Financial Statement assurance levels contractors should understand

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The year is coming to an end, and for many contractors, that means working with your CPA to get financial statements. These statements can be done at four different assurance levels with various indications for your business. Learn about each on this week’s episode.

Topics we cover in this episode include:

  • What is a financial assurance level and why might I need one?
  • Reasons contractors may need an audit
  • Why you should do your research before paying for an audit
  • Term Audit
  • Review level
  • Compilation level
  • Preparation level

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Rob Williams, Profit Strategist |
Wade Carpenter, CPA, CGMA |
Stephen Brown, Bonding Expert |


[00:00:00] Rob Williams: Welcome to the Contractor Success Forum. Today we’re talking about financial statement levels that contractors need to consider from their CPAs at the end of the year, or whenever it is that they’re getting these done from their contractors. Because here on the Contractor Success Forum, we discuss how to run a more profitable, successful construction business. And you need that information from your CPAs.

And who do we have with us? We have our CPA with us on this show, Wade Carpenter with Carpenter and Company, CPAs. And we have Stephen Brown with McDaniel-Whitley Bonding, an insurance agency. Who needs these from your CPAs and me? Rob Williams with IronGate Entrepreneurial. Support. Systems.

So, wow. Stephen, what do guys need from us? And what are all these–

[00:00:56] Stephen Brown: I need them, guys. I need them. I can’t do my job without a financial statement that hasn’t had some degree of assurance behind it from a CPA. That’s what we’re talking about here. So if I get your year-end financial statement and it’s not a review caliber or better, then there’s only a few bonding markets I can go to.

So a CPA verifying that information on the financial statement that you give out to your banker and your bonding company, maybe other contractors you want to do business with or some creditor of some sort. Hey, that financial assurance level is everything. And you know, we were talking about the different types of financial assurance levels and Wade’s gonna talk about that in today’s podcast. They go in rank from the most expensive to the least expensive. Why is that, Wade? Why don’t you just charge one price for all these? And what is a financial assurance level?

What is a financial assurance level and why might I need one?

[00:01:59] Wade Carpenter: Well, those that have lived through Enron and stuff like that, the reason that they’re so much different an audit is so much more expensive is there’s so much regulation on CPAs and there’s a lot more work that goes into them I wanted to talk today about the four different levels. Not just for bonding or for your bank, but sometimes contractors need them for state licensing or for a DBE status or a local government licensing. There’s many different times a contractor may need a financial statement, and as you said it’s, I hate to say, is from most expensive to least expensive, but there’s four levels we’re gonna talk about today.

[00:02:39] Stephen Brown: That was tacky of me, Wade talking– hey, because you get what you pay for. Pay for a bad statement, you get a bad statement. But I can’t pay you enough to make my statement look good, can I? If it’s bad.

[00:02:52] Wade Carpenter: Well, no, that’s why there’s regulation on us CPAs. We can’t just make it up.

[00:02:57] Stephen Brown: All right.

[00:02:58] Wade Carpenter: If we can, let’s talk about the most expensive level to the least expensive level.

The four assurance levels

[00:03:03] Wade Carpenter: The highest level, everybody is familiar with, the term audit. They may not really understand because they think IRS audit. The second level is a review level, that’s a step down where we’re doing some more testing and things like that. There’s a compilation level and as of 2015 there’s there’s a new preparation level and I’ll explain why we do that. But you know, there are different things that we have to do at different levels, as we go through that.

A lot of times in the industry, and I’ve been in this industry for over 30 years now, typically the rule of thumb on an audit has been, $10 million and up, you gotta have an audit. Is that true anymore?

[00:03:45] Stephen Brown: No, it’s not. Most surety companies will take a review. It just depends. If you’re a Contractor that has a lot of inventory and other moving parts at a higher sales level, they want an audit for sure. It can certainly never hurt to get an audit. It’s really a strong piece of evidence to hand out to your bank or your bonding company or your creditors or some other Contractor you wanna partner up with saying, this is what I have to back up what we want to do.

[00:04:16] Wade Carpenter:  As you said, I’ve had some bonding companies give them a pass when they’re 35, 50 million, but they’re incredibly strong contractors. So, I think it depends on the situation, but.

[00:04:27] Stephen Brown: A review is the minimum though.

[00:04:30] Wade Carpenter: Right.

[00:04:30] Stephen Brown: Maybe you can explain why that is. I can explain why I think it is.

I don’t know. I’m not an–

[00:04:36] Wade Carpenter: –talk about some exceptions to that too, but I’ll get to that.

