PROPOSED PRINCIPLES AND AUDIT STANDARDS

FOR FORECAST STATEMENTS

by

BARTLEY RAY VERNER, B.B.A.

A THESIS

IN

ACCOUNTING

Submitted to the Graduate Faculty of Texas Tech University in Partial Fulfillment of the Requirements for

the Degree of MASTER OF SCIENCE

IN

ACCOUNTING

Approved

Accepted ,J>

August, 1970

CONTENTS

INTRODUCTION 1

The Nature of Financlal Reporting 1

Forecasts in Financial Reports 3

The Nature of the Study 4

Methodology and Limitations 5

ANTECEDENTS OF CONTEMPORARY FORECASTING . . 7

Antique Forecasting 7

Modern Management Planning 9

Contemporary Financial Forecasts 11

Rationale of Audited Forecasts 17

Summary 22

PRINCIPLES OF FORECASTING AND STANDARDS FOR AUDITING FORECASTS 23

Principles of Forecasting 23

Auditing Standards for Forecasts 29

Summary 39

IMPLEMENTING FORECAST AUDITS -41

Restrictions and Restraints 4l

Acceptance of Principles and Standards ... 44

The Auditor's Ability to Extend Attestation. 45

A Proposed Statement Format 48

Summary 50

• •

n

;

V. CONCLUSION 51

BIBLIOGRAPHY 55

APPENDIX 58

• • .

111

í

CHAPTER I

INTRODUCTION

Today's complex, industrialized society depends on

the measurement and communication of information. The

originator of information must have the requisite skills

and knowledge to prepare and issue the information, and

the user must understand the standards for measurement

and summarization of the data. The communication must be

intelligible and utilitarian to the user.

The Nature of Financial Reporting

Historically, the communication of financial informa-

tion has raised such issues as who are the users of the

financial reports and why are financial reports made.

The corporate report is one of the most widely distributed

and comprehensive forms of comrnunication in the business p

community. The objective of publishing financial reports

is to supply needed information to different parties that

•̂ Herman W. Bevis, "The CPA's Attest Function in Modern Society," The Journal of Accountancy, CXXIII (February, 1962), 32. 2Donald E. Stone, "The Objective of Financial Reporting in the Annual Report," The Accounting Review, XLII (April, 1967), 331.

1

2

may have an interest or potential interest in the entities

for which the information is being supplied.

The basic objective of any financial information is

that it assist in making decisions, primarily of an eco-

nomic nature.-^ The corporate annual report attempts to

meet the needs of many different groups within the frame-

work of one form of í'inancial presentation. To the extent

that the interests of the different groups coincide, a

general-purpose report is possible. The implication is

that one form can serve the needs of all interested groups.

The different interest groups often consist of man-

agement, employees, customers, stockholders, suppliers,

creditors, governmental authorities, and the general pub-

lic. If the financial report is directed toward the domi-

nant group, the coincidental needs of all groups will be

met. Who is the dominant interest group? A logical

selection would be investing stockholders since their

need for information generally could be said to encompass

the range of needs of the other groups.

^Maurice Moontz, The Basic Postulates of Accounting (New York: American Institute of Certified Public Accoun-tants, 1961), p. 8.

Stone, "Financial Reporting," p. 333.

^ bid.

6Ibid.

3

Although the annual report does communicate informa-

tion, the question continually arises: Does it provide

enough information to satisfy the requirements of those

using the report?' Currently, there is a growing desire

for more and different types of information in the annual

report. It is this type of change that causes the audi-

tor's environrnent to be in a constant state of metamor-

phosis. Change in the financial reports must be an inher-

ent factor if the auditor is going to be responsive to the

needs of the users of business reports.

The makeup of human wants is a variable in the social process, not a constant, and this is of immense importance to accounting theory and practice in general. Only if we understand possible changes in human wants and needs in terms of a meaningful theoretical structure will we be able to adjust to the constantly changing environment in which the accounting profession operates.9

Forecasts in Financial Reports

Contemporary general-purpose reports consist of a

balance sheet, income statement, and (more recently)

?See M. 0. Alexander, "Financial Forecasting—a part of the accountant's professional work," Canadian Chartered Accountant, LXXXXV (October, 1969), 259, and Joseph L. Roth, "What's Ahead for the Auditor?" The Journal of Accountancy, CXXVIII (August, 1969), 60. "Sidney Davidson, "Accounting and Financial Report-ing in the Seventies," The Journal of Accountancy, CXXVIII (December, 1969), 29.

°Norton M. Bedford, ncome Determination Theory: An Accounting Framework (Reading, Massachusetts: Addison-Wesley Publishing Company, 1965), p. viii.

1

4

source and application of funds statement, all of which

provide historical information. However, significantly

absent from contemporary reports is a logical and very

necessary part of business management, namely, management

planning. The importance of forecasting can easily be

seen when one compares the results of two firms where one

firm has made use of adequate planning and the other firm

has given little or no thought to future operations.

The growth of companies is strongly tied to the

future expectations of the macro and micro-economic struc-

tures. The stock market and the financial community that

revolves around it are oriented toward the future and the

expectations concerning market investments. ° The tradi-

tional general-purpose statements do not provide all of

the desired and necessary information. ^ The hypothesis

of this paper is that management's plans should be included

as forecasts in the financial statements.

The Nature of the Study

The profound implications of including forecasts

within the scope of the auditor's opinion is the focus of

this study. The specific objective of this thesis is to

luT__eodore H. Pincus, "The Case for the Realistic Financ al Forecast," Management Review, CVII (June, 1969), 34. 1:LFrank J. Imke, "The Future of the Attest Function," The Journal of Accountancy, CXXII (April, 1967), 52.

1

5

develop principles and standards for forecasting to guide

the auditor in rendering an opinion as to the reasonable-

ness of forecast presentations.

Initially, this study reviews the general history

of forecasting and the current "state of the art." Against

this backdrop, the rationale of auditors' attestation to

forecasts will be examined. Chapter III will develop pro-

posed principles and standards to guide the auditor in

extending the attest function to include financial fore-

casts. Proposed innovations are never complete without

consideration of necessary changes and implementation

factors inherent in the innovation. Chapter IV will con-

sider the acceptance of forecast principles and standards,

restrictions and restraints, the auditor's ability to

extend attestation, and it will explain the proposed

statement format.

Methodology and Limitations

In a new and relatively unresearched area of any

discipline there are few structures of the discipline to

guide the researcher. The approach to this problem in

this thesis is one of logical reasoning utilizing standards

and principles of auditing that are now in use as the

foundation of the logic. This methodology applies the

conceptual knowledge of other areas of accounting to the

development of concepts in the new area. It is not within

6

the scope of this thesis to provide an empirical type of

study but only to give direction for further research

which may well include empirical methods.

In assuming the deductive approach, the study is

limited by the assurnption that current concepts, standards

and principles, and practices are valid. Clear and con-

cise objectives of accounting discipline have not been

stated and utilized. The inductive approach of account--

ing in the past has resulted in an array of principles and

practices that are often contradictory. To provide maxi-

mum practicality, this author chose the contemporary account-

ing framework as the logical foundation for forecasting

principles and standards.

