AICPA’s Accounting and Review Services Committee (ARSC) issued Statement on Standards for Accounting and Review Services (SSARS) No. 21 in October 2014. This Standard marked the conclusion of the ARSC’s Clarity Project, which clarified and modified existing standards covering the performance of review and compilation engagements for historic financial statements.
Most significantly, SSARS No. 21 introduced engagements to prepare financial statements. SSARS No. 21’s introduction of the preparation service and the requirement that all compilations be accompanied by a report effectively eliminated the “SSARS 8” management-use-only compilation engagement.
This article highlights loss prevention tips CPAs can use to safely implement SSARS No. 21 and reduce their risk exposure.
Historical Relevance of Landmark Case
The landmark 1136 Tenants’ casei resulted in a sizeable judgment against a CPA firm sued by its client for failing to uncover embezzlement. The firm was hired to perform write-up services by a managing agent who committed the fraud. The financial statements clearly stated, “No independent verifications were undertaken,” but the firm was found liable for failing to discuss or inquire about missing invoices. Without an engagement letter, the firm was unable to convince the court that the firm was not engaged to audit the financial statements.
In 1978, SSARS No. 1 was issued in part to address the professional liability exposure associated with such “plain paper” financial statements. The issuance of SSARS No. 21’s AR-C Section 70 again permits CPAs to prepare financial statements without reporting on them. To do so they must have a written understanding (engagement letter) with their client and include a legend on each page of the financial statement stating that no assurance is provided.
The Tenants case illustrates the importance of following up on unusual findings regardless of the level of service. Also integral to the Tenants decision was that the services were not delineated in an engagement letter. CPAs should be forewarned and learn from this. Yes, SSARS No. 21 makes clear that CPAs must engage with a written understanding (engagement letter) when reporting on or preparing an entity’s financial statements, but the Standard doesn’t require such documentation when only engaged to perform bookkeeping or assist with the preparation of an entity’s financial statements.
Don’t fall into that trap. The best defensive documentation in situations not subject to the SAS or SSARS is to delineate the services contemplated and specifically what services will not be performed — “we will not audit, review, compile or prepare financial statements.”
Differentiating from Bookkeeping Services
SSARS No. 21 distinguishes between whether accountants are engaged to prepare financial statements or to merely assist in preparing financial statements. If engaged to prepare financial statements, the accountant is subject to SSARS No. 21, but merely assisting with the preparation of financial statements is a bookkeeping function not subject to the SSARSs.
Without an engagement letter clearly indicating that the contemplated services do NOT include the audit, review, compilation or preparation of financial statements, clients might successfully allege the accountant was to have reported on or prepared financial statements. Claiming that the engagement letter would have detailed that a financial statement reporting or preparation service was to be performed may be an inadequate defense, as CPAs are generally expected by average individuals (e.g., jurors) to be scribes. So without a written understanding to the contrary, clients could prevail in arguing the CPA’s services included financial statement services.
CPAs should adopt the defensive documentation strategy of not only engaging for the bookkeeping services, but also having their engagement letters specify that their services don’t contemplate the audit, review, compilation or preparation of financial statements.
AR-C Section 70 is short, and fairly simple, but could be confusing to some accountants and their clients. Much of the discussion leading up to and after the issuance of SSARS No. 21 focused attention on a legend that would appear on each page of the financial statements. Interestingly, the SSARS No. 21 substitutes “statement” for “legend.”
The ARSC’s May 2014 Exposure Draft (ED) and a Journal of Accountancy articleii appearing shortly after SSARS No. 21’s release both state, “When an accountant is engaged to prepare financial statements, the accountant is required to include an adequate statement on each page of the financial statements indicating that no CPA provides any assurance on the financial statements.” (Emphasis added.)iii
Unfortunately, none of the guidance or examples offered in SSARS No. 21iv clearly state that no CPA is providing assurance, the implicit intent of the standard. Instead, the examples could suggest (and likely do suggest) that the entity whose financial statements are presented provides no assurance.
CAMICO recommends that all CPAs engaged to perform a preparation engagement make clear BOTH in their engagement letters and each page of the resulting financial statements that “No CPA provides any assurance on these financial statements.”