What is the purpose of an audit?

[00:04:40] Stephen Brown: So what do you do for an audit? What do you do for a review? What do you do for a compilation?

[00:04:44] Wade Carpenter: On the audit part, again, it’s not usually what you think of. You think of the IRS coming in and digging into every penny that you ever put through your financial statements. It’s not that. What we’re trying to do with an audit is hey, we’re giving you an opinion, number one, that the numbers would not materially be different following Generally Accepted Accounting Principles. And we did testing, relying on internal controls to see that we can say, according to these auditing standards that the AICPA puts out that these financial statements are not materially different and you can rely on this.

We’re giving an opinion that you can rely on these numbers essentially. Does that make sense?

[00:05:29] Stephen Brown: Yes, it does. When we were underwriter trainees, we were taught to take the financial statement and first of all, look at the table of contents to make sure all the pages are there. Then turn the next page and look for the cover letter and to see what level of financial assurance, is this an audit, a review, or a compilation? And then the next thing we would do is we would read the notes where you say, this is represented by Generally Accepted Accounting Principles. Sometimes there’ll be a note in there where the accountant says Information is substantially inaccurate. It came straight from the owner’s mouth.

Some of it doesn’t make sense, you know, and that’s when the account usually wants to put a note in that financial statement to explain something, and the contractor doesn’t want it in there.

[00:06:15] Wade Carpenter: Well, that’s true, and we have certain obligations that we have to follow to be able to say that. And again, situations like Enron are things that drove the prices of an audit up. Because one of the biggest firms in the country were pretty much lying about what they did.

[00:06:32] Stephen Brown: Oh yeah, that cost the surety industry almost $600 million in Enron bond claims alone.

[00:06:39] Wade Carpenter: Oh, wow.

[00:06:39] Stephen Brown: And They were depending on these, Arthur Anderson financial statements. It was very sneaky what they did, Wade.

[00:06:46] Wade Carpenter: Yeah.

[00:06:47] Rob Williams: Yeah.

I don’t think we as contractors really until that, and even after that, understood that it is an independent audit. I mean, we knew it when you were talking about it. We were thinking that they work for us and we can do this and make our numbers look and they’re here to help our financial statements look good.

But kind of the point is to have an independent audit to see where we are. Yes, we’re paying them, they’re working for us, but that is to give an independent review. I think it’s like a book review. Did somebody buy that review on Amazon that you can tell that they’re just making this up to, to fluff it up?

And I think that’s what contractors don’t understand. They’re buying an independent, honest review. Not that the CPA can’t tell you things that you can actually do to your company to do better. Maybe you do need to make some changes to make that statement better. But anyway, I won’t get into that. It was a different episode.

[00:07:45] Stephen Brown: Yeah, you make a good financial statement by making good decisions and having a good construction oriented CPA like Wade. They know what they’re doing and they know what’s needed by all of the entities, and they wanna make your statement look as good as possible. They really do.

[00:08:01] Rob Williams: So, given that, sorry, we can talk about that again. These statements are not about what we do. That’s a different episode to make them better.

[00:08:08] Wade Carpenter: Well, no, Rob, I think you actually made a good point that I will need to talk about here, is the independence level. Because as an auditor, you get to know these people. It’s not supposed to be adversarial like an IRS audit or, I hate to say it, sometimes even workers comp audits get that way.

Reasons contractors may need an audit

[00:08:24] Wade Carpenter: But, there are reasons that people may need an audit that we really haven’t mentioned, like they’re getting state licensing or something like that, depending on if they want be able to do a certain level of–

[00:08:36] Stephen Brown: Sure. Some states require an audit.

[00:08:39] Wade Carpenter: Yeah, it depends on the state, number one, and the industry.

Do your research before paying for an audit

[00:08:43] Wade Carpenter: If you’re a general Contractor and they, those are different levels, but a lot of times people will try to say, hey, I wanna do this level and let me just get an audit.

But sometimes they’re based on things like your net worth, and if you don’t have a certain level of net worth, the state’s not gonna give you that no matter what. So I would tell people, do a reasonable check before you go down that. And if you’re not even gonna come close to meeting that net-

[00:09:11] Stephen Brown: Don’t spend the money.

[00:09:13] Wade Carpenter: Don’t spend the money. Absolutely.

[00:09:14] Stephen Brown: Talk to your bonding agent too, because I’ve had some people say, You told me, get an audit. I got my audit. Yeah, but you don’t have any money. You have no net worth. Now, I’m not kidding. That’s happened many times to me in my career. So I think this is an important topic.

