Audit Engagement

Updated on May 1, 2024
Article byKumar Rahul
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Audit Engagement?

An audit engagement is an independent and systematic examination of a company’s financial records, systems, and controls by a qualified professional known as an auditor. The purpose of it is to provide an independent assessment of the financial position and performance of the organization being audited.

Audit Engagement

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Audit Engagement (wallstreetmojo.com)

Initial audit engagements aim to review the company’s financial statements, transactions, and accounting records. This ensures they are accurate, complete, and comply with relevant accounting standards and regulations. The auditor will also assess the company’s internal controls and risk management processes. This helps identify any weaknesses or deficiencies that could impact the accuracy and reliability of financial reporting.

Key Takeaways

  • Audit engagement is a process of independent examination of an organization’s financial statements. The aim of it is to provide reasonable assurance.
  • The auditor must follow a systematic and structured approach to collect sufficient and appropriate audit evidence. It involves assessing and addressing the organization’s financial statements’ inherent, control, and detection risks.
  • It results in an audit report that expresses the auditor’s opinion on the fairness of the financial statements.

Audit Engagement Explained

An audit engagement involves an auditor examining and compiling a company’s financial documents. It is essential for ensuring the integrity and accuracy of a company’s financial reporting and improving its financial performance and risk management processes.

The auditor will examine the company’s financial records, transactions, and accounting systems to ensure no errors, fraud, or irregularities. They will also assess the company’s internal controls and risk management processes. This is to identify any weaknesses or areas of improvement that can help the company prevent financial misstatements or losses.

The importance of it lies in assuring stakeholders that the company’s financial statements are reliable and trustworthy. This includes shareholders, creditors, lenders, investors, and regulators who rely on the company’s financial information to make crucial decisions. By having an independent auditor conduct such engagement, stakeholders can have greater confidence in the company’s financial reporting and make better-informed decisions.

It can also help the company improve its internal controls and risk management processes, leading to better financial performance and lower the risk of financial misstatements or losses. In addition, by identifying areas for improvement, the company can take corrective action and implement best practices to prevent future issues.

Accounting for Financial Analyst (16+ Hours Video Series)

–>> p.s. – Want to take your financial analysis to the next level? Consider our “Accounting for Financial Analyst” course, featuring in-depth case studies of McDonald’s and Colgate, and over 16 hours of video tutorials. Sharpen your skills and gain valuable insights to make smarter investment decisions.

Procedures

The procedure of an audit engagement generally involves the following steps:

  1. Planning: The auditor will first understand the company’s business, risks, and objectives under audit engagement planning. They will also assess the materiality of the financial statements and identify areas that require special attention during the audit.
  2. Risk Assessment: The auditor will assess the risks associated with the company’s financial statements, including fraud risks and other potential misstatements.
  3. Testing: The auditor will conduct testing of the company’s financial records, transactions, and systems to ensure that they are accurate, complete, and in compliance with relevant accounting standards and regulations. This may involve gathering evidence through various methods, such as sampling and analytical procedures.
  4. Evaluation of Internal Controls: The auditor will evaluate the company’s internal controls and risk management processes to ensure they effectively prevent financial misstatements or losses.
  5. Communication: Throughout the process, the auditor will communicate with the company’s management and other stakeholders to provide updates and discuss any findings or concerns.
  6. Reporting: At the end of it, the auditor will prepare a written report that includes their opinion on the accuracy and completeness of the company’s financial statements and any significant findings or recommendations for improvement. The information will be distributed to the company’s management and stakeholders, including shareholders and regulatory bodies.

Types

There are several types of audit engagements, each with its specific objective and scope.

  1. Financial Statement Audit: It focuses on the company’s financial statements. The auditor will examine the accuracy and completeness of the financial statements and ensure that they are prepared in compliance with applicable accounting standards and regulations.
  2. Compliance Audit: A compliance audit verifies whether the company follows specific laws, regulations, or contractual obligations. It ensures that the company complies with legal and regulatory requirements and can include areas such as tax compliance, environmental compliance, or data privacy compliance.
  3. Operational Audit: An operational audit is focused on reviewing the efficiency and effectiveness of the company’s operations, processes, and procedures. It may include inventory management, procurement processes, and employee productivity.
  4. Information Systems Audit: It examines the company’s information systems to ensure they are secure, reliable, and compliant with relevant regulations. The auditor will assess the integrity of the company’s data.
  5. Internal Audit: An internal audit is conducted by a company’s internal audit department or by an external auditor on behalf of the company. An internal audit aims to assess the effectiveness of the company’s internal controls and risk management processes and provide recommendations for improvement.

