Auditing Financial Statements

October 2, 2015 by Ed Becker

 An audit of financial statements by an external source allows users of the financial statements to have a professional, outside opinion regarding the truth and fairness of the statements. Because financial statements are often prepared by persons that are not the owners or stakeholders of the company, having an external audit offers reassurance that the accounts do not have misstatements and are true and fairly reported. Audits of this nature basically fall into the checks and balances required to assure that there is an accurate view of the financial status of the company.

Not only do stakeholders and owners need the assurance of accuracy, users of the financial statements outside of the company also rely on the auditor’s opinion.

• Tax professionals must use the financial statements to ensure the accuracy of tax returns. They rely on the external audits to assure that the financial statements are fairly reported.
• Financial institutions will usually require audited copies of the financial statements from companies wishing to borrow funds. This allows the financial institution to assess credit risk by analysis of the financial position and liquidity.
• Management is not an outside entity, but they rely on the financial statements after audit to evaluate risk management. It also allows them to reevaluate internal controls according to the auditor’s opinions and feedback during the audit.

Inherent limitations include the following:

• Professional judgement

Auditing standards provide guidelines to help produce sound and professional judgements and opinions. But there is still the inherent risk of personal judgement on the part of the auditor.

• Sampling

To stay within time and cost budgets, auditors will use sample testing of transactions and balances to test the accuracy. This creates an inherent risk that there could be misstatements that are not caught by the audit.

• Representations from management

Auditors collect their evidence from many sources. Preferably external sources, for reliability purposes. Not all evidence has external sources and must be retained from management. Management representations in areas where they have to use personal judgement, could be less reliable.

• Fraud risk

Anyone that is dealing in fraud intends to conceal it well. They hope, well enough that even an auditor will not suspect it. The risk of fraud detection is high even if the audit is thorough and complete.

• Time

Due to deadlines, an audit could be prioritized and miss something in the process. Auditors must prioritize tasks to meet the deadlines. This being the case a full and complete audit may or may not get completed.

• Independence issues

Using an external auditor should assure a non-bias opinion. But if the company is a major client for the auditor, they could possibly lower the level of ethics if they, even unconsciously, think they could lose revenue.

• Scope

Nonfinancial matters are not a part of the audit process, unless there is relevance to the financial statements. The audit is limited to detecting misstatements in the transactions and events.

The auditing of financial statements intends to offer reasonable assurance that the statements are accurate. However, there is no absolute guarantee of them being 100% free from misstatements. There are inherent limitations of an audit that will not allow for the possibility of absolute accuracy guarantees. The reasonable assurance is cost effective as well as time effective in order to offer a third party opinion and feedback.