Why your CPA may not be able to do your audit

[00:09:31] Wade Carpenter: And going back to what Rob said about independence, that is a requirement of an audit or a review level. A lot of what our firm has kinda pivoted to over the years is doing the whole back office of the bookkeeping and the whole accounting side for it.

So essentially we’re not independent when we do that for a contractor. So we can’t give an opinion on our own work. So that is an important thing to know. Hey, we definitely know the audit game and we can help a CPA and probably make it a lot cheaper to get an audit because we have it clean and we know exactly what they need, but there are levels that we just have to say, hey, we are not independent.

So even if we wanted to, even if we truly were up front and tried to do our best to make sure it’s on the level, then we still are, our ethics and all that, we can’t do it. Does that make sense guys?

[00:10:32] Rob Williams: It does. I had a CPA, and then I had a separate one that did my audits, and that’s all that guy did was the audits for these contractors. So that is important for you guys that don’t know this, that are listening, your CPA may not be the one that does your audit, your statement review or audit or compilation or preparation. All these different words, which, what do these mean, too?

[00:10:57] Stephen Brown: I would argue that you have a good enough accountant that their firm can handle both taxes and financial assurance statements like reviews and audits.

[00:11:07] Wade Carpenter: Oh yeah, that’s normal.

[00:11:08] Stephen Brown: Everybody’s working on the same team. Everybody’s pulling with the same set of oars.

[00:11:13] Rob Williams: I’m actually curious, Stephen, do you see that? because I know mine were different people. I had different firms doing it.

[00:11:18] Stephen Brown: Yeah. No,

[00:11:18] Rob Williams: –firms.

[00:11:19] Stephen Brown: Wade’s right. We see that all the time.

I do have some that are different, but don’t know really why but.

[00:11:26] Wade Carpenter: Well, like in our case, sometimes if we’re not independent, we will… I’ve got one that’s $150 million contractor. We ended up passing off the audit because we had some independence issues, so we partnered with another firm, but we still do the tax return. We still prepare a lot of. The back end stuff and we make the audit a lot cheaper.

But again, we’re not independent and we have to say we’re not.


[00:11:50] Wade Carpenter: Let’s talk about reviews.

[00:11:52] Stephen Brown: Okay. In my mind, a review, just basically verifies the bank balances and the receivables. Am I wrong there?

[00:12:02] Wade Carpenter: Well, not necessarily. Most people think of an audit as we’re gonna verify those kind of things.

[00:12:09] Stephen Brown: Everything, The number of pencils in the supply closet, that’s an audit.

[00:12:13] Wade Carpenter: No, we don’t do that. But with a review, there are no requirements that we actually go to the bank and verify these bank balances or, send confirmations to the owners or, whoever, General Contractor, whoever we’re dealing with.

What a review is, is number one, we’re looking at the numbers. We’re saying essentially that we are giving an opinion that these are still good numbers you can rely on, but we’re not going to the level of like test testing, all this stuff, testing internal controls. What we are doing is not just looking at the books, but we’re also doing some analytical procedures.

Do the ratios look right? Do things look outta whack? And if so, we need to investigate. But again, it’s a step down to where we can give some kind of opinion that these financial statements are actually numbers you can rely on.

[00:13:07] Rob Williams: I guess I’ll like Stephen throw out sort of my perception. The audit to me was verifying the receivables are really receivables. And now maybe this was a different kind of audit because I think we, we may have had an audit looking for security reasons in there, theft or something like that. But receivables and payables and contacting these vendors and these contractors to verify that these matched what the other people had.

I don’t know if that’s more of a security audit versus that, but–

[00:13:38] Wade Carpenter: No, that’s a regular financial statement audit, what you’re talking about. That is common. But review level, it’s not as common. We may be looking at or payable subcontractors, as you said, do we have all the, the payables recorded and those kind of things?

[00:13:53] Rob Williams: And we even had things I think where we had a lot of inventory. We had 80,000 square feet with all this lumber and materials and wall panels and so I think we even had some kind of a review on the inventory levels of maybe that was an audit.

[00:14:08] Wade Carpenter: That, well, that’s common. And like even on a review, you could do some testing on that. That’s not to say you can’t, it’s just saying, what are the requirements? And essentially none of it’s really required, but as long as you can say, we form an opinion that, hey, this is good, and you can rely on it. Just knowing that, hey, you could be sued for this. That can change a lot of the lines on it.

