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					Chapter 19 - Additional Assurance Services: Historical Financial Information



CHAPTER 19


                  Additional Assurance Services:
                  Historical Financial Information


Review Questions

19-1    This statement is incorrect. An audit can be a significant expense to a small company. The
        audit fee must be justified by the benefits received from the audit. The needs of the users of the
        financial statements of many small nonpublic companies are satisfied by financial statements
        that have been reviewed or compiled by the CPAs.

19-2    The term auditor is most frequently used when discussing CPAs' role of attesting to the annual
        historical financial statements and when they are performing an operational audit. The term
        accountant refers to CPAs when they are performing other attestation services and accounting
        services. Thus, while auditors do perform the attestation service of audits, the statement that
        auditors perform attestation services and accountants perform accounting services is
        incomplete.

19-3    In communications with clients, CPAs should refer to themselves as auditors only when the
        service they are rendering is an audit performed in accordance with generally accepted auditing
        standards. When rendering other services, they should refer to themselves as "accountants," or
        as "CPAs." The purpose of this distinction is to avoid leading the client to believe that the
        CPAs are acting as auditors when they actually are rendering other attestation or accounting
        services.

19-4    Yes. Auditors may express opinions on financial statements that are presented in accordance
        with the cash basis or any other comprehensive basis of accounting. Such auditors' reports are
        a type of special report and must state that the financial statements are not presented in
        conformity with generally accepted accounting principles, as well as indicate the accounting
        basis used.

19-5    Neither. While the performance of an agreed-upon procedures engagement is considered an
        attestation service (as is an audit), the two attestation services differ. Because agreed-upon
        procedures engagements are attestation services they are not considered accounting services.

19-6    Engagements to perform agreed-upon procedures are restricted because the specified parties
        have agreed to the nature and extent of the procedures to be performed to meet their needs.
        The nature and extent may not be appropriate for other parties.




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19-7    When a report is for use primarily outside the United States the auditors may issue (1) a U.S.
        report, modified as appropriate to reflect the principles of the other country, or (2) the report of
        the other country, if the auditors understand the related responsibilities.

19-8    No, generally accepted accounting principles for personal financial statements require the
        valuation of assets at estimated current values, not at historical cost. A CPA can issue an
        unqualified special report on Wilson's statements, however, because historical cost is a
        comprehensive basis of accounting even though it is not in accordance with GAAP.

19-9    The procedures applied during a review of the quarterly financial statements of a public
        company include: (1) procedures to obtain an understanding of the client’s business and
        internal control; (2) analytical procedures applied to the interim financial data to identify and
        provide a basis for inquiries about relationships that appear unusual and that may indicate a
        misstatement; (3) inquires of management about such matters as unusual analytical
        relationships, significant transactions occurring around period end, subsequent events, and the
        occurrence or allegations of fraud; (4) reading minutes of meetings of stockholders and
        directors and the interim financial information; (5) obtaining evidence that the interim financial
        information agrees to the accounting records, and (6) obtaining written representations from
        management regarding the presentation and completeness of the statements.

19-10 The most unique aspect of the required review of the quarterly financial information of public
      companies is the fact that the CPAs are not required to report on the engagements. Therefore,
      the CPAs must notify the SEC if the client files materially misstatement information.

19-11 The CPAs assist audit committees by communicating matters that assist them in performing
      their functions, including:

            Instances of fraud and illegal acts;
            Significant deficiencies related to the preparation of interim financial statements;
            Significant review adjustments found by the CPAs;
            The quality of accounting principles and estimates;
            Disagreements with management over accounting principles or review procedures; and
            Any other difficulties encountered performing the review.

19-12 In recognition of the fact that many small nonpublic companies do not need audits of their
      financial statements, the AICPA established the Accounting and Review Services Committee.
      That committee establishes standards for the compilation and review of the financial statements
      of nonpublic companies. CPAs may perform a compilation, a review, agreed-upon procedures,
      or an audit of the financial statements of a nonpublic company.

19-13 A review of financial statements of a nonpublic company does not involve a consideration of
      internal control, tests of the accounting records, or obtaining corroborating evidence, which are
      performed during an audit. Therefore, a review does not provide a basis for an opinion as to
      whether the financial statements are fairly presented in accordance with generally accepted
      accounting principles.




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19-14 The primary procedures for a review of financial statements include inquiry of client
      management, and analytical procedures performed on the financial information by reference to
      prior financial statements, budgets, and other operating data. The CPAs also inquire
      concerning the actions taken in meetings of stockholders, the board of directors, and
      committees of the board. The accountants' inquiries should focus on whether the financial
      statements conform to generally accepted accounting principles, changes in business activities,
      and significant subsequent events. The accountants are also required to obtain a representation
      letter from management of the company.

19-15 While not strictly required, engagement letters are important for accounting and review
      services. This importance is due to the fact that accounting and review services are quite
      different from audits and, therefore, the engagement letter should explain the nature of the
      services to be rendered and make clear to the client that the CPAs will not be performing an
      audit.

19-16 A comfort letter is designed to aid securities underwriters in the investigations of registration
      statements required under the Securities Act of 1933. In the letter, the CPAs provide
      assurances regarding various financial information included in the registration statement.

19-17 The auditors will normally provide an opinion on whether the condensed information is fairly
      stated in all material respects in relation to the basic financial statements.

