What is the Difference between an Audit, Review and Compilation?

And we're going to specifically go through five different criteria. The level of assurance these reports provide, the procedures performed during these engagements, what the accountant and auditor's report says, the relative cost of each, and how long each takes to complete. But the first question we have to answer is who exactly wants these reports? Who wants to read these financial statement reports or these engagements? Well, you're going to have lenders, you're going to have bankers, investors, board of directors, shareholders, vendors, stakeholders. These are going to be groups of people that want to read the financial statements and they want to be confident in the numbers that they are reading. That's why you go to an outside third party for this type of engagement. So, let's dive into these three different types of financial statement engagements. And the first one we're going to go through is a compilation. A compilation is a set of financial statements prepared by an outside accountant. A company is essentially going to provide data aka the trial balance. This is going to be your general ledger accounts out of your accounting system. You're going to provide that to the accountant and then they are going to prepare financial statements and possibly some disclosures. Now with a compilation, the accountant is strictly preparing financial statements. They're going to gain a general understanding of your business, but they are not going to document even look at your internal controls. They're not going to assess fraud. They're not going to do any substantive procedures. They are taking your data at face value and preparing financial statements. This is better than nothing. This is better than just you preparing and handing over financial statements. At least the people reading the report or receiving the report know an outside accountant prepared these financial statements in the appropriate format. With that being said, a compilation does not provide any assurance. There's no opinion of the financial statements. There's no assurance with a compilation. Now looking at the compilation report, we see that management is ultimately responsible for the financial statements. The engagement is performed in accordance with the statements standards for accounting and review services. The accountant doesn't provide an opinion as we discussed and provide any assurance in a compilation report. As we stated before, there's no assurance provided in a compilation. The cost, a compilation is going to be the cheapest, the least expensive of the three engagements that we're going to talk about. It does not cost as much as a review or an audit cuz you're simply providing your financial data to an accountant and they're preparing financial statements. They're not testing, validating, they're not the procedures that you have in place for your accounting records. Now, the time it takes a to prepare a compilation, this is like a week to two weeks tops. You're talking like a week to get that together back and forth, maybe one or two times for edits and this is done. This should be done within a week or two. A compilation does not take that long to prepare. If you've gotten any value out of this video so far, please smash that like button and consider subscribing. Okay, let's talk about reviewed financial statements. A review. Reviewed financial statements provide limited assurance that the financial statements do not contain any material modifications. This is the next step up from a compilation but a step down from a financial statement audit. An independent CPA, the key word is independent. Independent CPA account will perform analytical procedures to analyze trends, variances, and anything that looks out of the ordinary. They will also make inquiries inquiries of management and review certain documentation based on their analysis. Now I said the word independent that is a key term we need to go over for an outside accountant to prepare reviewed financial statements or an audit they need to be independent. So what is independence? What does independent actually mean? This means they must be objective and have integrity. This also means that they must be free of bias. So they cannot be an investor in the company. have family members who work for that company or have any sort of business relationship outside of the review or audit engagement. All right, let's look at the review report and see how it is different from a compilation. A review includes primarily applying analytical procedures to financial statement data along with inquiries to management. A review does not express an opinion. A compilation expressed no opinion and gave no assurance. A review at least gives limited assurance. Management is again responsible for the financial statements and these engagements will require a management representation a letter which indicates management is responsible for the company's financial statements. Typically the CEO and CFO have to sign off on the financial statements saying they do not they consider these statements to be presented fairly and they are responsible for those financial statements. The report only provides as we discussed limited assurance. It pro it's better than a compilation because a compilation provides no assurance. A review provides limited assurance that the financial statements are prepared fairly. A review will cost more than a compilation because the accountants will be validating some of the financial data. That's going to take additional time to conduct that analysis and to do those interviews. A compilation isn't doing any of those items. So, a review is more involved. You're actually looking at the data, looking at trends, looking at the information to see if anything looks out of the ordinary. Now, internal controls with a review are not tested. They might ask at the what the policies and procedures are during during a review engagement, but they're not testing or validating if internal controls are actually good, in place, and being followed. How long does a review take? A review is going to take longer than a compilation but less time than an audit. Same with the pricing. It's less It's going to be more than a compilation but less than an audit. A review is going to involve all that testing and those procedures that performing those analytical procedures and doing inquiries with management. It's going to take a little bit more time. It's going to be a little bit more involved. Preparing the financial statements should be about the same, but they're going to have a level. They want to make sure that there's no material modifications to provide that limited assurance. So, a review could take up to a couple weeks to a month. Conduct all the procedures, prepare the financial statements, review them, and get them out. Now, it can be done in 2 weeks, but sometimes this could take longer depending on the complexity of the company under review. Our third engagement will be a fullblown financial statement audit. A financial statement audit offers the highest level of assurance. Of the three reports discussed, the auditors will obtain reasonable assurance that the financial statements are free of material misstatements aka that the financial statements are presented fairly. With an audit, an audit is way more involved than a compilation