May 6, 2004
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 Ethics Interpretation
In late 2003 the AICPA issued a revision to Ethics Interpretation 101-3, Performance of Nonattest Services, which includes a major new documentation requirement.
The Interpretation is effective for nonattest services provided to attest clients after December 31, 2003. This change may affect the compilation, review, audit and other attest engagements you are performing right now.
According to the revised Interpretation, when you perform a nonattest service for an attest client you have lost your independence unless certain conditions are met.
The definition of “nonattest services” is very inclusive. It includes, for example, preparation of the client's depreciation schedule and preparation of journal entries even if management has approved the journal entries. I have confirmed these examples directly with the AICPA ethics division. The definition of “nonattest services” includes preparation of tax returns.
If you have lost your independence you can note that in your compilation report and issue the financial statements but you cannot perform review or audit engagements unless you are independent, so how do you continue to do those types of engagements?
How do you retain your independence? The client has to agree to take on certain functions in five areas, including internal control, and this agreement has to be in writing.
The understanding can be documented in a separate engagement letter that solely addresses the nonattest services, or simply in a memo in the working papers, or it can be included in the wording of the engagement letter obtained in connection with the audit, review or compilation engagement.
The AICPA has not provided sample wording to use in documenting your understanding for nonattest services.
Many of us use Practitioners Publishing Company (PPC) as a third party practice aid in our offices. Unfortunately PPC does not address this issue in its current edition of the Guide to Compilation and Review Engagements. However, in late December 2003 PPC published a "white paper" describing the new Interpretation on its web site and a sample engagement letter that includes suggested new wording.
PPC suggests that you add the following paragraph to your engagement letters for compilation and review clients:
You are responsible for management decisions and functions, and for designating a competent employee to oversee any bookkeeping services, payroll services, tax services, profit-sharing plan services, and other services we provide. You are responsible for evaluating the adequacy and results of the services performed and accepting responsibility for such services. You are responsible for establishing and maintaining internal controls, including monitoring ongoing activities.
The web address for PPC’s “white paper” is:
http://www.ppcnet.com/IntranetFiles/42693/etinterp101-3a1.pdf
The web address for PPC’s sample engagement letter is:
http://www.ppcnet.com/IntranetFiles/42689/engletter101-3.rtf
In February 2004 the AICPA Professional Ethics Executive Committee deferred until December 31, 2004 the effective date for the requirement to document in writing the understanding established with the client concerning nonattest services.
Peer Review Standards
In February 2004 the AICPA issued revised peer review standards. The effective date of the revisions is for peer reviews commencing on or after January 1, 2005. There were a number of significant revisions, among them a requirement that the firm undergoing peer review make written representations to the peer reviewer and to the state society administering the peer review. This is much like one of your audit or review clients providing you with a signed management representation letter. Under the revised standards if you are receiving a system peer review the peer reviewer cannot provide you with a list of the engagements selected for review any earlier than two weeks prior to the commencement of the review and at least one of the engagements selected cannot be identified until after commencement of the review. That engagement has to be from the firm’s highest level of service (e.g., an audit). The content and format of the system, engagement, and report review reports have all been changed, including a requirement that any significant comments in a report review be identified as such.
New Compilation and Review Standards
As discussed in our letter last year, Statement on Standards for Accounting and Review Services No. 9 issued in November 2002 revised the standard wording of the management representation letter obtained in a review engagement. In addition SSARS No. 9 requires written representations for all financial statements and periods covered by the review report. This is similar to the requirement for audits and means, for example, that if the financial statements include both the years ended December 31, 2003 and 2002, then the representation letter should address both 2003 and 2002.
SSARS Interpretation No. 25 issued in September 2003 provides guidance on compilation report wording when comprehensive income is present but both the display of comprehensive income and substantially all disclosures are omitted. If you compile financial statements that include all disclosures but omit the display of comprehensive income, the omission is reported as a GAAP departure. On the other hand, if you are omitting substantially all disclosures, you may simply note the omission of the comprehensive income in the same paragraph where you caution the financial statement user as to the omission of substantially all disclosures. The first sentence of that paragraph might read as follows: Management has elected to omit substantially all the disclosures, the statement of cash flows, and the display of comprehensive income required by generally accepted accounting principles.
