Certified Public Accountants
May 30, 2006
To our peer review clients:
Annually we make an effort to highlight recent changes in professional standards for our peer review clients. We hope what follows is helpful to you in your accounting and auditing practice.
New Compilation and Review Standards
There are several new Statements on Standards for Accounting and Review Services.
Statement on Standards for Accounting and Review Services No. 12 is effective for compilations and reviews of financial statements for periods ending after December 15, 2006 and provides guidance in four areas.
First, it amends SSARS No. 1 to require you to report any fraud detected during the engagement to management, even if the amount is inconsequential (inconsequential illegal acts do not have to be communicated). If you are providing a compilation service, your engagement letter wording might be revised to reflect the requirements in SSARS No. 12 as follows (similar wording would apply to a review engagement):
Second, SSARS No. 12 describes the circumstances under which the accountant's report should be restricted, such as when the presentation is on a regulatory basis or in accordance with the terms of a contractual agreement, and specifies the restricted use reporting language.
Third, it amends SSARS No. 2 to permit the successor accountant to report on the prior period when the successor accountant has written an adjusting journal entry that restates the prior year financial statements. Such a restatement adjustment has to be described in the compilation or review report.
Fourth, SSARS No. 12 amends SSARS No. 1 to provide new guidance on obtaining an updated representation letter during a review engagement.
Statement on Standards for Accounting and Review Services No. 13 is effective for engagements entered into after December 15, 2005, and allows you to compile specified elements, accounts or items of a financial statement if you wish (it does not require you to compile them).
Statement on Standards for Accounting and Review Services No. 14 is effective for engagements entered into after December 15, 2005, and allows you to compile pro forma financial information. A pro forma presentation should be appropriately labeled to differentiate it from the historical financial statements on which it is based.
New Accounting Standards
SFAS No. 150 requires recording a liability for stock buyback provisions with fixed dates and at fixed amounts (including amounts based on an external index) and is effective for periods beginning after December 15, 2004. The effective date for agreements containing variable provisions has been deferred indefinitely.
SFAS No. 153 represents a material change in the accounting for like-kind exchanges and is effective for fiscal periods beginning after June 15, 2005. Under current standards, like-kind exchanges generally do not generate capital gains except to the extent of boot received. Under the new standard capital gains will be recognized in most cases on the exchange, and the asset received in the exchange will be recorded at fair value rather than at carry over basis.
SFAS No. 154 significantly revises the presentation of a change in accounting principle and is effective for fiscal years beginning after December 15, 2005. The cumulative effect of a change from one generally accepted accounting principal to another generally accepted accounting principle has previously appeared on the statement of income. This has been the approach used to implement new standards unless the standard itself specified another method. Under SFAS No. 154, the cumulative effect adjustment will be made to the opening balance of retained earnings, similar to the accounting for a correction of an error in previously issued financial statements. A change in accounting estimate continues to be accounted for prospectively. A change in depreciation method will no longer be considered a change in accounting principle but will be deemed a change in accounting estimate.
SFAS No. 132R amends SFAS No. 132 to expand the disclosure requirements for defined benefit plans and is effective on issue. Disclosures for defined contribution and multi-employer pension plans are unaffected by this standard.
FASB Interpretation 46R may require consolidating into company financial statements assets owned by the company shareholders and is effective for the first annual period beginning after December 15, 2004. As described in our update letter last year, FIN 46R has been controversial, and has already generated six FASB Staff Positions. The most common scenario a practitioner in a local firm will face is a corporate client where, for income tax and liability reasons, the shareholders rather than the company own the real estate and possibly the equipment and lease them back to the corporation. Under FIN 46, such real estate and equipment rental companies may be classified as variable interest entities and therefore be subject to consolidation unless there are no significant mortgages outstanding on the property and unless the lease terms are at market.
If the client decides not to consolidate a VIE, where standards require consolidation, you may wish to prepare the financial statements on an income tax basis or modify your report on GAAP financial statements. The modifying paragraph on the primary beneficiary's financial statements when compiled without disclosures might read as follows:
Generally accepted accounting principles require that the Company test an entity from which the Company leases its office building, to determine whether the leasing entity is a variable interest entity that should be consolidated into the Company's financial statements. Management has informed us that the Company has not performed a test for consolidation and has not determined whether consolidation is warranted. The effects of this departure from generally accepted accounting principals on financial position and results of operations have not been determined.
FIN 46R was a response by the FASB to Enron, but applies to private as well as public companies. It may have been the tipping point for practitioners who had resisted the establishment of GAAP for private companies (the “big GAAP, little GAAP” concept). In May 2005 the AICPA issued a resolution in support of high quality GAAP for private companies. The AICPA and FASB have now formed a working group to consider implementing GAAP for private companies as distinct from GAAP for public companies.
