Reviews, the next phase

By Don Jeffreys & John Kirkwood
Illustration: Jason Schnieder

Revisions expand Section 7050 and impact auditors reviewing interim financial statements

What The Auditing and Assurance Standards Board has issued revised recommendations that will be of interest to all auditors engaged by clients to review their interim financial statements. The revisions result from adoption of recent changes in the equivalent standard in the US and of proposals contained in an international exposure draft. The revised Section 7050 of the CICA Handbook — Assurance, Auditor Review of Interim Financial Statements became effective concerning auditor communications made on or after April 1 with respect to an interim review. This timing was designed to coincide with the introduction of a National Instrument of the canadian Securities Regulators, Continuous Disclosure obligations, which was effective for interim financial statements in financial years beginning on or after January 1, 2004.

When it was first issued in April 2001, Section 7050 was modeled on AICPA Auditing Standards Board SAS  No. 71, Interim Financial Information. In November 2002 the board issued SAS No. 100, which substantially expanded on the procedural aspects of an interim review formerly set out in SAS No. 71. More recently, in June 2003 the International Auditing and Assurance Standards Board issued an exposure draft, Review of Interim Financial Information Performed by the Auditor of the Entity. (As this new standard had not been issued at the time of writing this article, the final outcome cannot be predicted.)
 
The revisions to Section 7050 update and expand the section. They deal mainly with the procedural aspects of an interim review and extend the guidance such that it is largely consistent with the procedural aspects of SAS 100 and, as far as possible, that of the proposed international standard.

In the revised section, the nature of the procedures remains the same — enquiry, discussion and analysis. A review of interim financial statements is very different from an audit of annual financial statements. Where an audit is comprehensive and definitive, an interim review is tentative and intuitive. If a review is performed on a timely basis, the auditor normally has at most a few days to complete the work after the statements have been prepared and before they are issued. An auditor must rely more heavily on his or her background knowledge of the business and internal control and must address differences in the nature of the accounting information available in support of the financial statements. What has changed is that the revised section provides more detailed guidance to assist the auditor in performing this type of review.

The main additions and changes in the section are as follows:

•  Reference to statements prepared in accordance with another appropriate basis of accounting has been deleted. The scope of the auditor's review is limited to interim statements to be issued under provisions of securities legislation or regulation. Consequently there is a presumption that statements under review will be prepared according to generally accepted accounting principles.

•  An illustrative example of an engagement letter is provided in the appendix.

•  Discussion of the auditor's procedures has been expanded in paragraphs 7050.34-.35 and in the appendix, which contains illustrations of analytical procedures and unusual and significant events and transactions to be considered. 

• There is a new requirement that the auditor obtain evidence that interim financial statements are in agreement with, or can be reconciled to, the accounting records, a shift from the general principle that the auditor's procedures do not go beyond enquiry, discussion and analysis. 

• A limitation in scope of the auditor's review is now considered to result in an incomplete review. Consequently, the auditor may not issue an interim review report, either written or oral. However, the auditor must still communicate to the audit committee any apparent misstatements, identified control weaknesses, or instances of actual, suspected or alleged fraud or illegal or possibly illegal acts, as discussed in paragraphs 7050.17, .39 and .47-.48.

• The importance of the auditor's knowledge of the business and internal control has been emphasized by expanding the discussion of these matters in paragraphs 7050.27-.33.

• New material dealing with the auditor's evaluation of the results of the review discusses apparent misstatements; the effect of misstatements in other periods; the effect of misstatements in the current period on statements of other periods; and the issue of materiality.

• The auditor is required to obtain written representations from management and the appendix includes illustrative examples of management representation letters.

In the introductory part of the section, several paragraphs have been added to explain why an auditor would not agree to issue a written consent to the publication of an interim review report. Securities legislation permits others to rely on the report of an expert such as an accountant or auditor and avoid liability for a misstate-ment in data such as financial statements, when the expert has issued a written consent to the use of the report.
 
However, in performing an interim review, the auditor does not apply the standards that characterize the auditor as an expert — that is, auditing standards. The AASB is concerned that if an auditor were to issue a written consent to the use of an interim review report, a court would hold the auditor to the "expert" standards of the profession — that is, auditing standards — and not to the very limited standards that apply to an interim review. For this reason, Section 7050 now contains a new recommendation that prohibits the auditor from issuing a written consent to the use of an interim review report, except in the rare circumstances when consent is required, according to securities legislation, to the use of the report in a prospectus.

In the United States and Canada, reporting has generally been done orally or in a private written communication to the audit committee. Although US and Canadian pronouncements provide a suggested form for a written report, such reports have been issued to the public in only a handful of cases. Section 7050 focuses on the auditor's review as a form of assistance to the audit committee in carrying out its responsibilities to review the interim statements. 

The only respect in which Section 7050 diverges significantly from SAS No. 100 and the IAASB exposure draft is in the reporting — the IAASB draft proposes requiring the auditor to issue a written report, while Section 7050 and SAS No. 100 do not. In July 2003, Canadian securities regulators (Canadian Securities administrators) stated "[the CSA] will consider whether by January 1, 2006, we should require for some, or all, reporting issuers a level of auditor involvement with interim financial statements that is transparent to the public through a report from the auditor that is filed with the commissions." Currently, Section 7050 provides that a written interim review report contain a final paragraph restricting its use to the audit committee or other addressee and disclaiming responsibility on the part of the auditor to any third party who may rely on it.

In anticipation of a possible requirement that a written report of the auditor be published, the AASB has undertaken to revisit the reporting issue to determine whether a more suitable form of written interim review report can be devised.

Don Jeffreys, CA, is a principal in the CICA's Assurance Standards department. John Kirkwood, CA, is a consultant to the CICA's Assurance Standards department.

Technical editor: Bob Rutherford, vice-president, Standards