As a business owner, you play many roles within your company including taking charge of day-to-day operations, generating new business and assuming the role of chief financial officer/controller. In the role of financial officer, you may be requested to supply financial statements prepared by an independent accountant.
Businesses frequently do not consider if they are getting the appropriate level of financial statement service. Understanding the levels of service can help businesses select the best match of services for their needs and the needs of their financial statement users. This article will summarize the different levels of financial statement service independent accountants provide and the key differences between them.
There are three levels of financial statement service that accountants provide: compilation, review and audit. The level of service is determined by business needs and by what outside third parties require. The higher the level of service required, the more time the accountant needs to complete the engagement, and therefore the more costly the engagement.
Compilations represent the most basic level of service accountants provide with respect to financial statements. Generally, compilations are the least costly form of financial statement service. In a compilation engagement, the accountant assists management in presenting financial information in the form of financial statements. However, a compilation does not provide any assurance that the accountant has detected all material modifications that should be made to the financial statements.
The accountant is required to have knowledge of the business entity’s industry and consider whether the financial statements are appropriate in form. Although not required, many accountants will obtain general support for major account balances such as bank reconciliations, account details and aging schedules. The accountant will issue a report stating that no assurance is being provided on the financial results reported.
Reviews provide a higher level of service than compilations but are substantially less in scope than audits. While reviews are more costly than compilations, they are usually significantly lower in cost than audits. Reviewed financial statements provide the user with the comfort that the accountant is not aware of any material modifications that should be made to the financial statements.
A review engagement consists primarily of inquiry and analytical procedures. Inquiry procedures may include asking how accounting estimates are determined or obtaining an explanation of unexpected financial results. Analytical procedures typically include performing trend analysis of operating results, computing financial ratios and benchmarking key performance indicators to industry averages. These inquiry and analytical procedures are in addition to the procedures performed in a compilation engagement.
Ultimately, these procedures are performed to determine that the financial results make sense. A review allows the accountant to express limited assurance that no material modifications should be made to the financial statements.
Audits—“Fairly Presented” Assurance
Audits can only be performed by a CPA. Audits are the highest level of assurance CPAs provide with respect to financial statements. Audits involve in-depth analysis and thorough testing of accounts.
Due to the detailed scope of items examined in an audit, audits are the most costly level of financial statement service. 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 financial reporting framework.
In an audit, the auditor is required to obtain an understanding of the entity’s internal control, assess fraud risk, and corroborate financial statement amounts through inquiry, inspection, observation, third-party confirmations, and examination of source documents. For example, in an audit, the CPA would observe the taking of physical inventory and inspect for obsolete or damaged items. In a review, however, an accountant would simply ask management how inventory quantities are determined.
At the conclusion of the audit, the auditor provides an opinion that the financial statements are fairly presented in all material respects and issues a report that states the audit was conducted in accordance with generally accepted auditing standards and the financial statements are the responsibility of management.
So what level of service does your business need? The appropriate level of service is dependent on the needs of the end user(s) of the financial statements. All three levels of financial statements are frequently relied on by business entities and third-parties (banks, creditors, investors, potential buyers, bonding agents, etc.) to evaluate a business’ performance and to make a decision about engaging in some form of relationship or transaction with the company.
Understanding the different levels of financial statement services will help you select the service that best meets your business’ needs. Discussion between the business entity, third parties and your CPA will generate a mutually beneficial balance for all parties involved.