Firms with Audit Clients
SAS No. 102 defines terminology used in professional standards and was effective upon issuance. Under the provisions of this standard, if a SAS uses the words “must” or “is required” the auditor has no option but to comply. If a SAS uses the word “should” the auditor should comply although in rare circumstances and if the justification for the departure is properly documented the auditor may apply alternative procedures.
SAS No. 103 supersedes SAS No. 96 on audit documentation and is effective for periods ending on or after December 15, 2006. This standard requires that audit documentation be sufficient to enable an “experienced auditor” having no previous connection to the engagement to understand procedures performed, audit evidence obtained and conclusions reached. This is a level of documentation comparable to that required by the GAO for governmental audits. Who performed the audit work and the date the work was completed must be documented, and who reviewed the specific audit documentation and the date of that review must be documented. Audit documentation should include the identifying characteristics of specific items tested. The auditor's report will now be dated on the date the auditor has obtained sufficient audit evidence to support the opinion (rather than on the last day of field work). The auditor will have no more than 60 days following the release of the audit report to assemble the final audit file. After that date the auditor cannot alter the audit documentation. The audit documentation must be retained for no less than five years after the report release date. (State statutes may specify a longer retention period. )
SAS No. 104 through 111 concern the auditor's risk assessment process and consideration of internal control and are effective for periods beginning on or after December 15, 2006. This “suite of SAS” provides a new framework for the audit of nonpublic companies and represents a comprehensive revision of audit standards comparable to the “expectation GAAP” SAS issued in 1988. The new SAS require improved documentation of the linkage between assessed risks and the nature, timing and extent of audit procedures performed in response to those risks. There is a new documentation requirement for materiality and tolerable misstatement. The concept of assessing risk “at the maximum” without support is eliminated. The auditor is required to determine if controls are suitably designed and if they are not to design and communicate proper controls to the client, which will encourage although not require more reliance on tests of controls. SAS No. 111 moves the guidance on sampling in SAS No. 39 from an appendix into the standards. These standards aren't effective until the 2008 audit season.
A proposed SAS will replace SAS No. 60 on communicating internal control related matters noted during the audit and will likely be issued later this year. A verbal communication will no longer be permitted. The concept of “reportable condition” will be replaced with “significant deficiency” and this will represent a lower threshold for a required communication with management.
Another proposed SAS will replace SAS No. 61 on communications with audit committees and will likely be issued later this year. If there is no audit committee or the equivalent, the auditor must now make those communications to the governing body. Significant audit findings must be communicated in writing.
Firms with Governmental Audit Clients
GASB Statement No. 42 on asset impairment, Statement No. 46 on net assets restricted by enabling legislation, and Statement No. 47 on accruing termination benefits are all effective for the fiscal years ended June 30, 2006. For those of you preparing CAFRs, Statement No. 44 on the statistical section is also effective this year.
GASB Statement No. 45 on accruing postemployment healthcare benefits isn't effective until fiscal years ended June 30, 2008 and then only for larger governmental units, but your large governmental clients should be planning to engage an actuary now.
Although revised as recently as 2003, the GAO plans to issue an updated 2006 Yellow Book by the end of the year. The new Yellow Book will include a definition of “abuse” and adds a discussion of the auditor's ethical responsibilities. There is more guidance on which nonaudit services would impair independence. The terminology for reporting deficiencies in internal control will change, to make them consistent with the proposed revision to SAS No. 60. Governmental audits will continue to utilize the AICPA auditing standards rather than adopt PCAOB standards. Peer review reports have to be made public and accelerated peer reviews are required if a firm receives a modified or adverse report. There is additional discussion that explicitly states the auditor's responsibility for detecting fraud and illegal acts. The new Yellow Book will be effective for periods ending on or after December 15, 2006.
Peer Review Standards
The AICPA established a board level task force to review the existing peer review standards and make recommendations for changes. This Task Force issued its report in February 2006, which recommends a new reporting model, the establishment of additional minimum requirements for peer reviewers, and a notification to state boards of those firms that receive a second consecutive modified or any adverse peer review report (similar to the notification requirements the Oregon State Board already has in place).
AICPA Ethics Ruling No. 112 on outsourcing will require you to make written disclosure to clients when you subcontract with another auditing firm to perform portions of the audit (e.g., inventory observation) and is effective this audit season. You will also need a written agreement with the other firm.
Our Peer Review Clients
When scheduling your peer review with the state society, the scheduling form requests information about the firm you have hired to perform the peer review. This is the information you will need if you select our firm to perform your peer review:
This letter will be posted on our award-winning home page, along with additional guidance on peer reviews. Our web site address is:
Our email address if your wish to contact us about peer review is:
Please do not hesitate to contact us if you have any questions. We appreciate your business.
Very truly yours,
Read & Bose, PC