May 10, 2002
To our peer review clients:
Annually we make an effort to highlight recent changes in professional standards for our peer review clients. We hope what follows is helpful to you in your accounting and auditing practice.
Peer Review Standards
In our letter last year, we discussed the three types of peer review: system, engagement, and report. System reviews focus on the quality control system, generally involve a visit to your office by the peer reviewer, and are for firms that have an audit practice. With engagement and report reviews, on the other hand, the peer reviewer is performing a desk review on a sample of the firm’s accounting engagements. The focus therefore is on the engagements themselves rather than on the firm’s quality control system. If your firm issues reviewed or full disclosure compiled financial statements, or has attest engagements, you will have an engagement review. Your accounting practice must be limited to compilations that omit all disclosures in order to qualify for a report review.
In an engagement review a firm submits selected working papers for review. The AICPA has recently clarified that since, under professional standards, working papers are not required for compilations of historical financial statements, peer reviewers should not request working papers on such compilation engagements selected for peer review. In the case of review engagements, the working papers submitted to the peer reviewer are limited to the management representation letter and the documentation of inquiry and analytical procedures, and what constitutes documentation of inquiry and analytical procedures is a matter of professional judgment and is construed liberally. There are other areas where a peer reviewer may ask for working papers or other documentation, however. For example, the standards for forecast and projection engagements require a management representation letter as well as documentation of the understanding with the client such as through the use of an engagement letter. Also, if you submit financial statements to your client without issuing a compilation report, as permitted under SSARS 8, you are required to document your communication with the client concerning the limitations inherent in compilation services, which is usually done through an engagement letter. The peer reviewer will ask for a copy of that engagement letter.
Recently the AICPA Peer Review Board has issued new guidance on how your firm’s licensing may affect your peer review report. Many state boards require that firms and individuals engaged in the practice of public accounting be separately licensed. The Peer Review Board has studied the matter and, after consulting with its legal counsel, has concluded that failure to have a separate firm license is a significant departure from professional standards and that, in most cases, it will lead to a modified peer review report. In the April 2002 update to the Peer Review Manual the AICPA has added steps to the checklists used by peer reviewers requiring them to inquire concerning state board of accountancy licensure.
As this letter is written, the United State House of Representatives has passed a bill in response to the Enron debacle that would establish an independent regulatory body to administer peer reviews for firms with a SEC practice. As you know, the accounting profession has always relied on self-regulation in the past, but this appears to be changing, at least for firms who audit public companies.
Quality Control Standards
The Peer Review Standards determine how your peer review is conducted, while the Quality Control Standards provide guidance on the design of your firm’s quality control system. Monitoring is a component of your quality control system. As discussed in our letter last year, the AICPA Peer Review Board has provided expanded guidance to peer reviewers on how to address monitoring in a peer review. Monitoring procedures may include pre-issuance or post-issuance review of selected engagements as well as other procedures. However, the AICPA peer review staff is emphasizing that pre-issuance reviews are acceptable as monitoring only if those performing the reviews are not directly associated with the performance of the engagement. Pre-issuance reviews by the individual with final responsibility for the engagement does not constitute a monitoring procedure. What does this mean, practically speaking? For one thing, it means that the pre-issuance review of an engagement performed by a sole practitioner is not monitoring. It means that sole practitioners and many smaller partnerships are compelled to conduct post-issuance reviews in order to comply with the monitoring requirement. This can be done either as part of a formal inspection, or in some other fashion as long as it is documented. Many firms perform a post-issuance review on an engagement in tandem with the planning for the following year. Although monitoring is required for all CPA firms, your peer reviewer considers it only if you have a system review. Call us and we can help set you up with an efficient and effective monitoring program that meets professional standards.
New Accounting Standards
FASB 141 on business combinations and the related FASB 142 concerning goodwill represent significant changes to the accounting standards. FASB 141 requires the purchase method for business combinations and prohibits the pooling method, but it is FASB 142 that may have the most impact on firms. FASB 142 addresses the accounting for goodwill. Under FASB 142, goodwill will not be amortized, which has been GAAP until now, but rather will be tested for impairment annually or on an interim basis if circumstances warrant it. When the fair value of the goodwill goes below the carrying amount goodwill is adjusted to the fair value. This new standard applies to existing goodwill and is effective for years beginning after December 15, 2001.
