CHAPTER 7

Chapter 20Attest and Assurance Services and Related Reports

Learning Check

20-1. a.Four levels of assurance that can be rendered by CPAs in a variety of engagements are (1) audit or examination level assurance, (2) review level assurance, (3) agreed-upon procedures level of assurance, and (4) no assurance.

b.The following table summarizes the 3 groups of professional standards that are issued by the Auditing Standards Board with examples of engagements that may be provided under each group of professional standards.

Group of Professional StandardsExample Engagements

Statements on Auditing StandardsSpecial reports include reports on:

Financial statement that are prepared in conformity with a comprehensive basis of accounting other than GAAP (OCBOA).

Specified elements, accounts or items of a financial statement.

Compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements.

Financial information presented in prescribed forms or schedules that require a prescribed form of auditors report.

Statements on Standards for Attestation EngagementsAttest engagements include engagements such as:

SSAE 101 engagements

Agreed-upon procedures engagements

Reporting on Prospective Financial Information

Reporting on Compliance Attestations

Reporting on Pro Forma Information

Reporting on Internal Control

Reporting on Managements Discussion and Analysis

Statements and Standards for Accounting and Review ServicesSSARS engagements include issuing the following levels of assurance on the financial statements of private companies:

Review level assurance

Compilation level assurance

20-2 a.The term special reports applies to auditors' reports issued in connection with

Financial statements that are prepared in conformity with a comprehensive basis of accounting other than generally accepted accounting principles.

Specified elements, accounts, or items of a financial statement.

Compliance with aspects of contractual agreements or regulatory requirements related to audited financial statements.

Financial presentations to comply with contractual agreements or regulatory provisions.

Financial information presented in prescribed forms or schedules that required a prescribed form of auditor's report.

b.A common characteristic of the types of data covered by special reports is that they are all historical financial data other than financial statements prepared in conformity with GAAP.

20-3. a.A basis of accounting is considered to be an "other comprehensive basis of accounting" (OCBOA) when it is

A basis used to comply with the requirements or financial reporting provisions of a governmental regulatory agency.

A basis used to file an income tax return.

The cash receipts and disbursements basis of accounting and modifications of the cash basis having substantial support.

A basis that uses a definite set of criteria that has substantial support such as theprice-level basis of accounting.

b.The reporting requirements for financial statements prepared on an OCBOA are:

A title that includes the word independent.

An introductory paragraph that is the same as in the auditor's standard report except that more distinctive titles should be used for the financial statements, such as statement of assets and liabilities arising from cash transactions.

A scope paragraph that is the same as in the auditor's standard report.

A paragraph that states (1) the basis of presentation and refers to the note to thefinancial statements that describes the basis and (2) the financial statements are not intended to be a presentation in conformity with GAAP. If the first category of OCBOA is involved, this paragraph should also indicate that the distribution of the report is restricted to those within the entity and the regulatory agency.

An opinion paragraph that expresses the auditor's opinion (or disclaims an opinion) on whether the financial statements are presented fairly, in all material respects, in conformity with the basis of accounting described.

20-4. a.An auditor would normally report on a specified element, account, or item in the financial statements when a contractual arrangement calls for an audit of an element such as royalties expense and royalties payable for when rentals are based on and audited sales amount. Perhaps the audit of profits calculated for profit participation plans purposes is the underlying reason for the audit.

b.The auditor report on a specified element, account or item of a financial statements would include the following:

A title that includes the word independent.

An introductory paragraph that is the same as in the auditor's standard report except that more distinctive titles should be used for the specified element, such as a schedule of royalties applicable to an agreement, including the date of the specific agreement.

A scope paragraph that is the same as in the auditor's standard report.

The auditor may include a middle paragraph that include significant interpretations of key contracts made by the companys management in prepared the schedule or information subject to audit.

An opinion paragraph that expresses the auditor's opinion (or disclaims an opinion) on whether the specified elements or accounts are presented fairly, in all material respects, the contractual agreement.

A paragraph limiting the distribution to parties to the contract.

20-5. a.An auditor may issue a negative assurance in a compliance report related to audited financial statements when

The auditor has audited the financial statements to which the agreements or regulatory requirements relate.

The assurance does not extend to covenants that relate to matters that have not been subjected to the audit procedures performed in the financial statement audit.

The audit did not result in an adverse opinion or a disclaimer of opinion.

b.The auditor's assurance on compliance may be given in a separate report or in one or more explanatory paragraphs following the opinion paragraph of the report on the audited financial statements.

20-6. a.An attest engagement is one in which a practitioner (CPA) is engaged to issue or does issue a written communication that expresses a conclusion about the reliability of a written assertion that is the responsibility of another party.

b.The three major activities involved in performing an attest engagement are:

Gathering evidence to support the assertion.

Objectively assessing the measurements and communications of the individual making the assertion.

Reporting the findings.

20-7. a.The attestation standards are classified into three groups-- general, field work, and reporting. The classifications, therefore, are the same as for generally accepted auditing standards.

b.There are three significant conceptual differences between the attestation standards and GAAS. The attestation standards:

Extend the attest function beyond historical financial statements. Thus, the standards omit references to financial statements and to GAAP.

Allow the CPA to give assurances on the assertions below the level expressed in the traditional financial statement audit ("positive opinion").

Provide for attest services tailored to the needs of specific users for agreed-upon procedures reports and for limited-use reports.

