A large amount of business owners are not fully aware of the various levels of assurance offered by a certified public accounting firms and the differences between the three. It’s an easy mistake to combine all assurance services (audit, compilation and review) under the term audit. But the truth is, depending on the situation at hand, an audit is not always required. There are three different levels of assurance – audit, compilation or review. These three services offer different levels of assurance including costs, time and reporting. In a lot of cases, a company’s situation will determine which assurance service is most appropriate (vendor applications, bank loans or internal planning).
This is the most basic accounting service with the lowest level of assurance. Having compiled financial statements shows lenders you have an association with a CPA, but doesn’t truly offer a deep level of assurance on the accuracy of the financial statements presented. Since the CPA does a cursory check on basic features of your financial statements to write a compilation letter, no special preparation is required on your part. A compilation may be sufficient for a small business owner seeking a personal loan. But most of the time, a more credible reviewed financial statements or an audit will be required for a business loan.
Less extensive than an audit, but more involved than a compilation, a review is typically performed through inquiry of management and applying a range of procedures to analyze the financial data provided by the client. A company may potentially require assurance that doesn’t reach the extent of a full audit. A review of the company’s financial statements is meant to provide limited assurance that there are no material modifications that should be made to the financial statements in order for them to conform to generally accepted accounting principles. This type of engagement still requires an understanding of the client’s industry and assessment of risk for material misstatements in the financial documents.
However, in these cases, the accounting firm conducting the review does not need to gain an understanding of the company’s internal controls. In addition, a review does not assess fraud risk, test the accounting records or involve the in-depth procedures of an audit.
An audit provides the highest level of assurance and is often prepared for companies because outside parties often require an auditor’s opinion on the financial statements. To organize an opinion requires extensive testing and evidence gathering (e.g., inquiry, physical inspection, observation, third-party confirmations, examination, analytical procedures, etc.) as well as analysis of the financial statements. In order to assess the risk of material misstatement in the financial statements, develop the appropriate tests and provide the necessary assurance, an accounting firm must gain a sufficient understanding of the audited company’s internal controls.
The end goal of an audit is to provide reasonable, but not absolute, assurance (based on the CPA firm’s opinion) that the financial statements comply with generally accepted accounting principles and are free of material misstatement by error, fraudulent financial reporting or misappropriation of assets.