In October 2014, the American Institute of CPAs’ (AICPA) Accounting and Review Services Committee released its new Statement on Standards for Accounting and Review Services No. 21 (SSARS 21). The new standards are considered by the profession to be the most substantial change to accounting standards since the 1970s. Plus, it introduced a financial reporting gift: a new level of service called preparation of financial statements.
The new standards are effective for financial reporting periods beginning on or after Dec. 15, 2015. While early adoption is permitted, there have been a lot of questions about the implementation of SSARS 21 over the past 12 months.
The purpose of this article is to analyze the implications of one piece of SSARS 21 – Section 70 – on the CPA profession, from the perspectives of both the provider and the user of accounting services.
What Changes with SSARS 21?
SSARS 21 consists of four sections that are codified with the prefix AR-C:
- Section 60, General Principles of Engagements Performed in Accordance with Statements on Standards for Accounting and Review Services
- Section 70, Preparation of Financial Statements
- Section 80, Compilation Engagements
- Section 90, Review of Financial Statements
AR-C sections 60 and 90 are largely unchanged compared with existing statements. AR-C Section 80 is the revised standard for compilation engagements, which was simplified and shortened. The main change in compilation standards is that they are now only applicable when the CPA is engaged to provide a compilation, instead of when the CPA “submits” the financial statements to management. The old criterion of submission (according to which a compilation report is required when the CPA “submits” financial statements) was removed in the new standard. The new standard also eliminates the “management’s use only” financial statements option and has replaced it with AR-C Section 70. It is AR-C Section 70 that is new, and it is the focus of this article.
AR-C Section 70, Preparation of Financial Statements
The new section applies when a CPA is engaged to prepare financial statements, but not engaged to perform an audit, review, or compilation. Like the compilation, the preparation of financial statements is a nonassurance service, it requires an engagement letter, can omit notes, and can be used outside of management. Unlike the compilation, however, there is no disclosure requirement regarding the CPA’s independence, and the financial statements do not have to be accompanied by a report.
In terms of disclosures, the preparation engagement only requires a legend on each page stating that no assurance is provided. The name of the CPA firm is not required. If the financial statements were prepared according to a special-purpose financial reporting framework (such as modified cash basis), a description of the framework should be added on the face of the financial statements or as a note. If the CPA is aware of a departure from GAAP or other chosen financial reporting framework, a disclosure should be added on the face of the financial statements or as a note. If the departure was intended to mislead users, the CPA should not prepare the financial statements.
It is important to note that AR-C Section 70 does not apply if the CPA is only engaged as a consultant to merely assist in preparing the financial statements or if the CPA prepares the financial statements as a by-product of another engagement, such as preparing tax returns or a personal financial plan. In addition, it does not apply when the CPA is an employee of the company.
Regarding whether or not the preparation engagement is subject to peer review, the AICPA clarified in early 2015 that it is subject to peer review if the CPA firm is already subject to peer review because of other engagements (compilation, review, or audit) or if the CPA firm elects to enroll. The preparation engagement is not subject to peer review if the firm only performs preparation engagements. The Pennsylvania CPA Statute only requires peer review if a firm perform audits, examinations, or reviews. So, firms that only prepare financial statements using the preparation standard will not be required to enroll and undergo peer review for Pennsylvania licensing purposes. If firms have any questions or are unsure, or are accounting practices outside Pennsylvania, they should consult their state board of accountancy to determine if enrollment in peer review is required.
The impact of SSARS 21 – and AR-C Section 70, in particular – is twofold. First, it creates a level of service that is better adapted to today’s business environment and needs. Second, it makes CPA firms more competitive in the outsourcing market.
Better Fit for Today’s Business Environment
AR-C Section 70 brings a level of service that was not codified until now. With these CPA-prepared financial statements, the standards are more in line with the needs of users who do not require a report, particularly among privately held companies.
Before SSARS 21, a CPA firm was required to provide a report if financial statements were to be used outside of management. “Management” was very narrowly defined, such that third-party users included even financially sophisticated investors and boards of directors that were relatively close to the company’s operations. In many accounting outsourcing arrangements where a CPA firm provided CFO/controller services, the firm would trip into the reporting requirement by way of simply submitting financial statements, despite neither the client’s management nor external constituencies needing or wanting the formality of compiled financial statements accompanied by a compilation report. (For an excellent summary of this issue, see “The Traps Inherent to Providing Accounting Services,” published in the spring 2014 Pennsylvania CPA Journal.)
