Nonprofits, construction companies, or companies with external investors are all examples of companies that may be required to get audits. However, these requirements may be dependent on certain circumstances. For instance, a nonprofit that recently reached a higher level of government funding may have crossed the audit requirement threshold. That said, there are many nuances involved in determining whether a switch to or from a review to an audit would be necessary. Regardless, companies do experience this transition and the following information is aimed at determining the difference between the two.
Audits
Definition and Description
An audit, by definition, "is an objective examination and evaluation of the financial statements of an organization to make sure that the records are a fair and accurate representation of the transactions they claim to represent." Which in layman's terms means, when a company is due to be audited they must hire an independent accountant to thoroughly examine the company's books, accounts, statutory records, etc. in order to provide reasonable assurance that they comply with the applicable accounting standards such as generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS).
Purpose
The purpose of an audit is to provide outside parties such as creditors, and investors with a high level of comfort on the reasonableness of an entity’s financial statements. For example, the insurance company that covers a construction company will likely require it to be audited annually in order to reduce the risk of insuring the company.
Requirements
Obtain reasonable but not absolute assurance. "Reasonable assurance" describes the satisfaction level with which auditors determine that the evidence obtained during an audit supports that the financial statements do not contain material misstatements. When an auditor obtains reasonable assurance they're stating that the financial statements are free from material misstatement in accordance with accounting standards such as GAAP.
Auditors do not obtain absolute assurance because limitations, uncertainties, and risks may exist that cannot be predicted confidently nor precisely. As such, it's considered impossible to establish absolute assurance.
To perform an audit the CPA must:
- Obtain reasonable assurance.
- Be independent.
- Obtain an understanding of internal control and assess control risks
- Perform inquiries and analytical procedures
- Perform verification and substantiation procedures
- Express one of the following opinions;
- Unqualified opinion
- Qualified opinion
- Disclaimer opinion
- Adverse opinion
- Obtain a management representation letter from the client.
Reviews
Definition and Description
A review, by definition, is "a service under which the accountant obtains limited assurance that there are no material modifications that need to be made to an entity's financial statements for them to be in conformity with the applicable financial reporting framework (such as GAAP or IFRS)." Which put simply, means that if a company requires a review, they also have to hire an independent accountant, however, the accountant needs only to establish limited assurance that the financial statements conform with the applicable accounting standards.
Purpose
To provide external parties with a basic level of assurance on the accuracy of financial statements. In other words, while an audit extensively examines whether or not the financial statements are free of material misstatements, reviews deduce whether or not the financial statements are plausible or credible.
Requirements
A review requires the accountant to perform fewer procedures to support a conclusion on the financial statements regarding whether anything has come to the auditor's attention to indicate that the financial statements are not prepared in accordance with the specific accounting standard.
Obtain limited assurance. To determine limited assurance auditors limit the amount of evidence they collect usually by performing different or fewer tests than that of an audit.
- For a review, the CPA must:
- Obtain limited assurance.
- Be independent.
- Perform inquiries and analytical procedures.
- Provide a conclusion.
- Obtain a management representation letter from the client.
Conclusion
Audits require much more in detailed work to establish reasonable assurance while reviews only need some of the same procedures in order to establish limited assurance. With regards to cost, CPAs general charge an hourly fee, therefore since reviews require less work they are generally much less costly than an audit.
For more in-depth information regarding the differences between financial statement services (Audits, Review, Compilations) the AICPA has provided this guide.
If you have questions or concerns regarding this information feel free to contact us.