Background
Since issuance of Statement on Standards for Accounting and Review Services No. 1 in December 1978, independence has been a performance requirement for review engagements and a reporting requirement for compilation engagements. However, many users of compiled and reviewed financial statements have asserted that the accountant’s integrity, expertise and objectivity are more important than whether the accountant has maintained his or her independence with respect to a client for whom the accountant performs certain accounting services.
This point of view was buoyed by an influential article in Accounting Horizons (“A Proposed Framework Emphasizing Auditor Reliability over Auditor Independence” by Mark H. Taylor, F. Todd DeZoort, Edward Munn, and Martha Wetterhall Thomas, Accounting Horizons, September 2003), contending that independence is a means to an end. The ultimate goal, the authors point out, is reliability. In their view, reliability comes from objectivity, which in turn comes not only from independence, but also from integrity and expertise.
For more than three decades, the Accounting and Review Services Committee’s (ARSC) compilation and review standards have treated the impairment of independence in the same way. If independence has been impaired for any reason, a CPA may perform a compilation but is required to report his or her lack of independence in the report. A CPA is prohibited from performing a review if independence is impaired.
Recently, financial statement users and other stakeholder groups have suggested that the AICPA’s independence rules are, in some cases, an obstacle to helping smaller entities provide reliable financial statements. This situation happens because CPAs engaged in certain control activities for a company are precluded from performing limited assurance engagements, meaning reviews, for that company. Yet the CPA serves as a trusted adviser to many small businesses. CPAs compiling or reviewing the financial statements of small- and medium-size businesses often also perform other services, such as bookkeeping, payroll or internal control projects. To reconcile the marketplace’s expanded needs for CPAs’ involvement in small companies’ financial reporting with the high ethical standards that embody the CPA profession, the ARSC undertook the Reliability Project in 2008.
The Issue
“Control activities, an element of the COSO framework of internal control, are procedures performed by management or by CPAs on behalf of management, to prevent, detect and correct misstatements in the financials,” said Chuck Landes, AICPA Vice President, Professional Standards Team. “The need for this involvement has become more prevalent because of all the complex accounting standards.”
Because of these accounting complexities, some smaller entities can no longer prepare reliable financial statements without their CPA playing an important role in certain internal control activities. However, CPAs cannot establish or maintain their clients’ system of internal control without it affecting their independence. Once they cross that threshold of control activities, CPAs cannot provide reviews on their clients’ financial statements. Some smaller entities that need a review of their financial statements for bank financing or for other reasons need to hire a second CPA to review their financial statements, even though their long-time CPA is better suited for the job.
The Exposure Draft
On April 28, 2009, the ARSC issued an exposure draft that proposed to revise the standards for compilation and review engagements. The proposed changes would affect the interplay between the standards and independence rules, permitting an accountant to issue a review report on financial statements when the accountant’s independence is impaired by performing nonattest services that were designed to improve the reliability of the client’s financial information.
The draft included a trio of proposed standards: Framework and Objectives for Performing and Reporting on Compilation and Review Engagements; Compilation of Financial Statements; and Review of Financial Statements. In drafting the proposed standards, the ARSC considered recommendations from the Private Company Practice Section (PCPS) Reliability Task Force. ARSC and PCPS believe the proposed standards will respond to many concerns of smaller business owners, users of small business financial statements and CPAs that serve smaller entities.
The PCPS task force recommended ARSC consider revising its standards for situations in which an accountant’s independence is impaired in connection with the performance of a nonattest service relating to the design or operation of an aspect of internal control over financial reporting. These nonattest services help management prepare higher quality or more reliable financial statements.
The proposed standards would also harmonize the AICPA’s review standard with the International Auditing and Assurance Standards Board’s (IAASB) review standard ISRE No. 2400
Significant proposed changes to the Statements on Standards for Accounting and Review Services (SSARSs) included:
- The introduction the new terms such as moderate assurance, review evidence and review risk to the review literature to harmonize with international review standards.
- A discussion of materiality in the context of a review engagement.
- A requirement that an accountant establish an understanding with management regarding the services to be performed through a written communication, that is, an engagement letter.
- The establishment of enhanced documentation requirements for compilation and review engagements.
