A business carries out several transactions in a year. How are auditors able to audit businesses and issue opinions? How do we perform financial statement audits?
I’ll take you on a short tour of how auditors perform financial statement audits. Taking the time to understand how financial statement audits are performed helps you get the most out of your annual audits.
Businesses prepare financial statements that other users depend on to make important decisions. These users must be certain that the information is reliable. Financial statement audits give users confidence that the financial statements are reliable.
How are financial statement audits performed?
The managers of a business structure their accounting systems to provide reliable information for running their business. The type and extent of tests that auditors perform depends on how they assess the risk of material misstatement. They do more tests if the risk is high and fewer tests if the risk is low. They have a variety of tests they can perform depending on the situation.
This is how typical financial statement audits are performed:
- The audit begins with planning and risk assessment. Here the auditor seeks to understand your business – its objectives, industry, market, competition, among others. He gathers all the relevant information about your business, so he can form a picture of the risks that could prevent your business from meeting its objectives. He focuses on those risks that could create errors in the financial statements and develops a detailed plan of how he will perform the audit.
- The next stage is the risk response phase- the auditor performs several tests and reviews various sources of evidence to answer these questions:
- Existence and occurrence – do the assets and liabilities exist? Have the transactions occurred and do they pertain to the business?
- Completeness – has the business recorded all transactions and events that occurred?
- Accuracy – are the amounts recorded correct and are transactions accurately classified?
- Valuation – are the value of assets, liabilities and equity appropriate?
- Presentation and disclosure – have the financial statements properly presented the assets, liabilities, income, expenses and other information? Are the disclosures accurate and complete?
- Finally, the auditor forms his audit opinion and prepares his audit report. At this stage, the auditor has gathered evidence from various sources and concluded on the different components of the financial statements. Putting it all together, he assesses whether the financial statements are free of errors, and whether they conform to the applicable reporting standards. The auditor then issues an appropriate opinion. He also sends a management letter containing observations and recommendations to management.
To get the most value out of your audit, you need to engage your auditor at each stage of the audit;
- Planning and Risk Assessment Stage – get your auditor to share his audit plan with you, key risks he has identified and how he plans to address those risks through the audit. You may learn about new risks that may pose a threat to your business during this stage, so you can put measures in place to mitigate them.
- Risk Response Stage – take a keen interest in your internal controls and ask the auditor to let you know if he finds any weaknesses when he tests your controls. Encourage your auditor to share audit issues with you as he discovers them, so you can help to resolve them.
- Reporting Stage – address the issues the auditor raises in the management letter and work to resolve them. Put systems in place to ensure that the audit issues do not recur.
Audits can help you build and strengthen your accounting systems for the growth and stability of your business. Now that you know how financial statement audits are performed, during your next audit engage your auditor to help you understand the weaknesses in your financial systems, so you can address them effectively.