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thesis entitled

A STUDY OF THE EFFECTS OF COMPILATION AND REVIEW
REPORTS ON CPAS' AND BANKERS' PERCEPTIONS OF
THE RELIABILITY OF FINANCIAL STATEMENTS

presented by

Larry Joe Rankin

has been accepted towards fulfillment
of the requirements for

Ph.D. Accounting, Business

degree in

Ca w

Alvin A. Arens

 

Major professor

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A STUDY OF THE EFFECTS OF COMPILATION AND REVIEW
REPORTS ON CPAS' AND BANKERS' PERCEPTIONS OF
THE RELIABILITY OF FINANCIAL STATEMENTS

By

Larry Joe Rankin

A DISSERTATION

Submitted to
Michigan State University
in partial fulfillment of the requirements
for the degree of

DOCTOR OF PHILOSOPHY

Department of Accounting

1982

 

 

ABSTRACT

A STUDY OF THE EFFECTS OF COMPILATION AND REVIEW
REPORTS ON CPAS' AND BANKERS' PERCEPTIONS OF
THE RELIABILITY OF FINANCIAL STATEMENTS

By

Larry Joe Rankin

This thesis empirically tested the effectiveness of the com-
munication process between CPAs and bankers within the framework of
financial reporting for nonpublic businesses. The aspect of the com-
munication process investigated was the similarities with which CPAs
and bankers perceive assurances about the reliability of financial
statements accompanied by no CPA report and statements accompanied
by the CPA's compilation report, review report, and audit report.
Reliability was defined as the extent to which financial statements
are (l) in conformity with generally accepted accounting principles,
(2) accompanied by all material disclosures, (3) free from the
effects of material unintentional errors, (4) free from the effects
of material management fraud, (5) free from the effects of material
employee fraud, and (6) evaluated by a CPA who is independent of
management.

Questionnaires were mailed to 200 randomly selected Michigan
CPAs, 130 randomly selected Michigan commercial bank loan officers

from large banks, and 70 randomly selected Michigan chief executive

Larry Joe Rankin
officers from small banks. The questionnaire depicted four conditions:
no CPA association with the financial statements and statements accom-
panied by the CPA's compilation report, review report, and audit
report. Following each condition, the CPAs and bankers rated each of
the six reliability surrogates on a seven-point rating scale which
ranged from "no confidence" to "complete confidence."

The following conclusions resulted from the analysis of
responses:

1. CPAs and users do not share similar views about the
reliability of financial statements when the statements are accomr
panied by the CPA's compilation report, review report, or audit
report. For each of these reports, users attribute less assurances
to the reliability of the statements than CPAs.

2. Both CPAs and users perceive differences in the relia—
bility of financial statements accompanied by no CPA report, com—
pilation report, review report, and audit report. CPAs and users
correctly perceive that CPAs provide increasing assurances about the
reliability of the statements in the order of compilation reports,
review reports, and audit reports.

The findings indicated that users do not attribute audit-type
assurances to compilation and review reports. The findings also sug—
gested that the accounting profession has successfully implemented an
assurance level approach with respect to CPA reports on financial

statements of nonpublic businesses.

 

Copyright by
LARRY J. RANKIN

1982

DEDICATION

To the Lord Jesus Christ, Son of God,
Who provides assurances to man about
forgiveness, salvation, and eternal life.

ACKNOWLEDGMENTS

I am grateful to the many people who assisted me with this
dissertation and to the special friends who encouraged me with my
doctoral studies.

First, I appreciate Professor Alvin A. Arens, Professor
D. Dewey Ward, and Professor James Stapleton for serving as my dis-
sertation committee. Professor Arens, chairman of the committee,
was especially helpful in the development of the research topic and
in the organization of the dissertation. Professor Ward offered
many useful suggestions about the research methodology and writing
style. Professor Stapleton provided excellent assistance in the
statistical aspects of the research. To all my committee members,

I valued their competence, wise counsel, and patience.

Several other people were instrumental in the completion of
this dissertation. Theresa Hornsby assisted in typing early drafts
of the dissertation. Jo McKenzie typed the final draft. Boonreang
(Nid) Kajornsior was extremely helpful in writing computer programs.
Ellen Foxman and Margo Bogart contributed significantly to the dis-
sertation with their editorial comments.

I am very thankful for the special friends who greatly encour-
aged me during my doctoral studies. I particularly appreciate Pearl
Bera, Carol Johns, and the James Bilby family for their loving friend—

ship and spiritual support. I also owe much to the congregation at

iv

the Saginaw First United Methodist Church and to the camp staff at
Lake Louise for their encouragement. Finally, I am especially grateful
to my loving parents and family for their faithful support and

assurances o

TABLE OF CONTENTS

ACKNOWLEDGMENTS. . . . . . . . . . . . . . . . . . . . . .

LIST OF TABLES . . . . . . . . . . . . . . . . . . . . . . .

LIST OF FIGURES. . . . . . . . . . . . . . . . . . . . . . .

Chapter

I.

II.

INTRODUCT ION . O O O O O O O O O O O O O O O O O 0

Overview . . . . . . . . . . . . . . . . . . . .
Organization . . . . . . . . . . . . . . . . .
Definition of Terms. . . . . . . . . . . . . . .
CPA-User Communication . . . . . . . . . . . .
CPA Association with Financial Statements . .
CPA Assurances on Financial Statements. . . .
Meaning of the Reliability of
Financial Statements . . . . . . . . . .
General Meaning of Reliability in
the Literature . . . . . . . . . . . . .
Specific Meaning of Reliability . . . . . .
Need for Research about the CPA-User
Communication Process . . . . . . . . . . . . .
Problems with Unaudited Financial Statements.
Potential Problems with Compilations
and Reviews. . . . . . . . . . . . . . . . .
Objectives of the Study. . . . . . . . . . . . .
Research Methodology . . . . . . . . . . . . . .
Sample Selection. . . . . . . . . . . . . . .
The Questionnaire . . . . . . . . . . . . . .
Statistical Analyses. . . . . . . . . . . . .
Contributions. . . . . . . . . . . . . . . . . .
Summary. . . . . . . . . . . . . . . . . . . . .

REVIEW OF PREVIOUS RESEARCH. . . . . . . . . . . .

Guy, Greenway, Miller, and Mills . . . . . . . .
Description of the Study. . . . . . . . . . .
Major Findings and Conclusions. . . . . . . .
Major Findings Related to the

Present Research . . . . . . . . . . . . . .

Winters. . . . . . . . . . . . . . . . . . .

Description of the Study. . . . . . . . . . .

vi

Page

iv

xiii

21
22

25
26
31
31
32
32
33
33

35

35
35
36

37
37
37

Page

Major Findings and Conclusions. . . . . . . . . . 39
Major Findings Related to the
Present Research . . . . . . . . . . . . . . . . 40
Fiebelkorn . . . . . . . . . . . . . . . . . . . . 40
Description of the Study. . . . . . . . . . . . . 40
Major Findings and Conclusions. . . . . . . . . . 41
Major Findings Related to the
Present Research . . . . . . . . . . . . . . . . 42
Bainbridge . . . . . . . . . . . . . . . . . . . . 43
Description of the Study. . . . . . . . . . . . . 43
Major Findings and Conclusions. . . . . . . . . . 44
Major Findings Related to the
Present Research . . . . . . . . . . . . . . . . 45
Pany . . . . . . . . . . . . . . . . . . . . . . . 46
Description of the Study. . . . . . . . . . . . . 46
Major Findings and Conclusions. . . . . . . . . . 47
Major Findings Related to the
Present Research . . . . . . . . . . . . . . . . 48
Libby. . . . . . . . . . . . . . . . . . . . . . 49
Description of the Study. . . . . . . . . . . . . 49
Major Findings and Conclusions. . . . . . . . . . 50
Major Findings Related to the
Present Research . . . . . . . . . . . . . . . . 51
Reckers and Pany . . . . . . . . . . . . . . . . 52
Description of the Study. . . . . . . . . . . . . 52
Major Findings and Conclusions. . . . . . . . . . 53
Major Findings Related to the
Present Research . . . . . . . . . . . . . . . . 53
Summary of Findings and Limitations. . . . . . . . . 54
Findings. . . . . . . . . . . . . . . . . . . . . 54

Limitations . . . . . . . . . . . . . . . . . . . 55
Improvements Made by the Present Research. . . . . . 58
Summary. . . . . . . . . . . . . . . . . . . . . . . 59
III. REVIEW OF LEGAL CASES. . . . . . . . . . . . . . . . . 60
Stanley L. Bloch, Inc. v. Klein. . . . . . . . . . . 62
Description of the Case . . . . . . . . . . . . . 62

Court Decision Related to the

Present Research . . . . . . . . . . . . . . . . 63
1136 Tenants' Corporation v. Max Rothenberg
and Co. . . . . . . . . . . . . . . . . . . . . . 63
Description of the Case . . . . . . . . . . . . . 63
Court Decision Related to the
Present Research . . . . . . . . . . . . . . . . 65
Ryan v. Kanne. . . . . . . . . . . . . . . . . . . . 66
Description of the Case . . . . . . . . . . . . . 66
Court Decision Related to the
Present Research . . . . . . . . . . . . . . . . 67
MacNerland v. Barnes . . . . . . . . . . . . . . . . 68
Description of the Case . . . . . . . . . . . . . 68

vii

Iv.

Page

Court Decision Related to the

Present Research . . . . . . . . . . . . . . . . 69
Bonhiver v. Graff. . . . . . . . . . . . . . . . . . 69
Description of the Case . . . . . . . . . . . . . 69
Court Decision Related to the
Present Research . . . . . . . . . . . . . . . . 70

Coleco Industries, Inc. v. Berman v.
Zelnick, Sobelman and Company . . . . . . . . . . . 71

Description of the Case . . . . . . . . . . . . . 71
Court Decision Related to the
Present Research . . . . . . . . . . . . . . . . 72
Seedkem, Inc. v. Safranek. . . . . . . . . . . . . . 72
Description of the Case . . . . . . . . . . . . . 72
Court Decision Related to the
Present Research . . . . . . . . . . . . . . . . 73
Summary of Court Decisions and Their
Relationship to the Present Research. . . . . . . . 74
Summary of the Court Decisions. . . . . . . . . . 74
Relationship to the Present Research. . . . . . . 76
Summary. . . . . . . . . . . . . . . . . . . . . . . 76

DEVELOPMENT OF COMPILATIONS AND REVIEWS. . . . . . . . 78

Developing Auditing Standards: 1896-1946. . . . . . 79
Recognizing Unaudited Financial Statements:

1947-1961 . . . . . . . . . . . . . . . . . . . . . 82
Unaudited Financial Statements. . . . . . . . . . 82
Limited Procedure Engagements . . . . . . . . . . 85

Standards for Unaudited Financial Statements:
1962—1976 . . . . . . . . . . . . . . . . . . . . . 86

Unaudited Financial Statements. . . . . . . . . . 86
Limited Procedure Engagements . . . . . . . . . . 92
Development of Compilations and Reviews. . . . . . . 94
Compilations. . . . . . . . . . . . . . . . . . . 97

ReViews O O O O O O O O O O O O O O O O O O O O O 100
Summary. . . . . . . . . . . . . . . . . . . . . . . 101

METHODOLOGY. . . . . . . . . . . . . . . . . . . . . . 103

Research Questions and Research Hypotheses . . . . . 103
The Questionnaire. . . . . . . . . . . . . . . . . . 107
Questionnaire Bias . . . . . . . . . . . . . . . . . 108
Rating Scale Errors . . . . . . . . . . . . . . . 108
Sequencing Effects of Repeated Measures . . . . . 109
Reliability . . . . . . . . . . . . . . . . . . . 110
Content Validity. . . . . . . . . . . . . . . . . 112
Confounding Variables . . . . . . . . . . . . . . 112
Bankers. . . . . . . . . . . . . . . . . . . . . . . 114
Sample Selection. . . . . . . . . . . . . . . . . 115
Response Analysis . . . . . . . . . . . . . . . . 116
Nonresponse Bias. . . . . . . . . . . . . . . . . 116

viii

VI.

VII.

Certified Public Accountants . .
Sample Selection. . . . . . .
Response Analysis . . . . . .
Nonresponse Bias. . . . . .

Statistical Analyses . . . . . .
Statistical Design. . . . . .
Multivariate Mbdel. . . . .
Multivariate Data Analysis.
Univariate Test Statistics.
Assumptions of the Models . .

Summary. . . . . . . . . . . . .

RESIJLTS O O O O O O O O O O 0

Mean Scores and Standard Errors.
Group Effects. . . . . . . . . .
Results . . . . . . . . . .
Meaning of the Results. . .
Degree of Association Effects. .
Results . . . . . . . . . .
Meaning of the Results. .
Reliability Surrogate Effects. .

Results . . . . . . . . . . .

Meaning of the Results. .
Familiarity Effects. . .

Results . . . . . . . . . .

Meaning of the Results. . .
Summary. . . . . . . . . . . . .

SUMMARY OF RESULTS, CONCLUSIONS, AND

IMPLICATIONS.

Summary of the Results and Conclusions . . . .

Secondary Objectives. . . . .
Implications . . . . . . . . . .
Limitations of the Results . . .
Suggestions for Future Research.

SELECTED BIBLIOGRAPHY. . . . . . . . . . .

APPENDIX

Banker Cover Letters and Questionnaire . . . . . .

CPA Cover Letter and Questionnaire .

Banker and CPA Follow-up Postcards
and Cover Letters . . . . . . .

Banker Demographic Data. . . .

CPA Demographic Data . . .

ix

Page

122
122
122
124
124
126
129
131
131
133
133

135

136
138
138
150
154
155
166
168
170
181
182
182
185
186

188
189
195
198
201
202

205

210

219

227

232

235

Table

LIST OF TABLES

Limitations of the Previous Research .
Unaudited Financial Statements: 1946. . .

Unaudited Financial Statements and
Limited Procedure Engagements: 1961 . .

Unaudited Financial Statements: 1976. .
Limited Procedure Engagements: 1976 . . .
Compilations and Reviews . . . . . . .

Results of ANOVA F-Tests: Sequencing
Effects of Repeated Measures . . . .

Banker Responses to Mailings .

Analysis of Inappropriate Banker Responses .

Results of ANOVA F—Tests: Large Bank
CBLO Responses by Time Periods . . . .

Results of 'ANOVA F—Tests: Small Bank
CEO Responses by Time Periods. . . . . .

Comparisons of Small Bank CEOs Responding
by Mail and by Telephone: Familiarity
with Compilations and Reviews. . . . . .

CPA Responses to Mailings. . . . . . . . .

Analysis of Inappropriate CPA Responses. .

Results of ANOVA F-Tests: CPA Responses
by Time Periods. . . . . . . . . . . . .

Results of Mean Scores and Standard Errors .

Results of Group Effects: Large Bank
CBLO and CPA Comparisons . . . . . . .

Results of Group Effects: Small Bank
CEO and CPA Comparisons . . . . . . . .

X

Page
56

81

84
89
93

98

111
117

117

119

120

121

123

123

125

137

139

140

Table

6-10

6-11

6-12

6-13

6-14

6-15

6-16

Results of Multivariate Repeated Measures
F-Tests on Five Dependent Variables:
Large Bank CBLO and CPA Comparisons. . .

Results of Multivariate Repeated Measures
F-Tests on Five Dependent Variables:
Small Bank CEO and CPA Comparisons . . .

Results of Repeated Measures F-Tests on
One Dependent Variable: Large Bank
CBLO and CPA Comparisons . . . . . . . .

Results of Repeated Measures F-Tests on
One Dependent Variable: Small Bank
CEO and CPA Comparisons. . . . . . . . .

Results of Degree of Association Effects:
Comparisons of No CPA Association
to Compilations. . . . . . . . . . . . .

Results of Degree of Association Effects:
Comparisons of Compilations to Reviews .

Results of Degree of Association Effects:
Comparisons of Reviews to Audits . . . .

Ratings of Independence when the Financial
Statements are Accompanied by the CPA's
Compilation Report . . . . . . . . . . .

Results of Reliability Surrogate Effects:
Pair Comparisons of Reliability Surro-
gates for No CPA Association . . . . . .

Results of Reliability Surrogate Effects:
Pair Comparisons of Reliability Surro-
gates for Compilations . . . . . . . . .

Results of Reliability Surrogate Effects:
Pair Comparisons of Reliability Surro-
gates for Reviews. . . . . . . . . . . .

Results of Reliability Surrogate Effects:
Pair Comparisons of Reliability Surro-
gates for Audits . . . . . . . . . . . .

Familiarity Effects: Responses of Large

Bank CBLOs and Small Bank CEOs to Questions

About Compilations and Reviews . . . . .

xi

Page

. . . . . . 148

O O O 148

O O O O O O 151

. . . . . 151

. . . . . . 156

O O O I O 157

. . . . . 158

. . . . . . 169

. . . . . . 172

O O O O O O 174

. . . . 177

. . . . . . 180

. . . . . 183

Table

6-17

7-1

7-2

Appendix
Table

D-l
D—2

D-3

Familiarity Effects: Responses of CPAs
to Questions About Compilations and Reviews. . . .

Results of Mean Scores . . . . . . . . . . . . . .

Results of Familiarity Questions . . . . . . . . .

Professional Titles of Responding Bankers. . . . .
Size (M? Bank Represented by Responding Bankers. . .

Commercial Banking Experience of Responding
Bankers. . . . . . . . . . . . . . . . . . . . . .

Age of Responding Bankers. . . . . . . . . . . . . .
Education of Responding Bankers-

Professional Titles of CPA Respondents . . . . . . .
Type of Firm Represented by CPA Respondents. . . .
Specialty Area of CPA Respondents.

Public Accounting Experience of
CPA Respondents. . . . . . . . .

Age of CPA Respondents . . . . . . . . . . . . . .

Education of CPA Respondents . . . . . . . . . . .

xii

Page

184
190

197

232

233

233
234
234
235
235

236

236
237

237

6-10

6-11

LIST OF FIGURES

Financial reporting framework for
nonpublic businesses. . . . . . . . . . . .

CPA—User communication process. . . . . . . .

Research questions and hypotheses . . . . . .

Two-by-four multivariate repeated
measures design . . . . . . . . . . . . . .

Two-by-three repeated measures design . . . .

Graph of mean

Graph of mean
disclosures

Graph of mean

scores for group effects: GAAP .

scores for group effects:

scores for group effects:

unintentional error . . . . . . . . . . .

Graph of mean scores for group effects:
management fraud. . . . . . . . . . . . .

Graph of mean

scores for group effects:

employee fraud. . . . . . . . . . . . . .

Graph of mean

scores for group effects:

independence. . . . . . . . . . . . . . . .

Graph of mean
association

Graph of mean
association

Graph of mean
association

Graph of mean
association

Graph of mean
association

scores for degree of
effects: GAAP. . . . . . . . .

scores for degree of
effects: disclosure. . . . . .

scores for degree of
effects: unintentional error .

scores for degree of
effects: management fraud. . .

scores for degree of
effects: employee fraud. . . .

xiii

Page

0 O O 0 8

. . . . . 22
. . . 27

O O O O 128

. . . . 129

. . . . 141

. . . . . 142

143

O O O O 144

. . . . . 145

. . . . . 146

. . . . . 159

O O O O O 160

. . . . . 161

O O O O 162

O O O O O 163

Figure

Page
6-12 Graph of mean scores for degree of
association effects: independence . . . . . . . . . . 164
6-13 Graph of mean scores for reliability surrogate

effects: no CPA association . . . . . . . . . . . . . 171

6-14 Graph of mean scores for reliability surrogate

effects: compilations . . . . . . . . . . . . . . . 173

6-15 Graph of mean scores for reliability surrogate
effects: reviews. . . . . . . . . . . . . . . . . . . 176

6-16 Graph of mean scores for reliability surrogate
effects: audits . . . . . . . . . . . . . . . . 179

xiv

CHAPTER I

INTRODUCTION

Overview

This thesis empirically tests the effectiveness of communication
from certified public accountants (CPAs) to bankers within the framework
of financial reporting for nonpublic businesses. The form of communica-
tion between a CPA and a banker is related to the function performed by
the CPA. When there is no association by a CPA with a firm's financial
statements, no report is issued. But when CPAs do associate with finan-
cial statements, they provide assurances about them by issuing either a
compilation report, review report, or an audit report. These three dif—
ferent types of reports represent increasing levels of assurance which a
CPA provides to the management of a nonpublic business. Other individ—
uals outside the firm (users) have a need for the information contained
in the financial statements and the CPA's assurances about the state-
ments, because they make economic decisions based on these documents.

While assurances about financial statements can take a number
of forms, the form of assurance investigated in the present study is
the reliability of financial statements. For the purposes of this
research, an aggregate definition of reliability is used.

This research focuses on a perceptual link in the CPArbanker
communication process. The study concerns the similarities with which
CPAs and bankers perceive assurances about the reliability of financial

1

2
statements presented under varying conditions: (1) when there is no
CPA association with the financial statements, (2) when the statements
are accompanied by the CPA's compilation report, (3) when the state-
ments are accompanied by the CPA's review report, and (4) when the
statements are accompanied by the CPA's audit report. The primary
objective of the study is to test research hypotheses about the percep-
tions of CPAs and bankers.

A questionnaire was used to assess the perceptions of randomly
selected Michigan CPAs and bankers. The questionnaire depicted four
conditions: no CPA association with the financial statements, a CPA's
compilation engagement, a CPA's review engagement, and a CPA's audit
engagement. Following each condition, respondents rated the reliability
of financial statements on a seven-point scale. Parametric statistics
were used to test specific hypotheses about the data.

The research contributes empirical information about the CPA-
banker communication process, particularly when compilation reports and
review reports are issued by CPAs. Further, the study provides infor-
mation on the extent to which CPAs and bankers understand that increasing
assurances about the reliability of financial statements are provided
by CPAs in the order of compilation reports, review reports, and audit

reports.

Organization

This chapter, which introduces the present research, includes
the definition of terms, CPA-banker communication, the meaning of reli-
ability, the need for research, objectives, research methodology, and

contributions.

3

Following the introductory chapter, Chapter II reviews previous
empirical research which is relevant to the present study. However,
this research is not limited to the perceptions of bankers; different
user groups' perceptions are described. The review covers the different
types of CPA reports on historical financial statements, and CPAs' and
users' perceptions of the reliability of these statements.

Chapter III reviews legal cases which uncovered problems in the
CPA-user communication process with respect to unaudited financial
statements. The purpose of this review is to describe examples in which
CPAs and users did not share similar perceptions about the substance of
the CPA's engagement, or CPA assurances accompanying unaudited financial
statements.

Chapter IV is a chronological review of significant events and
technical accounting pronouncements which preceded the development of
compilations and reviews. The chapter reviews how these events and pro-
nouncements were related to problems associated with unaudited financial
statements and limited procedure engagements. The chapter then describes
how the accounting profession's authoritative body responded to these
problems by issuing a separate compilation and review standard.

Chapter V discusses the methodology used in the present study
to empirically test the effectiveness of communication from CPAs to
bankers. Topics discussed are: the research questions and research
hypotheses, the questionnaire, the selection and responses of the CPA
and banker groups, and the statistical analyses.

Chapter VI presents the empirical results of the present study.
The chapter explains the data, the results of the statistical tests,

and the meanings of these data and tests. Tables and graphs are used

to support the presentation.
Finally, Chapter VII summarizes the present study's results,
presents the conclusions and implications of these results, describes

limitations of the results, and suggests topics for future research.

Definition of Terms
The following terms which are used throughout the present

research have these specific definitions:

Association with Financial Statements: A CPA is associated with finan—
cial statements when he (1) allows his name to be used in a written
communication containing the statements, or (2) prepares financial
statements which do not contain his name on the statements.1 The
present research refers to three types of CPA engagements--compilations,
reviews, and audits--each providing a different level of assurance
about the financial statements. The research also refers to situations

in which there is no CPA association with the financial statements.

Assurance Level: The level of assurance is the degree to which a CPA

 

is confident that financial statements are fairly presented in con-
formity with generally accepted accounting principles. Care must be
taken to avoid assuming that the achieved level of assurance is the
same as the expressed level of assurance. The achieved level of assur-

ance is that level of confidence the CPA actually has about the

 

1American Institute of Certified Public Accountants, State-
ments on Auditing Standards: Numbers 1 to 38, reprinted in AICPA
Professional Standards, Volume 1 (Chicago: Commerce Clearing House,
Inc., 1981), sec. 504.03 (hereafter cited as AICPA, Statements on
Auditing Standards: 1-38).

 

 

 

 

5
financial statements.2 The expressed level of assurance is that level
of confidence communicated by the CPA in a written report about the

financial statements.

Audit of Financial Statements: An audit is a type of CPA involvement

 

with the financial statements of either public or nonpublic businesses.
The objective of an audit by a CPA is to determine whether the finan-
cial statements are presented in accordance with generally accepted
accounting principles applied on a consistent basis.3 Auditing proce-
dures performed by a CPA include an evaluation of internal controls,

tests of transactions, and tests of account balances.

Compilation of Financial Statements: A compilation is a type of CPA

 

involvement with the financial statements of nonpublic businesses. The
objective of a compilation by a CPA is to present management's repre-
sentations in the form of financial statements without expressing any
assurances about the statements.4 Compilation procedures performed by

a CPA include preparing and reading the financial statements.

Financial Statements: Financial statements present financial data and

 

accompanying notes, which are derived from accounting records. They

 

2Alvin A. Arens and James K. Loebbecke, Auditing: An Inpggrated

Approach, 2nd ed. (Englewood Cliffs, New Jersey: Prentice-Hall, Inc.,
1980), p. 142.

3

 

AICPA, Statements on Auditing Standards: 1-38, sec. 110.01.

 

4American Institute of Certified Public Accountants, Accounting
and Review Services Committee, Statement on Standards for Accountipg
and Review Services Number 1: Compilation and Review of Financial
Statements (New York: AICPA, 1979), par. 4 (hereafter cited as ARSC,
Compilation and Review of Financial Statements).

 

 

9:

w'n

th

in

pr

St

6
are intended to communicate the economic resources and obligations of
a business at a particular time or the changes therein over a period
of time.5 The present research refers to three types of financial
statements: balance sheet, income statement, and statement of owner's

equity.

Nonpublic Business: A nonpublic business is a profit-seeking entity

 

which (1) does not trade securities on either a stock exchange or over-
the—counter market, (2) does not make a filing with a regulatory agency
in preparation for the trading of securities, and (3) is not a sub-

sidiary of or controlled by a public business.6

Reliability of Financial Statements: Generally, the reliability of

 

financial statements refers to the faithfulness with which the state-
ments represent what they intend to represent, combined with an assur-
ance for the user, that they have that representational quality.7 The
present research defines reliability as the extent to which financial
statements are (1) in conformity with generally accepted accounting
principles, (2) accompanied by all material disclosures, (3) free from
the effects of an existing material unintentional error, (4) free

from the effects of an existing material management fraud, (5) free
from the effects of an existing material employee fraud, and (6) evalu-

ated by a CPA who is independent of management.

 

5AICPA, Statements on Auditing Standards: 1-38, sec. 621.02.

6Ibid., sec. 504.02.

7Financial Accounting Standards Board, Statement of Financial
Accounting Concepts Number 2: ,Qualitative Characteristics of Accounting
Information (Stamford, Connecticut: FASB, 1980), par. 59 (hereafter
cited as FASB, Qualitative Characteristics of Accounting Information).

 

 

 

7
gliance on Financial Statements: Reliance on financial statements is
the us e of financial statements as a basis for decision making. Users
may be said to rely on financial statements when their perceptions of

the re: liability of the statements help them to make economic decisions.

Review of Financial Statements: A review is a type of CPA involvement
with the financial statements of nonpublic businesses. The objective
of a review by a CPA is to perform analytical and inquiry procedures
which provide the CPA with a reasonable basis for expressing limited
assurance that no material modifications should be made to the state-
ments :in order for them to be in conformity with generally accepted

accounting principles . 8

CPA-User Communication

Figure 1-1, adapted from the American Accounting Association's
"A Statement of Basic Auditing Concepts" (ASOBAC), depicts the finan-
cial reporting framework for nonpublic businesses.9 Within this frame-
work, CPAs perform two roles: investigation and communication.

ASOBAC describes the CPA's investigative role as obtaining and
evaluating evidence regarding assertions about economic actions and
events to ascertain the degree of correspondence between those asser-
tions and established criteria.10 The three types of investigation
Shown in Figure 1—1 are compilation, review, and audit engagements.
\

8

ARSC, Compilation and Review of Financial Statements, par. 4.

American Accounting Association, Auditing Concepts Committee,

“A Statement of Basic Auditing Concepts," Accounting Review (Supplement)
1~972, p. 27.

loIbid., p. 35.

 

 

 

 

 

 

 

 

 

 

 

 

Nonpublic ,
Business
3V
Financial
Engagements and Statements
_Ass 0 ciation
Comp :1. 1 ation
Review
Audit

 

 

 

 

 

CPA { User

,Rgports and Assurances
Compilation Report
Review Report

Audit Report

 

 

 

flL

 

User's
Decision

 

 

 

Fig. 1-1. Financial reporting framework for nonpublic businesses

9
That is, in compilations and reviews, a CPA reads the financial state-
ments to determine if the statements are appropriate and free from
material errors. Additionally, in reviews and audits, a CPA performs
analytical and inquiry procedures. Furthermore, in audits, a CPA per-
forms substantive and compliance tests and evaluates internal controls.
The present study does not emphasize the investigative role of CPAs,
but rather the communicative role, as defined in ASOBAC.

ASOBAC describes the CPA's communicative role as expressing the
results of the investigative process to users of accounting informa-
tion- 11 This communication helps users to assess the extent of the
reliability of financial statements. The three types of communication
shown in Figure 1-1 result from compilation, review, and audit engage-
ments respectively. The present study places particular emphasis on
two 0 f these types of communication: compilation reports and review

rePor t s .

9A Association with Financial Statements
CPAs are associated with the financial statements of nonpublic
businesses because of the demand for and value of the CPA's association.
Four factors related to problems a user might face in dealing with the
finaticial statements of a nonpublic business explain why users demand
CPA association with them. These factors are conflict of interest,
consequences, complexity, and remoteness. First, without independent
CPA association with financial statements, the business might prepare

biased statements to effect a favorable impression on users. A CPA

11Ibid., p. 57.

10

can mitigate this possible conflict of interest. Second, if a third
party makes an economically significant decision on the basis of infor-
mation contained in the financial statements, then CPA assurances on
the statements can reduce the risk of adverse consequences. Third, as
the process which generates financial statements becomes more complex,
users can rely on the CPA's technical proficiency. Finally, if users
are physically or legally separated from financial statement preparers,
then they can rely on the CPA's direct access to businesses.12

A CPA's association with financial statements is valuable to
the us er because he (1) controls the quality of information contained
in the statements, and (2) enhances the credibility of the statements.
First , a CPA controls the quality of accounting information by inde-
Pendently ascertaining that the information conforms to established
accounting criteria. Knowing that a CPA will be associated with the
statements motivates preparers to produce financial statements fairly.
Second , a CPA enhances the credibility of financial statements because
users perceive that the CPA controls the quality of accounting infor-
mation.13 Recent surveys confirm that users perceive the CPA's role

as a.dccling credibility to the reliability of financial statements.”

\

lZIbid., pp. 25-26.

13Ibid., pp. 27-29.

4Alan J. Winters. "Unaudited Financial Statements: A Deline-
ation of Issues, Survev of Practice, and Statement of Responsibility"
D-B.A. dissertation, Texas Tech University, 1974), p. 268 (hereafter
cited as Winters, "Unaudited Financial Statements: A Delineation of
8sues"); George A. Fiebelkorn, Jr., "The Role of the Certified Public
Qcountant in the Accounting Communication Process as Perceived by
SC313histicated Users, With an Empirical Analysis of Factors Affecting
nagement Credibility and Certified Public Accountant Credibility"
(Ph.D. dissertation, Georgia State University, 1977), p. 131 (hereafter
Cited as Fiebelkorn, "The Role of the Certified Public Accountant").

11
As a result of CPA association with financial statements, users believe

that they can rely on the statements for decision making.

CPA Assurances on Financial Statements

The degree of CPA association with the financial statements of

a nonpublic business relates to the level of assurance the CPA gives

about the statements. This section examines two types of CPA assur-

ances—-achieved and expressed--for the various degrees of CPA associa-

tion with financial statements: (1) no association, (2) a compilation

engagement, (3) a review engagement, and (4) an audit engagement.

First, if a CPA is not associated with financial statements,

then he can obviously neither achieve nor express any assurances about

the S tatements .

Second, in a compilation engagement, the CPA can achieve mini-

mum assurances about the financial statements, but cannot express any

assurances about the statements. The CPA can achieve these assurances

about the statements by reading the financial statements to consider

whether such statements appear to be appropriate in form and free from

material errors. In the compilation report, the CPA cannot express an

Opinion or any other form of assurance on the financial statements.15
Thomas P. Kelley, an AICPA Managing Director (Technical), relates the
Accounting and Review Services Committee's intentions with respect to
ac‘hieved and expressed assurances about compiled financial statements:

The committee did not intend to preclude accountants from
achieving any assurance as to compiled financial statements..

15ARSC, Compilation and Review of Financial Statements, pars.
13, 17.

 

12

, -But it did intend to preclude the expression of assurance
1.11 a compilation. . . . 16

Third, in a review engagement, the CPA both achieves and ex-
press as limited assurances about the financial statements. A CPA
achieves these assurances about the statements by reading the financial
statements and performing analytical and inquiry procedures. In a re-
view report, the CPA expresses limited assurances that he is not aware
of any material modifications that should be made to the financial
statements in order for them to be in conformity with generally
accep ted accounting principles.17

Finally, in an audit engagement, the CPA both achieves and ex—
presses reasonable assurances about the financial statements. The CPA
achieves these assurances about the statements by performing review
Procedures, evaluating internal controls, and performing substantive
and compliance tests. In an audit report, the CPA expresses reasonable
assurances that the financial statements, taken as a whole, are fairly
Presented, and in conformity with generally accepted accounting prin-

cii-Ples applied on a consistent basis.18

Meaninggof the Reliability of Financial Statements
The form of assurance investigated in the present research is

the reliability of financial statements. This section first reviews

16Thomas P. Kelley, "Compilation and Review--A Revolution in
Erectice," CPA Journal, April 1979, p. 20 (hereafter cited as Kelley,
Compilation and Review") .

l7ARSC, Compilation and Review of Financial Statements, pars.

 

 

7. 35.

18AICPA, Statements on Auditing Standards: 1-38, secs. 150,

 

411.

 

13
the general meaning of reliability according to the accounting litera-
ture- Next, the difficulty in using a general meaning of reliability

in the present study is discussed. Finally, a specific definition of

reliability which is useful in the present study is proposed.

General Meaning of Reliability in the Literature

The term "reliability" appears frequently in the accounting
literature. Reliability usually refers to a qualitative standard or
criterion by which CPAs and users of financial statements evaluate
accounting information. References to reliability are found in publi-
cations of the American Accounting Association, the Accounting Princi-
ples Board, and the Financial Accounting Standards Board.

Two official releases of the American Accounting Association
describe reliability. In A Statement of Basic Accounting Theory, the
standard of verifiability contains a reference to reliability. The
Statement finds that verifiability of accounting information enhances
Perceptions of the reliability of the information by persons who have
neither access to the underlying records nor the ability to audit
them - 19 In a later statement on accounting theory, Statement on
wnth/g Theory and Theory Acceptance, reliability denotes a quality
which permits users to depend on data with confidence that it repre-

2
gents what it intends to represent.

19American Accounting Association, Committee To Prepare a
Statement of Basic Accounting Theory, A Statement of Basic Accounting
% (Sarasota, Florida: AAA, 1966), p. 10.

