Engagement essentials preparation, compilation, and review of financial statements

In an audit engagement, the accountant issues a report that expresses an opinion as to whether the financial statements are fairly presented, in all material respects, in accordance with

E NGAGEMENT E SSENTIALS :

Notice to Readers

Engagement Essentials: Preparation, Compilation, and Review of Financial Statements 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

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T ABLE OF C ONTENTS

Chapter 1 1-1Introduction to Preparation, Compilation, and Review Engagements 1-1

Reporting on Financial Statements 1-2Evolution of Engagements to Prepare Financial Statements 1-5Hierarchy of Standards and Guidance 1-9Quality Control in Engagements Performed Under SSARSs 1-11Peer Review 1-16Summary 1-18Practice Questions 1-20

Chapter 2 2-1Pre-engagement Considerations 2-1

Financial Statement Considerations 2-2Other Accounting Frameworks 2-4Independence and Ethics 2-8Acceptance and Continuance of Client Relationships 2-13Summary 2-17Practice Questions 2-18

Chapter 3 3-1Performing an Engagement to Prepare Financial Statements 3-1

Performance Requirements 3-5 Documentation for Engagements to Prepare Financial Statements 3-10 Summary 3-12 Practice Questions 3-13

Chapter 4 4-1 Performing Compilation Engagements 4-1

Compilation Framework and Objectives 4-2 Compilation Performance Standards 4-7 Documentation for Compilation Engagements 4-10 Summary 4-14 Practice Questions 4-15

Chapter 5 5-1 Reporting on Compilation Engagements 5-1

Standard Compilation Reports 5-2 Common Modifications to Standard Compilation Reports 5-4 Reporting on SPF Financial Statements 5-11 Summary 5-13

Chapter 6 6-1 Other Compilation Engagements 6-1

Compiling Accounts, Elements, or Items of Financial Statements 6-2 Compilation Engagements for Pro Forma Financial Information 6-4 Compilation Engagements for Prospective Financial Statements 6-8 Compilation Engagements for Interim Financial Statements 6-10 Summary 6-13

Chapter 7 7-1 Performing Review Engagements 7-1

Review General Principles and Objective 7-2

Review Performance Standards 7-7 Documentation for Review Engagements 7-15 Change in Level of Service 7-19 Summary 7-20 Practice Questions and Case Studies 7-21

Chapter 8 8-1 Inquiry and Analytical Review Procedures 8-1

Analytical Procedures 8-2 Inquiry Procedures 8-10 Summary 8-13 Cases 8-14

Chapter 9 9-1 Reporting on Review Engagements 9-1

Standard Review Reports 9-2 Some Major Differences From Compilation Engagements 9-4 Common Modifications to Standard Review Reports 9-5 Restricting the Use of Review Reports 9-15 Special Purpose Framework Financial Statements 9-17 Summary 9-19 Cases 9-20

Appendix A A-1 Illustrative Engagements Letters A-1 Appendix B B-1 Sample Compilation Reports B-1 Appendix C C-1 Sample Review Reports C-1

Glossary Glossary 1Index Index 1Solutions Solutions 1

Chapter 1 Solutions 1Chapter 2 Solutions 4Chapter 3 Solutions 6Chapter 4 Solutions 9Chapter 5 Solutions 15Chapter 6 Solutions 21Chapter 7 Solutions 23Chapter 8 Solutions 28Chapter 9 Solutions 31

Recent Developments

Users of this course material are encouraged to visit the AICPA website at www.aicpa.org/CPESupplements to access supplemental learning material reflecting recent developments that may be applicable to this course The AICPA anticipates that supplemental materials will be made available on a quarterly basis Also Financial Reporting Center which include recent standard-setting activity in the areas

of accounting and financial reporting, audit and attest, and compilation, review and preparation

available on this site are links to the various “Standards Trackers” on the AICPA’s

Chapter 1

LE ARNING OBJE CTIVE S

After completing this chapter, you should be able to do the following:

Identify the types of engagements that require a report on the financial statements

Recognize how preparation engagements have evolved

Recognize the hierarchy of guidance that applies to preparation, compilation, or review engagements Recognize the elements of a quality control system

Identify different forms of peer review

Reporting on Financial Statements

Prior to 1978, accountants engaged to report on financial statements had two options: perform an audit

of the financial statements or issue a disclaimer of opinion on the financial statements Until that time, there was no option in the literature to offer reporting services that were less in scope than an audit that provided some level of comfort to users of financial statements Accountants could, and still can, provide bookkeeping services, but those services are not subject to Statements on Standards for Accounting and

Review Services (SSARSs) With the issuance of SSARS No 1, Compilation and Review of Financial

financial statements

Reporting Options

When accountants are engaged to report on financial statements, available options include audit, review,

or compilation Each of these engagements is considered an attestation engagement in that the

accountant has been engaged to issue a report on a subject matter or assertions (financial statements) that

is the responsibility of another party (management) The services offer different levels of assurance, ranging from the reasonable assurance provided by an audit to no assurance provided by a compilation

In an audit engagement, the accountant issues a report that expresses an opinion as to whether the financial statements are fairly presented, in all material respects, in accordance with the financial reporting framework used to prepare the financial statements In order to express an opinion on the financial statements, the auditor is required to obtain reasonable assurance about whether the financial statements

as a whole are free from material misstatement The auditor obtains reasonable assurance based on a rigorous evaluation of the financial statements An audit engagement begins with a set of financial

statements that are the responsibility of management In these financial statements, management asserts that the transactions and accounts underlying the financial statements (1) exist or occurred, (2) are complete, (3) represent rights and obligations of the company, (4) are valued and allocated correctly, and (5) are presented and provide disclosure in accordance with an applicable financial reporting framework, such as generally accepted accounting principles (GAAP) In order to obtain reasonable assurance, the auditor must obtain evidence

fraud risk; testing accounting records by obtaining sufficient appropriate audit evidence through

inspection, observation, confirmation, or the examination of source documents; and others to

When an engagement requires a lesser level of assurance, a review may be appropriate The objective of a review is to obtain limited assurance as a basis for reporting whether the accountant is aware of any material modifications that should be made to the financial statements for them to be in accordance with the applicable financial reporting framework, primarily through the performance of inquiry and analytical procedures In addition to accumulating review evidence through inquiries and analytical procedures, a management representation letter is also required for a review engagement There is no requirement to

The lowest level of reporting service on financial statements is a compilation engagement An accountant performing a compilation engagement obtains no assurance on the financial statements The objective of

a compilation service is to apply accounting and financial reporting expertise to assist management in the presentation of financial statements and report in accordance with this standard without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements in order for them to be in accordance with the applicable financial reporting

framework Compilation engagements can be performed on full disclosure financial statements; financial statements that omit substantially all disclosures; and accounts, elements, or items of a financial

statement

Statements, in 1978, accountants were provided other reporting opportunities related to their clients’

evidence—through such procedures as of the entity’s internal control; assessingcorroborate management’s assertions about the financial statements

obtain an understanding of or to test the client’s internal controls

Comparison of Reporting Options

The following table highlights several of the significant differences among audit, review, and compilation engagements Most notable is the idea that increasing the level of assurance requires an increased rigor in obtaining evidence regarding the underlying assertions in the financial statements

