Before making decisions involving a company, business owners, managers and third parties usually study the company’s financial statements. And third parties are particularly interested in what the external auditor has to say about those statements.
A CPA can provide various levels of service related to a company’s financial statements. But not all CPAs’ reports are the same. In addition to audits, CPAs can provide two other levels of service for unaudited financial statements – reviews and compilations.
Many companies provide their financial statements, along with the CPA’s report, to lenders, investors, suppliers and customers. Informed readers of the report will gain varied levels of comfort, based on the type of service provided.
Businesses should work with their external auditors to determine the appropriate level of service required.
Auditing is the highest level of financial statement service a CPA can provide. Some of the more important auditing procedures include:
- Evaluating the internal control system
- Testing documentation supporting account balances
- Observing the physical inventory count
- Confirming accounts receivable
In addition, the auditors’ tests provide reasonable assurance that the financial statements are not materially misstated as a result of fraud or errors in accounting.
Ideally, auditors will provide an unqualified, or clean, opinion on the company’s financial statements. An unqualified opinion will contain language such as “the financial statements present fairly in all material respects” and “in conformity with generally accepted accounting principles” (GAAP).
If auditors are unable to render an unqualified opinion, they may issue a qualified opinion. Some reasons opinions may be qualified include scope limitations and departures from GAAP.
A qualified opinion due to a scope limitation alerts the reader that the auditors are not able to provide an opinion on one or more material items that affect the overall fairness of the financial statements. If the scope limitation is severe enough, the auditors may disclaim an opinion on the overall financial statements.
A qualified opinion because of a departure from GAAP indicates that, except for a particular item or items, “the financial statements are fairly presented.”
However, if the auditors conclude that the departures from GAAP are so significant that the financial statements, overall, are not fairly stated, they must issue an adverse opinion. An adverse opinion will include language describing what the auditors believe is materially misstated in the financial statements.
Review engagements provide less assurance to the reader of the financial statements because the CPA does not perform any audit testing procedures. Rather, the CPA inquires as to the accounting practices and principles used by the business, the procedures for recording and accumulating financial information, and the actions taken at owners’ or directors’ meetings.
As part of a review, the CPA also performs analytical procedures, such as comparing the financial statements to those of prior periods and studying the financial statements to discern relationships that do not conform to expectations.
Based on those inquiries and analytical procedures, the CPA is able to express only negative assurance on the financial statements. Negative assurance means the CPA found nothing unfavorable or suspect during the review.
Because a review engagement is substantially less in scope than an audit, the CPA cannot express an opinion on the fairness of the financial statements taken as a whole.
In a compilation engagement, the CPA will assemble the financial statements and consider whether they are in appropriate form and free from obvious material errors. Because of the even more limited scope of compilation procedures, the CPA’s report disclaims any degree of assurance on the financial statements.
Although audits provide the highest degree of assurance, they tend to cost significantly more than reviews or compilations. It’s important to find the proper balance between the cost of your CPA’s services and the level of assurance the users of the financial statements require.