19-18 The minimum procedures required include reading the compiled statements for appropriate
      format and obvious material misstatement. But, when performing this service CPAs generally
      are asked to prepare the financial statements. Also, prior to performing a compilation the CPAs
      must have knowledge of the accounting principles and practices used within the client's
      industry and must have a general understanding of the client's business transactions and
      accounting records.

19-19 Yes. When performing compilations, CPAs may issue a compilation report that indicates that
      management has elected to omit substantially all of the disclosures required by GAAP. When
      performing a review, the CPA who is aware of a departure from GAAP (including adequate
      disclosure) must consider modifying the report to be issued to reflect such information or, if the
      statements appear to be misleading, consider resignation. In the case of audits, omission of
      such disclosures leads to either a qualified or an adverse opinion based on the inadequate
      disclosure.

19-20 If the accountants discover a material departure from GAAP, they should request that
      management revise the financial statements. If management refuses to do so, the CPAs should
      modify their report to describe the departure and its effect on the financial statements, if
      known.

19-21 When compiled financial statements are not expected to be used by a third party, the CPAs
      must still perform the standard compilation procedures. However, they have the following two
      reporting options:




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        (1)      Issue a compilation report, or
        (2)      Issue no report and document in an engagement letter the understanding with the client
                 that the financial statements will not be used by a third party. Also, make sure that the
                 financial statements include a restricting phrase, such as “Restricted for Management’s
                 Use Only.”

19-22 If the CPA firm discovers that it is not independent, the firm cannot issue a review report. The
      CPA firm can either resign from the engagement or perform a compilation of the financial
      statements with a report that discloses that the firm is not independent.

Questions Requiring Analysis

19-23 (a)        No. The AICPA Code of Professional Conduct prohibits direct interests by CPAs in
                 audit clients during the period of the professional engagement. Since interests of an
                 auditor's spouse and dependent children are attributed directly to the auditor, Bell &
                 Davis are not independent with respect to Worthmore.

        (b)      The report is deficient in the following three respects:

                 (1)      A CPA firm that is not independent cannot comply with the generally accepted
                          auditing standard requiring an independence in mental attitude in all matters
                          relating to the assignment. Therefore, the auditor must disclaim an opinion on
                          the financial statements. The AICPA, in SAS No. 26 (AU 504), suggests the
                          following form of report:

                                      We are not independent with respect to XYZ Company, and
                               the accompanying balance sheet as of December 31, 20Xl, and the
                               related statements of income, retained earnings, and cash flows for
                               the year then ended were not audited by us and, accordingly, we do
                               not express an opinion on them.

                 (2)      The report should not indicate the reason for the lack of independence by the
                          CPA firm.

                 (3)      The report should indicate that the financial statements do not contain a
                          statement of cash flows; the omission of this statement represents a departure
                          from generally accepted accounting principles.

19-24 (a)        Since Ambassador Hardware Co. is a nonpublic company, its financial statements may
                 be audited, reviewed, or compiled. A review of financial statements involves the
                 performance of inquiry and analytical procedures to provide a basis for limited
                 assurance that the financial statements are in accordance with generally accepted
                 accounting principles. The accountants do not perform procedures to corroborate the
                 financial statement information and they do not perform an assessment of internal
                 control. A compilation of financial statements involves the preparation of financial
                 statements from representations by management. The accountants provide no
                 assurance regarding the "fairness" of the financial statements.




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        (b)      In selecting the type of service, Ambassador's management should consider the needs
                 of the users of the company's financial statements. For example, Ambassador's
                 creditors may be willing to extend necessary capital to the company on the basis of
                 compiled or reviewed financial statements. However, if the owners of the company are
                 considering issuing shares of stock to the public in the near future, they should
                 consider the need to obtain audited financial statements to comply with SEC
                 regulations.

19-25                                       Independent Auditors' Report

        The General Partner
        Dale, Booster & Co.

                We have audited the accompanying statement of assets, liabilities, and capital on an
        income tax basis of Dale, Booster & Co., a partnership, as of December 31, 20X1, and the
        related statement of revenue and expenses--income tax basis, and the statement of changes in
        partners capital accounts for the year then ended. These financial statements are the
        responsibility of the Company's management. Our responsibility is to express an opinion based
        on our audit.
                We conducted our audit in accordance with generally accepted auditing standards.
        Those standards require that we plan and perform the audit to obtain reasonable assurance as to
        whether the financial statements are free of material misstatement. An audit includes
        examining, on a test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used and significant
        estimates made by management, as well as evaluating the overall financial statement
        presentation. We believe that our audit provides a reasonable basis for our opinion.
                As described in Note X to the financial statements, the partnership's policy is to prepare
        its financial statements on the accounting basis used for income tax purposes, which is a
        comprehensive basis of accounting other than generally accepted accounting principles.
                In our opinion, the financial statements referred to above present fairly, in all material
        respects, the assets, liabilities, and capital of the Dale, Booster & Co. partnership as of
        December 31, 20X1, and its revenue and expenses and changes in its partners' capital accounts
        for the year then ended, on the income tax basis of accounting as described in Note X.

