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CHAPTER 30

NONAUDIT ENGAGEMENTS:
PROCEDURES AND REPORTS
Questions
1.

Examples of using what has held true in the past will hold true in the future:
(a) evaluating the collectibility of accounts receivable based on past collection
history,
(b) evaluating inventory obsolescence on the basis of past usage patterns,
(c) assessing the economic usefulness and useful lives of fixed assets based
upon experience with similar assets,
(d) relying on a control risk assessment for a period between the time of the
original assessment at interim and the fiscal year-end, and
(e) expecting to encounter classification and evaluation errors when
management has been known to have acted without sufficient decision
planning in the past.

2.

Financial statements are unaudited if the CPA has not applied any auditing
procedures or has not applied procedures which produced sufficient evidence
upon which to base an opinion on the financial statements as a whole.
With respect to unaudited statements, in addition to a disclaimer of opinion
(public companies), the following guides should be followed:
1.
2.
3.

3.

If the CPA should learn that the statements are not in conformity with
financial reporting standards (including adequate disclosures), he should
explain the departures in the disclaimer.
If prior years unaudited statements are present, the disclaimer should cover
them as well as the current year statement.
Each page of the statements should be clearly labeled as unaudited.

Prospective financial statements are defined as complete financial statements in


the same form as traditional income statements, statement of financial positions
and statements of changes in financial position. However, an abbreviated
presentation constitutes prospective financial statements if its contains all of
these items (if applicable):
1.
2.
3.
4.
5.

Sale or gross revenue


Gross profit
Unusual or infrequently occurring items
Provision for income taxes
Discontinued operations or extraordinary items

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6.
7.
8.
9.
10.

Net income
Primary and fully diluted earnings per share
Summary of significant changes in financial position
Summary of significant assumptions
Summary of significant accounting policies

Omission of any items 18 makes the presentation a partial presentation.


Omission of 9 or 10 makes it a deficient presentation.
4.

Similarities and Differences


Examination Report on a Forecast
a. Identification of financial
statements and what they intend to
represent.
b. Warning about ultimate
attainment of prospective results.
c. Statement about review in
accordance with ASPC standards.
d. Opinion / assurance about
presentation and reasonable
assumptions.
e. Statement about no responsibility
to update the report.
Compilation Report on a Forecast
a. Identification of financial
statements and what they
represent.
b. Warning about ultimate
attainment of prospective results.
c.
d.
e.

5.

Statement about compilation in


accordance with ASPC standards.
Disclaimer of opinion / assurance.
Statement about no responsibility
to update the report.

Audit Report
on Historical Statements
a. Identification of statements
audited.

c.
d.

Statement that audit was in


accordance with PSA.
Opinion about conformity with
PFRS.

Compilation Report
on Historical Statements
a. Identification of statements
compiled.
b.
c.
d.

Statement / warning that


information is the representation
of management (owners).
Same kind of statement about
compilation and ASPC standards.
Disclaimer of opinion / assurance.

Both review service and compilation service engagements are less than an audit.
A comparison of the three amounts to a hierarchy of assurance:
1.

Audit engagement

Auditor obtains sufficient competent


evidence that serves as a basis for an
opinion on financial statements.
The
auditor obtains reasonable assurance
within the inherent limitations of the audit

Nonaudit Engagements: Procedures and Reports

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process.
2.

Review engagement

Accountant obtains limited assurance


through analytical procedures that there are
no material modifications that should be
made to financial statements.

3.

Compilation engagement

Accountant puts client information in


financial statement form without obtaining
any assurance (because no procedures are
performed) that material modification
should or should not be made to the
financial statements.

Additionally, an accountant who is not independent may report on a compilation


service (providing that lack of independence is disclosed), but not on a review
service or audit engagement.
6.

7.

8.

A state of association exists whenever:


a.
b.

The CPAs name is used in a document containing the statements; or


The CPA has prepared or assisted in preparing the statements.

a.

Compilation: In compiling financial statements for a client, the CPA


presents information that is the representation of management without
undertaking to express any assurance on the statements.

b.

Review: More than a compilation, but less than an audit, a review consists
mainly of performing inquiry and analytical procedures. Such procedures
provide the CPA a basis for expressing limited assurance concerning
conformance with PFRS.

c.

