 Hello and welcome to the session. This is Professor Farhad in which we will discuss pro-forma financial information. Pro-forma financial information is part of the statement on standards for attestation engagement, which we were discussing throughout this chapter. First we looked at the level of service that we can provide, examination engagement, review engagement, agreed upon procedures. Now we are discussing the subject matter. In the prior session we looked at the prospective financial information. In this session we would look at pro-forma financial information. I want to make sure we know where everything fits in a sense to make context of it. Now prospective financial information and pro-forma financial information, they sound similar. Matter of fact, I'm going to go out on a limb and tell you they are the opposite of each other. Why? In what sense? Prospective means we are dealing with the future. Pro-forma financial statement, you're going to see shortly we are dealing with historical financial statements. So from a time perspective, they're totally different. The prospective is looking at the future. The pro-forma is looking at historical financial information. We learn in the prior session for the prospective financial information, we can conduct an examination. Examination, we can conduct and agree upon procedures. We cannot do a review because in a review you do analytical procedures and inquiries and you're looking at futuristic numbers. So it doesn't make any sense to do any analytical procedures or ask about the numbers when the numbers are already kind of guessed made up. Pro-forma financial information, we're looking at historical cost information. We're looking at past information, not historical cost, historical financial statement, historical. Under the historical financial statement, we can do an examination and we can do a review. Just like what we do with the historical financial statements, we can audit them or we can do a review. And for the pro-forma financial information, we can audit them. Remember audit is similar or the same as examination, except we cannot use the word audit. And a review is similar to a review of financial information, which makes sense because we are dealing with historical financial data. Now what is pro-forma financial information? Let's have a definition of it. What is pro-forma? Pro-forma is for the sake of form in Latin. So it's basically let's assume something for the sake of it. But basically it's a presentation that shows what the significant effect on historical financial statement might have been had a consummated or a proposed transaction or event occur at an earlier date. Simply put, believe it or not, here's what we're doing. We are looking at the financial statements and we are saying okay, let's do this. Let's play this game. Let's go back and let's assume something happened one year earlier. What would have happened to the financial statement? Believe it or not, going back and doing what if on historical financial statement. So we're doing what if event or a transaction that applied to historical financial information and what are we going to do? We're going to reflect this what if in adjustments. So simply put, we're going to go in there and adjust the historical financial statements. Now the best way to really understand this or get a hold of it is to show you an actual example from the real world. Before we proceed any further, I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true false questions, as well as exercises. Go ahead, start your free trial today. No obligation, no credit card required. To do so, I'm going to show you the example for Tesla. Tesla acquired on November 21st, 2016. That's the acquisition date. We completed our acquisition of Solar City Corporation or simply put Solar City. That's fine. Tesla purchased Solar City. But here's what Tesla did. They published unordered pro forma financial information. Well, why and for what purpose? Here's the purpose of it. And hopefully this will kind of give you a good example. This pro forma financial information is unordered and presented for illustrative purposes only. And it's not necessarily indicative of the operating result that would have occurred if the acquisition of Solar City and other transaction contemplated by this acquisition has been completed January 1st, 2015. So look, they completed the transaction. They completed the consolidation. They purchased the company. When was it? Let's go back to the date, November 21st, 2016. But what they did, they went back and they told you this is what the result would have been assuming we did this acquisition on January 1st, 2015. Simply put, what Tesla wanted to show, wanted to show the synergies, the operating effectiveness. What would have happened? And this is what it looks like seriously. This is like, I mean, it's basically playing a game in a sense that you are showing Tesla revenues, Solar City revenues. And for example, if they combined Tesla energy, energy generation and storage with Solar City energy generation and storage plus an adjustment, and you have to look at B to see what that adjustment is, would give you the pro forma revenue of that energy generation and storage. Same thing we will do for other effect. For example, energy generation and storage cost of revenue. This is the cost of revenue of Tesla. This is the cost of revenue of Solar City. And this would have been the adjustment and this would have been the pro forma cost of revenue for energy