Accounting

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Public accountants are qualified to provide a range of services related to financial statements. Among the services are reviews and compilations, which are less comprehensive than audits, which are required for publicly owned companies. Statements on Standards for Accounting and Review Services are issued by the Accounting and Review Services Committee, which is the senior technical committee of the American Institute of Certified Public Accountants (AICPA) designated to issue pronouncements in connection with the unaudited financial statements or other unaudited financial information of a nonpublic entity.

A reviewis less than an audit inasmuch as a reviewdoes not involve obtaining an understanding of internal control, assessing control risk, testing accounting records, and obtaining corroborating evidence to support the financial information shown in the financial statements. The public accountant provides limited assurance with a review. This type of assurance is limited in that the CPA firm states that it is not aware of any modifications that should be made to the financial statements in order for them to be in accordance with generally accepted accounting principles (GAAP). While the CPA firm is not stating that the statements are in accordance with GAAP, it is noting that nothing came to its attention to indicate that the statements are not in accordance with GAAP. In order to express this type of limited assurance, the CPA firm should perform more work than in a compilation, but less than in an audit.

A reviewrequires that public accountants make inquiry and perform analytical procedures, which is a type of analysis that examines the relationships among data. For example, if CPAs notice that a company's reported sales are much larger than in the prior year, they should ask management why this is the case. However, the extent of investigation of this change would be much less than if the CPAs were performing an audit. When CPAs issue a reviewreport, the report states explicitly that the procedures performed were much less stringent than what would be required to express an opinion on an audit and that they do not express such an opinion.

A compilation offers no assurance that the financial statements are in accordance with GAAP. The word "compilation" is a good description of the type of service performed—the CPAs actually "compile," or put together, the information supplied by the company's manage ment. While CPAs should be familiar with the practices specific to the client's industry, they do not have to perform the verification types of procedures associated with an audit. All the CPAs must do is to make sure the financial statements are free from obvious errors (e.g., the balance sheet should balance!) and make sure necessary footnote disclosures are included. In their compi lation reports, CPAs state explicitly that they have not performed a reviewor an audit and that they do not express an opinion or offer any type of assurance on the financial statements.

Accountants performing a compilation should possess a level of knowledge of the ac counting principles and practices of the industry in which the entity operates so that the financial statements compiled will be appropriate in form for a company operating in that industry. This does not mean accountants cannot accept an engagement to prepare a compilation for a com pany in an industry with which they are unfamil iar. However, accountants in this situation have the responsibility to obtain the required level of knowledge. There are many resources— including AICPA guides, industry publications, financial statements of other companies in the industry, periodicals, and Web sites—that pro vide the required background information.

To compile financial statements, accountants should have a general understanding of the na ture of the company's business transactions, the nature and extent of accounting records main tained, the qualifications of the accounting per sonnel responsible for the accounting process, and the accounting basis on which the financial statements are to be presented, as well as the form and content of the financial statements. Account ants are not required to make inquiries or per form other procedures to verify, corroborate, or reviewinformation supplied by the entity. However, inquiries are likely to be needed in order to become acquainted with the entity's accounting system.

Another important difference among these services provided by the CPA is the level of independence required of the CPA who performs the service. Independence is a state of separation between the CPA and the client. There are two types of independence mentioned in the standards—independence in fact, which is an impartial state of mind, and independence in appearance, which relates more to how others would perceive the relationship. For example, if the CPA were related to the client or served on the firm's board of directors, readers of the report might perceive it as biased. In order to provide any type of assurance, CPAs must be independent in fact and appearance. Therefore, both audits and reviews require independent CPAs. However, CPAs do not have to be independent to perform a compilation; but if they are not independent, they must disclose this to readers of their compilation report.

So, what type of a client hires a CPA to perform a compilation or a reviewinstead of a full-blown audit? To understand this issue, it is first necessary to understand why some companies need audits. If the management of the company is separate from the suppliers of funding (i.e., stockholders or banks), there is a "monitoring" problem. Basically, banks or stockholders cannot be sure the information provided is reliable, so they charge the company a higher interest rate (or offer them a lower return on their investment) because of the increased risk they face due to this uncertainty. The management of the company, therefore, hires an auditor to attest to the fact that the information is reliable in order to lower the company's "cost of capital."

Now, picture the case of a small sole practitioner who is both the owner and manager of her company. It might be the case that she wants financial statements prepared so that she can assess her own performance, but does not require a great deal of assurance regarding the reliability of the numbers because she is the one who provided them to the CPA. In essence, the person providing the information is also the user of the report, so it would not be necessary to have an independent auditor provide assurance on the reliability of the financial statements. In this case, the owner/manager would probably hire the CPA to perform a compilation because it would cost less money and would be sufficient for her purposes.

Many banks want some form of assurance from small-business owners before lending them money but realize that an audit might be too expensive. They therefore require an independent CPA to provide a reviewreport to give them limited assurance that the financial statements are fairly presented. This type of reviewis most often performed for nonpublic companies whose securities are not traded on an exchange.

Reviews are also performed for public companies. These companies are audited annually, but the Securities and Exchange Commission (SEC) also requires them to file quarterly financial statements, which are unaudited. Public companies often hire CPAs to perform a review of these interim financial statements. While a reviewis not required for quarterly reports, the Big Five international CPA firms in 1999 announced that they would not audit any public company that would not allow them to review their quarterly financial statements. They feel that this will provide them with ongoing access to firms' information and thus prevent any big audit surprises at the end of the year. While this Big 5 agreement is not an official accounting standard, it is an important development. Smaller accounting firms have not disclosed whether they will also followthis practice of requiring reviews of quarterly data, but it seems likely that a lot more reviewreports will be issued in the near future.

Audits require an independent CPA to perform a substantial amount of work in order to provide positive assurance that the client's financial statements are fairly presented in accordance with GAAP. A reviewrequires an independent CPA to perform more limited procedures to see if the financial statements seem reasonable enough to allowthe CPA to provide negative assurance that no problems were noted. To perform a compilation, the CPA does not have to be independent and does not provide any assurance as to whether or not the financial statements are presented in accordance with GAAP.

Accounting)

AICPA Professional Standards. New York: Author.

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