Comparing Financial Statement Audits, Reviews, Compilations and Preparations
Users of financial statements associate certified public accountants (CPAs) with audit reports on a company’s financial statements. However, CPAs can provide three other levels of service for unaudited financial statements. These other levels of service have historically included review and compilations, while, in recent years, the preparation standard has been added. The purpose of these engagements is to add credibility to and enhance the reliability of the company’s financial statements.
So, who chooses what level of CPA service is required? Sometimes regulatory bodies or possibly a non-management owner. Although, usually, it is a bank that provides loans! The following is a breakdown of the four primary levels of service.
The Audit engagement provides the highest level of assurance on the client’s financial statements. Thus, the audit is the costliest of the services that CPAs provide on financial statements since they take the most time. Audited financial statements provide the user with the auditor’s opinion that the financial statements are presented fairly, in all material respects, and in conformity with the applicable financial reporting framework.
Many important audit procedures are not required for reviews or compilations, including:
- Consideration and evaluation of the internal control system of the company, which may include testing the effectiveness of the system;
- Tests of the underlying documentation to support account balances;
- Observation of the physical inventory counts (if any); and
- Outside confirmation of account receivable balances.
In addition, the auditor is specifically 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 any assessment of fraud risk, nor are they required to consider fraud or search for fraud during the engagement. Their role is to inform management of any material errors, fraud or illegal acts that come to their attention during the engagement.
The Review is in between a compilation and an audit in terms of time to complete, fees and assurances. Reviewed financial statements provide the user with comfort that, based on the accountant’s review, the accountant is not aware of any material modifications that should be made to the financial statements for the statements to conform with the applicable financial reporting framework.
A review engagement requires all of the procedures necessary for a compilation engagement, plus other procedures that enable the accountant to provide limited assurance on the financial statements. These additional requirements are inquiries of client management and analytical procedures. 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 can 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.
The standard accountant’s report that accompanies the reviewed financial statements states that the review engagement is substantially less in scope than an audit engagement, and no opinion can be expressed on the financial statements taken as a whole.
The Compilation has historically been the most basic level of service that a CPA can provide concerning financial statements. A compilation engagement requires less time than a review or audit engagement because fewer procedures are required. The compilation is putting into the form of financial statements the information provided by the client without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements.
The compilation standards require the CPA to possess an adequate level of knowledge about the accounting principles and practices of the client’s industry and have a general understanding about the nature of the client’s business. The accountant is required to read the compiled financial statements and consider whether they are in the appropriate form and free from obvious material errors.
Compilation standards do not require the accountant to perform any procedures to verify or corroborate the financial statement information provided by the client. Glaring irregularities might be noticed, but the CPA is not checking facts or tracing transactions through the system. If the accountant has reason to believe the information supplied by the client is inaccurate, incomplete or otherwise unsatisfactory, the accountant is required to obtain revised or corrected information before reporting on the financial statements.
Because of the limited scope of compilation procedures, the standard compilation report disclaims any degree of assurance on the financial statements.
Preparation of Financial Statements
In recent years, the question of who has prepared financial statements has become more difficult to answer due to the expanded use of technology such as cloud computing. In response to this concern, the AICPA created the Preparation standard that eliminates the requirement for CPAs that prepared financial statements to, at a minimum, perform a compilation engagement with respect to any financial statements they presented to management or third parties.
The Preparation standard applies when the CPA is engaged to prepare financial statements but is not engaged to perform an audit, review or a compilation of those financial statements. The CPA is required to include a legend on each page of the financial statements stating that no assurance is being provided. The CPA must also obtain an engagement letter signed by both the CPA and the client’s management. When preparing financial statements, the CPA does not need to consider whether he or she is independent, which is similar to other non-attest bookkeeping and accounting services engagements. The Preparation standard may be applied to financial statements with or without disclosures.
Consider the CPA Providing the Service
In addition to the level of service, it is also important to consider the CPA providing the service! Financial statement users may have more confidence in the work of some CPA firms based on the reputation of the CPA and their history with them. This can be especially critical if a company is dependent on bank financing that requires audited or reviewed financial statements. In addition, your CPA is a service provider and should provide good service! Many CPA firms are having a difficult time with staffing and if your CPA is not able to provide quality service promptly then it might be time to consider whether another firm might better be able to meet your needs.
Contributing author: Victor W. Vaccaro, Jr., CPA/ABV, CFF, CDA, Partner-in-Charge of Assurance Services, at Dannible & McKee, LLP, has over 30 years of experience providing auditing, accounting and consulting services. For more information on this topic, you may contact Vic at firstname.lastname@example.org or any of our audit professionals at (315) 472-9127.