oversight

Outline of Statements On Auditing Standards and Procedures

Published by the Government Accountability Office on 1971-01-01.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

            Outline Of
            Statements
            On Auditing
            Standal·ds
            And
I           Procedures




    REFERENCE

     GAO
    HF
    5667
    . U457
     1971
               _OUTLINE OF
              .-

     STATEMENTS ON AUDITING
    STANDARDS AND PROCEDURES



      PREPARED FOR ADVANCED ACCOUNTING

I        AND AUDITING STUDY PROGRAM




       UNITED STATES GENERAL ACCOUNTING OFFICE
      /I   OF FICE OF PERSONNEL MANAGEMENT
                  WASHINGTON, D.C. 20548
                        1971

I
I



I
                        TABLE OF CONTENTS

    Statement
     number                  Subject                Page

        33      Statements on Auditing Procedure      2

        34      Long Term Investments                32

        35      Letters for Underwriters             35

        36      Inventory                            36

        37      Public Warehouses                    37

        38      Unaudited Financial Statements       45

        39      Working Papers                       50



I   v 40

        41
                Reports Following a Pooling of
                  Interest

                Subsequent Discovery of Facts Ex-
                  isting at the Date of the
                                                     53



                  Auditor's Report                   54

        42      Reporting When a CPA is Not Inde-
                  pendent                            57

        43      Confirmation of Receivables and
                 Observation of Inventories          60

                Reports Following a Pooling of
                  Interest                           66

    II 45       Using the work of another Auditor    68
    i/ 46       Piecemeal Opinions                   79
    J   47      Subsequent events                    84


I
                                 iii
Statement
 number                      Subject

    48      Letters For Underwriters                 97

    49      Reports   On   Internal Control         122

v   50      Reporting On The Statement Of Changes
              In Financial Position                 136




                                                          I



                                                          I
                                iv
                         INTRODUCTION

         The following outlines were taken from Statements
    on Auditing Procedure issued by the Committee on Audit-
    ing Procedure of the AICPA. Th~se outlines are not in-
    tended to replace the full discussion contained in the
    statements .

         The outlines were prepared by staff members of the
    General Accounting Office for use in their Advanced Ac-
    counting and Auditing Study Program, which includes an
    annual CPA Review Course.



                                  Leo Herbert, Director
                                  Office of Personnel
                                  Management



I



I
                    STATEMENT NO. 33
            STATEMENTS ON AUDITING PROCEDURE
                   SECTION I - GENERAL
CHAPTER 1
RESPONSIBILITIES AND FUNCTIONS OF
THE INDEPENDENT AUDITOR
     The objective of the ordinary examination of fi-
nancial statements by the independent auditor is the
expression of an opinion on the fairness with which
they present financial position and results of opera -
tions. In his report the auditor states whether his
examination has been made in accordance with generally
accepted auditing standards. These standards require
him to state whether, in his opinion, the financial
statements are presented in conformity with generally
accepted principles of accounting and whether such
principles have been consistently applied in the prepa-


                                                           I
ration of the financial statements of the current pe-
riod in relation to those of the preceding period.

     Management has the responsibility for adopting
sound accounting policies, for maintaining an adequate
and effective system of accounts, and for devising an
effective system of internal control. The fairness of
the representations made through financial statements
is an implicit and integral part of managements respon-
sibility. The independent auditor may make suggestions
as to the form or content of financial statements he
has examined; however, his responsibility is confined
to the expression of his opinion on them.

      The independent auditor must possess the profes-
sional qualifications of adequate education and experi-
ence and have the ability to exercise professional in-
formed judgment. His qualifications do not include
those of a person trained to engage in another profes-
sion or occupation, such as an appraiser or an attor-
ney .

     The independent auditor's ordinary examinatiQn di -
rected to the expression of an opinion on financial
                                                           I
                           2
    statements is not primarily or specifically designed,
    and cannot be relied upon, to disclose defalcations and
    similar irregularities, although their discovery may
    result. The responsibility of the independent auditor
    for failure to detect fraud arises only when such fail -
    ure clearly results from his noncompliance with gener-
    ally accepted auditing standards. Reliance for the
    prevention of fraud should be placed upon an adequate
    accounting system with good internal control.

         The independent auditor has a responsibility to
    his profession to comply with the standards accepted by
    bis fellow practitioners. The Institute has adopted,
    as part of its Code of Professional Ethics, rules which
    support the standards and provide a basis for enforce-
    ment of them.

         The Securities and Exchange Commission has said
    that the fundamental responsibility for the accuracy of
    financial information filed with the Commission and


I   disseminated among the investors rests upon management .
    For example, section 11 of the Securities Act of 1933
    imposes responsibility for false or misleading state-
    ments, or for omissions which render misleading the
    statements made, in an effective registration statement
    on accountants who have certified any part of the reg-
    istration statement .

    CHAPTER 2
    GENERALLY ACCEPTED AUDITING STANDARDS
         Auditing "standards" differ from auditing "proce-
    dures" in that procedures relate to acts to be per-
    formed, whereas standards deal with measures of the
    quality of the performance of those acts and the objec-
    tives to be attained by the use of the procedures un-
    dertaken . The generally accepted auditing standards,
    as approved and adopted by the membership of the Ameri-
    can Institute of Certified Public Accountants, are as
    follows:


I                              3
General Standards

1. The examination is to be performed by a person
   or persons having adequate technical training
   and proficiency as an auditor.

2. In all matters relating to the assignment, an
   independence in mental attitude is to be main-
   tained by the auditor or auditors .

3. Due professional care is to be exercised in the
   performance of the examination and the prepara-
   tion of the report.

Standards of Field Work

1 . The work is to be adequately planned and assis -
    tants, if any, are to be properly supervised .

2 . There is to be a proper study and evaluation of
    the existing internal control as a basis for
    reliance thereon and for the determination of
                                                       I
    the resultant extent of the tests to which au-
    diting procedures are to be restricted.

3 . Sufficient competent evidential matter is to be
    obtained through inspection , observation, in-
   quiries, and confirmations, to afford a reason-
   able basis for an opinion regarding the finan-
   cial statements under examination.

Standards of Reporting

1. The report shall state whether the finanCial
   statements are presented in accordance with
   generally accepted principles of accounting .

2 . The report shall state whether such principles
    have been consistently observed in the current
    period in relation to the preceding period.




                          4
                                                       I
         3. Informative disclosures in the financial state-
            ments are to be regarded as reasonably adequate
            unless otherwise stated in the report .

         4 . The report shall either contain an expression
             of opinion regarding the financial statements,
             taken as a whole, or an assertion to the effect
             that an opinion cannot be expr essed. When an
             overall opinion cannot be expressed, the rea-
             sons therefor should be stated . In all cases
             where an auditor's name is associated with fi-
             nancial statements, the report should contain a
             clear-cut indication of the character of the
             auditor's examination, if any , and the degree
             of responsibility he is taking .

         The elements of "materiality" and "relative risk"
    underlie the application of all the standards, particu-
    larly the standards of field work and reporting .



I   NOTE: Statements on Auditing Procedure No. 33 is es-
    sentially a codification of the substantive matters
    contained in earlier pronouncements of the AICPA Com-
    mittee on Auditing Procedure.

         Although the substance of the committee's 1954
    special report, Generally Accepted Auditing Standards--
    Their Significance and Scope, was consolidated in
    Statement No. 33, there is much in the 54-page booklet
    of continuing usefulness t o those inter ested in a more
    comprehensive study of generally accepted auditing
    standards.




                               5
        SECTION II - GENERALLY ACCEPTED AUDITING

      STANDARDS AND PROCEDURES - GENERAL STANDARDS

Cl:lAPTER 3

THE GENERAL STANDARDS

     The general standards are personal in nature and
are concerned with the qualifications of the auditor
and the quality of his work.

      The first general standard reads:

              The examination is to be performed by a
              person or persons having adequate tech-
              nical training and proficiency as an au-
              ditor.

     In the performance of the examination which leads
up to an opinion, the independent auditor holds himself
out as one who is proficient in accounting practice and
                                                          I
auditing procedure. The attainment of that proficiency
begins with the auditor's formal education and extends
into his subsequent experience. The independent audi-
tor must undergo training adequate to meet the require-
ments of a professional man . This training must be
adequate in technical scope and should include a com-
mensurate measure of general education.

     The second general standard reads:

              In all matters relating to the assign-
              ment, an independence in mental atti-
              tude is to be maintained by the auditor
              or auditors.




                               6
                                                          I
         To be independent, the auditor must be intellectu-
    ally honest; to be recognized as independent, he must
    be free from any obligation to or interest in the cli -
    ent, its management, or its owners.

        The third general standard reads:

             Due professional care is to be exercised
             in the performance of the examination
             and the preparation of the report.

         Due care imposes a responsibility upon each person
    within an independent auditor's organization to observe
    the standards of field work and reporting. Exercise of
    due care requires critical review at every level of su-
    pervision of the work performed and the judgment exer-
    cised by those assisting in the examination .




I



I                             7
             SECTION III - GENERALLY ACCEPTED

             AUDITING STANDARDS AND PROCEDURES

                   FIELD WORK STANDARDS

CHAPTER 4

ADEQUACY OF PLANNING AND THE TIMING
OF FIELD WORK

     The first standard of field work reads:

            The work is to be adequately planned and
            assistants, if any, are to be properly
            supervised.

     Adequately planning by an auditor is facilitated
by an early appointment by the client. Early appoint-
ment enables the auditor to plan his work so that it
may be done expeditiously and to determine the extent
to which it can be done before the balance-sheet date.
                                                           I
An early appointment is particularly helpful with re-
spect to planning for the observation of the taking of
physical inventory. The spreading of work throughout
the year also permits more efficient scheduling of
staff assignments.

     The first standard of field work concerns partic-
ularly the timeliness of the auditing procedures and
the orderliness of their application. The timeliness
with which auditing procedures are undertaken involves
the proper timing and synchronizing of their applica-
tion in the examination of related accounts. The need
for orderliness in carrying out audit procedures is ap-
parent, for example, in the application of procedures
for inventory observation.

     Although early appointment is preferable, an in-
dependent auditor may accept an engagement near or after
the close of the fiscal year. In such instances, before




                            8
                                                           I
    accepting the engagement, he should ascertain whether
    circumstances are likely to permit an adequate examina-
    tion and expression of an unqualified opinion; and, if
    they will not , he should discuss with the client the
    possible necessity for a qualified opinion or dis-
    claimer of opinion.

    CHAPTER 5

    EVALUATION OF INTERNAL CONTROL

         The second standard of field work reads:

                There is to be a proper study and eval-
                uation of the existing internal control
                as a basis for reliance thereon and for
                the determination of the resultant ex-
                tent of the tests to which auditing pro-
                cedures are to be restricted.


I         Internal control comprises the plan of organiza-
    tion and all of the coordinate methods and measures
    adopted within a business to safeguard its assets ,
    check the accuracy and reliability of its accounting
    data, promote operational efficiency, and encourage
    adherence to prescribed managerial policies. This def-
    inition recognizes that a " system" of internal control
    extends beyond those matters which relate directly to
    the functions of the accounting and financial depart-
    ments.

         In the broad sense, internal control includes con-
    trols which may be characterized as either accounting
    or administrative. Accounting controls encompass the
    methods of safeguarding assets and maintaining reliable
    financial records. They include authorization controls
    governing the acquisition and disposition of assets,
    physic al control of assets, internal auditing, and the
    separation of duties concerned with recordkeeping from
    those concerned with asset custody. Administrative
    controls are concerned with operational efficiency and

I                                9
adherence to managerial policies, and they usually re-
late only indirectly to the financial records . These
controls include time and motion studies, performance
reports, emp loyee training programs, quality controls,
and statistical analyses .

     The characteristics of a satisfactory system of
internal control would include:

     1. A p lan of organization that provides appropri-
        ate segregation of functional responsibilities.

     2 . A system of authorization and record procedures
         adequate to provide reasonable accounting con-
         trol over assets, liabilities, revenues, and
         expenses.

     3 . Sound practices to be followed in performance
         of duties and functions of each of the organi-
         zational departments .

     4 . Personnel of a quality commensurate with re-
         sponsibilities .

     These elements, as important as each is in its own
                                                            I
right, are all so basic to adequate internal control
that serious deficiencies in anyone normally would
preclude successful operation of the system .

     While the responsibility for the estab l ishment and
enforcement of internal control rests with management,
the degree to which such controls exist and are carried
out is of great concern to the independent auditor.
The independent auditor should make a proper study and
evaluation of the existing internal control to ascer-
tain the degree of reliance that may be placed on the
internal control in determining the extent of the tests
to which auditing procedures are to be restricted .

     Where feasible, the independent auditor's review
of internal control may be conducted as a separate




                           10
                                                            I
    phase of the examination, preferably at an interim
    date, by applying appropriate auditing procedures di-
    rected particularly to appraising the effectiveness of
    the client's system . As a by-product of this study and
    evaluation, the independent auditor is frequently able
    to offer constructive suggestions to his client on ways
    in which internal control may be improved.




    NOTE: Statements on Auditing Procedure No. 33 is es-
    sentially a codification of the substantive matters
    contained in earlier pronouncements of the AI CPA Com-
    mittee on Auditing Procedure .

         The substance of the committee's 1949 special re-
    port on Internal Control was consolidated in Statement
    No. 33. However, there is much in the 34-page booklet


I   of continuing usefulness to those interested in a more
    comprehensive study of internal control . (See Journal
    of Accountancy, August 1964, p . 63.)




I
                               11
CHAPTER 6

EVIDENTIAL MATTER

     The third standard of field work reads:

             Sufficient competent evidential matter is to
             be obtained through inspection , observation,
             inquiries, and confirmations, to afford a
             reasonable basis for an opinion regarding
             the financial statements under examination .

     The auditor obtains and examines evidential matter
in order to formulate an opinion on financial state-
ments . The value of evidential matter varies; there-
fore, the auditor must use judgment to determine what
evidential matter is to influence him most in develop-
ing his opinion on the financial statements.

     Evidential matter consists of underlying account-
ing data and corroborating information . Books of orig-
inal entry. the general and subsidiary ledgers, related
                                                             I
accounting manuals, and such informal and memorandum
records as work sheets supporting cost allocations,
computations, and reconciliations, all constitute evi -
dence in support of the financial statement . Corrobo-
rating information includes documentary material such
as checks, invoices, and confirmations; information
obtained through observation and physical examination;
and all other pertinent available evidence .

     To be   competent, evidence must be both valid and
relevant.    Although circumstances lead to exceptions to
rules, the   following presumptions about the validity of
evidential   matter in auditing have some usefulness:

     1 . Evidence from independent outside souces pro-
         vides greater assurance of reliability than in-
         ternal evidence .




                              12
                                                             I
         2. Accounting data developed under satisfactory
            conditions of internal control is more reliable
            than accounting data developed under unsatis-
            factory conditions of internal control.

         3 . Direct personal knowledge obtained through
             physical examination, observation, computation,
             and inspection is more persuasive than informa-
             tion obtained indirectly.

         Sufficiency of evidential matter is dependent upon
    the circumstances in each particular case. The circum-
    stances relate to the nature; materiality; degree of
    risk; internal control; and susceptibility to conver-
    sion, manipulation, or misstatement of each particu-
    lar case.

         Generally, the auditor finds it necessary to rely
    on evidence that is persuasive rather than convincing.


I   If substantial doubt exists as to the fairness of the
    financial statements, the auditor must not formulate an
    opinion on the statements until more evidence is
    gathered, or the auditor must express a qualified opin-
    ion or a disclaimer of opinion.

         The auditor must consider the economic limits on
    obtaining information . As a guiding rule, there should
    be a rational relationship between the cost of obtain-
    ing evidence and the usefulness of the information ob-
    tained . Statistical sampling techniques may be con-
    sidered, but these techniques should not reduce the use
    of judgment by the auditor .

         The auditor must consider the fact that the finan-
    cial statements may not be presented fairly. All rele-
    vant evidential matter must be considered whether it
    supports or contradicts the financial statements . It
    is not sufficient to offer an opinion only on the
    grounds that nothing came to the auditor's attention to
    cause him to question the assertions in the financial


I
    statements under examination.



                               13
     Confirmation of receivables and observation of in-
ventories were established in 1939 as generally ac-
cepted auditing procedures where they are practical
(capable of being done with available means) and rea-
sonable (sensible in the light of the surrounding cir-
cumstances) and the assets concerned are material to
financial position or results of operation. When these
procedures cannot be used, the auditor bears the burden
of justifying the opinion expressed.

       The number of confirmations and the method and
time of the confirmations are determined by the audi-
tor I s judgment in light of the circumstances which sur-
round the receivable (i.e., internal control, materi-
ality, and other factors).

      Where inventory quantities are determined solely
by physical count, the auditor should observe the count
and satisfy himself respecting the effectiveness of the
method of inventory- taking. The independent auditor may
observe inventory counts at interim dates if perpetual
inventory records are checked periodically by physical
                                                            I
c ount and comparisons .
     In all the discussion in this section pertaining
to the accumulation of competent evidential matter, it
is implied that the evidence gathered by the auditor
during the examination is included in the working
papers.

NOTE : In October 1964, the President of the AICPA is-
sued a special bulletin to the members of the American
Institute of Certified Public Accountants stating that
"The Council of the Institute, at its meeting Octo-
ber 2 , 1964, unanimously adopted recommendations that
members should see to it that departures from Opinions
of the Accounting Principles Board (as well as effec-
tive Accounting Research Bulletins issued by the former
Committee on Accounting Procedure) are disclosed,
either in footnotes to financial statements or in the
audit reports of members in their capacity as indepen-
dent auditors."
                                                            I
                            14
                  SECTION IV - GENERALLY ACCEPTED

        AUDITED STANDARDS AND PROCEDURES - REPORTING

    CHAPTER 7

    ADHERENCE TO GENERALLY ACCEPTED
    ACCOUNTING PRINCIPLES

         The first standard of reporting reads:

                The report shall state whether the financial
                statements are presented in accordance with
                generally accepted principles of accounting.

         The term "principles of accounting" includes not
    only accounting principles and practices but also the
    methods of applying them. The first reporting standard
    requires the auditor to form an opinion as to whether


I   the financial statements are presented in conformity
    with such principles.

         It is the responsibility of the auditor to become
    familiar with all generally accepted accounting prin-
    ciples, including those of limited usage which still
    have general acceptance . He must keep abreast of pro-
    nouncements issued by the American Institute of Certi-
    fied Public Accountants which give recognition to
    changes in generally accepted accounting principles.
    He should also be alert to changes which become accept-
    able through common usage by business although not a
    subject of an Institute pronouncement.




I
                                 15
CHAPTER 8

CONSISTENCY OF APPLICATION OF
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
     Th.e second standard of reporting reads:

            The report shall state whether such prin-
            ciples have been consistently observed in the
            current period in relation to the preceding
            period .

      It is implicit in the standard that such prin-
ciples have been consistently observed within each
period. The objective of the ~onsistency standard is
(1) to give assurance that the comparability of finan-
cial statements as between periods has not been mate-
rially affected by changes in the accounting principles
employed or in the method of their application or
(2) if comparability has been materially affected by
such changes, to require a statement of the nature of
the changes and their effects on the financial state-
ments .
                                                            I
     The consistency standard involves the consistent
application of accounting principles. Generally, lack
of consistency produces lack of comparability; but lack
of comparability may not be caused by lack of consis-
tency .

     In general, comparability of financial statements
as between years is affected by changes from (1) a
change in accounting principles employed, (2) changed
conditions which necessitate accounting changes but
which do not involve changes in the accounting prin-
ciples employed, and (3) changed conditions unrelated
to accounting . Distinguishing characteristics of the
types of changes included in each of these three
classes are briefly commented upon in the following
paragr aphs .


                                                            I
                            16
           ANALYSIS OF CAUSES OF LACK OF COMPARABILITY

                                                 Disclosure
                                                required in
          Compara bi l i ty                      auditor's
           affected by            Example            report

     A. Change in account -     Change in
          ing principles          method of
          employed                deprecia-
                                  tion         Yes

     B. Changed conditions      Change in      No, but i f
          which necessitate       estimated      amount is
          accounting changes      useful         material
          but which do not        life of        i t should
          involve changes in     an asset        be dis-
          the accounting                         closed by
          principles employed                    a note to


I    C. Changed conditions      Acquisi-
                                                 the finan-
                                                 cial state-
                                                 ments

                                               No, but may
          unrelated to           tion or         be dis-
          accounting             dispo-          closed by
                                 sition          a note to
                                 of a sub-       the fi-
                                 sidiary         nancial
                                                 state-
                                                 ments

          Reclassifications of items in the financial state-
     ments usually need not be disclosed unless they are ma -
     terial, in which case they may be disclosed by a note
     to the financial statements.

          The consistency standard is a i med at the compara-
     bility of the financial statements of the current year
     with those of the preceding year . If the auditor's


.1
                                17
OpLn10n is to pertain to a longer period, a change in
the wording of the short-form report is appropriate .

     A type "A" inconsistency (change in accounting
principles employed) which has a material effect on the
financial statements requires disclosure in the opinion
section of the auditor's report .

     The following chart suggests guides to be followed
in writing the auditor's op,n,on paragraph for various
type "A" inconsistencies.




