Auditing interpretations.

Auditing Interpretations of Statements on Auditing Standards (SASs) are Interpretive Publications pursuant to AU section 150, Generally Accepted Auditing Standards. Interpretive Publications are recommendations on the application of SASs in specific circumstances, including engagements for entities in specialized industries. Interpretive Publications are issued under the authority of the Auditing Standards Board.

The auditor should identify Interpretive Publications applicable to his or her audit. If-the auditor does not apply the auditing guidance included in an applicable Interpretive Publication, the auditor should be prepared to explain how he or she complied with the SAS provisions addressed by such auditing guidance.

The text of amended interpretations below has been marked to show changes from the existing text. New language is shown in boldface italics; deleted language is shown by strikethrough. (Interpretation 12 and Interpretation 14 under AU section 9623 are amended. Interpretation 15 under section 9623 is new, as is Interpretation I under AU section 9625.)

AU SECTION 9623

Special Reports: Auditing Interpretations of Section 623

12. Evaluation of the Appropriateness of Informative Disclosures in Insurance Enterprises' Financial Statements Prepared on a Statutory Basis (11)

.60 Question--Insurance enterprises issue financial statements prepared in accordance with accounting practices prescribed or permitted by insurance regulators (a "statutory basis") in addition to, or instead of, financial statements prepared in accordance with generally accepted accounting principles (GAAP). Effective January 1, 2001, most states are expected to adopt a comprehensively updated Accounting Practices and Procedures Manual, as revised by the National Association of Insurance Commissioners' (NAIC's) Codification project. The updated Accounting Practices and Procedures Manual, along with any subsequent revisions, is referred to as the revised Manual. The revised Manual contains extensive disclosure requirements. As a result, after a state adopts the revised Manual, its statutory basis of accounting will include informative disclosures appropriate for that basis of accounting. The NAIC Annual Statement Instructions prescribe the financial statements to be included in the annual audited financial report. Some states may not adopt the revised Manual or may adopt it with significant departures. How should auditors evaluate whether informative disclosures in financial statements prepared on a statutory basis are appropriate? [begin strikethrough]11[end strikethrough] (12)

.61 Interpretation--Financial statements prepared on a statutory basis are financial statements prepared on a comprehensive basis of accounting other than GAAP according to section 623, Special Reports, paragraph .(14). Section 623.09 states that "When reporting on financial statements prepared on a comprehensive basis of accounting other than generally accepted accounting principles, the auditor should consider whether the financial statements (including the accompanying notes) include all informative disclosures that are appropriate for the basis of accounting used. The auditor should apply essentially the same criteria to financial statements prepared on an other comprehensive basis of accounting as [begin strikethrough]those applied[end strikethrough] to financial he or she does statements prepared in conformity with generally accepted accounting principles. Therefore, the auditor's opinion should be based on his or her judgment regarding whether the financial statements, including the related notes, are informative of matters that may affect their use, understanding, and interpretation as discussed in section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, paragraph .04."

.62 Section 623.02 states that generally accepted auditing standards apply when an auditor conducts an audit of and reports on financial statements prepared on an other comprehensive basis of accounting. Thus, in accordance with the third standard of reporting, "informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report."

.63 Question--What types of items or matters should auditors consider in evaluating whether informative disclosures are reasonably adequate?

.64 Interpretation--Section 623.09 and .10 indicates that financial statements prepared on a comprehensive basis of accounting other than GAAP should include "all informative disclosures that are appropriate for the basis of accounting used." That includes a summary of significant accounting policies that discusses the basis of presentation and describes how that basis differs from GAAP. The provisions of the preamble of the revised Manual that states, "GAAP pronouncements do not become part of Statutory Accounting Principles until and unless adopted by the NAIC," do not negate the requirements of section 623.10, which also states that when "the financial statements [prepared on an other comprehensive basis of accounting] contain items that are the same as, or similar to, those in financial statements prepared in conformity with generally accepted accounting principles, similar informative disclosures are appropriate."

[.65-.66] [Paragraphs deleted by the issuance of Statement of Position 01-5, December 2001 ]

.67 Question--How does the auditor evaluate whether "similar informative disclosures" are appropriate for--

a. Items and transactions that are accounted for essentially the same or in a similar manner under a statutory basis as under GAAP?

b. Items and transactions that are accounted for differently under a statutory basis than under GAAP?

c. Items and transactions that are accounted for differently under requirements of the state of domicile than under the revised Manual?

