A review is a step up in the level of service from a compilation engagement, since some form of assurance on the financial statements will be expressed. Review procedures generally are limited to inquiries of company personnel and analytical procedures applied to financial data. These provide the accountant with a reasonable basis for expressing limited assurance that no material modifications need be made to the financial statements in order for them to be in conformity with generally accepted accounting principles (or another comprehensive basis of accounting).
Since review procedures do not include consideration of the client’s internal control or the gathering of competent evidential matter, an opinion may not be expressed. In a review, the practitioner may identify matters that significantly affect the financial statements. However, the review engagement may not be relied upon to disclose all significant matters that would surface in an audit.
Steps To Take In A Review Engagement
The steps in a review engagement should be tailored to each engagement, but generally include the following:
Step-1. If desired, obtain an engagement letter.
Step-2. Obtain a satisfactory level of knowledge of the accounting principles, methods, and practices of the industry in which the client operates.
Step-3. Obtain a general understanding of:
- The client’s organization
- The client’s operating characteristics
- The nature of the client’s assets, liabilities, equity, revenues, and expenses
- The client’s production, distribution, and compensation methods
- The types of products and services offered
- The client’s operating locations
- Any material related-party transactions
Step 4. Perform analytical procedures. Analytical procedures should be performed in order to identify and provide a basis for inquiries about unusual relationships and individual items that may be indicative of material misstatement. An accountant should:
- Develop 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.
- Compare recorded amounts, or ratios developed from recorded amounts, to accountant developed expectations.
To identify unusual relationships and individual items, an accountant should consider performing the following analytical procedures:
- Compare current period financial information with that of prior periods.
- Compare current period financial information with anticipated results. EXAMPLE: Budgeted and forecasted amounts.
- Compare current financial information with pertinent nonfinancial information. For example: Number of units of inventory to square footage of a storage facility.
- Compare current period financial ratios and other indicators with prior period expectations. For example: current ratio, gross margin, accounts receivable turnover, and debt to equity.
- Compare current-period financial ratios and other indicators to industry norms.
- Compare relationships among current period financial statement elements with corresponding prior period relationships. For example: a specific expense item as a percentage of sales. Analytical procedures may also encompass statistical techniques, including trend analysis and regression analysis.
Step 5. Consider making the following inquiries of management personnel who have financial and accounting oversight:
- Whether the financial statements have been prepared in conformity with generally accepted accounting principles (or an other comprehensive basis of accounting) on a consistent basis
- The accounting principles and practices and the methods followed in applying them and procedures for recording, classifying, and summarizing transactions, and accumulating information relevant to financial statement disclosure
- Unusual or complex situations that may affect the financial statements
- Significant transactions occurring or recognized near the end of the accounting period
- Uncorrected misstatements identified during the previous engagement
- Questions that have surfaced during the application of review procedures
- Subsequent events that could have a material effect on the financial statements
- Their knowledge of any fraud or suspected fraud affecting the entity involving management or others that could have a material effect on the financial statements, for example, communications received from employees, former employees, or others
- Significant journal entries and other adjustments
- Communications from regulatory agencies
- Actions taken at meetings of shareholders, board of directors, committees of the board of directors, or comparable meetings that may affect the financial statements.
Step 6. Perform other review procedures including:
- Reading the financial statements to consider, on the basis of information coming to the accountant’s attention, whether the financial statements appear to conform with generally accepted accounting principles or an other comprehensive basis of accounting.
- Obtaining reports from other accountants, if any, who have been engaged to audit or review the financial statements of significant components of the reporting entity, its subsidiaries, and other investees.
Step 7. Obtain a representation letter from management.
Step 8. Document the review engagement.
Management Representation Letter
It is important that the representation letter obtained from management cover all financial statements and periods that the accountant is reporting on.
Although the specific items to be addressed in the representation letter will vary depending on the circumstances of the engagement and the nature and basis of financial statement presentation, representations pertaining to GAAP financial statements should relate to the following:
- Management’s acknowledgment of its responsibility for the fairness of the financial statement presentation
- Management’s belief that the financial statements are fairly presented in conformity with GAAP
- Management’s acknowledgement of its responsibility for the prevention and detection of fraud
- Knowledge of any fraud or suspected fraud involving members of management or others that could materially affect the financial statements, including communications received from current or former employees, or others
- Management’s full and truthful response to all accountant inquiries
- Completeness of information
- Subsequent events
In general, the representation letter should be:
- Dated no earlier than the date of the accountant’s review report; and
- Signed by the chief executive officer and chief financial officer.
Note: In the event that the current management team is different from the management team of prior periods on which the accountant is reporting on a comparative basis, the current management team is responsible for all of the representations.
