Financial Statement Audit is considered to be one of the most important steps that are undertaken by listed companies in order to establish their compliance with the regulatory bodies. The main reason audits are performed two-fold.
Firstly, they help companies realize the shortcomings of their internal functions and how these can be subsequently improved in order to improve on metrics including efficiency and profitability.
Secondly, audits are conducted because they help protect external stakeholders in the sense that it identifies and further validates that there are no concerning thoughts within the organization.
In this regard, it can be seen that financial statement audits are perhaps the most widespread audits that are conducted are financial statement audits. Financial Statement Audits are considered imperative from the perspective of the company, as well as their stakeholders.
What is a Financial Statement Audit?
A financial statement audit is considered to be an examination of an entity’s financial statements as well as the relevant disclosures by an independent auditor. The best example of audit firms is KPMG, EY, PWC, and Deloitte. The main rationale behind conducting this particular audit is to ensure that all accounting principles, financial reporting standards, and related regulations are duly followed and to further validate that the financial statements are representative of the actual financial position of the organization.
It is probably the requirement of the shareholders of the company to have the financial statements audited by the independent auditor. In addition, and in most of the case, if the company is listed in the stock exchange, then the company need to get its financial statements audited by the auditor who approves by the stock exchange or regulator.
Therefore, when a financial statement audit takes place, the auditor is responsible for attesting to the fairness of the presentation of the financial statements, as well as related disclosures. In this aspect, the auditor’s assessment of the audit must also accompany the financial statements when they are duly issued to the reported entities.
What are the Stages followed in the Audit of Financial Statements?
There are five fundamental steps (or stages) that are followed during the Audit of Financial Statements. They are given below:
- Audit Planning
- Risk Assessment
- Audit Strategy
- Gathering evidence – Internal Control Testing
- Substantive Procedures
These five steps are conducted by auditors when they are auditing the financial statements. These five are fairly detailed steps, and the subsequent explanation for all these stages are mentioned below:
Audit Planning is considered to be the most important step that is undertaken by auditors before they officially begin the audit process. In this regard, it is important to properly plan the audit process so that the audit objectives are met.
This mainly involves gaining an understanding of the business, as well as the overall industry dynamics in this regard. The main premise behind understanding these dynamics is to assess the level of risks involved in the audit process and how these risks can be tackled in order to ensure that the audit is undertaken in a proper manner.
The audit planning is also involved with the timeline audit report setting as well as resources planning to make sure that the firm has enough resources to conduct the audit work. This stag is also involving the audit client’s KYC process depending on the individual firm’s policies.
As far as risk assessment is concerned, it can be seen that it is used to understand the inherent risk involved in the audit process. This mainly includes factors that they need to take into consideration in order to mitigate the amount of risk involved during the audit process.
Therefore, in order to do that, they need to identify the risks involved so that the overall risk profile is accordingly managed.
Devising an audit strategy before the actual audit process actually starts is considered to be an important phase in planning the audit process. It holds tantamount value in terms of determining the course of action in the audit process.
This strategy formulation helps the auditors to plan the audit process and ensure that all information and planning has been incorporated into their strategy for the way forward.
Devising a proper audit strategy is important because it helps to set up a trajectory regarding the future audit steps and how the audit team needs to cover ground pertaining to those subsequent steps.
Internal Controls Testing
Internal Control Testing basically revolves around the idea of ensuring that the company has a policy in place that can protect itself against any fraud or embezzlement.
During the audit process, the auditors are supposed to assess the efficacy of these safeguards in place within the company and the extent to which these controls are properly followed in the organization. For example, they need to test authorization protocols when handling checks, safeguarding of assets, as well as segregation of duties in place in order to avoid any unprecedented conflict of interest.
Therefore, the auditors need to test not only for the existence of these controls but also for the effectiveness of these controls. In the case where there are sufficient controls present, it is important for auditors to back some of their later audit procedures.
Test of the control is performing on the key or significant account, in most cases. And in general, before testing the control, the auditor performs the walkthrough testing to make sure that auditors themselves have a basis of understanding of the internal control before they test the control.
Once the control is completely tested, the auditor will make the conclusion of the control is working as intended or, in order words, if the control is operated efficiently and effectively.
If the control is not working as intended, which means that the control could not be reliance on, then the auditor will decide the volume of transactions that they are going to test to comfort themselves on the accounting balance or transactions that they are testing.
Substantive Procedure Testing
Substantive Procedures are defined as activities that are performed by the auditor in order to detect material misstatement or fraud at an assertion level. There are numerous different assertions that are supposed to be tested in this regard.
They are referred to as audit assertions. These need to be tested across all financial statements, as well as transaction-level statements. The assertions that are commonly tested include existence, rights and obligations, occurrence, and completeness.
In the same manner, it can also be seen that these substantive procedures are designed so that auditors can prevent them as evidence after they issue a particular opinion regarding the company.
As far as substantive procedures are concerned, there are three types of substantive tests that are conducted. They include the following:
- Analytical procedures
- Test of details and transactions
- Tests of details and list of balances
The Audit Process – Points to Consider
When devising the audit process, there are a couple of points that need to be considered in this aspect. These factors are something that all auditors should follow and preferably implement during the audit process. These issues that need to be considered during the scope of financial audit can be broadly categorized into the following:
- Professional judgment and skepticism: Professional judgment and skepticism are important from the perspective of an auditor. The auditor is supposed to ensure that he is able to proceed with the audit process, knowing that all professional ethics are kept intact, and he is able to maintain a certain degree of professional skepticism. In the same manner, the client (the organization whose financial statements are being audited) is supposed to cooperate in every possible way they can to ensure that audit is carried out in a smooth manner.
- Inherent Limitation of an Audit: When the financial audit is considered, the auditor is always reasonably assured, regardless of their proper execution towards the audit process. It is important to consider the fact that these limitations still need to be disclosed. It needs to be understood that auditors are supposed to give their opinion and not guarantee a particular outcome. This is something that should be considered by auditors when writing reports because this is an important disclosure that needs to be made.
- Auditor Independence: During the audit process, auditors need to ensure that they are able to work independently towards the audit process, without any conflict of interest, per se. In this regard, it is also important to keep professional and personal interests separate. In the case where auditor independence seems to be impaired, the best course of action is to separate from the audit process so that it is free and fair.
Therefore, it can be seen that audit of financial statements tends to be an increasingly important dynamic. There are numerous different issues that need to be accounted for by the organization that is appointing the auditor, as well as the auditor himself.
Followed by global scandals like Enron, and WorldCom, the importance of having an effective audit strategy in place cannot be denied at any cost.