Audits, Reviews and Compilations: What’s the difference?
To anyone new to the accounting world or anyone trying to decide what service is right for them, the difference between audits, reviews and compilations can be confusing. Adding to the confusion, some organizations are required to have an audit or review due to grant funding or debt agreements.
Essentially, the difference comes down to the level of assurance provided by each service with audits providing the most assurance and compilations providing no assurance. Assurance can be described as the degree of investigation and subsequent validation of balances within the financial statements. The following are the general characteristics of the three services to help further understand them.
Goal: The goal of a financial statement audit is to provide reasonable assurance the financial statements are free from material misstatement and are fairly present based on the application of generally accepted accounting principles. Based on these goals, it begs the questions of “what is a material misstatement” and “what is reasonable assurance?” A material misstatement is an inaccuracy in the financial statements that could impact the decisions of the financial statement users. Reasonable assurance is not absolute but means there is a substantial likelihood the financial statements do not contain a material misstatement.
Procedures: Audit procedures may include internal controls testing, substantive testing and analytical procedures. Perhaps the best way to differentiate them is through examples. In a control test, the auditor is examining the control the organization has in place and if the control is operating as designed. For instance, a control at an organization might be the CFO or CEO are the only authorized check signers. To test the control, the auditor may take a sample of signed checks and examine if they were signed by the appropriate person.
A substantive test deals with dollar amounts. For example, confirming balances with outside parties or testing selected expenses by examining supporting invoices.
Analytical procedures involve evaluating organizational trends over time or a benchmark. An auditor may perform an analytical procedure on payroll expenses to test the reasonableness of the expense from year to year. The auditor may see a substantial increase in payroll expense from the previous year and investigate why the increase occurred.
Goal: Reviews are not as in depth as an audit. The goal of a review is to provide limited assurance that no material modifications to the financial statements are necessary to be in conformity with generally accepted accounting principles.
Procedures: As reviews are less in scope than audits, they only consist of analytical procedures and inquiries. Inquiries are simply asking questions about balances within the financial statements. See discussion above on analytical procedures.
Goal: The goal of a compilation is to take financial data provided by an organization and prepare financial statements that comply with general accepted accounting principles. A compilation provides no assurance on the financial statements.
Procedures: Since compilations provide no assurance, there is no testing or analytical procedures performed. During a compilation, general inquiries and knowledge of the organization industry are used to determine there are no obvious material errors.
Bottom line, audits use the most comprehensive procedures, reviews provide limited assurance, and compilations provide no assurance. It is not uncommon for creditors or grantors to require organization to have an audit, review or compilation. Governing boards may also elect to complete one of these services.
For questions or additional information, please contact any member of the nonprofit team at Ketel Thorstenson LLP.