              As discussed in Note Y to the financial statements, the Company is involved in
        continuing litigation relating to patent infringement. The amount of damages, if any, resulting
        from this litigation cannot be determined at this time.
                                                                                    Rose & Co., CPAs
                                                                                         March 1, 20X2

19-26 (a)        CPAs may report on specified elements, accounts, or items of a financial statement in
                 the following ways:

                 (1)      An opinion may be expressed as to whether the information is fairly presented
                          on the basis indicated. In such engagements, the auditors must apply auditing
                          procedures and materiality must be judged in relation to the items presented.




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                 (2)      A report may be expressed on the application of agreed-upon procedures to the
                          information. In such circumstances, the auditors must be assured that the
                          parties involved understand the nature and extent of the procedures. The
                          report should indicate the procedures performed, state the intended distribution
                          of the report, the CPAs' findings, provide a disclaimer of an opinion on the
                          information, and indicate that the report does not extend to the financial
                          statements taken as a whole.
                 (3)      A review of the information may be performed. In such a circumstance the
                          auditors would apply the appropriate analytical review and inquiry procedures
                          to allow them to provide limited assurance (e.g., “we are not aware of any
                          material modifications”) on the information.

        (b)      Such reports must be restricted as to distribution because the reports could potentially
                 mislead the general public. Only individuals that have a clear understanding of the
                 nature and extent of the auditors' procedures should have access to the reports.

19-27 (a)        The statement is incorrect because while no assurance is provided when accounting
                 services are performed, they are not considered special reports.

        (b)      Five types of reports are referred to as "special reports":

                 (1)      Financial statements prepared in accordance with a comprehensive basis of
                          accounting other than generally accepted accounting principles (e.g., cash-
                          basis statements).
                 (2)      Specific elements, accounts, or items of financial statements (e.g., a report on
                          net sales).
                 (3)      Compliance with aspects of contractual agreements or regulatory requirements
                          related to audited financial statements (e.g., client's compliance with
                          restrictions of a debt agreement).
                 (4)      Special-purpose financial presentations (e.g., a report on certain specified
                          assets being sold).
                 (5)      Audited financial information presented in prescribed forms (e.g., filings with
                          certain regulatory agencies).

        (c)      Examples of accounting services include compilations of financial statements,
                 compilations of prospective financial statements, and "unaudited" financial statement
                 association with financial statements of a public company (only one required).

19-28 (a)        The major procedures for a review of financial statements include:

                 (1)      Inquiries concerning the company's accounting principles and practices.
                 (2)      Inquiries concerning the company's system of accounting.
                 (3)      Analytical procedures to identify relationships and items that appear to be
                          unusual. The procedures include comparisons of accounting data with prior
                          financial statements and budgets and a study of relationships between accounts
                          that can be expected to conform to predictable patterns.
                 (4)      Inquiries concerning actions taken at meetings of stockholders, board of
                          directors, and committees of the board.
                 (5)      Reading the financial statements for conformity with generally accepted
                          accounting principles.


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                 (6)      Obtaining reports from other accountants, if any, who have audited or
                          reviewed the financial statements of components of the company.
                 (7)      Inquiries of management concerning the conformity of the financial statements
                          with generally accepted accounting principles and material subsequent events.
                 (8)      Obtaining a representation letter from management.

        (b)      The report on a review of financial statements should indicate that:

                 (1)      A review was performed in accordance with AICPA standards.
                 (2)      The financial statements are representations of management.
                 (3)      A review consists of inquiries of management and analytical procedures.
                 (4)      A review is substantially less in scope than an audit; therefore, no opinion is
                          expressed regarding the financial statements taken as a whole.
                 (5)      The accountants are not aware of any material modifications that should be
                          made in the financial statements for them to be in conformity with generally
                          accepted accounting principles.

        (c)      If the accountants discover a material departure from generally accepted accounting
                 principles, they should request that the client revise the financial statements. If the
                 financial statements are not revised, the departure should be disclosed in a separate
                 paragraph of the accountants' report, including the effects of the departure on the
                 financial statements, if known.

19-29 (a)        The accountants can provide negative assurance that the unaudited financial statements
                 comply with the 1933 Act and SEC pronouncements, and are fairly presented in
                 accordance with generally accepted accounting principles on a basis consistent with
                 that of the audited financial statements and schedules included therein.

        (b)      Comfort letters also typically contain the assurances as to:

                 (1)      The independence of the accountants.

                 (2)      Compliance of audited financial statements and schedules with the Securities
                          Act and related rules and regulations.

                 (3)      Changes in selected financial statement items during a specified period from
                          the date of the latest financial statements included in the registration statement.

                 (4)      Tables, statistics, and other financial information in the registration statement.

                 (5)      Pro forma financial information, financial forecasts.

                 (6)      Certain non-financial information included in the registration statement
                          complies with SEC regulations.

19-30 (a)        When accountants are associated with the financial statements of a public company,
                 they should look for guidance in Statements on Auditing Standards issued by the
                 Auditing Standards Board. In particular, SAS No. 26 (AU 504) applies to such
                 engagements.




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        (b)      When accountants are associated with the financial statements of a public company,
                 but have not audited or reviewed such statements, the financial statements should be
                 accompanied by a clearly written disclaimer of opinion. The accountants are
                 associated with financial statements when they consent to the use of their name in a
                 document containing the statements, or they submit to the client or others financial
                 statements that they have prepared or assisted in preparing.

