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1Chapter 25

Other Assurance Servicesand Nonassurance Services

Review Questions

25-1 Levels of assurance represent the degree of certainty the practitioner hasattained, and wishes to convey, that the conclusions stated in his or her report arecorrect.

Audits of historical financial statements prepared in accordance withgenerally accepted accounting principles are one type of examination. They aregoverned by auditing standards. An audit results in a conclusion that is in apositive form. In this type of report, the practitioner makes a direct statement as

to whether the presentation of the assertions, taken as a whole, conforms to theapplicable criteria. The level of assurance is high.In a review, the practitioner provides a conclusion in the form of a negative

assurance. In this form, the practitioners report states whether any informationcame to the practitioners attention to indicate that the assertions are notpresented in all material respects in conformity with the applicable criteria. Thelevel of assurance is moderate.

A compilation is defined in !!A"! as presenting, in the form of financialstatements, information that is the representation of management withoutundertaking to express any assuranceon the statements.

25-2 A negative assurance states, along with factual statements, that nothingcame to the auditors attention that would lead the auditor to believe that thefinancial statements were not prepared in accordance with #AA$ or othercomprehensive basis of accounting. The reason for including such a statement ina review report is to provide financial statement users with some level of assurancethat the financial statements are fairly stated. The level of assurance is less thanthat for an audit of historical financial statements, but more than the %ero&levelassurance for a compilation.

25-3 'ompilation is defined in !!A"! (o. 1 as presenting in the form offinancial statements information that is the representation of management, without

undertaking to express any assurance on the statements. "eview is defined by!!A"! (o. 1 as performing in)uiry and analytical procedures that provide theaccountant with a reasonable basis for expressing limited assurance that thereare no material modifications that should be made to the statements in order forthem to be in conformity with #AA$.

There is no level of assurance provided by a compilation. "eviews providelimited assurance, but considerably less than a typical audit.

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25-4 ne of three forms of compilation can be provided to clients-

Compilation With Full Disclosure 'ompilation of this typere)uires disclosures in accordance with generally acceptedaccounting principles, the same as for audited statements.

Compilation That Omits Substantially All Disclosures Thistype of compilation is acceptable if the report indicates the lack ofdisclosuresand the absence of disclosures is not, to the '$Asknowledge, undertaken with the intent to mislead users.

Compilation Without ndependenceA '$A firm can issue acompilation report even if it is not independent with respect to theclient, as defined by the Code of !rofessional Conduct. owever,the '$A firm must state its lack of independence in the report.

25-5 The following five things are re)uired by !!A"! (o. 1 for compilation.The preparer of the statements must-

/now something about the accounting principles and practices ofthe clients industry.

/now the client, the nature of its business transactions, accountingrecords and employees, and the basis, form, and content of thefinancial statements.

0ake in)uiries to determine if the clients information is satisfactory. "ead the compiled financial statements and be alert for any obvious

omissions or errors in arithmetic and generally accepted accountingprinciples.

isclose in the report any omissions or departures from generally

accepted accounting principles of which the accountant is aware. Thisre)uirement does not apply to a compilation that omits substantiallyall disclosures.

25-6 2or a compilation, the accountant does not have to make in)uiries orperform other procedures to verify information supplied by the entity beyond thoseidentified in the answer to "eview 3uestion *+&+. 4ut if the accountant becomesaware that the statements are not fairly presented, he or she should obtainadditional information. If the client refuses to provide the information, the accountantshould withdraw from the compilation engagement.

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25-7 The following types of procedures are emphasi%ed for review services-

btain knowledge of the accounting principles and practices of theclients industry. The level of knowledge for reviews should besomewhat higher than that for compilation.

btain knowledge of the client. The information should be about thenature of the clients business transactions, its accounting recordsand employees, and the basis, form, and content of the financialstatements. The level of knowledge should be higher than that forcompilation.

0ake in)uiries of management. The ob5ective of these in)uiries isto determine whether the financial statements are fairly presented,assuming that management does not intend to deceive the accountant.In)uiry is the most important of the review procedures. The followingare illustrative in)uiries-6 In)uire as to the companys procedures for recording,

classifying, and summari%ing transactions, and disclosinginformation in the statements.6 In)uire into actions taken at meetings of stockholders and

board of directors.6 In)uire of persons having responsibili ty for f inancial and

accounting matters whether the financial statements have beenprepared in conformity with generally accepted accountingprinciples consistently applied.

$erform analytical procedures. The analytical procedures are meantto identify relationships and individual items that appear to be unusual.The appropriate analytical procedures are no different from the

ones already studied in 'hapters 7 and 8 and in those chaptersdealing with tests of details of balances.

