AU 504: Association with Financial Statements

AU EFFECTIVE DATE AND APPLICABILITY

Original Pronouncements Statements on Auditing Standards (SASs) 26, 35, and 72.
Effective Date These statements currently are effective.
Applicability Accountants’ reports on:
1. Unaudited financial statements of public entities
2. Comparative financial statements of public or nonpublic entities when the financial statements of one period are audited
3. Financial statements of public entities when the accountant is not independent

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.

These requirements will be superseded by AU-C 600. For more information, see the separate chapter on AU-C 600.

AU DEFINITIONS OF TERMS

Association. An accountant is associated with financial statements when he or she has consented to the use of his or her name in a report, document, or written communication containing the statements, or when he or she submits to the client or others financial statements that he or she has prepared or assisted in preparing.

NOTE: The accountant would be associated with the financial statements even though his or her name did not appear.

Public entity. Any entity (1) whose securities trade in a public market either on a domestic or foreign stock exchange or in the over-the-counter market, including securities quoted only locally or regionally, (2) that makes a filing with a regulatory agency in preparation for the sale of any class of its securities in a public market, or (3) a subsidiary, corporate joint venture, or other entity controlled by an entity described in (1) or (2).

OBJECTIVES OF AU SECTION 504

In 1978, the Accounting and Review Services Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement on Standards for Accounting and Review Services (SSARS) 1, Compilation and Review of Financial Statements. SSARS 1 applies to unaudited financial statements of nonpublic entities.

The basic purpose of this section was to replace existing sections that covered all unaudited financial statements. It updated the SASs for SSARSs by removing guidance for unaudited financial statements of nonpublic entities.

This section provides guidance to the accountant when he or she is associated with a public entity’s unaudited financial statements:

1. Prepared in conformity with generally accepted accounting principles (GAAP)
2. Prepared in accordance with comprehensive basis of accounting (OCBOA) other than GAAP (see Section 623, Special Reports)
3. Not in conformity with GAAP or OCBOA
4. On which the accountant provides negative assurance

The section also provides guidance to the accountant when he or she is associated with:

1. A public entity’s financial statements that are unaudited because the accountant is not independent
2. A public or a nonpublic entity’s unaudited and audited financial statements presented in comparative form

FUNDAMENTAL REQUIREMENTS

Unaudited Financial Statements

The basic requirements are

1. When an accountant is associated with financial statements of a public entity, but has not audited or reviewed them, the accountant should disclaim an opinion. His or her report should only identify the financial statements and state that they were not audited and that no opinion is expressed.
2. Each page of the financial statements should be marked “UNAUDITED.”
3. The accountant should read the financial statements. He or she has no responsibility to apply any other procedures.
4. Procedures applied should not be described in the accountant’s report.
5. For public entities that do not have annual audits, the accountant should refer to SSARSs for guidance.

Report on GAAP Financial Statements

An accountant associated with a public entity’s unaudited GAAP financial statements should follow the preceding guidance and issue the following report illustrated in AU 504.05:

The accompanying balance sheet of Widget Company as of December 31, 20X1, and the related statements of income and retained earnings, and cash flows for the year then ended, were not audited by us and, accordingly, we do not express an opinion on them.

[Signature]

[Date]

Report on OCBOA Financial Statements

An accountant associated with a public entity’s unaudited OCBOA financial statements should basically follow the guidance presented earlier in “Unaudited Financial Statements,” but the report language should be modified to recognize the basis of accounting. An example of such a report is illustrated in AU 504.07.

The accompanying statement of assets and liabilities resulting from cash transactions of Widget Corporation as of December 31, 20X1, and the related statement of revenues collected and expenses paid during the year then ended were not audited by us and, accordingly, we do not express an opinion on them.

[Signature]

[Date]

A note to the financial statements should describe the basis of accounting and how it differs from GAAP; however, the monetary effect of the difference does not have to be presented.

Report Modified for Lack of Independence

An accountant who is not independent with respect to a public entity’s financial statements should basically follow the guidance in “Unaudited Financial Statements,” explained earlier in this section, but the report language should be modified to recognize the lack of independence. The accountant should disclaim an opinion on the financial statements and state that he or she is not independent. The reason the accountant is not independent, however, should not be described in the report. An example of such a report is illustrated in AU 504.10.

We are not independent with respect to Widget Company, and the accompanying balance sheet as of December 31, 20X1, and the related statements of income and retained earnings and cash flows for the year then ended were not audited by us and, accordingly, we do not express an opinion on them.

[Signature]

[Date]

If he or she is not independent with respect to the financial statements of a nonpublic entity, the accountant should follow the guidance in Statements on Standards for Accounting and Review Services (SSARSs).

