Sorting through the “levels of assurance” in financial reporting
How confident (or assured) are you that your financial reports are reliable, timely and relevant? In order of increasing level of rigor, accountants generally offer three types of assurance services: compilations, reviews and audits. What’s appropriate for your company depends on the needs of creditors or investors, as well as the size, complexity and risk level of your organization.
Compilations rely on data provided by management. They provide no assurance that financial statements are free from material misstatement and conform with Generally Accepted Accounting Principles (GAAP). Instead, the CPA puts financial information that management creates in-house into a GAAP financial statement format. Footnote disclosures and cash flow information are optional and often omitted.
Next are reviewed financial statements, which provide limited assurance that the statements are free from material misstatement and conform with GAAP. Here, the CPA 1) applies analytical procedures to identify unusual items or trends in the financial statements, and 2) inquires about these anomalies, as well as the company’s accounting policies and procedures.
Reviewed statements always include footnote disclosures and a statement of cash flows. But the accountant isn’t required to evaluate internal controls, verify information with a third party or physically inspect assets.
An audit provides a reasonable level of assurance that your financial statements are free from material misstatement and conform with GAAP. The Securities and Exchange Commission requires public companies to have an annual audit. Larger private companies also may opt for this service to satisfy outside lenders and investors. Audited financial statements are the only type of report to include an express opinion about whether the financial statements are fairly presented and conform with GAAP.
Beyond the analytical and inquiry steps taken in a review, auditors perform “search and verification” procedures. They also review internal control systems, tailor audit programs for potential risks of material misstatement and report on control weaknesses when they deliver the audit report.
Time for a change?
Should you change your level of assurance? Not every business needs audited financial statements, and audits don’t guarantee against fraud or financial misstatement. But the higher the level of assurance you choose, the more confidence you’ll have that the financial statements fairly present your company’s performance.