Service Comparison

Level of assurance

that the financial

statements are not

materially misstated

CPA does not obtain

or provide any assurance that there are no material modifications that should be made to the financial statements

CPA obtains limited assurance that there are no material modifications that should be made to the financial statements

The CPA obtains reasonable (defined as high, but not

absolute) assurance about whether the financial statements are free of material misstatement

Objective To apply accounting

and financial reporting expertise to assist management in the presentation of financial statements

To obtain limited assurance as a basis for reporting whether the CPA is aware of any material modifications that should be made to the financial statements for them

to be in accordance with the applicable financial reporting framework, primarily through the

performance of inquiry and analytical procedures

To obtain reasonable assurance about whether the financial statements as a whole are free of material misstatement, thereby enabling the CPA to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework and to report on the financial statements in accordance with the

The CPA is required

to be independent No If the CPA is not independent, the CPA

is required to indicate lack of independence compilation report

auditor’s findings

in the CPA’s

Compilation Review Audit

The CPA is required

to obtain an

understanding of the

control and assess

fraud risk

The CPA is required

to perform inquiry and

The CPA issues a

formal report on the

or credit are sought,

or there is significant collateral in place

Outside parties may appreciate the with a CPA, which is readily apparent in the formal compilation report

Typically appropriate

as a business grows and is seeking larger and more complex levels of financing and credit It is also useful when business owners themselves are seeking greater confidence in their financial statements to evaluate results and make key business decisions

An audit is typically appropriate and often required when seeking complex or high levels

of financing and credit Also appropriate when seeking outside investors, seeking to sell the business, or considering a merger

Differences in cost for

each level of service Least time consuming of the services in

which the CPA issues

a formal report

More time consuming than a compilation, but substantially less than an audit

Involves the most work and, therefore, the most CPA time

entity’s internal

business’s association

Evolution of Engagements to Prepare Financial

Statements

Reporting services have continued to evolve with changes in the financial reporting landscape Over time, other changes pointed to the need for basic accounting services beyond reporting on existing financial statements

Compilation Engagements in a Changing Landscape

Until 2014, accountants were required to perform a compilation of financial statements whenever they were (1) engaged to perform a compilation or (2) when the accountant submitted financial statements to the client or third parties Submission was defined as

worked well as a trigger for the compilation service when SSARS No 1 was issued in December 1978, cloud computing and other technology applications have made it difficult to answer the question as to

who (or what) has prepared the financial statements SSARS No 21, Statements on Standards for A ccounting

and Review Services: Clarification and Recodification (AICPA, Professional Standards), issued in October 2014,

eliminated the need for the accountant to determine an answer by eliminating the submission

requirement and making the compilation literature apply only when the accountant is engaged to perform

a compilation service

SSARSs Clarity Project

In 2014, the Auditing Standards Board (ASB) completed its project to clarify the auditing literature with the issuance of Statements on Auditing Standards Nos 122

clarity project results in the first redrafting and recodification of generally accepted auditing standards since 1972 The purpose of the clarity project was to make auditing standards easier to read, understand, and apply Additional information regarding the ASB clarity project may be found on the following website: www.aicpa.org/ clarity

In May of 2010, the Accounting and Review Services Committee (ARSC) approved a similar clarity project for compilations and reviews, noting that such a project best served the public interest, such that all professional literature for audits, compilations, and reviews are drafted using the same conventions The ARSC noted that there would be certain differences between its clarity drafting conventions and those adopted by the ASB Specifically, the ARSC determined not to include specific application guidance with respect to governmental entities and smaller, less complex entities In addition, whereas the ASB used, where applicable, the corresponding International Standards on Auditing (ISA) as a base when

drafting each clarified auditing standard, the ARSC has used AU-C section 930, Interim Financial

Information (AICPA, Professional Standards), as a base for the clarified review literature AU-C section 930

was clarified using the corresponding international standard for reviews of interim financial statements as

a base (International Standard on Review Engagements [ISRE] 2410, Review of Interim Financial Information

Performed by the Independent A uditor of the Entity), and there are no substantive differences between AU-C

section 930 and ISRE 2410 The ARSC determined that it was more appropriate to converge with the corresponding limited assurance engagement guidance in the U.S auditing literature than with ISRE 2400

(Revised), E ngagements to Review Historical Financial Statements Although the ARSC has considered

International Standard on Related Services (ISRS) 4410, E ngagements to Compile Financial Statements, and has

adopted certain requirements, section 80 of SSARS No 21 has not been fully harmonized with ISRS

4410 because some of the underlying premises (for example, the requirement to determine independence) are different in the United States

“prepares and presents.” Whereas submission

122–128 between 2011 and 2014 The ASB’s

Redrafted SSARSs now reflect the following conventions for each AR-C section:

Objective According to the ASB, the objective is the foundation of the clarity project for auditing and

better reflects a principles-based approach to standard setting This section provides the context for the standard, its overall purpose, and a framework for the application of judgment in the

interpretation of the standard

Definition This section defines terms and expressions introduced in the standard for the first time, if

any

Requirements

of the standard Those presented as unconditional requirements must be followed without departure However, those presented as presumptively mandatory provide opportunity to depart from the requirement in rare circumstances in order to achieve the intent of the requirement If the accountant judges it necessary to depart from a

presumptively mandatory requirement, he or she must document the justification for departure and how the alternative procedures performed were sufficient to achieve the intent of the presumptively mandatory requirement

A pplication and other explanatory material This section uses the term may when demonstrating how

requirements may be operationalized It provides examples and other explanatory information Application and other exp

separate section that follows the requirements Other techniques such as bulleted lists are often used

to enhance readability

Final clarified standards for compilations, reviews, and engagements to prepare financial statements were issued as SSARS No 21 in October 2014 One of the final pieces of the clarity project was SSARS No

22, Compilation of Pro Forma Financial Information (AICPA, Professional Standards), which was issued in

September 2016 and is effective for compilation reports on pro forma financial information dated on or after May 1, 2017 The other final piece of the clarity project included preparation and compilation of

prospective financial information, which was included in SSARS No 23, Omnibus Statement on Standards for

A ccounting and Review Services (AICPA, Professional Standards), issued in October 2016 The standards for

preparing or compiling prospective financial information are effective for prospective financial

information prepared on or after May 1, 2017, or compilation reports on prospective financial

information dated on or after May 1, 2017 Both pro forma and prospective financial information are covered in chapter 6

Preparation of Financial Statements

AR-C section 70, Preparation of Financial Statements (AICPA, Professional Standards), provides requirements

and guidance when an accountant is engaged to prepare financial statements but is not engaged to perform an audit, review, or compilation with respect to those financial statements

The accountant may accept an engagement to prepare financial statements without considering

independence issues (because the service is a nonattest service) Once the engagement is accepted, the accountant is required to obtain an engagement letter that sets forth the nature and scope of services The engagement letter is required to be signed by the accountant (or the accounting firm) and management (or, if appropriate, those charged with governance) After the financial statements are prepared, the accountant is not required to issue a report; however, the prepared financial statements are required to include an indication on each page of the financial statements stating that the accountant provides no assurance on them If the accountant is unable to include a statement on each page of the financial statements, the accountant is required to issue a disclaimer that makes clear that no assurance is provided

on the financial statements Such financial statements can be made available to third parties

