Revisiting review engagements:

There are two primary sources in the professional literature concerning an accountant's responsibilities in performing review engagements. Statement on Auditing Standards No. 100, Interim Financial Information (SAS 100), issued in 2002, establishes the standards for reviewing interim, or quarterly, financial statements of public companies (SEC registrants). It is part of the Public Company Accounting Oversight Board's Interim Professional Auditing Standards.

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For review engagements for which SAS 100 is not applicable, such as the review of financial statements of nonpublic companies, accountants are to follow the guidance in Statement on Standards for Accounting and Review Services No. 10, Performance of Review Engagements (SSARS No. 10), issued in 2004.

Although these two statements address dissimilar companies, both prescribe procedures with the same goal: provide accountants with a basis for communicating whether or not they are aware of any material modifications that should be made to the financial statements for them to conform with GAAP. Both statements also represent recent updates to their long-standing predecessors. SAS 100 supersedes SAS 71 issued in 1992, and SSARS No. 10 amends SSARS No. 1 issued in 1978.

WHAT'S NEW IN SAS 100

SAS 100 replaces SAS 71 with several enhancements and additions. First, SAS 100 clarifies the applicability of GAAS to a review of a public company's interim financial statements. Specifically, SAS 100 states that the general auditing standards--requirements pertaining to an accountant's technical training and proficiency, independence in mental attitude and due professional care--apply to review engagements.

With its timeliness, SAS 100 underscores the SEC requirement that a registrant, before filing its Form 10-Q, engage an independent accountant to review its interim financial information in accordance with this SAS. Although SAS 100 does not require the issuance of a review report at the engagement's conclusion, the SEC will require the report be filed with the interim financial information if the registrant states, in any filing, that an independent public accountant has reviewed such information.

The accountant's degree of knowledge about the company's business and internal controls is significant in properly performing the review because this knowledge, in large part, forms the basis for selecting the appropriate inquiries and analytical procedures to be applied to recent events, transactions and management assertions.

SAS 100 requires CPAs to update their knowledge of the company's business and internal controls, and prescribes procedures for carrying out this requirement.

For example, SAS 100 states that update procedures "should include" (a "presumptively mandatory responsibility" under the PCAOB, meaning accountants must comply unless they demonstrate that alternative procedures were sufficient in achieving the objectives of SAS 100), among others, reading prior years' and quarters' audit and review workpapers to "specifically consider the nature of any:

"(a) Corrected material misstatement;

"(b) Matters identified in any summary uncorrected misstatements;

"(c) Identified risks of material misstatement due to fraud, including the risk of management override of controls; and

"(d) Significant financial accounting and reporting matters that may be of continuing significance, such as weaknesses in internal control."

The types of past proposed or recorded adjustments are important considerations when assessing the likelihood of their existence in the current interim period, and, therefore, an accountant's inquiries and analytical procedures should be designed and tailored accordingly. Related to this, SAS 100 provides guidance to accountants reviewing a new client's interim financial statements without the benefit of having audited the client's financial statements in the prior period.

Also notable in SAS 100 is its expanded discussion of the requirement to establish an understanding with the accountant's client regarding the services to be performed. SAS 100 lists 10 matters to be communicated in that understanding, preferably in writing. The list is similar to the requirements for an audit engagement letter.

In terms of general categories of review procedures to be performed, inquiries and analytical procedures continue to be required. SAS 100, however, also specifies new items. For example, the accountant is required to inquire with management responsible for financial and accounting matters about the following:

* Their knowledge of any fraud or suspected fraud, and whether they are aware of allegations of fraud received in communication from employees, former employees, analysts, regulators or others;

* Status of uncorrected misstatements, or whether adjustments had been recorded subsequent to the prior period or audit;

* Significant transactions occurring in the last several days of the interim period; and

* Unusual or complex situations that may have an effect on the interim financial statements (there is a helpful appendix of examples).

SAS 100 also requires an accountant to make inquiries concerning the company's ability to continue as a going concern and presents reporting options, depending on whether the condition existed prior to the review or surfaced during the review.

