Comparing Audits, Reviews, and Compilations
Users of financial statements associate certified public accountants (CPAs) with Audit reports on a company’s financial statements. However, CPAs can provide two other levels of service for un audited financial statements – Compilations and Reviews. The purpose of these engagements is to add credibility to and enhance the reliability of the company’s financial statements.
So who chooses what level of CPA service is required?
- Sometimes regulatory bodies.
- Possibly non-management owners.
- Usually banks that provide loans!!
The Audit engagement provides the highest level of assurance on the client’s financial statements. Thus, the audit is the most costly of the services that CPAs provide on financial statements since they take the most time. 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 applicable financial reporting framework.
There are many important audit procedures that are not required for compilations or reviews including:
- Consideration and evaluation of the internal control system of the company, which may include testing the effectiveness of the system;
- Tests of the underlying documentation to support account balances;
- Observation of the physical inventory counts (if any); and
- Outside confirmation of account receivable balances.
In addition, the auditor is specifically required to obtain reasonable assurance that the financial statements are not materially misstated due to fraud. In a compilation or review engagement, the accountant is not required to document any assessment of fraud risk, nor are they required to consider fraud or search for fraud in the course of the engagement, just inform management of any material errors, fraud or illegal acts that come to his or her attention during the course of the engagement.
The Review is in between a compilation and an audit in terms of time to complete, fees and assurances. Reviewed financial statements provide the user with comfort that, based on the accountant’s review, the accountant is not aware of any material modifications that should be made to the financial statements for the statements to be in conformity with the applicable financial reporting framework.
A review engagement requires all of the procedures necessary for a compilation engagement, plus other procedures that enable the accountant to provide limited assurance on the financial statements. These additional requirements are inquiries of client management and analytical procedures. Analytical procedures include:
- Comparison of current-period financial statements with statements of prior periods or with current-period budgets or forecasts;
- Study of the financial statements to identify items or relationships between items that do not conform to expectations based on earlier reports or other information; and
- Review and consideration of adjustments made to the financial statements of prior periods.
The purpose of analytical procedures is to identify account balances or relationships that appear unusual so that additional inquiries can be made to determine the cause of the unexpected patterns. Based on these inquiries, any necessary adjustments to the financial statements may be made. Because of the inquiry and analytical procedures, accountants are able to express limited assurance on client financial statements that have been reviewed compared to the disclaimer of any assurance on client financial statements that have been compiled.
The standard accountant’s report that accompanies the reviewed financial statements states that the review engagement is substantially less in scope than an audit engagement, and no opinion can be expressed on the financial statements taken as a whole.
The Compilation has historically been the most basic level of service that a CPA can provide with respect to financial statements. A compilation engagement requires less time than a review or audit engagement because fewer procedures are required. The compilation is putting into the form of financial statements the information provided by the client without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements.
The compilation standards require the CPA to possess an adequate level of knowledge about the accounting principles and practices of the client’s industry and have a general understanding about the nature of the client’s business. The accountant is required to read the compiled financial statements and consider whether they are in appropriate form and free from obvious material errors.
Compilation standards do not require the accountant to perform any procedures to verify or corroborate the financial statement information provided by the client. Glaring irregularities might be noticed, but the CPA is not checking facts or tracing transactions through the system. If the accountant has reason to believe the information supplied by the client is inaccurate, incomplete or otherwise unsatisfactory, the accountant is required to obtain revised or corrected information before reporting on the financial statements.
Because of the limited scope of compilation procedures, the standard compilation report disclaims any degree of assurance on the financial statements
New Standard for Reviews, Compilations and Preparation of Financial Statements
In recent years, the question of who has prepared financial statements has become more difficult to answer due to the expanded use of technology such as cloud computing. In response to this concern, the AICPA issued Statement on Standards for Accounting and Review Services (SSARS) No. 21 – Clarification and Recodification. This new standard was issued in October 2014 and effective for 2015 financial statements with early implementation is permitted. SSARS No. 21 supersedes all existing AR sections in AICPA Professional Standards with the exception of AR section 120, Compilation of Pro Forma Financial Information.
An important provision of SSARS No. 21 is the elimination of the submission requirement that made CPAs responsible for determining whether they have prepared financial statements. This eliminates the potential for diversity in practice by CPAs in regards to financial statements produced using the client’s accounting software. The new standard eliminates a requirement from previous standards dating to 1978 that required accountants in public practice who prepared financial statements to, at a minimum, perform a compilation engagement with respect to any financial statements they presented to management or to third parties.
The requirements and guidance related to review engagements remain basically unchanged. In addition, the new standard retains most of the existing requirements for compilations. However, there were significant changes and clarifications related to the compilation report including:
- Compilation engagements always requires a report
- The compilation report is streamlined to differentiate the non-assurance compilation report from assurance (review and audit) reports so that the standard compilation report contains only one paragraph with no headings.
- Retains the requirement that the accountant modify the accountant’s compilation report whenever the accountant’s independence is impaired.
- Requires the accountant to obtain an engagement letter signed by both the accountant and the client’s management.
- May be applied to financial statements with or without disclosures.
SSARS 21 also introduced a new service for “Preparation” of financial statements. This applies when the CPA is engaged to prepare financial statements but is not engaged to perform an audit, review or a compilation on those financial statements. The CPA is required to include a legend on each page of the financial statements stating that no assurance is being provided. The CPA must also obtain an engagement letter signed by both the CPA and the client’s management. When preparing financial statements, the CPA does not need to consider whether he or she is independent, which is similar to other nonattest bookkeeping/accounting services engagements. The preparation standard may be applied to financial statements with or without disclosures.