.68 Interpretation--Disclosures in statutory basis financial statements for items and transactions that are accounted for essentially the same or in a similar manner under the statutory basis as under GAAP should be the same as, or similar to, the disclosures required by GAAP unless the revised Manual specifically states the NAIC Codification rejected the GAAP disclosures. (13) Disclosures should also include those required by the revised Manual.

[.69] [Paragraph deleted by the issuance of Statement of Position 01-5, December 2001.]

.70 Disclosures in statutory, basis financial statements for items or transactions that are accounted for differently under the statutory basis than under GAAR but in accordance with the revised Manual, should be the disclosures required by the revised Manual.

.71 If the accounting required by the state of domicile for an item or transaction differs from the accounting set forth in the revised Manual for that item or transaction, but it is in accordance with GAAP or superseded GAAP, the disclosures in statutory basis financial statements for that item or transaction should be the applicable GAAP disclosures for the GAAP or superseded GAAR If the accounting required by the state of domicile for an item or transaction differs from the accounting set forth in the revised Manual, GAAP or superseded GAAR sufficient relevant disclosures should be made.

[.72-.76] [Paragraphs deleted by the issuance of Statement of Position 01-5, December 2001.]

.77 When evaluating the adequacy of disclosures, the auditor should also consider disclosures related to matters that are not specifically identified on the face of the financial statements, such as (a) related party transactions, (b) restrictions on assets and owners' equity, (c) subsequent events, and (d) uncertainties. Other matters should be disclosed if such disclosures are necessary to keep the financial statements from being misleading.

[.78-.79] [Paragraphs deleted to reflect conforming changes necessary due to the issuance of FASB Statement No. 120, Accounting and Reporting by Mutual Life Insurance Enterprises and by Insurance Enterprises for Certain Long-Duration Participating Contracts, and FASB Interpretation No. 40, Applicability of Generally Accepted Accounting Principles to Mutual Life Insurance and Other Enterprises.]

[begin strikethrough].80 Question There may also be instances in which state requirements have not been revised to reflect a new GAAP disclosure requirement. What are the disclosure requirements in those situations?[end strikethrough]

[begin strikethrough].81 Interpretation Until state requirements are determined, the statutory basis financial statements should include disclosures required by new GAAP requirements that are relevant and significant to the statutory basis of accounting pending acceptance or rejection for inclusion in the revised Manual.[end strikethrough]

14. Evaluating the Adequacy of Disclosure and Presentation in Financial Statements Prepared [begin strikethrough]on the Cash, Modified Cash, or Income Tax[end strikethrough] in Conformity With an Other Comprehensive Basis of Accounting (OCBOA) (14)

.90 Question--Section 623, Special Reports, paragraph. 10, requires that financial statements prepared on a comprehensive basis of accounting other than generally accepted accounting principles (GAAP) include a summary of significant accounting policies that discusses the basis of presentation and describes how that basis differs from GAAP. It also states that when such financial statements contain items that are the same as, or similar to, those in statements prepared in conformity with GAAP, "similar informative disclosures are appropriate." To illustrate how to apply that statement, section 623.10 says that the disclosures for depreciation, long-term debt, and owners' equity should be "comparable to" those in financial statements prepared in conformity with GAAE That paragraph then states that the auditor "should also consider" the need for disclosure of matters that are not specifically identified on the Pace of the statements, such as (a) related party transactions, (b) restrictions on assets and owners' equity, (c) subsequent events, and (d) uncertainties. How should the guidance in section 623.10 be applied in evaluating the adequacy of disclosure in financial statements prepared [begin strikethrough]on the cash, modified cash, or income tax[end strikethrough] in conformity with an other comprehensive basis of accounting (OCBOA)?

.91 Interpretation--The discussion of the basis of presentation may be brief; for example: "The accompanying financial statements present financial results on the accrual basis of accounting used for federal income tax reporting." Only the primary differences from GAAP need to be described. To illustrate, assume that several items are accounted for differently than they would be under GAAP, but that only the differences in depreciation calculations are significant. In that situation, a brief description of the depreciation differences is all that would be necessary, and the remaining differences need not be described. Quantifying differences is not required.

