Welcome to “Accounting for Non-Accountants,” our how-to video series that answers your everyday questions about accounting.
In this video, we will be discussing how an organization can bring credibility to their financial statements which are done in one of three ways: a compilation, a review or an audit. All three statements require an organization to work with an auditor or a certified public accountant; all three statements involve a different level of scrutiny for your financial reports. So – what are the differences between these reports – and what level of report is correct for your organization?
A compilation is the most basic accounting service and includes a cover page written by a certified public accountant that accompanies a set of your financial statements. A compilation shows that an organization has an association with a CPA, but does not offer a deep level of assurance on the accuracy of the financial statements. The certified public accountant, as part of the compilation process, simply does a cursory check on basic features of the organization’s financial statements to issue their letter. There is however, no opinion issued by the CPA on the financial statements.
A compilation, therefore, may be sufficient in cases where a bank has a small business owner seeking a personal loan or when there would be no requirement for a formal opinion on an organization’s financial statements but the organization wants to exhibit to those being provided the financials their association with a CPA.
A review engagement is meant to ascertain whether or not the financial statements of an organization are believable or plausible and provides limited assurance that the financial statements conform to generally accepted accounting principles. This type of assurance is known as negative assurance. This means that the professional accountant is only providing assurance that nothing has come to their attention that would indicate the financial information is not presented in line with generally accepted accounting principles.
The review process involves all of the following: review and inquiries on financials; making inquiries related to the accounting practices and principles used by the business; and performing analytical procedures to understand current-year and prior-year balances, or current-year balances outside of the CPA’s expectations. In order for a certified public accountant to know where to look for potential accounting errors, they need to have an understanding in the industry in which the organization is operating and the accounting principles applicable to such industry as well as gather information on the company itself.
A review could be used by prospective lenders, buyers, and investors who don’t have a lot at stake. This could be in a case when an organization is seeking a small line of credit or small business loan. A review can also be used by an organization that is not required to undergo an audit, but wants to provide some limited assurance to their stakeholders that their financials conform to generally accepted accounting principles.
An audit is the most thorough assurance service at the end of which a certified public accountant will issue an opinion on the financial statements of the organization. The objective of an audit engagement is to enable the independent public accountant to issue an opinion on the fairness of the client’s financial statements. An audit is meant to provide “reasonable assurance” that the financial statements are free of material misstatement and are presented in accordance with generally accepted accounting principles. The term “reasonable” is necessary because absolute assurance is not possible. It acknowledges that limitations exist in all systems of internal control, and that uncertainties and risks may exist, which no one can confidently predict with precision. An audit requires an accountant to obtain evidence through inquiry with appropriate personnel, physical inspection, verification and substantive testing procedures. The CPA or auditor will then also examine supporting or source documents, send third party confirmations to confirm certain balances and legal matters, and perform analytical and other procedures.
An audit is required for all publicly traded companies. An audit might also be required when an organization needs an opinion issued on their financials for a funding source, under a contract or grant requirement, is planning to sell their business, or needs to raise equity.
All types of financial statements – compilation, review or audit – helps an organization bring credibility to their financial statements. So… what level of scrutiny of your financials is most appropriate for your organization?