25- 2or review services, if a client fails to follow generally accepted accountingprinciples, a modification of the report is needed. The accountant is not re)uiredto determine the effect of a departureif management has not done so, but thatfact must also be disclosed in the report. 2or example, the use of replacementcost rather than 2I2 for inventory valuation would have to be disclosed, but theeffect of the departure on net earnings does not re)uire disclosure.

25-! 'ompilations and reviews under !!A"! (o. 1 can only be issued for

nonpublic companies for which an audit has not been performed. They may befor monthly, )uarterly, or annual statements."eviews are issued on )uarterly information of publicly held companies

as a part of the clients reporting re)uirements to the !9' and are sub5ect to$'A4 standards. Although there are some minor differences in the wording ona review report for a nonpublic company and a public company review report,they are substantively the same.

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25-1" The review procedures are essentially the same for public company and!!A"! 1 reviews. !ome additional procedures are re)uired for public companyreviews that are beyond the scope of !!A"! 1 as follows-

The level of knowledge the accountant has about the clients internal

control is likely to be higher for public company reviews. 4ecausean annual audit is done for public companies that have an interimreview, the accountant must also obtain sufficient information aboutthe client;s internal control for both annual and interim financialinformation.

The auditors knowledge of the results of the audit proceduresperformed during the annual audit will affect the scope of theprocedures performed during the review of interim financial information.

The accountant will also have a good idea whether the )uarterlystatements were accurate after the annual audit is complete. Thisinformation will be useful in determining the review procedures insubse)uent years.

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25-12 #continued$

B. Online !ri"acy? nline privacy practices, ensuring that personalinformation obtained as a result of e&commerce is collected, used,disclosed, and retained as committed or agreed.

+. Confidentiality? 'onfidentiality practices, ensuring that informationdesignated as confidential is protected as committed or agreed.

A licensed '$A can issue a WebTrustopinion on an individual principleor on combinations of principles.

25-13 The purpose of a SysTrustengagement is for the licensed accountant toevaluate a company;s information technology system using Trust Ser"icesprinciplesand criteria and to determine whether controls over the system exist. Theaccountant then performs tests to determine whether those controls wereoperating effectively during a specified period. !ee the solution to "eview

3uestion *+&1* for the five Trust Ser"icesprinciples.

25-14 A prospecti"e financial statementis a predicted or expected financialstatement in some future period or at some future date. There are two generaltypes of prospective financial statements- forecasts and pro5ections. A forecastisa prospective financial statement that presents an entitys expected financialposition, results of operations, and cash flows for future periods, to the best of theresponsible partys knowledge and belief. A pro$ection is a prospective financialstatement that presents an entitys financial position, results of operations, andcash flows, to the best of the responsible partys knowledge and belief, given oneor more hypothetical assumptions.

An examination of prospective financial statements involves-

9valuating the preparation of the prospective financial statements. 9valuating the support underlying assumptions. 9valuating the presentation of the prospective financial statements

for conformity with AI'$A presentation guidelines. Issuing an examination report.

25-15 The purpose of an engagement of specified elements, accounts, or itemsis like that of an ordinary audit, but it is limited only to certain accounts or parts ofthe financial statements. An example is the audit of the sales account for a retail

store in a shopping mall.The following are four specific re)uirements for reports on specifiedelements, accounts, or items-

The specified elements, accounts, or items must be identified. The basis on which the specified elements, accounts, or items are

presented and the agreements specifying the basis must be described.

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,iscussion Questions and )ro&e(s

25-21 The accountant is responsible for the care in the preparation of compiledfinancial statements. The accountant must perform all five steps identified in theanswer in "eview 3uestion *+&+ with due care. The report must also be properly

prepared and reflect the findings of the accountant.

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25-23 a. The primary procedures performed in a review engagement consistof performing analytical procedures and in)uiries of management.4ut, in addition to those procedures, the accountant should alsoperform the following-

btain knowledge of the accounting principles and practicesof the client;s industry.

btain knowledge of the client;s business btain a letter of representation $erform additional procedures if the accountant becomes

concerned that information is incorrect, incomplete or otherwiseunsatisfactory.

Issue the review report.

b. 1. In)uire about the nature of repairs made to determine if anyrepresent expenses that should be capitali%ed. Ask about

whether any of the related property, plant, and e)uipmentshould be ad5usted to reflect permanent impairment andin)uire if any e)uipment that is currently included in thefinancial statements has been disposed of during the year.