This section presents the unconditional (indicated by “must”) or presumptivelymandatory (indicated by “should”) portions

explanatory material paragraphs use an “A” prefix and are presented in a

Comparison of Engagements

types of services related to the preparation or presentation of financial statements These services may be nonattest services (such as an engagement to prepare financial statements) or attestation services (such as compilation, review or audit) Within the attestation services, the accountant may offer services that provide assurance on the financial statements (such as audit or review) or no assurance (such as the compilation engagement)

KNOWLE DGE CHE CK

1 In comparing an audit to a compilation, what should an accountant do?

a Provide reasonable assurance on audited financial statements, but no assurance on compiled financial statements

b Perform procedures such as inquiry and analytical procedures on both audit engagements and compilation engagements

c Provide reasonable assurance on audited financial statements, and limited assurance on compiled financial statements

d Provide reasonable assurance on both audited financial statements and compiled financial statements

2 What does the review engagement provide?

a Absolute assurance on the financial statements

b Reasonable assurance on the financial statements

c Limited assurance on the financial statements

d No assurance on the financial statements

In contrast to the circumstances in effect prior to 1978, today’s accountants can offer their clients several

3 Which statement about preparation and compilation engagements is accurate?

a Both compilation and preparation engagements are attest engagements

b Neither compilation nor preparation engagements provide assurance on the financial

statements

c Both compilation and preparation engagements are nonattest engagements

d Compilation engagements provide assurance on financial statements, but preparation

5 Compilation engagements were required prior to 2014 whenever the accountant did what?

a Prepared and presented financial statements

b Prepared and reviewed financial statements

c Presented and audited financial statements

d Reviewed financial statements

6 Under the SSARSs clarity project, which convention is not included in each section of SSARSs?

a Definitions

b Objectives

c Summary of main requirements

d Application and other explanatory materials

Hierarchy of Standards and Guidance

Accountants conducting preparation, compilation, or review engagements must comply with the

de of Professional Conduct and with SSARSs SSARSs are issued by the Accounting and Review Services Committee (ARSC) of the AICPA

CODE OF PROFE SSIONAL CONDUCT

e of Professional Conduct, accountants performing compilation and review

Professional Standards, ET sec

1.300.001) The

performing a compilation or review engagement:

Professional competence A member should undertake only those engagements that he or she can

reasonably expect to complete with professional competence

Due professional care A member should exercise due professional care in the performance of an

engagement

Planning and supervision A member should adequately plan and supervise an engagement

Sufficient relevant data A member should obtain sufficient relevant data to afford a reasonable basis for

conclusions or recommendations in relation to an engagement

In addition, accountants performing preparation, compilation, or review services must comply with the

Professional Standards, ET sec 1.310.001) of the AICPA

Code of Professional Conduct

who performs preparation, compilation, or review engagements to comply with standards promulgated

by the ARSC

SSARS AND INTE RPRE TATIVE PUBLICATIONS

The ARSC issues standards in the form of Statement on Standards for Accounting and Review Services

(SSARSs) These standards are codified in AICPA Professional Standards as AR-C sections 60 90 AR-C section 60, General Principles for E ngagements Performed in A ccordance with SSA RS, sets forth the requirements for preparation, compilation, and review engagements AR-C section 70, Preparation of Financial Statements, provides requirements for performing preparation engagements AR-C section 80, Compilation

E ngagements, provides requirements for conducting compilation engagements, and AR-C section 90, Review

of Financial Statements, does the same for review engagements Each of the SSARSs is covered in the

following chapters

Beyond SSARSs, there is a significant body of literature to which accountants may turn for additional guidance, ranging from interpretative publications to other publications Interpretative guidance is available is SSARS interpretations, appendixes, exhibits, the AICPA Audit and Accounting Guide series, and applicable AICPA Statements of Position These interpretative publications are not standards for accounting and review services, but are recommendations on the application of SSARSs in specific circumstances Interpretive publications are issued under the authority of the ARSC only after all ARSC

AICPA’s Code

Within the AICPA’s Code

services must comply with the “General Standards Rule” (AICPA,

“General Standards Rule” requires members to comply with the following when

“Compliance With Standards Rule” (AICPA,

The “Compliance With Standards Rule” requires any AICPA member

generally expected that accountants will apply the guidance provided in the applicable interpretative publications

When applicable guidance is not provided by SSARSs or interpretative publications, accountants may seek further guidance from other publications, including the following:

AICPA Alert Developments in Preparation, Compilation, and Review E ngagements (published annually) Articles in the Journal of A ccountancy and other professional journals

Continuing professional education programs and instructional materials

Textbooks, guide books, programs, and checklists

Other publications from state CPA societies, other organizations, and individuals

Although these other publications have no authoritative status, they may help accountants to understand and apply SSARSs Accountants are not expected, however, to be aware of the full body of other

publications relevant to preparation, compilation or review engagements

In applying the guidance obtained from other publications, accountants should exercise professional judgment when assessing the relevance and appropriateness of such guidance to the circumstances of the engagement The accountant may presume that other publications published by the AICPA that were reviewed by the AICPA Audit and Attest Standards staff are appropriate When determining whether another publication that has not been reviewed by the AICPA Audit and Attest Standards staff is

appropriate to the circumstances of the engagement, the accountant may wish to consider the degree to which the publication is recognized as being helpful in understanding and applying SSARSs and the degree to which the issuer or author is recognized as an authority in matters addressing preparation, compilation, or review engagements Other publications that have not been reviewed by the AICPA Audit and Attest Standards staff that contradict other publications that have been reviewed by the AICPA Audit and Attest Standards staff are inappropriate

KNOWLE DGE CHE CK

7 Which guidance has the highest level of authority for accountants providing preparation, compilation

or review services?

a Textbooks

d Articles published in the Journal of A ccountancy

8 When publications have no authoritative status, what should accountants NOT typically consider in determining the appropriateness of guidance?

a The degree to which the publication is recognized as being helpful in understanding and applying SSARSs

b The degree to which the client has relied on the guidance in setting up its accounting system

c The degree to which the issuer or author is recognized as an authority in the subject matter

d The degree to which the publication contradicts other publications that have been reviewed

by the AICPA Audit and Attest Standards staff

AICPA’s annual alert

Conduct, “Compliance With Standards Rule.”

