When do the provisions of SSARS no. 1 apply?

Betty Montez, CPA, was engaged by Muller, Inc., to provide monthly accounting services consisting of write-up o cash receipts and disbursements journals and quarterly preparation of an adjusted trial balance. During one of Montez's visits to the company, Max Muller, the president, asked her to prepare some financial information for his brother-in-law, who is thinking of investing in the business.

Montez drafted the financial presentation shown in exhibit 1, page 63, and submitted it to Ray Oliver, CPA, the partner in charge of quality review at her firm. He returned the material to Montez with a note asking, "Where's the report."

Montez contended a report was not required because paragraph 2 of Statements on Standards for Accounting and Review Services no. 1, Compilation and Review of Financial Statements, says an accountant need not adhere to the performance and reporting requirements of SSARS no. 1 when preparing a working trial balance for a client. Oliver countered that Montez had prepared financial statements--not a trial balance--and must compile these statements. To support his position, he cited paragraph 7 of SSARS no. 1, which says an accountant should not submit unaudited financial statements of a nonpublic entity to a client or others unless, as a minimum, he or she compiles the statements.

This is a situation in which SSARS applicability is in question. Although SSARS no. 1 clearly excludes "other accounting services" such as preparing a working trial balance or assisting in adjusting the books of account, practitioner do not always agree whether a financial presentation is a financial statement or a trial balance or whether the accountant has "submitted" financial statements.

Consider an accountant who prepares journal entries and posts them to a client-prepared trial balance using computer software that generates financial statements. Has the accountant "submitted" financial statements? Would the answer be the same if the data processing occurred at the accountant's office rather than the client's or if the client entered the data and caused the computer to print the financial statements?

These are the kinds of questions practitioners asked at a public hearing held by the American Institute of CPAs accounting and review services committee (ARSC) in September 1989 to discuss "plain paper" financial statements. Plain paper refers to

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accountant-prepared statements with no indication a CPA is associated with them.

SSARS no. 1 does not permit accountants to submit plain paper historical financial statements to clients or others; however, many practitioners would like amendments permitting issuance of such statements and providing for a level of service below a compilation. SSARS no. 6, Reporting on Personal Financial Statements Included in Written Personal Financial Plans, exempts personal financial statements included in written plans.

After the hearing, ARSC decided not to amend SSARS no. 1 to provide for a level of service below a compilation but decided instead to draft guidance on whether the services practitioners perform are subject to SSARSs. That guidance, in the form of three ARSC-issued interpretations of SSARS no. 1 (see Official Releases, JofA, Sept. 90, page 145), is intended to help accountants answer these questions:

* What attributes differentiate a financial statement presentation from a trial balance?

* When has the accountant "submitted" financial statements?

* May an accountant submit draft financial statements without compiling them?

This article discusses how these interpretations have changed practice and illustrates how they are applied.

FINANCIAL STATEMENT VS.

TRIAL BALANCES

SSARS no. 1 says whenever accountants submit financial statements to clients or others, the financial statements must, at least, be compiled and reported on accordingly. SSARS no. 1 also says it does not establish standards or procedures for other accounting services such as preparing a working trial balance. However, even when doing such excluded work, accountants are obligated to follow the general standards of Rule 201 of the AICPA Code of Professional Conduct. Rule 201 says members should

* Undertake only services that can be expected to be completed with professional competence.

* Exercise due care.

* Adequately plan and supervise the performance of professional services.

* Obtain sufficient relevant data to support conclusions or recommendations.

To provide clients with timely, cost-effective financial information, some accountants try to avoid complying with SSARS no. 1 by submitting financial presentations with characteristics of both a financial statement and a trial balance. Are accountants bound by SSARS no. 1 when they submit such presentations to clients? The answer depends on the presentation's attributes.

ARSC recognized the need for clarifying guidance when it examined examples of accountant-submitted presentations that, in the committee's opinion, were financial statements. In most cases, no compilation reports accompanied these presentations in the erroenous belief they were trial balances. Such presentations blur the distinction between financial statements and trial balances because they contain attributes of both andhave the potential to mislead or confuse users who may make decisions based on them. Moreover, when these presentations are financial statements, the accountant has violated Rule 202, which requires compliance with standards promulgated by ARSC when performing compilation and review services.

Exhibit 1 is an example of a "hybrid" financial presentation; it has attributes of a financial statemetn and a trial balance. It resembles a trial balance because

* All general ledger accounts and corresponding debit or credit balances are listed. The accounts are not combined and are presented in general ledger account number order.

* "Accumulated depreciation," a contra account, is not netted against its related primary account, "furniture and fixtures."

* The net loss for the period is not closed out to retained earnings.