        (c)      Accountants have no responsibility to apply any auditing or review procedures to
                 unaudited financial statements, except to read the statements for obvious material
                 errors. If the accountants discover that the financial statements contain a material
                 departure from generally accepted accounting principles, they should insist on
                 appropriate revision, or explain their reservations in their report.

Multiple Choice Questions

19-31 (a)        (3)      Audits of financial statements include confirmations of accounts receivable,
                          reviews generally do not.

        (b)      (3)      A representation letter, but not an engagement letter, is required when a
                          review of a nonpublic company is being performed.

        (c)      (2)      Independence is only required for attestation services. Since compilation is
                          not an attestation service, independence is not required. Independence is
                          required on a review engagement.

        (d)      (3)      Inquiries of management ordinarily included those on subsequent events,
                          significant journal entries and other adjustments, and unusual or complex
                          situations affecting the financial statements. Inquiries about communications
                          with related parties are not specifically required.

         (e)     (3)      The auditors’ report on condensed financial statements includes an opinion on
                          whether the condensed information is fairly stated in all material respects in
                          relation to the basic financial statements.

        (f)      (2)      Management of public companies must engage CPAs to review their
                          company’s quarterly financial information.

        (g)      (3)      The appropriate report on compiled financial statements that omit disclosures
                          includes an indication that management has elected to omit the disclosures and
                          the financial statements are not intended for individuals not informed of such
                          matters.

        (h)      (4)      Agreed-upon procedures engagements always result in a restricted use (limited
                          distribution) report.

        (i)      (3)      Completeness is generally the most difficult assertion with respect to personal
                          financial statements due to poor internal control and motivation by some
                          individuals to omit assets and income.




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        (j)      (2)       Special reports are appropriate for attesting to compliance with contractual
                           agreements related to audited financial statements.

        (k)      (1)       A compilation report contains a disclaimer regarding the financial statements;
                           it should not include the expression of negative assurance.
        (l)      (1)       A comfort letter is issued by the independent auditors to the underwriters.
                           Accordingly, such letters are normally signed by the independent auditors.



Problems

19-32 SOLUTION: Jiffy Clerical Services (Estimated time: 30 minutes)

        (a) Audit report

                                   Independent Auditors' Report

                 The Board of Directors
                 Jiffy Clerical Services

                        We have audited the accompanying statement of assets and liabilities arising
                 from cash transactions of Jiffy Clerical Services as of December 31, 20X4, and the
                 related statement of revenue collected and expenses paid for the year then ended.
                 These financial statements are the responsibility of the Company's management. Our
                 responsibility is to express an opinion based on our audit.
                        We conducted our audit in accordance with generally accepted auditing
                 standards. Those standards require that we plan and perform the audit to obtain
                 reasonable assurance as to whether the financial statements are free of material
                 misstatement. An audit includes examining, on a test basis, evidence supporting the
                 amounts and disclosures in the financial statements. An audit also includes assessing
                 the accounting principles used and significant estimates made by management, as well
                 as evaluating the overall financial statement presentation. We believe that our audit
                 provides a reasonable basis for our opinion.
                        As more fully described in Note 1, the Company's policy is to prepare its
                 financial statements on the basis of cash receipts and disbursements, which is a
                 comprehensive basis of accounting other than generally accepted accounting
                 principles.
                        In our opinion, the financial statements referred to above present fairly, in all
                 material respects, the assets and liabilities arising from cash transactions of Jiffy
                 Clerical Services as of December 31, 20X4, and the revenue collected and expenses
                 paid during the year then ended, on the basis of accounting described in Note 1.

                                                                                         Blue, Gray & Co.
                                                                                        February 23, 20X5




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          (b)    The report must be modified because the statements are not in conformity with the
                 meaning of "generally accepted accounting principles" as used in the conventional
                 standard report. No opinion is expressed as to the statements' conformity to generally
                 accepted accounting principles because cash basis statements omitting assets or
                 liabilities of material amount are not in accordance with such principles.
                         Further, the financial statements are not called balance sheet or income
                 statement because of material differences from accrual statements. Special care must
                 be taken to avoid leading the reader to incorrect inferences. Cash basis statements
                 should be titled to reveal clearly what they represent and to avoid implying that they
                 present financial position or operating results in accordance with generally accepted
                 accounting principles.

19-33 SOLUTION: Brown & Brown (Estimated Time: 45 Minutes)

                                      Independent Auditors' Report

        To the Board of Trustees of
        Modern Museum, Inc.

               We have audited the accompanying statements of assets, liabilities and fund balances
        (modified cash basis) of Modern Museum, Inc., as of December 31, 20X4 and 20X3, and the
        related statements of support, revenues, and expenses and of changes in fund balances
        (modified cash basis) and changes in financial resources (modified cash basis) for the years
        then ended. These financial statements are the responsibility of the Company's management.
        Our responsibility is to express an opinion on these financial statements based on our audits.
               We conducted our audits in accordance with generally accepted auditing standards.
        Those standards require that we plan and perform the audit to obtain reasonable assurance
        about whether the financial statements are free of material misstatement. An audit includes
        examining, on a test basis, evidence supporting the amounts and disclosure in the financial
        statements. An audit also includes assessing the accounting principles used and significant
        estimates made by management, as well as evaluating the overall financial statement
        presentation. We believe that our audits provide a reasonable basis for our opinions.
               As described in Note X, the organization's policy is to prepare its financial statements on
        the basis of cash receipts and disbursements, which is a comprehensive basis of accounting
        other than generally accepted accounting principles.
               In our opinion, the financial statements referred to above present fairly, in all material
        respects, the assets, liabilities, and fund balances of Modern Museum, Inc., at December 31,
        20X4 and 20X3, and its support, revenues, and expenses and the changes in its fund balances
        and changes in financial resources for the years then ended, on the basis of accounting
        described in Note X.

