The Compilation Engagement (#252)
/In this podcast episode, we discuss how a compilation engagement works. Key points made are noted below.
The Full Audit
Most people are familiar with the full audit, since lenders usually require that a borrower have one each year. A full audit is quite detailed, and involves an examination of the client’s books and control systems. A review is a notch down from an audit, and mostly concentrates on analytical procedures, which means comparing financial and operational information to see if it makes sense. If it doesn’t make sense, the auditor has a discussion with management about it. Reviews are mostly used by publicly-held companies, which are required to have a review at the end of each fiscal quarter, plus an audit for the full year.
The Compilation Engagement
And then we have compilations, which are really just a service to assist a client in preparing its financial statements. The auditor doesn’t engage in any of the audit work that’s found in a full audit or a review, so there’s no examination of controls, or walk-throughs of transactions, or tracing account balances back to the supporting documentation. In short, a compilation isn’t designed to provide any assurance about the information contained within the financial statements.
Compilations don’t have to be for a complete set of financial statements. They could be just for a portion of the financials, such as the income statement, or for a budget or a forecast, or maybe just for a supporting schedule, such as a royalty schedule.
Compilation Activities
What does the auditor do in a compilation, since so far I’ve only mentioned what the auditor doesn’t do. First, the auditor reads the financial statements, checking to see if they’re in the correct form, and whether there are any obvious misstatements. This means the financials should be free of mathematical mistakes and errors in how the accounting standards are applied.
The auditor can also go down into one extra level of detail, and scan the supporting trial balance for unusual items. The same goes for the general ledger, where the auditor looks for things like unusual journal entry descriptions, or unusually large transactions, or one-time transactions, or recurring entries that seem to be missing in a few periods.
In other words, the auditor is looking for anomalies that don’t make sense. If so, there’s a discussion with management. Depending on the outcome of that discussion, the auditor can propose some adjusting journal entries. Once those changes are made, the auditor takes another look at the financial statements to see if they meet the requirements of generally accepted accounting principles, or international accounting standards, or whichever other accounting framework is being used.
Next up, the auditor reads the disclosures that accompany the financial statements, and makes improvement suggestions whenever there appears to be a missing disclosure or when something isn’t entirely clear.
If this examination uncovers an issue where the financial statements depart from the reporting framework, then the auditor needs to decide whether this departure is being adequately described in the disclosures. If not, the departure may need to go into the auditor’s compilation report.
Now, as the auditor works through this process, she may find situations in which records are incorrect or incomplete, or where the judgments used by management in regard to accounting issues are not correct in some way. If so, these issues have to be brought to the attention of management, along with a request to correct the situation.
Another possibility is that the auditor may find that the client can’t continue as a going concern, which is to say that it may go bankrupt. If so, another suggestion has to be made to disclose this possibility in the financial statements, since they’ll otherwise be misleading.
Material Misstatements
If an auditor starts a compilation engagement and begins to suspect that the financial statements may be materially misstated, she should investigate further, to see if this is the case. If it’s not possible to obtain the needed information, then the auditor should withdraw from the engagement. Or, if the auditor has proposed revisions to the financial statements that the client didn’t make, then it’s also a good idea to withdraw from the engagement.
Compilation Reporting
Once the financial statements have been completed, the auditor writes a report that the client should attach to the financial statements, which points out that this was not an audit or a review, so the auditor is not expressing an opinion about the financial statements, and is not providing any assurance that the financial statements are correct. The report can also point out any cases in which the financial statements depart from the related accounting framework.
Reasons Why Clients Want a Compilation
So why would a client want a compilation? Because it’s cheap. Or, knowing how expensive auditors can be, let’s call it the least expensive option. However, the users of a company’s financial statements might not want a compilation, because it doesn’t give them any assurance that the financial statements are correct. So, from the client’s perspective, it makes a lot of sense to check with the users to see if they’ll go along with a compilation. There’s a good chance they won’t.
Summary
In summary, to view a compilation from a high level, it’s essentially a consulting engagement for the auditor, who conducts a modest inspection of the books to see if any anomalies pop up. The auditor can then make suggestions to management for improving the financial statements; if management decides not to do so, then the auditor has grounds to pull out of the engagement.
Related Courses
How to Conduct a Compilation Engagement