What Is Financial Statement Audit?
A financial statement audit is defined as an independent examination of the company’s financial statement and its disclosures by auditors. It provides a true and fair view of its financial performance. The auditor ensures that the statements are in accordance with the framework of filing after a thorough check of the statements of the company.
The balance sheet, income statement, statement of retained earnings, and cash flow statement are the four major parts of the financial statement audit process. These statements are scrutinized to ensure no material errors are made and are in compliance with filing regulations. Only a Certified Public Accountant (CPA) can audit these statements and deem them fit for filing.
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Financial Statement Audit Explained
A financial statement audit is the process of scrutinizing the important statement of a company such as the income statement, cash flow statement, and balance sheet to ensure they are free from material errors and are fit according to the filing regulations or framework.
Let us understand the most important documents an auditor scrutinizes before submitting their financial statement audit report.
- Income Statement: This is the statement of a company’s financial performanceCompany's Financial PerformanceRatio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements. over a specific accounting period. It shows revenue, expenses incurred through operating and non-operating activities,es and net profit or loss incurred during this period.
- Balance Sheet: This is a statement of the company’s financial positionStatement Of The Company's Financial PositionStatement of Financial Position represents the current financial status of an entity in terms of assets and liabilities. This statement is used by the stakeholders and shareholders as it affects their investing decisions. at a specific point in time. It 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 based on the idea that Assets = Liabilities + Shareholders’ Equity.
- Cash Flow Statement: This is a statement of the company’s cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. during a specific accounting period.
These financial statements are the ones often utilized for audit purposesFor Audit PurposesThe primary purpose of an audit is to conduct an independent and unbiased verification of all financial and non-financial material information to ensure that it is in line with what the management has reported.. However, some adjustments might be made to the statements by the company after the finalization of the audit for a better representation of facts in the financial statement audit report.
Video Explanation of Audited Financial Statements
Below are some of the basic principles governing a financial statement audit process.
- #1 – Integrity, Objectivity, and Independence – The auditor should be straightforward, honest, and sincere in his professional work. He should be fair and must not be biased.
- #2 – Confidentiality – He should maintain the confidentiality of information acquired during his work and not disclose any such information to a third party.
- #3 – Skill and Competence – He should perform work with due professional care. The audit should be performed by persons having adequate training, experience, and competence.
- #4 – Work Performed by Others – The auditor can delegate work to assistants or use work performed by other auditors and experts. But he will continue to be responsible for his opinion on financial informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc..
- #5 – Documentation – He should document matters relating to the audit as the financial statement audit checklist.
- #6 – Planning – He should plan his work to conduct an audit effectively and timely. Plans should be based on knowledge of the client’s business.
- #7 – Audit Evidence – The auditor should obtain sufficient and appropriate audit evidenceAudit EvidenceAudit evidence is information gathered by auditors during the course of an audit, whether internal, statutory, or otherwise. These facts serve as the foundation for the opinion in the audit report. by performing compliance and substantive proceduresSubstantive ProceduresSubstantive procedures are methods designed by an auditor to evaluate a company's financial statements, which require an auditor to create conclusive evidence for verifying the completeness, accuracy, existence, occurrence, measurement, and valuation of the business's financial records.. Evidence enables the auditor to draw reasonable conclusions.
- #8 – Accounting System and Internal Control – Internal control system ensures that the accounting system is adequate and that all the accounting informationAccounting InformationAn accounting information system (AIS) refers to the computer-based method used by the companies to collect, store, and process the accounting and the financial data that the company's internal users operate to report various information to the company's stakeholders such as creditors, investors, and tax authorities, etc. has been duly recorded. The auditor should understand the management’s accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm. and related internal controls.
- #9 – Audit Conclusions and Reporting – The auditor should review and assess the conclusions drawn from the audit evidence obtained through the performance of procedures. The audit report should contain a clear written expression of opinion on the financial statements.
Let us understand the objectives of a financial statement audit report being prepared by every organization through the discussion below.
- The objective of a financial statementObjective Of A Financial StatementThe main objective of the financial statement analysis for any company is to provide the necessary data required by the financial statement users for the informative decision-making, assessing the company's current and past performance, predicting business success or failure, etc. audit is to enable the auditor to express an opinion on financial statements. The entity’s management prepares an audit.
- It is essential that financial statements are prepared as per the recognized accounting policiesRecognized Accounting PoliciesAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level. and practice and relevant statutory requirements, and they should disclose all material matters.
- However, his opinion does not constitute an assurance as to the future viability of the enterprise or the efficiency or effectiveness with which its management has conducted the enterprise’s affairs.
Let us understand the different steps in the financial statement audit process through the detailed explanation below.
