This is an explanation of the visual picture I drew in the previous post. I will try to explain the differences between audits, reviews, and compilations with a minimal amount of the technical words we CPAs usually bring to an issue. As we go down this path, please remember that means I won’t include all the conditions and fine-print disclaimers that would be needed if this were a technical explanation.
Picture the comfort level, or assurance, as a continuum with zero, or no assurance at one end. At the other end, there is 100% assurance, or a guarantee that the numbers are exactly, precisely, perfectly correct. Where then would a review, audit and compilation show up on that continuum?
When CPAs issue a compilation report on financial statements, the report says “We have not audited or reviewed the accompanying financial statements and, accordingly, do not express an opinion or any other form of assurance on them.” What this is supposed to mean is the numbers are all from management, so don’t look to us CPAs for any comfort that the numbers, classifications, and disclosures are right.
At the other end of the spectrum, when a CPA issues an audit report on the financial statements, this
provides means the accountant has gained reasonable, but not absolute, assurance for himself or herself that financial statements are fairly presented in accordance with the accounting rules. Reasonable assurance is a fairly high level of assurance. This means you can know that the accountant has a reasonable comfort level be fairly comfortable that the amounts, classifications, presentation, and disclosures are all in sync with the relevant accounting rules.
In between is a review. A review
provides means the accountant has obtained for himself or herself limited assurance that financial statements do not have any known errors or departures from the accounting rules. This means if the CPA identified any errors, mistakes or omissions, they were fixed. Doesn’t mean there won’t be huge errors in the numbers. It means that just based on looking at the relationships between the numbers and asking management a few questions, the CPA didn’t notice anything obvious.
The picture in the previous post tries to translate these relationships into a visual. Three things to point out.
First, “no assurance” on a compilation does not mean “zero”. The irony
is that there is the accountant gained some small amount of assurance. Why? Because if there is something really, really out-of-line, the CPA is obligated to discuss it with management and see that it is fixed. An example would be if the general ledger shows a lot of property and equipment but there is no depreciation expense. Or one of the big expenses is called loan payments but the balance sheet does not show any change in the loan balances, which means the loan was not amortized. In those cases, the CPA would track down the odd issue and make sure the financials get fixed. In one case depreciation needs to be recorded and in the other case some of the loan payment need to be applied to the loan balance. In addition, the CPA would read through the disclosures to make sure they contain all the items that should be present. In this example, there would be fixed asset and long term debt disclosures that must be made. If they are missing, the CPA would make sure they get included.
So, you can see there is some low level of comfort from the financial statements. Again, why? Because the CPA would read the financial statements and make sure the really big stuff was at least included. It might be off by a lot, but at least the disclosures are included. “No assurance” isn’t the same as zero assurance.
Second, an audit is a long way from 100% assurance. It is impossible to make sure that financial statements are 100% right. Thus a reader of the financials can not put 100% assurance on them. Why? Many reasons. First, 100% assurance would cost a fortune and take 3 or 6 months to perform the work. Second, sometimes the assumptions and estimates needed to develop financial statements are so difficult to determine that it might take years to find out if all of those assumptions and estimates are exactly correct. Third, human error. It is not possible to be 100% sure that there wasn’t some mistake made by staff, honest error by management, something missed by the auditor, or something missed by everyone. There are still more reasons, but you get the point. In my opinion, an
An audit is further away from 100% comfort level than a compilation is away from zero.
Third, a review gives the accountant some assurance but not a high amount. A review is in between but closer to a compilation than a review. I can not quantify each of the above points, but I would perceive that a review is below the half way point, probably by quite a bit.
There is my description of the relationships between a compilation, a review, and an audit, along with my interpretation of why they land on the continuum of assurance at different points.
(Updated 1-30-13 to reflect that an accountant gains assurance, but does not give assurance).