AR-C Section 70 states that the accountant’s name is not required to be included in the legend. However, some CPAs have expressed their intent to include their firm name in financial statement legends as part of their marketing strategy. Inclusion of your firm name may have some modest marketing benefit, but CAMICO’s claims experience suggests the added risk exposure from association with the financial statements outweighs any marketing advantage. Don’t associate your name with any AR-C Section 70 prepared financial statements unless compelled to do so in a disclaimer.
AR-C Section 70 establishes that if an accountant is unable to include an adequate statement on each page of the financial statements regarding the lack of assurance, the accountant must (1) issue a disclaimer that makes clear that no assurance is provided on the financial statements, or (2) compile the financial statements.
Having your name associated with financial statements suggests to some that the financial statements may be more reliable than identical financial statements omitting any reference to a CPA. As such, CAMICO anticipates that there will likely be more risk exposure to CPAs who issue a disclaimer or in some other way (such as adding their name to the legend) include their firm’s name within an entity’s financial statements.
Presumably what would prompt the need for a disclaimer would be if the computer software used to print the financial statements could not accommodate a suitable footer. The number of required characters expands when an entity opts for a reporting framework other than U.S. GAAP and when management elects to omit substantially all disclosures.
Some software providers permit only a limited number of characters in their footers, headers and titles. When, as permitted with compilation or preparation engagements, management elects to omit substantially all disclosures, the legend’s character length will need to be expanded.
To avoid the additional risk exposure of having your name unnecessarily associated with financial statements, CAMICO encourages practitioners to print preparation engagement financial statements on paper stock pre-printed with footers containing their preferred legend; e.g., “No CPA provides any assurance on these financial statements” or “No CPA provides any assurance on these financial statements, which lack substantially all disclosures required by
“Unilateral” engagement letters (when the letter is signed by the CPA but not the client) are commonly used for tax engagements but only rarely used for financial statement engagements. SSARS No. 21 removes that option by requiring engagement letters to be signed by the accountant and the client.
Unfortunately, the ARSC did NOT prohibit “evergreen letters,” which remain in effect until a party to the agreement terminates the agreement. The use of evergreen letters, although permitted by professional standards, is discouraged by CAMICO. Courts could deem that an engagement letter’s lack of a terminus date means the statute of limitations doesn’t begin until one of the parties terminates the agreement. In such an instance the statute of limitations could be held open indefinitely.
CAMICO strongly discourages the use of evergreen and multi-year letters. If used, however, the engagement letter should include a clause indicating each year’s service is a separate and distinct engagement, and CPAs should refresh their client management’s memory of their responsibilities and of the scope and limits of the engagement through the use and review of a memorandum outlining the terms of the current year’s engagement.
2015 Write-Up Work
In conjunction with performing monthly write-up services, CPAs are often engaged to provide their clients with financial statements. Unaudited financial statement engagements for the first 11 months of 2015 can be performed under either SSARS No. 19 or 21, but those for periods after December 14, 2015 (i.e., December 31, 2015) must comply with the SSARS No. 21 standards. Many CPAs, either unaware of SSARS No. 21 or choosing not to early adopt SSARS No. 21, used engagement letters developed to comply with SSARS No. 19 when continuing to service their write-up clients in 2015. While in many ways quite similar, engagement letters and reports under SSARS No. 21 require language and formatting different from those under SSARS No. 19. As such, peer reviewers may find the use of SSARS No. 19 language for periods after December 14, 2015, to be deficient. How to address this is a decision your firm must make.
For CPAs who engaged with their clients to perform interim and annual financial statement services without considering SSARS No. 21’s implications, CAMICO recommends having those clients sign an addendum to their 2015 engagement letters. The addendum would:
- inform clients that their December 31, 2015, financial statements must be performed in accordance with new clarified compilation standards effective for periods ending after December 14, 2015;
- include the revised report language (if applicable); and
- define the CPA and management’s responsibilities as required by SSARS No. 21’s clarified standards.
Sample addendums can be accessed below:
The AR-C Section 70 preparation of financial statements service is a nonattest service. When accountants perform such engagements, they are not usually contemplating performing audits or reviews of their clients’ financial statements for the same year. However, often clients that initially request bookkeeping and financial statement preparation services later request an audit or review of their financial statements. If precautions are not taken, the implications of Interpretation 101-3 Performance of Nonattest Servicesv may preclude the CPA from performing the desired attest services. When uncertain whether a request for attest services may be in the offing, CPAs should take precautions to have their engagement letters spell outvi the client’s responsibility to designate someone (preferably within management) to assume responsibility for the nonattest services performed (i.e., the bookkeeping and preparation of financial statements).