Examples

Let us understand it in the following ways.

Example #1

Suppose a fictional company called SmartFin Inc. has recently experienced significant growth in its business operations. SmartFin Inc. hires an external auditor to conduct a financial statement audit engagement to ensure that its financial statements accurately reflect this growth and comply with relevant regulations. The auditor reviews SmartFin Inc.’s financial statements and accounting practices to ensure they are accurate and complete and comply with applicable accounting standards and regulations. At the end of the engagement, the auditor issues a report that assures stakeholders that the financial statements are reliable and trustworthy.

Example #2

In 2020, the US Department of Justice (DOJ) announced it had reached a $2.9 billion settlement with Goldman Sachs regarding the bank’s role in the 1MDB scandal. As part of this settlement, Goldman Sachs engaged an independent compliance consultant to review and assess its anti-money laundering compliance program. The compliance consultant will conduct a compliance audit to evaluate the effectiveness of Goldman Sachs’ anti-money laundering policies and procedures and identify improvement areas. This ensures the company complies with applicable laws and regulations and takes appropriate measures to prevent financial crimes.

Risks

Audit engagements involve specific risks that can impact the outcome of the engagement.

  1. Inherent Risk: It refers to inherent risks like the company’s business or operations. The company may have a higher inherent risk if it operates in high-risk industries like mining or pharmaceuticals.
  2. Control Risk: Control risk refers to the chance that the company’s internal controls are ineffective in detecting misstatements in financial statements. The auditor must assess the company’s internal controls’ effectiveness and determine the control risk level.
  3. Detection Risk: Detection risk refers to the chance that the auditor will not detect a misstatement in the financial statements. This risk is affected by the auditor’s procedures’ nature, timing, and extent.
  4. Fraud Risk: Fraud risk is the chance that the company’s financial statements are intentionally or unintentionally misstated. The auditor must be alert to the possibility of fraud and take appropriate steps to assess the risk and detect any potential fraud.
  5. Legal and Regulatory Risk: Legal and regulatory risk refers to the risk that the company does not comply with applicable laws and regulations. The auditor must assess the company’s compliance with relevant laws and regulations and determine the potential impact of any non-compliance on the financial statements.
  6. Reputation Risk: Reputation risk refers to the risk that the auditor’s reputation may be damaged. This could happen if the auditor fails to identify a misstatement in the financial statements or if the audit report must be deemed adequate.

Audit Engagement vs Review Engagement

Review engagement and Audit engagement are assurance engagements conducted by auditors. However, they differ in scope, objectives, and level of assurance provided. Some of the key differences are:

Scope

  • Audit engagement: Its scope is broader than a review engagement. Auditors perform extensive procedures to obtain evidence about the financial statements, internal controls, and related matters to provide reasonable assurance.
  • Review Engagement: A review engagement’s scope is narrower than an audit engagement’s. Auditors perform limited procedures to obtain a basis for expressing little assurance that the financial statements are free from misstatement.

Objectives

  • Audit engagement: It aims to provide that the financial statements are free from misstatements arising out of fraud or error.
  • Review Engagement: The auditor provides negative security, which means they have yet to become aware of modifications to the financial statements for them to be by the applicable financial reporting framework.

Level Of Assurance

  • Audit engagement: It provides more assurance than a review engagement. The auditor expresses a favorable opinion of the financial statements as a whole.
  • Review Engagement: It provides less assurance than an audit engagement.

Frequently Asked Questions (FAQs)

What is an audit engagement letter?

It is a formal document outlining the engagement terms between an auditor and a client. It is a contractual agreement that sets out the scope, objectives, and responsibilities of the auditor and the client.

Who signs audit engagement letters?

The auditor and the client typically sign the letter. It is a contractual agreement between the parties and outlines the terms and conditions.

How to plan an audit engagement?

Planning involves understanding the organization, assessing the risks of misstatement, developing an audit strategy, developing an audit plan, communicating with the client, supervising the team, and continuously monitoring the engagement.

What is external audit engagement?

It is a type of audit where an organization engages an independent auditor to examine its financial statements and provide an opinion on their accuracy and completeness.

This article has been a guide to what is Audit Engagement & its meaning. We explain its comparison with review engagement, examples, types, procedures, and risks. You may also find some useful articles here –