Financial statement preparation: compilation, review and audit

Although we do not provide audit or review services, we do provide preparation and compilation services so it is important that you understand what each service does and does not do.

When accountants work on your financial statements, what takes place? A surprising number of business owners do not understand what the accountant does.

We would like to share with you the different services accountants perform in the attest and accounting functions. Follow this link where you will find the AICPA’s Guide to Financial Statement Services: Compilation, Review and Audit. When you are finished reading this guide you should know the difference between an attest function such as a review, or an audit, and an accounting non-attest function such as a compilation or preparation. You will also have an idea of which service is "right” for you. If you have any questions, give us a call and we will be happy to discuss your particular needs and circumstances.

Oh, in case you were wondering, whenever the CPA designation is used in a report, it means a sole practitioner CPA, or firm of CPAs, whose name is used to sign a report. A CPA is designated an auditing CPA for auditing engagements, a reviewing CPA for review engagements and a compiling CPA for compilation engagements and a preparing CPA for preparation engagements.

In all three types of engagements, the CPA is supposed to smell. As a matter of fact in all his work, the CPA is supposed to sniff. Sniffing is not a procedure. It is a pervasive requirement and attitude. It is called professional skepticism.

In a compilation engagement, the compiling CPA is supposed to sniff. But he is not required to perform any procedures unless he smells something "funny”, or worse, in a financial statement. In that case he is supposed to look into what smells and get some more information or, as the need may be, cause management to make or agree to corrections. Otherwise, he is not required to go beyond sniffing.

In a review engagement the CPA goes beyond sniffing and is required to perform so-called inquiries and analytical procedures, i.e., he is supposed to ask some questions and compare this year’s numbers in the financial statements with other numbers.

If the answers to his questions, or the comparison of the numbers, cause him to wonder about some of the figures in the financial statements, he is supposed to follow through with other procedures and, if need be, cause management to make or agree to corrections. Following through may consist only of asking some more questions. On the other hand, if he doesn’t get good answers, it may cause him to perform some verification procedures. But these additional procedures are performed only in connection with the figures he is wondering about. Otherwise he is only required to ask questions and compare numbers.

In an audit engagement, the CPA also sniffs, asks questions and compares numbers. But, in addition, he has to feel, touch and taste, so to speak. He has to examine the evidence; he has to get the facts.

But, for the greatest part, he only has to examine a portion of the evidence, a sample of it, sometimes a very small sample. He must do some testing. For example: usually he reconciles (tests the reconciliations of) some bank accounts; he asks some customers to verify their balances; he observes and test-counts some inventory items; he searches for some unrecorded liabilities; he examines and compares with the accounting records, some sales invoices, some purchase invoices and some expense invoices. When he performs these types of auditing procedures, sometimes he may be required to dig deeper, depending on his findings.

Upon completion of his engagement, the CPA renders his report. This report broadly states what he has done and the conclusions he has reached. In an auditors’ standard report, the auditing CPA expresses an opinion that the statements "present fairly, in all material respects...”. That is called reasonable assurance because he cannot express absolute assurance since he has only examined a portion of the evidence, sometimes a very small portion.

In a reviewers’ standard report, the reviewing CPA only expresses limited assurance that insofar as he is aware, the statements do not require any material modifications. The assurance is limited because the procedures are so limited.

In the compilers’ standard report, the compiling CPA expresses no assurance since he has performed no procedures upon which any assurance can be based.

None of these reports offers complete or absolute assurance that the financial statements are fairly presented.

Further reading