20American Accounting Association, Committee on Concepts and
Standards for External Financial Reports, Statement on Accounting
Eiory and Theor)7 Acceptance (Sarasota, Florida: AAA, 1977), p. 16.

14

In APB Statement Number 4, the Accounting Principles Board

 

maintains that CPA association with financial statements enhances users'
perceptions of financial statement reliability. As a result, third
parties can rely on the statements for decision making.21

In an effort to establish a conceptual framework for financial

accounting and reporting, the Financial Accounting Standards Board

(FASB ) develops a description of reliability. In Opjectives of Finan-

 

cial Reportiany Business Enterprises, the FASB recognizes that CPAs

 

audit financial statements to enhance confidence in the financial

stat ements' reliability.22 Later, in Qualitative Characteristics of

 

Accountipg Information, the FASB explains that accounting information
is reliable to the extent that users can depend on the information to
represent economic conditions or events.

Based on the literature, reliability appears to be an important
criterion by which users evaluate the credibility of financial state-
ments - But the literature only describes reliability in an abstract
manner; CPAs and users may not be able to apply such a general meaning
0f reliability to practical situations. In order to assess in the
Present research the extent to which CPAs and users perceive financial

Statements as reliable, a meaning of reliability which can be understood

 

 

21APB Statement Number 4: Basic Concepts and Accounting Prin-

gfles UnderlyinLFinancial Statements of Business Enterprises, re-
1)minted in AICPA, Professional Standards: Accounting, Volume 3
Chicago: Commerce Clearing House, Inc., 1975), secs. 1024.35, 1024.37.

22Financial Accounting Standards Board, Statement of Financial
£§SigountingConcepts Number 1: Objectives of Financial Reporting by
.llisiness Enterprises (Stamford, Connecticut: FASB, 1978), par. 8.

23FASB, Qualitative Characteristics of Accounting Information,
Pars. 59, 62.

 

 

15
by b0 th CPAS and users is necessary. The next section provides an

aggregate definition of reliability.

§pec1fic Meaniflg of Reliability

To avoid any confusion about the meaning of the term "reli-
abili ty," a composite of reliability surrogates is used. The present
research assumes that the financial statements of nonpublic businesses
are reliable insofar as they are (1) in conformity with generally
accepted accounting principles, (2) accompanied by all material disclo-
sures , (3) free from the effects of an existing material unintentional
error, (4) free from the effects of an existing material management
fraud , (5) free from the effects of an existing material employee
fraud , and (6) evaluated by a CPA who is independent of management.
Following a description of each of these reliability surrogates, AICPA

standards pertaining to assurances about compilations and reviews and

about audits are given.

In conformity witflenerally accepted accounting principles.
ConfOrmity with generally accepted accounting principles (GAAP) is a
criterion by which CPAs and users evaluate the quality of accounting
information. According to American Institute of Certified Public
Accountants (AICPA) auditing standards, GAAP refer to the conventions,

1“131-es, and procedures which define accepted accounting practice at a

particular time . 24

Statement on Standards for Accountitg and Review Services

N\‘Jluber l (SSARS #1) states that compilation reports must not contain

24AICPA, Statements on Auditing Standards: 1-38, sec. 411.02.

l6

assurances about GAAP. However, SSARS #1 allows the CPA to achieve
some assurances about GAAP. The CPA achieves these assurances by
knowing about accounting principles in the industry of which the busi-
ness :is a part, and by reading the financial statements to consider
whether the statements are appropriate in form and free from material
errors. An error in this context may be a mistake in the application
of an accounting principle.25

However, SSARS #1 requires that review reports contain limited
assurances that the CPA is not aware of any material modifications
that should be made to the financial statements in order for them to
be in conformity with GAAP. With respect to GAAP, SSARS #1 allows the
CPA to achieve limited assurances in two ways. The CPA achieves these
assurances by reading the financial statements to consider whether the
statements conform with GAAP and by asking the client's personnel
whether the financial statements have been prepared in conformity with
GAAP. 26

Professional auditing standards state that audit reports con—
tain reasonable assurances that financial statements conform to GAAP.
The f irst standard of reporting in the section on generally accepted
auditZing standards (GAAS), is that the audit report should state whether

the f inancial statements are presented in accordance with GAAP. AICPA

awaiting standards provide guidelines on how the CPA can achieve reason-

 

 

able assurances about the conformity of financial statements with GAAP.27
-\
10 25ARSC, Compilation and Review of Financial Statements, pars.

’ 130

26Ibid., par. 27.

411 27AICPA, Statements on Auditing Standards: 1-38, secs. 150.02,

si

as

ei

ca

(I)
III

i.
1'.

I”)
A A

’u—l

l7

Accompanied by all material disclosures. According to profes-
sional auditing standards, disclosures are: matters that relate to the
fornlg. arrangement, and content of the financial statements with their
appended notes; terminology used; amount of detail given; classifica-
tion. (of items in the statements; bases of amounts set forth; liens on
assets; and contingent liabilities.28

SSARS #1 allows the CPA to compile financial statements which
eidmee]: omit or include substantially all disclosures. In the former
case , the CPA disclaims responsibility for disclosures. The present
research refers to compilations which include substantially all disclo-
sures; - In such reports, SSARS #1 requires that the CPA not express
assrrrréances about disclosures. However, this standard enables the CPA
to alenieve some assurances about disclosures. The CPA achieves these
assrirréances by reading the statements to consider whether any mistakes
in t11£3 application of accounting principles, including inadequate dis-
CLDSlllres, have occurred.29

In review engagements, SSARS #1 requires that the CPA's review
rePC’Tr‘t: contain limited assurances that he is not aware of any material
mOdifications that should be made to the financial statements in order
for tlluem to be in conformity with GAAP. In this instance, GAAP compre-
hend the adequacy of disclosures. SSARS #1 allows the CPA to achieve

limit ed assurances about disclosures by performing analytical and in-

quiry procedures to test the adequacy of disclosures.30

\

28Ibid., sec. 430.02.

29ARSC, Compilation and Review of Financial Statements,
Pars. 13, 19-21.

30Ibid., par. 27.

 

18

Professional auditing standards state that audit reports con-
tain reasonable assurances about the adequacy of disclosures. They
also state that the fairness of financial statements in conformity with
GAAP comprehends the adequacy of disclosures involving material matters.
Further, based on the third standard of reporting in the section on
GAAS , informative disclosures in the financial statements are to be
regarded as reasonably adequate unless otherwise stated in the report.31
AICPA auditing standards provide guidelines on how the CPA can achieve

reasonable assurances about disclosures in financial statements.

Free from the effects of an existing material unintentional
error‘L management fraud, and employee fraud. One professional auditing
standard defines errors as unintentional mistakes in financial state-
ments , including clerical mistakes in underlying records and mistakes
in the application of accounting principles. Management fraud is de-
fined as an irregularity involving intentional distortions of financial
Statements, such as deliberate misrepresentations by management. The
Standard also defines employee fraud as an irregularity involving in-
tentional distortions of financial statements, such as deliberate mis-
representations by employees. Both management fraud and employee fraud
may result from misapplication of accounting principles and misappro-
pria"Zion of assets.32

With respect to errors, SSARS #1 permits the CPA to achieve

some assurances in both compilation and review engagements. The CPA

31AICPA, Statements on Auditing Standards: 1—38, sees.

430.02, 150.02.

321bid., secs. 327.02-.03.

19

achieves these assurances by reading financial statements to consider
whether the statements are appropriate in form and free from material
error 3. In this context, an error refers to mistakes in the compilation
of ffij;jnancia1 statements, including arithmetical or clerical mistakes,
and mistakes in the application of accounting principles, including
inadequate disclosures.33 However, SSARS #1 recommends that the CPA's
engagement letter regarding compilations and reviews establish an under—
standing with the client that the engagement cannot be relied on to
disc51.<ose management fraud or employee fraud.34

The professional auditing standard which defines errors and
frauri also states that audit reports contain reasonable assurances
that: jfinancial statements are not materially misstated because of
err131753, management fraud, or employee fraud. The CPA achieves these
asstlrnaances by planning and carrying out audits to search for errors
and. ixxrregularities that would have a material effect on the financial

s tat ements . 35

Evaluated by a CPA who is independent of management. Users rely
on CPA independence to neutralize conflicts of interest between finan-

cial statement preparers and users. The AICPA's Code of Professional

 

W views independence as the cornerstone of its philosophical

Str“-lcture. Opinions by CPAs may be of little value to third parties

33
Par - 13.
34

ARSC, Compilation and Review of Financial Statements,

 

Ibid., par. 8.

3SAICPA, Statements on Auditing Standards: 1—38, secs.
327 o 04'— .05 o

 

20
. . 36
unless independence 18 maintained.

With respect to compilation engagements, SSARS #1 provides

that: CPAs may or may not be independent. When the CPA is not independ-
ent, Ins must state that in the compilation report.37 The present
research refers to compilation engagements in which the CPA is inde-
pendent.

SSARS #1 requires that CPAs be independent in review engage-

ments -38 Furthermore, Interpretation 101-3 of the Code of Ethics pro-

 

vides guidelines on how CPAs are to achieve independence with respect
to compilations and reviews. These guidelines follow:

1. CPAs must not have any relationships or conflicts of
interest with clients which would impair integrity or objectivity.

2. Clients must accept responsibility for the financial
statements. Small clients may rely on CPAs to maintain accounting
records.

3. CPAs must not assume the role of employees or management
in Conducting enterprise operations.

4. CPAs must conform to GAAS when examining CPA-maintained

. 3
financial records or statements. 9

36American Institute of Certified Public Accountants, Code of

Srofwsional Ethics, reprinted in AICPA, Professional Standards,
Olume 2 (Chicago: Commerce Clearing House, Inc., 1979), p. 4291
(hereafter cited as AICPA, Code of Professional Ethics).

37

 

 

 

ARSC, Compilation and Review of Financial Statements,

 

Par- 22.

38Ibid., par. 38.

39AICPA, Code of Professional Ethics, pp. 4412 -44l4.

 

21
Finally, professional auditing standards require that CPAs be
independent in audits. Independence recognizes the obligation of fair-
ness to third parties who rely on CPA assurances. Further, based on
the second general standard in the section on GAAS, independence in

mental attitude is to be maintained by the CPA.40

Need for Research about the CPArUser Communication Process

 

The present research is needed for two reasons. First, there
has been a history of confusion about unaudited financial statements.
Second, even though the accounting profession has responded to this
confusion by issuing new standards, the potential for similar problems
with compilations and reviews still exists.

A model is useful in representing the CPA-user communication
Process within the framework of financial reporting for nonpublic
businesses. Figure 1—2, adapted from Libby,41 depicts this process.
The first link in the diagram refers to similarities between CPAs' and
users ' perceptions of assurances about the reliability of financial
Statements. The second link indicates that the user's perception of
the CPA's assurances determines the user's reaction to the assurances
as Perceived. Finally, in the third link, the user makes a decision
baSed on his perception of and reaction to the CPA's intended assur-
a“Ces . Obviously, if the user misperceives the CPA's intended assur-

anoes , he may make decisions on a faulty basis. 0n the other hand,
\

40AICPA, Statements on Auditing Standards: 1-38, secs.
150. 02, 220.02.

41Robert Libby, "Bankers' and Auditors' Perceptions of the
Message Communicated by the Audit Report," Journal of Accounting
w, Spring 1979, p. 100 (hereafter cited as Libby, "Bankers'
and Auditors' Perceptions").

 

22

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1
[—fl—F User's User's ‘
CPA' s Perception Reaction User's
. ‘ "——9 I a
Intended F—:—') :f CPS. 3 : to Perceived : Decision
As 5 urances l nten e I Assurances '
I : Assurances : g i
= ' | ' I
I i :
I l I
I | '
l ' '
l u 1
Link 1 Link 2 Link 3

Fig. 1-2. CPA-User communication process

when the user correctly perceives the CPA's intended assurances, valid
decis :ions are more likely to be made.

Because communication involves shared perceptions, it can be
assumed that the communication process is effective when CPAs and
users share similar perceptions of the reliability of financial state-
ments - Ideally, the user would perceive the same level of assurance
about the financial statements as the CPA. Past experience has shown,
howeVer, that CPAs and users differ in their perceptions of reliability.
Furthermore, there is reason to believe that these differences of per-
c“apticbn may still exist. This section first reviews the problems his-
toric ally related to communication from CPAs to users about unaudited
financial statements. Then, potential problems in the CPA-user com-
munI‘D-Cation process with respect to compilations and reviews are

described.

Er°b\lems with Unaudited Financial Statements

Before the development of compilations and reviews, a CPA was
associated with either unaudited or audited financial statements of a
nonPublic business. When associated with unaudited financial state-

ments, the CPA either did not apply auditing procedures to the

23
statements or did not apply auditing procedures sufficient to permit
the (expression of an audit report. The CPA reported on unaudited finan-
cial statements by issuing an opinion disclaimer, in which he did not
express any assurances about the reliability of the statements.42
Association with unaudited financial statements produced two major
problems, one investigative and one communicative. After examining
the nature of the investigative problem, the communicative problem is
described.

An investigative problem of association with unaudited financial
statements was that CPAs were uncertain about the extent of auditing
procedures to perform on them. Two factors, litigation and recommenda-
tions made by accounting academicians and practitioners, contributed to
this uncertainty. First, several legal cases, which will be discussed
in detail in Chapter III, encouraged CPAs to adOpt one of two approaches
concerning the extent of auditing procedures to perform on unaudited
financial statements. Some CPAs believed that performing limited
anditing procedures on unaudited financial statements would provide
Clients with a satisfactory level of service and preclude the CPA's
association with substandard statements. This approach risked that
users and the courts would attribute audit-type assurances to the reli-

ability of the statements.43 In recognition of this approach, two
\

42American Institute of Certified Public Accountants, Codifi-
é—w of Statements on Auditing Standards: Numbers 1 to 15 (Chicago:
0mmerce Clearing House, Inc., 1977), secs. 516.0l-.04 (hereafter cited
as AICPA, Codification of Statements on Auditing Standards: 1-15).

43Junius Terrell, "Minimum Standards for Unaudited Financial
Stateuaents," Journal of Accountancy, May 1973, p. 58 (hereafter cited
as Terrell, "Minimum Standards"); Dan M. Guy and Alan J. Winters, "Un-
audi ted Financial Statements: A Survey," Journal of Accountancy,
gicefllber 1972, p. 51 (hereafter cited as Guy and Winters, "Unaudited
Ilaneial Statements") .

 

 

(n

an

!

P‘-

H-

24

surveys indicated that many CPAs performed limited auditing procedures
on unaudited financial statements, and that many users perceived that
CPAS performed these procedures.44 Other CPAs believed that no audit-
ing procedures should be performed on unaudited statements to prevent
users and the courts from perceiving audit-type assurances about the
reliability of the statements. Holders of this view contended that
users and the courts would attribute audit-type assurances to the
statements merely because a CPA was associated with the statements.4

Second, many accounting academicians and practitioners, whose
articles will be cited in Chapter IV, contributed to CPAs' uncertain-
ties by proposing new auditing standards. They recommended that the
accounting profession issue guidelines with respect to limited audit-
ing procedures to be performed on unaudited financial statements.
These recommended guidelines would standardize limited procedure
engagements and enable CPAs to express limited assurances about the
reliability of the statements.

Eventually, a communicative problem emerged: it was not clear
to wh at extent users attributed to the CPA's opinion disclaimer assur-
ances about the reliability of the statements. If the CPA performed
11“lit—ed auditing procedures on the financial statements, then he might

achieve some assurances about the reliability of the statements

44Alan J. Winters, "Banker Perceptions of Unaudited Financial
Statements," CPA Journal, August 1975, p. 32 (hereafter cited as
WintEI-s, "Banker Perceptions"); Guy and Winters, "Unaudited Financial
Statements," p. 51.

45Robert H. Saunders, Jr., "Procedures In Minimizing Risk When
AS‘S<>0:::l'.ated With Unaudited Financial Statements," Connecticut CPA,
Marc-h 1973, p. 26 (hereafter cited as Saunders, "Procedures In Minimiz-
ing Risk"); Guy and Winters, "Unaudited Financial Statements," p. 51.

 

 

25
without expressing such assurances. In addition, users might attribute
reliability to the statements, even though the CPA gave no assurances
about their reliability.

In light of the confusion among CPAs about what auditing pro-
cedures they should perform and the possible misperceptions of CPA
assurances by users, the AICPA responded by issuing SSARS #1. Applying
to nonpublic businesses only, SSARS #1 replaced CPA association with
unaudited financial statements and the accompanying opinion disclaimer
report with two types of engagements and reports--compi1ation and re-
view. However, in spite of this response, the possibility still re-
mains that users may misperceive assurances about the reliability of
financial statements which are accompanied by compilation reports or

review reports.

Potential Problems with Compilations and Reviews

 

The focus of the present research is the first link in the CPA-
user communication process shown in Figure 1-2. The major issue is
whether that link is functioning effectively. As stated before, if
this communication process is to be considered effective, CPAs' and
users' perceptions of intended assurances about the reliability of
financial statements should be similar. Furthermore, within the con-
text of the present professional standards, CPAs should be able to
perceive the differences between the reliability of (1) financial
statements which are not accompanied by any CPA report, (2) statements
which are accompanied by the CPA's compilation report, (3) statements
which are accompanied by the CPA's review report, and (A) statements

which are accompanied by the CPA's audit report. Users must also

26
perceive these differences in order to effectively make decisions.
Based on past problems with unaudited financial statements,
it is reasonable to conjecture that communication problems with
compilations and reviews, which replaced unaudited statements, exist.
First, it may be the case that users do not perceive differences in
reliability among statements accompanied by compilation, review, and
audit reports. Thus, they may believe that CPAs are expressing audit-
type assurances for each report. Winters notes that such unwarranted
perceptions of the reliability of unaudited financial statements may be
caused by either inadequate communication from CPAs to users, or philo-
sophical differences between CPAs and users.46 Second, it is possible
that users do not have the accounting expertise with which to dif-
ferentiate between the various reports and assurances about reli-
ability. For example, users may be confused about the differences
between compilations and reviews. Also, they may not understand the
nature of CPA procedures performed during each type of CPA engagement.
Therefore, research is needed to determine the effectiveness
of the CPA-user communication process, particularly with respect to
the reliability of financial statements. If users misperceive intended
assurances about the reliability of financial statements, their economic

decision making could be jeopardized.

Objectives of the Study

 

The primary objective of the study is to provide empirical
information which will answer the following six research questions

and the corresponding hypotheses. Figure 1-3 depicts this objective.

 

46

Winters, "Unaudited Financial Statements: A Delineation of
Issues," pp. 116-118.

 

CPAs

 

 

 

 

Research Question 6

Do CPAs perceive
differences in the
reliability of
financial statements
which are accompanied
by no CPA report, by
the CPA's compilation
report, by the CPA's
review report, and by
the CPA's audit report?

(Hypotheses HCPl-HCP6)

Fig. 1-3.

27

Research Question 1

Do CPAs and users share similar
views about the reliability of
financial statements when there
is no CPA association with the
statements?

(Hypotheses “NI-ENS)

Research Question 2

Do CPAs and users share similar
views about the reliability of
financial statements when the
statements are accompanied by
the CPA's compilation report?

(Hypotheses Hc1-HC6)

 

Users

 

 

 

Research Question 3

Do CPAs and users share similar/[,z”/////’
views about the reliability of

financial statements when the
statements are accompanied by
the CPA's review report?

(Hypotheses aRl-aRb)

Research Question 5

Do users perceive
differences in the
reliability of
financial statements
which are accompanied
by no CPA report, by
the CPA's compilation
report, by the CPA's
review report, and by
the CPA's audit repord

(Hypotheses 3631-8036)

 

Research Question 4

CPAs and users share similar
views about the reliability of
financial statements when the
statements are accompanied by
the CPA's audit report?

(Hypotheses HAl-HA6)

Research questions and hypotheses

28
Research Question Number 1: Do CPAs and users share similar views
about the reliability of financial statements when there is no CPA

association with the statements?

Hypotheses HNl-HNS: When there is no CPA association with the

 

financial statements, CPAs and bankers share similar views that
the statements are:

HNl: in conformity with generally accepted accounting
principles.

HNZ: accompanied by all material disclosures.

HN3: free from the effects of an existing material unin-
tentional error.

HNA: free from the effects of an existing material manage—
ment fraud.

HNS: free from the effects of an existing material employee
fraud.

Research Question Number 2: Do CPAs and users share similar views
about the reliability of financial statements when the statements are
accompanied by the CPA's compilation report?

 

Hypotheses HCl-HC6: When the financial statements are accompanied by

 

the CPA's compilation report, CPAs and bankers share similar views that
the statements are:

H : in conformity with generally accepted accounting

Cl principles.
H02: accompanied by all material disclosures.
HCB: free from the effects of an existing material uninten—

tional error.

H : free from the effects of an existing material management

C4 fraud.
HCS: free from the effects of an existing material employee
fraud.

HC6: evaluated by a CPA who is independent of management.

Research Question Number 3: Do CPAs and users share similar views
about the reliability of financial statements when the statements are
accompanied by the CPA's review report?

 

29

Hypotheses HRl-HR6: When the financial statements are accompanied

 

by the CPA's review report, CPAs and bankers share similar views that
the statements are:

HRl: in conformity with generally accepted accounting
principles.

HRZ: accompanied by all material disclosures.
HR3: free from the effects of an existing material unin-
tentional error.
BRA: free from the effects of an existing material manage-
ment fraud.
HRS: free from the effects of an existing material employee
fraud.

HR6: evaluated by a CPA who is independent of management.

Research Question Number 4: Do CPAs and users share similar views
about the reliability of financial statements when the statements are
accompanied by the CPA's audit report?

 

Hypotheses H When the financial statements are accompanied

Al-HA6:
by the CPA's audit report, CPAs and bankers share similar views that
the statements are:

 

HA1: in conformity with generally accepted accounting
principles.

HA2: accompanied by all material disclosures.

HA3: free from the effects of an existing material unin-
tentional error.

HA4: free from the effects of an existing material manage-
ment fraud.

HA5: free from the effects of an existing material employee
fraud.

HA6: evaluated by a CPA who is independent of management.

Research Question Number 5: Do users perceive differences in the
reliability of financial statements which are accompanied by no CPA
report, by the CPA's compilation report, by the CPA's review report,
and by the CPA's audit report?

 

30

Hypotheses HCBl-HCBS: When the financial statements are accompanied

 

by no CPA report, by the CPA's compilation report, by the CPA's review
report, and by the CPA's audit report, bankers perceive that the
statements are equally:

H : in conformity with generally accepted accounting

CBl principles.
HCBZ: accompanied by all material disclosures.
HCBB: free from the effects of an existing material unin-
tentional error.
HCBA: free from the effects of an existing material manage-

ment fraud.

HCBS: free from the effects of an existing material employee
fraud.

Hypothesis H When the financial statements are accompanied

CB6:
by the CPA's compilation report, by the CPA's review report, and by
the CPA's audit report, bankers perceive that the statements are
equally:

 

HCB6: evaluated by a CPA who is independent of management.

Research Question Number 6: Do CPAs perceive differences in the
reliability of financial statements which are accompanied by no CPA
report, by the CPA's compilation report, by the CPA's review report,
and by the CPA's audit report?

 

Hypotheses H When the financial statements are accompanied

CP1‘HCP5'
by no CPA report, by the CPA's compilation report, by the CPA's review
report, and by the CPA's audit report, CPAs perceive that the state-
ments are equally:

 

HCPl: in conformity with generally accepted accounting
principles.

HCPZ: accompanied by all material disclosures.

free from the effects of an existing material unin-
tentional error.

Hcp3‘

H P4: free from the effects of an existing material manage-
C ment fraud.

HCPS: free from the effects of an existing material employee
fraud.

(I)
In

I .

f?

31

Hypothesis HCP6: When the financial statements are accompanied

 

by the CPA's compilation report, by the CPA's review report, and by
the CPA's audit report, CPAs perceive that the statements are equally:

H evaluated by a CPA who is independent of management.

CP6:

A secondary objective of the present study is to assess the
extent to which CPAs and users perceive different levels of confidence
among the reliability surrogates for each degree of CPA association.
For example, when the financial statements are accompanied by the CPA's
review report, which of the six reliability surrogates do bankers rate
the highest in terms of confidence in the financial statements?
Another secondary objective is to assess the extent to which CPAs and

users are familiar with compilations and reviews.

Research Methodology

 

Sample Selection

 

To accomplish the objectives of the study, questionnaires were
mailed to 200 Michigan practicing bankers and to 200 Michigan prac-
ticing CPAs. The sample of bankers was comprised of 130 commercial
bank loan officers (CBLOs) from large banks (the total assets of which
were greater than $100 million per bank) and 70 chief executive officers
(CEOs) from small banks (the total assets of which were less than $100

7

million per bank).4 CBLOs were randomly selected from the following

two sampling frames: Robert Morris Associates' 1979-1980 Membership

 

Directory and names of CBLOs provided by individual banks. CEOs were

randomly selected from Michigan National Corporation's 1979 Michigan

 

 

47In some cases other bankers replied on behalf of the targeted
CBLOs and CEOs.

32

Bank Directory. CPAs were randomly selected from the Michigan Asso-

 

ciation of Certified Public Accountants' 1979 Membership Directory.

 

The Questionnaire

 

The questionnaire presented a hypothetical loan situation (in-
volving a CPA, the financial statements of a nonpublic business, and a
banker) which provided respondents with a common frame of reference.
Hypothetical CPA reports (compilation, review, and unqualified audit)
depicted increasing levels of assurance about the financial statements
of the business, based on increasing degrees of CPA association. CPAs,
CBLOs, and CEOs rated the six reliability surrogates for the financial
statements accompanied by each of the three types of CPA reports.
CPAs, CBLOs, and CEOs also rated five reliability surrogates (excluding
CPA independence) for the condition of no CPA report (no association
with financial statements). Respondents' perceptions of reliability
were measured on a seven-point numerical rating scale with values
assigned which ranged from "0" (no confidence) to "6" (complete confi-
dence).

The questionnaire also presented six compilation and review
familiarity questions, demographic questions, and space for written

comments .

Statistical Analyses

 

Parametric multivariate repeated measures F-tests and univariate
t-tests were used to test the research hypotheses. Univariate t-tests
were also used to assess the respondents' relative confidence placed
in the reliability surrogates for each degree of association. Finally,

sample percentages were used to describe the extent to which respondents

 

33

were familiar with compilations and reviews.

Contributions

 

The present research provides empirical information about the
CPAruser communication process within the framework of financial re-
porting for nonpublic businesses. More specifically, the research
provides information about the effects of compilation and review
reports on CPAs' and bankers' perceptions of the reliability of finan-
cial statements. Besides accomplishing the primary and secondary ob-
jectives stated previously, the information gathered through this study
can help answer two related questions about compilations and reviews.
One is, Do users attribute audit-type assurances to compilation or
review reports? The other is, Do CPAs and users understand that CPAs
provide increasing levels of assurance about the reliability of finan-
cial statements as the statements are accompanied, in order, by com—

pilation reports, by review reports, and by audit reports?

Summary

This chapter introduced the present study with an overview of
the subject area, an outline of the organization of the thesis, and
definitions of terms. This chapter also described the financial
reporting framework in which CPAs perform engagements for nonpublic
businesses. The types of CPA association with financial statements
and their corresponding reports, including the levels of assurance
provided by each report, were presented also.

The chapter went on to describe the form of assurance investi-

gated in the present study, namely, reliability. In this section, an

34
aggregate definition of reliability made up of six surrogates was
specified for the purposes of this study. The next four subsections
described how accounting standards enable CPAs to provide assurances
about each of these reliability surrogates.

Next, this chapter discussed the need for the present
research by referring to past problems with CPAruser communication
regarding unaudited financial statements. It then discussed the poten-
tial for similar problems with compilations and reviews.

Then, the chapter presented the objectives of the present study
by listing the research questions and corresponding research hypotheses.
A brief description of the methodology used to accomplish these objec-
tives followed. Finally, the last section of the introduction described
contributions of the present study.

The next chapter reviews previous studies which are similar in

scope to the present research.

CHAPTER II

REVIEW OF PREVIOUS RESEARCH

The purpose of this chapter is to review previous studies which
are similar in scope to the present research. Each study is reviewed
in three parts: (1) a description of the study, (2) its major find-
ings and conclusions, and (3) how its major findings relate to the
present research. Following this review, the findings and limitations
of the previous research are summarized. The final section of this
chapter discusses how the present research improves upon the limita-

tions of these prior studies.

Guy, Greenwayj Miller, and Mills

 

Description of the Study

Guy, Greenway, Miller, and Mills investigated whether financial
statement users understand the relationship between financial statement
credibility and the extent of responsibilities assumed by a reporting
CPA.1 In addressing this question, the researchers examined CBLOs'
perceptions of the reliability of annual financial statements based on
a set of CPA-graded opinions.

The researchers mailed questionnaires to all Texas members of

Robert Morris Associates. Questionnaires were returned by 159 CBLOs

 

1Dan M. Guy, Roy M. Greenway, Ross M. Miller, and John C. Mills,
"Audit Reports, Financial Statements and Creditor Perceptions," nggg
CPA, January 1974, pp. 5-10.

35

36
(41% response rate).

The questionnaire mailed to CBLOs depicted a group of hypothet-
ical CPA reports to depict various audit opinions. These reports were:
unqualified audit; divided responsibility audit; audit qualified by an
inconsistency: audit qualified by omission of a statement of changes
in financial position; audit qualified by a material uncertainty; audit
qualified by an exception to generally accepted accounting principles;
adverse; and opinion disclaimer with respect to unaudited financial
statements. In addition, following each report the questionnaire con-
tained a ten-point rating scale on which respondents rated the extent
to which they would rely on financial statements accompanied by these
various CPA reports. The researchers analyzed the data by using

descriptive parametric statistics.

Major Findings and Conclusions

 

Guy et al. reported two major findings and related conclusions
about the research. Their first finding was that CBLOs did not ade-
quately perceive differences among qualified, adverse, and opinion dis-
claimer reports. With respect to these reports, the researchers con-
cluded that financial statement users (CBLOs) did not understand the
relationship between financial statement credibility and the extent of
responsibilities assumed by a CPA. Second, they found that CBLOs did
believe that financial statements accompanied by an unqualified audit
report were more reliable than financial statements accompanied by any
one of the other reports. With respect to the unqualified audit report,
the researchers concluded that financial statement users (CBLOs) did

understand the relationship between financial statement credibility and

37

the extent of responsibilities assumed by a CPA.

Major Findings Related to the Present Research

 

Like the present research, Guy et a1. examined whether CBLOs
perceived different assurances about the reliability of financial
statements among different types of reports. The results indicate
that CBLOs perceived different assurances about reliability between
opinion disclaimer reports and audit reports. When applied to the
present study, these results suggest that CBLOs may perceive differ-
ences in reliability (1) between compilations and audits and (2) be-

tween reviews and audits.

Winters

Description of the Study

 

Winters investigated the nature of CPA responsibilities for
unaudited financial statements.2 As part of this investigation, he
examined CPAs' and CBLOs' perceptions of the reliability of unaudited
financial statements.

Winters mailed questionnaires to randomly selected AICPA practi-
tioners and CBLOs located throughout the United States. Questionnaires
were returned by 375 CPAs (31% response rate) and 570 CBLOs (48%
response rate).

The questionnaire mailed to CPAs contained two questions rele-
vant to the reliability of financial statements. These were:

1. Do you believe that bankers, as a specific group of

users, place more confidence in unaudited statements,
if a CPA is associated with the statements?

 

2Winters, "Unaudited Financial Statements: A Delineation of
Issues."

38

2. To what extent do you feel that your association,
as a CPA, with unaudited financial statements affects
third party users' confidence that the statements are
prepared in conformity with generally accepted
accounting principles and are not false or misleading?

Following the first question, the questionnaire contained a two-point
rating scale on which respondents either agreed or disagreed. Follow-
ing the second question, the questionnaire contained a five-point
rating scale on which respondents rated the extent of increase in
confidence due to CPA association.

The questionnaire mailed to CBLOs contained two questions and
an assertion relevant to the reliability of financial statements.
These were:

1. To what extent do you feel that a CPA's association

with unaudited financial statements affects the
degree of reliability you place in such statements?

2. To what extent do you feel that a CPA's association
with unaudited financial statements affects the
likelihood that the statements are prepared in con-
formity with generally accepted accounting principles?

3. Although the CPA does not perform an audit when he is
associated with unaudited financial statements, and,
therefore, cannot express an opinion on the statements,
the professional integrity of the CPA provides a
reasonably high assurance that the unaudited financial
statements will not be false or misleading.

Following the first two questions, the questionnaire contained five—
point rating scales on which respondents rated the extent of increase
in reliability due to CPA association (first question) and the extent
of increase in likelihood due to CPA association (second question).
Following the assertion, the questionnaire contained a five-point
rating scale on which respondents rated the extent of their agreement

with the assertion. Winters described both CPA and CBLO responses by

using sample percentages.

39

Major Findings and Conclusions

Winters reported findings and conclusions about both CPA and
CBLO responses. With respect to CPA responses, Winters found that:

1. Most of the respondents (94%) agreed that bankers place
more confidence in unaudited financial statements if a CPA is asso-
ciated with the statements.

2. Most of the respondents (89%) perceived that CPA asso-
ciation with unaudited financial statements increases users' confi-
dence that the statements are not false or misleading and are pre-
pared in conformity with generally accepted accounting principles.
Winters concluded that most CPAs believed that their association with
unaudited financial statements increases users' confidence in the
statements.

With respect to CBLO responses, Winters found that:

1. Most of the respondents (78%) perceived that CPA asso-
ciation with unaudited financial statements increases the degree of
reliability they place in the statements.

2. Most of the respondents (86%) believed that CPA asso-
ciation with unaudited financial statements increases the likelihood
that the statements are prepared in conformity with generally accepted
accounting principles.

3. A majority of the respondents (58%) agreed that CPA asso-
ciation with unaudited financial statements provides assurance that
the statements are not false or misleading.

Winters concluded that a majority of CBLOs attributed increased
credibility to unaudited financial statements as a result of CPA

association.

40

Major Findings Related to the Present Research

Winters' study was similar to the present research because he
investigated both CPAs' and CBLOs' perceptions of the reliability of
unaudited financial statements for three reliability surrogates.
These surrogates were: the financial statements are reliable, the
financial statements are not false or misleading, and the financial
statements are in conformity with generally accepted accounting prin-
ciples. Although Winters did not statistically compare the percep-
tions of CPAs to CBLOs, he did find that both groups perceive different
assurances about the reliability of financial statements with which a
CPA has not been associated and unaudited financial statements with
which a CPA has been associated. When applied to the present study,
these results suggest that CPAs and CBLOs may perceive differences in
reliability (1) between financial statements which are not accompanied
by a CPA report and financial statements which are accompanied by a
CPA's compilation report, and (2) between financial statements which
are not accompanied by a CPA report and financial statements which are

accompanied by a CPA's review report.

Fiebelkorn

Description of the Study

 

Fiebelkorn investigated financial statement users' perceptions
of the CPA's role in the CPAeuser communication process.3 As part of
this investigation, he examined the attitudes of different user groups

toward the reliability of financial statements based on different

 

3Fiebelkorn, "The Role of the Certified Public Accountant."

41
degrees of CPA association with the statements.

Fiebelkorn mailed questionnaires to four user groups. Ques-
tionnaires were returned by forty-seven bank loan officers, ninety-two
bank trust officers, fifty-nine insurance investment officers, and
thirty—four investment counselors (response rates were 62%, 50%, 62%,
and 45% respectively). The subjects in each group were randomly
selected from large national organizations.

The questionnaire mailed to the user groups contained three
questions relevant to the users' reliance on financial statements.
These were:

1. How much concern or worry does the complete absence

of a CPA's association with a particular set of
financial statements have on your reliance on the
statements?

