Table of Contents
What Financial Statements Are Audited?
An audit of a company’s financial statements and disclosures is a process that provides an unbiased view of a company’s financial performance.
A financial statement is a statement that shows a company’s revenues, expenses, non-operating activities, and net profit. The audit process is intended to make the financial statements as accurate and reliable as possible.
Auditing Financial Statements
An audit of financial statements is a critical part of the financial reporting process for a company. During this process, an independent certified public accountant will examine a company’s financial statements to ensure they are true and accurate.
Financial statements generally include a balance sheet, statement of operations, cash flows, and detailed footnotes. The purpose of an audit is to give investors and decision-makers confidence in a company’s financial performance.
The first step in auditing financial statements is to verify the amounts shown in the summary calculations. This means comparing the total revenue and expense lines to each other.
An audit can verify the owner’s equity and the difference between revenue and expenses. In many cases, a company must review its quarterly financial statements, regardless of size.
The Financial Audit Manual outlines the audit methodology, a three-volume publication from GAO and the CIGIE.
The manual provides detailed implementation guidance, a checklist, and a set of standards for performing financial statement audits.
This manual is available as a Word document and PDF file. It can be downloaded and used immediately to audit financial statements.
Evaluating the quality of a company’s financial statements is critical. A firm’s financial statements often depend on the accuracy of its internal control over financial statements.
A company’s management needs to maintain the accuracy of its information. As a result, the audit process must ensure that it is rigorous. It must also consider the impact of recent events, such as the COVID-19 pandemic.
An audit also involves evaluating the effectiveness of the entity’s internal controls. The controls can include the separation of duties and proper authorization. An effective audit can minimize the risk of material misstatement.
The auditor can evaluate internal controls using risk assessment questionnaires or ratio comparisons to identify anomalies. An audit can be an important investment for a company, but it should not replace the internal control system.
Audited financial statements can add credibility to the company’s financial information. Investors often rely on them to determine whether a company is worth investing in. They can also use them to determine how the company’s performance compares with the industry’s overall health.
Stages of an Audit
The audit process is divided into stages, each involving a particular type of analysis. During the first stage, auditors examine financial statements and the control environment. They may verify transactions, oversee procedures, and request additional information.
Afterward, they prepare a report about the company’s financial statements. Some companies use internal auditors, and others hire external auditors to conduct this analysis. The level of the investigation varies depending on whether the company has internal controls and how robust the controls are.
Before determining the audit’s scope, auditors should understand the entity’s business and industry and relevant regulations and frameworks.
They should also be familiar with the entity’s objectives, strategies, and internal controls. This knowledge will help them identify and evaluate risks. The audit team will also need to establish a timeline for the audit.
The fourth phase of an audit of financial statements focuses on testing the effectiveness of internal controls to prevent financial misstatements. Well-run companies have systems to ensure that their financial reports are accurate.
With the rising labor cost and the complexity of business environments, many organizations have begun implementing automated internal controls. The audit team tests the effectiveness of these controls by changing situations, timing, and complexities.
After the audit, the client should prepare a final version of the financial statements. This version should incorporate the adjustments made by the auditor and be reviewed according to ISA 520 standards.
The auditor may also review the financial statement notes for completeness and compliance with financial reporting frameworks.
The auditor will examine current balances against previous years, as well as any unusual events that occurred.
He will also review internal accounting records and minutes of management meetings that have taken place since the year-end.
The auditor will discuss these events with the management. It is important to review any subsequent events that could affect the company’s financial statements.
After the planning stage, the audit will move to the analytical stage, where the auditor reviews the financial statements and collects evidence. This stage aims to improve the auditor’s understanding of the client’s business and identify areas for risk assessment.
Audit Opinion Letter
An audit opinion letter for financial statements is a crucial document that reflects the auditor’s findings.
A flawed financial statement will not reflect the proper health of an organization, and it will not be an excellent representation of lenders or investors.
Companies receiving audit opinion letters should make immediate changes to correct errors and issue re-audited financial statements.
An audit opinion letter will have two major components: the auditor’s qualifications and opinion. The audit report contains the opinion and will have an introductory section identifying the financial statements.
It will also contain the auditor’s opinion and a fourth optional section that may add further relevant information. In contrast, an unqualified opinion (or clean opinion) will state that the financial statements accurately reflect the client’s results and position.
This is the gold-standard opinion and will make raising funds from investors and lenders easier. However, a qualified opinion will detail the limitations of the audit and may also describe certain aspects that could not be audited.
The auditor will issue a limited scope of the audit, which indicates that they cannot audit specific areas of the financial statements.
An adverse audit opinion indicates a company has made material misstatements in its financial statements, which is a major red flag.
Investors and lenders usually avoid companies with an adverse audit opinion. This is because financial information with significant flaws is not a reliable representation of a company’s financial health.
If a company has slightly deviated from the standards set forth by GAAP, the auditor can issue a qualified opinion.
This opinion is typically given when the company’s management limits the scope of the audit. For example, during the COVID-19 pandemic, a company’s management may have limited its audit to ensure safety.
The auditor’s opinion is presented in an audit report. It begins with an introductory section outlining the audit firm’s responsibilities and management.
The second section identifies the financial statements, and the third outlines the auditor’s opinion. The fourth section explains if the opinion is qualified or adverse.
Cost of an Audit
The cost of an audit of financial statements depends on the complexity of the financial statements and the audit firm’s level of competence.
As the complexity of financial statements increases, auditors may need to perform more tests and use more sophisticated computer programs to detect irregularities. As a result, the cost of an audit can easily exceed $1 million.
In addition to auditing the financial statements, auditors may audit internal control over financial reporting.
This is necessary for specific initial public offerings but not for others. In such cases, an auditor forms an opinion on the effectiveness of internal controls over financial reporting. Regardless of the scope of the audit, an adverse opinion may hurt a nonprofit’s fundraising efforts.
Some audits may not be material to the company’s financial statements. However, a financial institution may choose to have an auditor examine these accounts even if they do not account for a significant portion of the company’s assets. In such a case, the auditor might opt to only perform substantive procedures on these accounts.
The purpose of an audit is to verify the accuracy of financial information. An auditor will look for material weaknesses in the internal control over financial reporting.
These weaknesses should be of significant magnitude or probability. The auditor will communicate their findings to management and other stakeholders. Generally, this information will help improve the quality of the financial information.
The cost of an audit of financial statements varies depending on the scope of the audit. As the scope of the audit increases, the auditor will need to perform additional work related to controls.
Depending on the significance of the controls, the auditor may have to conduct a walkthrough to understand how the process works.