Quality of Financial Statements

by David L. Perkins, Jr.

Business people regularly rely on financial statements to paint a picture of company. The only way to compare apples-to-apples is for each set to be prepared in a similar manner. The “similar manner” is Generally Accepted Accounting Principals” (i.e. GAAP). When you hear the term “quality of financial statements”, the issue is the degree to which the reader can expect that the statements conform to GAAP. There are three general “qualities” of financial statements: Compiled, Reviewed and Audited. You should know the difference.

• Company-Prepared Statements: The statements that you print from your accounting software are neither audited, reviewed nor compiled. They are simply your internal financial statements. Are they prepared according to generally accepted accounting principles (GAAP)? When you receive company-prepared statements of another company, they should raise more questions than answers.
  
  Before you rely on them, investigate how they were prepared. If you are not skilled at assessing company-prepared financial statements, get help.
  
• Compiled statements: These are not any more reliable than company-prepared. Compiled simply means that somebody, typically an accountant, put them in a format that conforms to what financial statements are supposed to look like.
  
• Reviewed financial statements. As the name implies, these have been “reviewed” by an accountant or accounting firm. Reviewed statements will include a letter from whoever did the review. Read it. Does it state that the reviewer found that the statements appeared to be prepared in accordance with GAAP? Or did the review give rise to doubts about the same? Regardless, keep in mind that a review is limited and does not guarantee accuracy.
  
• Audited financial statements: Audited statements have undergone the most in-depth assessment by the reviewing person or firm. Similar to reviewed statements, they should be accompanied by a letter from the auditor. Read the letter. Is the opinion qualified or unqualified? If qualified, that means that the auditor is concerned about whether the statements were prepared according to GAAP and/or represent a fair picture of the company.
  
  An unqualified opinion means that the auditor believes the statements were prepared according to GAAP. As far as assurances go, this is the highest level. But (1) GAAP rules are complex and allow substantial “room to maneuver,” so you’ll still want to know exactly how certain transactions were booked; (2) if company officers wish to deceive, an audit might not uncover it; and (3) sometimes the auditors are biased and/or asleep at the wheel.