Quality Control in Engagements Performed

Under SSARSs

auditing services by reducing the risks of error and noncompliance with professional standards, reducing

Quality control systems may also

increase the efficiency of delivering accounting and auditing services by standardizing operations and

documentation, thereby increasing productivity As administrative and operating procedures are clarified

be more effective

Quality Control Standards

In addition to SSARSs, AICPA members who perform engagements to prepare, compile, or review

Accountants must adopt a system of quality control in conducting an accounting practice Accordingly, firms should establish quality control policies and procedures to provide reasonable assurance that personnel comply with SSARSs in engagements to prepare, compile, or review financial statements The degree of operating aut

QC SE CTION 10

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 and the SSARSs use the same 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

Presumptively mandatory requirements are also requirements with which firms are required to comply;

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 may also increase the efficiency of delivering accounting and auditing services by standardizing operations and documentation, thereby increasing productivity As administrative and operating procedures are clarified and improved, the firm’s competitive edge and focused product strategy will be more effective

statements are governed by the AICPA’s Statements on Quality Control

nature and extent of a firm’s quality control policies and procedures may vary according to the size, degree of operating autonomy allowed to a firm’s personnel, nature of the practice, its organization, and cost-benefit considerations SQCSs establish requirements and provide guidance on a firm’s system of quality control

statements and SQCSs relate to the conduct of a firm’s accounting practice Quality controlthe accounting practice as a whole Note, however, that deficiencies in a firm’s quality control or specific

A Firm’s System of Quality Control

“must” to indicate an unconditional requirement

long as the firm documents the justification for the departure and notes how the alternative procedures

performed were sufficient to achieve the same objectives

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 to personnel its quality control policies and procedures Effective

communication will describe the policies and procedures and their associated objectives, and convey each

f quality control It is preferred, but not required, that this

communication be in writing

Elements of a System of Quality Control

following elements:

centered on quality of performing engagements That culture should be supported by policies and procedures, as well as clear and consistent messages

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

A cceptance and continuance of client relationships and specific engagements The firm should establish policies

and procedures for acceptance and continuation in order 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

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

es should provide that personnel selected for advancement have the qualifications necessary for fulfillment of the responsibilities that they will be called on to assume

E ngagement 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

inspection or a periodic review of engagement documentation, reports, and c

statements for a selection of completed engagements;

QC section 10 uses the word “should” to

firm member’s responsibility for the system of

The firm’s system of quality control must include policies and procedures addressing each of the

Leadership responsibilities for quality within the firm (the “tone at the top”).

from the firm’s management, emphasizing

the circumstances The firm’s policies and procedures

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

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

individuals

Engagement Quality Control Review

QC section 10 defines the engagement quality control review and states that firms should establish criteria against 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 th

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;

reading 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

AR-C section 60 provides additional requirements and guidance for establishing quality control at the engagement level for engagements covered by SSARSs The requirements of this SSARS section are in addition to, not in place of, the requirements set forth in QC section 10

Many of the

activities of the engagement partner The standards recognize that within each engagement, quality control assurance depends on the engagement team, for which the engagement partner ultimately takes responsibility Accordingly, the engagement partner should be competent and capable of performing the engagement This necessitates that the partner will specifically be competent in the area of financial reporting

With regard to each engagement to prepare financial statements, the engagement partner takes

responsibility for each of the following:

The overall quality of each engagement to prepare, compile, or review financial statements to which

he or she is assigned

With regard to the overall quality of the engagement, quality may be affected by actions taken by the engagement partner as well as messages sent to the engagement team The engagement partner is encouraged to reiterate the importance to overall quality of performing work that complies with

assign the performance of monitoring the firm’s system of quality control to qualified

the firm’s

Many of the SSARSs’ requirements related to quality control at the engagement level focus on specific

policies and procedures In addition, the engagement partner is encouraged to emphasize that the engagement team can raise concerns with the partner without fear of reprisals

The direction, supervision, planning, and performance of the engagement to prepare, compile or review financial statements in compliance with professional standards and applicable legal or

regulatory requirements

When considering the degree of direction, supervision, planning, and performance necessary for an engagement, the engagement partner may take into consideration the understanding and practical experience of the team with similar engagements; their understanding of professional standards and applicable legal and regulatory requirements; their technical expertise; their knowledge of relevant industries in which the client operates; their ability to apply professional judgment; and their

dence in the team increases, less oversight is required The need for oversight, however, is never fully relieved

procedures, including the following:

Confirmation that appropriate procedures regarding the acceptance and continuance of client relationships and engagements were followed, and that conclusions reached are appropriate (including the consideration of whether there is information that would lead the engagement partner to conclude that management lacks integrity)

Confirmation that the engagement team collectively has the appropriate competence and

capabilities to perform the engagement and expertise in financial reporting to

or regulatory requirements; and

Acceptance of responsibility for the maintenance of appropriate engagement documentation

Quality control standards at the engagement level remain relevant throughout the conduct of the

engagement If, for example, the engagement partner becomes aware of information that would have caused the firm to decline an engagement, the partner should communicate that information promptly to the firm for its consideration In addition, throughout the engagement, the partner should remain alert for any evidence of noncompliance by the engagement team or any relevant ethical requirements that affect the engagement If the engagement partner becomes aware of any such information, he or she should determine the appropriate action in consultation with others in the firm

In addition, the engagement partner should

aforementioned discussion of QC section 10) and whether any deficiencies noted in that information may

does not necessarily indicate that an engagement was not performed in accordance with professional standards

understanding of the firm’s quality control policies and procedures Certainly, as the engagement partner’s confidence in the team increases, less oversight is required The need for oversight,

however, is never fully relieved

The performance of the engagement in accordance with the firm’s quality control policies and

consider the results of the firm’s monitoring process (see theaffect the current engagement A deficiency noted in the firm’s system of quality control

KNOWLE DGE CHE CK

9 Which statement about QC section 10 is NOT correct?

a Accountants are encouraged to adopt a system of quality control in conducting an

accounting practice

b Firms should communicate their quality control policies and procedures to personnel

c

to a number of factors

d Firms should document their quality control policies and procedures

The nature and extent of a firm’s quality control policies and procedures may vary according

Peer Review

are performed by a peer reviewer, who is independent of the firm being reviewed, to ensure the work performed conforms to professional standards Peer reviews help to ensure the quality and effectiveness

of practices that provide accounting, auditing, and attestation services

The AICPA requires that its members (firms or individuals) enroll in an approved practice-monitoring program if they have an accounting and auditing practice The AICPA defines an accounting and auditing practice to include all engagements performed under Statements on Auditing Standards (SASs), SSARSs, Statements on Standards for Attestation Engagements (SSAEs), generally accepted government auditing standards (GAGAS) issued by the U.S Government Accountability Office, and certain engagements performed under PCAOB standards

Types of Peer Reviews

There are two types of peer reviews: system reviews and engagement reviews The purpose of a system review is to provide the reviewer with a reasonable basis for expressing an opinion as to whether (during section 10 and whether the firm was compliant with its own policies and procedures

review when the highest level of service engagements it performs, that are not subject to PCAOB

permanent inspection, include the following:

Audits under SASs or Government A uditing Standards (Yellow Book)

Examinations under SSAEs

Engagements under PCAOB standards

The system review

in effect during the peer review year The peer reviewer typically tests a

cross-engagements, focusing on engagements in various specialized, complex, or high-risk industries (such as banking, governments, employee benefit plans, and other engagements) in which there is a significant risk that the engagement was not performed or reported on in accordance with professional standards The

The purpose of an engagement review, on the other hand, is to evaluate whether engagements submitted for review are performed and reported on in conformity with applicable professional standards in all material respects Unlike a system review, the engagement review only consists of reading the financial

documentation required by professional standards If a firm performs only engagements in accordance with SSARSs or any engagements other than examinations in accordance with SSAEs (that is, not an audit or examination), that firm should have an engagement review Engagement reviews are not

available to firms that perform audits or examinations under SASs, GAGAS, SSAEs, or engagements under PCAOB standards Firms eligible for an engagement review may elect to have a system review The engagement review typically involves only one team member who performs the review off-site

