As a business owner, you know the value of a financial statements audit. Audits provide essential credibility to stakeholders, both internal and external, regarding the accuracy and reliability of financial information. Without the third party assurance provided by audits, lenders and investors would be rightfully leery of making loans and investments. While audits can be very valuable, there are also other financial reporting solutions that can be simpler and even more effective in the right situations.
What are financial statement audits and when are they necessary?
Financial statement audits provide the highest level of assurance and can be extremely useful in securing equity and debt financing from third parties. Audits provide an unbiased, objective examination of the financial statements of the company, including the selective verification of specific information such as inventory. Audits require gaining an understanding of internal controls, testing of selected transactions and communication with third parties.
At the conclusion of an audit, an auditor will issue a report on the financial statements, which can be shared with third parties, containing the auditor’s opinion as to whether the financial statements are presented fairly, in all material respects, in accordance with generally accepted accounting principles (GAAP). If you need a high level of assurance for external stakeholders such as banks when trying to secure a loan, an audit can be extremely valuable.
When is a full financial audit not the best solution?
While there is no doubt audits are valuable tools, a financial statement audit isn’t always the best or the only solution. When the level of desired assurance does not require a full audit, a review, compilation or agreed-upon-procedures engagement may provide a simpler and more effective solution.
Reviews are less extensive and provide the next level of assurance below an audit. Businesses in their first year of operations or businesses that are winding down operations can often benefit greatly from a review. Reviews typically take less time and cost less than financial audits. While banks often initially request or require an audit, they may depending on the situation, be willing to accept a review instead.
Compilations can provide value in the right circumstance. While they do not provide any assurance — they assume the data provided by management is accurate — they can be very useful when businesses need to organize and standardize financial reports for internal use. Compilations also can be accepted by banks when seeking smaller loans.
Agreed-upon-procedures engagements are designed to provide a report of findings based on specific procedures performed over specified information. When a need for reporting is limited to specific information or transactions, a financial audit may cover a lot of unnecessary ground and fail to address critical reporting topics.
For example, some retail lease agreements provide for lease payments that are contingent upon the revenue of the tenant — when the tenant brings in more revenue, rent increases. In such a case, an agreed-upon-procedures engagement could provide targeted testing and reporting to the lessor that revenues have been accurately reported. A full financial statement audit would provide broad assurance at a significant cost but may fail to provide detailed testing over reported sales numbers.
Which report is best to use?
Each report is designed to suit specific circumstances. Your internal needs and budget, as well as requirements from your bank or other parties, will determine the right solution. While large loans may require audited financial statements, banks may be willing to accept a review or compilation for smaller loans.
If you don’t believe a full financial statement audit is necessary, you may consider asking your accountant for his or her opinion or even asking your lender if he or she will accept a review or compilation. It won’t hurt anything to ask, and it just might save you a lot of time and money. Feel free to contact us if you still have any questions.