CPA Exam AUD: Reviews, Compilations, and Preparations

Reviews, Compilations, and Preparations: CPA Exam Guide

Beyond audits, CPAs perform other types of engagements related to financial statements, including reviews, compilations, and preparation engagements. Each provides a different level of assurance (or no assurance) and has distinct requirements. Understanding the differences is a core AUD exam topic, governed by AR-C Section 60 (General Principles), AR-C Section 70 (Preparation of Financial Statements), AR-C Section 80 (Compilation Engagements), and AR-C Section 90 (Review of Financial Statements).

Hierarchy of Assurance Levels

The four engagement types provide different levels of assurance, from highest to lowest. An audit provides reasonable assurance (a high level of assurance, but not absolute) through an opinion on the financial statements. A review provides limited assurance through a conclusion about whether the accountant is aware of any material modifications that should be made. A compilation provides no assurance; the accountant merely assists in presenting financial information. A preparation engagement involves preparing financial statements but provides no assurance and requires no report.

Preparation Engagements (AR-C 70)

A preparation engagement is the simplest form of financial statement service. The accountant is engaged to prepare financial statements on behalf of management. No assurance is provided, and no report is required. Each page of the financial statements must include a legend stating "No assurance is provided on these financial statements" or a substantially similar statement. The accountant is not required to be independent but must determine that the financial reporting framework is acceptable. If the accountant becomes aware that the financial statements are materially misstated, the accountant should inform management and, if management does not correct the misstatement, the accountant should withdraw from the engagement.

Compilation Engagements (AR-C 80)

In a compilation engagement, the accountant assists management in presenting financial information in the form of financial statements without undertaking to obtain any assurance that there are no material modifications needed. The accountant should obtain an understanding of the financial reporting framework and significant accounting policies, read the financial statements for obvious material errors, and obtain management's acknowledgment that management is responsible for the financial statements.

A compilation report is required and states that the accountant did not audit or review the financial statements and accordingly does not express an opinion or provide any assurance. The accountant is not required to be independent to perform a compilation, but if the accountant is not independent, a statement to that effect must be included in the report. The reason for the lack of independence need not be disclosed. Compilation reports may be issued on financial statements that omit substantially all disclosures, provided the omission is disclosed in the report and does not appear to be intended to mislead users.

Review Engagements (AR-C 90)

A review engagement provides limited assurance that there are no material modifications that should be made to the financial statements. The accountant performs primarily inquiry and analytical procedures to obtain limited assurance. The accountant must be independent to perform a review engagement. If independence is impaired, the accountant cannot perform the review.

Review procedures include inquiring of management about the entity's business activities, accounting principles, and financial statement preparation, performing analytical procedures to identify unusual items or trends, and inquiring about significant or unusual transactions. The accountant does not perform tests of controls, substantive tests of details, or confirmations in a standard review engagement, though the accountant may perform additional procedures if the accountant becomes aware that the financial statements may be materially misstated.

The review report contains a conclusion stated in the form of negative assurance: "Based on my review, I am not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in accordance with [the applicable financial reporting framework]." The report includes a description of the review procedures performed.

Key Engagement Letters and Management Representations

An engagement letter is required for all four types of engagements (though for preparation engagements, a less formal agreement may suffice). Management representation letters are required for review engagements and audits but not for compilation or preparation engagements. For reviews, the representation letter includes management's acknowledgment of responsibility for the financial statements, the completeness of information provided, and specific representations relevant to the review.

Reporting on Comparative Financial Statements

When the current-period financial statements are reviewed and prior-period financial statements were compiled, the accountant may either reissue the compilation report or include an Other-Matter paragraph in the review report describing the level of service performed in the prior period. If the accountant did not compile or review the prior-period statements, the review report should include an Other-Matter paragraph indicating that the prior-period statements were not audited, reviewed, or compiled.

Change in Engagement Level

An accountant may be asked to change from a higher level of service to a lower level (for example, from an audit to a review). Before agreeing, the accountant should consider whether there is a reasonable basis for the change, such as a change in client requirements. If a scope limitation is imposed by management and the accountant is asked to step down, the accountant should consider whether it is appropriate to do so. Stepping down is generally not appropriate if the scope limitation prevents the accountant from completing the original engagement.

Exam Tips for Reviews, Compilations, and Preparations

• Independence is required for audits and reviews but not for compilations or preparations.
• Preparation engagements require no report, only a legend on each page.
• Compilations provide no assurance; reviews provide limited (negative) assurance; audits provide reasonable (positive) assurance.
• Management representation letters are required for audits and reviews but not for compilations or preparations.
• If the accountant is not independent, compilations can still be performed but the lack of independence must be noted.