Chapter 1
Forecasts and Projections –
Overview and Authoritative Guidance
Learning Objectives
• Understand the general nature of prospective financial statements.
• Be aware of the key issues in preparing prospective financial statements.
• Recognize basic guidance found in AT section 301 regarding forecasts and projections.
• Be aware of the guidance found in the AICPA Audit Guide, Guide for Prospective
Financial Information.
Introduction
Forecasts and projections are of interest to a wide range of parties, including management,
present or potential owners of equity interests, credit grantors, and other informed third parties,
government agencies, and the public. Forecasts and projections are based on assumptions
regarding future events; the assumptions are, in turn, based on a combination of available
information and judgment, in which both history and plans play a part. Because no one can know
the future, and because forecasts and projections may be affected by many factors both internal
and external to the entity, judgment must be used to estimate when and how conditions are likely
to change. These judgments subsequently may prove to be unrepresentative of future conditions;
thus, the achievability and reliability of forecasts and projections can never be guaranteed. When
working with or using forecasts or projections, it is essential to understand their inherent
limitations.
Authoritative Guidance
The AICPA Audit and Accounting Guide, Guide for Prospective Financial Information (the
Guide), establishes guidelines for the preparation and presentation of financial forecasts and
projections (referred to as “prospective financial statements”). The Guide is also intended to
assist you in performing professional services on and reporting on such information.
Chapter 3 of Statement on Standards for Attestation Engagements (SSAE) No. 10 (AT section
301) sets forth the standards for engagements related to prospective financial statements.
Prospective financial statements are prospective financial information that presents financial
position, results of operations, and cash flows. There are two kinds of prospective financial
statements – financial forecasts and financial projections. In addition, you may be involved with
partial presentations. A partial presentation is a presentation of prospective financial information
that excludes one or more of the minimum items required for prospective financial statement
presentations.
AT section 301 states that you should perform an examination, compilation, or agreed-upon
procedures engagement prospective financial statements, whenever you –
• Submit, to your client or others, prospective financial statements that you have assembled
or assisted in assembling, that are or reasonably might be expected to be used by another
(third) party, or
• Report on prospective financial statements that are, or reasonably might be expected to be
used by another (third) party.
In deciding whether the prospective financial statements are or reasonably might be expected to
be used by a third party, you may rely on either the written or oral representations of the
responsible party, unless information comes to your attention that contradicts the responsible
party’s representation.
Observation: If third-party use of the prospective financial statements is not reasonably
expected, the provisions of AT section 301 are not applicable, unless you have been engaged to
examine, compile, or apply agreed-upon procedures to the prospective financial statements. In
other words, you can assemble prospective financial statements without reporting on them, if the
prospective financial statements are not reasonably expected to be used by a third party. See
Chapter 7 for further discussion of forecasts and projections prepared for internal use only.
In reporting on prospective financial statements, you may assist the responsible party in
identifying assumptions, gathering information, or assembling the statements. The responsible
party is nonetheless responsible for the preparation and presentation of the prospective financial
statements because the prospective financial statements are dependent on the actions, plans, and
assumptions of the responsible party, and only it can take responsibility for the assumptions.
Accordingly, your engagement should not be characterized in your report as including
“preparation” of the prospective financial statements.
Types of Prospective Financial Statements
There are two kinds of prospective financial statements – financial forecasts and financial
projections.
Forecast
Forecasts present, to the best of the responsible party’s knowledge and belief, an entity’s
expected financial position, results of operations, and cash flows. A financial forecast is based on
the responsible party’s assumptions reflecting the conditions it expects to exist and the course of
action it expects to take. A financial forecast may be expressed in specific monetary amounts as
a single point estimate of forecasted results or as a range, where the responsible party selects key
assumptions to form a range within which it reasonably expects the item or items to fall.