*. In)uire about whether management has documentation in thecontract of the real estate taxes not being the responsibility ofthe client until next year and ask to review that contract.$erhaps examine any public records of tax obligations for thecounty or municipality to determine the status of outstandingtaxes due.

:. Ask management to provide invoices from most recent

purchases of pipes for construction and estimate the inventoryvalues based on the most recent prices to determine theimpact of changes in market conditions on the ending inventorybalance.

B. 'alculate days sales in inventory and compare trends to prioryears to determine whether collections are slowing. Analy%eaging categories of accounts receivable relative to prior yearsto evaluate whether receivables are older.

+. 0ake in)uiries of the client;s legal counsel to obtain theirviews of the likely outcome of the lawsuit.

25-24 a. In addition to the in)uiries listed, the accountant must understandthe clients business to facilitate evaluating whether the statementsare reasonable. Analytical procedures must also be performed. Itmay also be appropriate to in)uire about such things as the possibilityof unbilled sales, authori%ation procedures for sales, whether theaccounts receivable control account has been reconciled with themaster file records, and the possible inclusion of consignmentshipments as sales.

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25-24 #continued$

b. In reviews, no procedures such as tests of controls, substantive testsof transactions, cutoff tests, or confirmation re)uests are done. Theonly things that are done are in)uiries and analytical tests. An

examination of the procedures for sales and receivables discussedin 'hapters 1B and 1C shows that there is considerable differencebetween an audit and those review procedures listed in this problem.

c. In)uiries would ordinarily be made of the chief financial officer in asmall or large business. rdinarily the chief financial officer in asmall business is the owner, but it may also be a controller or vice&president.

d. Additional procedures should be performed when the accountantbelieves, based on the information obtained through in)uiry and

analytical procedures, that the financial statements may bematerially misstated. 9xamples where this could be the case are-

G A material increase in the gross margin percentG A material decrease in allowance for uncollectible accounts

divided by accounts receivableG A statement by a bookkeeper that leads the accountant to

believe the clients personnel do not fully understand correctsales cutoff procedures

e. The achieved level of assurance for audits is ordinarily much higher

than for reviews. The differences in the procedures identified in thisproblem and those studied in 'hapters 1B and 1C are significantand result in large differences in the achieved levels of assurance.

25-25 a. It is notappropriate to do a !!A"! review service for a publicly heldcompany. !!A"! engagements are restricted to nonpublic companies.

Annual statements of public companies must either be audited orunaudited in accordance with generally accepted auditing standardsand re)uirements of the !ecurities and 9xchange 'ommission.This provides a clearer definition in the level of assurance for thefinancial statements of public companies. owever, a review&type

service can be provided for interim financial statements of publiccompanies.

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25-25 #continued$

b. There are some deficiencies in the approach taken-

4ecause Tidwell is a high risk client, indicating a high likelihoodof misstatement, and because the re)uired review procedures

include in)uiries and analytical procedure, the review should,at least in part, be performed by the more experiencedmember of the engagement team, and not be so completelydelegated.

4ecause there are some differences between an !!A"! 1review and a public company review, use of the firmsstandard procedures for !!A"! reviews without modificationis inappropriate. Additional procedures to be performed include@at a minimum-

"elating in)uiries to findings in the recent audit

"eading minutes

c. The followingproblems exist with regard to the report-

$ages should be marked HunauditedH not Hreviewed.H The report should be addressed to the client, not the

!ecurities and 9xchange 'ommission. The wording of the report should be changed from the

!!A"! review to the re)uired wording for public companies,including reference to $'A4 standards.

25-26

a. A client may re)uest a SysTrustengagement for a system that is inthe pre&implementation phase. In this engagement, the '$A wouldreport on the suitability of the design of the controls and the reportwould be as of a point in time rather than for a period of time.

b. The '$A cannot perform WebTrust assurance services withoutbeing licensed by the AI'$A to provide such services. '$As seekingto provide WebTrustservices must attend training, apply for theWebTrustlicense, and satisfy other )uality control re)uirements.

c. The '$A can perform the re)uested SysTrustassurance service

on compliance with the Availability principle. '$As can provideassurance about an entity;s compliance with a single TrustSer"icesprinciple or a combination of two or more principles.

d. The WebTrust seal cannot remain on the company;s >eb sitethrough 0ay :1, *1 without the '$A updating his or her work tosupport the seal. The WebTrustservice re)uires the '$A to updatehis or her testing once every twelve months to ensure the entitycontinues to comply with Trust Ser"icesprinciples and criteria.

