Are Your Financial Statements Meeting Stakeholder Expectations?
Understand the Key Differences Between Compilations, Reviews, and Audits
Introduction
Understanding Financial Statement Services
Financial reporting services are essential for any business seeking clarity and confidence in their financial health. Whether you’re managing day-to-day operations, preparing for a bank loan, or planning to sell your company, having reliable financial statements is critical for informed decision-making and building trust with stakeholders.
Compiled financial statements, financial statement reviews, and audited financial statements each play a unique role in addressing business audit and assurance needs. From providing internal clarity to meeting external compliance requirements, these services help businesses of all sizes maintain accuracy, transparency, and credibility in their financial reporting.
In this blog, we’ll explore the key similarities and differences between these three services. By understanding their purpose, scope, and assurance levels, you’ll be better equipped to choose the financial reporting solution that best fits your business needs.
What are Compiled Financial Statements?
Compiled Financial Statements: The Basics
What is a Compilation?
A compilation is the most basic level of financial reporting services and is designed primarily for internal use. Unlike audits or reviews, compiled financial statements do not include any assurance from the CPA regarding the accuracy or completeness of the financial information presented. Instead, the CPA works with management to organize financial data into a standardized statement format without verifying the underlying data. Additionally, there are no independence requirements for the CPA performing the compilation.
These services are typically used by businesses that have limited external reporting needs but require a formal presentation of their financial information to evaluate internal performance or efficiency. While a compilation lacks the rigor of an audit or review, it can still provide value for small businesses looking for basic financial reporting clarity.
When Do You Need a Compilation?
Compiled financial statements are ideal for businesses that need financial documentation for internal decision-making or to fulfill limited external requirements. For example, small businesses often use compiled statements to evaluate their financial health and performance without incurring the costs of more rigorous reporting services. Additionally, compilations might suffice when a business is seeking a small loan or working with stakeholders with minimal regulatory demands.
Key Features of Compiled Financial Statements
Cost-Effective: Compilations represent the most affordable financial reporting option for businesses.
Internal Focus: These statements are typically prepared for management and internal reporting purposes only.
No Assurance: The CPA does not provide assurance or perform verification procedures, and the responsibility for the accuracy of the data lies with the management team.
What is a Financial Statement Review?
Financial Statement Reviews: Striking a Balance
What is a Review?
A financial statement review strikes a balance between the simplicity of a compilation and the rigor of an audit. It provides limited assurance that the financial statements are free of material misstatements. CPAs conducting a review apply inquiry and analytical procedures to evaluate the plausibility of the information provided, ensuring it aligns with generally accepted accounting principles (GAAP). However, unlike an audit, a review does not involve an in-depth analysis of internal controls or detailed verification of underlying records.
For businesses seeking assurance but not requiring the level of scrutiny that comes with an audit, a review serves as a cost-effective solution. It demonstrates a higher standard of reliability than a compiled financial statement while remaining more affordable and less time-intensive than a full audit.
When Should You Opt for a Review?
Financial statement reviews are most suited for businesses needing to satisfy moderate external reporting demands. Common scenarios include:
Applying for Bank Loans: If you’re seeking funding, lenders often require a financial review to ensure they can rely on the financial statements when assessing your creditworthiness.
Attracting Modest Investors: When seeking smaller investments or partnerships, a review provides third-party financial statement assurance without the cost of an audit.
Reporting to Stakeholders: Shareholders and smaller-scale stakeholders may request a financial statement review to gain confidence in the company’s financial health without requiring a full audit.
Key Features of Financial Statement Reviews
Independence Requirements: The CPA providing a review must be independent of the business to ensure impartiality.
Limited Assurance: While a review does not offer the same depth as an audit, it still provides stakeholders with a level of confidence in the financial statements.
Surface-Level Analysis: CPAs focus on inquiries and evaluations rather than conducting detailed testing or validation.
Cost-Effective: Reviews are more affordable than audits, making them a practical choice for many small to mid-sized businesses.
What is an Audit?
Audited Financial Statements: The Gold Standard
What is an Audit?
An audit represents the highest level of assurance in financial reporting services, making it the gold standard for businesses seeking to establish credibility with external stakeholders. Unlike compilations and reviews, audits involve comprehensive, in-depth procedures designed to provide reasonable assurance that financial statements are free from material misstatements.
During an audit, CPAs conduct detailed testing and validation of financial data, examining internal controls, verifying account balances, and assessing compliance with generally accepted accounting principles (GAAP). Auditors also investigate fraud risks and ensure that financial records align with both internal policies and regulatory expectations. The rigorous approach of an audit ensures that stakeholders, such as investors and lenders, have absolute confidence in the accuracy and reliability of the financial information presented.
Audits also emphasize independence, as the CPA performing the audit must maintain objectivity and impartiality to uphold the integrity of the process.