                                                                                  Brown & Brown CPAs
                                                                                       March 12, 20X5

19-34 SOLUTION: Broadwall Corporation (Estimated time: 25 minutes)

        (a)      A review of interim financial statements does not provide a basis for the expression of
                 an opinion because a review is not an audit performed in accordance with generally
                 accepted auditing standards--that is, it does not include the collection of sufficient
                 competent evidence to support an opinion.


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        (b)      The procedures that Loman must perform consist primarily of inquiries and analytical
                 procedures concerning significant accounting matters relating to the financial
                 information to
                 be reported. The procedures that Loman should apply ordinarily may be limited to the
                 following:

                                      Procedure                                 Purpose of Procedure

                 Reviewing documentation of the most recent             To update the understanding of the
                 audit and financial statements, and considering        business and internal control.
                 the results of auditing procedures.

                 Inquiry concerning any significant changes in          To update the understanding of the
                 the company’s business activities.                     business and internal control.

                 Performing analytical procedures.                      To identify and provide a basis for
                                                                        inquiries to management and certain other
                                                                        procedures.

                 Making inquiries of management regarding               To obtain assurance that unusual
                 unusual relationships.                                 relationships are not the result of
                                                                        misstatements of the interim information.

                 Performing additional procedures if the CPAs           To obtain assurance that the interim
                 become aware that interim information may be           information is not materially misstated.
                 incorrect, incomplete, or otherwise
                 unsatisfactory.

                 Inquiring of officers and other executives             In order to become aware of significant
                 having responsibility for financial and                matters affecting the interim financial
                 accounting matters concerning:                         statements.
                     (a) Whether the interim financial
                         statements have been prepared in
                         conformity with generally accepted
                         accounting principles consistently
                         applied.
                     (b) Unusual or complex situations
                         affecting the interim financial
                         information.
                     (c) Significant transactions occurring
                         around the end of the period.
                     (d) Subsequent events.
                     (e) Whether management has knowledge
                         of fraud having been committed.
                     (f) Whether allegations of fraudulent
                         financial reporting have been made by
                         employees, former employees, or other
                         individuals.




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                 Reading the minutes of meetings of                     To identify actions that may affect the
                 stockholders, board of directors, and                  interim financial statements.
                 committees of the board of directors.
                                    Procedure                                    Purpose of Procedure

                 Reading the interim financial statements.              To consider, on the basis of information
                                                                        coming the accountants' attention,
                                                                        whether the information to be reported
                                                                        conforms with generally accepted
                                                                        accounting principles.

                 Obtaining reports from other accountants who           As a basis, in part, for the report.
                 may have been engaged to make a review of
                 the interim financial information of significant
                 components of the company.

                 Obtaining evidence that the interim financial          To obtain assurance that the interim
                 information reconciles with the accounting             information is not materially misstated.
                 records.


19-35 SOLUTION: Delano Company (Estimated Time: 20 minutes)

        Deficiencies in the staff assistant's draft are as follows:

        First paragraph:

            The statement of cash flows is not identified.
            Standards established by the AICPA, not generally accepted auditing standards, should be
             referred to.
            The financial statements are not stated to be the representations of management.
            The phrase "our review included such tests of the accounting records as we considered
             necessary in the circumstances" is inappropriate.

        Second paragraph:

                The phrase "analytical procedures applied to financial data" is omitted.
                The phrase "more in scope than a compilation" is inappropriate.
                An opinion should be disclaimed.
                An indication that "limited assurance" is expressed is not appropriate.

        Third paragraph:

            Reference to consistency is inappropriate.




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19-36 SOLUTION: Norman Lewis (Estimated time: 25 minutes)

                Deficiency                            Reason                       Correction

       (1)      The report does not      To avoid reader mis-                  The report should clearly
                identify the             understanding as to which             identify the compiled
                financial statements     financial statements were             statements, including the
                that were compiled.      compiled.                             company name, the
                                                                               individual statements, and
                                                                               their dates.
       (2)      A compilation            A compilation involves the
                report should not        preparation of financial              Reference to the performance
                indicate that            statements from representations       of analytical review
                analytical               of management, without                procedures should be deleted
                procedures were          performing procedures to audit        from the report
                applied to the           or review the information. To
                financial                indicate that procedures were
                statements.              applied to the financial
                                         statements could confuse the
                                         readers to the nature of the
                                         accountant's service.

                                                                                   .

       (3)      The report does not The reader should be clearly               The report should indicate
                indicate the nature informed as to the nature of the           that a compilation is limited
                of a compilation of accountants' service.                      to presenting in the form of
                financial statements.                                          financial statement
                                                                               information that is the
                                                                               representation of
                                                                               management.

       (4)      The report provides      A compilation of financial            The statement of negative
                negative assurance       statements does not provide a         assurance should be altered to
                regarding the            basis for the expression of           indicate that the accountants
                financial statements;    negative assurance regarding the      do not express an opinion or
                it states that nothing   statements. The accountants           any other form of assurance
                came to the              report on the compilation should      on the financial statements.
                accountants'             disclaim an opinion on the
                attention to indicate    financial statements.
                the financial
                statements are in
                error.