                                                          I



                                                          I
                          18
                                                       Diaclosure In
                                                 short-fOrm .udt; report

    A. Change to alternative gener-         1. Refer to change
         ally accepted accounting           2. No need to qualify conformity
         principle                               statement
                                            3 . Hay express approval

    B. Change from principle vb1ch          1. Refer to change
         lacks general acceptance to        2. Express approval
         a generally accepted ac_
         counting principle

    c. ebahge to principle or prac-         1. Qualification or adverse opin-
         tice which lacks general ac-           ion 1s necessary
         ceptance

    D. Change expected to bave mate-        1 . No need to dlsclose if there
         r1al future effect                       is a note to the financial
                                                  statements
    E. Change make. it desirable to
         restate financial informa-
         tion for prior years and the
         auditor reports on:




I
           1. The current year              1. Refer to change
                                            2. May express approval

           2. Years re stated and           1. Refer to change
                change made in cur-         2. Hay express approval
                rent year

           3. Years restated but            1. No need t o disclose if there
                change not ~de in                i. a note to the financial
                current year                     statements
    F. Change of accounting princi-
         ples employed but prior
        year' s financial information
        not restated and:

           1. Change took place In          1. Reference to consistency may
                the current year                 be omitted
                                            2. Insert a middle explanatory
                                                 paragraph
           2. Change took place in
                other than the cur-
                rent year and auditor
                1. reporting on

                    eo All the years        1. Refer to change

                     b. Only the current 1. No need to disclose if there



I
                         year                   is Ii note to the financial
                                                statements




                                       19
Special Conditions
A. Independent auditor's first
     report on:
   1. A newly organized company          1. No reference to conSistency
                                              needed
   2. An established company and:
      a. Vhere records are               1. Report on consistency
           adequate and it is
           practical to extend
           auditing procedures
      b. Same as lIa ll but limi-        1. Appropriate qualification
           tations on procedures             requ.ired
           are imposed by the
           client
      c. There are inadequate            1. No reference to consistency
           records and the au-           2. No reference to statement of
           ditor cannot form an               income and retained earn-
           opinion on consis_                 ings
           tency or accuracy of          3. Insert explanatory paragraph
           the statements of                  describing situation and
           income and retained
           earnings



      d. Prior years' account-
                                              inability to express opin-
                                              ion on the statements of
                                              income and retalned earn-
                                              ings and omit statement on
                                              consistency
                                         1. Insert a middle explanatory
                                                                            I
           ing records, kept on               paragraph
           a basis which did             2. Omit reference to consistency
           not result in a fair
           presentation of fi-
           nancial position and
           results of opera-
           tions for these
           years, not compa-
           rable wtch current
           year's statements

B. Pooling of interests and:
  1. Comparative financial               1. Refrain from use of standard
       statements are not in                  consistency expression
       accordance with Ac-               2. Refer to inconsistency in
       counting Research Bul-                 report
       letins Nos. 48 and 49
   2. Single-year statements only        1. ConSistency standard may be
        are presented                         used if appropriate note is



                                                                            I
                                              made to financial state-
                                              ments




                                    20
I   CHAPTER 9
    ADEQUACY OF INFORMATIVE DISCLOSURE
         The third standard of reporting reads:
                 Informative disclosures in the finan-
                 cial statements are to be regarded as
                 reasonably adequate unless otherwise
                 stated in the report
         The fairness of presentation of financial state -
    ments, apart from the relationship to generally ac-
    cepted accounting principles, is dependent upon the
    adequacy of disclosures of material matters. What con-
    stitutes a matter requiring disclosure is for the in-
    dependent auditor to decide in the exercise of his
    judgment in light of the circumstances and facts of
    which he is aware at that time. Certain kinds of in-
    formation that would be detrimental to the company and
    the stockholders should not be disclosed . Information


I
    that has been omitted from the financial statements,
    which the auditor believes is significant, should be
    disclosed in his report together with an accompanying
    qualification of his opinion .

         Somewhat related to the matter of disclosure is
    the matter of information which the auditor receives
    in confidence akin to the status of privileged commu-
    nication . If the information received does not, in
    his judgment, require disclosure for the financial
    statements not to be misleading, this standard does
    not require disclosure of such information .

    CHAPTER 10


    EXPRESSION OF OPINION, OR REASONS FOR NO OPINION,
    IN THE INDEPENDENT AUDITOR'S REPORT
         The fourth standard of reporting reads:

                 The report sha l l either contain an ex-


I                pression of opinion regarding the



                                 21
          financial statements, taken as a whole,
          or an assertion to the effect that an
          opinion cannot be expressed. When an
                                                           I
          overall opinion cannot be expressed,
          the reasons therefor should be stated .
          In all cases where an auditor's name is
          associated with financial statements,
          the report should contain a clear-cut
          indication of the character of the au-
          ditor's examination, if any, and the
          degree of responsibility he is taking .

     The objective of the fourth reporting standard is
to prevent misinterpretation of the degree of respon-
sibility the independent auditor is assuming whenever
his name is associated with the financial statements.
The auditor must bear in mind that justification for
the expression of his opinion, whether qualified or
unqualified, rests on the degree to which the scope of
his examination conforms with generally accepted au-
diting standards. This standard of reporting does not
preclude the expression of separate opinions on finan-
cial position and results of operations. By utilizing
a "piecemeal opinion" the independent auditor may ex-
press an unqualified opinion on one of the financial
statements and disclaim an opinion or express a quali-
fied or an adverse opinion on the others.

     The short- form report of the auditor is customar -
ily used in connection with the basic financial state-
ments. It is also often i ncluded as part of a long-
form report. The usual short-form report consists of
a "scope" paragraph which represents the work performed
and an "opinion" paragraph that reveals the independent
auditor's conclusions.

     An unqualified opinion that the financial state-
ments present fairly the financial position and results
of operations may be expressed only when the indepen-
dent auditor has formed the opinion based on an exami -
nation made in accordance with generally accepted au-
diting standards. The presentation of the financial


                           22
I   statements must also conform with generally accepted
    accounting principles applied on a consistent basis
    and include all necessary and material informative
    disclosures necessary to make the statements not mis-
    leading.

          When a qualified op,n,on is rendered because of
    a specific deviation from the essentials needed for an
    unqualified opinion, the auditor should refer specifi-
    cally to the subject of the qualification and reveal
     in his report the reasons for his qualification and
    the effect on the financial position and results of
    operations, if reasonably determinable. When a quali-
    fication is so material as to negative an expression
    of opinion as to the financial statements as a whole,
    an adverse opinion is required. An adverse opinion is
    an opinion that the financial statements do not pre-
    sent fairly the financial position or results of oper -
    ations in conformity with generally accepted account-


I   ing principles . A disclaimer of opinion should be
    rendered if the auditor has not obtained sufficient
    competent evidential matter to form an opinion as to
    the fairness of the statements. The necessity of dis -
    claiming an opinion may arise either from a serious
    limitation on the scope of examination or from the ex-
    istence of unusual uncertainties concerning the amount
    of an item or the outcome of a matter materially af-
    fecting financial position or results of operations,
    causing the independent auditor not to be able to form
    an opinion on the financial statements as a whole.
    When an adverse opinion or a disclaimer of opinion has
    been rendered on the financial statements as a whole,
    the auditor may express a "piecemeal opinion" as to
    the individual financial statements or accounts that
    comply with generally accepted accounting principles.

         Upon completion, the report should be appropri-
    ately addressed to the client, the board of directors,
    or the stockholders, depending upon the circumstances,
    and it should be signed by the independent auditor.


I
                               23
     If the auditor has prepared financial statements
without an audit, each page of the statements should
be conspicuously marked "without audit ll or "unaudited,"
                                                            I
whether accompanied by his comments or not. The in-
dependent auditor should refuse to be associated in
any way with unaudited financial statements which he
believes are false or misleading.

     Where the scope of the examination is limited by
the omission of necessary auditing procedures, reports
should not be issued which temper the qualification or
disclaimer of opinion by the inclusion of misleading
favorable expressions. However, negative assurances
are permissible in letters required by security under-
writers in which the independent auditor reports on
limited procedures. These letters usually state spe-
Cifically that no audit has been made, and distribu-
tion of the letter is restricted to parties to the un-
derwriting agreement.
     The usual circumstances which may require the in -
dependent auditor to deviate from the standard shor t-
form report and a guide to the app licable deviation
follow:




                           24
I                         Clrqa.tanc:,
    4. The .cope of hla , __ 1n.atlon la lilll1ced OT .f_
         facted:
                                                                        Cwld.   to d.vl.t12n



        1. By condition. which preclude the appl1c::.t1on
             of ne<:.u.ry .uditlng procedures and the
             audita; 1.:

            •. Able to . . claf)' himself by ot.her 'udit-     1. None I:'equhed
                 ina procedures

                   (1) Exception:                              2. Rafu In scope p'l'IIgraph to
                        omlul.on of confIrmation of re-            omlulon of customary p'rOce_
                         ceiv,b l . and obaervation of in-         dur.. and u •• of oth.r pro-
                         ventories at end of year                  cedure.

            b, Unable to utlaEy himself by ocher au-           3. Indicate in scopt! pauauph
                 ditlng procedures                                  and quaafy 01:' dl.clallll opln-
                                                                      '0"
        2. By ,nt:ric tlon. l.Jnpoaed by dlenu                 1. Indic.t. in scop. pn'ar.ph and
                                                                    qu.lIfy (rel.te to It.em) or
                                                                    dhclat. opinion
        3. Bee.us. pert of UlIIII1".tlon hit.! been lII,de
            by other Independ.nt .udito;. and prin-
            cip.l auditor b:

            '. Unlttlllna to • .sum. re'ponsLbUlt:y fot        1. Inc Iud. stata.nt to the .f_
                ocher 'udltor', work                                feet t.hat amounts ex_ined by




I
                                                                    oth.r auditors have been in_
                                                                    cluded on the buls of th.t
                                                                    .udItor'l I:'eport

            b. UnvllHI'I3   to   uulu.   report of other       2. Qua1tfy or dhc:1.u. opinion
                 .udl tor

            c . Willing to aUUllle respon!l1bility             3. No refer.nc. to other auditor
                                                                      n.c.sslry

    8, Th, fln.nclill IItlltamentll do not present fairly
         financtd position or reaults of o perat ions
         bee.uI. of:

        1. t..ck of confo1:lllity vlth 8el'le;.l1y aceapte<!   1. Qua 11 fy or .xpr••• adv.r.e
              account!"' principles                                   opinion

            a. R4:gubted companies                             1.   Qu.ll fy 01:' 'Xpr,ss Idv.na
                                                                     opinion if applicable

        2. Inadequate disclosure                               1. Supply suppl ..entat Info~t.lon
                                                                    and quallfy opinion



    D. Unusual unc.rtainths al to the efree't of fu-
         tur. d.velopmenta on c.rblin items which in-
         clude:
        1. Tho •• havlna • materl • .l effeet on financid      1. Qualify opinion
             atat_entll, and outcOlle 18 dependent on
             deelaion of p.nies other than management
        2. Qu.stions of v.lu.tion or «alIz.bility of           1. Hay require qualification of
             anets is depend.nt on management ' . ",uda-              opinion
             lIIent




I
        3. Inounu .0 mated.l thllt qu.liflcaUon i.             1. OlldalJD .n opinion
             inllpPl:'opl:'l.t.




                                                 25
     Prior year's statements presented for comparative
purposes do not require extension of auditor's opinion
to cover them unless no examination of prior year's
                                                          I
statements has been made or the auditor has significant
exceptions or reservations regarding them.

CHAPTER 11
REPORTING ON SUBSEQUENT EVENTS




         Superseded by SAP No. 47.
I   CHAPTER 12

    LONG-FORM REPORTS

         Long-form reports include greater details of the
    customary basic financial statements, statistical data,
    explanatory comments, and sometimes a more detailed
    description of the scope of the auditor's examination
    than the descript i on in the usual short-form reports.

         The language of the short-form report is gener-
    ally used in long-form reports . Accordingly, because
    the usual short-form report covers only the basic fi-
    nancial statements, the auditor should clearly estab-
    lish his position regarding the other data in the
    long-form report. The auditor may wish to clarify his
    position by a brief statement in his comments explain-
    ing that:

         1. His examination has been made for the purpose
            of formulating his opinion on the basic finan-
            cial statements, taken as a whole .

         2. The other data contained in the report for pur-
            poses of supplementary analysis either have
            been subjected to the audit procedures applied
            in the examination of the basic financial
            statements or have not been subjected to the
            audit procedures applied in the examination of
            the basic financial statements. He should
            state the source of this information and the
            extent of his examination and responsibility
            assumed, if any .

         Where a long-form report is coexisting with a con-
    ventional short-form report, the auditor should make
    sure that:

        1. The long-form report does not contain data
           which, if omitted from the short-form report,
           might support a contention that the short-
           form report was misleading because of



                               Z7
        inadequate disclosure of material facts known
        to the independent auditor.

     2. None of the comments or other data contained
                                                         I
        in the long-form report lend themselves to a
        contention that they constitute exceptions or
        reservations, as distinguished from mere ex-
        planations .

     In addition, the auditor must consider whether
the long-form report contains other financial data in
such form as to support a contention that he has made
factual representations with respect to the financial
statements or books of account rather than that he has
expressed an opinion on financial data consisting of
management representations.
I   CHAPTER 13


    SPECIAL REPORTS

         The term "special reports" has reference to re-
    ports for which the wording of the usual short-form
    report may be inappropriate . Special reports may in-
    clude:

         1 . Reports on financial statements of organiza-
             tions which maintain their accounts and pre -
             pare their statements on a basis other than
             the accrual basis.

         2. Reports on financial statements of some non-
            profit organizations which follow accounting
            practices differing from practices followed by
            profitmaking organizations .

         3. Reports prepared for l imited purposes, such as:

            a. Reports relating only to certain aspects of
               financial statements.
            b . Reports that are filed with various agencies
                on prescribed forms.

         The "general standards" and "standards of field
    work," to the extent appropriate in view of the char-
    acter of the engagement, are applicable to engagements
    involving special reports. Also applicable are the
    third and fourth "reporting standards." When the spe -
    cial report relates to statements which purport to pre-
    sent the financial position and results of operations,
    the second standard of reporting as to consistency in
    the application of generally accepted accounting prin-
    ciples is applicable .

         The first standard of reporting does not apply to
    statements which do not purpor t to present the finan -
    cial position and results of operations. Under these
circumstances, the independent auditor should express
his opinion as to whether or not the statements fairly
                                                           I
present the data on the basis indicated .

     In reporting on statements prepared on a cash ba-
sis which do not present the financial position and op-
erations, disclosure should be made in the statements
or their footnotes or, less preferably, in the inde-
pendent auditor's report (1) of the fact that the state-
ments have been prepared on the cash basis and (2) of
the general nature of any material items omitted, such
as accounts receivable and accounts payable, and of the
net effect of such omissions on the statements .

     Statements prepared on a modified accrual basis
of accounting may be judged by the independent au-
ditor as materially incomplete. In such cases the
nature and the amounts of the major variances should
be disclosed and the independent auditor should render
a qualified or adverse opinion.

     In reporting on nonprofit organization financial
statements, which have been prepared in accordance
with clearly defined generally accepted accounting
principles applicable to nonprofit organizations, the
independent auditor may state. his opinion as to the
conformity of the statements either with generally ac-
cepted accounting principles or with accounting prac-
tices for that particular field.

     Special reports in which incomplete financial
presentations or no financial presentations are made
should be drafted with a view to their special purpose
and, accordingly, should state what information is
presented, the basis on which it was prepared, and
whether, in the auditor's opinion, it is presented
fairly on that basis . Where the situation is such
that an independent auditor considers it appropriate
to express an opinion on an incomplete financial pre-
sentation, he should be cognizant of the added respon-
sibility he may be assuming and the possible neCessity
of extending the scope of his examination .
I        Statements prepared on printed forms designed by
    the authorities with which they are to be filed may
    require classifications or procedures that, in the
    independent auditor's opinion, do not fairly present
    the financial pOSition or results of operations of the
    company filing the statements, even though they pur-
    port to do so . Also, such forms may involve the addi-
    tional problem of conforming the prescribed auditor'S
    opinion or certificate to professional standards .
    Whenever the printed forms call upon the independent
    auditor to make an assertion which he believes he is
    not justified in making, he has no alternative but to
    reword them or to submit his separate report.




                              31
                          STATEMENT NO. 34

                     LONG TERM INVESTMENTS
                                                            I
  I. Purpose of the Statement: Long term investments
     make up a significant portion of the assets of
     many firms. This statement furnishes guidelines
     for conducting examinations of the financial state-
     ments of firms with such investments.

 II . Objective of the Examination: The auditor seeks
      to ascertain whether long term investments are
      stated in accordance with generally accepted ac -
      counting principles and whether the disclosures
      are adequate.

III . Types of Evidence

     A. Evidence pertinent to existence and ownership
        includes accounting records and supporting docu-
        ments.

        1 . In the case of securities (stocks, bonds and
            notes), inspection by the auditor or confir -
            mation in writing by the cognizant custodian
            is appropriate.

        2. In the case of loans, advances and similar
           debt obligations, written confirmation from
           the debtor or trustee should be obtained .

     B. Additional evidence may be in the following
        forms:

        1. Audited financial statements of the company
           whose securities are held as long term in-
           vestments, when the report is satisfactory
           to the principal auditor . If using reports
           of other auditor s is a major element of the
           competent evidence, the auditor should be
           guided by repor ting standards in chapter 10
           of Statements on Auditing Procedure #33 .


                              32
           2 . Market quotations, if the market is reasonably
               broad and active .

           3. Other evidence:
              a. Auditing procedures applied to the finan-
                 cial statements of the company in which
                 there is a long term investment.

              b. When the cost of the investment reflects
                 factors not in the financial statements of
                 the company invested in, (such as mineral
                 rights, patents, etc.) evidence may be in
                 the form of current evaluations of these
                 factors. Evaluations made by persons
                 within the invested - in company as well as
                 by independents constitute evidence . The
                 latter is usually more reliable.

              c. Often the long term investment is secured
                 by collateral. The auditor should satisfy
                 himself as to such collateral's existence
                 and, if the collateral is important in as-
                 suring collection, he should obtain addi-
                 tional evidence .

    IV . Effect of Evidence matter on Opinion .

       A. If the auditor has not obtained sufficient evi -
          dence as described above he is not in a position
          to express an unqualified opinion on financial
           statements.

       B. In such circumstances the auditor should qual-
          ify or disclaim an opinion, or give a piece-
          meal opinion . Examp l es follow:

           Qualified Opinion

                We have examined the balance sheet of XYZ


I          Investment Company , as of December 31, 19 , and
           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 audit-
                                                   I
ing procedures as we considered necessary in
the circumstances .

     Investments described in Note 1 are in com-
panies whose financial statements indicate they
are in the promotional and development stage (or
other wording descriptive of the facts) . Ac-
cordingly, the ultimate realization of these in-
vestments depends on circumstances which cannot
be evaluated currently .

     In our opinion, subject to the realization
of the carrying values of investments referred
to in the preceding paragraphs,

Disclaimer of Opinion

     Because the investments referred to in the
preceding paragraph enter materially into the
determination of financial position and results
of operations, we do not express an opinion on
the accompanying financial statements taken as
a whole.
    STATEMENT NO. 35

LETTERS FOR UNDERWRITERS




Superseded by SAP No . 48.




           35
   STATEMENT NO. 36

       INVENTORY



Superseded by SAP No. 43.




           J6
                   STATEMENT NO. 37

                  PUBLIC WAREHOUSES

I   Types of Warehouses :

    A. Terminal Warehouse . The principal economic
       function of a terminal warehouse is to furnish
       storage. It may, however, perform other func-
       tions, including packaging and billing . It may
       be used to store a wide variety of goods or
       only a particular type of commodity .

    B. Field Warehouse. A field warehouse is estab-
       lished in space leased by the warehouseman on
       the premises of the owner of the goods or the
       premises of a customer of the owner. In most
       circumstances, all or most of the personnel at
       the warehouse location are employed by the
       warehouseman from among employees of the owner
       (or customer) usually from among those who pre-
       viously have been responsible for custody and
       handling of the goods. Field warehousing is
       essentially a financing arrangement rather than
       a storage operation. The warehouse is estab-
       lished to permit the warehouseman to take and
       maintain custody of goods and issue warehouse
       receipts to be used as collateral for a loan or
       other form of credit .

      Warehouses may be classified also by types of
      goods stored. Foods and other perishable prod-
      ucts may be stored in refrigerated warehouses,
      constructed and equipped to meet controlled
      temperature and special handling requirements .
      Certain bulk commodities, such as agricultural
      products and chemicals, are stored in commodity
      warehouses; these warehouses often are designed
      and equipped to store only one commodity, and
      fungible goods are frequently commingled with-
      out regard to ownership . A wide variety of
      goods, usua lly not requiring special storage,


                            37
       are stored in general merchandise warehouses.
       Some warehouses confine their activities to
       storing furniture, other household goods, and
       personal effects.

II. Warehouse Receipts:

   A. Warehouse receipts may be in negotiable or non-
      negotiable form and may be used as evidence of
      collateral for loans or other forms of credit.
      Goods represented by a negotiable warehouse re-
      ceipt may be released only upon surrender of
      the receipt to the warehouseman for cancella-
      tion or endorsement, whereas goods represented
      by a non-negotiable receipt may be released
      upon valid instructions without need for sur-
      render of receipt. Other important ways in
      which the two kinds of receipts differ concern
      the manner in which right of possession to the
      goods they represent may be transferred from
      one party to another and rights acquired by
      bona fide purchasers of the receipts .

    B. Since goods covered by non-negotiable receipts
       may be released without surrender of the re-
       ceipt, such outstanding receipts are not neces-
       sarily an indication of accountability on the
       part of warehouseman or of evidence of owner-
       ship by the depositor. Since goods are fre-
       quently withdrawn piecemeal, the warehouseman's
       accountability at any given time is for the
       quantity of goods for which receipts have been
       issued minus the quantities released against
       properly authorized withdrawal instructions.