20-8.The following table identifies six types of attest engagement that have been recognized under attestation standards and the levels of assurance associated with each type of attest engagement.

a. Type of Attest Engagementb. Level of Assurance

Reporting on Agreed-upon Procedures EngagementsAgreed-Upon Procedures

Reporting on Forecasts and ProjectionsExamination

Agreed-Upon Procedures

Compilation (no assurance)

Reporting on Pro Forma InformationExamination

Review

Reporting on Internal ControlsExamination

Agreed-Upon Procedures

Reporting on Compliance AttestationsExamination

Agreed-Upon Procedures

Reporting on Managements Discussion and AnalysisExamination

Review

20-9. a.In the United States a WebTrust engagement is performed as an attest engagement under the AICPAs Statement on Standards for Attestation Engagements (SSAE) No. 101. The WebTrust client makes an assertion about whether they met the WebTrust principles and criteria, about its business practices, its internal controls related to executing the transaction as agreed with a customer using e-commerce, and its internal controls related to the privacy of customer information. The CPA then attests to managements assertions regarding these matters.

b.WebTrust engagements address the following three risks associated with electronic commerce.

1. An entitys business and information privacy practices; that is the entity discloses its business and information privacy practices for e-commerce transactions and executes transactions in accordance with its disclosed practices.

2. Transaction integrity; that is whether the entity maintains effective controls to provide reasonable assurance that customers transactions using e-commerce are completed and billed as agreed.

3. Information protection; that is whether the entity maintains effective controls to provide reasonable assurance that private customer information obtained as a result of e-commerce is protected from uses not related to the entitys business.

The WebTrust principles were designed to address these three specific risks.

c.The primary professional standards that apply to a WebTrust engagement in the United States are the Attestation Standards. Additional standards that apply are the WebTrust criteria the have been jointly developed by the AICPA and the CICA.

d.The key components of a WebTrust report include:

An introductory paragraph that identifies managements assertions regarding the WebTrust principles and criteria and is clear that the reports applies to a specific time period.

A paragraph describing managements responsibility.

A scope paragraph that describes the scope of the engagement and professional standards that were followed.

A paragraph on inherent limitations that discusses the risk that error or fraud might occur and not be detected and the risk that past findings may not apply to future periods due to the risk of possible changes in (1) the system or controls, (2) processing requirements, or (3) other changes required by the passage of time.

An opinion on managements assertion regarding the WebTrust principles and criteria.

A paragraph that makes the scope of the opinion clear in that it does not related to the quality of the clients good or service.

20-10. a.In a SysTrust engagement a CPA provides assurance about the reliability of an information system rather than reliability about the information itself. In an era of joint ventures and strategic alliances, many partners make decisions based on information that is not under their control. SysTrust engagements are designed to provide assurance about the reliability of the underlying system.

b.The four broad principles involved in a SysTrust engagement are:

System availability: Whether the system is available for operation and use at times set forth in the service level statements or agreements. System security: Whether the system is protected against unauthorized physical and logical access. System integrity: Whether the system processing is complete, accurate, timely and authorized. System maintainability: Whether the system can be updated when required in a manner that continues to provide for system availability, security, and integrity.

c.The three categories of criteria associated with each of the four broad principles are as follows:

1. The entity has defined and communicated performance objectives, policies, and standards for system availability (or security, integrity and maintainability).

2. The entity utilizes procedures, people software, data, and infrastructure to achieve system availability (or security, integrity and maintainability) objectives in accordance with established policies and standards.

3. The entity monitors the system and takes action to achieve compliance with system availability (or security, integrity and maintainability) objectives, policies and standards.

d.The primary professional standards that apply to a SysTrust engagement in the United States are the Attestation Standards. Additional standards that apply are the SysTrust criteria the have been jointly developed by the AICPA and the CICA.

e.A report on a SysTrust engagement should include the following. An introductory paragraph that identifies managements assertions regarding the SysTrust principles and criteria and is clear that the reports applies to a specific time period. The paragraph also describes managements responsibility and the auditors responsibility to express and opinion on the assertion.

A scope paragraph that describes the scope of the engagement and professional standards that were followed.

A paragraph on inherent limitations of the engagement and the risk that past findings may not apply to future periods due to the risk of possible changes in (1) the system or controls, (2) processing requirements, or (3) other changes required by the passage of time.

An opinion on managements assertion regarding the SysTrust principles and criteria.

20-11. a.The following conditions should be met in order to accept an agree-upon procedures engagement.

a. The practitioner is independent.

b.One of the following conditions is met.

(1)The party wishing to engage the practitioner is responsible for the subject matter, or has a reasonable basis for providing a written assertion about the subject matter when the nature of the subject matter is such that a responsible party does not otherwise exist.

(2)The party wishing to engage the practitioner is not responsible for the subject matter but is able to provide the practitioner, or have a third party who is responsible for the subject matter provide the practitioner with evidence of the third party's responsibility for the subject matter.

c.The practitioner and the specified parties agree upon the procedures performed or to be performed by the practitioner.

d.The specified parties take responsibility for the sufficiency of the agreed-upon procedures for their purposes.

e.The specific subject matter to which the procedures are to be applied is subject to reasonably consistent measurement.

f.Criteria to be used in the determination of findings are agreed upon between the practitioner and the specified parties.

g.The procedures to be applied to the specific subject matter are expected to result in reasonably consistent findings using the criteria.

h.Evidential matter related to the specific subject matter to which the procedures are applied is expected to exist to provide a reasonable basis for expressing the findings in the practitioner's report.

i.Where applicable, the practitioner and the specified parties agree on any materiality limits for reporting purposes.

j.Use of the report is restricted to the specified parties.

k.For agreed-upon procedures engagements on prospective financial information, the prospective financial statements include a summary of significant assumptions.b.The practitioners report on agreed-upon procedures should include the following elements: A title that includes the word independent

Identification of the specified parties.

Identification of the subject matter (or the 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 responsibility for the sufficiency of those procedures

A list of the procedures performed (or reference thereto) and related findings.

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 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.