2. How much influence does the presence of only an

association by a CPA (no opinion is rendered) with
a particular set of financial statements have on
your reliance on the statements?

3. How much influence does the presence of a CPA's opinion

on a particular set of financial statements have on

your reliance on the statements?
Following the questions, the questionnaire contained nine—point rating
scales on which respondents rated the extent of their concern about
reliance (first question) and the amount of influence on their reli-
ance (second and third questions). Fiebelkorn analyzed the data by

using descriptive statistics and by testing hypotheses with respect to

median rating scores.

Major Findings and Conclusions

 

Based on a composite of user groups' responses, Fiebelkorn

found that:

42

1. Users believed that the absence of CPA association with
financial statements causes them considerable concern about relying
on the statements.

2. Users perceived that CPA association with unaudited finan-
cial statements influences reliance, but is not vital to reliance.

3. Users believed that the presence of the CPA's audit
opinion on financial statements is vital to reliance.
Fiebelkorn concluded that the presence of a CPA's opinion on financial
statements is vital to users' reliance. Further, users perceived that
the extent of reliance increases as the degree of the CPA's association

with the financial statements increases.

Major Findings Related to the Present Research

 

Fiebelkorn's research is comparable to the present study be-
cause he examined the reliance users place on financial statements
prepared with different degrees of CPA association. The results indi-
cated that the users placed varying amounts of reliance on statements
prepared under the conditions of no CPA association with financial
statements, CPA association with unaudited financial statements, and
audits. When applied to the present study, these results suggest that
users may perceive differences in reliability of financial statements
prepared (1) under the conditions of no CPA association with financial
statements, compilations, and audits and (2) under the conditions of

no CPA association with financial statements, reviews, and audits.

43

Bainbridge

 

Description of the Study

Bainbridge investigated the CPA's ability to detect management
fraud when associated with small business financial statements.4 In
investigating this subject, he examined CPAs' and CBLOs' perceptions
of various aspects of the CPA's ability to detect management fraud.

Bainbridge mailed questionnaires to randomly selected CPAs and
CBLOs in Pennsylvania. Questionnaires were returned by 121 CPAs (43%
response rate) and 120 CBLOs (40% response rate).

The primary section of the questionnaire contained a number of
assumptions and factors which represented various aspects of the CPA's
ability to detect management fraud. These items were separately listed
for CPA association with unaudited financial statements and with audited
financial statements. Following the items, the questionnaire contained
six-point rating scales on which both CPAs and CBLOs rated either the
extent of agreement with each item or the degree of importance of each
item. Bainbridge used nonparametric Kolmogorov—Smirnov statistics to
test hypotheses about the data.

A secondary section of the questionnaire contained two asser-
tions relevant to the reliability of financial statements. These were:

1. The unaudited financial statements prepared by an owner-

manager or his employees are as reliable as the un-
audited financial statements with which a CPA has been
associated.

2. Unaudited financial statements are as reliable as

audited financial statements if a CPA has been asso-
ciated with the unaudited financial statements.

 

4Dunham R. Bainbridge, "Perceptions of the CPA's Ability to
Detect Misrepresentations of the Smaller Business's Financial
Statements" (Ph.D. dissertation, Lehigh University, 1978).

44

Following each assertion, the questionnaire contained six-point
rating scales on which CPA and CBLO respondents rated the extent of
their agreement with each assertion. Bainbridge described the data on

responses to these two assertions by using sample percentages.

Mnjor Findings and Conclusions

 

Bainbridge reported findings and conclusions about both sec-
tions of the questionnaire. First, with respect to the CPA's ability
to detect management fraud, Bainbridge found that:

l. CPAs and CBLOs did not share similar views about the
accuracy of various assumptions which may affect the CPA's ability to
detect management fraud when preparing small business financial state-
ments. Instances of disagreement included the extent to which CPAs
rely on inquiry and the extent to which CPAs perform analytical pro-
cedures.

2. CPAs and CBLOs generally shared similar views about the
accuracy of various assumptions which may affect the CPA's ability to
detect management fraud when auditing small business financial state-
ments.

Second, with respect to the two assertions about the reli-
ability of financial statements, Bainbridge found that:

1. Approximately 80% of the CPA and CBLO respondents believed
that unaudited financial statements prepared by an owner-manager or
employees were not as reliable as unaudited financial statements with
which CPAs are associated.

2. Approximately 90% of the CPA and CBLO respondents

believed that unaudited financial statements with which CPAs are

45

associated were not as reliable as audited financial statements.

Mnjor Findings Related to the Present Research

Bainbridge's study was similar to the present research because
he compared the extent to which CPAs' and CBLOs' perceptions of the
reliability of financial statements were similar. Also, like the
present study, he investigated whether CPAs and CBLOs have similar per-
ceptions of the reliability of financial statements based on different
degrees of CPA association.

With respect to the CPA's ability to detect management fraud
as a reliability surrogate, Bainbridge found that the type of CPA
association with financial statements appears to affect the comparison
of CPA and CBLO perceptions. Given CPA association with unaudited
financial statements, CPAs and CBLOs did not share similar views about
the accuracy of various assumptions which may affect the CPA's ability
to detect management fraud. However, given CPA association with
audited financial statements, CPAs and CBLOs did share similar views
about the accuracy of those same assumptions. When applied to the
present study, these results suggest that CPA and CBLO perceptions of
the reliability of financial statements may not be similar for com-
pilations and may not be similar for reviews. Furthermore, the re-
sults suggest that CPA and CBLO perceptions of the reliability of
financial statements may be similar for audits.

Bainbridge also found that CPAs and CBLOs have different per-
ceptions of the reliability of statements under the conditions of no
CPA association with financial statements, CPA association with un-

audited financial statements, and audits. When applied to the present

46

research, these results suggest that CPAs and CBLOs may perceive dif—
ferences in the reliability of statements (1) under the conditions of
no CPA association with financial statements, compilations, and audits;
and (2) under the conditions of no CPA association with financial

statements, reviews, and audits.

Pany

Description of the Study

 

Pany investigated whether different types of CPA association
with quarterly income information affects users' perceptions of the
reliability of the information.5 As part of this investigation, he
examined questionnaire responses from fifty-seven financial analysts.
Pany nonrandomly selected these analysts from five large commercial
banks located in a large Midwestern city.

Pany used four questionnaire forms in this field experiment.
Each form contained a different degree of CPA association with quar-
terly income information. These were: (1) no CPA association with the
quarterly income information; (2) a limited review conducted at year
end, reported by a footnote in the annual financial statements; (3) a
limited review conducted at the end of the quarter, reported by an
opinion disclaimer at the end of the quarter; and (4) an audit con-
ducted at the end of the quarter, reported by a short form audit
report at the end of the quarter. Following each condition, the
questionnaire contained an eleven-point rating scale on which respond-

ents rated their degree of confidence that the quarterly information

 

5Kurt J. Pany, "Quarterly Financial Reporting: A Test of
Varying Forms of Auditor Association" (Ph.D. dissertation, University
of Illinois at Urbana-Champaign, 1978).

47

was free from accounting errors. Pany analyzed the data by using
parametric F-tests and multiple comparisons to test hypotheses about

the mean scores.

Major Findings and Conclusions

 

Pany found that the financial analyst respondents attributed
greater reliability to the income information as the conditions of
CPA association progressed from no CPA association to year-end limited
review to quarterly limited review to quarterly audit. Pany added
another dimension to his study by specifying the inaccuracy or accu-
racy of the client's past financial information. If Pany specified
that the client's past financial information was inaccurate, he found
that:

1. Users attributed significantly more reliability to the
financial information under the condition of a quarterly audit than
to information under the condition of a year-end limited review.

2. Users attributed significantly more reliability to the
financial information under the condition of a quarterly audit than
to information under the condition of no CPA association.

3. Users attributed significantly more reliability to the
financial information under the condition of a quarterly limited
review than to information under the condition of no CPA association.

4. Users attributed significantly more reliability to the
financial information under the condition of a year-end limited
review than to information under the condition of no CPA association.
If Pany specified that the client's past financial information was

accurate, he found that respondents perceived no significant

48

differences in the reliability of the financial information produced
under the four conditions. As a result of this research, Pany con-
cluded that respondents perceived an effect on the reliability of
quarterly income information according to the degree of CPA associa-
tion with the information. Further, he noted that the often stated
fear of CPAs, that users do not understand the limitations of audits,

was not substantiated by the results of this study.

Major Findings Related to the Present Research

 

Pany's research is comparable to the present study in that it
examined whether users perceived different assurances about the reli-
ability of financial information based on different degrees of CPA
association. The results indicated that the financial analysts per-
ceived (l) differences in reliability between quarterly income infor-
mation under the conditions of no CPA association and the CPA's limited
review, (2) differences in reliability between quarterly income infor-
mation under the conditions of no CPA association and the CPA's quar-
terly audit, and (3) no differences in reliability between quarterly
income information under the conditions of the CPA's limited review
and the CPA's quarterly audit. When applied to the present study,
these results suggest that users may perceive (l) differences in reli-
ability between financial statements under the conditions of no CPA
association and the CPA's review, (2) differences in reliability be-
tween financial statements under the conditions of no CPA association
and the CPA's audit, and (3) no differences in reliability between
financial statements under the conditions of the CPA's review and the

CPA's audit.

Libby
Description of the Study

 

Libby investigated whether messages which CPAs intend to con-
vey by audit reports are consistent with financial statement users'
perceptions of these messages.6 In addressing this question, he com—
pared CPAs' and CBLOs' perceptions of the reliability of financial
statements based on different types of audit reports.

Libby nonrandomly selected thirty CPAs and twenty-eight CBLOs
to complete questionnaires in a laboratory setting. The CPAs were
audit partners from five international public accounting firms. The
CBLOs were senior officers from five large Chicago banks.

TNuaquestionnaire completed by the CPAs and CBLOs used hypo-
thetical CPA reports to depict various audit opinions. These reports
were: unqualified audit; audit qualified by an uncertainty about
asset realization; audit qualified by an uncertainty about litigation;
audit qualified by a circumstance-imposed scope limitation; audit
qualified by a client-imposed scope limitation; audit disclaimed by
an uncertainty about asset realization; audit disclaimed by an uncer-
tainty about litigation; audit disclaimed by a circumstance-imposed
scope limitation; audit disclaimed by a client-imposed scope limita-
tion; and opinion disclaimer with respect to unaudited financial
statements.

The questionnaire was divided into two sections, which con-
tained two different types of rating scales. The first section

followed each report with thirteen ten-point rating scales. Three

 

6Libby, "Bankers' and Auditors' Perceptions."

50
of the scales relevant to the reliability of financial statements were:
1. Reliability or verifiability of the financial
statement data (Statements of Financial Position,
Earnings, and Changes in Financial Position).
2. Degree to which financial statement users must rely
on the auditor's judgment to estimate the effects of
the information in the report.
3. How heavily the financial statement data can be relied
upon in decisions (the usefulness of the statement
data).
In the second section, respondents were given fifty pairs of hypothet-
ical CPA reports. They rated the relative similarity of each pair of
reports on a ten-point rating scale.
Libby examined the data by means of three approaches. These
were the construction of models of the CPAs' and CBLOs' perceptions
of the messages intended by the reports, the identification of per-
ceptual dimensions, and the analysis of individual differences in

perceptions within each group of subjects. Libby applied the INDSCAL

method of multidimensional scaling to analyze the data.

Major Findings and Conclusions

 

Libby reported findings and conclusions about (1) the extent
to which CPAs' and CBLOs' perceptions of the reliability of financial
statements were similar and (2) the extent to which CPAs and CBLOs
perceived differences in reliability among financial statements
accompanied by different types of CPA reports. First, Libby found no
large differences between CPAs' and CBLOs' perceptions of reliability.
As a result, he concluded that fears of miscommunication of CPAs' in-
tended messages by audit reports may not have been justified, at least

insofar as more sophisticated users are concerned. Second, Libby

51

found that both CPAs and CBLOs perceived differences in reliability
among financial statements accompanied by categories of reports. He
found that respondents attributed greater reliability to financial
statements as the categories of the reports accompanying them pro-
gressed from disclaimer reports to qualified audit reports to unquali—

fied audit reports.

Major Findings Related to the Present Research

 

Libby's research was similar to the present study because he
compared the extent to which CPAs and CBLOs had similar perceptions
of the reliability of financial statements. Also, like the present
study, he examined whether CPAs and CBLOs perceived different assur-
ances about the reliability of financial statements accompanied by
different types of reports. Like the present study, Libby's research
used more than one meaning of reliability. These were reliability of
financial statement data, reliability of auditor's judgement, and
reliability of financial statement data for decisions.

Libby found that, given CPA reports on both unaudited and
audited financial statements, CPAs and CBLOs shared similar views about
the reliability of the statements. When applied to the present study,
these results suggest that CPAs' perceptions of the reliability of
financial statements may be similar to those of CBLOs when the state-
ments are accompanied (1) by no CPA report, (2) by the CPA's compila-
tion report, (3) by the CPA's review report, and (4) by the CPA's
audit report.

Libby also found that CPAs and CBLOs perceived different

assurances about the reliability of financial statements under the

52

conditions of CPA association with unaudited financial statements and
the CPA's audit. When applied to the present research, these results
suggest that CPAs and CBLOs may perceive differences in reliability

(1) between compiled and audited financial statements and (2) between

reviewed and audited financial statements.

Reckers and Pany

 

Description of the Study

 

Reckers and Pany investigated whether different forms of CPA
association with quarterly financial information affects users' per-
ceptions of the reliability of the information.7 In addressing this
question, the researchers examined financial analysts' perceptions of
the reliability of quarterly financial information disclosed under
different forms of CPA association.

The researchers mailed questionnaires to randomly selected
Chartered Financial Analysts (CFAs) located throughout the United
States. Questionnaires were returned by sixty-one CFAs (31% response
rate).

The questionnaires depicted three conditions of CPA association
with quarterly financial information: no CPA association, a quarterly
limited review, and a quarterly audit. Following each condition, the
questionnaire contained an eleven-point rating scale on which respond-
ents rated their degree of confidence that the quarterly information
was free from accounting errors. Reckers and Pany analyzed the data

by using descriptive parametric statistics.

 

7Philip M. J. Reckers and Kurt J. Pany, "Quarterly Statement
Reliability and Auditor Association," Journal of Accountancy, October
1979, pp. 97-100.

 

53

Major Findings and Conclusions

Reckers and Pany found that CFA respondents attributed greater
reliability to the financial information as the degree of CPA associ-
ation progressed from no CPA association to quarterly limited reviews
to quarterly audits. However, the researchers found only a small dif—
ference between quarterly limited reviews and quarterly audits with
respect to the CFAs' perceptions of reliability. As a result, they
concluded that the CFA respondents might have attributed unwarranted

reliability to the quarterly limited reviews.

Major Findings Related to the Present Research

Like the present research, Reckers and Pany investigated
whether users perceive differences in the reliability of financial in-
formation under different conditions of CPA association with the infor-
mation. The results indicated that financial analysts (1) perceived
differences in reliability between no CPA association with quarterly
financial information and quarterly limited reviews, (2) perceived
differences in reliability between no CPA association with quarterly
financial information and quarterly audits, and (3) perceived less
clearly differences in reliability between quarterly limited reviews
and quarterly audits. When applied to the present research, these
results suggest that users may (I) perceive differences in the reli-
ability of financial statements with no CPA association and financial
statements reviewed by a CPA, (2) perceive differences in the reli-
ability of financial statements with no CPA association and financial
statements audited by a CPA, and (3) perceive less clearly differences

in the reliability between reviewed and audited financial statements.

54
Summary of Findings and Limitations
This section first summarizes the findings of the previous

research and then describes the limitations of these studies.

Findings

Previous research has contributed empirical information which
can be helpful in answering the following general research questions:

1. Do CPAs and users share similar perceptions about

the reliability of financial statements under the
conditions of no CPA association with the state-
ments and CPA association?

2. Do CPAs and users perceive differences in the reli-
ability of financial statements under the conditions
of no CPA association with the statements and CPA
association?

Two studies (Bainbridge, Libby) addressed the first general
research question. Given CPA association with audited financial state-
ments, both researchers found that CPAs and CBLOs shared similar views
about the reliability of the statements. However, given CPA associa-
tion with unaudited financial statements, the researchers reported
different results. Bainbridge found that CPAs and CBLOs did not share
similar views about the reliability of unaudited statements while Libby
reported that CPAs and CBLOs did share similar views about the reli—
ability of the statements.

With respect to the second general research question, the
studies provided two kinds of results. First, five studies (Guy et a1.
Winters, Fiebelkorn, Bainbridge, Libby) indicated that CPAs and users
perceived differences in the reliability of financial statements with

no CPA association, CPA association with unaudited financial statements,

and audited financial statements. According to these studies, CPAs

55
and users attributed increasing reliability to financial statements as
the degree of CPA association progressed from no CPA association with
financial statements to CPA association with unaudited financial state-
ments to CPA association with audited financial statements. Second,
two studies (Pany, Reckers and Pany) indicated that financial analysts
perceived no differences in the reliability of financial information

under the conditions of limited review and audit.

Limitations

 

Limitations of the previous studies relate to (1) the types of
CPA association with financial statements, (2) the meaning of "relia-
bility," and (3) the generalizability of their results. Table 2-1 sum-
marizes the limitations of the previous research.

One limitation, as shown in the first column of Table 2-1, is
that none of the researchers examined compilations and reviews as types
of CPA association with financial statements. Instead, these researchers
considered: no CPA association with financial statements (Fiebelkorn,
Bainbridge, Pany, and Reckers and Pany); CPA association with unaudited
financial statements, reported by an opinion disclaimer (Guy at al.,
Winters, Fiebelkorn, Bainbridge, Libby); CPA association with unaudited
financial statements, reported by a limited review (Pany, Reckers and
Pany); CPA association with audited financial statements, reported by
an opinion disclaimer (Libby); CPA association with audited financial
statements, reported by a qualified opinion (Guy et al., Libby); and
CPA association with audited financial statements, reported by an un-
qualified opinion (Guy et al., Fiebelkorn, Bainbridge, Pany, Libby,

Reckers and Pany).

56

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57
Another limitation, indicated in the second column of Table
2-1, is that the researchers did not explain clearly the meaning of
"reliability" in their questionnaires. These researchers suggested

the concept of reliability through different expressions. These were:

H I? H H

"rely, reliance, reliable," or "reliability" (Guy et al., Winters,
Fiebelkorn, Bainbridge, Libby); "not false or misleading," and "in con-
formity with generally accepted accounting principles" (Winters); and
"free from accounting errors" (Pany, Reckers and Pany). Questionnaire
respondents could have misinterpreted these meanings of reliability.
For example, respondents could have interpreted "reliance on financial
statements" as a perception of the reliability of financial statements
or as a measure of their actual reliance on the statements for decision
making. Respondents could have interpreted "accounting errors" as un-
intentional bookkeeping mistakes or as intentional distortions.

A final limitation which is summarized in the last three columns
of Table 2—1 concerns three aspects of the generalizability of results.
This limitation was apparent when the researchers either (1) did not
obtain representative perceptions of CPAs and users or (2) did not apply
inferential statistics to the data. In two studies (Pany, Libby), the
researchers selected subjects nonrandomly. Also, in three studies
(Fiebelkorn, Pany, Libby), the researchers either selected CPAs from
large firms only, or selected CBLOs or financial analysts from large
banks only. Finally, in three studies (Guy et al., Winters, Reckers,
and Pany), the researchers did not apply inferential statistics to the

data. Therefore, their results could not be generalized to larger

populations.

58

QInprovements Made by the Present Research

The present research contributes empirical information about
the general research questions stated in the preceding section by im-
proving upon the limitations of previous research. These limitations
relate to (1) the types of CPA association with financial statements,
(2) the meaning of "reliability," and (3) the generalizability of
results.

The present research first improves upon the previous research
by referring to compilation and review reports instead of opinion dis-
claimer reports. For nonpublic businesses, compilation and review re-
ports replaced opinion disclaimer reports on unaudited financial state-
ments. Thus, the present study refers to four conditions: no CPA
association with financial statements; CPA association with compiled
financial statements, accompanied by a compilation report; CPA associa-
tion with reviewed financial statements, accompanied by a review report;
and CPA association with audited financial statements, accompanied by
an unqualified audit report.

Next, the present study improves upon prior research by speci-
fying the definition of "reliability." An aggregate meaning of relia-
bility designed to be understandable to both CPAs and users is used.
The definition of reliability used in the present study is the extent
to which financial statements are (l) in conformity with generally
accepted accounting principles, (2) accompanied by all material disclo-
sures, (3) free from the effects of an existing material unintentional
error, (4) free from the effects of an existing material management
fraud, (5) free from the effects of an existing material employee fraud,

and (6) evaluated by a CPA who is independent of management.

59
Finally, the present research improves upon the limitation
concerning generalizability of results. In this study, CPAs were ran-
domly selected from firms of different sizes and bankers were randomly
selected from banks of different sizes in order to obtain representative
views of CPAs and bankers. Further, inferential statistics were applied
to the data to permit generalizations about the perceptions of CPAs and

bankers.

Summary

This chapter reviewed seven studies which were similar in scone
to the present research. Following this review, the chapter summarized
both the findings and limitations of these previous studies. A final
section of the chapter described how the present research improves upon
the limitations of these studies.

The next chapter reviews legal cases in which CPAs and users
did not share similar perceptions about either (1) the substance of the
CPA's engagement, or (2) the CPA's assurances accompanying unaudited
financial statements. The chapter describes how the courts' decisions
in these cases exposed problems in the CPA-user communication process

regarding unaudited financial statements.

CHAPTER III

REVIEW OF LEGAL CASES

This chapter reviews legal cases which uncovered problems in
the CPA-user communication process with respect to unaudited financial
statements. As described in Chapter I, AICPA auditing standards be-
fore 1979 did not require the CPA to perform auditing procedures on
the unaudited financial statements of nonpublic businesses. The CPA
reported on these statements by issuing an opinion disclaimer, in which
the CPA did not express any assurances about the reliability of the
statements. Problems related to the auditing procedures CPAs performed
on unaudited financial statements and user's perceptions of assurances
about these statements resulted from these standards.

The purpose of reviewing the legal cases is to describe actual
situations in which CPAs and users did not share similar perceptions
about either (1) the substance of the CPA's engagement, or (2) supposed
CPA assurances accompanying unaudited financial statements. The term,
"the substance of the CPA's engagement" refers to the type of CPA
engagement performed: either an unaudited financial statement engage-
ment or an audit engagement. In some of the legal cases, users under-
stood that the statements were audited, whereas CPAs denied that the
engagements involved audit-type responsibilities. The term "CPA assur-
ances accompanying unaudited financial statements" refers to the
assurances supposedly implied by an unaudited financial statement

60

61

opinion disclaimer. In some cases, users perceived audit-type assur-
ances about the financial statements, whereas CPAs believed that the
disclaimer provided no assurances whatsoever about the statements.
The courts resolved these disputes by interpreting AICPA standards to
determine either the substance of the CPA's engagement or the CPA's
responsibilities with respect to unaudited financial statements. In
addition, the courts applied a number of legal criteria to the cases.

Limitations of reviewing legal cases involve (l) the meaning of
"reliability," (2) the selection of cases, and (3) the generalizability
of court decisions. The first limitation is that the court decisions

often refer to users' "reliance on financial statements,‘ and do not

refer to users' perceptions of the "reliability of financial statements."
(See definitions of these terms in Chapter I.) The present study empha-
sizes CPAs' and users' perceptions of the reliability of financial
statements. Another limitation of reviewing legal cases is the case
selection. This review covers only selected common law cases dealing
with users' reliance on unaudited financial statements, but there may
be others. A final limitation is the degree to which the courts' deci-
sions can be generalized to other cases. The ruling in each case is
based on the facts and circumstances of that particular case. Because
each case is, to some extent, unique, a ruling in one case may not
apply to other cases.

The chapter first reviews the legal cases. Each case is re-
viewed in terms of: the arguments to support the user's position;
the arguments to support the CPA's position; the decision of the court;

and the relationship of the court's decision to the present research.

A concluding section summarizes the legal cases and relates the

62

decisions of these courts to the present research.

Stanley L. Bloch, Inc. v. Klein

 

Description of the Case

 

In Bloch v. Klein,1 a business owner attributed audit-type

 

assurances to financial statements prepared by Klein, a CPA. In par-
ticular, Bloch, the business owner, alleged that Klein negligently
misrepresented an April 30, 1957, balance sheet, which overstated in-
ventory by $37,000. The basis of Bloch's claim was that the balance
sheet was issued on the CPA's stationery without an opinion disclaimer.
Since an AICPA auditing standard required Klein to disclaim audit
responsibility on each page of the statements, the absence of the dis—
claimer implied that he was responsible for auditing the statements.
Furthermore, Klein knew of facts which indicated that the balance
sheet was erroneous. Klein argued that the oral retainer indicated an
unaudited financial statement engagement and consequently, no responsi-
bility existed to detect the inventory error.

The New York County Supreme Court agreed With Bloch that the
absence of the opinion disclaimer on each page of the financial state-
ments implied Klein's audit responsibility for the statements. Further,
the court determined that Klein should have exercised the care and com-
petence reasonably expected of CPAs to ascertain the facts on which the
report was based. Klein's failure to notify Bloch about the erroneous

balance sheet constituted actionable negligence.

 

1Stanley L. Bloch, Inc. v. Klein, 258 N.Y.S. 2d 501, 1965.

63

Court Decision Related to the Present Research

The decision in Bloch v. Klein was one of the first examples of

 

a court's distinguishing between unaudited financial statement engage-
ments and audit engagements. The court determined that, in accordance
with AICPA auditing standards, the substance of the CPA's engagement

was an audit. Therefore, the CPA was responsible to third parties for
audit-type assurances accompanying the financial statements. By dis-
tinguishing unaudited financial statement engagements from audits, the
court recognized that CPA assurances accompanying unaudited financial
statements were different from assurances accompanying audited financial
statements. The present research examines whether CPAs and users have
similar perceptions of the reliability of financial statements for com-

pilation, review, and audit engagements.

1136 Tenants' Corporation v. Max Rothenberg and Co.

 

Description of the Case

 

1136 Tenants' Corporation v. Max Rothenberg and Co.2 was an-

 

other example of a case in which a CPA and user did not share similar
perceptions about the substance of the CPA's engagement. 1136 Tenants'
Corporation, an apartment owner group, relied on financial statements
prepared by Max Rothenberg and Company, a CPA firm. After discovering
that Riker, the apartment manager, perpetrated accounts payable

defalcations, the corporation charged that the CPA firm negligently

 

21136 Tenants' Corporation v. Max Rothenberg and Company, 277
N.Y.S. 2d 996, 1967; 319 N.Y.S. 2d 1007, 1971; 281 N.E. 2d 846, 1972;
Emanuel Saxe, "Unaudited Financial Statements: Rules, Risks and
Recommendations," CPA Journal, June 1972, pp. 457-464+ (hereafter
cited as Saxe, "Unaudited Financial Statements").

 

64

misrepresented the financial statements. Furthermore, the corporation
contended that they hired the CPA firm as auditors, not as bookkeepers.
Consequently, 1136 Tenants' Corporation argued that the CPAs failed to
perform expected auditing procedures and that they did not exercise due
care when they failed to inform the corporation about the suspicious
accounts payable. Max Rothenberg and Company countered that the oral
retainer provided that the CPA firm should prepare tax returns, perform
bookkeeping services or write-up work, and prepare financial statements
without verification. The CPA firm went on to argue that past letters
accompanying the financial statements asserted that the statements were
prepared from the books of the corporation without independent verifi-
cation. Because they were associated with unaudited financial state-
ments, Max Rothenberg and Company claimed that professional standards
did not require them to detect defalcations in the statements.

The New York County Supreme Court ruled on four issues in this
case. First, the court determined that Max Rothenberg and Company was
engaged to audit and not merely to write up the corporation's books and
records. The court relied on evidence that some auditing procedures
were performed which would not normally have been done in write-up
work. Second, the court challenged an AICPA auditing standard which
stated that CPAs were not responsible to perform any auditing procedures
in the preparation of unaudited financial statements. In this case,
the court ruled that certain auditing procedures were necessitated and
mandated under the oral retainer. Third, the court judged that the
CPA firm was responsible for detecting the defalcations. Regardless
of whether the CPAs received the accounts payable invoices for purposes

of audit or otherwise, a duty existed to detect the defalcations based

65
on the evidence in the case. Finally, the court recognized the CPA's
duty to inform the corporation of known suspicious circumstances. Max
Rothenberg and Company had a duty to inform the corporation when they
became aware that material invoices purportedly paid by Riker were

missing.

Court Decision Related to the Present Research

 

The court in the 1136 Tenants' Corporation case determined that

 

the substance of the CPA firm's engagement was an audit. By challenging
AICPA auditing standards, which did not require the CPA to perform
auditing procedures on unaudited financial statements, this decision
helped to expose three problems in the CPAruser communication process
with respect to unaudited financial statements. First, the decision
contributed to uncertainties among CPAs as to what auditing procedures
they should perform on unaudited statements. Some CPAs performed
limited auditing procedures on unaudited financial statements in order
to provide clients with a satisfactory level of service and to preclude
the CPA's association with substandard statements.3 Other CPAs per-
formed no auditing procedures on unaudited financial statements in
order to avoid users' perceptions of audit-type assurances about the
statements.4 A second problem was that if a CPA performed limited
auditing procedures on unaudited financial statements, then the CPA
might have achieved some assurances about the statements, despite a

denial of assurances contained in the Opinion disclaimer. A final

 

3Terrell, "Minimum Standards," p. 58.

4Saunders, "Procedures In Minimizing Risk," p. 26.

66

problem was that users might attribute some assurances to the state-
ments despite the opinion disclaimer.

The present study examines possible communication problems
between CPAs and users for different types of CPA engagements. It pro-
vides empirical information about CPAs' and users' perceptions of the

reliability of compiled, reviewed, and audited financial statements.

Ryan v. Kanne

 

Description of the Case

 

5 . .
In Ryan v. Kanne, a user attributed audit-type assurances to

 

part of the financial statements despite the CPA's opinion disclaimer
accompanying the unaudited financial statements. Kanne Lumber and
Supply, Inc. relied on the balance sheet of Mid-States Enterprises,
Inc. to form a corporate charter and to induce investors to buy stock.
Although the financial statements contained an opinion disclaimer by
Ryan, a CPA, the oral employment contract allegedly contained a repre-
sentation made by Ryan with respect to accounts payable. Kanne charged
that Ryan negligently misrepresented accounts payable and other
accounts. Furthermore, it was proved that Ryan knew that Kanne relied
on the report and statements when lug contemplated the stock purchase.
Ryan argued that the opinion disclaimer nullified any CPA responsibili-
ties and that no contract existed between him and Kanne.

The Iowa Supreme Court awarded damages to Kanne, but only to
the extent of the loss, due to the erroneous accounts payable. The
court reasoned that liability must depend on the CPA's undertaking and

not on a denial of assurances contained in the opinion disclaimer.

 

5Ryan v. Kanne, 170 N.W. 2d 395 Iowa, 1969.

 

67
The court explained:
He must perform as agreed whether the work is certified or
not. This being so, we have here fact questions as to the
substance of the agreement between the parties, as to the
care exercised in its performance, and as to the represen-
tations made, rather than whether the report was certified
or uncertified.
In regard to Ryan's claim of no contract, the court determined that CPA

liability for negligence was possible in accordance with the principle

of foreseeability.

Court Decision Related to the Present Research

 

The Ryan v. Kanne ruling was one of the first court decisions

 

to establish CPA responsibilities for unaudited financial statements.
The court challenged AICPA auditing standards, which stated that the
CPA's opinion disclaimer on unaudited financial statements contained
no assurances about the statements. The court determined that the CPA
was responsible for part of the financial statements based on the care
exercised by the CPA, the representations made by the CPA, and the

principle of foreseeability. The Ryan v. Kanne case further exposed

 

the communication problems between CPAs and users regarding unaudited
financial statements. One problem was that CPAs might have achieved
some assurances about a part of the financial statements without ex-
pressing such assurances. Another problem was that users might have
attributed some assurances to part of the financial statements despite
the CPA's denial of assurances. The present research examines the
possibility that users may attribute some assurances to the reliability

of financial statements accompanied by either compilation or review

 

6Ibid., 170 N.W. 2d 404 Iowa, 1969.

68

reports.

MacNerland v. Barnes

 

Description of the Case

 

Like Ryan v. Kanne, MacNerland v. Barnes7 was a case in which

 

a user attributed audit-type assurances to part of the unaudited finan-
cial statements. MacNerland relied on financial statements to purchase
45,090 stock shares of Continental Rent-AeCar of Georgia, Inc. After
discovering erroneous "Automobiles" and "Accounts Payable" accounts,
MacNerland contended that Barnes, a CPA, negligently misrepresented the
accounts. Barnes countered that the financial statements contained an
opinion disclaimer, and that no contract existed between him and
MacNerland.

Judge Quillian of the Georgia Court of Appeals cited AICPA

auditing standards and a previous case, Ultramares,8 to reject CPA

 

liability for negligence when there was an opinion disclaimer and no
contract. Quillian emphasized the nature of the CPA's opinion dis-
claimer on unaudited financial statements:

The statement is designed as a red flag that the accountant
in question was not independent with respect to the company
on which the financial report was prepared and the statements
given were not audited by the accountant. As set forth in
No. 38 of the Statement on Auditing Procedures "although the
certified public accountant may have prepared, or assisted in
preparing, unaudited financial statements, the statements are
representations of management, and the fairness of their
representation is management's responsibility." In the situ-
ation in which we are considering the accounting firm acts as
a mere conduit through which the information passes and does

 

7MacNerland v. Barnes, 129 Ga. App. 367; 199 S.E. 564, 1973.

 

8Ultramares Corporation v. Touche, 255 N.Y. 170; 174 N.E.
441, 1931.

 

69

not assume any responsibility for the correctness of
the statements which are management's responsibility.9

Despite this decision, however, the court ruled that CPAs could be
liable to third parties if the CPA agreed to verify certain accounts

contained in the financial statements and neglected to do so.

Court Decision Related to the Present Research

Unlike the court which decided the Ryan v. Kanne case, the

 

MacNerland v. Barnes court associated the CPA's responsibilities for

 

unaudited financial statements with the CPA's opinion disclaimer re-
port. The court accepted AICPA auditing standards which stated that

the CPA's opinion disclaimer on unaudited financial statements con-
tained no assurances about the statements. The compilation report,

one of the two reports which replaced the opinion disclaimer, also con-
tains no assurances about the financial statements. A possibility
remains that users may perceive some assurances about compiled financial
statements in spite of the CPA's denial of assurances. The present
research examines to what extent CPAs and users perceive assurances
about financial statements which are accompanied by the CPA's compil-

ation report.

Bonhiver v. Graff

 

In Bonhiver v. Graff,10 a user attributed audit-type assurances

 

to financial information contained in the CPA's working papers. Graff,
a CPA, was engaged to prepare working papers and adjusting entries for

American Allied, an insurance company. During his engagement, state

 

9MacNer1and v. Barnes, 199 S.E. 566, 1973.

 

10Bonhiver v. Graff, 248 N.W. 2d 291, 1976.

 

70

insurance examiners inspected American Allied's financial statements.
Bonhiver, the receiver of American Allied, argued that Graff allowed
the examiners access to the working papers. As a result, it was alleged
that the insurance commissioner relied on Graff's representations in the
working papers to indicate that American Allied was solvent. After dis-
covering that American Allied was insolvent and that the company's
officers misappropriated over $2 million, Bonhiver contended that Graff
negligently misrepresented the company's financial situation. Graff
disputed the liability because he did not produce audited financial
statements, but rather a set of incomplete and unaudited working papers.

