma financial information, the accountant should ascertain that management has fulfilled its obligations to do what?

a. Include the most recent historical financial statements with the document including the pro forma information.

b. Present the pro forma financial information as though it were historical financial information. c. Demonstrate that the underlying transaction or event has occurred. d. Provide a written representation letter to the accountant.

6. What is accurate of compilation reports on pro forma financial information?

a. They make no reference to the compilation, review, or audit report on the historical financial statements.

b. They provide limited assurance on the pro forma financial information if the historical financial statements from which the information was derived were reviewed.

c. They reference the relevant historical financial statements from which the information was derived.

d. They make no reference to the accountant’s lack of independence.

7. A compilation of prospective financial statements:

a. Does not require the accountant to establish an understanding with the client in writing. b. Requires the accountant to obtain an understanding of the client and its industry. c. Requires the accountant compiling them to gather evidence regarding the reasonableness of

the underlying assumptions. d. Prohibits the accountant from obtaining additional information.

8. The accountant’s report on compiled prospective statements:

a. Should not include a statement about an accountant’s lack of independence. b. Should not be issued when the accountant has also compiled the related historical information. c. Should not include a statement that the information was not reviewed or audited and that no

conclusion or opinion is provided. d. Should not be issued if a summary of significant assumptions is excluded.



Determination and use of materiality judgments in review engagements Appropriate circumstances for issuing a modified conclusion in a review engagement Reporting a modified conclusion in a review engagement Other changes to SSARSs engagements included in SSARS No. 25 Performance and reporting requirements for financial statements prepared in accordance with

accounting principles generally accepted in another country Performance and reporting requirement for compilation and review engagements performed in

accordance with another country’s standards for compilation and review Performance and reporting requirements for addressing going concern in a review engagement Referencing the work of other accountants in a compilation or review engagement Definition of pro forma and prospective financial information Performance and reporting requirements for compilation engagements of pro forma financial information Performance and reporting requirements for prospective financial information


Case study: Going concern

GreenThumb.com is a small company in its fourth year of existence. GreenThumb has carved out a niche by providing indoor plant design and maintenance for businesses in the state. It began the business with capital from some locally financed debt. Revenue growth was strong in the first two years but has decreased in years two and three. The current revenue is approximately $450,000, and GreenThumb.com has signed three-year agreements to provide biweekly services with 20 businesses. Several other businesses have purchased services on a month-to-month basis.

With the decline in revenue growth and cash flow difficulties, GreenThumb.com has identified concerns about its ability to remain a going concern without either increased profitability or a cash infusion. Accordingly, GreenThumb.com has the following plan in place:

Seek an additional loan. Sign three-year agreements with an additional 40 businesses during the year. Improve profit margins by finding new vendors for plants and supplies.

GreenThumb.com’s lender requires a reviewed set of financial statements each year. Your firm has been hired to provide the review engagement for the current year.

1. What is your responsibility to consider going concern assuming that the financial statements are prepared in accordance with U.S. GAAP? How does that responsibility change if the financial statements are prepared in accordance with the income tax basis of accounting?

2. What period of time do you have to determine whether GreenThumb.com has a going concern issue?

3. Assume that you conclude the conditions and events facing GreenThumb.com are sufficient to raise substantial doubt about its ability to continue as a going concern. What are your responsibilities regarding management’s plans?

4. Assume the financial statements are GAAP-basis and that substantial doubt exists and is not mitigated by management’s plans. Further assume that management has made the appropriate disclosures regarding going concern. How will your review report be affected?


Case study: Prospective financial information

B&J Microbrewery is owned by Bill and Jane, craft brewers. They began producing their special brand of craft beer out of a small facility owned by a family member with production primarily sold in their hometown. Over time, as the craft beer industry grew, and microbreweries were in increasing demand, Bill and Jane began to expand in response to demand for their product.

Currently located in a small business incubator facility in the state capital, Bill and Jane’s business is producing sufficient beer to supply a local grocery store with six locations in the state. Over the past several months, Bill and Jane have been working to obtain contracts for distribution through a larger regional grocery company with 200 locations. Recently, the regional company contacted them with the good news that the company will begin to distribute their product. The company also asked for a set of historical and prospective financial statements.

Bill and Jane have approached your firm asking for prospective financial statements to help with their planning. They have provided compiled financial statements for the current year.

1. As you prepare for your first meeting with Bill and Jane, think through some of the questions that you need to ask them.

2. Based on their answers to your questions, Bill and Jane will need an additional capital infusion to support the increase in demand. You want to build the cost of borrowing into the projection, but Bill and Jane are adamant that the projections should reflect only changes in revenue and variable costs. Further, they are hesitant to fully describe the assumptions underlying the projected financial information. What is your response?

3. You reach an agreement with Bill and Jane about the significant assumptions underlying the prospective information and you proceed with the compilation engagement. Describe the steps you will follow and document in your compilation engagement.

4. Once you have finished your compilation, what would the compilation report look like?


Solutions

Recent Statements on Standards for Accounting and Review Services Developments


1.

a. Incorrect. This is a common element of materiality. The “reasonable user” test is a common element in determining materiality across different financial reporting frameworks.

b. Correct. This is not a common element of materiality. The determination of materiality is made in light of the surrounding circumstances and is affected by the size and nature of a misstatement.

c. Incorrect. This is a common element of materiality. Materiality is evaluated both in terms of financial impact (quantitative) as well as the nature of the misstated item (qualitative).

d. Incorrect. This is a common element of materiality. Materiality determinations should take into consideration the common financial needs of users as a group, not the needs of specific individuals.

2.

a. Correct. This is not an option available under the circumstances. Disclaimers of opinion can be used in auditing financial statements, but there is no option to use a disclaimer in a review engagement.

b. Incorrect. This is an option available under the circumstances. The accountant may choose to withdraw from the review engagement if the financial statements are materially misstated.

c. Incorrect. This is an option available under the circumstances. The accountant may issue a review report with a qualified conclusion when financial statements are materially, but not pervasively, misstated.

d. Incorrect. This is an option available under the circumstances. The accountant may issue a review report with an adverse conclusion when the financial statements are materially and pervasively misstated.


3.

a. Correct. The omnibus standard does not address issues related to fraud or illegal acts. Recall accountants conducting review engagements are under no obligation to search for fraud or illegal acts.

b. Incorrect. The omnibus standard provides guidance regarding when and how accountants conducting a review engagement should make reference to the work of other accountants.

c. Incorrect. The omnibus standard provides guidance regarding engagements involving financial statements prepared in accordance with a financial reporting framework generally accepted in another country as well as accountants performing compilation and review engagements in accordance with SSARSs and the standards of another country.

d. Incorrect. The omnibus standard harmonizes the requirements for considering going concern issues in a review engagement with the corresponding audit requirements.

4.

a. Incorrect. Accountants may conduct a compilation engagement in accordance with another country’s standards for compilation as long as they also comply with SSARSs, even if this requires the accountants to perform additional procedures beyond those typical of a SSARSs engagement.

b. Incorrect. Accountants may conduct a review engagement in accordance with another country’s standards for reviews as long as they also comply with SSARSs, and SSARSs require accountants to obtain sufficient appropriate review evidence in a review engagement.

c. Correct. SSARS No. 24 allows accountants to perform compilation or review engagements on financial statements prepared in accordance with a financial reporting framework generally accepted in another country. Accountants must obtain an understanding of the purpose of the financial statements, the intended users and steps taken by management to determine that the financial reporting framework is acceptable in the circumstances.

d. Incorrect. Accountants may conduct either a compilation or review engagement in accordance with another country’s standards for compilation or review as long as they also comply with SSARSs.


5.

a. Correct. Management should include the relevant historical financial statements in any document containing the pro forma financial information.

b. Incorrect. Pro forma financial information should be carefully labeled to distinguish it from historical financial statements.

c. Incorrect. There is no requirement that the underlying transaction or event actually occur.

d. Incorrect. Written representation letters are not required for compilation engagements.

6.

a. Incorrect. The compilation report on pro forma financial information should make reference to the compilation, review, or audit report on the relevant historical financial statements.

b. Incorrect. Compilation reports do not provide any assurance.

c. Correct. The accountant’s report on compiled pro forma financial information should include a reference to the source of the related historical financial statements.

d. Incorrect. The accountant’s report on compiled pro forma financial information should disclose a lack of independence, if applicable.

7.

a. Incorrect. A compilation of prospective financial information is like any compilation — it requires the accountant to establish an understanding with the client in writing.

b. Correct. As in any compilation, the accountant must obtain an understanding of the client and industry sufficient to allow the accountant to perform the engagement.

c. Incorrect. Compilation engagements do not require accountants to gather evidence.

d. Incorrect. An accountant may be required to obtain additional information in order to compile the financial statements.

8.

a. Incorrect. Compilation reports on prospective financial information should disclose an accountant’s lack of independence when applicable.

b. Incorrect. Accountants are not prohibited from compiling historical and prospective financial information for the same entity.

c. Incorrect. Accountants’ reports on compiled prospective information should include a statement that no assurance is provided.

d. Correct. Accountants should not issue a report on compiled financial information if a summary of significant assumptions is not included.


Case study solutions: Going concern

1. Accountants performing review engagements are required to consider whether, during the performance of the review procedures, evidence or information came to the accountant’s attention indicating that there could be an uncertainty about the entity’s ability to continue for a reasonable period of time. Some financial reporting frameworks, like GAAP, require management to evaluate an entity’s ability to continue as a going concern. When this evaluation by management is required, the accountants is responsible for determining the following:

Whether the going concern basis of accounting is appropriate

Management’s evaluation of whether there are conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern

If there are conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern, and management’s plans to mitigate those matters

The adequacy of the related disclosures in the financial statements.

If the financial reporting framework, like the income tax basis of accounting, does not require management to evaluate the entity’s ability to continue as a going concern, the accountant should do the following:

Inquire of management whether the going concern basis of accounting is appropriate

Inquire of management about its plans for dealing with the adverse effects of the conditions and events

Consider the adequacy of disclosure about such matters in the financial statements

2. A reasonable period of time is defined as “the period of time required by the applicable financial reporting framework or, if no such requirement exists, within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable.”

3. The accountant should consider management’s plans and the degree to which they may mitigate the effects of the identified conditions or events. With regard to GreenThumb.com’s plans to borrow money, the accountant might consider the availability and terms of new financing and the possible effects of additional borrowing or the sufficiency of collateral. With regard to plans to sign additional contracts, the accountant may consider the feasibility of these plans. For example, how large is the market for these services, and how much capacity does GreenThumb.com have to service additional contracts? With regard to the plans to find to new vendors for plants and supplies, the accountant might consider whether more favorable terms are available and whether there are existing contracts with vendors.

4. Assuming that the accountant concludes that the disclosures included in the notes to the financial statements are adequate, the accountant will add an emphasis-of-matter paragraph describing the conditions and events giving rise to substantial doubt and referencing the note disclosure. The conclusion of the review report will not be modified.


Case study solutions: Prospective financial information

1. You would need to discuss the following with Bill and Jane:

What is projected demand based on the new contract?

What is the capacity for production in current facility?

If this facility is not going to be used, then where will production occur?

What would the cost of a new facility be?

Is there a need to obtain additional federal, state, or local licensure?

Are sufficient raw materials available to meet the projected demand?

How secure is the supply chain?

Have Bill and Jane put an appropriate distribution chain in place for the new contract?

Are there sufficient employees to support the new contract? If not, how will Bill and Jane secure and train new employees?

2. A summary of significant assumptions is essential to understanding the prospective financial statements, so you should not undertake the engagement without one. You should focus further conversation on the usefulness of the prospective financial statements in their planning process—the more realistic the statements, the more helpful they will be for Bill and Jane and to the regional company.

3. Performance requirements for a compilation engagement include all of the following:

Establish an understanding with the client.

Have appropriate knowledge and understanding of the entity’s financial reporting framework.

Obtain an understanding of the underlying transaction or event.

Read the financial information, considering the underlying transaction or event and the source of the historical financial statements.

Ascertain that management has fulfilled its agreements.

Required documentation for a compilation of prospective financial information includes

the signed, written engagement letter documenting the understanding with the client. This letter is required to be signed by both management and the accountant.

a copy of the financial statements.

a copy of the accountant’s report.

The authors recommend additional documentation, including documentation of the understanding of the financial reporting framework, underlying transaction or event, and a work program.


4. The compilation report will look as follows:

[The responsible party]1 is responsible for the accompanying financial forecast of XYZ Company, which comprises the forecasted balance sheet as of December 31, 20XX and the related statements of income, changes in stockholders’ equity, and cash flows2 for the years then ending, and the related summaries of significant assumptions and accounting policies in accordance with guidelines for the presentation of a financial forecast established by the American Institute of Certified Public Accountants (AICPA). I (We) have performed a compilation engagement in accordance with Statements on Standards for Accounting and Review Services promulgated by the Accounting and Review Services Committee of the AICPA. I (We) did not examine or review the financial forecast nor was (were) I (we) required to perform any procedures to verify the accuracy or completeness of the information provided by management. Accordingly, I (we) do not express an opinion nor provide any form of assurance on this financial forecast.

The forecasted results may not be achieved. I (We) assume no responsibility to update this report for events and circumstances occurring after the date of this report.

[Additional paragraph(s) may be added to emphasize certain matters relating to the compilation engagement or the subject matter.]

[Signature of practitioner’s firm or practitioner, as appropriate] [Practitioner’s city and state] [Date of the practitioner’s report]

1 Even when the practitioner prepared the forecast, he or she cannot take responsibility for the assumptions.

2 The description would be modified as appropriate to refer to the statements or partial presentation subjected to

the compilation engagement.


Current Practice Issues

Learning objectives

Identify AICPA resources relevant to preparation, compilation, and review engagements.

Recognize current independence and ethics issues.

Identify current issues identified by the Accounting and Review Services Committee (ARSC).

Recall the fundamentals of QC section 10, A Firm’s System of Quality Control (AICPA Professional Standards).


AICPA resources The AICPA has significant resources available to practitioners who perform reviews, compilations, and

engagements to prepare financial statements. This section provides an overview of those resources.

Center for Plain English Accounting

The Center for Plain English Accounting (CPEA) is the AICPA’s national audit and accounting resource

center, available exclusively to Private Company Practice Section member firms. Practitioners often have

questions about the application of authoritative literature to specific facts and circumstances. The CPEA

provides expertise and resources in a straightforward and clear style to answer those questions. The

CPEA provides written responses to technical inquiries, webcasts on hot topics, and monthly reports to

help practitioners understand and implement appropriate guidance. For example, the CPEA regularly

publishes reports and frequently asked questions on the implementation of Statements on Standards for

Accounting and Review Services (SSARSs), especially questions about the requirements for accountants

engaged to prepare financial statements. This resource is available at

https://www.aicpa.org/interestareas/centerforplainenglishaccounting.html

Financial Reporting Center of AICPA.org

Noting that CPAs face unprecedented changes in financial reporting, the AICPA has created the Financial

Reporting Center to support the execution of high-quality financial reporting. The Financial Reporting

Center provides timely and relevant news, guidance, and examples supporting the financial reporting

process as well as resources for accounting, preparing financial statements, and performing various

types of engagements, including compilation and review, audit and attest, and assurance and advisory.

For example, the Financial Reporting Center currently offers a section dedicated to the FASB revenue

recognition standard with the latest supporting resources. This center can be accessed at

www.aicpa.org/frc.

Publications and standards

The AICPA offers a large number of publications and standards that support practitioners. Some of the

publications and standards that might be most useful to practitioners performing review, compilation, or

financial statement preparation engagements include the following:

Codification of Statements on Standards for Accounting and Review Services SSARS No. 22, Compilation of Pro Forma Financial Information SSARS No. 23, Omnibus Statement on Standards for Accounting and Review Services—2016 SSARS No. 24, Omnibus Statement on Standards for Accounting and Review Services—2018 SSARS No. 25, Materiality in a Review of Financial Statements and Adverse Conclusions

https://www.aicpa.org/interestareas/centerforplainenglishaccounting.html


AICPA Guide Preparation, Compilation, and Review Engagements—2020: This guide provides information on recent developments, guidance, observations, and suggestions, and illustrative examples when applying the standards for compilation and review engagements.

U.S. GAAP Financial Statements—Best Practices in Presentation and Disclosure: This resource provides comprehensive coverage of virtually every required disclosure in accounting principle generally accepted in the United States of America (GAAP). This resource also provides hundreds of high-quality disclosure examples from a variety of organizations.

Resources for applicable financial reporting frameworks

Throughout the SSARSs guidance, there are references to the “applicable financial reporting framework.”

These references recognize that accountants may prepare, compile, or review financial statements using

a variety of alternatives, ranging from U.S. GAAP to International Financial Reporting Standards. These

frameworks can differ significantly in terms of guidance, complexity, cost, and acceptability to third

parties. The following table provides a list of the the frameworks available to nonpublic companies, a

general description of the bases, and a reference to the applicable guidance.

Framework Description Guidance (Publisher)

U.S

. GA

AP

U.S. GAAP Accrual based framework

Significant body of guidance results in

complexity

Recognized as authoritative standards

Widely used

Accepted by third parties

Codification (FASB)

Statements on Financial

Accounting Standards

(FASB)

Interpretations of

Statements on Financial


(FASB)

Private Company Council – U.S. GAAP

Modification of U.S. GAAP for private

companies


Referred to as “Little GAAP”

Accepted by third parties

ASU No. 2014-02,

Intangibles—Goodwill and

Other (Topic 350):

Accounting for Goodwill (a

consensus of the Private

Company Council) (FASB)

ASU No. 2014-03,

Derivatives and Hedging

(Topic 815): Accounting for

Certain Receive-Variable,

Pay-Fixed Interest Rate

Swaps—Simplified Hedge

Accounting Approach (a



ASU No. 2014-07,

Consolidation (Topic 810):

Applying Variable Interest



Entities Guidance to

Common Control Leasing

Arrangments (a consensus

of the Private Company

Council) (FASB)

ASU No. 2014-18, Business

Combinations (Topic 805):

Accounting for Intangible

Identifiable Assets in a

Business Combination (a



Sp

ec

ial p

urp

os

e f

ram

ew

ork

s Income-tax

basis Basis used to prepare income taxes

Recognized as an authoritative standard

Can be used by any entity that files a

return

— Relatively easy to understand

— Widely used

— Commonly accepted by third parties

SSARS No. 21, General

Principles for Engagements

Performed in Accordance

With Statements on

Standards for Accounting

and Review Services (ARSC

of the AICPA)

Practice Aid Accounting

and Financial Reporting

Guidelines for Cash- and

Tax-Bases Financial

Statements (Association of

International Certified

Professional Accountants)

Cash basis Basis used to record cash receipts and

disbursements


Easy to understand, not complex

Infrequently used in its purest form

Limited to certain industries

May not be accepted by third parties

Modified cash basis

Common modifications to cash basis

include depreciation, recording of

liabilities


Easy to understand, not complex

No bright lines for the number of

modifications to the cash basis

Diversity in application across entities

May not be accepted by third parties

Regulatory or contractual basis

Basis used to comply with a regulatory

agency or agreement between entities


Accountant’s report restricts use to

specified parties

Typically accepted by regulators or

parties to the contract



Other basis Basis that uses a definite set of logical,

reasonable criteria applied to all material

items


Usually not accepted by third parties

AIC

PA

Financial Reporting Framework for SMEs

Simplified version of U.S. GAAP

Not recognized as authoritative

standards

Less complex and less costly

Not widely used

Unknown whether third parties will

accept

Financial Reporting

Framework for SMEsTM

(AICPA)

Financial Reporting

Framework for SMEs

toolkits - for CPAs, financial

statement users, or small

businesses (AICPA)

Decision Tool for Adopting

FRF for SMEs (AICPA)

IFR

Ss

International Financial Reporting Standards (IFRSs)

Principles-based accounting guidance

Similar to GAAP, but fewer rules


Not widely used by private companies

Third parties are not usually familiary

with this framework

IFRS (International


Board)

IFRS for SMEs Stand-alone version of IFRS


Simplified with fewer disclosures

Not widely used by U.S. accountants

Third parties are not usually familiar with

this framework

IFRS for Small- to Medium-

Sized Entities (International


Board)

Knowledge check

1. Which of the following applicable financial reporting frameworks is not recognized as an authoritative standard?

a. Private Company Council — U.S. GAAP. b. Income tax basis of accounting. c. AICPA’s Financial Reporting Framework for Small- to Medium-Sized Entities. d. International Financial Reporting Standards.


Current independence and ethics issues The Professional Ethics Executive Committee (PEEC) of the AICPA is charged with interpreting and

enforcing the AICPA Code of Professional Conduct (the code), for promulgating new interpretations, and

for monitoring those interpretations and making revisions as needed. Recent changes by PEEC are

covered in this section.

Ethics codification

In January 2014, PEEC adopted the final version of the revised code so that members can apply the code

and reach correct conclusions more quickly and intuitively. The revised code was effective December 15,

2014.

The code is organized as follows:

Preface. Provides general information about the code and its structure, contains the broad principles of professional conduct and definitions, and includes new guidance on changes to the code and the related effective dates. This section is applicable to all members.

