Depending on the size, nature, and industry of a business, there are varying financial reporting requirements for every business entity. Small and medium enterprises usually do not prepare formal financial statements and rely on bookkeeping. However, there are many circumstances when the presentation of formal financial statements is necessary.
A company may decide to prepare the financial statements in-house or hire an outside CPA to prepare the financial statements formally. In the former situation, the company will have to incur a regular cost of hiring a CPA that can be very costly. However, the latter scenario is more affordable and convenient for the small-budget companies as they can get the services of a CPA without incurring a recurring cost.
Depending on the company’s needs, the business entity can hire a certified public accountant to prepare one or more compilation financial statements. In this article, we will discuss the compilation of financial statements and how does the compilation of financial statements works in any business entity.
What Is Compilation Of Financial Statements?
Compilation of financial statements can be defined as,
When a company’s financial statements are prepared or compiled by an external certified public accountant, it refers to a compilation of financial statements.
The definition of the compilation does not clear its purpose. However, the essence of the compilation is hidden in the purpose of the compilation. Basically, the business entity provides accounting data in the form of entries, ledger, journal, trial balance, etc., and the accountant converts it into formal financial statements.
The implications of compilation also include no assurance, review, or internal control check, as in the case of reviewed or audited financial statements. Therefore, an accountant does not ensure that the financial statements present a fair view. There is also no assurance that all the GAAP or IRS have been followed.
Let’s redefine financial statements compilation.
The external accountant, mostly a CPA, assists a company’s management in presenting the accounting data in the form of financial statements. The presentation of data does not cover any assurance about any material modifications needed to make the statements according to a prescribed accounting framework(GAAP or IFRS).
The definition of the compilation also clarifies the scope of management’s and accountant’s work that will be discussed in the next part of the article.
What Is A Compilation Financial Statements?
The definition of a compilation financial statement or compiled financial statement can be derived from the above definition. Therefore, we will define it as,
The financial statements(usually income statement, balance sheet, and cash flow statement) prepared by an external accountant based on the amounts or accounting data provided by the client business entity are called compiled financial statements. These statements are not reviewed or audited by the accountant to confirm that generally accepted accounting framework has been followed by the business entity or not.
Which Financial Statements Are Compiled?
The compiled financial statements present the financial status of the company through the financial data. The compiled financial statements usually include:
- Balance Sheet
- Income Statement
- Statement Of Cash Flows
Standards Governing Compilation Of Financial Statements
Certain standards govern hiring an external accountant and the scope of compilation. In this case, the American Institute Of Certified Public Accountants(AICPA) has outlined the standards and regulations for the compilation of financial statements. Everything about compiled financial statements has been described under AR Section 80. Every CPA undergoing compilation process must understand and engage in compilation according to regulations outlined under Section AR 80. He should also present a compilation report to the client under prescribed regulations.
Duties Of Management
Under AR Section 80, the management is responsible for:
- Identification and insurance that the company follows all the laws and regulations applicable to the business entity
- Management is responsible for making all financial records, data, and information readily available for the accountant(CPA).
- It is the responsibility of the management that the financial statements are prepared and presented fairly according to the applicable financial reporting framework(GAAP or IFRS).
- Detection and prevention of fraud is also the responsibility of the company’s management.
- A company’s management is liable to design, implement, and maintain the internal check and control procedures regarding financial statements’ preparation and fair representation.
Duties Of Accountants
Section 80 also explains the duties and scope of the accountant’s work in case of compilation. Under regulations, the accountant has the following duties and responsibilities.
Under the standards of AICPA, the certified public accountant is liable to conduct the engagement according to Statements on Standards for Accounting and Review Services(SSARSs). The special condition in compilation engagement is that there is no requirement of disclosing errors, frauds, or illicit activities. If any material errors or evidence are found during the engagement, the accountant will inform the management about it. However, he is not responsible for reporting any fraud found during the engagement.
Understanding Client’s Business
The accountant conducting compilation engagement is required to have knowledge of the client in the following aspects:
- Understanding of the client’s business
- Understanding of accounting principles and applicable accounting framework used by the client.
- General understanding of the client’s company includes but is not limited to nature of business, operating characteristics, income, revenues, expenses, assets, and experience.
- He must understand the accounting procedures and practices that the client uses for measuring, recording, recognizing, and disclosing accounting information and statements.
The accountant must possess an understanding level of the industry in which the client’s business operates. It includes an understanding of generally used accounting frameworks, procedures, and principles in most industry entities that will help accountants compile industry standards.
This requirement is not a compulsory one for an accountant to accept compilation engagement. If he has no previous industry experience, he can consult AICPA guides, industry publications, other entities’ financial statements to develop an understanding.
Reading The Financial Statement
When the accountant has completed the engagement and prepared financial statements, he must read the statements to confirm that there are no material errors. He should also ensure that the financial statements are in an appropriate form. He should check for errors and mistakes, including arithmetical errors, clerical errors, errors in accounting principles application, and inadequate disclosure.
AICPA also defines the scope of the accountant’s work regarding documentation during the compilation engagement. The purpose of documentation is to provide enough description and understanding of the procedures followed. The accountant should furnish the following documents from the start to the end of the engagement:
- Engagement letter to explain the understanding with the client’s business
- Any results or findings in his judgment about material misstatements
- The compilation procedures are undertaken to resolve those issues
- Documentation for communication, oral or written, to record any communication with management about any fraud or illegal act he found during the engagement.
- All the financial statements that the accountant has compiled
After completing the engagement, the accountant is required to submit financial statements. When the financial statements prepared by the accountant are to be used by external parties, he must also submit a report along with the financial statements. The report aims to prevent misinterpretation of the information and degree of responsibility of the accountant related to compilation.
What Is Included In The Compilation Report?
The compilation report prepared by the accountant has the following basic elements:
- Title indicating the accountant’s compilation report and his association with the business entity. For instance, the ‘independent accountant’s compilation report’ represents that the independent external accountant has performed compilation.
- Addressee depends on the circumstances of the engagement.
- Introductory paragraph including the name of the entity, stating the compilation of financial statements, identification of statements that have been compiled, specifying date or period for which compilation was made, a statement explaining the scope of accountant works does not include review or audit.
- Management responsibility for preparing true and fair financial statements, performing internal control procedures, and maintaining internal control.
- Accountant’s responsibility statement to explain the scope and conduct of accountant during the engagement
- Signature of accountant
- Date of accountant’s report
Why Do Companies Go For Compilation Financial Statements?
Many people might be concerned about the objective of compilation if it is not equivalent to a review or audit of the financial statements. The audit is a formal requirement of many corporations and business entities.
The Certified Public Accountant compiles the statement according to the specific circumstances of the business entity. For instance, if a company is looking to get a small amount of loan requiring collateral, he will need his financial statements. As the financial statements themselves do not provide any assurance, if a CPA has compiled the statements, the outside parties are more confident in transacting with such business entities.
For instance, a business needs machinery to add to the current facility. If the company goes to the bank, only the tax return will not be enough to get a loan. The bankers will require you to furnish, compiled, reviewed, or audited statements. In case compiled statements are required, the CPA involvement adds confidence to your financial status. The credit institutions have more faith in CPA’s prepared statements.
The compilation statement is a requirement of many business entities seeking loans or other purposes. However, there are certain limitations in some cases. Many financial institutions or creditors do not rely on the compilation statements as there is no assurance provided in the statements.
However, we have explained the concept of compilation and when do the companies usually go for compilation. You can also understand the scope and duties of a CPA performing compilation.