Judge Sheran of the Minnesota Supreme Court issued three rulings
in this case. He first ruled that Graff made negligent representations
to known and reliant third parties. Next, he determined that the CPA
should have known about or at least suspected the misrepresented
accounts. Finally, the court ruled that Graff's working papers and

representations breached the ordinary standard of care.

Court Decision Related to the Present Research

 

The Bonhiver v. Graff decision was similar to the Ryan v. Kanne

 

 

ruling in that both courts established CPA responsibilities for un-
audited financial statements. The court ignored AICPA auditing stand-
ards, which protected the confidentiality of the CPA's working papers,
and determined that the CPA was responsible for the financial informa-
tion based on other criteria. These criteria were: the representations
made by the CPA to known third parties, the care exercised by the CPA,
and the CPA's knowledge of suspicious circumstances. This case is

another in which a CPA and user did not share similar perceptions of

 

71

assurances accompanying unaudited financial statements. The present
research examines whether CPAs and users share similar perceptions of
the reliability of financial statements which are accompanied by com-
pilation and review reports.

Coleco Industries, Inc. v. Berman v.
Zelnick, Sobelman and Company

 

 

Description of the Case

 

In the Coleco case,11 a user attributed audit-type assurances
to quarterly financial statements despite the CPA firm's opinion dis-
claimer on the statements. Coleco Industries acquired the Royal All-
Aluminum Swimming Pool Corporation by a 100% stock purchase. Coleco
relied on Royal's April 30, 1973, unaudited financial statements to
consummate the acquisition. The CPA firm of Zelnick, Sobelman and
Company was engaged by Royal to prepare the quarterly statements.
Coleco and Royal sued the CPA firm for negligently overstating inven-
tory by nearly $50,000. A relevant fact in the case was that the CPA
firm admitted that they failed to mechanically calculate inventory
correctly and failed to deduct overhead from inventory. Zelnick,
Sobelman and Company argued that lack of a contract and association
with unaudited financial statements nullified the liability.

The United States Pennsylvania District Court applied the fore-
seeability principle to establish CPA liability, despite the CPA's asso-

ciation with unaudited financial statements and the lack of a contract.

The court determined that Zelnick, Sobelman and Company knew that Royal

 

11Coleco Industries, Inc. v. Berman v. Zelnick, Sobelman and
Conpany, 423 F. Supp. 275, 1976; 567 F. 2d 569, 1977.

 

m};

72

relied on the statements in order to warrant the financial condition of
the company to Coleco. The CPAs were held legally responsible to known
third parties who reasonably relied on financial statements prepared
and submitted to them. Further, the court ruled that avoidance of the
inventory errors would have required neither a costing check nor a
physical inventory. Coleco recovered $350,000 from the CPA firm in an

out-of—court settlement.

Court Decision Related to the Present Research

 

Like the Ryan v. Kanne court, the Coleco court established CPA

 

responsibilities for unaudited financial statements, despite an opinion
disclaimer. The care exercised by CPA firms in handling inventory
accounts and the ability to foresee that third parties would use the
statements were used as criteria in determining the CPA firm's respon-
sibilities. Like the previous cases, this one exemplified the dis-
similar perceptions between CPAs and users of assurances accompanying
unaudited financial statements. The present study provides empirical

information about this CPA-user communication problem.

Seedkem, Inc. v. Safranek

 

Description of the Case

 

Seedkem v. Safranek12 is a final example of a case in which a

 

user attributed audit-type assurances to unaudited financial statements
in spite of the CPA's opinion disclaimer on the statements. Seedkem
relied on 1975 financial statements prepared by Safranek, a CPA, in

order to advance credit of more than $700,000 to Agri-Products, Inc.

 

leeedkem, Inc. v. Safranek, 466 F. Supp. 340, 1979.

 

73
After suffering loan defaults from Agri-Products, Seedkem charged that
Safranek recklessly and wantonly prepared the statements and knew that
the statements did not conform to generally accepted accounting prin-
ciples. Safranek contended that the unaudited financial statements
contained an express disclaimer of opinion and that no other represen-
tations on the statements were made.

Judge Denney of the United States Nebraska District Court
remanded the case to ascertain whether any express representations or
understandings existed 'between the parties. In his Opinion, Denney
cautioned that Safranek could be liable for negligence despite an
opinion disclaimer on unaudited financial statements:

Despite the fact that financial statements were ex~

pressly marked "unaudited" and the fact that they con-

tained an express disclaimer of opinion would not neces-

sarily mean that the accountant charged with negligence

in preparing the statements and with recklessly and

wantonly allowing his name to be attached to the state-

ments would not be liable to a third party who advances

credit in reliance on the statements.13
Applying the foreseeability principle, Denney noted that CPAs could be
liable to those who, although not individually foreseen, were members

of a limited class whose reliance on the representation was specifi—

cally foreseen.

Court Decision Related to the Present Research

 

The Seedkem v. Safranek case was another in which a court ruled

 

the CPAs were not relieved of responsibilities for unaudited financial
statements. The court suggested that, despite an opinion disclaimer,

CPAs were responsible for negligent misrepresentations made to known

 

l31b1d., 466 F. Supp. 340, 1979.

 

74
and reliant third parties. In this case, a CPA and user did not share
similar perceptions of assurances accompanying unaudited financial
statements. Given the replacement of unaudited financial statements
by compiled and reviewed statements, CPAs and users may not share
similar perceptions of assurances contained in compilation or review
reports. The present research examines this possibility.

Summary of Court Decisions and Their
Relationship to the Present Research

 

This section summarizes the court decisions, and the next sec-

tion relates the court findings to the present research.

Summary of the Court Decisions

 

The legal cases cited are examples of cases in which CPAs and
users did not share similar perceptions about either (1) the substance
of the CPA's engagement, or (2) supposed CPA assurances accompanying

unaudited financial statements. In two cases (Bloch, 1136 Tenants'),

 

users believed that the CPAs audited the financial statements while
the CPAs contended that they were merely associated with unaudited

statements. In five other cases (Ryan, MacNerland, Bonhiver, Coleco,

 

Seedkem), users attributed audit-type assurances to unaudited financial
statements, despite the CPA's denial of assurances.

The courts in these cases interpreted AICPA auditing standards
to determine either the substance of the CPA's engagement or the CPA's
responsibilities for unaudited financial statements. In addition, the
courts applied a number of legal criteria to resolve these disputes.

In both the Bloch and 1136 Tenants' cases, the courts ruled that the

 

substance of the CPA's engagement was an audit. In the Bloch case,

75
the court used AICPA auditing standards to determine whether the CPA
was associated with unaudited or audited financial statements. Because
the CPA violated these standards with respect to disclaiming responsi-
bility for unaudited financial statements, the court found that the
CPA was responsible for audited statements. The court in the lléé
Tenants' case, however, reached its decision by challenging the AICPA
auditing standard which specified that CPAs need not perform auditing
procedures on unaudited financial statements. The courts in five other
cases (Ryan, MacNerland, Bonhiver, Coleco, Seedkem) determined the CPA's

responsibilities for unaudited financial statements. The MacNerland

 

court accepted AICPA auditing standards which state that the CPA's
opinion disclaimer contains no assurances about the financial state-
ments. This court determined that the CPA's opinion disclaimer
relieved the CPA of responsibilities for the correctness of the state-

ments. However, in four cases (Ryan, Bonhiver, Coleco, Seedkem), the

 

courts challenged these AICPA auditing standards. In three of these

cases (Ryan, Coleco, Seedkem), the courts decided that the CPA's opinion

 

disclaimer does not necessarily relieve the GPA of all responsibilities
pertaining to unaudited financial statements. In the Bonhiver case,
the court ruled that the CPA's association with unaudited working papers
did not relieve the CPA of all responsibilities for the financial infor-
mation contained in the working papers.

The courts also determined that CPAs were responsible for parts
of the financial statements based on other criteria. These were:

(1) duty of care and competence (Bloch, Ryan, Bonhiver, Coleco);

 

 

(2) representations made about the accounts (Ryan, MacNerland, Bonhiver,

 

Seedkem); (3) knowledge of suspicious circumstances (Bloch, 1136

 

 

76

Tenants', Bonhiver); and (4) foreseeability of users (Ryan, Bonhiver,

 

 

Coleco, Seedkem).

 

Relationship to the Present Research

 

These legal cases helped to expose the problems previously
referred to in this chapter concerning the CPA's association with un-
audited financial statements. The AICPA responded to these problems by
issuing a compilation and review standard. Applying to nonpublic busi-
nesses only, the standard replaced unaudited financial statement engage-
ments and the accompanying opinion disclaimer reports with two types of
engagements and reports--compilation and review. But the possibility
still remains that CPAs and users may not share similar perceptions
about the assurances contained in compilation and review reports. Like
the users described in the legal cases, users may attribute audit-type
assurances to compilation and review reports.

A primary objective of the present research is to provide
empirical information about the similarities with which CPAs and users
perceive assurances about the reliability of financial statements
accompanied by no CPA report, by the CPA's compilation report, by the
CPA's review report, and by the CPA's audit report. If the results of
the study indicate that users perceive audit-type assurances for compi-
lation or review reports, then fears of legal risks for CPAs in compi-

lation or review engagements may be well-founded.

Summagy

This chapter reviewed seven legal cases in which CPAs and users
did not share similar perceptions about either (1) the substance of the

CPA's engagement, or (2) supposed CPA assurances accompanying unaudited

77

financial statements. In both types of cases, users attributed audit-
type assurances to the financial statements, whereas CPAs denied audit-
type responsibilities for the statements. Most of the courts in these
cases interpreted AICPA auditing standards to determine either the
substance of the CPA's engagement or the CPA's responsibilities for
unaudited financial statements.

The next chapter chronologically reviews significant events in
the AICPA's development of a compilation and review standard intended
to overcome problems associated with unaudited financial statements and

limited procedure engagements.

CHAPTER IV

DEVELOPMENT OF COMPILATIONS AND REVIEWS

This chapter chronologically reviews significant events in the
development of AICPA standards which led to the establishment of compi-
lations and reviews. Formerly, there were two types of CPA engagements
on the financial statements of nonpublic businesses: unaudited finan-
cial statement engagements and certain limited procedure engagements.
The chapter describes various communication problems between CPAs and
users which resulted from these types of engagements. The chapter then
describes how the AICPA responded to these problems with the issuance
of auditing standards and a separate compilation and review standard.

The chapter is comprised of four sections. The first section
describes the significant events in the development of AICPA standards
pertaining to unaudited financial statements for the time period, 1896-
1946. During this period, CPAs were associated with unaudited finan—
cial statements, but the accounting profession emphasized procedural
and reporting guidance for audit engagements. The next section
describes the events and standards associated with unaudited financial
statements and limited procedure engagements for the time period, 1947-
1961. During this period, the accounting profession first officially
recognized unaudited financial statement engagements. Also, CPAs began
to practice certain types of limited procedure engagements during this
time. The third section describes the events and standards related to

78

 

79
unaudited financial statements and limited procedure engagements for
the time period, 1962-1976. These events and standards immediately
preceded the development of compilations and reviews. Finally, the
last section describes how the accounting profession responded to the
problems associated with unaudited financial statements and limited
procedure engagements by issuing a separate compilation and review

standard for nonpublic businesses.

Developing Auditing Standards: 1896-1946

 

During this period, the accounting profession recognized the
need on the part of third parties for CPA association with financial
statements, and the American Institute of Accountants (AIA)1 developed
and issued auditing standards to guide such an association. For ex-
ample, bankers wanted CPA association with a loan customer's audited
financial statements, because they relied on the CPA's assurances to
provide input for the loan decision.2 Before these standards were
developed, third parties received a variety of CPA reports as a result
of different types of CPA engagements. In addition, the absence of
professional guidelines for these engagements and the corresponding
reports contributed to this variety.3 In 1939, the AIA issued

Statement on Auditing Procedure Number 1: Extensions of Auditing

 

 

1The name of the American Institute of Accountants (AIA) was
changed in 1957 to the American Institute of Certified Public
Accountants (AICPA) .

2Charles C. Kimball, "Accountant's Reports from a Banker's
VieWpoint," Journal of Accountancy, April 1937, pp. 268-269.

3Ibid.; William H. Bell, "Staff Preparation and Editing of
Reports," Journal of Accountancy, February 1925, pp. 116-117.

 

 

80

Procedures (SAP #1) in response to this problem. This standard

 

required the CPA to issue either an audit opinion on the fairness of
the financial statements, taken as a whole, or to report on the find-
ings of the engagement without expressing an opinion.4 With the pub-
lication of SAP #1 and other auditing standards, the AIA emphasized
the CPA's association with audited financial statements and related
audit reports.

The AIA did not recognize the CPA's association with unaudited
financial statements during this period. However, Robert H. Montgomery's
auditing book reported that the preparation of a balance sheet from
the unaudited books of a client was within the scope of a CPA's ser-
vices. Montgomery further acknowledged that CPAs reported on unaudited
financial statements by (l) issuing the statements on plain paper with-
out CPA comments, (2) issuing the statements on the CPA's letterhead
without CPA comments, or (3) issuing the statements on the CPA's
letterhead with CPA comments. Comments were either a report of find-

' or "Pro

ings or a disclaimer, such as "Without Audit," "Tentative,'
Forma."S Table 4-1 summarizes the authoritative bodies, AICPA stand-
ards, engagement tasks, and report forms which were in effect for un-
audited financial statements in 1946 at the end of the first time
period under consideration.

Misunderstandings between CPAs and users resulted from the CPA's

association with unaudited financial statements. For example, Montgomery

 

4American Institute of Accountants, Committee on Auditing Pro-
cedure, reprinted in Journal of Accountancy, December 1939, p. 380.

5Robert H. Montgomery, Auditing Theory and Practice, 5th ed.
(New York: The Ronald Press Company, 1934), pp. 694-695.

 

81

TABLE 4-1

UNAUDITED FINANCIAL STATEMENTS: 1946

 

 

Unaudited Financial Statements

 

Authoritative Body None

AICPA Standards None

Engagement Tasks Prepare financial statements

Report Forms Financial statements on plain paper

without CPA comments, or

Financial statements on CPA's
letterhead without CPA comments, or

Financial statements on CPA's
letterhead with marking i.e.
"Tentative," "Without Audit,"
"Pro Forma," or

Financial statements on CPA's
letterhead with report of findings

 

explained that CPAs did not intend to give assurances to third parties
about unaudited financial statements: "The representation by a client
that a statement obtained in this manner has behind it the auditor's
assurances of its correctness is pure fraud on the part of the client."6
Nevertheless, when the financial statements appeared on the CPA's letter-
head, it was feared that users attributed audit-type assurances to the
statements merely because a CPA was associated with the statements.

Also, there was uncertainty about how third parties perceived the asso-

ciation of CPAs with financial statements which appeared on the CPA's

 

6Ibid.

7Ibid., p. 695; John L. Carey, "Editorial," Journal of
Accountancy, September 1941, p. 195.

 

82

letterhead without comments. Bankers could, for example, variously
perceive that the CPA typed the statements, prepared the statements
without audit, applied limited auditing procedures to the statements,

or audited the statements.

Recognizing Unaudited Financial Statements: 1947-1961

The accounting profession continued to emphasize the CPA's attest
function during this period. This function comprised the CPA's associ-
ation with audited financial statements and the CPA's expression of an
opinion on the fairness of the statements taken as a whole. Performance
of this function gave credibility to the financial statements and in-
creased users' reliance on the statements. Reporting problems remained,
however, when CPAs performed unaudited financial statement engagements
and limited procedure engagements. One problem was that users might
not have understood the CPA's responsibilities for either unaudited
financial statements or limited procedure engagements. A related prob-
lem was that users might have attributed audit-type assurances to either

unaudited financial statements or limited procedure engagements.

Unaudited Financial Statements

 

The AIA first recognized the CPA's association with unaudited

financial statements in Statement on Auditing Procedure Number 23:

 

Clarification of the Accountant's Report When Opinion is Omitted (SAP

 

#23). SAP #23 modified SAP #1 by requiring the CPA to issue either an

audit opinion or an opinion disclaimer about the fairness of the

 

8Victor H. Stempf, "Whose Balance Sheet Is It?" New York
Certified Public Accountant, May 1941, p. 443.

 

83

financial statements.9 SAP #23 required the CPA to report on unaudited
financial statements by (l) issuing the statements on plain paper with-
out CPA comments or (2) issuing the statements on the CPA's letterhead
with CPA comments. Comments were specified as either a report of
findings, accompanied by an opinion disclaimer, or the disclaimer,
"Prepared from the Books Without Audit," appearing prominently on each
page of the financial statements.10 Table 4-2 summarizes the authorita-
tive bodies, AICPA standards, engagement tasks, and report forms which
were in effect for unaudited financial statements in 1961 at the end

of the time period under consideration.

SAP #23 was intended to reduce misunderstandings between CPAs
and users in two ways. First, the standard eliminated the issuance of
unaudited financial statements on the CPA's letterhead without comments.
Second, the standard required the CPA's disclaimer as a warning to third
parties that the statements were not audited. Two problems, however,
were not resolved by SAP #23. One problem was that CPAs continued to
issue financial statements on plain paper without comments. Users of
these statements may have been uncertain about the degree of CPA asso-
ciation with and responsibilities for such statements.11 The second
problem was that users may not have understood the meaning of the CPA's

opinion disclaimer. For example, bankers may have attributed to the

 

9American Institute of Accountants, Committee on Auditing
Procedure, reprinted in Journal of Accountancy, June 1949, p. 469.

 

10Ibid.

11Richard A. Nest, "Statement No. 38--Unaudited Financial
Statements," Journal of Accountancy, February 1968, pp. 63-64; W. H.
Turlington, "Letters to the Journal," Journal of Accountancy, November
1965, p. 30.

 

 

84

 

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85
statements audit-type assurances about the reliability of the financial

l
statements, merely because a CPA was associated with the statements.

Limited Procedure Engagements

 

During this period, CPAs practiced a limited procedure engage-
ment that was similar to today's review engagement under SSARS #1. The
limited procedure engagement was a review of interim financial state-
ments. In carrying out this review engagement, the CPA read minutes of
meetings, read the interim financial statements, and performed analyti-
cal and inquiry procedures. The CPA reported the results of this review
by issuing a "comfort letter," which was addressed to the client but
normally used by underwriters. In this letter, the CPA provided
limited assurance that nothing came to his attention during the review
which would require modification of the unaudited financial statements.13
Table 4-2 summarizes the authoritative bodies, AICPA standards, engage-
ment tasks, and report forms which were in effect for limited procedure
engagements at the end of 1961.

The review of interim financial statements created two problems
for CPAs and users. One problem, shown in Table 4-2, was that the
accounting profession provided neither procedural nor reporting
guidance for CPAs who performed this review. As a result, CPAs were
uncertain about what auditing procedures they should perform on these

engagements.14 Another problem was that users might have attributed

 

lzJ. S. Seidman, "Letters to the Journal," Journal of
Accountancy, March 1966, p. 29.

13A. P. L. Prest, "The Limited Review of Unaudited Interim
Statements," Journal of Accountancy, October 1957, p. 50.

141b1d., p. 52.

 

 

 

86

audit-type assurances to the financial statements because CPAs per-

formed certain auditing procedures on the statements.15

Standards for Unaudited Financial Statements: 1962-1976

 

Despite continued emphasis on the CPA's attest function, in 1962
the accounting profession began to issue reporting standards with re-
spect to CPA association with unaudited financial statements. However,
the new standards did not provide procedural or reporting guidance for
CPAs who performed limited auditing procedures on unaudited financial
statements. This situation contributed to communication problems be-
tween CPAs and users concerning the CPA's association with unaudited

financial statements and limited procedure engagements.

Unaudited Financial Statements

 

The AICPA issued two standards and a guide regarding CPA associ-

ation with unaudited financial statements. These were: Statement on

 

AuditingiProcedure Number 32: Disclaimers (SAP #32); Statement on

 

 

Auditing Procedure Number 38: Unaudited Financial Statements (SAP #38);

 

and Guide for Engagements of CPAs to Prepare Unaudited Financial State-

ments (Guide).

 

SAP #32 was the first AICPA standard to provide reporting guid-
ance regarding CPA association with unaudited financial statements.
Major points of this standard included:

1. Definition of unaudited financial statement engagements
as the performance of no auditing procedures or insignificant auditing

procedures.

 

15Ibid.

87

2. Requirement that the CPA report on unaudited financial
statements by marking "Unaudited" on each page of the statements, with
or without other CPA comments.

3. Recommendation that the CPA report on unaudited financial
statements by issuing an opinion disclaimer when the unaudited state-
ments were not accompanied by other CPA comments.

4. Requirement that the CPA report on unaudited financial
statements by issuing an opinion disclaimer when the statements were
accompanied by other CPA comments.16

SAP #38 was the first AICPA standard to separately consider
unaudited financial statements. Major provisions of this standard
accomplished the following:

1. Distinguished an accounting service from an audit engage-
ment.

2. Described an unaudited financial statement engagement as
an accounting service. An accounting service included assistance in
adjusting and closing the general books, and preparation of or assist-
ance in the preparation of financial statements.

3. Described unaudited financial statement engagements as the
performance of no auditing procedures, or the performance of insuffi-
cient auditing procedures to permit the expression of an audit opinion.

4. Required CPA association with plain paper financial state-

ments .

 

16American Institute of Certified Public Accountants, Committee
on Auditing Procedure, Statement on Auditing Procedure Number 32:
Qualifications and Disclaimers. Reprinted in Journal of Accountancy,
January 1963, pp. 68-69.

 

 

 

88

5. Required the CPA to report on unaudited financial state-
ments by issuing an opinion disclaimer and marking "Unaudited" on each
page of the statements.

6. Permitted CPA association with general-use and internal-
use unaudited financial statements. General-use unaudited statements,
which required appropriate disclosures, were distributed to third
parties. Internal-use unaudited statements, which did not require
appropriate disclosures, were not distributed to third parties. The
CPA reported on internal-use statements by adding a disclosure disclaimer
to the report.17 Table 4-3 summarizes the authoritative bodies, AICPA
standards, engagement tasks, and report forms which were in effect for
these two unaudited financial statement engagements in 1976 at the end
of the time period under consideration. Standards for accounting and
review services rendered by CPAs on public business financial statements
after 1976 are not discussed in the present research.

Because of legal uncertainties pertaining to the CPA's respon-
sibilities for unaudited financial statements, the AICPA appointed a
task force in 1972 to offer guidance with respect to unaudited state-

ments. In 1975, the task force issued Guide for Engagements of CPAs to

 

Prepare Unaudited Financial Statements, which improved procedural and

 

reporting guidelines for CPAs who were associated with unaudited finan-

l
cial statements.

 

17American Institute of Certified Public Accountants, Committee
on Auditing Procedure, Statement on Auditing Procedure Number 38:
Unaudited Financial Statements. Reprinted in Journal of Accountancy
November 1967, pp. 59-60.

18American Institute of Certified Public Accountants, Task Force

on Unaudited Financial Statements, Guide for Engagements of CPAs to Pre-
pare Unaudited Financial Statements (New York: AICPA. 1975). pp. 1-34.

 

 

 

 

 

89

 

memeova

sowsfioo cam .muamEoumum mo

mwma somm so vmxume :woufivsmcs:
Lufis vmmfiumuuma m.<mu no momma
camaa :o mucmEoumum Hmwoamafim

mmHSmoaomHv mumHumouaam £ua3

mmSIHmumamw pom mwusvmoopm
mafiufivsm vmuHEHH wcfihaaom >9
mucmEmumum Hmfiocmafiw mumamum

Amamfiv muumucmum wcfiufiu=<
co mucmEmumum He m<m

Aeomflv moamEmumum
Hmfluamaam amufiusmas mme m<w

Amomav mumawmfiomwn cam
mcowumofimwamso Nme m<m

mmuufiEEoo m>fiusomxm
mvumwcmum wcHqu=<

umefimaomwo wusmoaomfim

umafimaomfiv

coacfiao mam .muamEmumum mo
mwma sumo co cmxum8:vmufiv:mcp:
suwa vmmsumuuma m.<mu no umama
sfimaa so mucmEmumum Hmfiocmafim

mmHSmoHomfiv mumwuaouaam usonufia
mmsnamapmuca you mousomooua
wcfiuwwsm wawzammm usonuws
muaofimumum Hmwosmcfim mumamum

“means msumucmum wannacs<
so mucmamumum He m<m

Aeomav magmamumum
Hmaocmafie cmuawsmss mme m<m

Amoaav mumefimaomwo cam
msowumoHMfiHmso mme m<m

mmuuaasoo m>fiusomxm
mwnmvamum wcwufiws<

mEuom uuoamm

mxmmH ucmamwmwcm

mwumwcmum <mUH<

zoom m>flumufiuonus<

 

mucmsmumum Hmaosmcflm
wouficomcs mmDIHmuwamo

mucmsoumum Hmwosmcwm
vmufiwsmcp omDIHmanmuaH

 

 

onaa

"mHZMZMH<Hm A<Hoz<sz QMHHQD<ZD

mum mqmda

90

Although SAP #32, SAP #38, and the Guide explained the CPA's

 

engagement and reporting responsibilities with respect to unaudited
financial statements, several problems remained. These included un-
certainty among CPAs about the extent of auditing procedures to per-
form on unaudited financial statements, unauthorized distribution of
internal-use financial statements to users, and confusion by users
regarding limited scope opinion disclaimers and unaudited financial
statement opinion disclaimers.

The first problem of association with unaudited financial state-
ments was that CPAs were uncertain about the extent of auditing proce-
dures to perform on unaudited statements. As described in Chapters I
and III, litigation prompted CPAs to perform either limited auditing
procedures on unaudited financial statements, or no auditing procedures
on the statements. Tables 4-3 and 4-4 summarize these two approaches
to CPA engagements with general-use unaudited financial statements.

In addition to litigation, the recommendations of a number of
accounting academicians and practitioners contributed to CPA uncer—
tainty about the extent of auditing procedures to perform on unaudited
financial statements. Many academicians and practitioners recommended
that the accounting profession issue guidelines which would standardize
these practices and enable CPAs to express limited assurances about the
reliability of the statements. Articles of recommendation came from
Chan in 1968, Saxe in 1972, Terrell in 1973, Guy and Mannzh11973,

Olson in 1975, and Meddaugh in 1977.19 The AICPA, however, neither

 

19Stephen Chan, "A Review of Statement on Auditing Procedure
Number 38," New York Certified Public Accountant, March 1968, p. 188
(hereafter cited as Chan, "A Review of Statement Number 38"); Saxe,

 

91
recognized nor provided procedural or reporting guidelines for CPAs
who performed these limited procedure engagements. They were performed
under the guise of unaudited financial statements and reported on by
opinion disclaimers and the marking of "Unaudited” on each page of the
statements.

Another problem of association with unaudited financial state-
ments was the unauthorized distribution of internal-use unaudited
statements to third parties. For example, a survey found that 79% of
responding bankers reported at least some use of internal-use unaudited
financial statements. This unauthorized distribution indicated that
businesses either misunderstood or intentionally disregarded the dis-
tribution limitation. In addition, it was possible that users may
have attributed unwarranted reliability to these statements, which
lacked the appropriate disclosures.

A final problem of association with unaudited financial state—
ments was that third parties might not have understood the differences

between a limited scope opinion disclaimer and an unaudited financial

statement opinion disclaimer.22 The former disclaimer referred to a

 

"Unaudited Financial Statements," p. 461; Terrell, "Minimum Standards,"
pp. 54-60; Dan M. Guy and Herschel Mann, "A Practical Guide for Re-
porting on Limited Examinations of Financial Statements," CPA Journal,
July 1973, pp. 557-558; Wallace E. Olson, "A Look at the Responsibility
Gap," Journal of Accountancy, January 1975, pp. 56-57; and E. James
Meddaugh, "Toward the Limited Review of Unaudited Statements," Journal
of Accountancy, June 1977, p. 78.

20AICPA, Codification of Statements on Auditing Standards:
1-15, sec. 516.04.

 

 

 

 

2J'Winters, "Banker Perceptions," p. 30.

22D. R. Carmichael, "Accounting and Auditing Problems," Journal
of Accountancy, January 1971, pp. 74-75.

 

I'du
S 15
S \

1

92
CPA's audit engagement in which restrictions on auditing procedures
precluded an audit opinion. The latter disclaimer referred to the
CPA's association with unaudited financial statements in which no

auditing procedures or only limited auditing procedures were performed

by the CPA.

Limited Procedure Engagements

 

CPAs during this period performed two types of limited proce-
dure engagements which were similar to review engagements under SSARS
#1. These were applying limited auditing procedures to unaudited
financial statements and reviewing interim financial statements. Table
4—4 summarizes the authoritative bodies, AICPA standards, engagement
tasks, and report forms which were in effect for these limited proce-
dure engagements at the end of 1976. Engagements in which CPAs per—
formed limited auditing procedures on unaudited statements have already
been discussed in the preceding section of this chapter. As for reviews
of interim financial statements, the AICPA intended to reduce misunder-
standings between CPAs and users by issuing two standards. These were

Statement on Auditing Standards Number 10: Limited Review of Interim

 

Financial Information (SAS #10), and Statement on Auditing Standards

 

 

Number 13: Reports on Limited Review of Interim Financial Information

 

(SAS #13). As part of his review of interim financial statements,
SAS #10 required the CPA to read the minutes of meetings, read the
23

interim statements, and perform analytical and inquiry procedures.

SAS #13 required the CPA to report on the results of this review by

 

23AICPA, Codification of Statements on Auditing Standards:

1-15, sec. 720.10.

 

93

 

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Imumum mo mwma 50mm 60 cmxnma
:vmuncsmoa: nuns unoomn 3mn>om

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wanunvsm vmunsna wanhaaam ha
mncmsmumum Hmnocmanw 3mn>mm

Acnmnv conumEHomcn
amnocmanm EnnmucH mo 3on>mm

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no 3mn>mm emanann one m<m

mmuunEEoo m>nn=omxm
mvnmvcmum wanunv=<

nmanmaomnv

concnao cam .mucmEmumum mo mwma
Sumo co pmxnms :wmnnpsmco:
nun3 vmmnnmuuoa m.<mo no nmama
anmae co muaoamumum Hmnocmcnm

monsvmoona
wcnunpsm cmunEnH wcnhaaom up
mucosmumum Hmnoamanm Swn>mm

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so mummEoumum He m<m

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Hmnosmanm councsmcs wme m<m

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mconumoHMfiHmso mme m<m

mmuunEEoo m>Hnsomxm
mwnmmamum wcnunp=<

manom unoamm

mxmmH ucmEmmmwcm

munmvamum <moH<

neon m>numnnnonua<

 

mucosmnmum Hmnocmcnm
EnnmuaH

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pounvsmcs mmDIHmnmamo

 

 

onma

umHzmzmo<Uzm mmsamoomm DMHHZHA

«IQ mqm<H

94
stating the objectives of the review, issuing an opinion disclaimer,
and marking "Unaudited" on each page of the statements.2
The increasing frequency of limited procedure engagements cre-

ated several problems for CPAs and users. One problem was the diffi-
culty CPAs and users had in understanding differences among unaudited
financial statements, limited procedure engagements, and audits. An
accounting practitioner noted this problem:

The auditor might keep in mind that the difference between

significantly audited, partially audited, and unaudited has

not been sufficiently defined by the Institute's Auditing

Procedure Committee and is often dependent upon 298 type of

engagement and intent of the auditor and client.
Another problem was that the CPA reported on these engagements by
issuing an opinion disclaimer on the financial statements. As a result,
the CPA might have achieved some assurances about the financial state-
ments but expressed no assurances in the report. Also, users might

have perceived some assurances about the statements in spite of the

CPA's denial of assurances.

Development of Compilations and Reviews

 

Users of nonpublic business financial statements and CPAs
recognized the problems associated with unaudited financial statements
and limited procedure engagements. For example, users were concerned
that AICPA auditing standards did not enable CPAs to express limited
assurances about the financial statements as a result of limited pro-

cedure engagements. Also, CPAs were concerned that these standards

did not provide procedural or reporting guidelines for CPAs who

 

24Ib1d., sec. 519.04.

25Chan, "A Review of Statement Number 38," p. 188.

 

95

performed limited procedure engagements.26 At the same time, two AICPA
spokesmen challenged the CPA's attest function by advocating an assur-
ance level approach. They explained the need for an assurance level
appropriate to the CPA's report on a limited procedure engagement:

What is needed are forms of assurance that are less than

that ascribed to an opinion audit but greater than those

ascribed to unaudited financial statements.2

...the realities of the business world and increasing

complexity of professional standards have created.a need

for a new form of assurance that is less than that ex-

pressed as a result of an audit made in accordance with

generally accepted auditing standards but certainly

greater than that included in the present disclaimer on

unaudited financial statements.28
The AICPA responded to these concerns and other problems associated
with unaudited financial statements and limited procedure engagements
by developing a standard for compilations and reviews. Significant
events in this development are described below.

In 1975, the AICPA established the Accounting and Review Ser-

vices Committee (ARSC) as a subcommittee of the Auditing Standards
Executive Committee (AudSEC).29 After two years, the ARSC became a

senior technical committee with authority to issue standards for

accounting and review services rendered by CPAs on nonpublic business

 

26

Kelley, "Compilation and Review, p. 19.

27D. R. Carmichael, "The Assurance Function--Auditing at the
Crossroads," Journal of Accountancy, September 1974, p. 69.

28William R. Gregory, "Unaudited, But OK?" Journal of
Accountancy, February 1978, p. 61 (hereafter cited as Gregory, "Un-
audited, But OK").

29The Committee on Auditing Procedure (CAP) was reorganized in
1973 and renamed the Auditing Standards Executive Committee (AudSEC).
The Auditing Standards Executive Committee (AudSEC) was reorganized in
1978 and renamed the Auditing Standards Board (ASB).

 

 

 

96
financial statements. At this point, the ARSC issued four statements
which provided directions for its work. Gregory cites them this way:

1. Auditing and accounting services are distinguishable,
both conceptually and pragmatically.

2. Financial statement users and CPAs should recognize that
providing accounting services in connection with unaudited statements
is an acceptable and useful service.

3. The complexity of auditing standards creates a need for
lower cost alternatives for CPA association with financial statements.

4. The accounting profession needs specific accounting and
review guidance, in the form of standards.30

Following these statements, the ARSC issued an exposure draft of its

first standard, Compilation and Review of Financial Statements. This

 

proposed standard included the following major provisions:

1. Recognition that businesses need accounting services,
compilations, and reviews.

2. Definition of compilations and reviews as the two accounting
services for unaudited financial statements.

3. Identification of standards and procedures for compilations
and reviews.

4. Requirement that the CPA report on a compilation by issuing
a compilation report.

5. Requirement that the CPA report on a review by issuing a
review report.

6. Requirement that the CPA express limited assurance in the

 

3OGregory, "Unaudited, But OK?" p. 63.

97
review report.
7. Permission for third parties to use compiled financial
statements which omit substantially all disclosures.31
After this exposure draft was reviewed, the ARSC in 1978 issued State-

ment on Standards for Accounting and Review Services Number 1: Com—

 

pilation and Review of Financial Statements (SSARS #1). In 1979, the

AICPA modified Rule 204 of its Code of Professional Ethics in order to

 

enforce the standards issued by the ARSC. Rule 204, as modified, re-

quired CPAs to comply with or justify departures from ARSC standards.32

Compilations

 

Since its enactment in 1978, SSARS #1 has enabled CPAs to per-
form two types of compilation engagements on the financial statements
of nonpublic businesses. One type is a compilation of financial state-
ments which omits substantially all disclosures. This compilation is
similar to the former internal-use unaudited statements, which did not
require appropriate disclosures. The other type is a compilation of
financial statements which includes substantially all disclosures. This
compilation engagement resembles the former general-use unaudited finan-
cial statement engagement in which CPAs performed no auditing procedures
on the statements. Table 4-5 summarizes the authoritative bodies, AICPA
standards, engagement tasks, and report forms which pertain to these

two types of compilations.

