Differences between audits, reviews, and compilations of financial statements

Comparing Audits, Reviews, and Presentations of Financial Statements

Introduction

Users, who use numbers to optimise their decisions get impacted by financial statement assurance. This article describes the main differences between audits, reviews and compilations. It seeks to distinguish between assurance levels and usual engagement protocols for all services. We'll explore how each one impacts financial reporting and decision making for readers.

Understanding assurance levels

Assurance is the extent of confidence provided by a practitioner about financial information. Audits provide the most assurance, which means that a practitioner gives an opinion. The reviews provide very limited assurance i.e. the practitioner is telling you nothing came to their attention that suggests problems. Compilations offer no guarantees – the practitioner merely reproduces what management gives them.

There are distinct differences in the work performed and language used in reports at the various assurance levels. Users need to determine whether the practitioner provides an opinion, limited assurance or no assurance. The wording in each document indicates how much users can hang their hat on the figures. Transparency in statements is important for helping readers evaluate the quality of financial reporting.

Audits purpose and process

The objective of an audit is to obtain reasonable assurance that the financial statement is free from material misstatement. The practitioner designs and performs procedures to obtain sufficient evidence on the amounts and disclosures. Audits include tests of controls and substantive procedures on account balances and transactions, which result in an auditor's opinion that the statements present fairly.

Audit procedures typically include risk assessment, testing and corroboration. Auditors judge business risks and identify areas where misstatements might exist. They check internal controls, source documents, confirmations and other types of evidence. Together, these processes enable a high degree of assurance for users.

• Evaluate business risks and areas of risk of material misstatement
• Test evidence for both controls and substantive transactions
• Review documents and obtain confirmations from third parties

Review engagements scope and techniques

A review has a low level of assurance and practitioners use analytical procedures and inquiries. They are only looking for signs that those statements could not be true. Transactions or control reviews do not include in-depth testing. The practitioner finalizes with a report, expressing that nothing has come to their attention: limited assurance.

Compared to audit procedures, review engagement procedures are more limited, less invasive and based on inquiry. The practitioner engages management and carries out trend and ratio analyses for indications of abnormality. Whenever discrepancies occur, the practitioner can perform several procedures to address issues. Reviews provide a measure of comfort for users while balancing effort with cost.

• Inquiries to management on large transactions and estimates
• Conduct analytical procedures and trend analysis
• Dig into things that look odd or out of the ordinary

Compilations role and limitations

Compilation takes financial data and puts it into a financial statement format but does not provide assurance. The practitioner collects the numbers given to them by management, and prepares statements from those figures. Inquiry or testing intended to identify errors or fraud are not part of compilations. The practitioner states in the report that no assurance is provided and also clearly indicates that they have neither audited nor reviewed the statements.

Compilations only cater to users who require statement lines structured but do provide no guarantee of accuracy. Compilations, which create financial statements for internal purposes or basic reporting needs, are often used by small businesses. Because the practitioner does not verify data, individuals should exercise more caution when trusting these claims. The disclaimers must be explicit to avoid misinterpretation by the practitioner.

• Prepare statements only from data supplied by a client
• Do not execute testing or verification processes
• Provide a clear no-assurance disclaimer in the report

Reviewing reports and figuring out engagement

Choosing an audit as opposed to a review or compilation depends on user needs, regulatory requirements, and cost. Audits are required by users who need high confidence and compliance. A review may appeal to those who want more assurance than a compilation without the full costs of a complete audit. If an entity has limited external needs, it may be possible to choose a more affordable solution such as a compilation.

Considerations include users, legal requirements and confidence in management information. For substantial decisions, lenders, investors and regulators tend to seek greater assurance. Management needs to balance assurance benefits against the time and cost of any engagement. Clarifying needs with stakeholders helps determine the most suitable service.

Conclusion

The distinctions between audits, reviews and compilations help readers interpret financial reports correctly. Each engagement offers different levels of assurance and employs unique engagement procedures. Users can select the service that corresponds to the confidence level required for their statements.