M&A Vocabulary – Experten verstehen: „Audit vs Review vs Agreed-upon Procedure vs Compilation”

A classic Financial Due Diligence (FDD) attempts to explain reliable results in such a way that existing information asymmetries can be satisfactorily resolved. However, the degree of reliability of the financial data depends on whether it has been subjected to an audit or less rigorous tests. We want to address the differences between Audit, Review, Agreed-upon Procedures (AUP), and Compilation here.

Audit

An audit provides reasonable assurance that the financial statements do not contain material misstatements. Reasonable assurance is a high level of assurance, but not a guarantee that an audit will always detect a material misstatement when it exists.
The selection of audit procedures is at the auditor’s professional discretion, taking into account their assessment of the risk of material misstatements occurring. In making this risk assessment, the auditor considers the internal control system insofar as it is relevant to the preparation of the company’s financial statements in order to determine appropriate audit procedures. However, no audit opinion is expressed on the effectiveness of the company’s internal control system. A separate, different type of audit would be necessary for that.
The financial statement audit also includes assessing the appropriateness of the accounting and valuation methods applied and the estimates made by the legal representatives, as well as evaluating the overall presentation of the financial statements. Conclusions are also explicitly drawn about the appropriateness of the going concern basis of accounting applied by management. If material uncertainties exist regarding the company’s ability to continue as a going concern, the auditor is required to draw attention to the related disclosures in the financial statements in their audit report or—if these disclosures are inadequate—to modify their audit opinion.
The audit is conducted in accordance with either the International Standards on Auditing (ISA) or corresponding local auditing standards. Reporting, including the opinion, is provided in an “Independent Auditors’ Report.”

Review

A review provides limited assurance that no material modifications need to be made to the financial statements (conclusion). A review consists primarily of inquiries of personnel and analytical procedures applied to financial data. Typical audit procedures, such as observations or obtaining confirmations, do not take place here.
The work follows either the International Standard on Review Engagements (ISRE) 2400 or a corresponding local standard. Reporting is provided in an “Independent Practitioners’ Review Report.”

Agreed-upon Procedures

Agreed-upon Procedures (AUP) are tests of specific selected areas of the balance sheet and/or income statement. Here, individually agreed-upon procedures, such as budget-to-actual comparisons, reconciliations, and confirmations, are performed and identified variances are presented. There is no opinion or conclusion here. Rather, it is left to the recipient of the report to draw their own conclusions from any variances.
Properly conducted AUPs follow the International Standard on Related Services (ISRS) 4400 or a corresponding local standard. Reporting is provided in an “Independent Practitioners’ Report” (on Applying Agreed-upon Procedures) or “Report on Factual Findings.”

Compilation

A compilation is a presentation of information and data from management in the form of preparing financial statements. It consists essentially of consolidating the accounting records after any accrual entries. Nothing is tested here. Therefore, there are no variances and no opinion or conclusion. Independence of the practitioner is not a requirement here, in contrast to the previously described variants.
The preparation of financial statements is to be performed in accordance with the International Standard on Related Services (ISRS) 4410 or a corresponding local standard. Reporting is provided in a “Practitioners’ Compilation Report.”

Conclusion

In summary, the various types of financial statement engagements can be presented according to the level of assurance as follows:

When dealing with unaudited financial statements or those that have been audited by a local auditor whose audit quality cannot be assessed, it is advisable to modify an FDD to focus on the reliability of the financial data as well or instead.

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M&A Vocabularies