The compilation report is often viewed as little more than a “necessary evil,” with limited value and a paradoxical message to the reader in its attempt to distinguish between financial statement presentation and management’s underlying information, which itself is often the result of the CPA’s own work in an accounting outsourcing engagement. As a result, the outsourcing engagement becomes more expensive for the client due to the additional cost of the compilation procedures and report. This has put CPA firms at a competitive disadvantage when vying for outsourcing engagements versus non-CPA firms or independent consultants that provide interim management, financial advisory services, or business processing outsourcing. It also made it more difficult for CPA firms to position themselves as a cost-effective alternative to the client’s own internal accounting function that would not face these same compliance requirements. To be competitive, CPA firms often had to absorb the additional cost and sacrifice profitability.
AR-C Section 70 eliminates this issue.
From a user perspective, when financial statements are to be distributed to third parties, the preparation engagement is expected to be more convenient and efficient than the predecessor compilation engagement. Clients that previously received management-use-only financial statements can now freely distribute those financial statements to third parties if or when necessary. In the past, the client would be prohibited from doing so unless the financial statements were upgraded to a compilation accompanied by a report.
From the CPA firm’s perspective, the preparation engagement makes it easier to provide outsourced accounting and controller and CFO services in a way that is cost-effective relative to non-CPA firm competitors or internal staff. The provider no longer needs to choose between issuing a compilation report (at a greater cost to the client or to itself) or restricting the financial statements to management’s use only. In addition, CPAs no longer have to be concerned about whether simply submitting the financial statements would be a trigger for determining if a compilation report is required or not, a decision process that had become increasingly ambiguous with today’s cloud-based accounting systems. With AR-C Section 70, CPAs can more easily adapt their services to the realities of today’s business environment.
More Competitive Accounting Outsourcing Services
In response to growing demand for outsourcing services among small- and medium-sized businesses, CPA firms have embraced cloud-based software technology and have significantly expanded their accounting outsourcing practices. According to the AICPA’s 2014 MAP Survey, adoption of cloud-based software among CPA firms has increased from 29 percent to 48 percent between 2012 and 2014. Accounting outsourcing services accounted for 13 percent of total net client fees among CPA firms, with the smaller practices having the highest accounting outsourcing revenues as a percentage of total fees. Indeed, accounting outsourcing services as a percentage of total fees range from 27 percent for the smallest firms down to 3.9 percent for the largest firms. In addition, compilations (as a percentage of total fees) range from 7 percent for the smallest firms down to 2.3 percent for the largest firms. Cloud technology has made CPA firms more efficient and effective, and as a result, it has made accounting outsourcing more profitable for CPA firms and more economical for their clients.
SSARS 21 should improve the competitiveness of CPA firms because the new statement is better suited for accounting outsourcing services. AR-C Section 70 allows CPA firms to approach the preparation of historical financial statements within the context of an outsourcing engagement in a manner comparable to internal CFOs or controllers, without being hamstrung by the cost of producing compilation reports that clients and their constituencies do not need or want.
Accounting outsourcing is a vast market where CPA firms compete against non-CPA firms. With AR-C Section 70, CPA firms will be able to leverage their accounting expertise and differentiate themselves by offering CPA-prepared financial statements according to AICPA standards. Contrary to non-CPA firm competitors, CPA firms are licensed and are subject to codes of ethics and the regulations of state boards of accountancy and CPA professional organizations. Although CPA-prepared financial statements are provided with no assurance, they are prepared by professionals with acknowledged expertise and under recognized standards. In addition, where the value proposition of other accounting outsourcing industry players is focused on labor arbitrage and cost reductions in transactional back-office accounting activities, CPA firms can differentiate themselves with broader capabilities, ranging from strategic advisory services (such as business planning, business valuation, CFO services, performance analytics, benchmarking, and working capital management optimization) to highly specialized and technical advisory services (such as mergers and acquisitions, technology consulting, and tax advisory services).