In November 2003 the AICPA issued an exposure draft that will revise the guidance in SSARS No. 1 on how to conduct review engagements, including more stringent working paper documentation requirements for inquiries and analytical review procedures.
Another proposed SSARS would establish a SSARS hierarchy, similar to the existing GAAP hierarchy.
New Accounting Standards
FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, will require you to reclassify as liabilities mandatory redeemable stock, such as the stock buy-back agreements that are common in privately-held companies. However, FASB has deferred indefinitely the effective date of the portion of this standard that relates to stock buy-back agreements held by nonpublic companies. As long as there is no date fixed in the agreement for the stock redemption a liability will not have to be recorded.
FASB Interpretation No. 46, Consolidation of Variable Interest Entities, governs how business enterprises assess interests in another entity in determining whether to consolidate that entity. This Interpretation deals with Variable Interest Entities (VIEs). Many such entities are commonly referred to as Special Purpose Entities (SPEs). You will recall that Enron abused the concept of SPEs. A company may be participating in a joint venture with outside investors, for example, that may be deemed a VIE. The Interpretation is effective for fiscal years beginning after September 15, 2003.
For many years the AICPA Accounting Standards Executive Committee has been issuing Statements of Position (SOPs) on accounting and auditing matters. The AICPA has now agreed to stop issuing general-purpose accounting SOPs and to defer to FASB. The AICPA will continue to work on industry-specific audit and accounting guides.
Firms with Audit Clients
As noted in our letter last year, 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 from a third-party practice aid such as Practitioners Publishing Company.
SAS No. 99, Consideration of Fraud in a Financial Statement Audit, supercedes SAS No. 82 and is effective for periods beginning on or after December 15, 2002. 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. At a minimum SAS 99 requires you to consider whether there is improper revenue recognition and to respond to possible management override. First, you need an overall response. This response might be to assign more experienced professional staff to the audit or to introduce an element of unpredictability in your selection of audit procedures. Second, you need a response to identified risk factors. You might respond by increasing sample sizes or performing more extensive tests for unauthorized disbursements if there is a lack of segregation of duties in the cash disbursements area, for example. Finally, you are required to address the risk of material misstatement due to management override. Procedures in this area include review of adjusting journal entries and related supporting documentation, the review of management estimates for bias, and the evaluation of the business rationale for unusual transactions.
The Accounting Standards Board has issued seven proposed SASs concerning the auditor’s risk assessment process that, if adopted, would result in a new framework for the audit of nonpublic companies.
Firms with Governmental Audit Clients
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, the GAO appeared to place 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. However, in July 2002 the GAO issued an Interpretation that allows this and other common practices, such as maintenance of the depreciation schedule by the auditor, to continue as long as the auditor does not make management decisions in the process and as long as the nonaudit services are properly addressed in the management representation letter.
The documentation requirements under the new independence rule are stringent. For example, before you prepare the financial statements for a governmental audit client you will need to document the factors that led to your conclusion that this activity would not impair your independence. The safest course of action to ensure compliance is to complete the checklists on independence in your third party practice aid. There are new and expanded checklists designed to deal with this.
In June 2003 the GAO issued a revised Yellow Book that incorporated the new independence rule and made many other changes. It supersedes the 1994 edition and is effective for periods ending on or after January 1, 2004. Perhaps the most controversial aspect to the revised Yellow Book is the requirement that anyone on your staff (including non-CPAs) who works on a governmental audit will need 80 hours of continuing education in accounting and auditing (no tax) every two years. Also the GAO will become more involved with your peer review under the provisions of the new Yellow Book. Any extension of the due date for your peer review beyond three months can be granted only by the GAO and will only be granted in extraordinary circumstances. The 1994 edition of the Yellow Book required that you provide your governmental clients with a copy of your peer review report. The new Yellow Book requires submission of the letter of comments as well. There are numerous other changes and those of you involved in governmental auditing may wish to include a class on this topic in you continuing education plan.
Office of Management and Budget Circular A-133 was recently revised increasing the threshold for an A-133 Single Audit from $300,000 to $500,000 effective for fiscal years ending after December 31, 2003.
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
_____________________________
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