    C. Prenumbered receipt forms should be used, and
       procedures established for accounting for all
       forms used and for cancellation of negotiable
       receipts when goods have been delivered . Un-
       used forms should be safeguarded against theft
       or misuse and their custody assigned to a re-
       sponsible employee who is not authorized to
        prepare or sign receipts. Receipt forms should
        be furnished only to authorized persons, and in
        a quantity limited to the number required for
        current use. The signer of receipts should as-
        certain that the receipts are supported by re-
        ceiving records or other underlying documents.
        Receipts should be prepared and completed in a
        manner designed to prevent alteration. Autho-
        rized signers should be a limited number of re-
        sponsible employees.
III. Insurance:
          The adequacy as to type and amount of insur-
     ance coverage carried by the warehouseman should
     be reviewed at appropriate intervals.
 IV. Warehouseman:
    A. Internal Controls:
        1. Goods held in custody for others are not
           owned by the warehouseman and, therefore, do
           not appear as assets in his financial state-
           ments. Similarly, the related custodial re-
           sponsibility does not appear as a liability.
           However, as in other businesses, the ware-
           houseman is exposed to the risk of loss or
           claims for damage stemming from faulty per-
           formance of his operating functions. Faulty
           performance may take the form of loss or im-
           proper release of goods, improper issuance
           of warehouse receipts, failure to maintain
           effective custody of goods so that lenders'
           preferential liens are lost, and other forms.
        2. In the broad sense, internal controls of a
           business may be characterized as either ac-
           counting or administrative. Accounting con-
           trols generally bear directly and impor-
           tantly on reliability of financial records,
           and therefore require evaluation by the in-
           dependent auditor. Administrative controls
           are concerned mainly with operational effi-
           ciency and adherence to managerial policies.
           Administrative controls ordinarily relate
           only indirectly to financial records and,
           therefore, would not require evaluation by
      the auditor. However, if the auditor be-
      lieves that certain administrative controls
      may have an important bearing on the reli -
      ability of the financial records, he should
      consider the need for evaluatin~ such con-
      trols . The recommendation hereln that the
      independent auditor of the warehouseman make
      a study and evaluation of administrative
      controls is based upon the important rela-
      tionship of such controls to the custodial
      responsibilities of the warehouseman, which
      are not reflected in his financial state-
      ments . Significant unrecorded liabilities
      may arise if these custodial responsibili-
      ties are not discharged properly.
   3. Whether and to what extent the suggested
      control procedures that follow may be appli-
      cable to a particular warehouse operation
      will depend on nature of the operation, of
      the goods stored, and of the warehouseman's
      organization. Appropriate segregation of
      cuties in the performance of the respective
      operating functions should be emphasized .
B. Receiving. Storing. and
   Delivering Goods :
   Receipts should be issued for all goods admit -
   ted into storage. Receiving clerks should pre-
   pare reports as to all goods received. The re-
   ceiving report should be compared with quanti-
   ties shown on bills of lading or other docu-
   ments received from owner or other outside
   sources by an employee independent of receiv-
   ing, storing and shipping. Goods received
   should be inspected, counted, weighed, mea-
   sured, or graded in accordance with applicable
   requirements . There should be a periodic check
   of the accuracy of any mechanical facilities
   used for these purposes .
  Unless commingling is unavoidable, such as with
  fungible goods, goods should be stored so that
  each lot is segregated and identified with the
  pertinent warehouse receipt . Warehouse office
  records should show the location of the goods
represented by each outstanding receipt .
Instructions should be issued that goods may
be released only on proper authorization
which, in the case of negotiable receipts,
includes surrender of the receipt. Access
to the storage area should be limited to
those employees whose duties require it, and
custody of keys should be controlled.

Periodic statements to customers should
identify the goods held and request that
discrepancies be reported~o a specified em-
ployee who is not connected with receiving,
storing and delivery of goods. The stored
goods should be physically counted or tested
periodically, and the quantities should be
reconciled with the records by an employee
independent of the storage function; the ex-
tent to which this is done may depend on the
nature of the goods, the rate of turnover,
and the effectiveness of other control pro-
cedures . Where the goods are perishable, a
regular schedule for inspection of condition
should be established .

Protective devices such as burglar alarms,
fire alarms, sprinkler systems, and tempera-
ture and humidity controls should be in-
spected regularly .

Goods should be released from the warehouse
only on basis of written instructions re-
ceived from an authorized employee who does
not have access to the goods. Counts of
goods released as made by stock clerks
should be independently checked by shipping
clerks or others and the two counts should be
compared before the goods are released .




                    41
 V. Prior Pronouncements:

    A. In the case of inventories which in the ordi-
       nary course of business are in the hands of
       public warehouses or other outside custodians,
       direct confirmation in writing from the custo-
       dians is acceptable provided that where the
       amount involved represents a significant pro-
       porti on of the current assets or total assets,
       supplemental inquiries are made to satisfy the
       independent auditor as to the bona fides of the
       situation .

    B. Generally accepted auditing standards are
       broad criteria as to the quality of performance
       and objectives to be attained by an independent
       auditor in his examination of financial state-
       ments and in reporting on them. Auditing pro-
       cedures, on the other hand, relate to steps to
       be taken by auditor in complying with the stan-
       dards in making his examination.

    C. The management of a business has the responsi-
       bility for proper recording of transactions in
       its books of account, for safeguarding its as -
       sets, and for the substantial accuracy and ade-
       quacy of its financial statements . The inde-
       pendent auditor is not an insurer or guarantor;
       his responsibility is to express a professional
       opinion on the financial statements he has ex-
       amined .

VI. Summary of Recommendations :

    A. Make a study and evaluation of the effective-
       ness of both accounting controls and adminis -
       trative controls, as defined in paragraph five
       of Chap . 5 of Statements on Auditing Procedure
       No. 33, relating t o the accountability for and
       the custody of all goods placed in the ware-
       house .



                            42
     B. Test the warehouseman's records relating to ac-
        countability for all goods placed in his cus-
        tody.

     C. Test the warehouseman's accountability under
        recorded outstanding warehouse receipts.

     D. Observe physical counts of the goods in cus-
        tody, wherever practicable and reasonable, and
        reconcile tests of such counts with records of
        goods stored.

     E . Confirm accountability (to the extent consid-
         ered necessary) by direct communication with
         holders of warehouse receipts.

        The independent auditor should apply such other
        pr ocedures he considers necessary in the circum-
        stances.

        Warehousing activities are diverse because the
        warehoused goods are diverse, the purposes of
        placing goods in custody are varied, and the
        scope of operations of warehouses is not uni-
        form. The independent auditor has responsibil-
        ity to exercise his judgment in determining
        what procedures, including those recommended
        in this report, are necessary in the circum-
        stances to afford a reasonable basis for his
        opinion on the financial statements.

VII . Investigation of   ~arehouseman   by Owner:

     A. Before goods are placed in a warehouseman's
        custody the owner should:

        1. Consider the business reputation and finan-
           cial standing of the warehouseman .

        2 . Inspect the physical facilities .




                              43
   3 . Inquire as to the type and adequacy of the
       warehouseman's

      a. Insurance

      b. Control procedures

      c. Licensing and bonding

      d. Results of inspection by governmental
         agencies

   4. Review the warehouseman's financial state-
      ments and the relat ed reports of indepen-
      dent auditors .

B. After goods are placed in a warehouseman's cus-
   tody the owner should:

   1. Physically count the goods wherever practi-
      cable and reasonable.

   2 . Reconcile quantities shown on statements re-
       ceived from the warehouseman with the owner
       owner's records .

C. Auditor'S responsibility:

  Review owner's control procedures; observe
  physical counts of goods wherever practicable
  and reasonable; discuss with owner his proce-
  dures in investigating the warehouseman; ob-
  tain from lenders pertinent details of any
  warehouse receipts that have been pledged as
  collateral by direct confirmation.
I                     STATEMENT NO . 38

               UNAUDITED FINANCIAL STATEMENTS

           (Supersedes par . 17 & 18 of Chap . 10 of
          Statements on Auditing Procedure No. 33)


      I . A CPA may be engaged to prepare, or to assist his
          c l ient in preparing, unaudited financial state-
          ments. This type of engagement is an accounting
          service as distinguished from an examination of
          financial statements in accordance with generally
          accepted auditing standards . This accounting
          service, which may include assistance in adjust-
          ing and closing the general books, frequently is
          rendered as an adjunct to the preparation of tax
          returns . Although a CPA may have prepared, or
          assisted in preparing , unaudited financial state-
        ments, the statements are representations of man-
        agement, and the fairness of their representation
        is management's responsibi l ity .

     II. For purposes of this Statement, financial state-
         ments are unaudited if the CPA (a) has not ap-
         plied any auditing procedures to them , or (b) has
         not applied auditing procedures which are suffi-
         cient to permit him to express an opinion concern-
         ing them. The CPA has no responsibility to apply
         any auditing procedures to unaudited financial
         statements .

    III. A CPA is associated with unaudited financial
         statements when he has consented to use of his
        name in a repor t, document or written communica-
        tion setting forth or containing the sta tements .
        Further, when a CPA submits to his client or
        others , with or without a covering letter , unau-
        dited financial statements which he has prepared
        or assisted in preparing, he is deemed to be as -
        sociated with such statements. This association
        is deemed to exist even though the CPA does not


                               45
    append his name to the financial statements or
    uses "plain paper" rather than his own statio-
    nery. However, association does not arise if the
    CPA, as an accommodation to his client, merely
    types on " plain paper" or reproduces unaudited
    financial statements so long as he has not pre-
    pared or otherwise assisted in preparing the
    statements and so long as he submits them only to
    his client .

IV . The committee believes that a disclaimer of opin-
     ion should accompany unaudited financial state-
     ments with which a CPA is associated . Disclaimer
     of opinion is the means by which a CPA clearly
     indicates the fact that he has not audited the
     financial statements and accordingly does not ex-
     press an opinion on them. An example of such a
     disclaimer of opinion is as follows:

               "The accompanying balance sheet of
         X Co . as of Dec. 31, 19xx and the re-
         lated statement(s) of income and re-
         tained earnings for the year then ended
         were not audited by us and accordingly
         we do not express an opinion on them. II

    The disclaimer of opinion may accompany the au-
    dited financial statements , or it may be placed
    directly on them . In addition, each page of the
    financial statements should be clearly and con-
    spicuously marked as unaudited.

 V. A CPA may be retained by his client to perform
    routine bookkeeping services or to prepare finan-
    cial statements for the client's internal use
    only, possib l y on a monthly or quarterly basis .
    For such statements, it may not be necessary to
    include all footnotes or other disclosures that
    might otherwise be desirable. Under these cir-
    cumstances , the accountant should add to the dis -
    claimer of opinion a sentence to the effect that
      financial statements are restricted to internal
      use by the client and therefore do not necessar -
      ily include all disclosures that might be re-
      quired for a fair presentation .

  VI. Because unaudited financial statements, by defini -
      tion, have not been audited by the CPA, he cannot
      be expected to have an opinion as to whether such
      statements have been prepared in conformity with
      generally accepted accounting principles . How-
      ever, if the CPA concludes on the basis of facts
      known to him that unaudited financial statements
      with which he may become associated are not in
      conformity with generally accepted accounting
      principles, which includes adequate disclosure,
      he should insist (except under the conditions de-
      scribed in paragraph v) upon appropriate revi-
      sion; failing that, he should set forth clearly
      his reservations in his disclaimer of opinion.
      His disclaimer should refer specifically to the
      nature of his reservations and to the effect, if
      known to him, on the financial statements.

 VII. If, under circumstances such as those described
      in paragraph VI, the client will not agree to ap-
      propriate revision or will not accept the accoun-
      tant's disclaimer of opinion with the reserva-
      tions clearly set forth, the accountant should
      refuse to be associated with the financial state-
      ments and, if necessary, withdraw from the en-
      gagement . Further, the CPA should refuse to pro-
      vide typing or reproduction services or to be as-
      sociated in any way with unaudited financial
      statements which, on the basis of facts known to
      him , he concludes are false or intended to mis-
      lead.

VIII . Any auditing procedures that may have been per-
       formed in connection with unaudited financial
       statements ordinarily should not be described in
       the accountant's report; to do so might cause the




                            47
   reader to believe that the financial statements
   have been audited . However, in connection with
   letters for underwriters (see Statements on Au-
                                                          I   ,


   diting Procedure #35) or letters pursuant to
   agreements between a prospective buyer and seller
   of a business, or in similar circumstances, it
   may be appropriate for an accountant to describe
   the limited procedures a pplied with respect to
   unaudited financial statements. The accountant
   should specify in such letters or reports that
   their distribution is to be restricted solelY to
   the parties involved.

IX . Normally, a CPA's name would not appear in client-
     prepared reports setting forth unaudited financial
     statements. If an accountant is aware that his
     name is to be included, he should request (a)
     that his name not be included in the report, or
     (b) that the financial statements be marked as
     unaudited and that there be a notation that he
     does not express an opinion on them. If the cli-
     ent does not comply, the accountant should advise
     him that he has not consented to the use of his
   name .

X. Published annual reports of companies customarily
   include financia l statements for the prior year
   for comparative purposes . Paragraph 48 of
   Chp . 10 of Statements on Auditing Procedure
   No . 33 states that where an independent auditor
   "has not made an examination of prior year ' s
   statements, there should be appropriate disclo-
   sure in the statement or in auditor's report . "
   If the prior year's statements have not been au-
   dited by anyone , they should be clearly and con-
   spicuously marked on each page as unaudited, or
   the auditor should insert in his report a dis-
   claimer such as :




                         48
                "We did not examine the financial
          statements for the year      , and, ac-
          cordingly, do not express an opinion on
          them . "

     If the prior year's statements are appropriately
     marked as unaudited , the disclaimer above is not
     necessary because the report of the independent
     auditor limits his opinion to the current year's
     financial statements. It should be noted that
     paragraph 48 of Chapter 10 of Statements on Au-
     diting Procedure No . 33 also states that the au-
     ditor should make appropr iate disclosure in his
     report where he has significant exceptions or
     reservations as to the prior year's statements.

 XI. A similar situation exists for documents filed
     with the SEC, wherein financial statements cover-
     ing a number of years and possibly interim periods
     may be required. Under rules and regulations of
     the COmmission, certain of these financial state-
     ments must be audited by independent public ac-
     countants, whereas others may be included in the
     filings without audit . In such cases, it is not
     necessary that a disclaimer of opinion accompany
     the unaudited financial statements . For a dis-
     cussion of certain responsibilities of accountants
     resulting from inclusion of their reports in doc -
     uments filed with the SEC , see Paragraph 10 through
     16 of Chapter 1 of Statements on Auditing Procedure
     No . 33.

XII. This Statement does not apply to tax returns and
     other data prepared solely for submission to taxing
     authorities .




                           49
                  STATEMENT NO. 39
                   WORKING PAPERS
I . Purpose of Thi s Statement:
       The purpose of this statement is to provide
   guidance for the independent auditor regarding
   working papers for examination of financial state-
   ments or other engagements to which any of the
   generally accepted auditing standards apply. There
   is no intention to specify the form or details of
   content of working papers since they should be de-
   signed to meet the circumstances and the auditor's
   needs on the individual engagement; nor is there
   any intention to imply that the auditor would be
   precluded from supporting his opinion and his rep-
   resentation as to compliance with auditing stan-
   dards by other means in addition to working papers.
   Since this is the first statement the Committee has
   issued dealing with the subject of working papers,
   it recognizes that some of the guidelines set forth
   herein may go beyond current general practice .
II. Functions and Nature of Working Papers:
   A. Working papers serve mainly to:
      1. Aid the auditor in the conduct of his work;
         and
      2. Provide important support for the auditor 's
         opinion, including his representation as to
         compliance with auditing standards .
   B. Working papers are the records kept by the in-
      d~pendent auditor of procedures he followed,
      tests he performed, information he obtained,
      and conclusions he reached pertinent to his ex-
      amination. Working papers, accordingly, may in-
      clude wlrk programs, analyses, memoranda, let-
      ters 01 confirmation and representation, ab-
      stracts of company documents, and schedules of
      commentaries prepared or obtained by the audi -
      tor.



                            so
     c.   Working papers should fit the circumstances and
          the auditor's needs on the engagement to which
          they apply. Factors affecting the independent
          auditor's judgment as to quantity, type and con-
          tent of working papers desirable for a particular
          engagement include: (a) the nature of the audi-
          tor's report; (b) the nature of financial state-
          ments, schedules or other information upon which
          the auditor is reporting; (c) the nature and con-
          dition of the client's records and internal con-
          trols; (d) the needs in the particular circum-
          stances for supervision and review of the work
          performed by any assistants .
III. Guidelines:
    A. Although the quantity, type and content of work-
       ing papers will vary with circumstances, they
       generally would include or show:
          1 . Data sufficient to demonstrate that the finan-
              cial statements or other information upon
              which the auditor is reporting were in agree-
              ment with (or reconciled with) the client's
             records.
          2 . That the engagement had been planned, such as
              by use of work programs, and that the work of
              any assistants had been supervised and re-
              viewed, indicating observance of the first
              standard of field work .
          3. That the client ' s system of internal control
             had been reviewed and evaluated in determin-
             ing the extent of the tests to which audit-
             ing procedures were restricted, indicating
             observance of the second standard of field
             work.
          4. The auditing procedures followed and testing
             performed in obtaining evidential matter ,
             indicating observance of the third standard
             of field work. The record in these respects
             may take various forms, including memoranda,




                              51
         check lists, work programs and schedules and
         would generally permit reasonable identifi-
         cation of the work done by the auditor .

      5. How exceptions and unusual matters, if any,
         disclosed by the independent auditor's pro-
          cedures were resolved or treated.

      6. Appropriate commentaries prepared by the au-
         ditor indicating his conclusions concerning
         significant aspects of the engagement .

IV. Ownership and Custody of Working Papers:

   A. Working papers are the property of the indepen-
      dent auditor, and in a number of states, there
      are statutes which designate the auditor as the
      owner of working papers. The auditor's rights
      of ownership of the working papers, however,
      are subject to those ethical limitations de-
      signed to prevent improper disclosures by the
      auditor of confidential matters relating to his
      clients' affairs .

   B. While the independent auditor's working papers
      may serve as a useful r eference source from time
      to time for his client, the papers should not be
      regarded as constituting a part of, or as a sub-
      stitute for, the client's accounting records .

   C. An independent auditor should adopt reasonable
      procedures for safe custody of his working pa-
      pers and should retain them for a period of
      time sufficient to meet the needs of his prac-
      tice and to satisfy any pertinent legal re-
      quirements of records retention .
            STATEMENT NO. 40

REPORTS FOLLOWING A POOLING OF INTERESTS



        Superseded by SAP No . 44 .




                   53
                   STATEMENT NO. 41

       SUBSEQUENT DISCOVERY OF FACTS EXISTING

         AT THE DATE OF THE AUDITORS REPORT

 I. The purpose of this statement is to establish
    procedures to be followed when the auditor learns
    facts subsequent to his report which might have
    affected the report had he known them at the re-
    port date .

II . These procedures are often generalized. The
     auditor is advised to consult his attorney when
     circumstances to which this statement may apply
     arise.

III. It is not suggested that the auditor has any
     obligation to make inquiry or perform audit
     procedures after the report date, unless new in-
     formation comes to his attention. Also, this
    statement does not apply to events occurring
    after the report date. This statement is not
    intended to be retroactive.

IV . When the auditor learns of facts which may have
     caused him to investigate if he had known them,
     he should discuss the matter with the client and
     request cooperation .

 V. If the subsequently discovered facts are reli-
    able and if they existed at the date of th~ au-
    ditor's report, and if

    A. the report would have been affected and,

    B. he believes that persons are relying on or
       attaching importance to the report (giving
       consideration to the time elapsed since the




                          54
       report was issued) then he should advise the
       client to make appropriate disclosure of the
       facts.
        If the effects can be promptly determined,
    revised financial statements and auditor's re-
    ports should be issued. Reasons for the revi-
    sion should be disclosed in a note to the state-
    ments and referred to in the report. Generally
    only the most recent statements will need to be
    revised .

        If the issue of new statements and the ac-
    companying auditor's report is imminent the re-
    vision can be disclosed therein .

         If a prolonged investigation is required,
    the client should notify persons who rely on the
    statements and report. If the SEC, stock ex-
    changes, or regulatory agencies are involved,
    the client should be advised to discuss the mat-
    ter with them.

VI . The auditor should satisfy himself that the
     client has made the disclosures.

VII. If the client refuses to make such disclosures,
     the auditor should notify all members of the
     board of directors of the refusal and proceed
     to take the following steps: (if the attorney
     does not advise differently and if applicable)

     A. Notify the client that the auditor's report
        must no longer be associated with the finan-
        cial statements.

     B. Notify any regulatory agencies having juris-
        diction over the client not to rely on the
        report.




                          55
      c.   Notify each person known to rely on the re-
           port that it is no longer reliable. (This
           step is often impracticable and b, above is
           often the only way disclosure can be made . )

VIII. The contents of the auditors' disclosure to per-
      sons other then the client should be governed by
      the following guides:

      A. If the investigation is satisfactory and the
         information reliable:

           1. describe the effect the information would
              have had had the auditor known it. In-
              clude a description of the subsequently
              acquired information and of its effect on
              the financial statements.

           2. present the information as precisely and
              factually as possible . Avoid comments
              concerning the conduct or motives of any
              person.

      B. If the auditor was unable to conduct a satis-
         factory examination due to the client's non-
         cooperation, the auditor should merely indi -
         cate that information has come to his atten-
         tion which the client has not cooperated in
         substantiating, and that if the information
         is true then the report must not be relied
         upon or associated with the financial state-
         ments.

  IX. The concepts set forth above apply to all cases
      where auditors have examined and reported on
      financial statements.




                           56
                       STATEMENT NO. 42

    Reporting When a Certified Public Accountant
    is Not Independent

      I. The purpose of this Statement is to clarify the
         position of the certified public accountant when
         he is considered not independent with respect to a
         client with whose financial statements he is asso-
         ciated (See Rule 1.01 of Article I of the Code of
         Professional Ethics) and to specify the type of
         disclaimer of opinion which the accountant should
         express in such circumstances . This type of dis-
         claimer applies whenever the certified public ac-
         countant is not independent, regardless of the ex-
         tent of services performed. Thus it is applicable
         when the type of disclaimer illustrated in State-
         ment on Auditing Procedure Ro . 38 would otherwise
         apply.


I    II. The second general standard of generally accepted
         auditing standards, as approved and adopted by the
         membership of the American Institute of Certified
         Public Accountants, requires that "In all matters
         relating to the assignment an independence in men-
         tal attitude is to be maintained by the auditor or
         auditors." The independent auditor " must be with-
         out bias with respect to the client under audit,
         since otherwise he would lack that impartiality
         necessary for the dependability of his findings
         . . . ." When a certified public accountant who
         is not independent is associated with financial
         statements, any procedures he might perform would
         not be in accordance with generally accepted au-
         diting standards, and accordingly he would be pre-
         cluded from expressing an opinion on such state-
         ments .

    III . Under these circumstances the accountant should
          disclaim an opinion with respect to the financial


I
          statements and should state specifically that he



                               57
   is not independen t. However, the reason for lack
   of independence should not be described; including
   the reason might confuse the reader concerning the
   importance of the impairment of independence.
   Whether or not the accountant is independent is
   something he must decide as a matter of profes-
   sional judgment.

IV. The recommended disclaimer of op,n,on, regardless
    of the extent of services performed, is as fol-
    lows:

        We are not independent with respect to XYZ
   Company, and the accompanying balance sheet as of
   December 31, 19 __ and the related statement(s) of
   income and retained earnings for the year then
   ended were not audited by us; accordingly, we do
   not express an opinion on them.

                                  (Signature and Date)

    Each page of the financial statements should
    clearly and conspicuously be marked "Unaudited--
    see accompanying disclaimer of opinion," unless
    the disclaimer of opinion appears thereon.
                                                         I
V. Any procedures that may have been performed by the
   accountant in connection with such financial state-
   ments should not be described in his report; to do
   so might cause the reader to bel ieve that the fi -
   nancial statements have been audited.

VI. If the accountant concludes on the basis of facts
    known to him that financial statements with which
    he is associated are not in conformity with gener-
    ally accepted accounting principles, which include
    adequate disclosure, he should insist upon appro-
    priate revision; failing that, he should set forth
    clearly his reservations in his disclaimer of
    opinion. The disclaimer should r efer specifically
    to the nature of his reservations and to the



                          58
                                                         I
    effect, if known to him, on the financial state-
    ments. If the client will not agree to the appro-
    priate revision or will not accept the accoun-
    tant's disclaimer of opinion with the reservations
    clearly set forth, the accountant should refuse to
    be associated with the financial statements and,
    if necessary, withdraw from the engagement .




I



I                           59
                       STATEMENT NO. 43
              CONFIRMATION OF RECEIVABLES AND

                  OBSERVATION OF INVENTORIES

       (Supersedes paragraphs 16- 20 of Chapter 6 and
        paragraphs 27 -29 of Chapter 10 of Statement
               No. 33, and Statement No. 36)
 I. The purposes of this statement are to provide additional
    guidelines for the independent auditor in confirming
    receivables and observing inventories and to modify ex-
    isting reporting requirements. This statement relates
    only to confirmation of receivables and observation of
    inventories and does not deal with other important au-
    diting procedures which generally are required for the
    independent auditor to satisfy himself as to the fair
    presentation of these assets.
II. Receivables

   A. Confirmation of receivables requires direct communi-
      cation with debtors either during or after the pe-
      riod under audit; the confirmation date, the method
                                                                I
      of requesting confirmations and the number to be re-
      quested are determined by the independent auditor.
      Such matters as the effectiveness of internal con-
      trol, the apparent possibility of disputes , inaccu-
      racies, or irregularities in the accounts, the prob-
      ability that requests will receive consideration or
      that the debtor will be able to confirm the informa-
      tion requested, and the materiality of the amounts
      involved are factors to be considered by the auditor
      in selecting the information to be requested and the
      form of confirmation, as well as the extent and tim-
      ing of his confirmation procedures.

   B. Two forms of confirmation requested are (a) the
      "positive form of request , wherein the debtor is
      asked to respond whether or not he is in agreement
      with the information given, and (b) the "negative"
      form of request, wherein the debtor is asked to re-
                                                                I
      spond only if he disagrees with the information given .
                                 60
    C. Because the use of the positive form results in
       either (a) the receipt of a response from the debtor
       constituting evidence regarding the debt or (b) the
       use of other procedures to provide evidence as to the
       validity and accur acy of significant nonresponding
       accounts, the use of the positive form is preferable
       when individual account balances are relatively large
       or when there is reason to believe that there may be
       a substantial number of accounts in dispute or with
       inaccuracies or i r regularities. The negative form is
       useful particularly when internal control surrounding
       accounts receivable is considered to be effective,
       when a large number of small balances are involved,
       and when the auditor has no reason to believe the
       persons receiving the requests are unlikely to give
       them consideration. If the negative rather than the
       positive form of confirmation is used, the number of
       requests sent or the extent of the other auditing
       procedures applied to the receivable balance should


I      normally be greater in order for the independent au-
       ditor to obtain the same degree of satisfaction with
       respect to the accounts receivable balance.
    D. In many situations a combination of the two forms may
       be appropriate, with the positive form used for large
       balances and negative form for small balances.
    E. Confirmation procedures may be directed toward account
       balances with debtors or toward individual items in-
       cluded in such balances. The latter procedure may be
       particularly useful when the nature of the accounts
       or the debtor's records are not likely to permit suc -
       cessful confirmation of account balances.

    F. When the independent auditor sets out to confirm re-
       ceivables by means of positive requests, he should
       generally follow up with a second and sometimes an
       additional r equest to those debtors from whom he re-
       ceives no reply. The auditor should employ such
       alternative procedures as are practicable to obtain


I      adequate evidence necessary to satisfy himself as to
       those significant requests for which he receives no
       replies. These procedures may include examination of

                               61
        evidence of subsequent cash receipts, cash remit-
        tance advices, sales and shipping documents, and
        other records.
III. Inventories

    A. When inventory quantities are determined solely by
       means of a physical count, and all counts are made
       as of the balance sheet date or as of a single date
       within a reasonable time before or after the balance
       sheet date or as of a single date within a reason-
       able time before or after the balance sheet date,
       it is ordinarily necessary for the independent au-
       ditor to be present at the time of count and, by
       suitable observation, tests and inquiries, satisfy
       himself respecting the effectiveness of the methods
       of inventory--taking and the measure of reliance
       which may be placed upon the client's representa-
       tions about the quantities and physical condition
       of the inventories.

    B. When well-kept perpetual inventory records are
       checked by the client periodically by comparisons
       with physical counts, the auditor's observation
                                                              I
       procedures usually can be performed either during
       or after the end of the period under audit.
    C. In recent years, some companies have developed in-
       ventory controls or methods of determining inven-
       tories including statistical sampling, which are
       highly effective in determining inventory quanti-
       ties and which are sufficiently reliable to make
       unnecessary an annual physical count of each item
       of inventory. In such circumstances, the indepen-
       dent auditor must satisfy himself that the client's
       procedures or methods are sufficiently reliable to
       produce results substantially the same as those
       which would be obtained by a count of all items
       each year. The auditor must be present to observe
       such counts as he deems necessary and must satisfy


                                                              I
       himself as to the effectiveness of the counting
       procedures used.


                               62
           If statistical sampling methods are used by the
           client in the taking of the physical inventory, the
           auditor must be satisfied that the sampling plan has
           statistical validity, that it has been properly ap-
           plied and that the resulting precision and reliabil-
           ity, as defined statistically, are reasonable in the
           circumstances.
        D. When the independent auditor has not satisfied him-
           self as to inventories in the possession of the
           client through the procedures described in para-
           graphs A-C, tests of the accounting records alone
           will not be sufficient for him to become satisfied
           as to quantities; it will always be necessary for
           the auditor to make, or observe, some physical counts
           of the inventory and apply appropriate tests of in-
           tervening transactions. This should be coupled with
           a review of the records of any client's counts and


I
           procedures relating to the physical inventory on
           which the balance sheet inventory is based.

       E. The independent auditor may be asked to make an ex-
          amination of financial statements covering the cur-
          rent period and one or more periods for which he had
          not observed or made some physical counts of prior
          inventories. He may nevertheless, be able to become
          satisfied as to such prior inventories through ap-
          propriate procedures, such as tests of prior trans-
          actions, reviews of the records of prior counts, and
          the application of gross profit tests, provided that
          he has been able to become satisfied as to the cur-
          rent inventory.

    IV. Reporting Requirements

       A. If the independent auditor has been unable to con-
          firm receivables or observe the client's taking of
          physical inventories solely because it was impossible
          to do so but has satisfied himself as to receivables
          or inventories by means of other auditing procedures,

I         no comment need be made in his report, although he
          may wish to disclose the circumstances of the en-
          gagement and describe the other procedures.

                                 63
B. When the independent auditor is unable to satisfy
   himself by the application of other auditing proce-
   dures, depending on the degree of materiality of the
   amounts involved, he should indicate clearly in the
   scope paragraph (or in a middle paragraph) the limi -
   tations on his work and either qualify his opinion
   on the financial statements taken as a whole or dis-
   claim an opinion on them.

c.   If either confirmation of receivables or observation
     of inventories is omitted because of a restriction
     imposed by the ~lient, and such inventories or re-
     ceivables are material, the auditor should indicate
     clearly in the scope paragraph (or in a middle para-
     graph) the limitations on his work and, generally,
     should disclaim an opinion on the financial state-
     ments taken as a whole.

D. The ommission of these procedures at the beginning of
   the year is not required to be disclosed in situations
   where the independent auditor has satisfied himself
                                                             I
   by means of auditing procedures. Nevertheless, he
   may wish to disclose the circumstances of the engage-
   ment and briefly describe the other procedures.
E. If the independent auditor has not satisfied himself
   by means of other auditing procedures with respect to
   opening inventories, he should either disclaim an
   opinion on the statement of income or qualify his
   opinion thereon, depending on the degree of material-
   ity of the amounts involved. An illustration of such
   a disclaimer follows:

     Scope paragraph

          We have examined the balance sheet of X company
     as of September 30, 1970, and the related statements
     of income and retained earnings for the year then
     ended. Our examination was made in accordance with
     generally accepted auditing standards, and accord-
     ingly included such tests of the accounting records
     and such other auditing procedures as we considered
                                                             I
     necessary in the circumstances, excepted as stated in
     the following paragraph.
                             64
        Middle paragraph
              Because we were not engaged as auditors until
        after September 3D, 1969, we were not present to ob-
        serve the physical inventory taken at that date and
•       we have not satisfied ourselves by means of other
        procedures concerning inventory quantities . The
I       amount of the inventory at September 3D, 1969, en-
        ters materially into the determination of the re-
        sul ts of operations for the year ended September 3D ,
        1970. Therefore, we do not express an opinion on
        the accompanying statements of income and retained
        earnings for the year ended September 3D, 1970.

        Opinion paragraph
             In our opinion, the accompanying balance sheet
        presents fairly the financial position of X company
        at September 3D, 1970, in conformity with generally

    I   accepted accounting principles applied on a basis
        consistent with that of the preceding year .




    I
                                  65
                    STATEMENT NO. 44

        REPORTS FOLLOWING A POOLING OF INTERESTS

              (Supersedes Statement No. 40)
                                                                "
I.   When companies have merged or combined in accor-
     dance wi th the accounting concept known as a "pool-
     ing of interests," appropriate effect of the pool-
     ing should be given in the presentation of finan-
     cial position, results of operations and other
     historical financial data of the continuing busi-
     ness for the year in which the combination is con-
     summated and, in comparative financial statements,
     for years prior to the year of pooling, as de-
     scribed in Accounting Principles Board Opinion
     No. 16, "Business Combinations." If prior year
     financial statements, presented in comparison with
     current year financial statements, are not re-
     stated to give appropriate recognition to a pool-
     ing of interests, the comparative financial state-
     ments are not presented on a consistent basis. In
     this case, the inconsistency arises not from a
     change in the application of an accounting princi-
                                                            I
     ple in the current year, but from the lack of such
     application to prior years. Such inconsistency
     would require a qualification in the independent
     auditor's report. In addition, failure to give
     appropriate recognition to the pooling in compara-
     tive financial statements is a departure from an
     Opinion of the Accounting Principles Board.
     Therefore, the auditor must also give appropriate
     consideration to the provisions of the Special
     Bulletin of the AICPA issued in October 1964 re-
     lating to disclosures of departures from Opinions
     of the Accounting Principle Board.

II. When sin',le-year statements only are presented for
    the year in which a combination is consummated, a
    note to the financial statements should adequately
    disclose the pooling transaction and state the

                                                            I
                           66
    revenues, extraordinary items and net earning of
    the constituent companies for the preceding year
    on a combined basis . In such instances, the dis-
    closure and consistency standards are met. Omis-
    sion of disclosure of the pooling transaction and
    its effect on the preceding year would require a
    qualification as to the lack of disclosure and
    consistency in the independent auditor's report.




I



I                          67
                 STAIEMENT NO. 45

      USING THE WORK AND REPORTS OF OTHER AUDITORS
(Supersedes paragraphs 32 to 36 of Chapter 10 of
Statement No. 33)

  I. The purpose of this Statement is to establish
     guidelines for reporting on financial statements
     when the independent auditor (referred to herein
     as the principal auditor) utilizes the work and
     reports of other independent auditors who have
     examined the financial statements of one or more
     subsidiaries, divisions, branches, or other com-
     ponents included in the finanCial statements pre-
     sented.

II . Principal Auditor's Course of Action

    A. The auditor in this situation may have per-
       formed all but a relatively minor portion of
       the work, or significant parts of the examina-
       tion may have been performed by other audi-
       tors. In the latter case he must decide
                                                         I
       whether his own participation is sufficient to
       enable him to serve as the principal auditor
       and to report as such on the financial state-
       ments. In deciding this question, the auditor
       should consider, among other things, the mate-
       riality of the portion of the finanCial state-
       ments he has examined in comparison with the
       portion examined by other auditors, the extent
       of his knowledge of the overall financial
       statements and the importance of the compo-
       nents he examined in relation to the enter-
       prise as a whole .

    B. If the auditor decides that it is appropriate
       for him to serve as the prinCipal auditor, he
       must then decide whether to make reference in
       his report to the examination made by another
       auditor. If the prinCipal auditor decides to
       assume responsibility for the work of the
       other auditor insofar as that work relates to
                                                         I
                          68
           the principal auditor's expression of an opin-
           ion on the financial statements taken a s a
           whole, no reference should be made to the
           other auditor's examination. On the other
           hand, if the principal auditor decides not to
           assume that responsibility, his report should
           make reference to the examination of the other
           auditor and should indicate clearly the divi-
           sion of responsibility between himself and the
           other auditor in expressing his opinion on the
           financial statements. Regardless of the prin-
           cipal auditor's decision, the other auditor
           remains responsible for the performance of his
           own work and for his own report .
    III. Decision Not to Make Reference

        A. If the principal auditor is able to satisfy
           himself as to the independence and profes-


I          sional reputation of the other audito~and
           takes steps he considers appropriate to
           satisfy himself as to the other auditor's ex-
           amination,he may be able to express an opinion
           on the finanCial statements taken as a whole
           without making reference in his report to the
           examination of the other auditor. If the
           principal auditor decides to take thi s posi-
           tion, he should not state in his report that
           part of the examination was made by another
           auditor because to do so may cause a reader to
           misinterpret the degree of responsibility
           being assumed.
        B. Ordinarily, the principal auditor would be
           able to adopt this position when:

           1. Part of the examination is made by another
              independent auditor which is an associated
              or correspondent firm and whose work is ac-
              ceptable to the principal auditor based on


I
              his knowledge of the professional standards
              and competence of that firm; or



                              69
      2. The other auditor was retained by the prin-
         cipal auditor and the work was performed
         under the principal auditor's guidance and
         control; or
      3. The principal auditor, whether or not he
         selected the other auditor, nevertheless
         takes steps he considers necessary to sat-
         isfy himself as to the other auditor's ex-
         amination and accordingly is satisfied as
         to the reasonableness of the accounts for
         the purpose of inclusion in the financial
         statements on which he is expressing his
         opinion; or

      4. The portion of the financial statements ex-
         amined by the other auditor is not material
         to the financial statements covered by the
         principal auditor's opinion.

IV. Decision to Make Reference

   A. On the other hand, the principal auditor may
      decide to make reference to the examination of
                                                       I
      the other auditor when he expresses his opin-
      ion on the financial statements. In some sit-
      uations, it may be impracticable for the prin-
      cipal auditor to review the other auditor's
      work or to use other procedures which in the
      judgment of the principal auditor would be
      necessary for him to satisfy himself as to the
      other auditor's examination. Also, if the fi-
      nancial statements of a component examined by
      another auditor are material in relation to
      the total, the principal auditor may decide,
      regardless of any other conSiderations, to
      make reference in his report to the examinA-
      tion of the other auditor.

   B. When the principal auditor decides that he
      will make reference to the examination of the
      other auditor, his report should indicate
      clearly, in both the scope and opinion para-
      graphs, the division of responsibility as
                         70
                                                       I
         between that portion of the financial state-
         ments covered by his own examination and that
         covered by the examination of the other audi-
         tor. The report should disclose the magnitude
         of the portion of the financial statements ex-
         amined by the other auditor. This may be done
         by stating the dollar amounts or percentages
         of one or more of the following: total as-
         sets, total revenues or other appropriate cri-
         teria, whichever most clearly reveals the por-
         tion of the financial statements examined by
         the other auditor. The other auditor may be
         named, but only with his express permission
         and provided his report is presented together
         with that of the principal auditor.

    C. Reference in the report of the principal au-
       ditor to the fact that part of the examination


I
       was made by another auditor is not to be con-
       strued as a qualification of the opinion but
       rather as an indication of the divided respon-
       sibility between the auditors who conducted
       the eXAm; DA tions of various components of the
       overall financial statements.
    D.   An example of appropriate reporting by the
         principal auditor indicating the division of
         responsibility when he makes reference to the
         examination of the other auditor follows:
              We have examined the consolidated balance
              sheet of X Company and subsidiaries as of
              December 31, 197_ and the related consol-
              idated statements of income and retained
              earnings and of changes in financial po-
              sition for the year then ended. Our ex-
              amination was made in accordance with
              generally accepted auditing standards and
              accordingly included such tests of the
              accounting records and such other audit-

I             ing procedures as we considered necessary
              in the circumstances. We did not examine
              the financial statements of B Company, a
              consolidated subsidiary, which statements
                              71
           reflect total assets and revenues consti-
           tuting 20 percent and 22 percent, respec-
           tively, of the related consolidated to-
           tals. These statements were examined by
           other auditors whose report thereon has
           been furnished to us and our opinion ex-
           pressed herein, insofar as it relates to
           the amounts included for B Company, is
           based solely upon the report of the other
           auditors.

           In our opinion, based upon our examina-
           tion and the report of other auditors,
           the accompanying consolidated balance
           sheet and consolidated statements of in-
           come and retained earnings and of changes
           in financial position present fairly ...

      When two or more auditors in addition to the
      principal auditor participate in the examina-
      tion, the percentages covered by the other au-
                                                       I
      ditors may be stated in the aggregate.

V. Procedures Applicable to
   Both Methods of Reporting

  A. Whether or not the principal auditor decides
     to make reference to the examination of the
     other auditor, he should make inquiries con-
     cerning the professional reputation and in-
     dependence of the other auditor. He also
     should adopt appropriate measures to assure
     the coordination of his activities with those
     of the other auditor in order to achieve a
     proper review of matters affecting the con-
     solidating or combining of accounts in the
     financial statements. These inquires and
     other measures may include procedures such as
     the following:

  1. Make inquiries as to the professional reputa-
     tion and standing of the other auditor to one
     or more of the following:
                                                       I
                         72
       a. The American Institute of Certified Public
          Accountants, the applicable state society
          of Certified Public Accountants and / or the
          local chapter, or in the case of a foreign
          auditor, his corresponding professional or-
          ganization .
       b. Other practitioners.

       c. Bankers and other credit grantors .

       d. Other appropriate sources.
    2. Obtain a representation from the other auditor
       that he is independent under the requirements
       of the American Institute of Certified Public
       Accountants and, if appropriate, the require-
       ments of the Securities and Exchange Commis-
       sion.

I   3 . Ascertain through communication with the other
        auditor:
        a. That he is aware that the financial state-
           ments of the component which he is to ex-
           amine are to be included in the financial
           statements on which the principal auditor
           will report and that the other auditor's
           report thereon will be relied upon (and,
           where applicable, referred to) by the
           principal auditor.
      b . That he is familiar with accounting prin-
          ciples generally accepted in the United
          States and with the generally acceptea au-
          diting standards promulgated by the Ameri-
          can Institute of Certified Public Accoun-
          tants and will conduct his examination and
          will report in accordance therewith .

      c. That he has knowledge of the relevant fi-

I        nancial reporting requirements for state-
         ments and schedul es to be filed with regu-
         latory agencies such as the Securities and
         Exchange Commission , if appropriate .
                            73
       d. That a review will be made of matters af-
          fecting elimination of intercompany trans-
          actions and accounts and, if appropriate
          in the circumstances, the uniformity of ac-
          counting practices among the components in-
          cluded in the financial statements.
    B. If the results of inquiries and procedures by
       the principal auditor with respect to matters
       described in paragraph V-A lead him to the
       conclusion that he can neither assume respon-
       sibility for the work of the other auditor
       insofar as that work relates to the principal
       auditor's expression of an opinion on the fi-
       nancial statements taken as a whole, nor re-
       port in the manner set forth in paragraph
       IV-~he should appropriately qualify his opin-
       ion or disclaim an opinion on the financial
       statements taken as a whole . His reasons
       therefor should be stated, and the magnitude
       of the portion of the financial statements to
                                                        I
       which his qualification extends should be dis-
       closed.
VI. Additional Procedures Under Decision
    Not to Make Reference

   A. When the principal auditor decides not to
      make reference to the examination of the
      other auditor, in addition to satisfying him_
      self as to the matters described in paragraph
      V-A, he should also consider whether to per-
      form one or more of the following procedures:

      1. Visit the other auditor and discuss the au-
         dit procedures followed and results
         thereof.

       2 . Review the audit programs of the other au-
           ditor. In some cases, it may be appro-
           priate to issue instructions to the other
           auditor as to the scope of his audit work.
                                                        I
                          74
            3 . Review the working papers of the other au-
                ditor, including his evaluation of internal
                control and his conclusions as to other
                significant aspects of the engagement.

         B. In some circumstances the principal auditor
            may consider it appropriate to participate in
            discussions regarding the accounts with man-
            agement personnel of the component whose fi-
            nancial statements are being examined by
            other auditors and/or to make supplemental
            tests of such accounts. The determination of
            the extent of additional procedures, if any,
            to be applied rests with the principal au-
            ditor alone in the exercise of his profes-
            sional judgment and in no way constitutes a
            reflection on the adequacy of the other au-
            ditor's work. Because the principal auditor
            in this case assumes responsibility for his


I           opinion on the financial statements on which
            he is reporting without making reference to
            the other auditor's examination, his judgment
            must govern as to the extent of procedures to
            be undertaken.
    VII. Qualifications in Other Auditor's Report

        A. If the opinion of the other auditor is quali-
           fied, the principal auditor should decide
           whether the subject of the qualification is
           of such nature and significance in relation
           to the financial statements on which the
           principal auditor is reporting that it would
           require qualification of his own report. If
           the subject of the qualification is not ma-
           terial in relation to such financial state-
           ments and the other auditor's report is not
           presented, the principal auditor need not make
           reference in his report to the qualification;
           if the other auditor's report is presented,


I          the principal auditor may wish to make refer-
           ence to such qualification and its disposi-
           tion .

                              7S
VIII. Restated Financial Statements of Prior
      Years FolloWing a Pooling of Interests

     A. Following a pooling of interests trans-
        action, an auditor may be asked to report
        on restated financial statements for one or
        more prior years when other auditors have
        examined one or more of the entities included
        in such financial statements. In some of
        these situations the auditor may decide that
        he has not examined a sufficient portion of
        the financial statements for such prior year
        or years to enable him to serve as principal
        auditor. Also, in such cases, it often is
        not possible or it may not be appropriate or
        necessary for the auditor to satisfy himself
        with respect to the restated financial state-
        ments. In these circumstances, it may be
        appropriate for him to express his opinion
        solely with respect to the compilation of
        such statements; however, no opinion should
                                                        I
        be expressed unless the auditor has examined
        the statements of at least one of the enti-
        ties includetl in the restatement for at
        least the latest period presented. The fol-
        lowing is an illustration of appropriate re-
        porting on compilation which can be pre-
        sented in an additional paragraph of the
        auditor's report following the standard
        scope and opinion paragraphs covering the
        consolidated financial statements for the
        current year:

            We previously examined and reported upon
            the consolidated statements of income
            and of changes in financial position of
            XYZ Company for the year ended Oecem-
            ber 31, 19__ prior to its restatement
            for 19__ poolings of interests. The
            contribution of XYZ Company to revenues
            and net income represented --- percent
            and ___ percent of the respective re-
            stated totals . Separate financial state-
                                                        I
            ments of the pooled companies included
                          76
          in the 19    restated consolidated state-
          ment of income were examined and reported
          upon separately by other auditors. We
          a lso have reviewed, as to compilation
          only, the accompanying consolidated
          statements of income and of changes in
          financial position for the year ended
          December 31, 19__ after restatement for
          19__ poolings of interests; in our opin-
          ion, such consolidated s tatements have
          been properly compiled on the basis de-
          scribed in Note X of notes to consoli-
          dated financial statements .

    B. In reporting on the compilation of restated
       financial statements as described in the
       preceding paragraph, the auditor does not
       assume responsibility for the work of other
       auditors nor the responsibility for express-


I
       ing an opinion on the restated financial
      statements taken as a whole.   His review is
      directed toward procedures which will enable
      him to express an opinion as to proper com-
      pilation only . These procedures include
      checking the compilation for mathematical
      accuracy and for conformity of the compila-
      tion methods with generally accepted account-
      ing principles. For example, the auditor
      should review and make inquiries regarding
      such matters as the following:

      1 . Elimination of intercompany transactions
          and accounts.

      2. Combining adjustments and reclassifica-
         tions .

      3. Adjustments to treat like items in a com-
         parable manner, if appropriate.

      4. The manner and extent of presentation of
         disclosure matters in the restated finan-
         cial statements and notes thereto .

                          77
      The auditor should also consider the appli-
      cation of procedures contained in paragraph
      V-A .
IX. Predecessor Auditor

   A. When one auditor succeeds another, the suc-
      cessor auditor must establish the basis for
      expressing his opinion on the financial
      statements for the first year he examines '
      and on the consistency of the application of
      accounting principles in that year as com-
      pared with the preceding year . This may be
      done by applying appropriate auditing proce-
      dures to the account balances at the begin-
      ning of the period under examination . The
      scope of this work may be reduced by consul-
      tation with the predecessor auditor and re-
      view of the predecessor auditor's working
      papers. In such cases, it is customary for
      the predecessor auditor, as a matter of pro-
      fessional courtesy, to make himself available
                                                       I
      to the successor auditor for consultation and
      to make his working papers available for re-
      view .   However, in reporting on his examina-
      tion, the successor auditor should not make
      reference to the report or work of the prede-
      cessor auditor as the basis in part for his
      own opinion. If the successor auditor is un-
      able to obtain satisfaction as to the opening
      balances insofar as they affect the financial
      statements for the period on which he is re-
      porting, he shoul d appropriately qualify his
      opinion or disclaim an opinion and state his
      reasons for doing so.




                          78
                                                       I
                      STATEMENT NO. 46

                     PIECEMEAL OPINIONS

    (Supersedes paragraphs 22-25 of chapter 10 of State-
    ment No. 33 and pertinent portions of paragraph 9 of
    Statement No. 34)
      I. The purposes of this Statement are to identify
         the circumstances in which the auditor's expres-
         sion of a piecemeal opinion may be appropriate,
         to clarify the scope of an examination necessary
         to support a piecemeal opinion, and to set forth
         the precautions which should be taken when a
         piecemeal opinion is expressed.
     II. Scope of Examination
        A. The auditor should recognize that the expres-


I
           sion of a piecemeal opinion with respect to
           specific items included in financial state-
           ments usually requires a more extensive exam-
           ination of such items than would ordinarily be
           required if he were expressing an opinion on
           the financial statements taken as a whole.
           Three basic factors influence the sufficiency
           and competence of evidence necessary to sup-
           port a piecemeal opinion as to specific items
           in financial statements:
           1 . Client-imposed restrictions on scope limit
               the auditor's freedom to select procedures
               and examine evidence.
            2. Many items within financial statements are
               interrelated.
            3 . The materiality threshold for financial
                statement items considered individually is
                ordinarily lower than for such items con-


I
                sidered as components of financial state-
                ments taken as a whole.


                                79
B. A piecemeal opinion should not be expressed,
   if, as a result of restrictions imposed by the
   client (such as not being permitted to examine
   a sufficient number of subsidiaries of a hold-
   ing company, not being permitted to observe
   physical inventories, etc.), the auditor is
   unable to examine evidence supporting finan-
   cial statement items or is prevented from ap-
   plying auditing procedures he believes would
   be necessary to support an unqualified or
   qualified opinion on the financial statements
   taken as a whole. Exceptions to this general
   prohibition can be made only in the following
   special circumstances:

  1. The report on the client' s financial state-
     ments is intended solely for the internal
     information of the client' s management; the
     auditor specifies in his report that its
     distribution is to be so restricted; and
     the nature and source of the limitations on
     his work are clearly described.

  2. The report is issued pursuant to an agree-
     ment between a prospective buyer and seller
                                                    I
     of a business; the parties involved agree
     to the limitations imposed on the auditor's
     work; the auditor describes in the report
     the nature and source of such limitations;
     and the auditor specifies in his report
     that its distribution is to be restricted
     to the parties involved.

  In these special circumstances, the readers
  normally would be fully aware of the nature
  and significance of the scope limitation and
  would be unlikely to misinterpret the dis-
  claimer of opinion and the piecemeal opinion.
C. Many financial statement items are interre-
   lated, for example, sales and receivables, in-
   ventory and payables, and fixed assets and de-
   preciation. A piecemeal opinion on specific
                                                    I
                       80
           itens can be expressed only after the auditor
           is satisfied that the reservations, limita-
           tions or insufficiency of evidence which pre-
           vent the expression of an opinion with respect
           to items to be excluded from the piecemeal
           opinion do not materially affect, directly or
           indirectly, the items on which the opinion is
           issued.

        D. For purposes of reporting on individual fi-
           nancial statement items, the threshold of ma-
           teriality is ordinarily lower since, rather
           than being measured in relation to the state-
           ments as a whole, the individual items stand
           alone, thus affording a smaller base. There-
           fore the auditor ordinarily should extend his
           auditing procedures because of such material-
           ity considerations.
    III. Expression of Piecemeal Opinion


I       A. A piecemeal opinion should be carefully worded
           so as not to contradict or overshadow the dis-
           claimer of opinion or adverse opinion with re-
           gard to the financial statements taken as a
           whole. A piecemeal opinion should clearly in-
           dicate that no opinion on financial position
           or results of operations is intended. The re-
           port should identify the specific accounts
           covered by the piecemeal opinion, such as
           "cash, accounts receivable and securities. tl
           In some cases, when there are only a few ac-
           counts not covered by the piecemeal opinion,
           clear identification may be accomplished by
           reference to the excluded accounts, such as
           "assets other than accounts receivable." Use
           of broad phrases in identifying the items on
           which an opinion is being given, such as "in
           all other respects," could lead users of the
           report to believe that the opinion applies to
           items other than those intended, and, conse-


I          quently, use of such phrases should be
           avoided.

                              81
B. When the auditor expresses a piecemeal opin-
   ion, the interrelationship of the accounts af-
   fected should be carefully considered. For
   example, when an opinion on financial state-
   ments is disclaimed because the auditor has
   been unable to satisfy himself as to the val-
   uation of inventories , it would ordinarily be
   improper for the auditor to express his piece-
   meal opinion upon "accounts other than inven-
   tories." To do so would extend his opinion
   to related items as to which audit satisfac-
   tion has not been obtained, such as cost of
   sales, gross profit, earnings before income
   taxes, income taxes, net earnings, accrued in-
   come taxes ane: retained earnings.

c.   The piecemeal opinion should also avoid any
     implication that the accounts upon which an
     opinion is expressed present financial posi-
     tion or results of operations. Reference
     should not be made to "financial position" and
     "results of operations" within the piecemeal
     opinion portion of the report.
                                                      I
D. If a piecemeal opinion is considered appropri-
   ate, it should follow immediately after the
   disclaimer of opinion or adverse opinion
   covering the financial statements. The piece-
   meal opinion should be expressed either in the
   paragraph in which the disclaimer of opinion
   or adverse opinion appears or in an additional
   paragraph. The following report is an example
   of wording that might be used in a piecemeal
   opinion. This example is not intended to im-
   ply that in cases where there are uncertain-
   ties of the kinds indicated that a disclaimer
   of opinion is necessarily required; rather it
   is assumed that in this case the auditor has
   concluded that a qualified opinion is not jus-
   tified in the circumstances.




                         82
                                                      I
    (Scope paragraph--standard wording)
    (Middle paragraph)

    Deferred development costs of $     relate
    to the development of computer programs
    and educational films and books. The re-
    covery of such costs is dependent on suc-
    cessful development of these projects and
    the company's ability to sell the related
    products profitably in the future . (See
    note X to the financial statements.) Also,
    as indicated in note Y, the company is de-
    fendant in a legal action wherein the
    plaintiffs are claiming damages of $____
    and the company is counterclaiming $____
    against the plaintiffs. The ultimate out-
    come of this litigation is uncertain.



I
    (Opinion paragraph)

    Because of the possible material effect of
    the uncertainties described in the preced-
    ing paragraph on financial position and re-
    sults of operations, we do not express an
    opinion on the financial statements taken
    as a whole. In our opinion, however, the
    following items in the accompanying finan-
    cial statements are presented fairly at De-
    cember 31, 197_ and for the year then
    ended, in confcrmity with generally ac-
    cepted accounting principles applied on a
    basis consistent with that of the preceding
    year: cash; trade accounts receivable; in-
    ventories; property and equipment; notes
    payable to banks; accounts payable; long-
    term debt; capital stock; sales; selling,
    general and administrative expenses; and
    interest expense.



I                         83
                   STATEMENT NO. 47

                   SUBSEQUENT EVENTS

      (Supersedes chapter II of Statement No. 33)

I . There are two types of subsequent events that re-
    quire consideration by management and evaluation by
    the independent auditor .

  A. The first type consists of those events that
     provide additional evidence with respect to con-
     ditions that existed at the date of the balance
     sheet and affect the estimates inherent in the
     process of preparing financial statements. All
     information that becomes available prior to the
     issuance of the financial statements should be
     used by management in its evaluation of the con-
     ditions on which the estimates were based. The
     financial statements should be adjusted for any
     changes in estimates resulting from the use of
     such evidence .
                                                          I
  B. Identifying events that require adjustment of
     the financial statements under the criteria
     stated above calls for the exercise of judgment
     and knowledge of the facts and circumstances .
     For example, a loss on an uncollectible trade
     account receivable as a result of a customer's
     deteriorating financial condition leading to
     bankruptcy subsequent to the balance sheet date
     would be indicative of conditions existing at
     the balance sheet date, thereby calling for ad-
     justment of the financial statements before
     their issuance . On the other hand, a similar
     loss resulting from a customer's major casualty
     such as a fire or flood subsequent to the bal-
     ance sheet date would not be indicative of con-
     ditions existing at the balance sheet date and
     adjustment of the financial statements would not
     be appropriate. The settlement of litigation         tIIf
                          84
           for an amount different from the liability re-
           corded in the accounts would require adjustment
           of the financial statements if the events, such
           as personal injury or patent infringement, that
           gave rise to the litigation had taken place
           prior to the balance sheet date.

        C. The second type consists of those events that
           provide evidence with respect to conditions that
           did not exist at the date of the balance sheet
           being reported on but arose subsequent to that
           date. These events should not result in adjust-
           ment of the financial statements. Some of these
           events, however, may be of such a nature that
           disclosure of them is required to keep the fi-
           nancial statements from being misleading. Oc-
           casionally such an event may be so significant
           that disclosure can best be made by supplement-
           ing the historical financial statements with


    I      pro forma financial data giving effect to the
           event as if it had occurred on the date of the
           balance sheet. It may be desirable to present
           pro forma statements, usually a balance sheet
           only, in columnar form on the face of the his-
           torical statements.

r       D. Examples of events of the second type that re-
           quire disclosure in the financial statements
           (but should not result in adjustment) are:

          1. Sale of a bond or capital stock issue.

          2. Purchase of a business.

          3. Settlement of litigation when the event giv-
             ing rise to the claim took place subsequent
             to the balance sheet date.

          4. Loss of plant or inventories as a result of
             fire or flood.


    I                           85
   5. Losses on receivables resulting from condi-
      tions (such as a customer's major casualty)
      arising subsequent to the balance sheet date.

E. Subsequent events affecting the realization of
   assets such as receivables and inventories or
   the settlement of estimated liabilities ordi-
   narily will require adjustment of the financial
   statements because such events typically repre-
   sent the culmination of conditions that existed
   over a relatively long period of time. Subse-
   quent events such as changes in the quoted
   market prices of securities ordinarily should
   not result in adjustment of the financial state-
   ments because such changes typically reflect a
   concurrent evaluation of new conditions.

F. When finanCial statements are reissued, for ex-
   ample, in reports filed with the Securities and
   Exchange Commission or other regulatory agen-
   cies, events that require disclosure in the re-
   issued financia l statements to keep them from
                                                       I
   being misleading may have occurred subsequent to
   the original issuance of the financial state-
   ments. Events occurring between the time of
   original issuance and reissuance of financial
   statements whould not result in adjustment of
   the financial statements unless the adjustment
   meets the criteria for the correction of an er-
   ror or the criteria for prior period adjustments
   set forth in Opinions of the Accounting Princi-
   ples Board.   Similarly, financial statements
   reissued in comparative form with financial
   statements of subsequent periods should not be
   adjusted for events occurring subsequent to the
   original issuance unless the adjustment meets
   the criteria stated above.

G. Occasionally, a subsequent event of the second
   type has such a material impact on the entity
   that the auditor may wish to include in his re-
   port an explanatory paragraph directing the
   reader's attention to the event and its effects .
                                                       I
                         86
    II. Auditing Procedures in the Subsequent Period

       A. There is a period after the balance sheet date
          with which the auditor must be concerned in
          completing various phases of his examination.
          This period is known as the "subsequent period"
          and is considered to extend to the date of the
          auditor's report. Its duration will depend
          upon the practical requirements of each exam-
          ination and may vary from a relatively short
          period to one of several months. Also, all
          auditing procedures are not carried out at the
          same time and some phases of an examination
          will be performed during the subsequent period,
          whereas other phases will be substantially
          completed on or before the balance sheet date.
          As an audit approaches completion, the auditor
          will be concentrating on the unresolved audit-
          ing and reporting matters and he is not expected


I         to be conducting a continuing review of those
          matters to which he has previously applied au-
          diting procedures and reached satisfaction.
       B. Certain specific procedures are applied to
           transactions occurring after the balance
          sheet date such as (1) the examination of
          data to assure that proper cutoffs have been
          made, and (2) the examination of data which
          provide information to aid the auditor in his
          evaluation of the assets and liabilities as
          of the balance sheet date.

       C. In addition, the independent auditor should
          perform other auditing procedures with respect
          to the period after the balance sheet date for
          the purpose of ascertaining the occurrence of
          subsequent events that may require adjustment
          or disclosure essential to a fair presentation
          of the financial statements. These procedures
          should be performed at or near the completion


I         of the field work . The auditor generally
          should:



                              87
    1. Read the latest available interim financial
       statements; compare them with the financial
       statements being reported upon; and make
       any other comparisons considered appropriate
       in the circumstances. In order to make
       these procedures as meaningful as possible
       for the purpose expressed above, the auditor
       should inquire of officers and other execu-
       tives having responsibility for financial
       and accounting matters as to whether the in-
       terim statements have been prepared on the
       same basis as that used for the statements
      under examination.

   2. Inquire of and discuss with officers and
      other executives having responsibility for
      financial and accounting matters as to:

       (a) Whether any substantial contingent lia-
           bilities or commitments existed at the
           date of the balance sheet being reported
           on or at the date of inquiry.

       (b) Whether there was any significant change
                                                      I
           in the capital stock, long-term debt,
           or working capital to the date of in-
           quiry.

       (c) The current status of items, in the fi-
           nancial statements being reported on,
           that were accounted for on the basis of
           tentative, preliminary, or inconclusive
           data.
       (d) Whether any unusual adjustments had
           been made during the period from the
           balance sheet date to the date of
           inquiry.

3. Read the available minutes of meetings of
   stockholders, directors and appropriate
   committees; as to meetings for which minutes
   are not available, inquire about matters
                                                      I
   dealt with at such meetings .

                        88
       4. Obtain from legal counsel a description and
          evaluation of any litigation, impending
          litigation, claims and contingent liabili-
          ties of which he has knowledge that ex-
          isted at the date of the balance sheet
          being reported on, together with a descrip-
          tion and evaluation of any additional mat-
          ters of such nature coming to his attention
          up to the date the information is furnished.

       5 . Obtain a letter of representations, dated
           as of the date of the auditor ' s report,
           from appropriate off icials, generally the
           chief executive officer and chief finan-
           cial officer, as to whether any events oc-
           curred subsequent to the date of the finan -
           cial statements being reported on by the
           independent auditor that in the officer'S
           opinion would require adjustment or dis-
           closure in these statements .

       6 . Make such additional inquiries or perform
           such procedures as he considers necessary
           and appropriate t o d is pose of questions that
           arise in carrying out the foregoing proce-
           dures, inquiries and discussions.
III . Dating of Independent Auditor's Report

    A. Generally, the date of completion of the
       field work should be used as the date of the
       independent auditor 's report.

    B. The auditor has no responsibility to make any
       inquiry or carry out any auditing procedures
       for the period after the date of his report.




                            89
IV. Events Occurring After Completion
    Of Field Work But Before Issuance of Report
                                                            I
   A. In case a subsequent event of the type requir-
      ing adjustment of the financial statements oc-
      curs after the date of the independent au-
      ditor's report but before its issuance, and the
      event comes to the attention of the auditor,
      the financial statements should be adjusted or
      the auditor should qualify his opinion. When
      the adjustment is made without disclosure of
      the event, the report ordinarily should be dated
      in accordance with paragraph III-A. However, if
      the finanCial statements are adjusted and dis-
      closure of the event is made, or if DO adjust-
      ment is made and the auditor qualifies his opinion,
      the procedures set forth in paragraph IV-C should
      be followed.

   B. In case a subsequent event of the type requir-
      ing disclosure occurs after the date of the au-
      ditor's report but before issuance of his re-
      port, and the event comes to the attention of
      the auditor, it should be disclosed in a note to
      the finanCial statements or the auditor should
      qualify his opinion. If disclosure of the event
      is made, either in a note or in the auditor ' s re-
      port, the auditor would date his report as set
      forth in the following paragra ph.

   C. The independent auditor has two methods avail-
      able for dating his report when a subsequent
      event disclosed in the financial statements oc-
      curs after completion of his field work but be-
      fore issuance of his report. He may use "dual
      dating," for example, "February 16, 19_, except
      for Note_ as to which the date is March 1, 19_,"
      or he may date his report as of the later date.
      In the former instance, his responsibility for
      events occurring subsequent to the completion of
      his field work is limited to the specific event
      referred to in the note (or otherwise disclosed).



                           90
      In the latter instance, the independent auditor's
      responsibility for subsequent events extends to
      the date of his report and, accordingly, the pro-
      cedures outlined in paragraph II-C generally
      should be extended to that date.

V. Reissuance of the Independent Auditor's Report

  A. An independent auditor may reissue his report on
     financial statements contained in annual reports
     filed, with the Securities and Exchange Commis-
     sion or other regulatory agencies or in a long-
     form report subsequent to the date on which his
     report on the financial statements included
     therein was first issued. An independent auditor
     may also be requested by his client to furnish
     additional copies of a previously issued report.
     Use of the original report date in a reissued
     report removes any implication that records,
     transactions or events after that date have been
     examined or reviewed. In such cases, the inde-
     pendent auditor has no responsibility to make
     further investigation or inquiry as to events
     which may have occurred during the period between
     the original report date and the date of the re-
     lease of additional reports.
  B. In some cases, it may not be desirable for the
     independent auditor to reissue his report in the
     circumstances described in paragraph V-A because
     he has become aware of an event that occurred
     subsequent to the date of his original report
     that requires adjustment or disclosure in the fi-
     nancial statements. In such cases, adjustment
     with disclosure or disclosure alone should be
     made as described in paragraph I-F. The inde-
     pendent auditor should consider the effect of
     these matters on his opinion and he should date
     his report in accordance with the procedures
     described in paragraph IV-C.




                          9l
c.   If an event of the type requiring disclosure
     only occurs between the date of the independent
     auditor's original report and the date of the
     reissuance of such report, and if the event comes
     to the attention of the independent auditor, the
     event may be disclosed in a separate note to the
     financial statements captioned somewhat as fol-
     lows:

         Event (Unaudited) Subsequent to the Date
         of the Report of Independent Auditor .

     Under these circumstances, the report of the in-
     dependent auditor would carry the same date used
     in the original report.




                          92
I. Independent Auditor's Report
   In Filing Under Securities Act of 1933

  A. Section 11 of the Securities Act of 1933 makes
     specific mention of the i ndependent auditor's
     responsi bility as an expert when his report is
     included in a registration statement filed
     under that Act . Section 11 states, in part,
     that no person s hall be liable as provided
     therein if such person shall sustain the burden
     of proof that as to the part of the registra-
     tion statement purporting to be made on his au-
     thority as an expert

           he had, after reasonable investigation,
           rea s onable ground to believe and did be-
           lieve, at the time such part of the regis-
           tration statement became effective that
           the s tatements therein were true and that
           there was no omission to state a material
           fact required to be stated therein or
           necessary to make the statements therein
           not misleading . •. .

     Section 11 further provides that, in determin-
     ing what constitutes reasonable investigation
     and reasonable ground to believe, "the standard
     of reasonableness shall be that required of a
     prudent man in the management of his own prop-
     erty.1I

  B. To sustain the burden of proof that he has made
     a "reasonable investigation" as required under
     the Securities Act of 1933, the auditor should
     extend his procedures with respect to subse-
     quent events from the date of his report up to
     the effective date or as close thereto as is
     reasonable and practicable in the circum-
     stances. In this connection, he should arrange
     to be kept advised by his client of the




                        93
   progress of the registration proceedings so
   that his review of subsequent events can be
   completed by the effective date. The likeli-
                                                         I
   hood of the auditor discovering subsequen t
   events must necessarily decrease following the
   completion of field work and, as a practical
   matter, subsequent to that time the independent
   auditor may rely, for the most part, on in-
   quiries of responsible officials and employees .
   In addition to performing the procedures out-
   lined in paragraph II-C at or near the effec-
   tive date, the auditor generally should:

   1. Read the entire prospectus and other perti-
      nent portions of the registration statement.

   2. Inquire of and obtain written confirmation
      from officers and other executives having
      responsibility for financial and accounting
      matters as to whether there have occurred
      any events other than those reflected or
      disclosed in the registration statement
      which, in the officers' opinion, have a ma-
      terial effect on the audited financial
      statements included therein or which should
      be disclosed in order to keep those state-
      ments from being misleading.

C. Because the independent auditor has not exam-
   ined the unaudited financial statements which
   may be included in the registration statement,
   he cannot be expected to have an opinion as to
   whether such statements have been prepared in
   conformity with generally accepted accounting
   principles. However, if he concludes on the
   basis of facts known to him that the unaudited
   financial statements are not in conformity with
   generally accepted accounting principles, he
   should insist upon appropriate revision; failing
   that, he should add a comment in his report calling
   attention to the departure; further, he should



                       94
  consider, probably with advice of legal coun-
  sel, withholding his consent to the use of his
  report on the audited financial statements in
  the registration statement.

D. A registration statement filed with the Securi-
   ties and Exchange Commission may contain the
   reports of two or more independent auditors on
   their examinations of the financial statements
   for different periods. An auditor who has not
   examined the financial statements for the most
   recent audited period included in the registra-
   tion has a responsibility relating to events
   subsequent to the date of the financial state-
   ments on which he is reporting which continues
   to the effective date, and he generally should:

   1. Read pertinent portions of the prospectus and
      of the registration statement.

   2. Obtain a letter of representations from the
      successor independent auditor as to whether
      his examination (including his procedures
      with respect to subsequent events) revealed
      any matters which, in his opinion, might
      have a material effect on the financial
      statements reported on by the predecessor
      auditor or would require disclosure in the
      notes thereto.

E. If the predecessor auditor becomes aware of any
   events or transactions which require adjustment
   or disclosure in the financial statements exam-
   ined by him, the financial statements should be
   adjusted or the subsequent event should be dis-
   closed in a note to the financial statements or
   the auditor should qualify his report . The
   predecessor auditor should follow the proce-
   dures set forth in paragraph IV-C with respect
   to dating his report . He should satisfy him-
   self as to the propriety of any adjustment or
   disclosure affecting the financial statements


                      9S
covered by his report. This may be done by
performing appropriate auditing procedures or
by obtaining a letter of representations from
                                                  ,
the successor auditor . In the latter instance,
he may decide to express reliance on the suc-
cessor auditor .




                      96
                      STATEMENT NO . 48
                  LEITERS FOR UNDERWRITERS

                 (Supersedes statement No. 35)

    1. General

      A. The services of independent certified public ac-
         countants include examining financial statements
         and schedules contained in registration state-
         ments filed with the Securities and Exchange Com-
         mission (the "SEX::") under the Securities Act of
         1933 (the "Act"). In connection with this type
         of service, accountants often are called upon to
         confer with clients, underwriters, and their re-
         spective counsel concerning the accounting and
         auditing requirements of the Act and of the SEC
         as well as to perform other services. One of


I        these other services is the issuance of letters
         for underwriters, commonly called "comfort let-
         ters."

      B. Underwriters, in requesting comfort letters, are
         generally seeking assistance on matters of impor-
         tance to them. They wish to perform a "reason-
         able investigation" of financial and accounting
         data not "expertized" (covered by a report of in-
         dependent accountants, who consent to be named as
         experts, based on an examination made in accor-
         dance with generally accepted auditing standards)
         as a defense against pOSSible claims under the
         Act. Accountants have a corresponding wish aris-
         ing in response to the same statutory phrase,
         "reasonable investigation," with respect to au.-
         dited financial statements included in a prospec-
         tus in reliance on their audit report and their
         consent. The accountants' reasonable investiga-
         tion must be premised upon an audit; it cannot be
         accomplished short of an audit . In contrast,


I
         what constitutes a reasonable investigation of
         unaudited financial and accounting data suffi-
         cient to satisfy an underwriter's purposes has

                              97
  never been authoritatively established. It seems
  clear, however, that the purposes of the investi-
  gations are quite different. Accountants nor-
  mally will be entirely willing to furnish to the
  underwriters such assistance as is within their
  professional capabilities; however, the extent of
  the assistance which accountants can provide by
  way of comfort letters is subject to limitations.
  One such limitation is that an independent certi-
  fied public accountant can properly comment in
  his professional capacity only upon matters to
  which his professional expertise is substantially
  relevant. Another limitation is that procedures
  short of an audit (which are all that a comfort
  letter contemplates) by their nature are ordinar-
  ily not such as to furnish accountants grounds
  for expressing an opinion, but, at the most, neg-
  ative assurance. Finally, the Committee has con-
  cluded that it is not practicable to establish


                                                       I
  standards comparable to generally accepted audit-
  ing standards by which the sufficiency of proce-
  dures to support negative assurances can be mea-
  sured; therefore, such assurances in specific
  situati ons cannot reasonably imply any definite
  or uniform degree of certainty regarding the mat-
  ters to which they relate . Accordingly, there is
  necessarily a risk that matters against which
  negative assurance is sought may prove to be
  present even though negative assurance has been
  given.

C. Comfort letters are not required under the Act,
   and copies are not filed with the SEC. It is
   nonetheless a common condition of an underwriting
   agreement in connection with the offering for
   sale of securities registered with the SEC under
   the Act that the accountants are to furnish a
   comfort letter. Some underwriters do not make
   the receipt of a comfort letter a condition of
   the underwriting agreement but nevertheless ask


                                                       I
   for such a letter.



                         98
    D. The accountant s should suggest to the underwriter
       that they mee t together with the client to dis-
       cuss the procedures to be followed in connection
       with a comfort letter; in this connection, the
       accountants may describe procedures frequently
       followed. Because of the accountant s ' knowledge
       of the client , such a meeting may substantially
       benefit the underwriter in reaching his decision
       as to the procedures to be followed by the ac-
       countants . However , because of the lack of
       cl ear-cut standards , it is advisable to accompany
       any discussion of procedures with a clear state-
       ment that the accountants cannot furnish any as-
       surance as to the sufficiency of the procedures
       for the underwriter' s purposes and it i s advi s-
       able for the comfort letter to contain a state-
       ment to this effect.

      Comfort letters will generally refer to one or
      more of the following subjects :

       (a) The independence of the accountant s .

       (b) Compliance as to form in all material re-
           spects of the audited financial statements
           and schedules with the applicable accounting
           requirements of the Act and the published
           rules and regulations thereunder.

       (c) Unaudited financial statements and schedules
           in the registration statement .

       (d) Changes in selected financial-statement items
           during a period subsequent to the date and
           period of the latest financial statements in
           the registration statement.

       (e) Tables, statistics and other financial infor-
           mation in the registration statement .



I
      These matters are discussed in greater detail be-
      low. Matters dealt with in a particular letter


                             99
  usually are limited to ones specified in the un-
  derwriting agreement.

F. Because the underwriter will be looking to the
   accountants to furnish a comfort letter of a
   scope to be specified in the underwriting agree-
   ment, the client and the underwriter, when they
   have tentatively agreed upon a draft of the
   agreement, are well advised to furnish a copy of
   it to the accountants so that the latter can in-
   dicate whether they will be able to furnish a
   letter in acceptable form. A desirable practice
   is for the accountants, promptly after they have
   received the draft of the agreement (or have been
   informed that a letter covering speCified mat-
   ters, although not a condition of the agreement,
   will nonetheless be requested), to prepare a
   draft of the form of letter that they expect to
   furnish. To the extent possible, the draft


                                                       I
   should deal with all matters to be covered in the
   exact terms to be used in the final letter (sub-
   ject, of course, to the understanding that the
   comments in the final letter cannot be determined
   until the procedures underlying it have been per-
   formed). The draft letter should be identified          I
   as a draft in order to avoid giving the impres-
   sion that the procedures described therein have
   been performed . This practice of furnishing a
   draft letter at an early point permits the ac-
   countants to make clear to the client and the un-
   derwriter what they may expect the accountants to
   furnish, and gives the client and the underwriter
   an opportunity to change the proposed underwrit-
   ing agreement if they so desire . The underwriter
   thus furnished with a draft letter is afforded
   the opportunity of discussing further with the
   accountants the procedures that the accountants
   have indicated they expect to follow, and of re-
   questing any additional procedures which the un-
   derwriter may desire . If the additional proce-


                                                       I
   dures pertain to matters to which the accoun-
   tants' professional competence is relevant, the
   accountants would ordinarily be willing to

                       100
     perform them and it is desirable for them to fur-
    nish the underwriter an appropriately revised
    draft letter. The account ants may reasonably as-
     sume that the underwriter, by indicating his ac-
    ceptance of the draft comfort letter, and subse-
    quently, by his acceptance of the letter in final
    form, considers the procedures described suffi-
    cient for his purposes . It is important, there-
    fore, that the procedures to be followed by the
    accountants be clearly set out in the comfort
    letter, in both draft and final form, so that
    there will be no misunderstanding as to the basis
    upon which the accountants' comments have been
    made and so that the underwriter can decide
    whether the procedures performed are sufficient
    for his purposes . Statements or implications
    that the accountants are carrying out such proce-
    dures as they consider necessary should be
    avoided since this may lead to misunderstanding

I   about the responsibility for the sufficiency of
    the procedures for the underwriter'S purposes . A
    suggested form of legend which may be placed on
    the draft letter for identification and explana-
    tion of its purposes and limitations is as fol-
    lows:

         This draft is furnished solely for the pur-
    pose of indicating the form of letter which we
    would expect to be able to furnish [ name of un-
    derwriter] in response to their request, the mat-
    ters expected to be covered in the letter and the
    nature of the procedures which we would expect to
    carry out with respect to such matters. Based on
    our discussions with [name of underwriter], it is
    our understanding that the procedures outlined in
    this draft letter are those they wish us to fol-
    low. Unless [name of underwriter] informs us
    that there are additional procedures they wish us
    to follow, we shall assume that they consider
    those procedures outlined sufficient for their

I   purposes. The text of the letter itself will de-
    pend, of course, upon the results of the


                          101
     pr~edures, which we would not expect to complete
     unt11 shortly before the letter is given and in
     no event before the cutoff date indicated
     therein.

II. Dating

   A. The letter ordinarily is dated at or shortly
      before the "closing date" (the date on which
      the issuer or selling security holder delivers
      the securities to the underwriter in exchange
      for the proceeds of the offering). The under-
      writing agreement ordinarily specifies the
      date, often referred to as the "cutoff date,"
      to which the letter is to relate (e.g., a date
      five business days before the date of the let-
      ter); the accountants should see that the cut-
      off date will not place an unreasonable burden
      on them. The letter should state that the in-
      quiries and other procedures carried out in
      connection with the letter did not cover the
                                                        I
      period from the cutoff date to the date of the
      letter.
   B. Letters may also be dated at or shortly before
      the "effective date" (the date on which the
      registration statement becomes effective) and,
      on rare occasions, letters have been requested
      to be dated at or shortly before the "filing
      date" (the date on which the registration
      statement is first filed with the SEC). If
      more than one letter is requested, it will be
      necessary to carry out the specified procedures
      and inquiries as of the cutoff date for each
      letter. Although comments contained in an
      earlier letter may on occasion conveniently be
      incorporated by reference in a subsequent let-
      ter, any subsequent letter should relate only
      to information in the registration statement
      as most recently amended as of the cutoff date
      of the subsequent letter.
                                                        I
                         102
       Addressee

       A. Because the letter is a result of the under-
          writer's request, many accountants address the
          letter only to the underwriter, with a copy
          furnished to the client. When this is done,
          the appropriate addressee is the underwriter
          who has negotiated the underwriting agreement
          with the client, and with whom the accounts
          will deal in discussions as to the scope and
          sufficiency of the letter, rather than the
          group of underwriters for whom that under-
          writer acts as representative. Some accoun-
          tants address the letter instead to the client,
          or to both the client and the underwriter. If
          the accountants are requested to address the
          letter to any person other than the underwriter
          or the client, they would do well to consult
          their counsel.

       Introductory Paragraph

       A. It is desirable to include an introductory
          paragraph substantially as follows:
                    We have examined the [identify the fi-
         nancial statements and schedules examined] in-
          cluded in the Registration Statement
          (No. 2-00000) on Form _ _ filed by the Com-
         pany under the Securities Act of 1933 (the "Act");
         our reports with respect thereto are also in-
         cluded in such Registration Statement. Such
         Registration Statement, as amended as of
                                   , is herein referred to as the
         ~";;;R:-e-g7i-s:-tr-at=io-n Statement."

    V. Independence

      A. I t is customary for the underwriting agreement
         to provide for the accountants to make a state-


I        ment concerning their independence in the let-
         ter. This may be done substantially as follows:


                                103
           We are independent certified public ac-
      countants with respect to The Blank Company,
      Inc. within the meaning of the Act and the ap-
      plicable published rules and regulations there-
      under and the answer to [ identify the item num-
      ber that refer s to the relationship with regis-
      trant of experts named in the registration
      statement; e.g., Item 24 of Form S-l] of the
      Registration Statement is correct insofar as
      it relates to us .
VI. Compliance With SEC Requirements

    A. The accountants may be requested to express an
       opinion concerning compliance as to form of the
       financial statements covered by their report
       with the pertinent published accounting require-
       ments of the SEC. This may be done substan-
       tially as follows:

           In our opinion, [ include phrase, "except
      as disclosed in the Registration Statement,"
      if applicable] the [ identify the financial
      statements and schedules examined ] examined by
                                                         I
      us and included or incorporated by reference in
      the Registration Statement comply as to form
      in all material respects with the applicable
      accounting requirements of the Act and the pub-
      lished rules and regulations thereunder.
      If there is a material departure from the per-
      tinent published requirements, the departure
      should be disclosed in the letter. Normally,
      representatives of the SEC will have agreed to
      such departure; when this occurs, such agree-
      ment should be mentioned in the comfort let-
      ter.

   B. Since published SEC requirements do not deal
      with the form of pro forma financial state-
      ments or pro forma adjustments applied to
      historical financial statements, there is no
      basis for accountants to comment on whether
                                                        I
      such pro forma information complies as to form
      wi th SEC requirements.
                          104
        Accountants' Report

        A. Underwriters occasionally request that the
           accountants repeat in the comfort letter their
           opinion with respect to the audited financial
           statements included in the registration state-
           ment. Because of the special significance of
           the date of an accountants' report, the ac-
           countants should not repeat their opinion.
           Underwriters sometimes request negative assur-
           ance as to the accountants' report . Because
           accountants have a statutory responsibility
           with respect to their opinion as of the effec-
           tive date, and because the additional signifi-
           cance, if any, of a negative assurance is un-
           clear and such assurance may therefore give
           rise to misunderstanding, it is inadvisable to
           give such negative assurance.

I   VIII. Unaudited Financial Statements
           and Subsequent Changes
                          In General
         A. Comments included in the letter will often
            concern (i) unaudited financial statements and
            schedules included in the registration state-
            ment, (ii) changes in capital stock and long-
            term debt , (iii) decreases in other specified
            financial-statement items,and (iv) pro forma
            financial statement s. In commenting on these
            matters, the following guides are important:

             (1) Any statements by the accountants with re-
                 spect to unaudited financial statements
                 and schedules and subsequent changes or
                 decreases should be limited to negative
                 assurance.



I
             (2) The agreed upon procedures performed by
                 the accountant s should be set forth in the
                 letter .


                              105
(3) Terms of uncertain meaning such as "re-
    view," "general review," "limited review,"
    "check, II or "test'l should not be used in
    describing the work, unless the procedures
    comprehended by the term are described in
    the comfort letter.
(4) The letter should specifically identify
    any unaudited financial statements and
    schedules to which it refers. The letter
    should state that the accountants have not
    examined such financial statements and
    schedules in accordance with generally ac-
    cepted auditing standards and do not ex-
    press an opinion concerning them.

(5) The accountants should not give negative
    assurance with respect to unaudited
    financial statements and schedules or
    changes or decreases unless they have made
    an examination of the client's financial
                                                  I
    statements for a period including or imme-
    diately prior to that to which the nega-
    tive assurance relates or have completed
    an examination for a later period.

(6) The accountants should not give negative
    assurance with respect to financial state-
    ments and schedules that have been exam-
    ined and are reported on in the registra-
    tion statement by other accountants .

(7) The accountants should not give negative
    assurance on pro forma adjustments applied
    to historical financial statements unless
    they have made an examination of the his-
    torical financial statements of the client
    (or, in the case of business combinations,
    of a significant constituent part of the
    combined financial statements) (1) for the
    period presented, or (2) in the case of
    interim periods , for the latest fiscal pe-
    riod which includes or precedes the in-
    terim period .
                                                  I
                      106
        (8) The procedures followed with respect to
            interim periods may not disclose changes
            in capital stock or long-term debt or de-
            creases in the specified financial-
            statement items, inconsistencies in the
            application of generally accepted account-
            ing principles, instances of noncompliance
            as to form with accounting requirements of
            the SEC, or other matters as to which neg-
            ative assurance is requested .
       (9) The working papers relating to comfort
           letters should be prepared in a manner so
           as to constitute adequate evidence of what
           has been done .




I
          Unaudited Financial Statements

    B. Comments in the comfort letter concerning the
       unaudited financial statements, summary of
       earnings, and schedules appearing in the reg-
       istration statement should always be made in
       the form of negative assurance . Frequently,
       such comments relate to (a) conformity with
       generally accepted accounting principles,
       (b) consistency with the audited financial
       statements, summary of earnings, and schedules
       included in the registration statement, and
       (c) compliance as to form with applicable ac-
       counting requirements.

    C. When the most recent figures included in a
       summary of earnings (or statement of income)
       are for a period of less than one year, the
       SEC usually requires that comparative figures
       be shown for the corresponding short period of
       the preceding year . Frequently the financial
       statements for the latest interim period are

I      unaudited, and financial statements for the
       interim period of the preceding year are ordi-
       narily unaudited, even though that period is


                           107
   part of a year for which the financial state-
   ments have been audited. In these circum-
   stances the unaudited status of the financial
   statements of the earlier period should be
   made clear in the comfort letter .

            Capsule Information
D. In many registration statements, the informa-
   tion shown in the summary of earnings (or
    statement of income) is supplemented by unau-
   dited information as to subsequent sales and
   earnings (coDDDonly called "capsule informa-
   tion"). This later information (either in
   narrative or in tabular form) is often shown
   in a paragraph following the summary, for a
   period within the current year and for the
   corresponding period of the prior year, and
   usually consists only of selected income-
   statement items. "Fair presentation," as used
                                                    I
   by independent certified public accountants,
   ordinarily relates to presentation in conform-
   ity with gen.e rally accepted accounting prin-
   ciples of financial statements as a whole, in-
   cluding the notes thereto; therefore accoun-
   tants, in giving negative assurance regarding
   selected income-statement items, should not
   make reference to fair presentation but should
   only refer to whether the dollar amounts were
   determined on a basis substantially consistent
   with that of the corresponding amounts in the
   audited statement of income .

E. In connection with capsule information, the
   underwriter occasionally asks the accountants
   (a) to give negative assurance with respect to
   the related unaudited financial statements and
   (b) to state that the capsule information
   agrees with amounts set forth in such state-
   ments. Although this is another means of ac-
   complishing the same objective as the method
   described in paragraph D, it is ordinarily not
                                                    I
   practicable. Even though trial balances , sum-

                       10 8
      mary financial data, or financial statements
      normally prepared for management use may be
      available in final form so as to provide an
      appropriate basis for the company to present
      capsule information, they will seldom have
      been prepared in such form or detail, includ-
      ing relevant notes, as to permit the indepen-
      dent public accountant to give negative assur-
      ance on fair presentation in conformity with
      generally accepted accounting principles. If
      the underwriter requests it, however, and if
      it is practicable for the client to prepare
      financial statements on a timely basis in con-
      formity with generally accepted accounting
      principles , it is appropriate for the accoun-
      tants to agree to the underwriter's request
      described in the first sentence of this para-
      graph.



I               Subsequent Changes

    F. Comments as to subsequent changes also should
       be in the form of negative assurance. They
       should not relate to "adverse changes" since,
       despite long use under Statement No. 35 and
       prior thereto, that term has not acquired any
       defined or clearly understood meaning in an
       accounting sense . In fact, upon reexamination,
       it appears that the term may , on some occa-
       sions, have been misinterpreted by underwrit-
       ers as encompassing judgments and conclusions
       not contemplated by the accountants. For ex-
       ample, there has been no agreement among ac-
       countants, clients, and underwriters as to
       whether the term relates only to absolute
       changes or also includes trends in amounts or
       ratios. Further, there are differences of
       view as to whether an adverse change in re-
       sults of operations is indicated solely by a
       decrease in net income or whether it also en-


I
       compasses changes in sales, cost of sales, and
       other factors which separately or together
       might indicate the beginning or accentuation

                           109
  of an adverse trend . Also, the term has some-
  times been construed as contemplating comments
  by accountants regarding matters to which
  their professional competence has little rele-
  vance, such as evaluating whether certain
  types of expenses that may decrease cu=ent
  income but are designed to increase future in-
  come (e . g . , research and development costs ,
  major advertising campaigns, and systems in-
  stallations) are adver se or not. In order
  that comments on subsequent changes be unam-
  biguous and their determination be within the
  professional competence of accountants, the
  comments should not relate to adverse changes ,
  but should ordinarily relate to whether there
  has been any change in capital stock or long-
  term debt or "decreases" in other specified
  financial-statement items during a period
  known as the "change period . " Usually these
  items would include the amounts of net current
  assets, net assets (stockholders ' equity) and
  net sales, and the total and/or per-share
                                                     I
  amounts of income before extraordinary items
  and of net income .

G. The discussion concerning subsequent changes
   is not intended to suggest that accountants
   should avoid mentioning in their letter any
   changes other than defined decreases or any
   other matters known to them which 10 their
   opinion would be of interest to the under-
   writer. However , since matters to be covered
   by the letter should be made clear in the
   meetings with the underwriter and should be
   contemplated by the underwriting agreement and
   in the draft comfort letter, and since there
   is no way of anticipating other matters which
   would be of interest to an underwriter, ac-
   countants should not make a general statement
   in comfort letter s that, as a result of ca=y-
   ing out the specified procedures , nothing else
   has come to their attention which would be of
   interest to the underwriter .
                                                     I
                        110
    H. In the context of a comfort letter, a decrease
       occurs when the amount of a financial-
        statement item at the cutoff date or for the
       change period (as if financial statements and
       their notes had been prepared at that date and
       for that period) is les s than the amount of
       the same item at a specified earlier date or
       for a specified earlier period. With respect
       to the items mentioned in paragraph F, the
       term "decrease" means (a) any combination of
       changes in amounts of current assets and cur-
       rent liabilities that results in decreased net
       current assets , (b) any combination of changes
       in amounts of assets and liabilities that re-
        sults in decreased net assets, (c) decreased
       net sales , and (d) any combination of changes
       in amounts of sales and expenses and/or
       outstanding shares that results in decreased


I
       total and/or per-share amounts of income be-
       fore extraordinar y items and of net income
       (including, in each instance, a greater loss
       or other negative amount). The change period
       for which the accountants give negative assur-
       ance in the comfort letter ends on the cutoff
       date and ordinarily begins (a) for balance-
       sheet items, immediately after the date of the
       latest balance sheet in the registration
       statement, and (b) for income-statement items,
       immediately after the latest period for which
       such items are presented in the registration
       statement . The comparison relates to the en-
       tire period and not to portions thereof. A
       decrease during one part of a period may be
       offset by an equal or larger increase in
       another part of the period; however, because
       there was no decrease for the period as a
       whole, the comfort letter would not report the
       decrease occurring during one part of the pe-
       riod.


I
                          111
I. Underwriters occasionally request that the
    change period begin immediately after the date
    of the latest audited balance sheet (ordi-
    narily also the closing date of the latest au-
    dited statement of income) in the registration
    statement, even though the registration state-
   ment includes a more recent unaudited balance
    sheet and statement of income . The use of the
    earlier date may defeat the underwriter's pur-
    pose since it is possible that an increase in
    one of the items referred to in paragraph F
    occurring between the dates of the latest au-
   dited and unaudited balance sheets included
    in the registration statement might more than
   offset a decrease occurring after the latter
   date. A similar situation might arise in the
   comparison of income- statement items . In
   these circumstances , the decrease occurring
   after the date of the latest financial state-
   ments included in the registration statement
   would not be reported in the comfort letter.
   It is desirable for the accountants to explain
                                                     I
   the foregoing considerations to the under-
   writer; however, if the underwriter nonethe-
   less requests the use of a change period or
   periods other than those described in para-
   graph H, the accountants may use the period or
   periods requested.

J. The underwriting agreement usually specifies
   the dates and periods with which data at the
   cutoff date and for the change period are to
   be compared . For balance-sheet items the com-
   parison date is normally that of the latest
   balance sheet included in the registration
   statement (i.e., immediately prior to the be-
   ginning of the change period); for income-
   statement items the comparison period or pe-
   riods might be one or more of the following:
   (a) the corresponding period of the preceding
   year , (b) a period of corresponding length im-
   mediately preceding the change period , (c) a
                                                     I
                        112
•      proportionate part of the preceding fiscal
       year, or (d) any other period of corresponding
       length chosen by the underwriter . Whether or
       not specified in the underwriting agreement,
       the date and period used in comparison should
       be identified in the comfort letter in both
       draft and final form so that there is no mis-
       understanding as to the matters being compared
       and so that the underwriter can determine
       whether the comparison period is suitable for
       his purposes.

    K. In addition to making the comparisons indi-
       cated above using the financial statements
       made available to them, the accountants will
       ordinarily be requested to read minutes and
       make inquiries of company officials relating
       to the whole of the change period . For the
       period between the date of the latest finan-

I      cial statements made available and the cutoff
       date, the accountants must necessarily base
       their comments solely on the limited proce-
       dures actually performed with respect to that
       period (which in most cases will be limited to
       the reading of minutes and the inquiries of
       company officials referred to in the preceding
       sentence), and their comfort letter should
       make this clear.

       Disclosure in Registration Statement

    L. Comments on the occurrence of changes in cap-
       ital stock or long-term debt and decreases in
       other specified financial-statement items are
       limited to changes or decreases not disclosed
       in the registration statement . This limita-
       tion is referred to in the letter by the
       phrase, " except for changes or decreases which
       the Registration Statement discloses have oc -
       curred or may occur ." Whenever it appears to


I      the accountants that a change or decrease has
       occurred during the change period, they should
       refer to the registration statement to deter-
       mine whether the change or decrease is dis-
       closed therein .
                          113
IX. Effect of Qualified Opinion

  A. The foregoing discussion contemplates that the
     accountants' opinion on the financial state-
     ments and schedules and the summary of earnings
     in the registration statement is unqualified .
     This usually is the case, Except in extraordi-
     nary circumstances, the requirements of the SEC
     do not permit a registration statement to be-
     come effective when the accountants' opinion is
     qualified as to the scope of their examination
     or as to the accounting principles reflected in
     the financial statements and schedules and the
     summary of earnings . However, such circum-
     stances do occasionally arise and, although the
     SEC may permit the registration statement to
     become effective even though the opinion is
     qualified, the accountants may not be in a po-
     sition to give an unqualified opinion that the
     financial statements in the registration state-
     ment comply as to form in all material respects
                                                        I
     with the published rules and regulations of the
     SEC under the Act .

  B. The SEC ordinarily will accept a " subject to"
     type of qualification in the accountants' opin-
     ion when there is uncertainty as to (a) the
     outcome of controversial matters such as liti-
     gation, renegotiation of contracts, or disputes
     concerning income taxes; (b) recovery of re-
     search and development costs or other deferred
     charges; or (c) other matters which are not
     susceptible of reasonable accounting determina-
     tion, but which might have a material effect on
     financial position or results of operations.

  C. If the opinion is qualified, the qualification
     should be referred to in the opening paragraph
     of the comfort letter by saying, for example,
     " ... our reports (which contain a qualification
     as set forth therein) with respect thereto are
     also included in such Registration Statement."
                                                        I
                          1 14
      D. If the letter includes negative assurance with
         respect to subsequent unaudited financial
         statements included in the registration state-
         ment or with respect to an absence of specified
         subsequent changes or decreases, the effect
         thereon of the subject matter of the qualifica-
         tion should also be considered.

    X.Other Accountants

      A. Comfort letters are occasionally requested from
         more than one accountant (for example, in con-
         nection with registration statements to be used
         in the subs equent sale of shares issued in re-
         cently effected mergers). In these circum-
         stances, each accountant must, of course, be
         sure he is independent within the meaning of
         the Act and the applicable published rules and
         regulations thereunder. In connection with


I
         opinions expressed prior to the acquisitions,
         the accountants for previously nonaffiliated
         companies recently acquired by the registrant
         would not be required to have been independent
         with respect to the company whose shares are
         being registered. In such a case, the accoun-
         tants should modify the wording suggested in
         paragraph V-A and make a statement regarding
         their independence along the following lines:

              As of [ insert date of the accountants'
         most recent report on the financial statements
         of their client] and during the period covered
         by the financial statements on which we re-
         ported, we were independent certified public
         accountants with respect to [ insert the name of
         their client] within the meaning of the Act and
         the applicable published rules and regulations
         thereunder and the answer to Item 24 of the
         Registration Statement is correct insofar as it
         relates to us.


I     B. There may be situations in which more than one
         accountant is involved in the examination of


                            115
the financial statements of a business and
where the reports of more than one accountant
appear in the registration statement. For ex-
ample, certain significant divisions, branches,
or subsidiaries may be examined by other ac-
countants. The principal accountants (those
who report on the consolidated financial state-
ments and consequently are asked to give a com-
fort letter with regard to information ex-
pressed on a consolidated basis) should read
the letter or letters of the other accountants
reporting on significant units. Such letters
should contain statements similar to those con-
tained in the comfort letter prepared by the
principal accountants, including statements as
to their independence. The principal accoun-
tants should state in their comfort letter that
(a) reading letters of other accountants was
one of the procedures followed, and (b) the


                                                   I
procedures performed by the principal accoun-
tants (other than reading the letters of the
other accountants) relate solely to (1) com-
panies examined by the principal accountants
and (2) the consolidated financial statements.
If 'the letters of the other accountants dis-
close decreases in financial-statement items
or any other matters that affect the negative
assurance that is given, the principal accoun-
tants should make mention of these matters in
their letter. Where appropriate, the principal
accountants may comment that there were no de-
creases in the consolidated financial-statement
items despite the decreases mentioned by the
other auditors. In such a case, the principal
accountants could give negative assurance that
nothing had come to their attention regarding
the consolidated financial statements as a re-
sult of the spec ified procedures (which, so far
as the related company was concerned, consisted
solely of reading the other accountants' let-
ter) that caused them to believe that ••.•




                       11 6
                                                   I
       c.   At the earliest practicable date, the client
            should advise any other accountants who may be
            involved as to any letter that may be required
            from them and should arrange for them to re-
            ceive a draft of the underwriting agreement so
            that they may make arrangements at an early
            date for the preparation of a draft of their
            letter (a copy of which draft should be fur-
            nished to the principal accountants ) and for
            the performance of their procedures .

       D. When a comfort letter is furnished to other ac-
          countants, it should be addressed in accordance
          with paragraph III-A, with copies furnished to
          the principal accountants and their client.

    XI.Tables, Statistics and Other
       Financial Information



I     A. The underwriting agreement sometimes calls for
         a comfort letter which includes comments on
         tables, statistics and other financial informa-
         tion appearing in the registration statement.

       B. The accountants should refrain from commenting
          on matters to which their competence as inde-
          pendent public accountants has little rele-
          vance . Accordingly, except as indicated in the
          next sentence, they should comment only with
          respect to information (a) which is expresed
          in dollars (or percentages derived from such
          dollar amounts) and has been obtained from ac-
          counting records which are sub j ect to the in-
          ternal controls of the company's accounting
          system or (b) which has been derived directly
          from such accounting records by analysis or
          computation . The accountants may also comment
          on quantitative information which has been ob-
          tained from an accounting record if the infor-
          mation is of a type that is subject to the same


I
          controls as the dollar amounts. Accountants
          should not comment on matters involving primar-
          ily the exercise of business judgment of

                               1 17
  management. For example, changes between peri-
  ods in gross profit ratios or net income may be
  caused by factors that are not necessarily
  within the expertise of accountants. Simi-
  larly, even though the accountants might appro-
  priately comment on amounts shown as profit con-
  tributions for each line of business as defined
  by management, it would seldom be appropriate
  for them to comment on the reasonableness of
  management's determination of the client's
  lines of business . The accountants should not
  comment on matters merely because they happen
  to be present and are capable of reading,
  counting, measuring or performing other func-
  tions which might be applicable. Examples of
  matters that, unless subjected to the internal
  controls of the formal accounting system (which
  is not ordinarily the case), should not be com-
  mented on by the accountants include square
  footage of facilities , number of employees (ex-
  cept as related to a given payroll period) and
  backlog information. The accountants should
                                                      I   I
  not comment on tables, statistics and other fi-
  nancial information relating to an unaudited
  period unless they have made an examination of
  the client's financial statements for a period
  including or immediately prior to the unaudited
  period or have completed an examination for a
  later period .

C. As with comments relating to financial state-
   ment information, it is important that the pro-
   cedures followed by the accountants with respect
   to other information be clearly set out in the
   comfort letter, in both draft and final form,
   so that there will be no misunderstanding as to
   the basis of comments thereon . Further, so
   that there will be no implication that the ac-
   countants are furnishing any assurance as to
   the sufficiency of the procedures for the un-
   derwriter's intended purpose, it is advisable
   for the comfort letter to contain a statement
   to this effect.
                                                      I
                        118
    D. In order to avoid ambiguity, the specific in-
       formation commented on in the letter should be
       identified by reference to captions, tables,
       page numbers, or specific paragraphs or sen-
       telces. It should not refer, for example, to
       "all financial and statistical information" set
       forth (a) in the registration statement, (b)
       under specific captions, or (c) in response to
       specific item numbers in the registration
       statement.
    E. Comments in the comfort letter concerning ta-
       bles, statistics, and other financial informa-
       tion appearing in the registration statement
       should be made in the form of a description of
       the procedures followed, the findings (ordi-
       narily expressed in terms of agreement between
       items compared), and in some cases, as de-
       scribed below, statements with respect to the

I      acceptability of methods of allocation used in
       deriving the figures commented upon . Whether
       comments upon the allocation of income or ex-
       pense items between such categories as military
       and commercial sales, or lines of business, may
       appropriately be made will depend upon the ex-
       tent to which such allocation is made in, or
       can be derived directly by analysis or computa-
       tion from, the client's accounting records. In
       any event such comments, if made, should make
       clear that such allocations are to a substan-
       tial extent arbitrary, that the method of allo-
       cation used is not the only acceptable one, and
       that other acceptable methods of allocation
       might produce significantly different results.

    F. In comments concerning tables, statistics, and
       other financial information the expression,
       "presents fairly" (or a variation of it),
       should not be used. That expression, when used
       by independent certified public accountants,


I      ordinarily relates to presentation of financial
       statements and should not be used in commenting
       on other types of information. Except with

                           119
       respect to requirements for financial state-
       ments, the question of what constitutes appro-
       priate information for compliance with the re-
       quirements of a particular item of the regis-
       tration statement form is a matter of legal in-
       terpretation outside the competence of the ac-
       countants . Consequently, the letter should
       state that the accountants make no representa-
       tions as to any matter of legal interpretation.
       Since the accountants will not be in a position
       to make any representations as to the complete-
       ness or adequacy of disclosure or as to the ad-
       equacy of the procedures followed, the letter
       should so state. It should point out as well
       that such procedures would not necessarily dis-
       close material misstatements or omissions in
       the information to which the comments relate.

XlI. Concluding Paragraph
    A. In order to avoid misunderstanding as to the
                                                         I
       purpose and intended use of the comfort letter,
       it is desirable that the letter conclude with a
       paragraph along the following lines:

            This letter is solely for the information
       of, and assistance to, the underwriters in con-
       ducting and documenting their investigation of
       the affairs of the Company in connection with
       the offering of the securities covered by the
       Registration Statement, and is not to be used,
       circulated, quoted or otherwise referred to
       within or without the underwriting group for
       any other purpose, including but not limited to
       the registration, purchase, or sale of securi-
       ties, nor is it to be filed with or referred to
       in whole or in part in the Registration State-
       ment or any other document, except that refer-
       ence may be made to it in the underwriting
       agreement or in any list of closing documents
       pertaining to the offering of the securities
       covered by the Registration Statement.
                                                         I
                            120
~XIII'   Miscellaneous

         A. Accountants who discover matters that may re-
            quire mention in the final comfort letter but
            which are not mentioned in the draft letter
            that has been furnished to the underwriter,
            such as decreases or changes in specified items
            not disclosed in the registration statement,
            will naturally want to discuss them with their
            client, so that consideration can be given to
            whether disclosure should be made in the regis-
            tration statement. If such disclosure is not
            to be made, the accountants should inform the
            client that mention thereof will be made in the
            comfort letter and suggest that the underwriter
            be promptly so informed . It is recommended
            that the accountants be present when such mat-
            ters are discussed between the client and the
            underwriter.


I



I
                              121
                   STATEMENT NO. 49

              REPORTS ON INTERNAL CONTROL

 1. General

    A. Independent auditors are sometimes requested to
       furnish reports on their evaluation of internal
       control for use by management, regulatory agen-
       cies, other independent auditors, or the general
       public. The purpose of this Statement is to
       improve the understanding of such reports with
       reference to the nature and effectiveness of
       internal control and the independent auditor's
       evaluation of it.

    B.   As used in this Statement, management includes
         directors, officers, and others who perform
         managerial functions; regulatory agencies in-
         clude both governmental and other agencies, such
         as stock exchanges, that exercise regulatory,
                                                             I
         supervisory, or other public administrativefunc-
         tions; and the general public includes present
         and prospective investors, creditors, customers,
         and others who have an interest in particular
         organizations.

II. Nature and Effectiveness of Internal Control

   A. Internal control is described in Statement on
      Auditing Procedure No. 33, as follows:

              In the broad sense, internal control in-
         cludes ... controls which may be characterized as
         either accounting or administrative , as follows:

              1. Accounting controls comprise the plan of
                 organization and all methods and proce-
                 dures that are concerned mainly with, and
                 relate directly to, safeguarding of as_
                 sets and the reliability of the financial
                 records. They generally include such
                                                             I
                 controls as the systems of authorization

                             122
               and approval, separation of duties con-
               cerned with record keeping and accounting
               reports from those concerned with opera-
               tions or asset custody , physical controls
               over assets, and internal auditing.

            2. Administrative controls comprise the plan
               of organizati on and all methods and pro-
               cedures that are concerned mainly with
               operational efficiency and adherence to
               managerial policies and usually relate
               only indirectly to the financial records.
               They generally include such controls as
               statistical analyses, time and motion
               studies, performance reports, employee
               training programs, and quality controls.

    B. Th.e establishment and maintenance of a system of
       internal control is an important responsibility


I
       of management. In exercising this function, it
       is appropriate for management to recognize that
       the cost of internal control should not exceed
       the benefits derived . The benefits consist of
       reductions in the risk of failing to achieve the
       objectives implicit in the definition of inter-
       nal control. Although the cost-benefit rela-
       tionship is the primary conceptual criterion
       that should be considered in designing a system
       of internal control, precise measurement of
       costs and benefits usually is not possible; ac-
       cordingly, any evaluation of the cost-benefit
       relationship requires estimates and judgments by
       management.
    C. There are inherent limitations that should be
       recognized in considering the potential effec-
       tiveness of any system of internal control. In
       the performance of most control procedures er-
       rors can result from misunderstanding of in-
       structions, mistakes of judgment, carelessness,


I
       or other personal factors. Control procedures
       whose effectiveness depends on segregation of
       duties can be circumvented by collusion.

                            123
       Similarly, control procedures can be circum-
       vented intentionally by management with respect
       to (1) the execution and recording of transac-
       tions or (2) the estimates and judgments re-
       quired in the preparation of financial state-
       ments.

    D. A satisfactory system of internal control can
       be expected to provide reasonable, but not ab-
       solute, assurance that its objectives will be
       accomplished. Conversely, weaknesses in a
       system do not necessarily mean that errors and
       irregularities will occur.

    E. In addition to the limitations discussed above,
       any projection of a current evaluation of inter-
       nal accounting control to future periods is
       subject to the risk that the procedures may be-
       come inadequate because of changes in conditions
       and that the degree of compliance with the pre-
       cedures may deteriorate.
                                                          I
III. Purpose and Scope of Auditor's Study and Evaluation

    A. The purpose of the auditor's study and evaluation
       of internal control incident to his examination
       of financial statements is to establish a basis
       for reliance thereon in determining the nature,
       timing, and extent of audit tests to be applied.
       This is expressed in th.e second standard of field
       work:

            There is to be a proper study and evaluation
       of the existing internal control as a basis for
       reliance thereon and for the determination of the
       resultant extent of the tests to which auditing
       procedures are to be restricted.

       Suggestions for improvement in internal control
       frequently arise from audit engagements and may
       also arise from special engagements undertaken
       for that or other purposes.
                                                          I
                          124
    B. The subdivision of internal control into account-
       ing control and administrative control was made
       primarily to clarify the scope of the study re-
       quired under generally accepted auditing stan-
       dards. The conclusions in that respect, as ex-
       pressed in Statement on Auditing Procedure No. 33,
       were as follows:

           The independent auditor is primarily con-
      cerned with the accounting controls. Accounting
      controls, as previously described, generally bear
      directly and importantly on the reliability of
      financial records and require evaluation by the
      auditor. Administrative controls, also previously
      described, ordinarily relate only indirectly to
      the financial records and thus would not require
      evaluation. If the independent auditor believes,
      however, that certain administrative controls may
      have an important bearing on the reliability of


I     the financial records, he should consider the need
      for evaluating such controls. For example, sta-
      tistical records maintained by production, sales
      or other operating departments may require eval-
      uation in a particular instance.
    C. The overriding criterion inherent in the preced-
       ing excerpt is the bearing that particular con-
       trols have on the reliability of financial rec-
       ords, regardless of their classification as ac-
       counting or administrative controls. For prac-
       tical purposes, this is tantamount to including
       within the definition of accounting control any
       administrative control procedures that have been
       evaluated by an auditor because he believed they
       had an important bearing on the reliability of
       the financial records. This concept of account-
       ing control is applied for convenience hereafter
       in this Statement.

      The study made as the basis for the auditor's
      evaluation of accounting control includes two
      phases, as indicated by Statement on Auditing
      Procedure No. 33:


                            125
            Adequate evaluation of a system of internal
       control requires [ 1] knowledge and understanding
       of the procedures and methods prescribed and [2]
       a reasonable degree of assurance that they are
       in use and are operating as planned.

      These two phases of the study are referred to in
      this Statement as (1) the review of the system
      and (2) tests of compliance with the system, re-
      spectively .
    E. Since the purpose of the evaluation required by
       the second standard of fieldwork is to provide
       a basis for determining the "extent of the tests
       to which auditing procedures are to be restricted,"
       it is clear that its purpose is to contribute to
       the "reasonable basis for an opinion" comprehended
       in the third standard which is quoted below:

            Sufficient competent evidential matter is
       to be obtained through inspection, observation,
       inquiries and confirmations to afford a reason-
                                                           I
       able basis for an opinion regarding the finan-
       cial statements under examination.
    F. The evidential matter required by this standard
       1s obtained through audi ting procedures deSigned
       to test the validity and the propriety of account-
       ing treatment of transactions and balances. The
       second standard does not contemplate that the
       auditor should place complete reliance on inter-
       nal accounting control to the exclusion of other
       auditing procedures with respect to material
       items in the financial statements. Consequently,
       the auditor's review and tests of internal ac-
       counting control should be recognized as being
       only a part of his examination of financial state-
       ments.

IV . Usefulness of Reports on Internal Control




                           126
                                                           I
    A. Because of the technical nature and complexity
       of internal accounting control and the conse-
       quent problem of understanding reports thereon,
       questions have been raised as to whether such re-
       ports serve a useful purpose for all persons to
       whom they might be issued. The usefulness of
       such reports depends on the understanding of the
       reports and on the action that can be taken by
       those to whom the reports are issued. The ex-
       pected usefulness to the principal classes or
       groups of such persons is discussed in the re-
       mainder of this section.

       Management, Regulatory Agencies, and Independent
       Auditors

    B. Management is responsible for establishing and
       maintaining internal accounting control. Regula-
       tory agencies may be concerned with such control


I
       because it is relevant to their primary regula-
       tory purpose or to the scope of their examination
       functions . Independent auditors of one entity
       or organization unit may be concerned with inter-
       nal accounting control of another because it is
       relevant to the scope of their examination. It
       may be presumed that these groups include persons
       whose training and experience or intimate knowl-
       edge of the organization should provide a reason-
       able basis for understanding the nature and ef-
       fectiveness of internal accounting control and
       the auditor's evaluation of it. Consequently, it
       is evident that reports on internal accounting
       control can Serve a useful purpose for management,
       regulatory agencies, and other independent audi-
       tors.

      General Public

    C. In contrast to the foregoing groups, the useful-
       ness of reports on internal accounting control


I
       to the general public is questionable. The
       groups discussed in the preceding paragraph are


                            127
   directly concerned with internal accounting con-
   trol and are in a position to take direct action
   as a result of reports thereon. On the other
   hand, any possible action that could be taken by
   the general public as a result of such reports
   would be indirect since it ordinarily would be
   limited to making decisions about either a com-
   pany's financial statements or its management.
   The usefulness of reports on internal accounting
   control for these purposes is discussed in the
   next three paragraphs.

D. Insofar as audited financial statements are con-
   cerned, the auditor's evaluation of internal ac-
   counting control is only an intermediate step in
   forming the opinion he expresses on such state-
   ments. Therefore, an auditor's report on his
   evaluation of internal accounting control would
   not provide any additional credibil i ty to audited


                                                         I
   financial statements .
E. Insofar as interim or other unaudited financial
   statements are concerned, a report on an auditor's
  evaluation of internal accounting control for an
  earlier period could only be used to project the
  evaluation into the future as a basis for reliance
  on the unaudited statements. Depending on the
  evaluation expressed in the report, such projec-
  tions into the future could either increase or
  decrease the reliance that otherwise would be
  placed on the unaudited statements. Some believe
  that such proj ections would serve a useful pur-
  pose because the public is interested in unaudited
  statements and because the effectiveness of inter-
  nal accounting control has a bearing on the prob-
  ability that such statements will be reliable.
  Although conceding the relevance of internal ac-
  counting control in this respect, others believe
  that projections of auditors' evaluations thereof
  would result in either unwarranted reliance on,


                                                         I
  or unduly negative inferences concerning, unau-
  dited financial statements. The latter group be-
  lieves that unwarranted reliance would result

                          12 8
---.

•      from improper understanding of the inherent lim-
       itations on any system of internal accounting
       control,of the purpose and scope of the auditor's
       evaluation, and of the risks of projecting such
       evaluations into the future. Conversely, this
       same group believes unduly negative inferences
       would result from improper understanding that
       weaknesses in internal accounting control relate
       to conditions that could, but would not necessarily,
       cause unaudited financial statements to be mislead-
       ing.

    F. There are also different views as to the useful-
       ness of reports on internal accounting control
       for the purpose of making decisions about manage-
       ment's performance. Some believe such reports
       would be useful for that purpose because inter-
       nal accounting control is an important area of
       management responsibility. Others believe the


I
       relative importance of this area of management
       responsibility, as compared to other areas for
       which reports are not presently available or fea-
       sible, is such that reports on internal account-
       ing control alone would result in distorted ap-
       praisals of management performance.

    G. Although the general public has been defined
       broadly in this Statement, the Committee recog-
       nizes that within this group there may be con-
       siderable variation in the degree to which the
       conflicting expectations expressed in paragraphs
       E and F will materialize. This variation may
       arise from, and reflect differences in, circum-
       stances such as the type and extent of invest-
       ment or other interest in the organization and
       the related influence on management action, and
       the level of understanding of the nature and
       limitations of internal accounting control.

    H. Considering the conflicting views discussed


I
       above and the limited experience with such re-
       ports, the Committee has concluded that the de-
       cision as to whether reports on an auditor's

                             129
       evaluation of internal accounting control
       be useful for some portion or all of the generar
       public in particular cases or classes of cases
       is the responsibility of management and/or any
       regulatory agencies having jurisdiction.

    1. In no event, however, should an audi tor autho-
       rize a report on his evaluation of internal ac-
       counting control t o be issued to the general
       public in a document that includes unaudited
       financial statements .

V. Form for Reports on Internal Control

  Reports Based on Audits

  A. If reports on auditors' evaluations of internal

     tee believes the risk of misunderstanding can
     reduced by adopting a form of report that de-
     scribes in reasonable detail the objective and
                                                    bel
     accounting control are to be issued, the Commit-



     limitations of internal accounting control and
     the auditor's evaluation of it. Therefore, the
     following language should be used for such pur-
     pose except as di scussed in the subsequent para-
     graphs in this Statement.
          We have examined the financial statements of
     ABC Company for the year ended December 31, 1970
     and have issued our report thereon dated Febru-
     ary 23, 1971. As a part of our examtnation, we
     reviewed and tested the Company's system of in-
     ternal accounting control to the extent we con-
     sidered necessary to evaluate the system as re-
     quired by generally accepted auditing standards .
     Under these standards the purpose of such evalua-
     tion is to establish a basis for reliance thereon
     in determining the nature, timing, and extent of
     other auditing procedures that are necessary for
     expressing an opinion on the financial state-
     ments.



                            130
                                                         I
          The ebjective ef internal acceunting centrel
    is to. previde reasenable, but net abselute, as-
    surance as to. the safeguarding ef assets against
    less frem unautherized use er dispesitien, and
    the reliability ef financial recerds fer prepar-
    ing financial statements and maintaining acceunt-
    ability fer assets. The cencept ef reasenable
    assurance recegnizes that the cest ef a system ef
    internal acceunting centrel sheuld net exceed the
    benefits derived and also. recegnizes that the
    evaluatien ef these facters necessarily requires
    estimates and judgments by management.
          There are inherent limitatiens that sheuld
    be recegnized in censidering the petential effec-
    tiveness ef any system ef internal acceunti ng
    centrel . In the perfermance ef mest centrel pre-
    cedures, errers can result frem misunderstanding
    ef instructiens, mistakes ef judgment, careless-
    ness, er ether persenal facters. Centrel prece-


I   dures whese effectiveness depends upen segrega-
    tien ef duties can be circumvented by cellusien .
    Similarly, centrel precedures can be circumvented
    intentienally by management with respect e i ther
    to. the executien and recerding ef transactiens er
    with respect to. the estimates and judgments re-
    quired in the preparatien ef financial state-
    ments . Further, prejectien ef any evaluatien ef
    internal acceunting centrel to. future perieds is
    subject to. the risk that the precedures may be-
    ceme inadequate because ef changes in cenditiens,
    and that the degree ef cempliance with the prece-
    dures may deterierate.

         Our study and evaluation ef the Company' s
    system ef internal acceunting centrel fer the
    year ended December 31, 1970, which was made fer
    the purpese set ferth in the first paragraph
    abeve, was net designed fer the purpese ef ex-
    pressing an epinien en internal acceunting cen-
    trel and it weuld net necessarily disc lese all


I   weaknesses in the system. Hewever, such study
    and evaluatien disclesed the fellewing cenditiens
    that we believe to. be material weaknesses.

                           131
   The above paragraphs should be followed by appro-
   priate description of the material weaknesses .
   The descriptions should indicate whether the
   weaknesses relate to the prescribed procedures or
   to compliance with them . The report may also in-
   clude recommendations for improvements, comments
   concerning corrective action taken or in process,
   or other comments appropriate in the circum-
   stances . The basis for any comments concerning
   subsequent corrective action should be indicated,
   including the scope of any review and tests by
   the auditor. Although the Committee believes the
   first paragraph of the foregoing form of report
   clearly indicates that weaknesses in the system
   are considered in determining the nature, timing,
   and extent of auditing procedures necessary for
   expressing an opinion on financial statements,
   some auditors may want to include further com-
   ments in this respect.

B. In some cases the auditor may conclude that for
   certain weaknesses corrective action by manage-
   ment is not practicable in the circumstances and
   he. may decide to exclude such weaknesses from his
                                                        I
   report. If such weaknesses are excluded , the
   last sentence of the above form of report should
   be modified as follows:
        However, such study and evaluation disclosed
   the following conditions that we believe to be
   material weaknesses for whi ch corrective action
   by management may be practicable in the circum-
   stances.

  Such a report should include appropriate descrip-
  tion of material weaknesses for whi ch the auditor
  has either (1) concluded that correcti ve action
  by management is practicable, or (2) formed no
  conclusion in this respect.

C. If there are no conditions to be reported in ac-
   cordance with the two preceding paragraphs, t he
   word "no" should be substituted for "the follow-
                                                        I
   ing" in the above form of report .
                         132
    ~
'- )0.   The auditor may want to report other weaknesses,
         regardless of his judgment as to materiality or
         practicability of corrective action by manage-
         ment. The latter might include situations in
         which the organization is too small to permit
         adequate segregation of duties of employees. In
         any of these situations the language in para-
         graph A should be modified as appropriate. If
         some weaknesses are reported to one group but not
         to another (for example, to management but not to
         regulatory agencies or to the general public),
         the more extensive report should distinguish the
         weaknesses that are excluded from the other re-
         port and the auditor should be prepared to sup-
         port, if necessary, his judgment in making the
         distinction.

    E. In some cases reports on internal accounting con-
       trol may include comments on additional matters .


I
       For example, a regulatory agency may require com-
       ments on certain aspects of administrative con-
       trol or on compliance with certain provisions in
       contracts or regulations. In such cases the
       language in paragraph A should be modified to
       identify clearly the additional matters and dis-
       tinguish them from internal accounting control,
       to describe in reasonable detail the scope of the
         review and tests concerning them, and to express
         conclusions in language comparable to that in
         paragraphs A through 0 as appropriate. The iden-
         tification of the additional matters covered in
         the report should be as specific as the auditor
         considers necessary to prevent misunderstanding
         in this respect. Such identification can be made
         in some cases by reference to specific portions
         of other documents such as contracts or regula-
         tions.

    F. Since auditors are aware of the objective and
       limitations of internal accounting control and of
       auditors' evaluations of it, use of the form of

I      report in paragraph A is optional for reports is -
       sued solely for another independent auditor.

                             133
                             ·                        (~
G. Use of the form of report 10 paragraph A is op- \   ~
   tional also for reports issued solely for the in-
   ternal information of management. Suggestions or
   other comments concerning specific aspects of in-
   ternal accounting control and various other mat-
   ters are often submitted to management by audi-
   tors as a result of observations made during
   their examinations of financial statements.
   These comments are often submitted by letters,
   memoranda, and other less formal means. The Com-
   mittee encourages this practice and this State-
   ment is not intended to preclude the use of such
   means of communication.

Reports Based on Special Studies

H. Reports on internal accounting control sometimes
   are issued as a result of special studies. As
   used in this Statement, special studies are those
   in which the scope of the study and evaluation
   being reported is substantially more extensive
   than that required for an examinatio.n of finan-
                                                      I
   cial statements in accordance with generally ac-
   cepted auditing standards. Special studies may
   relate either to an existing system or to a pro-
   posed system.

I. If reports on special studies of internal ac-
   counting control are to be issued to regulatory
   agencies or to the general public, the form of
   report in paragraph A should be adapted by re-
   placing the first paragraph and modifying the
   fourth paragraph therein. The first paragraph
   should describe the purpose and scope of the
   study. This description should be in reasonable
   detail and should indicate whether the scope in-
   cluded both a review of the system and test of
   compliance with it . The fourth paragraph should
   be modified to refer to the purpose of the
   special study and any related limitations and to
   refer to the weaknesses disclosed or the absence
   thereof by using the language included in para-
   graphs A through C as appropriate in the circum-
   stances .
                       134
                                                      I
    J. For reports issued solely for use by management
       or other independent auditors, the flexibility in
       reporting provided for in paragraphs F and G ap -
       plies also to reports based on special studies.




I



I                           135
                   STATEMENT NO . 50

        REPORTING ON THE STATEMENT OF CHANGES

                IN FINANCIAL POSITION

       (Supersedes paragraphs 6 of Chapter 10 of
                   Statement No. 33)

 I. The purpose of this statement is to revise the rec-
    ommended short-form auditor's report in order to
    foster uniformity of language in giving recognition
    to the provisions of APB Opinion No. 19 in report-
    ing on financial statements that purport to present
    financial position and results of operations .

II. Short-Form Report

   A. The following short form of independent audi-
      tor ' s report is recommended to replace the re-
      port set forth in Statement on Auditing Proce-
      dure No . 33:

           We have examined the balance sheet of X
      Company as of December 31, 19__ and the related
      statements of income and retained earnings 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 account-
      ing records and such other auditing procedures
      as we considered necessary in the circumstances .

           In our opinion, the aforementioned finan-
      cial statements present fairly the financial
      position of X Company at December 31, 19__ ,
      and the results of its operations and the
      changes in its financial position for the year
      then ended, in confOrmity with generally ac-
      cepted accounting principles applied on a basis
      consistent with that of the preceding year .



                          13 6
                                                          I
    III. Variations in Format and
         Presentation Between Periods

        A. In APB Opinion No. 19, the Board concluded
           that " . .. the statement summarizing changes in
           financial position should be based on a broad
           concept embracing all changes in financial
           position . . .. " In APB Opinion. No. 19, how-
           ever, the Board recognized " ... the need for
           flexibility in form, content, and terminology
           ... " of the statement of changes . Accordingly,
           variations between periods in the format of the
           statement of changes, such as changing to or
           from a balanced form, are deemed to be reclas-
           Sifications. If such variations materially af-
           fect comparability, they should be disclosed
           in the finanCial statements and ordinarily will
           not be referred to in the independent auditor's
           report.


I       B. However, variations between periods in the
           terms used to express changes in finanCial
           position, such as changing from cash to working
           capital, constitute a change in the application
           of accounting principles and involve the con-
           sistency standard . When such a change occurs,
           and the independent auditor deems it to be
           material, he should express in his opinion an
           exception as to consistency. An entity making
           such a change in the current period may present
           comparative financial statements for a prior
           period that have been restated to conform with
           those of the current period. Such a restate-
           ment places both periods on the same basis with
           respect to the use and application of account-
           ing principles. The restatement should be dis-
           closed and the auditor should refer to it in
           his report.




I                            137
IV. Omission of Information Considered Essential
     for a Fair Presentation

   A. APB Opinion No . 19 sets forth various types of
      information that should be disclosed in the
      statement of changes. When the auditor believes
      that information essential for a fair presenta-
      tion has been omitted from the statement of
      changes, he should provide that information in
      his report and appropriately qualify his opinion.

V. Omission of Statement of Changes

   A. If an entity issues finanCial statements that
      purport to present finanCial position (balance
      sheet) and results of operations (statement of
      income and retained earnings) but omits the re-
      lated statement of changes, and if the omission
      is not sanctioned by Opinion No . 19 of the Ac-
      counting Principles Board, the omission should
      be treated in accordance with the provisions of
                                                        I
      the Special Bulletin of the American Institute
      of Certified Public Accountants issued in Octo-
      ber 1964 relating to disclosures of departures
      from Opinions of the Accounting Principles
      Board. Accordingly, the auditor normally will
      conclude that the omission requires qualifica-
      tion of his opinion as discussed in paragraph B
      below.

   B. An entity's failure to disclose required in-
      formation normally results in the auditor in-
      cluding that information in his report . Al-
      though this procedure is appropriate with re-
      spect to specific disclosures relating to
      financial statements that are presented, the
      committee has concluded that it is not appropri-
      ate to require the auditor to prepare a basic
      financial statement (a statement of changes for
      one or more years) and include it in his report,
      when the client's management has declined to
      present such a statement. Accordingly, in thes


                         138
       cases the auditor should qualify his report,
       ordinarily in the following manner:

            We have examined the balance sheet of X
       Company as of December 31, 19__ and the related
       statements of income and retained earnings 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 othe r audit-
       ing procedures as we considered necessary in the
       circumstances.

            The company declined to present a s tatement
       of changes in financial position for the year
       ended December 31, 19__ . Presentation of such a
       statement summarizing the company's financing
       and investing activities and other changes in
       its financial position is required by Opinion
       No. 19 of the Accounting Principles Board .

             In our opinion, except that the omission of
       a statement of changes in financial position re-
       sults in an incomplete presentation as explained
       in the preceding paragraph, the aforementioned
       financial statements present fairly the finan-
       cial position of X Company at December 31, 19__ ,
       and the results of its operations for the year
       then ended, in conformity with generally ac-
       cepted accounting principles applied on a basis
       consistent with that of the preceding year.

    C. A certified public accountant may be a s sociated
       with unaudited financial statements that purport
       to present financial position (balance sheet)
       and results of operations (statement of income
       and retained earnings), but omit the related
       statement of changes. In such a case, the ac-
       countant is not required to prepare a statement
       of changes and i nclude it in his accompanying


I      report . However:



                          139
(1) When such statements are restricted to in-
    ternal use by the client, the accountant
    normally will conclude that the omission
    requires him to add to his accompanying dis-
    claimer of opinion, in addition to other re-
    quired information, an indication that the
    statement of changes has been omitted .

(2) When such s tatements are not so restricted,
    the accountant normally will conclude that
    the omission requires him to add to his ac-
    companying disclaimer of opinion, in addi-
    tion to other information that may be re-
    quired, an indication that such financial
    statements do not conform to generally ac-
    cepted accounting principles becau se the
    related statement of changes in not pre-
    sented.




                       140
                                                   I
I