Financial statement review definition
/What is a Financial Statement Review?
A financial statement review is a service under which the accountant obtains limited assurance that there are no material modifications that need to be made to an entity's financial statements for them to be in conformity with the applicable accounting framework (such as GAAP or IFRS). A review does not require the accountant to obtain an understanding of internal control, or to assess fraud risk, or other types of audit procedures. Consequently, a review does not provide the accountant with assurance that he has become aware of all the significant matters that would normally have been discovered and disclosed in an audit.
In a review, management takes responsibility for the preparation and presentation of the entity's financial statements, while the accountant should have a sufficient level of knowledge of both the industry and the entity to review the financial statements.
How Expensive is a Financial Statement Review?
The review is more expensive than a compilation and less expensive than an audit. It is preferred by those businesses whose lenders and creditors will allow them to use this approach, thereby saving the cost of a full audit. Given their cost constraints, smaller businesses are more likely to attempt to get by with just a review.
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Procedures Used in a Financial Statement Review
In a financial statement review, the accountant performs those procedures necessary to provide a reasonable basis for obtaining limited assurance that no material changes are needed to bring the financial statements into compliance with the applicable financial reporting framework. These procedures are more heavily concentrated in areas where there are enhanced risks of misstatement. The types of procedures that would be reasonable to conduct for a review include:
Conduct a ratio analysis with historical, forecasted, and industry results
Investigate findings that appear to be inconsistent
Inquire about the procedures for recording accounting transactions
Investigate unusual or complex situations that may impact reported results
Investigate significant transactions occurring near the end of the accounting period
Follow up on questions that arose during previous reviews
Inquire about material events that occurred after the date of the financial statements
Investigate significant journal entries
Review communications from regulatory agencies
Read the financial statements to see if they appear to conform with the applicable financial reporting framework
Review the management reports of any accountants who reviewed or audited the entity's financial statements in prior periods
There are also a number of review steps that can be utilized in specific areas, such as:
Cash. Are cash accounts being reconciled? Have checks written but not mailed been classified as liabilities? Is there a reconciliation of intercompany transfers?
Receivables. Is there an adequate allowance for doubtful accounts? Are any receivables pledged, discounted, or factored? Are there any non-current receivables?
Inventory. Are physical inventory counts performed? Were consigned goods considered during the inventory count? What cost elements are included in the cost of inventory?
Investments. How are fair values determined for investments? How are gains and losses recorded following the disposal of an investment? How do you calculate investment income?
Fixed assets. How are gains and losses on the disposal of fixed assets recorded? What are criteria for capitalizing expenditures? What depreciation methods are used?
Intangible assets. What types of assets are recorded as intangible assets? Is amortization being appropriately applied? Have impairment losses been recognized?
Notes payable and accrued expenses. Are there sufficient expense accruals? Are loans properly classified?
Long-term liabilities. Are the terms of debt agreements properly disclosed? Is the entity in compliance with any loan covenants? Are loans properly classified as short-term or long-term?
Contingencies and commitments. Are there guarantees to which the entity has committed itself? Are there any material contractual obligations? Are there liabilities for environmental remediation?
Equity. What classes of stock have been authorized? What is the par value of each class of stock? Have stock options been properly measured and disclosed in the financial statements?
Revenue and expenses. What is the revenue recognition policy? Are expenses recorded in the correct reporting period? Have the results of discontinued operations been properly reported in the financial statements?
The preceding list represents a sampling of the review activities that an accountant could engage in.
If the accountant believes that the financial statements are materially misstated, he should perform additional procedures to obtain a limited assurance that there is no need to make material modifications to the financial statements. If the statements are materially misstated, the accountant must choose between disclosing the issue in the report that accompanies the financial statements, or of withdrawing from the review.
The Accountant’s Review Report
Once the accountant’s work has been completed, it is time to prepare a written review report. The accountant has several alternatives for what to include in this report, but there are some basic requirements, which are as follows:
Title. The title should include the word “independent,” to indicate the status of the accountant. An example of an appropriate title would be “Independent Accountant’s Review Report.”
Addressee. The name of the party to whom the report is addressed, which is usually the party for whom the report was prepared. Thus, it may be addressed to those charged with governance, or perhaps to the entity whose financial statements are being reviewed.
Introductory paragraph. The introductory paragraph of the report should identify the entity whose financial statements have been reviewed by the accountant, note that the financial statements were reviewed, identifies the financial statements, specifies the date or date range covered by each financial statement, and points out that a review primarily involves the use of inquiries and analytical procedures. The paragraph should also point out that a review has a significantly lower scope than an audit, so the accountant does not express an opinion, as would be the case with an audit. If the reviewed financial statements will be included in a document that contains other information (such as the client’s annual report), it is reasonable to consider identifying the page numbers on which the reviewed financial statements are presented.
Management’s responsibility paragraph. A separate paragraph explains that management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework, along with a properly designed, implemented, and maintained system of internal control that can be used as the basis for financial statements.
Accountant’s responsibility paragraph. A separate paragraph, stating that the accountant is responsible for conducting the review engagement in accordance with SSARSs (so that users are informed that the engagement was conducted in accordance with established standards). The paragraph should also note that these standards require the accountant to perform the procedures in order to obtain limited assurance as a basis for reporting whether the accountant is aware of any material modifications that should be incorporated into the financial statements, so that they will be in compliance with the applicable financial reporting framework. There is also a statement that the accountant believes the collected review evidence to be sufficient and appropriate to provide a basis for the accountant’s conclusion.
Concluding paragraph. A final paragraph with an appropriate header states whether the accountant is aware of any material modifications that should be made to the financial statements, so that they will be in accordance with the applicable financial reporting framework. If applicable, the country of origin of those accounting principles should be stated.
Signature block. Include the manual or printed signature of the accountant’s firm, as well as the city and state where the accountant practices, and the date of the report. The date should be no earlier than the date on which the accountant completed those procedures needed to obtain limited assurance as a basis for reporting whether there is awareness of any material modifications that should be made to the financial statements, so that they will be in accordance with the applicable financial reporting framework.
There are multiple variations on what this report might look like, depending on the circumstances. For example a report might cover an interim period, a single year, or comparative financial statements for several years; the report might also cover statements prepared in accordance with the tax basis of accounting, or financial statements that contain a departure from GAAP, or statements where other accountants were engaged in a significant component of the review work. Of these options, we provide two examples in the following exhibits that are relatively common – a review of comparative financial statements, and for financial statements that contain a departure from GAAP.
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