Audit: An audit provides reasonable assurance concerning conformance of


financial statements with PFRS. In addition to inquiry and analytical
procedures, an audit involves a study of the clients internal controls and
application of such evidence gathering procedures as confirmation,
observation, inspection, vouching, and examination.

The major procedures applied in a review consist of reading the financial


statements, inquiry as to accounting procedures, and analytical procedures. A
compilation, in contrast to a review, consists of obtaining an understanding of
industry accounting principles and practices and reading the financial
statements.

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9.

A CPA who lacks independence may compile financial statements; but may not
perform an audit, review, or any other form of attestation service.

10. Procedures to be applied in compiling prospective financial statements should


include the following:
a.
b.
c.
d.
e.
f.

Inquire about the accounting principles used in preparing the statements.


Ask how the key factors are identified and how the assumptions are
developed.
Obtain a list of assumptions and consider whether there are any omissions
or inconsistencies.
Test the mathematical accuracy of computations.
Read the statements for conformity with PSA presentation guidelines.
Obtain client representations concerning compliance with the guidelines.

Multiple Choice Questions


1.
2.
3.
4.

c
c
b
b

5.
6.
7.
8.

a
b
a
c

9.
10.
11.
12.

a
d
a
b

13.
14.
15.
16.

b
b
a
b

17.
18.
19.
20.

c
d
a
b

Comprehensive Cases
1. a.

Liability to Delcee and other stockholders:


Delcee in its own right may bring an action, or the other stockholders may
bring a derivative action against Canada and Canada on behalf of the
corporation, for negligent performance in failing to detect the fraud
(embezzlement).
A lawsuit based on constructive fraud might be asserted against C & C,
because the conduct of the review may be characterized as gross negligence
with reckless disregard for the truth. Individual shareholders and lending
institutions will claim this is the case, and if upheld, privity of contract will
not be a valid defense.

b.

Liability to financial institutions:


Third-party financial institutions have rights to sue accountants for
negligence in performing review engagements. As a general rule, third
parties, even though not direct parties to an audit contract, may successfully
assert negligence if they can show that they are members of a class of
persons intended to benefit from the services performed by the CPA and that
their use of the statements was reasonably foreseeable by the CPA.

Nonaudit Engagements: Procedures and Reports

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2.
Assumption

Evidence Sources and Procedures

a. Sale of real estate

1. Determine market value of real estate:


* Review appraisals (if any), inquire of real
estate broker for the selling price of similar
pieces of land.
2. Determine cost and tax basis of land:
* Examine underlying documents (use
financial statement cost presentations, if
previously audited) deeds, purchase
contracts.
* Review National Internal Revenue Code and
appropriate publications to determine proper
tax basis, tax rates, treatment.
3. Determine after-tax profit and proceeds:
* Based on above information, compute profit
and proceeds. Compare amounts to client
representations to determine reasonableness.
4. Determine authority for use of proceeds:
* Examine minutes of directors and officers
meetings for evidence of authority to sell the
real estate and a formal plan for using the
proceeds to retire bonds.

b. Retire outstanding
debentures.

1. Determine probable cost of repurchasing


bonds:
* Examine amount, terms of bonds
outstanding.
* Review current forecasted market for bonds,
in light of terms, amount.
* Compute estimated cost of repurchase.
2. Determine adequacy of funding for repurchase:
* Compare amount of proceeds [computed in
(a)] to amount estimated for repurchase.
3. Determine authority for retirement:
* Examine minutes of executives and officers
meetings for evidence of approval of
retirement.

c. Labor contract

1. Determine probable wage increase:


* Examine
prior
contract
settlements,
including subjective analysis of labormanagement relations. Confer with union
officials.

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* Examine documents, memos, and minutes
regarding upcoming labor negotiations.
* Examine managements proposed contract.
2. Determine effect of higher than predicted wage
settlement:
* Recompute effect of percent change in wage
increase to net income and correlate to
managements figures.
d. Sales projections

1. Determine estimated completion date of Tarlac


facility:
* Examine contract plans, consult with
contractor, observe facility.
* Examine
contracts
for
machinery,
installation; consult with vendor dates,
type of equipment, product capacity.
* Compare auditor-estimated completion date
to managements for reasonableness.
* Consider if company can meet personnel
requirements of the new facility.
2. Estimate financial impact of Tarlac production:
* Compare productive capacity to forecasted
sales
figure
(presumed
determined
reasonable by the auditor).
* Recompute probable effect of delay in
Tarlacs completion date and compare to
managements figures.

