AICPA’s Accounting & Review Services Committee (ARSC) issued SSARS No. 25, Materiality in a Review of Financial Statements and Adverse Conclusions, in February 2020 – fewer than 50 days before the COVID-19 pandemic quarantine. While the standard does not require application until reporting periods ending after Dec. 15, 2021, there are strong arguments for early adoption of SSARS 25 for 2020 review engagements.
About SSARS 25
SSARS 25 emphasizes that the significance of materiality in a review is no less relevant than in an audit. Aligning review materiality with generally accepted auditing standards (GAAS), it adds explicit requirements for CPAs to determine materiality for the financial statements as a whole and to apply this materiality in designing review procedures and evaluating the results obtained from those procedures. Currently, determining and assessing materiality is implied, although the presumption has always been that without such determination the CPA is unable to meet the fundamental objectives of a review engagement. Materiality has a significant impact on risk and identifying, assessing, and accounting for risk has become the principal focus of financial reporting, most emphatically in an assurance engagement. In a review, the CPA must obtain sufficient review evidence to serve as the basis for a conclusion on the financial statements as a whole. The CPA must also design and perform analytical procedures to address all material items in the statements (including disclosures) and all areas where the CPA believes there are increased risks of material misstatement.
There had never been a provision for CPAs to provide an adverse conclusion in a review engagement. SSARS 25, however, permits modified conclusions when the procedures performed and evidence obtained indicate that the financials are materially misstated. CPAs may apply “Qualified Conclusion” (an “except for” qualification) when the matter giving rise to the modification is material, but not pervasive, to the financial statements; or apply “Adverse Conclusion” when the matter is both material and pervasive to the financial statements (providing convergence with international guidance in ISRE 2400). Prior options had been either satisfactory remediation of the misstatements or the CPA must withdraw from the engagement. Caveat emptor: document and disclose like crazy and let the reader/user interpret the implications.
One less-publicized procedure considers inquiries of management. SSARS 25 formally codifies a requirement to make inquiries toward identifying related parties and related-party transactions, as well as inquiries about the purpose of those transactions. Another explicitly dictates the application of professional skepticism in all SSARS engagements.
One last modification: review reports must include a statement that the accountant is required to be independent of the entity and to meet the relevant ethical requirements related to the review (under the Accountant’s Responsibilities heading of the review report).
The ARSC never anticipated a pandemic that would result in economic losses in the trillions. That said, the changes in review engagements seemed almost prophetic.
In light of COVID-19, there is a lot of weight behind new stipulations for inquiries when there has been significant, unusual, or complex transactions, events, or matters that may affect the entity’s financial statements. This may include significant changes in activities or operations, or terms of contracts with material affect; any significant journal entries or adjustments; any significant transactions occurring or recognized within the reporting period; uncorrected misstatements identified in previous periods; and the effects/implications of transactions or relationships with related parties.
Consider Early Adoption
Look at what is going on around you: adoption and application of new GAAP accounting standards (such as ASC 606 or ASC 842), potential asset impairments, liabilities for contingencies and uncertainties, increased debt from various COVID-19-response funding options, maxed-out draws on credit, unreliable financial analytics, and likely going concern issues. The ability to modify a review report provides an opportunity for the company to meet covenant requirements for a review, while a qualified or adverse report can convey misstatements and the extent of pervasiveness so the third-party users can assess and evaluate. Since there has never been an option for a modified review report, pretty much no business has a loan covenant, bonding requirement, or other user-stipulated requirement for a review report that would preclude the modified review report from triggering noncompliance by the reporting entity (as there might be in a covenant requiring an audited financial statement with an unqualified report).
Early adoption of SSARS 25 would provide greater transparency and better management over the current and long-term implications of COVID-19 on the reporting entity. Whether or not this decision impacts the future creditworthiness of the business or has some other adverse implications is something management and the CPA firm should discuss and assess in the engagement planning. But without comparable analytics of a COVID-19 year to assess the reporting entity against, calendar 2020 review engagements will hinge on professional judgment and principles-based procedures to determine whether material modifications are required for the financial statements to be in accordance with the financial reporting framework.
Early adoption could be a win-win for the business and its CPA firm.
James J. Newhard, CPA, is a sole practitioner in Paoli, a CPE presenter for Kaplan Financial Education, and a past-president of PICPA’s Greater Philadelphia Chapter. He is a member of the
Pennsylvania CPA Journal Editorial Board, and serves on the AICPA Professional Ethics Executive Committee. He can be reached at firstname.lastname@example.org or on Twitter @CatalystJimCPA.