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 report20-12.a.The two types of prospective financial information are

Financial forecast. Prospective financial statements that present, to the best of the responsible party's knowledge and belief, an entity's expected financial position, results of operations, and cash flows.

Financial projection. Prospective financial statements that present to the best of the responsible party's knowledge and belief, given one or more hypothetical assumptions, an entity's expected financial position, results of operations, and cash flows.

b.The CPA's standard report on an examination of prospective financial statements should include

A title indicating that the accountant is independent.

An identification of the prospective financial statements presented.

A statement that the examination of the prospective financial statements was made in accordance with AICPA standards and a brief description of the nature of such an examination.

The accountant's opinion that the prospective financial statements are presented in conformity with AICPA presentation guidelines and that the underlying assumptions provide a reasonable basis for the forecast or a reasonable basis for the projection given the hypothetical assumptions.

A caveat that the prospective results may not be achieved.

A statement that the accountant assumes no responsibility to update the report for events and circumstances occurring after the date of the report.

c.As in the case of reports on historical financial statements, other types of opinions may be expressed on prospective financial statements. The following table explains when the auditor might use various opinions. In each case, the report should contain an explanatory paragraph that describes the circumstances.

CircumstancesOpinion

The prospective financial statements depart from AICPA presentation guidelinesqualified opinion or an adverse opinion

If the presentation departs from the presentation guidelines because it fails to disclose assumptions that appear to be significantadverse opinion

One or more significant assumptions do not provide a reasonable basis for the forecast, or a reasonable basis for the projection given the hypothetical assumptionsadverse opinion

The practitioners examination is affected by conditions that preclude application of one or more procedures he or she considers necessary in the circumstancesdisclaim an opinion and describe the scope limitation in his or her report.

20-13. a.To reduce the risk of misunderstandings between users and independent accountants, agree-upon procedures engagements should only be performed when the following conditions are met: (1) management accepts responsibility for the entity's compliance with specified requirements and the effectiveness of the entity's internal control over compliance, (2) management evaluates the entity's compliance with specified requirements or the effectiveness of the entity's internal control over compliance and (3) management provides to the practitioner its written assertion about the entitys compliance with specified requirements or about the effectiveness of the entitys internal control over compliance.

b.In an agreed-upon procedures engagement, management, users of the accountants report, and the accountant must all agree upon the nature of the agree-upon procedures.

c.In an examination of a compliance attestation the CPA should consider attestation risk the same way he or she would consider audit risk in a financial statement audit. The attestation standards provide guidance an assessing inherent risk (including the risk of fraud), control risk, and detection risk. Furthermore, in an examination of entitys compliance with specified requirements, the practitioners consideration of materiality is affected by a) the nature of the compliance requirements, which may or may not be quantifiable in monetary terms, b) the nature and frequency of noncompliance identified with appropriate consideration of sampling risk, and c) qualitative considerations, including needs and expectations of the reports users. Most of the same logic that is used in an audit, including the consideration of subsequent events, applies to an examination of compliance with specified requirements.20-14. a.The objective review of the financial statements of a nonpublic entity is to perform inquiry and analytical procedures that provide the accountant with a reasonable basis for expressing limited assurance that there are no material modifications that should be made to the financial statements in order for them to be in conformity with GAAP or an other comprehensive basis of accounting.

b.A review of the financial statements of a nonpublic entity normally includes:

Making certain prescribed inquiries of management and others with financial and accounting responsibilities concerning the entity's accounting principles and practices and any changes therein.

Performing analytical procedures designed to identify relationships and individual items in the financial information that appear to be unusual.

Obtaining information about actions taken at meetings of stockholders and the board of directors and its committees that may affect the financial information.

Reading the financial information to consider whether on the basis of information coming to the accountant's attention, the information appears to conform with GAAP.

Obtaining written representations from management concerning the reviewed financial information and management's responsibility for it.

c.The accountants reports associated with a review of the financial statements of a nonpublic entity would include:

A title that includes the word independent.

An introductory paragraph that describes financial statements that have been subjected to review procedures and indicates managements responsibility for the information. The introductory paragraph also refers to fact that a review was performed in accordance with Statements and Standards for Accounting and Review Services issued by the ACIPA.

A scope paragraph that describes the scope of the accountants review procedures.

A paragraph that expresses negative assurance on the financial statements.

20-15. a.The objective of a compilation service is to present, in the form of financial statements, information supplied by an entity without giving any assurance about the conformity of the statements with either GAAP or an OCBOA. The nature of the service is to prepare or assist in preparing the financial statements. A CPA is not required to verify the information furnished by the client. However, he or she may deem it necessary to perform other accounting services during the engagement.

b.The accountant should perform the following procedures when performing a compilation of financial statements for a nonpublic entity.

The accountant should possess a level of knowledge of the accounting principles and practices of the industry in which the entity operates that will enable him to compile financial statements that are appropriate in form for an entity operating in that industry.

The accountant should possess a general understanding of the nature of the entity's business transactions, the form of its accounting records, the stated qualifications of its accounting personnel, the accounting basis on which the financial statements are to be presented, and the form and content of the financial statements.

The accountant should read the compiled financial statements and consider whether such financial statements appear to be appropriate in form and free from obvious material errors.

c.The accountant's report on the compilation of historical financial statements should state that

A compilation has been performed in accordance with standards established by the AICPA.

A compilation is limited to presenting in the form of financial statements information that is the representation of management (owners).

The statements have not been audited or reviewed and, accordingly, the accountant does not express an opinion or any other form of assurance on them.

