Maybe you’re on the board of a nonprofit and you’ve seen the terms “audit”, “review” and “compilation” mentioned on a form 990. Or maybe you’ve heard the terms in a meeting with those weird finance people from down the hall. Never really understood what they all mean and what the differences are between them, though? Let me explain. Each of those terms represent something an accountant might be engaged to do to a set of financial statements. Sometimes one of the three is required by state law. Other times one is required by a donor. Sometimes none of the three is required but the organization has elected to have one performed anyway. There are some similarities among each, and even some similar procedures that may be performed in each type of engagement, but there are some big differences. Here’s the skinny…
Of an audit, review and compilation, an audit provides the highest level of assurance over the accuracy of an organization’s financial statements. It provides the reader of the financial statements what’s called “reasonable assurance” – defined as a high but not absolute level of assurance – about whether the financial statements are free from material misstatement. In conjunction with an audit a report is issued with the financial statements which expresses the accountant’s opinion about the financial statements as a whole. In an audit engagement, the auditor is required to obtain an understanding of an organization’s internal controls, assess the risk of fraud, and must verify and substantiate the financial statement information, on a test basis, in order to provide the basis for their opinion. An auditor is also required to report to you any significant or material weaknesses in the system of internal controls identified during the audit. An audit will be more expensive than either a review or a compilation.
A review provides a lower level of assurance over the accuracy of an organization’s financial statements than an audit. In a review engagement, an accountant performs analytical procedures, inquiries and other procedures, but is not required to verify or substantiate any of the financial statement information using the procedures applied in an audit. They’re also not required to assess internal controls or the risk of fraud. In conjunction with a review engagement a review report is issued with the financial statements that includes a conclusion as to whether the accountant is aware of any material modifications that should be made to the financial statements in order for them to be in accordance with the applicable financial reporting framework (accrual basis, cash basis, etc.). Note they’re not expressing an actual opinion as to the accuracy of the statements, they’re just letting you know whether they’ve aware of anything significant that’s wrong with them. A review will be less expensive than an audit, but more expensive than a compilation.
A compilation of financial statements doesn’t provide any assurance over the accuracy or completeness of an organization’s financial statements. Rather, in a compilation engagement the accountant typically creates financial statements from records provided by the client based on the agreed upon accounting framework. A compilation report, which states that the accountant did not audit or review the financial statements and, accordingly, does not express an opinion, a conclusion or provide any assurance on them, is included with the financial statements. A compilation is the least expensive of the three types of engagements.
Clear as mud, right? The key takeaway is that an audit is the only type of engagement where you’ll get an actual opinion on the financial statements. That’s why its something that many states require for larger nonprofit organizations, and why so many donors require one. That doesn’t necessarily mean your organization has to have one, though. Many smaller nonprofits may not need an audit, review or a compilation, especially if they’re working with a CPA along the way. If you’re serving on a board, though, you have responsibilities, so you’ll want to make sure you’re comfortable that whatever is being done is enough.
Need some help sorting through it? Just contact us, we’d be glad to help.