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Levels Of Assurance - Understanding Audits, Reviews And Compilations CPAs provide three distinct services when reporting on financial statements. Each is designed to meet different needs. Audit An audit provides the highest level of assurance that the financial statements are presented fairly in conformity with generally accepted accounting principles (GAAP). An audit is appropriate for businesses that must offer a higher level of assurance to outside parties – all public companies, most non-profit entities and private companies with significant inventories, large loans, outside stockholders or companies planning to merge, sell or go public in the future. Note: Companies acquired by public companies whose income or assets are greater than 20% of the public company’s income or assets are required to provide unqualified, audited financial statements to the SEC within 90 days of the merger or sale. To gather evidence on the reliability of financial statements, the CPA performs "search and verification" procedures. This generally includes:
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. The audit provides a reasonable level of assurance that the financial statements are free of material errors. Review An unaudited review report provides limited assurance that material changes to the financial statements are not necessary in order for them to be presented in conformity with GAAP. A review may be adequate for entities that must report their financial positions to third parties, such as regulatory agencies or banks and their loan limits are generally less than $5 million. In a review, a CPA will inquire about accounting principles and practices, accounting policies, actions of the board of directors, and changes in business activities. Then the CPA will make other inquires and apply analytical procedures 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. A review is substantially less in scope than an audit, and provides only limited assurance that the financial statements are free of material misstatement. Compilation A compilation is useful to small, privately-held companies whose in-house capabilities are limited and who need help preparing their financial statements. A compilation report offers no assurance as to whether material or significant changes are necessary for the statements to be in conformity with GAAP. In a compilation, the CPA compiles (or prepares) the financial statements based on information provided by the company. After compiling the statements, the CPA must read them and consider whether they are appropriate in form and free from obvious material errors. Compiled financial statements may be presented with or without footnotes. A compilation provides no assurance that the financial statements are free of material misstatement.
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