Part 1: “Members in Public Practice.” Contains all guidance applicable to members in public practice. Part 2: “Members in Business.” Contains all guidance applicable to members in business. Part 3: “Other Members.” Contains all guidance applicable to all other members, such as individuals

who are retired or not currently in the workforce.

Parts 1–3 use an organizational structure that starts with topics, which are then broken down by

subtopic and, when necessary, further broken down by sections, with each subsequent level providing

more specific information to the user. After this material, a link to any nonauthoritative information that is

applicable to the topic, subtopic, or section is shown in boxed text. PEEC has developed a mapping

document that will assist members’ understanding of where to find the interpretative guidance from the

former code to the revised code by showing links cross-referenced to the former code.

The restructured code also introduces a citation numbering system similar to that of the FASB

Accounting Standards Codification® (ASC). The system begins with a single digit, followed by up to two

sets of three-digit numbers (for example, ET section X.XXX.XXX). The single digit at the beginning of each

citation identifies specifically where the content resides, such that the preface begins with a 0, content

for members in public practice begins with a 1, content for members in business begins with a 2, and

content for all other members begins with a 3. The following sets of three-digit numbers identify the

topics and subtopics, respectively.

In an effort to make the code easier to use, the AICPA has made it available on a dynamic online platform

accessible at http://pub.aicpa.org/codeofconduct/Ethics.aspx. It is broken down into different parts by

line of practice. It is intuitively arranged by topic, and, where necessary, subtopic and section, and

incorporates the conceptual framework approach described in the next section. The new format allows

for quick and easy navigation and also identifies when nonauthoritative content is available on a

particular topic.


Conceptual framework for AICPA independence rules

The code contains three conceptual frameworks: one for members in public practice, one for members in

business, and one to specifically address independence. The conceptual framework approach, also known as

the “threats and safeguards” approach, is a way of identifying, evaluating, and addressing threats that may

exist and safeguards that may be applied to eliminate or reduce those threats to an acceptable level. The

conceptual framework for independence requires the following:

Identify threats. The relationships or circumstances that a member encounters in various engagements and work assignments will often create different threats to complying with the rules. When a member encounters a relationship or circumstance that is not specifically addressed by a rule or an interpretation, under this approach, the member should determine whether the relationship or circumstance creates one or more threats. The existence of a threat does not mean that the member is in violation of the rules; however, the member should evaluate the significance of the threat.

Evaluate the significance of a threat. In evaluating the significance of an identified threat, the member should determine whether a threat is at an acceptable level. A threat is at an acceptable level when a reasonable and informed third party who is aware of the relevant information would be expected to conclude that the threat would not compromise the member’s compliance with the rules. Members should consider both qualitative and quantitative factors when evaluating the significance of a threat, including the extent to which existing safeguards already reduce the threat to an acceptable level. If the member evaluates the threat and concludes that a reasonable and informed third party who is aware of the relevant information would be expected to conclude that the threat does not compromise a member’s compliance with the rules, the threat is at an acceptable level, and the member is not required to evaluate the threat any further under this conceptual framework approach.

Identify and apply safeguards. If, in evaluating the significance of an identified threat, the member concludes that the threat is not at an acceptable level, the member should apply safeguards to eliminate the threat or reduce it to an acceptable level. The member should apply judgment in determining the nature of the safeguards to be applied because the effectiveness of safeguards will vary, depending on the circumstances. When identifying appropriate safeguards to apply, one safeguard may eliminate or reduce multiple threats. In some cases, the member should apply multiple safeguards to eliminate or reduce one threat to an acceptable level. In other cases, an identified threat may be so significant that no safeguards will eliminate the threat or reduce it to an acceptable level, or the member will be unable to implement effective safeguards. Under such circumstances, providing the specific professional services would compromise the member’s compliance with the rules, and the member should determine whether to decline or discontinue the professional services or resign from the engagement.

The code defines safeguards as “actions or other measures that may eliminate a threat or reduce a threat

to an acceptable level,” and it includes a discussion on the effectiveness of safeguards, as well as an

expansive (but not all-inclusive) listing of safeguards that the member may consider applying in the

circumstances.

The conceptual framework is used for topics in which the code lacks guidance. These conceptual

frameworks allow members to reach conclusions even if specific guidance is not written in the code.

Failure to apply the conceptual framework when specific guidance is not written in the code will be

considered a failure to comply with the code.


In addition, to assist with implementation, PEEC has developed separate toolkits for each conceptual

framework to assist with implementing this risk-based approach. The toolkits include the following:

Steps of the conceptual framework to provide members with detailed guidance on what to do when applying the conceptual framework approach

A flowchart that serves as a visual aid for breaking down the steps of the conceptual framework approach

A worksheet to aid members with applying the steps of the conceptual framework. An example of how to use this worksheet is included in the toolkit.

Examples of relationships or circumstances that are not addressed in the AICPA code and how the conceptual framework may be applied in such situations

The toolkits are available at www.aicpa.org/InterestAreas/ProfessionalEthics/Resources/Pages/

default.aspx.

New and proposed independence interpretations

Several revisions were issued by PEEC from 2017 through 2020.

Revised definitions

In October 2017, PEEC issued revisions that clarify the existing definitions of client and attest client,

relocated guidance for government auditors from the client definition to a more appropriate location in

the AICPA code. PEEC also answered the following questions when one entity engages the member to

perform services on another entity:

Of which entity is the member required to be independent? To which entity does the member owe a duty of confidentiality? To whom may the member respond to requests for records and work product?

The definitions of client and attest client are as follow:

A client is defined as any person or entity, other than the member’s employer, that engages a member or member’s firm to perform professional services (engaging entity) and also a person or entity with respect to which a member or member’s firm performs professional services (subject entity). When the engaging entity and the subject entity are different, although there is only one engagement, they are separate clients.

An attest client is defined as a person or entity with respect to which an attest engagement is performed.

Note that the revised definition of a client clarifies that when the engaging entity is not also the subject of

the engagement, members will have two separate clients within the same engagement.

Part of the motivation for the revised definition of a client came from relocating an exception for

government employees. The exception permitted government employees to audit the government that

employs them without impairing their independence when certain safeguards are in place. The exception

was moved out of the definition of “client” and into the “Simultaneous Employment or Association with an

Attest Client” interpretation (ET sec. 1.275.005) to give it better visibility.

www.aicpa.org/InterestAreas/ProfessionalEthics/Resources/Pages/default.aspx

www.aicpa.org/InterestAreas/ProfessionalEthics/Resources/Pages/default.aspx


The revised definition of the attest client requires members to be independent of only the subject entity

when engaged by an entity that is not the subject of the engagement. An exception would occur when

the engaging entity meets the definition of an affiliate under the “Client Affiliates” interpretation (ET sec.

1.224.010); for example, if the engaging entity is the attest client’s parent entity and the attest client is

material to the parent. In addition, the engaging party should consider whether conflicts of interest exist

under the circumstances.

The revised definitions also have implications for confidentiality. The clarifications are premised on the

principle that the member owes the duty of confidentiality to the beneficiary of the services. So, if a

company (engaging entity) hires a member to perform personal tax services for the company'’ executives

(subject entities and beneficiaries), the member should not disclose information obtained during the tax

engagement to the company without first obtaining the executive’s (beneficiary’s) permission to do so.

PEEC further clarified their intent when the engaging party benefits from the services. For example, if

Company A engages the member to value certain assets of Company B for A’s possible acquisition,

PEEC believes that Company A and B would typically have an agreement in place to share engagement-

related information with each other. In other words, the member generally would not need to obtain B’s

permission to disclose the results of the services and other relevant information to A (engaging entity).

With regard to records requests, PEEC concluded that members should return client-provided records to

the party who provided them. For the member’s work product, the member should provide that

information to the beneficiary of the engagement (like the “Confidential Client Information Rule”” [ET sec.

1.700.001]) unless the member made other arrangements with the client. Using the previous examples,

note the following:

A member hired to perform personal tax services for company executives (beneficiaries) should provide the work product (tax returns) to the executives, not the company that engaged the member.

A member hired to value Company B’s assets for Company A’s possible acquisition should provide the work product to Company A (beneficiary) unless the parties came to some other agreement.

The interpretation is effective December 31, 2017.

Leases

In 2018, PEEC adopted a new interpretation that addresses the effect on independence when a covered

member enters into a leasing agreement with an attest client. The interpretation states that under these

circumstances, self-interest, familiarity, and undue influence threats to independence may exist. The

interpretation addresses the effect on independence when a covered member, an individual in the

position to influence the attest engagement or the firm, enters into a lease or renegotiates terms of an

existing lease with an attest client during the period of the professional engagement. Under these

circumstances, the threats to independence are not at an acceptable level and could not be reduced to

an acceptable level by the application of safeguards.


Independence would be impaired unless both of the following safeguards are in place at the time of

entering into, or renegotiating, the lease:

The lease is on market terms and established at arm’s length.

The lease is not material to any of the parties to the lease. When evaluating materiality, all leases

between the covered member and the attest client should be considered in the aggregate.

With respect to existing leases, the interpretation provides a list of circumstances that the covered

member should use to evaluate the significance of any threats to determine whether the threats are at an

acceptable level. If the covered member determines the threats are not at an acceptable level, the

covered member should apply safeguards to eliminate or reduce the threats to an acceptable level. If no

safeguards are available to eliminate or reduce threats to an acceptable level, independence would be

impaired.

Finally, the interpretation notes failure to pay lease amounts in accordance with the lease terms or

provisions by the due date or within any grace period during the period of the professional engagement

also pose threats to independence. These threats to independence would not be at an acceptable level

and could not be reduced to an acceptable level by the application of safeguards, meaning independence

would be impaired.

Originally, the leases interpretation was scheduled to be effective for fiscal years beginning after

December 15, 2019, with early implementation allowed. Due to the coronavirus pandemic, PEEC has

delayed the effective date one year, for fiscal years beginning after December 15, 2020. Early

implementation is still allowed.

Hosting services

In January 2017, PEEC adopted a new interpretation that provides independence guidance when firms

provide hosting services to their attest clients. The interpretation states that hosting services are

nonattest services that involve a member accepting responsibility for any of the following:

Acting as the sole host of a financial or nonfinancial information system of an attest client Taking custody of or storing an attest client’s data or records whereby that data or records are

available to the attest client only from the member, such that the attest client’s data or records are otherwise incomplete

Providing electronic security or back-up services for an attest client’s data or records

Because a member would be maintaining the attest client’s internal control over its data or records when

providing these services, independence would be impaired.

The interpretation is effective September 1, 2018.

Information system services

In June 2019, PEEC adopted a new interpretation that addresses members in public practice providing

nonattest services related to an attest client’s information system. The interpretation seeks to minimize

threats to independence stemming from self-review and management participation.


The first section of the interpretation addresses issues related to the general financial information

system. The interpretation notes that when a member designs or develops an attest client’s financial

information system, independence is considered impaired. When a member performs design,

development, or implementation services that are not related to an attest client’s financial information

system, threats can be brought to an acceptable level by following the requirements of “Nonattest

Services” subtopic of the Independence rule.

To determine whether a nonattest service is related to a financial information system, members are

encouraged to consider all relevant factors, such as whether the service will affect the following:

System controls or system output that will be subject to attest procedures. A system that generates data that are used as input to the financial statements, including data or

information that is either reflected in or used in determining amounts and disclosures included in the financial statements.

A data-gathering system, such as an analytical or reporting tool, that is used in management’s decision-making about matters that could significantly affect financial reporting.

A system that is part of the attest client’s internal controls over financial reporting, including information systems used to effect internal controls over financial reporting (for example, a system used to ensure that information produced for the financial statements is accurate). However, information systems used only in connection with controlling the efficiency and effectiveness of operations are considered unrelated to the financial statements and accounting records.

The later sections of the interpretation address various activities related to commercial off-the-shelf (COTS)

financial information system software solutions. For each type of activity (e.g., implementation, installation,

configuration, etc.), the interpretation notes whether threats deriving from those services may be reduced

to an acceptable level either through the application of safeguards or meeting all requirements of the

“Nonattest Services” subtopic of the Independence Rule. There are a few services for which the

interpretation states that threats cannot be reduced to an acceptable level, including the following:

Customization services are provided when a member modifies or enhances the features and functions of software in ways that go beyond options provided by the third-party vendor when configuring the COTS software. — Threats deriving from customization services may not be reduced to an acceptable level through the applications of safeguards. Independence would be impaired.

Interface services are provided when a member connects two or more systems by designing and developing software code that passes data from one system to another. — Threats deriving from interface services cannot be reduced to an acceptable level through the application of safeguards. Independence would be impaired.

Maintenance, support and monitoring services are provided after a financial or nonfinancial system or network is implemented. — If post-implementation services involve an attest client outsourcing an ongoing function, process or activity to a member that results in the member assuming management responsibility, threats would not be reduced to an acceptable level by the application of safeguards. Independence would be impaired. The interpretation goes on to note that independence will not be impaired provided all requirements of the “Nonattest Services” subtopic of the Independence Rule are met and the maintenance, support or monitoring services are individually separate, distinct and not ongoing.

Examples of services that would not impair independence may include the following:

– Analyzing a network and providing observations or recommendations – Applying virus protection solutions or updates that the member did not design or develop


– Applying certain updates and patches that the member did not design or develop – Providing advice, training, or instruction on a software solution – Assessing the design or operating effectiveness of an attest client’s security over information

technology systems – Assessing the attest client’s information technology security policies or practices

Originally, the information services interpretation was scheduled to be effective January 1, 2021, with

early implementation allowed. Due to the coronavirus pandemic, PEEC has delayed the effective date one

year, to January 1, 2022. Early implementation is still allowed.

Disclosing client information in connection with a quality review

This interpretation, issued in 2019, provides guidance to members obtaining or performing a quality

review of a tax practice and the disclosure of client information. Specifically, the interpretation notes that

using a third party to perform a review of the member’s tax practice may create threats to compliance

with the Confidential Client Information Rule. In these circumstances, members are encouraged to

comply with Treasury Regulation 301.7216-2(p) and applicable state or local regulations related to

disclosure of any federal, state, or local tax return information obtained. The interpretation also notes that

members should not use any information obtained from this type of review to their advantage, nor should

they disclose any confidential client information.

State and local government client affiliates

In June 2019, PEEC issued this interpretation to clarify the requirements for considering independence

with regard to state and local government clients. The interpretation

clarifies examples of state and local government entities; changes the language in the standard to refer to financial statement attest client rather than state or

local government entity; clarifies the definitions of investor and investment; and clarifies the circumstances or relationships that create threats to independence.

Originally, the revised state and local government interpretation was scheduled to be effective for years

beginning after December 15, 2020. Due to the coronavirus pandemic, PEEC has delayed the effective

date one year, to December 15, 2021.

New FAQs

In March 2018, staff added a nonauthoritative question and answer to the document, “Frequently Asked

Questions: General Ethics Questions,” under the topic “Long Association of Senior Personnel of the

Engagement Team.” The answers to frequently asked questions (FAQs) are based on guidance that

PEEC staff provided in response to members’ inquiries. The FAQs are not rules, regulations, or

statements of PEEC and, therefore, are not authoritative guidance.

The FAQ answered two questions in this area. The first question inquired as to whether the familiarity

threat to independence increases when senior personnel of the engagement team have been on an attest

engagement team for a long period of team. In this context, senior personnel are defined as partners,

partner equivalents, and any other individuals on the attest engagement team who have responsibility for


decision making on significant auditing, accounting and reporting matters that affect the results of the

attest engagement and who maintain regular contact with attest client management or those charged

with governance.

The staff’s answer was that the familiarity threat to independence may increase when senior personnel

serve on an attest engagement for a long period of time. They noted that senior personnel will need to

determine the significance of these threats and evaluate the threat to independence. They suggested

considering the following factors:

a. Factors relating to senior personnel who are on the attest engagement team may include these: i. The overall length of the individual’s relationship with the attest client, including whether such

relationship existed while the individual was at a prior firm ii. How long the individual has been on the attest engagement team and the nature of the roles

performed iii. The extent to which the work of the individual is directed, reviewed, and supervised by other

senior personnel iv. The extent to which, due to the individual’s seniority, the individual has the ability to influence

the outcome of the attest engagement, for example, by making key decisions or directing the work of others on the attest engagement team

v. The closeness of the individual’s personal relationship with the attest client’s senior management or those charged with governance

vi. The nature, frequency, and extent of the interaction between the individual and the attest client’s senior management or those charged with governance

b. Factors relating to the attest client may include the following: i. The attest client’s accounting and financial reporting issues and whether they have changed ii. Whether there have been any recent changes in senior management or those charged with

governance iii. Whether there have been any structural changes in the attest client’s organization that affect the

nature, frequency, and extent of interactions the member may have with senior management or those charged with governance

The combination of two or more factors may increase or reduce the significance of these threats. For

example, familiarity threats created over time by an increasingly close relationship between the senior

personnel on the attest engagement team and an individual in the attest client’s senior management

would be reduced by the departure of that individual in the attest client’s senior management and the

start of a new relationship. This change in senior management at the attest client could reduce or

eliminate the familiarity threat.

The second question addressed by the staff in the FAQ was whether a firm can still perform the attest

engagement if it has been determined that there is a significant familiarity threat to the “Independence

Rule” because one or more senior personnel has served on the attest engagement team for a long period

of time.


The staff answered that the firm may still be able to perform the engagement if safeguards can be

applied to eliminate the threat or reduce it to an acceptable level. The staff provided the following

examples of safeguards, noting that the list in not all inclusive:

a. Changing the role of the senior personnel on the attest engagement team or the nature and extent of the tasks the senior personnel performs

b. Having a professional accountant who was not included in the attest engagement team review the work of the senior personnel

c. Performing an independent internal or an external quality review of the attest engagement d. Rotating the senior personnel off the attest engagement team for an appropriate period based on the

significance of the threats

If there are no safeguards that could be applied that would eliminate the threat or reduce it to an

acceptable level, then independence will be impaired. When the member applies safeguards to eliminate

or reduce significant threats to an acceptable level, the member should document the identified threats

and safeguards applied.

Proposed interpretation – Records requests

At its May 2020 meeting, PEEC approved to expose for comment revisions to the “Records Requests”

interpretation (ET sec. 1.400.200) under the “Acts Discreditable Rule” (ET sec. 1.400.001). PEEC believes

the proposed revisions will help members better understand their ethical responsibilities with respect to

requests for records.

The existing interpretation requires that client-provided records in the member’s custody or control be

returned to the client upon request. The interpretation permits withholding such records if the client does

not pay for the time and expense the member charges to retrieve and copy client-provided records.

Client-provided records are accounting or other records, including hard copy and electronic reproductions

of such records, belonging to the client that were provided to the member by, or on behalf of, the client.

PEEC continues to agree that withholding for payment of these fees should be permitted. The proposed

revision in the exposure draft clarifies that PEEC’s intent is to permit it only with respect to copies of

client-provided records that a member previously provided to the client.

Withholding is not permitted when responding to a client’s initial request for these records to be returned.

The current interpretation requires members to return or to provide member-prepared records and work

products in certain situations. Questions have arisen about whether members would be in compliance

with the interpretation if they made this information available to the client (for example, picked up or via

portal). PEEC believes making this information (as well as the member’s copy of client-provided records

previously provided to the client) available to the client would satisfy the member’s ethical responsibility

under this interpretation, even though this could result in placing some responsibility on the client.

The current interpretation also requires the provision of a member’s work products only to a beneficiary .

However, PEEC believes it inadvertently overlooked extending this requirement to member-prepared

records and, as such, proposed adding member-prepared records to the previous paragraph to correct

this oversight.


Regarding the effective date, PEEC believes that some members may need time to implement the

proposed revisions. PEEC recommends that the interpretation be effective 60 days after publication in

the Journal of Accountancy.

Knowledge check

2. A member is considering performing a nonattest service for a client for whom he or she performs a review engagement. This is an area for which the code lacks specific guidance, so the member plans to apply the conceptual framework to determine how to proceed. Which is not part of the conceptual framework?

a. Issue a disclaimer of opinion on the attestation service. b. Identify the threats to independence posed by providing the nonattest service. c. Evaluate the significance of the threats identified. d. Apply safeguards to eliminate the threats to independence or reduce them to an acceptable

level.

3. Which would not impair independence?

a. A member provides electronic back-up services for an attest client’s data. b. A member takes custody of an attest client’s data or records such that the data or records are

available to the attest client only from the member. c. A member has access to an attest client’s nonfinancial information system. d. A member acts as the sole host of a nonfinancial information system of an attest client.

4. Which service related to an attest client’s financial information system is most likely to impair independence?

a. A member assesses an attest client’s information technology security policies and practices. b. A member analyzes a network and provides recommendations. c. A member designs and implements improvements to the client’s financial information system

that exceed options provided by the third-party vendor. d. A member helps an attest client implement the choices and decisions the client has made for

the financial information system based on options provided by the third-party vendor.


Current issues from ARSC This section covers issues identified by ARSC that providers of compilation, review, and preparation

engagements may currently face. The subjects covered in this section represent some of the more

frequent questions that the AICPA’s Accounting & Auditing Technical Hotline receive regarding

preparation, compilation and review engagements. These issues have been addressed by the current

standards but are given further consideration in the following sections. New standards and exposure

drafts issued by ARSC are beyond the scope of this course.

