Business owners should consider the level of assurance they need from their accounting firm. Let's talk about audits, reviews and compilations.
Compliance vs. Consulting Services
CPA firms provide services in two basic areas: compliance services and business consulting services.
If your entire accounting budget is being absorbed by compliance work, it leaves little room for the typically higher-value consulting services from which you can benefit, such as succession planning, profitability analysis and technology consulting.
Compliance services primarily consist of preparation of tax returns and financial statements. Unfortunately, not much can be done to reduce the level of tax compliance you receive from your CPA firm. If anything, required tax filings get more complex each year.
However, when it comes to the level of financial statement reporting you are getting, there is some real opportunity to lower costs.
There is often significant confusion about what accountants “provide” when they prepare financial statements. Often, for example, accountants are referred to as auditors when in fact they are not providing audit services.
Under current accounting rules, accountants are allowed to prepare compiled, reviewed and audited financial statements for privately-held businesses. Each service provides a different level of assurance. As you move up the level of assurance the cost to the business owner increases, with the highest jump being between a review and audit.
Compiled Financial Statements
Compiled financial statements offer the lowest level of assurance. They can be prepared without footnotes, unlike reviews and audits. In a compilation the accountant gives no assurance that the statements are materially correct (i.e., in accordance with generally accepted accounting principles or some other accounting basis such as the income tax basis). This does not mean the financial statements are wrong, or that the accountant can prepare a financial statement that obviously has errors. It only means that certain analytical or independent third-party verification, which you see in reviews and audit opinions, was not done.
Reviewed Financial Statements
A reviewed financial statement provides what I describe as “negative” assurance. In other words, nothing came to the accountant’s attention that suggested the statements were not materially correct. This assurance is accomplished primarily from applying analytical procedures to the financial statements.
Audited Financial Statements
An audit provides a “positive” assurance that the statements are materially correct. This involves applying both analytical procedures and significant inquiries and third-party verification of the numbers.
What Level of Service Is Right for You?
With each increased level of assurance comes increased costs, especially when jumping from a review to an audit.
I remember taking on a new construction client a few years ago. They asked for an audit and when I asked them who requests the audited financial statements, they told me their bonding company required it and that's s what they’ve always done. I don’t believe the contractor had a clear understanding of the different levels of assurance. I quickly made some inquiries to the bonding company and surety, and was able to get the required level of service lowered to a review. This significantly lowered the contractor’s accounting costs.
To determine which level of assurance is right for your business, you have to first figure out who wants your financial statements. If no third party is asking for them, and you still want something beyond an internally prepared statement, then a compilation probably makes the most sense and comes with the lowest cost.
If a third party such as a bank requires an independent report, you will likely need a review or audit. Banks often require reviewed or audited financial statements to support a line of credit. If your bank or surety requests an audit, I still suggest questioning whether a review would suffice given the common confusion on levels of reporting. If your bank or another third party agrees to a review instead of an audit, you will save your business a lot of money.
While I generally believe in going with the lowest level of assurance, there are times when it might make sense to go with a higher level of service in anticipation of future events. For instance, if you are looking to potentially sell the business in the next several years, it makes sense to have either reviewed or audited statements for several years as opposed to internally prepared or compiled statements.
As you look to get the most from your relationship with your CPA firm, make sure the level of compliance services you receive makes sense in terms of costs and benefits. By doing this you can often significantly lower costs and be in a better position to invest in services to help your business succeed.
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