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Understanding Compilation
Review and Audit
Reporting on Financial
Performance
Almost every organization, whether it's
a privately held business, a publicly owned corporation,
or a nonprofit organization, must prepare reports
on its financial performance. Such reports help owners
and managers make operating decisions, enable creditors
to evaluate loan applications, and provide individuals
with information to make investment decisions.
The accounting profession recognizes that
different entities have different accounting needs.
Acknowledging these differences, the profession has
developed standards that enable CPAs to offer a range
of financial statement services.
Diverse Accounting
Services for Diverse Needs
A CPA may provide a client with three distinct
services involving financial statements. Each is
designed to meet a different need.
A compilation is
useful to small, privately held entities that need
help in preparing their financial statements. A review,
on the other hand, may be adequate for entities that
must report their financial positions to third parties,
such as creditors or regulatory agencies. Reviewed
financial statements may also be useful to business
owners who are not actively involved in managing
their companies.
An audit is
the third and most extensive service. An audit is
appropriate for entites that must offer a higher
level of assurance to outside parties. An unqualified
opinion from a CPA after an audit provides reasonable
assurance to outside parties that the entity's financial
statements fairly present its financial position
and results of operation in accordance with certain
accounting principles.
Compilation, review, and audit engagements
are explained in greater detail on the following
pages.
Compilation
Preparing
financial statements of private entities based
on information
provided by the entityís management.
Through compilation services, a CPA prepares
monthly, quarterly, or annual financial statements.
However, he or she offers no assurance as to whether
material, or significant, changes are necessary for
the statements to be in conformity with generally
accepted accounting principles, the cash basis, or
the income tax basis of accounting. During a compilation,
the data is simply arranged into conventional financial
statement form. No probing is conducted beneath the
surface unless the CPA becomes aware that the data
provided is in error or is incomplete.
However, before agreeing
to perform a compilation, a CPA will take a "common sense" look
at the entity to decide whether the client needs
other accounting
services, such as help in adjusting the accounting
records.
Here's what a compilation
entails:
The CPA becomes familiar
with the accounting principles and practices common
to the client's industry,
and acquires a general understanding of the clientís
transactions and how they are recorded.
After compiling the financial statements,
the CPA is obliged to read them and consider whether
they are appropriate in form and free from obvious
material errors. The CPA then issues a standard report
that says, in effect, that the financial statements
were compiled, but because they were not audited
or reviewed, no opinion is expressed.
Compilation standards
permit an accountant to compile financial statements
that omit footnote
disclosures required by generally accepted accounting
principles or another comprehensive basis of accounting
(cash or income tax). This is allowable as long as
the omission is clearly indicated in the report and
there is no intent to mislead users. However, when
footnote disclosures have been left out, the CPA
adds a paragraph to the compilation report stating
that management has elected to omit disclosures.
This paragraph lets the user know that if the financial
statements contained this information, it might affect
the userís conclusions.
A compilation is sufficient for many private
companies. However, if a business needs to provide
some degree of assurance that its financial statements
are reliable, it may be necessary to engage a CPA
to perform a review or an audit.
Here is an illustrative compilation report:
Accountant's Compilation
Report
Stockholders and Board of Directors
XYZ Company
We have compiled the accompanying balance
sheet of XYZ Company as of December 31, 19X5, and
the related statements of income, retained earnings,
and cash flows for the year then ended, in accordance
with Statements on Standards for Accounting and Review
Services issued by the American Institute of Certified
Public Accountants.
A compilation is limited to presenting
in the form of financial statements information that
is the representation of management (owners). We
have not audited or reviewed the accompanying financial
statements and, accordingly, do not express an opinion
or any other form of assurance on them.
Able, Baker and Charlie, CPAs
February 15, 19X6
Review
Inquiry and analytical
procedures applied to financial statements of private
entities.
A private entity may engage a CPA to perform
a review of its financial statements and issue a
report that provides limited assurance that material
changes to the financial statements are not necessary.
With respect to reliability and assurance, a review
falls between a compilation, which provides no assurance,
and the more extensive assurance of an audit.
Before a review, the
CPA may have to compile the financial statements;
however, in all cases,
the financial statements are managementís statements,
not the CPA's. Management must have a sufficient
understanding of the financial statements to assume
responsibility for them.
Two other factors differentiate
a review from a compilation ó the CPA must remain
independent of the client during a review, and
all appropriate
footnotes must be included in the reviewed statements.
Here's what a review
entails:
The CPA obtains a working knowledge of
the industry in which the entity operates and acquires
information on key aspects of the organization, including
operating methods, products and services, and material
transactions with related parties.
