A frequent question of business owners is, “Should I have an audit?” The inevitable response is “It depends.” Before we get to an answer, we need to cover some background material.
Almost every organization—whether it’s a privately held business, a publicly owned corporation, or a nonprofit organization—prepares financial statements reporting on its financial performance. Such statements help owners and managers make operating decisions, enable creditors to evaluate loan applications, and provide individuals with information to make investment decisions.
Frequently, regulatory bodies, non-management owners, banks that provide loans, or other organizations that transact business with a company (such as suppliers that sell on credit or leasing companies) will request that an external certified public accountant (CPA) issue a report on an organization’s financial statements. The purpose of the CPA’s involvement is to add credibility and reliability to the organization’s financial statements.
There are typically three levels of service that CPAs provide to organizations as part of this process. Below is a discussion of each of these levels.
Audit—A CPA examines financial statements by obtaining an understanding of an organization and its environment, including internal controls, direct correspondence with outside parties, completing physical inspections and observations, applying inquiry and analytical procedures, and testing selected transactions by examining supporting documents. An audit provides the highest level of assurance that the financial statements fairly represent the organization’s financial position and results of operation in accordance with generally accepted accounting principles (GAAP).
An audit is the most extensive (and expensive) of the three services provided by a CPA. An audit is appropriate for organizations that must offer a higher level of assurance to outside parties. An unqualified opinion or “clean” opinion from a CPA after an audit provides reasonable assurance to outside parties that the organization’s financial statements fairly present its financial position and results of operation in accordance with GAAP.
An additional benefit of an audit is that the CPA performing the audit will identify and communicate significant weaknesses in internal controls of the organization identified during the performance of the audit. This first line of defense against fraud is the internal control environment of the organization. Any weaknesses in that line of defense represent opportunities for fraud to occur.
Review—A CPA applies inquiry and analytical procedures to financial statements provided by management to determine if they are reasonable. A review provides limited assurance that no material changes need to be made to the financial statements for them to be in accordance with GAAP.
A review is much less intensive than an audit and may be adequate for organizations that must report their financial performance to third parties, such as creditors or regulatory agencies. Reviewed financial statements may also be useful to business owners who are not actively involved in managing their companies.
Compilation—A CPA prepares financial statements from information provided by management.
A compilation is the least expensive of the three types of reports discussed here and may be useful to small, privately held organizations that need help in preparing their financial statements. In a compilation, a CPA reads the financial statements and makes sure there are no obvious errors such as incorrect titles, etc. in the statements but provides no assurances that the information in the statements is reasonable.
What to Do
Okay, let’s get to the answer. First, you need to know if you are required to have one of these services by a regulatory body. Some examples of regulatory required audits include those required by the Securities and Exchange Commission (SEC) for publicly traded companies, audits required by the U.S. Department of Labor for pension plans, and audits, reviews or compilations required by the state for construction contractor licenses. If a service is required by a regulatory body, you normally don’t have a choice—you have to have that level of service.
Next, consider your business needs. Would your organization benefit from the increased scrutiny of an audit? Would a review provide enough information for you or your management to make informed decisions?
The third thing to consider are the requirements imposed by banks, outside investors and other third parties. Sometimes, these groups will require one level of service but you may be able to negotiate with them to reduce the level of service to a less expensive alternative.
Finally, talk to your accountant. They will be able to help you determine the best solution for you. After all, the real answer to this question is, “It depends.”
Steve Johnston is a partner at Blair, Bohlé & Whitsitt, PLLC, a CPA firm that provides accounting, assurance, tax compliance and planning services in addition to strategic planning and tax minimization strategies to privately held businesses. Contact him at 704-841-9800 or visit www.bbwpllc.com.