Audit vs. Review vs. Compilation: Which Does Your Business Need?

Introduction

Businesses and nonprofit organizations may need different levels of financial statement services depending on their circumstances. A lender may request reviewed or audited financial statements before approving financing. Investors may want greater confidence in a company’s financial statements. A nonprofit board or grant provider may require a particular type of CPA report. An ownership agreement may also establish specific financial reporting requirements.

Understanding the difference between an audit, a review, and a compilation can help you ask better questions. It can also help you avoid choosing a service that does not meet your stakeholders’ expectations. The main distinction is the level of assurance a CPA provides about the financial statements: no assurance, limited assurance, or reasonable assurance.

The right choice depends on your organization’s size, complexity, financing plans, and contractual obligations. It also depends on the needs of lenders, investors, boards, and other stakeholders. It may also depend on whether the financial statements are prepared using accounting principles generally accepted in the United States or another applicable financial reporting framework.

The Three Common Financial Statement Services

A CPA can provide compilation, review, and audit services for an organization’s financial statements. Each involves different procedures and results in a different type of report.

• Compilation: The CPA helps present financial information in financial statement form but provides no assurance.
• Review: The CPA performs inquiries and analytical procedures and provides limited assurance.
• Audit: The CPA performs more extensive procedures and provides reasonable assurance.

Assurance refers to the level of confidence the CPA provides that the financial statements are not materially misstated. A material misstatement is an error or omission significant enough that it could influence a reasonable person’s decisions.

An audit generally provides the highest level of assurance among these three services. However, reasonable assurance is not absolute assurance. No audit can guarantee that financial statements are completely accurate or free from fraud.

What Is a Compilation?

How Compilation Accounting Works

Compilation accounting involves presenting an organization’s financial information as financial statements based on information provided by management. The CPA usually helps organize the information and may format it to match the applicable accounting framework.

A compilation typically involves:

• Obtaining financial information from management
• Presenting that information in financial statement form
• Applying knowledge of accounting and financial reporting
• Reading the financial statements for obvious issues or inconsistencies
• Issuing a compilation report

The CPA does not generally verify the accuracy of the information through confirmations, detailed testing, or extensive analysis. Management remains responsible for the financial statements and the underlying accounting records.

No Assurance

A compilation provides no assurance. The CPA does not express an opinion or conclusion about whether the financial statements are fairly presented. The compilation report states that the CPA did not perform an audit or review. Therefore, the CPA does not provide assurance.

A compilation may be appropriate when an organization needs professional financial statements for internal use. It can support management planning or meet the needs of a stakeholder that does not require assurance. For example, a small, owner-managed business may use a compilation to present its results to a potential investor during early discussions, provided the investor does not require a review or audit.

A compilation may also be less appropriate if a bank, grant provider, or investor specifically requires assurance. Before engaging a CPA, confirm whether the recipient will accept compiled financial statements.

What Is a Financial Statement Review?

What It Means to Review Financial Statements

A financial statement review is more extensive than a compilation but less extensive than an audit. During a review, the CPA generally performs inquiries of management and analytical procedures.

Inquiries may involve asking about:

• Significant transactions
• Changes in revenue or expenses
• Accounting policies
• Unusual balances
• Relationships among financial statement accounts
• Events that may affect the organization’s financial position

Analytical procedures may include comparing current results with prior periods, budgets, or expectations and investigating unusual fluctuations.

Limited Assurance

A review provides limited assurance, sometimes described in plain language as a lower level of confidence than an audit. The CPA’s report generally states that the CPA is not aware of any material modifications that should be made to the financial statements based on the review procedures performed.

A review does not involve the same depth of testing as an audit. The CPA typically does not perform extensive confirmation, observation, inspection, or detailed testing procedures. As a result, a review cannot provide the same level of assurance as a financial statement audit.

A business may need to review its financial statements when a lender, investor, board, or stakeholder needs more confidence. A compilation may not be enough. However, an audit is not required. For example, a growing professional services company seeking a moderate loan may provide reviewed financial statements if the bank’s requirements permit that level of service.

What Is a Financial Statement Audit?

How an Audit Works

A financial statement audit is the most extensive of the three common financial statement services. The CPA obtains evidence to evaluate whether the financial statements are fairly presented, in all material respects, under the applicable accounting framework.

Audit procedures may include:

• Assessing risks of material misstatement
• Understanding relevant internal controls
• Testing selected transactions and account balances
• Examining supporting documentation
• Confirming certain balances with outside parties
• Observing physical assets or inventory when appropriate
• Evaluating estimates and accounting policies
• Performing procedures related to fraud risks
• Reviewing subsequent events and other relevant information

The exact procedures depend on the organization’s size, industry, risks, accounting system, and financial statements.

