Your Underwriter Says You Need a CPA-Prepared Statement. What Now? Part II

CPA Prepared Statement Part 2 of 3Co-written with Halli Williams, CPA, CCIFP, Senior Manager for CBIZ CPAs, P.C.

Construction accounting is complex. Getting guidance on the expected time and capital investment, as well as a clear understanding of the role of a CPA in preparing compiled, reviewed or audited statements, is imperative. In Part 2 of this three-part blog, Kelly Kimmel, Branch Bond Manager for Old Republic Surety Company and Halli Williams, CPA, CCIFP, Senior Manager for CBIZ CPAs, P.C., provide insight into the types of financial statements that a construction accountant can provide and when each may be required.

What level statement do I need to request?

Compilation

This is the lowest level financial statement a CPA will prepare. For a compilation, the CPA conducts no detail testing or inquiries into the data unless they determine the initial responses are questionable. The CPA provides no assurances as to the accuracy of the financial information provided. In general, sureties put little weight on the information included in compilation statements and treat them much like internal statements or tax returns.

Review

When performing a review, CPAs make inquiries into the numbers provided and analyze data to ensure that the information accurately ties together. During their review, they identifying and discuss needed adjustments with the contractor, when necessary, to create a GAAP-compliant statement. As a review requires only analytical procedures and inquiries into data with no detailed testing, which is only a fraction of the requirements for an audit, the CPA provides limited assurance that the financial statements are not materially misstated.

Depending on the region, a reviewed statement with full disclosures and schedules that have been prepared by a CPA experienced in construction accounting will cover bonding requirements for most mid-sized construction companies. Job sizes, total open jobs carried, organizational complexities and growth expectations are some of the characteristics in addition to revenue and overall aggregate backlog that can affect whether the surety will accept this level of financial statement.

To provide a review, the CPA should possess an understanding of your industry, including the accounting principles and practices needed to obtain limited assurance that financial statements are not materially misstated. The accountant should make inquiries that allow them to gain understanding of your organization, including:

  • The organizational structure and the type of business they conduct.
  • Operating characteristics, including the nature of assets, liabilities, revenues and expenses.
  • Accounting principles and practices specific to the company, including how you measure, recognize, record and disclose any significant accounts; and
  • Any unusual accounting principles and practices being implemented in the company.

After gaining an understanding of your company, the accountant will determine the analytical procedures needed to review your internal financial data, so that they can provide a limited assurance of its accuracy in Accordance with GAAP. In other words, outline a plan and the information they need to conduct a review.

Analytical procedures involve comparing recorded amounts and ratios to reasonable expectations of amounts based on known client operations (for example, prior financial year-end statements) and industry standards (for example, expected gross margins). CPAs should focus on the areas that they previously identified as having increased risk for misstatement. The CPA’s areas of investigation will focus on fluctuations and inconsistencies within the internal financial information provided by the contractor. Since the review is only a “limited assurance,” the investigation is through inquiries made of management and other key company individuals. Reviews do not generally require other information to corroborate your company’s response, for instance, checking receipts against job costs.

As a review requires significantly less investigation than an audit, the level of assurance for accuracy of the data is limited. It does, however, provide a standardized presentation of your financial information that is formatted using GAAP standards. It should provide full disclosures including notes that outline accounting principles and procedures, schedules of general and administrative (G&A) expenses, cash flow, breakout of debt, work-in-progress and completed job schedules. These schedules should align with your balance sheet and income statements.

Audit

A CPA audited financial statement provides reasonable assurance that a company’s financials are not material misstated. This is the highest level of assurance a CPA can provide. During an audit, the CPA has to conduct a much deeper investigation into the data provided by the construction company. Many factors can contribute to a surety’s need for an audited statement, including a complicated entity organizational structure (such as a developer with a construction entity) or ownership structures (an ESOP, for instance), growing job complexity, sizes, backlogs or long project durations.

During the audit, the CPA should verify management’s assertions by gathering evidence to evaluate the accuracy of the financial claims made by the owners and management of a company. CPAs begin this process by establishing an overall audit plan, so the audit can be performed in an effective manner.

The CPA should establish the expected scope, timing and extent of resources necessary to perform the audit by using their previous knowledge and expertise on the nature of the company’s business and the complexities of its accounting standards. The CPA should also use their preliminary identification of factors specific to the company, for example:

  • Statutory requirements that a construction company is bound by,
  • Sophistication of the company’s internal controls,
  • Their accounting and project management systems, and
  • Ease and availability of information transfer.

The company-specific information is generally gathered by reviewing initial questionnaires, interviewing and observing owners, management and key employees, and conducting a high-level review of the financial information as it has been provided. This process helps the CPA to gain an understanding of the company’s business and the systems, policies and procedures it has in place to collect data and prepare their internal financial reports. This initial analysis and risk assessment procedures allow the CPA to identify areas with the potential for material misstatement.

These investigations and the identification of potential risk for misstatement allow auditors to assess and design the auditing procedures required to move forward with the audit strategy. This strategy outlines the quality (appropriateness) and the quantity of audit evidence (sufficiency) required to determine the reliability of the financial performance. While learning about your companies’ policies and procedures, they also can assist in providing feedback on the best practices for controls as they review the internal practices a company has in place.

From here, the auditor will gather and test evidence to confirm the accuracy of the previously identified material transactions, account balances, presentations and disclosures. They can do this in several ways, for example:

  • Inspect tangible evidence by physically examining it,
  • Observe the process of counting inventories,
  • Obtain formally written responses to carefully worded questions and evaluate their responses,
  • Obtain third-party confirmation of transactions,
  • Check mathematical calculations of information, and
  • Analyze anomalies in ledgers or transaction listings.

They will provide analytics for data, assess the health of the construction company, and they will perform fraud and internal control testing. Be aware that audits are not designed specifically to detect fraud, so don’t rely solely on the CPA to protect your company against this.

Once the evidence has been analyzed and any necessary adjustments required for GAAP compliance have been made and confirmed, the CPA will communicate their findings to the organization’s management team. This communication should include discussions of any issues identified, recommendations for improvement and other material factors.

Continue reading:

Part 1 of 3

Part 3 of 3

 

Resources

https://www.ispartnersllc.com/blog/five-types-testing-methods-used-audits/

https://us.aicpa.org/content/dam/aicpa/research/standards/compilationreview/downloadabledocuments/ar-00090.pdf

https://www.procore.com/library/construction-financial-audit

https://us.aicpa.org/content/dam/aicpa/research/standards/auditattest/downloadabledocuments/au-00326.pdf

https://us.aicpa.org/content/dam/aicpa/research/standards/auditattest/downloadabledocuments/au-c-00300.pdf

Kelly Kimmel

Kelly Kimmel is Bond Manager at the Kansas City Contract office. Kelly joined Old Republic Surety in 2020. Kelly is a seasoned surety professional coming to us from IMA Financial Group, Inc where she was a Surety Account Manager. Prior to that she worked in various Marketing positions at Bostrom Corporation and Marcus Evans. She will be a key team member in helping our branch service our agents and clients along with growing the Kansas City Contract office. Kelly has her Bachelor's degree in Marketing from the University of Kansas.