Financial Statements - Levels of Assurance

Most small/medium sized business either require or want formal financial statements prepared at the end of the year. These could be for a 3rd party such as a bank or simply for internal use. Not all financial statements are created equal though.
As a business owner you have 3 options. Compilation, Review, and Audit. Each generates different reports, that accompany the financials statements even though the financials themselves should be very similar. Many business owners are unsure or unaware of their options, so I thought I would outline them for you.
Compilation Engagement
This is the most common, the least expensive, and generally all that is required for most businesses. A compilation will provide financials statements with a 'Notice To Reader' (NTR) report attached. Under this engagement the financial statement preparer will merely take the information provided by a client, and assemble them into standard financial statements. Unless there are obvious or clearly incorrect information the financial statements will represent what the client has provided. In fact the preparer through the NTR report is not providing any assurance that the contents of the statements are accurate. The financial statements should still be presented in a consistent and readable manner.
There will be minimal notes to the financial statements, and they require less detail then in other types of engagements. An Income Statement and Balance Sheet are usually included.
An example of the amount of verification that is done in a compilation agreement would be. The owner of a retail outlet will say they had $100,000 of inventory on hand at the end of the year. The financial statement preparer under a compilation agreement will accept that value as correct and not misleading.
Review Engagement
With a review a more detailed report will be prepared and accompany the financial statements. In this case the accountant is required to do much more analysis, inquiry and disclosure. The financial statements must be prepared in accordance with GAAP (or IFRS), and any deviations must include significant disclosures.
Some of the notes to the financials could include: capital asset details, long term debt information, related party transactions, among others. There will also be disclosures about significant accounting policies in place. There will generally be an Income Statement, Balance Sheet, and Cash Flow Statement.
Using the inventory example again, the preparer of the review engagement wouldn't simply take the owner's word for it. He might take a look at prior years inventory levels and compare. He might ask how the value of each unit was derived, and possibly even verify the cost per unit to the market, to ensure that it is reasonable.
Audit Engagement
Audited financial statements require the most thorough work to assess the accuracy of the information provided. In addition to GAAP, accountants must follow GAAS (Generally Accepted Auditing Standards). These dictate the how the audit will be conducted. At the end the auditor is providing 'reasonable assurance' that there is no material misstatements on the financial statements. As such they are required to perform a variety of tests to ensure that the information is captured correctly. The way 'material misstatement' is defined in this instance is simply that the user of the statements decisions will not be affected by any errors contained in the statements. As with a review engagement, the audited statements will contain many disclosures and notes that will highlight anything that the users may need to know when assessing the statements.