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Levels of assurance: Choosing the right option for your business today
The COVID-19 crisis is causing private companies to re-evaluate the type of financial statements they should generate for 2020. Some are considering downgrading to a lower level of assurance to reduce financial reporting costs — but a downgrade may compromise financial reporting quality and reliability. Others recognize the additional risks that work-from-home and COVID-19-related financial distress are causing, leading them to upgrade their assurance level to help prevent and detect potential fraud and financial misstatement schemes.
When deciding what’s appropriate for your company, it’s important to factor in the needs of creditors or investors, as well as the size, complexity and risk level of your organization. Some companies also worry that major changes to U.S. Generally Accepted Accounting Principles (GAAP) and federal tax laws in recent years may be overwhelming internal accounting personnel — and additional guidance from external accountants is a welcome resource for them to rely on while implementing the changes.
The term “assurance” refers to how confident (or assured) you are that your financial reports are reliable, timely and relevant. In order of increasing level of rigor, accountants generally offer three types of assurance services:
1. Compilations. These engagements provide no assurance that financial statements are free from material misstatement and conform with Generally Accepted Accounting Principles (GAAP). Instead, the CPA puts financial information that management generates in-house into a GAAP financial statement format. Footnote disclosures and cash flow information are optional and often omitted.
2. Reviews. Reviewed financial statements provide limited assurance that the statements are free from material misstatement and conform with GAAP. Here, the accountant applies analytical procedures to identify unusual items or trends in the financial statements. She or he inquires about these anomalies, as well as the company’s accounting policies and procedures.
Reviewed statements always include footnote disclosures and a statement of cash flows. But the accountant isn’t required to evaluate internal controls, verify information with third parties or physically inspect assets.
3. Audits. The most rigorous level of assurance is provided by an audit. It offers a reasonable level of assurance that your financial statements are free from material misstatement and conform with GAAP.
The Securities and Exchange Commission requires public companies to have an annual audit. Larger private companies also may opt for this service to satisfy outside lenders and investors. Audited financial statements are the only type of report to include an express opinion about whether the financial statements are fairly presented and conform with GAAP.
Beyond the analytical and inquiry steps taken in a review, auditors perform “search and verification” procedures. They also review internal control systems, tailor audit programs for potential risks of material misstatement and report on control weaknesses when they deliver the audit report.
Time for a change?
Not every business needs audited financial statements, and audits don’t guarantee against fraud or financial misstatement. But the higher the level of assurance you choose, the more confidence you’ll have that the financial statements fairly present your company’s performance.