The Difference Between an Audit, Review and Compilation

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Businesses frequently do not consider if they are getting the appropriate level of financial statement services.  Most often, business default to audits because that is what they are familiar with.  But accountants provide three levels of financial statement services, two of which are most often forgotten.  Compilations and reviews are cheaper alternatives to audits that many businesses do not take advantage of properly.  Part of this may come from not properly understanding what each of these services entail.   Understanding the level of services can help businesses select the best match of services for their needs and the needs of their financial statement users.

A compilation is the one of the lowest level financial statement services an accountant can provide.  A compilation consists essentially of presenting information obtained from a client in financial statement format.  There is no assurance being provided by the accountant.  A compilation does not contemplate the accountant performing inquiry, analytical procedures or other procedures.  There is no required testing of accounting records.  In practice, many accountants still obtain general support for significant numbers such as bank statements, detail schedules of accounts and aging schedules.  The accountant also asks for documents such as operating agreements, loan agreements and leases so that the footnotes may be drafted.  The compilation report specifically states that no assurance is being provided.  An accountant need not be independent to perform a compilation engagement.  The report states if the accountant is independent or not.  Generally, compilations are the least costly form of financial statement services.  Compilations are most often used for personal financial statements.  Compilations are generally acceptable to local banks.  Most regional and national banks will generally not accept a compilation engagement.

Reviews provide a limited level of assurance that there are no material modifications that should be made to the financial statements.  Reviews consist primarily of inquiry and analytical review of numbers.  A review is best summarized as what do you do and do your numbers make sense.  Much like a compilation, a review does not contemplate the accountant to verifying information with supporting documents.  Procedures in a review typically consist of accountants comparing prior year results with the current year, comparing results to other similar companies through ratio analysis and comparing key non-financial items such as unit sales over similar time periods and the number of employees as compared to payroll costs.  The accountant then inquires of management when unexpected results are encountered.  If the accountant does not get a satisfactory explanation, then often supporting documents are obtained for evidence of the change.  Much like a compilation, many accountants obtain bank statements, detail schedules and aging schedules as additional support.  In addition, any legal documents required to draft the financial statements are also obtained.  Compilations are most often used for small to medium sized companies and are most widely accepted by regional banks.  Some national banks will accept reviews on a customer by customer basis.  Reviews are more costly than compilations but are usually 40% – 60% of the cost of an audit.

An audit is the highest level of assurance accountants provide.  An audit consists of obtaining an understanding of internal control, assessing fraud risk and obtaining evidence to support the numbers through observation, inspection, confirmation or examination of source documents.  The understanding required to be obtained under current auditing standards requires auditors to obtain documentation of the client’s business processes and verify that documentation is accurate.  In addition, auditors will ask for significant numbers of schedules such as fixed asset details, bank statements and reconciliations, aging schedules, revenue details and many others.  These schedules are then tested through various procedures such as confirmation, examining subsequent cash receipts and tracing them to bank statements, confirmations with third parties, or testing of controls.  Audits are the most generally accepted by lenders of all sizes and provide a high level of assurance that the financial statements are free of material misstatement.  Audits are the highest cost assurance service accountants generally provide because of the scope of detail items examined in order to issue an opinion.

So which service is the right level of service for your business?  The easiest way to determine that is to ask the bank want they want.  Unless you are a public company that is required to file audited financial statements, banks are generally the largest users of financial statements.  Discussing the level of service the bank requires can often lead to the ability to negotiate down to a lower level of service that will be less costly.  Also, consider the level of assurance, if any, other users of the statements such as other partners that may not be involved in the daily operations of the business require.   It can be difficult to strike the appropriate balance between various users but taking the time to discuss the matter with them as well as your accountant can help in making the decision about the right level of service for your business.

 

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