Compiling financial statements that omit substantially all disclosures

A common method that clients use to control the costs of compilation engagements is to request that

the financial statements be compiled without adding all the necessary footnote disclosures. Given the

large volume of disclosures required for most financial reporting frameworks, this can significantly

reduce the time and effort required to perform a compilation engagement on the financial statements.

Accountants are allowed to issue compilation reports on financial statements that omit substantially all

disclosures if the omission is not, to the practitioner’s knowledge, intended to mislead the user of the

financial statements.

When reporting on financial statements that omit substantially all disclosures, the compilation report

should be modified to include a statement that the accountant did not audit or review the financial

statements. Many practitioners have questioned whether they can issue a compilation report on financial

statements that omit substantially all disclosures when they have previously issued a review or audit

report on such financial statements with the inclusion of related notes. The concern is primarily with the

statement in the accountant’s compilation report that the accountant “did not audit or review the financial

statements.”

The answer is that the accountant can issue a compilation report on the financial statements that omit

substantially all disclosures when the accountant has issued a review or audit report on such financial

statements with related notes included. The reason is that the financial statements are substantially

different, and the accountant would look at the financial statements as separate sets that, although

obviously related, are not the same. Therefore, the statement that the accountant did not “audit or review

the financial statements” that omit substantially all disclosures is an accurate statement.

Although not required, to be transparent, the accountant may consider adding an other-matter paragraph

to the accountant’s compilation report, which states that corresponding full disclosure financial

statements were audited or reviewed, including a reference to the auditor’s or accountant’s review report

on those full-disclosure financial statements.


Review of interim financial information

Practitioners are often confused about when to apply the requirements of AR-C section 90, Review of

Financial Statements, versus the similar, but different, requirements of AU-C section 930, Interim Financial

Information, to a review of interim financial information.1

A good rule of thumb is to default first to performing the engagement in accordance with AR-C section

90 because that is usually the standard that applies to reviews of financial statements. AU-C section 930

is intended to address those instances in which the accountant has a level of knowledge of the entity that

would not usually be considered in a review of financial statements. That increased level of knowledge is

because the accountant is the auditor of the entity’s annual financial statements and, therefore, has

obtained knowledge through testing of internal control, risk assessment, and other procedures that are

not normally considered part of a review of financial statements. Therefore, the issue about which set of

literature applies boils down to a simple question — has the accountant obtained (or will the accountant

obtain) an audit level of knowledge with respect to the entity’s financial statements?

So, when do accountants apply the guidance in AR-C section 90? The first question accountants should

consider is whether they or a predecessor audited the entity’s latest financial statements for the annual

period that was completed. If those financial statements were not audited, then there is no audit base of

knowledge at the commencement of the engagement. Therefore, the engagement would be performed in

accordance with AR-C section 90.

If the entity’s latest annual financial statements were audited, then the second question accountants

would consider looks to the future — at the current-year financial statements for the period that has yet

to be completed. If any of the following are true, the accountant should perform the engagement in

accordance with AR-C section 90:

The accountant has not been engaged to audit the entity’s current-year financial statements The accountant audited the entity’s latest annual financial statements and, when the current-year

financial statements are expected to be audited but the engagement of another accountant to audit the current-year financial statements is not effective prior to the beginning of the review

No audit is planned for the current-year financial statements

If the accountant (or predecessor) audited the latest financial statements, and at least one of the three

statements about the future financial statements is true, the accountant must also consider whether the

entity prepares its interim financial information in accordance with the same financial reporting

framework as the one used to prepare the annual financial statements. If the frameworks are not the

same (for example, the entity prepares its annual financial statements in accordance with GAAP but

prepares its interim financial information in accordance with a modified cash basis of accounting), then

the “audit base of knowledge” has not been obtained on the interim financial information, and the

accountant would perform the review in accordance with AR-C section 90.

1 AR-C and AU-C sections are found in AICPA Professional Standards.


Preparation engagements

ARSC has identified two current practice issues related to preparation engagements. The first involves

determining when an accountant has been engaged to prepare financial statements, and the second

involves preparation of financial statements for review or audit by other accountants.

Preparation engagement when in public practice and providing certain consulting services

Paragraph .01 of AR-C section 70, Preparation of Financial Statements, states that the section applies

“when an accountant in public practice is engaged to prepare financial statements or prospective

financial statements.” AR-C section 70 does not apply to CPAs who perform functions, including the

preparation of financial statements, in their role as an employee. In those instances, the CPA is not in the

practice of public accounting. Some accountants in public practice have expressed a level of confusion

regarding when they have been “engaged” to prepare financial statements.

Although the term engaged in not defined in SSARSs or the AICPA’s Code of Professional Conduct, it

refers to the action that commences the engagement to prepare financial statements. The accountant is

“engaged” when the accountant and the entity mutually understand that the accountant has been hired to

prepare the entity’s financial statements. Such an engagement may be part of a broader service to

provide accounting or bookkeeping services.

Whether an engagement is a bookkeeping or accounting service or is an engagement to prepare financial

statements remains an area of confusion for practitioners. However, the determination should actually

be fairly easy. Although a level of professional judgment is necessary, the accountant has only been

engaged to prepare financial statements if the client has “hired” the accountant to do so. If the

accountant has been engaged to merely assist in preparing the financial statements, or if the accountant

prepares financial statements as a byproduct of certain other specified engagements (for example,

prepare tax returns or a business valuation), the accountant was not engaged to prepare financial

statements.

However, when engaged to perform consulting services, such as serving as an outsourced controller,

treasurer, or chief financial officer, and a part of those responsibilities includes the preparation of periodic

historical financial statements or prospective financial information, AR-C section 70 applies to the

preparation of the financial statements or financial information. In these circumstances, the accountant

is required to agree upon the terms of the engagement to prepare financial statements with

management or those charged with governance and document the agreed-upon terms of the

engagement in an engagement letter or other suitable form of written agreement between the parties.

When the accountant has been engaged to perform controllership services that include the preparation

of financial statement, an engagement letter is not required for other aspects of the controllership

services, although it is advised that the written agreement with the client include all aspects of the

engagement. If the controllership service does not include the preparation of financial statements, the

accountant may want to obtain an engagement letter that clearly states that the engagement does not

include the preparation of financial statements.


In addition, AR-C section 70 requires the accountant to ensure that a statement is included on each page

of the financial statements that the accountant prepared, indicating at a minimum that “no assurance” is

provided on the financial statements. The accountant may want to expand on the statement to indicate

the accountant’s role. For example, the accountant might include a statement such as “These financial

statements were prepared by Jane Doe, CPA, in her role as Treasurer. No assurance is provided on these

financial statements.”

Preparation of financial statements prior to review or audit by another accountant

An entity may engage an accountant to prepare financial statements for review or audit by another

accountant. Often, these engagements are undertaken because the accountant engaged to review or

audit the financial statements is concerned about potential independence impairments. If an accountant

is engaged to prepare financial statements in such circumstances, AR-C section 70 applies.

Frequently, the accountant engaged to perform the review or audit will expect “issuance-ready” financial

statements and therefore will balk at the inclusion of the required statement on each page of the financial

statements stating that no assurance is provided. In such instances, the accountant engaged to prepare

the financial statements may issue a disclaimer such as the following:

The accompanying financial statements of XYZ Company, as of and for the year ended December

31, 20X2, were not subjected to an audit, review, or compilation engagement by me (us) and

accordingly, I (we) do not express an opinion, a conclusion, nor provide any assurance on them.

[Signature of accounting firm or accountant, as appropriate]

[Accountant’s city and state]

[Date]

Knowledge check

5. When accountants are engaged to compile financial statements that they have previously reviewed or audited:

a. Management cannot elect to omit substantially all disclosures. b. The accountant’s compilation report must be modified to reference the reviewed or audited

set of financial statements. c. No changes are required to the accountant’s compilation report. d. The accountant’s report must include a statement that the accountant is not independent.


QC section 10, A Firm’s System of Quality Control Quality control systems that are properly designed and implemented improve a firm’s accounting and

auditing services by reducing the risks of error and noncompliance with professional standards, reducing

the risk of litigation, and enhancing the firm’s professional reputation. Quality control systems also

increase the efficiency of delivering accounting and auditing services by standardizing operations and

documentation, thereby increasing productivity. And, as administrative and operating procedures are

clarified and improved, the firm maintains its competitive edge and a focused product strategy.

QC section 10

QC section 10, A Firm’s System of Quality Control (AICPA Professional Standards), requires each firm to

establish a system of quality control designed to provide the firm with reasonable assurance that the firm

and its personnel comply with professional standards and applicable regulatory and legal requirements,

and that the firm or practitioners-in-charge issue reports that are appropriate in the circumstances. A

system of quality control consists of policies designed to achieve these objectives and the procedures

necessary to implement and monitor compliance with those policies.

Degree of responsibility imposed

The section identifies two categories of professional requirements to describe the degree of

responsibility imposed on firms. Unconditional requirements are those with which the firms are required

to comply in all cases in which such a requirement is relevant. QC section 10 uses the word “must” to

indicate an unconditional requirement.

Presumptively mandatory requirements are also requirements with which firms are required to comply,

but in rare circumstances the firm may depart from a presumptively mandatory requirement as long as

the firm documents his or her justification for the departure and notes how the alternative procedures

performed were sufficient to achieve the same objectives. QC section 10 uses the word “should” to

indicate a presumptively mandatory requirement.

Documentation and communication

Each firm should document its quality control policies and procedures. The extent of documentation may

vary according to the size, structure, and nature of the firm.

Each firm should also communicate its quality control policies and procedures to its personnel. Effective

communication will describe the policies and procedures and their associated objectives and convey

each firm member’s responsibility for the system of quality control. It is preferred, but not required, that

this communication be in writing.


Elements of a system of quality control

The firm’s system of quality control must include policies and procedures addressing each of the

following elements:

Leadership responsibilities for quality within the firm (the “tone at the top”)—The firm should build a culture centered around quality in performing engagements. That culture should be supported by policies and procedures, as well as clear and consistent messages from the firm’s management, emphasizing quality control.

Relevant ethical requirements—The firm should establish policies and procedures designed to provide it with reasonable assurance that the firm and its personnel comply with relevant ethical requirements.

Acceptance and continuance of client relationships and specific engagements—The firm should establish policies and procedures for acceptance and continuation to provide reasonable assurance that it will undertake or continue relationships or engagements where the firm has considered the integrity of the client and the risks associated with providing professional services, its competence to adequately perform the engagement, and its compliance with legal and ethical requirements.

Human resources—The firm should establish policies and procedures designed to provide it with reasonable assurance that it has sufficient personnel with the capabilities and competence to commit to ethical principles necessary to perform its engagements in accordance with professional standards and regulatory and legal requirements and to enable the firm to issue reports that are appropriate in the circumstances. The firm’s policies and procedures should provide that personnel selected for advancement have the qualifications necessary for fulfillment of the responsibilities that they will be called on to assume.

Engagement performance—The firm should establish policies and procedures designed to provide it with reasonable assurance that engagements are performed in accordance with professional standards and regulatory and legal requirements, and that the firm or the practitioner-in-charge issues reports that are appropriate in the circumstances. Such policies and procedures should include the following: – Matters relevant to promoting consistency in the quality of engagement performance – Supervision responsibilities – Review responsibilities

Monitoring—The firm should establish a monitoring process designed to provide it with reasonable assurance that the policies and procedures relating to the system of quality control are relevant, adequate, and operating effectively. This process should – include an ongoing consideration and evaluation of the firm’s system of quality control, including

inspection or a periodic review of engagement documentation, reports, and clients’ financial statements for a selection of completed engagements;

– require responsibility for the monitoring process to be assigned to a partner or partners or other persons with sufficient and appropriate experience and authority in the firm to assume that responsibility; and

– assign the performance of monitoring the firm’s system of quality control to qualified individuals.


Engagement quality control review

QC section 10 defines the engagement quality control review and states that firms should establish

criteria in which all engagements covered by this section should be evaluated to determine whether an

engagement quality control review should be performed. The structure and nature of the firm’s practice

are important considerations in establishing such criteria. Engagement quality control review is a process

designed to provide an objective evaluation before the report is released by a partner, other person in the

firm, suitably qualified external person, or a team made up of such individuals, none of whom are part of

the engagement team, with sufficient and appropriate experience and authority to objectively evaluate

the significant judgments that the engagement team made and the conclusions it reached in formulating

the report. This review is often referred to as a concurring review. The engagement quality control review

should include

discussion of significant findings and issues with the engagement partner; review of the financial statements or other subject matter information and the proposed report; review of selected engagement documentation relating to significant judgments that the engagement

team made and the related conclusions it reached; and evaluation of the conclusions reached in formulating the report and consideration of whether the

proposed report is appropriate.

Knowledge check

6. Which is a correct statement about quality control?

a. Acceptance and continuance of client relationships and specific engagements are elements of quality control.

b. Leadership responsibilities for quality within the firm is not an element of quality control. c. A quality control system is not required for accounting firms. d. Monitoring is not an element of quality control.

7. Policies and procedures that include an ongoing consideration and evaluation of the firm’s system of quality control are an example of which element?

a. Leadership responsibilities. b. Monitoring. c. The AICPA Code of Professional Conduct. d. Segregation of duties.


Summary We have just discussed the following:

AICPA resources for review, compilation, and engagements to prepare financial statements Resources for financial reporting frameworks The ethics codification Changes to independence interpretations Compiling financial statements that omit substantially all disclosures Review of interim financial statements Preparation engagements QC section 10


Practice question — Quality control 1. The firm’s system of quality control must address several elements. For each element described in

the following information, discuss some of the specific policies and procedures a firm can include to achieve the objectives of that element.

a. A firm’s system of quality control should be designed to provide the firm with reasonable assurance that client relationships and specific engagements are accepted or continued only where the firm has considered the client’s integrity and associated risk, is competent to perform the engagement, and can comply with legal and ethical requirements. Discuss some of the policies and procedures a firm may establish for the acceptance and continuance of client relationships.

b. A firm’s system of quality control should be designed to provide it with reasonable assurance that it has sufficient personnel with the capabilities and competence to commit to ethical principles necessary to perform its engagements in accordance with professional standards and regulatory and legal requirements. Discuss some of the specific policies and procedures a firm may establish for the assignment of engagement teams.

c. A firm’s system of quality control should be designed to provide it with reasonable assurance that engagements are performed in accordance with professional standards and regulatory and legal requirements, and that the firm or the practitioner-in-charge issues reports that are appropriate in the circumstances. Discuss some of the specific policies and procedures a firm may establish for supervision and review.


Case preparing financial statements

The accounting firm of Regal and Associates is a small, local CPA firm. The partnership has 25 professionals on its payroll. The firm primarily provides compilation, review, and tax services. It currently has no audit clients.

Regal and Associates has several “write-up” clients for which it currently provides compilation services. Regal prepares the financial statements for about 90% of those compilation engagements. Regal discloses a lack of independence on those compilation reports. Regal has a few clients for whom they perform compilation engagements in which the client actually prepares the financial statements for the compilation engagement.

George King, a senior partner with Regal, is in charge of most of the write-up work. George recently completed a continuing education course on engagements to prepare financial statements, and he believes that there may be some opportunity for Regal to offer such services rather than compilation engagements to some of their clients. Before he engages the other partners in a conversation about engagements to prepare financial statements, George wants to consider the kinds of client needs that may be best met by an engagement to prepare financial statements rather than a compilation engagement.

Required: Review each of the following independent situations and consider the implications of accepting these engagements.

1. A client engages Regal and Association to serve as an outsourced chief financial officer. In this capacity, George King will act as CFO and prepare the financial statements for the organization. These financial statements are provided to the client’s primary lender. Do SSARSs apply to this engagement? How should Regal and Associates document the scope of the engagement?

2. A client needs Regal to prepare its year-end financial statements for review by another accountant. Do SSARSs apply to this engagement?


Solutions

Current Practice Issues


1.

a. Incorrect. The standards issued by FASB on the recommendation of the Private Company Council are part of an authoritative framework for private companies.

b. Incorrect. The income tax basis of accounting is a special purpose framework with authoritative guidance provided in the SSARSs.

c. Correct. The AICPA’s Financial Reporting Framework for SMEs™ is an option for financial reporting for private companies, but it has not been approved by FASB.

d. Incorrect. IFRS are promulgated by the International Accounting Standards Board, which is recognized as an authoritative standard-setter.

2.

a. Correct. The conceptual framework provides opportunities for a member to reach a conclusion when the code lacks guidance. Issuing a disclaimer due to a lack of independence on the attest engagement is not necessary until the member determines whether the threat(s) can be adequately mitigated or eliminated.

b. Incorrect. Identifying the threats to independence is the first step in applying the conceptual framework.

c. Incorrect. Evaluating the significance of identified threats is the second step in applying the conceptual framework.

d. Incorrect. Applying safeguards to eliminate the threats to independence or reduce them to an acceptable level is the third step in applying the conceptual framework.


3.

a. Incorrect. A member providing electronic backup services for an attest client’s data is maintaining the attest client’s internal control over its data or records. This service impairs independence.

b. Incorrect. A member taking custody of an attest client’s data or records such that those data and records are available to the client only through the member is maintaining the attest client’s internal control over data and records. This service impairs independence.

c. Correct. This situation does not threaten independence, because the member only has access to information, but is not responsible for maintaining internal control over the data and records.

d. Incorrect. A member acting as the sole host of a nonfinancial or financial information system of an attest client is maintaining the attest client’s internal control over its data or records. This service impairs independence.

4.

a. Incorrect. Providing an assessment of a financial information system does not impair independence.

b. Incorrect. Providing an analysis and recommendations to management, that management may or may not implement, does not impair independence.

c. Correct. Designing and implementing improvements beyond options provided by the vendor creates threats to independence.

d. Incorrect. Assisting the client in implementing his or her choices among the options provided by the vendor does not impair independence.

5.

a. Incorrect. Management can elect to omit substantially all disclosures in a compilation engagement as long as the omission is not intended to mislead users of the financial statements.

b. Incorrect. The accountant is allowed, but not required, to add an other-matter paragraph referencing the audited or reviewed financial statements.

c. Correct. The financial statements being compiled are a different set of statements than those that were audited or reviewed. The statement that the accountant did not audit or review the compiled financial statements is accurate.

d. Incorrect. Whether the accountant is independent is not affected by the fact that he or she previously audited or reviewed the financial statements.


6.

a. Correct. The firm should establish policies and procedures for acceptance and continuation to provide reasonable assurance that it will undertake or continue relationships or engagements in which the firm has considered the integrity of the client and the risks associated with providing professional services, its competence to adequately perform the engagement, and its compliance with legal and ethical requirements.

b. Incorrect. Leadership responsibilities for quality within the firm is an element of quality control.

c. Incorrect. Quality control is required for public accounting firms.

d. Incorrect. Monitoring is an element of quality control.

7.

a. Incorrect. Leadership responsibilities are part of the “tone at the top” element.

b. Correct. Firms are responsible to assign responsibility for monitoring to a person of appropriate authority.

c. Incorrect. The AICPA Code of Professional Conduct does not set forth quality control policies and procedures.

d. Incorrect. Segregation of duties is a type of internal control, not an element of quality control.

Practice question solutions: Quality control

a. To minimize the risk of misunderstanding, policies and procedures should provide for obtaining an understanding with the client regarding the nature, scope, and extent of services to be performed.

When issues have been identified, and the firm has decided to accept or continue the client relationship or specific engagement, it should document how those issues were resolved.

Regarding the integrity of the client, factors to consider include

the identity and business reputation of the client’s principal owners, key management, related parties, and those charged with governance;

the nature of the client’s operations, including its business practices; and

information regarding the attitude of the client’s principal owners, key management, and those charged with governance toward such matters as aggressive interpretation of accounting standards and internal control over financial reporting.


In determining whether the firm has the capabilities, competence, and resources to undertake a new engagement, factors to consider include the following:

Firm personnel have knowledge of relevant industries or subject matters.

Firm personnel have experience with relevant regulatory or reporting requirements, or the ability to effectively gain the necessary skills and knowledge.

The firm has sufficient personnel with the necessary capabilities and competence.

Specialists are available, if needed.

Individuals meeting the criteria and eligibility requirements to perform an engagement quality control review are available, where applicable.

The firm is able to complete the engagement within the reporting deadline.

b. The firm’s policies and procedures should include the following:

Each engagement should be assigned a practitioner-in-charge.

The identity and role of the practitioner-in-charge should be communicated to client management and those charged with governance.

The practitioner-in-charge should have the appropriate capabilities, competence, authority, and time to perform the role.

The responsibilities of the practitioner-in-charge should be clearly defined and communicated to that individual.

Systems should be in place to monitor the workload and availability of the practitioner-in-charge in order to enable that person to have sufficient time to adequately discharge his or her responsibilities.

Staff with the necessary capabilities, competence, and time to perform engagements in accordance with professional standards and regulatory and legal requirements should be assigned to engagement.

