Financial Statement Audit (Definition, Objectives, Principles)

What is Financial Statement Audit?

Financial Statement audit is defined as an independent examination of the company’s financial statement and its disclosures by auditors and provides with a true and fair view of its financial performance.

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.

Objectives of Financial Statement Audit

The objectives of a Financial Statement Audit-

The objective of a financial statement audit is to enable the auditor to express an opinion on financial statements Audit prepared by the management of the entity.
For this, it is essential that financial statements are prepared as per the recognized accounting policies and practice and relevant statutory requirements and they should disclose all material matters.
However, his opinion does not constitute an assurance as to future viability of the enterprise or the efficiency or effectiveness with which its management has conducted the affairs of the enterprise.

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.

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#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.

Responsibility for Financial Statements Audit

Below are the Responsibility for the financial statements-

The management is responsible for maintaining an up to date and proper accounting system and finally to prepare financial statements.
The auditor is responsible for forming and expressing an opinion on the financial statements.
The audit of the financial statement does not relieve the management of its responsibility.

Scope of a Financial Statement Audit

The auditor decides the scope of his audit having regards 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.

Importance

Enhances Qualify 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 the not absolute, level of 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 report provides the user with an audit opinion which states that financial statements are showing true and fair view in all material aspects and are in accordance with 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.

Limitations

The auditor cannot obtain absolute assurance.
This is due to inherent limitations of an audit due to which auditor obtains persuasive evidence rather than conclusive.
It arises from Nature of financial reporting, Nature of audit procedures and Limitations with respect to time and cost

Due to aforesaid inherent limitations, there is an unavoidable risk that some material misstatements may remain undetected.

Basic Principles Governing a Financial Statement Audit

Below are some of the basic principles governing a financial statement audit.

#1 – Integrity, Objectivity, and Independence – 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. 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 information.
#5 – Documentation – He should document matters relating to the audit.
#6 – Planning – He should plan his work to conduct an audit in an effective and timely manner. Plans should be based on knowledge of the clients business.
#7 – Audit Evidence – Auditor should obtain sufficient and appropriate audit evidence by performing compliance and substantive procedures. 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 information has been duly recorded. The auditor should understand the accounting system and related internal controls adopted by the management.
#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.

Financial Statement Audit