The objective of both types of CPA compilations is to present

management's representations in the form of financial statements

 

31Kelly, "Compilation and Review," p. 19.

32AICPA, Code of Professional Ethics, sec. 204.01, Appendix D.

 

98

 

mucmEmumum Hmwocmcnm
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Sana unoamn 3mn>mm

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wcnzaamm an mucmamumum
Hmnoamanm 3on>mm

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Hmnocmcnm mo 3mn>om cam

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3mn>mm cam wanucsooo<

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Hmnocmcnw man mo

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:unoemm conumanmaou
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mcoHumHHmEoo

 

 

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mlq mqm<fi

99

without expressing any assurances about the statements. SSARS #1
requires the CPA to read the financial statements to consider whether
the statements appear appropriate in form and free from material
errors.33 The CPA is required to communicate the results of a compil-
ation by issuing a compilation report and marking each page of the
financial statements with a reference such as "See Accountant's Com-
pilation Report."34 An example of a compilation report provided by

the ARSC follows:

The accompanying balance sheet of XYZ Company as of
December 31, l9xx, and the related statements of income,
owner's capital, and changes in financial position for
the year then ended have been compiled by us.

A compilation is limited to presenting in the form
of financial statements information that is the repre—
sentation of management. We have not audited or reviewed
the accompanying financial statements and, accordingly,
do not express an opinion or any other form of assurance
on them.3

If the financial statements omit substantially all disclosures, then
SSARS #1 requires that the CPA add a third paragraph to the compilation
report:

Management has elected to omit substantially all of
the disclosures required by generally accepted accounting
principles. If the omitted disclosures were included in
the financial statements, they might influence the user's
conclusions about the company's financial position, re-
sults of operations, and changes in financial position.
Accordingly, these financial statements are not designed
for those who are not informed about such matters.3

 

33ARSC, Compilation and Review of Financial Statements,

 

par. 13.

34Ibid., pars. 4, 14, 16.

35Ibid., par. 17.

36Ibid., par. 21.

100

Further, if the CPA is not independent in a compilation engagement,
then SSARS #1 requires the CPA to add the following sentence to the
compilation report, "We are not independent with respect to XYZ Com-

pany."37

Reviews

The enactment of SSARS #1 also established the current defini-
tion of a review as a limited procedure engagement on the financial
statements of nonpublic businesses. A review is similar to a limited
procedure engagement dealing with both unaudited and interim financial
statements. In both reviews and limited procedure engagements, the
CPA is required to read the financial statements and to perform
analytical and inquiry procedures.38 Table 4-5 summarizes the
authoritative bodies, AICPA standards, engagement tasks, and report
forms which pertain to reviews.

The objective of a review by a CPA is to perform certain audit-
ing procedures which provide the CPA with a reasonable basis for ex-
pressing limited assurance that no material modifications should be
made to the statements in order for them to be in conformity with
generally accepted accounting principles.39 The CPA is required to
communicate the results of a review by issuing a review report and
marking each page of the financial statements with a reference such

"40

as "See Accountant's Review Report. An example of a review report

 

37Ibid., par. 22.

381bid., par. 27.

39Ibid., par. 4.
401b1d., pars. 32, 34.

101
provided by the ARSC follows:

We have reviewed the accompanying balance sheet of
XYZ Company as of December 31, l9xx, and the related state-
ments of income, owner's capital, and changes in financial
position for the year then ended, in accordance with
standards established by the American Institute of Certi-
fied Public Accountants. All information included in these
financial statements is the representation of the manage-
ment.

A review consists principally of inquiries of company
personnel and analytical procedures applied to financial
data. It is substantially less in scope than an examin-
ation in accordance with generally accepted auditing
standards, the objective of which is the expression of
an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material
modifications that should be made to the accompanying
statements in order for them to be in conformity with
generally accepted accounting principles.

This review report assumes that the financial statements include appro-

priate disclosures and that the CPA is independent.

Summary

This chapter chronologically reviewed significant events in
the development of an AICPA standard for compilations and reviews.

This standard was developed in response to problems associated with un-
audited financial statements and limited procedure engagements.

In spite of the issuance of this new standard, CPAs and users
may still misperceive assurances about the financial statements accom—
panying compilation or review reports. For example, users may misper-
ceive the various levels of assurances provided by compilation reports,
review reports, and audit reports. Another possibility is that users

may attribute audit-type assurances to financial statements accompanied

 

41Ibid., par. 35.

102

by compilation reports or review reports. A primary objective of the
present study is to provide empirical information on CPAs' and users'
perceptions of the reliability of financial statements which are accome
panied by no CPA report, by the CPA's compilation report, by the CPA's
review report, and by the CPA's audit report. If the results of the
present study indicate that users do not perceive different assurances
among the reports, or that users attribute audit-type assurances to
compilation or review reports, then fears of communication problems
regarding compilations and reviews may be warranted.

The next chapter explains the methodology used in the present

research to provide this empirical information.

CHAPTER V

METHODOLOGY

This chapter discusses the methodology used in the present
research to empirically test the effectiveness of the communication
process between certified public accountants (CPAs) and bankers.
Methodological topics are: the research questions and research hypoth-
eses; the questionnaire; questionnaire bias; the sample groups of

bankers; the sample group of CPAs; and statistical analyses.

Research Questions and Research Hypotheses

 

The present study was undertaken to provide empirical informa-
tion about six research questions and related research hypotheses.
These research questions and hypotheses examined the similarities with
which CPAs and bankers perceive assurances about the reliability of
financial statements accompanied by no CPA report, by the CPA's come
pilation report, by the CPA's review report, and by the CPA's audit
report. Reliability was defined as the extent to which financial
statements are (1) in conformity with generally accepted accounting
principles, (2) accompanied by all material disclosures, (3) free from
the effects of an existing material unintentional error, (4) free from
the effects of an existing material management fraud, (5) free from
the effects of an existing material employee fraud, and (6) evaluated

by a CPA who is independent of management. The research questions

103

104
and corresponding hypotheses follow:
Research Question Number 1: Do CPAs and users share similar views

about the reliability of financial statements when there is no CPA
association with the statements?

 

Hypotheses HNl-HNS' When there is no CPA association with the

 

financial statements, CPAs and bankers share similar views that
the statements are:

HNl' in conformity with generally accepted accounting
principles.

HNZ: accompanied by all material disclosures.

HN3: free from the effects of an existing material un-
intentional error.

HN4' free from the effects of an existing material
management fraud.

HNS: free from the effects of an existing material
employee fraud.

Research Question Number 2: Do CPAs and users share similar views
about the reliability of financial statements when the statements
are accompanied by the CPA's compilation report?

 

Hypotheses H When the financial statements are accompanied

Cl-HC6'
by the CPA's compilation report, CPAs and bankers share similar
views that the statements are:

 

HCl: in conformity with generally accepted accounting
principles.

HCZ: accompanied by all material disclosures.

H free from the effects of an existing material un-

C3 intentional error.

HC4: free from the effects of an existing material
management fraud.

H05: free from the effects of an existing material
employee fraud.

C6: evaluated by a CPA who is independent of management.

105

Research_Qpestion Number 3: Do CPAs and users share similar views
about the reliability of financial statements when the statements
are accompanied by the CPA's review report?

 

Hypotheses HRl-HR6: When the financial statements are accompanied

 

by the CPA's review report, CPAs and bankers share similar views
that the statements are:

HRl: in conformity with generally accepted accounting
principles.

H accompanied by all material disclosures.

R2:
HR3: free from the effects of an existing material un-
intentional error.

HR4' free from the effects of an existing material
management fraud.

HRS: free from the effects of an existing material
employee fraud.

HR6: evaluated by a CPA who is independent of management.

Research Question Number 4: Do CPAs and users share similar views
about the reliability of financial statements when the statements are
accompanied by the CPA's audit report?

 

Hypotheses H When the financial statements are accompanied

Al-HA6 ‘
by the CPA's audit report, CPAs and bankers share similar views
that the statements are:

 

H in conformity with generally accepted accounting

Al principles.

HA2: accompanied by all material disclosures.

H

A3: free from the effects of an existing material un-

intentional error.

3A4: free from the effects of an existing material
management fraud.

HA5: free from the effects of an existing material
employee fraud.

HA6: evaluated by a CPA who is independent of management.

 

106

Research Question Number 5: Do users perceive differences in the
reliability of financial statements which are accompanied by no CPA
report, by the CPA's compilation report, by the CPA's review report,
and by the CPA's audit report?

Hypotheses H When the financial statements are accompanied

CBl’HCBS‘
by no CPA report, by the CPA's compilation report, by the CPA's
review report, and by the CPA's audit report, bankers perceive that
the statements are equally:

 

HCBl: in conformity with generally accepted accounting
principles.

HCBZ: accompanied by all material disclosures

H033: free from the effects of an existing material un-
intentional error.

H034: free from the effects of an existing material
management fraud.

HCBS: free from the effects of an existing material

employee fraud.

Hypothesis H When the financial statements are accompanied

CB6 ‘
by the CPA's compilation report, by the CPA's review report, and
by the CPA's audit report, bankers perceive that the statements
are equally:

 

H evaluated by a CPA who is independent of management.

CB6:

Research Question Number 6: Do CPAs perceive differences in the
reliability of financial statements which are accompanied by no
CPA report, by the CPA's compilation report, by the CPA's review
report, and by the CPA's audit report?

 

Hypotheses H When the financial statements are accompanied

CP 1—HCP5 °
by no CPA report, by the CPA's compilation report, by the CPA's
review report, and by the CPA's audit report, CPAs perceive that the
statements are equally:

 

HCPl: in conformity with generally accepted accounting
principles.
HCPZ: accompanied by all material disclosures.

HCPB: free from the effects of an existing material un-
intentional error.

as

re

Va]

107

HCP4' free from the effects of an existing material
management fraud.

free from the effects of an existing material

CPS employee fraud.

Hypothesis H When the financial statements are accompanied by

0P6:
the CPA's compilation report, by the CPA's review report, and by
the CPA's audit report, CPAs perceive that the statements are equally:

 

HCP6: evaluated by a CPA who is independent of management.

The Questionnaire

 

A four-part questionnaire was used to assess the perceptions of
randomly selected CPAs and bankers. The questionnaire first presented
six questions about the respondents' familiarity with compilations and
reviews. These were used to screen appropriate subjects and to assess
the extent to which CPAs and bankers were familiar with compilations
and reviews. Next, the questionnaire presented a hypothetical loan
situation (involving a CPA, the financial statements of a nonpublic
business, and a banker) which provided respondents with a common frame
of reference. Hypothetical CPA reports (compilation, review, and un-
qualified audit) depicted increasing levels of assurance about the
financial statements, based on increasing degrees of CPA association.
The CPAs and bankers rated the six reliability surrogates for the
financial statements accompanied by each of the three types of CPA
reports. CPAs and bankers also rated five reliability surrogates
(excluding CPA independence) for the condition of no CPA report (no
association with financial statements). Respondents' perceptions of
reliability were measued on a seven-point numerical rating scale with

values assigned which ranged from "0" (no confidence) to "6" (complete

108
confidence). A third section of the questionnaire contained demo-
graphic questions. Finally, the questionnaire provided space for
respondents to write comments about compilations, reviews, and audits.
The construction of the questionnaire and other items in the
questionnaire package followed the guidelines set forth by Dillman

in Mail and Telephone Surveyy.1 Each questionnaire package included

 

a cover letter, a questionnaire, and a return envelope. Appendix A
illustrates the initial cover letters and questionnaire which were
mailed to the bankers. Appendix B illustrates the initial cover
letter and questionnaire which were mailed to the CPAs. Appendix C
illustrates the follow-up cover letters and postcard reminders which

were mailed to the CPAs and bankers.

Questionnaire Bias

 

Five sources of possible questionnaire bias in the present
study were investigated. These were: rating scale errors, sequencing
effects of repeated measures, reliability, content validity, and con-

founding variables.

Rating Scale Errors

 

Rating scale errors might have caused questionnaire bias.
Three possible errors were leniency, central tendency, and logic.
Leniency is a rating scale error which occurs when respondents tend to

rate familiar items more favorably than unfamiliar items.2 In the

 

lDon A. Dillman (New York: John Wiley and Sons, 1978).

2J. P. Guilford, Paychometric Methods, 2nd ed. (New York:

McGraw-Hill Book Company, 1954), p. 278.

 

 

109
present study, for example, respondents might have been more familiar
with audits than with compilations and reviews, and consequently, might
have placed more confidence in audited financial statements than in
compiled or reviewed statements. This error was minimized by not
using the responses of CPAs or bankers who were unfamiliar with com-
pilations and reviews. Another rating scale error, central tendency,
occurs when respondents tend not to use the extreme points of a rating
scale.3 For example, a central tendency error could have occurred in
the present study if the respondents did not use the "no confidence"
or "complete confidence" ratings. This error was minimized by describ-
ing the meaning of each of the-seven response categories on the ques-
tionnaire. Finally, logic is a rating scale error which occurs when
respondents tend to rate similar sounding items similarly.4 A logic
error could have occurred in the present study if respondents rated
"free from the effects of an existing material management fraud" and
"free from the effects of an existing material employee fraud"
similarly because they sound similar. This error was minimized by

randomizing the initial ordering of the reliability surrogates.

Sequencing Effects of Repeated Measures

 

The ordering of the CPA reports contained in the questionnaire
represented a possible source of questionnaire bias.5 The effect of

this source of bias was minimized by changing the ordering of the CPA

 

31bid., pp. 278—279.

4Ibid., p. 279.

5B. J. Winer, Statistical Principles in Experimental Design,

2nd ed. (New York: McGraw-Hill Book Company, 1971), pp. 516-517.

 

110

reports in half the questionnaire forms. These forms and ordering of
reports were:

1. Form 1: Audit, Compilation, Review, No CPA Association

2. Form 2: Audit, Review, Compilation, No CPA Association
Forms 1 and 2 were sent to an equal number of large bank commercial
bank loan officers (CBLOs), small bank chief executive officers (CEOs),
and CPAs. ANOVA F-tests were used to test whether these groups re-
sponded differently on two forms of the questionnaire, based on combined
dependent variable scores. Table 5-1 illustrates the mean scores and
F-test results for large bank CBLOs, small bank CEOs, and CPAs. The
results indicated that the sample groups did not respond differently
on two forms of the questionnaire, based on combined dependent vari—

able scores.

Reliabiligy

 

Two forms of questionnaire reliability might affect question-
naire bias. These were instrument reliability and subject reliability.
Instrument reliability refers to the extent to which the same scores
are reproduced when the same questions are measured repeatedly. Sub-
ject reliability refers to the extent to which respondents produce
consistent scores for similar questions.6 A common problem of all
questionnaire surveys which measure perceptions is the difficulty of
investigating these forms of reliability. The use of a questionnaire
survey precluded an investigation of instrument and subject reliability

in the present research.

 

6Hugh D. Grove and Richard S. Savich, "Attitude Research in
Accounting: A Model for Reliability and Validity Considerations,"
Accounting Review, July 1979, p. 524.

 

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112

Content Validity

 

Content validity represented another possible source of ques-
tionnaire bias. Content validity refers to (l) the extent to which
sampling procedures minimize selection bias and nonresponse bias, and
(2) the extent to which respondents understand the contents of the
questionnaire.7 Two steps were taken to minimize questionnaire bias
related to content validity. First, the sampling procedures of ran-
domly selecting CPAs, randomly selecting two groups of bankers, and
mailing follow-up questionnaires to nonrespondents helped to minimize
selection bias and nonresponse bias. (These procedures to minimize
sources of bias are further explained in other sections of this
chapter.) Second, a pretest of the questionnaire resulted in changes
which improved the understandability of its contents. These contents
included the hypothetical loan situation, the sample CPA reports, reli-
ability surrogates, and the rating scale response categories. The pre-
tests were performed in October, 1979, by five Michigan practicing CPAs,
five Michigan practicing bankers, and five Michigan State University

faculty members.

Confounding Variables

 

Finally, confounding variables were a possible source of ques-
tionnaire bias in that they might have biased respondents' ratings of
the reliability surrogates. These possible variables pertained to the
hypothetical loan situation contained in the questionnnaire. Three

possible variables were: the extent of the banker's familiarity with

 

71bid., p. 525.

113
the client and the client's past financial statements, and the size of
the CPA firm.

The respondents' perceptions about the extent of the banker's
familiarity with his loan customer and his loan customer's CPA firm
might have biased their ratings of the reliability surrogates. If
respondents perceived that the banker was familiar with his customer
and the CPA firm, then they might have rated all the reliability sur—
rogates favorably without considering the different CPA assurances
about the financial statements. To control this possible bias, the
loan situation depicted the banker as being unfamiliar with the loan
customer and the CPA firm. This depiction, however, might have caused
a negative bias in the respondents' ratings. Several banker respond-
ents indicated in written comments on the questionnaire that their
ratings of the reliability surrogates were lower as a result of this
unfamiliarity.

Respondents' beliefs about the extent of the CPA firm's
familiarity with the client and the client's past financial statements
might also have confounded the results. If respondents perceived that
the CPA firm was associated with past financial statements of the
client, then they might have rated all the reliability surrogates
favorably without considering the different CPA assurances accompanying
the statements. The loan situation controlled this possible bias by
depicting the CPA firm as lacking experience with the past financial
statements of the client. However, as with the previous variable, this
depiction might have caused a negative bias in the respondents' ratings.
Written comments from several bank respondents indicated that their

ratings of the reliability surrogates were lower as a result of this

114
unfamiliarity.

Finally, respondents' perceptions about the size of the CPA
firm might have biased their ratings of the reliability surrogates.
If respondents believed that the CPA firm was a large international
firm and also believed that larger firms consistently outperformed
smaller firms, then they might have rated the reliability surrogates
higher. To control this possible bias, the loan situation depicted
the CPA firm as reputable without referring to the size of the firm.
As a result of this depiction, respondents might have perceived that
the CPA firm was a smaller firm, and consequently, might have rated
the reliability surrogates lower. Several CPA respondents indicated
in written comments that they believed that the CPA firm was a smaller
firm, and that they rated the reliability surrogates lower.

The following sources of possible questionnaire bias in the
present study were investigated: rating scale errors, sequencing
effects of repeated measures, reliability, content validity, and con-
founding variables. In light of the actions taken to minimize ques-
tionnaire bias, such bias was not considered a significant problem in

the present study.

Bankers
This section discusses the two sample groups of bankers with
respect to sample selection, response analysis, and nonresponse bias.
Appendix D includes selected demographic characteristics of the bank

respondents.

115

Sample Selection

 

Michigan practicing bankers comprised the target and sample
banker populations. Because a single listing of all Michigan bankers
did not exist, a sampling plan was devised to establish two sampling
frames according to bank sizes. Using Michigan National Corporation's
1979 Michigan Bank Directory, the total number of Michigan banks (364)
was divided into (1) 70 large banks (the total assets of which were
greater than $100 million per bank), and (2) 294 small banks (the
total assets of which were less than $100 million per bank).

The first sampling frame was a list of 578 commercial bank loan
officers (CBLOs) who worked for the 70 largest Michigan banks. This
list contained 534 CBLOs who were named in the Robert Morris Assoc—

iates' 1979-1980 Membershieroster, and 44 CBLOs who were not members

 

of Roben:Morris Associates. Telephone calls were made to thirteen
banks who were not members of Robert Morris Associates in order to list
these 44 CBLOs. A random sample of 130 CBLOs was then drawn from this
frame without replacement.

The second sampling frame was a list of the chief executive
officers (CEOs) of the 294 small banks. A random sample of 70 banks
was drawn from this frame without replacement. Then, using the 1212

Michigan Bank Directory for addresses, a questionnaire was mailed to

 

the CEO of each selected bank. Each CEO was asked to complete the
questionnaire or to delegate a loan officer to complete the question-
naire. In a few cases other bankers replied on behalf of the targeted
CEOs.

A possible source of selection bias was the manner in which

the sampling plan for bankers divided them into two different groups.

116
These were CBLOs from the 70 largest Michigan banks, and CEOs repre-
senting the 294 smallest Michigan banks. Because these two groups
represent different units of statistical analysis, they were not com-
bined to formulate generalizations about the population of Michigan
practicing bankers. As a result, the research hypotheses related to

bankers were tested separately for CBLOs and CEOs.

Response Analysis

 

Questionnaires were mailed to 130 CBLOs and to 70 CEOs on
November 26, 1979. A postcard reminder was sent to these groups on
December 3, 1979. A second questionnaire was mailed to all nonrespond-
ents on December 17, 1979. A third mailing was sent to all nonrespond-
ing CBLOs on January 24, 1980. Finally, telephone calls were made to
all nonresponding CEOs on February 11-12, 1980. Tables 5-2 and 5-3
summarize the response analysis. Telephone responses were not counted
in this analysis. Bankers who answered "no" to all six questions
about familiarity with compilations and reviews were considered to be
unfamiliar with compilations and reviews. As a result, these bankers
were counted as inappropriate subjects and their responses were not

included in tests of the research hypotheses.

Nonresponse Bias

 

Possible nonresponse bias of the sample groups of CBLOs and CEOs
was investigated by (l) follow-up procedures on the initial mailing of
questionnaires, (2) statistical comparisons of banker responses by time
period of response, and (3) telephone calls to nonresponding small bank
CEOs.

Follow-up procedures on the initial mailing of questionnaires

117

TABLE 5-2

BANKER RESPONSES TO MAILINGS

 

 

 

Number of Large Number of Small
Bank CBLOs Bank CEOs
Bankers in Sample Groups 130 70
Inappropriate Bankers* 5 __9
Appropriate Bankers 125 .61
Responses to First Mailing 79 11
Responses to Second Mailing 14 18
Responses to Third Mailing 8 ._:
Total Responses 101 _29
Response Percentage 80.8 47.5

 

*See Table 5-3 for the analysis of inappropriate bankers

TABLE 5-3

ANALYSIS OF INAPPROPRIATE BANKER RESPONSES

 

 

 

Number of Large Number of Small
Bank CBLOs Bank CEOs
Not Familiar with Compilations
and Reviews 4 6
Bank's or Individual's Policy
Not to Respond to Surveys 1 2

Partially Completed Questionnaire

Total

Hm In
No In

 

118
reduced possible nonresponse bias by increasing the response rates for
large bank CBLOs and for small bank CEOs. These procedures included a
postcard reminder mailed to the sample groups one week after the initial
mailing, a second questionnaire mailed to nonrespondents three weeks
after the initial mailing, and a third questionnaire mailed to large
bank nonrespondents eight weeks after the initial mailing.

ANOVA F-tests were used to test whether the early respondents
and late respondents answered the questionnaire differently, based on
combined dependent variable scores. These tests were performed for
large bank CBLOs with respect to four degrees of association and three
mailings of the questionnaire, and for small bank CEOs with respect to
four degrees of association and two mailings. Tables 5-4 and 5-5
illustrate the mean scores and F-test results for the respective groups,
CBLOs and CEOs. The results indicated that both early respondents and
late respondents did not answer the questionnaire differently, based on
combined dependent variable scores.

Finally, telephone calls to the CEOs of nonresponding small
banks were made in order to investigate possible nonresponse bias in
this sample group. In these calls, the CEOs or their delegated repre-
sentatives responded to the six questions about familiarity with com-
pilations and reviews, and to a general question on their concerns
about the research. Table 5-6 compares small bank CEOs who responded
by mail to small bank CEOs who were contacted by telephone with respect
to responses to the six familiarity questions. As shown by these come
parisons, the CEOs who were contacted by telephone were not quite as
familiar with compilations and reviews as the CEOs who returned ques-

tionnaires. Therefore, a nonresponse bias might be possible because

119

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120

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121

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122
nonresponding small bank CEOs were not quite as familiar with compil-

ations and reviews as responding small bank CEOs were.

Certified Public Accountants

 

This section discusses the sample group of CPAs with respect to
sample selection, response analysis, and nonresponse bias. Appendix E

includes selected demographic characteristics of the CPA respondents.

Sample Selection

 

Michigan practicing CPAs comprised the target CPA population.
Michigan practicing CPAs who were members of the Michigan Association
of Certified Public Accountants (MACPA) comprised the sample population.

The sampling frame was MACPA's 1979 Membership Directory, which listed

 

3,714 practicing CPAs (after deleting CPAs who worked for government,
education, or business organizations). A random sample of 200 CPAs

was drawn from this frame without replacement.

Response Analysis

 

Questionnaires were mailed to 200 CPAs on November 26, 1979.
A postcard reminder was sent to these CPAs on December 3, 1979. A
second questionnaire was mailed to all nonrespondents on December 17,
1979. Finally, a third mailing was sent to all nonrespondents on
January 24, 1980. Tables 5-7 and 5-8 summarize the response analysis.
CPAs who answered "no" to all six questions about familiarity with com-
pilations and reviews were considered to be unfamiliar with compilations
and reviews. As a result, these CPAs were counted as inappropriate
subjects and their responses were not included in tests of the research

hypotheses.

123

TABLE 5-7

CPA RESPONSES TO MAILINGS

 

 

Number of CPAs

 

CPAs in Sample Group 200
Inappropriate CPAs* 20
Appropriate CPAs 180

Responses to First Mailing 75
Responses to Second Mailing 32
Responses to Third Mailing 13

Response Percentage 66.7

 

*See Table 5-8 for the analysis of inappropriate
CPAs

TABLE 5-8

ANALYSIS OF INAPPROPRIATE CPA RESPONSES

 

 

Number of CPAs

 

Not Familiar with Compilations
and Reviews 2

Firm's or Individual's Policy

Not to Respond to Surveys 3
No Longer in Public Accounting 13
Undeliverable

Total

II” |
O N

 

124

Nonreaponse Bias

 

Possible nonresponse bias of the sample group of CPAs was
investigated by (l) follow-up procedures on the initial mailing of
questionnaires and (2) statistical comparisons of CPA responses by
time period of response.

Follow-up procedures on the initial mailing of questionnaires
reduced possible nonresponse bias by increasing the response rate for
CPAs. These procedures included a postcard reminder mailed to the
sample group one week after the initial mailing, a second questionnaire
mailed to nonrespondents three weeks after the initial mailing, and a
third questionnaire mailed to nonrespondents eight weeks after the
initial mailing.

ANOVA F-tests were used to test whether the early respondents
and late respondents answered the questionnaire differently, based on
combined dependent variable scores. These tests were performed on four
degrees of association and three mailings of the questionnaire. Table
5-9 illustrates the mean scores and F-test results. The results indi—
cated that both early and late CPA respondents did not answer the ques-

tionnaire differently, based on combined dependent variable scores.

Statistical Analyses

 

This section describes the statistical design, multivariate
model, multivariate data analysis, and univariate test statistics,
which were used to test the research hypotheses. The section also dis-
cusses the assumptions of the multivariate and univariate statistical

models.

125

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126

Statistical Design

 

Two repeated measures parametric F-tests were used to test the
research hypotheses. Repeated measures tests were used because each
subject responded to each dependent variable for each degree of associ-
ation. Parametric statistical models were chosen despite the ordinal
scale properties of the rating scales contained in the questionnaire.
Some researchers believe that parametric tests (e.g. F-tests and t-tests)
should not be applied to ordinal scale data because the data fails to
meet required assumptions of independence, distribution normality, and
variance equality. Instead, these researchers would apply nonpara-
metric tests to this data.8 But because the failure to meet parametric
data assumptions does not usually affect the results anyway, this re-
searcher chose to apply parametric tests to ordinal scale data.

Gardner supported this position when he stated that parametric tests
are highly robust and that treating ordinal data as interval data would
not normally lead the researcher to improper conclusions.9 Further-
more, it was believed that parametric F-tests and t-tests used in the
present study were more powerful and more easily used than similar non-
parametric tests.

One repeated measures F—test was a multivariate test which was
used to test hypotheses with respect to five dependent variables (reli-

ability surrogates). These hypotheses were those identified as: HN1

through HNS’ HC1 through HCS’ HR1 through HRS, HAl through HAS’ HCBl

 

8Paul L. Gardner, "Scale and Statistics," Review of Educational
Research, Winter 1975, pp. 43-45.

9

 

Ibid., p. 51.

127

through HGBS’ and H through H Figure 5-1 illustrates the two-

CPl CPS'

by-four multivariate repeated measures design. This design contained
three sets of independent factors and five dependent variables. CPAs
and bankers comprised the fixed group factor. Next, a randomly
selected number of subjects were nested within each group. Four degrees
of association comprised another independent factor. These degrees,
shown in Figure 5-1, were: no CPA association, compilation, review,
and audit. Finally, the five dependent variables, represented by V1
through V5 in Figure 5-1, measured the extent to which respondents per-
ceive that financial statements are (1) in conformity with generally
accepted accounting principles, (2) accompanied by all material dis-
closures, (3) free from the effects of an existing material uninten—
tional error, (4) free from the effects of an existing material manage-
ment fraud, and (5) free from the effects of an existing material
employee fraud.

Another repeated measunxsF-test was used to test hypotheses
with respect to one dependent variable. These hypotheses were those

identified as: HC6’ HR6’ HA6’ HCB6, and H Figure 5-2 illustrates

CP6'
the two-by-three repeated measures design. Compared to the two-by-four
design, this design contained the same sets of fixed group and random
subjects factors, but excluded "no CPA association" from the degree of
association factor. In addition, this design contained one dependent
variable, represented by V6 in Figure 5-2, which measured the extent

to which respondents perceived that financial statements are evaluated

by a CPA who is independent of management.

NO CPA
ASSOCIATION

128

 

 

 

 

 

 

 

 

COMPILATION REVIEW AUDIT
*
SUBJECTS Vl .. V5 V1 .. VS 1 .. V V1 .. V5
:11
12
BANKERS
Slnl
:21
22
CPAs
San
*where:
V1 = in conformity with generally accepted accounting
principles
V2 = accompanied by all material disclosures
V3 = free from the effects of an existing material
unintentional error
V4 = free from the effects of an existing material
management fraud
VS = free from the effects of an existing material

Fig. 5-1.

employee fraud

Two-by-four multivariate

repeated measures design

 

129

COMPILATION REVIEW AUDIT

it
SUBJECTS V6 V6 V6

 

 

11
12

U)

BANKERS

1nl

 

21
22

U)

CPAs

2n

 

 

 

 

 

 

*where:
V6 = evaluated by a CPA who is independent of management

Fig. 5-2. Two-by-three repeated measures design

Multivariate Model

 

The parametric multivariate model used in the present research

was a linear statistical model, which was applied to each dependent

variable:10

Yijk = u + aij + Bj + Yk + (8y)jk + Eijk

 

loR. Darrell Bock, Multivariate Statistical Methods in Be-

havioral Research (New York: McGraw-Hill Book Company, 1975), pp.
470—471.

 

 

130

where:
Yijk = score of subject i, in group j, responding to degree
of association k
u = arbitrary location constant
aij = individual difference component for subject i in group j
Bj = main effect of group j
Yk = main effect of degree of association k
(8y)jk = interactive effect of group j on degree of association k
ijk = error component of subject 1 in group j on degree

of association k

The model's parametric assumptions were:

2
l. aij ” N(O: O )
2. The vectors Eij = (Eijl’ €ij2’ Eij3, Eij4

each with a multivariate normal distribution with a zero mean

) were independent,

vector, and equal covariance matrices for all i's and j's.

Another restriction was:

2: -"' 2: = z = z 5 =
jBJ kYk j‘ (BY)jk k ( Y)jk O

The following statistical null hypotheses were tested for each dependent
variable:
1. (By)jk = 0 for all j's and k's; there were no group-by-degree of

association interaction.

2. Bj

Yk

0 for all j's; there were no group main effects.

0 for all k's; there were no degree of association
main effects.

131
Multivariate Data Analysis
The data collected were transferred to computer input for the
FINN program, "Multivariate Repeated Measures ANOVA.11 One program

tested hypotheses related to dependent variables V

through V Another

1
program tested hypotheses pertaining to dependent variable V

5.
6' The
initial step in the analysis tested for group-by-degree of association
interaction on the dependent variables. If interaction appeared to be
statistically insignificant, then group and degree of association main
effects were meaningfully evaluated. If at least one dependent variable

was affected by significant interaction, then individual univariate t—

tests were performed to test the research hypotheses.

Univariate Test Statistics

 

The data collected were transferred to computer input for the

SPSS program, "Subprogram T-test: Comparison of Sample Means.12 Two

forms of this program were used to test the research hypotheses, namely,
"Comparison of Means--Independent Samples" and "Paired Samples."

First, the statistical test, "Comparison of Means--Independent

H
Samples was used to test research hypotheses HN1 through HNS’ H

C1

through HCS’ HR1 through HRS’ and HA1 through HA This test computed

5.

CPA-banker mean score differences with respect to specific reliability

surrogates and degrees of CPA association. For example, the test

 

11Jeremy D. Finn, A General Model for Multivariate Analysis
(New York: Holt, Rinehart and Winston, Inc., 1974); William Schmidt
and Verda Scheifley, "Jeremy D. Finn's Multivariance," (Occasional
Paper Number 22 [East Lansing, Michigan: Office of Research Consul-
tation, Michigan State University, 1973]).

 

12Norman H. Nie, Statistical Package for the Social Sciences,
2nd ed. (New York: McGraw—Hill Book Company, 1975), pp. 267-274.

 

132

evaluated whether CPAs and bankers shared similar views that compiled
financial statements were in conformity with generally accepted

accounting principles (HC1)° An appropriate t-statistic for these

tests was:

 

 

t = (x1 x2)

8% 8.3.

Fin—z

where:

t = test statistic value
i1 = sample mean score of group 1
x2 = sample mean score of group 2
sE-= sample variance of group 1
8% = sample variance of group 2
n1 = sample size of group 1
112 = sample size of group 2

Under the null hypotheses tested, this t-statistic has an approximate
standard normal distribution for large sized sample groups.
Second, the statistical test, "Paired Samples" was used to test

research hypotheses H through HCBS’ and H through H This test

CPl CP5°

computed degree of association mean score differences with respect to

C81

specific reliability surrogates and respondent groups. For example, the
test evaluated whether CPAs perceive differences between the reliability
of financial statements accompanied by the CPA's compilation report and
by the CPA's review report, on the basis that the financial statements

were accompanied by all material disclosures (H An appropriate

CP2)'

t-statistic for these tests was:

133

 

a
t = S
d
VB
where:
= test statistic value
d1 = difference in observations made in pairs

(xli‘XZi) for i = l, 2, ...n observations

sample variance of di'

DaN

Under the null hypotheses tested, this t-statistic has a t-distribution

with n-l degrees of freedom if the normality assumptions of Eijk hold.

Assumptions of the Models

The assumptions of the statistical models described above could

not hold exactly. For example, the e referred to in the multivariate

ij
model could not have normal distributions because the observations mea-
sured in the present study were discrete. Since these models were
idealizations, it was believed that they would generally hold so that
the conclusions, stated in probabilities, would be approximately correct.
In the present study, the sample sizes were large enough for the re-
searcher to believe that the probability statements were good approxi-
mations of their true values. For example, if a test of a null hypoth-

esis were significant at the .03 level, then the true significance

level might be .01 or .05, but probably would not have been .001 or .10.

Summary

This chapter described the methodology used in the present
research to test the effectiveness of the communication process between

CPAs and bankers. Methodological topics described were: the research

134

questions and research hypotheses; the questionnaire; questionnaire
bias; the sample groups of bankers; the sample group of CPAs; and
statistical analyses. Three types of possible bias related to the
methodology were investigated in this chapter: (1) questionnaire bias,
(2) selection bias, and (3) nonresponse bias. First, precautions were
taken in the design of the questionnaire to minimize possible question-
naire bias. Second, the random sampling of practicing bankers from
both large banks and small banks, and the random sampling of practicing
CPAs minimized possible selection bias. Finally, response rates and
statistical comparisons of early and late respondents were used to
determine that respondents did not differ from nonrespondents in any
significant respects. The chapter also described the statistical design
of the present research. As part of this design, the chapter explained
how multivariate repeated measures F-tests and univariate t-tests were
used to test the research hypotheses.

