By Judith H. O’Dell, CPA, CVA, O’Dell Valuation Consulting CPA LLC

SSARS No. 21 with its Section 70, Preparation of Financial Statements, creates new opportunities for CPA firms to provide a much needed service to small and not-so-small business clients. SSARS No. 21 is effective for periods ending on or after Dec.15, 2015. Perhaps a good way to show the value of SSARS No. 21 and its Section 70 is to provide an example of how it can be useful. The recent client experience provided below offers a practical implementation, though it does not cover the full scope of Section 70.

Marian Johnson owned and operated a successful retail embroidery business; unfortunately, she also was in the process of a divorce. I was engaged to perform a valuation of the business, so I requested five years of financial statements. “Although my company is an LLC, my business income and expenses are reported on Schedule C of our joint tax return,” Marian replied. “I don’t have any financial statements. My CPA uses my accounting software to prepare the tax return.”

I explained that the business valuation process typically starts with analyzing five years of financial data to determine net asset value, cash flows, and trends to compare the business to others in the industry. Because she did not have financial statements those would have to be created from the tax returns and accounting software, which would add significantly to the cost of the valuation. The valuation report would need to comply with professional standards and be detailed enough to stand up in court.

Marian pulled up the balance sheets and income statements from her software program. Although the CPA had used the software information to prepare the tax returns, he had never given Marian any adjusting entries and ignored the balance sheet because that was not needed for the tax return. Since most of the assets had been expensed under Section 179, no fixed assets or depreciation expense were ever recorded on the books, which were maintained on the cash basis so no accounts payable or receivables had been recorded. I assisted Marian with recreating accounts receivable and accounts payable balances. She was tasked with taking an inventory of all of her equipment and supplies and determining the current fair market value of each. From this and other information, a fair market basis balance sheet was created for purposes of the valuation used in the divorce settlement. “Why didn’t my CPA help me set up my books properly to begin with?” she asked. “Why didn’t he recommend annual financial statements?”

Marian’s CPA told me that he didn’t offer further services to Marian because she had no bank debt or outside investors, thus there was no need for financial statements. His was a tax practice, and performing a compilation would subject his firm to peer review. SSARS No. 21, Section 70, has changed the game for clients like Marian and practitioners like her CPA.

SSARS No. 8’s management-use-only financial statements did not solve the problems associated with “submission and presentation” of financial statements. Now, with SSARS No. 21, we have a standard that clarifies the CPA’s responsibility for preparing financial statements. Section 70 applies when the accountant is engaged to prepare financial statements but not engaged to perform an audit, review, or compilation on those financial statements. However, Section 70 does not apply when an accountant has been engaged to merely assist in preparing the financial statements or when the accountant prepares financial statements as a by-product of another engagement. If Marian’s CPA is engaged only to prepare her tax return using her accounting software and makes any necessary adjustments, he could print out the financial statements and give them to her for her files. Under Section 70, he was not engaged to prepare the financial statements. They are a by-product of the tax engagement. Many CPAs may not be comfortable with this. In that case, they can add a “preparation” service to their tax engagement letters and follow the requirement of Section 70. But what about peer review, you may ask? Well, firms that only perform preparation engagements are not required to enroll in the AICPA Peer Review Program, although state licensing requirements may be different.

Every business owner will one day exit the business, whether through sale, retirement, gifting, death, closing the doors, or, in some cases, divorce. Clients without debt may one day need to approach a bank for a loan. Financial statements are usually the first thing a banker, buyer, valuation analyst, attorney, or other interested party will request. Tax returns are generally used as a check against what is reflected in the financial statements, but they are difficult to work with since information is scattered throughout the return. CPA firms, especially those providing services to small, closely held business face increasing competition from cloud-based accounting services and tax preparation services. To maintain the role of “trusted advisor” CPAs should discuss with their clients the advantages of having a history of annual financial statements on hand. The discussion can include the traditional levels of service that can be provided as well the new tool in the tool box – the Section 70 preparation service - when appropriate. Your client may thank you for your foresight one day.