Financial statements is a term used to describe a set of individual statements a company might use to assess and analyze its business. Financial statements always include a balance sheet and income statement. They may also include a statement of cash flows, a statement of owner’s equity, or footnotes. Supplementary information like detailed cost information or contract information may also be part of financial statements. Each of these statements provides different information that, when used together, helps owners and other users gain a better understanding of the overall financial position of the business.
This article will not discuss the specifics of each statement. Rather, it is meant to introduce you to the different types of “players” in the financial statements “game.” Each player performs a different role on the team, brings different performance expectations, and uses varying methods of preparation in advance of the big game.
Now introducing: The four financial statement team players — Audited, Reviewed, Compiled, and Prepared. Audited, reviewed, compiled, and prepared are names that are used to describe a particular set of financial statements prepared by your CPA. They each reflect a certain level of assurance to users or indicate the procedures a CPA is required to perform when preparing his or her report on the statements.
You’ve already met our leadoff batter, Audited, in a previous article, so let’s focus on the remaining three that round out our hitters! All of the players have some similarities that we will address, but there are also several primary differences which we will illustrate, those being the level of “assurance” they provide and the requirements for the preparer when issuing a particular type of statement. Finally, we’ll address some common misconceptions about the different players.
Other than audited financial statements, reviewed financial statements provide the highest level of assurance of all the statements discussed in this article. Keep in mind that the assurance provided is “negative” assurance, not a traditional concept outside the world of public accounting. The CPA is not stating affirmatively that the statements are accurate. Instead the report issued on reviewed financial statements states that the CPA is “not aware of any material modifications” required to be made in order for the statements to be in conformity with generally accepted accounting principles (GAAP).
In reading the “Independent Accountant’s Review Report,” it is clear that the statements are the responsibility of management. It is the accountant’s responsibility to apply analytical procedures and perform inquiries of management that allow CPAs to state their conclusions.
When preparing reviewed financial statements, CPAs must also maintain their “independence” from the client, and there are very definitive requirements related to this. The CPA must also have knowledge of the industry in which the client operates.
Reviewed financial statements are most often used when a business is growing and potentially looking for additional borrowing sources such as lenders or investors. A set of reviewed financial statements is typically the most detailed of those discussed in this article, including all of the statements, footnotes, and supplemental information described above.
Next in the lineup are compiled financial statements. Compiled statements are different from reviewed statements in many ways. However, the primary difference relates to the use of the word “assurance.” Audited and reviewed financial statements provide certain levels of assurance related to the financial statements being reported on. It is important to note that the compiled financial statements provide NO level of assurance on the information being reported.
With the compilation report it is made clear that the CPA is not providing any level of assurance because the CPA has performed no procedures on management’s financial statements. The compilation report also clearly defines any statements or items not included in the financial statements.
Compiled financial statements are most often required by lenders who are working with a business that is either just starting or in the emerging stages. If a third party is unsure of a new business’s ability to establish reliable internal statements, the third party may require a compilation. Lenders may also reduce their requirements from reviewed statements to compiled statements if a business is performing well for a sustained period and they feel the company has a strong internal accounting staff in place.
In preparing compiled statements, the CPA can assist the client with bookkeeping services that include adjustments to various financial statement accounts, reconciliation of detailed balances in the statements to supporting ledgers and organization of the statements into accepted formats. In essence, the CPA works with management to transform their internal financial statements to a format that is more useful to other third parties. It is important to understand what your CPA is and is not doing for you when they are engaged to compile your financial statements.
The newest player in the game and batting cleanup is the prepared financial statements. This is a recently established concept that allows a CPA to assist a client with the bookkeeping and preparation of internally prepared financial statements without requiring a “report” once complete. As with the compilation, it should be noted that no procedures are completed that would verify the accuracy of the information and that the CPA is offering no level of assurance on the statements.
The prepared statements are most often used for internal purposes and ongoing business management. These statements can be prepared on a schedule that is most suitable for the business – monthly, quarterly, or annually. As with other internally prepared statements, they may be provided to lenders as part of a regular reporting requirement. If provided to third-party users, the statements indicate that “no assurance was provided.”
This option is good for many small or startup companies because they typically need assistance with their internal accounting functions. Now their CPAs can assist in that capacity while still producing the final statements from the clients’ information.
Quite often people will use the terms audited, reviewed, or compiled interchangeably when discussing their financial statements. As you can see, each type of statement varies greatly in what is being presented as it relates to assurance as well as the level of service required for a CPA to obtain that comfort.
As expected, additional work required does equate to additional costs. What that difference is can be largely dependent on your business and the ability of your internal accounting staff. Prepared financial statements can cost as much to prepare as compiled statements if the CPA is performing the majority of the bookkeeping function for the client.
At the end of the day, always assess the level of service that is right for your business and third-party users. Costs tend to increase when the level of service increases because of the procedures required to report on the set of financial statements. It is quite common for businesses that are just starting out to have a lower level of required financial statement preparation by their owners or third-party users. As the business grows, typically so do the requirements for more detailed information, and with that comes additional reporting requirements.
As the game is winding down, just a few last-minute tips for determining the best financial statements fit for your team:
- Assess the needs of your third-party users such as banks and investors. More often than not this is what will drive the change in reporting requirements.
- Discuss with your Wipfli business advisor the information you’re currently using to assess and analyze your business. What can you do to improve? Remember that financial statements are the responsibility of management, and it’s important that you as the business owner and primary user have an understanding of each individual piece of your statements.
- Make sure that you look for the “value add” because at the end of the day, the preparation of financial statements is a historical look at how your business has performed. Make sure that you’re using a trusted advisor who can help you not only look back, but forge ahead!