SEC requires an interim financial information review before it is filed in a registrant’s quarterly report on Form 10-Q. SAS 100 provides guidance which is primarily in response to the requirement. The requirement is also applicable to a non-SEC registrant that makes a filing with a regulatory agency in preparation for a public offering or listing if the entity’s latest annual financial statements have been or are being audited.
An exception to the rule is that if the client states in a document that the interim financial information has been reviewed and accountant’s report must be filed with the interim financial information. When a report is issued it provides limited (negative) assurance about whether material modifications should be made to the information.
The objective of an interim review is to provide the accountant with a basis for communicating whether he or she is aware of any material modifications that should be made to the interim financial information for it to conform with GAAP. This post outlines guidance of interim financial information review based adapted from SAS 100. Read on…
Basically, a review consists primarily of the performance of inquiry and analytical procedures to form a basis for reporting on whether material modifications should be made for the information to conform with GAAP. Although such a review must be conducted for SEC registrants, the accountant ordinarily only issues a review report if the registrant requests it. Otherwise, the procedures are performed with no report issuance.
A review does not contemplate:
- Tests of accounting records through inspection, observation, or confirmation
- Tests of controls
- Corroborating evidence in response to inquiries
- Application of other procedures ordinarily performed during an audit
An accountant (CPA) should obtain and document (preferably in writing) an understanding regarding:
- Objective of a review (see objective above)
- Management’s responsibility for: (1) the interim financial information; (2) internal control over financial reporting; (3) company’s compliance with laws and regulations; (4) making financial records and related information available to the auditor; and (5) adjusting interim financial information to correct material misstatements.
- Accountant’s responsibility for conducting the review in accordance with AICPA standards.
- A review includes obtaining sufficient knowledge of the business and internal control to; (1) identify types of potential misstatements and their likelihood of occurrence; and (2) select appropriate inquiries and analytical procedures.
Although a review may identify reportable conditions, it is not designed to do so; nor is it designed to provide assurance on internal control.
Accountant’s Knowledge Of Entity’s Business And Internal Control
To be able to do an interim financial review, an accountant should have knowledge of the business and its internal control to aid in determining appropriate review procedures. In general she/he should have sufficient knowledge to:
- Identify types of potential misstatements and to consider the likelihood of occurrence
- Select inquiries and analytical procedures to provide accountant a basis for communicating whether he or she is aware of material modifications that should be made for the information to conform with GAAP.
And here are procedures he/she should perform to update his/her knowledge:
- Read documentation of preceding year’s audit and preceding reviews
- Read most recent annual and comparable prior interim period financial information
- Consider results of any audit procedures that were performed with respect to current year’s financial statements
- Inquire of management about changes in entity’s business activities
- Inquire of management about significant changes in internal control as it relates to the interim financial information
If the accountant has not performed an audit on this client (i.e., for a new client), adequate procedures must be performed relating to internal control to allow the accountant to perform the review.
In an initial review make inquiries of a predecessor auditor and review predecessor accountant’s documentation for preceding annual audit and any prior interim periods in the current year that have been reviewed (if the predecessor permits such access); consider:
(1) Corrected misstatements;
(2) Uncorrected misstatements;
(3) Risks of material misstatement due to fraud, including management override of controls; and
(4) Significant financial and reporting matters, such as weaknesses in internal control.
If the accountant has not audited the most recent annual financial statements, perform procedures to obtain sufficient understanding of internal control. A restriction on the scope of the review may be imposed by poor internal control and this may result in resignation because it will be impossible to complete the review.
Analytic Procedures, Inquiries, and Other Procedures
Here are analytical procedures for interim financial information review:
- Compare interim financial information with preceding period(s).
- Consider plausible relationships among financial and non-financial information (e.g., board of director information package).
- Compare amounts or ratios to expectations developed by accountant (1) Expectations developed by an accountant during a review are ordinarily less precise than those developed in an audit.
- Compare disaggregated revenue data; for example, compare revenue by month and by product line with that of comparable prior periods.
Inquiries and other review procedures are as follows:
1. Read minutes (stockholders, directors, others) and inquire about matters dealt with at meetings for which minutes are not available
2. Obtain reports from other accountants (if any) who are reviewing components of entity
3. Inquiries of members of management with financial and accounting responsibility, including:
- Whether information conforms with GAAP
- Unusual or complex situations
- Significant transactions in last several days of period
- Status of uncorrected misstatements identified during previous audits and reviews
- Matters about which questions have arisen during review
- Events subsequent to date of interim financial information
- Fraud—knowledge of, suspected, allegations
- Significant journal entries and other adjustments
- Communications from regulatory agencies
- Significant deficiencies in internal control
The accountant should also obtain evidence that interim financial information agrees or reconciles with accounting records (e.g., compare interim financial information to general ledger, consolidating schedule, other support), read interim financial information, and read other information accompanying interim financial information (e.g., Form 10-Q).
