Two common Accounting terms you may have heard over and over are taxes and audits. Most people are familiar with taxes – income taxes, payroll taxes, sales taxes, the list goes on and on. Every business files at least one type of tax annually, usually income taxes. How about audits? A fraction of small businesses require audit services. What is more common among small businesses are what I call ‘distant cousins’ of audits because they include some aspects of an audit but are not as involved as an audit. I am talking about reviews, compilations, and financial statement compilations. Like audits, these three services are handled by CPAs (non-CPAs can perform financial statement compilations). The depth of what is involved in each procedure is outside the scope of this blog as it may cause confusion, which is not our goal here. Instead of diving deep into the procedures, we will simply look at the significant differences among the procedures, focusing on the following:

  • How is the procedure defined?
  • Why does a business need it?

A review is the next ‘step down’ from an audit. It involves a limited examination of a business’s financial books performed by an independent CPA. An independent CPA means, in a nutshell, that the CPA has no close ties with the business; for example, she is not a relative, she is not on the Board of the business, or she is not the business’ ongoing accountant who manages the business’s financial transactions and books. Unlike an audit, where the auditor focuses on various accounts, the reviewer focuses on analyzing the business’ financial books using analytical procedures and management assessment. Because the examination is limited, the reviewer only provides limited assurance that the business’ financials are free from material misstatement and meet the General Accepted Accounting Principles – GAAP.

Reviews are not legally required of small businesses; however, they provide some peace for business owners and their creditors that the financial books are free of material errors.

Compilations are a ‘step down’ from reviews. A compilation is a summary report of a business’s financial statements that is based on the financial data provided by the business that requested the compilation service. For compilations, the CPA does not need to be independent; however, he does need to disclose the lack of independence in his compilation report. This provides transparency to any third party who reads the report. Unlike a review, no analytical procedures or management assessment is required. The compiler is only required to examine the financial books for lack of apparent misstatements and ensure the appearance of the financial statements is in a proper format. Since no tests are done, the compiler does not give any assurance that the business’ financials are free from material misstatement or that they comply with the General Accepted Accounting Principles – GAAP.

You are probably thinking, ‘Why would a business pay for a service that does not provide any assurance?’ The simple answer is that usually, the request for a compilation report is made by a third party, like a financial institution. If the third party has transacted with the business in the past, they may not require much assurance that the business’s financial books are accurately stated.

A Financial statement compilation (FSC) is a ‘step down’ from a compilation report. An FSC is when a business attains the service of an outside accountant to compile its bookkeeping data into specified financial statements. The financial statements may include an income statement, a balance sheet, a statement of cash flows, and a statement of equity. The accountant does not perform any auditing, review, or compilation procedures or testing. However, she may inquire if the data appears to be materially incorrect.

Usually, a business that does not have an accountant to manage its books will request FSC services, particularly at year-end, if it needs its financial statements. Another reason a business may request FSC services is if a third party has requested the business’s financial statements and states that an accountant must prepare the statements.

How do you know which service your business needs? Think about the purpose of each service (as explained above) and who you will be sharing the information with. If you are unsure which service you need, contact your CPA. Though your CPA may not be able to provide the service, she can point you in the right direction.

DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.