As for analytical procedures, SAS 100 devotes an entire appendix to listing descriptive examples of analytical procedures relevant to a review. A new item is the requirement to compare disaggregated revenue data, such as comparing revenue by month and by product line to comparable periods.

In addition to inquiries and analytical procedures, SAS 100 adds a third "should do" category of performing "other procedures that address significant accounting and disclosure matters relating to the interim financial information to be reported."

These other procedures include obtaining evidence that the interim financial information agrees or reconciles with the accounting records, as well as reading other information accompanying the interim financial statements sent to shareholders or the SEC to allow the accountant to conclude that there are no material inconsistencies.

SAS 100 also provides new guidance on evaluating the results of the review procedures, with a focus on dealing with likely mis-statements. Last, but not least, it discusses the importance of an accountant's workpaper documentation procedures, noting that "documentation is the principal record of the review procedures performed and the conclusions reached by the accountant in performing the review."

WHAT'S NEW IN SSARS NO. 10

SSARS No. 10, effective for periods ending on or after Dec. 15, 2004, amends SSARS No. 1 with a new focus on fraud and provides expanded guidance on analytical procedures and new requirements on workpaper documentation.

Whereas fraud has become a recognizable topic in auditing literature, it has not been so in SSARS literature until now. An accountant "should consider" making inquiries of management. SSARS No. 10 includes inquiries relating to management's "knowledge of any fraud or suspected fraud affecting the entity involving management or others where the fraud could have a material effect on the financial statements, for example, communications received from employees, former employees or others."

While the aforementioned wording appears to mirror SAS 100, SAS 100 states an accountant "should make" such inquiry.

More exacting is the fraud-related requirement relating to management representations. An accountant is now required to obtain specific written representation from management regarding fraud in connection with "management's acknowledgement of its responsibility to prevent and detect fraud," and management's "knowledge of any fraud or suspected fraud affecting the entity," similar to the format of the inquiry the accountant should consider as discussed above.

In its newly expanded guidance on analytical procedures, SSARS No. 10 emulates SAS 56, Analytical Procedures, in describing what analytical procedures should include: (1) "developing expectations by identifying and using plausible relationships that are reasonably expected to exist based on the accountant's understanding of the entity and the industry in which the entity operates," and (2) "comparing recorded amounts, or ratios developed from recorded amounts, to expectations developed by the accountant." It then appends a list of examples similar to those in SAS 100.

SSARS No. 10 is helpful in its guidance on inquiries of management as it updates the appendix of "illustrative inquiries" with much more detail. Lastly, SSARS No. 10 is more descriptive in what the accountant's workpaper documentation should include, an requirements similar to those in SAS 100.

REVIEW FROM A LITIGATION PERSPECTIVE

Both SAS 100 and SSARS No. 10 state that an accountant's inquiries, analytical and other procedures should be tailored to the engagement based on the CPA's knowledge of the entity's business and internal controls. Knowing the client's business well will likely result in the selection of meaningful analytical procedures. In addition, work program "templates" should be adjusted accordingly to prescribe procedures that properly reflect an accountant's knowledge and understanding of the client's business and internal control.

Further, the successful conclusion of the review engagement depends on developing appropriate inquiries and on whom those inquiries are directed. Asking the right people the right questions will likely yield the kinds of answers that are good enough so that CPAs have a basis for communicating whether they are aware of any material modifications that should be made to the financial statements for them to conform with GAAP.

In a recent case against a CPA firm, the jury awarded damages to the CPA's public client in connection with the CPA's reviews of the interim financial statements and related comfort letter. The client's accounting expert presented evidence to show that the review team, despite being aware of weaknesses in the client's internal controls:

* Did not tailor the review program "template;"

* Did not direct certain inquiries to client personnel knowledgeable in areas the review team deemed "high risk;"

* Disregarded information contained in board minutes that impacted the quarterly financial statements; and

* Did not propose certain adjustments relating to significant accounts that historically were adjusted on a "catch-up basis" at year-end.

BY A. CHRISTINE DAVIS, CPA

A. Christine Davis, CPA, is a manager of Litigation Consulting and Forensic Accounting at Hemming Morse in San Francisco. She can be reached at davisc@hemming.com

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