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Secrets of Bonding #47: Compilation, Review, Audit?

Steve GoliaLeave a comment

When it comes to Bid and Performance Bonds everyone knows that financial statement numbers are important.  But before surety underwriters get to them, they evaluate the method of financial presentation, its quality and credibility.

  • Is a CPA needed or can a PA or Tax Preparer be used?
  • Audits are expensive.  Can contractors avoid the cost?
  • Are there times when you can’t you use the same accounting method for tax and financial reporting?

There are a number of variables to consider.  Let’s go over what to use and when.

Accounting Professionals

A CPA is a Certified Public Accountant. These people are the premiere accounting professionals.  Bonding companies expect contractors to have a CPA prepared fiscal year-end (FYE) financial statement if individual bonds will be in the range of $1 million or more.

Below a CPA is a PA, Public Accountant, and then there are bookkeepers and tax preparers. Accounting professionals with lower credentials should only be used by contractors with small bond needs.

Accounting Methods

There are four accounting methods.  Any can be used for tax purposes, but banks and bonding companies are more selective.

  1. Accrual Method – probably the most common for construction companies.  May be acceptable for all bonding situations.
  2. Percentage of Completion – more sophisticated than Accrual.  Often used by larger contractors.
  3. Completed Contract – used by contractors that have multi-year projects such as road and bridge builders.
  4. Cash Method – acceptable for tax purposes, but not for financial reporting to banks or sureties.

Financial Presentation

The presentation can vary greatly. This too, is an important element. Surety underwriters expect to make a number of financial evaluations.  If the presentation is inadequate, they will not have info they need (schedules, notes and other elements).you-decide

Audit – the accountant’s cover letter states an “unqualified opinion” meaning they vouch for the accuracy of the report without reservation.  This is the most expensive presentation and is required when bonds and bank credit are in high amounts ($2 – 5 million and above).

Review – This report includes some “review” and verification by the preparer, but less than an Audit. Review reports are required by bonding companies starting with projects around $1 million.

Compilation – This is merely a typing job by the accounting firm, using the numbers provided by the client.  They make no verifications with outsiders and may not even double check the arithmetic. Normally this is acceptable for clients needing bonds below $1 million.

QuickBooks – Financial Statements produced from the client’s computer may be adequate for small bonding lines, or to provide a mid-year update.  “Internal” financial statements are not used as primary underwriting info for sizable obligations.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

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Secrets of Bonding #25: World’s Cheapest Audit

Steve GoliaLeave a comment

When it comes to financial statements prepared by a CPA (Certified Public Accountant), there are three levels of presentation:

Compilation – This is the lowest level and does not include any checking or verification of the numbers by the accounting firm. The numbers are merely “compiled” by the CPA.

Review – Some checking and “review” by the CPA.

Audit – The CPA performs analysis and verifications to authenticate the numbers.

Bond underwriters expect better prepared financials for higher amounts of surety credit.  This means contractors that have large bonding lines must provide Audited company financial statements (FSs).  Sureties and bankers are more confident when analyzing an audited FS – we assume everyone would have these high quality financial reports if it wasn’t for the cost.

Because of the time and human resources involved, a Review is less expensive than an Audit, and a Compilation is the least expensive of the three.

So in comes your contractor client who, for a number of reasons, decided to have a Compilation at the last fiscal year-end.  Now a large project needs to be bonded, and from a size standpoint, the underwriter normally expects a Reviewed FS.  If it is not practical to go back and upgrade the Compilation to a Review, what are your options?

The underwriter may be willing to work with the Compilation FS if some key elements are documented and / or verified.  Such an analysis is the heart of the difference between a Compilation and a Review.

At the minimum the underwriter is likely to ask for proof of cash, aged receivables (A/R) and payables (A/P), and a Work in Process (WIP) Schedule.  Let’s go over each one briefly.

Cash: If the FS date is 12/31, the idea would be to provide proof of the cash amount shown on the FS on that date.  If the FS shows $52,125 cash, you need bank or brokerage statements adding up to that figure for 12/31.

A/R & A/P: These reports should be as of the FS date and add up to the receivable and payables listed on the FS.  The A/R should be broken down by age showing how much is current, 60, 90, and over 90 days old. Retainages should be identified since they are not regular “trade receivables.” It is also beneficial to indicate which receivables were subsequently collected after the fiscal date. Payables should also be aged.

WIP Schedule: Needed as of the fiscal date to support the analysis of the company balance sheet.

This strategy is not as good as actually having a CPA Review, but the analysis performed by the underwriter could substitute for a Review and justify issuance of a bond. Plus, such services performed by the underwriter are free!  So, even though this is not really an Audit or Review, you can think of it as the “World’s Cheapest Audit.”  It can be just what you need to get a bond and keep moving forward with the file.

For the future, if similar sized bonds are likely, the client should plan on having a Review performed at the next fiscal year-end – it will help with surety and bank credit.  Added bonus: The company will have better documents for management review and the accountants will provide professional guidance that is not included with a Compilation.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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