May 21, 2003
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.
Peer Review and Quality Control Standards
The peer review standards determine how your peer review is conducted, while the quality control standards provide guidance on the design of your firm’s quality control system.
In prior letters we have often filled a page or two with information concerning new Peer Review and Quality Control Standards. Although the AICPA is planning to issue an exposure draft on peer review standards in late May or early June 2003, very little happened in these areas during the past year, and what did happen was on a positive note.
In our letter last year we wrote about how your firm’s licensing may affect your peer review report. You are licensed individually but many state boards require that your firm also be licensed. We reported last year that the Peer Review Board had concluded that failure to have a separate firm license is a significant departure from professional standards that would lead to a modified peer review report. In August 2002 the Peer Review Board reversed its decision and this matter no longer results in a modified peer review report.
The only Quality Control Standard issued in the past year, SQCS No. 6, was quite brief and simply clarified that deficiencies in individual audit and accounting engagements do not in and of themselves indicate that the firm’s system of quality control is inadequate.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 created the Public Company Accounting and Oversight Board (PCAOB) to oversee audits of public companies. In April 2003 the PCAOB announced its decision to independently develop both auditing and other accounting standards for firms auditing public companies. Although the Sarbanes-Oxley Act generally will not affect firms that do not audit public companies, the Act does direct state regulators such as state boards of accountancy to make an independent determination of the proper standards applicable to such firms.
New Compilation and Review Standards
Recently issued Statement on Standards for Accounting and Review Services No. 9 revises the standard wording of the management representation letter obtained in a review engagement. The new representation letter will replace the sample letter in Appendix F of SSARS No. 1. You may obtain a copy on the AICPA web site. SSARS No. 9 also includes the following revisions:
- Requires a reference in the report to the statement of comprehensive income when there is such a statement.
- Clarifies that the statement of retained earnings is not a required statement and that if it is not presented as a separate statement, reference to the omission in the report is not necessary. (Please note, however, that professional standards do require disclosure of a change in capital. This disclosure can be made in the footnotes or, when the change is limited to the retained earnings account, as part of one of the basic financial statements such as the income statement or in the equity section of the balance sheet.
- Specifically requires a signature on the report, which can be manual, stamped, electronic, or typed. This had not been addressed in SSARS previously.
- Allows for a separate report on supplementary information in a compilation engagement, consistent with the existing guidance for review engagements. Many accountants have been issuing a separate compilation report on supplementary information. If you have, you may want to make sure those reports conform to the new guidance.
- Suggested inquiries to make of the predecessor accountant when considering the acceptance of an engagement.
All of the changes under SSARS No. 9 described above have been added to the April 2003 editions of the engagement checklists used by peer reviewers.
In April 2002, the AICPA issued Interpretation No. 21 of SSARS No. 1 on the subject of controllership services. There had been some question as to whether a CPA functioning as a controller should comply with SSARS No. 1 and perform a compilation when submitting financial statements to the client. The Interpretation says that if you are in the practice of public accounting and are not a stockholder, partner, director, officer, or employee of the client, you must comply with SSARS No. 1 and issue a compilation report.
In December 2002, the AICPA issued Interpretation No. 22 of SSARS No. 1 concerning the use of the label “Selected Information – Substantially All Disclosures Required by Generally Accepted Accounting Principles Are Not Included”. The Interpretation clarifies that although the use of this label, along with disclosure in your report that management has elected to omit substantially all disclosures, is appropriate when the client wishes to “include disclosures about only a few matters,” when the client’s financial statements include “more than a few” but not all of the disclosures required by GAAP you will need to describe the omitted disclosures in the compilation or review report.
In our letter last year, when discussing new accounting standards, we described FASB 142. Under FASB 142, goodwill is not amortized. It is tested for impairment and when the fair value goes below the carrying amount goodwill is adjusted to the fair value. FASB 142 applies to existing goodwill and is effective for years beginning after December 15, 2001. If your client chooses not to implement FASB 142 because of the costs involved in determining fair value you should modify your compilation or review report to disclosure the departure. The departure might be communicated in a paragraph such as the following:
Generally accepted accounting principles require that goodwill be tested for impairment and not be amortized. Management has informed us (me) that the Company has not tested goodwill for impairment and is continuing to amortize goodwill. The effects of this departure from generally accepted accounting principles have not been determined.
New Accounting Standards
The last year has been a busy one for the standard setters. All of the standards discussed below have been added to the April 2003 editions of the engagement checklists used by peer reviewers.
A new standard likely to affect many of your engagements is SOP 01-6, Accounting by Certain Entities That Lend to or Finance the Activities of Others. The SOP requires specific disclosures for trade receivables, in particular, the policies for credit losses and doubtful accounts. This disclosure can be made through a standard note in the summary of significant accounting policies. When management has concluded an allowance for doubtful accounts is unnecessary, the following disclosure would be sufficient:
Trade accounts receivable are stated at the amount management expects to collect from balances outstanding at year end. Based on management’s assessment of the credit history with customers having outstanding balances and current relationships with them, it has concluded that realization losses on balances outstanding at year end will be immaterial.
