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What kind of financial reports do you need?

01/03/2005


In recent years there have been significant changes in the accounting industry. In response to the Enron and Worldcom scandals, the rules, called Generally Accepted Accounting Principles (GAAP), that accountants must follow to provide assurance on a business’ financial statements have been significantly expanded. Given the extra amount of work, and therefore expense, that is now mandatory on many financial statements, it is a good time to look at the level of service you need from your accountant.

Three levels of work can be performed on a set of financial statements. The level of accounting assurance that should be performed depends not only on what you need, but also on what the other people who rely on your financial statements want. These users, like the bank or a potential purchaser, want to be assured their interests are protected. If your business has a large bank loan, the bank will want to ensure the company is doing well and will require a copy of your financial statements. If you are considering selling your business, a potential purchaser will rely on your financial statements to make their purchase decision.

Accountants provide these “outside users” with assurance that someone independent has looked at your business’s activity and is satisfied it is accurately and completely reflected in your financial statements. The more assurance that is required by the users of your business’s financial statements, the more work is required from the accountant, and the higher your accounting bill will be.

The three levels of assurance an accountant can give are compilation, review and audit.

1. Compilation or Notice to Reader Statements
When an accountant “compiles” financial statements, no assurance is given that the financial statements are complete or accurate. The accountant simply takes the figures provided by the company’s management and puts them into a standard financial statement format, which usually includes a balance sheet and income statement. Very little work is done by the accountant to ensure that the financial statements are a true reflection of the business’s activity.

The users of compiled statements must trust the management’s honesty and record keeping skills for the accuracy of the information. Compiled statements are not required to follow GAAP. To ensure that the users of compiled financial statements are aware of the statement’s limitations, there is always a “Notice to Reader” report attached detailing the limited work performed by the accountant.

The accounting fees are lowest for this type of service. If your users do not require any assurance, this would be the most inexpensive way to have your financial statements prepared. Generally this is sufficient if your financial statements are only used to prepare your corporate tax return.

2. Review Engagement
The next level of assurance that an accountant can provide is a review engagement. This gives the financial statement users “negative assurance” that nothing has come to the accountant’s attention that causes them to believe that the financial statements are not presented fairly. The accountant must perform sufficient work to assure the user that the financial statements are “plausible”. They check for internal consistency, analyze specific account balances, and require explanations from management for anything that seems unusual.

Reviewed financial statements must comply with GAAP, which ensures that all activity is recorded and disclosed in standardized way. Compliance with GAAP is more costly as your accountant must follow defined procedure and disclosure requirements. The statements will normally consist of a balance sheet, income statement and statement of cash flows, as well as notes that accompany the financial statements and give further information to the users.

This requires more work on the accountant’s part and is more expensive than a compilation engagement. From the user’s point of view, however, they can have increased confidence that the financial statements accurately and completely reflect the transactions of the business for the year. If your company has significant bank loans, or non-active shareholders, reviewed financial statements will often be required.

3. Audit Opinion
The highest level of assurance that an accountant can provide is an audit opinion. This requires the most work, and is therefore the most expensive. The accountant will analyze the accounts, and ask management to explain any inconsistencies. He will inspect assets and confirm balances, often with outside sources. The accountant will also recalculate entries and perform sufficient work to ensure that the financial statements are not materially misstated. Most owner-operated businesses do not require audited financial statements.

To determine what level of service you need, first ask yourself who will be using your statements. If you have bank loans, ask your banker if they require reviewed financial statements. Consider whether you are planning to sell your business in the next three years. If you are, many purchasers will want statements with some assurance from an accountant. Once you’ve considered your user’s needs, talk to your accountant and determine which level of service you require.

You need the services of a good accountant; ask the right questions to be sure that you are purchasing the services you need in order to take care of your business.

By Wendy Lewis, CA. Originally published in Comox-Valley Record (March 23, 2005). For more information, please contact your local MNP advisor or Michelle Balmer, Director of Assurance Services, at 403.263.3385.