Question of Conformity: The Materially Nonconforming Engagement.

• Author: McCrone, Linda

the type Of report a firm receives in peer review is largely dependent on whether any of the engagements that the peer reviewer reviews arc materially nonconforming. Nonconformity ran result from deficiencies in reporting, financial statement presentation, disclosure or documentation.

In an engagement review' where the peer reviewer looks at compilations and reviews, if all the engagements arc materially nonconforming, then the peer review report rating will be a fail. If some, but not all, of the engagements reviewed are materially nonconforming, the report rating will be a pass with deficiency.

System reviews are required for firms that perform audits. In a system review, the peer reviewer looks over the system of quality control for the firm's accounting and auditing practice. If an engagement is materially nonconforming, then the peer reviewer must identify the reason the deficiency occurred and determine whether the problem is isolated or results in a systemic deficiency. The firm must be able to show that other engagements with similar circumstances were performed correctly for a problem to be considered isolated. If a firm has only a handful of engagements, this may be difficult to accomplish.

Examinations under the Statements on Standards for Attestation Engagements (SSAEs) also require a system review, but the other level of services such as agreed upon procedures can be reviewed under an engagement review.

Documentation Issues

Financial statement presentation and disclosure issues cause engagements to be nonconforming if, in the reviewer's judgment, they cause the financial statements to be misleading.

Failure to include a material demand note payable in current liabilities, misclassifying a material asset or liability, failure to present or disclose material-related party transactions or failure to provide all the required disclosures for defined benefit plans arc examples of issues that would cause an engagement to be nonconforming. Presenting accounts receivable in cash basis financial statements is another example of a presentation issue that will cause a nonconforming engagement.

For preparation, compilation and review engagements, the most common material documentation issue is the failure to obtain an engagement letter signed by both the client and the firm. Also, if the engagement letter is written for a different level of service than the service performed, the engagement will be considered nonconforming.

For example, if a firm issues a compilation report but the engagement letter is for a preparation engagement, then the engagement would be considered nonconforming.

For audit documentation, the most common deficiencies relate to lack of documentation of audit planning. A client's internal control system must be documented. Fraud risk assessment and analytical review analysis also must be documented. Audit programs are required for planning and significant...