In determining the nature and extent of supervision required for a particular engagement, the firm’s quality control system should provide for consideration of capabilities and competence based on

an understanding of, and practical experience with, engagements of a similar nature and complexity through appropriate training and participation;

an understanding of the professional standards as well as regulatory and legal requirements;

appropriate technical knowledge, including knowledge of relevant information technology;

knowledge of relevant industries in which the client operates;

ability to apply professional judgment; and

an understanding of the firm’s quality control policies and procedures.


c. Policies and procedures for engagement supervision might address the following:

Tracking the progress of the engagement

Considering the capabilities and competence of individual members of the engagement team whether they have sufficient time to carry out their work, whether they understand their instructions, and whether the work is being carried out in accordance with the planned approach to the engagement

Addressing significant issues arising during the engagement, considering their significance, and appropriately modifying the planned approach

Identifying matters for consultation or consideration by more experienced engagement team members during the engagement

Policies and procedures related to the review of work performed by less experienced team members might address the following:

The work has been performed in accordance with professional standards and regulatory and legal requirements.

Significant matters have been raised for further consideration.

Appropriate consultations have taken place and the resulting conclusions have been documented and implemented.

There is a need to revise the nature, timing, and extent of work performed.

The work performed supports the conclusions reached and is appropriately documented.

The evidence obtained is sufficient and appropriate to support the report.

The objectives of the engagement procedures have been achieved.

Case solutions: Preparing financial statements

1. In this circumstance, Regal and Associates has been engaged to perform consulting services with one part of those responsibilities including the preparation of financial statements.

SSARSs apply to the preparation of the financial statements but not to the performance of other consulting services.

For the preparation portion of the service, Regal and Associates must agree on the terms of the engagement with management and document that agreement in an engagement letter.

The ARSC and the authors recommend that the entirety of the service be documented in the engagement letter, with specific emphasis on the preparation service.

Although not required, Regal and Associates may want to consider altering the “no assurance” statement on each page of the financial statements. In this case, the statement may include “these financial statements were prepared by Regal and Associates in their role as Chief Financial Officer. No assurance is provided on these financial statements.”


2. Yes, Regal and Associates has been engaged to prepare financial statements, so SSARSs apply. Note that the reviewing accountants may not wish to have the “no assurance” statement on each page of the financial statements. Regal and Associates may opt then to issue a disclaimer on the prepared financial statements rather than placing the “no assurance” statement on each page.


Current Accounting and Reporting Issues

Learning objectives

Identify some of the more common peer review findings in compilation and review engagements.

Recall basic elements of some recently issued accounting standards.

Recognize the financial reporting framework for small-to-medium size entities (FRF for SMEs™) as an alternative to accounting principles generally accepted in the United States of America (GAAP) and special purpose frameworks (SPFs).


Common deficiencies in peer reviews In order to be admitted to or retain their membership in the AICPA, members who are engaged in the

practice of public accounting in the United States or its territories are required to be practicing as

partners or employees of firms enrolled in an approved practice-monitoring program. If practicing in

firms that are not eligible to enroll, members must enroll in an approved practice-monitoring program if

the services performed by such a firm or individual are within the scope of the AICPA’s practice-

monitoring standards, and the firm or individual issues reports purporting to be in accordance with AICPA

professional standards.

Firms have peer reviews because of the public interest in the quality of the accounting, auditing, and

attestation services provided by public accounting firms. In addition, firms indicate that peer review

contributes to the quality and effectiveness of their practices. Furthermore, most state boards of

accountancy require their licensees to undergo peer review, or compliance assurance, to practice in their

state. Other regulators require peer review in order to perform engagements and issue reports under their

standards.

Peer review process

Firms are required to perform engagements in accordance with professional standards, and accordingly,

the standards are the basis for peer reviews. Based on their reviews of individual engagements or a firm’s

system of quality control, peer reviewers document issues identified in peer review engagements as a

matter for further consideration (MFC). These MFCs arise from evaluations of whether an engagement

submitted for review was performed or reported on in conformity with applicable professional standards,

or both. The evaluation includes reviewing the financial statements or information as well as the related

accountant’s reports, and assessing the adequacy of procedures performed, including related

documents.

Depending on the resolution of a matter and the process of aggregating and evaluating peer review

results, a matter may develop into a finding. Findings will also be evaluated. After considering their nature

and relative importance, including whether they are material to the understanding of the report or

financial statements, or whether they represent the omission of a critical procedure including

documentation, they may or may not be elevated to a deficiency. A deficiency may or may not be further

elevated to a significant deficiency.

The AICPA Peer Review Program reports on several thousand peer reviews annually. A significant portion

of those peer reviews pertain to compilation and review engagements. The following section provides a

summary of deficiencies over the last several years by area.

Note that for purposes of complying with AICPA membership requirements, a firm that only performs

engagements to prepare financial statements under AR-C section 70, Preparation of Financial


Statements,1 is not required to enroll in a peer review program. For firms already enrolled in the AICPA

Peer Review Program, engagements to prepare financial statements would fall within the scope of peer

review. Independent of AICPA requirements, note that some state boards of accountancy require firms

that only perform those engagements to enroll in peer review as a licensing requirement. Practitioners

should check with the state board(s) where they perform such engagements to determine whether there

is a need to enroll in peer review.

Common peer review findings—review engagements

Failure to obtain a proper management representation letter for a review engagement. (Comment: A

management representation letter is required in all review engagements. This letter should be updated to

include all current information and cover all periods presented in the financial statements. The letter

should ordinarily be tailored to include additional appropriate representations from management relating

to matters specific to the entity’s business or industry. The representation letter should be signed by

those members of management whom the accountant believes are responsible for and knowledgeable

about the matters covered in the letter.) In addition, the representation letter should be dated as of the

date of the accountant’s review report.

Specifically, the management representation letter should include that management does the following: — Acknowledges its responsibility for the preparation and fair presentation of the financial

statements in accordance with the applicable financial reporting framework, as set out in the terms of the engagement.

— Believes that the financial statements are fairly presented in accordance with the applicable financial reporting framework.

— Acknowledges its responsibility for designing, implementing, and maintaining internal control relevant to the preparation and fair presentation of financial statements.

— Acknowledges management’s responsibility to prevent and detect fraud. — Has disclosed to the accountant its knowledge of any fraud or suspected fraud affecting the

entity involving management or others where the fraud could have a material effect on the financial statements, including any communications received from employees, former employees, or others.

— Has responded fully and truthfully to all of the accountant’s inquiries. — Has communicated that all transactions have been recorded and are reflected in the financial

statements. — Has disclosed whether management believes that the effects of uncorrected misstatements are

immaterial, individually and in the aggregate, to the financial statements as a whole. A summary of such items should be included in, or attached to, the written representation.

— Has disclosed to the accountant all known actual or possible litigation and claims whose effects should be considered when preparing the financial statements and has appropriately accounted for and disclosed such litigation and claims in accordance with the applicable financial reporting framework.

— Has disclosed whether management believes that significant assumptions they use in making accounting estimates are reasonable.

1 AR-C sections are found in AICPA Professional Standards.


— Has disclosed to the accountant the identity of the entity’s related parties and all of the related party relationships and transactions of which it is aware and has appropriately accounted for and disclosed such relationships and transactions.

— Has disclosed all events occurring subsequent to the date of the financial statements and for which the applicable financial reporting framework requires adjustment or disclosure have been adjusted or disclosed.

Basic reporting elements — Failure to prepare reports in accordance with professional standards

Note: Practitioners should note that financial statements reviewed by the accountant should be

accompanied by a written report. The basic elements of a review report include a title, addressee,

introductory paragraph, management’s responsibility for the financial statements, accountant’s

responsibility, accountant’s conclusion, signature of the accountant, the city and state where the

accountant practices, and date of the accountant’s report. Specifically, peer reviewers have noted

that reports fail to

— include appropriate titles or lack of a title; — properly specify the date or period covered by the reviewed financial statements; — include appropriate section headings; or — be updated in conformity with the applicable professional standard.

Supplementary information — Failure to report the degree of responsibility taken with respect to supplementary information

Note: The accountant’s report should describe the accountant’s responsibility, if any, for

supplementary or required supplementary information included with the financial statements.

The accountant may include this in a separate paragraph in the accountant’s report or in a separate

report on the supplementary information.

Engagement letters — Omissions and errors

Note: Illustrative engagement letters for revised Statements on Standards for Accounting and Review

Services (SSARSs) are included in the appendix of AR-C section 90, Review of Financial Statements.

Note also that SSARSs require the engagement letters to be signed by both the accountant and the

client’s management or those charged with governance.

Review documentation — Failure to document expectations or the comparison of expectations to recorded amounts for analytical procedures

Note: Analytical procedures compare amounts or ratios developed from recorded amounts to

expectations. When the comparison demonstrates an unusual or unexpected result, the accountant

should investigate that unexpected result. These unexpected results then may require additional

analysis or inquiry to understand why the associated accounts did not behave as expected.

When designing and performing analytical procedures, the accountant should do the following:

— Determine the suitability of particular analytical procedures. — Consider the reliability of data from which the accountant’s expectation of recorded amounts or

ratios is developed, considering the source, comparability, and nature and relevance of information available.


— Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise to provide the accountant with limited assurance that a misstatement will be identified that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated.

— Determine the amount of any difference or recorded amounts from expected values that is acceptable without further investigation and compare the recorded amounts, or ratios developed from recorded amounts, with the expectations.

Common peer review findings—compilation engagements

Reporting on the financial statements — Failure to prepare reports in accordance with professional standards

Note: Practitioners should note that financial statements compiled by the accountant should be

accompanied by a written report. Specifically, a compilation report should include the following:

— A statement that management (owners) is (are) responsible for the financial statements — Identity of the financial statements that have been subjected to the compilation engagement — Identity of the entity whose financial statements have been subjected to the compilation

engagement — The date or period covered by the financial statements (all those periods that are presented) — A statement that the accountant performed the compilation engagement in accordance with

SSARSs promulgated by ARSC — A separate paragraph indicating that the financial statements were prepared in accordance with

an SPF and that framework differs from GAAP — A statement that the accountant did not audit or review the financial statement nor was the

accountant required to perform any procedures to verify the accuracy or completeness of the information provided by management and, accordingly, does not express an opinion or a conclusion, nor provide any assurance on the financial statements

— Appropriate headings throughout the report — The signature of the accountant or the accountant’s firm — The city and state where the accountant practices — The date of the report, which should be the date that the accountant has completed the

procedures required by AR-C section 80, Compilation Engagements

Supplementary information — No explanation of the degree of responsibility taken with respect to supplementary information

Note: The accountant’s report should describe the accountant’s responsibility, if any, for

supplementary or required supplementary information included with the financial statements. The

accountant may include this in a separate paragraph in the accountant’s report or in a separate report

on the supplementary information.

Reporting on financial statements — Failure to report that substantially all required disclosures have been omitted


Note: Accountants may compile financial statements with disclosures omitted, as long as the omission of

disclosures is clearly indicated in the compilation report, and the disclosures are not omitted with the

intent to “mislead” those who might reasonably be expected to use the financial statements.

A final paragraph should be added to the compilation report as follows:

Management has (the owners have) elected to omit substantially all of the disclosures ordinarily

included in financial statements prepared in accordance with generally accepted accounting

principles in the United States of America. If the omitted disclosures were included in the financial

statements, they might influence the user’s conclusions about the company’s assets, liabilities,

equity, revenue, and expenses. Accordingly, the financial statements are not designed for those

who are not informed about such matters.

This paragraph should be labeled as “Selected Information – Substantially All Disclosures Required

by [Applicable Financial Reporting Framework] Are Not Included.”

Engagement letters — Omissions and errors

Note: Illustrative engagement letters for revised SSARSs are included in the appendix of AR-C section 80.

Note also that SSARSs require the engagement letters to be signed by both the accountant and the

client’s management or those charged with governance.

Specifically, the following failures to document the agreed-upon terms of the engagement have been

cited in peer reviews:

Failure to properly include the expected form and content of the accountant’s compilation report when the accountant’s independence has been impaired

Failure to properly identify the applicable financial reporting framework for the preparation of the financial statements

Failure to identify nonattest services provided Failure to have the engagement letter signed by all required parties

Other issues identified in peer review

The following is a brief summary of other problematic areas identified in peer review for compilation and

review engagements:

Code of Professional Conduct. Peer reviewers noted several exceptions to the requirements of the Code of Professional Conduct. Practitioners have failed to establish and document in writing the understanding with the client with regard to nonattest services provided. In addition, practitioners have failed to document sufficiently management’s responsibilities to oversee and evaluate the results of services performed. Finally, practitioners have not collected fees for professional services provided more than one year prior to the date of the current report, causing independence to be impaired.

Independence. Although an accountant may report on compiled financial statements when the accountant is not independent, the SSARSs require modification of the compilation report to clearly indicate this lack of independence by adding a one-sentence paragraph to the compilation report,


specifically, “I am [We are] not independent with respect to XYZ Company.” Accountants are permitted, but not required, to provide a description of the reason for that lack of independence. However, if the accountant elects to disclose the reason for the lack of independence, all of the reasons should be disclosed. Note also that accountants must be independent to issue a review report.

Omission of the statement of cash flows in financial statements prepared in accordance with GAAP. Per FASB Accounting Standards Codification (ASC) 230, Statement of Cash Flows, if financial statements include both a balance sheet and an income statement, the statement of cash flows should be provided for each period that the income statement is provided. Given this fact, the statement of cash flows should be provided with the CPA reviewed or compiled financial statements or the failure to include the statement of cash flows should be disclosed as a departure from GAAP in the accountant’s report. When the statement of cash flows is omitted in a compilation in which management elects to omit substantially all disclosures, the omitted statement of cash flows can be referenced in the paragraph of the accountant’s report that reports the fact that disclosures have been omitted.

Significant departures from the financial statement formats prescribed by industry accounting and audit guides. In many cases, this deficiency is prevalent if the accountant is preparing and reporting on financial statements of clients in “special industries” in which they try to “fit” the standard financial statement formats for use in these industries. For example, for healthcare clients, there is a requirement for a performance indicator to be included in the financial statements. If accountants try to use formats that are applicable to normal business entities, it is not uncommon for some of the special industry guidance not to be followed. CPAs should refer to the appropriate AICPA audit and accounting guides when financial statements are being compiled or reviewed.

Omission of significant matters related to the understanding of the financial statements and the cumulative material effect of a number of deficiencies. This deficiency occurs if several minor deficiencies result in a cumulative material effect on the financial statements when viewed in the aggregate.

Compliance with statements on quality control — Leadership responsibilities for quality within the firm—Peer reviewers have noted a failure to have

a written quality control document, to communicate quality control policies and procedures with staff, and to devote sufficient resources for the support of the firm’s quality control policies and procedures.

— Ethical requirements—Peer reviewers have noted failure to obtain written confirmation on independence for all personnel.

— Acceptance and continuance—Peer reviewers have noted failure to obtain a license in all states where engagements were accepted and failure to evaluate the risk of performing an engagement in a specialized industry or to obtain the necessary knowledge of current standards in specialized areas prior to performance of the audit, or both.

— Human resources—Peer reviewers have noted a failure to design policies that ensure partners and staff obtain appropriate CPA to meet state board requirements, membership requirements, and so on, failure to design policies to require relevant CPE for levels of service and industries of engagements performed, and failure to maintain current licenses in all jurisdictions in which the firm practices.

— Engagement performance—Peer reviewers have noted failure to properly complete or use purchased practice aids to assist in performing and documenting engagements, failure to establish appropriate criteria for engagement quality control review, failure to perform engagement quality review controls on engagements that meet the firm’s criteria, failure to maintain current quality control materials for the performance of engagements, and failure to establish a policy for the retention of engagement documentation.


— Monitoring—Peer reviewers have noted failure to design appropriate policies and procedures for the completion of monitoring, failure to include all elements of quality control in monitoring procedures, and failure to document the results of monitoring and inspection.

Knowledge check

1. The management representation letter for a review engagement would typically include what?

a. Results of inquiry and analytical procedures. b. A statement that the review engagement was conducted in accordance with SSARSs. c. The expected form of the accountant’s review report. d. Disclosure of related parties.

2. When substantially all required disclosures have been omitted from compiled financial statements:

a. Each page of the financial statements must be clearly labeled “No assurance is provided on these financial statements.”

b. The accountant is prohibited from issuing a compilation report. c. The accountant must provide the substance of the missing disclosures in the accountant’s

compilation report. d. The accountant must add a paragraph to the accountant’s report indicating that management

elected to omit the disclosures.


Recent accounting standards overview In 2020, FASB issued several new accounting pronouncements, many of which should be considered by

accountants who perform SSARSs engagements. The following table includes new pronouncements

issued as of December 2020:

Table – Recent Accounting Standards Updates

ASU No. 2020-01 (January 2020)

Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)

Clarifies (1) accounting for certain equity securities when applying or discontinuing the use of the equity method of accounting, and (2) scope considerations for forward contracts and purchased options for certain securities.

ASU No. 2020-02 (February 2020)

Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842) – Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842) (SEC Update)

Applicable to public business entities that meet the definition of a public business entity only because of a requirement to include or inclusion of its financial information or financial statements in another entity’s SEC filing. Allows these entities to adopt FASB ASC 842, Leases, using the effective implementation date of nonpublic entities.

ASU No. 2020-03 (March 2020)

Codification Improvements to Financial Instruments

Amends and clarifies topics related to financial instruments, including fair value option disclosures, disclosures for depository or lending institutions, interaction among standards for financial instruments and other topics, etc.

ASU No. 2020-04 (March 2020)

Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting

Provides optional guidance in accounting for reference reform on financial reporting. Applies only to contracts, hedging relationships, and other transactions that reference London Inter-bank Offered Rate or another reference rate expected to be discontinued due to the reference rate reform initiative.

ASU No. 2020-05 (June 2020)

Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities

Discussed in revenue recognition section later in this course.


Table – Recent Accounting Standards Updates

ASU No. 2020-06 (August 2020)

Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity

Simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, with a focus on convertible instruments and contracts in an entity’s own equity. Requires expanded disclosures for convertible instruments.

ASU No. 2020-07 (September 2020)

Not-for-Profit Entities (Topic 958): Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets

Enhanced presentation and disclosure requirements for contributed nonfinancial assets (gifts in-kind) made to not-for-profit entities. These nonfinancial assets may include fixed assets, use of fixed assets or utilities, materials and supplies (such as food, clothing, or pharmaceuticals), intangible assets, services, and unconditional promises of those assets.

ASU No. 2020-08 (October 2020)

Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs

Clarifies that an entity should reevaluate whether a callable debt security is within the scope of FASB ASC 310-20-35-33 that requires amortization of excess of amortized cost over amount repayable by the issuer for each reporting period.


Debt (Topic 470): Amendments to SEC Paragraphs Pursuant to SEC Release No. 33-10762

Provides additional instruction for purposes of preparing interim financial statements. Waives requirement for guarantors or issuers of guaranteed registered securities to file financial statements under certain conditions.


Codification Improvements

Amends FASB ASC by including all disclosure guidance in the appropriate disclosure section (section 50); this guidance was previously included in the other presentation matters section (section 45) of FASB ASC.

ASU No. 2020-11 (November 2020)

Financial Services – Insurance (Topic 944): Effective Date and Early Application

Defers the effective date of ASU No. 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, by one year for all insurance entities. Also provides transition relief to facilitate early application of the ASU and encourage accelerated delivery of better information to investors and other financial statement users.


Selected Accounting Standards Updates

The following table presents several significant ASUs issued prior to 2020 that have effective dates in

2019 through 2023.

Table – Select Accounting Standards Updates with upcoming effective dates


Update Description Effective date

ASU No. 2014-09,

Revenue from Contracts

with Customers (Topic

606)

Presents a single, common

revenue recognition model

applicable across industries.

Effective for annual reporting

periods beginning after December

15, 2018, for public companies and

after December 15, 2019, for

nonpublic companies.

ASU No. 2016-01,

Financial Instruments –

Overall (Subtopic 825-

10): Recognition and

Measurement of

Financial Assets and

Financial Liabilities

Requires equity investments

to be measured at fair value,

simplifies impairment

assessment for equity

investments without readily

determinable fair values, and

changes some disclosure and

presentation requirements.

Effective for fiscal years and

interim periods within fiscal years

beginning after December 15,

2017, for public companies, and

fiscal years and interim periods

within fiscal years beginning after

December 15, 2019, for nonpublic

companies.

ASU No. 2016-13,

Financial Instruments –

Credit Losses (Topic

326): Measurement of

Credit Losses on

Financial Instruments

Measures loss impairment to

reflect expected credit losses.


interim periods beginning after

December 15, 2019, for public

companies that are SEC filers, and

December 15, 2020, for all other

public companies. Effective for

fiscal years and interim periods


2021, for nonpublic companies.





ASU No. 2016-02,

Leases (Topic 842)

Requires capitalization of

virtually all leases.




companies and fiscal years and



2021, for nonpublic companies.

ASU No. 2018-07,

Compensation – Stock

Compensation (Topic

718): Improvements to

Nonemployee Share-

Based Payment

Accounting

Expands the scope of FASB

ASC 718, Compensation—

Stock Compensation, to

include share-based payment

transactions for acquiring

goods and services from

nonemployees.




companies. Effective for fiscal

years beginning after December

15, 2019, and interim periods

within fiscal years beginning after

December 15, 2020, for all other

entities. Early adoption is

permitted, but no earlier than an

entity’s adoption date of FASB ASC

606.

ASU No. 2018-13, Fair

Value Measurement

(Topic 820): Disclosures

Framework – Changes

to the Disclosure

Requirements for Fair

Value Measurement

Removes some and modifies

other disclosure requirements

on fair value measurements

based on the concepts in the

concepts statement, including

the consideration of costs and

benefits.

