Understanding Financial Audits: Process, Purpose, and Key Stages

Introduction to Financial Audits

A financial audit, or more accurately, an audit of financial statements, is the review of the financial statements of a company or any other legal entity (including governments), which results in the publication of an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented.

Financial audits are typically performed by firms of practicing accountants due to the specialist financial reporting knowledge they require. The financial audit is one of many assurance or attestation functions provided by accounting and auditing firms, whereby the firm provides an independent opinion on published information.

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. External auditors may choose to place limited reliance on the work of internal auditors.

Purpose of a Financial Audit

Financial audits exist to add credibility to the implied assertion by an organization's management that its financial statements fairly represent the organization's position and performance to the firm's stakeholders (interested parties). The principal stakeholders of a company are typically its shareholders; but other parties such as tax authorities, banks, regulators, suppliers, customers, and employees may also have an interest in ensuring that the financial statements are accurate.

The audit is designed to reduce the possibility of a material misstatement. A misstatement is defined as false or missing information, whether caused by fraud (including deliberate misstatement) or error. Material is very broadly defined as being large enough or important enough to cause stakeholders to alter their decisions.

The exact 'audit opinion' will vary between countries, firms, and audited organizations. In the US, the Certified Public Accountant (CPA) firm provides written assurance that financial reports are 'fairly presented in conformity with generally accepted accounting principles (GAAP).' The measure for 'fairly presented' is that there is less than 5% chance (5% audit risk) that the financial statements are 'materially misstated'.

Stages of an Audit

A financial audit is performed before the release of the financial statements (typically on an annual basis), and will overlap the 'year-end' (the date to which the financial statements relate).

The following are the stages of a typical audit:

1. Planning and Risk Assessment

Timing: Before year-end

Purpose:

• To understand the business of the company and the environment in which it operates.

What Should Auditors Understand?