Exhibit 1 resembles a financial statement because

* Balance sheet accounts are segregated from income statement accounts, and column headings are financial statement title--"balance sheet" and "income statement."

* Account groupings have capitons, subtotals and totals commonly found in financial statements, such as "current assets," "total liabilities" and "total expenses."

* The caption "net loss" is included to identify the net results of operations.

ARSC believes financial presentation users are served best when a presentation easily can be identified as either a financial statement or a trial balance--but not a combination. SSARS no. 1, Interpretation no. 15, "Differentiating a Financial Statement Presentation from a Trial Balance," helps accountants evaluate a presentation by summarizing and comparing financial statement and trial balance attributes. Obviously, that involves the accountant's judgment; Interpretation no. 15's goal is to help accountants avoid the gray area between the two presentation types.

Exhibit 2, above, summarizes Interpretation no. 15's listing of financial statement and trial balance attributes. If the accountant concludes a presentation cannot easily be identified as either a financial statement or a trial balance, he or she should modify it according to its purpose by adding appropriate attributes.

Proponents of plain paper financial statements argue the time and effort required to comply wit hSSARS no. 1 prevent them from providing nonpublic clients with the timely, inexpensive, interim financial information necessary for business operation. A trial balance, however, is not always a satisfactory alternative because it may not include all the information a client needs. (See JofA, Apr.90, page 59.)

One practical solution is described in SSARS no. 1, paragraphs 19-21: The accountant reports on compiled financial statements that omit substantially all the disclosures required by generally accepted accounting principles. The practitioner may do this as long as the accompanying report discloses the omission of footnotes and the omission is not, to the accountant's knowledge, undertaken to mislead those who might reasonably be expected to use the financial statements. In addition, the accountant may forgo making certain adjustments ordinarily required when compiling full GAAP financial statements, as long as the report describes the resulting GAAP measurement departures. Paragraphs 39-41 of SSARS no. 1 provide guidance on reporting on financial statements containing material GAAP departures.

This option provides management with useful and efficiently produced financial information and also allows the accountant to provide professional-level service. Benefits of such statements are the accompanying report clearly states the statements' limitations and provides readers with adequate warning.

Exhibit 3, page 67, is a sample report appropriate for financial statements that omit a statement of cash flows and have not been adjusted to reflect an income tax accrual or change in inventory. Such reporting is suitable for monthly or interim computer-prepared statements and can be adapted to reflect other GAAP departures.

The report also may be adapted for financial statements presented in accordance with other comprehensive bases of accounting (OCBOA)--such as cash or tax basis. OCBOA financial statements must disclose the basis of accounting on their face or in the footnotes. If they don't, the accountant needs to modify the report to disclose this information.

SUBMISSION OF FINANCIAL STATEMENTS

A more difficult problem for accountants is determining if the services they perform constitute submission of financial statements. Paragraph 1 of SSARS no. 1 says an accountant should not submit a nonpublic entity's unaudited financial statements to a client or others unless he or she complies with SSARS no. 1. However, SSARS no. 1 does not stipulate which acts constitute "submission of financial statements." As a result, accountants provide numerous services adn are not sure if they are crossing the line and inadvertently submitting financial statements without complying with professional standards.

Interpretation no. 16, "Determining If the Accountant Has 'Submitted' Financial Statements Even When Not Engaged to Compile or Review Financial Statements," provides guidance on submission. It defines submission of financial statements as presenting to a client or others financial statements the accountant has

* Generated, either manually or with computer software.

* Modified by materially changing account classification, amounts or disclosures directly on client-prepared financial statements.

ARSC found many accountants issue compilation reports for services that do not result in submission of financial statements. For exampel, some accountants believe they are subject to SSARSs when assisting management in preparing standard monthly journal entries to record depreciation or accrue revenue and expenses. Others believe just reading client-prepared financial statements subjects them to SSARSs.

Interpretation no. 16 clarifies these misconceptions. Exhibit 4, page 70, lists services and indicates which ones result in submission of financial statements based on Interpretation no. 16's definition. As the exhibit illustrates, there are numerous services accountants may perform that do not subject them to SSARS no. 1.

Some practitioners believe Interpretation no. 16 is too specific in its definition of submission. For example, a client asks an accountant to read client-prepared financial statements, and the accountant identifies the need for a material adjustment. The accountant who marks the effects of a material correcting journal entry or writes a needed disclosure on client-prepared financial statements must adhere to SSARS no. 1; the accountant who prepares the material adjustment in journal entry format and submits it to the client to record is exempt.

In the context of computer-generated financial statements, it actually comes down to who pushes the button. The interpretation is structured to allow an accountant who performs all services, including input of adjusting entries, to avoid the requirements of SSARS by having the client push the computer print button to generate the financial statements. Although Interpretation no. 16 would allow such actions, accountants should not perform services that bring them so close to the boundary of submitting financial statements. Such unprofessional practices do not reflect the spirit of the interpretation.

