United States: "Plain Paper" Financial Statements Made Not So Plain: An Overview Of SSARS 21

Co-authored by Vincent J. Love, CPA/CFF, CFE, chairman of VJL Consulting, LLC and a member of The CPA Journal Editorial Board.

We are what we pretend to be, so we must be careful what we pretend to be.
—Kurt Vonnegut,
Mother Night (Introduction)

For most of the last quarter of the 19th century, accounting practice consisted mostly of making original entries for transactions and preparing financial statements for owners. Continuing into the early part of the 20th century, the work of accountants and the greater need for accurate financial information raised accounting to a profession with legal status and resulted in the formation of various self-regulatory organizations. A variety of standards (e.g., Statements on Auditing Procedure 23, 33, and 38) issued by the American Institute of Accountants (AIA), and later its successor the AICPA, in the middle of the century addressed the preparation of unaudited, unverified financial statements, called "plain paper" statements, attempting to correct misconceptions about CPAs' attestation (or lack thereof) to the information in such statements.

But it was not until the judgment in 1136 Tenants' Corp. v. Max Rothenberg & Co. [36 A.D.2d 804 (N.Y. App. Div. 1971)], however, that the need for professional standards for accounting and review services became apparent. The trial court in 1136 Tenants' Corp. ruled that a CPA firm was negligent in its duties when it used "inadequate, incomplete, and improperly deployed" procedures when providing its services. Moreover, the appeals court found that "even if defendant were hired to perform only 'writeup' services, it is clear, beyond dispute, that it did become aware that material invoices purportedly paid by [the building management company] were missing, and, accordingly, had a duty to at least inform plaintiff of this." This case, as well as studies sponsored by professional associations that included an analysis of the perception of the users of unaudited financial statements prepared by CPAs, eventually led the profession to develop the Statements on Standards for Accounting and Review Services (SSARS).

SSARS 1, Compilation and Review of Financial Statements, issued in December 1978, established the standards for CPAs reporting on a client's unaudited financial statements. It prohibited CPAs from issuing a report on the unaudited financial statements of a non-public entity unless either compilation or review procedures were applied to those statements. In addition, a report addressing the procedures applied and the level of assurance given, whether limited or none, was required to accompany the financial statements. SSARS 1 explicitly precluded the preparation of financial statements unless the CPA "complies with the provisions of [SSARS 1] applicable to a compilation engagement." Therefore, preparation of plain paper financial statements was prohibited.

Subsequent to SSARS 1, many leaders in the profession lobbied for standards that would allow the preparation of financial statement services that did not require even the application of compilation procedures. This was needed, they argued, to serve small entities that did not have the internal capability to prepare their own financial statements, and it could be accomplished if certain safeguards were in place.

In October 2000, SSARS 8, Amendment to Statement on Standards for Accounting and Review Services No. 1, Compilation and Review of Financial Statements, was issued. It addressed the performance and communication requirements for financial statements of nonpublic entities that were not intended for third-party use, but rather for sole distribution to individuals in management with sufficient knowledge to understand the statements in their proper context. There was a requirement that each page of the financial statements contain a legend indicating that they were "Restricted for Management's Use Only" or similar language. This change to the SSARS did not completely resolve the issue, since some in the profession believed that there still existed a need to help smaller clients prepare their financial statements for distribution outside of management.

SSARS 21

SSARS 21, Statements on Standards for Accounting and Review Services: Clarification and Recodification, allowed CPAs to prepare financial statements from the unaudited financial books and records. Section 70 of SSARS 21 "applies when an accountant in public practice is engaged to prepare financial statements." It also states that the procedures may be used and adapted to the specific engagement circumstances in the preparation of other prospective or historical financial data. (SSARS 26, Statements on Standards for Accounting and Review Services: Omnibus Statement, did not significantly change SSARS 21; it clarified it and added prospective financial statements to the list of information that can be prepared without applying any audit, review or compilation procedures.) This essentially allowed a CPA to perform the same nonattest services on financial data that were a part of many practices during the early days of the profession. There are, however, some important concerns and issues that CPAs should consider before providing such services.

Times have changed. What was available to the profession and its clients in the industrial age is far different than what is available in the information age. In addition, the legal climate is drastically different. Finally, the public perception of, and expectation concerning the work-product delivered by, CPAs has changed drastically.

SSARS 21, while ostensibly requiring no verification similar to that required in an audit or review, does require some procedures similar to those for a compilation, and failure to follow them can lead to allegations of insufficient performance. The standard also sets the stage for third parties to profess that they placed greater reliance on the financial statements because a CPA was involved in their preparation.