CHAPTER II

ANTECEDENTS OF CONTEMPORARY FORECASTING

Probably forecasting has been a part of business for

as long as there has been a business. Man certainly would

not have ventured into unknown parts of the world had he

not expected economic gains from the possible future sale

1 2

of goods derived from his ventures. Though today the entrepreneur is not faced with an unknown physical envir-

onment, he is faced with the unknown of the future itself.

Thus, a major concern of an on-going business is the

future.

Antique Forecasting

Before the Industrial Revolution, the entrepreneur

formulated plans mentally. Only when two or more indi-

viduals were involved in the venture or business were the

plans revealed. Even revelations were kept secret and

rarely documented. The businessman of that time based

his forecasts on years of experlence, skill, and intui-

tion. Because his environment, at that time, had not

become complicated, the businessman had the mental ability

Davidson, "Accounting and Financial Reporting," 29.

7

8

to know his environment and to respond to changes in it.

Companies and business in general became larger and

more complicated as ventures expanded into new areas of

the world. During the age of mercantilism, accounting

was recognized as a discipline. Paciole recorded the

double entry system before the mathematics of calculus

was discovered. During this era, businessmen began to

recognize accounting as a tool to aid them in producing

greater profits. After the recognition of accounting as

a discipline, detailed records began to become more com-

monplace. The businessman or bookkeeper seldom recognized

the relationship between the records of the business and

the planning/operations of the business. The primary

objective of accounting at that time was the production

of data in such a way that the financial position was

reflected in the balance sheet.

The Industrial Revolution changed business almost

overnight. The increased complexity and mechanization

promoted the development and use of scientific management. 3

The growth in size and mportance of the commercial enter-

prises forced managers to begin to operate under theories

of planning and control. Ownership and management were,

for the most part, still the same parties, and as users

^-^W. Warren Haynes and Joseph L. Massie, Management: Concepts and Cases (Englewood Cliffs, New Jersey: Prentice-Hall, Inc.), p. 249.

9

of the accounting results they needed only their financial

position audited primarily for fraud and negligence by

employees.

As management and ownership began to separate via

stocks and absentee ownership, the dominant users of the

financial statements were more interested in operations

than in the balance sheet. The change of user emphasis

brought a new set of objectives and a new emphasis to the

financial audit. The auditor moved away from the detailed

verification of transactions and into the examination of

internal control.

It was during the period 1900 to 1960 that account-

ing and auditing changed the most, The pace of change

has been and still is at a geometric rate. Accountants

are facing this environment of change and must cope with

it to perform their service to the public.

Modern Management Planning

In the past decade computer technology has brought

within management's grasp the capability of accumulating

vast amounts of raw data concerning micro and macro-business

environments. Even with the extreme complexity of these

environments, management also has the capability to sift

and filter the raw data for that which is pertinent to

particular objectives. New quantitative methods of man-

agement planning are now feasible with the computer.

10

Statistical analysis and advanced planning techniques, such

as Program Evaluation and Review Technique (PERT) and rnodel

simulation, are now in use.

In addition to new methods, management has access to

a wealth of specialists to assist in different areas of

business. Engineers are available to design products that

have been recommended by the market researcher. The cost

accountant assists in reducing and controlling costs for

the most economic production. Distribution is then han-

dled by the marketing specialists . Managernent specialists

work with upper management to coordinate all the activities

into effective production and distribution of goods and

services to the public. Upper management's role is to

plan and to control in such a way that a profit, as well

as goods and services, is provided. Only a very low level

of production is possible without planning.

One of the basic tools in any competent management's

planning operation is the accounting budget. There are

few managerial decisions made without the assistance of

the budgeted forecast of cost and profit (or benefits).

These forecasts are based on the projections of the sales

department, the estimated costs of production, and other

relevant factors. Current quantitative methods in account-

ing, marketing, finance, and management assist in sound

forecasting if they are administered properly. The methods

are an aid to management in decision making. The methods

11

cannot replace or remove subjective judgment, which is

present in all decisions, but they temper decisions with

reason and objectivity.

Contemporary Financial Forecasts

Content.—It is apparent that managemcnts do make

plans and forecasts, but few of the projections are rnade

public in any expllcit form. In a survey of sixty annual

reports, 90% of the firms included the previous year's

balance sheet and income statement. Certainly it is man-

agement' s intention that these comparative staternents

indicate a trend and an implicit forecast, in a general

manner, of the future. In the same survey five of the

annual reports included at least one trend-line chart as

a growth indicator of the firm. It was noted that the

lines never extended beyond the current period, but only

seemed to imply a projection into the next period. The

use of bar charts was another attempt of managements to

indicate expected performance. Eleven of the sixty reports

contained some form of bar chart. These charts also

appeared to infer from past performance a forecast of the

future.

Of the sixty reports, twenty-three included a source

and application of funds statement. Management felt pres-

sure enough to account for the use of reported profits

and retained earnings. The funds statement fills the need

12

for analysis of financial changes and financing, and over-

comes an apparent breakdown in communications in the bal-

ance sheet and income statement.l21 In addition to the

implications in statement presentation, the statements

already contain estimates of the future. Depreciation

expenses on the income státement and the accumulated depre-

ciation on the balance sheet are two good examples. In-

herent in the matching concept of revenues and expenses

is the estimation of revenues and expenses accruing in the

future period. A forecast statement might prove to be as

"accura'te" as last year's income statement.

Dominant Interest Group.—The users of financial

reports and other financial data are as varied as the

makeup of society itself. Management and stockholders

are the two groups usually thought of as having the great-

est interest in the reports; but there are others of sig-

nificant importance. Employees, customers, suppliers, and

the general public have definite interests but to a lesser

extent. Governmental tax and regulatory agencies, credi-

tors, and investment analysts have interests in the pub-

lished reports also. Because of the varied interest

groups, a determination must be made of the dominant inter-

est group. This determination will allow reports with

±4Hector R. Anton, Accounting for the Flow of Funds (Boston: Houghton Mifflin Company^ 1962), p. vT~.

13

supplementary disclosures directed toward them to suffice

for the needs of other groups.

Governmental tax and regulatory agencies will probably

continue to require particular and meticulous reports and

filings. Their position is unique in the type of reports

required; thus, no general-purpose report is sufficient.

These interest groups are not eliminated, but they are not,

as of yet, the dominant groups even though their influence

is recognized.

Employees and customers have interests in the finan-

cial data that generally coincide with that of the stock-

holders. Labor groups sometimes are desirous of special

data and analyses, but the contemporary financial report

provides the necessary data to meet any moral obligation

the firm may have toward labor. This is also true to the

extent that the financial report does not meet the specific

needs of customers. Both the employees and customers are

interest groups, but they have less interest and influence

than either the governmental agencies or the stockholders.

Contemporary thought about financial reports is that

management is communicating adequate financial data to the

stockholders and creditors. This has been a matter of in-

ductive practice since the stockholders and creditors have

held the dominant position historically. If one analyzes

the transactions made by stockholders and creditors in

today's business, the investment analyst appears most often

14

behind the scenes. The bankers and insurance companies

employ these specialists as members of their regular staffs.