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19-37 SOLUTION: Ajax Company (Estimated time: 25 minutes)

        Deficiencies in the report on the compiled financial statements are as follow:

        Within the first Paragraph
         (1)    The financial statements are not properly identified.
         (2)    Standards established by the AICPA should be referred to.
         (3)    The expression “to obtain limited assurance” should not be used.

        Within the second paragraph
         (4)    The information is not stated to be the representations of management.
         (5)    The phrase “less in scope than an audit” is inappropriate.
         (6)    Reference to the financial statements not being reviewed is omitted.
         (7)    Reference to “any other form of assurance” is omitted.

        Within the third paragraph
         (8)    Reference to the omission of the statement of cash flows is omitted.
         (9)    There should be a statement that the financial statements are not designed for those
                uninformed about the omitted disclosures.
        (10)    It is inappropriate to refer to changes in financial position.

        Within the fourth paragraph
        (11)    The reason for the accountant’s lack of independence should not be described.
        (12)    Inclusion of the fifth paragraph is inappropriate.
        (13)    The accountant’s compilation report is not dated October 25, 20X8.


19-38 SOLUTION: Unaudited Financial Statements (Estimated time: 35 minutes)

        (a)      Write-up work and compilation of financial statements represent an accounting service
                 and not an audit of the financial statements. It is important that the client understand
                 this distinction and more important that there be a clear understanding between the
                 client and the CPAs of the nature of each engagement.
                         Verbal commitments, such as a telephone conversation, can often be
                 misunderstood and therefore should be followed up with an engagement letter that
                 spells out the terms, nature, and limitations of the services to be performed. A copy of
                 this letter should be signed and returned by the client to acknowledge its understanding
                 and approval of the scope of the engagement.

          (b)    Even a regular audit engagement cannot provide absolute assurance of detecting
                 irregularities, and in an engagement to compile financial statements the CPAs have no
                 responsibility to apply any auditing or review procedures. However, as professionals,
                 the CPAs do have a responsibility to exercise due care in carrying out their
                 engagements, to apply professional judgment in the preparation of financial statements,
                 and to bring to the client's attention any unusual or suspicious matters they note during
                 their work. The CPAs have an obligation to investigate information that appears to be
                 in error, incomplete, or otherwise inadequate.




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          (c)    The word "audit" should be avoided in non-audit engagements. The CPAs should
                 persuade their client to change the account title to "Accounting Services," and should
                 be certain their client understands the difference between an accounting service and an
                 engagement to examine the financial statements in accordance with generally accepted
                 auditing standards.

          (d)    Using language in a cover letter such as "... to which we have performed certain
                 auditing procedures" can imply that an attest engagement of some type was made and
                 the CPAs may find that they have assumed more responsibility than they intended. A
                 short, concise disclaimer of opinion should always accompany unaudited financial
                 statements with which the CPAs are associated, and each page should be clearly and
                 conspicuously marked as unaudited. If a separate covering letter is used it should
                 contain no language that would expand upon the simple disclaimer of opinion. The
                 recommended disclaimer in Statement on Auditing Standards No. 26 (AU 504) is as
                 follows:

                              "The accompanying balance sheet of X Company as of December
                        31, 20X1, and the related statements of income, retained earnings, and
                        changes in financial position for the year then ended were not audited by
                        us and accordingly we do not express an opinion on them."

          (e)    While the CPAs do not have a responsibility to perform any auditing or review
                 procedures in a compilation engagement, they do have responsibility to perform all
                 services with reasonable skill and care.
                        A situation involving missing invoices should have caused the CPAs to question
                 the accuracy and completeness of the financial information submitted to them. They
                 should have rejected the information and investigated the situation. If it appeared that
                 irregularities existed, the CPAs should have advised the client of the missing invoices
                 and suggested that the client follow up on the matter or, if the client so desired, the
                 CPAs could pursue it further as an additional accounting service.

          (f)    By definition, unaudited financial statements have not been audited and the CPAs
                 cannot be expected to have an opinion as to whether they are prepared in conformity
                 with generally accepted accounting principles. However, they do have a responsibility
                 to complete a compilation engagement in a professional manner, and if they conclude
                 on the basis of facts known to them that the unaudited financial statements are not in
                 conformity with generally accepted accounting principles, they should insist upon
                 appropriate revisions.
                        In this situation the land and building should be adjusted to historical cost less
                 depreciation. If the CPAs cannot persuade their client to adjust the land and building,
                 they should set forth clearly in their compilation report the departure from generally
                 accepted accounting principles and the effect, if known to them, on the financial
                 statements. Further, if the client refuses to accept the CPAs' report with their
                 reservations clearly set forth, the CPAs should refuse to be associated with the
                 financial statements and formally withdraw from the engagement.




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          (g)    Financial statements may be compiled that omit substantially all the disclosures
                 required by generally accepted accounting principles. CPAs may compile them as long
                 as they have no reason to believe that the financial statements are intended to mislead,
                 and their compilation report clearly indicates that the financial statements omit the
                 necessary disclosures.




