FINANCIAL AUDITING

One fundamental reason for the continued progressive and profitable existence of the capital markets is the confidence and assurance on their profit or nonprofit making endeavors that organizations have sought to demonstrate to the world at large and specifically to investors in terms of audits. Audit gives confidence to investors and supports effective capital markets. It provides independent assurance to shareholders that the directors have prepared the financial statements properly and that those statements provide a true and fair view. Additionally, although not its primary purpose, the existence of an audit acts as a deterrent to fraud. The price of implementing the most effective anti fraud controls including financial controls, operational controls, physical security of inventory, employee training, detailed fraud assessment, audits and the like- would never amount to more than one-tenth the amount of money lost to fraud in a year (Goldmann and Kaufman 1953) Given its importance, audit must be done well and investors must have justifiable confidence in its quality. Audit quality is not driven by auditors alone. Auditors report on the financial statements which have been prepared under particular accounting standards. Corporate behavior also plays a significant role. Boards are stewards of investors money and have a responsibility for ensuring that the corporate culture and environment is one which encourages open dialogue with their auditors at all levels. An independent financial statement audit is conducted by a registered certified public accountant or public accounting firm. It includes examining, on a test basis, evidence supporting the amounts and disclosures in the companys financial statements, an assessment of the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation to form an opinion on whether the financial

statements taken as a whole are free of material misstatement. The independent auditors main goal is to provide financial statement users with reasonablebut not absoluteassurance that the financial statements prepared by management are fairly presented. To communicate that assurance, the independent auditor provides a report that includes an opinion about whether the companys financial statements are fairly presented, in all material respects, in conformity with generally accepted accounting principles (GAAP).

There are four different audit steps followed in every financial or system audit: planning and risk assessment, testing of internal controls, substantive procedures, and finalization. The purpose of these audit steps is to provide a standard process that is used in every audit. In most organizations, an audit is conducted by the internal audit department or an external auditing or accounting firm. Planning and risk assessment audit steps are typically conducted before the fiscal year end and are used to gather information. The auditor takes the time to learn about the industry, regulations, accounting policies, and information systems. During this stage, many auditors work from a remote location, as most of this information is available from independent sources. In order to effectively plan the audit, the overall scope must be evaluated and documented. A standard financial audit is limited in scope to transactions that occurred in the current period and is often completed at a summary level. The number of transactions and dollar values are used to determine the upper and lower bounds that will be used to set the audit values. The industry, strength of internal controls, and any issues raised by management determine the risk assessment for the audit.

One of the most important of all the audit steps is the process of testing the internal controls. These processes and procedures are used to ensure that proper approvals are in place before

payment is made or transactions entered in the system. The primary method of internal control testing is to randomly select transactions and check the source documentation. If a random selection from a representative sample finds controls were weak or missing, then the sample size must be increased. The general auditing standard requires that the auditor exercise due professional care in the planning and performance of the audit. Due professional care requires that the auditor exercise professional skepticism, which is an attitude that includes a questioning mind and a critical assessment of audit evidence. Substantive procedures is the actual process of collecting physical evidence of transactions and verifying the value posted to a specific account is supported by actual documents. This aspect of the audit is the most time consuming and is very detailed work. The account selected for this type of review varies, but is typically one that tracks a range of high and low dollar value activity. The last stage of the audit is finalization. This is the creation of a report to management that summarizes all the procedures used to conduct the audit, the result of the various processes, and supporting documentation. Audit reports have a variety of formats or layouts used, depending on the audience. For example, most banks require audited financial statements when applying for a business loan. They often have a preferred format, making the comparison and review a simpler process. At the conclusion of the audit, the independent auditor issues the audit report. This report contains three main elements: An introduction that identifies the financial statements that were audited and the division of responsibility between the independent auditor and management. A discussion of the scope of the engagement, which

describes the nature of the audit. The independent auditors opinion on the financial statements. If the independent auditor concludes that the financial statements, taken as a whole, present fairly, in all material respects, the financial position, results of operations and cash flows of the company in accordance with the appropriate financial reporting framework (e.g., U.S. GAAP), the independent auditor issues what is known as a standard unqualified opinion. It is important to recognize that, even though the audit is planned and performed at the individual account level, independent auditors express an opinion on the financial statements taken as a whole. Independent auditors do not provide opinions on individual accounts or disclosures.

References

Boynton, William C. and Johnson, Raymond N. (2005). Modern auditing: Assurance services and the integrity of financial reporting. Cunningham, Lawrence A (2009). Introductory accounting, finance and auditing for lawyers. Switzer, Susan M. (2007). Internal Audit reports post Sarbanes Oxely: A guide to process driven reporting Verschoor, Curtis C. (2008). Audit committee essentials