What Financial Statement Do You Require?
The Bottom Line Is That Each Product Serves a Different NeedYour certified public accountant (CPA) is able to assist you with many items throughout the year. As a business owner, one of the ways that you may be most familiar with is in the reporting on your annual financial statements.
There are three different levels of engagements that can be performed by your CPA when reporting on your financial statements: compilations, reviews, and audits. Deciding which you need should be based on an understanding of each level, your needs, and the needs of those with whom you will be sharing these statements. This article will help equip you to make this decision.
Compilation engagements are the most basic type to be performed and offer no assurance regarding the overall financial activity being reported on. Your CPA will gather financial records that you provide and will assist in compiling them into a set of financial statements that are in conformity with generally accepted accounting principles (GAAP). While your CPA will look for obvious errors and misstatements, no testing of balances or activity will be performed. In order to make the conclusion that there are no obvious errors or misstatements, an understanding of your business and industry are required.
There are two advantages to compilation engagements, as compared to reviews and audits. First, compilation reports are allowed to omit footnote disclosures. This can save time and money, by not including disclosures that are required in standard GAAP reports, but may not be relevant to your needs or the needs of those reading the financials. Second, while your CPA generally must be independent, a compilation does not require that. The benefit of this is that, for small companies, it allows for your CPA to also assist in bookkeeping throughout the year.
These types of engagements are most beneficial for small, privately held businesses, where financials are sometimes required for equipment financing and insurance purposes.
Review engagements are the middle level of service and provide limited assurance that the financial statements and related activity are free of error or misstatement. As with a compilation, specific testing of balances and activity are not required.
Through an understanding of your business and industry, your CPA will perform a series of analytical procedures and discuss a number of inquiries with you. These will include, but not be limited to, discussions of activity during the year, development of expectations, trending analysis and the review of various financial and industry-specific ratios. It should be noted that no audit procedures are performed during a review and that review engagements are substantially smaller in scope than an audit.
Reviews are typically best-suited for financial statements that are required by third parties, such as when applying for bank debt. Additionally, they are also common in situations with non-active owners who want greater assurance that there are no financial-statement errors.
Audit engagements are the highest level of assurance. Accordingly, they can be very expensive, depending on the size of the entity being audited. Audits provide the users with reasonable assurance that the financial statements are free of error or misstatement.
In order to complete an audit engagement, your CPA will be required to gain an understanding of your internal control environment, as well as to perform tests over account balances and activity. These tests include, but are not limited to, confirmations, observations, and review of other third-party evidence. Additionally, while audits are not designed to detect all instances of fraud or illegal acts, your CPA must consider these in audit planning.
Audit engagements are performed for many reasons. In some instances, such as not-for-profit entities, publicly traded companies, and certain employee benefit plans, audits are required by various regulations. In other instances, based on the size of the company and the nature of the business, third parties such as banks, insurance companies, or large customers may require an audit report.
There are a few exceptions to the rules above that everyone should be aware of. First, even though you may engage your CPA to perform a review or compilation engagement, they can be contracted by you to perform special procedures related to certain account balances or activities. This can be particularly helpful to clients who have large inventory or accounts-receivable balances, but do not want to ultimately pay for a full audit.
Additionally, banks and other third parties are oftentimes willing to accept a compilation or review engagement, with additional procedures performed over certain areas. This provides them with added comfort over their areas of exposure, while helping to reduce your overall accounting fees.
Additionally, there are instances where you may be able to report your financial statements on a basis other than GAAP, otherwise known as an other comprehensive basis of accounting (OCBOA). The most common form of OCBOA financial statements include tax basis, cash basis, or modified accrual basis. There are two key benefits to such reporting. The first is that, depending on how information is displayed in your internal accounting records, such reporting may require fewer adjustments as compared to adjusting to GAAP. Second, there are certain disclosures, such as the consolidation of variable interest entities, which can be avoided by reporting on OCBOA as opposed to GAAP. This can be beneficial, and cost-effective, in cases where there may be two companies under common ownership, as well as in the case of real-estate holding companies.
Overall, the third parties that you deal with tend to have the final decision in directing the level of financial statement that you are required to produce in order to provide for their needs and concerns. However, being knowledgeable about the different options that are available may allow you to discuss with them their needs and concerns with an end result of saving real dollars and a lot of valuable time. Additionally, it will allow you to have a better appreciation for the services that are being performed by your CPA, as well as a better understanding of what you are receiving from them in the end.
Jim Krupienski, CPA, is an audit manager for Meyers Brothers Kalicka, P.C., a certified public accounting firm based in Holyoke. He provides accounting and audit services to for-profit businesses, as well as employee-benefit audit services to for-profit and not-for profit organizations. He is also part of MBK’s Health Care Services Division, providing niche accounting services to medical and dental practices in Western Mass. and Connecticut.