What Are Financial Statement Review Procedures?

A financial statement review is a service performed by a Certified Public Accountant (CPA) to provide limited assurance that a company’s financial statements do not require any material modifications to conform with the applicable financial reporting framework. It occupies a middle ground, offering more scrutiny than a basic compilation but significantly less than a detailed audit. A review does not involve the in-depth testing and verification characteristic of an audit. It provides comfort to users that the financial information is plausible without the higher cost and time commitment of a full audit.

Core Procedures in a Review Engagement

A review is governed by standards from the American Institute of Certified Public Accountants (AICPA), specifically the Statements on Standards for Accounting and Review Services (SSARS). The engagement centers on two main activities: analytical procedures and inquiries of management. These procedures help the accountant identify relationships and individual items that appear unusual and might signal a material misstatement.

Analytical procedures involve evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. An accountant will compare current financial statement balances, like revenue or accounts receivable, to balances from prior periods to identify unexpected fluctuations. They might also compare financial data to relevant operational data, such as correlating reported revenue growth with an increase in units sold.

Another analytical procedure is the analysis of financial ratios. The accountant will examine ratios like the current ratio or the debt-to-equity ratio to see how they compare to previous periods or industry benchmarks. A sudden, unexplained change in these ratios can highlight areas requiring further questioning with management.

Inquiries of management are a structured series of questions directed at the individuals responsible for the company’s financial and accounting operations. The accountant will ask about the specific accounting principles and practices the company uses and whether they have been applied consistently. Questions also cover the procedures for recording transactions and the basis for significant accounting estimates.

The accountant also inquires about actions taken at meetings of stockholders or the board of directors that could affect the financial statements. They will ask about any significant transactions or events subsequent to the balance sheet date that might require adjustment or disclosure.

Procedures Not Performed in a Review

A review’s scope is intentionally narrower than an audit’s, so it provides less assurance and cannot be relied upon to detect all significant errors or fraud. The primary difference is the absence of procedures aimed at obtaining corroborating evidence to verify the information provided by management.

An accountant performing a review does not conduct an assessment of the company’s internal controls or test their effectiveness in preventing or detecting material misstatements. This is a part of an audit that is explicitly excluded from a review engagement.

Furthermore, a review does not involve verifying accounting records by inspecting source documents like sales invoices or supplier invoices. There is no physical observation of assets, such as attending a year-end inventory count.

The accountant also refrains from seeking corroborating evidence from independent third parties. They will not send confirmation letters to a company’s bank to verify cash balances or contact customers to confirm accounts receivable balances. These procedures are hallmarks of an audit, and their absence is the reason a review provides only limited assurance.

Understanding the Accountant’s Review Report

The accountant’s report communicates the scope of the work and the conclusion reached. The report’s language is standardized by SSARS, and its defining feature is the expression of “limited assurance,” which is different from the opinion provided in an audit report.

Limited assurance means the accountant states they are not aware of any material modifications that should be made to the financial statements to conform with the accounting framework. This is sometimes called “negative assurance” because the conclusion is framed by the absence of discovered issues. An audit report, in contrast, provides “positive assurance” by issuing an opinion on the fairness of the financial statements.

A standard review report begins by identifying the financial statements that were reviewed. A “Management’s Responsibility” paragraph follows, clarifying that management is responsible for preparing the financial statements. This is followed by the “Accountant’s Responsibility” paragraph, which describes the nature of a review and states it was conducted in accordance with SSARS and is substantially less in scope than an audit.

The conclusion paragraph explicitly states the accountant’s conclusion based on the procedures performed. The standard language reads, “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 accordance with accounting principles generally accepted in the United States of America.” This phrasing conveys the limited scope of the engagement.

Common Scenarios for a Review

Businesses choose a financial statement review when a full audit is not required but some independent assurance is necessary. A review provides a cost-effective solution to enhance the credibility of financial information for various stakeholders, striking a balance between a compilation and a full audit.

One of the frequent drivers for a review is a requirement from a third party, particularly lenders. Banks or other creditors often mandate reviewed financial statements as part of their loan covenants for privately held companies. This gives the lender comfort that the financial figures they use to monitor the borrower’s health have been subject to professional scrutiny by a CPA.

A review is also a useful tool for internal management and governance. Business owners or a board of directors may want a higher level of confidence in their financial reporting than a compilation can offer, without incurring the cost of an audit. This is common in companies where owners are not involved in daily operations and rely on the financial statements to oversee performance.

Closely held companies often use reviewed financial statements for reporting to non-active shareholders or outside investors. It provides these stakeholders with credible financial information to assess their investment. Similarly, a business preparing for a potential sale or merger may undergo a review to lend credibility to its financial data during preliminary negotiations.