CHAPTER 30

NONAUDIT ENGAGEMENTS:
PROCEDURES AND REPORTS

Questions and Answers:

1. Give examples of how an auditor might assume that “what was held true in
the past for the enterprise under examination will hold true in the future.”

Answer:

Examples of using “what has held true in the past will hold true in the
future:”
(a)evaluating the collectibility of accounts receivable based on past
collection history,
(b)evaluating inventory obsolescence on the basis of past usage patterns,
(c)assessing the economic usefulness and useful lives of fixed assets based
upon experience with similar assets,
(d)relying on a control risk assessment for a period between the time of the
original assessment at interim and the fiscal year-end, and
(e)expecting to encounter classification and evaluation errors when
management has been known to have acted without sufficient decision
planning in the past.

2. What are unaudited statements? In connection with unaudited statements,

which general reporting guides should the auditor follow for public
companies?

Answer:

Financial statements are unaudited if the CPA has not applied any auditing
procedures or has not applied procedures which produced sufficient
evidence upon which to base an opinion on the financial statements as a
whole.

With respect to unaudited statements, in addition to a disclaimer of opinion

(public companies), the following guides should be followed:
30-2 Solutions Manual – Public Accountancy Profession
1. If the CPA should learn that the statements are not in conformity with
financial reporting standards (including adequate disclosures), he should
explain the departures in the disclaimer.
2. If prior years’ unaudited statements are present, the disclaimer should
cover them as well as the current year statement.
3. Each page of the statements should be clearly labeled as unaudited.

3. How are prospective financial statements defined?

Answer:

Prospective financial statements are defined as complete financial

statements in the same form as traditional income statements, statement of
financial positions and statements of changes in financial position.
However, an abbreviated presentation constitutes prospective financial
statements if its contains all of these items (if applicable):
1. Sale or gross revenue
2. Gross profit
3. Unusual or infrequently occurring items
4. Provision for income taxes
5. Discontinued operations or extraordinary items
6. Net income
7. Primary and fully diluted earnings per share
8. Summary of significant changes in financial position
9. Summary of significant assumptions
10.Summary of significant accounting policies
Omission of any items 1–8 makes the presentation a partial presentation.
Omission of 9 or 10 makes it a deficient presentation.

4. What are the similarities and differences between examination reports on

forecasts and audit reports on historical financial statements? Compilation
reports on forecasts? Compilation reports on historical financial
statements?

Answer:

Similarities and Differences

Audit Report
 Nonaudit Engagements: Procedures and Reports 30-3
Examination Report on on Historical
a Forecast Statements
a. Identification of a. Identification of
financial statements statements audited.
and what they
intend to represent.
b. Warning about
ultimate attainment
of prospective
results.
c. Statement about c. Statement that audit
review in was in accordance
accordance with with PSA.
ASPC standards.
d. Opinion / assurance d. Opinion about
about presentation conformity with
and reasonable PFRS.
assumptions.
e. Statement about no
responsibility to
update the report.
Compilation Report
Compilation Report on on Historical
a Forecast Statements
a. Identification of a. Identification of
financial statements statements
and what they compiled.
represent.
b. Warning about b. Statement / warning
ultimate attainment that information is
of prospective the representation
results. of management
(owners).
c. Statement about c. Same kind of
compilation in statement about
accordance with compilation and
30-4 Solutions Manual – Public Accountancy Profession
ASPC standards. ASPC standards.
d. Disclaimer of d. Disclaimer of
opinion / assurance. opinion / assurance.
e. Statement about no
responsibility to
update the report.

5 What is the difference between a review services engagement and a

compilation service engagement regarding historical financial statement?
Compare both of these to an audit engagement?

Answer:

Both review service and compilation service engagements are less than an
audit. A comparison of the three amounts to a hierarchy of assurance:
1. Audit engagement Auditor obtains sufficient
competent evidence that
serves as a basis for an
opinion on financial
statements. The auditor
obtains reasonable
assurance within the
inherent limitations of the
audit process.
2. Review Accountant obtains
engagement limited assurance through
analytical procedures that
there are no material
modifications that should
be made to financial
statements.
3. Compilation Accountant puts client
engagement information in financial
statement form without
obtaining any assurance
(because no procedures
 Nonaudit Engagements: Procedures and Reports 30-5

are performed) that

material modification
should or should not be
made to the financial
statements.

Additionally, an accountant who is not independent may report on a

compilation service (providing that lack of independence is disclosed), but
not on a review service or audit engagement.

6. What conditions determine whether a CPA is “associated” with financial

statements?

Answer:

A state of association exists whenever:

a. The CPA’s name is used in a document containing the statements; or
b. The CPA has prepared or assisted in preparing the statements.

