AU 625: Reports on the Application of Accounting Principles

AU-C 915: Reports on Application of Requirements of an Applicable Financial Reporting Framework

AU EFFECTIVE DATE AND APPLICABILITY

Original Pronouncement Statements on Auditing Standards (SASs) 50 and 97.
Effective Date These statements currently are effective.
Applicability Reports providing advice on the application of accounting principles to specific transactions or providing advice on the type of opinion that may by rendered made as a part of a proposal or otherwise by an accountant other than the entity’s continuing accountant. (See the following sections.)

AU-C EFFECTIVE DATE AND SUMMARY OF CHANGES

SAS No. 122, Codification of Auditing Standards and Procedures, is effective for audits of financial statements with periods ending on or after December 15, 2012.

AU-C 915 does not change extant requirements in any significant respect.

The term “financial reporting framework” replaces the term “generally accepted accounting principles,” and “requirements of an applicable financial reporting framework” replaces “application of accounting principles.”

APPLICABILITY

Section 625 applies to providing written advice

1. On the application of accounting principles to specified transactions (completed or proposed) involving facts and circumstances of a specific entity
2. On the type of opinion that may be rendered on a specific entity’s financial statements

The section applies to these situations whether the advice is provided as part of a proposal to obtain a new client or as a separate engagement.

Section 625 applies to oral advice in the following circumstances:

1. The reporting accountant concludes the advice is intended to be used by a principal as an important factor in reaching a decision; and
2. The advice relates to the application of accounting principles to a specific transaction or the type of opinion that may be rendered on a specific entity’s financial statements.

Section 625 does not apply to:

1. A continuing accountant engaged to report on the financial statements of a specific entity
2. An engagement to either assist in litigation involving accounting matters or provide expert testimony in litigation (i.e., litigation service engagements)
3. Advice provided to another accountant in public practice
4. Position papers on accounting principles or the type of opinion that may be rendered, including: newsletters, articles, speeches, lectures, or other public presentations; letters to standard-setting bodies

However, if position papers are intended to provide guidance on specific transactions or the type of opinion on a specific entity’s financial statements, the section applies.

When facing a hypothetical transaction, a reporting accountant cannot know whether a continuing accountant has reached a different conclusion on applying accounting principles to the same transaction or how the specific entity previously accounted for similar transactions. Therefore, written reports on hypothetical transactions are prohibited.

AU DEFINITIONS OF TERMS

Continuing accountant. An accountant who has been engaged to report on the financial statements of a specific entity. An accountant engaged to perform services other than reporting on the entity’s financial statements is not considered a continuing accountant.

Hypothetical transactions. Transactions that do not involve facts and circumstances of a specific entity.

Reporting accountant. An accountant other than the continuing accountant, engaged in the practice of public accounting as defined by American Institute of Certified Public Accountants (AICPA) Rules of Conduct, who prepares a written report or provides oral advice on the application of accounting principles to specified transactions involving facts and circumstances of a specific entity, or the type of opinion that may be rendered on a specific entity’s financial statements.

Specific transactions. Completed or proposed specified transactions of a specific entity.

Written report. For the purposes of applying this section, a written report includes any written communication that expresses a conclusion on the appropriate accounting principles to be applied or the type of opinion that may be rendered on an entity’s financial statements.

AU-C DEFINITIONS OF TERMS

Source: AU-C 915.08

For purposes of this section, the following terms have the meanings attributed as follows:

Continuing accountant. An accountant who has been engaged to report on the financial statements of a specific entity or entities of which the specific entity is a component.

Hypothetical transaction. A transaction or financial reporting issue that does not involve facts or circumstances of a specific entity.

Reporting accountant. An accountant, other than a continuing accountant, in the practice of public accounting, as described in ET Section 92, Definitions, who prepares a written report or provides oral advice on the application of the requirements of an applicable financial reporting framework to a specific transaction or on the type of report that may be issued on a specific entity’s financial statements (a reporting accountant who is also engaged to provide accounting and reporting advice to a specific entity on a recurring basis is commonly referred to as an advisory accountant).

Specific transaction. A completed or proposed transaction or group of related transactions or a financial reporting issue involving facts and circumstances of a specific entity.

Written report. Any written communication that provides a conclusion on the appropriate application of the requirements of an applicable financial reporting framework to a specific transaction or on the type of report that may be issued on a specific entity’s financial statements.

OBJECTIVES OF AU SECTION 625

In today’s complex financial reporting environment, there is an increasing tendency for entities to consult with CPA firms other than their own auditors on accounting or financial reporting issues. This practice is sometimes called “opinion shopping”—a term that implies that the client will shop around until it finds an auditor who will agree with its position and then hire that auditor. A less pejorative term for the practice is obtaining a “second opinion.” The implication of the term “second opinion” is that the motivation of the client arises from lack of clear-cut answers to accounting problems created by the fluid and constantly evolving environment of business today.