20-16. a.The purpose of a risk assessment engagement focuses on the identification of business risks and steps that management might take to limit business risks. The most likely customers of a risk assessment engagement are management and the board of directors who need to control and respond to business risks on a regular basis.

b.Three major types of services associated with a risk assessment engagement are:

Identification and assessment of primary potential risks faced by a business or entity

Independent assessment of risks identified by an entity

Evaluation of an entity's systems for identifying and limiting risks

c.A useful way to classify an entitys business risks is as follows.

Strategic environment risks - threats from broad factors external to the business including changes in customers' tastes and preferences, creation of substitute products, or changes in the competitive environment, political arena, legal/regulatory rules, and capital availability.

Operating environment risks - threats from ineffective or inefficient business processes for acquiring, transforming, and marketing goods and services, as well as loss of physical, financial, information, intellectual, or market-based (such as a customer base) assets, loss of markets or market opportunities, and loss of reputation.

Information risks - threats from the use of poor quality information for operational, financial, or strategic decision making within the business and providing misleading information provided to outsiders.

d.The auditor likely obtains knowledge of each of these risks while performing the financial statement audit. For example:

The auditor might obtain knowledge about strategic environment risks associated with changes in customers tastes and preferences or changes in the competitive environment when auditing the revenue and production cycles.

The auditor often obtains knowledge of the risk of adverse changes in the market for the clients products in order to evaluate the net realizable value of the clients inventory.

The auditor might obtain knowledge about operating environment risks related to inefficient business practices when auditing the production cycle.

The auditor might obtain knowledge about information risks associated with poor-quality financial information when obtaining an understanding of the entitys system of internal control.

Auditors also consider these types of risks when evaluating whether an entity is likely to continue as a going concern. Understanding the clients business risks is important to making audit judgments regarding accounting estimates and evaluating the reasonableness of the entitys profitability.20-17. a.The purpose of an assurance engagement on business performance measurement is to provide assurance regarding an organization's use of both financial and non-financial measures to evaluate the effectiveness and efficiency of its activities. The most likely customers of a performance measurement engagement are the board of directors, as well as management at virtually any level within the entity.

b.The potential performance measurement services that might be offered by a CPA are as follows:

Organizations that have performance measurement systems -

Assessing the reliability of information being reported from the organization's performance measurement system.

Assessing the relevance of the performance measures (that is, how well they inform management about achievement of the performance objectives they have set).

Organizations that do not have performance measurement systems -

Identifying relevant performance measures.

Helping design and implement a performance measurement system.

All organizations -

Providing advice on how the organization can improve their performance measurement system and their actual results.

c.The following table identifies the four elements of the balanced scorecard, along with examples goals and related measures.

Element of the

Balanced ScorecardExample GoalsExample Measures

Customer PerspectiveNew customer acquisitionReport of new customers ranked by volume of activity or gross profit margins

Internal PerspectiveManufacturing efficiencyProduct cycle time

Innovation PerspectiveProduct InnovationPercent of revenues from new products

Number of suggestions made and implemented

Financial PerspectiveOverall financial goalsReturn on investment

Overall cash flow generation

d.The auditor may learn about each of these perspectives when obtaining an understanding of the business and industry and using this information to develop expectations of the financial statements. The auditor might plan to use particular information to support analytical procedures and may become aware of the absence of such information in the process.

20-18. a.The purpose of a CPA ElderCare engagement is assure family members that elderly relatives no longer able to be totally independent are receiving the type and kind of care they need. The likely client for this service would possibly be the children of elderly tax clients who are unable to personally determine the quality of care received by their parents who live in a different part of the country.

b.The following table describes three type of services that might be offered by CPAs and provides examples of each.

Type of ElderCare ServiceExample

Attestation engagements such as a compliance attestation where the CPA performs tests of a health care facilities assertion that it complied with stated regulations or policies in accordance with AT 500 on Compliance Attestations. Alternatively the CPA might perform and an agreed-upon procedure attestation where the CPA issues a report of procedures and findings associated with the measurable care-giving performance (AT 600 on Agreed-Upon Procedure Engagements). An attest service might also include a review of the financial performance of a trust in accordance with AR 100, Compilation and Review of Financial Statements. Financial

Review and report on financial transactions

Test for asserters adherence to established criteria

Review investments and trust activity

Audit third-party calculations, such as pension, insurance and annuity payouts

Review reports from fiduciaries

Nonfinancial

Measure and report on care provider performance against established goals

Evaluate and report on the performance of other outside parties, such as contractors

Direct services such as paying bills for elderly individuals or ensuring that expected revenues are received in the process of managing an elderly individuals checking account. Performing direct services for an elderly client may impair independence associated with other services for that client.Financial

Receive, deposit and account for client receipts

Ensure expected revenues are received

Make appropriate disbursements

Submit claims to insurance companies

Nonfinancial

Arrange for transportation, housekeeping and other services

Manage real estate and other property

Visit and report on elderly on behalf of children in distant locations

Consulting services such as assisting the elderly or their families in determining the range of housing and care alternatives. Consulting services might also include performing such services as helping a family member monitor care or financial services such as estate planning or establishing a trusteeship.

Financial

ElderCare Planning for

Housing and support service needs

Death or disability of one or both spouses

Alternative costs of retirement communities and other housing

Nonfinancial Consulting Services

Help family monitor care

Establish standards of care expected

Communicate expectations to care providers

Establish performance measurement systems

c.An important trend that motivates the need for CPA ElderCare engagements is the overall aging of the US population. The proportion over age 65 is increasing, it has a greater degree of wealth and disposable income available to it, and as the US population has become more mobile parents may live significant distances from their children. The combination of these trends leads to an increased need for CPA ElderCare services.

Comprehensive Questions

20-19.(Estimated time - 25 minutes)

a.

Independent Auditor's Report

We have audited the accompanying statement of assets and liabilities arising from cash transactions of Jiffy Clerical Services as of December 31, 20XO, and the related statement of revenue collected and expenses paid for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards. 'nose 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.

