By Glen Swanson, CPA
Most of us don’t have extensive mechanical knowledge or tools to determine if a used car has been well cared for, so we ask a mechanic to look at the car before purchasing it. Similarly, most users of financial statements don’t have the knowledge or experience to determine if financial statements are accurate, so a CPA firm is engaged to provide a certain level of assurance about the accuracy of those financials.
While audits are well known and provide the highest level of assurance, they are also the most expensive option. A trustworthy CPA firm’s goal is to assist clients in finding the right service to meet stakeholder needs while being financially prudent – this goal has been heightened with the current economic challenges. The following paragraphs introduce the various levels of assurance services provided by CPA firms:
The CPA firm’s objective in an audit is to express an opinion, with reasonable assurance, that a set of financial statements are fairly presented in accordance with a selected accounting framework (typically Generally Accepted Accounting Principles). In order to express this opinion, the CPA firm will evaluate the organization’s internal control system, make inquiries of management and others within the organization, confirm information with 3rd parties (e.g. banks, customers), perform analytical procedures, test reconciliations and obtain documentation to support balances. At the conclusion of an audit, the CPA firm will issue its opinion on the financial statements, along with a letter describing significant internal control deficiencies and potential fixes. An audit is the highest level of assurance a CPA firm can provide on financial statements and is also the costliest.
If considering the purchase of a used car, this would be the equivalent of bringing the car to a mechanic to have him/her spend hours looking at all key components of the car to determine that they are working properly. The mechanic will give you a letter stating if he/she believes the car is running properly and provide you a letter with suggestions on how to keep the car running its best.
In a review engagement, the CPA firm’s objective is to provide a report with limited assurance that the financial statements are free of material misstatement. In order to make this determination, the CPA firm will apply analytical procedures to the financial statements and make inquiries of management; the CPA firm will typically not test reconciliations or request supporting documentation. In addition, the CPA firm will not assess the internal control environment, nor will it issue a letter with recommendations on how to improve internal controls.
If considering the purchase of a used car, this would be the equivalent of asking a mechanic to take a 15-minute look at the car and drive it around the block. The mechanic will give a letter stating if he/she identified any significant concerns about how the car is running. In general, you feel fairly confident purchasing the car, but there is greater chance that something isn’t running quite right.
In a compilation engagement, the CPA firm’s objective is to take information provided by management and present it in the form of financial statements. Unlike in audit and review engagements, there is flexibility to not present footnotes, a statement of cash flows, and/or a statement of functional expenses. The CPA firm will not test any of the information or make any inquiries of management and accordingly the CPA’s report will express no assurance on if the financial statements are fairly presented.
If considering the purchase of a used car, the mechanic will look at the car for 1 second and give you a letter stating that it is car and he/she has not looked at it to see how it is running.
A preparation engagement is similar to a compilation, but the CPA firm will not issue any report on the financial statements. Instead, a disclaimer will be added to each page of the financial statements that no assurance is provided.
For a used car, this would be the mechanic seeing the car and verbally telling you that it is a car and he/she has no idea on how the car is running.
Agreed Upon Procedures
The objective of an agreed upon procedures engagement is not to issue financial statements, but rather issuance of report summarizing the results of certain procedures requested by management. This provides the organization an opportunity to discuss specific concerns with the CPA and collaboratively determine procedures to test around those specific concerns. For example, if the board is concerned that management has properly determined if contributions are with or without donor restriction, the CPA could perform a procedure to test a sample of 25 contributions during the year to evaluate if donor restrictions have been properly recorded in the general ledger. Many times an agreed upon procedures engagement is partnered with one of the financial statement options described above – this provides a full set of financial statements and testing around specific concerns.
For purchasing a used car, this would be the equivalent of having the mechanic check the thickness of the brake pads. The mechanic will provide a document stating what the thickness of the pads are, but the document will not state if the brake pads will continue to work properly into the future.
As members of MHCS’s nonprofit team, we commonly receive calls requesting proposals for audit services. However, as we discuss the needs with potential clients, we find that they don’t need an audit and a lower level of service would suffice. Whether you’ve had audits performed for years or have never worked with a CPA firm, feel free to reach out to MHCS to discuss your organization’s needs and find the right fit.
Glen Swanson, CPA | Manager