A financial audit ensures that the financial statements are prepared in accordance with the applicable reporting framework (GAAP). It increases the confidence of the public, the government, and other stakeholders in the company about the reliability of the financial statements.
The law requires publicly listed companies to perform a statutory audit every year. Private companies need to get their financial statements audited to avoid any discrepancies and errors in the company’s records. This article will guide you about how an accounting process audit can be performed smoothly.
Types of Financial Audits
There are different kinds of audits because an audit could include investigating a company’s financial records, analyzing a company’s internal controls, or focusing on the efficiency of management’s operating procedures.Â
Various types of audits are used for specific areas, for instance, when you need to check the data privacy measures of a company, an information system audit will be performed.
Some of the types of audits are mentioned below:
1. Internal Audit
An internal audit is performed by the employees within a company who ensure the effectiveness of management operations, internal control, and policies. It helps businesses evaluate their risks and make informed decisions.
2. External Audit
External audits are performed by an independent firm that is not a permanent employee of the company. External auditors are hired by the shareholders to boost their confidence in the credibility of the financial statements.
3. Financial Statement Audit
A financial statement audit is performed by independent auditors. The auditors examine the financial statements for any material misstatements and give an opinion based on evidence if the financial statements are prepared in accordance with the applicable reporting framework.
4. Operational Audit
Operational audits can be performed by internal and external auditors. Operational auditing includes analyzing the processes, systems, and procedures of the company’s activities.
5. Forensic Audit
A forensic accountant will look out for any manipulation in the company’s accounts. If any illegal activity is observed, the forensic accountant will gather evidence regarding it to use in court.
Steps While Conducting an Accounting Audit
Once you have a clear understanding of different audits and their purpose, the next step will be to divide the big picture into smaller steps.
In the coming section of the article, we have listed all the steps while conducting an accounting audit process:
Understand Your Purpose
It’s important for stakeholders to understand the purpose of hiring a CPA. The primary purpose of a CPA is to give an independent, qualified opinion, and for that, a CPA must have strong ethical values and necessary certifications.
Since each audit is different, you may need a different strategy to interpret the financials of a company.
For example, if a CPA is hired to perform a statutory audit, then the CPA will perform various procedures to ensure the credibility of the financial statements.
Decide the Audit Criteria
If you are going to perform an audit, then it is mandatory to decide the accounting standards against which the subject matter will be evaluated.
If the audit criteria are not defined, then the purpose of the audit is lost.
For instance, for a financial statement audit, the suitable criteria is to use Generally Accepted Accounting Principles (GAAP).
Engagement Letter
To legally confirm that the audit engagement has been taken by a firm, an audit engagement letter is signed by the management.
The CPA is given an engagement letter in which all the necessary terms and agreements are mentioned. If the auditor and the company verbally agreed on something then it must be written down in the engagement letter.
The engagement letter includes:
- Remuneration
- Audit Criteria
- Scope of the audit
- Invoices, bills
- Financial statements, etc.
Gather Financial Records and Organize the data
Once it’s decided that an audit will be carried out by an independent firm, the management is supposed to give all the financial records to the CPA.
The CPA then analyzes the records, such as sales receipts, invoices, and bank statements, to find any discrepancies.
It’s better to classify data into sub-groups so that a CPA can compare internal records with external evidence. For example, you can corroborate internal purchase records against external supplier receipts.
Note: companies are required to keep financial records with them for 7 years by the IRS. It is advised to keep digital documents rather than hard copies because they are more accessible. Paper copies can be lost and manipulated in the process. However, digital copies must be secured.
Analyze Tax Records
Companies are subject to paying taxes to the government. It is critical to analyze a company’s tax filing status. The CPA’s responsibility is to check whether the company has accurate tax records or not. It can be done by extracting a company’s tax receipts from the IRS website and using them to verify the company’s tax records, such as the amount of tax due and paid.
Take Help From an Experienced CPA About Taxes
Moreover, a CPA can help you identify tax credits, relief, and exemptions that your company can take advantage of.
Plan the Process
Once a CPA has a clear understanding of goals, he or she creates a documented audit plan in order to test the internal controls and look into the accuracy of items in the financial statements.
The audit plan basically aligns with the audit strategy that will be used to identify and reduce material misstatements.
Perform the Risk Assessment
A CPA should assess the risk of the company’s financial statements to determine the amount of time that should be spent on an audit.
If the financial statements contain material misstatements, then it will take more time to perform the audit.
Risk assessment is done by comparing the industry-specific and business risks together. The accounts that have material misstatements pertain to high risk and are given more attention to reducing the risk.
Risk assessment has the following steps:
- Understand the entity and its environment
- Understand the Internal controls
- Use preliminary analytical procedures to identify risk
- Perform fraud risk analysis
- Assess and Evaluate risk
Review Internal Controls
Strong internal controls mean that the entity has a low possibility of fraud. A CPA looks into the internal control environment of the company to determine the potential for material misstatements that could occur.
Internal control procedures include things like assigning various staff separate accounting responsibilities, locking safes to retain pending bank deposits, and password-protecting accounting software to keep track of who does what and when.
For instance, if the same person handles sales receipts and revenue, then that person could embezzle funds. That is why duties should be segregated between different employees to avoid fraud.
Gather Evidence
A CPA must ensure that all the material misstatements found in the financial statement are backed by evidence in order to give an opinion.
For instance, if your company issues a purchase order for 30 items of inventory, it should be backed up with a physical inventory count.
Stay Updated with New Accounting Standards
As time changes, new and revised accounting standards are put into action. A CPA must be aware of the changes that have been made to the rules and laws of the accounting standard.
For instance, there are new tax laws that can have a material effect on the financials of the company, so it’s better to be well-informed about the new policies to conduct the audit fairly.
You can stay updated by visiting the website of the Financial Accounting Standards Board (FASB). It has all the latest updates to the new accounting standards.
Opinion
After gathering enough evidence, a CPA then gives an opinion based on its findings. An opinion could either be:
- Modified Opinion: states that material misstatements are present in the financial statements.
- Unmodified Opinion: states that financial statements are presented fairly in all material aspects in accordance with the applicable reporting framework (which is usually GAAP).
- Adverse Opinion: In adverse opinion, an auditor states that no opinion by him will be given regarding the financial statement.
Management Letter
After giving an opinion, a CPA gives the management a management letter in which the auditor states all the things that need to be improved.
It is just the CPA’s opinion or advice on the company’s internal control; it’s not mandatory to fulfill the management letter.
When the next fiscal year comes, the auditors will see if the company has complied with the management letter’s advice.
Conclusion
The information mentioned above only list generic methods to go through an audit, however, only an experienced CPA with a financial background has the authority to audit your financials
Since each company has a different financial background, and generic information may not help you, it’s important to consult with a CPA about your accounting audits.