Implications for Engagements to Prepare Financial Statements

When the ARSC issued SSARS No 21, it was clear that engagements to prepare financial statements are subject to quality control policies and procedures What was not clear at the time was whether such

a public accounting firm’s accounting and auditing

the year under review) the firm’s system of quality control has been designed in accordance with QC

tests a cross section of the firm’s

is designed to provide an evaluation of a firm’s quality control policies and procedures

system review involves a team that performs the review at the reviewed firm’s offices

cross-section of the firm’s

statements, or information submitted by the reviewed firm, and the associated accountant’s reports

engagements would be subject to peer review Although most state boards of accountancy require their licensees to participate in peer review, which may also be called compliance assurance, in order to

continue practicing in that state, there is some diversity among states as to whether compilation

engagements are subject to peer review For example, the Illinois state board specifically exempts firms that perform only compilation engagements from the peer review requirements The state of Arizona requires that compilations of full disclosure financial statements be subject to peer review, but excludes compilation of financial statements that omit substantially all disclosures Alternatively, firms in California and New Jersey that perform compilation engagements that do not result in a report (for example, the management-use-only option, which is no longer allowed under SSARS No 21) are not subject to peer review This is only one example of different requirements by state at the time of this writing

Practitioners should carefully consult the requirements for each state in which they operate

In January 2015, the AICPA Peer Review Board (board) approved guidance that would not require firms that perform only engagements to prepare financial statements to be enrolled in an approved peer review program However, if that same firm remains enrolled or elects to enroll, then it would be required to undergo a peer review For a system review, engagements to prepare financial statements would not be required to be selected For engagement reviews, engagements to prepare financial statements would be selected in certain circumstances Although the board felt that a user of financial statements prepared by

a CPA could inappropriately place reliance on those financial statements if they were subject to peer review, the

accountancy licensing requirements and mitigate any mobility challenges that may arise if these

engagements were not subject to peer review in some capacity

The peer review guidance related to engagements to prepare financial statements is effective for peer reviews commencing on or after February 1, 2015

b It evaluates whether engagements are performed and reported on in conformity with

applicable professional standards in all material respects

c It is required for firms whose highest level of service provided is an audit conducted under GAGAS

d

board wanted to facilitate AICPA members’ and others’ compliance with the state board of

It evaluates whether the firm’s quality controls have been designed in accordance with the

A peer reviewer tests a cross section of a firm’s engagements

Summary

We have just discussed the following points:

The differences among the types of engagements to report on financial statements

The evolution of engagements to prepare financial statements

The hierarchy of standards and guidance that apply to preparation, compilation and review

engagements

Quality control standards

Peer review types and requirements

Case 1-1

Mad Vlad is a restaurant company that owns several bar and grill locations throughout the local area In 1981, Mad Vlad retained Sherman CPA to provide accounting services to the restaurant company After several discussions with management, the entities agreed that Sherman CPA would do the following on a monthly basis:

Reconcile the bank statements

Prepare the cash to accrual-basis conversions

Prepare the depreciation calculation

Provide all adjusting entries necessary for the financial statements

During the first 10 years of their relationship (1981 1991), Mad Vlad maintained its financial records manually, using paper journals and ledgers, and monthly financial statements were not prepared Sherman CPA did prepare a full set of financial statements including disclosures at management team, but on occasion, management shared the financial statements with third parties Sherman CPA did not audit or review these financial statements

In 1991, on recommendation from Sherman CPA, Mad Vlad purchased accounting software and converted from a paper-based accounting system to an electronic-based accounting system Sherman CPA continued to provide the same monthly services as before, as well as reading monthly financial statements Sherman CPA input monthly adjustments to financial information

s software

Beginning in 2006, Mad Vlad took advantage of cloud computing to maintain and store its

financial information Sherman CPA continued to perform those same monthly services

Required

1 Should the services provided by Sherman CPA firm from 1981 to 1991 have been

performed in accordance with SSARSs?

2 Should the services provided by Sherman CPA firm from 1991 to 2006 have been

performed in accordance with SSARSs?

3 Should the services provided by Sherman CPA firm after 2006 have been performed in accordance with SSARSs?

4 In accordance with SSARS No 21, what options are available to Sherman CPA?

the end of each year These financial statements were primarily for the use of Mad Vlad’s

using Mad Vlad’s software

financial information For the first time, Sherman CPA could remotely access Mad Vlad’s

Practice Questions

1 What advantages does SSARS No 21 offer for your practice?

2 How would you explain the difference between an engagement to prepare financial statements and a compilation engagement to your existing or prospective clients?

Chapter 2

LE ARNING OBJE CTIVE S

After completing this chapter, you should be able to do the following:

Distinguish special purpose framework (SPF) financial statements from GAAP-basis financial

statements

Identify other accounting standards (frameworks) available for use in preparation, compilation, or review engagements

Identify independence issues related to preparation, compilation and review engagements

Recall the pre-engagement principles required for SSARS engagements

Identify the requirements for engagement letters

RE SOURCE S

Appendix A Illustrative Engagement Letters

Financial Statement Considerations

A financial reporting framework is a set of criteria used to determine measurement, recognition,

presentation, and disclosure of all material items appearing in the financial statements The standards of a financial reporting framework are established by an authorized or recognized standards-setting

organization The requirements of the applicable financial reporting framework determine the form and content of the financial statements Financial reporting frameworks include both U.S generally accepted accounting principles (GAAP) and special purposes frameworks (SPFs) GAAP is promulgated by FASB, the GASB, and the Federal Accounting Standard Advisory Board SPFs include other comprehensive bases of accounting (OCBOA), the contractual-basis of accounting, and International Financial

Reporting Standards issued by the International Accounting Standards Board

Management, or those charged with governance, is ultimately responsible for selec

applicable financial reporting framework as well as choosing among individual accounting policies when the framework provides acceptable alternatives

SPF FINANCIAL STATE ME NTS

Quite often, preparation, compilation, and review engagements are performed on financial statements presented in accordance with an SPF As noted above, SPFs include a number of common bases,

regulatory basis, contractual basis and any other basis having substantial support This section provides

an overview of the financial statement differences between GAAP and SPF financial statements

Reporting on SPF financial statements is covered separately in the reporting chapters for preparation, compilation and review

Titles of Financial Statements

One of the first significant differences in reporting on SPF financial statements is that the financial statements do not purport to present financial position or results of operations in accordance with GAAP Accordingly, the financial statement captions or titles should be modified so as not to refer to balance sheets, income statements, and so on In addition, the basis being used should be identified in the statement title Current standards recommend the following titles:

Statement of Assets, Liabilities, and Equity _Basis

Balance Sheet _ Basis

Income Statement Basis

Statement of Revenues and Expenses _ Basis

Statement of Revenues, Expenses, and Retained Earnin

_ Basis

Statement of Retained Earnings _ Basis

_ Basis Statement of Cash Flows _ Basis

A complete set of financial statements prepared in accordance with an SPF will typically include a

statement of retained earnings or appropriate disclosure The presentation of the statement of cash flows

is, however, optional

selecting the entity’s

Retained Earnings (Partners’ Capital, Proprietor’s Capital) –Statement of Changes in Stockholders’ Equity (Partners’ Capital, Proprietor’s Capital) –

Footnote Disclosures

AU-C section 800, Special Considerations A udits of Financial Statements Prepared in A ccordance With Special

