Accounting 101

Reviewed financial statements may be adequate for entities that must report their financial positions to third parties, such as creditors orĀ banks.

Two businesswomen in the accountancy officeReviewed financial statements may also be useful to business owners who are not actively involved in managing their companies. A review consists of inquiry and analytical procedures applied to financial statements. It provides limited assurance that no material changes need to be made to the financial statements.

A private company may engage a CPA to perform a review of its financial statements and issue a report that provides limited assurance that material changes to the financial statements are not necessary. With respect to reliability and assurance, a review falls between a compilation, which provides no assurance, and the more extensive assurance of an audit.

Before a review, a CPA may have to compile the financial statements; however, in all cases the financial statements are considered the representation of the entity’s management, not of the CPA. Management must have a sufficient understanding of the financial statements to assume responsibility for them.

Two other factors differentiate a review from a compilation – the CPA must remain independent of the client during a review, and all appropriate disclosures must be included in the reviewed statements.

In performing a review, the CPA obtains a working knowledge of the industry in which the entity operates and acquires information on key aspects of the organization, including operating methods, products and services, and material transactions with related parties. The CPA will then make inquiries concerning such financial statement-related matters as accounting principles and practices, record keeping practices, accounting policies, actions of the Board of Directors, and changes in business activities. Finally the CPA will apply analytical procedures designed to identify unusual items or trends in the financial statements that may need explanation.

Essentially, a review is designed to see whether the financial statements “make sense” without applying audit-type tests. Keep in mind that during a review, a CPA does not confirm balances with banks or creditors, observe inventory counting, or test selected transactions by examining supporting documents. However, in many instances, a review, with its limited assurance, may be adequate for a business or its creditors. If more assurance is necessary, the organization may need to engage a CPA to perform an audit.