As described in Note X, these financial statements were prepared on the basis of cash receipts and disbursements, which is a comprehensive basis of accounting other than generally accepted accounting principles.

In our opinion, the financial statements referred to above present fairly, in all material respects, the assets and liabilities arising from cash transactions of Jiffy Clerical Services as of December 31, 20XO, and its revenue collected and expenses paid during the year then ended, on the basis of accounting described in Note X.

Signature

Date

b.Modifications of standard report:

The introductory paragraph has more distinctive titles for the financial statements--e.g., statement of assets and liabilities arising from cash transactions.

An explanatory paragraph follows the scope paragraph and states the basis of presentation and refers to the note to the financial statements that describes the comprehensive basis of accounting other than GAAP.

An opinion paragraph that expresses an opinion (or disclaims an opinion) on whether the financial statements are presented fairly, in all material respects, in conformity with the basis of accounting described.

20-20.(Estimated time - 20 minutes)

Independent Auditor's Report

Board of Directors

XYZ Company, Inc.

We have audited, in accordance with generally accepted auditing standards, the financial statements of XYZ Company, Inc. for the year ended June 30, 20X3, and have issued our report thereon dated August 15, 20X3. We have also audited the current and deferred provision for the Company's federal and state income taxes for the year ended June 30, 20X3, included in those financial statements, and the related asset and liability tax accounts as of June 30, 20X3. This information is the responsibility of the Company's management. Our responsibility is to express an opinion on it based on our audit.

We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the provision (and related accounts) is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures related to the provision (and related accounts). An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the provision (and related accounts). We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the XYZ Company, Inc. has paid or, in all material respects, made adequate provision in the financial statements referred to above for the payment of all federal and state income taxes and for related deferred income taxes that could be reasonably estimated at the time of our audit of the financial statements of XYZ Company, Inc., for the year ended June 30, 20X3.

Young & Young, CPAs

August 22, 20X3

20-21.(Estimated time - 20 minutes)

a.

Independent Auditor's Report

Board of Directors

ABC Company

We have audited, in accordance with generally accepted auditing standards, the balance sheet of ABC Company at December 31, 20XO, and the related statements of income, retained earnings, and cash flows for the year then ended, and have issued our report thereon dated February 16, 20X1.

In conducting our audit, nothing came to our attention that caused us to believe that the Company was not in compliance with any of the terms, covenants, provisions, or conditions of sections 14 to 30, inclusive, of the loan agreement dated July 1, 20XO, with the Main Street Bank insofar as they related to accounting or auditing matters. It should be noted, however, that our audit was not directed primarily toward obtaining knowledge of such noncompliance.

This report is intended solely for the information and use of the board of directors and management of ABC Company and the Main Street Bank.

(Signature)

(Date)

b.The second and third paragraphs above would be added following the opinion paragraph of the auditor's report on the financial statements.

20-22.(Estimated Time: 30 minutes)

a.The purpose of a WebTrust engagement is to provide customers assurance about three aspects of electronic commerce. WebTrust addresses an entitys business and information privacy practices; issues of transaction integrity; and issues of information protection. If a customer is satisfied that you have significant assurances in place to protect and maintain privacy regarding information disclosed in a transaction, it is likely that a consumer will transact business through that website. This is one way of ensuring that concerns over information integrity do not discourage customers from purchasing golf equipment through your website. Assurance about business practices through a WebTrust engagement might allow you to extend the size and scope of your marketplace through your internet presence and focus on the other factors that have make your business a competitive force in the marketplace.b.The client makes three major assertions in a WebTrust engagement about its electronic commerce practices. The principles involved in a WebTrust engagement address the following:

An entitys business and information privacy practices; that is the entity discloses its business and information privacy practices for e-commerce transactions and executes transactions in accordance with its disclosed practices.

Transaction integrity; that is whether the entity maintains effective controls to provide reasonable assurance that customers transactions using e-commerce are completed and billed as agreed.

Information protection; that is whether the entity maintains effective controls to provide reasonable assurance that private customer information obtained as a result of e-commerce is protected from uses not related to the entitys business.

The client needs to represent that it has met the specific criteria related to these assertions and the CPA will attest to that assertion.

c.A business may make representations about these three criteria without asking for an assurance report from a CPA. However, the public may not attach the same degree of credibility as they would if the assertion was the subject of an attest engagement. The business needs to make a judgment about the importance of having the assertion attested to by a CPA.

d.The inherent limitations involved in a WebTrust engagement include:

Because of inherent limitations of controls, errors or fraud may occur and not be detected. Even a strong system of internal control might not find every fraud, particularly fraud that involves collusion.

Users should not project any conclusions, based on our findings, to future periods. There is a risk that changes made to the system or controls, changes in processing requirements, or failure to make changes required because of the passage of time, may alter the validity of conclusions on past performance.

20-23.(Estimated Time: 20 Minutes)

a.The primary clients that would be interested in a SysTrust engagement are entities that prepare, process, or maintain information that is used by others for decision-making. For example, a supplier in a strategic alliance may make production decisions based on information obtained from customer about its sales and inventory levels. The supplier may want assurance about the reliability of information obtained from the customer because of its strategic importance to decisions made by the supplier. Hence, the customer might engage the CPA to attest to the reliability of the system. If the end customer must coordinate product obtained from several suppliers, the need for SysTrust engagement may increase to ensure coordination of strategic decisions by all parties.

b.The SysTrust principles and criteria address four major concerns about system reliability: (1) System availability, (2) system security, (3) system integrity, and (4) system maintainability. A SysTrust engagement provides reasonable assurance that these four principles and related criteria were achieved during a specific time period. Users should understand the inherent limitations associated with the fact that:

Because of inherent limitations of controls, errors or fraud may occur and not be detected. Even a strong system of internal control might not find every fraud, particularly fraud that involves collusion.