Purpose Frameworks (AICPA, Professional Standards), indicates that cash-, modified cash-, and income

tax-basis financial statements should be informative of matters that may affect their use, understanding, and interpretation Essentially, this means that SPF financial statements typically require the same level of disclosure as GAAP-basis financial statements:

If financial statement items that are the same as, or similar to, those in GAAP-basis financial

statements, the SPF financial statements should provide the relevant disclosure or provide

information that communicates the substance of the disclosure

If GAAP requirements apply to the presentation of financial statements, SPF financial statements should either comply with those requirements or provide information that communicates the

substance of those requirements

If GAAP requires disclosures of other matters, the accountant should consider the need for the same disclosure or one that communicates the substance of the disclosure

SPF financial statements should provide a summary of significant accounting policies that describes the basis of presentation and how that basis differs from GAAP This description can be brief, for example:

Cash Basis The basis of cash receipts and disbursements

Modified Cash Basis The basis of cash receipts and disbursements with some liabilities recorded Income Tax Basis The basis of accounting used for federal income tax reporting

As for describing the primary differences between the SPF and GAAP-basis financial statements, the description can be limited to those that have a material effect on the financial statements For example, for financial statements presented in accordance with the tax-basis of accounting, these disclosures might include that depreciation is calculated using tax methods and uncollectible accounts are recognized only when they become uncollectible Quantifying the effects of those differences is not required

KNOWLE DGE CHE CK

1 Which are NOT considered SPF financial statements?

a Income tax-basis financial statements

b Cash-basis financial statements

c Modified cash-basis financial statements

d GAAP basis financial statements

2 What should SPF financial statements include?

a A title such as Balance Sheet or Income Statement

b

c A description of the primary differences between the SPF and GAAP-basis financial

statements

d Only special footnotes required by the SPF

A description of management’s reasons for selecting the basis

Other Accounting Frameworks

In the past, when private, for-profit entities have sought an accounting framework that is less

modified-cash basis, tax basis, and so on In recent years, however, new accounting frameworks have become available to meet the financial reporting needs of these entities Two of those options are

described in the following sections In response, FASB has incorporated the recommendations of the Private Company Council (PCC) to provide modifications to GAAP that are responsive to the needs of these smaller, private, for-profit entities Although these modifications are actually GAAP, rather than another framework, this option is included in this section with a discussion of other frameworks

FINANCIAL REPORTING FRAME WORK FOR SMALL- AND

ME DIUM-SIZE D ENTITIE S

In 2013, the AICPA published the Financial Reporting Framework for Small- and Medium-Sized Entities

-contained SPF intended for use by private, for-profit, small- and medium-sized entities 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 by considering the context and minimizing 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 AICPA developed the FRF for SMEs accounting framework for small- to medium-sized entities that previously required non-GAAP financial statements for either internal or external users There is no standard definition of what constitutes a small- or medium-sized entity, so the decision regarding whether

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 based financial statements

GAAP-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

found among the SPF’s

(FRF for SMEs™ accounting framework), a self-contained

this framework best meets an entity’s reporting

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 owe

The entity does not operate in an industry such as financial 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 t

s may have greater interest in cash flows, liquidity, statement

of financial position, strength, and interest coverage

s support applications for bank financing when the banker does not base a lending decision solely on the financial statements, but also on 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 AICPA staff and the task force that created this framework plan to monitor and assess input on the framework after its initial release and propose modifications as necessary Because of the limited

accounting resources typically available to the entities that would use this framework, it is intended to be

a stable platform that does not undergo frequent amending or updating

The AICPA has developed free toolkits to help CPAs and CPA firms, users, and small businesses learn more about the FRF for SMEs accounting framework option

IFRS AND IFRS FOR SMES

Because the AICPA Governing Council has recognized IASB as an accounting body for purposes of establishing international financial accounting and reporting standards, AICPA members have the option

to use IFRS, as well as, IFRS for SMEs, as an alternative to GAAP Accordingly, private companies may consider whether IFRS or IFRS for SMEs are a more appropriate reporting option than GAAP The authors suggest, however, that practitioners should proceed with caution Although these standards have been recognized by the AICPA, there are still significant issues to be addressed, such as the costs of conversion, the impact on taxes and tax planning strategies, and the willingness of users of a private

s to accept IFRS or IFRS for SMEs In addition, practitioners should also check with their state boards of accountancy to determine the status of reporting on financial statements prepared in accordance with IFRS for SMEs within their state

IFRS for SMEs (fewer than 300 pages) is a simplified version of IFRS The guidance resulted from an overall cost-benefit analysis by the IASB in considering the needs of non-publicly accountable entities and their financial reporting users, with the goal of providing a practical alternative to IFRS As a result of this analysis, the IASB eased certain recognition and measurement requirements, simplified accounting treatments, and reduced disclosure requirements In addition, the IASB limited revisions to IFRS for SMEs to once every three years These simplifications provide a version of IFRS that is less costly to implement than IFRS, and perhaps more relevant to users Some of the key concepts under IFRS for SMEs that do not exist under GAAP include the following:

Disclosures are simplified in a number of areas, including pensions, leases, and financial instruments LIFO is prohibited

Key users of the entity’s financial statements have direct access to the entity’s management

Users of the entity’s financial statements

The entity’s financial statements

company’s financial statements

Depreciation is based on a components approach

The temporary difference approach to income tax accounting is simplified

Reversal of impairment charges, if certain criteria are met, is allowed

Accounting for financial assets and liabilities makes greater use of cost

FASB AND THE PRIVATE COMPANY COUNCIL

In May 2012, the Financial Accounting Foundation (FAF) created the PCC, a 9 12 member board selected and appointed by FAF The charge of the PCC is to determine whether GAAP is appropriate for private company users and to act as a primary advisory board to FASB if changes to GAAP for private companies are considered appropriate If FASB agrees with the proposals of the PCC, then FASB will proceed to expose, discuss, and finalize these projects in accordance with its existing process Any changes resulting from this process then are considered GAAP

Since 2013, FASB has endorsed several alternatives to GAAP that were proposed by the PCC These proposals involve accounting for intangible assets acquired in business combinations and applying variable interest entity (VIE) guidance to common control leasing arrangements, goodwill, and certain types of interest rate swaps All were issued in final form in 2014

KNOWLE DGE CHE CK

3 For what is the PCC responsible?

a Publishing a self-contained SPF, such as the FRF for SMEs framework

b Advising FASB if changes to GAAP for private companies are considered appropriate

c Publishing a self-contained IFRS for SMEs, which is a simplified version of IFRS

d Publishing changes to GAAP for private companies as considered appropriate

FINANCIAL STATE ME NT OR FINANCIAL INFORMATION

Accountants may be engaged to perform preparation, compilation, or review engagements on complete sets of financial statements or information included in the financial statements that may be useful for the decision-making process This information may include individual financial statements, specified

elements, accounts, or items of a financial statement For example, management may engage an

accountant to prepare, compile, or review schedules of rentals, royalties, profit participation or provisions for income taxes

Accountants may also be engaged to prepare, compile, or review supplementary information and required supplementary information The SSARSs distinguish between supplementary and required supplementary information Required supplementary information is required by a designated accounting standard setter (such as FASB, GASB, the Federal Accounting Standards Advisory Board, or the International

