As a business owner, you might find yourself navigating through the financial reporting landscape, wondering which type of assurance is necessary for your financial statements: an audit, a review, or a compilation. Each of these services fulfills a different purpose and offers varying levels of assurance. Understanding the differences can help you make the right decision for your business in various situations. It also helps to identify the end users or readers of the financial statements, and in doing so, understand their needs.
Audit
An audit is the most comprehensive and rigorous type of financial statement service. It involves a detailed examination, of your company’s financial statements and supporting documentation by a certified public accountant (CPA). Such procedures include examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Audits provide a high degree of assurance that the financial statements being inspected, as a whole, are free from material misstatements, whether due to fraud or error.
When to consider an audit:
- Regulatory Requirements: If your business is publicly traded or if it needs to comply with specific regulatory bodies, an audit is often required.
- Investor Assurance: Potential investors or lenders may request audited financial statements to ensure the accuracy and reliability of your financial information.
- Complex Financial Situations: Businesses with complex transactions, large operations, or significant financial risks may benefit from the thoroughness of an audit.
- Merger and Acquisition: If you deal in mergers and acquisitions, both parties would request an audit.
- Risk Management: Audits can sometimes uncover weaknesses related to financial reporting, which might stem from things like operational inefficiencies, lax internal controls, or even fraud.
What you need to know about audits:
- Nature: An audit is a comprehensive examination of the financial statements, including verification and testing of underlying transactions and internal controls, to provide a high level of assurance.
- Procedures: The auditor performs extensive procedures, including but not limited to testing transactions, confirming balances directly with third parties, observing inventory counts, and obtaining an understanding of internal controls. They gather sufficient and appropriate evidence to support their opinion.
- Assurance Level: Reasonable assurance. The auditor expresses their opinion on whether the financial statements were prepared fairly in all material aspects, and that they meet with all Generally Accepted Accounting Principles (GAAP).
- Independence: Per the applicable standards, the auditor needs to be independent of the business.
Review
A review delivers a limited level of assurance and is substantially less in scope than an audit, the objective of which is the expression of an opinion regarding the financial statements as a whole. Accordingly in a Review, no such opinion is expressed. In a review, the CPA performs analytical procedures to management’s financial data and makes inquiries of company management to verify whether or not any material modifications should be made to the financial statements in order for them to be in accordance with GAAP. However, the CPA generally does not conduct detailed testing of transactions and balances.
When to consider a review:
- Seeking Limited Assurance: If you need some level of assurance but not the extensive scrutiny of an audit, a review might be appropriate.
- External Stakeholder Requests: Some banks, creditors, or private investors might request reviewed financial statements to assess your financial health without requiring a full audit.
- Cost Considerations: A review is typically less expensive and less time-consuming than an audit, making it a cost-effective option for many businesses.
What you need to know about reviews:
- Nature: A review involves using analytical methods and making managerial inquiries that provide a limited level of assurance that the financial statements are reasonably accurate.
- Procedures: The accountant conducts inquiries and engages analytical methods, such as trend analysis, ratio analysis, review of management-prepared reconciliations, and discussions with management, but does not perform detailed testing of transactions or internal controls.
- Assurance Level: Limited assurance. The accountant provides a conclusion stating that based on the independent accountant’s review, they are either aware or not aware of any material modifications that should be made to the respective financial statements in order for them to be in accordance with GAAP.
- Independence: Per the applicable standards, the accountant needs to be independent of the business.
Compilation
A compilation involves presenting financial data without providing any assurance on the completeness or accuracy of the information. The CPA assists in assembling the financial data into a structured format but does not perform any verification or analytical procedures.
When to consider a compilation:
- Internal Use: A compilation may suffice if financial statements are needed primarily for internal management purposes and not for external stakeholders.
- Early-Stage Companies: Startups or small businesses with straightforward financial activities may opt for a compilation to maintain basic financial records without the need for assurance services.
- Cost Efficiency: Compilations are the least expensive option among the three services, making them suitable for businesses with limited budgets or less complex financial needs.
What you need to know about compilations:
- Nature: A compilation involves presenting financial information based on representations by management, without providing any assurance on the financial statements.
- Procedures: The accountant compiles the financial data into a proper financial statement format without performing any verification or analysis.
- Assurance Level: No assurance provided, and no opinion or conclusion provided.
- Independence: Per the applicable standards, the accountant does not need to be independent of the business in order to compile its financial statements. However, the compilation report should specifically disclose the lack of independence.
Making the Right Choice
Choosing the appropriate financial statement service depends on your business’s specific needs, regulatory requirements, and the expectations of your stakeholders. Here’s a quick summary to help guide your decision:
Audit: High assurance, required by regulations, investor/lender confidence, complex financial environments.
Review: Limited assurance, often requested by stakeholders and lenders, cost-effective compared to an audit.
Compilation: No assurance, often used for internal purposes, may be requested by lenders, cost-efficient, suitable for straight-forward financial activities.
Understanding these differences ensures that you select the right service to meet your business needs and maintain confidence among your stakeholders. Whether it is a joint venture driven by a shared agreement, or a bank looking to assist you with financing, if you’re unsure which service is best for you, consulting with a CPA like LSL can provide valuable guidance tailored to your specific situation.
| OVERVIEW OF AUDIT, REVIEW, AND COMPILATION SERVICES | ||||
| SERVICE | ASSURANCE LEVEL | NATURE | PROCEDURES | COST |
|
Audit |
High level, but not absolute; Independence is required |
Comprehensive, inclusive. |
Detailed Testing, Evaluating, Observing Inventory counts and Internal Controls, etc. |
High |
|
Review |
Limited; Independence is required |
Limited-level analytical work and inquiries. |
Simple Trend & Ratio analyses, reconciliations and Management discussion. |
Medium |
|
Compilation |
None; Independence is not required |
Clean-up. |
Help with assembling financial data without verification or analytical procedures.
|
Low |
Conclusion
There are times when companies can use each accounting service, whether it’s a simple clean-up compilation, a more extensive review, or an all-encompassing audit. These distinctions reflect the depth of the work performed and the level of confidence users can place in the financial statements based on each type of engagement.
Still unsure which level is right for your company, or do you need an audit, review or compilation done? Please feel free to contact us so we can help you decide what’s right for your company today or in the future.
