(Reference: SEC Committee Joint Meeting with SEC Staff - June 27, 2000)

May 24, 2000

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Dear Practitioner:

We understand that your firm has audited the financial statements of one or more small businesses that file reports with the Securities and Exchange Commission. There are a number of accounting and auditing issues that arise frequently in the course of our reviews of filings by small businesses. To help you better serve your client, this letter identifies some of the more common issues that you will want to consider before your audit report is included in a filing with the Commission.

Current issues of interest to practitioners. Information about small business forms and rules and current accounting and disclosure issues is available at the SEC web site www.sec.gov. Two staff outlines that may be useful to you are "Frequently Requested Accounting and Financial Reporting Interpretations and Guidance," available at www.sec.gov/offices/corpfin/cfactfaq.htm, and "Current Accounting and Disclosure Issues in the Division of Corporation Finance," available at www.sec.gov/offices/corpfin/acctdisc.htm. Recent Staff Accounting Bulletins that discuss staff interpretations of GAAP are available at www.sec.gov/rules/acctindx.htm.

Attestation reports filed with the Commission. Audit reports that are qualified as to the scope of the audit or compliance with generally accepted accounting principles (GAAP) do not satisfy the requirements of the Commission's forms. Compilation reports should not be included in any filing because the association of the accountant provides no basis for reliance.

Reviews of interim financial statements. Recently enacted rules require that interim financial statements be reviewed by the independent auditor prior to filing on Form 10-Q or 10-QSB. However, your review report is not required to be included in the filing unless the company indicates that a review was performed. If your client files interim financial statements before you have performed a review and does not disclose that deficiency, or if your review report on the filed interim financial statements would be qualified in any respect, you should consider whether continuation of your relationship with the client is appropriate in the circumstances.

Qualifications to practice before the Commission. Unless specifically suspended from practice by the Commission, an independent certified public accountant who is registered and in good standing under the laws of the place of his principal of lice or residence may issue audit reports for use in filings with the Commission. You should consult the appropriate state licensing agencies in other states regarding your ability to audit clients located there. Generally accepted auditing standards (GAAS) require appropriate training and proficiency for any audit engagement. You should be familiar with the Commission's accounting and disclosure rules for public companies, such as those contained in Regulations S-X and S-B, 17 CFR 210 and 17 CFR 228, respectively, and with SEC staff interpretations of those rules.

Special Independence Rules. Rules established by the accounting profession and your state identify practices which may impair your independence with respect to your client's financial statements. The Commission has codified additional rules and interpretations that an accountant must observe if its reports are used in connection with either exempt or registered securities offerings or are filed with the Commission. For example, the Commission believes an accounting firm cannot be deemed independent with regard to auditing financial statements of a client if it has participated closely in maintenance of the basic accounting records, such as bookkeeping services, or if the firm performs other services through which it participates with management in operational decisions.

Reporting illegal acts. In addition to the requirements imposed by GAAS, Section 10 A of the Securities Exchange Act requires that the auditor of a public company report to the board of directors certain uncorrected illegal acts, that the company notify the Commission when it receives that report, and that the auditor inform the Commission if the company has not done so on a timely basis. See www.sec.gov/rules/final/34-38387.txt or 17 CFR 240.10A-1. Also, we ask that accounting firms advise the Office of the Chief Accountant as soon as their relationship with a public client is terminated, so that we can monitor whether the company reports promptly the information required by Item 4 of Form 8-K.

Business combination issues. Unusual accounting and reporting issues arise if shareholders of the company issuing stock in a business combination do not hold the majority of voting common shares outstanding immediately following the transaction, and the transaction did not meet the criteria for a pooling of interests. In this circumstance, accounting rules for reverse acquisitions or reorganizations may be applicable. A summary of those rules is available at the SEC web site in the outline of "Frequently Requested Accounting and Financial Reporting Interpretations and Guidance." In addition, purchase accounting is not appropriate if the merging entities are under common control, as discussed in the FASB's Technical Bulletin 85-5.

Redeemable equity securities. Equity securities must be excluded from permanent stockholders' equity if they must be redeemed by the company at the holder's option, or at a fixed date, or under circumstances outside the control of the company. For a summary of guidance applicable to these securities, refer to the staff's outline of "Frequently Requested Accounting and Financial Reporting Interpretations and Guidance."

Assets received from promoters. Prior to becoming publicly traded, companies may receive non-monetary assets from promotes in exchange for stock or other consideration which can be monetary or nonmonetary. These assets ordinarily should be recorded by the company at the lower of the fair value of the asset or the cost of the asset in the promoter's records, determined in conformity with GAAP. Staff Accounting Bulletin 48 discusses this accounting when no monetary consideration is present. Consistent with that guidance, monetary consideration paid to a promoter by the registrant which is in excess of the asset's cost to the promoter should be accounted for as a special dividend to the promoter.

Nonmonetary transactions. In addition to the guidance in APB Opinion No. 29, you may want to review the guidance in EITF Issue Nos. 93-11 and 99-17 concerning barter transactions. Also, note that equity securities issued for nonmonetary consideration to persons who are not promoters probably should not be recorded at an amount greater than that which the registrant has received in cash in recent arms-length transactions for comparable blocks of its securities. Look to Staff Accounting Bulletin Topic l:B for guidance concerning the accounting for costs incurred by related parties on behalf of the company. Also, if related parties render services to the registrant without receiving consideration, recognition of the fair value of the services as a capital contribution and matching expense may be necessary to prevent operating results reported in the financial statements from being misleading.

Deferred costs. The AICPA's Statement of Position 98-5 prohibits the capitalization of organization costs, pre-opening costs and all similar start-up costs. FASB Statement No. 2 requires expensing of research and development costs until engineering activity has advanced the design of a product to the point that it meets specific functional and economic requirements and is ready for manufacture. Advertising costs must be expensed as incurred except for the very limited circumstances specified in SOP 93-7. Additional guidance about SOP 93-7 is included in the staff's outline of "Frequently Requested Accounting and Financial Reporting Interpretations and Guidance."

Statement of cashflows. Be sure to exclude noncash investing and financing activities from the cash flows reported in this statement. Examples of noncash investing and financing transactions are converting debt to equity, acquiring assets by assuming directly related liabilities, and exchanging noncash assets or liabilities for other noncash assets or liabilities. Some transactions are part cash and part noncash; only the cash portion should be reported in this statement.

Revenge recognition issues. Commission enforcement actions involving financial statements arise most frequently from improper recognition of revenue. Revenue Recognition Audit Issues, a compilation of accounting guidance concerning revenue recognition issues, prepared by the American Institute of Certified Public Accountants, is available at www.aicpa.org. In addition, Staff Accounting Bulletin No. 101, available at the Commission's web site, provides other important revenue recognition guidance. If you have additional questions concerning qualifications to practice or the Commission's rules on independence, please call the Office of the Chief Accountant at (202) 942-4400. If you have questions concerning the instructions to forms which small business issuers file with the Commission or other general questions, please call the Office of Small Business at (202) 942-2950. Answers to your questions about the financial statements required in a filing may be obtained from the Division of Corporation Finance's accounting office at (202) 942-2850.

Sincerely,

Robert A. Bayless
Chief Accountant
Division of Corporation Finance