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19-39 SOLUTION: Calhoun (Estimated time: 35 minutes)

                                                                        What Brown Should Have Done
                     Inappropriate Action                               to Avoid Inappropriate Action

       (1)      Brown was aware that the client             Brown should have established a clear
                misunderstood the nature of the             understanding with the client, preferably in writing,
                engagement.                                 through an engagement letter.

       (2)      Brown's agreement with Calhoun              The fee arrangement should have been based on the
                provided for the payment of a               nature and difficulty of the engagement
                contingent fee; specifically, the
                understanding called for the payment
                of a substantial fee if the work was
                completed in two weeks. Contingent
                fees for such clients are prohibited by
                the AICPA Code of Professional
                Conduct.


       (3)      Brown should not have suggested that        Brown should have insisted that his fee be recorded
                his fees be recorded in an account          in an account that clearly indicated the nature of his
                entitled "Fees for Limited Audit            services, such as "Fees for Accounting Services."
                Engagement." This action
                contributed further to the
                misunderstanding with the client
                concerning the nature of his services.

       (4)      Brown should have performed a               Brown should have investigated the possibility of
                further investigation of the situation      irregularities as indicated by the missing invoices.
                indicated by the missing invoices.
                Even though a compilation does not
                involve the performance of
                procedures to substantiate the
                financial statement information, the
                accountants should investigate any
                situation that indicates that the
                information is incorrect, incomplete,
                or otherwise unsatisfactory.

       (5)      Brown did not insist upon disclosure        The notes should have been drafted to clearly
                of the method of valuation of fixed         indicate the method of valuation of the fixed assets.
                assets in the notes to the financial
                statements. A separate letter is not an
                appropriate means to disclose and
                explain the effects of accounting
                principles.




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                                                                        What Brown Should Have Done
                       Inappropriate Action                             to Avoid Inappropriate Action

       (6)      Brown did not disclose the departure        A report should have been drafted to include a
                from generally accepted accounting          separate paragraph referring to the departure from
                principles in accounting for fixed          generally accepted accounting principles, including
                assets.                                     the effect of the departure, if known.

       (7)      The financial statements did not            A report should have been drafted with a separate
                include a statement of cash flows, and      paragraph referring to the departure from generally
                Brown did not disclose this departure       accepted accounting principles.
                from generally accepted accounting
                principles in a properly drafted
                compilation report.

       (8)      Brown marked each page with a note          Each page of the financial statements should have
                indicating that the financial               been labeled "See Accountants' Compilation
                statements were submitted without           Report."
                complete audit verification. The
                financial statement reader cannot
                determine the type of service
                performed by Brown or the
                responsibility he was assuming.

       (9)      The financial statements were not           The financial statements should have been
                accompanied by a properly drafted           accompanied with a compilation report, which
                accountants' report.                        included the paragraphs discussed above referring to
                                                            the departures from generally accepted accounting
                                                            principles.


In-Class Team Case

19-40 SOLUTION: Webstar (Estimated Time: 60 minutes)

        a.       Review of financial statements

                 (1)       Yes.
                 (2)       The procedures applied during a review of the quarterly financial statements of
                           a public company include: procedures to obtain an understanding of internal
                           control; analytical procedures applied to the interim financial data by reference
                           to prior interim information, budgets, and other data; reading minutes of
                           meetings of stockholders and directors; and obtaining written representations
                           from management regarding the presentation and completeness of the
                           statements.




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                 (3)
                 (4)      Limited (negative) assurance.
                 (5)      Departures from generally accepted accounting principles. Review reports are
                          not required to be altered in cases involving consistency or uncertainties,
                          including going concern. In addition, when a scope limitation is involved, the
                          review is considered incomplete and no review report should be issued.
                 (6)      Williams has confused the public company requirement of a review of interim
                          information with a review of a nonpublic company's annual statements.
                          Webstar is not required to have a review of its financial statements.

        b.       Compilation of financial statements

                 (1)      Yes.
                 (2)      The minimum procedures required include reading the compiled statements for
                          appropriate format and obvious material misstatement. But, when performing
                          this service CPAs generally are asked to prepare the financial statements.
                          Also, prior to performing a compilation the CPAs must have knowledge of the
                          accounting principles and practices used within the client's industry, and must
                          have a general understanding of the client's business transactions and
                          accounting records.
                 (3)      A compilation report need not be issued if the financial statements are not
                          intended to be used by a third party. In such case, the CPAs must document in
                          an engagement letter this fact, and the financial statements should be labeled as
                          being restricted to management’s use.
                 (4)      A compilation report includes a disclaimer with no explicit assurance.
                 (5)      Compilation reports are modified for (a) departures from generally accepted
                          accounting principles, (b) lack of all disclosures, and (c) a lack of
                          independence.

        c.       Financial Statements

                 (1)      Yes.
                 (2)      This is considered a "special report" on an other comprehensive basis of
                          accounting.
                 (3)      The titles to the financial statements will be modified and a paragraph will be
                          added to the report indicating that a comprehensive basis of accounting other
                          than generally accepted accounting principles has been used.

        d.       Auditing a Small Portion of the Financial Statements

                 (1)      Yes.
                 (2)      This is a "special report" on specified elements, accounts or items. The two
                          types of engagements are expressing an opinion (i.e., examination form of
                          association) and performing agreed-upon procedures.
                 (3)      When expressing an opinion on specified elements, accounts, or items,
                          positive assurance may be provided. An agreed-upon procedures report
                          includes a summary of findings.