When considering whether circumstances impair their independence, CPAs have long considered potential threats in isolation. Recent changes to the AICPA’s Code of Conduct now require CPAs to consider the cumulative effect of threats to their independence. Preparing financial statements is a typical nonattest service performed when engaged to audit or review financial statements, and when initially engaged to perform these attest services, the CPA anticipates conforming to Interpretation 101-3. When not so engaged, CPAs should still consider whether to take steps to avoid impairing their independence.
Sample Reports in Engagement Letters
Many CPAs choose to include anticipated report language within their engagement letters. Doing so in engagement letters for services including both interim and annual financial statements for periods before December 15, 2015, and after December 14, 2015, is convoluted when CPAs haven’t early adopted SSARS No. 21. In recognition of the wish to shorten/condense engagement letters wherever possible, CAMICO has often suggested omitting the illustrative report from the engagement letter as a way to shrink engagement letters. However, we recommend CPAs’ engagement letters include the report language expected to be used when the CPA expects the report to differ from the standard report. The migration from SSARS No. 19 report language to that of SSARS No. 21 isn’t sufficient to warrant that engagement letters contain sample report language. Modifying engagement letters to include anticipated report language would be desirable when an anticipated deviation from the standard reporting language is contemplated for going concern issues or other financial statement matters the accountant believes should be emphasized (i.e., when the new AR-C Section 80 compilation one-paragraph report is unacceptable).
If you early implement SSARS No. 21 for one client, must you early implement for ALL your clients?
No. That decision is up to your firm and your clients. CPAs should study the new standard and become familiar with its requirements before meeting with clients to introduce them to the clarified review and compilation standards and the new preparation of financial statements service.
When engaged to prepare comparative financial statements for a client for which an audit, review or compilation was performed for the prior period, must the CPA include or reference the prior period’s report?
No. However, from a risk management perspective, CPAs asked or choosing to provide comparative financial statements for their preparation engagement clients should specify in their engagement letter that neither the prior period’s report nor a reference to the prior report will be included in the comparative financial statements.
Association with Financial Statements
The AICPA Auditing Standards Board (ASB), as part of its project to clarify the auditing standards, deleted AU section 504, Association With Financial Statements (AICPA, Professional Standards), expecting the ARSC to address these responsibilities. This guidance addressed accountants’ responsibilities when their names were associated with financial statements that the accountant had not audited, reviewed or compiled.
The ARSC proposed a SSARS Association With Financial Statements, but later determined that the SSARS should not be issued. The proposal would have addressed instances when an accountant permits the use of the accountant’s name in a report, document, or written communication containing financial statements on which the accountant had not issued a compilation, review, or audit report. In such cases, the accountant would have been required to read the financial statements in order to identify material misstatements, and if dissatisfied, request that management revise the financial statements, as appropriate. If management didn’t revise the financial statements, as appropriate, the accountant would not permit the use of the accountant’s name. If the accountant permitted the use of the accountant’s name, the accountant would have been required to determine that the financial statements were marked to indicate that no CPA provides any assurance on the financial statements or issue a disclaimer on the financial statements.
CAMICO supports the decision not to adopt the proposal, as doing so would have invited litigation suggesting CPAs had “permitted” (difficult to define or disprove) the use of their name in association with financial statements.
The proposed SSARS would have applied regardless of whether the accountant prepared the financial statements.
Peer Review Implications
The previous significant changes to compilation and review standards occurred when the ARSC issued SSARS No. 19, effective for periods ending after December 14, 2010. Peer review results plunged and deficiencies increased dramatically when SSARS No. 19 took effect. Although not a risk management issue, if SSARS No. 21’s adoption follows SSARS No. 19’s track, peer review results may again plummet if practitioners don’t take the time to learn and embrace the changes.
SSARS No. 21 (AR-C Section 80) mandates that reports accompany all compiled financial statements, so management-use-only (formerly SSARS 8) compiled financial statements will no longer be permitted for periods after December 14, 2015. Also, the ARSC chose to distinguish compilation reports from those for audits and reviews by altering the standard report to be one paragraph with no headings. There is no title required for compilation reports, and adding a title would defeat the objective of making compilation reports appear dramatically different from assurance engagements.