Reasonable Assurance—not Absolute Assurance

An audit provides reasonable assurance, which is a high level of assurance but not an absolute guarantee. An audit is not meant to find every error, stop all fraud, or ensure financial statements are fully accurate or fraud-free.

At the end of an audit, the CPA issues an audit report expressing an opinion about whether the financial statements are presented fairly, in all material respects, under the applicable accounting framework. Because an audit requires more evidence and testing than a review or compilation, it is generally more involved.

For example, a nonprofit receiving significant grant funding may require audited financial statements to satisfy a grant provider, board policy, or regulatory requirement. Similarly, a company seeking substantial financing or preparing for an ownership transition may need audit services.

Differences:

The difference between an audit vs. review is primarily the extent of procedures and the resulting level of assurance. The difference between a compilation and a review is simple. A review includes inquiry and analytical procedures. It provides limited assurance. A compilation provides no assurance.

When Might a Lender or Stakeholder Require a Particular Service?

The required service may be determined by someone outside the organization. Banks may state if they need compiled, reviewed, or audited financial statements for a loan or financing agreement. Investors may request an audit before purchasing an ownership interest. Grant providers may require a particular level of reporting from a nonprofit.

Other requirements may come from:

• A nonprofit board or governing document
• A bonding company
• A regulator
• A franchise or licensing agreement
• An ownership or purchase agreement
• A government contract
• A private equity or investment arrangement

Requirements can vary based on the organization and the agreement. Confirm the exact requirement with the lender, investor, grant provider, or other recipient before engaging a CPA. A financial statement service that is appropriate for one stakeholder may not satisfy another.

Cost and Complexity Considerations

At a general level, compilations are usually the least extensive service. Reviews fall in the middle. Audits usually require the most work. The difference reflects the amount of evidence gathered, testing performed, documentation prepared, and professional judgment required.

Cost and complexity may also be affected by:

• The organization’s size and number of locations
• The condition of the accounting records
• The complexity of revenue and expense transactions
• Inventory, debt, leases, or investments
• Estimates and related-party transactions
• The strength of internal controls
• The organization’s industry and reporting framework

Improving bookkeeping and organizing supporting documents can make the process faster.
However, it does not change the level of service a stakeholder needs.

How to Determine Which Service May Be Appropriate

When considering an audit vs. review vs. compilation, evaluate the following questions:

1. What do stakeholders require? Obtain the specific wording from lenders, investors, grant providers, boards, or contract parties.
2. Are you planning to obtain financing? A financing application may require a particular type of financial statement report.
3. How complex is the organization? Multiple locations, significant debt, inventory, investments, or complex transactions may affect the appropriate service.
4. Are there regulatory or contractual obligations? A law, grant agreement, loan covenant, or ownership agreement may establish the requirement.
5. What internal reporting does management need? Some organizations may want more procedures and insight even when external stakeholders do not require an audit.
6. What level of assurance is desired? Consider whether no assurance, limited assurance, or reasonable assurance best fits the organization’s circumstances.

These factors offer a framework for discussion.
They do not replace advice based on the organization’s specific facts and applicable requirements.

How to Prepare for an Audit, Review, or Compilation

Good preparation can reduce delays and help the CPA understand the organization’s financial information. A practical checklist may include:

• Update bookkeeping records through the reporting date
• Reconcile bank, credit card, loan, and other significant accounts
• Gather bank statements and supporting documents
• Organize loan, lease, and other financing agreements
• Prepare payroll, tax, and benefits records
• Review accounts receivable and accounts payable
• Identify unusual or significant transactions
• Document new contracts, major purchases, or changes in operations
• Prepare schedules requested by the CPA
• Assign a primary contact to coordinate questions and information requests

The CPA may request additional records depending on the type of engagement and the organization’s circumstances. Keeping financial data organized throughout the year may also make it easier to respond to questions about company financial statements.

When to Talk With a CPA

It is often helpful to speak with a CPA early. This is especially true before you apply for financing. It also helps before you submit a grant proposal. Talk to a CPA before you accept a grant. Do the same before you sign an agreement with reporting requirements. Early communication may help identify the required service, reporting period, accounting issues, and preparation work involved.

A CPA firm in Spokane can also help business owners and nonprofit leaders understand whether a compilation, review, or audit aligns with the needs of their stakeholders. Organizations seeking audit services should confirm that the CPA understands the organization’s industry and reporting requirements.

Conclusion: Understanding Audit vs. Review vs. Compilation

The choice between an audit, a review, or a compilation depends on the organization’s situation and stakeholder needs. A compilation gives no assurance, a review gives limited assurance, and an audit gives reasonable assurance. More extensive procedures support an audit. An audit provides high confidence, but it does not guarantee financial statements are free of errors or fraud.

Not sure which level of financial statement service your organization needs? Learn more about BSK Tax Advisors’ Audit & Attestation Services or contact our team to discuss your requirements.