On the surface, it appears ARSC has drawn the boundary so narrowly that it has eliminated the need to use judgment when evaluating the submission question. Although some may hold that view, ARSC believes the only effective way to provide practical and clear guidance is to be specific. ARSC has not, however, dispensed with the accountant's need to exercise judgment; consider the following situation.

The clients of Fagan and Best, CPAs, generally need compiled or reviewed financial statements at yearend and monthly compiled financial statements for management use. Many of the firm's clients operate small businesses such as hair salons and taverns and do not have the computer equipment or expertise to perform in-house data processing. Fagan and Best has an account with an independent electronic data processing service bureau that provides the firm's clients with a discount on data processing fees. Clients submit monthly cash receipts and disbursements data directly to the service bureau, which processes them, generates financial statements and mails them to the firm's clients with copies to Fagan and Best. Is Fagan and Best obligated to compile these financial statements?

A careful reading of Interpretation no. 16 should cause an accountant to conclude the answer is no. The key factor is whether the accountant has generated financial statements. Some might argue the service bureau acted as an agent for Fagan and Best and the firm indirectly generated financial statements. However, the accountants have not directly performed any act that generates financial statements; therefore, Fagan and Best is not required to compile the financial statements generated by the service bureau. Sometimes technology makes it difficult to discern the substance of an event, and the ultimate test of this interpretation will be its usefulness in situations that are not clear-cut.

In developing its position, ARSC said Interpretation no. 16 conflicts with the last sentence of SSARS no. 1, paragraph 7, which says the accountant is precluded from merely typing or reproducing financial statements as an accommodation to clients. Interpretation no. 16 says the accountant is not obligated to compile financial statements he or she has not generated or materially modified. Accordingly, if the accountant merely types or reproduces client financial statements, he or she is not obligated to compile those statements. ARSC plans to delete the last sentence of paragraph 7 via a proposed omnibus SSARS scheduled for exposure early this year. In the meantime, it's prudent to avoid providing accommodation typing or reproducing services.

DRAFT FINANCIAL STATEMENTS

SSARS no. 1 does not contain any guidance about whether accountants may issue draft financial statements; however, accountants frequently submit such statements to clients when information needed to complete the compilation or review of the statements will not be available until a later date or to enable the client to review the statements before final issuance. ARSC turned its attention to the practice of issuing draft financial statements when it became aware of practice abuses. Some practitioners issue monthly financial statements, label them "draft" and never follow up with monthly compiled financial statements under the erroneous belief the yearend compiled financial statements serve as final financial statements for the 12 monthly drafts.

Accountants have asked if it is appropriate for them to issue draft financial statements without reporting on them under SSARS no. 1. ARSC issued Interpretation no. 17, "Submitting Draft Financial Statements," to answer that question. The interpretation describes situations in which submission of draft financial statements frequently occurs. ARSC concluded once information is available, and after the client has reviewed the draft financial statements, the accountant should submit the final financial statements to the client accompanied by his or her compilation or review report. In such cases, draft financial statements clearly identified as being in draft form serve a purpose useful for the client.

As a result, Interpretation no. 17 permits an accountant to issue draft financial statements without issuing a compilation or review report as long as the accountant.

* Intends to submit the financial statements in final form.

* Labels each page of the draft financial statements with words such as "Draft," "Preliminary draft," "Draft--subject to change" or "Working draft."

There may be, however, rare instances when an accountant intends to but never submits financial statements in final form. For example, the client may terminate the engagement after the accountant has submitted draft financial statements for review but before the accountant is able to submit the statements in final form. In those circumstances, the interpretation says the accountant may want to document in the engagement working papers the reasons why he or she was unable to submit final statements.

CLARIFYING QUESTIONS

The applicability of SSARS interpretations has clarified many questions on whether the accounting services accountants perform for nonpublic clients are subject to SSARS no. 1. When an accountant has submitted (as defined by Interpretation no. 16) financial statemets (as defined by Interpretation no. 15) to a client or others, he or she must at least compile those statements in accordance with SSARS no. 1 (unless those statements are draft statements as defined by Interpretation no. 17).

Interpretation no. 16 has probably produced the biggest change in practice. Before publication, conventional guidance was if an accountant handled the input (that is, prepared adjusting journal entries) or the output (looked over the financial statements before submitting them to a client), SSARS no. 1 performance and reporting standards applied. Moreover, if the accountant's assistance was critical to the client's ability to produce financial statements, SSARS no. 1 was frequently followed. Now, the question is whether the accountant has generated or materially modified financial statements or a trial balance that is, in substance, a financial statement. If the answer is yes, SSARS no. 1 applies.