Compilation vs. Review vs. Audit for Factoring Companies
Introduction to Financial Statement Services
Welcome to Sounding Board, where we bring clarity, confidence, and practical insight into conversations that matter most to your factoring business. I am Becky Gibbs, an audit partner at Boyum Barenscheer. And today I have a special guest with me, Kevin McCarty.
Hi, I’m Kevin McCarty. I’m an audit manager at Boyum Barenscheer and I work with a number of factoring companies.
Thanks for joining me today Kevin.
Him and I are going to discuss the various test services that we provide at Boyum. So we are going to go through what a compilation is, how we approach doing those engagements, what a review is, how we approach those engagements, and then finally what an audit is.
Compilation Engagements
First we’re going to start with a compilation.
So a compilation is where we put together a financial statement based on your trial balance. So we do not provide any assurance behind those numbers. We do not perform any procedures and there are two different types of compilations.
Limited Disclosure Compilation
The first is a limited disclosure compilation and what that is is that it just presents an accountant report done by us, the accountants, and financial statements behind that.
So usually it will include a balance sheet, income statement, a cash flow statement, and then if there’s any other supplemental schedules.
Full Disclosure Compilation
The second type of compilation is a full disclosure compilation. So, it’s the same as a limited disclosure. However, we do include the footnotes, which are items that provide clarity to how you record your financial statements along with some financial statement backup.
Kevin, do you want to go into how you approach doing a compilation engagement and how someone would be ready to put one together?
Approach to a Compilation Engagement
Sure, Becky. With the compilation engagement, really, our primary focus is to make sure that all the accounts have been properly closed out through the year.
So, we’re going to get your trial balance and we’re going to go through it. We’re going to have a conversation and look at whether last year’s net income and distributions were properly closed out to retained earnings and some of the key things that need to roll.
I mean, look at some of your accounts and see if they’ve changed from the last year and just, you know, really get an understanding of how you’re reporting certain transactions.
And then, if we’re doing footnotes or disclosures, full disclosure, then we’ll ask for more information to fill those out about debt and any number of other circumstances.
Is there any certain items that a factoring company should make sure they have correct before they start a compilation engagement?
Sure. For instance, your accounts receivable should be reconciled. We should have an aging that ties out to your trial balance and any support for any related accounts like client escrows or reserves and allowances for credit losses and all those should be properly tied out to the trial balance.
I bet that’s a big one that a number of new companies, new factoring companies miss is that allowance for credit losses, especially as you grow and your receivable balances continue to increase.
We do have to make sure that that appropriately reflects the risk related to your receivables. So if you’re writing off a number of items that is a significant amount, there should be something there to reflect a loss and do that in future.
Yeah, a compilation’s really a good place to start if you are going to need financial statements and you are a growing company, but you’re not to that level yet where you’re going to need more assurance behind the financial statements.
Reviewed Financial Statements
The second piece we are going to talk about is reviewed financial statements.
So what a review is when we as the accountants perform inquiry and analytics on your financial statements. So it provides a limited assurance behind it.
Kevin, how do you approach doing a review?
Approach to a Review Engagement
So with the review, really the primary thing we’re doing is comparing balances against prior years and other expectations as far as how we went.
So, ideally, we’d have a conversation with you before the end of the year if you’re an onboard client and see how you expect to finish the year. And then when we have your full-year numbers, we can see if that played out.
We’ll also look at the relationships of different accounts. We’ll look at the relationships of your receivable balance to your purchases for the year for the last quarter of the year.
We’ll look at relationships between your accounts receivable and your line of credit balance and we’ll ask you questions about those changes.
And really, we’re just looking to get responses that make sense.
And we will tie out key items like agings and notes payable and bank reconciliations. But really the idea is that we have a conversation and understand the reason for why things change from one year to the next.
Key Metrics and Calculations
Is there key metrics or calculations that you look at? I know NFE is probably one of them.
Yeah, we’re looking at NFE, allowances as a percent of NFE. We’re looking at several things related to NFE.
We also want to make sure that there’s sufficient reserves based on your agreements. So, we’re going to look at the relationships between your receivable balance and your reserves as well.
Yeah, we do like to understand the rates, the average rates depending on the industry you’re in.
That is able to provide us a bit of assurance on your financial statements too. And if you’re giving average rate or your average rate can be a little more steady based on whether you’re in trucking or you’re in healthcare or whatever it might be, that does drive a lot the average rates.
Audited Financial Statements
Great. Well, and then the last piece of service that we provide is audited financial statements.
Those are what are going to be the most assurance that you can get from us as the auditors.
So an audit revolves around us doing similar items as the review. However, we will increase our knowledge base on the company.
So we get a greater understanding of the entity, the internal controls that are behind the entity around your financial statement processes.
We will understand various programs and softwares that you use to create your financial statements and verify that those are properly controlled.
So meaning things can’t be adjusted and then result in a material misstatement to your financial statements.
We also dive into the numbers on your balance sheet and income statement further.
So we’ll do more substantive testing. So what that means is we’ll confirm cash balances, we will confirm debt, we will dive deeper into your receivable balances, dive deeper into your accruals, things like that to provide us more assurance on the financial statements.
Kevin, you want to go through what you go through as an auditor?
Approach to an Audit Engagement
Yes, Becky, of course.
Really we start the audit in the planning phase and in this phase we’re going to have discussions about controls and about processes at the organization.
We want to make sure that the company has processes in place to ensure that their assets are managed appropriately and their financial statements are accurately reported.
We’re going to want to make sure that our processes and that they’re accurately followed.
Once we have an understanding of that is really when we start testing the numbers side and we basically start with what we do for a review, but then we essentially have to verify any significant balances.
So we go down your balance sheet and we obtain third party verifications in some instances or we tie to schedules in other instances.
We test revenue to ensure that it’s properly recorded for the right amounts at the right times.
We might test expenses depending on our assessment in planning.
So we’ll pull transactions for a number of random transactions throughout the year and ask you to provide support for the business purpose and the approval of these transactions.
And then we’ll prepare the financial statements and other letters depending on what we find in the audit.
Management Recommendations
Yeah. And with each of the different engagements, if we’re finding areas of weakness or areas where we think that either controls can be increased or just areas of recommendation of our knowledge of the industry, we will give you a management comment letter if we want to put it in formal writing.
Or even just verbally discuss with you throughout the engagement things that we see that could be improved or help provide greater controls around your financial statement processes.
Advice for Companies Seeking Assurance Services
Is there any last tidbits you have Kevin of advice for someone going into needing one of these assurance levels?
I would just say that ensure you’re communicating with your team, what time your books are going to be closed and when you’re going to be ready to go and then just maintain open communication throughout.
Really, it’s for the most part a conversation and we’re here to help you achieve your goals and get what you need to get.
So, we’re not scary generally to work with. And we’re here to have a good relationship and help you hopefully for years to come have success.
Yeah, that’s great advice. The more communication there is, it’s always the easier it goes.
And we try not to make it a scary process.
Granted, we know it can be a heavy lift, especially the first year as we’re gathering a lot more from you to understand the entity.
All right, that was a great discussion, Kevin. And maybe one day I’ll have you back on as a future guest and we’ll dive even deeper into some of those.
Yeah, that’d be great, Becky. Thanks for having me on.
Thanks.
Closing Remarks
Well, that wraps up today’s Sounding Board conversation. We hope the discussion gives you a clear picture of each of the service levels between a compilation, a review, and an audit.
And we hope you found today’s insights helpful or if it sparked any further questions about how the topic can apply to your company.
We are here as a resource for you. So feel free to reach out to either of us and thanks for spending time with us. Have a great day.