7. Differentiate among the following:

a. Compilation
b. Review
c. Audit

Answer:

a. Compilation: In compiling financial statements for a client, the CPA

presents information that is the representation of management without
undertaking to express any assurance on the statements.
b. Review: More than a compilation, but less than an audit, a review
consists mainly of performing inquiry and analytical procedures. Such
procedures provide the CPA a basis for expressing limited assurance
concerning conformance with PFRS.
c. Audit: An audit provides reasonable assurance concerning conformance
of financial statements with PFRS. In addition to inquiry and analytical
procedures, an audit involves a study of the client’s internal controls and
30-6 Solutions Manual – Public Accountancy Profession
application of such evidence gathering procedures as confirmation,
observation, inspection, vouching, and examination.

8. What are the major procedures applied in a review? In compilation?

Answer:

The major procedures applied in a review consist of reading the financial

statements, inquiry as to accounting procedures, and analytical procedures.
A compilation, in contrast to a review, consists of obtaining an
understanding of industry accounting principles and practices and reading
the financial statements.

9. What type of accounting service may be performed by a CPA who lacks

independence?

Answer:

A CPA who lacks independence may compile financial statements; but may
not perform an audit, review, or any other form of attestation service.

10.What are the major procedures applied in compiling prospective financial

statements?

Answer:

Procedures to be applied in compiling prospective financial statements

should include the following:
a. Inquire about the accounting principles used in preparing the statements.
b. Ask how the key factors are identified and how the assumptions are
developed.
c. Obtain a list of assumptions and consider whether there are any
omissions or inconsistencies.
d. Test the mathematical accuracy of computations.
e. Read the statements for conformity with PSA presentation guidelines.
f. Obtain client representations concerning compliance with the guidelines.

Multiple Choice Questions and Answers:

 Nonaudit Engagements: Procedures and Reports 30-7
Comprehensive Cases

1. a. Liability to Delcee and other stockholders:

Delcee in its own right may bring an action, or the other stockholders
may bring a derivative action against Canada and Canada on behalf of
the corporation, for negligent performance in failing to detect the fraud
(embezzlement).

A lawsuit based on constructive fraud might be asserted against C & C,

because the conduct of the review may be characterized as gross
negligence with reckless disregard for the truth. Individual shareholders
and lending institutions will claim this is the case, and if upheld, privity of
contract will not be a valid defense.

b. Liability to financial institutions:

Third-party financial institutions have rights to sue accountants for
negligence in performing review engagements. As a general rule, third
parties, even though not direct parties to an audit contract, may
successfully assert negligence if they can show that they are members
of a class of persons intended to benefit from the services performed by
the CPA and that their use of the statements was reasonably foreseeable
by the CPA.

2.
Assumption Evidence Sources and
Procedures
a. Sale of real 1. Determine market value of
estate real estate:
* Review appraisals (if any),
inquire of real estate
broker for the selling price
of similar pieces of land.
2. Determine cost and tax basis
of land:
30-8 Solutions Manual – Public Accountancy Profession
* Examine underlying
documents (use financial
statement cost
presentations, if previously
audited) – deeds, purchase
contracts.
* Review National Internal
Revenue Code and
appropriate publications to
determine proper tax
basis, tax rates, treatment.
3. Determine after-tax profit
and proceeds:
* Based on above
information, compute profit
and proceeds. Compare
amounts to client
representations to
determine reasonableness.
4. Determine authority for use
of proceeds:
* Examine minutes of
directors’ and officers’
meetings for evidence of
authority to sell the real
estate and a formal plan
for using the proceeds to
retire bonds.
b. Retire 1. Determine probable cost of
outstanding repurchasing bonds:
debentures.
* Examine amount, terms of
bonds outstanding.
* Review current forecasted
market for bonds, in light
of terms, amount.
 Nonaudit Engagements: Procedures and Reports 30-9
* Compute estimated cost of
repurchase.
2. Determine adequacy of
funding for repurchase:
* Compare amount of
proceeds [computed in (a)]
to amount estimated for
repurchase.
3. Determine authority for
retirement:
* Examine minutes of
executives’ and officers’
meetings for evidence of
approval of retirement.
c. Labor 1. Determine probable wage
contract increase:
* Examine prior contract
settlements, including
subjective analysis of
labor-management
relations. Confer with
union officials.
* Examine documents,
memos, and minutes
regarding upcoming labor
negotiations.
* Examine management’s
proposed contract.
2. Determine effect of higher
than predicted wage
settlement:
* Recompute effect of
percent change in wage
increase to net income and
correlate to management’s
figures.
30-10 Solutions Manual – Public Accountancy Profession

d. Sales 1. Determine estimated

projections completion date of Tarlac
facility:
* Examine contract plans,
consult with contractor,
observe facility.
* Examine contracts for
machinery, installation;
consult with vendor –
dates, type of equipment,
product capacity.
* Compare auditor-estimated
completion date to
management’s for
reasonableness.
* Consider if company can
meet personnel
requirements of the new
facility.
2. Estimate financial impact of
Tarlac production:
* Compare productive
capacity to forecasted
sales figure (presumed
determined reasonable by
the auditor).
* Recompute probable effect
of delay in Tarlac’s
completion date and
compare to management’s
figures.