However, additional paragraphs would be required whenever:
- financial statements are prepared in accordance with a special purpose framework (formerly “OCBOA”);
- management elects to omit substantially all required disclosures;
- the CPA’s independence is impaired; and
- the financial statements have a known departure from the applicable financial reporting framework — the disclosure may be within the header, title, or legend.
Each of the foregoing SSARS changes could trip up the unwary CPA.
If currently subject to peer review, and the highest level of service your firm performs is the preparation engagement, you can opt out of peer review. However, if you should later accept an engagement that would subject your firm to peer review, the date by which your peer review must be performed will be accelerated.
Prospective Financial Statements
SSARS No. 21’s clarified standards supersede the existing compilation guidance other than AR Section 120, Compilation of Pro Forma Financial Information. The AICPA chose to have the compilation of prospective financial information, previously contained within the Statements on Standards for Attestation Engagements, fall under the purview of the ARSC. As such, the ARSC is in the process of reviewing these standards and expects shortly to expose a draft standard addressing prospective financial statements (i.e., financial statement forecasts and projections). Initial impressions of these discussions suggest significant changes in this arena, as the ARSC appears to wish to fit much of the prospective financial statement services within the newly introduced preparation framework.
CAMICO’s own experience has shown that the ARSC seriously considers feedback received on its exposure drafts. If your firm practices or is thinking about practicing in this arena, please consider reading and commenting upon the exposure draft once it is released.
Understand the Exceptions to AR-C Section 70
SSARS No. 21 provides for four exceptions to having to comply with AR-C Section 70 when preparing financial statements and when not engaged to perform an audit, review or compilation of the financial statements. Those exceptions occur when the financial statements are (1) to be included in personal financial plans, (2) in conjunction with litigation services, (3) in conjunction with business valuation services, and (4) solely for submission to taxing authorities. (Emphasis added.)
Some may misinterpret the exception based on submission to taxing authorities as meaning CPAs preparing an entity’s income tax returns would be allowed to prepare the entity’s financial statements without complying with AR-C Section 70. The preparation of financial statements exception when preparing tax returns does not mean that CPAs engaged to prepare tax returns may now circumvent AR-C Section 70’s provisions. Instead, it means that income statements and balance sheets within an entity’s federal income tax return do not count as financial statements subject to AR-C Section 70.
Educate Clients and Their Financial Statement Users
SSARS No. 21 may be implemented early. Accountants should read and understand the full text of the new section and have thorough discussions with their clients to ensure clients understand:
- the service nature of the service to be performed,
- whether the service will include a report, and
- whether a legend indicating the CPA provides no assurance will be present on each page of the financial statements.
Some clients and their bankers or investors may have become used to, or expect to have, an accountant’s report accompany financial statements. Bankers have long been prohibited from receiving management-use-only financial statements. The demise of the “SSARS 8” financial statement service and the introduction of the preparation service are expected to result in fewer compilation engagements. CPAs must avoid the trap of assuming clients and their bankers will be satisfied with a preparation engagement. Many bankers unfamiliar with the new Standard will likely wish to have a report accompany their clients’ financial statements. CPAs and clients should familiarize bankers and other financial statement users with AR-C Section 70’s Preparation Engagement service and contrast the service with the compilation service. To avoid confusion and the related risk resulting from the expectation gap, CPAs should meet with clients and local bankers to educate them about the new standard. That way, users can make an informed decision regarding the financial statement that best suits their needs, and CPAs can avoid performing services that don’t meet user expectations or needs.
As always, CAMICO members can call 800.652.1772 / 650.378.6800 for additional risk management guidance.
(i) 1136 Tenants’ Corporation v. Max Rothenberg and Company (1971)
(ii) “A bright line in SSARSs,” Journal Of Accountancy, December 2014, By Michael L. Brand, CPA, CGMA; Michael P. Glynn, CPA, CGMA; and Charles J. McElroy, CPA
(iii) SSARS No. 21, Section 70 paragraphs .10c and Application Paragraph .A11
(iv) AR-C Section 70 paragraphs .10c, .14 and .A11
(v) The AICPA Code of Conduct’s Nonattest Services subtopic [1.295] under the Independence Rule [1.200.001]
(vi) AICPA Interpretation 101-3 and AICPA Code of Conduct Rule 202