As your business grows, you may need audited, reviewed, or compiled financial statements. Lenders, investors, and many other external stakeholders may request these financial statements to learn more about your business, and in some cases, you may even need these reports for internal purposes.
To help you decide which assurance services you need, this post provides an overview of financial audits, reviews, and compilations. Then, it looks at the differences between these three options.
What Is a Financial Audit?
A financial audit is when a third-party auditor reviews your organization’s financial statements, accounting processes, and internal controls in depth. The auditor examines your financial statements to ensure the information is presented in accordance with Generally Accepted Accounting Principles (GAAP), and to assess the accuracy of the information, they also analyze how you created the statements by looking at your operational procedures and internal controls.
The auditor examines accounting processes to look for any risks that may impair the validity of your records. They also look at your internal controls to examine your risk of fraud. This includes looking at personnel access, authorization processes, and duty segregation.
When the auditor digs into your financial records, they look at cash, bank reconciliation, financial and capital assets, accounts receivables, accounts payable, inventory, and debts. They also analyze your expenses and examine your revenue in comparison to sales transactions.
Finally, after reviewing everything, the auditor drafts financial statements. These statements summarize your profit and losses, assets and liabilities, shareholder’s equity, and cash flows. However, audited financial statements also contain very valuable disclosures that outline your accounting policies and revenue recognition processes. They also note any material misstatements.
Audited financial records are generally designed for outside parties such as lenders, investors, or acquirers. Audited statements give these outsiders reassurance that they can rely on the accuracy of your financial statements. However, you can also use audited records to improve your processes internally. For instance, you can ask the auditor to provide you with suggestions on how to improve your internal controls.
What Is a Review?
A financial review is when a CPA analyzes the plausibility of your financial statements. They examine your processes and assess managerial procedures, and they issue a report about whether or not your statements are compliant with GAAP or any other financial reporting frameworks.
This process is not as time-consuming or as in-depth as an audit. However, it can be useful if you’re working with lenders or investors who need some extra assurance that your records are accurate.
What Is a Compilation?
A compilation is when an external accountant converts an organization’s bookkeeping records into financial statements. The business specifies which statements it prefers, but compilations tend to focus on the most popular accounting statements including profit and loss reports, balance sheets, and cash flow statements.
To create compiled financial statements, a business hires a Certified Public Accountant (CPA) and gives them access to journals, trial balances, and other bookkeeping records as needed. Then, the accountant works up the requested statements.
These statements can be useful for many different purposes, but you have to keep in mind that they don’t come with any assurance services.
What Are the Differences?
Audits, reviews, and statement compilations all involve having a third party look at your business’s financial statements. All of these processes can be useful at different times, but they have different applications and varying levels of assurance. Take a look at how these processes differ in the following categories:
- Assurance level — An audit provides the highest level of assurance about the accuracy of your financial statements. A review provides some limited assurance, and financial compilations don’t provide any assurance.
- Reliance on internal information— When a CPA prepares compiled statements, they are relying entirely on the organization’s internal information. Unless there is a clear misstatement, they don’t make any adjustments or question any information. With a financial review, the accountant tests some of the presented information. Finally, with an audit, they don’t exclusively rely on any internal details. Instead, they dig deep to assess the accuracy of the presented information.
- Internal control testing — To assess the accuracy of the presented information, an auditor must test your internal controls. This doesn’t happen with financial reviews or statement compilations.
- Work involved — Compiling financial statements is relatively easy and straightforward. You provide the accountant with access to your bookkeeping records, and they generate the statements that you need. Reviews are more time-consuming, and an audit can take anywhere from a week to a few months.
- Cost — The cost of these services vary based on the complexity of your business, but they are also dependent on the depth of the review. To that end, compilations have the lowest cost, reviews are in the mid-range, and audits require the most significant investment.
Compiled, reviewed, and audited financial statements can be critical for a vast range of business applications. If you’re trying to sell your business, attract investors, apply for loans, or go public, you need financial statements that have been reviewed by an outside specialist. However, you need to ensure that you invest in the right services.
For example, while many people think that a review is a precursor to an audit, these services involve significantly different processes, and they analyze different aspects of your accounting procedures. If you start with a review, you often can’t just switch to an audit midstream. In most cases, you will have to start over. That’s why it’s critical to consult with a specialist to ensure that you select the optimal choice for your needs.
Wondering which option is right for your business? Want to talk more about the differences between these types of statements? Then, contact us directly. At DHJJ, we provide a range of accounting services including compilations, reviews, and audits to small and medium-sized businesses. Let us help you preserve your financial well-being.