My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, December 16, 2013

Financial Statement Reports for Dummies

In March 2011, I wrote a blog post titled Reading Financial Statements For Dummies. That post dealt with some tips on what to look for when reading financial statements ("F/S"). Today, I discuss the various types of reports that are attached to a set of F/S and the circumstances under which those reports are typically prepared.

Of course, "Dummies" is used in the popular culture context; since I even asked for help from my accounting standards quality control person in preparing this blog post. After all, I am first and foremost a tax guy, who the heck wants to be known as a boring audit guy :).

When you pick up a set of F/S for a private or public company, the first thing you will typically notice is the report attached to the financial statements. These reports which are signed by an individual accountant or accounting firm, indicate the level of assurance or credibility that a company wants or requires for its users (i.e. the readers of the F/S).

The type of report and the continuum of assurance goes like this:

Notice to Reader/Compilation Reports 

The lowest level report that can be provided by the preparer (typically an accountant or accounting firm) is a Notice to Reader report, often referred to as a compilation report; which actually provides no level of assurance. For these reports, the preparer receives information supplied by management or the owner of the company and “compiles” the financial information into a set of financial statements. It is clearly stated in the report that the preparers work is limited and that there is no assurance provided on the set of statements.

In a compilation engagement, the F/S do not have to be prepared in accordance with a financial reporting framework such as Canadian Accounting Standards for Private Enterprises (“ASPE”) (i.e. they could be prepared on a cash basis instead of the accrual basis, as long as this is specifically indicated).

A compilation engagement is typically prepared in circumstances where the only users are management and there is no need for all the disclosures necessary for a general purpose use (in most cases there are no notes attached to these F/S) and the company does not have any financing or arm's length shareholders. Thus, these statements are often just used to file income tax returns and as such, are the most cost effective F/S alternative.

The report contains a cautionary statement that the statements may not be appropriate for the users’ purposes. Even though no assurance is provided, when preparing a compilation report, the preparer must comply with professional standards, basic accounting principles and consider the reasonability of the information provided. The overall concept is that the preparer must ensure that the financial statements are not “false or misleading.”

Compilation services are not regulated in all provinces. One should check if the engagement is regulated and that the person engaged to perform the engagement is regulated.

The next type of report on the continuum of assurance is the Review Report:

Review Reports 

In comparison to a compilation report, a review report provides a moderate level of assurance. Specifically, a review engagement is commonly referred to as “Negative assurance” – meaning that nothing during the review has come to preparers’ attention causing them to believe that that the F/S are not, in all material respects, in accordance with Canadian ASPE.

The preparer determines the “plausibility” of the financial statements, primarily through the use of enquiry, analytical procedures and discussion with management and/or owner. “Plausible” is used in the sense of being worthy of belief, which is a moderate level of assurance.

This type of engagement is useful when a company does not need audited statements (which will be discussed next – which provide the highest level of assurance) – however, management or third parties want some assurance that the financial statements are plausible. For many of our client's who borrow money from the large banks, a review engagement is accepted in lieu of an audit and is the mid-price alternative (not that our clients are every concerned with price in respect of their F/S :).

Audit Reports 

An audit is the highest level of assurance that can be provided on financial statements. The procedures in an audit are much more encompassing than a review – such that the preparer can provide an opinion that the company’s financial statements are presented fairly, in all material respects, in accordance with the applicable Canadian accounting framework.

Although auditing has changed from the days of examining every document, current day computer assisting testing still requires extensive testing.

It is important to note that the audit provides “reasonable” assurance meaning that the preparer does not provide absolute assurance. Absolute assurance is not obtainable given the need for judgment, the use of testing and the fact that audit evidence is generally persuasive rather than conclusive.

Because of the detailed nature and the amount of work done, the cost to perform an audit and prepare audited financial statements can be expensive.

The type of report required is a matter to be discussed and agreed upon by the accountant/accounting firm and the client. You may be surprised to know that for each type of engagement, management is responsible for the preparation and fair presentation of the F/S.

As discussed above, each type of report provides a different level of assurance or credibility to the financial statements. If you have need to review a financial statement, it is important that you understand the level of reliance given to those set of statements, as all F/S reports are not created equal.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

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