Audit, Review or Compilation: How Are They Different?
In the accounting world, the terminology used to define the level of assurance your manufacturing company has been provided from a CPA firm as it relates to your financial statements can often be confusing. It is important to understand the various services that a CPA firm offers and the level of confidence in the services they are providing as these reports are often provided to lenders, investors, customers and suppliers.
The three most common types of assurance services are audit, review and compilation.
An audit engagement’s intent is to provide creditors, investors and other outside parties the highest level of comfort on the accuracy of the company’s financial statements. Audited financial statements provide the user with the auditor’s opinion that the financial statements are presented fairly, in all material respects, in conformity with the applicable financial reporting framework.
Important audit procedures that are not required for compilations or reviews include:
- Consideration and evaluation of the internal control system of the company;
- Tests of the underlying documentation to support account balances;
- Observation of the physical inventory counts; and
- Outside confirmation of account receivable balances.
In addition, the auditor is required to obtain reasonable assurance that the financial statements are not materially misstated due to fraud. In a compilation or review engagement, the accountant is not required to document their assessment of fraud risk and are required to consider fraud or search for fraud in the course of the engagement.
A review engagement is intended to provide lenders and other outside parties with a basic level of assurance on the accuracy of the financial statements. A review is narrower in scope than an audit, still providing an evaluation of your company’s books, but limiting the auditor’s analysis to analytical procedures and assessment of management.
Analytical procedures include:
- Comparison of current-period financial statements with statements of prior periods or with current-period budgets or forecasts;
- Study of the financial statements to identify items or relationships between items that do not conform to expectations based on earlier reports or other information; and
- Review and consideration of adjustments made to the financial statements of prior periods.
The purpose of analytical procedures is to identify account balances or relationships that appear unusual so that additional inquiries can be made to determine the cause of the unexpected patterns. Based on these inquiries, any necessary adjustments to the financial statements may be made. Because of the inquiry and analytical procedures, accountants are able to express limited assurance on client financial statements that have been reviewed compared to the disclaimer of any assurance on client financial statements that have been compiled.
A compilation engagement is a basic summary of the company’s financial statements and provides no level of assurance. There are no tests performed and the auditor does not examine any internal controls.
The compilation standards require the CPA to possess an adequate level of knowledge about the accounting principles and practices of the company’s industry and have a general understanding about the nature of the company’s business. The accountant is required to read the compiled financial statements and consider whether they are in appropriate form and free from obvious material errors.
As you can see, not all CPA reports are alike and it is important to understand who the user of your financial statement is and level of comfort they will need. Factors that may require a certain level of service may be a bank debt covenant, regulatory requirement, or even preference of management or the board of directors for additional oversight.
An audit, unlike a review or compilation will require the CPA to obtain and evaluate the internal control system as well as testing documentation supporting balances or classes of transactions. An audit also requires direct communication with those charged with governance within your company.
Dannible & McKee offers you the highest quality assurance services within the manufacturing industry. Contact us today to determine which level of service is right for your manufacturing company.
Contributing Author: Charla A. Roth, CPA, CDA, is an audit partner with over 18 years of experience providing auditing, accounting and consulting services. Charla specializes in working with manufacturers, architecture and engineering firms, and nonprofit organizations.