This is the second installment in a series on financial statement analysis.
THE OPINION LETTER
When a Certified Public Accountant (CPA) prepares financial statements,
they should issue a cover letter indicating the scope of work they have performed and
their opinion with respect to the financial statement.
A CPA may perform one of three types of services with respect to
1. Audit the financial statements.
2. Review the financial statements.
3.Compile the financial statements.
The highest level of service is the audit and the lowest level of
service is the compilation. The CPA's legal liability varies with the degree of service
1. Audit -- liable to all third parties who use the financial
statements. This would include investors in the stock market.
2. Review -- some legal liability.
3. Compilation -- very little liability. Legally liable if fraud is known and not properly
The opinion issued by the CPA will be one of three:
1. Unqualified -- this is considered the best type of report.
3. Disclaimer of Opinion.
Only a licensed CPA may issue an opinion.
The letter will also inform the reader, the accounting method used by
the organization in reporting its' numbers. The two methods are generally GAAP or Income
GAAP stands for Generally Accepted Accounting Principles and is
considered the standard set of rules used as the basis for financial reporting. A firm
must comply with these rules to receive an unqualified letter of opinion stating that the
financial statements are a fair representation of the firm's financial position and
results of operations. Key GAAP are:
1. Going concern -- financial statements are prepared based upon the
assumption that the firm will remain in business for the foreseeable future.
2. Conservatism -- sufficient consideration has been given to the various risks the firm
3. Matching -- expenses are recorded in the same accounting period as the revenue that
they were responsible for generating. 4. Cost -- the value of what was given up to acquire
5. Objective evidence -- the financial statement is based on evidence that individuals
could all agree on within reason.
6. Materiality -- errors in financial reports only require correction if they are material
in amount. An error becomes material if an individual would make a different decision if
they knew the difference between the correct information and the incorrect information.
7. Consistency -- the same accounting methods are used from one accounting period to the
8. Full disclosure -- financial statements disclose all the information necessary needed
to assure that the reports are a fair representation.
Next week the Notes.
I wish you well.