The next chapter presents the data and results of statistical
tests used to assess the effectiveness of the CPA-user communication

process.

CHAPTER VI

RESULTS

This chapter presents the data and results of statistical tests
used in the present study to assess the effectiveness of the communi-
cation between certified public accountants (CPAs) and bankers. The
chapter first describes the respondents' ratings of the six relia-
bility surrogates in terms of mean scores and standard errors of these
scores. The six reliability surrogates refer to the extent to which
financial statements are (l) in conformity with generally accepted
accounting principles (GAAP), (2) accompanied by all material disclo-
sures (disclosures), (3) free from the effects of an existing material
unintentional error (unintentional error), (4) free from the effects of
an existing material management fraud (management fraud), (5) free from
the effects of an existing material employee fraud (employee fraud), and
(6) evaluated by a CPA who is independent of management (independence).
Then, the chapter discusses the results in terms of four categories:
group effects, degree of association effects, reliability surrogate
effects, and familiarity effects. One section of the chapter describes
group effects, which refer to the similarities with which CPAs as a
group and bankers as a group perceive assurances about the reliability
of financial statements. Another section reports degree of association
effects. These are defined as the extent to which respondents perceive
different assurances about the reliability of financial statements

135

136

accompanied by no CPA report, by the CPA's compilation report, by the
CPA's review report, and by the CPA's audit report. Then,a section
describes reliability surrogate effects. These effects refer to the
respondents' relative evaluations of the reliability surrogates for
each degree of association. The final section of the chapter describes
familiarity effects, or the extent to which respondent groups are

familiar with compilations and reviews.

Mean Scores and Standard Errors

 

Respondents' perceptions of the reliability of financial state-
ments are summarized in Table 6-1 by mean scores and standard errors of
these scores. This table shows both the mean scores and standard
errors of each group's ratings of the reliability surrogates for each
degree of association. Respondents indicated these ratings on the ques-
tionnaire by marking one of the seven responses following each relia-
bility surrogate. The response categories and numerical values
assigned were: no confidence, 0; very weak confidence, 1; weak confi-
dence 2; medium confidence, 3; strong confidence, 4; very strong confi-
dence, 5; and complete confidence, 6. The mean scores of each group
were computed by adding the numerical values of the responses, and
dividing these sums by the number of responses. The standard errors
of these mean scores were then computed by dividing the standard devia-
tion of each mean score by the square root of the sample size. The
mean scores were further used to (1) plot the graphs in Figures 6-1
through 6-16, and (2) statistically assess group effects, degree of

association effects, and reliability surrogate effects.

1L37

 

 

 

 

 

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138

Group Effects

 

Group effects related to the following research questions
(for corresponding research hypotheses, see Chapter V):
Research Question Number 1: Do CPAs and users share similar views
about the reliability of financial statements when there is no CPA
association with the statements?
Research Question Number 2: Do CPAs and users share similar views
about the reliability of financial statements when the statements
are accompanied by the CPA's compilation report?
Research Question Number 3: Do CPAs and users share similar views
about the reliability of financial statements when the statements
are accompanied by the CPA's review report?
Research Question Number 4: Do CPAs and users share similar views
about the reliability of financial statements when the statements
are accompanied by the CPA's audit report?
This section first reports the mean score results pertaining to group
effects in both tabular and graphic forms. Then, the results of

multivariate and univariate statistical tests of the research hypoth-

eses are presented. Finally, the meaning of these results is discussed.

Results

The mean score results of group effects are shown in the first
two columns ofTables 6-2 and 6-3. Table 6-2 compares the perceptions
of CPAs to those of large bank CBLOs. Table 6-3 compares the percep-
tions of CPAs to small bank CEOs. Figures 6-1 through 6-6 graphically
illustrate these respondent groups' mean scores for each reliability
surrogate.

Four repeated measures F-tests and forty univariate t-tests
were used to test the research hypotheses associated with group effects.

These hypotheses were identified as: HN1 through HNS’ HC1 through HC6’

HR1 through HR6’ and HA1 through HA6.

139

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141

Confidence
Levels

6 1

 

  

._ _ ...— Large Bank CBLOs
I n. .. - .. .. Small Bank CEOs
- CPAs

 

Degrees of
Association

 

No CPA Compilation Review Audit
Association

Fig. 6-1. Graph of mean scores for group effects: GAAP-

142

Confidence
Levels

6

 

  

.._.. _.. .... Large Bank CBLOs
’ ._ _ _ _ _ _, Small Bank CEOs

/ CPAs

 

Degrees of
Association

 

No CPA. Compilation Review Audit
Association

Fig. 6-2. Graph of mean scores for group effects: disclosures.

143

    

 

 

 

Confidence
Levels
.6 .
5 4
4 q ,0
3 .
2 I
/ I _ ._ .... Large Bank CBLOs
n ’ _ _ _ __ .. Small Bank CEOs
1.l , CPAs
:?'
Degrees of
0 Association
j I . 4‘
No CPA Compilation Review Audit
Association

Fig, 6-3. Graph of mean scores for group effects:
unintentional error.

[mi i
Lev

La.)
A

 

 

144

   

 

 

Confidence
Levels
61
5.
J
41
/
3+
2.
/ _ ..... .... Large Bank CBLOs
I _ _ _ _ _, _ Small Bank CEOs
l, CPAs
23’
Degrees of
0 Association
No CPA Compilation Review ‘Audit
Association

Fig. 6-4. Graph of mean scores for group effects:
management fraud.

145

   

 

 

 

Confidence
Levels
6
1
5
q
z.
(b
I
3“
21
.... _ ...n. Large Bank CBLOs
_ .. .. .. .. Small Bank CEOs
l, CPAs
a
Degrees of
0 Association
No CPA Compilation Review Audit
Association

Fig. 6-5. Graph of mean scores for group effects:
employee fraud.

Leaf i

Lev

“

 

 

Confidence
Levels

6

 

146

 

..... _ ...— Large Bank CBLOs
.. .. .. .. ..... Small Bank CEOs

CPAs

 

 

Fig. 6-6.

j

U 1
Compilation Review Audit

Graph of mean scores for group effects:

Degrees of
Association

independence.

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147
Two repeated measures F—tests, which reflected the two-by-four
statistical design (see Figure 5-1) were used first to test research

hypotheses HN1 through HNS, HC1 through H05, HRl through HRS, and HA1
through HAS. Table 6-4 illustrates the F-test results for the compari-
gsons of CPAs to large bank CBLOs. Table 6-5 illustrates the F-test
Iresults for the comparisons of CPAs to small bank CEOs. The tables
g;how that, for both tests, the null hypothesis (that there is no group-

tgjy-degree of association interaction) was rejected at the .01 level of

5;:ignificance. Figures 6-1 through 6-5 support this conclusion because

ezzach graph illustrates the presence of disordinal interaction between

group and degree of association factors. A consequence of rejecting

tzlmis null hypothesis was that the multivariate repeated measures F-tests
(zcawfld not be used to test the research hypotheses. Forty univariate
t:-— tests were then used to test these hypotheses. These t-tests com—
p>zaxred the mean scores of CPAs with those of large bank CBLOs and of
(II’AAS with those of small bank CEOs for each of five reliability surro-
gates and for each of four degrees of association. Tables 6-2 and 6-3
SIICDW the computed t-values and two-tail probabilities, and the resulting
aczczeptance or rejection of the hypotheses.

For the condition of no CPA association with the financial
Stliiitements, the results of the t-tests, illustrated by Tables 6-2 and
9‘33, indicated that responding CPAs and bankers shared similar views
abOut the financial statements for five reliability surrogates (GAAP,

d14sclosures, unintentional error, management fraud, and employee fraud).
Thus, hypotheses HN1 through HN5 were accepted.

For financial statements accompanied by the CPA's compilation

report, Tables 6-2 and 6-3 illustrate that the t-test results were

 

 

$01

Gr:
Deg

Gm

SC:

Gr

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148

TABLE 6-4

RESULTS OF MULTIVARIATE REPEATED MEASURES F-TESTS ON FIVE
DEPENDENT VARIABLES: LARGE BANK CBLO AND CPA COMPARISONS

 

 

 

 

P Value
Sources of Variation F-Value Significance
Group 3.55 .0043*
Degree of Association 529.95 .0001*
Group-by-Degree of Association 7.1249 .0001*
*Null hypothesis rejected at a significance level of

.01 or less

TABLE 6-5

RESULTS OF MULTIVARIATE REPEATED MEASURES F-TESTS ON FIVE
DEPENDENT VARIABLES: SMALL BANK CEO AND CPA COMPARISONS

 

 

 

 

P Value
Sources of Variation F-Value Significance
Group 2.41 .0394
Degree of Association 373.10 .0001*
Group-by-Degree of Association 3.72 .0001*
*Null hypothesis rejected at a significance level of

.01 or less

 

 

 

149
mixed. With respect to two reliability surrogates (GAAP and disclo-
sures), responding CPAs had higher levels of confidence in the finan-
cial statements than bankers. Consequently, hypotheses HCl and HC2
taere rejected. With respect to three reliability surrogates (uninten-
t:ional error, management fraud, and employee fraud), responding CPAs

21nd bankers placed a similar amount of confidence in the financial

sstatements. As a result, hypotheses H03, HC4’ and HC5 were accepted.

For financial statements accompanied by the CPA's review re-
I><3rt, Tables 6—2 and 6-3 show that the results of the t-tests again
were mixed. With respect to three reliability surrogates (GAAP, dis—
czllosures, and unintentional error), responding CPAs had higher levels
c215 confidence in the financial statements than bankers. Thus, hypoth—
ezsses HRl’ HRZ’ and HR3 were rejected. With respect to two reliability
sstjrrogates (management fraud and employee fraud), responding CPAs and
t>£1rmers shared similar views about the reliability of the financial
s tatements. Therefore, hypotheses HR4 and HRS were accepted.

Finally, for financial statements accompanied by the CPA's
Eilaxdit report, Tables 6-2 and 6-3 illustrate that the t—test results
were mixed again. With respect to two reliability surrogates (disclo-
Suites and unintentional error), responding CPAs had higher levels of
c<>lnfidence in the financial statements than bankers. So, hypotheses

'1 and H were rejected. With respect to two reliability surrogates

A2 A3

(Unanagement fraud and employee fraud), responding CPAs and bankers
Eflnared similar views about the reliability of the financial statements.
As a result, hypotheses HA4 and HA5 were accepted. With respect to the

reliability surrogate, GAAP, responding CPAs had higher levels of con-

fidence in the financial statements than large bank CBLOs. Based on

 

150

this comparison, hypothesis HAl was rejected. However, regarding the
same reliability surrogate, responding CPAs had views similar to those
of small bank CEOs about the reliability of the financial statements.

.Based on this comparison, hypothesis H was accepted.

A1
Next, two repeated measures F—tests, which reflected the two-
Iay-three statistical design (see Figure 5-2) tested research hypotheses
IIC6’ HR6’ and HA6. Table 6-6 illustrates the F-test results for the
c:omparisons of CPAs to large bank CBLOs. Table 6-7 illustrates the
jE?-test results for the comparisons of CPAs to small bank CEOs. The
‘cpables show that, for both tests, the null hypothesis (that there is no
ggfiroup-by-degree of association interaction) cannot be rejected at the
- (31 level of significance. Because interaction was not statistically
s;ngnificant, these tests were used to test the research hypotheses.
GCIIe results of the F-tests, as shown in Table 6-6 and 6-7, indicated
tiflat group effects for both comparisons were significant. Figure 6-6
graphically illustrates these effects. These results indicated that
treeasponding CPAs and bankers did not share similar views about the

extent to which financial statements are evaluated by a CPA who is

iLIJxflependent of management. For compilation, review, and audit reports,

CIPAKS perceived higher levels of reliability than bankers. Consequently,

were rejected.

h~371>otheses H HR6’ and H

C6’ A6

ggning of the Results
The computed mean scores, as shown in Tables 6—2 and 6-3, indi-
cated three results. One result was that CBLOs from large banks shared
consistently similar views with CEOs from small banks about the relia-

bility of financial statements for each degree of association and

Fin

 

151
TABLE 6-6

RESULTS OF REPEATED MEASURES F-TESTS ON ONE DEPENDENT
VARIABLE: LARGE BANK CBLO AND CPA COMPARISONS

 

 

 

P Value
Sources of Variation F Value Significance
Group 62.77 .0001*
Degree of Association 147.32 .0001*
Group-by-Degree of Association 3.50 .0318

 

*Null hypothesis rejected at a significance level of
.01 or less

 

TABLE 6-7

RESULTS OF REPEATED MEASURES F-TESTS ON ONE DEPENDENT
VARIABLE: SMALL BANK CEO AND CPA COMPARISONS

 

 

 

P Value
Sources of Variation F Value Significance
Group 29.79 .0001*
Degree of Association 91.79 .0001*
Group-by—Degree of Association 1.85 .1613

 

*Null hypothesis rejected at a significance level of
.01 or less

 

 

152

reliability surrogate. A second result was that, when there was no

CPA association with the financial statements, bankers consistently

placed more confidence in the statements than CPAs for each relia—

bility surrogate.l Finally, when CPAs compiled, reviewed, or audited

.financial statements, CPAs consistently placed more confidence in the
sstatements than bankers for each reliability surrogate.

The decision to accept or reject hypotheses, as shown in

Tables 6-2 and 6-3, also indicated three results. First, with respect
t:o twenty-two out of twenty-three hypotheses tested, there were no
(itifferences between the results of comparing CPAs to large bank CBLOs
garnd the results of comparing CPAs to small bank CEOs. Second, when
t:11ere was no CPA report accompanying the financial statements, the
Ireasults indicated that all five hypotheses (HN1 through HNS) were
aaczcepted. Third, when the financial statements were accompanied by
c:c>nmilation, review, or audit reports, the results were nearly consist-

ent for each reliability surrogate. For disclosures and independence, '

. . F
8L1“1.six hypotheses (HCZ’ HC6’ HR2’ HR6’ HA2’ and HA6) were rejected or

GlAJAP, all three hypotheses (HCl HRl’ and HA1) were rejected.3 For
9
unintentional error, two hypotheses (HR3 and HA3) were rejected and one

h37130thesis (HC3) ‘was accepted. For management fraud and employee

1An exception to this result was that CPAs and large bank CBLOs
Shared similar views about employee fraud.

sz0 exceptions to this result were: (1) CPAs and small bank

CEOs shared similar views about management fraud in audits and
(2) small bank CEOs placed more confidence in audited financial state-

mEnts with respect to employee fraud.

3An exception to this result was that hypothesis HAl’ as
regards the comparison of CPAs to small bank CEOs, was accepted.

 

153

fraud, all six hypotheses (HC4’ HCS’ HR4’ HRS’ HA4’ and HA5) were
accepted.

Possible reasons for the results of both the mean scores and
tests of hypotheses are discussed next. The first result was that
(SBLOs from large banks and CEOs from small banks share similar views
zabout the reliability of financial statements. This indicated that
t:he bank size did not appear to affect the bankers' perceptions of the
Ireliability of the statements. The second result was that, when there

‘aras no CPA association with the financial statements, bankers placed
gsjlightly more confidence in the reliability of the statements than
(:JPAS. There are two possible explanations for this result. One rea-
5;(Dn might be that bankers, compared to CPAs, were more familiar with
tit1eir loan customers, and consequently, placed more confidence in the
sawtzatements. Another reason might be that CPAs, compared to bankers,
aveere more skeptical about the reliability of the financial statements
t><21=ause they were not associated with the statements. As a result,
C31?1&s placed less confidence in the statements than bankers. The final
‘reassult was that CPAs placed more confidence in the reliability of
iFilaancial statements than bankers when the statements were accompanied
b)? the CPA's compilation report, review report, or audit report. There
alfe: three possible explanations for this finding. One possibility
“Elsght be that bankers did not understand the extent or nature of CPA
PI13cedures performed on the financial statements for compilation,
‘feview, or audit engagements. For example, bankers might have per-
CEived that the extent of CPA review procedures was less than that
required by SSARS #1 and less than that actually performed by CPAs.

A second possibility might be that philosophical differences existed

 

154
between CPAs and bankers. For example, bankers might have been
skeptical of any CPA assurances achieved or expressed about compiled
financial statements because of the disclaimer-type language con-
tained in the compilation report. A third possibility might be that
(SPAS perceived the achievement of more assurances about the relia—
laility of the financial statements than that actually expressed in

the CPA' 3 report .

Degree of Association Effects

Degree of association effects refer to the extent to which
(ZIEAS and bankers perceive different assurances about the reliability
c):E financial statements accompanied by no CPA report, by the CPA's
czcampilation report, by the CPA's review report, and by the CPA's audit
zreaport. These effects relate to the following research questions (for
c:c>rresponding research hypotheses, see Chapter V):
Research Question Number 5: Do users perceive differences in the
treaLliability of financial statements which are accompanied by no
CII’AA report, by the CPA's compilation report, by the CPA's review
r'eelport, and by the CPA's audit report?
Ileassearch Question Number 6: Do CPAs perceive differences in the
fialliability of financial statements which are accompanied by no
CI?£X report, by the CPA's compilation report, by the CPA's review
r€31>ort, and by the CPA's audit report?
Tnlzts section first presents the mean score results for degree of associ-
atlion effects in both tabular and graphic forms. The section then re-
PCDITts the results of multivariate and univariate statistical tests of

tile research hypotheses. Finally, the meaning of these results is

discussed.

H

 

155

Results

The mean score results of degree of association effects are
shown in the first two columns of Tables 6-8, 6-9, and 6-10. Table 6-8
compares CPAs' and bankers' perceptions of five reliability surrogates
with respect to no CPA association and compilations. Table 6-9 come
pares CPAs' and bankers' perceptions of six reliability surrogates with
respect to compilations and reviews. Table 6-10 compares CPAs' and
bankers' perceptions of six reliability surrogates with respect to
reviews and audits. Figures 6-7 through 6-12 graphically illustrate
these respondent groups' mean scores for each reliability surrogate.

Four repeated measures F-tests and forty-five univariate t-
tests were used to test the research hypotheses identified as: H

CB1

through H and H through H

CB6 CPl CP6°

The first two repeated measures F-tests, described in the

Iprevious section, were used to test research hypotheses H through

CB1

13 and H through H Tables 6—4 and 6-5 illustrate the F-test

CBS CPl CPS'
results. The tables show that, for both tests, the null hypothesis
(that there is no group-by-degree of association interaction) was re-
jected at the .01 level of significance. A consequence of rejecting
the interaction null hypothesis was that the multivariate repeated mea-
sures F-tests could not be used to test the research hypotheses.
Forty-five univariate t-tests were then used to test these hypotheses.
These t-tests compared: no CPA association to compilations; compila-
tions to reviews; and reviews to audits. These comparisons of mean
scores were made for each of five reliability surrogates and for each

of the three respondent groups. Tables 6—8, 6-9, and 6-10 show the

computed t-values and two-tail probabilities, and the resulting

 

156

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m-w mHmHe

 

157

 

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ale mHm<H

158

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159

 

 

Confidence
Levels
64
Audit
5‘ J
4' / Renew
3 .
Compilation
2‘ \/
l .
-“PI—~_—~_~—‘\“\P‘~H\~‘. No CPA Association
0 i ' 4' 1 Groups
Large Small CPAs
Bank Bank
CBLOs CEOs

Fig. 6-7. Graph of mean scores for degree of association

effects:

GAAP.

 

160

 

 

 

Confidence
Levels
6 q
5 . Audit
4 ,
Review
3 1
2 .
Compilation
1 .
//\ No CPA Association
0 7 , ~_j Groups
Large Small CPAs
Bank Bank
CBLOs CEOs

Fig. 6-8. Graph of mean scores for degree of association
effects: disclosures.

 

 

r—-v ":1
‘1.

a

i

3

161

Confidence
Levels

61

5 .
Audit

4 ' -_—‘—-‘~_.—J///////////
Review

3‘ \/

2 .
Compilation

1 .

-———————————‘\\\\\\P“~‘. No CPA Association

 

 

0 t ' 1 Groups
Large Small CPAs
Bank Bank
CBLOs CEOs

Fig. 6-9. Graph of mean scores for degree of association
effects: unintentional error.

 

162

 

 

 

Confidence
Levels
61
5 u
4 .
3.
____,__—————"""'—‘—'—- Review
2 .
Compilation
14 \/
-——‘——‘—————\~‘\I\\\“‘~ No CPA Association
0 r 1 4: Groups
Large Small CPAs
Bank Bank
CBLOs CEOs

Fig. 6-10. Graph of mean scores for degree of association
effects: management fraud.

 

Confidence
Levels

61

5:

44

3.

 

163

/\ Andit

Review

2. //

14 //-/ compilation

a”””””’-\‘P\“\P‘- No CPA Association

 

O s 1. .oej Groups
Large Small CPAs
Bank Bank
CBLOs CEOs
Fig. 6-11. Graph of mean scores for degree of association

effects: employee fraud.

 

 

 

 

164

Confidence
Levels

6 '1

Audit

Review

 

 

Compilation

 

 

 

 

 

 

 

 

1 H_n Groups
Large Small CPAs

Bank Bank

CBLOs CEOs

 

Fig. 6-12. Graph of mean scores for degree of association
effects: independence.

 

 

 

 

 

165
acceptance or rejection of the hypotheses.

The results of the t-tests shown in Tables 6-8, 6-9, and 6-10
indicated that both CPAs and large bank CBLOs perceived differences
among no CPA association, compilations, reviews, and audits. For each
of the reliability surrogates, confidence in no CPA association was

lower than confidence in compilations; confidence in compilations was

 

.‘7’.
lower than confidence in reviews; and confidence in reviews was lower 4'
than confidence in audits. Figures 6-7 through 6-11 graphically illus-
1::Jrate these differences. With respect to large bank CBLOs, hypotheses
HCBl through HCBS were rejected. With respect to CPAs, hypotheses k
HCPl through HCPS were also rejected. ow

The t-test results shown in Tables 6-8, 6-9, and 6-10 were
mixed regarding the responses of small bank CEOs. The tests first indi-
cated that CEOs did not perceive differences in the reliability of
E imancial statements prepared with no CPA association and those accom-
Pamied by compilation reports. With respect to these comparisons,

h)Vlmtheses H through H were accepted. However, CEOs perceived

CB1 CBS

(11 :fferences in reliability among compilations, reviews, and audits.
F0 2: each of the reliability surrogates, confidence in compilations was
lower than confidence in reviews, and confidence in reviews was lower
th an confidence in audits. With respect to these comparisons,

hy potheses H through H were rejected.

CB1 CB5

Next, the second two repeated measures F-tests, described in

the previous section, tested research hypotheses H and H Tables

CB6 CP6'
6‘6 and 6-7 illustrate the F-test results. The tables show that, for
b0th tests, the null hypothesis (that there is no group-by-degree of

association interaction) cannot be rejected at the .01 level of

 

 

 

 

166
significance. Because interaction was not statistically significant,
these tests were used to test the research hypotheses. The results of
the F-tests shown in Tables 6-6 and 6-7 indicated that degree of asso-
ciation effects for all comparisons were significant. Figure 6-12
graphically illustrates these effects. The results indicated that CPAs

and bankers perceived different assurances about the extent of independ-

[‘1

ence among CPAs who perform compilations, reviews, and audits. For this
reliability surrogate, confidence in compilations was lower than con-
f idence in reviews, and confidence in reviews was lower than confidence I.

in audits. With respect to these comparisons, hypotheses HCB6 and i

 

HCP6 were rejected.

fleaning of the Results

The computed mean scores, as shown in Tables 6-8, 6-9, and

E3‘-- 10, indicated that CPAs and bankers consistently attributed increasing
tf<Ea=liability to financial statements as the degree of CPA association
“713[. th the statements progressed from no association to compilation to
r‘<-_=.=:‘view to audit. The decisions to accept or reject hypotheses, as
Sh own in Tables 6-8, 6-9, and 6-10, indicated a similar result. First,
'“VZI.'th respect to all six hypotheses tested (HCB1 through HCB6)’ the in-
cIE‘eases in bankers' confidence levels were statistically significant
5‘35‘ the degree of CPA association progressed from no association to

C1<Eitnpilation to review to audit.4 Second, with respect to all six

t1‘.’:i"‘|potheses tested (HCPl through HCP6)’ the increases in CPAs'

4An exception to this result was that small bank CEOs per-
<1eived no differences between no CPA association and compilation with

respect to five reliability surrogates.

 

 

167
confidence levels were also statistically significant as the degree of
CPA association progressed from no association to compilation to review
to audit. Because CPAs and bankers were able to perceive different
assurances among the reports, the communication process between CPAs
and financial statement users appears to be effective.

The next result, illustrated in Figures 6-7 through 6—11, per-
tained to bankers' confidence in financial statements accompanied by
the CPA's compilation report. As shown in these graphs, the confi-

dence bankers placed in compilations was more like the confidence
placed in statements with no CPA association than the confidence placed
in reviews. Since SSARS #1 requires CPAs to express no assurances
ab out the financial statements in a compilation report, users appar-
en tly perceived accurately the intent of the CPA's compilation report.

A third result concerned CPAs' confidence in financial state-

nle Ilts accompanied by the CPA's compilation report. As shown in
F1 gures 6-7 through 6-11, CPAs expressed confidence about the reli-
ab :ility of compiled financial statements in a range from very weak
CO tnfidence to medium confidence. This finding suggests two possible
explanations. One possibility might be that CPAs perceived the
achievement of some assurances about the reliability of compiled
financial statements, despite the denial of assurances contained in
the compilation report. Another possibility might be that CPAs did
not understand compilation procedural or communication guidelines
sI>ecified by SSARS #1. For example, CPAs might have believed that the
CPA's responsibilities for compiled financial statements were greater
than those required by SSARS #1. As another example, CPAs might have

believed that the assurances contained in the CPA's compilation report

 

168
were greater than those intended by SSARS #1.

A final result was related to CPAs' and bankers' responses to
the reliability surrogate of independence when the financial statements
were accompanied by the CPA's compilation report or review report.
SSARS #1 requires the CPA to be independent in a review engagement and

requires the CPA to be independent in a compilation engagement unless

sszpecifically disclaimed in the compilation report. Since the hypothet-

i cal compilation report contained in the questionnaire did not disclaim
the CPA's independence, it was expected that the respondents would
place equally high confidence in the CPA's independence for compila-
tions, reviews, and audits. However, the results graphically shown in
Figure 6-12 indicated that CPAs and bankers attributed increasing inde-
P endence to the CPA as the degree of association progressed from com-
Pi lation to review to audit. There are two possible explanations for
Ch is finding. One possibility might be that CPAs and users might have
P e Iceived the CPA's independence as a function of the degree of associ—

at :ion. A second possibility might be that CPAs and bankers did not

 

understand SSARS #1 requirements with respect to independence. A
fl-Ilzrther analysis of respondents' ratings of confidence in the CPA's
independence, illustrated by Table 6-11, revealed a diversity of

1'-“E‘-Sponses. CPAs and bankers may have been confused about independence

recluirements contained in SSARS #1.

Reliability Surrpgate Effects

 

A secondary objective of the present research was to investi-
gate reliability surrogate effects. These effects refer to the respond-

ents' relative evaluations of the reliability surrogates for each degree

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2.0 E:

 

 

 

 

 

170

of association. This section first presents the mean score results

for reliability surrogate effects in graphic form. Then, the results
of univariate statistical tests of mean score pair comparisons are

reported. Finally, the meaning of these results is discussed.

Itesults
The mean score results of reliability surrogate effects for

eaeach degree of association are graphically illustrated by Figures 6-13
through 6-16. Each graph plots the mean scores of the reliability

as 1Larrogates for each responding group and for a particular degree of

zauzsssociation. One hundred and sixty-five univariate t-tests were then
tzasszed to test the differences in mean scores for all possible reliability
Surrogate pair comparisons. These t-tests were performed for each

Sample group and for each degree of association. Tables 6-12 through

6— 15 show the computed t-values and two-tail probabilities for the

F>aEaL.ir comparisons. Table 6-1 lists the mean scores of the reliability

Surrogates plotted on the graphs and used in the t-test pair compari-

S=<:>»1ns.

Figure 6-13 and Table 6-12 present the results of reliability

s"--11'rogate effects when there was no CPA association with the financial

S tatements. These results are described below:

1. Large bank CBLOs placed more confidence in two reliability

$1LIlll:rogates (GAAP and unintentional error) than in the other three reli-
aEEDleity surrogates (disclosures, management fraud, and employee fraud).

2. Small bank CEOs placed equal levels of confidence in all
tine reliability surrogates.

3. CPAs placed more confidence in two reliability surrogates

 

 

 

 

 

171

 

 

 

 

Confidence
Levels
3 q
2 ‘ GAAP
__ __ Disclosures
__ _ _ _ Unintentional Error
______ Management Fraud
._.... ._ __ , Employee Fraud
1 n
O . . H. Groups
Large Small cpAs
Bank Bank
CBLOs CEOs

Fig. 6—13. Graph of mean scores for reliability
surrogate effects: no CPA association.

 

 

172

 

 

 

 

 

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173

 

 

 

Confidence
Levels
3 1
2 .
l .
GAAP
__ __ Disclosures
__ _ _ __ Unintentional Error
.. .. .. .. .. Management Fraud
__ _ _- Employee Fraud
_ _ __ Independence
0 v , ; Groups
Large Small CPAs
Bank Bank
CBLOs CEOs

Fig. 6—14. Graph of mean scores for reliability
surrogate effects: compilations.

’1':

 

174

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2.0 BE

175
(GAAP and unintentional error) than in the surrogate, disclosures.

Figure 6-14 and Table 6-13 present the results of reliability
surrogate effects when the financial statements are accompanied by the
CPA's compilation report. These results are described below:

1. Both CPAs and large bank CBLOs placed more confidence in
two reliability surrogates (GAAP and independence) than in the other
four surrogates (disclosures, unintentional error, management fraud,
and employee fraud).

2. Small bank CEOs placed more confidence in two reliability

satzrrogates (GAAP and independence) than in the surrogate, management
.1fczraud.

3. Small bank CEOs placed more confidence in the reliability
8 urrogate of independence, than in the surrogate of employee fraud.

4. Large bank CBLOs placed more confidence in the reliability
Ez'ttnsrrogate of unintentional error, than in the three surrogates of
<1 i sclosures, management fraud, and employee fraud.

5. CPAs placed more confidence in two reliability surrogates
(l':3.:isclosures and unintentional error) than two other surrogates
(htllaanagement fraud and employee fraud).

Figure 6-15 and Table 6-14 present the results of reliability
S31L-‘1‘JL-rogate effects when the financial statements are accompanied by

the CPA's review report. These results are described below:

1. CPAs, large bank CBLOs, and small bank CEOs placed more

c:Cb‘llfidence in two reliability surrogates (GAAP and independence) than
tflhe other four surrogates (disclosures, unintentional error, manage-
Inent fraud, and employee fraud).

2. Large bank CBLOs placed more confidence in the reliability

 

C onfidence

 

176

GAAP

Disclosures

 

Unintentional Error

 

 

 

Levels _- ..
_ _ _ _ __ Management Fraud
5 # Employee Fraud
Independence
4 «I
3 4
~\‘ ~
\ / ' ‘ " a
\’ v ‘ fl
’ " ‘ ’ ., vi" " ’-
p ’ ' ’i'
O /
2 Large Sm'all WAS GmUPS
Bank Bank
CBLOs CEOs

Fig. 6-15. Graph of mean scores for reliability

surrogate effects: reviews.

‘5

 

 

177

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178
surrogate, unintentional error, than in three other surrogates (dis-

closures, management fraud, and employee fraud).

3. Large bank CBLOs placed more confidence in the two relia-

bi l ity surrogates of disclosures and management fraud than in the sur-

to gate of employee fraud.

4. CPAs placed more confidence in the two reliability surro-

ga t es of disclosures and unintentional error than in the two surrogates
o f management fraud and employee fraud.

5. CPAs placed more confidence in the reliability surrogate of

i‘lldependence than in the surrogate of GAAP.

 

Figure 6-16 and Table 6-15 present the results of reliability l

S “Irogate effects when the financial statements are accompanied by the

CPA's audit report. These results are described below:

1. Both CPAs and large bank CBLOs placed more confidence in

t71‘1e two reliability surrogates of GAAP and independence than in the
Q ther four surrogates (disclosures, unintentional error, management
f raud, and employee fraud).

2. Both CPAs and large bank CBLOs placed more confidence in

hero reliability surrogates (disclosures and unintentional error) than

in two other surrogates (management fraud and employee fraud).

3. Small bank CEOs placed more confidence in the reliability

surrogate, GAAP, than in the four surrogates of disclosures, uninten-

tional error, management fraud, and employee fraud.

4. Small bank CEOs placed more confidence in the reliability

Surrogate of independence than in the surrogate of employee fraud.

179

 

 

 

 

_________ GAAP
____ Disclosures
C confidence —
Levels _ _ __ Unintentional Error
.. .. .. - .. Management Fraud
6 1
Employee Fraud
___ Independence
5‘ I
4 q
3 Large Smgll CPAs Groups
Bank Bank
CBLOS CEOS

Fig. 6-16. Graph of mean scores for reliability
surrogate effects: audits.

180

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181
Me gaming of the Results
One indication of the results was that when the financial state-
ments are accompanied by compilation, review, or audit reports, CPAs
and bankers consistently placed more confidence in both GAAP and inde-
Pendence than in each of the other reliability surrogates. There are
two possible explanations for the higher confidence levels attributed
't:;“::=D GAAP. One might be that the respondents believed that CPAs achieved
and expressed more assurances about GAAP than the other reliability
=55;“I_JLjrrogates. Another possible explanation might be that respondents
w ere more familiar with GAAP. This familiarity with GAAP might have
1t:=>'<E3en achieved by previous experience or by references to GAAP contained
3:!1—fln the CPA's review and audit reports. An explanation for the higher
“::=Ionfidence in independence might be that AICPA standards require a CPA
“t:<o be independent in audit and review engagements. Further, the AICPA
‘=::<ompilation and review standard requires a CPA to be independent in
‘::40mmilation engagements, unless specifically disclaimed in the compila-
t ion report.
A second indication of the results was that when the financial
ESVtatements are accompanied by compilation, review, or audit reports,
(ZIRAS and bankers consistently placed less confidence in both manage-
Inuant fraud and employee fraud than in each of the other reliability
Surrogates. There are three possible explanations for this finding.
()Ile might be that CPAs and bankers believed that CPAs were not respon-
sible for detecting the effects of management fraud or employee fraud.
IXIlother possibility might be that CPAs and bankers believed that CPAs
‘Vtare not capable of detecting the effects of management fraud or

employee fraud. A final possibility is that fraud might be related

 

182
more to the integrity of management personnel and employees than to
financial statements. In support of this last possibility, several
respondents indicated in written comments on the questionnaire that
the ir ratings of management fraud and employee fraud were lower than
the other reliability surrogates. Their reason was that evaluating
the integrity of a company's personnel would be more likely to uncover

the effects of fraud than evaluating its financial statements.

Familiarity Effects

Another secondary objective of the present study was to in-
vestigate the extent to which CPAs and bankers were familiar with
compilations and reviews. Table 6-16 presents the percentages of
responding large bank CBLOs and small bank CEOs who answered "yes" to
Six questions about their familiarity with compilations and reviews.
Table 6—17 presents the percentages of responding CPAs who answered
"yes " to six similar questions about their familiarity with compila-
tions and reviews. This section first describes these percentages and

then discusses the meaning of the results.