.92 If [begin strikethrough]cash, modified cash, or income tax basis[end strikethrough] OCBOA financial statements contain elements, accounts, or items for which GAAP would require disclosure, the statements should either provide the relevant disclosure that would be required for those items in a GAAP presentation or provide information that communicates the substance of that disclosure. That may result in substituting qualitative information for some of the quantitative information required for GAAP presentations. For example, disclosing the repayment terms of significant long-term borrowings may sufficiently communicate information about future principal reduction without providing the summary of principal reduction during each of the next five years that would be required for a GAAP presentation. Similarly, disclosing estimated percentages of revenues, rather than amounts that GAAP presentations would require, may sufficiently convey the significance of sales or leasing to related parties. GAAP disclosure requirements that are not relevant to the measurement of the element, account, or item need not be considered. To illustrate:

a. The fair value information that FASB Statement No. 115, Accounting for Certain investments in Debt and Equity Securities [AC section I80], would require disclosing for debt and equity securities reported in GAAP presentations would not be relevant when the basis of presentation does not adjust the cost of such securities to their fair value.

b. The information based on actuarial calculations that FASB Statement No. 87, Employers' Accounting for Pensions [AC section P16], would require disclosing for contributions to defined benefit plans reported in GAAP presentations would not be relevant in income tax or cash basis financial statements.

.93 If GAAP sets forth requirements that apply to the presentation of financial statements, [begin strikethrough]then cash, modified cash, and income tax basis[end strikethrough] OCBOA financial statements should either comply with those requirements or provide information that communicates the substance of those requirements. The substance of GAAP presentation requirements may be communicated using qualitative information and without modifying the financial statement format. For example:

a. Information about the effects of accounting changes, discontinued operations, and extraordinary items could be disclosed in a note to the financial statements without following the GAAP presentation requirements in the statement of results of operations, using those terms, or disclosing net-of-tax effects.

b. Instead of showing expenses by their functional classifications, the income tax basis statement of activities of a trade organization could present expenses according to their natural classifications, and a note to the statement could use estimated percentages to communicate information about expenses incurred by the major program and supporting services. A voluntary health and welfare organization could take such an approach instead of presenting the matrix of natural and functional expense classifications that would be required for a GAAP presentation, or, if information has been gathered for the Form 990 matrix required for such organizations, it could be presented either in the form of a separate statement or in a note to the financial statements.

c. Instead of showing the amounts of, and changes in, the unrestricted and temporarily and permanently restricted classes of net assets, which would be required for a GAAP presentation, the income tax basis statement of financial position of a voluntary health and welfare organization could report total net assets or fund balances, the related statement of activities could report changes in those totals, and a note to the financial statements could provide information, using estimated or actual amounts or percentages, about the restrictions on those amounts and on any deferred restricted amounts, describe the major restrictions, and provide information about significant changes in restricted amounts.

.94 Presentations using [begin strikethrough]the cash basis of accounting, the modified cash basis, or the cash basis used for income tax reporting[end strikethrough] OCBOA often include a presentation consisting entirely or mainly of cash receipts and disbursements. Such presentations need not conform with the requirements for a statement of cash flows that would be included in a GAAP presentation. While a statement of cash flows is not required [begin strikethrough]in presentations using the cash, modified cash, or income tax basis of accounting[end strikethrough], if a presentation of cash receipts and disbursements is presented in a format similar to a statement of cash flows or if the entity chooses to present such a statement, for example in a presentation on the accrual basis of accounting used for federal income tax reporting, the statement should either conform to the requirements for a GAAP presentation or communicate their substance. As an example, the statement of cash flows might disclose noncash acquisitions through captions on its face.

.95 If GAAP would require disclosure of other matters, the auditor should consider the need for that same disclosure or disclosure that communicates the substance of those requirements. Some examples are contingent liabilities, going concern considerations, and significant risks and uncertainties. However, the disclosures need not include information that is not relevant to the basis of accounting. To illustrate, the general information about the use of estimates that is required to be disclosed in GAAP presentations by Statement of Position 94-6, Disclosure of Certain Significant Risks and Uncertainties, would not be relevant in a presentation that has no estimates, such as one based on cash receipts and disbursements.

15. Auditor Reports on Regulatory Accounting or Presentation When the Regulated Entity Distributes the Financial Statements to Parties Other Than the Regulatory Agency Either Voluntarily or Upon Specific Request

.96 Question--Occasionally, certain state and local governmental entities, as well as other regulated entities, prepare their financial statements in conformity with the requirements or financial reporting provisions of a governmental regulatory agency. If the financial statements and report are intended for use by parties other than those within the entity and one or more regulatory agencies to whose jurisdiction the entity is subject or the financial statements and report are distributed by the entity to parties other than the regulatory agencies to whose jurisdiction the entity is subject, either voluntarily or upon specific request, what report should the auditor issue?

