Financial audits are one of several different types of audits conducted in the United States. They are a review of the financial statements of an organization to determine their accuracy. The organization can be a company, a nonprofit or government agency. The audits are conducted by an independent third party, who issues a finding when the audit is complete. The audit report describes the scope of the audit performed and the opinion, or summary. The opinion is published with the Securities and Exchange Commission and becomes public information.
Financial Statement Audits
A financial audit looks at the balance sheet, which is a summary of an organization’s financial position at a specific point in time. It examines the income statement, which measures a company’s financial performance over a period of time. The audit also examines the cash flow statement, which discloses all of the inflows and outflows of cash over a given time period. In addition to the financial statements, an audit performs ratio computations on the data provided by the statements. These ratio computations determine the company’s financial health. They demonstrate the company’s ability to pay long- and short-term debt.
Understanding the Audit Process
External and internal audits focus on the financials of an organization. While an external audit is conducted by an independent third party, the internal audit is conducted by the company's own auditors. The purpose of an internal audit is to determine whether the organization has any material weaknesses in its internal-controls processes. Internal audits are meant to uncover problems and fix them prior to the external audit engagement. If the independent audit publishes poor results, it will weaken the company’s credibility with potential investors. Audits reassure the public that a company is providing accurate and credible financial data. This reduces the risk of investing in companies with poor financial performance. Investors can research a company’s financials and make an educated decision on whether they can tolerate the level of risk that is associated with that particular organization.
Audits of public companies are recorded and published with the Securities and Exchange Commission. This organization oversees the financial and trading activities of the companies that are open for investment on the public markets. The SEC makes sure that the trading activities are transparent and accurate. This is meant to ensure stability in the stock markets. However, there have been several high-profile frauds that have called the regulating standards into question.
Stages of Financial Audits
The stages of a financial audit are: planning and risk assessment, internal controls testing, substantive procedures and finalization. In the planning and risk assessment stage, the major audit risks are determined. During the internal-controls testing phase, the effectiveness of internal controls are tested. They determine whether there is a proper separation of duties and verify account reconciliations. The substantive-procedures process is designed to reduce the possibility of a material misstatement. The finalization stage wraps up the audit with a report to management and the SEC certifying the findings.
Once the audit is complete, the opinion is rendered. There are four types of audit opinions: unqualified opinion, qualified opinion, adverse opinion and disclaimer. With the unqualified opinion, the auditor is stating that the financial statements are clean and accurate. The qualified opinion states that the audit was limited in scope but that the financial statements appear to be accurate. An adverse opinion means that the financial statements are misrepresented, misstated and do not accurately reflect the company’s financial position. Lastly, there is the disclaimer; it is the auditor's statement disclaiming any opinion concerning the company's financial position as a result of the inability to obtain relevant facts.
Financial audits are conducted by public accounting firms. These firms employ certified public accountants who have completed the educational and experience requirements to practice in that capacity. The certification consists of a four-part exam that covers audit standards and procedures. They are called the generally accepted auditing standards or GAAS. These standards set the rules and guidelines for conducting all audits within the United States.
Financial audits verify the information used to create financial statements. They help determine the liquidity, solvency and overall financial health of an organization. The investing community relies on this information to make responsible investing decisions. Without financial audits, fraud and financial deception would be rampant. It would be impossible to know whether a company was providing accurate information. Investing would be as risky as gambling in a casino.