Compilations, Reviews, and Audits: Understanding the Levels of Assurance
CPAs produce reports that provide different levels of assurance regarding the information contained in the financial statements of their clients. The clients’ lenders, investors, and shareholders (or other users of financial information) will experience varied levels of comfort from those reports based on the type of service performed by the CPA. In order to identify the type of service that is right for your organization, it’s critical to understand the significant differences and nuances in the three general levels of financial statement services available: compilation, review, and audit.
In a compilation engagement, the CPA does not provide any assurance about whether material changes to the financial statements are needed in order for the financial statements to be in conformity with accounting standards. The CPA applies their accounting and financial reporting expertise to assist management in the presentation of financial statements. The CPA does not verify the accuracy or completeness of the information provided by management, and the CPA does not dig into the numbers unless they become aware that information provided by management is an error or incomplete.
In a review engagement, the CPA provides limited assurance about whether material changes to the financial statements are needed in order for the financial statements to be in conformity with accounting standards. In performing a review, the CPA makes inquiries and performs analytical procedures designed to identify unusual items that may need further explanation by management. A CPA must have an understanding of the industry the entity operates in and knowledge of the entity’s business. However, the CPA does not obtain an understanding of internal control, assess control risk, test accounting records by inspection, observation, confirmation, recalculation, re-performance, or obtain corroborating evidential matter.
In an audit engagement, the CPA provides reasonable assurance (high, but not absolute) about whether the financial statements are free of material misstatement whether due to error or fraud.
In performing an Audit, the CPA:
- Obtains an understanding of the entity and its internal control
- Determines and applies appropriate materiality levels
- Based on that understanding, identifies and assesses risk of material misstatement
- Responds to those assessed risks by performing procedures using a combination of inspection, observation, confirmation, re-calculation, re-performance, analytical procedures, and inquiry
- Obtains sufficient and appropriate audit evidence about whether material misstatement exist
Benefits of an Audit Include:
- Training and assistance with understanding accounting standards and best practices
- Identification of internal control weaknesses and recommendations for strengthening controls
- An independent, second set of eyes (for those charges with governance and other users of the financial statements) to help ensure that management has not omitted or misstated important financial information
An Auditor’s Role in Detecting Fraud
Auditors are tasked with designing procedures to provide reasonable assurance that financial statements are free of material misstatement, whether caused by error or fraud. Audit standards require an auditor to specifically identify and assess risks that may result in a material misstatement of the financial statements due to fraud and to respond to the results of the assessment when gathering and evaluating audit evidence. There are two types a fraud that are relevant to the auditor’s consideration of fraud: misstatements resulting from fraudulent financial reporting and misstatement resulting from misappropriation of assets. An auditor is primarily concerned with fraud that causes a material misstatement of the financial statements. As such, the auditor has no responsibility to plan and perform the audit to detect immaterial misstatements due to fraud.
Comparison of an Audit, Review, and Compilation
To identify the type of assurance service that is right for you, it’s critical to understand the significant differences between a compilation, a review, and an audit of your organization’s financial statements.