Financial Statement Compilations, Reviews, and Audits – What’s the Difference?
Maybe you own a business or are involved in managing a business. Perhaps you are in a leadership role at a not-for-profit or serve on its board of directors. You likely have a deep familiarity with the financial inner-workings of those entities and maybe you are involved in conversations about bringing in an outside accounting firm to have some level of involvement with your financial statements. We will discuss the three main types of accountants’ reports – compilations, reviews, and audits, and highlight the differences between them.
Of the three types of engagements, financial statement compilations are the most basic. The accountants’ responsibility is to take the accounting information of the client and put it into the form (“compile”) of financial statements - balance sheet, profit and loss, cash flows and footnotes without expressing any level of assurance over those financial statements – in fact, issuing a report stating no level of assurance is being provided. Now you may ask, “why pay the accountant if they are not going to provide assurance on the financials?” Fair question. When you hand off the financial information to the accountants for compilation you are ensuring that the financials are subject to an outside party’s second set of eyes – trusted CPAs with the accounting knowledge and industry experience necessary to compile the financials. While they won’t be issuing an opinion, their firm’s signature goes on the report they issue.
The next step up from a compilation is the financial statement review. In this form of engagement, the accountants provide limited assurance on the financial statements. A review’s scope is still not to the level of an audit, but it is greater in scope than a compilation. The accountants’ review procedures consist of inquiries to management and analytical procedures. While the accountants will not be performing tests of individual transactions, you can still expect that they will request various client-prepared schedules to use in their analysis – bank reconciliations, receivables and payables agings, property and equipment listings, inventory listings, etc. At the end the accountants will reach a conclusion as to whether they are “aware of any material modifications that should be made to the financial statements for them to be in accordance with accounting principles generally accepted in the United States of America” (limited assurance).
And finally, the most comprehensive engagement is a financial statement audit. In an audit, the accountants are engaged to obtain reasonable assurance on the financial statements. The steps the accountants take to reach this goal are more in depth than the review – obtaining an understanding of internal controls, confirmations of balances with third parties, physical inspection of underlying transactional detail, and more. In the audit report the accountants will opine on whether “the financial statements present fairly, in all material aspects, the financial position of the Company as of the balance sheet date, and the results of their operations and their cash flows for the year then ended in accordance with accounting principles generally accepted in the United States of America” (reasonable assurance).
Note that the requirement for a compilation, review, or audit are sometimes dictated by a lender or by the board of directors. If the above are not required, but you are considering engaging the involvement of an outside CPA firm, it is important to assess your entity’s needs, as the costs are directly related to the scope.
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