Firms with Audit Clients
The AICPA has issued a new statement on audit working papers, SAS No. 96, that provides guidance on the nature and extent of documentation necessary to support an auditor’s report. In addition, this standard changes the nomenclature. Now, instead of calling them “working papers” the new standard would have you call them “audit documentation”. Under SAS No. 96, audit documentation should be sufficient to enable members of the engagement team with supervision and review responsibilities to understand the nature, timing, extent and results of procedures performed. In addition, the audit documentation should indicate the engagement team members who performed and reviewed the work (e.g., initialing) and show that the accounting records reconcile with the financial statements. It is significant that SAS No. 96 requires only that the engagement team be able to interpret the audit documentation. The exposure draft would have required that independent reviewers, including concurring reviewers and peer reviewers, have that understanding. More specifically, SAS No. 96 requires audit documentation include an identification of the items tested in tests of controls and substantive tests of details; abstracts or copies of significant contracts or agreements supporting significant transactions; and identification of audit findings that in the auditor’s opinion are significant, the actions taken to address them, and the basis for conclusions reached. Further, the new standard requires documentation for the nature and effect of aggregated misstatements, for substantive analytical procedures, and for going concern considerations. The standard is effective for periods beginning on or after May 15, 2002.
Although the AICPA issued SAS No. 82 on fraud just five years ago, the Enron scandal has put a new fraud standard on the fast track. This new standard, which is currently in the exposure draft stage, would replace SAS No. 82.
Firms with Governmental Audit Clients
On January 25, 2002, the General Accounting Office (GAO) issued its new independence rule for audits performed under Government Auditing Standards (Yellow Book audits). With this new rule, the GAO is placing strict limits on what nonaudit services you can provide your governmental audit clients. Under this rule, you cannot perform management functions for the client and you cannot audit your own work or provide nonaudit services that are material to the subject matter of the audits. If you are a larger firm, there is some flexibility in the rule. You can provide nonaudit services to the client as long as the personnel providing those services are excluded from planning, conducting or reviewing audit work related to the nonaudit service. There are seven safeguards to follow, however, if you perform nonaudit services for the audit client, and considerable documentation is required of how you complied with these safeguards. The new audit standard, which is effective for periods beginning on or after October 1, 2002, is available at the GAO web site: www.gao.gov.
The GAO has proposed changes to the Yellow Book beyond the independence rules discussed above and, since the changes will be comprehensive, the GAO plans to issue a revised Yellow Book that will supersede the 1994 revision, including amendments one and two. The most controversial aspect to the revised Yellow Book is the requirement that anyone on your staff (including non-CPA’s) who works on a governmental audit will need to have 80 hours of continuing education in accounting and auditing (no tax) every two years. The 1994 version of the Yellow Book allowed CPE in areas other than accounting and auditing to count toward the 80 hours. Incidentally, the revised Yellow Book places several new requirements on peer review. For example, if you need an extension on your peer review, and you have governmental audit clients, the GAO will have to approve that extension. The exposure draft is available on the GAO web site.
Firms with Attest Clients
The AICPA has issued SSAE No. 11 on documentation requirements. It was issued in tandem with SAS No. 96 discussed earlier in this letter. The requirements are similar to those in the audit standard. The standard is effective for attest engagements when the subject matter or assertion is as of or for a period ending on or after December 15, 2002.
Our Peer Review Clients
When scheduling your peer review with the state society, the scheduling form requests information about the firm you have hired to perform the peer review. This is the information you will need if you select our firm to perform your peer review:
- Name of Reviewing Firm: Read & Bose
- AICPA Firm Number: 10083621
- Team Captain’s Name: Harry Bose
- AICPA Member Number: 01153765
This letter will be posted on our award-winning home page, along with additional guidance on peer reviews. Our web site address is:
Please do not hesitate to contact us if you have any questions. We appreciate your business.
Very truly yours,
Read & Bose, PC