Financial Review vs. Audit: What’s Right for Me?
When most people consider a process for verifying the information in a company’s financial reports, they think of an audit. Although a full audit of a company’s accounting records provides the highest level of assurance, a financial review, although it only provides limited assurance, can also be adequate for a company looking for an independent review of the financial statements for compliance with Generally Accepted Accounting Principles (“GAAP”).
So, what’s the difference? Well, let’s take a look.
What Is a Level of Assurance?
When considering a financial review vs. audit, the most critical distinction is related to levels of assurance in financial reporting and how the different accounting services provide for these levels. There are three types of assurance services: compilation, review, and audit.
The level of assurance is an assessment of how confident the auditors are that the financial statements are reliable, timely, and relevant.
Compilation: This type of engagement uses the company-provided data to create financial reports in GAAP format. Because the accounting firm is using client-provided, unverified data, there is no assurance provided. The compilation report is in the form of the compiled financial statements.
Review: Reviews are performed with limited analytical procedures in order to identify and inquire about unusual items or trends. These engagements provide limited assurance.
Audit: Audits provide the highest level of assurance possible: Reasonable assurance. As compared to a review, this higher level of assurance is provided by verifying the financial information with third parties and through a review of internal control processes.
What about absolute assurance, can that be obtained? Unfortunately, no. Absolute assurance would require that the auditor is absolutely sure there is no misstatement or material modifications to the financial statements. Audits include many inherent limitations that naturally prevent this level of assurance.
What Is Financial Review?
A review engagement performed by a Certified Public Accountant (CPA) examines the company’s financial statements for compliance with GAAP. This process provides limited assurance that the financials are free from material misstatement.
A financial review does not include an examination of the company’s internal control procedures compared to an audit where the CPA firm performs specific audit procedures to test the internal control system a . Minus this level of service, the external auditor is unable to evaluate the company’s fraud risk. Assurance related to a company’s internal controls can be of utmost importance to lenders and boards of directors for non-profit organizations.
An additional important distinction between a financial review vs. audit is in a review, the auditor does not independently validate any of the financial transactions through third-party confirmation.
What Is Financial Audit?
A financial audit is performed by a CPA independent of the company, charged with inspecting the financial records that when compiled, form the company’s financial statements.
The auditors use a series of audit procedures including physical inspection of source documents, third party confirmation from outside vendors, and gaining an understanding of the internal control environment in order to create the body of audit evidence forming the basis for the audit report. A full audit involves using standard audit procedures to test information at the transaction level for compliance with accounting standards.
3 Types of Audits
Although there are several different types of audits, the three primary types of financial audits are internal, external, and Internal Revenue Service (IRS).
Internal audit: Internal audits are performed by accounting staff within the company to evaluate compliance with laws and processes, including internal controls. The recommendations of independently performing internal audits give assurance that internal control processes are operating effectively, and will suggest process improvements to result in an improved financial position.
External audit: External audits are performed by auditors outside of the company. This type of auditing provides the highest level of assurance possible that the financial statements are free of material misstatement. The deliverable is an audit report made to the business owners or board of directors outlining the results of the audit.
IRS audit: An IRS audit is conducted by auditors working for the IRS with the purpose of verifying the accuracy of information used for tax reporting purposes. These audits can result in no changes to the tax return or changes that result in additional tax liability.
Although CPAs may perform many different advisory services for their clients, it is important to distinguish a financial review and audit services as much higher levels of service with auditing standards CPA’s must follow as outlined by the AICPA (American Institute of Certified Public Accountants).
When considering a financial review vs. audit, there are many considerations that must be made including the need for either of these levels of financial statement examination.