[00:14:31] Rob Williams: Yeah. Yeah. because we had a huge amount of dead inventory at. Parts of the economy like that oh seven to oh nine, where we had built a lot of wall panels and trusses, and then they didn’t end up like the customers went under or something happened and the job stops. We had all this inventory that was on our books. It’s, do we write this off? And that’s, what is that value? So, so that came up in some of those audits.

[00:14:55] Stephen Brown: Okay, so instead of saying most expensive to least expensive, you know who might wanna say fair, good, better, best? I don’t know.

[00:15:04] Wade Carpenter: I mean, most complex to least complex, I guess.

And just to throw some other situations out there, as I said, depending on, like if you’re crossing state lines and you need a license in a different state, a lot of times they’re looking for, again, net worth level or whatever.

But I’ve had contractors show up in my office actually saying, Hey, I got this piece of paper. All I need you to do is sign. I had no book, believe it or not, had no books, but he brought me like car titles and all this stuff that said he came up to $250,000 worth of stuff. No it is not that simple. I can’t do that. And he was mad and left and I’m like, I’m sorry, maybe you’ll find somebody to sign off on it, but I’m not putting myself on the line for that.

Audits are subject to a peer review

[00:15:50] Wade Carpenter: And another part of this whole thing is, audit reviews and all this stuff they are subject to, peer review for a CPA. So we have to have other CPAs come in and give an opinion on did we do this correctly? And so that drives up the price too. But you know, generally speaking, depending on the level, usually a bank’s not gonna require an audit unless they’re talking about really large numbers. But there are situations where say city, county, government or whatever, sometimes requires them. City of Atlanta sometimes has some of their own regulation on stuff like that.

[00:16:25] Rob Williams: So that’s audit and then review.

Compiled Financial Statements

[00:16:27] Wade Carpenter: So can we move on to the third level? The compilation or compiled financial statements. Now that is a level where that used to be the bottom level. And essentially all it’s saying is we put together the numbers based on what you gave us in the simplest form. We didn’t really do any testing.

We didn’t do any analytical procedures to really say that they’re in conformity with General Accepted Accounting Principles. Sometimes a bonding agent will take a compilation. Sometimes they require a review. But a compilation is essentially used to be the lowest level.

There is actually opportunity for a compilation to say, hey, we’re not independent. We don’t have to be independent, but we have to disclose the fact that we are not independent and sometimes you state the reason why you’re not independent. Say we’re doing bookkeeping or something like that for a contractor.

One other point I wanted to make on a compilation with, we don’t have to be independent, we just have to disclose it. We can also do a report. And all of these are gonna have a report, except there’s an exception on the last one we’re gonna talk about, but the report says on an auditor review that these are in conformity with General Accepted Accounting Principles.

On a compilation, sometimes we’ll say it’s in conformity with income tax basis, or it could be a completed contract basis or sometimes they’re on hybrid basis of accounting, but we have to, if it’s not agreeing with what’s normal, what’s accepted accounting practices, we have to disclose that.

Does that make sense?

[00:18:09] Stephen Brown: Sure.

[00:18:10] Wade Carpenter: Okay. Wanna move on to the last level here?

[00:18:14] Rob Williams: Yeah.

What is this? What is this?

Preparation Level

[00:18:16] Wade Carpenter: Okay. Well, so preparation level, this is actually something new. And actually we were allowed to start doing this for years after December 15th, 2015. It falls under SARS 21, which is, which nobody really needs to care about but a bean counter like me.

But essentially what we found is after Enron, it drove the prices up so much and there’s people out there that are not CPAs. I should say, nobody can issue a legitimate report from a bookkeeping firm and say, you know, they can’t issue an audit review or a compilation. But I see these non-CPA firms putting a report on it and making it sound like they do. Like they’re a review or something like that.

They legally can’t do that, number one. But number two, we had no option as a CPA to say, Hey, we don’t have to do all this work. Just throw it out there. So a lot of people that were doing just bookkeeping would stick a financial statement out there, and they had no requirement to do all these other things.

So it wasn’t really fair to the CPA profession. So our regulators all got together and said, how can we streamline this, make it simpler, and be able to compete with that, not have the same level of liability for it?

[00:19:41] Stephen Brown: Yeah, and it’s called a preparation.

