Financial statements are extremely important in understanding whether or not a business has performed according to the standards or expectations. An understandable and accurate statement will also help figure out its financial position, as well as the value of its assets. But financial statements go in more directions. And when it comes to financial statements explained, some of them can be trickier to understand for the less experienced user. For instance, an audit could be fairly simple to figure, but what about a compilation? How about a review?
Let’s find out what each of them means and when to use them.
Becoming Familiar With the Audit
The audit is one of the main financial statements out there. It’s complex and requires a thorough analysis because it’s mostly done prior to important transactions.
An audit could be done before selling a company or perhaps considering an acquisition. It’s also required before a potential merger, not to mention finding external investments for further growth.
According to Dimov Audit, an audit requires an independent CPA with no connections to any of the parties involved. At the same time, the accountant will conduct different analyses and inquiries in order to understand everything about the business, including:
- Internal controls
- Potential misstatements
- Risks of fraud
Other procedures for the audit include different substantiation and verification processes, only to ensure the final statement has all the information required.
Now, while the audit does include all the small bits related to the financial situation of a business, the truth is it’s only an opinion. It doesn’t offer any form of insurance or assurance for those interested in the respective business.
Understanding the Review
Reviews aren’t as common as audits. Their main role is to showcase the growth and potential of a business. They’re usually required when the respective business needs financing. A different level of financing compared to what it already has.
Again, the accountant performing the review must be independent and offer an objective point of view. Inquiries and analyses are conducted to offer a limited form of assurance for anyone who might get involved with the company. It’s not a guarantee whatsoever.
What About the Compilation?
The compilation is similar in definition, but it’s most commonly used when a business, such as a startup or smaller enterprise, looks for a lower level of financing. A compilation is also required for initial financing, so it’s quite common among new companies.
While other forms of financial statements do offer a form of assurance to a certain level, the compilation doesn’t have any assurance whatsoever.
On the other hand, the accountant doesn’t necessarily have to be independent. However, if they’re not, they need to showcase this lack of independence in the compilation.
Compilation is ideal for businesses that prioritize cost-effectiveness and simplicity in their financial reporting. It provides a practical solution for businesses which are not ready for the rigorous scrutiny of reviews or audits.
Showcasing the Main Differences
The assurance level is one of the main differences between audits, reviews and compilations. Audits offer more assurance than other forms of statements. Reviews are somewhere in the middle, while compilations offer no assurance whatsoever.
The dependence on management is just as important. For each of these statements, the auditor starts with documents given by the company management. The review goes into deeper details, while the compilation mainly depends on what’s given by the management.
The hours of work put into the project will also count, especially since more hours will obviously cost more. A comprehensive audit takes much more than a review, while a compilation requires minimum effort.
On the same note, costs are just as varied. Since the audit takes more time and offers more data, it will clearly cost more. Throw in the procedures and information required as well. Compilations are the cheapest, while reviews are in-between.
Most certified public accountant (CPA) professionals will charge based on the amount of time put into each project, so the time is directly proportional with the cost, simple as that.
Last, but not least, it’s worth considering the internal controls as well.
Take the audit, for instance. Since it goes into such small details, it requires analyzing some of the internal controls of the company. As for reviews and compilations, they don’t require any of this.
Overall, the choice between audits, reviews, and compilations depends on the level of assurance needed, the company’s budget and the importance of verifying internal controls. Each of these options serves a different purpose which helps businesses and investors to make more informed decisions.
How to Choose Between Audits, Reviews and Compilations
Whether the business needs an audit, review or compilation, it will require a CPA to perform the financial statement.
In theory, if you refer to the actual definitions, there aren’t many differences between these three forms of financial statements. The goal does make the difference though, but also some of the details included, as well as the level of independence required for the CPA.
The choice of the right document depends on the client’s needs. Sure, a business owner can ask the CPA for advice regarding what document would be better for what the business needs.
An expert CPA can guide you through this process. They will explain the pros and cons of each option considering factors like cost, time and detail. This clearly means that the overall needs or goals of the business are the main factors in making a decision.
When seeking consultation, the CPA should provide details about each of these financial statements and how they can help a business. Each option will help the company in a different way, hence the necessity to understand all these.
In order to avoid dealing with too many services, some businesses prefer to work with the same CPA who handles the general accounting for the company, not to mention bookkeeping or even tax returns on a yearly basis.
The company already has a relationship with the respective CPA, so it looks easier.
However, the CPA’s independence could be an important requirement in the process. This means using the same CPA isn’t always an option, despite being more convenient.
In the end, when it comes to financial statements, audit, review and compilation each of them serves a unique purpose. It all depends on what your business needs, your goals, and how much you’re willing to spend. A CPA can help you decide, ensuring your finances are clear and trustworthy. Understanding these options helps keep everything transparent and builds trust with stakeholders.
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Audit, Review or Compilation are NOT types of financial statements. They are three different levels of service a CPA firm can perform on a company’s or other entity’s financial statements. The decision as to which service should be provided is in the vast majority of cases dictated by a third party (think lender, potential buyer, government or regulatory agency).
Good to know. Thanks for the clarification, Kev.