W

The results first indicated that nearly all responding large
bank CBLOs (95.2%) and CPAs (95.97.) have read materials about compila—
tions and reviews. About half of the responding small bank CEOs
(51 - 4%) have read materials about compilations and reviews. A smaller
pet‘Centage of large bank CBLOs (32.4%), small bank CEOs (2.97.), and
CPAS (51.6%) reported attendance at a seminar or educational workshop
on compilations and reviews sponsored by their bank or firm. However,

a higher percentage of large bank CBLOs (59.0%), small bank CEOs

 

183

TABLE 6-16

FAMILIARITY EFFECTS: RESPONSES OF LARGE BANK
CBLOs AND SMALL BANK CEOS TO QUESTIONS
ABOUT COMPILATIONS AND REVIEWS

 

 

 

 

Familiarity Questions

Percentage of Percentage of

Large Bank CBLOs Small Bank CEOs

Answering "Yes" Answering "Yes"

 

Have you read any materials
about compilations and reviews? 95.27.

Have you attended a seminar or
educational workshop on com—

pilations and reviews sponsored

by your bank? 32.4%

Have you attended a seminar or

educational workshop on com-

Pilations and reviews sponsored

by an organization other than

your bank? 59.0%

Have you seen a CPA's compilation
r‘-:-’-P<> rt accompanying the financial
Statements of any of your bank's
C118 tomers? 74 . 37.

HaVe you seen a CPA's review report
accompanying the financial state-

ments of any of your bank's

GUS tomers? 76 . 27°

Do you now use or expect to use in
the future compilation reports or
re‘riew reports prepared by CPAs'? 93.37.

\

lqc>t:¢3.;

The percentages in this table are sample
fore, are subject to sample variability.

51.4%

17.1%

54.3%

45.77.

68.67.

percentages and, there-
The standard error of

a sample percentage is approximately 50% divided by the square

root of the sample size.

 

1‘.

184
TABLE 6-17

FAMILIARITY EFFECTS: RESPONSES OF CPAS TO
QUESTIONS ABOUT COMPILATIONS AND REVIEWS

 

 

 

 

, Percentage of CPAS
i

Famlliarity Quest ons Answering "Yes"

Have you read any materials about

compilations and reviews?

 

 

95.9% ___
Hm
Ilarxrea you attended a seminar or educational
wwc>1r1<shop on compilations and reviews
sponsored by your firm? 51.6%
Ilaxrea you attended a seminar or educational
workshop on compilations and reviews ,
sponsored by an organization other than
your firm? 63.9% L“
Have you seen a CPA's compilation report
accompanying the financial statements of
any of your firm's clients? 73.87.
Have you seen a CPA's review report
accompanying the financial statements of
any of your firm's clients? 63.97.
DO you now or in the future do you
expect to participate in compilation
01‘ review engagements? 91.0‘7o
\
NO te :

The percentages in this table are sample percentages and, there-
fore, are subject to sample variability. The standard error of

a sample percentage is approximately 50% divided by the square
root of the sample size.

185

(1‘7 .17.), and CPAS (63.9%) reported attendance at a seminar or educa-
tional workshop sponsored by an organization other than their bank or
firth. The results also indicated that a majority of responding large
bank CBLOs (74.37.), small bank CEOs (54.3%), and CPAS (73.8%) reported
seeing a compilation report in practice. A similar number of respond-
ing large bank CBLOs (76.27.), small bank CEOs (45.77.), and CPAs (63.9%)
reported seeing a review report in practice. Finally, most responding
large bank CBLOs (93.37.) and small bank CEOs (68.6%) used or expected

to use a CPA's compilation or review report. In a related question,

nearly all responding CPAS (91.0%) had participated or expected to

participate in compilation or review engagements.

flaming of the Results

Responses to these familiarity questions first indicated that
the CPAS and large bank CBLOs were more familiar with compilations and
reviews than the small bank CEOs. There are two possible reasons for
this finding. One reason might be that small bank CEOs relied more on
their familiarity with loan customers than on CPA reports as a basis
for making loan decisions. Consequently, these banks might not need
to use compilation reports and review reports. Another reason might
be that small banks did not have sufficient financial resources or
time to justify education in the area of compilations and reviews.

The results next indicated that fewer respondents had gained
familiarity with compilations and reviews by attending a seminar or
e"111cational workshop sponsored by their organization. It may be that
many of the large bank CBLOs attended seminars sponsored by large CPA

f1‘ll‘ms, the Michigan Association of Certified Public Accountants (MACPA),

 

186
or Robert Morris Associates. Another reason might be that many of
the CPAs who were sole practitioners or local firm members attended
Seminars sponsored by large CPA firms or the MACPA. A final reason
might be that most small banks probably did not have sufficient
resources to justify sponsoring a seminar or workshop.

Next, the results indicated that a high percentage of all
respondents reported seeing compilation and review reports in prac-
tice, and expected to either use such reports or participate in such

engagements. This finding suggested that compilations and reviews
were relevant to the loan decision process involving CPAs, financial
statements of nonpublic businesses, and bankers.

Finally, the results indicated that the respondents were
generally familiar with compilations and reviews. A possible explan-
ation for this result might be that the accounting and banking pro-

fessions educated most of their members about compilations and reviews.

Summary

This chapter presented the data and results of statistical
teS ts used in the present research to assess the effectiveness of the
conununication process between CPAS and bankers. The chapter described
the results in terms of four categories. These were group effects,
degree of association effects, reliability surrogate effects, and
familiarity effects. First, the results associated with group effects
i13(11cated that CPAs placed more confidence in the reliability of finan-
cial statements than bankers did when the statements were accompanied

by compilation reports, review reports, or audit reports. Second, the

reStilts related to degree of association effects showed that both CPAS

 

187

and bankers attributed increasing reliability to the financial state-
ments as the degree of CPA association progressed from no association
to compilation to review to audit. Third, the results pertaining to
reliability surrogate effects demonstrated that both CPAS and bankers
(1) placed more confidence in GAAP and independence than in each of
the other reliability surrogates, and (2) placed less confidence in
management fraud and employee fraud than in each of the other relia- F.“
bility surrogates. Finally, the results regarding familiarity effects
showed that both CPAs and bankers were generally familiar with compila-

tions and reviews.

 

The last chapter summarizes the results of the present study, !
Irreassents conclusions, and discusses implications of these results.
1316: chapter also describes limitations of the results and suggests

topics for future research.

CHAPTER VII

SUMMARY OF RESULTS, CONCLUSIONS, AND IMPLICATIONS

 

This thesis empirically tested the effectiveness of the com- Fir-
munication process between certified public accountants (CPAS) and
bankers within the framework of financial reporting for nonpublic ‘
businesses. The aspect of the communication process investigated was i
L

the similarities with which CPAS and bankers perceive assurances about

financial statements accompanied by no CPA report, by the CPA's com-
Pilation report, by the CPA's review report, and by the CPA's audit
report. The form of assurance investigated was the reliability of

the financial statements. This was defined as the extent to which

financial statements are (1) in conformity with generally accepted
accounting principles (GAAP), (2) accompanied by all material disclo—
shires (disclosures), (3) free from the effects of an existing material
unintentional error (unintentional error), (4) free from the effects
of an existing material management fraud (management fraud), (5) free
from the effects of an existing material employee fraud (employee
fraud), and (6) evaluated by a CPA who is independent of management
( independence) .

To accomplish the objectives of the present study stated in

mapter I, questionnaires were mailed to 200 randomly selected CPAS

Pr"Elcticing in Michigan. Questionnaires were also mailed to 200

tarldomly selected bankers practicing in} Michigan. Of these, 130

188

189
we re commercial bank loan officers (CBLOs) from large banks and 70
were chief executive officers (CEOs) from small banks. Appendices
A and B illustrate the questionnaires which were mailed to the CPA
and banker groups. Responses from 120 CPAs, 101 large bank CBLOs,
and 29 small bank CEOs comprised the results of the study. The ques-
tionnaire measured respondents' perceptions of the reliability of
financial statements for six reliability surrogates and for four
degrees of CPA association with financial statements. Respondents'
perceptions of reliability were measured on a seven-point rating
scale provided after each reliability surrogate on the questionnaire.
The seven scale points and numerical values assigned to them were:
no confidence, 0; very weak confidence, 1; weak confidence, 2; medium
confidence, 3; strong confidence, 4; very strong confidence, 5; and
Complete confidence, 6. Table 7-1 summarizes the numerical mean
Scores of these responses for each sample group. Parametric multi-
Variate F-tests and univariate t-tests were then used to test research
hYIhotheses about these data.
This chapter first presents a summary of the results and con-
clusions based on these results. The chapter then discusses the im-
P11 cations of the findings. Next, a section describes the limitations

of the results. A final section suggests topics for future research.

Summary of the Results and Conclusions
This section first presents summaries of the results and con-
cl‘1310ns with respect to the primary objectives of the study: to pro-
vide empirical information about six research questions. Each ques-

t1(>11 (or group of questions) is presented below and is followed by a

 

190

TABLE 7-1

RESULTS OF MEAN SCORES

 

 

 

 

De g rees of Large Bank Small Bank
As 5 ociation and CBLOs CEOs CPAS
Re :1. iability Surrogates (n=lOl) (n=29) (n=120)

 

 

No CPA Association

GAAP 9 .8 5
Disclosures 5 .6 3
Unintentional Error 8 .9 6
Management Fraud 6 .7 4
Employee Fraud 5 .8 5
Compilation
GAAP 1.9 1.6 2.6
Disclosures 1.0 1.0 1.8
Unintentional Error 1.5 1.3 1.8
Management Fraud 1.0 .9 1.2
Employee Fraud .9 1.0 1.1
Independence 2.1 2.0 3.4
Ibexerew
GAAP 3.2 3.2 4.0
Disclosures 2.4 2.3 3.5
Unintentional Error 2.7 2.5 3.3
iManagement Fraud 2.2 2.3 2.4
Employee Fraud 2.0 2.2 2.3
Independence 3.4 3.3 4.6
And 1 I;
GAAP 4.5 4.6 5.2
Disclosures 4.0 3.9 5.0
‘Unintentional Error 4.1 4.0 4.8
Management Fraud 3 . 6 3 . 8 3 . 8
Employee Fraud 3.6 3.9 3.8
Independence 4.4 4.4 5.3

\

 

191
summary of the results and conclusions. Then, summaries of the results

and conclusions with respect to secondary objectives of the study are

presented .

Research Question Number 1: Do CPAs and users share similar views
about the reliability of financial statements when there is no CPA
association with the statements?

The mean scores shown in Table 7-1 indicate that, for each
reliability surrogate, bankers placed more confidence in financial
statements than CPAS did when there is no CPA association with the
statements. The results of the statistical tests of hypotheses, how-
ever, demonstrate that none of these differences are significant.
These findings suggest that CPAs and users share similar views about
the reliability of financial statements when there is no CPA associa-
tion with the statements. Furthermore, the mean scores for both CPAS
and bankers are all below 1.0, indicating that both groups place almost

no confidence in the reliability of financial statements prepared with
no CPA association.

Research Question Number 2: Do CPAs and users share similar views
ab out the reliability of financial statements when the statements
are accompanied by the CPA's compilation report?
R&earch Question Number 3: Do CPAS and users share similar views
about the reliability of financial statements when the statements
are accompanied by the CPA's review report?

Re\Search Question Number 4: Do CPAs and users share similar views

ab Out the reliability of financial statements when the statements
are accompanied by the CPA's audit report?

 

The mean scores listed in Table 7-1 show that, for each relia-
bility surrogate, CPAS placed more confidence in the reliability of the
financial statements than bankers do when the statements are accom-

Panied by the CPA's compilation report, review report, and audit

"1

 

 

192

report.1 The results of the statistical tests of hypotheses further
indicate that (1) differences for three reliability surrogates (GAAP,
disclosures, independence) are significant with respect to
compilation reports, and (2) differences with respect to four relia-
bility surrogates (GAAP, disclosures, unintentional error, independ-
ence) are significant for review and audit reports.2

These results support the conclusion that CPAs and users do FT-‘&;
not share similar views about the reliability of financial statements
when the statements are accompanied by compilation, review, or audit

reports. When CPAS associate with and report on financial statements,

 

users attribute less assurances to the reliability of the statements 1
than CPAS. Three factors could cause bankers to place less confi-
dence in the financial statements than CPAS. One is that bankers may
be less familiar with the statements than CPAs because they do not
understand the extent or nature of CPA procedures performed on the
statements. For example, bankers may believe that the extent of CPA
review procedures is less than that either required by SSARS #1 or
actually performed by CPAS. Another factor is that bankers may be
skeptical of any CPA assurances about the reliability of financial
statements. Philosophical differences between CPAs and bankers may
be responsible for this skepticism. A final factor is that CPAs may

know that they achieve more assurances about the reliability of

 

1An exception to these results was that small bank CEOs per-
ceived more assurances about employee fraud in audits than CPAs.

2An exception to this result was that, in the comparison of
CPAs to CEOs, the difference pertaining to GAAP was not significant
for audits.

193
financial statements in compilation, review, and audit engagements

than they express in related compilation, review, and audit reports.

Research Question Number 5: Do users perceive differences in the
reliability of financial statements which are accompanied by no CPA
report, by the CPA's compilation report, by the CPA's review report,
and by the CPA's audit report?

Research Question Number 6: Do CPAs perceive differences in the

reliability of financial statements which are accompanied by no CPA
report, by the CPA's compilation report, by the CPA's review report, W
and by the CPA's audit report?

 

The mean scores shown in Table 7-1 indicate that both CPAS and

bankers perceived increasing assurances about the reliability of finan-

 

cial statements as the degree of CPA association progresses from no L
association to compilation to review to audit. Further, Table 7-1 shows
that CBLOs from large banks and CEOs from small banks perceived simi-
larly the increasing assurances about the reliability of the statements.
The results of the statistical tests of hypotheses demonstrate that all
these differences are significant.3 These findings support the conclu-
sion that both CPAS and users perceive differences in the reliability

of financial statements which are accompanied by no CPA report, by the
CPA's compilation report, by the CPA's review report, and by the CPA's
audit report. Furthermore, both CPAS and users correctly perceived

that CPAs provide increasing assurances about the reliability of the
statements in the order of compilation reports, review reports, and
audit reports.

Another result pertains to CPAs' and bankers' confidence in

 

3An exception to this result was that small bank CEOs' per-
ceptions about the differences between no CPA association and com-
pilations were not significant.

194
financial statements accompanied by the CPA's compilation report.
First. the confidence bankers placed in compilations was more like the
confidence placed in statements with no CPA association than the
confidence placed in reviews. Consequently, bankers perceived that a
CPA's compilation report provides almost no assurances about the finan-

cial statements. Since SSARS #1 requires CPAs to express no assur-

‘1

ances about the financial statements in a compilation report, bankers
apparently perceived accurately the intent of the CPA's compilation
report. Second, unlike the bankers, CPAS placed some confidence in

compiled financial statements. This finding suggests two possible

 

explanations. One is that CPAS may know that they achieve some L-.«H
assurances about the financial statements, despite the denial of
assurances contained in the compilation report. A second explanation
is that CPAS may not understand compilation communication guidelines
required by SSARS #1. For example, CPAS may believe that their respon-
sibilities for compiled financial statements are greater than those
required by SSARS #1. As another example, CPAs may believe that the
assurances contained in the compilation report are greater than those
intended by SSARS #1.

A final result concerns CPAs' and bankers' perceptions of a
CPA's independence in compilations and reviews. The results first
show that CPAs had medium confidence and bankers had weak confidence
that CPAs are independent in compilations. The results next show that
bankers had only medium confidence that CPAs are independent in re-
views. These results appear to be contrary to the accounting pro—
fession's guidelines about independence found in SSARS #1. This

standard requires a CPA to be independent in reviews and requires a

195
CPA to be independent in compilations unless specifically disclaimed
in the compilation report. There are two possible explanations for
this finding. One is that both CPAs and bankers perceive a CPA's
independence as a function of the degree of association. A second
possible reason is that both CPAS and bankers may be confused about

the independence requirements contained in SSARS #1.

 

 

rm“

Secondary Objectives '
Secondary objectives of the present study were to provide

empirical information about the relative effects of the reliability

surrogates and to measure respondents' familiarity with compilations l

and reviews. Each objective is presented below and followed by a sum-
mary of the results and conclusions.

One secondary objective was to investigate reliability surro—
gate effects, which refer to the respondents' relative evaluations of
the reliability surrogates for each degree of association. The mean
scores shown in Table 7-1 and the results of univariate t-tests of
pair comparisons indicate that both CPAS and bankers consistently
place (1) more confidence in GAAP and independence than in the other
four reliability surrogates, and (2) less confidence in management
fraud and employee fraud than in the other surrogates. Several con-
clusions can be drawn based on these results. First, both CPAs and
users believe that a CPA's report on financial statements provides
more assurances about GAAP than about the other reliability surrogates.
Two possible reasons explain the higher levels of assurances perceived
about GAAP. One is that both CPAs and bankers believe that CPAS

achieve and express more assurances about GAAP than about the other

196
reliability surrogates. Another reason is that CPAS and users are more
familiar with GAAP due to previous experience or due to references to
GAAP contained in the CPA's review and audit reports. Second, the
higher levels of assurances about independence indicated by CPAS and
users may be attributed to professional standards which require a CPA
to be independent when associated with financial statements. Finally,
the results concerning management fraud and employee fraud suggest that

both CPAs and users believe that CPAs provide less assurances about

 

fraud than about the other reliability surrogates. Three possible

reasons explain this finding. One is that CPAs and bankers may

 

believe that CPAS are not responsible for detecting the effects of L
either management or employee fraud. Another reason is that CPAs and
bankers may believe that CPAs are not capable of detecting the effects
of either management or employee fraud. A final reason is that fraud
may be related more to the integrity of management personnel and
employees than to financial statements.

The other secondary objective was to investigate the extent to
which CPAs and users are familiar with compilations and reviews.
Table 7-2 shows the percentages of large bank CBLOs, small bank CEOs,
and CPAs who answered "yes" to six questions about their familiarity
with compilations and reviews. The percentages shown in Table 7-2
first indicate that CPAs and large bank CBLOs are more familiar with
compilations and reviews than small bank CEOs. Two reasons may ex-
plain this finding. One is that small bank CEOs may rely more on
their familiarity with loan customers than on CPA reports as a basis
for making loan decisions. Consequently, these CEOs may not need to

use compilation reports and review reports. A second possible reason

197

 

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198
is that small banks may not have sufficient financial resources or
time to justify education in the area of compilations and reviews.
Next, the results show that a high percentage of all respondents report
that they see compilation and review reports in practice, and expect to
either use such reports or participate in such engagements. These
results support two conclusions: (1) both CPAs and users are gener-
ally familiar with compilations and reviews, and (2) compilations and
reviews are relevant to the loan decision process involving CPAs, the

financial statements of nonpublic businesses, and bankers.

Implications

 

A number of implications of the present study and its results
are stated below. These implications represent the views of the
researcher.

First, the findings support the Accounting and Review Services
Committee's (ARSC's) successful implementation of an assurance level
approach to CPA reports on financial statements of nonpublic busi-
nesses. This approach intends that CPAS provide increasing assurances
about the financial statements in the order of compilation reports,
review reports, and audit reports. The results of the present study
support two aspects of this implementation. The results first indi-
cate that both CPAs and users are generally familiar with compilations
and reviews. This finding suggests that both accounting and banking
professions have educated most of their members about compilations and
reviews. Next, the results show that both CPAs and users correctly
perceive that CPAs provide increasing assurances about the financial

statements accompanied by compilation reports, review reports, and

199
audit reports in that order.

Second, the finding that users perceive increasing assurances
about the reliability of compiled, reviewed, and audited financial
statements, in that order, replicates a general finding of previous
research. That is, as the degree of CPA association with financial
statements increases, users attribute more reliability to the state-
ments.

Third, the results tend to mitigate the fears that users might

 

attribute audit-type assurances to financial statements accompanied by

compilation or review reports. Both the results of legal cases reviewed

 

in Chapter III and the results of AICPA auditing standards reviewed in L
Chapter IV show that users attributed audit-type assurances to un-
audited financial statements. Since SSARS #1 replaced unaudited finan-
cial statements with compilations and reviews, there is concern about
whether users attribute audit-type assurances to compilation or review
reports. The results of the present study indicate that, on the aver-
age, users do not attribute audit-type assurances to compilation or
review reports. It is the researcher's opinion that this finding
should also minimize the CPA's fear of the legal risks of unwarranted
user reliance on financial statements in compilation or review engage-
ments.

Fourth, the findings suggest a potential problem dealing with
CPAs' and users' perceptions about a CPA's independence in compila-
tions and reviews. As stated in Chapter I, the AICPA views independ-
ence as the cornerstone of its philosophical structure. In accordance
with this view, SSARS #1 requires CPAS to be independent in reviews,

and requires CPAs to be independent in compilations unless specifically

200
disclaimer in the compilation report. The results indicate that the
extent of both CPAs' and users' confidence in a CPA's independence was
less than that expected. Perhaps the ARSC should examine the adequacy
of its independence guidelines contained in SSARS #1. At the same
time, perhaps the AICPA's Ethics Committee should examine the adequacy
of independence guidelines with respect to unaudited financial state-

ments contained in its Code of Professional Ethics.

 

Fifth, the results suggest a possiblenfisunderstanding among
both CPAS and users regarding the CPA's assurances about GAAP. As
stated in Chapter I, GAAP refer to the conventions, rules, and proce-
dures which define accepted accounting practice at a particular time.
According to this definition, GAAP comprehend the adequacy of material
disclosures and the avoidance of material unintentional errors. If
GAAP comprehend disclosures and unintentional errors, it was expected
that respondents would perceive a level of assurance about GAAP equal
to or less than the level of assurance attributed to either disclosures
or unintentional errors. However, the findings of the present study
show that both CPAS and users perceive more assurances about GAAP than
about either disclosures or unintentional errors. Therefore, CPAs and
users may not understand the comprehensive nature of assurances implied
by GAAP.

Sixth, the findings suggest that the ARSC and the Auditing
Standards Board (ASB) continue to take a careful approach to estab-
lishing CPA responsibilities for fraud. The results of the present
research indicate that both CPAs and users perceive less assurances

about management fraud and employee fraud than about the other

201

reliability surrogates. The results further suggest the possibility
that fraud may be related more to the integrity of management personnel
and employees than to financial statements. Finally, the results do
not support a concern that users might perceive more assurances about
fraud than CPAS do.

Seventh, the finding that bankers perceive almost no assurances
about compilations may affect their demands for either compilations or
reviews. This suggests that bankers may require CPAs to review loan
customers' financial statements in order to receive some assurances
about the statements.

Finally, the results of the present study indicate that the bank
size does not appear to affect bankers' perceptions about the relia-
bility of financial statements. Bankers from both large and small
banks understand the different CPA assurances contained in compilation,

review, and audit reports.

Limitations of the Results

 

The results of the present research have several limitations.
These include the scope and application of the study, the general-
izability of results, the questionnaire, and respondents who are un-
familiar with compilations and reviews.

One limitation of the results is the scope and application of
the study. The study is limited to: nonpublic businesses; historical
annual financial statements; the CPArbanker communication process
involving CPA written reports (compilation, review, unqualified audit);
the context of the loan situation; and the specified aggregate meaning

of "reliability."

 

202

A second limitation refers to the generalizability of the
results. These results are generalizable only to (1) practicing
Michigan CPAs who were members of the Michigan Association of Certi-
fied Public Accountants, (2) practicing Michigan CBLOs from large
banks, and (3) practicing Michigan CEOs from small banks.

Two limitations of the questionnaire also limit the results of
the present study. One is that the questionnaire measured perceptions
of the reliability of financial statements. It did not measure re-

spondents' actions or other decision-making behavior with respect to

 

reliance on financial statements. A second aspect is that the ques-
tionnaire's reliability was not investigated.

Finally, the results represent the responses of CPAS and
bankers who answered "yes" to at least one of the six familiarity ques-
tions on the questionnaire. The CPAs and bankers who answered "no" to
all six of the familiarity questions were considered to be unfamiliar
with compilations and reviews, and their responses were not used in
the study. Therefore, the results do not represent the perceptions of

CPAS or bankers who are not familiar with compilations and reviews.

Suggestions for Future Research

 

Follow-up studies on various aspects of the present research
can further explain the present findings or provide additional infor-
mation about compilations and reviews. These topics are: variables
in the present study which can be manipulated; the extent and nature of
CPA procedures in compilations and reviews; a CPA's independence in
compilations and reviews; and the costs and benefits of compilations

and reviews.

203

Future studies can address the same research questions dif-
ferently by manipulating variables found in the contents of the ques-
tionnaire. Variables that could be manipulated in the hypothetical
loan situation are: the extent of the banker's familiarity with the
loan customer and the loan customer's CPA firm; the extent of the CPA
firm's familiarity with the client and the client's past financial
statements; size of the CPA firm; terms of the loan agreement; and
time period covered by the financial statements. Other studies can
change the language of the CPA reports or modify the meaning of
"reliability."

Another aspect is the extent and nature of CPA procedures per-
formed on financial statements in compilations and reviews. One con-
clusion of the present study is that CPAs may know that they achieve
more assurances about financial statements in compilations and reviews
than they express in compilation and review reports. What is the
extent and nature of CPA procedures performed on financial statements
in compilations and reviews? Do these procedures comply with AICPA
compilation and review standards? Do all CPAS practice similar proce-
dures in compilation and review engagements? Future research can pro-
vide answers to these questions.

A potential problem disclosed by the present study is that CPAs
and users believe that CPAS may not be as independent in compilations
and reviews as they should be, according to AICPA compilation and
review standards. Future research can explore this issue by investi-
gating the adequacy of these standards and by surveying CPAS and users
about their perceptions of a CPA's independence in compilations and

reviews.

 

204

A final suggestion for future research concerns the costs and
benefits of compilations and reviews. For example, an implication of
the present study is that bankers may require CPAS to review loan
customers' financial statements, in lieu of compiling them. Is the
benefit to the banker of receiving some assurances about the financial
statements greater than the cost of the loan customer of paying a CPA
for a review of the statements? Are bankers requiring reviews instead
of either compilations or audits? Do CPAS recommend to their clients
that reviews replace audits? Studies about the costs and benefits
of compilations and reviews can provide answers to these and similar

questions.

p4

 

SELECTED BIBLIOGRAPHY

SELECTED BIBLIOGRAPHY

Books

Arens, Alvin A., and James K. Loebbecke. Auditing: An Integrated

Approach. 2nd ed. Englewood Cliffs, New Jersey: Prentice—
Hall, Inc., 1980.

Bock, R. Darrell. Multivariate Statistical Methods in Behavioral
Research. New York: McGraw—Hill Book Company, 1975.

Dillman, Don A. Mail and Telephone Surveys. New York: John Wiley
and Sons, 1978.

Finn, Jeremy D. A General Model for Multivariate Analysis. New York:
Holt, Rinehart and Winston, Inc., 1974.

Guilford, J. P. Psychometric Methods. 2nd ed. New York: McGraw-
Hill Book Company, 1954.

 

Montgomery, Robert H. Auditing Theory and Practice. 5th ed. New York:
The Ronald Press Company, 1934.

Nie, Norman H. Statistical Package for the Social Sciences. 2nd ed.
New York: McGraw—Hill Book Company, 1975.

Rand Corporation. A Million Random Digits. Glencoe, Illinois: The
Free Press, 1955.

Winer, B. J. Statistical Principles in Experimental Design. 2nd ed.
New York: McGraw-Hill Book Company, 1971.
Articles

Bell, William H. "Staff Preparation and Editing of Reports," Journal
of Accountancy, February 1925, pp. 114-124.

 

Carey, John L. "Editorial," Journal of Accountancy, September 1941,
pp. 193-200.

 

Carmichael, D. R. "Accounting and Auditing Problems," Journal of
Accountancy, January 1971, pp. 74-75.

 

 

"The Assurance Function—-Auditing at the Crossroads,"
Journal of Accountancy, September 1974, pp. 64-72.

 

 

205

206

Chan, Stephen. "A Review of Statement on Auditing Procedure No. 38,"
New York Certified Public Accountant, March 1968, pp. 187—190.

 

Gardner, Paul L. "Scales and Statistics," Review of Educational
Research, Winter 1975, pp. 43-57.

 

Gregory, William R. "Unaudited, But OK?" Journal of Accountancy,
February 1978, pp. 61-65.

 

Grove, Hugh D., and Richard S. Savich. "Attitude Research in
Accounting: A Model for Reliability and Validity Consider-
ations," AccountinggReview, July 1979, pp. 522-537.

 

Guy, Dan M., and Herschel Mann. "A Practical Guide for Reporting on
Limited Examinations of Financial Statements." CPA Journal,
July 1973, pp. 555-561.

 

Guy, Dan M., and Alan J. Winters. "Unaudited Financial Statements: A
Survey." Journal of Accountancy, December 1972, pp. 46-53.

 

Guy, Dan M., Roy M. Greenway, Ross M. Miller, and John C. Mills.
"Audit Reports, Financial Statements and Creditor Perceptions,’
Texas CPA, January 1974, pp. 5-10.

Kelley, Thomas P. "Compilation and Review--A Revolution in Practice,"
CPA Journal, April 1979, pp. 19-27.

 

Kimball, Charles C. "Accountant's Reports from a Banker's Viewpoint,"
Journal of Accountancy, April 1937, pp. 267-278.

 

Libby, Robert. "Bankers' and Auditors' Perceptions of the Message
Communicated by the Audit Report," Journal of Accounting
Research, Spring 1979, pp. 99-122.

 

Meddaugh, E. James. "Toward the Limited Review of Unaudited State-
ments," Journal of Accountancy, June 1977, pp. 77-80.

 

Nest, Richard A. "Statement No. 38--Unaudited Financial Statements,"
Journal of Accountancy, February 1968, pp. 63-67.

 

Olson, Wallace E. "A Look at the Responsibility Gap," Journal of
Accountancy, January 1975, pp. 52-57.

 

 

Prest, A. P. L. "The Limited Review of Unaudited Interim Statements,"
Journal of Accountancy, October 1957, pp. 49-53.

Reckers, Philip M. J., and Kurt J. Pany. "Quarterly Statement Relia-
bility and Auditor Association," Journal of Accountancy,
October 1979, pp. 97-100.

 

Saunders, Robert H., Jr. "Procedures in Minimizing Risk When Asso-
ciated With Unaudited Financial Statements," Connecticut CPA,
March 1973, pp. 26-29.

 

207

Saxe, Emanuel. "Unaudited Financial Statements: Rules, Risks, and
Recommendations," CPA Journal, June 1972, pp. 457-464+.

 

Seidman, J. 8. "Letters to the Journal," Journal of Accountancy,
March 1966, p. 29.

 

Stempf, Victor H. "Whose Balance Sheet Is It?" New York Certified
Public Accountant, May 1941, pp. 442-458.

 

 

Terrell, Junius H. "Minimum Standards for Unaudited Financial
Statements," Journal of Accountancy, May 1973, pp. 54-60.

 

 

 

Turlington, W. H. "Letters to the Journal," Journal of Accountancy, &
November 1965, pp. 29-31.
Winters, Alan J. "Banker Perceptions of Unaudited Financial State-
ments," CPA Journal, August 1975, pp. 29-33.
Official Releases L

 

 

American Accounting Association. Auditing Concepts Committee. "A
Statement of Basic Auditing Concepts," Accounting Review
(Supplement) 1972, pp. l7-7l.

Committee on Concepts and Standards for External Finan-
cial Reports. Statement on Accounting Theory and Theory
Acceptance. Sarasota, Florida: AAA, 1977.

 

 

Committee to Prepare a Statement of Basic Accounting
Theory. A Statement of Basic Accountinngheory. Sarasota,
Florida: AAA, 1966.

 

 

American Institute of Accountants. Committee on Auditing Procedure.
Statement on Auditing Procedure Number 1: Extensions of
Auditing Procedure. reprinted in Journal of Accountancy,
December 1939, pp. 377-385.

 

. Statement on Auditing Procedure Number 23:
Clarification of Accountant's Rgport When Opinion is Omitted
(Restatement). reprinted in Journal of Accountancy, June
1949, pp. 468-469.

 

 

 

American Institute of Certified Public Accountants (formerly American
Institute of Accountants). Accounting and Review Services
Committee. Statement on Standards for Accountinggand Review
Services Number 1: Compilation and Review of Financial State-
ments. New York: AICPA, 1979.

Accounting Principles Board. APB Statement Number 4:
Basic Concepts and Accounting Principles Underlying Financial
Statements and Business Enterprises. reprinted in Professional
Standards: Accounting. Volume 3. Chicago: Commerce Clearing

 

208
House, Inc., 1975, pp. 7171-7335.

American Institute of Certified Public Accountants. Statements on
Auditing Standards: Nos. 1 to 38. reprinted in AICPA
Professional Standards. Volume 1. Chicago: Commerce
Clearing House, Inc., 1981, pp. 51-2167.

 

 

Code of Professional Ethics. reprinted in AICPA Profes-
sional Standards. Volume 2. Chicago: Commerce Clearing
House, Inc., 1979, pp. 4269-5176.

 

 

. Codification of Statements on Auditicg Standards: Nos. 1
to 15. Chicago: Commerce Clearing House, Inc., 1977.

 

Committee on Auditing Procedure. Statement on Auditing
Procedure Number 32: Qualifications and Disclaimers.
reprinted in Journal of Accountancy, January 1963, pp. 67-73.

 

 

. Statement on Auditinngrocedure Number 38:
Unaudited Financial Statements. reprinted in Journal of
Accountancy, November 1967, pp. 59-61.

 

 

 

 

Task Force on Unaudited Financial Statements. Guide for
Engagements of CPAS to Prepare Unaudited Financial Statements.
New York: AICPA, 1975.

 

Financial Accounting Standards Board. Statement of Financial Accounting
Concepts Number 1: Objectives of Financial Reporting by Business
Enterprises. Stamford, Connecticut: FASB, 1978.

 

Statement of Financial Accounticg Concepts Number 2:
Qualitative Characteristics of Accounting Information.
Stamford, Connecticut: FASB, 1980.

 

Legal Cases

 

Bonhiver v. Graff. 248 N.W. 2d 291, 1976.

 

Coleco Industries,glnc. v. Berman v. Zelnickl Sobelman and Company.
423 F. Supp. 275, 1976; 567 F. 2d 569, 1977.

1136 Tenants' Corporation v. Max Rothenberg and Company. 277 N.Y.S.
2d 996, 1967; 319 N.Y.S. 2d 1007, 1971; 281 N.E. 2d 846, 1972.

MacNerland v. Barnes. 129 Ga. App. 367; 199 S.E. 564, 1973.

 

Ryan v. Kanne, 170 N.W. 2d 395 Iowa, 1969.

 

Seedkem, Inc. v. Safranek. 466 F. Supp. 340, 1979.

 

StanleycL. Bloch, Inc. v. Klein. 258 N.Y.S. 2d 501, 1965.

 

209

Ultramares Corporation v. Touche. 255 N.Y. 170; 174 N.E. 441, 1931.

Dissertations

 

Bainbridge, Dunham R. "Perceptions of the CPA's Ability to Detect
Misrepresentations of the Smaller Business's Financial State—
ments." Ph.D. dissertation, Lehigh University, 1978.

Fiebelkorn, George A., Jr. "The Role of the Certified Public
Accountant in the Accounting Communication Process as Perceived
by Sophisticated Users, With an Empirical Analysis of Factors
Affecting Management Credibility and Certified Public Accountant
Credibility." Ph.D. dissertation, Georgia State University, 1977.

Pany, Kurt J. "Quarterly Financial Reporting: A Test of Varying Forms
of Auditor Association." Ph.D. dissertation, University of
Illinois at Urbana-Champaign, 1978.

Winters, Alan J. "Unaudited Financial Statements: A Delineation of

Issues, Survey of Practice, and Statement of Responsibility,"
D.B.A. dissertation, Texas Tech University, 1974.

Papers and Directories

 

Michigan Association of Certified Public Accountants. 1979 Membership
Directory. Southfield, Michigan: MACPA, 1979.

