Financial Statement Assurance Levels: Audit - Review - Compilation
KEY POINTS
The users of your financial statements will dictate if you need an audit, review engagement or compilation report
Audits are expensive and time consuming, but are often required and can provide valuable insights into the company
Shareholders of public companies may have different requirements than investors of private companies
What is Financial Statement Assurance?
An entity’s management team is responsible for the preparation of its financial statements. Users of such financial statements may include management, directors, shareholders, potential investors, banks, creditors, and more. Each will demand varying levels of independent third-party validation of the financial statements.
Management may require a basic set of financial statements with limited, if any, note disclosure and no need for independent third-party validation. Management may rely on financial statement ratios, financial metrics, and related reports when making financial, operational, and capital allocation decisions.
Third-party users of the financial statements have more stringent demands. Prospective shareholders and financial lending institutions will require an independent third-party, being free of conflicts of interest, to perform procedures with respect to the financial statements to ensure such are materially accurate and compliant with the appropriate accounting standards.
What is materially?
Materiality is a concept focused on the users of financial statements. Any financial or non-financial matter that could reasonably impact the decisions of the users of the financial statements is considered material.
The independent third-party providing assurance on the financial statements must ensure all material items are properly accounted for and disclosed in the financial statements.
Materiality will vary by entity and such entity will likely see their materiality fluctuate year-to-year. The auditor will rely on their professional judgment while using a selected benchmark to calculate materiality.
For example, an auditor may calculate materiality of a mature manufacturing company at 5% of pre-tax income, whereas, the same auditor may calculate materiality of a mutual fund at 1% of net assets.
How many levels of financial statement assurance exist?
There are three primary levels of assurance:
Audit
Review
Compilation
The following chart provides a comparative overview of the three options,
Compilation Engagement Report (“CER”)
A CER, also known as a Notice to Reader, does not provide any third-party assurance regarding whether the financial statements are free from material misstatement. The entity’s internal controls are not tested.
The financial statements will be compiled to comply with the presentation dictated by the respective accounting standards (e.g., IFRS, GAAP, ASPE), and are often issued without a statement of cash flows or notes to the financial statements.
Such financial statements are the least expensive to prepare and are appropriate for internal purposes, tax filings, and some regulatory filings.
Review Engagement Report (“RER”)
A RER provides limited negative third-party assurance whether it is plausible the financial statements are free from material misstatement. Negative assurance is a level of certainty the given balances are accurate as nothing to the contrary was discovered.
The review engagement process is primarily comprised of inquiry and analytical review. The potential for fraud is considered, but not opined upon. Procedures are designed to focus on areas identified as having a material risk of misstatement. Circumstances may dictate that alternative procedures be performed due to the material nature of a specific matter or for efficiency purposes. Such procedures may include, but are not limited to; external confirmations, reviewing contracts, or reviewing accounting records.
Such financial statements are more costly to prepare than CER and less costly than audited financial statements. They may be appropriate for banks in support of current or proposed financing arrangements, shareholders that are not involved in the company, and to support the pending sale of the business.
Audited Financial Statements
An audit is performed in accordance with generally accepted audit standards and provides positive third-party assurance that the financial statements are free of material misstatement.
The audit process is comprised of a review of internal controls, external confirmations, physical verification of assets (e.g., inventory count), substantive sample testing of transactions, analytics, and more. The potential for fraud is considered, but not opined upon.
Audited financial statements provide the strongest assurance and are the most timely and costly to produce. They may be appropriate for banks, shareholders, and regulatory bodies. An audit may provide insights into the entity and highlight business risks for consideration by management, the board of directors, and shareholders.
Summary
The financial statement users’ needs should drive the decision process when choosing which type of engagement is appropriate. The cost of such engagements increases in both terms of money and employee time as the degree of assurance increases. Such increased assurance may be mandated by the users of the financial statements and the process may yield additional insights into the business that reduce risk while increasing profitability.
We invite you to access the following independent sources to learn more,
Chartered Professional Accountants Canada
Association of International Certified Professional Accountants