Preparation of Financial Statement Engagements
The specific requirements under AR-C Section 70, Preparation of Financial Statements, are relatively straightforward. As discussed earlier, key requirements include a written engagement agreement, a statement on the financial statements that no assurance is provided, and disclosure of departures from GAAP (or other chosen financial reporting framework) either on the face of the financial statements or in notes to the financial statements. Documentation requirements are limited to the engagement letter and a copy of the financial statements prepared. Documentation of significant consultations or significant professional judgments may also be included.
When applicable under SSARS 21 or required for licensure, a peer review on financial statement preparation engagements is more in-depth than a management-use-only engagement review.
The peer review should include the following:
- The engagement letter.
- The legend on each page stating that no assurance is provided.
- Titles for any special-purpose frameworks used.
- Whether or not the financial statements are in accordance with the framework chosen.
- The disclosures of departures if applicable.
Although not specifically set forth in AR-C Section 70, we recommend that CPA firms also consider the following as they define their internal policies and processes, and develop the related tools, checklists, and methodologies for delivering preparation engagements:
- Pre-engagement determination as to whether the engagement constitutes a preparation engagement or merely assistance in preparing financial statements, which is considered a bookkeeping service not subject to SSARS.
- Quality controls around the underlying accounting processes that, in an outsourced accounting engagement, may be integral to the preparation of financial statements, including month-end closing adjustments, reconciliations, and significant estimates.
- Quality controls to ensure that the financial statements are in compliance with GAAP (or other chosen financial reporting framework), or that known departures are appropriately identified and disclosed.
- Internal review and approval of prepared financial statements by an appropriately qualified professional prior to issuance.
- Standardization of language that will be used on the financial statements. While AR-C Section 70 requires that, at a minimum, there be a statement indicating that no assurance is provided, there is flexibility allowed in the full statement that is used. Standard language for GAAP exceptions should also be defined.
- Although the firm’s name is not required on the financial statements, firms may wish to consider a consistent “look and feel” for the resulting deliverable, including formatting, placement of the necessary “no assurance” statement, and any other disclosures.
To take advantage of the benefits of AR-C Section 70, CPA firms may seek to convert existing compilation engagements to financial statement preparation engagements, assuming there is no explicit client need for a compilation report. In addition to executing new engagement letters, CPA firms should be diligent about communicating and explaining this new level of service and the resulting deliverable, not only to clients but also to their external constituencies, such as investors and lenders who have become accustomed to receiving compilation reports.
Although CPA firms should gain efficiencies by replacing compilation reports with financial statements prepared under AR-C Section 70, existing engagements for management-use-only financial statements may actually become a bit more complicated, at least during the initial process of converting them to preparation engagements. Management-use-only financial statements are eliminated by SSARS 21, so these “plain paper” financial statements will have to have the necessary statement that no assurance is provided, and known GAAP exceptions must be disclosed when they may not have been previously. This change should be carefully communicated to clients, along with the advantage that they are free to distribute the financial statements when warranted.
CPA firms that, for whatever reason, do not wish to offer the new preparation of financial statements service should note that, to the extent they have management-use-only engagements, these will be eliminated under SSARS 21. So, if management-use-only engagements are not converted to preparation engagements, they must be converted to formal compilations.
As CPAs transition to the new service, it is critical that their internal processes be aligned with the new statements to minimize litigation risk. It is too early to evaluate the litigation threat with these engagements, but it is expected to be similar to compilation engagements. As with most firm services, litigation risk can be mitigated by adhering to applicable AICPA standards, defining and following quality-control policies within the firm, and documenting compliance in both instances.
With SSARS 21, the CPA profession has taken a significant step toward addressing the needs of both the users and providers of accounting services in today’s cloud-technology-driven world. The profession has enhanced its position by aligning with market needs and enabling CPA firms to capitalize upon the growing market for accounting outsourcing in small to midsized companies. Most importantly, it will do so and still maintain the professional standards that distinguish the value proposition of CPA firms from other service providers.
This article was reprinted with permission from the “Pennsylvania CPA Journal,” a publication of the Pennsylvania Institute of Certified Public Accountants.