(Cross-posted from my other blog, Nonprofit Update, not because CPAs need this information, but because it might be helpful for your clients. You might also be able to use this illustration as a tool to explain different service levels to your clients.)
Let’s think about a football team and how they are positioned for scoring the winning points in the last few seconds of a tied game. They could be 4th-and-goal or perhaps not yet to a position for a field goal attempt.
Let’s use that illustration to explain the services provided by your outside accountant.
A CPA can provide four levels of services if you’re looking for financial statements.
You can hire a CPA firm to provide:
- audit,
- review,
- compilation, or
- preparation service.
What is winning the game?
We all know what that is in football.
In our accounting illustration a winning score would be perfect financial statements. Every number is correct. Not just close-enough, but exactly correct. Every disclosure complies with every single requirement. The presentation and classification are picture perfect.
That probably never happens in real life, so let’s simplify it by saying that there is nothing even close to materially incorrect in any number, presentation, or disclosure. The financial statements are as close to perfect as is humanly possible.
That is what a win looks like.
Audit
Let’s say there is under a minute left in a tied game. Our favorite football team has just completed a successful drive and is sitting on the 1 yard line on fourth down. There’s only one play left in 30 seconds and the game is over.
Likelihood of getting a touchdown and winning the game is pretty good. Right about now the odds look incredible.
But it is not a guarantee. A fumble, incredible block, or interception of a short pass would be heartbreaking and leave the score tied.
An audit is sort of like getting to that 1 yard line. It is not a guarantee that the financial statements will be completely accurate (or even materially correct in every respect), but your odds are pretty good. That’s a great place to be.
Review
Let’s change the game just a little bit, still with about 30 seconds left in the game with the score tied. However, your favorite team is not in good field goal position. It’s third down and a decent play, whether an okay run or a short pass, will put your team in good position for the superb field goal kicker to score the winning points.
Odds are a little bit longer for this football team. They have to do well on this play so they get into a good position. Then they have to score that long field-goal. Doable, but it is much more of a stretch than a team sitting on the 1 yard line.
A review is sort of like having third down with 30 seconds left in the game and not quite yet in good field goal position. There is a decent chance at getting financial statements that are materially correct (all the numbers that matter to readers of the financial statement are close enough to result in sound decisions by the readers).
But it is a far longer shot at having materially correct financial statements than an audit.
Compilation
Let’s imagine that it is the divisional playoff game down there on the field.
Your team didn’t do too well this season, so they aren’t even in the game. They’re not on the field.
They happen to be having a scrimmage in the soccer field outside the stadium (yeah, yeah, I have thoroughly butchered the football analogy, but come on, work with me here). There’s a slim chance in their kicking practice that a powerful wind gust could grab the ball, lift it even higher in the air, with the strange currents around the stadium lifting the ball over the wall, dropping the ball in the end zone.
Extremely unlikely.
I would not want to make any bets on that play.
A compilation is sort of like that. The accountant will read the financials and asked the client to fix anything that’s crazy out of line. For example, if an organization has lots and lots of fixed assets but the financial statements show zero, I mean zero, depreciation the accountant will know something is wrong and insist it be fixed.
However, the accountant will not even ask questions about whether income was calculated correctly, or the allowance for loan losses is correct, or there’s been any adjustment for sales returns, or if you counted inventory, or whether you lost the lawsuit and a litigation liability needs to be accrued. The accountant won’t even ask if one of your factories burned to the ground.
Someone reading the financial statements can probably make decisions based on compiled financials, but needs to keep in mind the accountant wasn’t in the game.
Preparation
Oh boy, a preparation engagement. That means the accountant takes the client’s numbers and drops them into the proper format. Nothing beyond.
In terms of the football analogy, imagine a football team that did not know the playoff was taking place today.
That’s a good analogy for a preparation engagement. Whatever was on the general ledger is going into the financial statement and the report is going out the door. There will probably be a comment on the financial statements that substantially all notes have been omitted because there aren’t even any disclosures.
Conclusion
There is a drastic difference in the amount of work an accountant puts in when performing an audit, or review, or compilation, or preparation.
This is because there is an extreme variation in the level of assurance that an accountant gains whether the financial statements are materially correct.
In an audit, the accountant gains “reasonable assurance.”
In a review, the accountant gains “limited assurance.”
In a compilation, the accountant gains no assurance, merely reading the financial statements, checking to see if there are any errors so massive that they knock the accountant off her chair or kick him across the room.
In a preparation engagement, the accountant assembles whatever numbers are on the general ledger and sends them out the door, likely not looking at them beyond making sure the debits equal the credits.
In a football game the comparisons would be:
- Audit – team sitting at the one yard line on fourth down with 30 seconds left in the game.
- Review – third down, 30 seconds left, not yet in field-goal position.
- Compilation – not in the game.
- Preparation – there’s a game today?
Thanks to Mike Glynn, from the staff of the American Institute of Certified Public Accountants, who gave a very short version of this illustration (basically the last four points at the end of this post) at the California Society of CPAs’ Accounting and Auditing Conference in October 2020. Thanks Mike for all you do to help us practicing CPAs!