3. Nicky has no accounting staff and has little expertise in preparing financial
statements himself. However, he needs them occasionally, apparently for
credit purposes.
 Nonaudit Engagements: Procedures and Reports 30-11
Three kinds of compiled financial statements are available:
1. Compilation Without Independence. Brother Kian can prepare the
compiled financial statements (with or without all disclosures), but he
will need to disclose in this report his lack of independence.
2. Compilation With Full Disclosure . CPA Bryan can compile the statements
and present them in the complete form used for audited financial
statements.
3. Compilation That Omits Substantially All Disclosures . CPA Bryan can
compile statements without footnote disclosures, but his report will
indicate the lack of disclosure and will warn users.

4. a. Yes, this is a negative assurance.

b. Negative assurance is generally prohibited in audit reports because the

profession wishes such reports to contain positive assertions based on
evidence instead of negative statements based on “what did not come to
my attention.”

c. A review service is less than an audit, hence the report can be less than
positive assurance. Clients get what they paid (less) for.

5.
To the Board of Directors of Francisco Company

I have reviewed the accompanying statement of financial position of

Francisco Company as of December 31, 2014, and the related statements of
income, retained earnings, and changes in financial position for the year
then ended, in accordance with standards established by the Auditing
Standards and Practices Council. All information included in these financial
statements is the representation of the management of Francisco Company.

A review consists principally of inquiries of company personnel and

analytical procedures applied to financial data. It is substantially less in
scope than an examination in accordance with auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, I do not express such an
opinion.
30-12 Solutions Manual – Public Accountancy Profession
Based on my review, I am not aware of any material modifications that
should be made to the 2014 financial statements in order for them to be in
conformity with financial reporting standards.

The accompanying 2013 financial statements of Francisco Company were

compiled by other accountants whose report dated January 11, 2014,
stated that they did not express any opinion or any other form of assurance
of those statements.

Jo Cee, CPA
January 15, 2015

Note:This report presumes:

1. Jo Cee is independent.
2. Francisco and Associates, CPAs made no modifications in their
2003 compilation report.
3. Francisco and Associates, CPAs was independent.
4. The 2003 statements contained all necessary disclosures.

6.
Service Report Procedures
a. Compilation Compilation Read and inquire
b. Agreed upon Review As agreed and
procedures applied to
specified
elements
c. Review Review Read, inquire, and
apply analytical
procedures
d. Examination Opinion Evaluate
preparation
(attestation) Examine and
evaluate
underlying
assumptions
Determine
whether
presentation is
 Nonaudit Engagements: Procedures and Reports 30-13
in conformity
with PSA
guidelines.

7. a.
Nature of Type of Principal
Engagement Report Procedures
a. Audit Opinion; Study and
positive evaluate
internal
control;
observe,
examine,
confirm,
reconcile,
calculate, and
vouch.
b. Opinion; Same as (a)
positive
Comprehensi
ve basis
other than
PFRS
c. Review; Review; Inquiry;
nonpublic limited analytical
entity procedures
d. Compilation; Compilation; Understand
nonpublic none industry
entity accounting
practices;
read the
financial
statements
e. Agreed-upon Review; As specified
procedures limited by
30-14 Solutions Manual – Public Accountancy Profession

engagement
letter
f. Letter for Review; Inquiry-as
underwriter limited specified by
agreement;
read the
financial
statements

g. Examination Opinion; Examine

of positive evidence
prospective supporting
financial assumptions;
statements- determine
projection whether
assumptions
provide a
reasonable
basis for the
projection;
evaluate
preparation
and
presentation
of projected
financial
statements.
h. Review of Review; Inquiry;
interim limited analytical
financial procedures
information
 Nonaudit Engagements: Procedures and Reports 30-15
b.
a. General.
b. Restricted to management, the board of directors, and the regulatory
commission.
c. General.
d. General (but a fourth paragraph must be added which states that the
CPA is not independent.)
e. Restricted to the parties named in the agreement.
f. Restricted to the underwriters, Candy and Lolli.
g. Restricted to management, the board of directors, and the prospective
lender.
h. General.