Not every set of financial statements follows GAAP. A small contractor may report on the cash basis because its bank only wants cash numbers. A partnership may report on the income tax basis because its owners work from the return. A nonprofit may have a grant agreement that prescribes how revenue is recognized. AU-C section 800, Special Considerations: Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks, adds requirements to the rest of the AU-C sections for these audits. The audit is still a full audit under GAAS. What changes is the acceptability judgment, the disclosures and the report.
This page paraphrases the standard. Read AU-C 800 and the AICPA's illustrative reports in AICPA Professional Standards for the full text and wording.
What is a special purpose framework?
A special purpose framework is a financial reporting framework other than GAAP, designed to meet the financial information needs of specific users. The standard recognizes these types:
| Framework | What it is |
|---|---|
| Cash basis | Revenue recognized when received and expenses when paid. A modified cash basis adds specific accruals or capitalizations, for example capitalizing fixed assets or recording payables |
| Income tax basis | Statements prepared under the rules the entity uses to file its tax return |
| Regulatory basis | A framework prescribed by a government regulator to which the entity is subject, such as a state insurance or utility commission |
| Contractual basis | A framework in a contract, such as a loan agreement or grant that sets out how the financial statements are to be prepared |
| Other basis | A definite set of logical, reasonable criteria applied to all material items, with substantial support |
Whether the framework is a fair presentation framework or a compliance framework determines the form of the opinion. Most special purpose frameworks are fair presentation frameworks, and the opinion says the statements present fairly, in all material respects, in accordance with the named basis.
What does the auditor do?
AU-C 800 builds on AU-C 210 and AU-C 700. The additions at each stage:
Acceptance. The auditor determines whether the framework is acceptable in the circumstances. Part of that is understanding the purpose of the financial statements, the intended users and the steps management took to conclude the framework is acceptable. If management could have used GAAP, or the statements will go to users who expect GAAP, ask why not.
Presentation and disclosure. The auditor evaluates whether the financial statements include a description of the framework and a summary of significant accounting policies, and whether they describe how the framework differs from GAAP. The description of differences can be general. It does not have to quantify them. The auditor also considers whether the titles of the statements are appropriate for the framework, for example a statement of assets, liabilities and equity arising from cash transactions rather than a balance sheet implying accrual accounting.
Disclosure level. Special purpose statements still need informative disclosure of matters that affect users' understanding: related party transactions, significant commitments, subsequent events and the like. The disclosures need not copy GAAP, but they must be adequate for the framework.
Report. The auditor's report differs from a GAAP report in these respects:
- The opinion paragraph refers to the special purpose framework by name.
- The report includes an emphasis-of-matter paragraph, often headed "Basis of Accounting," that states the statements are prepared in accordance with the framework, refers to the note that describes the basis, and says the framework is a basis other than GAAP. That paragraph is required in every report on special purpose framework statements, whether or not the framework is named in the opinion. See AU-C 706.
- A restriction on use of the report is required where the statements are prepared on a contractual basis, or on a regulatory basis designed to meet the needs of specific regulators. A regulatory framework designed to meet the common financial information needs of a broad range of users can allow general use. See AU-C 705 for modifications generally.
- The special purpose framework audit report template shows the layout.
A worked illustration: cash basis versus accrual
Illustrative numbers only. A small contractor reports on the cash basis. During the year it collected $950,000 from customers and paid $700,000 of expenses. Accounts receivable rose from $120,000 to $170,000 and accounts payable rose by $30,000.
| Cash basis | Accrual basis (GAAP) | |
|---|---|---|
| Revenue | $950,000 | $950,000 + $50,000 = $1,000,000 |
| Expenses | $700,000 | $700,000 + $30,000 = $730,000 |
| Net income | $250,000 | $270,000 |
The difference in net income is $20,000, which is the $50,000 increase in receivables less the $30,000 increase in payables. A reader of the cash-basis statements sees $250,000. The note to the statements must say the basis is cash and that it differs from GAAP, for example in not recording receivables and payables. The auditor does not need to quantify the $20,000 in the report, but may find the reconciliation useful as an analytic check on the cash records. A modified cash basis that records payables but not receivables would report revenue of $950,000, expenses of $730,000 and net income of $220,000.
What goes wrong in practice?
Practice observations, not requirements of the standard:
- A GAAP-style balance sheet with a cash-basis label. Statements titled "Balance Sheet" with accrual-looking lines and no basis note confuse readers and fail the disclosure evaluation.
- No note describing the basis. The emphasis-of-matter paragraph points to a note. Without one, the report has nothing to refer to.
- Wrong or missing restriction on use. Contractual-basis and certain regulatory-basis reports need it. Check the framework against the user group.
- Using the framework as a way around GAAP when the lender or grantor expects GAAP. Read the agreement.
- Tax-basis statements that quietly depart from the return. If the statements say tax basis, the accounting should follow the return method, with the departure described.
- Treating cash basis as no audit. The audit work on cutoff, bank reconciliations, subsequent disbursements and unrecorded liabilities still matters, because cash basis statements are exposed to timing shifts around year end.
Frequently asked questions
Does AU-C 800 apply to cash-basis financial statements?
Yes. Cash basis and modified cash basis are special purpose frameworks. An audit of cash-basis statements follows AU-C 800 along with the other AU-C sections.
Does the report have to say the statements are not GAAP?
The report must include an emphasis-of-matter paragraph stating the statements are prepared in accordance with the special purpose framework, referring to the note that describes the basis, and saying the framework is a basis other than GAAP.
When is a restriction on use required?
For contractual basis statements, and for regulatory basis statements where the framework is designed to meet the needs of specific regulators. A regulatory framework designed for a broad range of users may allow general use.
Do tax-basis statements need to quantify the differences from GAAP?
No. The description of how the framework differs from GAAP can be general and need not be quantified.
Sources
- AICPA, SAS No. 122 as amended, AU-C section 800, Special Considerations: Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks, with AU-C 700, 705, 706 and 905
- AICPA, illustrative auditor's reports for special purpose frameworks, in the AICPA Audit and Accounting Guide and in AU-C Appendix material
Related
Part of CORAA University · Evidence and audit procedures: related guides, calculators and templates.
AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error