Compiled, Reviewed and Audited Financial Statements: What is the Difference?
Most business owners have their company’s annual financial statements prepared by a Certified Public Accountant (CPA). These statements are one of three types — compiled, reviewed or audited. Ideally, your CPA should have explained the differences in these statements before beginning their work.
It’s important that you, as the business owner, have a good understanding of the different levels of service involved and any options available within them. This will allow you to make a more informed decision on not only the type of service you need annually, but whether or not you need the same service on a monthly or quarterly basis. There may be another option that would fit your needs and save you time and money.
Following is a brief summary of some of the differences and options in the three levels of service which may help in determining the appropriate level of service for you.
The most common level of service offered by CPAs is a compilation. This level involves examining the financial statements and related account balances and determining whether or not the balances appear reasonable based on the accountant’s knowledge of the accounting principles followed, practices of the industry and an understanding of the client’s business. Known departures from GAAP must be disclosed by modifying the accountants’ compilation report. Two primary characteristics of a compilation that differ from both reviews and audits are that substantially all disclosures required by GAAP may be omitted and the CPA is not required to be independent of the client.
There are several advantages of a compilation over a review and/or audit. First, financial statements may be compiled on a comprehensive basis of accounting other than GAAP such as a cash or tax basis. This is also true for reviewed financial statements.
Second, if you do not feel full disclosure statements are cost-effective, the accountant may compile financial statements that omit substantially all of the disclosures required by GAAP. Another option available is that management-use-only financial statements can be compiled if the financial statements are “not reasonably expected to be used” by third parties.
A third option available is a compilation may be performed on selected or summarized financial or operational information. This information may consist of specific account balances, such as sales, cash or accounts receivables; operating information, such as labor utilization, average sale per customer, number of units produced or sold; or a combination of both. This can be a cost-effective alternative to having monthly or quarterly compiled statements prepared. For example, if you need monthly or quarterly compiled financial statements because it is required by a bank loan secured by accounts receivable you may be able to convince the bank to allow you to have a compilation performed solely on the accounts receivable balance rather than on the entire financial statement.
The second most common level of service is a review which offers more assurance than a compilation and less than an audit. This type of service is more costly since it requires more procedures to be performed by the accountant. A review provides some assurance, but limited, as to whether or not the financial statements are in conformity with generally accepted accounting principles (GAAP). While the accountant needs the same knowledge of the client’s accounting principles and practices of the industry, a review also requires an increased understanding of the client’s business. Unlike with a compilation, it is necessary for an accountant to make specific inquiries of management and perform certain analytical procedures.
For a review, all disclosures required by GAAP must be included in the financial statements. Like a compilation, any known departures from GAAP must be disclosed by modifying the report to note the departures. When performing a review, the accountant is also required to obtain “representation” from the client that states that the client has provided the accountant with all of the pertinent information requested and has not withheld or given dishonest information that, if known, may impact the user’s conclusions about the entity’s financial situation. Independence of the CPA from the client is also required.
The highest level of service is an audit. Substantially larger in scope than both a compilation and a review, an audit provides assurance, through the expression of an “opinion” in the “Auditor’s Report,” as to whether or not the financial statements are presented in accordance with generally accepted accounting principles (GAAP). An audit requires that the accountant obtain extensive knowledge of the economy, the relevant industry and the client’s business. Like a review, it requires that the accountant make specific inquiries of management and that analytical procedures be performed. However, it also requires that other procedures be performed whether or not any account balances or other information appear questionable or unreasonable. The accountant is required to obtain “representation” from the client similar to the “representation” required in a review, but with a few additional details and changes. The accountant must be independent of the client in order to perform an audit. Because an audit is substantially larger in scope, it requires a greater understanding of the client and the client’s industry, and requires substantially more procedures to be performed than a review or compilation. It is also substantially more time consuming and costly.
