Do you know the differences between financial compilations, reviews and audits? CPAs engage in all three types of financial statement reporting for auto dealerships and other businesses. But each endeavor has its own level of requirements, depth and outcomes.
It’s important to understand that, depending on the level of assurance selected, CPAs perform procedures of varying degrees of complexity when evaluating a company’s assets, liabilities, revenues and expenses. Here are descriptions of the three main types of CPA engagements.
Sticking to the basics
Compilations (or “comps”) rely on data provided by the borrower. As such, the CPA provides no assurance that financial statements are free from material misstatement and conform to GAAP. Instead, the CPA simply reports on management’s financial information in a GAAP financial statement format. Footnote disclosures and cash flow information are optional and are often omitted from comps.
Comps may be appropriate for small or highly profitable dealerships where no outside lender requires a higher level of assurance. Comps also may be desirable for dealers who need assistance organizing their financial data and preparing a financial statement for interested parties such as prospective buyers.
Stepping it up
Next are reviewed financial statements, which provide limited assurance that the statements are free from material misstatement and conform to GAAP. Like comps, reviews are based on internal financial data. Here, the CPA:
- Applies analytical procedures to identify unusual items or trends in the financial statements, and
- Inquires about these anomalies, as well as the company’s accounting policies and procedures.
Reviewed statements must include footnote disclosures and a statement of cash flows. But CPAs aren’t required to evaluate internal controls, verify information with a third party or physically inspect assets — unless, through their analytics and inquiries, they’re uncomfortable that the numbers are accurate.
Going the full nine yards
An audit provides a reasonable level of assurance that a borrower’s financial statements are free from material misstatement and conform to GAAP. The SEC requires all public companies to have an annual audit. Additionally, privately held dealerships also may require an audit as a part of the lending covenants established within their debt agreements.
Audited financial statements are the only type of report to include an expressed opinion about whether the financial statements are fairly presented in all material respects, in conformity with GAAP (or other comprehensive bases of accounting).
Beyond the analytical and inquiry steps taken in a review, auditors perform “search and verification” procedures. Among other things, auditors obtain written confirmations for accounts receivable, physically observe year-end inventory counts and randomly test sales transactions by examining contracts and other supporting documents. They also consider the dealership’s internal control over financial reporting and may issue a report on internal control systems along with the audit report.
Although audits provide the highest level of assurance, there are no absolute guarantees against “creative accounting” or inadvertent errors.
Having an audit can provide a dealership with more than a reliable financial statement. Good auditors will share ideas for improving operations that they gathered throughout the audit process. For example, your auditor can help you determine whether a change in inventory accounting methods would be appropriate to help lower your taxes.
Auditors also may share their financial analysis tools. For instance, your auditor may use benchmarks to compare your store’s performance over time and against industry averages. In addition, auditors often use analytics to boost audit efficiency. These metrics can reveal much about your dealership’s strengths and weaknesses.
Making the decision
Discuss with your CPA the purposes you have in preparing your financial statements. Together, you can decide which type of engagement will work best for your dealership.