The CPA will then make
inquiries concerning such financial statement-related
matters as accounting
principles and practices, recordkeeping practices,
accounting policies, actions of the board of directors,
and changes in business activities. Then the CPA
will apply analytical procedures designed to identify
unusual items or trends in the financial statements
that may need explanation. Essentially, a review
is designed to see whether the financial statements "make
sense" without applying audit-type tests.
Keep in mind that during
a review, a CPA does not confirm balances with
banks or creditors,
observe inventory counting, or test selected transactions
by examining supporting documents. However, in many
instances, a reviewówith its limited assurance ómay
be adequate for a business or its creditors. If more
assurance is necessary, the organization may need
to engage a CPA to perform an audit.
Here is an illustrative review report:
Accountant's Review
Report
Stockholders and Board of Directors
XYZ Company
We have reviewed the accompanying balance
sheet of XYZ Company as of December 31, 19X5, and
the related statements of income, retained earnings,
and cash flows for the year then ended, in accordance
with Statements on Standards for Accounting and Review
Services issued by the American Institute of Certified
Public Accountants. All information included in these
financial statements is the representation of the
management of XYZ Company.
A review consists principally of inquiries
of company personnel and analytical procedures applied
to financial data. It is substantially less in scope
than an audit in accordance with generally accepted
auditing standards, the objective of which is the
expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our review, we are not aware of
any material modifications that should be made to
the accompanying financial statements in order for
them to be in conformity with generally accepted
accounting principles.
Able, Baker and Charlie, CPAs
February 15, 19X6
Audit
Includes such procedures
as confirmation with outside parties, observation
of inventories, and testing selected transactions
by examining supporting documents.
A public or private company may engage
a CPA to audit its financial statements and to issue
a report that provides the highest level of assurance
that the financial statements are presented fairly
in conformity with generally accepted accounting
principles.
In an audit, as in a review, the CPA must
be independent of the client and the financial statements
must contain all required footnotes.
Here's what an audit
entails:
To gather evidence on
the reliability of the financial statements, the
CPA performs "search
and verification" procedures. In an audit, the CPA
generally confirms balances with banks or creditors,
observes inventory counting, and tests selected transactions
by examining supporting documents. In addition, the
CPA contacts sources outside the client organization
to gather information that may be more objective
than that obtained from internal sources. For example,
the CPA usually obtains written confirmation from
a clientís customers about amounts owed to the client
at a specific date. By accumulating this type of
evidence, the CPA tries to reduce the risk that the
financial statements will be materially misstated.
The auditor then issues a report stating
that the financial statements are presented fairly,
in all material respects, in conformity with generally
accepted accounting principles.
An audit is planned
and performed with an attitude of professional
skepticism; that is,
the auditor designs the audit to provide "reasonable
assurance" that material errors or fraud are detected.
However, fraud concealed through forgery or collusion
may not be found because the auditor is not trained
to catch forgeries, nor will customary audit procedures
detect all conspiracies.
An audit provides a reasonable level of
assurance that the financial statements are free
of material errors and fraud. An audit does not,
however, provide a guarantee of absolute assurance.
Here is an illustrative audit report:
Independent Auditor's
Report
Stockholders and Board of Directors
AU Company
We have audited the accompanying balance
sheet of AU Company as of December 31, 19X5, and
the related statements of income, retained earnings,
and cash flows for the year then ended. These financial
statements are the responsibility of the Companyís
management. Our responsibility is to express an
opinion on these financial statements based on
our audit.
We conducted our audit in accordance with
generally accepted auditing standards. Those standards
require that we plan and perform the audit to obtain
reasonable assurance about whether the financial
statements are free of material misstatement. An
audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the
accounting principles used and significant estimates
made by management, as well as evaluating the overall
financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements
referred to above present fairly, in all material
respects, the financial position of AU Company as
of December 31, 19X5, and the results of its operations
and its cash flows for the year then ended in conformity
with generally accepted accounting principles.
Able, Baker and Charlie, CPAs
February 15, 19X6
What Services Do
You Need?
Compilation CPA
prepares financial statements from information provided
by management.
A compilation is useful when limited in-house capabilities for preparing
financial statemetns exist.
Review CPA
applies inquiry and analytical procedures to financial
statements provided by management to determine if
they are reasonable.
A review provides limited assurance that no material changes need to
be made to the finacial statemtns.
Audit CPA
examines financial statements by conferring with
outside parties, completing physical inspections
and observations, and testing selected transactions
by examining supporting documents.
An audit provides the highest level of assurance that the financial
statements fairly represent the entity's financial position and results
of operation in accordance with generally accepted accounting principles.
AICPA
The CPA. Never Underestimate The Value.
Communications Division
American Institute of Certified Public Accountants
1211 Avenue of the Americas
New York, NY 10036-8775
338568
copy 1992, revised 1996
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