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25-27 a. It would be acceptable to undertake the engagement only if all ofthe following conditions exist-

The accountant has sufficient competence to properly completean examination of the forecasted financial statements.

The client is willing to take responsibility for preparation @withthe accountants assistance of the forecast in accordancewith guidelines, established by the AI'$A in Statements onStandards for Accountant%s Ser"ices on !rospecti"e FinancialStatements.

The accountant believes a reasonably accurate forecast ispracticable in the circumstances.

The client understands and agrees to the examinationprocedures and reporting re)uirements the accountant mustcomply with.

b. If 0onson believes the accountant can issue an opinion about theachievability of the forecast, but later finds that such an opinioncannot be given, 0onson is likely to be unhappy. The result wouldbe a loss of fee, loss of a client for other services, and perhaps evena lawsuit. !imilarly, 0onson must understand his responsibilitiesconcerning the forecast of the assumptions and other aspects ofthe report, again to avoid a misunderstanding later.

c. The primary information the '$A firm will need to help in completingthe forecast are the following-

Audited financial statements for the past several years. @9asilyavailable because 0onson is an audit client. Information about the economic conditions of the industry. The

'$A firm will likely need knowledge beyond that re)uired forperforming the audits.

Information about the offer he has made for the new businessand the offer he has received for the existing assets. 4ecausethe financial statements will be a forecast, and not a pro5ection,it is necessary to determine that there is a reasonable likelihoodof the transaction being completed and the forecasted result,assuming both transactions are finali%ed.

d. The report will be a report on a forecast and will include the followingcomponents-

An identification of the prospective financial statementspresented.

A statement that the examination of the prospective financialstatements was made in accordance with AI'$A standardsand a brief description of the nature of such examination.

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25-27 #continued$

The accountants opinion that the prospective financial state&ments are presented in conformity with AI'$A presentationguidelines and that the underlying assumptions provide a

reasonable basis for the forecast. A caveat that the prospective results may not be achieved. A statement that the accountant assumes no responsibility to

update the report for events and circumstances occurringafter the date of the report.

25-2 a. The purpose of a debt compliance letter is to provide the lenderwith an independent opinion of the existence or nonexistence ofsome condition. The lender usually will re)uest a '$A to determinewhether certain loan covenants are being adhered to by the debtor.

b. An audit of the company is necessary before a debt complianceletter is issued because a compliance letter would be difficult toprepare without an audit. This stems from the fact that the '$A isusually concerned with financial balances and ratios of the companywhen preparing a debt compliance letter. An audit is virtually re)uiredin order to verify these amounts.

c. A '$A firm could issue a debt compliance letter on the amount ofthe current ratio and the owners e)uity. The firm may report onthese two aspects because it is )ualified to evaluate such matters.owever, the other three re)uests re)uire legal expertise and

sub5ective 5udgment that a '$A firm does not claim to possess.Therefore, the '$A should restrict the debt compliance letter to thetwo )uantitative re)uests.

25-2! a. We ha"e audited& in accordance with generally accepted auditingstandards& the balance sheet of !ollution Control De"ices& nc' asof and the related statements of income& retainedearnings& and cash flows for the year then ended& and ha"e issuedour report thereon dated '

n connection with our audit& nothing came to our attentionthat caused us to belie"e that the Company failed to comply with

any of the pro"isions of the indenture dated with (lender)insofar as they relate to accounting matters' *owe"er& our auditwas not directed primarily toward obtaining knowledge of suchnoncompliance'

This report is intended solely for the information of theboards of directors and management of !ollution Control De"ices&nc' and (lender) and should not be used for any other purpose'

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25-2! #continued$

b. The supplemental report would have to state that the company wasnot in compliance with the provisions of the indenture because netearnings did not exceed dividends by at least J1,,.

c. The supplemental report would be the same as discussed in b.Assuming that a default in the provisions of the indenture results inthe loan becoming due immediately, the auditors report would haveto include either an adverse or )ualified opinion depending uponthe materiality of the misstatement. 4ecause the mortgage is for JBmillion, which is material to the client, violation of the indenture andpotential default cannot be dismissed as being immaterial.

d. 'ontingencies due to a lawsuit may affect the liabilities of the clientthat will affect the indenture provisions. The auditor will be unable

to express an opinion in the debt compliance letter because of thisuncertainty. This should be disclosed in the supplemental report.