#1 – Planning & Risk assessment
The initial stage of financial statement audit checklist involves putting together an audit team and laying down general guidelines for effectively carrying out an audit. The next step is to determine any risks that could lead to material errors in the statements. Identifying such risks requires the auditor to have a thorough knowledge of the industry and business environment in which the company operates.
#2 – Internal Controls Testing
This stage involves a critical analysis of internal controlsInternal ControlsInternal control in accounting refers to the process by which a company implements various rules, policies, or procedures to ensure the accuracy of accounting and finance information, safeguard the various assets of the business, promote accountability in the business, and prevent the occurrence of frauds in the company. 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, safeguard assets, and ensure 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 verification of such statements from the banks and any commercial entities a company is engaged in business with.
Let us try to understand the concept of financial statement audit opinions with the help of an example.
Let us assume ABC Ltd is a furniture manufacturing company which has engaged an audit firm for the financial audit purpose. So initially the auditor will the objective and scope of the procedure for that organization. They will try to identify the main risk areas and timeline of the audit and gather information about the company operation and accounting and reporting system.
Then they will try to find any kind of misstatement or incomplete transactions which are not satisfactory. For this purpose they may pick up samples of transactions and check them thoroughly for completeness and accuracy.
They also compare the data with current and past data, industry benchmarks or other relevant information to identify unusual trends. They will also interact with third parties like customers, suppliers, lenders, for information and consider management decisions and suggestions regarding any issue.
Finally, they will create a report and give their opinion regarding the true and fair view about the financial condition of the business. This report is valuable for management, and all other stakeholders.
Preparing a fool proof report requires the management to carry out a certain standard of record keeping and consistency throughout the year. Let us understand their responsibilities towards ensuring an up to data financial statement audit report.
- The management is responsible for maintaining an up-to-date and proper accounting system and preparing financial statements.
- The auditor is responsible for forming and expressing opinions on the financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels..
- The financial statement audit does not relieve the management of its responsibility.
The auditor decides the scope of his audit and the financial statement audit opinions having regard to;
- The requirement of the relevant legislation
- The pronouncements of the institute
- Terms of engagement
However, the terms of engagement cannot supersede the pronouncement of the institute or the provisions of relevant legislation.
Let us discuss the importance of such a detailed and a tedious process that companies conduct every single year through the points below.
- Enhances Qualification of Business Process – A rigorous audit process may also identify areas where management may improve their controls or processes, further adding value to the company by enhancing the quality of its business processes.
- Assurance to Investors – An audited financial statement provides a high, but not absolute, assurance that the amounts included in the company’s financial statements and notes to accounts (disclosures) are free from any material misstatement.
- True and Fair View – An unqualified (“clean”) audit reportAudit ReportAn audit report is a document prepared by an external auditor at the end of the auditing process that consolidates all of his findings and observations about a company's financial statements. provides the user with an audit opinion, stating that financial statements show a true and fair view in all material aspects and are by generally accepted accounting principles.
- Provides Consistency – Financial statements Audit provides a level of consistency in financial reporting that users of the financial statements can rely on when analyzing different companies and decision-making.
The limitations of the financial statement audit process are as discussed below.
- The auditor cannot obtain absolute assurance.
- It is due to the inherent limitations of an audit due to which the auditorAuditorAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country's local operating laws. obtains persuasive evidence rather than conclusive.
- It arises from the Nature of financial reportingFinancial ReportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making., audit proceduresAudit ProceduresAudit Procedures are steps performed by auditors to get evidence regarding the quality of the financial information provided by the management of a company. It enables them to form an opinion on financial statements and ensure whether they reflect the true and fair view or not. , and Limitations concerning time and cost.
Due to aforesaid inherent limitations, there is an unavoidable risk that some material misstatements may remain undetected.
Financial Statement Audit Vs Integrated Audit
Both the above concepts are related to external audit procedures done by auditors. However, there are some differences between them as follows:
- The auditor of the former has the responsibility of identifying areas of misstatement or incompleteness of financial statements and find the reasons behind them, whereas the latter goes beyond financial statements and looks into auditing of the company’s internal control system also.
- The former verifies whether the financial statements are reported as per the financial standards, which is GAAP or IFRS. But the latter checks the efficiency and effectiveness of the internal control system.
- The former involves checking the income statement, balance sheet, cash flow statement and statement of changes in equity for any misstatement or fraud in the same but the latter concentrates on the type, design and operation of the company and evaluates the procedures for reliability.
- The report produced by the auditor in case of the former presents the fairness of the financial statements and identify the misstatements, whereas the latter produces report regarding the strength and weakness of the internal controls.
Thus, what kind of audit is required depends on the company the type of industry or products they deal with, the regulator requirements, competition, risk profile, etc. But both are equally important in the financial market.
This article has been a guide to what is Financial Statement Audit. We explain it with example, objectives, benefits, differences with integrated audit & principles. You may learn more about basic accounting from the following articles –