Effective for all entities for fiscal

years, and interim periods within

those fiscal years, beginning after

December 15, 2019.





ASU No. 2018-15,

Intangibles – Goodwill

and Other – Internal-Use

Software (Subtopic 350-

40): Customer’s

Accounting for

Implementation Costs

Incurred in a Cloud

Computing

Arrangement That is a

Service Contract (a

consensus of the FASB

Emerging Issues Task

Force)

Provides additional guidance

on accounting for costs of

implementation activities

performed in a cloud

computing arrangement that

is a service contract.


interim periods within those fiscal


15, 2019, for public companies.

Effective for fiscal years beginning

after December 15, 2020, and

interim periods within annual

periods beginning after December

15, 2021. Early adoption of the

amendments in this ASU is

permitted, including adoption in

any interim period, for all entities.

ASU No. 2019-12,

Income Taxes (Topic

740): Simplifying the

Accounting for Income

Taxes

Simplifies accounting for

income taxes by removing

certain exceptions to the

general principles of

accounting for income taxes.


interim periods within those fiscal


15, 2020, for public entities.

Effective for fiscal years beginning

after December 15, 2021, and



2022, for all other entities.

Current updates or those with upcoming effective dates that have particular significance to preparation,

compilation, and review engagements are briefly explained in the following sections.

Revenue recognition standards

ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), issued in May 2014, is a joint

issuance of the International Accounting Standards Board (IASB) and FASB. This ASU presents a single,

common revenue recognition model that can be applied to a wide range of industries and transaction

types. As part of the boards’ efforts to converge GAAP and the International Financial Reporting

Standards, the ASU eliminates the transaction- and industry-specific revenue recognition guidance under

current GAAP and replaces it with a principles-based approach for revenue recognition. The intent is to


avoid inconsistencies in accounting treatment across different geographies and industries. In addition to

improving comparability of revenue recognition practices, the new guidance provides more useful

information to financial statement users through enhanced disclosure requirements. FASB and the IASB

have essentially achieved convergence with these standards, with some minor differences related to the

collectability threshold, interim disclosure requirements, early application and effective date, impairment

loss reversal, and nonpublic entity requirements.

The ASU was originally going to be effective for annual periods beginning after December 15, 2016, and

interim periods within that reporting period for public entities, with a one-year deferral for nonpublic

entities. In 2015, however, FASB issued ASU No. 2015-14 that deferred the effective date for all entities by

one year. The deferral allowed entities additional time to implement systems, gather data, and resolve

implementation questions. Public entities, certain not-for-profit entities, and certain employee benefit

plans should apply the guidance to annual reporting periods beginning after December 15, 2017,

including interim periods within that reporting period. Earlier application is permitted only as of annual

reporting periods beginning after December 15, 2016, including interim reporting periods within that

reporting period. All other entities should apply the ASU No. 2014-09 to annual reporting periods

beginning after December 15, 2018 and interim reporting periods within annual reporting periods

beginning after December 15, 2019.

The ASU applies to any entity that either enters into contracts with customers to transfer goods or

services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within

the scope of other standards, for example, insurance or lease contracts. The ASU provides a more robust

framework for addressing various revenue recognition issues; improves comparability of revenue

recognition practices across entities, industries, jurisdictions, and capital markets; and simplifies the

preparation of financial statements by reducing the number of requirements to which entities must refer.

The ASU also affects guidance on recognizing gains or losses on the sale of some nonfinancial assets

that are not an output of the entity’s ordinary activities.

The core principle of the update is that an entity should recognize revenue from contracts to depict the

transfer of goods or services to customers in an amount that reflects the consideration to which the

entity expects to be entitled in exchange for those goods or services. The following are the five steps to

implement the core principle on revenue recognition.

1. Identify the contract(s) with the customer. 2. Identify the separate performance obligations in the contract. 3. Determine the transaction price. 4. Allocate the transaction price to the separate performance obligations. 5. Recognize revenue when (or as) the entity satisfies each performance obligation.

Under the new ASU, revenue is recognized when a company satisfies a performance obligation by

transferring a promised good or service to a customer (which is when the customer obtains control of

that good or service).

The ASU also provides two options for implementation: the full retrospective method and the modified

retrospective method. Under the full retrospective method, the core principle of revenue recognition is


applied to all contracts that would have existed during all periods presented if the new ASU had been

applied from contract inception. A cumulative effect of changes to periods prior to those presented is

reflected in the opening balance of retained earnings. Under the modified retrospective method, the core

principle of revenue recognition is applied to any contracts existing as of [effective date] (as if new ASU

had been applied since inception of contract), as well as any new contracts from that date forward. A

cumulative effect of changes is reflected in the opening balance of retained earnings in the most current

period presented. Disclosure requirements under the modified retrospective approach are expanded to

include all financial statement line items in the year of adoption as if they were prepared under current

guidance, effectively requiring two sets of records during the year of adoption.

FASB has released a number of clarifying updates to FASB ASC 606 since its original issuance. The

following provides a summary of those updates:

ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Consideration (Reporting Revenue Gross versus Net), provides clarification in determining whether an entity is a principal or agent.

ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, provides clarification to help identify promised goods and services in a contract. It also clarifies whether revenue should be recognized at a point in time or over time for licenses of intellectual property. This ASU also provides implementation guidance on recognizing revenue for a sales-based or usage-based royalty promised in exchange for a license of intellectual property.

ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, provides additional guidance on contract modifications, assessing collectability, reporting sales and similar taxes, measuring noncash consideration and applying transition guidance.

ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, provides guidance on impairment testing, additional scope exceptions, provisions for losses on construction-type and production-type contracts, and disclosure of remaining performance obligations.

ASU No. 2017-05, Other Income – Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets, provides guidance on the definition of an “in-substance” nonfinancial asset, noting that such an asset may include nonfinancial assets transferred within a legal entity to a counterparty. It also addresses derecognition of distinct nonfinancial assets or in-substance nonfinancial assets promised to counterparties, partial sales transactions, and contributions of nonfinancial assets to a joint venture or other noncontrolled investee.

ASU No. 2017-13, Revenue Recognition (Topic 605), Revenue from Contracts with Customers (Topic 606), Leases (Topic 840), and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to the Staff Announcement at the July 20, 2017 EITF Meeting and Rescission of Prior SEC Staff Announcements and Observer Comments, states that public entities that do not meet the definition of a public business entity except for a requirement to include financial information in another entity’s filing with the SEC may adopt the effective date for nonpublic entities.

ASU No. 2019-08, Compensation – Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements – Share-Based Consideration Payable to a Customer, requires that share-based payment awards granted to a customer in conjunction with selling goods or services should be accounted for under the new revenue recognition guidance (FASB ASC 606).


ASU No. 2020-05 provides a limited deferral of the effective dates of ASU No. 2014-09 for franchisers that are not public business entities, not-for-profit organizations, and other entities that have not yet issued their financial statements reflecting the adoption of the new revenue standard. These entities may defer application to the fiscal year beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.

Due to the potential for significant changes that may result from the issuance of the new standards,

FASB and IASB have received an abundance of implementation questions from interested parties. To

address these questions, the boards have formed a joint Transition Resource Group (TRG) for revenue

recognition to promote effective implementation and transition to the converged standard. The TRG has

met several times to discuss implementation issues raised by concerned parties and actions to take to

address these issues. The TRG website (www.fasb.org/jsp/FASB/Page/LandingPage&cid=1176

164065747) provides information on this group and the status of their efforts, including meeting

materials and meeting summaries.

Upon implementation of the new standard, consistency of revenue recognition principles across

geography and industries will be enhanced, and financial statement users will be provided better

insight through improved disclosure requirements. To provide CPAs with guidance during this time of

transition, the AICPA’s Financial Reporting Center (FRC) offers resources on the topic, including a

roadmap to ensure that companies take the necessary steps to prepare themselves for the new

standard. In addition, the FRC includes a list of conferences, webcasts, and other products to keep

accountants informed on upcoming changes in revenue recognition. The FRC website can be found at

www.aicpa.org/interestareas/frc/accountingfinancialreporting/revenuerecognition.html.

Leases

In February 2016, FASB issued ASU No. 2016-02, Leases (Topic 842). The objective of the ASU is to

increase transparency and comparability in financial reporting by requiring balance sheet recognition of

leases and disclosure of certain information about lease arrangements. The ASU consists of four

subtopics; overall, lessee, lessor, sale and leaseback transactions and leveraged lease arrangements.

This ASU was originally effective for fiscal years of public companies, which include public business

entities; certain not-for-profit entities with conduit financing arrangements; and employee benefit plans

beginning after December 15, 2018, including interim periods within those years. For all other entities, the

ASU was to be effective for fiscal years beginning after December 15, 2019, and interim periods within

fiscal years beginning after December 15, 2019. In 2020, FASB issued ASU No. 2020-05 that retains the

implementation date for public business entities and certain not-for-profits that have not issued financial

statements or made financial statements available for issuance as of June 3, 2020. ASU No. 2020-05

postpones implementation for all other entities for fiscal years beginning after December 15, 2021, and

interim periods within fiscal years beginning after December 15, 2022. Early application is permitted for

all entities.

Originally, the transition method required a modified retrospective approach. In July 2018, FASB issued

ASU No. 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842, to

provide an additional (optional) transition method to adopt the new standard. The update also provides


lessors with a practical expedient to account for lease and non-lease components as a single component

under certain circumstances.

The ASU defines a lease as a contract in which the right to control the use of a specified asset is

conveyed, for a period, in exchange for consideration. The ASU applies to any entity that enters into a

lease with a term of greater than 12 months and applies to all leases and subleases of property, plant,

and equipment. Certain items, including leases of intangible assets, nonregenerative natural resources,

biological assets, inventory, and assets under construction, are excluded. In addition, leases should be

separated into lease and non-lease components when the lessee can both benefit from the right-of-use

asset and that right-of-use is not highly dependent on nor highly interrelated with other underlying assets

in the contract.

Changes to current practice are most notable from a lessee’s perspective. Here all leases are classified

as either finance or operating leases, but the operating lease classification is very different from current

guidance. Under ASU No. 2016-02, regardless of classification, lessees will recognize a right-of-use asset

and corresponding liability at commencement of a lease. Income statement effects vary according to

classification of the lease. Operating leases result in a single straight-line lease expense; whereas,

finance leases result in both amortization and interest expense. One of the objectives of this update was

to avoid the “off-balance-sheet” financing made possible by current accounting standards. Under ASU

No. 2016-02, there is no longer an option for a lessee to recognize expenses as payments are made.

Lessors may classify leases as either sales-type, direct financing or operating leases. For both sales-type

and direct financing leases, the lessor will derecognize the underlying asset and recognize its net

investment in the lease which includes the lease receivable and unguaranteed residual value. The primary

difference between a sales-type and direct financing lease at the commencement date the lessor will

recognize a selling profit or loss from the sales-type lease. Only a selling loss is recognized at

commencement for a direct financing lease. Subsequently both sales-type and direct financing leases

will recognize interest income, certain variable lease payments and impairment losses. When a lease

does not meet the criteria for classification as a sales-type or direct financing lease, the lessor may

classify it as an operating lease and recognize income over the lease-term on a straight-line basis.

FASB has released a number of clarifying updates to FASB ASC 842 since its original issuance. ASU No.

2018-10, Codification Improvements to Topic 842, Leases, addresses several areas of improvement,

including the following:

Residual value guarantees Rate implicit in the lease Lessee reassessment of lease classification Lessor reassessment of lease term and purchase option Variable lease payments that depend on an index or a rate Investment tax credits Lease term and purchase option Transition guidance for amounts previously recognized in business combinations Certain transition adjustments Transition guidance for leases previously classified as capital leases


Transition guidance for modifications to leases previously classified as direct financing or sales-type leases

Transition guidance for sale and leaseback transactions Impairment of net investment in the lease Unguaranteed residual asset Effect of initial direct costs on rate implicit in the lease Failed sale and leaseback transaction

In addition, FASB has released a number other updates to FASB ASC 842 including the following:

ASU No. 2018-01 permits an entity to elect a practical expedient to forego evaluating existing or expired land easements not previously accounted for as leases under FASB ASC 840.

ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, provides guidance on comparative reports at adoption for entities that choose the modified retrospective transition method. It also provides guidance for lessors who elect a practical expedient that allows them to combine lease and nonlease components of a contract.

ASU No. 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors, provides guidance for lessors for sales and similar taxes collected from lessees, certain lessor costs, and recognition of variable payments for contracts with lease and nonlease components.

ASU No. 2019-01, Leases (Topic 842): Codification Improvements, provides guidance for the following: — Determining the fair value of the underlying asset by lessors that are not manufacturers or

dealers — Presentation on the statement of cash flows — sales-type and direct financing leases — Transition disclosures related to the guidance on accounting changes and error corrections

ASU No. 2019-10, Financial Instruements – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates, provides a deferral of the effective date for all other entities by an additional year. Therefore, FASB ASC 842 is effective for entities other than public business entities and other entities defined by this ASU for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Early application continues to be allowed.

ASU No. 2020-05 provides a limited deferral of the effective dates of ASU No. 2014-09 for franchisers that are not public business entities, not-for-profit organizations, and other entities that have not yet issued their financial statements reflecting the adoption of the new revenue standard. The effective date for relevant not-for-profit organizations is fiscal years and interim periods within fiscal years beginning after December 15, 2019. For all other entities, the effective date is for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.

Financial instruments

In January 2016, FASB issued ASU No. 2016-01 to enhance the reporting model for financial instrument

and to provide users of financial statements with more decision-useful information. The amendments in

the ASU are intended to improve certain aspects of recognition, measurement, presentation and

disclosure of financial instruments.


The new guidance will accomplish the following:

Require equity investments (except those accounted for under the equity method of accounting or those that results in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income.

Replace the impairment model for equity investments without readily determinable fair values with a qualitative impairment assessment.

Eliminate the requirement to disclose the fair values of financial assets and financial liabilities measured at amortized cost for entities that are not public business entities.

Eliminate the requirement for public business entities to disclose the methods and significant assumptions used to estimate fair value that is required to be disclosed for financial assets and financial liabilities measured at amortized cost on the balance sheet.

Require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.

Require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.

Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.

Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale debt securities in combination with an entity’s other deferred tax assets.

Eliminate an entity’s ability to estimate the disclosed fair values of financial assets and financial liabilities on the basis of entry prices.

The ASU is effective for public business entities for fiscal years and interim periods within fiscal years

beginning after December 15, 2017. For all other entities, the ASU is effective for fiscal years beginning

after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. All

nonpublic business entities may adopt the amendments in this ASU earlier, as of the fiscal years

beginning after December 15, 2017, including interim periods within those fiscal years.

The following updates have been issued related to FASB ASC 825, Financial Instruments, since its original

issuance:

ASU No. 2018-03, Technical Corrections and Improvements to Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, clarifies the following issues: — Equity securities without a readily determinable fair value – discontinuation and application of the

fair value method — Forward contracts and purchased options — Presentation requirements for certain fair value option liabilities — Fair value option liabilities denominated in a foreign currency — Transition guidance for equity securities without a readily determinable fair value

ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, provides scope clarifications, amends the fair value disclosures for held-to-maturity debt securities, clarifies the measurement alternative for equity securities without readily determinable fair values, and the remeasurement of those securities at historical exchange rates.


ASU No. 2019-05, Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief, provides an option to irrevocably elect the fair value option applied on an instrument-by-instrument basis for certain financial assets previously measured at amortized cost. The fair value option election does not apply to held-to-maturity debt securities.

Impairment

In June 2016, FASB issued ASU No. 2016-13 to provide more decision-useful information about the

expected credit losses on financial instruments and other commitments to extend credit held by a

reporting entity at each reporting date. Upon the effective date of this ASU, the incurred loss impairment

methodology in current GAAP is replaced with a methodology that reflects expected credit losses and

requires consideration of a broader range of reasonable and supportable information to inform credit

loss estimates.

The ASU eliminates the probable initial recognition threshold under current GAAP and requires entities

that measure financial assets (or a group of financial assets) at amortized cost bases to present such

assets at the net amount expected to be collected. The ASU broadens the information that an entity must

consider in developing its expected credit loss estimate for assets measured either collectively or

individually. In addition to past events and current conditions, entities should also consider reasonable

and supportable forecasts that affect the collectability of the reported amount. However, an entity may

revert to historical loss information that is reflective of the contractual term considering the effect of

prepayments for periods that are beyond the time frame for which the entity is able to develop

reasonable and supportable forecasts.

An entity may apply any method for measuring expected credit losses as long as the method reasonably

reflects its expectations of the credit loss estimate.

The ASU defines purchased financial assets with credit deterioration (PCD assets) as acquired individual

financial assets (or acquired groups of financial assets with similar risk characteristics) that, as of the

date of acquisition, have experienced a more-than-insignificant deterioration in credit quality alone since

origination as determined by the acquirer’s assessment. The allowance for credit losses for PCD assets

that are measured at amortized cost basis is determined in a similar manner to other financial assets

measured at amortized cost basis. The initial allowance for credit losses is added to the purchase price,

rather than being reported as a credit loss expense. Entities record only subsequent changes in the

allowance for credit losses as a credit loss expense for PCD assets. Furthermore, an entity should

recognize interest income for PCD assets based on the effective interest rate, excluding the discount

embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at

acquisition.

The ASU also requires entities to present credit losses on available-for-sale debt securities as an

allowance, rather than a permanent write-down. Entities will now be allowed to record reversals of credit

losses on debt securities in current period net income, thus aligning income statement recognition of

credit losses with the reporting period when changes occur. However, an entity may not record an

allowance for credit losses exceeding the amount by which fair value is below amortized cost.


The allowance for credit losses for purchased available-for-sale debt securities with a more-than-

insignificant amount of credit deterioration since origination is also determined in a similar manner to

other available-for-sale debt securities. However, the ASU requires an entity to add the initial allowance

for credit losses to the purchase price, rather than reporting it as a credit loss expense. Entities record

only subsequent changes in the allowance for credit losses as a credit loss expense. Furthermore, an

entity should recognize interest income based on the effective interest rate, excluding the discount

embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at

acquisition.

ASU No. 2016-13 affects entities holding financial assets and net investment in leases that are not

accounted for at fair value through net income. It also affects loans, debt securities, trade receivables, net

investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other

financial assets not excluded from the scope that have the contractual right to receive cash.

Because there is a diversity in practice in applying the incurred loss methodology, ASU No. 2016-13 will

affect entities to varying degrees depending on the credit quality of the assets held by the entities, their

duration, and how the entity currently applies GAAP.

The ASU is effective for fiscal years and interim years within fiscal years beginning after December 15,

2019, for public business entities that are SEC filers. The ASU is effective for fiscal years and interim

years within fiscal years beginning after December 15, 2020, for all other public entities. For all other

entities, the ASU is effective for fiscal years and interim years within fiscal years beginning after

December 15, 2021. All entities may adopt the ASU earlier, as of the fiscal years beginning after

December 15, 2018, including periods within those years.

Due to the potential for significant changes that may result from the issuance of ASU No. 2016-13, FASB

formed the Transition Research Group (TRG) for credit losses with the following goals:

To solicit, analyze, and discuss stakeholder issues arising from the implementation of the new guidance

To inform FASB about those implementation issues, which will help FASB determine what, if any, action will be needed to address those issues

To provide a forum for stakeholders to learn about the new guidance from others involved with the implementation

The TRG will meet to discuss and share its views on potential implementation issues raised by

concerned parties and, subsequent to each meeting, FASB will determine what actions, if any, will be

taken on each issue.

Stock compensation

In June 2018, FASB issued ASU No. 2018-07 as part of its simplification initiative. The amendments in

this ASU expand the scope of FASB ASC 718, Compensation—Stock Compensation, to include share-

based payment transactions for acquiring goods and services from nonemployees. An entity should

apply the requirements of FASB ASC 718 to nonemployee awards, except for specific guidance on inputs

to an option-pricing model and the attribution of cost (that is, the period of time over which share-based


payment awards vest and the pattern of cost recognition over that period). The amendments specify that

FASB ASC 718 apply to all share-based payment transactions in which a grantor acquires goods or

services to be used or consumed in a grantor’s own operations by issuing share-based payment awards.

The amendments also clarify that FASB ASC 718 does not apply to share-based payments used to

effectively provide (a) financing to the issuer or (b) awards granted in conjunction with selling goods or

services to customers as part of a contract accounted for under FASB ASC 606.

The amendments in this ASU are effective for public business entities for fiscal years beginning after

December 15, 2018, including interim periods within that fiscal year. For all other entities, the

amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within

fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than an entity’s

adoption date of FASB ASC 606.

An entity should only remeasure liability-classified awards that have not been settled by the date of

adoption and equity-classified awards for which a measurement date has not been established through a

cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption.

Upon transition, the entity is required to measure these nonemployee awards at fair value as of the

adoption date. The entity must not remeasure assets that are completed. For example, finished goods

inventory or equipment that has begun amortization should not be remeasured upon transition.

Disclosures required at transition include the nature of and reason for the change in accounting principle

and, if applicable, quantitative information about the cumulative effect of the change on retained earnings

or other components of equity.