Institutional investors are responsible for over 50 percent

of the stock transactions conducted on the national stock

exchanges.15 Acting in all of these transactions is the

investment analyst. The public sector that places trans-

actions through the brokerage houses usually relies on the

broker handling that account for information and data con-

cerning particular investments. Most brokers certainly

are not the technicians that manipulate the accounts of

mutual 'funds, but they may be classified as investment

analysts since they act in that capacity for many investors.

The potential investor, except in the case of closely held

corporations, may be expected to act through the broker

or the institutional investor.

The moral obligation of a firm to report to the

general public is met within the framework of the

general-purpose report when this report is directed

toward the dominant interest group. The investment

analysts comprise the dominant interest group since they

are the specialists actually using the financial data.

Auditing Current Forecasts.—Today the auditor in the

U.S., Congress, House, Committee on Interstate and Foreign Commerce, Securities Markets Agencies, Hearings, before a subcommittee of the Committee on Interstate and Foreign Commerce, House of Representatives, on H.R. 91-9, 91st Cong., lst sess., 1969, p. 6.

15

United States will not attest to a forecast of any kind.

He will attest to the historical financial statements pre-

sented in the prospectuses of offerings in the investment

market. Comfort letters are issued to bankers and under-

writers, but still the auditor refuses to assume any

responsibility for financial' data that is not historical

f act.

In the United Kingdom, the auditor has been required,

as a result of the governing laws of the English stock

exchange, to attest to the accounting bases and calcula-

1 /

tions for profit forecasts. The requirement is only

applicable where the statements circulated are concerned

with takeovers or mergers. It would seem that if the

auditor can attest to the profit forecast under such con-

ditions, he could also render an opinion on other forecasts

included in statements which do not result from a takeover

or merger.

The Council of the Institute of Chartered Accountants

in England and Wales prepared a statement to guide the

auditor who is asked to give a report on profit forecasts.

The following excerpt of that statement clearly defines the

role of the auditor:

5, In consequence profit forecasts, as defined in paragraph I above, are not capable of confirmation

l°"Accountants' Reports on Profit Forecasts," The Accountant, CLX (May 3, 1969), 629.

and verification by reporting accountants in the same way as financial statements which present the final results of completed accounting periods and there is no question of their being "audited," even though the reporting accountants may also be the company's auditors. It is important that

. reporting accountants should make this clear when they accept instruction to review the accounting bases and calculations for profit forecasts, and in the wording of their report they should take care to avoid giving any impression that they are in any. way confirming, underwriting, guaranteeing or otherwise accepting responsibility for the ultimate accuracy and realization of forecasts. Moreover, bearing in mind their special status and authority, reporting accountants should do or say nothing to encourage directors, third parties or the public to place mistaken reliance on statements as to future profits the achievement of which must always be subject to uncertainty.

6. Reporting accountants can, however, within limits which are further discussed below, properly undertake a critical and objective review of the accounting bases and calculations for profit fore-casts, and verify that the forecasts have been properly computed from the underlying assumptions and data and are presented on a consistent basis. '

In providing guidance for the auditor, the statement identifies four main points that should be considered in the accountant's review: the nature and background of the company's business, the accounting practices normally

followed by the company, the assumptions on which the

forecasts are based, and the procedures followed by the

company for preparing forecasts.1^ The opinion rendered

on forecasts covers profit forecasts. It states: "In our

1 7 bid.

l8Ibid., 630.

17

opinion the forecasts . . . have been properly compiled

on the footing of the assumptions made by the Board . . .

and are presented on a basis consistent with the account-

ing practices normally adopted by the company."19 To the

extent that profit forecasts are associated with a merger

or takeover, the auditor in-the United Kingdorn is cur-

rently rendering an opinion on forecasts.

It is indeed a bold step for the auditor to render

an opinion on forecasts, but the current users of cor-

porate reports demand that creditability be given to

forecasts. Thus, the auditor today is standing on the

threshold of rendering credence to explicit forecasts

rather than ignoring the implicit forecasting present in

published corporate reports today.

Rationale of Audited Forecasts

The Purpose of Forecasts.--Before developing a

framework for independent audits of forecasts, it seems

first appropriate to probe the rationale for forecast

reports. Several major reasons for forecast reports are

apparent.

Forecasts should be included in financial statements

because emphasis is on the future in the going-concern

concept of a business enterprise. Indeed the expectations

19Ibid., 631.

18

and estimates of the future share an equal position with

the historical facts as management plans and controls the

operations in the going concern. From the control stand-

point, management is concerned with the historical facts.

Management planning, by definition, is concerned with the

future.

This concern with the future demonstrates a second

reason for forecast statements. As stated previously,

successful operations in today's complex business environ-

ment depend, to a large extent, on how good a job manage-

ment do'es in planning the operations of the firm. If

management is persuaded by the conditions of the business

environment to provide statements of forecasts that are

to be audited, management v/ill be compelled to undertake

appropriate methods and procedures that are conducive to

better operations in a business. Management is compelled

to do a better job in areas of deficiency and to expose

publicly a more accurate picture of their performance as

managers.

The greater exposure of the performance of management

to the different interest groups allows those interest

groups to make better decisions about that firm. These

better decisions are a third reason for including forecast

statements in the corporate report. More relevant infor-

mation results in a better evaluation of the alternatives

available. Forecast statements provide the investor with

an improved quantification method with which he may con-

sistently evaluate expectations. Because the investor

has a more rational basis for his decisions, market values

of securities are more realistic.

Creditors also have a more rational basis for their

decisions on withholding, granting, or extending credit.

The historical data provide the financial position of a

firm but gives little indication of 'that firm's ability

to meet obligations incurred for future periods. The

forecast statement supplies the creditor with indicators

of the firm's ability to meet short term obligations and,

to a general extent, long term obligâtions. The qual ty

of management planning, as evidenced by the forecasts,

give the creditor an indication of the degree of risk in-

volved with a particular firm. Forecasts will reveal to

the credit grantor data that currently are in the realm

of the intuitive assumption.

Through the utilization of forecasts made by other

firms in the industry, management will be able to formu-

late better plans. This fifth reason would appear, on

the surface, to have implications of giving the competi-

tion an advantage over a firm making explicit forecasts.

However, information that would be disclosed by projected

financial statements is not of the specific nature that

allows the competition to capitalize on the additional

knowledge. If the system compels all firms to issue

20

forecasts, as historical statements are now issued, the

firms in an industry as a whole are on an equal competi-

tive basis. The benefits of having inforrnation about the

industry as a whole outweighs the siight disadvantage of

disclosure of plans.

The last major reason'for the issuance of forecast

statements by businesses pertains to the public in general.

Information relevant to the national economy is furnished

by the accumulated aggregate of forecast data. The govern-

ment would be able to develop macro-economic plans frorn

this ag'gregate of data, especially in the areas of taxation

and price controls. The general welfare of our society

depends on the government's ability to exercise macro-

economic planning and control. Better decisions for this

planning and control will result from an information system

that provides explicit forecast data of individual firms.

The Purpose of Auditing Forecasts.—Currently, the

dominant users—investment analysts--as well as subordi-

nate users may be utilizing more unaudited than audited

information. Investment analysts often rely on sources

of information, such as the public relations man, where

the audited statements do not provide the necessary data.

