In PART I, I discussed some important factors regarding “canned” accounting package financials and the simplest form of financial statements which are Compiled Financial Statements, which a CPA prepares. In this Section I will discuss some general items in regards to Reviewed Financial Statements.
Just as in Compiled Financials the most common basis of accounting used in reviewed financial statements are either Modified Cash, GAAP and the Income Tax Basis of accounting. In some cases where the financials are prepared based on industry or other regulatory accounting rules -Statutory Basis may be used.
The basic methodology used in the preparation of reviewed financials is similar to compiled financial statements. There are many rules which must be observed for the proper disclosure and the fair presentation of financial information. In addition there are the minimum set of financials that are typically reported on. The underlying accounting and the financial statements themselves are the assertions of management. As such management is responsible for the contents of the financial information. The difference from Compiled financials is that analytical procedures and professional analysis and judgment are applied to gain an additional level of assurance that the financial statements present fairly management’s assertions. Some of these procedures might involve calculation of financial ratios, comparison to past historical financials to current financials or industry standard metrics. Review of accounting records, statement line items and other reconciliations. Additionally, inquiries are made of management to make sure all the relevant facts regarding the company and its financial affairs are either presented in the body of the financial statements or in the notes and other disclosures that may be provided. This inquiry is later confirmed by management to the CPA by means of a “Management Representation Letter” which details all these "representations” and is signed by management for the benefit of the CPA’s. A fair amount of work is involved for a CPA to issue reviewed financial information. Yet it is not as much or as extensive as those procedures employed in an audit. For that reason Reviewed financials are regarded as an intermediate type of financial statement to audited statements. In fact many auditors might require that at minimum a new client have at least Reviewed financials prior to having audited financials. This is because it provides a good base from which to perform audit work. However, not having Reviewed financials would not necessarily preclude you from being auditable. An important point is that CPA’s must be independent in order to issue a Reviewed financial. This means they generally can not audit their own accounting, or be so involved with the client in providing additional services so as to audit their own work.
The reason for undergoing a review typically is a matter of compliance. It is possible some user of your financial information may require you to undergo this process in order to satisfy a condition of their involvement with the company. For example, investors often make Reviews a condition in the operating agreement of a company, banking institutions might require it also as part of a loan agreement. Likewise bonding companies, which provide for different types of insurance and many regulatory and licensing agencies also may require at minimum Reviewed financial statements. In some cases it can be triggered because some event in a company causes an interested party to force the company to undergo a Review. For instance a dissatisfied investor or partner or even a divorce. Given the state of the financial markets, Reviews may become much more common or even a requirement as many banks and lenders try to reduce their lending risks by requiring CPA prepared financials that are prepared on higher standards.
A Review is a valuable exercise for any company who attains a level of success. It does require that a formal accounting system be in place and that management has some system of internal control. For many first time companies, it is an exercise that prepares the company and its management for even higher standards of financial reporting.
A company that is planning to undergo a Review might hire another CPA firm, such as mine, to make preparations for the Review process. This has the potential of reducing Review costs and fees and also to address weaknesses the company might have in its accounting systems and controls.
In the next part of this series I will address Audited financials.
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