16.2 Preparation of Financial Statements (AR-C 70)

16.2 Preparation of Financial Statements (AR-C 70)

Core Principle: Introduced in SSARS No. 21, AR-C Section 70 established an entirely new level of service: the Preparation of Financial Statements. A preparation engagement is a non-attest, non-assurance accounting service where a CPA assists management in assembling financial statements without verifying, corroborating, or reviewing management's assertions. Crucially, no accountant's report is issued, making the required on-page legend the primary safeguard informing third-party readers of the lack of assurance.

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1. Evolution and Nature of AR-C 70

Prior to SSARS 21, whenever a CPA submitted financial statements to a client that were reasonably expected to be used by third parties, the CPA was required to perform at least a compilation and issue a compilation report. SSARS 21 decoupled financial statement preparation from reporting by introducing AR-C 70.

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|                                 AR-C 70 NATURE AND BOUNDARIES                                     |
|                                                                                                   |
|   - Classification: Non-Attest Accounting Service                                                 |
|   - Assurance Level: Zero Assurance (No opinion, conclusion, or verification)                     |
|   - Report Issued: NONE. The CPA never signs or releases an accountant's report                   |
|   - Primary Safeguard: "No assurance is provided" legend on EVERY page of the statements          |
|   - Independence: NOT REQUIRED, and lack of independence is NOT DISCLOSED                         |
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When AR-C 70 Applies

AR-C 70 applies when an accountant in public practice is engaged to prepare financial statements for a non-issuer. This includes:

• Preparing complete financial statements (balance sheet, income statement, cash flows, equity).
• Preparing a single financial statement (e.g., an income statement only).
• Preparing financial statements using U.S. GAAP or a Special Purpose Framework (Cash basis, Tax basis, Regulatory basis, Contractual basis).
• Preparing financial statements prior to an audit, review, or compilation performed by another accounting firm.

Explicit Scope Exemptions (When AR-C 70 Does NOT Apply)

The AICPA explicitly excludes specific routine accounting and administrative services from AR-C 70. The standard does not apply when an accountant is engaged merely to:

1. Enter transactions into cloud accounting software (e.g., entering bills, invoices, or customer payments in QuickBooks or Xero).
2. Maintain depreciation schedules or prepare routine month-end bookkeeping adjusting journal entries.
3. Prepare tax returns or personal financial statements included solely within a tax return.
4. Process payroll or prepare payroll tax reports.
5. Prepare financial statements solely for submission to taxing authorities.
6. Prepare financial statements in connection with litigation or business valuation services, or personal financial statements for written personal financial plans.
7. Prepare financial statements it is also engaged to audit, review, or compile (those engagements follow their own standards).

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2. Engagement Acceptance and Mandatory Written Agreement

Under AR-C 70, the accountant must document the terms of the engagement in a written engagement letter signed by both the accountant and client management (or those charged with governance). An oral understanding is strictly non-compliant.

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|                          MANDATORY AR-C 70 ENGAGEMENT LETTER CONTENTS                             |
|                                                                                                   |
|   1. Objective and scope of the preparation engagement.                                           |
|   2. Responsibilities of the accountant (to prepare statements in accordance with framework).     |
|   3. Responsibilities of management:                                                              |
|      - Selection and application of the financial reporting framework.                            |
|      - Design, implementation, and maintenance of internal controls.                              |
|      - Prevention and detection of fraud.                                                         |
|      - Full access to all information, records, and personnel.                                    |
|   4. Identification of the applicable financial reporting framework (e.g., U.S. GAAP).            |
|   5. Explicit agreement that EACH PAGE of the financial statements will include a statement       |
|      indicating that NO ASSURANCE IS PROVIDED (or a disclaimer will be issued).                   |
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3. Independence in Preparation Engagements

Because a preparation engagement under AR-C 70 is a non-attest service, the accountant is not required to be independent.

• The accountant is not auditing, reviewing, or compiling the financial statements.
• Because no report is issued, there is no mechanism or requirement to disclose a lack of independence.
• Even if the CPA possesses direct financial interests, serves as an advisory director, or performs controllership functions that impair independence under the AICPA Code of Professional Conduct, the CPA may still prepare the statements under AR-C 70 without mentioning independence.