FASB 143, Accounting for Asset Retirement Obligations, requires asset retirement obligations be recognized at fair value when incurred and when a reasonable estimate of fair value can be determined. The value determined should be capitalized by increasing the carrying value of the related long-lived asset by the amount of the liability. There are also disclosure requirements. It is effective for fiscal years beginning after June 15, 2002.
FASB 144, Accounting for the Impairment or Disposal of Long-Lived Assets, supersedes the longstanding guidance in APB Opinion No. 30. The new standard has presentation and disclosure requirements and may affect your clients if they close down a store, a division or a product line. It is effective for fiscal years beginning after December 15, 2001.
FASB 146, Accounting for Costs Associated with Exit or Disposal Activities, is effective for disposal activities initiated after December 31, 2002. Whereas FASB 144 concerns discontinuing an entire segment of an entity, FASB 146 addresses the discontinuance of an activity that is less than an entire segment. Although this standard is intended primarily to address publicly traded companies that took one-time “restructuring charges” in order to improve financial performance in subsequent periods, it may affect your clients who incur costs associated with the termination of an operating lease or who incur employee costs after operations cease but before a facility is closed. The standard describes the conditions under which a liability may be accrued and, significantly, does not permit a liability to be recorded simply because the company has made a commitment to an exit plan (as the old standard allowed).
FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, requires your clients to recognize a liability for the fair value of the obligation at the time they issue the guarantee. Interestingly, the Interpretation provides no guidance on where to post the debit side of this entry. Based on our practice, this Interpretation may apply most often to personal financial statements, where the stockholders of a closely held company guarantee the company bank debt. The debit side of the entry would not be a significant consideration if the personal financial statement engagement is limited to a statement of financial condition. Although the Interpretation applies prospectively to guarantees issued or modified after December 31, 2002, the new disclosure requirements apply to all guarantees effective for periods ending after December 15, 2002.
Firms with Audit Clients
So much is changing in this area due to the Enron and related scandals. From a peer review perspective this may be the most important thing to remember from this letter as you start your audit season: In order to ensure that your documentation and procedures meet the requirements in the new professional standards it is very important to review and revise your existing audit documentation, in particular, if you rely on a carryforward planning form or checklist form a third-party practice aid such as Practitioners Publishing Company.
As described in our letter last year, the AICPA has issued a new statement on audit working papers, SAS No. 96, that provides guidance on the nature and extent of documentation necessary to support an auditor’s report. The standard is effective for periods beginning on or after May 15, 2002.
SAS No. 99, Consideration of Fraud in a Financial Statement Audit, supercedes SAS No. 82. Your existing planning documentation insofar as fraud is concerned may meet the requirements of SAS No. 82 but procedures and documentation are expanded under SAS No. 99, which is effective for period beginning on or after December 15, 2002. Experts in the area of professional liability are encouraging early application of the provisions. Under SAS No. 99, you will be required to modify your audit program if there are any identified fraud risk factors. The option under SAS No. 82 of relying on the “canned” audit procedures to address identified risk factors is no longer available. Among other things, the new standard requires you to select general journal entries and examine the underlying support for evidence of fraud. It requires expanded inquiries of management and other employees about fraud. You may wish, for example, to inquire of staff outside of the finance department about the actions and lifestyle of finance department personnel. You need to specifically consider the financial stress of employees. All of these steps will have to be documented. SAS No. 99 also changes the wording of the management representation letter. It might be a good idea to include a course on SAS No. 99 in your continuing education plan or to obtain the related practice aid from the AICPA. The practice aid is entitled Fraud Detection in a GAAS Audit – An Auditor’s Field Guide.
Firms with Governmental Audit Clients
The AICPA has published a new Audit and Accounting Guide Audits of State and Local Governments that is effective for audits of state or local governments for the first fiscal period ending after June 15, 2003, in which the government adopts the new governmental financial reporting model required under GASB Statements No. 34 or No. 35.
On January 25, 2002, the General Accounting Office (GAO) issued its new independence rule for audits performed under Government Auditing Standards (Yellow Book audits). With this new rule, also known as amendment three to the Yellow Book, the GAO placed strict limits on what nonaudit services you can provide your governmental audit clients. The new rule appeared to prohibit an auditor from also preparing the financial statements, for example, although an Interpretation issued by the GAO in July 2002 may allow this and other common practices, such as maintenance of the depreciation schedule by the auditor, to continue. At the same time that the GAO issued the Interpretation it extended the effective date for the rule from audits for periods beginning on or after October 1, 2002, to audits for periods beginning on or after January 1, 2003.
The GAO has proposed changes to the Yellow Book beyond the independence rules discussed above and, since the changes will be comprehensive, the GAO plans to issue a revised Yellow Book that will supersede the 1994 revision, including amendments one, two and three. Perhaps the most controversial aspect to the revised Yellow Book is the requirement as described in the exposure draft that anyone on your staff (including non-CPAs) who works on a governmental audit will need to have 80 hours of continuing education in accounting and auditing (no tax) every two years. The AICPA has responded to the exposure draft and the revised Yellow Book has not yet been issued.
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:
Name of Reviewing Firm: Read & Bose, PC
AICPA Firm Number: 10083621
Team Captain’s Name: Harry Bose
AICPA Member Number: 01153765
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Please do not hesitate to contact us if you have any questions. We appreciate your business.
Very truly yours,
Read & Bose, PC