[00:19:43] Wade Carpenter: Yep. It’s called preparation level. There’s an option if you want to put a report on there. There’s certain wording, but generally we do have to put some headers and footers on there for say, a balance sheet or Profit and Loss Statement that says, hey, there’s no assurance provided on these financial statements. Even though it’s coming from a CPA firm, we’re not saying it’s completely in conformity with GAAP. So you know, that’s what that is and it’s definitely the lowest level to do this. And I know what you said, they always require a bond, but you know, true story, I’ve had bonding companies that trust my work enough on a compilation for years. But I’ve since, like just this past year, I had a contractor that got a three and a half million dollar bond based on a preparation level that we provided because we are not independent, because we were doing the bookkeeping.

[00:20:38] Stephen Brown: Wade. That’s very important for our listeners to know. Because your construction oriented CPA’s reputation in the community, your bonding agent will tell you it’s really worth its weight in gold. Because think of it, you’re Wade Carpenter, you’ve been doing this for 30 years, your father before you, and folks are getting bonds from your financial statements. Folks are getting bank credit from your financial statements that you prepare. And that’s because when a claim happens, which do happen, they can go back from your information and see what happened. It all makes sense. It all ties together so that comfort level is everything and it opens doors like magic.

It really does.

[00:21:22] Wade Carpenter: Well, that’s not to say that, we knew this bonding company. We knew the agent and we’d worked with them before. We gave them statements that they wouldn’t, you know, normally get, they got the full notes and the contract schedules and all that stuff. But, that’s not to say anybody would do that.

But as you said, it can go a long way as long as you provide the information that they need. I’ll be quite frank, a lot of times a bank will ask for at minimum compilation and we’ll give them a preparation. And quite frankly, they don’t know the difference.

One thing I would tell you is that, if you’re a brand new company and eventually you know you want to get into bonding, the bonding company is like a bank. They’re, or a teenager trying to get credit for the first time. Typically, they’re not gonna really look at your financial statement until you got three years of history.

So what I advise contractors to do that, maybe they’ve been doing this all their life, but now they jumped out on their own, is I would say, you know, if eventually you’re going to need to get bonding, you want to probably start with a review year one. A lot of times it’s a lot simpler, but if you can get three years of reviewed history, that’ll go a long way as well to getting a bond.

[00:22:37] Stephen Brown: You’re exactly right. And a a compilation or preparation statement that has a balance sheet income statement and a work on hand schedule and they all tie together, that helps a lot. Midterm, when you’re stress stretching your bond program, you’re pushing it a little bit, there’s more bonds out there, that’ll get the job done. But a year end review is the cornerstone and it’s something that you prepare for with your accountant before the year end to make it look as good as possible. And it’s all about teamwork.

[00:23:12] Wade Carpenter: Right. Absolutely. I hope this has helped everybody at least get some kind of perspective. And again, sometimes you gotta go look at whether it’s the state or county or whoever’s requiring this or the bonding company of the bank, you’ve gotta comply with what they’re gonna require for you.

So any other wrap up thoughts or questions?

[00:23:35] Rob Williams: Maybe we could have a future episode with a lawyer’s opinion on this as well. It would be interesting to see what the legal aspect of this would be on the liabilities, because I’m curious if when something hits the fan the question I’m asking myself is, I wonder how this all comes out in the legalese, if things get ugly.

[00:23:55] Wade Carpenter: Well, sometimes it’s not so much the financial statement that makes it ugly. It’s issues between, say, a general contractor and a subcontractor. And I could tell some funny stories about a particular lawyer that almost got me fired because I brought him to a Christmas party at one of the firms I used to work at.

I introduced him to a big GC here in Atlanta and they’re known for screwing over subs and they were sitting there going, you know, he was like, I’ve sued you guys so many times for, he just chewed him out. So anyway, I’m not sure a lawyer in this context– it was nothing to me.

[00:24:31] Rob Williams: Shouldn’t have brought him to that Christmas party.

[00:24:34] Wade Carpenter: Anyway.

[00:24:35] Rob Williams: All right. Well, I’ll take us out here and we appreciate everybody coming to the Contractor Success Forum. This is a great episode that I, I think some of our guys will need to put on that little favorite button and listen to this when it comes to year end tax timers, send it to your buddy who may need to know this because I tell you, these contractors we really need to know this information and we don’t.

And I don’t know where else we can hear it but the Contractor Success Forum with Wade Carpenter Carpenter and Company, CPAs, Stephen Brown, McDaniel-Whitley Bonding and insurance agency. And I am Rob Williams with IronGate Entrepreneurial Support Systems. We will see you on the next show.

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