Projection
Projections present, to the best of the responsible party’s knowledge and belief, given one or
more hypothetical assumptions, an entity’s expected financial position, results of operations, and
cash flows. A financial projection is sometimes prepared to present one or more hypothetical
courses of action for evaluation, as in response to a question such as, “What would happen if…?”
A financial projection is based on the responsible party’s assumptions reflecting conditions it
expects would exist and the course of action it expects would be taken, given one or more
hypothetical assumptions. A projection, like a forecast, may contain a range.
Prospective financial information may be referred to by a number of different names, such as
forecasts, projections, feasibility studies, break-even analyses, and budgets. Whatever such
information is called, it is considered to be prospective financial statements if the presentation
fits the description of prospective financial statements.
Uses of Forecasts and Projections
Clients may prepare prospective financial information for a variety of reasons. For example, a
client may want to obtain external financing, consider a change in operations or accounting, or
prepare a budget. The reason for which the prospective financial information is prepared
determines the type of prospective information developed. Prospective financial information is
for either “general use” or “limited use.”
General Use
General use of prospective financial statements refers to the use of the statements by persons
with whom the responsible party is not negotiating directly, for example, in an offering statement
of an entity’s debt or equity securities. Recipients of prospective financial statements distributed
for general use are unable to ask the responsible party directly about the presentation. Therefore,
the presentation most useful to them is the one that portrays, to the best of the responsible party’s
knowledge and belief, the expected results. Thus, only a financial forecast is appropriate for
general use.
Limited Use
Limited use of prospective financial information refers to the use of prospective financial
statements by the responsible party alone, or by the responsible party and third parties with
whom the responsible party is negotiating directly. Examples include use in negotiations for a
bank loan, submission to a regulatory agency, and use solely within the entity. Third-party
recipients of prospective financial statements intended for limited use can ask questions of the
responsible party and negotiate directly with it. Any type of prospective financial statements that
would be useful in the circumstances would normally be appropriate for limited use. Thus, the
presentation may be a financial forecast or a financial projection.
Because a financial projection is not appropriate for general use, it should not be distributed to
those who will not be negotiating directly with the responsible party (for example, in an offering
statement of an entity’s debt or equity interests), unless the projection is used to supplement a
financial forecast and is for a period covered by the forecast.
A partial presentation also may be appropriate in many limited-use situations. For example, a
responsible party may prepare a partial presentation to analyze whether to lease or buy a piece of
equipment or to evaluate the income tax implications of a given election, since it may only be
necessary to assess the impact on one aspect of financial results rather than on the financial
statements taken as a whole. Therefore, a partial presentation is often appropriate for use by third
parties who will be negotiating directly with the responsible party. However, a partial
presentation is not ordinarily appropriate for general use.
Classification
The classification of prospective financial information use as either general or limited is not
dependent on the number of users. Rather, the use is considered limited if each of the users
negotiates directly with the responsible party; the use is considered to be general if the users do
not. Thus, prospective financial information to be used by even one passive user would be
considered general use, whereas use by a number of persons who all negotiate directly with the
responsible party would be considered limited use.
The responsible party should have a reasonably objective basis to present a financial forecast in
order for it to be appropriate for general use. Because users expect financial forecasts to present
the responsible party’s “best estimate,” the term reasonably objective basis is intended to
communicate to responsible parties a measure of the quality of information necessary to present
a forecast. The responsible party has a reasonably objective basis to present a forecast if
sufficiently objective assumptions can be developed for each key factor. In some instances, the
nature of one or more assumptions may be so subjective that the responsible party could have no
reasonably objective basis to present a forecast. In that case, the responsible party generally
should not present prospective financial statements for general use.
If the responsible party does not have a reasonably objective basis for one or more assumptions,
it nonetheless may be able to present prospective financial information for limited use. For
example, it might be appropriate for the responsible party to (a) establish hypothetical
assumptions that have no reasonably objective basis and present a financial projection or (b)
present a partial presentation that omits the element, item, or account that does not have a
reasonably objective basis.
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