Auditors Special ReportsSeveral types of special reports exist where auditor can examine information not in the form of financial statements presented according to US generally accepted accounting principles. SAS No. 62, Special Reports [AU 623], identifies the following five types of special reports: [1] Reports on financial statements prepared on comprehensive bases of accounting other than GAAP [2] Reports on specified elements, accounts, or items of a financial statement [3] Reports on compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements [4] Reports on financial presentations to comply with contractual agreements or regulatory provisions and [5] Reports on financial information presented in prescribed forms or schedules that require a prescribed form of auditor’s report.

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Through this post, I am going to overview each type of the auditor’s special report. Examples and its annotation is presented for a better illustration. Enjoy!

 

 
Other Comprehensive Bases of Accounting Report

Auditors frequently examine financial statements that are prepared on a basis of accounting that differs from GAAP. SAS No. 62 recognizes this and provides reporting guidance to the auditor when financial statements are prepared on “other comprehensive bases of accounting” [OCBOA]. The auditor’s report should provide reasonable assurance that the financial statements conform to OCBOA.

According to SAS No. 62, a measurement basis must meet one of four criteria to be classified as an OCBOA. The measurement must be:

  • A basis of accounting that the reporting entity uses to comply with the reporting provisions of a government regulatory agency to whose jurisdiction the entity is subject. For example, insurance companies use bases of accounting pursuant to the rules of state insurance commissions.
  • A basis of accounting that the reporting entity uses or expects to use to file its federal income tax return for the period covered by the financial statements.
  • The cash receipts and disbursements basis of accounting, and modifications of the cash basis having substantial support, such as recording depreciation on fixed assets or accruing income taxes.
  • A definite set of criteria having substantial support that is applied to all material items appearing in the financial statements, such as the price level basis of accounting.

 

Below example indicates auditor’s report on financial statements prepared on the entity’s income tax basis.

Example: Report on compliance with contractual provisions

We have audited, in accordance with auditing standards generally accepted in the United States, the balance sheets of Lie Company as of December 31, 2010 and 2009, and the related statements of income, retained earnings, and cash flows for the years then ended, and have issued our report thereon dated February 16, 2011.
[This paragraph identifies the financial statements audited and states that they were audited in accordance with GAAS]

In connection with our audits, nothing came to our attention that caused us to believe that the Company failed to comply with the terms, covenants, provisions, or conditions of Sections 10 to 15, inclusive, of the Indenture dated July 21, 2008, with XYZ Bank insofar as they relate to accounting matters. It should be noted, however, that our audits were not directed primarily toward obtaining knowledge of such noncompliance.
[This paragraph provides negative assurance about contract violations. The auditor notes that the audit was not directed toward obtaining such knowledge.]

This report is intended solely for the information and use of the board of directors and management of Lie Company and XYZ Bank and should not be used for any other purpose.
[This paragraph indicates that distribution of the report is limited to the parties to the contract.]

 

Opinions on Specified Elements, Accounts, or Items of a Financial Statement

Sometimes auditors are requested to issue a report on certain aspects of the financial statements. For example, a shopping mall may charge rent to its tenants based on a percentage of the tenants’ sales. In this situation, the mall may require a report by the auditor that the sales reported by the tenants are fairly presented in conformity with GAAP. Other examples include reports on royalties and profit participations.

The audit of specified elements, accounts, or items may be undertaken as a separate engagement or in conjunction with an audit of financial statements. In such an engagement, the auditor expresses an opinion on each of the specified elements, accounts, or items encompassed by the report; therefore, the measurement of materiality must be related to each individual element, account, or item audited rather than to the aggregate thereof or to the financial statements taken as a whole. Consequently, the audit is usually more extensive than if the same information were being considered in conjunction with an audit of the financial statements taken as a whole.

An example of a report related to the amount of sales for the purpose of computing rental charges is shown below.

 

Example: Report relating to amount of sales for the purpose of computing rental charges

We have audited the accompanying schedule of gross sales [as defined in the lease agreement dated March 4, 2008, between XYZ Company, as lessor, and Steffanie Stores Corporation, as lessee] of Steffanie Stores Corporation at its East Street store, Brewster, New York, for the year ended December 31, 2010. This schedule is the responsibility of the Steffanie Stores Corp. management. Our responsibility is to express an opinion on this schedule based on our audit.
[This paragraph identifies the sales schedule, the lease agreement, and the parties to the agreement. The auditor also indicates that the schedule is management’s responsibility]

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the schedule of gross sales is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the schedule of gross sales. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall schedule presentation. We believe that our audit provides a reasonable basis for our opinion.
[The scope paragraph above states that the audit was conducted in accordance with GAAS.]

