Financial Statement Audit
A financial statement audit is the examination of an entity’s financial statements and accompanying disclosures by an independent auditor, with the result being a report by the auditor, attesting to the fairness of presentation of the financial statements and related disclosures.
The auditor’s report must accompany the financial statements when they are issued to the intended recipients.
The main purpose of a financial statement audit is to add credibility to the reported financial position and performance of a business. The Securities and Exchange Commission requires that all entities that are publicly held must file annual reports with it that are audited.
Similarly, lenders typically require an audit of the financial statements of any entity to which they lend funds.
Suppliers may also require audited financial statements before they will be willing to extend trade credit (though usually only when the amount of requested credit is substantial).
Audits have become increasingly common as the complexity of the two primary accounting frameworks, Generally Accepted Accounting Principles and International Financial Reporting Standards, have increased, and because there has been an ongoing series of disclosures of fraudulent reporting by major companies.
Before we proceed further, it is considered necessary that one should understand the relationship between accounting and auditing.
The need for independent audits of financial statements can be attributed to four conditions as follows:
Many users of financial statements are concerned about ah actual or potential conflict of interest between themselves and the management of the reporting entity.
This apprehension extends to a fear that the financial statements and accompanying data prepared by management may be intentionally biased in management’s favor.
Thus, users seek assurance from outside independent auditors that the information is both;
i. free from management bias, and neutral concerning the various user groups.
Published financial statements are the only source of information for users in making significant investments, lending and other decisions.
So statement users look to the independent auditor for assurance’ that the financial statements have been prepared in conformity with GAAP, including all the appropriate disclosures.
As the level of complexity of accounting increases, so does the risk of misinterpretations and unintentional errors. So to evaluate the quality of the financial statements, users rely on independent auditors.
Distance, time and cost make it impractical even for the most knowledgeable users of financial statements to seek direct access to the underlying accounting records to perform their verifications of the financial statement assertions. So users rely on the independent auditor’s report to meet their needs.
The present-day the need for independent audits of financial statements is increasing day by day.
On account of the following advantages people get their accounts audited:
1. Conflicts of interest exist among the different classes of users of financial statements, such as creditors and stockholders. In this case, auditing helps the users by assuring from outside independent auditors that the information is both: (1) free from management bias and (2) neutral concerning the various user groups.
2. Users want financial statements to contain as much relevant data as possible. This relevance is assured by the independent auditors.
3. Since the subject matter of accounting and the process of preparing financial statements have become increasingly complex, the risk of misinterpretations and unintentional errors is increasing. To evaluate the quality of the financial statements, users rely on independent auditors to access the quality of the information contained therein.
4. Distance, time and cost make it impractical for the most knowledgeable users of financial statements to seek direct access to the underlying accounting records. So users rely on the independent auditors report meeting their needs.
5. Errors and frauds are located at an early date and in future no attempt are made to commit such frauds or one is rather careful not to commit an error or a fraud as the accounts are subject to regular audit.
6. The auditing of accounts keeps the accounts clerks regular and vigilant as they know that the auditors would complain against-them if the accounts -are not prepared up-to-date or if there is any irregularity.
7. In case of fire, the insurance company may settle the claim based on the audited accounts of the previous years.
8. Money can be borrowed easily based on the previous audited balance sheet.
9. If the business is to be sold as a going concern, there will not be much difficulty regarding the valuation of assets and goodwill as the accounts have already been subject to audit by an independent person.
10. Income tax authorities generally accepted the profit and loss account which has been prepared by a qualified auditor and they do not go into details of the accounts.
11. The management may consult the auditor and seek his advice on certain technical points although it is not the duty of an auditor to give advice.
12. If the accounts have been prepared on a uniform basis, accounts of one year can be compared with other years and if there is any discrepancy, the cause may be enquired into.
13. Audited accounts are considered more or less correct by the sales tax authorities.
14. It would facilitate the settlement of the accounts of a deceased partner.
15. Auditing acts as an alternative to an internal control system.
Sole traders and partnerships are under no legal obligation to get their accounts audited but because of the advantages derived, they generally have their accounts audited.