.97 Interpretation--Section 623.05f, footnote 4, states in part that the auditor is precluded from using the form of report set forth in section 623 "in circumstances in which the entity distributes the financial statements to parties other than the regulatory agency either voluntarily or upon specific request." Footnote 5 states further that the auditor should follow the guidance in section 544, Lack of Conformity With Generally Accepted Accounting Principles, if the financial statements and report are intended for use by parties other than those within the entity and one or more regulatory agencies to whose jurisdiction the entity is subject. Section 544.04, in turn, states in those circumstances [referring to circumstances in which the financial statements and reports will be used by parties or distributed by the entity to parties other than the regulatory agencies to whose jurisdiction the entity is subject] the auditor should use the standard form of report modified as appropriate because of the departures from generally accepted accounting principles and then in an additional paragraph express an opinion on whether the financial statements are presented in conformity with the regulatory basis of accounting.

The following is an illustration of a report prepared on a regulatory basis of accounting prescribed by a regulatory agency, to whose jurisdiction an entity is subject, that requires a presentation of cash and unencumbered cash, cash receipts and disbursements, and budgetary comparisons and the financial statements are not prepared solely for filing with that agency:

Independent Auditor's Report

We have audited the accompanying statement of cash and unencumbered cash; cash receipts and disbursements; and disbursements--budget and actual for each fund of City of Example, Any State, as of and for the year ended June 30, 20XX. These financial statements are the responsibility of City's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 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 more fully in Note X, City has prepared these financial statements using accounting practices prescribed or permitted by [name of regulatory agency], which practices differ from accounting principles generally accepted in the United States of America. The effects on the financial statements of the variances between these regulatory accounting practices and accounting principles generally accepted in the United States of America, although not reasonably determinable, are presumed to be material.

In our opinion, because of the effects of the matter discussed in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with accounting principles generally accepted in the United States of America, the financial position of each fund of City as of June 30, 20XX, or changes in financial position or cash flows (15) thereof for the year then ended.

In our opinion, the financial statements referred to above present fairly, in all material respects, the cash and unencumbered cash balances of each fund of City as of June 30, 20XX, and their respective cash receipts and disbursements, and budgetary results for the year then ended, on the basis of accounting described in Note X.

[Signature]

[Date]

.98 If the auditor issues a report in accordance with section 623.05f, nothing precludes the auditor, in connection with establishing the terms of the engagement, from reaching an understanding with the client that the intended use of the report will he restricted, and from obtaining the client's agreement that the client and the specified parties will not distribute the report to parties other than those identified in the report.

AU SECTION 9625

Reports on the Application of Accounting Principles: Auditing Interpretations of Section 625

1. Requirement to Consult With the Continuing Accountant

.01 Question--SAS No. 50, Reports on the Application of Accounting Principles [AU sec. 625], provides guidance to a reporting accountant when asked to provide a written report or oral advice on (a) the application of accounting principles to specified transactions, either completed or proposed, involving facts and circumstances of a specific entity or (b) the type of opinion that may be rendered on a specific entity's financial statements.

.02 AU sec. 625.02 refers to a reporting accountant as an accountant in public practice. Footnote 3 to that paragraph states: "See ET section 92.25 of the AICPA Code of Professional Conduct for a definition of 'practice of public accounting.'"

.03 AU sec. 625.09 states in part:

   When evaluating accounting principles that
   relate to a specific transaction or determining
   the type of opinion that may be rendered on
   a specific entity's financial statements, the reporting
   accountant should consult with the
   continuing accountant of the entity to ascertain
   all the available facts relevant to forming
   a professional judgment. The continuing accountant
   may provide information not otherwise
   available to the reporting accountant
   regarding, for example, the following: the
   form and substance of the transaction; how
   management has applied accounting principles
   to similar transactions; whether the
   method of accounting recommended by the
   continuing accountant is disputed by management;
   or whether the continuing accountant
   has reached a different conclusion on the
   application of accounting principles or the
   type of opinion that may be rendered on the
   entity's financial statements.

.04 In today's environment, primarily driven by independence concerns, a nonissuer may engage an accountant in public practice (or his or her firm), other than the entity's independent auditor, as an advisory accountant (1) to assist management in certain recurring accounting or reporting functions (for example, bookkeeping or assistance in preparing financial statements or notes, performing fair value impairment tests, or assistance in preparing regulatory filings). In this capacity, an advisory accountant may be frequently asked to provide advice on the application of accounting principles or to assist management formulate its accounting positions prior to discussing such positions with its auditor. In these situations, an advisory accountant is not engaged to provide a second opinion and would generally be in a position to have full access to management and have Full knowledge of the form and substance of the transaction, how management has applied similar transactions in the past, and whether this method of accounting has been discussed with the continuing auditor.

