AUDIT:
  A financial audit, or more accurately, an audit of financial statements, is the review of the financial statements of a company or any other legal entity (including governments), resulting in the publication of an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented.
  Financial audits are typically performed by firms of practicing accountants due to the specialist financial reporting knowledge they require. The financial audit is one of many assurance or attestation functions provided by accounting and auditing firms, whereby the firm provides an independent opinion on published information.
  Many organisations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organization. External auditors may choose to place limited reliance on the work of internal auditors.
   
  Purpose:
  Financial audits exist to add credibility to the implied assertion by an organization's management that its financial statements fairly represent the organization's position and performance to the firm's stakeholders (interested parties). The principal stakeholders of a company are typically its shareholders, but other parties such as tax authorities, banks, regulators, suppliers, customers and employees may also have an interest in ensuring that the financial statements are accurate.
  The audit is designed to reduce the possibility of a material misstatement. A misstatement is defined as false or missing information, whether caused by fraud (including deliberate misstatement) or error. Material is very broadly defined as being large enough or important enough to cause stakeholders to alter their decisions.
  The exact 'audit opinion' will vary between countries, firms and audited organisations.
  In the US, the CPA firm provides written assurance that financial reports are 'fairly presented in conformity with generally accepted accounting principles (GAAP).' The measure for 'fairly presented' is that there is less than 5% chance (5% audit risk) that the financial statements are 'materially misstated'.
   
  Stages of an audit:
  A financial audit is performed before the release of the financial statements (typically on an annual basis), and will overlap the 'year-end' (the date which the financial statements relate to). The following are the stages of a typical audit:
   
  Planning and risk assessment:
  Timing: before year-end
   
  Purpose:
 
  • To understand the business of the company and the environment in which it operates.
  • What should auditors understand?[1]
  • The relevant industry, regulatory, and other external factors including the applicable financial reporting framework
  • the nature of the entity
  • the entitys selection and application of accounting policies
  • the entitys objectives and strategies, and the related business risks that may result in material misstatement of the financial statements
  • the measurement and review of the entitys financial performance
  • internal control relevant to the audit
  • to determine the major audit risks (i.e. the chance that the auditor will issue the wrong opinion). For example if sales representatives stand to gain bonuses based on their sales and they account for the sales they generate they have both the incentive and the ability to overstate their sales figures thus leading to overstated revenue. In response the auditor would typically plan to increase the rigour of their procedures for checking the sales figures.
   
  Internal controls testing:
  Timing: before and/or after year-end
   
  Purpose:
 
  • To assess the operating effectiveness of internal controls (e.g. authourisation of transactions, account reconciliations, segregation of duties). If internal controls are assessed as effective, this will reduce (but not entirely eliminate) the amount of 'substantive' work the auditor needs to do (see below).
   
  Notes:
 
  • In some cases an auditor may not perform any internal controls testing, because he/she does not expect internal controls to be reliable. When no internal controls testing is performed, the audit is said to follow a substantive approach.
  • This test determines the amount of work to be performed i.e. substantive testing or test of details.
   
  Substantive procedures:
  Financial audits exist to add credibility to the implied assertion by an organization's management that its financial statements fairly represent the organization's position and performance to the firm's stakeholders (interested parties). The principal stakeholders of a company are typically its shareholders, but other parties such as tax authorities, banks, regulators, suppliers, customers and employees may also have an interest in ensuring that the financial statements are accurate.
  The audit is designed to reduce the possibility of a material misstatement. A misstatement is defined as false or missing information, whether caused by fraud (including deliberate misstatement) or error. Material is very broadly defined as being large enough or important enough to cause stakeholders to alter their decisions.
  The exact 'audit opinion' will vary between countries, firms and audited organisations.
  In the US, the CPA firm provides written assurance that financial reports are 'fairly presented in conformity with generally accepted accounting principles (GAAP).' The measure for 'fairly presented' is that there is less than 5% chance (5% audit risk) that the financial statements are 'materially misstated'.
   
  Finalization:
  Timing: at the end of the audit
   
  Purpose:
 
  • To compile a report to management regarding any important matters that came to the auditor's attention during performance of the audit,
  • To evaluate and review the audit evidence obtained, ensuring sufficient appropriate evidence was obtained for every material assertion
  • To consider the type of audit opinion that should be reported based on the audit evidence obtained.