Know which financial statement is best for your farm

This article is a follow-up to a previous article I wrote about farms and corporate financial statements. I commented that I am not an accountant but I am a management consultant who has some expertise and an interest in financial management. Through my career, I have gained some understanding of what accountants do in preparing financial statements.

I previously stated that a set of financial statements will include a balance sheet, statement of earnings and statement of cash flows. The descriptions of the statements can vary a bit from accountant to accountant, but they all are presented in accordance with Canadian generally accepted standards.

There are three types of financial statements: compilation, review engagement and audited statements, each including the component parts mentioned above. Most farms will receive compilation or review engagement financial statements.

The following is an edited summary of text from the Certified Professional Accountant website.

Compilation engagement (notice to reader)

“Notice to Reader” financial statements are unaudited, and there is no assurance provided by the CPA that the amounts are free from materially misstatements. The CPA simply compiles the financial statements with information provided by the client, or the client’s bookkeeper.

Review Engagement

A review engagement is requested by stakeholders in a company (bank, shareholders, etc.) to ensure that the amounts within the financial statements are plausible. Whereas in a Notice to Reader, where there is no assurance provided, a review engagement provides a low level of assurance from the CPA. The accountant will perform various analytical procedures, as well as discussions with the client, to ensure that the financial statement information is plausible.

When accountants publish financial statements, they comment on the assurance provided in the accuracy of the financial information so anyone reading the statements understands the basis upon which the statements are presented. A review engagement includes more assurance than a notice to reader. Greater assurance requires more activity and diligence by the accountant in preparing the statements. More time and thus, higher costs. Costs are certainly a factor but so is time when a farmer is waiting on financial statements to provide to lenders and creditors or to use the information for future management and planning activities.

When lenders loan money to a farmer, they accept a certain level of financial risk in the transaction. The ultimate risk is the loan not being repaid. They believe that larger amounts of debt correlate with higher risk. To compensate for that risk, lenders assess different interest rates (the spread over bank prime increases with greater risk). Reporting and information is also a method applied by lenders to mitigate risk. Inventory reports are one example but also financial reports.

When the level of debt on a farm increases, lenders may require that a review engagement set of financial statements be provided. The assumption is that the accountant is providing more assurance on the financial information, which is a measure of comfort for a lender. I am not aware of any hard and fast number on the amount of debt in the business where a farmer may be asked to move from a compilation to a review. When I started consulting many years ago, the threshold of debt was about $500,000 before a review engagement was needed. Now the order of magnitude is $5 million.

Review engagements can cost several thousand dollars more than a notice to reader. I often wonder if a farmer understands that there are options to the type of statements being provided. A farm’s financial statements belong to the owners or shareholders, not the accountant or lender. A farmer can have input into the type of statement provided. He or she should first have a discussion with the accountant, who may have a good reason why a review or compilation should be used. The next discussion should be with the lender(s).

Let’s assume that a farm is getting a review engagement and would rather use a notice to reader. Lenders approach the discussion primarily from a function of risk. The question to ask a lender is why they are requiring a review engagement. The next question is what needs to happen / what additional information (purposed to mitigate risk) could be provided so they would accept a notice to reader. Then negotiate.

I’ve come across numerous examples through my discussions with farm families. Some examples follow.

A farm with two incorporated businesses with well in excess of $5 million in debt and lenders accepting notice to reader statements (as long as the businesses stay onside on covenants). It took some negotiation, but the lender agreed.

A farm with over $15 million in debt and providing notice to reader financial statements.

A farm that has about $3 million in debt and is getting review engagement financial statements and is in the process of switching to a notice to reader.

This article is not intended to pass judgment on any accountant or lender. Farmers, lenders and accountants have business relationships. I am simply suggesting that a discussion about the presentation of financial statements occurs for the purpose of getting to a mutually acceptable solution for all.

Terry Betker, PAg, is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or terry.betker@backswath.com.

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