Financial Statements Not in Conformity with GAAP

An accountant associated with a public entity’s unaudited financial statements that are not in conformity with GAAP (for inadequate disclosure, see below) should suggest that they be revised. If the statements are not revised, the accountant should describe the departure in his or her report. The description should refer to the nature of the departure and, if possible, state the effects on the financial statements. If the effects are not reasonably determinable, the report should state this fact. (Accountants’ reports on unaudited financial statements not in conformity with GAAP are presented in the “Illustrations” section.) If management does not revise the financial statements or does not accept the accountant’s report with the description of the departure, the accountant should refuse to be associated with the financial statements and, if necessary, withdraw from the engagement.

Inadequate Disclosure in Financial Statements

An accountant associated with a public entity’s unaudited financial statements that do not contain adequate disclosure should describe this departure from GAAP in his or her report and, if practicable, include the necessary information for adequate disclosure. When it is not practicable to include omitted disclosures in the report, the accountant should state this fact. For example, when all, or substantially all, disclosures have been omitted, the accountant should indicate this in the report; however, he or she is not expected to include the omitted disclosures. (An accountant’s report on unaudited financial statements that do not include adequate disclosure is presented in “AU Illustrations.”) If the client does not revise the financial statements or does not accept the accountant’s report with the description of the inadequate disclosure, the accountant should refuse to be associated with the financial statements and, if necessary, withdraw from the engagement.

NOTE: If a nonpublic entity omits all, or substantially all, disclosures from its unaudited financial statements, the accountant should follow the guidance of SSARSs in reporting on these financial statements. SSARSs prescribe specific wording for this situation. That wording may be used in a similar report on a public entity, but this section does not require use of that specific language.

Audited and Unaudited Financial Statements in Comparative Form

For documents filed with the SEC, unaudited financial statements presented in comparative form with audited financial statements should be marked “UNAUDITED.” The unaudited financial statements should not be referred to in the auditor’s report.

NOTE: The reason for this different treatment is the legal significance of including a “report” in an SEC filing.

For all other documents, the unaudited financial statements should be marked “UNAUDITED,” and the report on the prior period should be reissued or the report on the current period should include a separate paragraph describing the responsibility assumed for the prior period’s financial statements.

NOTE: For information on the reissuance of auditors’ reports, see Section 530, Dating of the Independent Auditor’s Report; for information on the reissuance of compilation or review reports, see SSARS 2 (Section 3200).

Prior Period Audited—Current Period Unaudited

When the prior period financial statements were audited and the report on the current period will have a separate paragraph about those financial statements, the separate paragraph should contain the following:

1. The financial statements of the prior period were audited previously
2. The date of the previous period’s report
3. The type of opinion previously issued
4. If the opinion of the previous period was other than unqualified, the reason
5. No auditing procedures were performed after the date of the previous period’s report

An example of an appropriate separate paragraph from AU 504.16 is as follows:

The financial statements for the year ended December 31, 20X1, were audited by us, and we expressed an unqualified opinion on them in our report dated March 1, 20X2, but we have not performed any auditing procedures since that date.

Prior Period Unaudited—Current Period Audited

When the financial statements of the prior period were not audited and the report on the current period will have a separate paragraph about those financial statements, the separate paragraph should contain the following:

1. A statement indicating the service performed in the prior period
2. The date of the previous period’s report
3. A description of any material modifications noted in the previous period’s report
4. A statement that the service was less in scope than an audit and that the service does not provide a basis for expressing an opinion on the financial statements taken as a whole

Public Entity Financial Statements

If the financial statements are those of a public entity, the separate paragraph should include an “unaudited” disclaimer of opinion or a description of a review, whichever is appropriate.

Nonpublic Entity Financial Statements

If the financial statements are those of a nonpublic entity and they were compiled or reviewed, the separate paragraph should describe the service performed. The separate paragraph describing a review, illustrated in AU 504.17, might be as follows:

The 20X1 financial statements were reviewed by us, and our report thereon, dated March 1, 20X2, stated we were not aware of any material modifications that should be made to those statements for them to be in conformity with generally accepted accounting principles. However, a review is substantially less in scope than an audit and does not provide a basis for the expression of an opinion on the financial statements taken as a whole.

The separate paragraph describing a compilation, also illustrated in AU 504.17, might be as follows:

The 20X1 financial statements were compiled by us, and our report thereon, dated March 1, 20X2, stated we did not audit or review those financial statements and, accordingly, express no opinion or other form of assurance on them.

Negative Assurance

Ordinarily, when a disclaimer of opinion is issued, it should not be modified by the accountant’s expression of assurance that he or she has no knowledge of departures from generally accepted accounting principles. Exceptions to this general rule follow:

1. Review reports as described in SSARS 1
2. Letters for underwriters in which the auditor reports on his or her limited procedures with respect to unaudited financial statements or other financial data necessary for a securities offering (see Section 634, Letters for Underwriters and Certain Other Requesting Parties)
3. Review reports on interim financial information (see Section 722, Interim Financial Information)

Client-Prepared Communication

A public entity may prepare a written communication containing financial statements that have not been audited or reviewed and name the accountant in the document. In these circumstances, the accountant should request that (1) his or her name not be included or (2) that the financial statements be marked “UNAUDITED” and a notation made that he or she does not express an opinion on them. If the client does not comply, the accountant should advise the client that the accountant has not consented to the use of his or her name and should consider other actions, such as consulting his or her lawyer.

