When I tell people I am a CPA, they often think of taxes. When I tell people that I am an auditor, they think IRS auditor. I am a CPA, but I don’t do taxes and I don’t work for the IRS. So what should I tell people? Unfortunately, I don’t think there is a more descriptive term than “auditor”.
The American Institute of Certified Public Accountants have not done a good job educating the general public. When I talk to people, even friends and family, they don’t even know that there are different types of certified public accounts (CPA). This problem seems to be exclusive to the CPA profession. Attorneys and doctors don’t have this problem. People know that “attorney” is a catchall term, and when they seek out the professional services of an attorney they specifically look for a divorce attorney, a patent attorney, a litigator, etc. People know better than go to a dermatologist for ulcers or a cardiologist when they have a really bad sinus infection.
People do, however, hire one “CPA” to handle their accounting needs, their tax needs, and to be their financial advisor. They do hire one CPA to deal with anything numbers related. This is a mistake. As with attorneys and doctors, people need to hire the right CPA for the job at hand.
Before I go on, I should point out that there are practicing CPAs who are great general practitioners who can handle both tax and accounting needs of their clients; however, due to the growing complexity of IRS regulations and accounting rules, these CPAs are a dying breed.
The Flavors
General practitioners aside, CPAs come in two flavors: the tax CPA and the auditor.
As you might guess, a tax CPA can handle most of your individual and business tax needs. Most tax CPAs are in the business of tax compliance; this means that they take your information and complete your individual or business tax returns. Within the category of tax CPAs there are specialties. There are tax CPA that deal with corporate taxes, estate taxes, tax shelters (not so popular with the U.S. government), and on and on. For most people and business, a general tax CPA will satisfy most of your tax compliance needs.
The auditor is a CPA that specializes in accounting and financial statements that adhere to generally accepted accounting principles (GAAP). They are the experts in accounting for complex transactions and financial statement presentation. Auditors are important for business who want to ensure that their financial statements are presented in accordance with GAAP or that their transactions are accounted for in accordance with GAAP. Most individuals don’t require the services of an auditor (one exception is the high net worth individual).
The Auditor
Because most people are familiar with what a tax CPA does, I’ll focus on what an auditor does.
For the most part, auditors provide “attestation” services; sometimes attestation services are called “assurance” services. This means that they auditor attests to, or assures, that a set of financial statements are presented in accordance with GAAP. They are in essential issuing a report that states their opinion on the condition of the financial statements. These reports are called opinion reports and they consist of three paragraphs.
The Compilation
There are different levels of attest services that auditors offer. The lowest level of attest service is a compilation and is not really an attestation service. In a compilation, you provide the auditor with your financial records (trial balance, bank statements, etc) and the auditor “compiles” financial statements with footnotes to the financial statements in accordance with GAAP.The auditor report that accompanies the compiled financial statement does not provide any assurance; that is, the auditor does not express any pinion on the condition of the financial statements.
Does this mean that a compiled financial statement is not trustworthy? Not at all. In the process of compiling financial statements, the auditor will point out and fix obvious errors so that the financial statements are presented in accordance with GAAP. They will also perform some light validation of the data. For example, if you tell the auditor that you have a $1,000,000 in the bank, then the auditor will look at your bank statement to ensure that you actually have $1,000,000.
The Review
A step above the compilation is the review. In a review report the auditor expresses limited assurance about the condition of the financial statement. The limited assurance basically means that no “material modifications” is required to make the financial statements be in compliance with GAAP. The auditor can provide this assurance because they scrutinize the financial data more.
In a review, the auditor will inquire about changes in account balances, and develop analytics and expectations based on those analytics. If the numbers don’t tell a story that consistent with the analytic or responses to inquires, the auditor will dig deeper to determine whether the financial statements need to be modified.
The Audit
The highest level of assurance offered by the auditor is the audit. In an audit, the auditor performs inquires, develop analytics and expectations for those analytics, and they will also test the accounts. For example, if a business says they have $250,000 of accounts receivable, the auditor will send out letters to the business’ customers to confirm that the receivables exists.
Auditors will not perform tests to cover the entire population; that is, they take only a sample of the population to test. So, in the example of the $250,000 of accounts receivable, they may send out confirmation letters that cover only $175,000 worth of accounts receivable. The test performed by the auditor does not provide 100% assurance; as such, the auditor’s report is indicative of less than 100% assurance.
In the audit report, the auditor, expresses an opinion on the condition of the financial statements; however, they express state that there are no “material misstatements” that prevent the financial statements from being on compliance with GAAP. Of course, this means that there could be some immaterial misstatements.
So why doesn’t an audit report provide 100% assurance when it is the highest form of assurance? Well, it cost prohibitive to test a 100% of anything. For some companies, with billions of dollars in assets or revenues, it is too cumbersome to test 100% of $1 billion. It is the same reasoning that the U.S. census does not count everyone in the United States.
What does this all mean?
Now that you know there is a different, make sure that you are hiring the right CPA for your needs. Ask the CPA whether they received their experience in tax compliance or in auditing. For most small business, its probably okay to go with a general practitioner: someone who is knowledgeable in both tax and accounting. For medium to large business, you should really considering hiring a tax CPA and CPA who is a GAAP expert.
