Audit or Review: Which is Best for My Business in a Changing Financial Environment?

The financial services industry is facing its most significant regulatory reforms since the Great Depression. The Dodd-Frank Wall Street Reform and Consumer Protection Act, Solvency II, Basel III, and other new regulations present challenges that transcend compliance. These ever-evolving regulations are causing financial services companies to reconsider significant business and operating strategies as well as their compliance needs.
Banks are particularly focused on industry sectors that have tolerated the brunt of the recent recession, such as real estate (commercial as well as residential), construction, print media, restaurants, and retail. Companies in these sectors, as well as businesses in general, should be prepared to respond to changes in their lender’s reporting requirements.

In order to receive or continue to receive credit from banks, companies should be aware of the types of financial statements that a bank may request:

• Compiled statements – Provide no assurance that the financial statements are accurate, but are complete and comply with generally accepted accounting principles (GAAP).
• Reviewed statements – Provide limited assurance that the financial statements are accurate. Typically, your accountant will review the statements to ensure that obvious errors or misstatements are corrected and will perform analytical procedures on the underlying financial data.
• Audited statements – Provide the highest level of assurance (“reasonable assurance”) that the documents fairly present the company’s financial performance consistent with GAAP.

In the past, many lenders accepted compiled financial statements from many borrowers. Today, we are seeing many instances where the requirements have been stepped up to where the lender is requiring reviewed financial statements. The same holds true that once where reviewed financial statements were sufficient, lenders are now requiring audited statements. As the level of assurance required by the lender increases, so too can the associated costs to prepare statements. A close partnership between your company’s CFO/controller and your CPA firm is crucial to minimizing the cost and lead time associated with preparing financial statements.

A Closer Look

Audits are often required for organizations, no matter how small they may be. These requirements may in some instances vary from state to state. While not an exhaustive list, here are some examples of when an audit is required:

• Although the amounts vary from state to state, not-for-profit organizations are required to present either audited or reviewed financial statements based on the amount of charitable contributions received.
• Organizations receiving federal or state grants or contract dollars may be required to present audited financial statements if the dollars received exceed certain thresholds.
• Publicly held companies are required to present audited financial statements and comply with numerous additional financial reporting standards.
• Organizations may be required to present audited financial statements in connection with the requirements under a loan agreement. They may also need to report that they have met with certain financial metrics, or covenants, as stipulated in the loan agreement.

It’s important to note that a financial statement audit can also be beneficial to a company, even if the audit is not required. Auditors often serve as consultants to a company’s accounting department and their management to help trouble shoot problems, whether they are related to a company’s financial statements or not. Many companies, large and small, leverage this as a best practice to ensure efficient and effective operations.

Reviews are a less costly alternative to audits and can be very useful to a company as well. For example, by performing inquiries and analytical procedures, an accounting firm can assist a company in determining why financial ratios may be falling short of budgeted expectations or assist them with putting their financial information into a format that allows them to benchmark against relevant financial data from comparable organizations. However, reviews offer a lower degree of assurance than audits and as such do not allow for as in depth look at the financial workings as audits.

The type of report utilized should be determined by mutual agreement between you and your CPA. The decision usually depends on many factors, such as the needs of your business, requirements of creditors or funding sources, and the size and complexity of your organization. Regardless of the level of service that is selected, working hand-in-hand with your CPA provides valuable insight into your business from a historical perspective, allowing you to understand operations over time and plan ahead for the future.