Objectives of a Financial Statement Audit
This article explains the objectives of the financial statement audit. These audits are meant to provide reasonable assurance to creditors and investors that the the financial statements are correct.
Audits are intended to disclose any irregular or illegal practices. At the end of an audit, the CPA issues an opinion as to the health of the company. Such opinions must be objective.
When they are not, the public is misled and legal action can be taken against the companies. For example, in 2001, Enron, an energy provider, and their CPA firm, Arthur Anderson, were found guilty of misstating the financial statements. Enron, once a blue-chip stock company, was falsely reporting revenues and profits. Arthur Anderson was issuing positive audit opinions that supported Enron, and masked the fraud. Enron was bankrupt and sold. Arthur Anderson, once one of the largest CPA firms in the world, was dissolved.
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Objective
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The objective of a financial statement audit is to provide an opinion, based on the assertions of management, as to the health and stability of the organization being audited. An audit relies on the records of the organization's management. It is the responsibility of the auditor to gather supporting evidence from management's records, customers and creditors to support an opinion.
Opinions
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The opinion rendered as a result of the financial statement audit can be
- A disclaimer of opinion, meaning the auditor can't give an opinion on the financial statements.
- Adverse, meaning the auditor has found the financial statements to be materially misrepresented.
- Qualified, meaning the auditor found one or two situations where the statements did not follow GAAP (Generally Accepted Accounting Practices).
- Unqualified, the best opinion, where the auditor found the financial statements are presented fairly, in accordance with GAAP.
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Assertions
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Financial statement audits are used to ensure that creditors and investors have a reasonably presentation to decide on lending limits and stock safety.
The assertions of management are stated in the financial statements. The financial statements are made up of the balance sheet, the income statement, and the cash flow statement. The balance sheet represents the net worth of the organization. The income and cash flow statements support the balance sheet, and represent the overall accounting management of the organization.
Balance Sheet
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The balance sheet represents the health and stability of the organization. On the statement, the assets, liabilities and net worth are presented. The objective of the financial audit is to test the truth of these three assertions and present an opinion that the assets are sufficient to cover the liabilities.
The assets represent the liquidity of the organization. This liquidity contains short-term and long-term assets. The liquidity is the amount that could be used by creditors and investors to cover the liabilities of the organization and obtain some return on investment.
The liabilities represent the outstanding debt of the company. Ideally, the assets should cover the liabilities. The assets less the liabilities equal the net worth.
Income Statement and Cash Flow Statement
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Retained earnings and current net income, as stated in the income statement, represent the net worth. The retained earnings represent the funds or investment of the organization in itself, and retained for the purpose of paying dividends and debt.
The current net income, as reported on the income statement, represents the ability of management to generate revenue and pay expenses with funds left over each month.
The cash flow statement shows creditors and investors the operational, funding and investment activities of the organization.
The financial statement audit is intended to render an opinion on the management's ability to sufficiently protect the assets of the organization and properly manage the funds.
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