Meaning of Preparation and Compilation in Accounting

Meaning of Preparation and Compilation in Accounting

Both preparation and compilation of financial statements are accounting services performed by professionals, typically for entities that do not require an audit or review. While both terms involve the creation of financial statements, they have distinct definitions and responsibilities attached to them under accounting standards. The key difference between them lies in the level of involvement, responsibilities, and professional standards applicable to each.

1. Preparation of Financial Statements

Definition

Preparation of financial statements refers to the process in which an accountant or accounting professional helps management create financial statements directly from the entity’s books and records without performing any verification or providing any assurance. The financial statements are typically prepared for internal use or external reporting based on the accounting data provided by the client.

Preparation engagements are governed by the International Standard on Related Services (ISRS) 4410 (Revised), but the International Standard on Related Services (ISRS) 4410 (Revised) deals specifically with compilation engagements. For the preparation of financial statements, professional standards like ISRS 4410 do not apply, as no public report is issued.

Key Features of Preparation

• No Assurance: The accountant prepares financial statements without performing any procedures to verify the data or assess its accuracy. No audit or review procedures are performed.

• No Public Report: The accountant does not issue a report on the financial statements (such as an audit or compilation report). The financial statements are prepared for management’s use.

• Management Responsibility: Management remains fully responsible for the underlying financial data, accounting policies, and the accuracy of the financial statements.

• No Opinion or Conclusion: The accountant does not express any opinion or conclusion regarding the reliability of the financial statements.

Example of Preparation

A small business may engage an accountant to prepare financial statements from its trial balance and other accounting records for submission to tax authorities. In this case, the accountant’s role is limited to putting the financial statements into the proper format (e.g., income statement, balance sheet) based on the client’s data.

2. Compilation of Financial Statements

Definition

A compilation of financial statements involves the accountant assembling and presenting financial statements based on information provided by management, but with no assurance that the financial statements are accurate or free from material misstatements. Unlike preparation, a compilation report is issued under ISRS 4410 (Revised), clarifying that no assurance is provided.

Compilation is more formal than preparation and is generally used when financial statements need to be provided to external users (such as banks or shareholders) who require professionally prepared financial statements but do not need the assurance of an audit or review.

Key Features of Compilation

• No Assurance: Like preparation, compilation does not involve providing any assurance or verification of the accuracy of the information provided by management.

• Compilation Report Issued: The accountant provides a compilation report with the financial statements, stating that the financial statements were compiled based on management-provided information, and no assurance is expressed.

• Responsibility for Accuracy: Management is responsible for the accuracy and completeness of the financial data. The accountant’s role is to present the financial statements in accordance with an appropriate financial reporting framework (e.g., IFRS or IFRS for SMEs).

• No Verification or Testing: The accountant does not perform audit procedures, such as verification of assets, liabilities, or transactions, nor do they assess internal controls.

Example of Compilation

A company needing financial statements for submission to its bank might engage an accountant to compile the financial statements based on its financial records. The accountant prepares the financial statements and issues a compilation report stating that no audit or review was performed.

Example of a Compilation Report:

“We have compiled the accompanying financial statements of [Company Name] based on information provided by management. We have not audited or reviewed these financial statements and, accordingly, express no assurance on them.”

Comparison of Preparation vs. Compilation

Feature Preparation Compilation

Standard Applied Not governed by ISRS 4410 Governed by ISRS 4410 (Revised)

Public Report Issued No Yes, a compilation report is issued

Assurance Provided No assurance or opinion No assurance or opinion

Verification of Data No verification or testing of data No verification or testing of data

Management Responsibility Full responsibility for financial data Full responsibility for financial data

Professional Role Prepare and format financial statements Compile and present financial statements

Conclusion

Both preparation and compilation of financial statements involve creating financial statements based on client data, but the key difference lies in the issuance of a compilation report and the formal application of ISRS 4410 (Revised) in the case of a compilation. In a preparation engagement, no public report is issued, and the accountant’s role is limited to organizing the financial data in the proper format. In a compilation engagement, while no assurance is provided, the accountant formally compiles the financial statements, issues a compilation report, and presents them according to an applicable financial reporting framework.

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