Section 625 addresses the concerns of financial statement users and regulators about opinion shopping. It would be inappropriate to prohibit second opinions because it would stifle the free exchange of ideas within the financial community and would restrict the ability of reporting entities and others to consider alternatives in determining appropriate financial reporting for new or emerging issues. Also, as a practical matter, the AICPA cannot afford to take action that might be viewed by the Federal Trade Commission as restricting competition.

Before providing advice to another CPA’s client, a CPA should inform the entity of the need to consult with the other CPA and communicate with that CPA. The objective of this communication is primarily to determine whether the entity and its auditors have disagreed, and if so, whether the disagreement is about facts or about how relevant accounting principles should be applied.

SAS 50 permitted reports on hypothetical transactions, which were reports on the application of accounting principles not involving facts and circumstances of a particular principal. The SEC subsequently expressed concerns about the appropriate use of these reports and whether such reports were in the best interest of the public. In response to the SEC’s concerns, the Auditing Standards Board issued SAS 97, Amendment to Statement on Auditing Standards No. 50, Reports on the Application of Accounting Principles, in June 2002. SAS 97 revised SAS 50 to prohibit written reports on hypothetical transactions.

OBJECTIVES OF AU-C SECTION 915

AU-C 915.07 states that:

. . . the objective of the reporting accountant, when engaged to issue a written report or provide oral advice on the application of the requirements of an applicable financial reporting framework to a specific transaction or on the type of report that may be issued on a specific entity’s financial statements, is to address appropriately

a. the acceptance of the engagement.
b. the planning and performance of the engagement.
c. reporting on the specific transaction or type of report.

FUNDAMENTAL REQUIREMENTS

Performance Standards

1. The reporting accountant should:
a. Exercise due professional care
b. Be adequately trained and proficient
c. Plan the engagement adequately and supervise the work of assistants, if any
d. Accumulate sufficient information to provide a reasonable basis for the professional judgment described in the report
2. The reporting accountant should evaluate:
a. The circumstances under which the written report or oral advice is requested
b. The request’s purpose
c. The intended use of the written report or oral advice
3. The reporting accountant should:
a. Understand the form and substance of the transaction(s)
b. Review applicable generally accepted accounting principles (GAAP)
c. If appropriate, consult with other professionals or experts
d. If appropriate, perform research or other procedures to identify appropriate precedents or analogies
4. When evaluating accounting principles for a specific transaction or determining the type of opinion that may be issued on a specific entity’s financial statements, the reporting accountant should:
a. Consult with the entity’s continuing accountant to determine all the available facts relevant to forming a professional judgment
b. Obtain available facts that the continuing accountant may be able to provide that include:
(1) The transaction’s form and substance
(2) How management has applied accounting principles to similar transactions
(3) Whether management disputes the accounting method the continuing accountant recommends
(4) Whether the continuing accountant has arrived at a different conclusion than the reporting accountant
c. In communicating with the continuing accountant, follow the guidance on communications between predecessor and successor auditors (Section 315).

Reporting Standards

A written report should be addressed to the requesting entity (for example, management or the board of directors of the entity) and should ordinarily:

1. Briefly describe the engagement
2. State that the engagement was performed in accordance with applicable AICPA standards
3. Identify the specific entity and describe the following:
a. The transactions
b. Relevant facts, circumstances, and assumptions
c. Sources of information
4. Present a conclusion on the appropriate accounting principles (including an identification of the country of origin) to be applied or type of opinion that may be rendered.
5. If appropriate, describe the reasons for the conclusion.
6. If appropriate, state that the responsibility for proper accounting treatment rests with preparers of financial statements who should consult their continuing accountants.
7. State that any differences in the facts, circumstances, or assumptions presented might change the report.
8. Include a separate paragraph at the end of the report that:
a. States that the report is intended solely for the information and use of the specified parties
b. Identifies the parties
c. States that the report is not intended to be, and should not be, used by nonspecified parties

INTERPRETATIONS

Requirement to Consult with the Continuing Accountant (Issued January 2005)

An advisory accountant does not need to consult with the continuing accountant when the facts and circumstances of the engagement indicate that he or she is not being asked for a second opinion, and has obtained all relevant information to provide guidance to the client. This is especially the case for a recurring engagement, where the client is likely to be shopping for an opinion. If the advisory accountant does not consult with the continuing accountant, then consider documenting the reasons for not doing so.

TECHNIQUES FOR APPLICATION

The following practice problems that might arise are discussed:

1. Engagement acceptance
2. Applicability to proposals
3. Responding to intermediaries
4. Documentation

Engagement Acceptance

A CPA firm should adopt policies and procedures concerning the acceptance and approval of engagements to furnish an opinion letter on the application of accounting principles or the type of opinion to be rendered on financial statements.

It is important to understand the purpose of the request, the nature of the issue on which advice is requested, and whether there is a disagreement between the client and its continuing accountant. Before Section 625 was issued, many CPAs would not accept such an engagement if the client would not permit contact with the continuing accountant. However, some firms made a distinction between completed and proposed transactions and did not insist on contact before providing advice on proposed transactions.

