Sometimes, a lender or other outside party will request a copy of a business’s financial statements. They may ask for financial statements that have been audited, reviewed, or compiled by a CPA. What they’re really asking for is some form of “assurance” that the company’s financial statements are accurate.
However, there are significant differences between an audit, a review, and a compilation — in terms of cost as well as the level of assurance provided.
Audited Financial Statements
An audit is the highest level of assurance a CPA can provide. The objective is to obtain “reasonable assurance” about whether the company’s financial statements as a whole provide a fair view of the company’s financial position. An audit also ensures that the financial statements conform to the applicable reporting framework, such as U.S. Generally Accepted Accounting Principles (GAAP).
To reach that level of reasonable assurance, the auditors corroborate the amounts and disclosures in the financial statements by:
- Making inquiries of management and others to get an understanding of the company’s internal control and assess the risk of fraud
- Evaluating the company’s internal control system
- Performing analytical procedures to look for unexpected variances in account balances or transactions
- Gathering documentation to support amounts shown in the financial statements, including bank statements and reconciliations, accounts payable and accounts receivable aging schedules, revenue records, contracts, etc.
- Making observations, such as watching a physical inventory count or viewing fixed assets
- Confirming amounts with third parties, such as cash, accounts receivable, and loan balances
The keyword here is “reasonable.” Auditors cannot offer absolute assurance that there are no errors in the company’s accounting records because there are inherent limitations of audit procedures. For example, auditors typically test a sample of transactions, rather than 100% of transactions, and auditors assess the company’s accounting based on their interpretation of accounting standards.
Because of the work involved, audits are typically the highest-cost assurance service that a firm provides.
Reviewed Financial Statements
A financial statement review aims to provide the user with assurance that the firm is not aware of any material modifications required in the financial statements. Essentially, it asks, “Do the numbers make sense?” This is a step down from the level of assurance that an audit provides.
During a review, accountants perform analytical procedures to look for trends and unusual variances. These analytical procedures may include comparing prior year numbers to the current year and comparing financial ratios to industry benchmarks. If the accountants find unexpected variances, they may ask management more questions or seek out supporting documentation.
Accountants don’t evaluate the company’s internal controls, assess fraud risk, test accounting records, or perform other audit procedures.
CPAs must be independent to perform audits and reviews. This generally means that the accountant doesn’t have a financial interest in the company they’re auditing or reviewing, doesn’t serve the client in an advisory or management role, and isn’t under pressure to promote or defend the client’s interest.
Compiled Financial Statements
The objective of a compilation is to assist management in presenting financial information in the form of financial statements. Essentially, the accountant takes company-provided data and creates financial reports in the appropriate format.
During a compilation, the accountant gains a general understanding of the business and its financial reporting policies and procedures. An accountant does not perform analytical procedures, evaluate the company’s internal controls, assess fraud risk, or test accounting records. However, the accountant might ask for certain documents — such as bank statements, loan amortization schedules, and contracts — in order to properly draft the financial statement footnotes.
Because a compilation’s scope is so limited, the compilation report doesn’t offer any assurance that the financial statements are free from error or conform to the applicable reporting framework.
Accountants can issue compilation reports even if they’re not independent. However, the compilation report must disclose that fact.
The Bottom Line on Audits, Reviews, and Compilations
If your business receives a request for audited or reviewed financial statements, discuss the request with us to determine what the lender, investor, or other outside party really needs. It can be tricky to strike the right balance, but taking the time to discuss the matter can ensure you select the right level of assurance for your company and your budget. It’s important to select the appropriate level of assurance that balances the costs and the benefits.
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