3. Nicky has no accounting staff and has little expertise in preparing financial
statements himself. However, he needs them occasionally, apparently for credit
purposes.
Three kinds of compiled financial statements are available:
1.
2.
3.

Compilation Without Independence. Brother Kian can prepare the compiled


financial statements (with or without all disclosures), but he will need to
disclose in this report his lack of independence.
Compilation With Full Disclosure. CPA Bryan can compile the statements
and present them in the complete form used for audited financial
statements.
Compilation That Omits Substantially All Disclosures. CPA Bryan can
compile statements without footnote disclosures, but his report will indicate
the lack of disclosure and will warn users.

Nonaudit Engagements: Procedures and Reports


4.

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a.

Yes, this is a negative assurance.

b.

Negative assurance is generally prohibited in audit reports because the


profession wishes such reports to contain positive assertions based on
evidence instead of negative statements based on what did not come to my
attention.

c.

A review service is less than an audit, hence the report can be less than
positive assurance. Clients get what they paid (less) for.

5.
To the Board of Directors of Francisco Company
I have reviewed the accompanying statement of financial position of Francisco Company
as of December 31, 2014, and the related statements of income, retained earnings, and
changes in financial position for the year then ended, in accordance with standards
established by the Auditing Standards and Practices Council. All information included in
these financial statements is the representation of the management of Francisco
Company.
A review consists principally of inquiries of company personnel and analytical procedures
applied to financial data. It is substantially less in scope than an examination in
accordance with auditing standards, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole. Accordingly, I do not
express such an opinion.
Based on my review, I am not aware of any material modifications that should be made
to the 2014 financial statements in order for them to be in conformity with financial
reporting standards.
The accompanying 2013 financial statements of Francisco Company were compiled by
other accountants whose report dated January 11, 2014, stated that they did not express
any opinion or any other form of assurance of those statements.
Jo Cee, CPA
January 15, 2015
Note:

This report presumes:


1. Jo Cee is independent.
2. Francisco and Associates, CPAs made no modifications in their
2003 compilation report.
3. Francisco and Associates, CPAs was independent.
4. The 2003 statements contained all necessary disclosures.

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6.
a.
b.
c.
d.

7.

Service
Compilation
Agreed upon
procedures
Review

Report
Compilation
Review

Examination
(attestation)

Opinion

Review

Procedures
Read and inquire
As agreed and applied to
specified elements
Read, inquire, and apply
analytical procedures
Evaluate preparation
Examine and evaluate
underlying assumptions
Determine whether
presentation is in
conformity with PSA
guidelines.

a.
Nature of
Engagement

Type of
Report

Principal
Procedures

a.

Audit

Opinion; positive

Study and evaluate


internal control;
observe, examine,
confirm, reconcile,
calculate, and vouch.

b.

Comprehensive
basis other than
PFRS

Opinion; positive

Same as (a)

c.

Review;
nonpublic entity

Review; limited

Inquiry; analytical
procedures

d.

Compilation;
nonpublic entity

Compilation; none

Understand industry
accounting practices;
read the financial
statements

e.

Agreed-upon
procedures

Review; limited

As specified by
engagement letter

f.

Letter for
underwriter

Review; limited

Inquiry-as specified by
agreement; read the
financial statements

Nonaudit Engagements: Procedures and Reports

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g.

Examination of
prospective
financial
statementsprojection

Opinion; positive

Examine evidence
supporting assumptions;
determine whether
assumptions provide a
reasonable basis for the
projection; evaluate
preparation and
presentation of
projected financial
statements.

h.

Review of
interim financial
information

Review; limited

Inquiry; analytical
procedures

b.
a.
b.
c.
d.
e.
f.
g.
h.

General.
Restricted to management, the board of directors, and the regulatory
commission.
General.
General (but a fourth paragraph must be added which states that the
CPA is not independent.)
Restricted to the parties named in the agreement.
Restricted to the underwriters, Candy and Lolli.
Restricted to management, the board of directors, and the prospective
lender.
General.