The rationale for not insisting on contact for proposed transactions was that future transactions could not affect current financial statements. Interpretation 201-3 of the Code of Professional Ethics, which was in effect at the time, referred to providing advice on matters in connection with the financial statements of another CPA’s client. Section 625 now clearly requires contact with the other CPA in these circumstances because it applies to specific transactions, both completed and proposed.

Applicability to Proposals

For many practitioners, the most common situation in which Section 625 will apply is making a proposal for a new client. Not every proposal will be affected, but the requirements are applicable when a prospective client asks for the proposal to include the proposing firm’s position on a specific accounting issue or the type of opinion that may be rendered on its financial statements in specific circumstances.

In all circumstances, before accepting an engagement, the successor auditor needs to communicate with the predecessor (Section 315, Communications Between Predecessor and Successor Auditors). However, when Section 625 applies, the communication should include more specific inquiries explicitly directed to disagreements about the subject on which a position is requested and should take place before the proposal is made rather than merely before acceptance of the audit engagement. In ordinary circumstances, communication does not take place until a predecessor has been terminated and does not take place during the proposal process (see Section 315). A request to include an opinion on accounting principles or type of audit opinion in a proposal changes the requirements.

Note that Section 625 focuses on accounting matters and the type of opinion that may be rendered. It does not broadly address auditing matters. This means that a proposal may discuss general matters of audit scope, such as overall approach, locations to be visited, and similar matters without creating a requirement to contact the continuing accountant before making the proposal.

Documentation

Section 625 does not impose any requirement to document the procedures used or information obtained to provide a basis for the professional judgment described in the report. However, the authors recommend the following documentation:

1. A description of the problem, including all relevant facts and circumstances. (Preferably this should be prepared by the client.)
2. If applicable, a summary of the discussions with the continuing accountant.
3. A description of the procedures followed to determine the accounting practices that would be appropriate in the circumstances, including citations to relevant authoritative literature.

If the engagement is terminated before a report is issued, documentation of the engagement to that point is generally desirable but not essential.

AU ILLUSTRATION

The following example of a report on the application of accounting principles to a specific transaction is from AU 625.11.

Illustration 1. Report on the Application of Accounting Principles to a Specific Transaction
Introduction
We have been engaged to report on the appropriate application of accounting principles generally accepted in [country of origin of such principles] to the specific transaction described below. This report is being issued to Widget Company for assistance in evaluating accounting principles for the described specific transaction. Our engagement has been conducted in accordance with standards established by the American Institute of Certified Public Accountants.
Description of Transaction
The facts, circumstances, and assumptions relevant to the specific transaction as provided to us by the management of Widget Company are as follows:
[Describe facts, circumstances, and assumptions or refer to attached description.]
Appropriate Accounting Principles
[Describe the advice on application of GAAP.]
Concluding Comments
The ultimate responsibility for the decision on the appropriate application of accounting principles generally accepted in [country of origin of such principles] for an actual transaction rests with the preparers of financial statements, who should consult with their continuing accountants. Our judgment on the appropriate application of accounting principles generally accepted in [country of origin of such principles] for the described specific transaction is based solely on the facts provided to us as described in a prior section; should these facts and circumstances differ, our conclusion might change.
Restricted Use
This report is intended solely for the information and use of the board of directors and management of Widget Company and is not intended to be and should not be used by anyone other than these specified parties.

AU-C 915 ILLUSTRATION

Illustration 1. Illustrative Written Report to the Requesting Party
The following is an illustration of the reporting accountant’s written report to the requesting party (for example, management or those charged with governance) on the application of the requirements of accounting principles generally accepted in the United States of America to a specific transaction.
Introduction
We have been engaged to report on the appropriate application of the requirements of accounting principles generally accepted in the United States of America to the specific transaction described below. This report is being issued to ABC Company for assistance in evaluating accounting policies for the described specific transaction. Our engagement has been conducted in accordance with Statement on Auditing Standards No. 122, Section 915, Reports on Application of Requirements of an Applicable Financial Reporting Framework.
Description of Transaction
The facts, circumstances, and assumptions relevant to the specific transaction as provided to us by the management of ABC Company are as follows:
[Text discussing the facts, circumstances, and assumptions relevant to the specific transaction]
Appropriate Accounting Principles
[Text discussing accounting principles generally accepted in the United States of America and how they apply to the described transaction]
Concluding Comments
The ultimate responsibility for the decision on the appropriate application of the requirements of accounting principles generally accepted in the United States of America for an actual transaction rests with the preparers of financial statements, who should consult with their continuing accountant. Our conclusion on the appropriate application of the requirements of accounting principles generally accepted in the United States of America for the described specific transaction is based solely on the facts provided to us as previously described; should these facts and circumstances differ, our conclusion may change.
Restricted Use
This report is intended solely for the information and use of those charged with governance and management of ABC Company and is not intended to be and should not be used by anyone other than these specified parties.
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