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 entities 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 Preparing financial
statements of private entities based on information provided by the entity?s
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 client?s
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 user?s 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.
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 modifications 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 management?s 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 ? 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 typically does not confirm balances with banks or
creditors, observe inventory counting, or test selected transactions by
examining supporting documents. However, in many instances, a review?with its
limited assurance ?may 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.
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
client?s 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.
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 statements 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 financial statements.
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.
