Financial statement audits: 10 things you need to know

There comes a time in the lives of most growing businesses when audited financial statements become necessary or desirable. Here are 10 things to consider as you prepare your business for its first audit.

1. What is an audit?

An audit is the highest level of financial statement service CPAs offer. An unqualified (“clean”) audit opinion provides financial statement users with a high — though not absolute — level of assurance that a company’s financial statements and related disclosures are presented fairly and conform, in all material respects, to generally-accepted accounting principles (GAAP).

2. Who needs one?

An audit may be required by a third-party user of your company’s financial statements, such as a lender, investor (or other funding source) or government regulator. Public companies are required to provide audited financial statements to their shareholders and file them with the Security and Exchange Commission. Even if not required, many companies choose to have audits performed anyway because they can yield valuable benefits. For example, an audit can help a company ensure the accuracy of its financial information, and can help identify weaknesses in internal controls and ways to improve internal controls.

3. What types of evidence does an auditor examine to verify the accuracy of your financial statements?

Typically, auditors obtain evidence through inspection (of documents or tangible assets, for example), inquiries, observation, third-party confirmations, testing of selected transactions and other procedures.

4. Is the auditor required to examine all transactions underlying the financial statements?

No. The purpose of an audit is to provide reasonable, but not absolute, assurance that the financial statements are free of material misstatements. The auditor exercises professional judgment in determining whether the magnitude of a misstatement or misstatements is sufficient to be material to financial statement users — that is, whether it could influence users’ economic decisions. Practically speaking, an auditor can’t test every transaction, but he or she will conduct more extensive testing in areas that present a greater risk of material misstatement.

5. Does the auditor review your company’s internal controls?

Yes. The auditor gains an understanding of internal controls over financial reporting in order to understand your business, assess risk and design appropriate audit procedures. For example, if the auditor discovers internal control weaknesses in certain areas, he or she may conduct more rigorous testing in those areas. The auditor does not, however, express an opinion on the effectiveness of the company’s internal controls.

6. Are there options short of an audit that will satisfy lenders or other financial statement users?

CPAs also provide review and compilation services, which may be acceptable to some financial statement users. A review provides limited assurance, based primarily on analytical procedures and inquiries, that the CPA is not aware of any material modifications necessary for the financial statements to conform to GAAP. It does not involve gaining an understanding of the company’s internal controls or any testing of the underlying data. Reviewed financial statements include the same disclosures as audited financial statements. In a compilation, the CPA simply assists management in presenting financial information in financial statement format, without offering any assurance as to its reliability.

7. Do all CPAs perform audits?

No. It’s important to work with a CPA firm that has significant auditing expertise as well as experience auditing companies in your industry and size range.

8. How should you prepare for your first audit?

Ensure that your financial documents and accounting software are in order. This includes ensuring that all account balances are reconciled with supporting documentation. Work closely with the audit firm to define mutual expectations regarding time commitments and deliverables.

9. Can your auditor prepare your company’s tax returns or financial statements?

Yes. Care must be taken, however, to ensure that the auditor does not impair his or her independence, as CPAs must be independent of the companies that they audit.

10. What are the most important criteria in selecting an audit firm?

Make sure the firm you choose has a solid reputation in the financial community and the qualifications, staffing, and industry experience to perform the audit.

Published in Audit & Assurance

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