Understanding the Implications: Accounting Firms' Reports on Financial Statements: Commercial Lenders and Credit Analysts Should View with Extreme Caution Any Financial Statements That Do Not Include the Accountants' Report

Article excerpt

A critical part of commercial loan approval involves evaluating the financial condition and repayment capacity of the borrower. As a result, before it makes a loan, a bank will have its commercial lenders and credit analysts obtain and review three to five years of financial statements from business borrowers. It is important to remember, however, that all financial statements are not created equal!

An accounting firm may audit, review, or compile a borrowing entity's financial statements. Each of these services provides users of financial statements with a different level of assurance as to the veracity of those statements.

When a public accounting firm associates itself with an entity's financial statements and related note disclosures, it must include in the financial statements an accountants' report, which is generally directed to the board of directors, the stockholders, or the management of the borrowing entity. The purpose of the accountants' report is to explain to financial statement users the procedures the accounting firm has followed with respect to the financial statements.

This article will explain the contents of the accountants' report on the financial statements of nonpublic entities and highlight the corresponding implications for the lending institution's loan approval process.

Background

Most financial institutions have formal loan policies that govern commercial lending relationships. For instance, if a bank has a relationship with a commercial entity that involves a loan of $5 million or more, policy may dictate that the borrowing entity is to provide the bank with audited financial statements on an annual basis. In order to comply with loan policy, it is not enough for the borrower to provide financial statements that it indicates were audited by a public accounting firm. It is critical that the financial statements include not only the related note disclosures, but also the accounting firm's report on the financial statements.

In rather straightforward language, the accountants' report will clearly state the extent of the procedures the accounting firm applied to the financial statements. The report also may highlight certain matters the accountants believe deserve additional scrutiny or attention. Commercial lenders and credit analysts should view with extreme caution any financial statements that do not include the accountants' report.

Financial Statement Audit

Preparation of the entity's financial statements is the responsibility of its management. The purpose of a public accounting firm's audit is to express an opinion on whether the entity's financial statements, as prepared and presented by management, are in accordance with generally accepted accounting principles (GAAP). The auditor's report on the financial statements is the mechanism by which the audit firm communicates to the users of the statement three specific elements:

* Whether the financial statements are presented in conformity with GAAP.

* Whether the accounting firm believes it is necessary to highlight any unusual aspects of its audit.

SSARS No. 19, Compilation and Review Engagements In December 2009, the American Institute of Certified Public Accountants issued Statement on Standards for Accounting and Review Services No. 19, Compilation and Review Engagements. Here are some of the changes contained in the new guidance, which became effective for periods ending on or after December 15, 2010:

* Revises the wording of accountants' compilation and review reports.

* Removes the prohibition against allowing an accounting firm to disclose in the compilation report reasons for a lack of independence with respect to the client.

* Requires that if the accounting firm questions the veracity of an amount in the financial statements during the course of a compilation or review engagement, the specifics of the issue and how it was resolved, if significant, must be documented. …