Audit, Review, or Compilation – What Financial Statements Do You Need?
This is a brief, non-technical explanation of the differences in assurance engagements provided by Certified Public Accountants. A Compilation is the most basic (cheapest) engagement to prepare financial statements, followed by a Review, which provides limited assurance (and is more expensive), and ending with an Audit, which provides the greatest level of assurance (at the greatest cost to the company).
Although a Compilation does not have the assurance level of a Review or Audit, a CPA would not sign the report if he or she became aware of any material errors in the financial statements. Basically, the CPA takes the numbers from the company and puts (compiles) them in the form of financial statements. Every compilation report contains this disclaimer: “A compilation is limited to presenting in the form of financial statements information that is the representation of management.”
A Review provides limited assurance that the financial statements are in conformity with generally accepted accounting principles and significant errors have not been found. The Review report, signed by the CPA, states that the financial statements are the responsibility of management and includes the following description of work performed: “A review consists principally of inquiries of the Corporation’s personnel and analytical procedures applied to financial data.” The report goes on to say that an audit has not been performed, and accordingly no opinion has been expressed.
An Audit is the most thorough examination of an organization’s books, providing an attest function to third parties such as banks, shareholders, and potential investors that the financial statements paint a fair picture of the organization. All publicly traded companies must have annual audits. The audit report and audited financial statements are presented in the annual report to shareholders. An audit requires extensive understanding of internal controls, testing of accounting records, confirmation of ownership of assets, corroboration of evidential matter, etc. The audit report assures the reader that the audit was “performed in accordance with generally accepted auditing standards,” and that the “financial statements present fairly the entity’s financial position and results of operations.”
Here is a short history of audits. When business corporations gained prominence in America in the 1800s, more and more corporations were owned by absentee owners (shareholders who were not part of management, and who lived in another state). To ensure that the financial statements produced by management were accurate, the need for Certified Public Accountants was born. Initially, they provided outside assurance and attestation that the financial statements presented fairly the activity and financial position of the corporation.
In practice, many local, small businesses are required by their lenders (usually local banks) to engage a CPA to provide either a compilation or a review. Many non-accountants refer to all assurance work performed by CPAs as audits, when the majority of the assurance work they actually need is either a compilation or a review, not the expensive audits required by publically traded companies.
