What is a Compilation Engagement, and why should I care?
Wait, don’t look away! This won’t take long.
Effective December 14, 2021, there will be mandatory changes to the financial statements we prepare for you. We want you to be better prepared, so keep reading, and we’ll help you learn what to expect.
You’re likely familiar with the term ‘Notice to Reader’ (NTR). This is the report at the beginning of a set of financial statements that says ‘To Management of ABC company, On the basis of information provided by management…’
Ring a bell? You probably don’t read it word for word, but it’s essential as it helps to set out what you can and can’t be assured of.
Our Auditing and Assurance Standards Board (AASB) friends have outlined further enhancements to the section, detailed under CSRS 4200 in our trusty accounting handbook.
The CSRS 4200 standard itself, as you can imagine, makes for riveting reading. If you can resist the temptation to dive into it straight away, we’ll summarize it for you here.
In a nutshell:
The basics of a compilation engagement are still there – we are compiling the information you give us – but a few additions give some important clarity on i) what we do/don’t do and ii) how we do it.
Update 1: Clarifying the purpose of the document
In the NTR report, you would have seen a phrase stipulating that the exercise does not constitute an audit or review. Those are technical terms that may not mean a great deal to a non-accountant.
So, the new Compilation Engagement explains what we mean by this in more detail by clarifying the role we (the accounting practitioners) have played in the process.
In an audit, the onus is on us to verify the accuracy and completeness of your financial data. This is a lengthy exercise, and the outcome is ‘reasonable assurance’ (i.e. our opinion says your financials don’t have any significant (or “material”) errors). A review is a slightly less invasive exercise which provides ‘limited assurance’ (i.e. our opinion says nothing came to our attention to make us think your financials have any material errors). Although the opinion differs, you are getting our opinion in writing with both of these engagements.
A Compilation Engagement is used when we have only assisted management in formatting the information. We take that shoebox and turn it into a set of financials, but we don’t provide an opinion on the numbers themselves.
This is important, as you might be taking these financial statements to a group of shareholders or the bank to obtain financing. Without realizing it, someone is taking assurance from a set of financial statements that were never meant to give assurance.
The new standard more explicitly outlines what our role is to prevent confusion and improve transparency between accountants and the users of the financial statements.
Update 2: Defining the accounting basis
Unless you have training in accounting, the term ‘accounting basis’ may require some explanation. Basically, when you prepare financial statements, there are various ways to slice and dice the data on its way to the financial statements.
For example, do you record revenue from the time an invoice is issued or when it’s actually settled? That’s called accrual vs cash accounting. You might record everything on a cash basis, but then record the accounting fees for the year before the bill is paid, which is an accrual. Or how about bad debt? When do you write off an invoice when the customer doesn’t seem like they’re going to pay?
As you can imagine, this can get complex. The accounting basis used will differ from company to company despite them being in a similar industry.
The new standard requires that the Compilation Engagement should specify, point by point and in precise terms, the basis that was used in preparing the accounts.
Why does this matter? It makes it possible for readers of the financial statements to understand how the results of the company arose. This will help shareholders make wiser investments, and commercial lenders understand your business when reviewing your application.
Think of it like a James Bond telling the bartender he wants his Martini shaken, not stirred. It’s quicker than trying to reverse-engineer by taste and intuition; the bartender now has the details to create the drink correctly. What, you’ve never done that? Seriously? It’s pretty standard, at least at our office. Probably a good time for us to move on.
None of the above is earth-shattering from your perspective and certainly should not keep you up at night. It does place a little more strain on our shoulders, as any new regulation would do, and it will mean a slight increase in the fees we charge for an engagement.
The upside is that the result will be a more straightforward set of financial statements to help you, your investors and your advisors assess your past so you can continue achieving success in the future.
For those who can’t contain their excitement any longer, check out this document from the CPA website.
For the others, we hope this hasn’t been too painful! Till next time!