.05 When an accountant in public practice, acting in the capacity of an advisory accountant, has been engaged by a nonissuer to assist management with recurring accounting matters and is asked to provide advice (not a second opinion) on the application of accounting principles to specified transactions, either completed or proposed, based on the specific facts and circumstances of the client, and the advisory accountant has full access to management and full knowledge of the form and substance of the transaction, is he or she still required to consult with the continuing accountant?

.06 Answer--SAS No. 50 [AU sec. 625] was issued to provide guidance to a reporting accountant when engaged to provide a "second opinion" on the application of accounting principles to a specific transaction or transactions. In those cases, the reporting accountant may not have been provided all the relevant facts by management or he or she may not have full knowledge of the form and substance of the transaction in order to form a "second opinion." To help eliminate this issue, SAS No. 50 states that the reporting accountant should consult with the continuing accountant so the continuing accountant has an opportunity to convey relevant facts and circumstances that the reporting accountant may not have.

.07 An advisory accountant may be able to overcome the presumptive requirement (2) of AU sec. 625.09 to consult with the continuing accountant when he or she believes, due to the facts and circumstances of the engagement, that he or she is not being asked to provide a second opinion and that he or she has obtained all relevant information from management to provide written or oral guidance regarding the application of accounting principles to that client's specified transactions.

.08 An important distinction to consider in overcoming the presumptive requirement to consult with the continuing accountant is the nature of the engagement and whether the services are recurring as contrasted to periodic. A recurring engagement may constitute the effective outsourcing of certain controllership or other financial reporting functions that would typically not be indicative of opinion shopping and would typically allow the advisory accountant to have complete access to management. A member in public practice engaged in the capacity of an advisory accountant nonetheless should be alert to any instances in which the nonissuer attempts to use the advisory accountant to "opinion shop." The advisory accountant should establish an understanding with the client that includes the substance of AU sec. 625.10(d) (3) and that the client, along with the advisory accountant will notify the continuing accountant and members of any governance body (such as audit committee) of the arrangement.

.09 The advisory accountant should document his or her conclusion that consultation with the continuing accountant was not considered necessary under the circumstances. Additionally, the advisory accountant should comply with the other requirements of SAS No. 50, including AU sec. 625.08, which requires the accountant to (a) obtain an understanding of the form and substance of the transaction(s); (b) review applicable generally accepted accounting principles; (c) if appropriate, consult with other professionals or experts; and (d) if appropriate, perform research or other procedures to ascertain and consider the existence of creditable precedents or analogies.

(1) The term advisory accountant is used in this interpretation rather than the term "reporting accountant" to distinguish the fact that an accountant in this capacity is not engaged to provide a second opinion and is typically engaged to provide accounting and reporting advice on a recurring basis.

(2) The ability to overcome this presumption would apply only to the application of accounting principles. If the advisory- accountant was asked to provide oral advice or a written report on the type of opinion that may be rendered by the continuing accountant, the advisory accountant would not have the ability to obtain all relevant information and, therefore, the requirements of AU sec. 625.09 to consult with the continuing accountant would apply.

(3) The advisory accountant's understanding would include a statement that the responsibility for the proper accounting treatment rests with management, who should consult with their continuing accountant.

(11) Interpretation No. 14, Evaluating the Adequacy of Disclosure and Presentation in Financial Statements Prepared in Conformity With an Other Comprehensive Basis of Accounting (OCBOA), provides interpretive guidance applicable to all OCBOA presentations. This interpretation provides additional guidance regarding the appropriateness of informative disclosures in insurance enterprises' financial statements prepared on a statutory basis.

[begin strikethrough](11)[end strikethrough] (12) It is possible for one of three different situations to occur: The state adopted the revised Manual without significant departures, adopted the revised Manual with significant departures, or has not yet adopted the revised Manual.

(13) The provisions of the preamble of the revised Manual that states, "GAAP pronouncements do not become part of Statutory Accounting Principles until and unless adopted by the NAIC" or any other explicit rejection of a GAAP disclosure does not negate the requirements of section 623.10.

(14) White this interpretation provides guidance applicable to all OCBOA presentations, Interpretation No. 12 provides additional interpretive guidance regarding the appropriateness of informative disclosure in insurance enterprises' financial statements prepared on a statutory basis.

(15) Reference to cash flows would not be needed if the entity, under generally accepted accounting principles, is not required to present a statement of cash flows.