Section 70.04 states that "an engagement to prepare financial statements does not require the accountant to verify the accuracy or completeness of the information provided by management or otherwise gather evidence to express an opinion or a conclusion on the financial statements or otherwise report on the financial statements." In the following sections, however, SSARS 21 addresses the need for an engagement letter, including management's agreement that either each page of the financial statements will include a statement that no assurances are given on those statements or the CPA will be required to issue a disclaimer that makes the lack of such assurances clear. Moreover, section 70 requires the accountant to comply with section 60, "General Principles for Engagements Performed in Accordance With Statements on Standards for Accounting and Review Services."

A reading of sections 60 and 70 leads one to realize that several matters are critical to consider when performing a financial statement preparation service under SSARS 21. The most important business consideration when deciding whether to offer financial statement preparation services is the risk involved. This is more than simply labeling the service as "high risk." The risk cannot be mitigated by extending procedures, because a preparation engagement does not require any verification procedures. Consequently, if verification procedures are used, they may significantly increase a CPA's exposure to liability. The CPA or the firm will be associated with the financial statements, no matter what legend or report is used to disclose the lack of any verification of the underlying transactions and balances displayed on the face of the statements or the sufficiency of any note disclosures. CPAs must also consider whether the level of work is so far below the expertise attached to the CPA designation that it lowers the professional image of the CPA or firm providing the service.

Client acceptance and continuance is another factor. As stated above, the information given to the CPA will not be verified. Furthermore, clients desiring this service will tend to be smaller and less sophisticated, which presumably means that the data is more susceptible to error (and manipulation). CPAs should therefore exercise greater scrutiny of the character and integrity of the prospective or continuing client before a preparation engagement is accepted. The client's behavior should be considered throughout the relationship, and if there is any doubt about management's integrity, serious consideration should be given to withdrawing from the engagement.

CPAs also need to have an understanding of the client's business, structure, its accounting system, environment, and the financial reporting framework being used, including the acceptability of that framework. Because clients may not have the ability to prepare their own financial statements, CPAs should consider whether the necessary information and data will be available and reliable. If additional data is needed, this could be construed as evidence that the CPA was aware that a higher-level service than preparation was needed. This could expose a CPA to greater exposure if the financial statements turn out to be fraudulent or contain material errors.

Certain representations are needed to prepare financial statements. In other services, these are contained in a "representation letter." Here, they need to be included in a client-signed engagement letter. The letter should state that the client is responsible for—

  • the selection of the reporting framework used,
  • the internal controls related to the preparation and presentation of the financial statements,
  • the prevention and detection of fraud,
  • compliance with relevant laws and regulations,
  • the accuracy and completeness of the underlying financial records and documents and the significant judgments required for the preparation of the financial statements,
  • providing the CPA with access to information needed to prepare the financial statements, and
  • unrestricted access to client personnel.

In essence, the engagement letter becomes a representation letter, and CPAs must remember that all of these representations are coming from a client who may be unable internally to prepare its own financial statements.

Finally, CPAs are expected to exercise professional judgment throughout the preparation engagement, and the basis of that judgment should be appropriately documented in the working papers. SSARS 21 also requires CPAs to discuss the judgments reflected in the financial statements with management so that management understands the significant ones and accepts responsibility for the judgments used. This may not absolve the CPA from any liability, however, as those judgments are made by management that might not even have the financial knowledge necessary to prepare its own financial statements.

SSARS 21 further states that if the CPA "becomes aware that the records, documents, explanations, or other information, including significant judgments" are not complete or accurate, she should bring that to management's attention and request additional or corrected information. This requirement does place some burden on CPAs, even while they do not have to verify the data. With hindsight, a case could sometimes be made that a CPA should have known of the problem and asked for additional or corrected data. There is also the question of whether the fact that the necessary information is incomplete or inaccurate reflects on the character and integrity of the client.

The Profession and What It Represents

CPAs are required to adhere to one or more of the AICPA, state society, or regulatory codes of conduct and their general standards or provisions when performing any service, such as professional competence, due professional care, planning and supervision, and obtaining sufficient relevant data. The vast majority of state societies use the AICPA Code of Professional Conduct or one with essentially the same provisions. All of them recognize the need to place integrity and the public good above commercial considerations.

The CPA designation is earned only after education and experience criteria are met and a difficult examination is passed. It is a license to practice using the title of Certified Public Accountant. There are continuing education requirements that must be met to remain licensed, as well as requirements to comply with regulatory and self-regulatory organizations' ethics and performance criteria. These requirements, which center on the CPA's exclusive right to report on financial statements, have raised the public's image of the financial competency of the CPA to a very high level. Unlike other organization-conferred designations, which ostensibly only demonstrate a special skill, the CPA designation is an exclusive, government regulatory authority–granted license to practice and perform certain services.