or review. Audit will have procedures such as testing the internal controls, making sure the segregation of duties is in place. They'll be testing access to certain systems, review the authorization of those who have access to systems. With an audit, you want to validate the internal controls are effective and are in place. You also want to assess the risk of fraud. Is there fraud happening? Is there any indications that fraud could happen? You want to document those and assess whether there is a risk of fraud. You will also perform analytical procedures like you did with the review. Also make inquiries with management just like you did with the review. But you will also go into sampling documentation to support amounts shown in the financial statements. You're going to pull a list within the general ledger account. Select 10, 15, 30 items. And you want to pull the support to validate that that information is correct. And you can provide the support that justifies the number in the general ledger. You also confirm balances with third parties. This would be bank confirmations, maybe legal uh fee confirmations where you actually send it to the vendor and they come back and validate the numbers and the information that you provided during the audit. In addition, you'll make observations of fixed asset physical physical inventories. You go out and make sure that these companies actually have these items or they have this inventory. Heck, you might even do inventory counts a that is just a general sense of what audit procedures can be during a financial statement audit. During the fieldwork phase of the audit, auditors will be on site of the company performing audit procedures and gathering documentation. Now, auditors can be there as long as a couple weeks or maybe months depending the complexity and the level of audit that is being performed. After field work, the auditors will draft the audited financial statements and provide their opinion. Audit letter opinions come in four flavors. There's one particular flavor that you want when you're getting a financial statement audit. So, let's look at an audit opinion letter and see exactly what it says. What are the key aspects of the audit opinion? One, presented fairly in all material respects. Let's talk about materiality real quick. This means the auditors believe that they are reasonably sure a material misstatement is not in the financial statements. And to go over materiality, let's say you have a company with 100 million of revenue. If they mispost $10,000, that more than likely is not going to be material to the audit. However, if the company misposs $5 million, that would most likely be material to the financial statement audit. This where we get into this concept of materiality. Materiality just means is the misstatement going to change the opinion of the financial statement reader. Two, they have conducted the audit within the generally accepted auditing standards framework. This is gas ga generally accepted auditing standards. There's there's a whole list of standards that are written out. You can see how to conduct a audit. Audit ev audit evidence was sufficient to form an opinion. All the evidence provide during the audit was valid. It tied to the general ledger. You feel good about the evidence the company provide. Reasonable assurance is provided. There is not a material misstatement in the financial. Reasonable assurance is not a guarantee. It basically means how we conducted the audit was very reasonable. But we felt good about the what was provided but that does not mean there isn't a material misstatement or there was something that possibly could have been missed in the audit. And here we're discuss there's further discussion on a what a material misstatement means and what it could do to the financial statements. Now with now we slightly we started talking about audit opinion letters. So what are the four audit opinions that an auditor can uh issue when conducting a financial statement audit? One is you definitely want there's another one that's h it's it's not great but you can live with but there's two you definitely do not want that audit opinion when issuing financial statements. The first one is a unqualified opinion. This is the opinion you want. This means you have had a clean audit and the auditor believes your financial statements are presented fairly. Qualified opinion. a material misstatement was found and is documented, but the material misstatement is not found throughout the financial statement. Not a great audit opinion, but you can you can kind of live with a qualifi you really don't want a qualified opinion, but it's not the end of the world if you if you issue a qualified opinion. And maybe there's a an accounting treatment that you just disagree with the auditors, but they will not give you a unqualified opinion. Ultimately, you want to get to an unqualified opinion, but qualified isn't the the the death blow. These other two are adverse opinion. This is not an opinion you want. This is basically your financial statements are full of material material misstatements and should not be relied upon. This is the worst. The these next two are the are terrible to get and basically your financial statements are should not be relied upon and that's not going to go well for anyone reading the financial statements. They're going to have zero confidence in your financials. Disclaimer opinion. The auditor could not obtain sufficient evidence to form an opinion. This is also not a desirable opinion to get. Basically, the auditor could not substantiate or gain information, evidence to support your financial statements and is issuing a disclaimer opinion. That's it's probably not as bad as an adverse opinion, but it's right there with an adverse opinion. Anyone with a disclaimer opinion, there's not a lot of confidence in those financial statements with a disclaimer opinion. Ultimately, your audience wants to see an unqualified audit opinion, the clean audit opinion. What does an audit cost? It's going to be the most expensive of the three engagements that we just talked. There's a lot more testing, proving a lot that lot more that goes into an audit compared to a review or a compilation. You could have auditors at your company for a couple of months if you have a very sophisticated complex audit. Audits and audits are expensive. Uh they will they will range with your the size of your company and the complexity. They're not a cheap engagement to go through. How long does an audit take? Um, an audit maybe you can get done in a couple of weeks if you have a small audit that you're trying to get through, but more than likely you're a couple a month, maybe a couple months to get through an audit. And if you're a large company, you might have auditors in your place, you know, 6 months out of the year. Uh, it really depends on the size of your your your company, the complexity, uh, but I would say at minimum you're looking at 3 weeks to a month to get through a financial statement audit from fieldwork to actually preparing and issuing the financial statements. All right, those are three key engagements that you can see with financial statements. The compilation, a review, and an audit. I hope you've learned something from this video. Have a good rest of the day, and I will see you in the next video. Take care and goodbye. [Music] Yeah, yeah, yeah.