The unaudited information is accepted on faith. The user

of that type of information must know and rely on his

20Mautz, The Philosophy of Auditing, pp. 181-186.

source for any credence in the information.

The utilitarian value of information depends on the

reliability and credibility of the information in finan-

cial statements. Users of those financial statements

employ the data in making decisions of future expectations.

Forecasts included in financial statements should be a

necessary link in the communication of information for

those decisions. Unaudited forecasts would be subject to

the same deficiencies as unaudited historical statements.

To be utilitarian to the users of financial statements,

the for'ecasts require a credibility resulting from the

opinion of an independent third party. The independent

auditor now performs the attest function for historical

statements. He could perform the same service for the

users of forecast data if principles and standards are

established as the foundation for the auditor's opinion.

The opinion must be rendered by recognized inde-

pendent authority, and the Certified Public Accountant

has the authority of a profession already developed for

and acquainted with the processes necessary for rendering

such an opinion. The CPA is farniliar with techniques and

procedures used to gather evidence of a nature that permits

the exercise of judgment. He is also experienced in the

exercise of judgment based on the evidence he has accumu-

lated. As an independent auditor, he is the most logical

22

party with the necessary qualifications to render opinions

on the forecasts of firms.

Summary

Forecasting has been in existence for ages but was

not recognized or developed until the time of modern man-

agement. Modern management planning developed forecasting

with little standardization, reliability, or credibility.

Forecast projections are often made on the basis of un-

audited data. To lend standardization, reliability, and

credibility to forecasting, the data must be audited. The

established profession of CPA's is the most logical group

to audit forecast data. To undertake this task of audit-

ing, the CPA must have well-founded principles and standards.

Chapter III will develop these principles and standards of

forecasting.

CHAPTER III

PRINCIPLES OF FORECASTING AND STANDARDS

FOR AUDITING FORECASTS

Given the assumption that statements of forecasts

are to be audited, there needs to be developed a body of

knowledge to guide the auditor. This body of knowledge

will consist primarily of principles and standards very

similar to those now existing in accounting for historical

costs. In addition tothe principles and standards, cer-

tain audit procedures dealing specifically with forecast-

ing should be developed to complement the auditing stand-

ards. Infrequent reference to and examples of procedures

may be made, but these could receive just treatment only

in a detailed study beyond the scope of this paper.

Principles.of Forecasting

Conventional accounting principles are generaliza-

tions of theory that imply alternative rules and procedures.

They should only indicate the best alternatives available

to express significant relationships that exist in

23

2

21 accounting.

Classification.—Current accounting principles can

be drawn on as a frarne of reference for the development

of principles of forecasting. The first of six major

forecasting principles is that of classification. From

the analyst's position, the'best classification of data

is one which provides the most utilitarian form for his

purposes .

Historical financial data will form the largest base

for forecast inferences and calculations. To lend credi-

tâbility to forecasts, it is necessary that the forecast

data be classified in the same manner as the historical

data.

The current balance sheet, income statement, and

funds flow statement recognize significant similarities,

dissimilarities, and relevant interrelationships of enter-

22 prise progress and financial position. It is logical then that forecast data must follow the same classifica-

tion as that utilized in current accounting.

Measurement.—The second principle of forecasting

is the measurement of data. The measurement of forecast

^ Study Group at the University of Illinois, A Statement of Basic Accounting Postulates and Principles (Urbana, Illinois: The Board of Trustees of the Univer-sity of Illinois, 1964), p. 23-22Ibid., p. 25.

25

data begins with the historical financial data as the basis

for calculations. Proven and consistent trends In data,

such as that of rent, should be distinguished, where pos-

sible, from iterns that are more irregular and volatile.

Where distinction is not possible, the use of tolerances

throughout the statement data will prov_i de indicators of

confidence (not statistical confidence level) for the dif-

ferent items on the statement.

The calculations of different items will be derived

in the logical method where the projections for sales pro-

vide the base for calculation. Procedures of budgeting

that are based on sound and reasonable assumptions will

yield accurate calculations. A management procedure of

explicitly stating all assumptions and relevant informa-

tion provides a basis for credibility. Since many of the

calculations will have major projected items as bases,

management must disclose with each major projection the

relevant information and the assumptions made for that

projection.

Measurement for forecasting is actually attempting

to determine, with some degree of accuracy, an intangible

fact existing in the future. This places management in

the position of mak ng sound, reasonable assumptions from

the relevant information, and then making reasonable infer-

ences from the assumptions.

26

Reasonable Inferences.—The principle of reasonable

inferences is that of an expression of the relationship

between the verifiable historical data and the projected

data. The inferences are made from assumed data, such as

industry and/or economic trends, the trend of the firm's

past financial record, and other relevant information,

such as possible changes in labor contracts or tax legis-

lation.

The foundation for reasonableness would be found in

the development of probability for different alternatives

for a particular assumption or other relevant factor. It

is logical, then, that the alternative with the greatest

probability will be the most reasonable for inference. p o

In the paper, "Toward Probabilistic Profit Budgets," J the

authors have demonstrated three different techniques for

determining the probability of individual items on a

profitability budget. These same techniques are equally

applicable when developing the projections for the state-

ment of forecast.

Reasonable inferences made from explicit assumptions

w ll yield realistic forecasts.

Consistency.—A fourth principle of forecasting

treats consistency in two distinct areas (i.e., internal

23william L. Ferrara and Jack C. Hayya, "Toward Prob-abilistic Profit Budgets" (unpublished paper presented at the American Accounting Association Convention, Notre Dame, Indiana, 1969), n.p.

27

and external). The internal consistency, as one would

expect, deals with data internal to the f'irm. There are

two aspects of this area: consistency between current

and past estimates and consistency among current esti-24 mates. The bases and calculations for a particular item

of data in the current estimates should be the same or

consistent with the bases and calculations used for esti-

matés-in prior periods. If, for example, a firm estimates

the production level for 1970 to be 10,000 units, the same

level of production would be used for 1971, unless the

factors causing change have been explained.

Consistency in the current estimates pertains to the

un formity of basic assumptions for different items in the

forecast. For instance, if the production capacity is

estimated to be 10,000 units, then production costs should

also be based on 10,000 units; similarly, if the production

capacity of product A is based on the assumption that plant

slze will be increased in the forecast period, then (if

product B is produced in the process with A), the effect

of the change in plant size will have to be recognized in

the estimate for product B.

Internal consistency deals with topics that are more

easily recognized and considered by managernent. External

^Yuju Ijiri, "On Budgeting Principles and Budget-Auditing Standards," The Accounting Review, XLIII (Octo-ber, 1968), p. 665.

28

consistency is the relationship between the firm and the

business environment. Where estimates of industrial and

economic trends indicate one particular pattern, then it

may be reasonable to infer that the flrm must reflect the

same trend in its estimates or explain why the estimates

are more reliable (and therefore more reasonable) in the

circumstances.

Generally Accepted Accounting Principles.—Contempor-

ary accounting is structured around generally accepted

accounting principles. Inductively, these principles

have produced the methods and procedures that accountants,

and others, use in the manipulation of financial data in

the communication process. Contemporary financial state-

ments embody these principles as the foundations of finan-

cial measurement. It is logical, since historical finan-

cial statements form the major bases for forecasts, that

principles of forecasting also include generally accepted

accounting principles.

