Photo of printed financial reports

Financial Reporting and the 4 Levels of Service

When asking a Certified Public Accountant (CPA) for a report and financial statements, it is important to know what type is needed and what will be delivered for each type.

In the world of CPA services applied to financial statements, there are four primary levels of service: preparation, compilation, review, and audit.

The results from each level come with varying degrees of “assurance” or reliability to their users. This assurance ranges in scale from none to reasonable assurance and markedly varies in both the accounting effort and the amount of fees an organization may be charged to receive those financial statements.

The level of service an organization requires ultimately depends on its needs, the needs of the financial statement users and the perceived risk to that user. Higher risk usually requires a higher level of service. For example, an organization may require financial statements for the purpose of:

  1. Grant funding
  2. Regulatory compliance
  3. Surety bonding
  4. Bank loan covenants
  5. Capital raises or financing
  6. Out of area owners

The best way to discern the level of financial statement services required is to consult with the financial statement users to determine what is necessary. The following is a breakdown of the primary levels of service by the amount of work involved by the CPA.

PREPARATION

With a basic financial statement preparation engagement, the CPA is merely assisting management or the business owner in preparing financial statements for internal company use, in a similar manner to what an in-house controller or chief financial officer might prepare for the company. The financial statements can be prepared in any frequency that is most useful for the company (e.g. monthly, quarterly or annually), and can be prepared with or without disclosures. The financial statements may fulfill some lenders’ documentation requirements for small loans and basic reporting on the company’s activity during the reporting period, which can be useful in making organizational decisions. The CPA does not include any formal report with these financial statements and independence is not required.

CPA prepared financial statements can be shared outside of the company, as long as they  include a notice that “no assurance is provided”. The CPA is not required to verify the accuracy or completeness of the information as the financial statements are prepared directly from the information provided by the company.

COMPILATION

In a compilation engagement, the CPA’s objective is to apply accounting and financial reporting expertise by assisting management in the presentation of their financial statements in accordance with General Accepted Accounting Principles (GAAP). These can be prepared with or without disclosures. The primary requirement of the CPA is to read the financial statements and propose adjustments to them if anything comes to his or her attention that is not materially correct or may impact how the user may view the magnitude of those inconsistencies. Depending on the significance of the inconsistencies, the financial statements may need to be adjusted to be in compliance with GAAP.

With a compilation, there are some key aspects that make this level of service different from a preparation, review or audit:

  1. The CPA is not required to perform inquiries, analytic, substantive or other procedures on the information provided by management.
  2. The CPA is not required to obtain an understanding of the entity’s internal controls or assess fraud risks; however, if fraud comes to the CPA’s attention it should be reported to management.
  3. The CPA is not required to be independent. If the CPA is not independent, the lack of independence must be disclosed in the accountant’s compilation report.

REVIEW

The next level of service is a review engagement. This  type goes more in-depth than a compilation and gives the user a limited level of assurance that there are no material modifications that should be made to the financial statements. This limited assurance is obtained primarily through inquiry and analytic procedures which are not required in a preparation or compilation.

For a review, the CPA is required to:

  1. Have an understanding of the industry in which the client operates.
  2. Obtain knowledge about the business and the accounting principles and practices that the client uses.
  3. Perform inquiry, analytic, substantive or other procedures on any information provided by management that can be analyzed in relation to peer, industry and historical data. 
  4. Be independent in order to perform the engagement.

Similar to a compilation, a review does not require the CPA to obtain an understanding of the entity’s internal controls or assess fraud risks; however, if fraud comes to the CPA’s attention it should be reported to management.

AUDIT

A financial statement audit is the highest level of service a CPA can provide. The CPA’s objective is to obtain reasonable (defined as high, but not absolute) assurance about whether the financial statements as a whole are free of material misstatement. The CPA then expresses an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with GAAP.

Some important characteristics of the financial statement audit include:

  1. The CPA is required to obtain an understanding of the entity’s internal controls and assess fraud risks.
  2. Professional standards require the CPA to perform risk assessment procedures on significant areas that could have an impact on the financials if they were not deemed materially correct.
  3. The CPA is required to perform inquiry and analytic procedures.
  4. Information from management is confirmed or corroborated with third party information.
  5. The CPA is required to be independent in order to perform an audit engagement.

During the course of completion, an auditor spends much of the time attempting to gain an understanding of the appropriateness of the assertions or claims made by management. Professional standards require the auditor to look at the organization through the lens of management’s assertions in six key areas.

Existence or Occurrence – Amounts or transactions recognized in the financial statements pertain to valid transactions that actually occurred and/or items that both exist and relate to the entity.

Completeness – All transactions that were supposed to be recorded have been recognized in the financial statements.

Rights and Obligations – The entity has the right to ownership or to use the recognized assets, and the liabilities in the financial statements represent the obligations of the entity.

Accuracy or Classification – Transactions in the financial statements are recorded accurately at their appropriate amounts and are classified and presented fairly.

Valuation or Allocation – Transactions in the financial statements are properly valued. Estimates are reasonably calculated and applied.

Cutoff – Transactions have been recognized in the correct accounting periods.

When evaluating an organization’s financial statement needs, it is important to consider the purpose and desired information of the end user. If a financial statement audit is required, the work a CPA puts into those engagements may yield recommendations for improved internal controls and streamlined processes. However, some organizations may decide not to pursue an audit when simply a compilation or review from a well-known CPA firm will do.

It is important to consider organizational needs and consult options with a trusted CPA to determine which approach combines the right marriage of effort, cost, and assurance requirements.

Creative image of the word "Benefits"

Benefits 2.0: Looking at the Future of Talent Retention