|Accountant · Bookkeeping · Trial balance · General ledger · Debits and credits · Cost of goods sold · Double-entry system · Standard practices · Cash and accrual basis · GAAP / IFRS|
|Balance sheet · Income statement · Cash flow statement · Equity · Retained earnings|
|Financial audit · GAAS · Internal audit · Sarbanes–Oxley Act · Big Four auditors|
|Fields of accounting|
|Cost · Financial · Forensic · Fund · Management · Tax|
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.
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 that a material misstatement is not detected by audit procedures. 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.
Audits exist because they add value through easing the cost of information asymmetry, not because they are required by law. For example, a privately-held company that does not issue securities on a public exchange might engage a firm to audit its financial statements in order to obtain more desirable loan terms from a financial institution or trade accounts with its customers. Without the audit, the lending party would not have assurance as to whether or not the company's financial position is accurate. In turn, the lender could price protect against this information asymmetry.
The exact form and content of the "audit opinion" will vary between countries, firms and audited organizations.
In the US, the CPA firm provides written assurance that financial reports are fairly presented, in all material respects, in conformity with generally accepted accounting principles (GAAP), where the threshold for materiality is determined via auditor's judgment.
The earliest surviving mention of a public official charged with auditing government expenditure is a reference to the Auditor of the Exchequer in England in 1314. The Auditors of the Imprest were established under Queen Elizabeth I in 1559 with formal responsibility for auditing Exchequer payments. This system gradually lapsed and in 1780, Commissioners for Auditing the Public Accounts were appointed by statute. From 1834, the Commissioners worked in tandem with the Comptroller of the Exchequer, who was charged with controlling the issue of funds to the government.
As Chancellor of the Exchequer, William Ewart Gladstone initiated major reforms of public finance and Parliamentary accountability. His 1866 Exchequer and Audit Departments Act required all departments, for the first time, to produce annual accounts, known as appropriation accounts. The Act also established the position of Comptroller and Auditor General (C&AG) and an Exchequer and Audit Department (E&AD) to provide supporting staff from within the civil service. The C&AG was given two main functions – to authorise the issue of public money to government from the Bank of England, having satisfied himself that this was within the limits Parliament had voted – and to audit the accounts of all Government departments and report to Parliament accordingly.
Auditing of UK government expenditure is now carried out by the National Audit Office. Sing industry (acting through various organisations throughout the years) as to the accounting standards for financial reporting, and the U.S. Congress has deferred to the SEC.
This is also typically the case in other developed economies. In the UK, auditing guidelines are set by the institutes (including ACCA, ICAEW, ICAS and ICAI) of which auditing firms and individual auditors are members.
Accordingly, financial auditing standards and methods have tended to change significantly only after auditing failures. The most recent and familiar case is that of Enron. The company succeeded in hiding some important facts, such as off-book liabilities, from banks and shareholders. Eventually, Enron filed for bankruptcy, and (as of 2006) is in the process of being dissolved. One result of this scandal was that Arthur Andersen, then one of the five largest accountancy firms worldwide, lost their ability to audit public companies, essentially killing off the firm.
A recent trend in audits (spurred on by such accounting scandals as Enron and Worldcom) has been an increased focus on internal control procedures, which aim to ensure the completeness, accuracy and validity of items in the accounts, and restricted access to financial systems. This emphasis on the internal control environment is now a mandatory part of the audit of SEC-listed companies, under the auditing standards of the Public Company Accounting Oversight Board (PCAOB) set up by the Sarbanes-Oxley Act.
Many countries have government sponsored or mandated organizations who develop and maintain auditing standards, commonly referred to generally accepted auditing standards or GAAS. These standards prescribe different aspects of auditing such as the opinion, stages of an audit, and controls over work product (i.e., working papers).
Some oversight organizations require auditors and audit firms to undergo a third-party quality review periodically to ensure the applicable GAAS is followed.
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:
Timing: before year-end
Timing: before and/or after year-end
Timing: after year-end (see note regarding hard/fast close below)
Timing: at the end of the audit
One of the major issues faced by private auditing firms is the need to provide independent auditing services while maintaining a business relationship with the audited company. The auditing firm's responsibility to check and confirm the reliability of financial statements may be limited by pressure from the audited company, who pays the auditing firm for the service. The auditing firm's need to maintain a viable business through auditing revenue may be weighed against its duty to examine and verify the accuracy, relevancy, and completeness of the company's financial statements. Numerous proposals are made to revise the current system to provide better economic incentives to auditors to perform the auditing function without having their commercial interests compromised by client relationships. Examples are more direct incentive compensation awards and financial statement insurance approaches. See, respectively, Incentive Systems to Promote Capital Market Gatekeeper Effectiveness and Financial Statement Insurance.