INTERPRETATIONS

Annual Report Disclosure of Unaudited Fourth Quarter Interim Data (Issued November 1979; Revised November 2002; June 2009)

Unless specifically engaged to do so, the auditor does not have an obligation to audit interim data—such as disclosure of fourth quarter adjustments—presented in a note to annual audited financial statements. Disclosure of fourth quarter adjustments is a requirement, in certain circumstances, of FASB ASC 270-10-50 on interim financial information, and is not essential for fair presentation of annual financial statements in conformity with GAAP. The note would ordinarily be marked to indicate it has not been audited. Omission of the note disclosure when required should be mentioned in the audit report, but would not result in a qualified opinion because the annual financial statements reported on would conform with GAAP.

Auditor’s Identification with Condensed Financial Data (November 1979)

Financial reporting services, such as Dun & Bradstreet, furnish subscribers with information that frequently includes identification of the entity’s auditor, condensed financial information, and other data. The auditor and the entity do not have the ability to restrain a financial reporting service from publishing this information. In this context, the accountant has not consented to the use of his or her name, there is no “association” in the sense of Section 504, and there is no reporting obligation.

Applicability of Guidance on Reporting When Not Independent (November 1979)

In determining whether he or she is independent and whether the reporting requirements of Section 504 therefore apply, the accountant should consider the ethical requirements of the AICPA and the relevant state society of CPAs or state board of accountancy. These ethics requirements should be considered in evaluating independence whether the financial statements are audited or unaudited.

TECHNIQUES FOR APPLICATION

Reporting on Tax Returns

SAS and SSARS requirements do not apply to any tax returns or other forms (such as Form 990) filed solely with taxing authorities. This means: If it is a tax form, the accountant may sign it and not issue a report. Financial statements that correlate with the data in the return may be attached as a supplement to the return without triggering a reporting obligation. If the client wants it or if the CPA firm adopts a policy requiring it, however, an accountant’s report in conformity with the applicable SAS or SSARS is permissible.

Unaudited Financial Statements in SEC Filings

The Securities Act of 1933 imposes a heavy legal burden on the auditor and other professionals. Section 11 of the Act allows any person who purchased securities described in the registration statement to sue the auditor. Under this section, all the purchaser must do is prove that the financial statements were misleading or materially misstated. The auditor has the burden of demonstrating as a defense that, among other things, an adequate audit was conducted in the circumstances.

Because of the burden placed on the auditor by Section 11 of the 1933 Act, he or she should not explicitly report on unaudited statements in a registration statement filed with the SEC under the 1933 Act.

AU ILLUSTRATIONS

When an accountant reads a public company’s unaudited financial statements, he or she may become aware of departures from GAAP, including inadequate disclosures. Following are reports describing these departures in the following situations:

1. Inventories stated below cost—effects of departure not determined
2. Land recorded at appraised values—effects of departure determined
3. Omission of disclosure—restrictions on retained earnings

If the effects of a GAAP departure have been determined, the effects should be disclosed, but the accountant need not undertake to determine the effects.

Illustration 1. Inventories Stated Below Cost—Effects of Departure Not Determined
The accompanying balance sheet of the XYZ Company as of December 31, 20X1, and the related statements of income and retained earnings and cash flows for the year then ended were not audited by us, and accordingly, we do not express an opinion on them.
Under generally accepted accounting principles, the components of inventory cost are material, labor, and overhead. Management has informed us that the inventory of finished goods is stated in the accompanying financial statements at material cost only. The effects of this departure from generally accepted accounting principles on the accompanying financial statements have not been determined.
Illustration 2. Land Recorded at Appraised Values—Effects of Departure Determined
The accompanying balance sheet of the XYZ Company as of December 31, 20X1, and the related statements of income and retained earnings and cash flows for the year then ended were not audited by us, and accordingly, we do not express an opinion on them.
Under generally accepted accounting principles, land is ordinarily stated at cost. Management has informed us that the Company has recorded its land at appraised value and that if generally accepted accounting principles had been followed, the land account would have been decreased by $______.
Illustration 3. Omission of Disclosure—Restrictions on Retained Earnings
The accompanying balance sheet of the XYZ Company as of December 31, 20X1, and the related statements of income and retained earnings and cash flows for the year then ended were not audited by us, and accordingly, we do not express an opinion on them.
The financial statements do not disclose that the debentures issued on July 31, 20X1, limit the payment of cash dividends to 50% of earnings for 20X1 and thereafter. Generally accepted accounting principles require disclosure of matters of this nature.
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