About "Generally Accepted" Forecasting Principles.—

"Generally accepted" has been construed by the accounting

profession as that characteristic meaning substantial

authoritative support. This same definition would apply

to principles of forecasting in such a way that they are

the foundations of forecasting just as current accounting

principles are the foundations of contemporary accounting.

Proposed principles will be adopted by the same methods

29

and procedures as generally accepted accounting principles.

The foregoing principles for forecasting are not a

comprehensive inventory, but appear, at present, to be the

most important. It is recognized that other principles

may arise, and present principles may change.

Auditing Standards for Forecasts

Auditing standards are concerned with measures of

quality in performance, in the objectives of the procedures

undertaken, and in the professional judgment exercised.

The scope of this paper is not to delineate the auditing

procedures that insure auditing standards but, instead,

to draw upon contemporary auditing standards as examples

for standards for auditlng forecasts. The new standards

will then act as guides for developing procedures that

implement those standards.

Contemporary Auditing Standards.~~Just as principles

of forecasting are complementary to current accounting

principles, auditing standards for forecasts are comple-

25 mentary to current generally accepted auditing standards. The first seven generally accepted auditing standards are

almost universally applicable to auditing forecasts.

General Standards.—The first three general standards

concerning qualifications, attitude, and professional

p jr

^Auditing Standards and Procedures (New York: The American Institute of.Certified Public Accountants, 1963)3 pp. 15-16.

30

conduct of work are as important to forecast auditing as

they are to historical auditing.

The examination is to be performed by a person or persons having adequate technical training and proficiency as an auditor.26

Without formal education and experience an auditor

cannot meet the requirements of auditing standards. Before

he can become proficient in auditing forecasts, he must

master accounting practice and auditing procedure. The

seasoned judgment required in a forecast audit necessitates

a technical background in budgeting, statistics, financial

planning, probability, and some advanced mathematics.

Through the technical background and practical experience

of different circumstances, the auditor will become skilled

in accounting and auditing with the ability to exercise

independent judgment as to the reasonableness of the infer-

ences made in forecasting.

However technically proficient the auditor may be,

he must be without bias with respect to his client.

In all matters relating to the assignment an independence in mental attitude is to be main-tained by the auditor or auditors.2'

The auditor may be intellectually honest, but he must also

be independent in appearance. This entails that he be

free from obligation to and interest in the client. Since

Ibid., p. 18.

Ibid.

31

forecasting is constituted of decisions of planning, the

auditor could not audit forecasts that he had a part in

preparing. The foundation of public confidence in the

independent auditor is that of his independence. If the

profession is to continue to provide a service to the

public, independence, and thus public confidence, must

be protected.

The exercise of due care in the performance of work

is required of the auditor in the third general standard.

Due professional care is to be exercised in the- performance of the examination and the preparation of the report.2°

Due professional care consists of the observance of stan-

dards of fieldwork and reporting, and requires critical

review of the work performed and the judgment exercised.

Cooley on Torts stated, " . . . he [the professional audi-

tor] is liable to his employer for negligence, bad faith,

or dishonesty, but not for losses consequent upon pure

errors of judgment." This is most applicable to the audi-

tor where forecasting is concerned, not as an evasion of

responsibility, but as a statement of the relationship

that actually should exist between the professional audi-

tor and those relying on his work.

Standards of Fieldwork.—The auditor cannot, in good

faith, exercise due care without planning appropriate

Ibid.

procedures and seeing that those procedures are carried

out properly. The first standard of fieldwork is:

The work is to be adequately planned ?nd assistants, if any, are to be properly supervised.29

Since the nature of forecasting is concerned with events

and with when they will occur, the tirning of the audit

work on forecasts should be as near the date of the

report as possible. When planning the forecast audit,

the auditor must consider the effect of events subsequent

to the balance sheet date but prior to the report date.

Disclosure of subsequent events will be discussed with the

standards on reporting. A critical review of the work

done at all levels includes the proper supervision of

assistants . The responsibilities of proper supervision

should be the same regardless of the work being performed

by the auditor.

The evaluation of internal control is of primary

concern for the auditing of historical data, but because

such data form the major bases for the forecast, internal

control for such forecasts must receive equal study and

evaluation:

There is to be a proper study and evaluation of the existing internal control as a basis for reliance thereon and for the determination

29Ibid., p. 23.

of the resultant extent of the tests to which auditing procedures are to be restricted.30

In a well-developed system of control, some elements of

forecasting are present; cost methods, budgets, periodic

operating reports, and statistical analyses are the more

prominent. As a by-product of the study and evaluation

of internal control, the auditor is able to add to the

confidence of his judgment as to the reasonableness of

management's assumptions and inferences.

Sufficient competent evidential matter is the crux

in determining a reasonable basis for an opinion:

Sufficient competent evidential matter is to be obtained through inspection, observation, inquirles, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under examination. JJ-

The auditor will have to evaluate the forecast working

papers of management for sufficient competent evidence.

The primary concerns for competence are the validity and

relevance of the assumptions made for the forecast.

Authoritative sources, such as published industrial and

economic trend analyses, provide verifiable data for rea-

sonable assumptions and inferences. Certainly the trends

established by past audited financial statements are valid

and verifiable as cases for projections.

30 bid., p. 27.

31Ibid., p. 34.

Sufficiency of evidence rests with the consideration

of all relevant information concerning a particular projec-

tion. Reasonable inferences will depend on the persuasive

nature of the assumptlons made for a given projection. The

auditor's objective, then, is to determine whether or not

management has included in its assumptions adequate factors

for reasonable inference. Where management's assumptions

are lacking in verifiability, the auditor must rely on the

supposition that, if the assumption appears reasonable,

the relevant factors affecting the assumption are the choice

of management. Therefore, the assumption should be accepted

as valid for the projections based on it, but where the

item is critical, the auditor may qualify the scope of his

opinion (see Fifth Standard of Reporting).

The application of the first seven generally accepted

auditing standards to the audit of forecasts is largely a

matter of interpretation of the wording in the standards

as they relate to forecasting. Developing newly worded

standards would only be an exercise in semantics.

Standards of Reporting for Forecast Statements.—The

first standard of reporting for forecast statements is very

similar to the first standard of reporting for historical

statements. The proposed standard reads as follows:

The report shall state whether the forecast statement is presented in accordance with generally accepted principles of forecasting,

"Principles of forecasting" is construed, for purposes of

35

reporting, to include the forecasting principles, forecast-

ing practices, and forecasting methods. The standard of

forecasting requires an opinion as to whether the forecast

statement is presented in conformity with such principles.

Should the auditor's examination be limiteci in such a way

that he cannot form an opinion as to conformity, he must

qualify his report approprlately.

The auditor must exercise judgment as to whether the

principles used are generally accepted. Alternate princi-

ples may be acceptable, thus requiring familiarity with a

broad range of forecasting principles that may have only

limited usage and still be generally accepted.

The second proposed standard of reporting for fore-

cast statements reads:

The report shall state v.hether such principles have been consistently observed in the prepara-tion of the forecast with relation to the preced-ing period.

