Accounting 101: Introduction to Accounting and Auditing services
Let’s face it – your strength is in running a successful company. You understand the ins and outs of your business and industry, but when it comes to accounting and auditing services, you may not have received any formal training on the specifics. With our new “Accounting 101” series, we hope to help businesses of all sizes understand the basics of accounting so you can make timely, sound, and educated financial decisions.
In this inaugural post, we will give you a basic overview on the range of year-end financial engagements, and the context in which they are typically required.
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By law, every incorporated entity in Canada is required to file annual corporate income tax returns with the Canada Revenue Agency (‘CRA’). In addition, a separate set of financial statements may be prepared based on your specific needs as an owner.
Annual financial statements provide a ‘snapshot’ of your company’s financial status and position at a specific point in time. The financial detail of that snapshot, and the level of assurance with which it is submitted, will vary depending upon the nature of engagement that is performed.
A third-party reader of the financial statements (i.e. a lending institution or outside investor) will typically dictate which level of assurance is required, particularly if borrowing is involved. ‘Assurance’ is a term used to indicate the nature and level of work performed by the accountant in support of the presented financial statement and accompanying notes.
There are three types of year-end engagements, each corresponding to an increased level of assurance and inherent work:
- Notice to Reader (NTR) – also known as a Compilation
The foundation of any year end engagement is the preparation of the actual financial statements. The initial production of the financial statements is prepared by you and/or your management team, and then provided to your accountant for the completion of the engagement, culminating in externally prepared financial statements with accompanying notes and engagement report on the accountant’s letterhead.
1) Notice to Reader (NTR) or Compilation
This is the most basic of the year-end engagements and is typically used when the readers of the financial statements are limited to the business owner and CRA. Common uses include internal documents for shareholders and providing support for annual corporate tax returns.
The figures contained in a NTR are compiled by the accountant with information gathered from existing internal records, subject to year-end adjustments prepared by the accountant. The financial statements are not in accordance with GAAP (Generally Accepted Accounting Principles), nor are there notes to the financial statements or any presentation requirements. The financial figures (Balance Sheet and Income Statement) contained in an NTR are neither audited nor reviewed, and are presented without any form of assurance to a limited set of users.
A Review is a more thorough engagement than a NTR. It is considered an “Assurance engagement,” in accordance with GAAP, requiring specific note disclosures and presentation. The concept of ‘materiality’ is applied in the performance of the Review engagement, as are other engagement requirements mandated by CPA Canada. Reviews are often required by banks, financiers, or outside investors to ensure that a business actually meets loan covenants, or to assure potential investors that the business is a legitimate, secure investment.
Financial statement information is provided by the client to the accountant, and then reviewed, discussed, and analyzed by the engagement team to a benchmark of plausibility, subject to year-end adjustments that are considered material in nature. The accountant may also have a need to contact the client’s financial institutions and/or lenders and management team, in order to ensure the financial statements are not materially misstated, typically in accordance with Canadian accounting standards for private enterprises (‘ASPE’).
Finally, we have the Audit, which provides the highest level of assurance to financial statement users, in accordance with GAAP, also requiring specific note disclosures and presentation similar to the Review engagement. An Audit is considered the most stringent of the three year end engagements, and is typically performed on private corporations and businesses as a lender requirement, or upon request by an absentee shareholder. They are the preferred option for “professionalizing” a business, when the client desires greater accuracy and assurance in connection with their year-end financial statement figures. Audits are also often mandated in highly regulated businesses or industries, particularly those in receipt of public funding.
The client’s source documentation (i.e. supplier/customer invoices, bank statements, cancelled cheques, etc.) are examined and vouched by the accountant in order to ensure the absence of material misstatement as a result of fraud or human error. The client’s financial reporting practices are rigorously tested and internal controls are assessed for any perceived weaknesses or risks. Due to the increased level of verification and work performed, the assurance provided by conducting an Audit exceeds that provided by an NTR or Review.
Although commonly viewed as a commodity service, a thorough and well-executed assurance engagement can provide the business owner with a wealth of ideas for tightening controls, increasing profitability and efficiencies, while addressing potential areas of risk and possible fraud. When it comes to sourcing an accounting firm for the preparation of your year-end financial statements, be sure to select a firm that goes above and beyond the numbers to provide added value towards the overall success of your business. Contact us today.