Attestation services are when a certified public accountant (CPA) expresses a conclusion about the reliability of a company's financial statements. There are three levels of scrutiny and review included under the umbrella term attestation services, with only the most intensive level called a financial audit.
Private companies are usually not registered with the Securities and Exchange Commission (SEC). However, private companies may undertake activities in which the other party may require some level of attestation services. Understanding the definitions and requirements of these services can be helpful, as it can help draw insights on what you may be able to negotiate if and when you're asked to have a financial audit.
“I often have discussions with companies that believe they are required to have an audit and are not aware of the alternatives," says Jeff Kovacs, CPA, partner at Cohen & Company. "We make them aware that are other attestation services that a CPA may perform, that are less rigorous than an audit and yet may accomplish their financial reporting objectives."
Getting Familiar With Attestation Services
There are three types of attestation services: compilation, review and audit.
"Review and compilation engagements can be completed more quickly, cost less and have less involvement of company staff," Kovacs explains. "With whatever level of attestation you go with, be prepared before engaging a CPA firm."
Often a small business cannot afford to have an accounting staff, so they may outsource their financial statement preparation. When a CPA prepares these statements, it is called a compilation.
Since the CPA cannot certify his or her own work (i.e. it would not be an independent review), there is no opinion expressed if the statements are fairly presented and are prepared in accordance with Generally Accepted Accounting Principles (GAAP). A small business often uses a compilation when it wants to demonstrate that the company utilized a CPA in the preparation of its financial statements.
The next level of scrutiny is called review. It is similar to a full financial audit (which I'll explain more below), but it is significantly narrower in scope.
Reviews are generally intended for lenders and other outside parties to receive a limited assurance with the completeness and accuracy of the financial statements. The best assurance that can be obtained in a review is that the CPA provided limited assurance that they are not aware of any material modifications that should be made to the financial statements in order for them to be in accordance with GAAP.
An audit is used if you need to provide creditors, investors and others with reasonable assurance about whether your company's financial statements are free from material misstatement. The auditor's opinion that many companies hopes to achieve is an “unmodified" or “clean" opinion.
An audit can take up more of a CPA's time and resources and thus costs more than a review. Likewise, a review costs more than a compilation. In addition to auditor engagement, the company tends to be more involved in an audit by:
- preparing the statements for the auditors to review,
- providing footnotes to the financial statements,
- having documented accounting policies and procedures,
- providing evidence to support the underlying transactions that comprise the financial statements and
- answering any questions the CPA may have.
So, if you are in discussions with a party that says they will require an audit, see if you can negotiate a review. Maybe there can even be a mix. For example, one company I am associated with took out a sizeable bank loan and was able in the first year to have an audit of the balance sheet and a review of the other financial statements, leading to an audit for all the financial statements in subsequent years.
When You May Need Attestation Services
One day, you might undertake transactions that may require an attestation service. These events might include:
1. Taking out a bank loan.
This is probably the most common situation for a small business needing some type of attestation service. There may be opportunities to consider a review rather than an audit.
2. Taking equity investments from angel or venture capital investors.
Angel investors usually do not require a financial audit, as they understand established small to mid-sized businesses typically do not have the staffing or cash resources to undertake an audit. Moreover, they may be a member of your board so they will see your financials and financial planning. VCs typically invest larger amounts in more mature companies so usually some level of assurance is required—and often it is an audit.
3. Contracting with the government.
When applying for a federal government contract, the contracting officer must make a determination about the selected firm being a “responsible contractor" prior to awarding a contract. This process might not be called a financial audit, but it will feel like it. To be determined responsible, prospective contractors must meet general standards.
4. Doing an equity crowdfunding campaign under the SEC 2015 regulations.
The SEC developed a program in which everyone, not just high-net-worth individuals, can invest in startups, early-stage ventures and small privately held companies. In a gross over-simplification of the rules, an entrepreneur can raise up to $1 million in a 12-month period by posting a business plan, equity term sheet and—if seeking more than $500,000—audited financial statements, on an approved crowdfunding platform.
5. Selling your company.
If you are selling the assets of the company—hardware, software, customer list, etc.—there is probably no need for a financial audit, as the potential buyer will assess these items during its due diligence. However, if you are selling the legal entity, the buyer might require a financial audit especially of the balance sheet and any net operating losses. But since you usually do not know the structure of the sale (asset or stock) until the final negotiations, audits may be performed.
In summary, you may enter into transactions in which the other party may request or require a financial audit. With some knowledge about the three types of attestation services, you may be able to push back and negotiate a compilation or review, which are each less rigorous for the company and cost less than an audit.
Read more articles on financing.
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