Clients Can Benefit from a Review or a Compilation
While an audit provides the highest level of assurance that a client’s financial statements are fairly stated and free of material misstatements, many companies do not have an audit of their financial statements performed. A review or compilation could be enough to satisfy their stakeholders (employees, customers, suppliers, bankers, sureties and the community).
All public companies are required to be audited annually. Certain nonpublic entities also must have an annual audit including local governments, nonprofits and organizations receiving government grants.
Although some financial institutions require an audit of nonpublic companies to obtain financing, others do not. It depends on the amount of the loan and/or the bank’s assessment of the company’s risk. An audit might also be required if the company has a surety company and/or absentee owners such as investment firms or individuals who are not involved in the daily operations.
It is important to determine why a client wants an audit. Depending on the answer, CPAs can save clients money while providing some level of assurance on their financial statements.
A review engagement consists primarily of analytical procedures applied to financial statements and various inquiries into the client’s management team. A review is less extensive than an audit but more involved than a compilation. A review provides limited assurance from a CPA without the expense of an audit.
If the financial statements or supporting information appears inconsistent or otherwise questionable, additional procedures may need to be performed. This could include questioning the accounting practices and principles of the business.
The client will need to provide a trial balance, bank reconciliations, accrual schedule, deferred revenue income statement and additional information for the CPA to conduct a review of their financial statements.
A review does not require a study or evaluation of the client’s internal controls. Third-party data does not have to be verified. A physical inspection of company assets also does not have to be done.
Because the same level of testing is not done as in an audit, a review report expresses limited assurance in the form of the statement: “We are not aware of any material modifications” for the financial statements to be in conformity with Generally Accepted Accounting Principles (GAAP). However, reviewed financial statements must include all required footnotes and other disclosures.
A review will usually satisfy lenders and investors who do not have a lot at stake. Generally, reviewed financial statements are used for seeking a small bonding line and a business loan or line of credit. When the loan requires a company to comply with certain loan covenants, a review versus an audit discussion is probably needed.
A compilation requires the CPA to simply present financial statements based on the representations made by management. This information is not verified. The CPA expresses no opinion or assurance on the financial statements. Compilations do not require inquiries of management or analytical procedures. Instead, the CPA relies on their knowledge of accounting principles and a general understanding of their client’s business.
Banks often require compilations from an independent CPA as part of their lending covenants. Although a compilation provides the lowest level of assurance, banks like to know that a CPA looked over the financial statements.
Footnotes and Disclosures
The footnotes to the financial statement describe the practices and reporting policies of the company’s accounting methods. Additional information that cannot be shown in the financial statements is sometimes also disclosed. The footnotes describe the company’s accounting methods, revenue recognition policies, and important company operational and financial results. Companies can provide detailed information on the impact that the COVID-19 pandemic had on their business and why they have reduced revenue and earnings forecasts. Increased borrowing, closures, staff reductions and any changes to internal controls can be explained.
Each type of financial statement report is applicable for certain situations. It depends on the requirements of the client’s bank or other parties and budgetary needs. Although an audit engagement is the highest level, it may not be necessary to perform, and a review or compilation may satisfy the client’s needs.
Richard P. Higgins
Richard P. Higgins, CPA, is the managing principal of the New Jersey office of McCarthy & Company, PC, a leader in construction accounting. He is a member of the NJCPA.
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This article appeared in the July/August 2020 issue of New Jersey CPA magazine. Read the full issue.