According to Webster’s Dictionary, assurance means “something that inspires or tends to inspire confidence” – a very attractive quality for a set of financial statements. You want your investors, creditors, major customers, potential buyers and other stakeholders to get warm and cozy feelings about reliability of your financial statements. So where does assurance come from?
Public accountants, independent from your business, are equipped with a set of tools to provide various levels of assurance, which in turn would trigger various degrees of these “warm and cozy feelings”.
Audit engagements provide the highest level of assurance (the technical term is “reasonable assurance”). They involve performance of various risk assessment procedures to determine where errors are likely to occur, an evaluation of the company’s internal controls, and a number of detailed procedures, which require obtaining independent third-party evidence to support amounts recorded in the company’s financial statements. Audits are typically required by lenders who provide a significant amount of capital, government organizations providing subsidies or grants, and certain regulatory bodies. Depending on the ownership structure of a company, inactive shareholders/partners may require that the financial statements be audited. It gives them a level of comfort that their investment is being managed properly by those active in the day to day operations.
Review engagements aim to provide “limited assurance”, which is less than “reasonable assurance” provided by audits. Similarly to audits, reviews involve an element of risk assessment and an understanding of the company’s internal processes. The procedures involved are much less detailed, and usually involve ratio analysis and discussions with management. Verification of the balances against independent third-party evidence is not required. As public accountants, we are entitled to accept management’s explanations for the variances without corroboration, unless the explanations appear not to be plausible, or believable. Review engagements are a good compromise for those who want the financial statements to be prepared with a full set of note disclosures and have an independent party have some involvement, without detailed verification of the balances. Like audits, review engagements are often required by various stakeholders, such as banks, regulatory bodies, etc.
Lastly, Notices to Reader, reports most commonly issued by public accounting firms and least understood by financial statement users. A Notice to Reader, also known as a Compilation, requires public accountants to compile a set of financial statements (usually without supporting note disclosures) based on information provided by the client. There is no requirement to verify the accuracy of these balances, unless they look obviously wrong or misleading. Unfortunately, the general public is not well aware of the limited nature of public accountants’ involvement in Notices to Reader and derives an undue level of assurance from these reports. For lenders who have substantial amounts of security, and business owners intimately involved in day to day financial matters of a business, a Notice to Reader is often satisfactory.
So how much assurance is enough for you and your users? As in most things in accounting, it depends. Who are the current users of the financial statements? Who are the intended future users? How much trust does the owner place in the finance department personnel? How much day to day involvement does the owner have/want to have in financial matters? Would another set of eyes be helpful? What is the incremental cost of more assurance and do benefits outweigh this cost? We are happy to talk you through these considerations and assist in making the right choice for your company.