Which of the following statements is true about required procedures in a review of annual financial statements?
A. Obtaining an understanding of internal control is not required, but confirmations of accounts receivable is required.
B. Obtaining an understanding of the client’s operations is not required, but corroboration of management’s material estimates is required.
C. Assessment of fraud risk is not required, but obtaining a representation letter from management is required.
D. Analytical review procedures are not required, but communication with the predecessor accountant is required.
The correct answer and explanation is:
Correct Answer: C. Assessment of fraud risk is not required, but obtaining a representation letter from management is required.
A review of annual financial statements is a type of assurance engagement that provides limited assurance, rather than the reasonable assurance provided by an audit. The primary objective of a review is to determine whether the financial statements are free of material misstatement based on the application of analytical procedures and inquiry.
In a review engagement, an accountant is not required to assess fraud risk or to perform procedures typically associated with an audit, such as evaluating internal control or sending out confirmations. Instead, the accountant focuses on limited procedures, including inquiry and analytical procedures. Therefore, an assessment of fraud risk is not a necessary component of a review.
However, one required procedure in a review engagement is the obtaining of a representation letter from management. This letter confirms that management has provided all relevant information and acknowledges its responsibility for the fairness of the financial statements. It is essential because it provides a written record of management’s representations, helping to support the accountant’s conclusion and reduce potential liability.
Let’s consider why the other options are incorrect:
- Option A is incorrect because while an understanding of internal control is not required, confirmations of accounts receivable are also not required in a review; that is an audit-level procedure.
- Option B is incorrect because understanding the client’s operations is required in a review, while corroboration of management’s estimates is not necessary at this level of assurance.
- Option D is incorrect because analytical review procedures are a key component of a review engagement, and although communication with a predecessor accountant is encouraged, it is not a required procedure.
In conclusion, a review is a more limited service than an audit, focusing on analytical procedures and inquiries, and requires certain specific procedures such as obtaining a management representation letter.