A compilation consists of a CPA preparing financial
statements based on information provided by management. In order to perform a
compilation, the CPA must become familiar with the accounting principles and
practices common to the client’s industry and acquire a general understanding of
the client’s transactions and how they are recorded. During a compilation, the
financial data is simply arranged into a conventional financial statement form.
No probing is conducted beneath the surface unless the CPA becomes aware that
the data provided is in error or is incomplete. After compiling the financial
statements, the CPA is obliged to read them and consider whether they are
appropriate in form and free from obvious material errors.
A compilation provides no assurance as to whether material or
significant changes are necessary for the statements to be in conformity with
generally accepted accounting principles, which are the rules accountants’
follow when preparing and reporting financial information. The compilation
standard report says, in effect, that the financial statements were compiled,
but because they were not audited or reviewed, no opinion is expressed.
Compilation standards permit an accountant to compile financial statements that
omit footnote disclosures required by generally accepted accounting principles.
This is allowable as long as the omission is clearly indicated in the report and
there is no intent to mislead users.
A review consists of inquiry and analytical procedures
applied to financial statements. Before a review, the CPA may have to compile
the financial statements in order to perform the necessary inquiry and
analytical procedures. In a review, the CPA must be independent of the client
and the financial statements must contain all required disclosures. In order to
perform a review, the CPA must obtain a working knowledge of the industry in
which the entity operates and must acquire information on key aspects of the
organization, including operating methods, products and services, and material
transactions with related parties. The CPA will then make inquiries concerning
such financial statement related matters as accounting principles and practices,
recordkeeping practices, accounting policies, actions of the board of directors
and changes in business activities. Then the CPA will apply analytical
procedures designed to identify unusual items or trends in the financial
statements that may need explanation. Essentially, a review is designed to see
whether the financial statements “make sense” without applying audit-type
tests.
A review report provides limited assurance that material
changes to the financial statements are not necessary. With respect to
reliability and assurance, a review falls between a compilation, which provides
no assurance, and the more extensive assurance of an audit.
An audit includes such procedures as confirmation with
outside parties, observation of inventories, and testing selected transactions
by examining supporting documents. In an audit, as in a review, the CPA must be
independent of the client and the financial statements must contain all required
disclosures. While performing an audit, the CPA generally contacts sources
outside the client organization to gather information that may be more objective
than that obtained from internal sources. For example, the CPA usually obtains
written confirmation from a client’s customers about amounts owed to the client
at a specific date. By accumulating this type of evidence, the CPA tries to
reduce the risk that the financial statements will be materially misstated. An
audit is planned and performed with an attitude of professional skepticism; that
is, the auditor designs the audit to provide “reasonable assurance” that
significant errors or fraud are detected.
An audit provides a reasonable level of assurance that the
financial statements are free of material errors or fraud. An audit does
not, however, provide a guarantee of accuracy. The audit report states
that the financial statements are presented fairly, in all material respects, in
conformity with generally accepted accounting principles.