Comparability is the primary objective of this standard.

The impetus of forecasting is the comparability of the

forecasted data with the historical data. Without the

consistency of application regarding principles, there

cannot be support for reasonable inferences drawn from

the assumption in historical data. The forecast data must

be recorded consistently with the recording of historical

data. The forecast will establish in advance the record-

ing treatment of data in the coming period. The auditor

3 6

must determine whether the rnethod determined in advance

will be consistent with the preceding period.

Where a change materially affects the projections

of the forecast, the auditor may refer to a note explain-

ing the change and its effect, or he may describe the

change and its effect in his report. Where a change has

been made that requires retroactive adjustments, it is

desirable to disclose the presence of such adjustments

in the report. No reference as to consistency need be

made in instances where new companies are formed since no

previous period exists for comparison.

One of the most important aspects of forecast audits

is that the assumptions and inferences in the forecast are

made by management. Due to the critical nature of assum-

ing responsibility of any kind for a projection, the audi-

tor should specify in his report the originator of the

assumptions and inferences. The third standard of report-

ing for forecast statements is:

The report shall state that the inferences are made by management and based on explicit assump-tions of management.

Clearly the auditor can only attest to the reasonableness

of the assumptions made and the reasonableness of the in-

ferences drawn from those assumptions. The third stan-

dard of reporting provides for a clear, explicit statement

of the presentation being attested to by the auditor.

Taken from the third standard of reporting for

historical financial statements, the fourth standard of

reporting for forecast statements defines the quality of

disclosux-o that must be in the forecast staternent. This

standard states:

Informative disclosures in the forecast statement are to be regarded adequate unless otherwise stated in the report.

Forecast staternents must be explicit in setting forth the

assumptions made as to the logical foundation for the

inferences. The statement should, in notes to the state-

ment, delineate the "relevant factors affecting the assump-

tions. A subjective judgment which does not explicitly

state its basic precludes verification of the reasonable-

ness of the judgment.

Where factors of a critical nature are relatively

uncertain, the auditor should require disclosure of the

treatment (pessimistic or optimistic) in the notes to the

statement, or he should include the treatment of the fac-

tors in his report and appropriately qualify his opinion.

The last standard of reporting for forecast state-

ments deals with the expression of an opinion as follows:

The report shall either contain an expression of opinion regarding the reasonableness of the assumptions and inferences in the forecast state-ment, taken as a whole, or an expression to the effect that an opinion cannot be expressed. In all cases where the auditor's name is associated with forecast statements the report should con-tain a clear-cut indication of the character of the auditor's exam nation, if any, and the degree of responsibility he is assuming.

The aud tor should issue a qualified opinion when

the scope of his examination and review is limited in such

a way that reasonableness cannot be established. If the

qualification is so material that the effect is a negative

opinion, the auditor is required to issue a disclaimer or

adverse opinion.

The disclaimer of opinion should be issued by the

auditor when he has not obtained sufficient competent

evidential matter to support an opinion on the reasonable-

ness of the statement as a whole. Severe limitations on

the scope of the examination or unusual uncertainty of

critical items may warrant a disclaimer of opinion. When

disclaiming an opinion, the auditor should state the rea-

sons for disclaimer and his reservations concerning the

reasonableness of the forecast.

An adverse opinion should be given when the forecast

statement does not present reasonable inferences or when

the statement is not in conformity with generally accepted

forecasting principles. The auditor should disclose all

of the major reasons in the middle paragraph of the report

when issuing an adverse opinion.

Taken as a whole, the standards proposed here for

forecast statements closely parallel contemporary auditing

standards. These standards are embraced in the auditor's

report. The following report is proposed as the form for

the auditor's report on forecasts:

We have examined the Statement of Forecast of the XYZ Company for the future period (date to date). Our examination was made in accordance with generally accepted auditlng standards for forecasts, and accordingly inciuded such review and tests of the financial assumptions and such other auditing procedures as we considered neces-sary in the circumstances.

In our opinion, the Statement of Forecast presents reasonable inferences of management, based on management's explicit assumptions as to the future condition of the XYZ Company at (date), and the expected results of operations for the period then ended, in conformity with generally accepted forecasting principles applied on a basis consistent with the preceding period.

This form is recommended where the forecast is presented separate from the historical statements. Where the fore-cast is incorporated with the traditional statements, the

proposed scope paragraph and the contemporary scope para-

graph could easily be intergrated. Due to the terminology

utilized in the proposed opinion paragraph, separate

opinion paragraphs are recommended.

Summary

Auditing standards for forecasts, as presented,

closely parallel contemporary auditing standards. This

chapter has attempted to develop the apparent deviations

in meaning where the standards for forecasts differ from

the contemporary standards. It is felt that the con-

cepts of contemporary standards not described herein

are better described in Auditing Standards and Procedures

Auditing Standards and Procedures.

40

and are equally applicable to both contemporary standards

and the proposed standards.

CHAPTER IV

IMPLEMENTING FORECAST AUDITS

It has been observed that, generally, CPA's quail

at the proposal that they accept any responsibility for

forecasts. They think of themselves as reporters of past

events and shrink from even attesting to the reasonable-

ness of assumptions and methods by which the estimates

are made. This attitude on the part of CPA's raises sev-

eral implications of implementing the proposal in this

study. This chapter deals with some of the reservations

and restraints, and other practical considerations involved

in attesting to forecast data.

Restrictions and Restraints

Ethical Restrictions .—Some accountants will object

to forecast attestation. Their rationalizations will in-

clude prohibition of such attestat on by The Code of Pro-

fessional Ethics. Rule 2.04 provides that "A member or

associate shall not permit his name to be used in con-

junction with any forecast of the results of future trans-

actions in a manner which may lead to the belief that the

4l

42

member or associate vouches for the accuracy of the fore-

cast."33

Opinion No. 10 of the code explains the meaning

behind paragraph 2.04.3^ The opinion states that the mem-

ber is not prohibited from preparing or assisting the

client in the preparation of forecasts. The member is

only prohibited from attesting to the "accuracy" of the

forecast. This study recognizes that the auditor could

not, and should not, vouch for the accuracy of forecasts.

However, he is able to attest to the reasonableness of the

assumptions and inferences of forecasts. The auditor is

not restricted by the code, as construed, in attesting to

the reasonableness of management's assumptions and infer-

ences .

The explanation further states that the member must

clearly indicate that he does not vouch for the accuracy

of the forecast, that he should make full disclosure of

the source of the information and the major assumptions,

and that he should disclose the character of the work that

he performed. The proposed standards and principles of

forecasting closely parallel these ethical requirements.

In the auditor's opinion he will clearly state the degree

33The Code of Professional Ethics (New York: American Institute of Certified Public Accountants, 1969), p. 4. 3i|lbid., p. 19.

43

of responsibility assumed. The opinion only vouches for

the reasonableness of assumptions and inferences, thus

implying no responsibllity for accuracy. The scope para-

graph of the auditor's opinion states the character of

his work. Major assurnptions are disclosed in the state-

ments as required by the standard of reporting dealing

wlth disclosure.