Exam Trap: Be alert to questions asking: "If a CPA firm lacks independence with respect to a non-issuer client, how must this impairment be disclosed in an AR-C 70 preparation engagement?" The correct answer is that no disclosure is made. Disclosing lack of independence is a requirement for compilations (AR-C 80), not preparations.

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4. The Mandatory Legend Requirement

Because the accountant does not issue an official report, the primary mechanism to protect third-party users is the mandatory legend on the financial statements.

                   FINANCIAL STATEMENT PAGE LEGEND PROTOCOL
                                      |
        +-----------------------------+-----------------------------+
        |                                                           |
  ACCOUNTANT CAN INCLUDE LEGEND                             ACCOUNTANT UNABLE TO INCLUDE
  Place on EACH page:                                        (e.g., automated client software restriction)
  "No assurance is provided on                               Must choose one of three options:
   these financial statements"                               1. Issue a formal CPA disclaimer;
  (or state which framework applies)                         2. Upgrade to a Compilation (AR-C 80); OR
                                                             3. Withdraw from the engagement.

Authoritative Legend Language

The accountant must ensure that a statement is included on each page of the financial statements clearly indicating that no assurance is provided. Examples of acceptable wording include:

• "No assurance is provided on these financial statements."
• "These financial statements have not been subjected to an audit, review, or compilation engagement, and no assurance is provided."

What if Management Restricts or Excludes the Legend?

If the accountant is unable to include a statement on each page of the financial statements (for example, if client software generates immutable page templates), the accountant must take one of the following remedial steps:

1. Issue a formal Disclaimer: Place a written disclaimer on CPA letterhead preceding the statements making clear that the accountant prepared the statements and no assurance is provided.
2. Upgrade the Engagement: Perform a compilation engagement in accordance with AR-C Section 80 and issue an Accountant's Compilation Report.
3. Withdraw: Withdraw completely from the engagement.

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5. Omission of Substantially All Disclosures

Management frequently requests financial statements without accompanying footnote disclosures (e.g., for internal monthly budget reviews or tax filings). Under AR-C 70, the accountant may prepare financial statements that omit substantially all disclosures required by the applicable financial reporting framework.

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|                         RULES FOR OMISSION OF SUBSTANTIALLY ALL DISCLOSURES                       |
|                                                                                                   |
|   Condition 1: The omission must be CLEARLY DISCLOSED on the face of the financial statements     |
|                (e.g., "Selected Information - Substantially All Disclosures Required by GAAP      |
|                Are Not Included").                                                                |
|   Condition 2: The omission must NOT BE UNDERTAKEN with the intention of MISLEADING users.       |
|   Condition 3: If disclosures are omitted, the statements must still be mathematically accurate    |
|                and clearly labeled.                                                               |
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Misleading Omissions

If the accountant believes that the omission of disclosures is intended to mislead users (for example, omitting debt default disclosures, bankruptcy filings, or related-party guarantees to mislead an existing lender), the accountant must refuse to prepare the statements and withdraw from the engagement.

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6. Departures from the Applicable Financial Reporting Framework

What happens if the accountant becomes aware that the financial statements contain a known material departure from U.S. GAAP (or the special purpose framework)?

1. Request Correction: The accountant must discuss the departure with management and request that the statements be adjusted.
2. Disclose Departure: If management refuses to adjust the statements, but agrees to disclose the departure, the accountant must ensure the departure is clearly disclosed on the face of the financial statements or in a selected note.
3. Mandatory Withdrawal: If the financial statements are materially inaccurate or misleading, and management refuses both to correct the statements and to disclose the departure, the accountant must withdraw from the engagement.

Exam Trap: In an audit (AU-C 705), a material GAAP departure results in a qualified or adverse opinion. In a review (AR-C 90), it results in a modified review conclusion. But in a preparation engagement (AR-C 70), the accountant cannot modify a report because no report exists! If management refuses to correct or disclose a misleading error, withdrawal is the CPA's only authoritative recourse.