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        e.       Auditing Assets to be purchased

                 (1)      Yes.
                 (2)      If a small number of accounts are involved, the engagement may represent a
                          "special report" on elements, accounts, or items of financial statements. More
                          likely it will be a considered a special-purpose financial presentation type of
                          special report. Note that the client would need to obtain the permission of the
                          company selling the assets to engage the CPAs in an engagement such as the
                          one described.

Research and Discussion Case

19-41 Dallas McBain (Estimated time: 45 minutes)

        (a)      The undocumented disbursements should be of concern to the auditor even though this
                 engagement is a "balance sheet only" audit. Forbes appears to have complete personal
                 control over McBain's assets, including access to large amounts of cash. This
                 constitutes an internal control significant deficiency, which an auditor should
                 communicate to his or her client (McBain). Furthermore, Forbes is not properly
                 executing his fiduciary responsibilities as he is disbursing McBain's funds without
                 either direct authorization or proper documentation. Some risk exists that Forbes is
                 embezzling assets from McBain. The 1136 Tenants Case illustrates the problems that
                 an accountant (or an auditor) may encounter as a result of failing to advise a client of
                 undocumented disbursements made by a managing agent.
                        There is a possibility that the undocumented disbursements are related to
                 material misstatements in McBain's statement of assets and liabilities. For example,
                 the disbursements could be for payments on material unrecorded liabilities. Also, the
                 approximately $365,000 represents only the funds accounted for during the current
                 year. If McBain is accumulating hidden assets, the amount of these assets might be
                 quite material if the practice has been going on for a number of years. Therefore, the
                 auditor has reason to be concerned about the completeness of the statement of assets
                 and liabilities.

        (b)      The auditor should give consideration to the following courses of action:

                 (1)      Advise McBain in writing of the weaknesses in internal control over the star's
                          assets. This action is required by SAS No. 60 (AU 325) Required
                          Communication of Control Related Matters During an Audit, and by the
                          concept of due professional care. McBain should sign a copy of this
                          communication to acknowledge receipt; this copy should be retained in the
                          auditor's working papers.
                 (2)      Request that McBain sign a representation letter regarding the completeness of
                          the financial statement and acknowledging awareness and approval of the
                          undocumented disbursements and the diversion of the proceeds of the sale of
                          securities. This letter is necessary to assist the auditor in forming an opinion as
                          to the completeness of the statement of assets and liabilities and also to prevent
                          the auditor from being personally liable in the event that Forbes is perpetrating
                          a fraud against McBain.




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                 (3)      Issue an unqualified auditor's report. This action would be appropriate only if
                          the auditor was satisfied that the undocumented disbursements were personal
                          expenditures, not related to unrecorded assets or liabilities. Whether the
                          auditor personally approves of the way in which McBain spends money is not
                          relevant to the auditor's report on McBain's financial statements.
                 (4)      Issue a qualified opinion or a disclaimer of opinion. The argument for this
                          course of action is that the weak internal control and the lack of documentation
                          in the accounting records may be viewed as a scope limitation that prevents the
                          auditor from being satisfied as to the completeness of the statement of assets
                          and liabilities.
                 (5)      Withdraw from the engagement. The argument for this course of action would
                          depend upon whether the auditor concluded that Forbes and/or McBain
                          appeared so lacking in integrity that the auditor should not be associated with
                          them. Withdrawing from the engagement, however, would not eliminate the
                          auditor's responsibilities to advise McBain of the undocumented
                          disbursements, unaccounted for proceeds of the sale of securities, and
                          weaknesses in internal control.

        (c)      Our recommendation:

                 We would definitely advise McBain in writing of the weakness in internal control and
                 request that McBain sign a letter representing the awareness and approval of the
                 undocumented disbursements. We would then have to make a judgment call as to
                 whether to issue an unqualified or a qualified (scope limitation) auditors' report.
                 Barring any other indications of unrecorded assets or liabilities, we lean toward the
                 unqualified opinion. We recognize that individuals generally do not maintain strong
                 internal control or accounting records comparable to those found in business entities.
                 Also, we do not consider it highly unusual for an individual in McBain's position to
                 spend money lavishly, often with little or no documentation. Our principal concern is
                 that our auditors' report not be used to assist Forbes in concealing the misuse of assets
                 from McBain. This concern, however, can better be resolved by written
                 communication with McBain than by qualification of the auditors' report.

          (d)    The purpose in posing this last question is to spark a discussion of the "real-world"
                 pressures upon a CPA to retain important clients. As the case was originally stated, the
                 CPA was young and just starting a practice. Under these circumstances, the auditor
                 might feel very uncomfortable in antagonizing either Forbes or McBain. Either of
                 these individuals might be so influential in the community as to prevent the CPA's
                 practice from getting off the ground.
                        By making the CPA well established and independently wealthy, and by making
                 this engagement only a small part of the CPA's total practice, we remove much of this
                 pressure. Theoretically, this should make no difference in the way that a CPA resolves
                 a professional judgmental decision. In reality, however, such factors may exert great
                 pressure on a sole practitioner or on an individual partner within a CPA firm. Such
                 pressure to keep an important client is one reason that large CPA firms often require a
                 "second partner review" of the working papers of each audit by a partner who has no
                 responsibilities with respect to that client.




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