Users should not project any conclusions, based on our findings, to future periods. There is a risk that changes made to the system or controls, changes in processing requirements, or failure to make changes required because of the passage of time, may alter the validity of conclusions on past performance.

c.A CPA that sells time on its accounting system to small business clients where they can log onto the system and maintain their own general ledger, could engage another independent CPA to issues a SysTrust report on the accounting system associated with the systems availability, security, integrity and maintainability. The CPA could not issue an attestation report on its own system as it would not be independent. Further, there may be a risk that users may misunderstand the SysTrust report and expect that the CPAs system will ensure that financial statements that result from the system are prepared in accordance with GAAP. No such assurance could be provided as the CPA would not know the basis transactions recorded using the system. 20-24.(Estimated Time - 25 minutes)

Inappropriate ActionWhat Fred should have done to avoid the Inappropriate Action

Only HDI signed the engagement letterFred should have had both HDI and HEC sign the engagement letter and agree to the procedures set forth in the engagement letter.

Only HDI agreed to the procedures to be performed.Fred should have had both HDI and HEC sign the engagement letter and agree to the procedures set forth in the engagement letter.

Fred demanded information from HEC and threatened litigationFred should not have threatened litigation as this violates independence standards.

Fred advocated HDIs positionFred should not have advocated HDIs position. As a client advocate he was no longer independent.

Fred turned information received from HEC over to HDIThe work product of an agreedupon procedures engagement is an audit report. The information that would have supported the report was confidential client information and could not be shared with HDI without HEC express permission.

20-25. (Estimated time - 20 minutes)

a. 1.An accountant who reports on or assembles prospective financial statements for use by third parties should perform any one of three engagements. The accountant may compile, examine, or apply agreed-upon procedures to the prospective financial statements.

2."General use" of prospective financial statements refers to use of the statements by persons (creditors, stockholders, etc.) with whom the responsible party (management) is not negotiating directly. 'Limited use" of prospective financial statements refers to the use of prospective financial statements by the responsible party alone or by the responsible party and third parties with whom the responsible party is negotiating directly.

3.Only a financial forecast is appropriate for general use, but any type of prospective financial statements (either a financial forecast or a financial projection) would normally be appropriate for limited use.

b.The accountant's standard report on a compilation of a financial projection should include

An identification of the projection presented by the responsible party.

A statement that the accountant has compiled the projection in accordance with standards established by the AICPA.

A separate paragraph that describes the limitations on the use of the presentation.

A statement that a compilation is limited in scope and does not enable the accountant to express an opinion or any other form of assurance on the projection or the assumptions.

A caveat that the prospective results may not be achieved.

A statement that the accountant assumes no responsibility to update the report for events and circumstances occurring after the date of the report.

20-26.(Estimated time - 35 minutes)

1.Write-up work and preparation of financial statements are normally an engagement for an accounting service and not an audit of the financial statements. It is important that the client understand this distinction, and, more important, that there be a clear understanding between the client and the CPA of the nature of each engagement.

Verbal commitments, such as a telephone conversation, can often be misunderstood and therefore should be followed up with an engagement letter which spells out the terms, nature, and limitations of the services to be performed. A copy of this letter should be signed by the client to acknowledge the client's agreement, understanding, and approval of the scope of the engagement and returned to the CPA.

2.Even a regular audit engagement cannot be relied upon to disclose defalcations, and in an engagement for unaudited financial statements the CPA has no responsibility to apply any auditing procedures. However, as a professional, the CPA does have a responsibility to exercise due care in carrying out engagements, to apply professional judgment in the preparation of financial statements, and to bring to the client's attention any unusual or suspicious matters noted during the engagement.

In a typical situation of principal and agent, a third party may rely on an agent's representations. To avoid misunderstanding in this situation, the CPA should have a clear understanding and written statement from the client (the businessman) that the CPA may rely on information and representations from the independent agent.

3.The word "audit" should be avoided in nonaudit engagements. The CPA should persuade the client to change the account title to 'accounting services," and should be certain the client understands the difference between an accounting service and an engagement to examine the financial statements in accordance with generally accepted auditing standards.

4.Using language in a covering letter such as "which we have reviewed" can imply that an examination of some type was made and the CPA may find that he or she has assumed more responsibility than intended. A short, concise disclaimer of opinion should always accompany unaudited financial statements with which the CPA is associated and each page should be clearly and conspicuously marked as unaudited. If a separate covering letter is used, it should contain no language that would expand upon the simple disclaimer of opinion. 'The recommended disclaimer is as follows:

"The accompanying balance sheet of X Company as of December 31, 19XX, and the related statements of income and retained earnings, and cash flows for the year then ended were not audited by us and accordingly we do not express an opinion on them."

5.While the CPA does not have a responsibility to perform any auditing procedures in an unaudited engagement, he or she does have a responsibility to perform all services undertaken in a professional capacity with reasonable skill and care.

The fact that the CPA was reviewing invoices only to determine account classification and the missing invoices did not affect the total financial statements does not eliminate his or her responsibility to bring to the client's attention any potential problem areas. The CPA should have advised the client of the missing invoices and suggested that the client follow up on this matter or, if the client so desired, the CPA could pursue it further as an additional accounting service.

6.By definition, unaudited financial statements have not been audited by the CPA and he or she cannot be expected to have an opinion as to whether they are prepared in conformity with generally accepted accounting principles. However, the CPA does have a responsibility to complete the unaudited engagement in a professional manner, and if he or she concludes on the basis of facts known to him or her that the unaudited financial statements are not in conformity with generally accepted accounting principles, the CPA should insist upon appropriate revisions.

