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CHAPTER 19

FINANCIAL AUDIT

A financial audit is an independent, objective evaluation of an organization's financial reports and financial reporting processes. The primary purpose for financial audits is to give regulators, investors, directors, and Managers reasonable assurance that financial statements are accurate and complete.

The audit opinion is intended to provide reasonable assurance, but not absolute assurance, that the financial statements are presented fairly, in all material respects, and/or give a true and fair view in accordance with the financial reporting framework.

The purpose of an audit is to provide an objective independent examination of the financial statements, which increases the value and credibility of the financial statements produced by management, thus increase user confidence in the financial statement, reduce investor risk.

Through a variety of different audit procedures such as interviews, observation, and test work, financial auditors can determine if controls and processes needed to produce accurate financial statements are in place.

If the controls and processes are in place, then they can conclude that the financial statements are accurate and reasonable, but they still can't guarantee that there were no human errors or miscommunications that may lead to a mistake.

There are many different groups of stakeholders that want to make sure the financial statements they see are accurate and complete.

Regulators want to make sure organizations comply with applicable laws and present their financial health accurately for tax reasons.

Investors select investments based on financial health, so their investments are only as good as the information they have.

Managers and directors want to be assured that there are controls in place to stop assets from being misused or lost.

The person who performs the work of audit is known as auditor.

In accounting and business, there are two types of auditing – external auditing and internal auditing.

External auditing

It refers to the independent examination of an entity’s financial statements and other accounting records that an entity publishes for the use of external parties.

The auditor gives his opinion about the fairness of all accounting information examined by him.

An important element of “fairness” is the compliance of financial statements with the generally accepted accounting principles (GAAP).

Financial audits are typically performed by firms of practicing accountants who are experts in financial reporting.

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Internal auditing

Many organizations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organization.

Internal auditing is performed to determine whether or not the policies and procedures set by management are being followed.

An important purpose of internal auditing is to evaluate whether the activities performed by the employees at various levels are in line with the goals set by management.

Internal auditing may be performed by the existing accountants; however, many companies employ special staff for this purpose.

Auditor’s Opinion on Financial Statements

Auditors must release an opinion of the overall financial statements in the auditor's report.

The opinions can be as follows:

Unqualified report

The unqualified auditor's opinion is the opinion that the financial statements are presented fairly.

Qualified report

A qualified opinion is that the financial statements are presented fairly in all material respects in accordance with Generally Accepted Accounting Principles(GAAP), except for a material misstatement that does not however pervasively affect the user's ability to rely on the financial statements.

A qualified opinion can also be issued for a scope limitation that is of limited significance.

Disclaimer of Opinion

Further the auditor can instead issue a disclaimer, because there is insufficient and appropriate evidence to form an opinion or because of lack of independence.

In a disclaimer the auditor explains the reasons for withholding an opinion and explicitly indicates that no opinion is expressed.

Adverse report

An adverse audit opinion is issued when the financial statements do not present fairly due to departure from GAAP and the departure materially affects the financial statements overall.

In an adverse auditor's report the auditor must explain the nature and size of the misstatement and must state the opinion that the financial statements do not present fairly in accordance with GAAP.

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Basic Procedures for a Financial Audit

Generally, four key phases are outlined for financial audit process.

These phases include planning the audit, determining the working of internal control, testing significant assertions about the data and evaluating compliance, and reporting the evaluations.

These phases are explained below:

 Planning

The process of financial audit begins with a plan that involves the method of collecting data to form an opinion about the organization or company’s financial status.

A way is planned to collect a sample reflecting a point in time in the life of the company or organization.

The financial transactions and documents are then looked at.

It is noteworthy that the sample should show compliance with GAAP.

 Internal controls

The next step involves giving a look at the internal controls.

The auditor demands info, looks closely at the records, and watches financial procedures in action.

Without these steps, the auditor cannot give a statement about the financial status of the organization.

 Testing

Testing implies checking whether the internal controls are working or not.

An auditor requests more info, returns to the company for more inspections, and watches how financial procedures are being performed.

If the evidence demonstrates GAAP compliance, the auditor determines that the company successfully detects and prevents the errors.

 Reporting

The final step in financial audit involves giving a conclusion on how the company adheres to accounting standards.

The audit from an Auditor gives the organization an unqualified approval, a qualified approval, a disclaimer, or an adverse finding.

The unqualified approval is considered as the best result and the adverse finding is considered to be the worst result.

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Visual / diagram content

There are no separate diagrams, tables, or illustrations in these three pages. The material is text-based and covers:

• Financial audit and its purpose

• External auditing

• Internal auditing

• Four types of auditor's opinions:

  • Unqualified report

  • Qualified report

  • Disclaimer of Opinion

  • Adverse report

• Four basic financial-audit procedures:

  • Planning

  • Internal controls

  • Testing

  • Reporting