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Deciding Between a Compilation, Review or Audit

Deciding Between a Compilation, Review or Audit

Even a successful, privately held small business may be asked for an audited financial statement by a banker, investor, creditor or buyer. These third parties often want some assurance that the financial statements provided by your business are reasonably accurate and free of any major oversights or material errors.  Similarly, a compilation may be useful for you right now, but third parties, such as banks, may want a greater level of assurance.  The following insights into the differences between audits, reviews and compilations may help you better understand why they can be helpful for you and your business.

Audits provide the highest level of assurance to the user of the financial statements. Some companies report that providing banks with audited financial statements have resulted in lower interest rates than companies that don’t have their statements audited. Of course, not all banks require an audit. A review provides less assurance, but for some banks that may be enough, and it generally costs less than an audit.

As explained by the American Institute of CPAs, compilations are “intended for use by lenders and other outside parties who may appreciate the business’s association with a CPA without requiring a level of assurance on the accuracy of financial statements.” A review, however, is “intended to provide lenders and other outside parties with a basic level of assurance on the accuracy of financial statements.” It may be necessary when you’re seeking extensive financing.

Consider the differences:

  • Audit: This provides the most assurance. An audit entails understanding internal controls, outside verification of selected items and many other detailed procedures that allow an accounting firm to render an opinion on the financial statements.
  • Review: This provides some assurance. It is the most common form of assurance of financial statement accuracy for small businesses. It’s not an audit — it is much less extensive and provides limited assurance that financial statements are basically in conformity with generally accepted accounting principles (GAAP).
  • Compilation: A compilation entails obtaining information internally and placing it in the form of financial statements, without expressing an opinion or assurance on them.

A review is more thorough than a compilation. It is considered the base level of CPA assurance services. In a review engagement, your CPA is required to understand your industry, including its accounting principles and practices. An accountant obtains knowledge about you — your business and the accounting principles and practices. This identifies areas where material misstatements may arise.

In a review, a CPA performs analytical procedures and inquiries to obtain limited assurance about financial statements that are intended to provide a user with a level of comfort about their accuracy. It’s substantially narrower in scope than an audit is, but it still may be suitable for your purposes.

Most experts agree that it’s not sufficient to simply rely on your banker’s interpretation of your internal financials. Some level of assurance is a good idea…and quite possibly a requirement at any lending institution. Ask if the bank requires or recommends an audit — it may be worth the money.

Getting Outside Funding

A common question is whether there’s a need for audited statements when you’re seeking cash from outside sources, such as a venture capital or private equity group. The answer is generally yes. A lot may depend on what stage the company is in. An early-stage company may not need an audit or review, because possible investors are more concerned with your company’s potential. However, if it’s a more established company, and it’s relying on its history as an important basis for seeking funding, then it may have to show audited statements.

No matter what the investor group requires upfront, however, you can expect that it will require audits going forward as part of the terms of its investment.

Similarly, if you’re at a later stage in your company’s life — for example, seeking to be acquired as part of a retirement plan — you’ll need to have audited financial statements to show any potential suitors, even if you’re privately held.

You may have questions about whether an audit, a review or a compilation would be suitable for your business. Give us a call to discuss your business, your particular situation and we’ll help you make the right decision.

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