Legal Implications.--All professions today are suf-

fering from an increasing number of legal claims. These

claims for damages are based on alleged negligence, fraud,

or malpractice on the part of the practicioner. The ex-

tens on of the attest function Is discouraged by possible

effects and ramificatlons of legal liability. Some accoun-

tants believe that an extension of the attestation function

leaves the auditor open for more legal suites.

Certainly the auditor may be held liable for his acts

of crime or tort (and rightfully so), but the extension of

the attest function as proposed in this paper should raise

no greater concern than conducting a conventional historical

audit. The auditor is exposed to no more legal responsibil-

ity in the realm of forecasting principles and standards

than he is under contemporary principles and standards.

The onslaught of claims cannot continue to increase

or even remain at the current level. The profession is

attempting in several ways (e.g., liability insurance,

agreements, and statutory relief) to solve the problem.

44

The ultimate solution appears to be the education of the

public and better definitions in the accounting discipline.

Better defined civil liability allows the business public

more confidence in the accountant's certificate. While

responsible accountants recognize their moral and legal

responsibilities, the knowledge of attached civil and

criminal liabilities acts as a deterrent to the careless

and indifferent.3^

Acceptance of Principles and Standards

The extension of the attest function to forecast is

predicated on the acceptance of the proposed principles

and standards. These principles and standards govern the

auditor more than any other factor. The American Insti-

tute of Certified Public Accountants could establish a

committee to analyze the philosophy of auditing and the

theories of accounting. The objective of the committee

should be the development of unequivocal principles and

standards of forecasting. The proposed principles and

standards would be embraced by the auditor along with

contemporary practices of forecasting.

Although different forecasting practices are being

used by firms today, standardization in forecasting would

be more easily accomplished than standardization in

35j0hn L. Carey, The CPA Plans for the Future (New York: American Institute of Certified Public Accountants, 1965), PP. 414-415.

contemporary accounting. With the authoritative support

from the AICPA, the auditor can direct the practices

employed in forecasting. Management will rely on the

auditor to deterrnine what and how data should be utilized

and reported. It is through this influence that the

aud tor has an opportunity for constructive direction in

business and the accounting profession.

The Auditor's Ability to Extend Attestation

Another important aspect of this proposal is the

capability of the accounting profession to perform the

additional service. Public accountants can accept only

additional business which they are qualified to perform.

Providing additional service now means adding additional

personnel to the accounting task force.

Knowledge and Education.--The auditor must become

more educated in the methods and techniques of forecasting

before he can perform his examination. This education

entails learning more in the areas of advanced statistics

and quantitative mathematics. In examining forecasts the

auditor must be able to recognize from different methods

and techniques the most reasonable and reliable ones under

particular business conditions.

Since the prediction of future events in a firm has

a correlation with the overall economic predictions, the

accountant must be familiar with economic indicators. The

accountant is not expected to be a prognosticator of eco-

nomic conditions, but he must evaluate the forecast of

the firm under exarnination as to consistency with the

industry and economic trends. The accountant will be

required to maintain an acute awareness of economic

theories and applications.

Although cost accounting and budgeting are major

areas of accounting study, the auditor is generally not

sufficiently acquainted with them to perform forecast

examinations. In this specific aspect of forecasting

the auditor has the advantage of being at least super-

ficially acquainted with costing and budgeting. Certainly

many public accountants are well acquainted with cost

accounting. Fewer have in-depth knowledge of budgeting.

Forecast examinations entail a healthy working knowledge

of budgeting and cost accounting. Auditors will have to

return to textbooks to reinforce cost accounting and bud-

geting know-how.

Just as practicing accountants must learn new tools

and theories, the students must learn the same tools and

theories in their education. The practicing accountant

has the advantage of only relearning some subjects which

the student is learning for the first time. The student

has the advantage of formal instruction and an academic

environment. More breadth and depth in knowledge by the

profession will be expected; thus, more time may be

47

required in educating the new accountant before he enters

the profession.

This author is not implying that accountants today

are deficient in some subjects of accounting or that some

accountants do not possess the knowledge and experience

to perform a forecast examination. This study only

attempts to bring attention to certain aspects of fore-

casting knowledge considered important in general.

The Auditor's Workload.—Attestation to forecast

statements means the auditor will have additional workload.

Many current auditing procedures will be extended to assure

the auditor reasonableness of assumptions based on histori-

cal data. New auditing programs and procedures will require

more man-hours to complete audit fieldwork and review.

Some accountants question extending attestation when the

profession is not able to accept the volume of work now

offered. Others feel that extending the scope of an audit

examination will force the cost of an audit beyond limits

clients will accept. The profession must certainly deter-

mine whether it can absorb new work within time and cost

limits .

Additional procedures will add to the cost, but ex-

tending current procedures adds only a very minimum amount

to the cost of an audit. Without determining what addi-

tional procedures are needed and experiencing utilization

of them, one cannot estimate the added cost. Under current

48

conditions the added cost might offset the benefits

derived.

The solution to the increased amount of work and

the additional cost of forecast audits is better utiliza-

tion of the trained auditor's time. Computers will take

over more of the detail tasks now performed by the audi-

tor. The auditor will begin to use the computer as an

effective tool in actually perforrning his tests and exam-_>

inations. Just âs the "tick and holler" techniques no

longer serve the auditor, today's techniques will give

way to more efficient techniques complementary to the

"new" audit. Tomorrow's auditor will be able to accept

more work and perform additional work within very accept-

able time and cost limits.

A Proposed Statement Format

The presentation of financial data is irnportant in

that it should communicate the proper picture of the firm.

Financial statements should prov de ease of communication

to the user and should "present fairly." The statements

should compare past history, past projections, present

condition, and present projections.

The appendix (p. 58) contains an example of proposed

statement presentation. In comparative form the first

column of figures is the financial data for the preceding

period. The second column is the forecast made for the

current period. The third column consists of data concern-

ing the present per od under examination. The last column

represents management's expectations for the coming period.

To place proper attention and ernphasis on these four

columns of figures, shades of colored background might be

used. A dark green might be used for the current period,

and a lighter shade of green rnight be used for the pre-

ceding period. Proper shading may also be used for the

projection columns. A red background for the current

forecast would lend the proper emphasis to that column.

The preceding forecast would be shaded with a lighter red

or pink. The user should be able to determine quickly

and easily the emphasis placed on the figures that he may

be comparing.

Comparisons of actual performance are presented by

columns one and three. Comparing column two and column

four provides a comparison of expectations. A comparison

of management's expectation and performance is made by

using columns two and three. The users of the statements

may determine the financial position in relation to the

preceding period. Management's performance may be eval-

uated in view of its past plans for the current period.

The user may then analyze management's forecast for the

coming period. The purposes of historical and forecast

statements is efficiently and effectively served in this

format.

50

The format for forecast statements must also enumer-

ate the major assumptions related to the current forecast.

Two acceptable methods may be used to provide the user

with additional information necessary for adequate dis-

closure. The first method is footnoting specific relevant

information for a particular inference. The second method

is to develop an additional statement of bases and assump-

tions which determine explicitly the inferences carried

to the forecast statement. Either method will serve the

purpose of nforming the reader of information he should

know about the forecast.

Summary

Forecast audits do not conflict with contemporary

ethics . Nor do they entail additional legal liability

provided that the auditor operates within the limits of

principles, standards and clearly defined liability.