- Guidance for practitioners who are engaged to perform a compilation or review engagement when they have also been engaged to perform nonattest services. The guidance includes reporting requirements for instances in which the accountant’s independence is impaired due to the performance of these services.
- The ability for an accountant to include a general description in the accountant’s compilation report regarding the reason(s) for an independence impairment.
The comment deadline was July 31, 2009.
Consideration of comment letters received
In response to the exposure draft, the ARSC received 169 comment letters from practitioners, firms, state societies, state boards, and other interested stakeholders. The ARSC considered those comment letters at its meeting on September 1-3, 2009 and made certain revisions to the proposed SSARS in response to the concerns raised in the comment letters.
Through the comment letter process, it became apparent that there is some confusion as to what it means to “establish or maintain internal controls” (and thus when independence is impaired).
ARSC approves the issuance of SSARS No. 19
At its November 2009 meeting, the ARSC approved a new compilation and review standard that includes the most significant changes since 1978. “The new standard makes important changes that should be welcomed and applauded by many smaller firm practitioners,” says Carol McNerney, chair of ARSC and a partner with the firm of SS&G Financial Services in Akron, Ohio. The final standard will be available by early 2010.
The standard’s effective date is for periods ending on or after December 15, 2010, with the exception of paragraph 2.21, which may be implemented early. Paragraph 2.21 states in part, “The accountant is not precluded from disclosing a description about the reason(s) that his or her independence is impaired.” According to McNerney, this particular change has long been supported by many smaller firm CPAs as well as users of compilation reports. “This amendment allows CPAs to explain in their compilation reports the reasons why they are not independent, providing transparency to users and offering flexibility for our members. They can either continue to merely say they are not independent or, if they choose, they can now describe the reasons for the independence impairment.”
Another significant change that smaller firms should appreciate is that this new standard separates the compilation guidance from the review guidance. Mike Glynn, technical manager for the project, says that he has heard this request over the years. “We have a large number of members who only perform compilations and no reviews. They’ve been saying we should split the two so that the compilation guidance is easier to use and not mixed in with the review guidance. I’m happy that this project has allowed us to make that change to help smaller firm practitioners,” says Glynn.
Other significant changes to the SSARSs included the following:
- A discussion of how the accountant obtains limited assurance through the performance of review procedures..
- The introduction of the term review evidence to the review literature.
- A discussion of tailoring the review procedures based on the accountant’s understanding of the client’s industry, knowledge of the client, and awareness of the risk that he or she may unknowingly fail to modify the accountant’s review report on financial statements that are materially misstated..
- A discussion of materiality in the context of a review engagement.
- A requirement that an accountant document the establishment of an understanding with management through a written communication (that is, an engagement letter) regarding the services to be performed.
- The establishment of enhanced documentation requirements for compilation and review engagements.
The final standard differs from the exposure draft in two major ways:
First, the ARSC decided to retain the concept of limited assurance rather than moderate assurance. The ARSC had proposed to use the term moderate assurance to describe the level of assurance that the accountant aims to obtain in a review engagement in order to harmonize with the terminology used in the international review standards. However, after the exposure draft was issued, the International Audit and Assurance Standards Board began looking to revise the international review standard from moderate to limited.
The other major difference is that the non-independent review is not part of the final standard. The ARSC received a number of comments on this proposal, both for and against. As a result of the great interest in this topic, the ARSC decided it made the most sense to defer this issue so it could hold additional meetings with key stakeholders. These additional meetings will be used to further discuss with stakeholders the issues that many smaller firm members face in trying to serve their small business clients and to better understand why some stakeholders are opposed to the non-independent review concept. The focus of the issues deal with the ARSC proposal that would have permitted an accountant to provide a review service while also performing a nonattest service to help smaller businesses maintain aspects of their internal control over financial reporting, the purpose of which is to improve the reliability of the client’s financial statements. This topic will be revisited by the ARSC in 2010.
For more information: Chuck Landes, AICPA Vice President Professional Standards, clandes@aicpa.org; Mike Glynn, AICPA Technical Manager, mglynn@aicpa.org.
Visit the AICPA Store for a copy of SSARS No. 19 — Compilation and Review Engagements.
Resources of Interest: