Prospective Financial Statements: Forecasts, Projections, and CPA Exam Standards

Understanding Prospective Financial Statements

Prospective financial statements present expected future financial position, results of operations, and cash flows based on assumptions about conditions expected to exist and courses of action expected to be taken. Under AICPA standards, there are two types of prospective financial statements: financial forecasts and financial projections. Understanding the differences between these types and the practitioner's responsibilities for each is important for the CPA AUD exam.

Forecasts vs. Projections

Financial Forecasts

A financial forecast presents, to the best of the responsible party's knowledge and belief, the entity's expected financial position, results of operations, and cash flows. A forecast is based on assumptions reflecting conditions the responsible party expects to exist and the course of action it expects to take. Forecasts may be expressed as a single-point estimate or as a range. Forecasts may be distributed to the general public or to parties with whom the entity does not have a direct relationship.

Financial Projections

A financial projection presents, to the best of the responsible party's knowledge and belief, the entity's expected financial position, results of operations, and cash flows given one or more hypothetical assumptions. Unlike forecasts, projections are based on hypothetical assumptions, which are conditions or courses of action that are not necessarily expected to occur. Because of the hypothetical nature of the assumptions, projections are restricted to the party that engaged the practitioner and parties with whom the responsible party is negotiating directly. They should not be distributed to the general public.

Types of Engagements

Examination Engagements

Under AT-C Section 305, a practitioner may examine prospective financial statements and express an opinion on whether the statements are presented in conformity with AICPA presentation guidelines and whether the underlying assumptions provide a reasonable basis for the forecast or a reasonable basis for the projection given the hypothetical assumptions. The examination provides reasonable assurance.

Compilation Engagements

A practitioner may also compile prospective financial statements, which involves assembling them based on the responsible party's assumptions. In a compilation, the practitioner does not express any assurance on the statements or the underlying assumptions. However, the practitioner should not compile prospective financial statements that contain obviously inappropriate assumptions.

Agreed-Upon Procedures

A practitioner may also perform agreed-upon procedures on prospective financial statements, reporting findings without providing assurance.

Examination Procedures

When examining prospective financial statements, the practitioner evaluates the preparation of the statements, the support underlying the assumptions, and the presentation of the statements. Key procedures include evaluating whether the assumptions are suitably supported and provide a reasonable basis for the statements, testing the mathematical accuracy of the computations, assessing the adequacy of disclosures, and evaluating whether the presentation conforms to AICPA guidelines.

Evaluating Assumptions

The practitioner evaluates whether the assumptions are internally consistent, whether they are consistent with the entity's plans, and whether they are supported by available information. For forecasts, the assumptions should reflect conditions that the responsible party expects to exist. For projections, the practitioner evaluates whether the hypothetical assumptions are consistent with the purpose of the projection and whether the remaining assumptions are reasonable given the hypothetical assumptions.

Reporting

The practitioner's report on examined prospective financial statements includes a statement identifying the prospective financial statements, an indication of the responsible party's responsibility for the statements and the practitioner's responsibility, a statement that the examination was conducted in accordance with attestation standards, a caveat that prospective results may not be achieved, and the practitioner's opinion. For projections, the report also identifies the hypothetical assumptions and states that the projection is restricted to specified parties.

CPA Exam Key Points

• Forecasts use expected assumptions and may be distributed generally; projections use hypothetical assumptions and are restricted in distribution.
• An examination of prospective financial statements provides an opinion on presentation and reasonableness of assumptions, not on the accuracy of the expected results.
• The practitioner's report must include a caveat that prospective results may not be achieved.
• Compilations provide no assurance on prospective financial statements.
• A practitioner should not examine or compile prospective statements for periods exceeding three years unless the engagement is for a specific purpose such as a long-term capital project.