When you cut yourself and you need to apply a bandage to the wound, you often ask for a Band-Aid. Technically, Band-Aid is a brand name for an adhesive bandage, but the words have become interchangeable in our everyday language.
We hear this same sort of commentary as part of the accounting vernacular when we are onsite doing year-end work. “We have our corporate audit this week” or “the auditors are here.” We hear this even if we are not technically doing an audit. The term “audit” is one that some business people use loosely, but – unlike using Band-Aid to refer to a bandage – it is vitally important for business owners and the company’s accounting personnel to note the difference between an audit and the two other common forms of financial statement reports – reviews and compilations.
Of primary importance is that the financial statements – the balance sheet, income statement, statement of cash flows, notes to the financial statements, and any other required or supplementary statements – are the property and responsibility of the business or organization. The CPA firm is there to provide a level of service on those statements and issue a report on them.
The level of service on your financial statements is often dictated by a third party, whether it is a bank, a different type of lender, a bonding company, the Board of Directors, or as an edict from a governmental authority. Lenders will request a specific level of service based upon debt load and/or risk in the loan portfolio, whereas a governmental dictate is usually driven by revenue levels.
Audits involve the most scrutiny of an organization’s books and records. Source documents are reviewed; confirmations are sent to third-parties, such as banks, vendors, and customers, in order to corroborate information included in the underlying books; and additional tests are performed to further validate the company’s financial data.
The notable aspect of an audit lies in the report; an auditor actually issues his or her opinion of the presentation of the financial statements.
Reviews require the CPA to perform analysis of accounts and go through inquiry of the business happenings during the year. The accountant does not issue an opinion in a review like he or she does in an audit; rather, the conclusion on the review report indicates, unless there are exceptions, that the accountant noted no material changes that need to be made to the statements for them to be in conformity with the stated basis of accounting. This is called negative assurance.
Compilations are the lowest form of service of the three main types of statements. A compilation is often performed on a smaller company that may not have as many people in its accounting department. The CPA issues no assurance as part of a compilation, but pulls together the numbers and makes sure that they are in an appropriate financial statement format and presentation.
The differences in these three levels of service are important to note and each term has its own place in accounting parlance.
By Dan Massey, CPA, Manager