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A Nonprofit’s Guide to Financial Statement Services: Audit, Review, Compilation, and Preparation

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Nonprofit

Financial statements are a critical component used by management and boards of nonprofit organizations (NPO) to gauge how well the organization is performing, determine the strength of financial position, and to make informed decisions for the future of the organization. Financial statements are also utilized by a various external users for a variety of reasons.

Many nonprofits seek out a CPA firm to perform a financial statement audit, review, compilation, or preparation engagement. But what do those services really involve, and how do you determine which one is right for your nonprofit?

Before deciding on a service, it’s important to know the differences so that you can make an educated decision that will best suit your nonprofit. With each of these services, there are key differences in the scope of the work that the CPA will perform, the cost of the service, and the factors that drive the need for one service over the other.

The level of service an organization needs depends on the needs of the financial statement users (management & board of directors, external agency, etc.). Each service provides a different degree of assurance (or “reliability”), to the users of the financial statements. The four services to consider are preparation, compilation, review, and audit.

Preparation

The CPA’s objective in a financial statement preparation engagement is to prepare the financial statements in accordance with a specified reporting framework. Management provides the CPA with financial records and information needed and the CPA then prepares the financial statements with that information. It’s important to note with this level of service that the CPA is not required to verify the accuracy or completeness of the information provided by management or otherwise gather evidence to express an opinion or conclusion on the financial statements. The CPA is not required to review any underlying support for accounting transactions or perform any analytical procedures. No report is issued. Essentially, this level of service is merely taking the financial records of the organization and putting them into financial statement presentation.

This level of service could be appropriate for a nonprofit who would like to have financial statements prepared by a CPA. A small to mid-sized nonprofit may seek out prepared financial statements if their accounting team needs the expertise of a CPA in order to prepare financial statements. While CPA prepared financial statements can be used externally, they are generally utilized mostly by management and/or the board of directors internally. The financial statements will make note that “no assurance is provided.”

Compilation

The CPA’s objective in a compiled financial statement engagement is to apply accounting and financial reporting expertise to assist management in the presentation of the financial statements. The CPA does not provide any assurance that there are no material modifications that should be made to the financial statements.

The CPA will read the financial statements and propose adjustments or modifications if anything comes to light that is not materially correct. Unlike a preparation engagement, the CPA’s role is more transparent in a compilation engagement for external users. For example, if the CPA is not independent of the nonprofit in a compilation engagement, this would be required to be disclosed in the report that is issued along with the financial statements. Similar to a preparation engagement, the CPA is not required to review support for underlying accounting transactions, perform analytical procedures, or gain an understanding of internal controls.

This level of service could be appropriate for a nonprofit who would like to have financial statements compiled by a CPA and would like to go one step further than the preparation engagement in having the CPA issue a report and notify management of any material adjustments or modifications identified during the compilation of the financial statements. Internally, these financial statements could be used by management and the Board. Externally, donors, other grantor agencies or lending institutions may request compiled financial statements from a nonprofit, which can be what drives the need for a compilation engagement.

Review

The CPA’s objective in a review engagement is to provide limited assurance that there are no material modifications that should be made to the financial statements. The CPA will make inquiries of management and perform analytical procedures over the accounting records to obtain this level of assurance. Independence is required with this level of service. The CPA will also issue a report that describes management’s responsibilities with respect to the financial statements, the CPA’s responsibilities, and what the CPA’s conclusion is regarding whether or not the CPA is aware of any material modifications that should be made to the financial statements. If the CPA identifies material modifications during the review, the CPA will bring these to the attention of management and give them the opportunity to correct those matters before the final report is issued.

This level of service could be appropriate for a nonprofit who wants some level of assurance that the financial statements are materially correct. If the nonprofit is obtaining or has significant financing, especially in the case where the financing arrangement has financial covenants, reviewed financial statements may be required by the lending institution. Another scenario that could necessitate a review is a donor/grantor requirement for the grantee to provide annual reviewed financial statements. Aside from these external factors, nonprofits of any size may decide to have annual reviewed financial statements. Knowing that an independent CPA has reviewed and provided limited assurance on the financial statements can give decision makers a greater level of confidence in their ability to rely on the financial statements of the nonprofit.

Audit

The CPA’s objective in an audit is to obtain reasonable assurance about whether the financial statements as a whole are free of material misstatement and to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable framework. An audit results in the highest level of assurance that a CPA can provide. The CPA is required to be independent in order to perform an audit. The audit process is very involved. The CPA is required to obtain an understanding of the internal controls of the nonprofit and perform risk assessment procedures. The CPA will also perform substantive and analytical procedures which includes reviewing support for underlying accounting transactions and reviewing results of analytics which are used as a whole to substantiate the auditor’s opinion on the financial statements. The CPA will often request that management provide things like bank statements and reconciliations, significant contracts and agreements, invoices, check copies, detailed receivable and payable aging schedules, and other records that support the accounting transactions in the books.

This level of service could be appropriate for a nonprofit who has an external reporting requirement. This requirement could come from a grantor agency who provides the nonprofit with significant funding or a lending institution. The need for an audit could also arise for a nonprofit who has significant federal award expenditures. More often than not, nonprofits that have an annual audit performed have some type of external agency that requires audited financial statements. With that said, there are some nonprofits that do choose to have an annual audit even when there is no external requirement to do so. This typically arises with mid-size to larger nonprofits who want the highest level of assurance from an independent CPA to give them the confidence that the financial statements are presented fairly in all material respects.

Service Comparison

  Preparation Compilation Review Audit
Assurance Provided No No Limited Assurance Reasonable Assurance (defined as high, but not absolute)
Report Provided No Yes Yes Yes
Opinion is given in a report as to whether or not the financial statements are presented fairly, in all material respects, in accordance with the applicable framework No No No Yes
CPA is required to obtain an understanding of the NPO’s internal controls and perform a risk assessment No No No Yes
CPA is required to make inquiries of management and perform analytical procedures No No Yes Yes
CPA is required to be independent No No; however, if the CPA is not independent, the lack of independence is required to be disclosed in the report Yes Yes
Cost Least expensive More expensive than a preparation engagement, less than a compilation or review More expensive than a preparation or compilation engagement, less than an audit Most expensive

Each nonprofit has a unique set of needs and factors to consider when choosing CPA services. If you have questions about which service might be right for your nonprofit, we encourage you to fill out the “Connect with an Advisor” form on our Contact Page for further guidance.


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