Financial statement audit is a professional review of a company’s financial statements. Its purpose is to determine whether the financial statements fairly and materially represent the company’s financial position and operations in accordance with generally accepted accounting principles.

 

Specifically, auditors express their opinion on the accuracy of the income statement, balance sheet, statement of cash flows, and all accompanying disclosures that support them.

 

Financial statement audit differs from other types of audits such as tax audits and internal audits. A tax audit is conducted to verify the accuracy of tax returns and the amount of taxes paid. Internal audit is conducted by the company’s employees and can take various forms as directed by the company’s management. When the internal audit department reviews financial statements, it is done for the benefit of the company’s management and is not considered an independent review for external stakeholders.

 

Stages of financial statement audit

Most sources will tell you that there are three stages in a financial statement audit, which ultimately lead to the auditor’s opinion. The duration and scope of each stage may vary depending on the complexity of the company’s business, the qualifications of its accounting staff, and whether it is an initial or recurring audit. Understanding these stages can help companies better prepare for the audit and make it a smoother process.

 

1. Planning and risk assessment: This stage begins when the company’s audit committee or board of directors hires an external auditor and enters into an engagement agreement. The auditor initiates a series of administrative steps, including the appointment of the audit team (including any specialists if needed), ensuring that the auditor(s) have no conflicts of interest with the company being audited, and establishing an audit schedule. Part of the risk assessment in this stage includes the audit team getting acquainted with the company’s business characteristics, industry, local accounting considerations, and any relevant regulatory requirements. This helps the auditor plan appropriate procedures for areas with a higher potential for errors. Additionally, the audit team discusses the vulnerability of the company’s financial statements to fraud. At the end of this stage, the audit strategy and tactical plan for the next two stages are documented. The plan may be updated if the auditor discovers anything unexpected in the subsequent stages.

 

2. Internal controls: This step involves identifying, documenting, and evaluating the company’s internal controls—processes and policies used by the business to reduce the likelihood of errors in financial reporting and fraud.

 

3. Substantive testing: The purpose of this stage is to confirm the balances in the accounting data. It involves selective examination of transactions and collecting evidence to support the data in the accounting records. The most desirable evidence is obtained from third parties, such as bank statements, confirmations from customers and suppliers, invoices, and statements. Additionally, the auditor may physically observe assets, such as inventory and equipment. In some cases, substantive testing may involve only analytical review or reperformance, such as for depreciation or allowances.

 

Stay tuned for more information on auditor’s reports, their purpose, and impact in future materials.