Accounting 101: Levels of Assurance
Posted by Benjamin Schuver on March 01, 2022
A financial expert’s analysis is only as reliable as the data it’s based on — and all financial statements aren’t created equal. The term “assurance” refers to how confident (or assured) you are that a company’s financial reports are reliable, timely and relevant. Here are three distinct levels of assurance that CPAs offer, in order of increasing level of rigor:
1. Compilations and preparation services. These engagements provide no assurance that financial statements are free from material misstatement and conform with Generally Accepted Accounting Principles (GAAP). With a compilation, the CPA puts financial information that management generates in-house into a GAAP financial statement format. Footnote disclosures and cash flow information are optional.
Alternatively, when financial statements will be used for internal purposes only, a CPA might prepare the company’s financial statements in conjunction with bookkeeping or transaction-processing services. This is no different from what an in-house controller or CFO would provide to management. Prepared financial statements may be shared with outside parties, but each page of the statements will include a notice that “no assurance is provided.”
2. Reviews. These statements provide limited assurance that they’re free from material misstatement and conform with GAAP. Here, the accountant applies analytical procedures to identify unusual items or trends in the financial statements. He or she inquires about anomalies, as well as the company’s accounting policies and procedures.
Reviewed statements include footnote disclosures and a statement of cash flows. But the accountant isn’t required to evaluate internal controls, verify information with third parties or physically inspect assets.
3. Audits. These statements offer a reasonable level of assurance — but not a guarantee — that the financial statements are free from material misstatement and conform with GAAP. The Securities and Exchange Commission requires public companies to have an annual audit. Larger private companies also may opt for this service to satisfy outside lenders and investors. Audited financial statements are the only type of report to include an express opinion about whether the financial statements are fairly presented and conform with GAAP.
Beyond taking the analytical and inquiry steps of a review, auditors evaluate internal control systems, tailor audit programs for potential risks of material misstatement and report on control weaknesses when they deliver the audit report. In addition, they may conduct third-party verifications, physical inspections, and detailed examinations of original source documents and computer records.
Reliability Matters
Financial statements may be used to value a business or estimate lost profits. Too often, a company’s owners and counsel assume that a CPA’s work always carries an independent audit’s stamp of approval. But that can sometimes be a faulty assumption.
for more information
As a manager, Ben’s responsibilities include the valuation of businesses, business interests, and intangible assets for purposes of financial reporting, transaction advisory, and tax planning and compliance. Additionally, Ben’s role includes the performance of various forensic accounting procedures, as agreed upon with clients. Ben’s prior experience includes performing assurance services for publicly traded companies within the aerospace and manufacturing industries, as well as large private companies and the gaming industry. He also has experience in testing and evaluating internal controls over financial reporting.