What is “review of historical financial statements”? (Part I)

 

Historical financial information is information expressed in financial terms in relation to a particular entity, derived primarily from that entity’s accounting system, about economic events occurring in past time periods or about economic conditions or circumstances at points in time in the past.

Reviews may be performed in a variety of circumstances. For example, they may be required for entities that are exempt from requirements specified in law or regulation for mandatory audit. Reviews may also be requested on a voluntary basis, such as in connection with financial reporting undertaken for arrangements under the terms of a private contract, or to support funding arrangements.

Unlike an audit of historical financial statements (which is reasonable assurance engagement), the review of historical financial statements is a limited assurance engagement. In a review of financial statements, the practitioner expresses a conclusion that is designed to enhance the degree of confidence of intended users regarding the preparation of an entity’s financial statements in accordance with an applicable financial reporting framework. The practitioner’s conclusion is based on the practitioner obtaining limited assurance. The practitioner performs primarily inquiry and analytical procedures to obtain sufficient appropriate evidence as the basis for a conclusion on the financial statements as a whole. If there is a matter that causes the practitioner to believe the financial statements may be materially misstated, then the practitioner shall design and perform additional procedures.

 Factors that influence acceptance and continuance of client relationships and review engagements

Unless required by law or regulation, the practitioner shall not accept a review engagement if:

(a)  The practitioner is not satisfied that there is a rational purpose for the engagement or that a review engagement would be appropriate in the circumstances. For example, the engagement is intended to meet compliance requirements of relevant law or regulation and such law or regulation requires the financial statements to be audited.

(b) The practitioner has reason to believe that relevant ethical requirements, including independence, will not be satisfied.

(c) The practitioner’s preliminary understanding of the engagement circumstances indicates that information needed to perform the review engagement is likely to be unavailable or unreliable.

(d)   The practitioner has cause to doubt the management’s integrity.

(e)  Management or those charged with governance impose a limitation on the scope of the practitioner’s work.

Terms of review engagement

The practitioner shall agree to the terms of the engagement with management or those charged with governance prior to performing the engagement. The agreed terms of engagement are recorded in an engagement letter or other form of written agreement and comprise of:

(a) The intended use and distribution of the financial statements, and any restrictions on use or distribution where applicable.

(b)   Identification of the applicable financial reporting framework.

(c)   The objective and scope of the review engagement.

(d)   The responsibilities of the practitioner.

(e)   The responsibilities of management.

(f)   A statement that the engagement is not an audit, and that the practitioner will not express an audit opinion on the financial statements; and

(g)  Reference to the expected form and content of the report to be issued by the practitioner, and a statement that there may be circumstances in which the report may differ from its expected form.

The performance of engagement to review historical financial statements.

It is possible to distinguish the following stages to perform engagement to review historical financial statements:

1.     Determine materiality for the financial statements as a whole and apply this materiality in designing the procedures and in evaluating the results obtained from those procedures.

2.   Obtain an understanding of the entity and its environment, and the applicable financial reporting framework, to identify areas in the financial statements where material misstatements are likely to arise.

3.      Design and perform inquiry and analytical procedures.

4.      Design procedures to address specific circumstances:

·      Indicate the existence of related party relationships or transactions that management has not previously identified or disclosed in the financial statements.

·       Indicate whether fraud or non-compliance with laws and regulations has occurred.

·       Consider the entity’s ability to continue as a going concern.

·   Obtain evidence that the financial statements agree with, or reconcile to, the entity’s underlying accounting records.

 Inquiries of entity management and others within the entity when performing a review of historical financial statements.

To arrive at a conclusion on the reviewed financial statements as a whole, the practitioner performs primarily inquiry and analytical procedures to obtain sufficient appropriate evidence.

The practitioner’s inquiries of management and others within the entity shall include the following:

·   How management makes the significant accounting estimates required under the applicable financial reporting framework.

· The identification of related parties and related party transactions, including the purpose of those transactions.

·   Whether there are significant, unusual or complex transactions, events or matters that have affected or may affect the entity’s financial statement.

·  The existence of any actual fraud or illegal acts affecting the entity or non-compliance with provisions of laws and regulations.

·    Whether management has identified and addressed events occurring between the date of the financial statements and the date of the practitioner’s report.

·    The basis for management’s assessment of the entity’s ability to continue as a going concern.

·    Whether there are events or conditions that appear to cast doubt on the entity’s ability to continue as a going concern.

·    Material commitments, contractual obligations or contingencies that have affected or may affect the entity’s financial statements, including disclosures.

·  Material non-monetary transactions or transactions for no consideration in the financial reporting period under consideration. 

Additional procedures to perform a review of historical financial statements when the practitioner becomes aware that the financial statements may be materially misstated.

If the practitioner becomes aware of a matter(s) that causes the practitioner to believe the financial statements may be materially misstated, the practitioner shall design and perform additional procedures.

Additional procedures focus on obtaining sufficient appropriate evidence to enable the practitioner to form a conclusion on matters that the practitioner believes may cause the financial statements to be materially misstated. The procedures may comprise of:

·   Additional inquiry or analytical procedures, for example, being performed in greater detail or being focused on the affected item.

·    Other types of procedures, for example, substantive test of details (for example inspection or external conformation).

Analytical procedures in performing a review of historical financial statements.

In a review of financial statements, performing analytical procedures assists the practitioner in:

·   Identifying areas where material misstatements are likely to arise in the financial statements.

· Identifying inconsistencies or variances from expected trends, values, or norms in the financial statements.

· Providing corroborative evidence in relation to other inquiries or analytical procedures already performed.

· Serving as additional procedures when the practitioner becomes aware of matter(s) that cause the practitioner to believe that the financial statements may be materially misstated.

Various methods may be used to perform analytical procedures. These methods range from performing simple comparisons to performing complex analysis using statistical techniques. The practitioner would compare recorded amounts, or ratios developed from recorded amounts to expectations developed by the practitioner from information obtained from relevant sources. Examples of sources of information include:

·   Financial information for comparable prior period(s), taking known changes into account.

· Information about expected operating and financial results, such as budgets or forecasts including extrapolations from interim or annual data.

·   Relationships among elements of financial information within the period.

·   Information regarding the industry in which the entity operates, such as gross margin information,

·  Relationships of financial information with relevant non-financial information, such as payroll costs to number of employees.