20 Jun What to Expect in a Financial Statement Review
Wondering what happens during a financial statement review? To help you better understand the process, here’s a breakdown of the key steps.
But first, here’s a quick overview of how reviews fit into the three levels of reporting we provide.
Reviews vs. Audits and Compilations
Reviews are the middle child when it comes to an examination of financial statements that a CPA firm can perform. They provide a limited level of assurance at a more reasonable cost than an audit. The rules for how to perform an audit are laid out in the Canadian Standard on Review Engagements (CSRE), and they’re typically performed on financial statements that are prepared in accordance with Canadian Generally Accepted Accounting Standards (GAAP).
Audit engagements are also conducted on GAAP financial statements but require significantly more work to be performed than with a review. Thus, reviews provide less assurance than an audit and also cost less.
Compilations are the simplest form of engagement that we perform on financial statements. These engagements are very limited in scope and thus they provide no assurance but are much less costly than reviews and audits.
For more information on the differences between audits, reviews and compilations, you can read our piece that explores the differences in more detail.
Understanding Your Organization
One of the first things we are required to do on a review is obtain an understanding of your organization—what it does and how it tracks financial and other information. We are required to update this understanding each year, which is why we will typically ask similar questions year after year. This process tends to be much more work in the first year an organization is reviewed and then less onerous in subsequent years unless the organization has gone through substantial changes.
Some of the primary procedures we perform in a review engagement are analytical procedures. This is where we develop an expectation and compare your organization’s data to it. As a simple example, if we have verified that you pay rent at $10,000 a month for a premise that you rented for 10 months of the year, then our preliminary expectation of your rent expense would be $100,000. We would then compare this to the actual rent expense account in your records and investigate any significant differences from our expectation.
Other types of analytical procedures include gross profit margin analysis, ratio analysis and trend analysis. As an example, if you have three main business lines, or departments, we might examine the gross profit margins for each business line and compare them to previous years. Analytical procedures can be quick and simple like the above rent and gross margin examples or they can be quite complex with lots of assumptions and calculations. The level of complexity is really dependent on the size and complexity of your organization.
In addition to analytical procedures, the other most common review engagement procedure is making inquiries of management and key employees. Here we will ask about changes in year end balances compared to the previous year as well as the results of our analytical procedures. So, a lot of our questions that we ask will be based on the analytical procedures we perform when the results of the procedures don’t coincide with our expectations. Some of the inquiries we make will be repeated each year and others will be dependent on what occurred during the year. By relying on inquiries, we can complete a review engagement faster and more efficiently than by performing more tedious audit tests.
Sometimes analytical procedures and inquiries just aren’t enough and we will make a judgement call to perform some other procedures that are typically reserved for audits. In certain cases it can also be more efficient to perform an audit procedure than a review procedure, but this is not the norm. Procedures that are typical of an audit that are sometimes performed in a review include detailed testing procedures as well as sending confirmations to banks, customers, or suppliers.
We are required by CSRE to inquire about the existence, or possible existence, of fraud during the year. However, unlike an audit engagement, we are not required to perform detailed fraud testing in a review engagement. This is one of the main differentiators between a review and an audit. So if you want fraud testing incorporated into your annual procedures you may want to consider an upgrade to an audit engagement.
We hope this helps you better understand what happens during a financial statement review so you can get the most out of the work we perform for you. As always, if you have questions about reviews or any other topic, please reach out to your key contact at Clearline.