Review Engagements Offer Benefits

For a company wanting some immediate assurance for its financial statements without undergoing an audit, a review engagement may be an attractive option.

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While a review engagement is much less comprehensive in scope than an audit engagement, it provides some limited assurance that no material modifications are needed for financial statements to conform with generally accepted accounting principles (GAAP). Businesses that may benefit from a review engagement include:

•    Companies that have incurred or intend to incur debt with a financial institution
•    Companies required to have reviewed financial statements for bonding purposes
•    Companies planning to undergo an audit engagement in the future
•    Companies whose accounting staffs may not be aware of the latest GAAP revisions
•    Companies seeking additional capital from partners
•    Companies that cannot afford an audit engagement but want some assurance.

The Statements on Standards for Accounting and Review Services (SSARS) issued by the American Institute of Certified Public Accountants (AICPA) enable a CPA to perform a review engagement. The CPA observes how the company records, classifies and summarizes transactions. The CPA will prepare any adjusting entries as necessary to ensure the data is correctly presented. Footnote disclosures are then written to explain accounting practices and principles used in preparing the financial statement information.

The CPA performs inquiries, analytics and other review procedures. This involves developing expectations based on relationships that are reasonably expected to exist for the company and its industry. Various analytics, such as ratios, are then applied to financial data to determine if they meet those expectations. Those analytics may include:

•    Comparisons of current-year account balances to prior-year balances
•    Comparisons of current financial information with budgets or forecasts
•    Days’ sales in accounts receivable
•    Bad debt as a percentage of sales
•    Allowance for bad debt as a percentage of accounts receivable
•    Inventory turnover
•    Depreciation as a percentage of property and equipment
•    Interest expense as a percentage of debt.

Examining those ratios and related expectations illustrates situations requiring additional evaluation. For example, interest expense as a percentage of debt might not meet expectations. The unusual percentage could indicate that interest payments were misclassified.  Additionally, when computing repairs and maintenance as a percentage of property and equipment, a ratio that is higher in comparison to prior years could indicate that some items were not properly capitalized.

Such analysis also illustrates opportunities for enhancing financial and operational functions. An examination of inventory turnover ratio, for example, may reveal that the company’s inventory turns over less often than what would be expected. Additionally, if a review of day’s sales in accounts receivable shows an increase over prior periods, this could indicate the company is having difficulty with collecting on its receivables. Promptly addressing the underlying reasons for the disparity may yield substantial benefits.

Prepare for future

While providing immediate benefits, a review engagement also helps a company prepare for the future by offering limited assurance to potential investors and financial institutions.

Required documentation for the review engagement includes a representation letter that confirms management’s responsibility for the financial statements, and their full and truthful responses to inquiries. While the review engagement does not provide absolute assurance that all significant matters affecting financial statements will be noted, it does provide the possibility of receiving an accountant’s report that specifically states:

“Based on our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in conformity with generally accepted accounting principles.”

Erin Ferreira, CPA, EMFerreira@weaverandtidwell.com, is a Strategic Business Services Manager for Weaver and Tidwell L.L.P.

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