Historically, your accountant probably issued an NTR as part of their offering, sometimes without considering who the users of the financial statements will be. Assuming you don’t need a Review or Audit Engagement and before choosing a Compilation Engagement, ask yourself this, “do you have any third parties that intend to use the financial information?” For our clients at Argento CPA, the third party is typically the bank. For example, you may be looking to get a mortgage, credit card, or business loan, and your bank will ask that you have financial statements prepared by a licensed Chartered Professional Accountant. If that sounds like you, you are probably going to need a Compilation Engagement.
As of December 2021, there will be substantial changes to your typical year-end financial statements. Here are the main points you need to know.
· What is a Compilation Engagement?
· What is the basis of accounting, and why does it matter?
· How does this affect your business?
· Why were there changes needed?
· What if you don’t want them?
· How can you prepare for a Compilation Engagement?
· Discuss with your accountant
What is a Compilation Engagement?
There are three types of engagements and financial statements your accountant can issue.
1. Compilation Engagements
2. Review Engagements
3. Audit Engagements
Formerly known as Notice to Reader (NTR) engagement, the new Compilation Engagement Report (CER) will replace the previously accepted standards of financial statement preparation. The CER resembles many characteristics from NTR and still no assurance by the practitioner; however, there are significant changes to the level of detail in the financial information. The most notable difference being the mandatory inclusion of disclosures around the basis of accounting.
What is the basis of accounting, and why does it matter?
There will be a note disclosure describing the basis of accounting. For example, was the accounting prepared on a cash or accrual basis, or a combination of both? What is the method for reporting inventory or investments? To determine the basis of accounting, you will have a conversation with your accountant. It’s important to know that third-party users of financial information (i.e., your bank) may require you to follow a specific basis of accounting, and those principles must apply to your bookkeeping method. For example, a cash vs. accrual basis can make a big difference on the bottom-line net income. You may have a significant number of accounts payable at year-end. If payables are not presented on the financial statements at year-end as a payable/expense, you are significantly overstating your profitability. A lender may want to know all your accrued liabilities and payables at year-end; therefore, they may not accept cash basis accounting and request you to prepare accrual-based. Talk to your bank about what basis of accounting they require, if any. Alternatively, if this stuff is way over your head, connect your CPA to the bank and let them handle the discussion.
How does this affect your business?
You will have extra discussions with your accountant to prepare your Compilation Engagement before finalizing your year-end. As a result, your accountant will get a better understanding of your business and how they can help you succeed. Here are some examples of the types of questions you will hear in the discussion.
· Who are the intended users of your financial information?
· What is the basis of your accounting?
· How are your accounting records kept?
· What accounting system do you use?
We will already know the answers to most of these questions for Argento CPA clients subscribed to our monthly bookkeeping service. However, if you prepare your bookkeeping, it will take some extra time to discuss and review your records to understand your basis of accounting.
Accounting costs will increase due to your accountant’s extra work, but at least now your financial information will be prepared to a higher standard.
Why were there changes needed?
The biggest reason for changes was to clarify the extent of work performed by Chartered Professional Accountants. The difference between various methods of accounting can make a significant impact on judgment when reviewing financial information. Disclosing the method of accounting or asking for the basis to be prepared in a certain way provides clarity to the user of the financial statement.
The current Notice to Reader standard assumes financial information is only used by management. However, financial information is most likely shared with your bank when considering you for a mortgage, credit card, or loan. The new standard ensures consideration for the third party since they are the ones who must make decisions based on the financial information presented to them.
The new Compilation Engagement gives your bank confidence that the financial information is not misleading and sets a standard for work performed by your accountant.
What if you don’t want them?
You can still engage your accountant to file a corporate tax return without compiling your financial information under these new standards.
We strongly recommend you engage your accountant for a Compilation Engagement Report! There is a 99% chance that your lender will ask for a Compilation Engagement Report before giving you a mortgage, credit card, or loan. Investors will also want to see this financial information before investing in your company.
We understand you may want to save some extra cash by not paying for a Compilation Report. However, if your bank asks for this information in the future and you don’t have it, you will have to go back and prepare it for them. For example, you may be under a time crunch to get approval on a mortgage for a new home, and your accountant may not have enough time to get this done in time for your bank’s approval. This can be costly and disastrous down the road if your accounting wasn’t prepared under the bank’s requested basis of accounting, since you are going to have to redo bookkeeping, which will impact previously filed corporate tax returns. In the end, this is going to cost you a lot to fix, and it would have saved significantly more time, money, and stress if you had just paid for a Compilation Engagement from the beginning.
How can you prepare yourself for a Compilation Engagement Report?
See below for a few tips to make sure you are ready for year-end and your Compilation Engagement Report.
· Schedule a consultation with your accountant and discuss your needs.
· Contact your bank and ask them what basis of accounting (if any) they want for your financial information.
· Get your books in order! Your accountant is obligated to determine your basis of accounting. If your financial information is unreconciled, contains errors, or is misleading, they will not be able to issue financial statements. Therefore, we strongly recommend requesting our team to handle your monthly bookkeeping. That way, you rest assured your books are ready at year-end for your Compilation Engagement Report.
Discuss with your accountant
The easiest thing to do is discuss with your accountant or contact Argento CPA for a free initial consultation. Your accountant will guide you with this new process and ensure your needs are met and comply with the new standards.
New engagement letters are issued for all December 2021 year-ends, and additional planning is required before getting started. Fall 2021 is the perfect time for you to contact your accountant and make sure you are set for success under this new process.
Contact Argento CPA for assistance on the new Compilation Engagement Report.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.