Changes to the Rules of Financial Information Compilation Engagements

The IAASB on October 28, 2010 released for public comment the exposure draft of Proposed International Standard on Related Services (ISRS) 4410, Compilation Engagements as the revision of the extant ISRS 4410, Engagements to Compile Financial Statements.

Within the Explanatory Memorandum of the ED, the IAASB noted that it believes the proposed ISRS will help practitioners performing compilation engagements around the world converge on use of a globally accepted benchmark for such engagements.

There are several key principles within the revision of ISRS 4410 which underlying the financial information compilation engagement :

1. Clearly distinguishable from audits and reviews of financial statements (that is, assurance engagements)
2. Meaningful for users, in context of the benefit delivered from application of professional expertise in accounting and financial reporting, and compliance with relevant professional standards and ethical principles
3. Able to be performed on a cost-effective basis

The proposed ISRS 4410 makes clear that the procedures employed in a compilation engagement are not designed, and do not enable the practitioner, to express any assurance on the financial information. It explains, however, that users of the compiled financial information derive benefit from application of the practitioner’s expertise in accounting and financial reporting and compliance with professional standards, including delivering the service in accordance with the ethical principles of integrity, objectivity, professional competence and due care.

The proposed engagement standard has also been developed to be capable of being used on a stand-alone basis for engagement performance purposes, without the need for practitioners to refer to the International Standards on Auditing (ISAs) or the review engagement standards. This recognizes that practitioners who regularly undertake compilations in their professional practices may not necessarily perform assurance engagements, and therefore may not maintain up-to-date familiarity with developments in assurance standards.

Within the Scope of Proposed ISRS 4410, the IAASB emphasized the importance to obtain respondents’ views on the intended scope of proposed ISRS 4410, which is different from the scope of extant ISRS 4410.

It said that the practitioners can have many different forms of involvement in compiling information in different situations to meet various types of needs. Practitioners may also provide a variety of communications in the course of providing various types of services commonly referred to as “accounting services.” The IAASB determined that the focus of proposed ISRS 4410, however should be on where the practitioner compiles historical financial information using the applicable financial reporting framework specified in the terms of the compilation engagement. This is the most common context for compilation engagements encountered in practice, and is the most relevant to a broad range of users of historical financial information, in particular in the SME sector.

Accordingly, the IAASB determined that proposed ISRS should be focused to apply in the following circumstances :

1. When the practitioner is engaged to compile historical financial information in accordance with the proposal ISRS; and
2. Where the practitioner provides a report for the engagement in accordance with the requirements of the proposed ISRS.

Proposed ISRS 4410 is premised on the basis that a firm providing compilation engagements under the standard is required to apply, or has applied, ISQC 1 or requirement that are at least as demanding.

The proposed ISRS also requires the practitioner to determine, at the time of accepting the engagement, that the applicable financial reporting framework to be used for the compilation is acceptable, in the practitioner’s judgment, in view of the intended use of the financial information and the intended users. The practitioner cannot accept an engagement under the proposed ISRS if this overall test is not met (see Proposed ISRS 4400 (revised), paragraph 23(b)).

Read further the publication of ED ISRS 4410 from the IFAC Press Center : IAASB Addresses Compilation Engagements; Exposes Enhanced Standard

The requirements of an independent auditor in forming an opinion on the audited financial statements

ISA 700 states that the objectives of the auditor (independent auditor) are :

1. To form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained; and
2. To express clearly that opinion through a written report that also describes the basis for that opinion

In this ISA, the meaning of financial statements is a complete set of general purpose financial statements, including the related notes, which ordinarily comprise a summary of significant accounting policies and other explanatory information.

Regarding the financial statements, the auditor (independent auditor) shall form an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

As stated in para. 11 of ISA 700, in order to form that opinion, the auditor shall conclude as to whether the auditor has obtained reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. That conclusion shall take into account :

1. The auditor’s conclusion, in accordance with ISA 330, whether sufficient appropriate audit evidence has been obtained;
2. The auditor’s conclusion, in accordance with ISA 450, whether uncorrected misstatements are material, individually or in aggregate; and
3. The evaluations required by paragraphs 12-15.

Then, para. 12 states that the auditor shall evaluate whether the financial statements are prepared, in all material respects, in accordance with the requirements of the applicable financial reporting framework. This evaluation shall include consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgments.

Following, para. 13 states that in particular, the auditor shall evaluate whether, in view of the requirements of the applicable financial reporting framework :

1. The financial statements adequately disclose the significant accounting policies selected and applied;
2. The accounting policies selected and applied are consistent with the applicable financial reporting framework and are appropriate;
3. The accounting estimates made by management are reasonable;
4. The information presented in the financial statements is relevant, reliable, comparable, and understandable;
5. The financial statements provide adequate disclosures to enable the intended users to understand the effect of material transactions and events on the information conveyed in the financial statements; and
6. The terminology used in the financial statements, including the title of each financial statement, is appropriate.

Further, para. 14 of ISA 700 prescribes that when the financial statements are prepared in accordance with a fair presentation framework, the evaluation required by paragraphs 12-13 shall also include whether the financial statements achieve fair presentation. The auditor’s evaluation as to whether the financial statements achieve fair presentation shall include consideration of :

1. The overall presentation, structure and content of the financial statements; and
2. Whether the financial statements, including the related notes, represent the underlying transactions and events in a manner that achieves fair presentation.

While, para. 15 requires the auditor to evaluate whether the financial statements adequately refer to or describe the applicable financial reporting framework (Hrd).

A guide to an initial assessment of Control Risk

Control Risk is the risk that a material error in an account will not be prevented or detected on a timely basis by the client’s internal control structure.

Assessing control risk is the process of evaluating the effectiveness of an entity’s internal control structure in preventing or detecting material misstatements in the financial statements.

Control risk must ultimately be assessed in terms of financial statement assertions. For example, there should be separate assessments of the existence and completeness assertions for sales.

Control risk may be assessed at the maximum level or below the maximum.

An initial assessment of control risk at the maximum occurs when (1) controls do not pertain to an assertion, (2) controls that pertain are unlikely to be effective, or (3) evaluating the effectiveness of relevant controls would be inefficient. An assessment of control risk below the maximum means that there are effective controls to prevent or detect misstatements in a financial statement assertion. The assessment of control risk below the maximum should be based on evidence of the operating effectiveness of the controls.

Control risk may be expressed qualitatively such as low, moderate, or high. Alternatively, the risk may be stated quantitatively as a percentage or a numerical probability such as .75 or 1.0. The initial assessment of control risk starts with the auditor’s understanding of the control environment followed by his knowledge of the accounting system. If management’s attitude toward controls is good, the likelihood of making an initial assessment of control risk below the maximum is enhanced. In some cases, the initial assessment may be based on the effectiveness of the controls in the prior year’s audit, provided that the auditor has determined that such controls are still effective in the current year.

Assessing control risk is a matter of professional judgment. In making the assessment, it is necessary for the auditor to :

1. Identify misstatements that could occur in financial statement assertions.
2. Identify the controls that could likely prevent or detect the misstatements.
3. Obtain evidence from test of controls as to whether the controls are operating effectively.

The first two steps should be performed for all material financial statement assertions. The third step is required only when the auditor assesses control risk below the maximum (Hrd).

Source : Modern Auditing – Walter G. Kell, William C. Boynton & Richard E. Ziegler