In our opinion, the schedule of gross sales referred to above presents fairly, in all material respects, the gross sales of Steffanie Stores Corporation at its East Street store, Brewster, New York for the year ended December 31, 2010, as defined in the lease agreement referred to in the first paragraph.
[The opinion paragraph above expresses the auditor’s opinion on whether the schedule presents fairly, in all material respects, the gross sales as defined in the lease agreement].

This report is intended solely for the information and use of the board of directors and management of Steffanie Stores Corp. and XYZ Company and should not be used for any other purpose.
[The final paragraph indicates that distribution of the report is limited to the parties identified]

 

Applying Agreed-Upon Procedures

An accountant may undertake an engagement to apply agreed-upon procedures to specified elements, accounts, or items of a financial statement or to nonfinancial statement subject matter, such as circulation statistics for advertising media and labor contract negotiation data. Statements on Standards for Attestation Engagements [SSAE] No. 10, “Attestation Standards: Revision and Re-codification”,  “Agreed-Upon Procedures” [AT 201], applies to these engagements. The general, field work, and reporting standards in SSAE No. “Attest Engagements” [AT 101], also should be followed by the practitioner in agreed-upon procedures engagements.

An agreed-upon procedures engagement is one in which the practitioner is engaged to issue a report of findings to specified parties based on specific procedures performed on financial or nonfinancial information [subject matter]. The practitioner and specified parties agree on the procedures and the specified parties accept responsibility for the sufficiency of the procedures in meeting their needs.

In an agreed-upon procedures engagement, the practitioner does not perform an examination and thus does not express an opinion on the subject matter. Instead, the practitioner’s report is expressed in the form of procedures and findings. AT 201 prohibits the practitioner from expressing negative assurance on the fair presentation of the subject matter.

The practitioner’s report in an engagement performed under AT 201 should contain the following elements:

  • A title that includes the word “independent”
  • Identification of the specified parties
  • Identification of the subject matter [or written assertion related thereto] and the character of the engagement
  • Identification of the responsible party
  • A statement that the subject matter is the responsibility of the responsible party
  • A statement that the procedures performed were those agreed to by the specified parties identified in the report
  • A statement that the agreed-upon procedures engagement was conducted in accordance with attestation standards established by the AICPA
  • A statement that the sufficiency of the procedures is solely the responsibility of the specified parties and a disclaimer of practitioner’s responsibility for the sufficiency of those procedures
  • A list of the procedures performed [or reference thereto] and related ?ndings
  • Where applicable, a description of any agreed-upon materiality limits
  • A statement that the practitioner was not engaged to and did not conduct an examination [or audit] of the subject matter, the objective of which would be the expression of an opinion, a disclaimer of opinion on the subject matter, and a statement that if the practitioner had performed additional procedures, other matters might have come to his or her attention that would have been reported
  • A statement of restrictions on the use of the report because it is intended to be used solely by the specified parties
  • Where applicable, reservations or restrictions concerning procedures or findings
  • For an agreed-upon procedures engagement on prospective financial information, all items included in AT 301.55
  • Where applicable, a description of the nature of the assistance provided by a specialist
  • The manual or printed signature of the practitioner’s firm
  • The date of the report

 

 
Compliance Reports Related to Audited Financial Statements

Companies may be required by contractual agreements or by regulatory agencies to furnish compliance reports by independent auditors. For example, loan agreements usually impose on borrowers a variety of covenants involving matters such as payments into sinking funds, payments of interest, maintenance of current ratio, restriction of dividends payments, and use of the proceeds of sales of property.

Under SAS No. 62, the auditor is allowed to give a negative assurance report on compliance with contractual agreements provided that:

  • He or she has audited the financial statements to which the contractual agreement or regulatory provision relates.
  • He or she has not issued an adverse opinion or disclaimer of opinion on such financial statements.
  • He or she only reports on matters that audit procedures were applied to during the audit of the financial statements.