Disclosure framework

In August 2018, FASB issued ASU No. 2018-13 as part of its disclosure framework project. The

amendments in this ASU modify the disclosure requirements on fair value measurements in FASB ASC

820 based on the concepts in the concepts statement, including the consideration of costs and benefits.

The ASU removed several disclosure requirements from FASB ASC 820, Fair Value Measurement,

including the following:

The amount of and reasons for transfers between level 1 and level 2 of the fair value hierarchy The policy for timing of transfers between levels The valuation processes for level 3 fair value measurements For nonpublic companies, the changes in unrealized gains and losses for the period included in

earnings for recurring level 3 fair value measurements held at the end of the reporting period

The ASU modified several disclosure requirements in FASB ASC 820 as follows:

In lieu of a rollforward for level 3 fair value measurements, a nonpublic entity is required to disclose transfers into and out of level 3 of the fair value hierarchy and purchases and issues of level 3 assets and liabilities.

For investments in certain entities that calculate net asset value, an entity is required to disclose the timing of liquidation of an investee’s assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly.


The amendments clarify that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date.

The ASU also added the following disclosure requirements for public entities only:

The changes in unrealized gains and losses for the period included in other comprehensive income for recurring level 3 fair value measurements held at the end of the reporting period.

The range and weighted average of significant unobservable inputs used to develop level 3 fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop level 3 fair value measurements.

The amendments in this ASU are effective for all entities for fiscal years, and interim periods within those

fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and

losses, the range and weighted average of significant unobservable inputs used to develop level 3 fair

value measurements, and the narrative description of measurement uncertainty should be applied

prospectively for only the most recent interim or annual period presented in the initial fiscal year of

adoption. All other amendments should be applied retrospectively to all periods presented upon their

effective date. Early adoption is permitted upon issuance of this ASU. An entity is permitted to adopt any

removed or modified disclosures early upon issuance of this ASU and delay adoption of the additional

disclosures until their effective date.

Internal-use software

In August 2018, FASB issued ASU No. 2018-15. The purpose of the ASU is to provide stakeholders

additional guidance on accounting for costs of implementation activities performed in a cloud computing

arrangement that is a service contract. The amendments in this ASU align the requirements for

capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the

requirements for capitalizing implementation costs incurred to develop or obtain internal-use software

(and hosting arrangements that include an internal-use software license).

Under this ASU, an entity (customer) in a hosting arrangement that is a service contract follows the

guidance in FASB ASC 350-40 to determine which implementation costs to capitalize as an asset and

which to expense. The amendments in this ASU also require the entity (customer) to expense the

capitalized implementation costs of a hosting arrangement that is a service contract over the term of the

hosting arrangement. The entity must also apply the existing impairment guidance in FASB ASC 350-40

to the capitalized implementation costs as if the costs were long-lived assets. The ASU further provides

guidance regarding the presentation of these costs in the income statement and statement of cash

flows.

The amendments in this ASU are effective for public business entities for fiscal years beginning after

December 15, 2019, and interim periods within those fiscal years. For all other entities, the amendments

in this ASU are effective for annual reporting periods beginning after December 15, 2020, and interim

periods within annual periods beginning after December 15, 2021. Early adoption of the amendments in

this ASU is permitted, including adoption in any interim period, for all entities.


The amendments in this ASU should be applied either retrospectively or prospectively to all

implementation costs incurred after the date of adoption.

Income taxes

The amendments in this ASU simplify the accounting for income taxes by removing certain exceptions to

the general principles in FASB ASC 740, Income Taxes. The amendments also improve consistent

application of and simplify GAAP for other areas of FASB ASC 740 by clarifying and amending existing

guidance.

Specifically, this amendment has removed the following exceptions:

The incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items (for example, discontinued operations or other comprehensive income)

The requirement to recognize a deferred tax liability for equity method investment when a foreign subsidiary becomes an equity method investment

The ability to not recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary

The general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year

In addition to the removal of these exceptions, the ASU has made the following amendments:

Requiring that an entity recognize a franchise tax (or similar tax) that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax.

Requiring that an entity evaluate when a step-up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction.

Specifying that an entity is not required to allocate the consolidated amount of current and deferred tax expense to a legal entity that is not subject to tax in its separate financial statements. However, an entity may elect to do so (on an entity-by-entity basis) for a legal entity that is both not subject to tax and disregarded by the taxing authority.

Requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date.

Making minor FASB ASC improvements for income taxes related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method.

Knowledge check

3. Which is not one of the five steps entities should follow in the revenue recognition standard?

a. Identify the contract(s) with a customer. b. Determine the transaction price. c. Identify the performance obligations in the contract. d. Recognize revenue when the transaction price has been determined and is collectible.


4. FASB ASC 842, Leases:

a. Applies to all leases, without exception. b. Covers contracts that result in the financed sale of an asset. c. Applies to publicly traded companies only. d. Requires lessees to classify leases as either finance or operating.


Other accounting frameworks In the past, when private for-profit entities have sought an accounting framework that is less complicated

and costly than GAAP, their options have been found among the SPFs including the cash-, modified cash-,

and tax-bases of accounting. In recent years, however, other options have become available. More

practitioners may be considering the use of alternative accounting frameworks for their clients due to the

substantial changes in GAAP. The approaching effective dates of the new revenue recognition standards

(FASB ASC 606) and the new leases standard (FASB ASC 842) are driving practitioners to focus on the

financial reporting challenges and significant costs of implementing these major accounting changes.

Faced with these challenges and costs, many practitioners are questioning the need for GAAP reporting

for their clients, as indicated in an informal survey conducted by the AICPA’s Center for Plain English

Accounting.

Millions of privately held companies throughout the United States do not need or are not required to have

financial statements prepared in accordance with GAAP. Although other SPF accounting bases are

available and acceptable, these bases may be insufficient or inappropriate for companies or users

looking for more robust and relevant financial information. In those situations, an alternative framework

is the AICPA’s FRF for SMEs accounting framework.

FRF for SMEs accounting framework

In 2013, the AICPA published the self-contained SPF intended for use by private, for-profit, small- and

medium-sized entities (SMEs). The FRF for SMEs accounting framework is intended to provide a less

complicated and less costly system of accounting for qualifying entities that do not need GAAP-based

financial statements.

The FRF for SMEs accounting framework represents a blend of traditional accounting principles and

accrual income tax methods of accounting. Historical cost is the primary measurement basis, and it

provides management with a reasonable degree of options when choosing accounting policies to better

meet the needs of the users of financial statements. The framework encourages the use of professional

judgment considering the context, and minimizes the details and voluminous disclosure requirements,

such that if the framework does not specifically address a transaction, event, or condition, management

should use its judgment and apply the general principles, concepts, and criteria contained in the

framework when developing accounting policies. Some of the key attributes include the following:

Objectivity. The framework is free from bias. Measurability. The framework permits reasonably consistent measurements. Completeness. The framework is sufficiently complete so that those relevant factors that would alter

a conclusion about financial statements are not omitted. Relevance. The framework is relevant to financial statement users.

The FRF for SMEs accounting framework was developed for small- and medium-sized entities that

require non-GAAP financial statements for either internal or external users. There is no standard


definition of what constitutes a small- and medium-sized entity, so that the decision regarding whether

this framework best meets an entity’s reporting needs rests with management. The following is a list of

characteristics of typical entities that might use this framework (note that the list is not meant to be all-

inclusive):

The entity does not have regulatory reporting requirements that essentially require it to use GAAP-based financial statements.

A majority of the owners and management of the entity have no intention of going public. The entity is for-profit. The entity may be owner-managed, which is a closely held company in which the people who own a

controlling ownership interest in the entity are substantially the same set of people who run the company.

Management and owners of the entity rely on a set of financial statements to confirm their assessments of performance, cash flows, and what they own and what they owe.

The entity does not operate in an industry such as finance or government where the entity is involved in transactions that require highly-specialized accounting guidance.

The entity does not engage in overly complicated transactions. The entity does not have significant foreign operations. Key users of the entity’s financial statements have direct access to the entity’s management. Users of the entity’s financial statements may have greater interest in cash flows, liquidity, statement

of financial position, strength, and interest coverage. The entity’s financial statements support applications for bank financing when the banker does not

base a lending decision solely on the financial statements but also in available collateral or other evaluation mechanisms not directly related to the financial statements.

The AICPA has no authority to require the use of the FRF for SMEs accounting framework for any entity.

Because the framework is completely optional, there is no effective date for its implementation.

FRF for SMEs approach to revenue recognition and leases

The FRF for SMEs accounting framework requirements related to revenue recognition are traditional,

broad, principle‐based guidance that is familiar to most accountants. Revenue should be recognized

when performance is achieved and ultimate collection is reasonably assured. For goods, performance is

achieved when the entity transfers the risks and rewards associated with the goods to a customer. For

services, performance should be determined using either the percentage of completion method or the

completed contract method. Performance should be regarded as having been achieved when reasonable

assurance exists regarding the measurement of the consideration that will be derived from rendering the

service or performing the long‐term contract. These requirements differ markedly from the new revenue

recognition model taking effect in GAAP.

For lease accounting, the FRF for SMEs accounting framework takes a traditional accounting approach

blended with some accrual income tax accounting methods. Lessees classify leases as either operating

or capital leases. Lessors account for leases as sales type, direct financing, or operating. The new lease

accounting model coming into effect in GAAP will differ significantly with this traditional approach by

requiring all lease assets and liabilities, including those related to operating leases, to be recorded on the

balance sheet.


Recent academic research

A recent research study published in the Journal of Accounting and Public Policy, “The Effect of SME

Reporting Framework and Credit Risk on Lenders’ Judgments and Decisions,” reports that the results of

the study suggest that the FRF for SMEs accounting framework provides a viable alternative to GAAP

when a loan applicant’s credit risk level is low. The likelihood of loan approval and interest rate results in

the study provide support for the assertion that the FRF for SMEs accounting framework provides a

reasonable alternative to traditional GAAP for smaller entities.

Considering the FRF for SMEs accounting framework for your clients

The AICPA has developed tool kits and resources to help practitioners understand the FRF for SMEs

accounting framework and decide whether it makes sense for their clients. Those resources are

maintained on the framework’s website. That website also shares frequently asked questions, as well as

perspectives and experiences from a CPA firm that implemented the framework.

Knowledge check

5. Which is a correct statement about the financial reporting framework for small-to-medium size entities (FRF for SMEs accounting framework)?

a. Private, for-profit entities are required to use GAAP as an accounting framework, which emphasizes historical cost over fair value.

b. Private, for-profit and not-for-profit entities are allowed to use the FRF for SMEs. c. Entities that use the FRF for SMEs may take a more traditional approach to revenue

recognition and accounting for leases compared to GAAP. d. The FRF for SMEs requires significantly more disclosure than GAAP to better meet the needs

of the end users of the financial statements.



Common deficiencies in peer review findings and how to address them Overview of FASB activities Revenue recognition standards Lease accounting standards Financial instruments Financial instrument impairment losses Other new standards AICPA’s financial reporting framework for SMEs


Practice questions Discuss each of the following statements, determining what response, if any, would be required of the

accountant performing a compilation or review engagement.

1. GAAP requires that a statement of cash flows must be presented for every period in which an income statement is presented.

2. The accountant’s compilation report states that the accountant is not independent of the client because the accountant is related to the client’s controller.

3. The management representation letter for a review engagement is signed by the chief financial manager and is limited to the last eight months covered by the financial statements because he or she was not in a position of financial responsibility prior to that.

4. Supplementary information is included with the basic financial statements being reviewed. Management has requested that the supplementary information not be subjected to review procedures and the accountant has agreed. No mention is made of this information in the accountant’s review report.


Solutions

Current Accounting and Reporting Issues


1.

a. Incorrect. Results of inquiry and analytical procedures are documented by the accountant in the working papers.

b. Incorrect. This statement regarding the accountant’s compliance with SSARSs is included in the accountant’s review report.

c. Incorrect. A statement of the expected form of the accountant’s review report is included in the engagement letter.

d. Correct. Management would typically provide disclosure of all related parties in the management representation letter.

2.

a. Incorrect. This is a required legend for prepared financial statements but is not required for compilation engagements.

b. Incorrect. The accountant may issue a compilation report on financial statements that omit substantially all required disclosures.

c. Incorrect. The accountant has no obligation to provide the omitted disclosures.

d. Correct. The accountant’s report must add a paragraph indicating that management elected to omit the disclosures and that if they had been included, the disclosures might have affected the user’s decisions.

3.

a. Incorrect. Identifying the contract(s) with a customer is the first step in the revenue recognition process.

b. Incorrect. Determining the transaction price is the third step in the revenue recognition process.

c. Incorrect. Identifying the performance obligations in a contract is the second step in the revenue recognition process.

d. Correct. This is not one of the five steps in the revenue recognition process. Revenue should be recognized when (or as) the entity satisfies a performance obligation.


4.

a. Incorrect. FASB ASC 842, Leases, provides several exceptions for nondepreciable assets including intangibles, biological assets, etc. as well as leases where the term is less than 12 months.

b. Incorrect. FASB ASC 842, Leases, covers all contracts in which the right to control the use of a specified asset is conveyed, for a period, in exchange for consideration.

c. Incorrect. FASB ASC 842, Leases, applies to all entities that enter into a lease.

d. Correct. Under FASB ASC 842, Leases, lessees must classify all leases as either finance or operating and must recognize a corresponding right-of-use asset and liability.

5.

a. Incorrect. Private for-profit entities have a choice among accounting frameworks, including using GAAP.

b. Incorrect. Private for-profit entities may use the Financial Reporting Framework for SMEs, but that framework is not intended for use by not-for-profit entities.

c. Correct. The FRF for SMEs requirements related to revenue recognition and lease accounting take a traditional accounting approach compared to current requirements under GAAP.

d. Incorrect. The FRF for SMEs eschew voluminous disclosure requirements.

Practice question solutions

1. This statement is true. Omitting a statement of cash flows from GAAP-basis financial statements constitutes a departure from GAAP that should be disclosed in the accountant’s report. Financial statements that are prepared in accordance with other comprehensive bases of accounting, which exclude either the balance sheet or statement of income, or present special purpose financial presentations in compliance with contractual agreements and personal financial statements, do not require a statement of cash flows.

2. The accountant is required to disclose his or her lack of independence in the compilation report. The accountant may elect, but is not required, to disclose the reason for lack of independence. However, if the accountant does elect to disclose the reason for the lack of independence, then all the reasons should be disclosed.

3. The management representation letter should cover all financial statements and all periods covered by the accountant’s review report.

Accountants should obtain a management representation letter for all review engagements. The management representation letter confirms oral representations made during the planning and performance of the review engagement and should be dated no earlier than the date of the accountant’s report. Failure to obtain the representation letter represents a scope limitation that precludes the accountant from issuing a review report. In addition, the client’s


refusal to supply a representation letter normally precludes the accountant from stepping down to a compilation service and issuing a compilation report.

The management representation letter should cover all financial statements and all periods covered by the accountant’s review report. The representation letter should be signed by those members of management whom the accountant believes are responsible for and knowledgeable about the matters covered in the representation letter. The first paragraph of the representation letter ordinarily allows management to limit its responses to his or her best knowledge and belief. Accordingly, even if management has changed over the period covered by the review engagement, current management should still provide this representation letter in order for a review report to be issued.

4. The accountant’s report should describe the accountant’s responsibility, if any, for supplementary or required supplementary information included with the financial statements. The accountant may include this in a separate paragraph in the accountant’s report or in a separate report on the supplementary information.


On the Horizon

Learning objectives

Identify standard-setting bodies and resources applicable when conducting SSARSs engagements.

Recall the future projects of AICPA’s Accounting and Review Services Committee (ARSC).

Identify current and future FASB projects.


Resources A wide variety of standard-setting bodies have provided guidance and numerous publications that may

be useful to accountants. This section identifies the standard-setting bodies as well as some of the

specific publications available.

Standard-setting bodies

Accountants performing Statements on Standards for Accounting and Review Services (SSARSs)

engagements can stay abreast of recent developments and forthcoming guidance that may affect their

engagements by reviewing the websites of various standard-setting bodies. For example, the following

websites typically provide information on outstanding exposure drafts, which can be downloaded, as well

as comments on closed exposure drafts, white papers, and so on — which may be of significant interest

to practitioners. Website information for those standard-setting bodies most likely to affect SSARSs

engagements include the following:

AICPA Auditing Standards Board (ASB) — Responsible for auditing standards for nonpublic entities. aicpa.org/research/standards/auditattest/asb.html

AICPA Accounting and Review Services Committee (ARSC) — Responsible for SSARS. aicpa.org/research/standards/compilationreview/arsc.html

AICPA Financial Reporting Executive Committee (FinREC) — Responsible for AICPA policies regarding financial reporting standards. aicpa.org/interestareas/frc/accountingfinancialreporting/finrec.html

FASB — Responsible for standards on financial accounting for nongovernmental organizations. www.fasb.org

GASB — Responsible for standards on financial accounting for U.S. state and local government. www.gasb.org

International Accounting Standards Board (IASB) — Responsible for developing International Financial Reporting Standards. www.iasb.org

Private Company Council (PCC) — Responsible for advising FASB on private company matters. www.accountingfoundation.org/jsp/Foundation/Page/FAFSectionPage&cid=1176158985794

Professional Ethics Executive Committee (PEEC) — Responsible for interpreting and enforcing the AICPA Code of Professional Conduct. aicpa.org/interestareas/professionalethics/community

Selected publications

Some of the publications available from AICPA that accountants may find helpful in performing

preparation, compilation, or review engagements include the following:

Codification of Statements on Standards for Accounting and Review Services. Available in paperback or e-book.

AICPA Guide Preparation, Compilation, and Review Engagements — 2020. Available in paperback, e-book, or online.

U.S. GAAP Financial Statements — Best Practices in Presentation and Disclosure (formerly Accounting Trends & Techniques). Available in paperback or online.

www.aicpa.org/interestareas/professionalethics/community


Financial Reporting Framework for Small- and Medium-Sized Entities. Available online at aicpa.org/content/dam/aicpa/interestareas/frc/accountingfinancialreporting/pcfr/downloadabledocuments/frf-sme/frf-smes-framework.pdf

FRF for SMEsTM toolkits: one for CPAs (https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-cpafirms.html), one for financial statement users (aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-users.html), and one for small business (aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-smallbiz.html). Available online and via e-book.

aicpa.org/content/dam/aicpa/interestareas/frc/accountingfinancialreporting/pcfr/downloadabledocuments/frf-sme/frf-smes-framework.pdf

aicpa.org/content/dam/aicpa/interestareas/frc/accountingfinancialreporting/pcfr/downloadabledocuments/frf-sme/frf-smes-framework.pdf

https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-cpafirms.html

https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-users.html

https://www.aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-users.html

aicpa.org/interestareas/frc/accountingfinancialreporting/pcfr/frf-smes-smallbiz.html


ARSC pipeline This section presents brief information about ongoing projects with particular significance to preparation,

compilation, and review engagements. Currently, the ARSC does not have any standards in public

exposure.

The ARSC is considering guidance that would help accountants perform high quality and reliable

preparation, compilation, and review engagements. At its meeting in November 2020, the ARSC

discussed specific practice issues identified through the peer review process with respect to SSARSs

engagements and considered vehicles for communicating best practices and guidance to practitioners.

Specifically, the ARSC considered the following issues:

Failure to obtain an engagement letter or a failure to include all required elements in the engagement letter

Failure to document expectations or the comparison of expectations to recorded amounts in the performance of analytical procedures in a review of financial statements

Failure to obtain appropriate management representation letters in a review of financial statements Failure to prepare compilation and review reports in accordance with AICPA Professional Standards

The ARSC posts the materials and highlights of its public meetings at www.aicpa.org/research/

standards/compilationreview/arsc/arscmeetingmaterialsandhighlights.html

http://www.aicpa.org/research/standards/compilationreview/arsc/arscmeetingmaterialsandhighlights.html

http://www.aicpa.org/research/standards/compilationreview/arsc/arscmeetingmaterialsandhighlights.html


FASB pipeline

FASB and IASB Memorandum of Understanding

On August 27, 2008, the SEC issued a press release announcing its intention to move toward mandatory

adoption of International Financial Reporting Standards (IFRS) by U.S. issuers — that is, those entities

issuing securities and subject to the Securities Exchange Act of 1934 — beginning in 2014. This

announcement came following several years of effort between FASB, the SEC, and IASB to harmonize

financial accounting and reporting. Further developments are discussed in the following section.

In September 2008, FASB and the IASB updated their Memorandum of Understanding (MoU), originally

published in 2006 to reaffirm their respective commitments to the development of high quality,

compatible accounting standards that could be used for both domestic and cross-border financial

reporting. In developing the original MoU, FASB and the IASB agreed on priorities and established

milestones as part of a joint work program to develop new common standards that improve the financial

information reported to investors. The goal of the joint projects is to produce common, principles-based

standards, subject to the required due process. In the MoU, the boards identified the following 13

convergence topics on which to focus:

Business combinations Financial instruments Financial statement presentation Intangible assets Leases Liabilities and equity distinctions Revenue recognition Consolidations Derecognition Fair value measurement Postemployment benefits (including pensions) Insurance contracts Conceptual framework

The current active joint projects in which IASB and the FASB work together as a team to create a similar,

high-quality standard include:

Business combinations, phase II (application of the purchase method) Liabilities and revenue recognition Short-term convergence Reporting comprehensive income (Financial Performance Reporting)

Most recently, convergence efforts have yielded the revenue recognition standard issued in May 2014

and the lease standard issued in February 2016.


