There comes a time when businesses need to obtain additional capital from external users such as banks or potential investors. These businesses will reach out to these users and try to obtain the capital that they need. However, these entities will not just lend the capital needed without some assurance that the company properly reflects its financial position on the financial statements. This is important because it allows potential investors to analyze the company’s information and help them make appropriate decisions regarding whether they should provide that capital. The problem is, simply providing your financials is not usually satisfactory. Instead, externals users want to see these financial statements verified by someone independent from the business, such as a Certified Public Accountant (CPA). Even then, there are different levels of assurance that examination of the financial statements can take, such as an audit and a review.
Now the question you may be asking yourself is, what is the difference between an audit and a review? When should your company be deciding between an audit and a review? Let’s look at the difference.
The purpose of an audit is to provide reasonable assurance that the financial statements being examined are reasonably stated. In an audit, the auditor will obtain evidence throughout the balance sheet and income statements and/or any additional supplemental information to evaluate that information. The scope of an audit is much more extensive than a review and involves testing different components of the financial statements. Based on the evidence obtained and the judgment of the auditor, the auditor will issue an opinion on the financial statements. The opinion they can provide in their report is either an unmodified, modified, disclaimer, or adverse opinion. The best type of opinion businesses seek is an unmodified opinion and tells external users that the financial statements can be reasonably relied on. Depending on the audit opinion provided, this can affect any outside user’s opinion on the trust they can put on the company’s financial statements. Audits are important because they allow external users, such as creditors, lenders, and investors, to feel as though the financial statements are reliable and will properly assist them in determining if they should invest in or lend to the company.
Now, an audit is mandatory for public companies that trades its securities in the stock market but is not the case for private companies. So then, if an audit is not mandatory, why should private companies spend more to have an audit performed? The fact is, if your company is looking for lending avenues, an audit gives more assurance than a review, as the lender will know the financial statements were scrutinized at a higher level and examined much more thoroughly than a review. This will provide confidence to a lender and allow the business to secure significant loans.
The other time an audit is important to private businesses is when they need to maintain certain debt covenants as outlined in the loan agreement they made with the lender. In these cases, audits will be necessary because they are outlined in the loan agreement.
In a review engagement, the focus is more on analytical procedures and inquiry of management to obtain assurance that is more limited than that seen with audit procedures. As such, less time and resources are committed to review services. Reviews can be helpful for growing businesses with little capital who need their financial statements scrutinized but are unable to afford the fees that come from a financial statement audit. Obviously, while audits are preferred by external users, reviews are still valuable in obtaining the necessary credit and financing that these growing businesses may be seeking. In addition, engaging an independent accountant to review your financial statements can allow management to obtain a better understanding of their financials, which should also help them when they are making future decisions.
Overall, businesses should seek reviews if they are in a growth phase and trying to obtain the necessary capital to grow or want to obtain a more detailed understanding of the differences affecting a company year after year. As for audits, this may be mandatory based on the company’s status, for example, if they trade in the public market. In other cases, lenders may determine if you need an audit or review. Some lenders have set thresholds and based on the amount of your loan, you will need a review or audit. The higher the dollar value loaned, the higher the level of assurance the lender will need.
If you have any further questions about review services versus audit services and which services would be most beneficial for business needs, contact us at ADKF. We would be happy to help and get you the expertise you need to ensure that we are providing you the proper service.