Accounting & Audit Alert- Preparations vs. compilations
Your business needs financial statements so management can monitor performance, attract investment capital and borrow money from a bank or other lender. But not all financial statements are created equal. Audited statements are considered the “gold standard” in financial reporting. While public companies are required to issue audited statements, smaller, privately held organizations have options. CPAs provide three other types of financial statements, which, in order of descending level of diligence, are: reviews, compilations and preparations.
Here’s some insight into the newest and most basic financial reporting service available to private businesses — preparations — and how these engagements differ from compilations.
Financial statement preparations are often created as part of bookkeeping or tax-related work. While some lenders may accept preparations in support of small lending arrangements, preparations are generally reserved for internal purposes to provide information on the business’s current financial condition and as a basis of comparison against future accounting periods.
Preparations provide no assurance regarding the accuracy and completeness of the financial statements. Assurance is critical if you plan to share the financial statements with third parties. Generally speaking, the greater the level of assurance, the more trust a reader will have in the accuracy and integrity of your company’s financial statements.
In addition, professional standards don’t require CPAs to be independent of a business when preparing its financial statements. In other words, it’s OK for an accountant to have a financial interest in a company that he or she prepares financial statements for.
To avoid misleading any third parties who might receive a copy of these statements, each page of a prepared financial statement must include a disclaimer or legend stating that no CPA provides any assurance on the financial statements. In addition, prepared financial statements must adequately refer to or describe the applicable financial reporting framework that’s used and disclose any known departures from that framework.
Like preparations, compilations provide no assurance that the financial statements are accurate and complete. And independence isn’t required when issuing compiled financial statements. But there are subtle differences when moving from a preparation to a compilation.
A compilation involves the issuance of a formal report by a CPA who’s required to read the statements and evaluate whether they’re free from obvious material errors. The CPA’s report appears on the first page, before the financial statements. If the CPA isn’t independent of the business, he or she must disclose this fact in the report.
Notably, the use of a compilation of financial statements can extend beyond the business owner to third parties, including investors, business partners and lenders who may view the input of a CPA as beneficial.
Building for the future
Preparations may be a cost-effective way for small business owners to monitor performance. But they provide limited usefulness as a business grows and needs to interact with third parties. Eventually, prepared statements may need to be upgraded to a compilation, review or audit to give stakeholders greater assurance about the company’s financial results. Contact us to determine what’s right for your current situation.