Although it is not ordinarily necessary to contact an entity’s lawyer concerning litigation, claims, and assessments, if certain information causes the accountant to question whether GAAP is being followed arises, it may be appropriate to inquire of the lawyer.
If matters concerning the entity’s ability to continue as a going concern come to the accountant’s attention, the accountant should inquire of management about plans for dealing with this matter and consider the adequacy of disclosures about such matters in the interim financial information.
If information leads the accountant to believe quarterly financial information does not follow GAAP, the accountant should make additional inquiries or perform other procedures. For example, if a sale is questioned, the accountant may discuss the transactions with appropriate personnel, read the sales contract, or both.
Procedures for the Management Representation
Written representations from management should be obtained, including:
1. Management acknowledges responsibility and believes that financial statements follow GAAP.
2. Management acknowledges responsibility for internal control and has disclosed any known or suspected fraud to the auditor.
3. Management makes available all: (a) Financial records; (b) Minutes of meetings; and (c) Communications with regulatory agencies
4. Recognition, measures, and disclosure of the following items:
- Uncorrected misstatements are immaterial
- Plans or intentions affecting carrying value of assets or liabilities
- Related-party transactions
- Significant estimates
- Violations or possible violations of laws or regulations
- Unasserted claims probable of assertion
- Other liabilities or gain or loss contingencies required to be disclosed by SFAS 5
- Satisfactory title to owned assets, etc.j. Compliance with contracts
5. Information on subsequent events.
6. When an accountant is unable to perform needed procedures, the review is incomplete, and resignation is ordinarily appropriate.
Communications To Management, Audit Committees, And Others
If the accountant believes there is a material misstatement: Inform management, and if management doesn’t respond appropriately, inform the audit committee (1) If the audit committee doesn’t respond appropriately, consider resigning; accountant may also wish to consult his/her attorney.
If the accountant becomes aware of fraud, this information should be communicated as required in AU 316. Here are the procedures:
- It should be brought to attention of appropriate level of management (at least one above the fraud).
- If senior management is involved or if results in a material misstatement, it should be communicated to audit committee.
- If illegal acts are involved, make certain audit committee is informed unless the matter is clearly inconsequential
- If reportable conditions have been identified, report them to audit committee. And, if any matters requiring communication to the audit committee are identified (AU 380), report them.
Accountant’s Report On Financial Information Review Engagement
The report should include:
- Title with word independent
- Information was reviewed
- Information is responsibility of management
- Review was conducted in accordance with AICPA standards
- Description of procedures
- Review substantially less in scope than an audit
- Statement on awareness of any necessary material modification to financial information
- Manual or printed signature of accountant’s firm
- Date of review report (ordinarily completion of review procedures)
Each page of interim financial information should be clearly marked un-audited. And departures from GAAP or inadequate disclosure—state nature of departure in an explanatory paragraph if practical, provide the effect.
Specifically regarding ‘Going Concern’ aspect, if prior year’s audit included a going concern modification, if there is adequate disclosure, no report modification is necessary. However, a paragraph describing the matter may be added to the review report.
If no prior going concern modification, but such a matter is here identified, no report modification is necessary, although an explanatory paragraph may be added to the report Subsequent discovery of facts existing at date of report.
Interim Financial Information Accompanying Audited Financial Statements
When the interim information is presented outside the audited financial statements, each page should be marked un-audited. The audit report on the annual information should be modified when:
- Interim financial information included in a note is not appropriately marked as unaudited—the auditor should disclaim an opinion on the interim financial information.
- Interim information doesn’t follow GAAP—the auditor need not modify report on audited financial statement if his/her review report accompanies the information; if it doesn’t, add explanatory paragraph to audit report.
- Required information omitted—add explanatory paragraph.
- Interim information not reviewed—add explanatory paragraph.
Documentation For Financial Information Review
The documentation should include findings and significant issues and should allow reviewer to:
- Understand nature, timing, extent, and results of review procedures.
- Identify who performed and reviewed work.
- Identify evidence accountant obtained in support of conclusion that reviewed information agreed or reconciled with accounting records.
Examples of documentation include:
- Review programs
- Memorandum (sometimes it is called ‘memoranda‘)
- Letters of representation
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