In this situation the land and building should be adjusted to historical cost less depreciation. If the CPA cannot persuade the client to adjust the land and building, he or she should set forth clearly in the disclaimer of opinion the departure from generally accepted accounting principles and the effect, if known, on the financial statements. Further, if the client refuses to accept the CPA's disclaimer of opinion with the reservations clearly set forth, the CPA should refuse to be associated with the financial statements and formally withdraw from the engagement.

7.The CPA must issue a disclaimer of opinion on the client's unaudited financial statements since, by assisting in their preparation, he or she has become associated with them. Additionally, if the client cannot be persuaded to add the footnote disclosures recommended by the CPA, the disclaimer of opinion should set forth clearly this departure from generally accepted accounting principles.

If the statements are only for internal use by the client's the footnote disclosures may not be necessary, but then the CPA must add to the disclaimer a sentence that the financial statements are restricted to internal use by the client and therefore do not necessarily include all disclosures that might be required for a fair presentation in conformity with GAAP.

If the client refuses to accept the CPA's disclaimer of opinion with the reservations clearly set forth, the CPA should refuse to be associated with the financial statements and formally withdraw from the engagement.

20-27.(Estimated time - 20 minutes)

a.In a compilation engagement, the accountant prepares the financial statements from information provided by the client. The CPA is not required to verify the information that is furnished. However, he or she may deem it necessary to perform other accounting services during the compilation engagement. Before issuing a report, the accountant should read the compiled statements to determine that they are appropriate in form and free from obvious material misstatements. A compilation service cannot result in any expression of assurance on the financial statements.

b.The report is as follows:

I (we) have compiled the accompanying balance sheet of Adams Cleaners as of December 31, 19X1, and the related statements of income, retained earnings, and cash flows for the year then ended in accordance with Statements on Standards for Accounting and Review Services issued by the American Institute of Certified Public Accountants

A compilation is limited to presenting in the form of financial statements information that is the representation of management [owners]. I [we] have not audited or reviewed the accompanying financial statements and, accordingly, do not express an opinion or any other form of assurance on them.

(Signature)

(Date)

c.In a review engagement, the auditor can give some assurance on the fairness of the financial statements by stating that he or she is unaware of any material modifications that should be made in the financial Statements for them to conform with GAAP.

d.An opinion cannot be given unless an audit of the financial statements has been made in accordance with GAAS.

20-28.(Estimated time - 25 minutes)

Deficiencies in the report on the compiled financial statements are as follows:

Within the first paragraph

The financial statements are not properly identified.

Standards established by the AICPA should be referred to.

The expression 'to obtain limited assurance' should not be used.

Within the second paragraph

The information is not stated to be the representation of management.

The phrase "less in scope than an audit" is inappropriate.

Reference to the financial statements not being reviewed is omitted.

Reference to "any other form of assurance" is omitted.

Within the third paragraph

Reference to the omission of the statement of cash flows is omitted.

There should be a statement that the financial statements are not designed for those uninformed about the omitted disclosures.

It is inappropriate to refer to changes in financial position.

Within the fourth paragraph

The reason for the accountant's lack of independence should not be described.

Inclusion of the fifth paragraph is inappropriate.

The accountant's compilation report is not dated October 25, 20XO.

20-29.(Estimated Time: 30 Minutes)

a.The purpose of a risk assessment engagement is to address concerns about business risk and about a threat that an event or action will adversely affect an organization's ability to achieve its business objectives and execute its strategies successfully. The scope of such an engagement must be responsive to the clients existing system for identifying and assessing business risks. If the new owner-manager has already assessed the risk of expansion into specific markets, the CPA might evaluate whether important business risks have been considered and independently assess the risks that have previously been considered by the owner manager. If the owner-manager has not engaged in any formal risk assessment the CPA might consider an engagement to identify and assessment of primary potential risks faced by the business as it expands into new and larger markets.

b.Following are several examples of competitive advantages that a CPA who is the companys auditor might bring to a risk assessment engagement.

The CPA may have a reputation as a trusted business advisor. For example, the CPA may have expertise in the construction industry that is important to this business client and may have experience in evaluating the impact of industry trends on the financial position, results of operations, and cash flows of those in the industry.

CPAs have a reputation for independence. The client may want the benefits that accrue from an independent analysis of the entitys business risks.

CPAs have experience with quality control and have systems in place to ensure uniformly high service.

c.

Risk IdentificationService to Assist Client

Strategic environment risk

Threats due to the changing economic climate that may result in a downturn in a construction of new homes.

Threats due to direct competitors in larger markets.

Threats due to economic forces that may dry up sources of capital needed to fund expansion.The likely service in each case will probably be an independent identification and assessment of the business risk.

Operating environment risk

Threats due to difficulty obtaining an adequately trained workforce to deliver the quality of service expected by customers.

Threats due to the challenges of marketing to the construction industry that may already have strong existing relationships with suppliers.The likely service in each case will probably be an independent identification and assessment of the business risk.

Information risk

Threats due to poor information about new markets and marketplace needs.

Threats due to poor information about the cash flow that will be needed to fund expansion.The likely service in each case will probably be an independent identification and assessment of the business risk.

Cases

20-30.(Estimated time -30 minutes)

Inappropriate ActionWhat Brown Should Have Done toAvoid Inappropriate Action

1.Brown should not have accepted the assignment without determining the intended use of the financial statements.Brown should have discussed with Calhoun the intended use of the financial statements Brown should have appraised Calhoun's needs and expectations and should have advised Calhoun about the types of professional services appropriate in light of Calhoun's objectives.