generation and storage. And they will do the same thing, for example, for R&D research and development. They'll combine the two, then they will make an adjustment as if the combination, not the combination, the consolidation took place on January 1st, 2015, practically almost two years earlier. And this is basically what a pro forma is showing you what would have happened assuming the transaction rather than November 21st, 2016 took place January 1st, 2015. And I hope this example will consolidate your knowledge that pun intended will basically clarify what we are trying to do. Now to conduct an examination or a review, you have to have certain preconditions. And hopefully looking after looking at Tesla example, those preconditions make sense. First, you must include historical financial statements. Of course you should because you are starting from there. So the users, they want to see what the information looked like originally. You have to show any audit or review report about the financial statement. For example, Tesla most likely audited, not most likely the audited their financial statement. And for the quarterly they review them. So you have to include this with the financial statements. Bear in mind, the level of assurance provided cannot be higher than the audited or the reviewed historical financial statement than the historical. So simply put, if you reviewed the historical, you can only provide a review, can only be reviewed. If you audited the historical, the audit is the highest, you can either do an examine them or review them examination or review, but it cannot be higher than the original historical financial statement. Now bear in mind, the company will have to give you a written representation because they have to tell you what they want you to do, what assumptions are they making? So no written representation you will withdraw. And obviously you must obtain the appropriate level of knowledge about the entity accounting and financial practice record. Now if you audit them or you review them, that should be easy. It's already done. What procedures you should do? Think about the procedures. Think about the procedures that you would do if you're working with Tesla and Solar City and preparing a pro forma, assuming the consolidation took place almost two years earlier. First you understand what if event. What are we trying to do here? Inquire with management about the assumption made about the what if event. What assumptions did they made? Because you are making assumption, go back and making assumption what if that happened January 1st? Gather sufficient evidence about the result of the adjustment. Okay, we're going to prepare adjustments. Let's look at the results and make sure it makes sense. Make sure the results include all the significant effect. So if you change revenues, you're going to change taxes. If you change expenses, you're going to change taxes and you're going to change other things as well. Make sure it includes all the significant event. Make sure management assumptions are presented and the pro forma adjustments are consistent. They have to be consistent together. Also check the computation for the adjustment. That's an obvious and make sure it's applied properly. Read the final product and make sure the transaction assumption and adjustment all of them make sense. This is what you have to do. Written representation again, without written representation, you just don't touch it. You just why? Because management is responsible for the assumption. Tell us that. Tell us that assumptions are reasonable and factually supported. You're just not making things up. Adjustments are properly reflected in the financial statement and fairly present the what if event. Well, the adjustments are for the purpose of showing you what would happen and you're going to you have to tell you that yes they are. Adjustments are aligned with the financial reporting framework. Simply they have to take responsibility for this and they provide us with all the adequate disclosure that's needed for the pro forma. Know the thing representation you will withdraw. Simply put, you cannot do a pro forma if the company is not taken responsibility for that because look, we're starting from assumptions made by the company. Then we are preparing adjustments. Then those adjustments flow through the historical. Simply put, let me review one more time what I just said. Three important factors. First, assumptions for the what if are reasonable and factual. We have to evaluate this. It's made by the management. We have to understand it, evaluate it. Then we have to make adjustments reflecting this what if. It's okay. What if the consolidation happened earlier? Well, let's prepare the adjustments and the adjustments made are properly reflected in the financial statements. Now those adjustments, they went through the financial statements and they made the appropriate changes. I mean the best way go back to Tesla and Solar City and look at their financial statement just to see how it makes sense. Now obviously the best way to illustrate this again is to look at a final product to see what the report would look like, which will summarize everything that we talked about here. What should you do now? Go to farhatlectures.com and work MCQs to help you understand this topic better. Those topics are covered on the exam and they're easy points once you understand them. Oftentimes they're not covered properly in a and an audit course. Good luck, study hard and stay safe.