 

Michigan National Corporation. 1979 Michigan Bank Directcry. Nashville,
Tennessee: R. L. Polk and Company, 1979.

 

Robert Morris Associates. 1979-1980 Membership Roster. Philadelphia,
Pennsylvania: RNA, 1979.

 

Schmidt, William, and Verda Scheifley. Jeremy D. Finn's Multivariance.
Occasional Paper No. 22. East Lansing, Michigan: Office of
Research Consultation, Michigan State University, 1973.

 

APPENDICES

APPENDIX A

BANK COVER LETTERS AND QUESTIONNAIRE

_I .|. .ru ...L .3 a... n. .. .. Lb Ti 3'. ¢. a}. wt. . 1 .HL. .» .e ..e... s. sf.

 

MICHIGAN STATE UNIVERSITY 211

 

GRADL‘ATF. SCHOOL OF BUSINESS ADMINISTRATION EAST LANSING - MICHIGAN - 48324
DEPARTMENT or ACCOUNTING 8. FINANCIAL ADMINISTRATION
November 26, 1979

Compilations and reviews are new CPA services which have replaced
unaudited financial statement engagements for nonpublicly-held
companies. These new services have created much interest and concern
among both bankers and CPAs. With any new professional standard,
potential exists for different interpretations of that standard by
various parties affected by its implementation. An important concern
regarding compilations and reviews is that bankers and CPAS may perceive
the value of the types of CPA reports differently, and subsequently
assign different degrees of reliability to the financial statements.

I am conducting research at Michigan State University to study this
problem. To investigate thoroughly the issues raised, I am seeking

the views of bankers and CPAs on this matter. As a lending institution,
your bank's input on how compilations and reviews affect your reliance
on financial statements is particularly important to this research.

To include your responses as part of the study's results, please
complete the enclosed questionnaire and return it at your earliest
convenience. If someone at your bank is interested in and familiar with
compilations and reviews, please forward this questionnaire to that
person and encourage his or her participation in this research. Based
on pretests, the questionnaire can be completed in less than twenty
minutes.

The person responding may be assured of confidentiality. The data will
be summarized, analyzed, and reported only in the aggregate form. The
identification number on the questionnaire will be used to check your
name off of the mailing list when the questionnaire is returned.

The aggregate results and policy recommendations derived therefrom
will be made available to Robert Morris Associates' Accounting Policy
Committee, appropriate accounting groups, and other interested
parties. You may receive a summary of the results by printing your
name and address on the back of the return envelope.

I would be most happy to answer any questions you might have.
Please write or call. The telephone number is (517) 792-3927.

Thank you for your assistance.
Sincerely,

Larry J. Rankin
Research Director

212

IILIAICE OR SMALL BUSINESS FINANCIAL STATEMENTS

A Study of Michigan Bankers' and Accountants'
Perceptions of Compilations, Reviews, and Audits

This survey will help me to develop an understanding
of how bankers and accountants rely on financial
statements which have been compiled. reviewed, audited,
or not reported on by a CPA. Please answer all the
Questions. If you wish to comment on any questions or
qualify your answers, please feel free to use the space
in the margins or page twelve of this questionnaire.

Thank you for your help.

Department of Accounting and Financial Administration
Graduate School of Business Administration

Michigan State University

East Lansing, Michigan 48824

213

First, 1 mid like to ask a few questions about your familiarity with
Cwilatiw and Review. (Circle the number of each appropriate answer)

1. lave you read any materials about Compilation and Review?

lYES
2N0

2. llave you attended a seminar or educational workshop on
Conilation and Review sponsored by your bank?

1 YES
2 IO

3. lave you attended a seminar or educational workshop on Coqilation
emd Ieview sponsored by an organisation other than your bank?

1m
2'0

6. lave you seen a CPA's Coqilation report accompanying the
financial statemnts of any of your bank's customers?

172$
2'0

5. lave you seen a CPA's Ieview report accompanying the
financial statements of any of your bank's customers?

lYES
2'0

6. Do you now or expect to utilise a CPA's Compilation
or Review reports?

The following situation is a hypothetical case involving a small
nonpublic business, a CPA, and a co-ercisl banker. It is
provided as a fra-s of reference for your subsequent responses.

 

 

Assume that C. M. Smith 8 Co.. a reputable CPA firm, is engaged
by Jones Manufacturing Coepany. a small nonpublic business, to
perform CPA services associated with Jones's financial statnents.
Il"he financial state-ents, which are for the year ended October 31, 1979.
include a Ialanee Sheet, Income Statement. Statement of Owner's
Capital. and Stat-sot of Changes in Financial Position. Assume
that the l0/31I79 Islance Sheet reflects the following:

current Assets 8330.0!” Total Liabilities 8200.000
Ioncurrent Assets $170,000 user's Capital $300,000
$500,000 $500,000

The lOI3l/79 Income Stet-ent reflects 350.000 net income after taxes
earned during the year. Assume that C.M. Smith 8 Co. is not previously
experienced with Jones Manufacturing Company financial stat-ents.

The CPA engagement will provide CPA-associated financial stat-ents,
which will partially coqrise Jones's application for a $50,000
short-term. unsecured, co-srcial bank cash loan. Asst-e that the
bank loan officer is not previously experienced with either Jonas
hufaeturing Coqeny or C. M. Smith A 0:. The banker utilises the
financial statements and CPA's report to facilitate the loan decision.

 

lest, I will provide you with four hypothetical situations
representing different levels of CPA association with financial
stat-ents. Following each situation. you will have the
opportunity to evaluate various aspects of reliance on financial
statnemts. Please answer all questions.

 

214

Please read the following AUDIT report and rate the six numbered items below.

 

To Jones Manufacturing Company:

He have examined the balance sheet of Jones Manufacturing Company
as of October 31. 1979. and the related statements of income,
owner's capital, and changes in financial position for the year then
ended. Our examination was made in accordance with generally accepted
auditing standards and, accordingly. included such tests of the
accounting records and such other auditing procedures as we considered
necessary in the circumstances. .

in our opinion. the financial statements referred to above present
fairly the financial position of Jones Manufacturing Coqany as of
October 31. 1979. and the results of its operations and the changes
in its financial position for the year then ended. in conformity with
generally accepted accounting principles applied on a basis consistent

Invader 30. 1979

 

with that of the preceding year.

C. M. Smith 6 Co.

Certified Public Accountants

 

 

Given the above AUDIT report, how confident are you that the Jones
financial statements are likely to be:

In conformity with generally accepted
aecetnting principles?

(Place a ‘J in applicable
box for each question)

 
 
 

Very Very
lo weak weak Strong
bafiduce Conf idence Loni idence Confidence Confidence

Cowlete
hgm! idence

 

Free of the effects of - existing
-terial uiatsntioeal error '
(i.e. clerical or misapplication
of an accounting principle)?

 

Evaluated by a CPA who is imdapandent
of Jane I-ufacturisg?

 

has of the effects of - eaistiag
-terisl namagem-t fraud (i.e.
negamsat'a intentional aisapprepriatiae
of assets or falsification of records)?

 

Aeceqeaied by all -terial disclosures
(i.e. contingent liability described in
note or footnote to financial stat-sets)!

 

hes of the effects of - existing
material enloyee fraud (i.e. qloyea's
intentional misappropriation of assets
or falsificatioe of records)?

 

 

 

 

 

 

 

 

 

l.

215

Please read the following COMPILATION report and rate the six nunbered items below.

 

louder SO. 1979

 

re Jones lhnufacturing Con-3y:

Ca "0

Smith 8 Co.

The accompanying balance sheet of Jones Manufacturing Company as
of October 31. 1979, and the related statements of income. owner's
capital. and changes in financial position for the year then ended
have been cowiled by us.

A eoqilation is limited to presenting in the form of financial
statuents information that is the representation of management.
Us have not audited or reviewed the accowanying financial statements
and, accordingly. do not express an opinion or any other form of
assurance on them.

Certified Public Accountants

 

 

Given the above COMPILATION report, 'how confident are you that the Jones
financial statements are likely to be:

in conformity with g-erally accepted
accounting principles?

Very
Io bleak
bond-Ice Con f idence

(Place a J in applicable
box for each question)

Weak
Cont idence

Pbdi.
Con! idence

Very
Strong Strong
Confidence _Co._nf_i§_e_n£‘

 

Complete
Confidence

 

Pres of the effects of - existing
material uintantional error ‘
(i.e. clerical er eieapplicatios
of - aecouating principle)?

 

helmated by a DA wb is indep-adent
of Jones Miami-g?

 

hoe of the effects of - .isting
nterial umagem-nt fraud (i.e.
naagsmeet's intentional Wane
of assets or falsification of records)?

 

Aceonaoied by all nterial disclosures
(i.e. contingent liability described in
note or footnote to financial stat-ants)?

 

Pres of the effects of . existing
ntarial -loyee freed (i.e. qloyee's
intentional misappropriation of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

l.

6.

216

Please read the following IlVlEU report and rate the six nunbered itens below.

 

love-bar 30. 1979

 

we have reviewed the

To Jones haufecturing Cowany:

ing balance sheet of Jones Hanufacturing
many as of October 31. 1979. and the related stetenents of intone.
owner's capital. and changes in financial position for the year then
ended. in accordance with standards established by the Anerican institute
of Certified Public Accountants.

All infornation included in these

C. If.

financial stat-ents is the representation of the nanagenent.

Slith & Co.

A review consists principally of inquiries of my personnel and
analytical procedures applied to financial data.
less in scope than an annination in accordance with generally accepted
auditing standards. the objective of which is the expression of an
opinion regarding the financial statenents taken as a whole.
Accordingly. we do not express such an opinion.

it is substantially

based on our review. we are not aware of any nsteriel nodifications
that should be nde to the eccoqanying financial statenents in order for
. th- to be in confornity with generally accepted accomting principles.

Certified Public Accountants

 

 

Given the above REVIEW report, how confident are you that the Jones
financial statements are likely to be:

in enfornity with g-erally accepted
accouting principles?

Conf idencs

Very
Dash

Mime:

(Place a J in applicable

box for each question)

Heal Ihdiu
(on! idence Confidence

Strong
Conf idence

very
Strong

2.1.12.5;

Conlete

mines.

 

tree of the affects of an existing
-terial aintentional error '
(i.e. clerical or nil-application
of an accounting principle)?

 

Evaluated by a CPA who is iadspudent
of Jones hufacuring?

 

Pres of the effects of an eaisting
ntarial snags-at fraud (i.e.

's intentional niaappropriatian
of assets or falsification of records)?

 

dccqenied by all netsrial disclosures
(i.e. contingent liability described in
note or footnote to financial stat-ate)?

 

Pres of the effects of n eniating
uterial salons fraud (i.e. qloyes's
intentional nisappropriatioa of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

5.

217

Given NO CPA ASSOCIATION and 80 REPORT, how confident are you that the

Jones financial statements are likely to be:

in confornity with morally accepted
accounting principles?

In
Confidence

V‘—

Very
Hank

Confidence

Rash

Con f idence

Hediun Strong
Conf idcnce Confidence
—— r—

(Place a J in applicable
box for each question)

Conpiete

Very
Strong
Confidence an idence

 

free of the effects of a existing
naterial mutational error

(i.e. clerical or nisqplication
of an accounting principle)?

 

free of the effects of n existing
nsteriel nnnsg-snt fraud (i.e.
nanegut's intntional niaeppropriation
of assets or falsification of records)?

 

Accoqanied by all uterial disclosures
(i.e. contingent lidility described in
note or footnote to financial state-ents)?

 

Free of the effects of n existing
nsterial snployee fraud (i.e. qloyea's
intutionsl nisepproprietion of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

10

218

71-11,. I Could like to ask a few d-ographic
questions to help with the analysis of the data.
(Circle the n-ber of each appropriate answer)

1.

hat is your

htisyour

u‘UNh-O

Iich is the
that you have

.U.UN~

position within your bank?

rusxom

SD‘IOR VICE-PRESIDENT
VICE-PRESIDENT
ASSISTANT VICE-P125113”?!
m OFFICER

CIDIT mt!

canon MYS‘I

can (please specify)

 

you worhed in c_rcial banking?

tassmsrms
61010“

highest level of education
coqleted?

amour-tn ll“ 8”
can count
mum counts
son ouwm won

4 GIADUATE om (specify degree)
one: (please specify)

 

Is there anything else you would like to tell me about compilations,
reviews, and audits? If so. please use this space for that purpose.

 

Your contribution to this research effort is greatly appreciated.

If you

would like a summary of the results, please print your name and address

on the back of the return envelope (NOT on this questionnaire).

11

APPENDIX B

CPA COVER LETTER AND QUESTIONNAIRE

MICHIGAN STATE UNIVERSITY 219

 

GRADUATE SCHOOL OF BUSINESS ADMINISTRATION EAST LANSING ' MICHIGAN ' 48824

DEPARTMENT or ACCOUNTING & FINANCIAL ADMINISTRATION
November 26, 1979

Compilations and reviews are new CPA services which have replaced
unaudited financial statement engagements for nonpublicly-held
companies. These new services have created much interest and concern
among both CPAs and bankers. With any new professional standard,
potential exists for different interpretations of that standard by
various parties affected by its implementation. An important concern
regarding compilations and reviews is that CPAs and bankers may perceive
the value of the types of CPA reports differently, and subsequently
assign different degrees of reliability to the financial statements.

I am conducting research at Michigan State University to study this
problem. To investigate thoroughly the issues raised, I am seeking
the views of CPAS and bankers on this matter. As a practicing CPA,
your input on how compilations and reviews affect your opinion as to
the reliability of financial statements is particularly important to
this research. To include your responses as part of the study's
results, please complete the enclosed questionnaire and return it at
your earliest convenience. Based on pretests, the questionnaire can
be completed in less than twenty minutes.

You may be assured of confidentiality. The data will be summarized,
analyzed, and reported only in the aggregate form. The identification
number on the questionnaire will be used to check your name off of

the mailing list when the questionnaire is returned.

The aggregate results and policy recommendations therefrom will be
made available to MACPA, AICPA's Accounting and Review Service
Committee, and other interested parties. You may receive a summary of
the results by printing your name and address on the back of the
return envelope.

I would be most happy to answer any questions you might have.
Please write or call. The telephone number is (517) 792-3927.

Thank you for your assistance.

Sincerely,

Larry J. Rankin
Research Director

220

IZLIAICE 0R SMALL BUSINESS FINANCIAL STATEMENTS

A Study of Michigan bankers‘ and Accountants'
Perceptions of Compilations, Reviews, and Audits

This survey will help me to develop an understanding

of how bankers and accountants rely on financial
statements which have been compiled, reviewed, audited,
or not reported on by a CPA. Please answer all the
questions. If you wish to consent on any questions or
qualify your answers, please feel free to use the space
in the margins or page twelve of this questionnaire.

Thank you for your help.

Department of Accounting and Financial Administration
Graduate School of Business Administration

Hichigan State University

East Lansing, Hichigan 6882b

221

first. 1 would like to est a few questions about your faniliarity with
Mihtion end leview. (Circle the Mr of each appropriate answer)

1. lave you read any materials about Coqilation and lsview?

1m
an

2. love you attended a seninsr or educational workshop on
Coqilation and leview sponsored by your fire?

116
2'0

3. five you attended a s-inar or educational workshop on Camilation
.d Isview sponsored by - orgnisation other than your firm?

1128
2.0

A. lave you seen a OA's Comilation report accowanying the
financial stat-nts of any of your firn's clients?

1783
2.0

S. lave you sent a CPA's leview report accmying the
financial stat-ate of my of your firm's clients?

1m
2m

6. b you now or expect to participate in Compilation or
leview engsg-nts!

1'3
2'0

the following situation is a hypothetical case involving a small
nonpublic business, a CPA. and a co-ercial banker. it is
provided as a frane of reference for your subsequent responses.

 

 

Asst-e that C. It. Inith & Om. a reputable CPA fire, is engaged
by Jones Henufecturing Cowsny, a -11 nonpublic business, to
perform CPA services associated with Jones's financial statements.
The financial stat-ents, which are for the year ended October 31, 1979,
include a Ielsnce Sheet, Income Statement. Stat-ent of Gunner's
Capital, and Stat-ant of Changes in Financial Position. Asst-e
that the 10131179 balance Sheet reflects the following:

Current Assets ”30,000 total Liabilities 3200.000
Ioncurrent Assets $110,000 miner's Capital 3300.000
8500.000 8500.000

Ithe min/19 Income Stat-sot reflects 850,000 net ineone after taxes
earned during the year. Asst-s that CJi. hith i Co. is not previously
experienced with Jones lanufacturing ansny financial statute.

the 0A engag-ent will provide CPA-associated financial .stat-ents,
which will partially cowrise Jones's application for a 350,000
abrt-tern. usecured. co—rcial bank cash low. Ass-e that the
bank loan officer is not previously experienced with either Jones
Ihnufacturing Coqsny or c. Ii. hith & Co. i'be banker utilises the
financial stat-ents and CPA's report to facilitate the loan decision.

 

last, 1 will provide you with four hypothetical situations
representing different levels of GA association with financial
state-ents. following each situation, you will have the
opportuity to evaluate various aspects of reliance on financial
statements. Please answer all questions.

 

222

Please read the following AUDIT report and rate the six numbered itens below.

 

lovefier 30, 1979

 

To Jones Manufacturing Conpany:

He have ex-ined the balance sheet of Jones lianufacturing Coqsny
as of October 31, 1979, and the related statenents of incone,
owner's capital, am changes in financial position for the year then
ended. Our es-ination was node in accordance with generally accepted
auditing standards and, accordingly. included such tests of the
accounting records and such other auditing procedures as we considered
necessary in the circustancea.

\

In our opinion, the financial state-nts referred to above present
fairly the financial position of Jones Hanufscturing Coqany as of
October 31, 1979, and the results of its operations and the changes
in its financial position for the year then ended, in confornity with
generally accepted accouting principles applied on a basis consistent
with that of the preceding year.

C. I. Snith S

Certified Public Accountants

CO.

 

 

Given the above AUDIT report, how confident are you that the Jones
financial statenents are likely to be:

in confornity with g-erally accepted
scoot-ting principles?

Very
In Heat
Confidence Coniidencs

(Place a J in applicable
box for each question)

Confid-ce
p——-1

 

Very
lhdiun Strong Strong
Confidence Confidence Confidence

Cowlete

M

 

Free of the effects of an enistiag
-terial mutational error '
(i.e. clerical er nisspolicatian
of u accounting principle)?

 

[saluted by a on who is indepudsnt
of Jones hufecturing?

 

free of the effects of - -isting
-terial nesgensnt fraud (i.e.
.age-nt‘s intentional misappropriation
Cf assets or falsification of records)?

 

AccoQanisd by all nterial disclosuna
(i.e. contingent liability described in
note or footnote to fin-cial stat-ents)?

 

has of the effects of - misting
-tasial eqloyes fraud (i.e. -loyse's
intentional nisappropriation of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

1.

223

Please read the following mxu'nou report and rate the six owered items below.

 

W 30. 1919

 

to Jones lbwfacturing quny:

The accowanying balance sheet of Jones lanufacturing Cowany as
of October 31. 1979. and the related statements of incone. owner's
capital, and changes in financial position for the year then ended
have been coqiled by us.

A coqilatisn is linitsd to presenting in the form of financial
state-eta information that is the representatin of n-agensu.
Us have not audited or reviewed the accoqanying financial stats-ents
and, accordingly. do not express an opinion or any other fern of
assurance on th-.

C. if. Snith b Co.
Certified Public Accotntsnts

 

 

Given the above COMPILATION report, 'how confident are you that the Jones

financial statements are likely to be:

in confer-airy with g-erelly accepted

. scoot-ting principles?

(Place a J in applicable

box for each question)

Very
lo llnah linnb Hi- Strong
unfiduee Confidence Confidence Confidocs Confi

Very
Strong
co gala-cs.

“late

22%

 

Pres of the effects of n existing
uterial mint-tional error '
(i.e. clerical or nisapplioation
of on scouting principle)?

 

Ivalusted by a 0A I“ is Mt
of Jones “factoring?

 

Pres of the effects of - existing
-terial .agant fraud (i.e.

's iatntioeal niseppropriation
or assets or falsification of records)!

 

decoqsniad by all -terinl disclosures
(i.e. eating-t liability described in
note or footnote to financial stat-ants)?

 

Pres of the effects of - existing
nterial Qloyee frad (i.e. m'a
intentional niaepprnpriatisn of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

C.
.

224

Please read the folluing SEVIE's' report and rate the six nunhered itens below.

 

lovember )0. I979

 

of Certified Public Accountants.
financial statements is the representation of the management.

to Jones “factoring Coqeny:

C. H. Smith 8 Co.
Certified Public Accountants

Us have reviewed the accoqanying balance sheet of Jones Manufacturing
Coweny as of October 31. 1979. ad the related statements of income,
‘ owner's capital, and charges in financial position for the year then
ended. in accordance with standards established by the Anerican Institute
All information included in these

A review consists principally of inquiries of cowany personnel and
analytical procedures applied to financial data.
less in scope than an examination in accordance with generally accepted
auditing standards. the objective of which is the expression of an
opinion regarding the financial statenenta taken as a whole.
Accordingly. we do not express such an opinion.

It is substantially

based on our review. we are not mere of any material modifications
that should be node to the sccoqenying financial statenents in order for
th- to be in conformity with generally accepted accomting principles.

 

 

Given the above REVIEW report, how confident are you that the Jones
financial statements are likely to be:

in conformity with generally accepted
actuating principles?

Very
lo weak Hash
Cnnfidnce Confidence mildews

(Place a J in applicable

box for each question)

lhd it.
Conf idence

Very
Strong Strong
Confidence M

Cowlete

Confident;

 

Pres of the effects of an enisting
-terial .intentional error ‘
(i.e. clerical or deapplicatian
of an eccsuting principle)?

 

hsluated by a GA wb is indepodent
of Jones llanufacturiag?

 

Pres ef the effects of - uisting
-terial mt freed (i.e.
mt's int-tional misappropriation
Cf assets or falsification of records)?

 

Accnanied by all ntarial disclosures
(i.e. catingent liability described in
note or footnote to fin-cial accounts)?

 

has of the effects of - anisting
-tarial euloyes fraud (i.e. -leyee's
int-tional misappropriation of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

225

Given NO CPA ASSOCIATION and NO REPORT, how confident are you that the

Jones financial statements are likely to he:

lr. conformity with guerally accepted
accounting principles?

Io

Confidence

Very
Hash

gmfldnne

 

Hash

Redh-

Coof i dence Conf idence

S trong

Confidence

Very
Strong
Confidence

(Place a J in applicable
box for each question)

Céaplcte

COnfidch-‘

 

 

free of the effects of - existing
material unintentional error

(i.e. clerical or nisapplication
of an scoot-ting principle)?

 

Pres of the effects of - eeiatiu
nsterisl mt fraud (i.e.
nsnagamtt's intentional ”appropriation
of meets or falsification of records)?

 

Accoqanied by all material disclosures
(i.e. contingent liability described in
note or footnote to finncial state—ts)?

 

Pres of the effects of . existing
material onloyea fraud (i.e. qloyee's
intentional misappropriation of assets
or falsification of records)?

 

 

 

 

 

 

 

 

 

 

1O

226

11

Pinally, I would like to ask a few demographic questions to help with

the analysis of the data.

1. what is your area of specialty within A.
your CPA fire?

1
2

AUDIT
TAX

3 HASAGEMENT SERVICES

A

OTHER (please specify)

 

2. Ihat is your position within your

CPA fire?

OUOUNH

PARTNER

HANAGER

SUPERVISOR

SEIIOR

STAFF ACCOUNTANT/JUNIOR

OTHER (please specify) 6.

 

3. Uhat is the site of your CPA firm?

EUNH

suntpnunnrnnms
Loau.nnm oucuuustnrnnwlnmx)
stardust PIRH (INTERSTATE OFFICES)
Imnmmuuamquuimun

(Circle the number of each appropriate answer)

how long have you worked in public
accounting?

U.UNb-i

what is your age?

1 LESS THAN 30 YEARS
2 30 TO 39 YEARS
3 ‘0 TO ‘9 YEARS
A 50 TO 59 YEARS
5 OVER 59 YEARS

Uhich is the highest level of
education that you have
completed?

COMPLETED HIGH SCHOOL

80!! COLLEGE

COMPLETED COLLEGE

SON! GRADUATE UORK

A GRADUATE DEGREE (specify degree)

 

O U5UNH

rOTHMlcase specify)

 

Is there anything else you would like to tell me about compilations,

reviews, and audits?

Your contribution to this research effort is greatly appreciated.

If so, please use this space for that purpose.

 

If you

would like a summary of the results, please print your name and address
on the back of the return envelope (NOT on this questionnaire).

APPENDIX C

BANKER AND CPA FOLLOW-UP POSTCARDS AND COVER LETTERS

227

December 3, 1979

Last week a questionnaire seeking your views on
compilations and reviews was mailed to you.

If you have already completed and returned the
questionnaire, please accept my sincere thanks.
If not, please do so today. It is extremely
important that your views on compilations and
reviews be included in the study's results.

If you did not receive the questionnaire or it
got misplaced, please call me collect (517)
792-3927, and I will send another one to you.

Sincerely,

Larry J . Rank in
Research Director

December 3, 1979

Last week a questionnaire seeking your bank's views
on compilations and reviews was mailed to you.

If you or another banker have already completed
and returned the questionnaire, please accept
my sincere thanks. If not, please do so today.
It is extremely important that your bank's
views on compilations and reviews be included
in the study's results.

If you did not receive the questionnaire or it
got misplaced, please call me collect (517)
792-3927, and I will send another one to you.

Larry J. Rankin
Research Director

MICHIGAN STATE UNIVERSITY 228

 

GRADUATE SCHOOL OF BUSINESS ADMINISTRATION EAST LANSING ° MICHIGAN ° 48824
DEPARTMENT OF ACCOUNTING & FINANCIAL ADMINISTRATION

December 17, 1979

About three weeks ago I wrote to you seeking your views on
compilations and reviews. I have not yet received your completed
questionnaire.

Compilations and reviews are new CPA services which have replaced
unaudited financial statement engagements for nonpublicly-held
companies. An important concern regarding compilations and reviews
is that bankers and CPAs may perceive the value of the types of
CPA reports differently, and subsequently assign different degrees
of reliability to the financial statements. To investigate this
issue, I am seeking the views of bankers and CPAs.

As a practicing loan officer, your input on how compilations and
reviews affect your reliance on financial statements is particularly
important to this research. To include your responses as part of
the study's results, please complete and return the enclosed
questionnaire. Based on pretests, the questionnaire can be
completed in less than twenty minutes.

I would be most happy to answer any questions you might have.
Please write or call. The telephone number is (517) 792-3927.

Thank you for your assistance.

Sincerely,

Larry J. Rankin
Research Director

IIIIIIIIIIIIlllllllllllllllllllll=======ECT—T’T’

 

MICHIGAN STATE UNIVERSITY 229

 

GRADUATE SCHOOL OF BUSINESS ADMINISTRATION EAST LANSING ’ MICHIGAN ° 48824
DEPARTMENT OF ACCOUNTING 8: FINANCIAL ADMINISTRATION

December 17, 1979

About three weeks ago I wrote to you seeking your bank's views
on compilations and reviews. I have not yet received your bank's
completed questionnaire.

Compilations and reviews are new CPA services which have replaced
unaudited financial statement engagements for nonpublicly-held
companies. An important concern regarding compilations and reviews
is that bankers and CPAs may perceive the value of the types of
CPA reports differently, and subsequently assign different degrees
of reliability to the financial statements. To investigate this
issue, I am seeking the views of bankers and CPAs.

As a lending institution, your bank's input on how compilations and
reviews affect your reliance on financial statements is particularly
important to this research. To include your responses as part of

the study's results, please complete and return the enclosed
questionnaire. If someone at your bank is interested in and familiar
with compilations and reviews, please have him or her complete and
return the enclosed questionnaire. Based on pretests, the questionnaire
can be completed in less than twenty minutes.

I would be most happy to answer any questions you might have.
Please write or call. The telephone number is (517) 792-3927.

Thank you for your assistance.

Sincerely,

Larry J. Rankin
Research Director

MICHIGAN STATE UNIVERSITY 230

 

GRADUATE SCHOOL OF BUSINESS ADMINISTRATION EAST LANSING ' MICHIGAN ° 48824
DEPARTMENT OF ACCOUNTING 8: FINANCIAL ADMINISTRATION

December 17, 1979

About three weeks ago I wrote to you seeking your views on
compilations and reviews. I have not yet received your completed
questionnaire.

Compilations and reviews are new CPA services which have replaced
unaudited financial statement engagements for nonpublicly-held
companies. An important concern regarding compilations and reviews
is that CPAS and bankers may perceive the value of the types of
CPA reports differently, and subsequently assign different degrees
of reliability to the financial statements. To investigate this
issue, I am seeking the views of CPAS and bankers.

As a practicing CPA, your input on how compilations and reviews

affect your opinion as to the reliability of financial statements

is particularly important to this research. To include your responses
as part of the study's results, please complete and return the
enclosed questionnaire. Based on pretests, the questionnaire can be
completed in less than twenty minutes.

I would be most happy to answer any questions you might have.
Please write or call. The telephone number is (517) 792-3927.

Thank you for your assistance.

Sincerely,

Larry J. Rankin
Research Director

 

MICHIGAN STATE UNIVERSITY 2
31

GRADUATE SCHOOL OF BUSLVESS ADMINISTRATION EAST LANSING ° MICHIGAN ' 48824
DEPARTMENT OF ACCOUNTING 8: FINANCIAL ADMINISTRATION

January 24, 1980

.A researcher I am working with at Michigan.State University is seeking
the views of practicing CPAs and bank loan officers regarding compilations
and reviews. I believe this research is important to continue trying

to resolve the problems of unaudited financial statements.

Please take about fifteen minutes to complete and return the enclosed
questionnaire. As supervisor of this research, I believe that your
responses are essential to the study's results. The research will

' contribute important knowledge to the accounting and banking professions.

If you have any questions, please call Larry Rankin collect at (517)
792-3927.

Thank you for your assistance.

S?flg7re?i:?(r\
I J}‘ I I! \
BIT/WI Vin Aféf'linsb

Professor of Acrounting

APPENDIX D

BANKER DEMOGRAPHIC DATA

232

TABLE D-l

PROFESSIONAL TITLES OF RESPONDING BANKERS

 

 

 

 

 

 

Large Banks Small Banks
Percent- Percent-
Professional Number of age of Number of age of
Title Respon— Respon— Respon— Respon-
dents dents dents dents
President 2 2.0/. 14 48. 3/0 F!
Senior Vice-President 7 6.9 3 10.3 '
Divisional Vice-President l 1.0 - -
Vice-President 32 31.7 7 24.1
Assistant Vice-President 17 16.8 1 3.5
Loan Officer 13 12.9 2 6.8
Credit Manager 6 5.9 — -
Credit Analyst 21 20.8 - —
Branch Manager 2 2.0 - -

 

 

 

Auditor - - l 3.5
Cashier - - _l_ 3.5
Total 101 100 0% .29 100 0%

 

 

 

 

 

 

233
TABLE D-2

SIZE OF BANK REPRESENTED BY RESPONDING BANKERS

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank Total Large Banks Small Banks
Percent- Percent-
Assets
Number of age of Number of age of
(Millions of
Dollars) Respon- Respon- Respon- Respon-
dents dents dents dents
Less than 25 - - 12 41.4%
25-49 - - 12 41.4 “A
50-99 - - 5 17 . 2 S
100-500 51 50.5% - -
Over 500 50 . ; -
Total 101 100.0% 22_ 100.0% [
-_—— -—— E
TABLE D-3

COMMERCIAL BANKING EXPERIENCE OF RESPONDING BANKERS

 

 

 

 

 

 

 

 

N b f Y Large Banks Small Banks
:mCer o ieirs Percent— Percent-
; Rimmegc a 1 Number of age of Number of age of
an ng xper ence Respon- Respon- Respon- Respon-
dents dents dents dents
Less than 6 43 42.6% 3 10.3%
6-10 21 20.8 5 17.3
11-15 17 16.8 6 20.7
16-20 9 8.9 7 24.1
Over 20 11 10.9 __§ 27.6
Total 101 100.0% ._2 100.0%

 

 

 

234
TABLE D-4

AGE OF RESPONDING BANKERS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Large Banks Small Banks
Percent- Percent-
Age in Number of age of Number of age of
Years Respon- Respon- Respon— Respon-
dents dents dents dents
Less than 30 36 35.7% 1 3.5%
30-39 38 37.6 11 37.9 1
40-49 l8 l7 8 7 24.1
50-59 8 7.9 9 31.0
Over 59 1 1.0 _1_ 3.5
Total 101 100.0% .29 100.0%
TABLE D—5
EDUCATION OF RESPONDING BANKERS
Large Banks Small Banks
Highest Educa- Percent- Percent-
tional Level Number of age of Number of age of
Completed Respond- Respon- Respon— Respon—
dents dents dents dents
High School 2 2.0% 3 10.3%
Some College Work 14 13.8 9 31.1
Bachelor's Degree 29 28.7 8 27.6
Some Graduate Work 24 23.8 6 20.7
Graduate Degree 32 31.7 _;3 10.3
Total 101 100.0% 22_ 100.0%

 

 

 

 

 

 

APPENDIX E

CPA DEMOGRAPHIC DATA

 

 

235

TABLE E-l

PROFESSIONAL TITLES OF CPA RESPONDENTS

 

 

 

 

 

 

 

 

 

 

 

Professional Number of Percentage of
Title Respondents Respondents

Owner 10 8.4%
Partner 74 61.7
Manager 21 17.5
Supervisor 7 5.8
Senior 5 4.2 F.
Staff Accountant/Junior 1 .8 5
Other 1 .8 ._
No Response 1 .8 'A

Total 120 100.0% pi

TABLE E-2
TYPE OF FIRM REPRESENTED BY CPA RESPONDENTS
Number of Percentage of

Type Of Firm Respondents Respondents
Sole Practice 17 14.2%
Local Firm 71 59.2
Regional Firm - -
National/International Firm 31 25.8
No Response 1 .8

..I
N
O
H
O
O
O
N

Total

 

 

 

 

236
TABLE E-3

SPECIALTY AREA OF CPA RESPONDENTS

 

 

 

 

 

 

 

 

 

 

Specialty Area REE‘S‘SEZSES P22223333?
Audit 47 39.2%
Tax 20 16.7
Management Services 12 10.0
Audit and Tax 10 8.3
Audit and Management Services 2 1.7
Tax and Management Services 4 3.3
Audit, Tax, and Management Services 21 17.5
Other 3 2.5
No Response ___1 .8
Total 129 100.0%
TABLE E-4

PUBLIC ACCOUNTING EXPERIENCE OF CPA RESPONDENTS

 

 

Number of Years of Public Number of Percentage of
Accounting Experience Respondents Respondents

Less than 6 16 13.3%
6-10 31 25.8
11-15 29 24.2
16-20 18 15.0
Over 20 25 20.8

No Response __1_ .9

 

Total 120 100.

O
N

 

 

 

237
TABLE E-S

AGE OF CPA RESPONDENTS

 

 

 

 

 

 

 

Age in Years RNumber of Percentage of
espondents Respondents
Less than 30 19 15.8%
30-39 55 45.8
40-49 22 18.3
50-59 14 11.7
Over 59 8 6.7
No Response ___2 1.7
Total 129_ 100.0%
TABLE E—6

EDUCATION OF CPA RESPONDENTS

 

 

 

Highest Educational Number of Percentage of
Level Completed Respondents Respondents

High School - _

Some College Work 7 5.8%
Bachelor's Degree 59 49.2
Some Graduate Work 19 15.8
Graduate Degree 34 28.3

No Response ___1 9

 

Total

I-‘
N
O
1.4
O
O
O
o\°