Technical agenda items

FASB has several projects on its technical agenda varying in progress from those in the initial stages of

discussion to those pending exposure draft. In general, projects are either focused on the conceptual

framework, recognition and measurement, or presentation and disclosure. The technical agenda and the

status of each project are reflected in the following table.

Table – FASB Technical Agenda

Focus Projects Status

Fra

me

wo

rk Conceptual Framework: Measurement Initial deliberations

Conceptual Framework: Presentation Exposure draft re-deliberations

Re

co

gn

itio

n a

nd

Me

as

ure

me

nt

Identifiable Intangible Assets and Subsequent Accounting for Goodwill

Post-comment letter deliberation

Accounting by a Joint Venture for Nonmonetary Assets Contributed by Investors

Initial deliberations

Codification Improvements Initial deliberations

Codification Improvements – Amendments to Remove References to the Concepts Statements

Exposure draft re-deliberations

Codification Improvements – Financial Instruments—Credit Losses (Vintage Disclosure: Gross Write-offs and Gross Recoveries)


Codification Improvements – Hedge Accounting Exposure draft re-deliberation

Consolidation of a Not-for-Profit Entity by a For-Profit Sponsor


Consolidation Reorganization and Targeted Improvements Exposure draft re-deliberations

Distinguishing Liabilities from Equity, Part 2 Initial deliberations

Effect of Underwriter Restrictions on Fair Value Measurement Initial deliberations

Goodwill – Triggering Event Assessment Alternative for Private Companies and Not-for-Profit Entities

Pending exposure draft

Hedging – Last-of-Layer Method Initial deliberations

https://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdateExpandPage&cid=1176175678353


Table – FASB Technical Agenda

Focus Projects Status

Improving the Accounting for Asset Acquisitions and Business Combinations (Phase 3 of the Definition of a Business Project)


Leases – Targeted Improvements Comment period

PCC Issue No. 2018-01, Practical Expedient to Measure Grant-Date Fair Value of Equity-Classified Share-Based Awards

Exposure draft re-deliberation

Recognition and Measurement of Revenue Contracts With Customers Under FASB ASC 805

Pending exposure draft

Reference Rate Reforms – Hedge Accounting Initial deliberations

Reference Rate Reform – FASB ASC 848 Scope Refinement Exposure draft re-deliberations

Revenue Recognition – Contract Modifications of Licenses of Intellectual Property


Revenue Recognition – Practical Expedient for Private Company Franchisors


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Disclosure Framework: Disclosure Review – Income Taxes Revised exposure draft re-deliberations

Disclosure Framework: Disclosure Review – Inventory Exposure draft re-deliberations

Disclosure Framework: Disclosures – Interim Reporting Initial deliberations

Disclosure Improvements in Response to the SEC’s Release on Disclosure Update and Simplification


Disclosure of Supplier Finance Programs Involving Trade Payables


Disclosures by Business Entities About Government Assistance


Financial Performance Reporting – Disaggregation of Performance Information


Segment Reporting Initial deliberations

Simplifying the Balance Sheet Classification of Debt Revised exposure draft re-deliberations

https://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdateExpandPage&cid=1176172383619


FASB’s exposure drafts

FASB issued the following exposure drafts of interest that have not been issued in final form as of

December 2020:

Proposed ASU, Compensation – Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Option Awards (a Proposal of the Private Company Council)

Proposed ASU, Financial Services – Insurance (Topic 944): Effective Date and Early Application Proposed Statement of Financial Accounting Concepts, FASB Concepts Statement No. 8, Conceptual

Framework for Financial Reporting – Chapter 4: Elements of Financial Statements

Knowledge check

1. The ARSC is considering the following practice issues identified through peer reviews except:

a. Failure to obtain appropriate management representation letters in a review of financial statements.

b. Failure to disclose lack of independence in a review report. c. Failure to obtain an engagement letter or a failure to include all required elements in the

engagement letter. d. Failure to prepare compilation and review reports in accordance with AICPA Professional

Standards.

2. The memorandum of understanding (MoU) regarding a single set of high quality accounting standards was between

a. FASB and IASB. b. SEC and FASB. c. SEC and IASB. d. AICPA and IASB.

3. Which standard-setter description is not correct?

a. PCC — Interprets and enforces the AICPA Code of Professional Conduct. b. GASB — Establishes financial accounting for U.S. state and local government entities. c. ARSC — Establishes Statements on Standards for Accounting and Review Services. d. IASB — Establishes International Financial Reporting Standards.



Standard-setting bodies Future projects of ARSC FASB’s technical agenda FASB’s exposure drafts


Solutions

On the Horizon


1.

a. Incorrect. Failure to obtain appropriate management representation letters in a review of financial statements is one of the practice issues considered by the ARSC.

b. Correct. Failure to disclose a lack of independence is not one of the practice issues considered by the ARSC.

c. Incorrect. Failure to obtain an engagement letter or a failure to include all required elements in the engagement letter is one of the practice issues considered by the ARSC.

d. Incorrect. Failure to prepare compilation and review reports in accordance with AICPA Professional Standards is one of the practice issues considered by the ARSC.

2.

a. Correct. The Memorandum of Understanding (MoU) was signed by FASB and the IASB.

b. Incorrect. The SEC was not a party to the MoU.

c. Incorrect. The MoU was between the IASB and FASB, not the SEC.

d. Incorrect. The AICPA was not a party to the MoU.

3.

a. Correct. The PCC advises FASB on issues related to private companies. The PEEC interprets and enforces the AICPA Code of Conduct.

b. Incorrect. This statement is true — GASB establishes financial accounting for U.S. state and local governments.

c. Incorrect. This statement is true — The ARSC established SSARSs.

d. Incorrect. This statement is true — The IASB establishes International Financial Reporting Standards.


AR-C Glossary analytical procedures. Evaluations of financial information through analysis of plausible

relationships among both financial and nonfinancial data. Analytical procedures also encompass such investigation, as is necessary, of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

applicable financial reporting framework. The financial reporting framework adopted by management and, when appropriate, those charged with governance, in the preparation and fair presentation of the financial statements that is acceptable in view of the nature of the entity and the objective of the financial statements or that is required by law or regulation.

basic financial statements. Financial statements excluding supplementary information and required supplementary information.

comparative financial statements. A complete set of financial statements for one or more prior periods included for comparison with the financial statements of the current period.

designated accounting standard-setter. A body designated by the Council of the AICPA to promulgate accounting principles generally accepted in the United States of America pursuant to the “Compliance With Standards Rule” (ET sec. 1.310.001) and the “Accounting Principles Rule” (ET sec. 1.320.001) of the AICPA Code of Professional Conduct.

emphasis-of-matter paragraph. A paragraph included in the accountant’s review report that is required by Statements on Standards for Accounting and Review Services (SSARSs), or is included at the accountant’s discretion, and that refers to a matter appropriately presented or disclosed in the financial statements that, in the accountant’s professional judgment, is of such importance that it is fundamental to the users’ understanding of the financial statements.

engagement partner.1 The partner or other person in the firm who is responsible for the engagement and its performance and for the report that is issued on behalf of the firm and who, when required, has the appropriate authority from a professional, legal, or regulatory body.

engagement team. All accountants and staff performing the engagement and any individuals engaged by the firm who perform procedures on the engagement.

error. Mistakes in the financial statements, including arithmetical or clerical mistakes, and mistakes in the application of accounting principles, including inadequate disclosures.

1 This term is also defined in paragraph .13 of QC section 10, A Firm’s System of Quality Control, for purposes of the Statements on Quality Control Standards. Refer to QC section 10 for specific language.


experienced accountant. An individual (whether internal or external to the firm) who has practical review experience and a reasonable understanding of

a. review processes; b. SSARSs and applicable legal and regulatory requirements; c. the business environment in which the entity operates; and d. review and financial reporting issues relevant to the entity’s industry.

financial reporting framework. A set of criteria used to determine measurement, recognition, presentation, and disclosure of all material items appearing in the financial statements (for example, accounting principles generally accepted in the United States of America [U.S. GAAP], International Financial Reporting Standards promulgated by the International Accounting Standards Board, or a special purpose framework).

financial statements. A structured representation of historical financial information, including related notes, intended to communicate an entity’s economic resources and obligations at a point in time or the changes therein for a period of time in accordance with a financial reporting framework. The related notes ordinarily comprise a summary of significant accounting policies and other explanatory information. The term financial statements ordinarily refers to a complete set of financial statements as determined by the requirements of the applicable financial reporting framework but can also refer to a single financial statement.

firm. A form of organization permitted by law or regulation whose characteristics conform to resolutions of the Council of the AICPA and that is engaged in the practice of public accounting.

fraud. An intentional act that results in a misstatement in financial statements.

generally accepted accounting principles (GAAP). References to generally accepted accounting principles in SSARSs means generally accepted accounting principles promulgated by bodies designated by the Council of the AICPA pursuant to the “Compliance With Standards Rule” (ET sec. 1.310.001) and the “Accounting Principles Rule” (ET sec. 1.320.001) of the AICPA Code of Professional Conduct.

historical financial information. Information expressed in financial terms regarding a particular entity, derived primarily from that entity’s accounting system, about economic events occurring in past time periods or about economic conditions or circumstances at points in time in the past.

interpretive publications. Interpretations of SSARSs; exhibits to SSARSs; the AICPA Audit & Assurance Guide Preparation, Compilation, and Review Engagements, guidance on reviews, compilations, and engagements to prepare financial statements included in AICPA Audit and Accounting Guides; and Statements of Position, to the extent that those statements are applicable to such engagements.

management. The person(s) with executive responsibility for the conduct of the entity’s operations. For some entities, management includes some or all of those charged with governance (for example, executive members of a governance board or an owner-manager).


misstatement. A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be presented fairly in accordance with the applicable financial reporting framework. Misstatements can arise from fraud or error. Misstatements also include those adjustments of amounts, classifications, presentations, or disclosures that, in the accountant’s professional judgment, are necessary for the financial statements to be presented fairly, in all material respects.

noncompliance. Acts of omission or commission by the entity, either intentional or unintentional, which are contrary to the prevailing laws or regulations. Such acts include transactions entered into, by, or in the name of, the entity or on its behalf by those charged with governance, management, or employees. Noncompliance does not include personal misconduct (unrelated to the business activities of the entity) by those charged with governance, management, or employees of the entity.

other-matter paragraph. A paragraph included in the accountant’s review report that is required by SSARSs, or is included at the accountant’s discretion, and that refers to a matter other than those presented or disclosed in the financial statements that, in the accountant’s professional judgment, is relevant to users’ understanding of the review, the accountant’s responsibilities, or the accountant’s review report.

other preparation, compilation and review publications. Publications other than interpretive publications. These include AICPA accounting and review publications not defined as interpretive publications; the annual Developments in Review, Compilation, and Financial Statement Preparation Engagements Alert; articles addressing reviews, compilations, and engagements to prepare financial statements in the Journal of Accountancy and other professional journals; continuing professional education programs and other instruction materials, textbooks, guide books, programs for reviews, compilations, and engagements to prepare financial statements, and checklists; and other publications addressing reviews, compilations, and engagements to prepare financial statements from state CPA societies, other organizations, and individuals.

professional judgment. The application of relevant training, knowledge, and experience, within the context provided by SSARSs and ethical standards, in making informed decisions about the courses of action that are appropriate in the circumstances of the review, compilation, or engagement to prepare financial statements.

report release date. The date the accountant grants the entity permission to use the accountant’s review report in connection with the financial statements.

required supplementary information. Information that a designated accounting standards-setter requires to accompany an entity’s basic financial statements. Required supplementary information is not part of the basic financial statements; however, a designated accounting standards-setter considers the information to be an essential part of financial reporting for placing the basic financial statements in an appropriate operational, economic, or historical context. In addition, authoritative guidelines for the methods of measurement and presentation of the information have been established.


review documentation. The record of review procedures performed, relevant review evidence obtained, and conclusions the accountant reached (terms such as working papers or workpapers are also sometimes used).

review evidence. Information used by the accountant to provide a reasonable basis for obtaining limited assurance.

special purpose framework. A financial reporting framework other than GAAP that is one of the following bases of accounting:

a. Cash basis. A basis of accounting that the entity uses to record cash receipts and disbursements and modifications of the cash basis having substantial support (for example, recording depreciation on fixed assets).

b. Tax basis. A basis of accounting that the entity uses to file its tax return for the period covered by the financial statements.

c. Regulatory basis. A basis of accounting that the entity uses to comply with the requirements or financial reporting provisions of a regulatory agency to whose jurisdiction the entity is subject (for example, a basis of accounting that insurance companies use pursuant to the accounting practices prescribed or permitted by a state insurance commission).

d. Contractual basis. A basis of accounting that the entity uses to comply with an agreement between the entity and one or more third parties other than the accountant.

e. Other basis. A basis of accounting that uses a definite set of logical, reasonable criteria that is applied to all material items appearing in financial statements.

The cash-basis, tax-basis, regulatory-basis, and other-basis of accounting are commonly referred to as other comprehensive bases of accounting (OCBOA).

specified parties. The intended users of the accountant’s review report.

subsequent events. Events occurring between the date of the financial statements and the date of the accountant’s review report.

subsequently discovered facts. Facts that become known to the accountant after the date of the accountant’s review report that, had they been known to the accountant at that date, may have caused the accountant to revise the accountant’s review report.

supplementary information. Information presented outside the basic financial statements, excluding required supplementary information, that is not considered necessary for the financial statements to be fairly presented in accordance with the applicable financial reporting framework.

those charged with governance. The person(s) or organization(s) (for example, a corporate trustee) with responsibility for overseeing the strategic direction of an entity and the obligations related to the accountability of the entity. This includes overseeing the financial reporting process. Those charged with governance may include management personnel (for example, executive members of a governance board or an owner-manager).


updated report. A report issued by a continuing accountant that takes into consideration information that the accountant becomes aware of during the accountant’s current engagement and that re-expresses the accountant’s previous conclusions or, depending on the circumstances, expresses different conclusions on the financial statements of a prior period reviewed by the accountant as of the date of the accountant’s current report.

written representation. A written statement by management provided to the accountant to confirm certain matters or to support other review evidence. Written representations in this context do not include financial statements, the assertions therein, or supporting books and records.


Accounting and Auditing Glossary account. Formal record that represents, in words, money or other unit of measurement, certain

resources, claims to such resources, transactions or other events that result in changes to those resources and claims.

account payable. Amount owed to a creditor for delivered goods or completed services.

account receivable. Claim against a debtor for an uncollected amount, generally from a completed transaction of sales or services rendered.

accountants’ report. Formal document that communicates an independent accountant’s (1) expression of limited assurance on financial statements as a result of performing inquiry and analytic procedures (Review Report); (2) results of procedures performed (type of Attestation Report); (3) non-expression of opinion or any form of assurance on a presentation in the form of financial statements information that is the representation of management (Compilation Report); or (4) an opinion on an assertion made by management in accordance with the Statements on Standards for Attestation Engagements (Attestation Report). An accountant’s report does not result from the performance of an audit.

accounting. Recording and reporting of financial transactions, including the origination of the transaction, its recognition, processing, and summarization in the financial statements.

accounting change. Change in (1) an accounting principle; (2) an accounting estimate; or (3) the reporting entity. The correction of an error in previously issued financial statements is not an accounting change.

accrual basis. Method of accounting that recognizes revenue when earned, rather than when collected. Expenses are recognized when incurred rather than when paid.

accrued expense. An expense incurred during an accounting period for which payment is not due until a later accounting period. This results from the purchase of services which at the time of accounting have only been partly performed, are not yet billable, or have not been paid for.

accumulated depreciation. Total depreciation pertaining to an asset or group of assets from the time the assets were placed in service until the date of the financial statement or tax return. This total is the contra account to the related asset account.

additional paid in capital. Amounts paid for stock in excess of its par value or stated value. Also, other amounts paid by stockholders and charged to equity accounts other than capital stock.

adjusting entries. Accounting entries made at the end of an accounting period to allocate items between accounting periods.

amortization. The process of reducing a recognized liability systematically by recognizing revenues or by reducing a recognized asset systematically by recognizing expenses or costs.


In accounting for postretirement benefits, amortization also means the systematic recognition in net periodic postretirement benefit cost over several periods of amounts previously recognized in other comprehensive income, that is, gains or losses, prior service cost or credits, and any transition obligation or asset.

analytical procedures. Substantive tests of financial information which examine relationships among data as a means of obtaining evidence. Such procedures include (1) comparison of financial information with information of comparable prior periods; (2) comparison of financial information with anticipated results (e.g., forecasts); (3) study of relationships between elements of financial information that should conform to predictable patterns based on the entity’s experience; and (4) comparison of financial information with industry norms.

annual report. The annual report to shareholders is the principal document used by most public companies to disclose corporate information to their shareholders. It is usually a state-of-the-company report, including an opening letter from the Chief Executive Officer, financial data, results of continuing operations, market segment information, new product plans, subsidiary activities, and research and development activities on future programs. The Form 10-K, which must be filed with the SEC, typically contains more detailed information about the company’s financial condition than the annual report.

assertion. Explicit or implicit representations by an entity’s management that are embodied in financial statement components and for which the auditor obtains and evaluates evidential matter when forming his/her opinion on the entity’s financial statements.

audit risk. The risk that the auditor may unknowingly fail to modify appropriately his/her opinion on financial statements that are materially misstated.

audit sampling. Application of an audit procedure to less than 100% of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class.

auditors’ report. Written communication issued by an independent certified public accountant (CPA) describing the character of his/her work and the degree of responsibility taken. An auditor’s report includes a statement that the audit was conducted in accordance with generally accepted auditing standards (GAAS), which require that the auditor plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, as well as a statement that the auditor believes the audit provides a reasonable basis for his/her opinion.

bad debt. All or portion of an account, loan, or note receivable considered to be uncollectible.

balance sheet. Basic financial statement, usually accompanied by appropriate disclosures that describe the basis of accounting used in its preparation and presentation of a specified date the entity’s assets, liabilities, and the equity of its owners. Also known as a statement of financial condition.

http://www.sec.gov/answers/form10k.htm

http://www.sec.gov/answers/form10k.htm


bond. One type of long-term promissory note, frequently issued to the public as a security regulated under federal securities laws or state blue sky laws. Bonds can either be registered in the owner’s name or are issued as bearer instruments.

book value. Amount, net or contra account balances, that an asset or liability shows on the balance sheet of a company. Also known as carrying value.

business combinations. Combining of two entities. Under the purchase method of accounting, one entity is deemed to acquire another and there is a new basis of accounting for the assets and liabilities of the acquired company.

business segment. Any division of an organization authorized to operate, within prescribed or otherwise established limitations, under substantial control by its own management.

capital stock. Ownership shares of a corporation authorized by its articles of incorporation. The money value assigned to a corporation’s issued shares. The balance sheet account with the aggregate amount of the par value or stated value of all stock issued by a corporation.

capitalized cost. Expenditure identified with goods or services acquired and measured by the amount of cash paid or the market value of other property, capital stock, or services surrendered. Expenditures that are written off during two or more accounting periods.

carrying value. Amount, net or contra account balances, that an asset or liability shows on the balance sheet of a company. Also known as book value.

cash basis. A special purpose framework in which revenues and expenditures are recorded when they are received and paid.

cash equivalents. Short-term (generally less than three months), highly liquid investments that are convertible to known amounts of cash.

cash flows. Net of cash receipts and cash disbursements relating to a particular activity during a specified accounting period.

casualty loss. Sudden property loss caused by theft, accident, or natural causes.

change in engagement. A request, before the completion of the audit (review), to change the engagement to a review or compilation (compilation) of financial statements.

class actions. A federal securities class action is a court action filed on behalf of a group of shareholders under Rule 23 of the Federal Rules of Civil Procedure. Instead of each shareholder bringing an individual lawsuit, one or more shareholders bring a class action for the entire class of shareholders.

common stock. Capital stock having no preferences generally in terms of dividends, voting rights, or distributions.

companies, going public. Companies become public entities for different reasons, but usually to raise additional capital. The SEC has prepared a guide for companies – Q&A: Small Business and the SEC – that provides a basic understanding about the various ways companies can become public and what securities laws apply. The SEC also has a list of some of the


registration and reporting forms and related regulations that pertain to small and large companies.

comparative financial statement. Financial statement presentation in which the current amounts and the corresponding amounts for previous periods or dates also are shown.

compilation. Presentation in the form of financial statements information that is the representation of management (owners) without the accountant’s assurance as to conformity with generally accepted accounting principles (GAAP).

comprehensive income. Change in equity of a business entity during a period from transactions and other events and circumstances from nonowner sources. The period includes all changes in equity except those resulting from investments by owners and distributions to owners.

confirmation. Auditor’s receipt of a written or oral response from an independent third party verifying the accuracy of information requested.

consolidated financial statements. Combined financial statements of a parent company and one or more of its subsidiaries as one economic unit.

consolidation. The presentation of a single set of amounts for an entire reporting entity. Consolidation requires elimination of intra-entity transactions and balances.

contingent liability. Potential liability arising from a past transaction or a subsequent event.