 

A report on compliance with contractual provisions is shown below

Example: Financial statements prepared on the entity’s income tax basis

We have audited the accompanying statements of assets, liabilities, and capital—income tax basis of Diamond Partnership as of December 31, 2010 and 2009, and the related statements of revenue and expenses—income tax basis and of changes in partners’ capital accounts—income tax basis for the years then ended. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
[This paragraph identifies the financial statements audited. The auditor also emphasizes that the financial statements are management’s responsibility]

We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 audits provide a reasonable basis for our opinion.
[The above scope paragraph states that the audit was conducted in accordance with GAAS]

As described in Note X, these financial statements were pre- pared on the accounting basis used for income tax purposes, which is a comprehensive basis of accounting other than generally accepted accounting principles.
[This paragraph refers to the note in the financial statements that states the basis of presentation upon which the statements were prepared]

In our opinion, the financial statements referred to above present fairly, in all material respects, the assets, liabilities, and capital of Diamond Partnership as of December 31, 2010 and 2009, and its revenue and expenses and changes in partners’ capital accounts for the years then ended, on the basis of accounting described in Note X.
[The above opinion paragraph expresses the auditor’s opinion on whether the financial statements are presented fairly, in all material respects, in conformity with the basis described]

 

 
Financial Presentations to Comply with Contractual Agreements or Regulatory Provisions

Auditors are sometimes requested to report on special-purpose financial statements prepared to comply with a contractual agreement or regulatory provisions. Generally, these types of reports are intended solely for the use of the parties to the agreement, regulatory bodies, or other specified parties. According to SAS No. 62, “Special Reports” [AU 623], these types of presentations fall into two categories:

  • Those that do not constitute complete presentation of the entity’s assets, liabilities, revenues, and expenses [an incomplete presentation] but are otherwise prepared in conformity with GAAP or an OCBOA
  • Those prepared on a basis of accounting prescribed in an agreement that result in presentations not in conformity with GAAP or an OCBOA

 

An auditor may be requested to report on a financial presentation to meet the special purposes of regulatory agencies or parties to an agreement. For example: the SEC may require a schedule of gross income and certain expenses of an entity’s real estate operation in which income and expenses are measured in conformity with GAAP, but expenses are defined to exclude certain items such as interest, depreciation, and income taxes.

Also, a buy-sell agreement may specified a schedule of gross assets and liabilities of the entity measured in conformity with GAAP but limited to the assets to be sold and liabilities to be transferred pursuant to the agreement. Such financial presentations are regarded as financial statements even though certain items may be excluded. The presentations differ from complete financial statements only to the extent necessary to meet the special purposes for which they are prepared.

An example of a special report on such financial presentations is shown below

Example: Report on a statement of assets sold and liabilities transferred to comply with a contractual agreement

We have audited the accompanying statement of net assets sold of Bender Company as of June 8, 2009. This statement of net assets sold is the responsibility of Bender Company’s management. Our responsibility is to express an opinion on the statement of net assets sold based on our audit.
[This paragraph identifies the audited statement of net assets sold. The auditor emphasizes that the statement is management’s responsibility]

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statement of net assets sold is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the statement of net assets sold. We believe that our audit provides a reasonable basis for our opinion.
[This paragraph states that the audit was conducted in accordance with GAAS]

The accompanying statement was prepared to present the net assets of Bender Company sold to XYZ Corporation pursuant to the purchase agreement described in Note X, and is not intended to be a complete presentation of Bender Company’s assets and liabilities.
[This paragraph identifies the note in the statement that describes the basis of presentation as defined in the purchase agreement]

In our opinion, the accompanying statement of net assets sold presents fairly, in all material respects, the net assets sold of Bender Company as of June 8, 2009, pursuant to the purchase agreement referred to in Note X, in conformity with principles generally accepted in the United States.
[The above opinion paragraph states whether the statement is fairly presented in all material respects, pursuant to the agreement in conformity with GAAP]

This report is intended solely for the information and use of the board of directors and management of Bender Company and XYZ Corporation and should not be used for any other purpose.
[This paragraph indicates that distribution of the report is limited to the parties to the contract]

 

An auditor also might be asked to report on a financial presentation prepared to comply with the provisions of a contract or regulatory agreement that results in a presentation not in conformity with GAAP or OCBOA. For example, a loan agreement might call for financial statements prepared in conformity with GAAP except for certain assets, such as inventories and property, plant, and equipment, for which the valuation basis is specified in the agreement. These financial statements are not prepared in conformity with GAAP or OCBOA since they do not meet the requirements of being a measurement basis having substantial support When reporting on a non-GAAP, non-OCBOA presentation, the auditor would modify the end of the third paragraph in the above example to read … and are not intended to be a presentation in conformity with GAAP