When Do You Need an Audit?
Audited financial statements are essential for businesses involved in high-stakes transactions or facing stringent external scrutiny. Here are common scenarios where an audit is necessary:
Selling a Business: If you’re planning to sell your company, potential buyers will typically require audited financial statements to evaluate its financial health and performance.
Securing Larger Loans or Funding: Banks and other lenders often insist on audits to verify the accuracy and reliability of financial data before approving significant loans.
Mergers and Acquisitions: An audit provides third-party financial statement assurance, giving confidence to all parties involved in complex transactions.
Meeting Regulatory Requirements: Some industries mandate audits to ensure compliance with laws and regulations, making them a necessity for certain organizations.
Key Features of Audited Financial Statements
Independence Requirements: The CPA conducting the audit must be completely independent from the business, ensuring objectivity.
Verification of Internal Controls: Auditors thoroughly evaluate the company’s internal processes to identify weaknesses or potential risks.
Detailed Substantiation Procedures: Auditors perform extensive testing of financial records, including tracing transactions to source documents, confirming account balances, and evaluating supporting evidence.
Assurance of Compliance: Audits verify adherence to GAAP, ensuring that the financial statements meet accounting and legal standards.
Highest Level of Assurance: Audits provide confidence for high-stakes decisions by confirming the accuracy and reliability of the company’s financials.
Comparing the Levels of Financial Assurance
Compiled vs Reviewed vs Audited Financial Statements
Key Similarities
Despite their differences, compiled financial statements, financial statement reviews, and audited financial statements share some commonalities:
CPA Expertise: All three services are conducted by certified public accountants (CPAs) with specialized financial reporting expertise.
Clarity for Stakeholders: Each service is designed to provide stakeholders—whether internal or external—with a clearer understanding of a company’s financial health.
These similarities underscore the importance of professional guidance in ensuring accurate and reliable financial reporting, regardless of the level of assurance required.
Key Differences
Assurance Levels
Compilation: Provides no assurance, as the CPA simply organizes financial data without verification.
Review: Offers limited assurance that the financial statements are free from material misstatements, relying on inquiry and analytical procedures.
Audit: Delivers reasonable assurance through extensive testing and verification, ensuring the highest level of accuracy and reliability.
Cost and Scope
Compilation: Most affordable option, as it involves minimal work.
Review: Moderately priced, requiring more time and effort than a compilation.
Audit: The most comprehensive and costly service, reflecting the depth of procedures required.
Intended Use
Internal Use (Compilation): Ideal for day-to-day decision-making within an organization.
Moderate External Use (Review): Suitable for stakeholders like lenders or smaller investors seeking limited assurance.
High-Stakes External Use (Audit): Essential for significant transactions such as mergers, acquisitions, or fundraising.
How to Choose the Right Service
Deciding Which Financial Reporting Service is Right for Your Business
Choosing the right financial reporting service depends on your business’s specific needs, goals, and stakeholder expectations. By understanding the purpose of each service and consulting with a CPA, you can ensure that your financial reports align with your objectives and provide the necessary level of assurance.
Consider Your Business Needs
Internal Decision-Making
If your focus is on internal operations, such as tracking cash flow or evaluating profitability, compiled financial statements are an excellent choice. They provide a snapshot of your company’s financial position without the added cost of assurance services, making them ideal for day-to-day decision-making within your organization.
Attracting Financing
When seeking funding or applying for a loan, lenders and bankers often require financial statement reviews to ensure they can trust the accuracy of your financial data. Reviews offer limited assurance and demonstrate that your company’s financial position has been analyzed by a CPA, which can build confidence with creditors.
Larger Transactions
If your business is preparing for significant external activities, such as a merger, acquisition, or sale, audited financial statements are essential. Audits provide the highest level of assurance, giving stakeholders confidence in the accuracy of your financials and reducing risk in high-stakes decisions.
Consult with a CPA
Every business is unique, and selecting the right financial reporting service often requires professional guidance. A CPA can help you balance your needs for assurance, cost, and scope, ensuring that you choose the most appropriate solution. They’ll evaluate your financial objectives, stakeholder requirements, and specific reporting needs to recommend the service that best supports your goals.
By carefully assessing your business needs and seeking expert advice, you’ll be able to make an informed decision and leverage financial reporting services to support your success.
Geri Wood and her team specialize in providing tailored financial reporting services designed to meet your unique business needs. Whether you require compiled financial statements for internal decision-making, a financial statement review to secure funding, or audited financial statements for bankers or compliance purposes, we’re here to guide you every step of the way.
Take the Next Step with Confidence:
Schedule a Consultation: Discuss your financial reporting needs with our experienced team and discover the service that’s right for you.
Download A Free Guide: Learn more about the best practices for financial reporting and how your business can benefit.