continuing accountant. An accountant who has been engaged to audit, review, or compile and report on the financial statements of the current period and one or more consecutive periods immediately prior to the current period.

control risk. Measure of risk that errors exceeding a tolerable amount will not be prevented or detected by an entity’s internal controls.

controls tests. Tests directed toward the design or operation of an internal control structure policy or procedure to assess its effectiveness in preventing or detecting material misstatements in a financial report.

current asset. Asset that one can reasonably expect to convert into cash, sell, or consume in operations within a single operating cycle, or within a year if more than one cycle is completed each year.

current liability. Obligation whose liquidation is expected to require the use of existing resources classified as current assets, or the creation of other current liabilities.

current value. (1) Value of an asset at the present time as compared with the asset’s historical cost. (2) In finance, the amount determined by discounting the future revenue stream of an asset using compound interest principles.

debt. General name for money, notes, bonds, goods, or services which represent amounts owed.


definite criteria. A special purpose framework using a definite set of criteria having substantial support that is applied to all material items appearing in financial statements, such as the price-level basis of accounting.

depreciation. Expense allowance made for wear and tear on an asset over its estimated useful life.

derivatives. Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security or index. For example, a stock option is a derivative because its value changes in relation to the price movement of the underlying stock.

detection risk. Risk that the auditor will not detect a material misstatement.

disclosure. Process of divulging accounting information so that the content of financial statements is understood.

discount. Reduction from the full amount of a price or debt.

dividends. Distribution of earnings to owners of a corporation in cash, other assets of the corporation, or the corporation’s capital stock.

earnings per share (EPS). The amount of earnings attributable to each share of common stock. For convenience, the term is used to refer to either earnings or loss per share.

employee stock options plans. An employee stock ownership plan is an employee benefit plan that is described by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986 as a stock bonus plan, or combination stock bonus and money purchase pension plan, designed to invest primarily in employer stock. Also called an employee share ownership plan. Employee Stock Options Plans should not be confused with the term “ESOPs,” or Employee Stock Ownership Plans, which are retirement plans.

employee stock ownership plans (ESOPs). An employee stock ownership plan (ESOP) is a retirement plan in which the company contributes its stock to the plan for the benefit of the company’s employees. With an ESOP, you never buy or hold the stock directly. This type of plan should not be confused with employee stock options plans, which are not retirement plans. Instead, employee stock options plans give the employee the right to buy their company’s stock at a set price within a certain period of time.

equity. Residual interest in the assets of an entity that remains after deducting its liabilities. Also, the amount of a business’ total assets, less total liabilities. Also, the third section of a balance sheet, the other two being assets and liabilities.

equity security. Any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, and call options) or dispose of (for example, put options) an ownership interest in an entity at fixed or determinable prices. However, the term does not include convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.


error. Act that departs from what should be done; imprudent deviation, unintentional mistake or omission.

executive compensation: Where to find in SEC reports. The federal securities laws require clear, concise and understandable disclosure about compensation paid to CEOs and certain other high-ranking executive officers of public companies. You can locate information about executive pay in (1) the company’s annual proxy statement; (2) the company’s annual report on Form 10-K; and (3) registration statements filed by the company to register securities for sale to the public.

expenditures. Expenditures to which capitalization rates are to be applied are capitalized expenditures (net of progress payment collections) for the qualifying asset that have required the payment of cash, the transfer of other assets, or the incurring of a liability on which interest is recognized (in contrast to liabilities, such as trade payables, accruals, and retainages on which interest is not recognized).

extraordinary items. Events and transactions distinguished by their unusual nature and by the infrequency of their occurrence. Extraordinary items are reported separately, less applicable income taxes, in the entity’s statement of income or operations.

Fair Disclosure, Regulation FD. On August 15, 2000, the SEC adopted Regulation FD to address the selective disclosure of information by companies and other issuers. Regulation FD provides that when an issuer discloses material nonpublic information to certain individuals or entities – generally, securities market professionals, such as stock analysts, or holders of the issuer’s securities who may well trade on the basis of the information – the issuer must make public disclosure of that information. In this way, the new rule aims to promote the full and fair disclosure.

fair market value. Price at which property would change hands between a buyer and a seller without any compulsion to buy or sell.

federal securities laws. The laws that govern the securities industry, include the Securities Act of 1933; Securities Exchange Act of 1934; Investment Company Act of 1940; Investment Advisers Act of 1940; and Public Utility Holding Company Act of 1935.

financial statements. Presentation of financial data including balance sheets, income statements and statements of cash flow, or any supporting statement that is intended to communicate an entity’s financial position at a point in time and its results of operations for a period then ended.

first in, first out (FIFO). Accounting method of valuing inventory under which the costs of the first goods acquired are the first costs charged to expense. Commonly known as FIFO.

fiscal year. Period of 12 consecutive months chosen by an entity as its accounting period which may or may not be a calendar year.

fixed asset. Any tangible asset with a life of more than one year used in an entity’s operations.


foreign currency translation. Restating foreign currency in equivalent dollars; unrealized gains or losses are postponed and carried in Stockholder’s Equity until the foreign operation is substantially liquidated.

Form 10-K. This is the report that most publicly traded companies file with the SEC on an annual basis. It provides a comprehensive overview of the company’s business and financial condition. Some companies choose to send their Form 10-K to their shareholders instead of sending a separate annual report. Currently, Form 10-K must be filed with the SEC within 90 days after the end of the company’s fiscal year.

Form 10-Q. The Form 10-Q is a report filed quarterly by most reporting companies. It includes unaudited financial statements and provides a continuing view of the company’s financial position during the year. The report must be filed for each of the first three fiscal quarters of the company’s fiscal year and is currently due within 45 days of the close of the quarter. In addition to Form 10-Q, companies provide annual reports to their shareholders and file Form 10-K on an annual basis with the SEC.

Form 8-K. This is the “current report” used to report material events or corporate changes that have previously not been reported by the company in a quarterly report (Form 10-Q) or annual report (Form 10-K).

Forms 3, 4, 5. Corporate insiders-meaning a company’s officers and directors, and any beneficial owners of more than 10% of a class of the company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934 – must file with the SEC a statement of ownership regarding those securities. The initial filing is on Form 3. Changes in ownership are reported on Form 4. Insiders must file a Form 5 to report any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting.

fraud. Willful misrepresentation by one person of a fact inflicting damage on another person.

gain. Excess of revenues received over costs relating to a specific transaction.

general ledger. Collection of all assets, liability, owners’ equity, revenue, and expense accounts.

generally accepted accounting principles (GAAP). Conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. The highest level of such principles is set by the Financial Accounting Standards Board (FASB).

generally accepted auditing standards (GAAS). Standards set by the American Institute of Certified Public Accountants (AICPA) which concern the auditor’s professional qualities and judgment in the performance of his/her audit and in the actual report.

going concern. Assumption that a business can remain in operation long enough for all of its current plans to be carried out.

going private. A company “goes private” when it reduces the number of its shareholders to fewer than 300 and is no longer required to file reports with the SEC.


goodwill. An asset representing the future economic benefits arising from other assets acquired in a business combination or an acquisition by a not for profit entity that are not individually identified and separately recognized.

gross income. A tax term meaning all income from whatever source derived, except as otherwise provided in the income tax code.

guaranty. Legal arrangement involving a promise by one person to perform the obligations of a second person to a third person, in the event the second person fails to perform.

hedges. Protect an entity against the risk of adverse price or interest-rate movements on its assets, liabilities, or anticipated transactions. A hedge is used to avoid or reduce risks by creating a relationship by which losses on positions are counterbalanced by gains on separate positions in another market.

historical cost. The generally accepted method of accounting used in the primary financial statements that is based on measures of historical prices without restatement into units, each of which has the same general purchasing power.

income. Inflow of revenue during a period of time.

income statement. Summary of the effect of revenues and expenses over a period of time.

income tax basis. A special purpose framework that the reporting entity uses or expects to use to file its income tax return for the period covered by the financial statements.

initial public offerings (IPO). IPO stands for initial public offering and occurs when a company first sells its shares to the public.

initial public offerings, lockup agreements. Lockup agreements prohibit company insiders – including employees, their friends and family, and venture capitalists – from selling their shares for a set period of time. In other words, the shares are “locked up.” Before a company goes public, the company and its underwriter typically enter into a lockup agreement to ensure that shares owned by these insiders do not enter the public market too soon after the offering.

insider trading. “Insider trading” actually includes both legal and illegal conduct. The legal version is when corporate insiders – officers, directors, and employees – buy and sell stock in their own companies. Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.

intangible asset. Asset having no physical existence such as trademarks and patents.

interest. Payment for the use or forbearance of money.

interim financial statements. Financial statements that report the operations of an entity for less than one year.


internal control. Process designed to provide reasonable assurance regarding achievement of various management objectives such as the reliability of financial reports.

inventory. Tangible property held for sale, or materials used in a production process to make a product.

investment. Expenditure used to purchase goods or services that could produce a return to the investor.

journal. Any book containing original entries of daily financial transactions.

last in, first out (LIFO). Accounting method of valuing inventory under which the costs of the last goods acquired are the first costs charged to expense. Commonly known as LIFO.

lease. Conveyance of land, buildings, equipment, or other assets from one person (Lessor) to another (Lessee) for a specific period of time for monetary or other consideration, usually in the form of rent.

leasehold. Property interest a lessee owns in the leased property.

ledger. Any book of accounts containing the summaries of debit and credit entries.

lessee. Person or entity that has the right to use property under the terms of a lease.

lessor. Owner of property, the temporary use of which is transferred to another (lessee) under the terms of a lease.

liability. Debts or obligations owed by one entity (Debtor) to another entity (Creditor) payable in money, goods, or services.

listing and delisting requirements. Before a company can begin trading on an exchange or the Nasdaq Stock Market, it must meet certain initial requirements or “listing standards.” The exchanges and the Nasdaq Stock Market set their own standards for listing and continuing to trade. The SEC does not set listing standards. The initial listing requirements mandate that a company meet specified minimum thresholds for the number of publicly traded shares, total market value, stock price, and number of shareholders. After a company starts trading, it must continue to meet different standards set by the exchanges or the Nasdaq Stock Market. Otherwise, the company can be delisted. These continuing standards usually are less stringent than the initial listing requirements.

long-term debt. Debt with a maturity of more than one year from the current date.

loss. Excess of expenditures over revenue for a period or activity. Also, for tax purposes, an excess of basis over the amount realized in a transaction.

lower of cost or market. Valuing assets for financial reporting purposes. Ordinarily, “cost” is the purchase price of the asset and “market” refers to its current replacement cost. Generally accepted accounting principles (GAAP) requires that certain assets (e.g., inventories) be carried at the lower of cost or market.


management discussion and analysis (MD&A). SEC requirement in financial reporting for an explanation by management of significant changes in operations, assets, and liquidity.

manipulation. Manipulation is intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security. Manipulation can involve a number of techniques to affect the supply of, or demand for, a stock. They include spreading false or misleading information about a company; improperly limiting the number of publicly-available shares; or rigging quotes, prices, or trades to create a false or deceptive picture of the demand for a security.

marketable securities. Stocks and other negotiable instruments which can be easily bought and sold on either listed exchanges or over-the-counter markets.

mark-to-market. Method of valuing assets that results in adjustment of an asset’s carrying amount to its market value.

matching principle. The concept that all costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues.

materiality. Magnitude of an omission or misstatements of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would change or be influenced.

mergers. Mergers are business transactions involving the combination of two or more companies into a single entity. Most state laws require that mergers be approved by at least a majority of the company’s shareholders if the merger will have a significant impact on the company.

modified cash basis. A special purpose framework that begins with the cash basis method (see Cash basis) and applies modifications having substantial support, such as recording depreciation on fixed assets or accruing income taxes.

NASDAQ. Nasdaq stands for the National Association of Securities Dealers Automated Quotation System. Unlike the New York Stock Exchange where trades take place on an exchange, Nasdaq is an electronic stock market that uses a computerized system to provide brokers and dealers with price quotes. The National Association of Securities Dealers, Inc. owns and operates The Nasdaq Stock Market.

net assets. Excess of the value of securities owned, cash, receivables, and other assets over the liabilities of the company.

net income. Excess or deficit of total revenues and gains compared with total expenses and losses for an accounting period.

net sales. Sales at gross invoice amounts less any adjustments for returns, allowances, or discounts taken.

net worth. Similar to equity, the excess of assets over liabilities.


nonpublic entity. Any entity other than (a) one whose securities trade in a public market either on a stock exchange (domestic or foreign) or in the over-the-counter market, including securities quoted only locally or regionally; (b) one that makes a filing with a regulatory agency in preparation for the sale of any class of its securities in a public market; or (c) a subsidiary, corporate joint venture, or other entity controlled by an entity covered by (a) or (b).

no-par stock. Stock authorized to be issued but for which no par value is set in the articles of incorporation. A stated value is set by the board of directors on the issuance of this type of stock.

no-par value. Stock or bond that does not have a specific value indicated.

notional. Value assigned to assets or liabilities that is not based on cost or market (e.g., the value of a service not yet rendered).

objectivity. Emphasizing or expressing the nature of reality as it is apart from personal reflection or feelings; independence of mind.

paid in capital. Portion of the stockholders’ equity which was paid in by the stockholders, as opposed to capital arising from profitable operations.

par value. Amount per share set in the articles of incorporation of a corporation to be entered in the capital stocks account where it is left permanently and signifies a cushion of equity capital for the protection of creditors.

parent company. Company that has a controlling interest in the common stock of another.

predecessor accountant. An accountant who (a) has reported on the most recent compiled or reviewed financial statements or was engaged to perform but did not complete a compilation or review of the financial statements, and (b) has resigned, declined to stand for reappointment, or been notified that his or her services have been or may be terminated.

preferred stock. Type of capital stock that carries certain preferences over common stock, such as a prior claim on dividends and assets.

premium. (1) Excess amount paid for a bond over its face amount. (2) In insurance, the cost of specified coverage for a designated period of time.

prepaid expense. Cost incurred to acquire economically useful goods or services that are expected to be consumed in the revenue-earning process within the operating cycle.

prescribed form. Any standard preprinted form designed or adopted by the body to which it is to be submitted, for example, forms used by industry trade associations, credit agencies, banks, and governmental and regulatory bodies other than those concerned with the sale or trading of securities. A form designed or adopted by the entity whose financial statements are to be compiled is not considered to be a prescribed form.

present value. Current value of a given future cash flow stream, discounted at a given rate.

principal. Face amount of a security, exclusive of any premium or interest. The basis for interest computations.


proxy statement. The SEC requires that shareholders of a company whose securities are registered under Section 12 of the Securities Exchange Act of 1934 receive a proxy statement prior to a shareholder meeting, whether an annual or special meeting. The information contained in the statement must be filed with the SEC before soliciting a shareholder vote on the election of directors and the approval of other corporate action. Solicitations, whether by management or shareholders, must disclose all important facts about the issues on which shareholders are asked to vote.

purchase method of accounting. Accounting for a merger by adding the acquired company’s assets at the price paid for them to the acquiring company’s assets.

quiet period. The term “quiet period,” also referred to as the “waiting period,” is not defined under the federal securities laws. The quiet period extends from the time a company files a registration statement with the SEC until SEC staff declares the registration statement “effective.” During this period, the federal securities laws limit what information a company and related parties can release to the public. Rule 134 of the Securities Act of 1933 discusses these limitations.

ratio analysis. Comparison of actual or projected data for a particular company to other data for that company or industry in order to analyze trends or relationships.

real property. Land and improvements, including buildings and personal property that is permanently attached to the land or customarily transferred with the land.

receivables. Amounts of money due from customers or other debtors.

reconciliation. Comparison of two numbers to demonstrate the basis for the difference between them.

Registration Under the Securities Act of 1933. Often referred to as the “truth in securities” law, the Securities Act of 1933 has two basic objectives: (1) To require that investors receive financial and other significant information concerning securities being offered for public sale; and (2) To prohibit deceit, misrepresentations, and other fraud in the sale of securities. The SEC accomplishes these goals primarily by requiring that companies disclose important financial information through the registration of securities. This information enables investors, not the government, to make informed judgments about whether to purchase a company’s securities.

Regulation D offerings. Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D (or Reg D) provides three exemptions from the registration requirements, allowing some smaller companies to offer and sell their securities without having to register the securities with the SEC.

regulatory basis. A special purpose framework that the reporting entity uses to comply with the requirements or financial reporting provisions of a governmental regulatory agency to whose jurisdiction the entity is subject. An example is a basis of accounting insurance companies use pursuant to the rules of a state insurance commission.


reissued report. A report issued subsequent to the date of the original report that bears the same date as the original report. A reissued report may need to be revised for the effects of specific events; in these circumstances, the report should be dual-dated with the original date and a separate date that applies to the effects of such events.

related party transaction. Business or other transaction between persons who do not have an arm’s-length relationship (e.g., a relationship with independent, competing interests). The most common is between family members or controlled entities. For tax purposes, these types of transactions are generally subject to a greater level of scrutiny.

research and development (R&D). Research is a planned activity aimed at discovery of new knowledge with the hope of developing new or improved products and services. Development is the translation of research findings into a plan or design of new or improved products and services.

retained earnings. Accumulated undistributed earnings of a company retained for future needs or for future distribution to its owners.

revenue recognition. Method of determining whether or not income has met the conditions of being earned and realized or is realizable.

revenues. Sales of products, merchandise, and services; and earnings from interest, dividend, rents.

review. Accounting service that provides some assurance as to the reliability of financial information. In a review, a certified public accountant (CPA) does not conduct an examination under generally accepted auditing standards (GAAS). Instead, the accountant performs inquiry 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 for them to be in conformity with GAAP or, if applicable, with a special purpose framework.

risk management. Process of identifying and monitoring business risks in a manner that offers a risk/return relationship that is acceptable to an entity’s operating philosophy.

security. Any kind of transferable certificate of ownership including equity securities and debt securities.

short-term. Current; ordinarily due within one year.

SSARS. Statements on Standards for Accounting And Review Services issued by the AICPA Accounting and Review Services Committee (ARSC).

start-up costs. (1) Costs, excluding acquisition costs, incurred to bring a new unit into production. (2) Costs incurred to begin a business.

statement of cash flows. A statement of cash flows is one of the basic financial statements that is required as part of a complete set of financial statements prepared in conformity with generally accepted accounting principles. It categorizes net cash provided or used during a


period as operating, investing and financing activities, and reconciles beginning and ending cash and cash equivalents.

statement of financial condition. Basic financial statement, usually accompanied by appropriate disclosures that describe the basis of accounting used in its preparation and presentation as of a specified date, the entity’s assets, liabilities, and the equity of its owners. Also known as balance sheet.

statutory basis. See Regulatory basis.

straight-line depreciation. Accounting method that reflects an equal amount of wear and tear during each period of an asset’s useful life. For instance, the annual straight-line depreciation of a $10,000 asset expected to last ten years is $1,000.

strike price. Price of a financial instrument at which conversion or exercise occurs.

submission of financial statements. Presenting to a client or third party’s financial statements that the accountant has prepared either manually or through the use of computer software.

subsequent event. Material event that occurs after the end of the accounting period and before the publication of an entity’s financial statements. Such events are disclosed in the notes to the financial statements.

successor accountant. An accountant who has been invited to make a proposal for an engagement to compile or review financial statements and is considering accepting the engagement or an accountant who has accepted such an engagement.

tangible asset. Assets having a physical existence, such as cash, land, buildings, machinery, or claims on property, investments or goods in process.

tax. Charge levied by a governmental unit on income, consumption, wealth, or other basis.

third party. All parties except for members of management who are knowledgeable about the nature of the procedures applied and the basis of accounting and assumptions used in the preparation of the financial statements.

trade date. Date when a security transaction is entered into, to be settled on at a later date. Transactions involving financial instruments are generally accounted for on the trade date.

treasury bill. Short-term obligation that bears no interest and is sold at a discount.

treasury bond. Long-term obligation that matures more than five years from issuance and bears interest.

treasury note. Intermediate-term obligation that matures one to five years from issuance and bears interest.

treasury stock. Stock reacquired by the issuing company. It may be held indefinitely, retired, issued upon exercise of stock options, or resold.

trial balance. A trial balance consists of a listing of all of the general ledger accounts and their corresponding debit or credit balances. Also, in a trial balance, no attempt is made to


establish a mathematical relationship among the assets, liabilities, equity, revenues, and expenses except that total debits equal total credits.

unearned income. Payments received for services which have not yet been performed.

updated report. A report issued by a continuing accountant that takes into consideration information that he/she becomes aware of during his/her current engagement and that re-expresses his/her previous conclusions or, depending on the circumstances, expresses different conclusions on the financial statements of a prior period as of the date of his/her current report.

valuation allowance. Method of lowering or raising an object’s current value by adjusting its acquisition cost to reflect its market value by use of a contra account.

variance. Deviation or difference between an estimated value and the actual value.

work in progress. Inventory account consisting of partially completed goods awaiting completion and transfer to finished inventory.

working capital. Excess of current assets over current liabilities.

working papers. (1) Records kept by the auditor of the procedures applied, the tests performed, the information obtained, and the pertinent conclusions reached in the course of the audit. (2) Any records developed by a certified public accountant (CPA) during an audit.

yield. Return on an investment an investor receives from dividends or interest expressed as a percentage of the cost of the security.

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