Accounting Standards Board) Supplementary information is that which management has chosen to include with the financial statements

Accountants can also prepare or compile pro forma or prospective financial information Note that accountants may not perform a review engagement on pro forma or prospective financial information Pro forma financial information is historical information to which the anticipated effects of a future transaction or event have been added In other words, pro forma financial information demonstrates what would happen to the historical financial statements if a specific event(s) occurs Typical uses of pro forma financial information are 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 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 chapter 6) but may also be referred to as feasibility studies, break-even analysis, and budgets Partial presentations that exclude one

or more relevant elements are also allowed

KNOWLE DGE CHE CK

4 What is true of accountants?

a They prepare or compile a schedule of rents, but they may not review it

b They may not compile a single financial statement, such as a Balance Sheet

c They may not review pro forma information

d They may compile or review supplementary information, but they may not prepare it

Independence and Ethics

Engagements to prepare, compile, or review financial statements must be conducted in accordance with

of the more complicated issues has to do with independence Although the preparation of financial statements is a nonattest service that does not require accountants to be or even to consider whether they are independent, compilation, review, and audit are attestation engagements for which the consideration

of independence is important When independence is impaired in an attestation engagement, accountants

(a) must disclose a lack of independence for compilation engagements, (b) are precluded from issuing a review report, and (c) may issue only a disclaimer of opinion on audited financial statements In addition,

accounting firms that prepare financial statements also often offer reporting services such as

compilations, reviews, and audits If a client were to request a change in service, the accountant would need to understand any related independence considerations The following sections present information about the recent changes to the code, including the conceptual framework, and independence issues related to nonattest services

AICPA ETHICS CODIFICATION PROJE CT

Changes to the code are proposed and adopted by the Professional Ethics Executive Committee (PEEC)

In January of 2014, the PEEC adopted the final version of the revised code that resulted from a six-year project to reorganize and reformat the code The new structure is intended to be easier for members to use and will allow them to reach correct conclusions more quickly and intuitively

During the course of reorganizing and reformatting the code, several sections were redrafted to clarify the existing guidance Some of the existing guidance was expanded to make it broader and more

understandable

All preexisting ethics rulings were either incorporated into ethics interpretations or proposed for deletion These rulings have historically been drafted in a question and answer format, covering a very narrow and specific set of facts In the revised code, all rulings were redrafted as interpretations that are broader in scope and intended to be more informative The reformatted 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 users

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 into

subtopics, which are then broken down into sections, with each subsequent level providing more specific information to the user A link to any nonauthoritative information that is applicable to the topic,

Professional Ethics Division staff has developed a mappi

understanding of where to find various matters in the revised code by showing links cross referenced to the former code

the ethical requirements of the AICPA’s Code of Professional Conduct (the code) Within the code, one

subtopic, or section is shown in boxed text at the end of the applicable standard The AICPA’s

Professional Ethics Division staff has developed a mapping document that will assist members’

The effective date of the revised code was December 15, 2014, and the effective date of the new

conceptual frameworks was December 15, 2015 Members are permitted to implement both the revised code and the conceptual frameworks prior to their effective dates; however, the PEEC decided that members should not implement the relevant conceptual framework prior to implementing the revised code

One of the more complex issues related to independence results from the provision of nonattest services

to an attestation client Recall that audit, review, and compilation are attestation services in which the accountant must either be independent (audit or review) or disclose any impairment (compilation) Often, however, accountants also provide nonattest services to their attestation clients; these services may include preparing the financial statements When nonattest services are provided to attestation clients, the accountant must consider whether these nonattest services have impaired independence

Independence Rule (ET sec 1.200.001) states the following:

When a member performs a nonattest service for an attest client, threats

with the Independence Rule [1.200.001] may exist Unless an interpretation of the Nonattest Services subtopic [1.295] under the Independence Rule states otherwise, threats would be at an

acceptable level, and independence would not be impaired, when all of the following safeguards are met:

a The member determines that the attest client and its management agree to

i assume all management responsibilities as described in the Management Responsibilities interpretation [1.295.030]

ii oversee the service, by designating an individual, preferably within senior management, who possesses suitable skill, knowledge, and experience The member should assess and be satisfied that such individual understands the services to be performed sufficiently to oversee them However, the individual is not required to possess the expertise to perform

or re-perform the services

iii evaluate the adequacy and results of the services performed

iv accept responsibility for the results of the services

b The member does not assume management responsibilities (See the Management

Responsibilities interpretation [1.295.030] of the Independence Rule ) when providing

nonattest services and the member is satisfied that the attest client and its management will

i be able to meet all of the criteria delineated in item a;

ii

iii accept responsibility for making the significant judgments and decisions that are the proper responsibility of management

If the attest client is unable or unwilling to assume these responsibilities (for example, the attest

client cannot oversee the nonattest services provided or is unwilling to carry out such responsibilities

onattest services would impair

independence

to the member’s compliance

make an informed judgment on the results of the member’s nonattest services; and

due to lack of time or desire), the member’s performance of nonattest

c Before performing nonattest services the member establishes and documents in writing his or

her understanding with the attest client (board of directors, audit committee, or management, as

appropriate in the circumstances) regarding

i objectives of the engagement,

ii services to be performed,

iv

v any limitations of the engagement

Because accountants must consider their independence when performing a compilation or review

engagement, it is important to examine some of the items that typically impair independence Examples

of activities that would be considered management responsibilities and, as such, impair independence if performed for an attest client, include

setting policy or strategic direction for the attest client

permitted when using internal auditors to provide assistance for services performed under auditing or attestation standards

authorizing, executing, or consummating transactions, or otherwise exercising authority on behalf of

an attest client or having the authority to do so

preparing source documents, in electronic or other form, that evidence the occurrence of a

transaction

deciding which recommendations of the member or other third parties to implement or prioritize reporting to those charged with governance on behalf of management

statements in accordance with the applicable financial reporting framework

accepting responsibility for designing, implementing, or maintaining internal control

activities

Revisions to the Nonattest Services Interpretation

Recently, the PEEC adopted some significant revisions to its interpretations on nonattest services that after December 15, 2014, financial statement preparation, cash-to-accrual conversions, and

reconciliations are considered nonattest services even if performed while performing an attest

engagement As such, to maintain independence when performing these nonattest services, the

provisions of the Nonattest Services subtopic of the Independence Rule must be applied

The interpretations under the Nonattest Services subtopic provide guidance to accountants concerning the performance of certain services that could impair independence It has also been revised numerous times to address new or changing practice issues Although the guidance in these interpretations has focused on various types of engagements and activities, it has not contained any requirements or specific guidance on the effect that multiple nonattest engagements might have on independence In August

2013, the PEEC approved a significant change to the interpretation that will now require an accountant performing multiple permitted nonattest services or engagements The new requirement was effective for engagements covering periods beginning on or after December 15, 2014

may affect an accountant’s independence Effective for engagements covering periods beginning on or

to consider the cumulative effect on independence that arises from an accountant or an accountant’s firm

