The financial statements of a business can be audited, reviewed, or compiled by the outside accountant. When looking at a financial statement, the first sentence in the accountant’s cover letter will normally state the level of the accountant’s service. An audited statement is the highest level and is required of all publicly owned companies. But, audited statements are the most expensive and most small businesses don’t have them prepared unless they are required to do so. Accountants do not do any checking of compiled statements. They merely take the clients information and put it into financial statement format. Reviewed statements are in-between. Accountants do some checking, but not as much as in an audited statement.
A good example of the differences in the types of financial statements is shown in how the calculation of inventory is handled in each. In preparing an audited statement, the accountant is likely to be present when the inventory is taken. The accountant will check the inventory records against some actual checking to confirm that they are accurate. In a review, the accountant is likely to look at a printout of the inventory detail that shows the count and value for each item in inventory. In a compilation, the accountant will take the number provided by the business owner without checking it further.
Some businesses may not have their accountant prepare any financial statements. The accountant only prepares the tax return. This does not mean there is anything wrong with the business. It could be that the business is financially strong and doesn’t need financial statements prepared by an accountant for any outside party, such as a lender.
A normal clause in a purchase and sale agreement for a business is that, to the best of the owner’s knowledge, the financial statements are true and correct. If the business has no financial statements prepared or they are only compiled statements, it is typical that the representation is made on the truthfulness of the tax returns. Even if the business has audited statements, there may be an additional representation that the tax returns are true and correct.
No matter what level of financial statements the business has, a prudent business buyer should still do his due diligence to confirm the accuracy of the financial, and other, information provided. Regardless of the type of financial statement the accountant prepares, businesses should have good records to support the information in the financial statements.