Understanding Financial Statement Engagements: Choosing the Right Level for Your Business 

Small and medium-sized businesses often require formal financial statements prepared at the end of each year, whether for third-party stakeholders like lenders or for internal use. However, not all financial statement engagements are equal. As a company owner, it's essential to understand the three main options available and their implications for your business.

Compilation Engagement:

A compilation engagement is the most common and cost-effective option for many businesses. Under this arrangement, the financial statement preparer compiles the information provided by the client into standard financial statements. However, it's important to note that the preparer does not provide any assurance regarding the accuracy of the statements unless there is obvious misinformation. While minimal notes and details are included in the financial statements, they are presented consistently and clearly.

For example, in a compilation engagement, if a retail store owner reports $100,000 of inventory at the year's end, the financial statement will accept that value as accurate without further verification.

Review Engagement:

In a review engagement, the accountant conducts more analysis, disclosure, and inquiry compared to a compilation engagement. The financial statements include additional notes such as information on capital assets, long-term debt, and related party transactions, along with disclosures on significant accounting policies.

Using the inventory example, in a review engagement, the preparer would conduct more thorough checks, such as comparing current inventory levels with previous years and verifying the valuation method used.

Audit Engagement:

Audited financial statements require the most comprehensive examination to ensure the accuracy of the information provided. The auditor provides "reasonable assurance" that there are no material misstatements in the financial statements, conducting various tests to validate the data.

Similar to a review engagement, audited statements include detailed disclosures and notes to provide users with relevant information for analysis. For instance, in the case of inventory valuation, the auditor may physically verify inventory counts at the year-end to ensure accuracy.

Choosing the Right Level:

The choice of engagement level often depends on external factors such as lending requirements or stakeholder demands. If a lender requires reviewed or audited statements for loan approval, the business owner would opt for a higher level of engagement. Similarly, if there are multiple unrelated owners or if a buyer demands greater confidence in the financials, a review or audit engagement may be necessary.

However, for many small businesses, a compilation engagement is sufficient, especially if no third-party stakeholders require a higher level of assurance. It provides a cost-effective option while still presenting financial information in a clear and consistent manner.

Conclusion:

Understanding the different levels of financial statement engagements is crucial for business owners to make informed decisions regarding their financial reporting requirements. Whether opting for a compilation, review, or audit engagement, each level offers varying degrees of assurance and disclosure to meet the needs of stakeholders. By selecting the appropriate level of engagement, businesses can ensure transparency, credibility, and compliance with regulatory standards.