Accurate financial statements are essential for all businesses. Publicly held companies must not only release them but also subject them to independent CPA audits, offering the highest level of assurance to external stakeholders regarding the absence of significant errors.
Privately held companies, especially smaller businesses, can find relief in the fact that the costly and labor-intensive process of formal audits may not be necessary. There are alternative, more cost-effective, and less burdensome approaches available.
The most basic: Preparations
True to its name, a financial statement preparation is simply the product of an accountant preparing a set of financial statements in accordance with an acceptable financial reporting framework. It’s usually done as part of bookkeeping or tax-related work.
A preparation provides no assurance of the accuracy and completeness of the financial statements in question. And assurance is typically critical if you plan to share the financial statements with third parties such as lenders and investors.
That said, some lenders may accept preparations in support of small lending arrangements. However, more often than not, preparations are used only for internal purposes to provide a business’s leadership with information on the company’s current financial condition and as a basis of comparison against future accounting periods. In fact, professional standards don’t even require a CPA to be independent of a business to perform a preparation.
To avoid misleading any third parties who might eventually receive a preparation, each page of the financial statements should include a disclaimer or legend stating that no CPA provides any assurance on the accuracy of the documents. In addition, a preparation must adequately refer to or describe the applicable financial reporting framework that’s used and disclose any known departures from that framework.
The next step up: Compilations
If you want to fortify the trust of potential third-party financial statement users a little more, consider a compilation. Like a preparation, a compilation is simply a set of financial statements generated in accordance with an acceptable financial reporting framework that provides no assurance of the documents’ accuracy and completeness.
The primary difference is a compilation includes a formal report by a CPA attesting that this professional has fully read the financial statements and evaluated whether they’re free from obvious material errors. If the CPA isn’t independent of the business, this fact must be disclosed in the report as well.
The use of a compilation can extend beyond the business’s leadership to third parties such as lenders, investors and collaborative partners who may view the input of a CPA as reassuring. However, many third parties might still insist on some level of formal assurance to accept your company’s financial statements.
The right level
We’d be remiss if we didn’t mention there’s another level in between audit (highest assurance) and preparation and compilation (no assurance). That would be a financial statement review. A review is performed by an independent CPA, who provides limited assurance that no material modifications should be made to the financial statements in question. If you need help deciding which level of financial statement services is right for your business, please contact your Rudler, PSC advisor at 859-331-1717.
RUDLER, PSC CPAs and Business Advisors
This week's Rudler Review is presented by Max Epplen, Staff Accountant and Matthew Topmiller, CPA.
If you would like to discuss your particular situation, contact Max or Matt at 859-331-1717.
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