Documentation Requirements Applicable To A Review Engagement
The form and content of the documentation should be tailored to meet the circumstances of the engagement. A review report may also be supported by other means in addition to the documentation of the review. For example, documentation of a compilation engagement and documentation contained in quality control files may supplement the documentation of the review engagement.
Specifically, the documentation of the review should include:
- Significant findings or issues that could result in material misstatement of the financial statements, including actions to address such findings or issues, and the accountant’s basis for his or her final conclusion
- The matters covered in the accountant’s inquiry
- The analytical procedures performed
- The accountant-developed expectations where significant expectations are not otherwise readily determinable from the documentation of the work performed, and factors considered in the development of those expectations.
- Results of the comparison of the expectations to the recorded amounts or ratios developed from recorded amounts.
- Additional procedures performed in response to significant unexpected differences arising from analytical procedures and the results of such additional procedures.
- Unusual matters identified by the accountant and their disposition.
- The representation letter
Reports on Reviewed Financial Statements
The accountant’s review report should include:
- An identification of the financial statements.
- A statement that a review was performed in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants [AICPA]
- A statement that all the information included in the financial statements is the representation of management (or owners).
- The definition of a review stating that a review consists principally of inquiries of company personnel and of analytical procedures applied to financial data.
- A statement that a review is substantially less in scope than an audit, the objective of which is the expression of an opinion on the financial statements taken as a whole, and that no such opinion is expressed.
- If warranted, the issuance of limited assurance; that is, a statement that the accountant is not aware of any material modifications that should be made to the financial statements in order for them to be in conformity with generally accepted accounting principles (or other comprehensive basis of accounting).
- Disclosure of any material modifications, if any, that should be made to the financial statements for them to be in conformity with generally accepted accounting principles (or other comprehensive basis of accounting).
- The date of the report, which should coincide with the completion of the inquiries and analytical procedures.
- The accountant’s signature.
Cautious In Review Engagements
If the practitioner is precluded from performing review procedures that he or she considers necessary, then a review report should not be issued. In such circumstances, the accountant might consider issuing a compilation report.
Note: Professional judgment must be exercised in considering the circumstances that precluded the review report. Independence is a requirement for the issuance of a review report.
An accountant may undertake an engagement to review less than a complete set of financial statements. For example: The practitioner may accept an engagement to review only a client’s balance sheet.
Under certain circumstances, a client may request that an accountant, who was engaged to perform an audit under GAAS, change the engagement to a lower level of service, namely a change to a compilation or a review. Before undertaking the step down, the accountant should take into consideration:
- The client’s reasons for the steps down, including any client-imposed scope limitations.
- The extent of any additional procedures to complete the audit engagement.
- The cost to the client of performing the additional auditing procedures.
When justification exists for the step-down, as in the case of a client who no longer requires an audit report to secure a bank loan because alternative financing was arranged, the accountant’s report should not refer to the step-down or to the application of any audit procedures performed. Accordingly, the standard compilation or review report is appropriate.
Notes: If the accountant is precluded from discussing litigation, claims, and assessments with the client’s legal counsel because the client refuses to authorize the communication or the client refuses to furnish a representation letter, then the situation is tantamount to a scope limitation sufficient to preclude the issuance of an opinion. Such scope limitations similarly preclude the accountant from issuing a review or compilation report on the financial statements.
Modification of The Standard Report
Departures from Generally Accepted Accounting Principles – When the accountant becomes aware of a material departure from generally accepted accounting principles, it is necessary to modify the standard report by:
- Beginning the third paragraph with wording such as “Based on my (our) review, with the exception of the matter(s) described in the following paragraph(s), I am (we are) not aware of any material modifications…”
- Presenting an additional paragraph in order to disclose the effects of the departure
In situations where the principal effects of the departure cannot reasonably be determined, the practitioner should state this in the report.
Supplementary Information – When the basic financial statements are accompanied by additional information, such as a supporting schedule of selling, general and administrative expenses, the accountant should indicate the responsibility he or she is taking with respect to this supplementary information. This may be accomplished by presenting either of two reports:
- One report that covers both the basic financial statements and the supplementary information
- Separate reports on the basic financial statements and the supplementary information
Whichever approach is followed, the report should include a statement that the additional information is presented for the purpose of analysis only and was or was not subjected to the review procedures applicable to the review of the basic financial statements.
Notes: If the additional information was reviewed, the report should contain the expression of limited assurance; that is, that the accountant is not aware of any material modifications that should be made to the additional information. On the other hand, if the practitioner did not review the supplementary information, the report should state this fact. In this circumstance, it would be appropriate to state that the additional information was compiled from information that is the representation of management, without audit or review, and that no opinion or any other form of assurance is being expressed.