Conceptual Framework for Independence Standards

Since 2006, the code has included a Conceptual Framework for AICPA Independence Standards, which is used by members when considering independence matters not specifically addressed in the code The existing conceptual framework, which is based on the risk-based approach that the PEEC and other standard setters typically apply in developing independence standards, was carried forward into the revised code The risk-based approach entails evaluating the threats that the member would not be independent, or that the member would be perceived as not independent, by a reasonable and informed third party with knowledge of all relevant information It requires the following three steps:

Identify and evaluate potential threats to independence and determine whether those threats are at an acceptable level

Where such threats are not at an acceptable level, the member must consider and apply appropriate safeguards to eliminate the threats or reduce them to an acceptable level

If no safeguards are available to eliminate an unacceptable threat or reduce it to an acceptable level, independence would be considered impaired

The code defines safeguards as actions or other measures that may eliminate a threat or reduce a threat

to an acceptable level

The PEEC decided that it would be helpful if the code contained guidance on how to address

relationships or circumstances that are not addressed in the code, but that give rise to threats to rules other than independence As a result, the PEEC developed two new conceptual frameworks: one for members in business and another for members in public practice Both of these new frameworks are to

be used only in situations for which the revised code does not contain specific guidance Failure to apply the conceptual framework in those circumstances will be considered a failure to comply with the code

Cumulative Effect on Independence of Nonattest Services

Accountants are also required to consider the cumulative effect on independence when CPAs provide multiple nonattest services Some nonattest services performed individually would not impair

independence because the safeguards discussed in the preceding section reduce the self-review and management participation threats to an acceptable level However, performing multiple nonattest services can increase the significance of these threats as well as other threats to independence

Before agreeing to perform nonattest services, accountants should evaluate whether the performance of multiple nonattest services in the aggregate creates a significant threat to their independence that cannot

be reduced to an acceptable level by the application of appropriate safeguards When the accountant determines that threats are not at an acceptable level, safeguards in addition to the general requirements

of this subtopic should be applied to eliminate the threats or reduce them to an acceptable level If no safeguards are available to eliminate or reduce the threats to an acceptable level, independence is

impaired

Note that accountants are not required to consider the possible threats created due to the provision of

Period in Which Independence is Impaired

Recently, the PEEC revised the requirements with respect to the period in which independence would be impaired if an accountant provided a prohibited nonattest service According to paragraph 03 of the Scope and Applicability of Nonattest Services

independence would not be impaired if the he or she performed nonattest services that would have nonattest services by other network firms within the member’s firm’s network

“Scope and Applicability of Nonattest Services” interpretation (ET sec 1.295.010), an accountant’s

impaired independence during the period covered by the financial statements, provided all of the

following conditions are met:

The nonattest services were provided prior to the period of the professional engagement

The nonattest services related to periods prior to the period covered by the financial statements The financial statements for the period to which the nonattest services relate were audited by another firm (or in the case of a review engagement, reviewed or audited by another firm)

KNOWLE DGE CHE CK

a Assuming management responsibilities will impair independence

b Exercising authority on behalf of the client does not impair independence

a The accountant must disclose all nonattest services

b The accountant must not perform management functions

c The accountant and client do not need to have an understanding (in writing) before

performing the nonattest services

d The accountant may supervise client employees performing their normal recurring activities

Which statement is correct regarding an accountant’s independence?

Having custody of the client’s assets does not impair the accountant’s independence

performed in the accountant’s report

Acceptance and Continuance of Client Relationships

AR-C section 60, General Principles for Engagements Performed in A ccordance with Statements on Standards for

A ccounting and Review Services (AICPA, Professional Standards), provides general principles for any SSARS

engagement Whether accountants are preparing, compiling, or reviewing financial statements, one of the first decisions to be made is whether to accept or continue a client relationship

PRE CONDITIONS FOR ACCE PTING OR CONTINUING AN ENGAGE ME NT TO

PRE PARE FINANCIAL STATE ME NTS

The decision to accept or continue a client relationship begins by weeding out those relationships that are not in the best interests of the firm or client Accountants should not accept or continue client

relationships if

the accountant has reason to believe that relevant ethical requirements will not be satisfied;

ircumstances indicates that information needed to perform the engagement is likely to be unavailable or unreliable; or

performance of the engagement

As a condition for accepting an engagement, the accountant should

determine whether preliminary knowledge of the engagement circumstances indicate that ethical requirements regarding professional competence will be satisfied

determine whether the financial reporting framework selected by management to be applied in the preparation of the financial statements is acceptable

obtain the agreement of management that it acknowledges and understands its responsibility

for the selection of the financial reporting framework to be applied in the preparation of

for preventing and detecting fraud

for ensuring that the entity complies with laws and regulations applicable to its activities

for the accuracy and completeness of the records, documents, explanations, and other

information, including significant judgments provided by management for the preparation of financial statements

to provide the accountant with

preparation and fair presentation of the financial statements, such as records, documentation, and other matters

purpose of the engagement

necessary to make inquiries

the accountant’s preliminary understanding of the engagement circumstances indicates that

the accountant has cause to doubt management’s integrity such that it is likely to affect the

It is worth noting that, particularly in smaller organizations, management may not be well-informed about its responsibilities Under those circumstances, the accountant may need to educate management about

In addition, for compilation or review engagements, management should agree that it acknowledges and understands its specific responsibilities:

Preparing and presenting the financial statements in accordance with the applicable financial

reporting framework and including all informative disclosures that are appropriate for the framework

accordance with a special purpose framework (SPF), this includes

a description of the SPF, including a summary of significant accounting policies and how the framework differs from U.S generally accepted accounting principles (GAAP), and informative disclosures similar to those required by GAAP if the SPF contains items that are the same as, or similar to, those prepared in accordance with GAAP

a description of any significant interpretation of the contract on which the SPF statements are prepared in the case of financial statements prepared in accordance with a contractual basis of accounting

additional disclosures beyond those specifically required by the framework that may be necessary for the special purpose framework to achieve fair presentation

o

financial statements that indicate that the financial statements have been compiled or

s accountant unless a different understanding is reached

should not accept or continue the engagement

E NGAGE ME NT LE TTE RS

For any preparation, compilation, or review engagement, the accountant is required to reach and

document an agreement about the terms of the engagement with the client The SSARSs require that the accountant and client agree upon the terms of the engagement and document that agreement in writing The SSARSs are very clear that an oral understanding between the accountant and client is not sufficient The written agreement is most commonly documented in the form of an engagement letter, but a formal contract is also suitable The written engagement letter helps avoid client misunderstandings, clearly indicates the scope of the engagement, reduces the potential legal liability, improves practice

management, and clarifies the contractual obligation between the accountant and client

Typically, a new engagement letter would be obtained annually, covering the services to be performed The authors believe that this is the best way to manage the risk that the understanding with the client has diminished over time or that the engagement is seen as continuous from a legal perspective

statements In that case, although the third party may sign the engagement letter, the accountant is still management to sign the engagement letter

SSARSs also require that the engagement letter or other written agreement be signed by the accountant

its responsibilities prior to obtaining management’s agreement on those responsibilities

the entity’s

Including the accountant’s compilation or review report in any document containingreviewed by the entity’s

If any of the aforementioned conditions are not met to the accountant’s satisfaction, the accountant

Under some circumstances, a third party may contract for an engagement to prepare an entity’s financialrequired to obtain management’s agreement to the terms of the engagement and would need

(or the accountant’s firm) and management or those charged with governance, as appropriate