25-3" a. Kones will probably have to conduct additional audit tests in order toreport on these items individually. It will be necessary for Kones toaccumulate additional evidence because the materiality of theindividual items is much lower than for the overall financial statements.The additional evidence will enable the auditor to obtain a higherlevel of assurance regarding the items than is attained withoutexpanding the audit procedures. The individual items have a lowerlevel of materiality because their magnitude is less than the overall

financial statements. Therefore, an amount that is not consideredmaterial to the financial statements as a whole may be materialwhen applied to the three accounts being considered.

b. The following additional tests are likely to be needed before thespecial report can be issued-

Sales 'utoff tests of sales may be expanded epending upon the previous results, tests of controls

and substantive tests of transactions for sales may be

increased

+et fixed assets 9xamine physical existence of a sample of fixed

assets etermine if fixed assets are still on the books but

not being used "ecalculate depreciation Increase vouching of additions in the current year

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25-3" #continued$

n"entory Increase the price test coverage of inventory value

It should be noted that the extent of these tests depends on theresults attained in these areas in the audit, the amount of evidencegathered in the audit, and the clients internal controls. The auditprocedures above are vague because of this and are intended tobe illustrative of the type of procedures that should be considered.

After&the&fact auditing has limitations in that some informationcannot feasibly be recreated. 2or instance, the auditor cannot extendtest counts of inventory in order to verify the )uantity of inventory.In these cases the auditor must attempt to satisfy the ob5ective byalternative methods.

c. We ha"e audited the schedules of sales& net fixed assets& andin"entory "alued at FFO (as defined in the lease agreement datedbetween (lessor) and Sarack ,umber Supply Co') of

Sarack ,umber Supply Co' for the year-ended ' Theseschedules are the responsibility of Sarack ,umber Supply Co%s'management' Our responsibility is to express an opinion on theschedules based on our audit'

We conducted our audit in accordance with auditing standardsgenerally accepted in the .nited States' Those standards re/uirethat we plan and perform the audit to obtain reasonable assuranceabout whether the schedules of sales& net fixed assets& and

in"entory "alued at FFO are free of material misstatement' Anaudit includes examining& on a test basis& e"idence supporting theamounts and disclosures in the schedules' An audit also includesassessing the accounting principles used and significant estimatesmade by management& as well as e"aluating the o"erall schedule

presentation' We belie"e that our audit pro"ides a reasonable basisfor our opinion'

n our opinion& the schedules of sales& net fixed assets& andin"entory "alued at FFO present fairly& in all material respects& thesales& net fixed assets& and in"entory "alued at FFO of Sarack,umber Supply Co' for the year-ended & on the basis

specified in the lease agreement referred to abo"e'This report is intended solely for the information and use ofthe boards of directors and management of Sarack ,umber SupplyCo' and (lessor) and should not be used for any other purpose'

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0nternet )ro&e( So&ution Accountin and Review Services Co((ittee

25-1 The Accounting and "eview !ervices 'ommittee @A"!' is responsiblefor issuing standards for compilations and reviews of financial statement issuedby nonpublic companies. isit the AI'$A website Mhttp-NNwww.aicpa.orgO and

answer the following )uestions about the operations of this committee-

1. ow are individuals chosen to serve on the A"!'P

AnswerAccording to the website- QThe A"!' is a committee of sevenmembers, all of whom are AI'$A members. 0embers are appointedto achieve an appropriate representation among small and mediumfirms actively involved in the provision of compilation and reviewservices. The irector, AI'$A Audit and Attest !tandards @theQirectorR, in consultation with the A"!' 'hair, nominates members

of the A"!'. The AI'$A 4oard of irectors approves nominationsfor members of the A"!'.R

*. ow long must an exposure draft of a new standard @i.e., a new!!A"! be made available for public commentP

AnswerAccording to the website- QIn determining an appropriate publicexposure period of a proposed !!A"!, including the comment duedate, the A"!' will take into consideration that the period from2ebruary 1 through April : of any calendar year represents the

traditional Qbusy seasonR for many practitioners. Although the A"!'will attempt to limit having a comment period for a proposed!!A"! end during the traditional Qbusy seasonR, the decisionregarding the comment due date will take into account the complexityof the sub5ect matter in the proposed !!A"! as well as thecircumstances surrounding the need for a new standard.R

:. 0ust meetings of the A"!' be open to the publicP

AnswerIn short the answer is Qno.R The A"!' may find it necessary to hold

private meetings to discuss matters of an administrative or confidentialnature. n the other hand, the A"!' may hold open meetings todiscuss the issuance of a new !!A"! or other matters that thecommittee believes are of interest to the public.

@Note- Internet problems address current issues using Internet sources. 4ecauseInternet sites are sub5ect to change, Internet problems and solutions may change. 'urrentinformation on Internet problems is available at www.pearsonhighered.comNarens.

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