What are Audited Financial Statements
As per law, all listed companies are required to get their financial statements audited by an authorized CPA. Audits play a critical role in lending that element of credibility to financial information about a company which would go a long way in assuring company stakeholders, especially ones involved in making economic decisions, about authenticity or otherwise of any financial declarations by the company. Usually, an independent financial auditor is hired by a company to carry out an audit of financial statements, whose opinion offers a kind of unbiased and competitive view of financial position and performance of a company.
In recent times, audits of financial statements have increased in significance after it was brought to light on several occasions how some of the big industry players have made fraudulent disclosures, which has only served to erode investor confidence. It is also the reason for the introduction of far more stringent norms widely employed in financial reporting standards.
Top Financial Statements to Audit
- Income Statement: This is the statement of the financial performance of a company over a specific accounting period. It shows revenue and expenses incurred through operating and non-operating activities as well as net profit or loss incurred during this period.
- Balance Sheet: This is a statement of the financial position of the company at a specific point in time. This is done by detailing the assets, liabilities and shareholders’ equity to give an idea of what the company owns along with the liabilities. The balance sheet is prepared on the basis of the idea that Assets = Liabilities + Shareholders’ Equity
- Cash Flow Statement: This is a statement of the cash and cash equivalents received and released by the company during a specific accounting period.
These financial statements are the ones often utilized for audit purposes. However, some adjustments might be made to the statements by the company after finalization of the audit for better representation of facts.
Phases of an Auditing Financial Statements
Let’s discuss the following phases.
#1 – Planning & Risk assessment
This is the initial stage which involves putting together an audit team and laying down of general guidelines for effectively carrying out an audit. Next step is to determine any risks that could lead to material errors in the statements. Identifying such risks require a thorough knowledge on part of the auditor in respect of the industry and business environment in which the company operates.
#2 – Internal Controls Testing
This stage involves a critical analysis of internal controls adopted by a company and their level of efficacy in eliminating any possibility of material misstatements in financial statements. These internal controls could include automated systems and processes employed by a company to ensure higher operational efficiency, safeguarding of assets and making sure that all transactions are accurately reported.
#3 – Substantive Testing
At this stage, the auditor looks for substantial evidence and cross-verification of facts and figures reported in the statements which might include the following:
- Physical inspection of assets if required.
- Cross-checking recorded figures in statements against actual documents and records with the company.
- Third-party or any external confirmations of financial transactions and their details reported by the company. This often includes an independent confirmation of such statements from the banks and any commercial entities a company is engaged in business with.
Issuance of Audit Opinion Letter:
This is the final step of auditing financial statement where an opinion letter is issued by the auditor to present the final opinion based on a complete examination of facts in keeping with the auditing standards. An auditor’s report is comprised of the following sections:
#1 – Report on the Audited Financial Statements:
This is the opening part where auditor details which financial statements were audited along with the relevant Financial Year of these statements. It also includes a summary of significant accounting policies applied while preparing the financial statements.
#2 – Management’s Responsibility for the Audited Financial Statements:
This part includes a declaration of the responsibility which lies with the management for preparation of audited financial statements in keeping with the regulatory requirements.
#3 – Auditor’s Responsibility
This is where an auditor declares his responsibilities while conducting such an audit. His responsibilities include forming and expressing an independent professional opinion on the audited financial statements in keeping with international financial auditing standards.
#4 – Basis for Qualified Opinion
It must be clarified here that an auditor need present his qualified opinion only if he thinks that there are material misstatements in the financial reports audited. In this section, he outlines the relevant evidence which led him to offer a qualified opinion in the first place.
#5 – Qualified Opinion
source: Colgate SEC Filings
This section includes the actually qualified opinion of an auditor if he is not satisfied with the application of accounting policies or finds that the data submitted for purposes of an audit was not sufficient. This forms a critical part of the auditor’s report.
Here it must be made clear what types of opinions can be expressed by the auditor.
- Unqualified Opinion: This form of an opinion is expressed when the auditor finds no issues with the factual nature of data included in the audited financial statements or with the application of accounting policies in their preparation. For obvious reasons, this kind of opinion is viewed most favorably by the stakeholders, investors, and banking institutions.
- Qualified Opinion: Already explained above.
- Adverse Opinion: This kind of opinion is expressed by the auditor if he thinks that there are material misstatements in the financial data presented. This would require a company to reissue audited financial statements and look for another audit.
- Disclaimer of Opinion: If an auditor thinks that the data presented is insufficient to form any kind of opinion, then he is forced to issue a disclaimer of opinion. This forms neither a qualified nor an unqualified opinion in and of itself, but merely the inability to express a proper opinion.
#6 – Report on Legal and other Regulatory Requirements:
This is the final section where the auditor outlines the relevant legal and other regulatory requirements which were kept in mind during the audit and preparation of the auditor’s report.
Difference between Accounting & Auditing Standards
All financial statements are prepared on the basis of widely accepted accounting frameworks of Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The accounting frameworks might differ based on the country or region in which the business is operating and the audits are taking place. While evaluating these financial statements, independent auditors employ a framework of Generally Accepted Auditing Standards (GAAS) which sets out guidelines on the proper way of conducting an audit.
It is important to not confuse the accounting and auditing standards and the difference is borne out by the fact that whereas accountants are supposed to be thoroughly conversant with the accounting framework they are using, but they need not be acquainted with auditing standards. On the other hand, auditors must have a thorough knowledge of both accounting and auditing frameworks, without which it won’t be possible to critically analyze and audit financial statements.
Conclusion – Audited Financial Statements:
As we have already discussed, audited financial statements are referred to by investors, stakeholders as well as financial institutions for forming a reliable opinion of the company. With the added element of professional veracity, they represent a realistic view of the business and its performance. However, a favorable audit report is not a commentary on whether the company is doing well as a business entity or not, but merely that its financial reporting is in order and can be relied upon, which goes a long way to build trust among investors and lenders, creditors and investors.
Audited Financial Statements Video
This has been a guide to audited financial statements. Here we discuss the phases of auditing financial statements along with the issuances of audit opinion letters. Also, we discuss the differences between accounting and auditing standards. You may learn more about accounting from the following article –
- List of Top 10 Importance of Financial Statements
- Top 10 Best Limitations of Financial Statement
- Top 10 Users of Financial Statements
- What is Audit Report Examples?
- Structure/Format of an Audit Report Contents
- Audit Report Opinions Types
- Advantages of Generally Accepted Accounting Principles
- What Does Financial Accounting Mean?
- Accounting Cycle
- Double Entry Accounting System
- Cash Basis Accounting
- Financial Accounting Careers