2.Brown should not have ignored Calhoun's confusion about the services provided.Brown should have explained to Calhoun that preparation of financial statements is normally an engagement for accounting services and not an audit of financial statements

3.There is no indication that Brown considered policies and procedures with regard to acceptance of this new clientBrown should have made appropriate inquiries to minimize any likelihood of association with a client whose management lacks integrity.

4.Brown should not have accepted a verbal engagement without confirming it in writing.The verbal commitment should have been followed up with an engagement letter that included a description, as specific as possible, of the nature and extent of the accounting service to be performed.

Brown should have accepted a fee arrangement that was based on the work to be performed, not on a contingency such as finishing within a certain time period.

6.Brown should not have suggested that the account name be changed to 'fees "for limited audit engagement."The word "audit" should not be used on nonaudit engagements. Brown should not have suggested any change or should have persuaded Calhoun to use the words "accounting services" and should have made certain that Calhoun understood the difference between an accounting service and an audit of the financial statements in accordance with generally accepted auditing standards.

7.Brown should not have ignored the missing invoices..Brown should have advised Calhoun of the missing invoices. Brown should have suggested that Calhoun expedite an investigation of the missing invoices, or, if Calhoun so desired, Brown could have investigated the matter as an additional accounting service.

8.Brown should not have prepared an incomplete set of financial statementsBrown should have prepared a statement of cash flows which SFAS No. 95 requires to be presented whenever a balance sheet and income statement are presented. If Calhoun did not wish to include a statement of cash flows with the other basic statements, Brown should have appropriately referred to the incomplete presentation in the disclaimer of opinion.

9.Brown should not have prepared a footnote that failed to disclose lack of conformity with generally accepted accounting principles.Brown should have insisted on appropriate revision of the unaudited statements so that they no longer reflect assets at replacement costs. If Calhoun did not wish to make revisions, Brown should set forth reservations in the disclaimer of opinion with respect to the unacceptable accounting, lack of disclosure, and the dollar effect.

10.Brown's attempt at a disclaimer did not clearly indicate that the statements had not been audited.Brown should have avoided using the words without complete audit verification." These words imply that some type of audit was performed, and, because of them, Brown may be assuming more responsibility than originally intended. Brown's disclaimer of opinion should have stated that the financial statements "were not audited by me and accordingly I do not express an opinion on them." In addition each page of the financial statements should have been clearly and conspicuously marked as "unaudited."

Professional Simulation

Various Assurance Engagements

SituationResearch

Following is the solutions regarding the assurance engagements discussed in items 1-8 based on the following four types of standard that would apply.

a. Statements on Auditing Standards

b. Statements on Standards for Attestation Engagements

c. Statements on Standards for Accounting and Review Services

d. The engagement is not appropriate under current professional standards

a.b.c.d.

1. A private company client would like to have your accounting firm provide reasonable assurance that a financial forecast of the next years financial position, results of operations, and cash flows will be achieved. ((((

2. A private company needs to provide a bank with financial statements. It does not want to pay for an audit, and the bank is willing to accept less than audited financial statements. Can your firm provide negative assurance that your firm is not aware of any material modifications that need to be made to the financial statements in order for them to be in accordance with GAAP.((((

3. A public company would like you to perform agreed-upon procedures regarding a royalty payable where the client owes royalties based on the number of parts produced under a licensing agreement. ((((

4. A private company would like to have you audit financial statements prepared on a federal income tax basis of accounting.((((

5. A public company would like to have you provide a report to lenders providing them with some level of assurance that the company complied with terms, covenants, and provisions of a debt agreement.((((

6. A local casino would like to provide a report to the public that provides reasonable assurance that that payout rate on its slot machines was greater than or equal to 97%. ((((

7. A private company client would like to you compile a financial projection, with no assurance, that would project financial position, results of operations and cash flows based on assumptions agreed-upon by the client and the bank. ((((

8. A public company in the petroleum industry would like to have your firm conduct an agreed-upon procedures engagement to the Environmental Protection Agency (EPA) that it complied with the EPA regulation that its gasoline product contained at least 2% oxygen.((((

Research

SituationVarious Assurance Engagements

Following is the solutions regarding the assurance engagements discussed in items 1-8Professional Standard Reference

1. A private company client would like to have your accounting firm provide reasonable assurance that a financial forecast of the next years financial position, results of operations, and cash flows will be achieved. (Note: A CPA can not provide assurance on the achievability of a forecast.)AT 301.33

2. A private company needs to provide a bank with financial statements. It does not want to pay for an audit, and the bank is willing to accept less than audited financial statements. Can your firm provide negative assurance that your firm is not aware of any material modifications that need to be made to the financial statements in order for them to be in accordance with GAAP.AR 100.04

3. A public company would like you to perform agreed-upon procedures regarding a royalty payable where the client owes royalties based on the number of parts produced under a licensing agreement. AT 201

4. A private company would like to have you audit financial statements prepared on a federal income tax basis of accounting.AU 326.04

5. A public company would like to have you provide a report to lenders providing them with some level of assurance that the company complied with terms, covenants, and provisions of a debt agreement.AU 623.19-.22

6. A local casino would like to provide a report to the public that provides reasonable assurance that that payout rate on its slot machines was greater than or equal to 97%. AT 101

7. A private company client would like to you compile a financial projection, with no assurance, that would project financial position, results of operations and cash flows based on assumptions agreed-upon by the client and the bank. AT 301

8. A public company in the petroleum industry would like to have your firm conduct an agreed-upon procedures engagement to the Environmental Protection Agency (EPA) that it complied with the EPA regulation that its gasoline product contained at least 2% oxygen.AT 601

Solutions Manual to Modern Auditing: Copyright ( 2005, John Wiley and Sons, Inc. 20-27