An important consideration for any business or non-profit organization lending relationship is the quality and quantity of information to request from the borrower. Should an organization rely on tax returns and internally generated financial statements, or request the involvement of a public accounting firm? If a decision is made to involve a public accounting firm, then what level of service should an organization request? There are three primary levels of service that can be requested from a public accounting firm: a compilation, review or audit. The following illustrates some key differences between these levels of service.
Compilation
A compilation consists of the accounting firm compiling financial statements from information received from company management. No assurance is offered on the information presented; and no inquiries, financial review or testing of accounting records is performed. The compilation report may contain complete footnote explanations of amounts and policies in the financial statements, or substantially all disclosures may be omitted. A compilation offers the lowest degree of assurance of the three service levels. As such, it is the lowest cost, in terms of accounting firm fees and internal labor for the borrower.
A compilation benefits the lending institution primarily by improving the quantity of information that is available, but not the quality, as no assurance is offered by this service. For unsophisticated borrowers, the inclusion of footnote disclosures and a statement of cash flows will likely offer the lender more information than would otherwise be available.
Review
During a review, the accounting firm reviews the financial statements and expresses limited assurance that no material modifications should be made in order for the statements to be in conformity with U.S. Generally Accepted Accounting Principles (GAAP). In order to express this assurance, analytical procedures are performed, such as ratio analysis, trending and prior period operations comparisons. Additionally, inquiries are made of company management and personnel regarding financial performance, operating results, industry expectations, and accounting policies and procedures. A review offers limited assurance on information quality at a cost that is higher than a compilation, but substantially lower than the cost of an audit.
A review benefits the lending institution by providing limited assurance on the quality of the information presented. In addition, similar to a compilation, the inclusion of footnote disclosures and a statement of cash flow in reviewed financial statements improve the quantity of information available—which can be significant to credit decisions.
Audit
An audit consists of the accounting firm issuing an opinion that the financial statements of the company or organization are free from material misstatements and are in conformity with GAAP. Audit procedures include obtaining an understanding of the entity’s internal controls and business practices, assessing fraud risks and testing accounting records through confirmation, observation, analytical and other substantive procedures. An audit is the most costly service alternative, both in terms of accounting fees and the labor cost imposed on the borrower’s personnel. However, it provides the highest level of assurance on the accuracy of the information presented.
Typically, an audit also assists borrower management with identifying process and control weaknesses, and offers suggestions for mitigation in order to improve the efficiency and effectiveness of operations. The information requirements of an audit can impose discipline on borrower personnel that improves the quality of interim financial information. An audit can also provide borrower personnel with a better understanding of the financial reporting process and improve the level of comfort management and the lender has over interim reporting.
If you have questions regarding which type of assurance is best for your institution, contact your Eide Bailly service provider.
