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Evaluating a used car as an illustration of the differences between compilation, review, and audit

(cross-posted from my other blog, Nonprofit Update.)

You could figure out how good a car is by looking at it from across the street.

Or you could look inside & drive it around the block.

Or you could take the car to your mechanic for a couple of hours to get it really checked out .

We can use that as an analogy of the differences between a compilation, a review, and an audit.

Stand across the street

You could try to figure out if that car would be a good one for you by looking at it from across the street. You could tell the make, model and age, maybe give or take a year. You could see the body was intact and at least didn’t have any crumpled bumpers. You can see that there are four tires on the ground but not their condition. You could see that all the windows are intact.

If you did that you could make a wild guess on the quality and price. But would you buy it based on that?

Not a chance.

That’s sort of what a compilation is like. You’ve got an idea what the numbers are, but you really shouldn’t make a ‘buy’ decision based on that.

Get inside and drive around the block

You could evaluate the quality of the car by getting inside, looking around, walking around the outside, looking under the hood, and taking a spin around the block.

What could you tell from that?

You would know the mileage, by looking at the plate on the door you could tell what month it was manufactured, and you could look around the interior to see what accessories it has and the condition of the upholstery. You could glance at the floorboard to see that the wear on the carpet is consistent with the mileage. You could look under the hood, listen to the engine for a minute and tell that it at least isn’t a disaster. Drive around the block and you could tell that the transmission shifts smoothly, the car accelerates nicely, brakes smoothly without pulling and has decent muffler, air-conditioning, heating, and sound system.

Would you now have a better basis for estimating it price and quality? You bet.

Might you be willing to negotiate a purchase based on that? Lots and lots of people do.

That is sort of what a review is like. The CPA looks at the numbers, asks a few questions, looks at trends and relationships, ponders a minute, then decides there’s nothing visibly wrong and issues a report.

Have a mechanic take it apart

You could take the car to a mechanic you trust. He would pull the tires, measure the tread, and inspect the brakes.  He would look under the hood to see whether it has been steam cleaned recently.  If yes, then something is being hidden, which is a warning sign something is wrong.  If no, he could tell a lot.  Maybe he can see that the alternator was replaced a few months ago and the water pump is only two or three years old. Maybe the radiator isn’t OEM.  That would suggest the previous owner took care of his vehicle.  Maybe some parts are about to fall off.

A mechanic could look at the oil, tell you whether it was just changed, and if not whether there’s metal in it. Maybe its been years since it was changed.  Likewise with the transmission fluid – is it brand-new fluid, way past when it should have been changed, or is there any metal in it?  Inspecting the bottom of the engine tells you whether there are any new or recently repaired leaks.  Hooking the engine up to the diagnostic equipment can give a really good understanding on the condition of the engine.

While you are waiting for your mechanic, you could check with DMV to see if there are any accident reports on the vehicle.

After he puts it all together you have a long heart-to-heart chat to find out the car’s condition.

Do you now have a really good understanding of its condition? Yes.  Do you have enough information to determine a very good price for the car? You bet. Can you make a really solid decision on whether you want the car or not and what a good price would be? Yeah.

That’s sort of what an audit looks like. You have a lot more information on which to make a decision whether to buy or not.

Does that mean the transmission won’t blow up next week or the air-conditioning won’t fail the first week of summer? No. There’s no guarantees.

But you have a lot better chance with a car the mechanic worked over than with something you drove around the block or something you just looked at from across the street.

How much will it cost to figure out the quality of that car?

What does it take in terms of time, money, and effort for each of those three options of figuring out the condition of the car?

Takes just a few moments and no cost to stand across the street and make a guess.

Takes some time and mental energy to look around the car and drive it around the block. You have to be thinking and observing very carefully.

Going to a mechanic will take you a few hours and cost you some money.

It comes down to a question of how much time/effort/money you want to spend for the quality of information you get.

So here’s my analogy:

  • Look at the car from across the street – very low cost for low quality information – compilation
  • Look around inside in the car and drive it around the block – moderate cost for better information – review
  • Have a mechanic work it over – highest cost in terms of time and money but the best information on the quality of the car – audit

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