Through education and technology the auditor will be able

to extend his attestation to forecasts and possibly to

other areas. Audited financial statements should effec-

tively and efficiently communicate to the reader emphasis

to be placed on different groups of data.

CHAPTER V

CONCLUSION

In past times forecasting was unrecognized and un-

revealed. The plans of the businessman were as uncompli-

cated as was his world. Thus, there was no necessity to

formulate and document, formally, plans and expectations.

Business entities changed v/ith tirne until statements

of financial position becarne the prominent result of

accounting records. These statements, being subject to

misstatement from fraud and negligence, were audited by

independent accountants to provide credibility to the

reported data. Still, little need for formal statements

of plans existed, and the auditor did not concern himself

with information beyond the scope of the balance sheet.

The age of mechanization and new technology brought

complexity to the business environment. Because of this

complexity the managers began to formulate plans. The

users of financial data recognized that current period

operations were as important as past history. Business

firms began to issue income statements as an attempt to

satisfy the users of financial statements. The inde-

pendent accountant attested to the income statement just

as he did the balance sheet.

51

52

The independent accountant, often referred to as the

auditor, has attained a position of prominence and influ-

ence in matters pertaining to representations in financial

statements. The auditor's profession dictates that he

consider third-party users of financial statements. The

users of financ al statements have changed from the owners

and managers in the past to the investment analyst behind

the shareholders and creditors of today.

By determining who the users of financial statements

are, the accountant/auditor is better able to determine

what data is being demanded. The analysts may determine

what type of data is relevant, but it is up to the audi-

tor to give that data credibility.

The credibility of the auditor's opinion is founded

on the principles and standards employed by him. Forecast

statements demanded by the users of financial statements

should be a product of managernent's adherence to forecast-

ing principles and of the auditor's adherence to auditing

standards for forecasts. Proposed principles of forecast-

ing in this study were logically developed from contemporary

principles of accounting. The proposed principles include:

(1) classification, (2) measurement, (3) reasonable infer-

ences, (4) consistency, (5) generally accepted accounting

principles. These principles provide forecast estimates

with utilitarian value. Standards of forecasting parallel

53

accepted standards of contemporary auditing. The proposed

standards are:

1. The examination is to be performed by a person or persons having adequate technical training and proficiency as an auditor.

2. In all matters relating to the assignment an independence in mental attitude is to be main-tained by the auditor or auditors.

3. Due professional care is to be exercised in the performance of the exarnination and the preparation of the report.

4. The work is to be adequately planned and assistants, if any, are to be properly super-vised.

5. There is to be a proper study and evaluation of the existing internal control as a basis for reliance thereon and for the determination of the resultant extent of the tests to which auditing procedures are to be restricted.

6. Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a rea-sonable basis for an opinion regarding the financial statements under exarnination.

7. The report shall state whether the forecast statement is presented in accordance with generally accepted principles of forecasting.

8. The report shall state whether such principles have been consistently observed in the prepa-ration of the forecast with relation to the preceding period.

9. The report shall state that the inferences are made by management and based on explicit assump-tions of management.

10, The report shall either contain an expression of opinion regarding the reasonableness of the assumptions and inferences in the forecast statement, taken as a whole, or an expression to the effect that an opinion cannot be expressed. In all cases where the auditor's name is associated

54

with forecast statements the report should contain a clear-cut indication of the char-acter of the auditor's examination, if any, and the degree of responsibility he is assuming.

General forecasting standards and forecast standards of

fieldwork are identical to contemporary standards since

they are concerned with general auditing performance.

Forecast auditing standards of reporting insure the user

against misrepresentations in the forecast statements.

Forecast standards are the basic guides for auditing

forecast statements'.

Implementing the proposed audit of forecasts entails

several practical implications. Limitations be professional

attitudes and the possible effects of legal liability

persuade the auditor to limit his activity. Through

education and technological advances the auditor will be

able to provide additional services of attestation to

society. The professional auditor should now take

another advancing step.

BIBLIOGRAPHY

"Accountants' Reports on Profit Forecasts." The Accoun-tant, CLX (May 3, 1969), 629-632.

"Accounting for Land, Buildings, and Equ pment." The Accounting Review, XXXIX (July, 1964), 693-69"47

Alexander, M. 0. "Financial Forecasting—A Part of the Accountant's Professional Work." Canadian Chartered Accountant, LXXXXV (October, 1969), 259-262.

Anton, Hector R. Accounting for the Flow of Funds. Bos-ton: Houghton Mifflin Company, 19~61T.

Auditing Standards and Procedures. New York: American Institute of Certified Public Accountants, 1969.

Bedford, Norton M. Income Determination Theory: An Accounting Framework. Reading, Massachusetts: Addison-Wesley Publishing Company, 1965-

Bevis, Herman W. "The CPA's Attest Function in Modern Society." The Journal of Accountancy, CXXIII (February, 1962), 28-35.

Carey, John L. The CPA Plans for the Future. New York: Ámerican Institute of Certified Public Accountants, 1965.

Cooper, W. W.; Dopuch, N.; and Keller, T. F. "Budgetary Disclosure and Other Suggestions for Improving Accounting Reports." The Accounting Review, XXXXIII (October, 1968), 640-648.

Davidson, Sidney, "Accounting and Financial Reporting in the Seventies." The Journal of Accountancy, CXXVIII (December, 19WT.

Ferrara, William L., and Hayya, Jack C. "Toward Probabi-listic Profit Budgets." Unpublished paper presented at the American Accounting Association Convention, Notre Dame, Indiana, 1969 .

55

56

"Fulminating on Forecasts." The Accountant, CLIX (August, 1968), 167-168. ' "

Haynes, W. Warren, and Massie, Joseph L. Management: Concepts and Cases . Englewood Cliffs, Nev/ Jersey: Prentice-Hall, Inc.

Hicks, Idris, and Johnson, E. C. "Expansion of Company Reporting." The Accountant, CLXI (November 15, 1969), 639-642. ~

Ijiri, Yuju. "On Budgeting Principles and Budget-Auditing Standards." The Accounting Review, XLIII (October, 1968), 662-667:

Imke, Frank J. "The Future of the Attest Function." The Journal of Accountancy, CXXII (April, 1967).

Miller-Bakewell, J. B. C. "Should the Audit Report Cover the Chairman's Review?" The Accountant, CLVIII (April, 1968), 449-450.

Moontz, Maurice, The Basic Postulates of Accounting. New York: American Institute of Certified Public Accountants, 1961.

Nielsen, Oswald. "New Challenges in Accounting." The Accounting Review, XXXV (October, 1960), 583-5W.

Pincus, Theodore H. "The Case for the Realistic Financial Forecast." Management Review, CVII (June, 1969), 33-37.

Quinn, James J. "SEC Cornmentary." The New York Certified Public Accountant, XXXVIII (June, 1969), 456-45».

"Reporting on Profit Forecasts." The Accountant, CLIX (July, 1968), 99-100.

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Wilkinson, James R., and Doney, Lloyd D. "Extending Aúdit and Reporting Boundaries." The Accounting Review, XXXX (October, 1965), 753-756.

I -

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