Given the high esteem in which the profession is held, why should CPAs perform services that could be performed extremely well, and at lower cost, by a good bookkeeper or even a computer program? As mentioned above, a legend stating that the financial statements were not audited may still put a third-party reader on notice that a CPA was involved in the preparation of the financial statements, even if the CPA's name is not included in the legend. SSARS 21 does not preclude a CPA from including his name in the legend, but this offers a greater risk of liability and could imply that the preparer is trading on the trust the public has in the CPA designation. It is far more sensible for a CPA to serve as a consultant, setting up the computer system and controls necessary for the client to achieve its internal reporting objectives. For reporting to third parties, the compilation engagement should, in the authors' view, be the lowest level of reporting, especially since its limitations are already recognized by the legal system. What is the difference in cost between the two services, even considering a lack of independence disclosure in the compilation report?

The high regard the public has for the profession is best protected by keeping the CPA's name off of plain paper financial statements. Eli Mason, an active critic of his profession when he believed it was going astray, said in a letter to the AICPA Accounting and Review Services Committee in 1997:

I have heard that your committee may reconsider "plain paper financial statements." As a long-time practitioner, I have had a negative feeling about such so called financial statements, as I believe they demean the professionality [sic] of certified public accountants. These statements are intended to avoid responsibility by those who prepare and are associated with said financial statements, but to the contrary, clients have historically submitted such statements to banks and credit grantors despite caveats, footnotes, and "poison warnings" appended thereto. ("No Plain Paper Please," The CPA Journal, May 1997, http://bit.ly/2pyW2Q8.)

Legal Considerations

The legal liability of CPAs who purport to perform SSARS 21 services could turn on whether those CPAs actually performed procedures beyond what the standard contemplates—in which case they will be beyond the legal protection that the standard attempts to create. This is precisely what occurred in 1136 Tenants' Corp. In that case, the accountant's testimony that certain services performed went beyond the scope of "write-up" work and the time records revealing that the accountants examined bank statements were sufficient to create an issue of fact as to the scope of services actually performed, with the accountants ultimately being held to the standard of having been engaged to perform an audit.

By SSARS 21's own terms, CPAs who undertake to do more in terms of verification or analysis could find themselves being measured against the higher standards applicable to compilation or review engagements. This is particularly a concern in jurisdictions where privity rules allow negligence suits to be brought against CPAs by non-clients, as those non-clients would not be subject to the argument that their signatures on the engagement letters prevents them from arguing that a higher level of service was actually intended. It is entirely foreseeable that an opportunistic creditor or bankruptcy trustee would advance such an argument to establish a CPA's liability.

As was the case in 1136 Tenants' Corp., a CPA's own billing and engagement documentation is likely to be the key evidence militating against the argument that he only performed limited-scope clerical services. If a CPA undertakes to provide such services, extra care must be taken not to create the appearance that a higher level of service was actually performed. In the past, similar arguments have been made by litigants trying to establish that a CPA did more than was required for a compilation.

Another factor that will weigh against any CPA is the "expectations gap." The public expectation that CPAs are learned, careful, and thorough professionals is challenged by the notion that a CPA can assemble a client's financial statements without some level of professional analysis or responsibility. As experience has proven, juries and judges harbor these expectations.

In Summation

SSARS 21 once again gives CPAs the authority to issue plain paper financial statements. In this regard, the profession has come full circle—but have CPAs learned from history? Hopefully, CPAs will take the steps necessary to reduce engagement risk to an acceptable level and to protect the profession's public image.

CPAs who decide to proceed with a financial statement preparation engagement should consider the following steps to reduce the engagement risk and comply with the standards:

  • Perform and document client acceptance and retention procedures
  • Adhere to engagement quality control standards
  • Obtain a written engagement letter clearly setting forth the client's and the CPA's responsibilities
  • Meet with management to be sure that the representations are clearly understood, and document the meeting
  • Follow up on any unusual or suspicious balances, activity, or unavailable data encountered
  • Avoid including the name of the CPA in the legend required on each page of the prepared "plain paper" financial statements.

Financial statement preparation engagements are risky and can be performed adequately, effectively, and at a lower cost by non-CPA bookkeeping firms or computerized accounting systems for many smaller clients. CPAs who decide to perform financial statement preparation engagements should ask themselves if it is in the client's best interest, if they want to accept the engagement risk, whether they have complied with all of the procedures required by the standards, and whether the engagement will increase or decrease their and the profession's public image.

Originally published by The CPA Journal, May, 2017.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions