What is Financial Audit? Type, scope, and Procedure

A financial audit is an independent examination of an organization’s financial statements and records to determine if they are accurate, complete, and in compliance with relevant laws, regulations, and accounting standards. The purpose of a financial audit is to provide assurance that the financial statements are a fair representation of the organization’s financial position and performance.

During a financial audit, an external auditor reviews the organization’s financial statements, including the balance sheet, income statement, and cash flow statement. The auditor will also review the organization’s accounting systems, internal controls, and compliance with laws and regulations. The auditor will also perform testing, such as inspecting invoices and reviewing bank statements and other records to ensure that transactions are accurately recorded.

Financial audits are typically required for a variety of organizations, including:

1. Publicly traded companies: Companies that are publicly traded on a stock exchange are required by law to have their financial statements audited by an independent auditor. This is to provide assurance to shareholders and investors that the financial statements are accurate and in compliance with relevant laws and regulations.
2. Non-Profit Organizations: Non-profit organizations, such as charities, foundations, and other not-for-profit organizations are required to have financial audits if they receive government funding or have a certain revenue threshold.
3. Banks and financial institutions: Banks and other financial institutions are typically required to have their financial statements audited by an independent auditor to ensure compliance with laws and regulations and to provide assurance to regulators and investors.
4. Governmental and Local Authorities: Local and national governments, municipalities, and other public sector organizations are required to have financial audits as a part of good governance.
5. Companies with lenders and investors: Companies that have loans or investors may be required to have a financial audit as a condition of the loan or investment agreement.
6. Companies with international operations: Companies that have international operations or do business in multiple countries may be required to have a financial audit to comply with local laws and regulations.

Scope of Financial Audit

During a financial audit, an auditor will review various aspects of an organization’s financial statements and records to ensure that they are accurate, complete, and in compliance with relevant laws, regulations, and accounting standards. The specific areas that will be audited can vary depending on the organization and the scope of the audit, but typically include the following:

1. Balance sheet: The auditor will review the organization’s assets, liabilities, and equity to ensure that they are accurately reported and in compliance with accounting standards.
2. Income statement: The auditor will review the organization’s revenues, expenses, and profits to ensure that they are accurately reported and in compliance with accounting standards.
3. Cash flow statement: The auditor will review the organization’s cash inflows and outflows to ensure that they are accurately reported and in compliance with accounting standards.
4. Accounting systems and internal controls: The auditor will review the organization’s accounting systems and internal controls to ensure that they are effective in preventing and detecting errors and fraud.
5. Compliance with laws and regulations: The auditor will review the organization’s compliance with laws and regulations, such as tax laws, labor laws, and securities laws, to ensure that they are in compliance.
6. Accounting principles and estimates: The auditor will review the organization’s use of accounting principles and estimates, such as depreciation and amortization, to ensure that they are in compliance with accounting standards.
7. Transactions: The auditor will review the organization’s transactions, such as purchases and sales, to ensure that they are accurately recorded and reported.
8. Subsidiary and related party transactions: The auditor will review the organization’s transactions with subsidiaries and related parties, to ensure that they are accurately recorded and reported.
9. Compliance with contracts and agreements: The auditor will review the organization’s compliance with contracts and agreements, such as loan agreements, to ensure that they are in compliance.
10. Compliance with accounting standards: The auditor will review the organization’s compliance with accounting standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) to ensure that they are in compliance.

Procedure of Financial Audit

Financial audits are not just data tabulation and cross-checking with the relevant paperwork and contracts. Auditing firms use a standard auditing procedure to give a reliable opinion on the audit objective and internal control procedures. A financial audit has six standard protocol features:

1. A Systematic Process

An audit is a systematic process of obtaining and evaluating financial evidence while considering its objectives. Audits use a logical and well-structured step-by-step process involving the following steps:

1. Planning of the audit program
2. Notifying the concerned departments of the date of the audit
3. Discussing the audit scope, purpose, and plan with the company personnel
4. The auditors conduct interviews with the appropriate department staff
5. A draft report is made after the fieldwork of interviews
6. The audit report is submitted to the management of the audited department for their response
7. Management responds with an action plan for any misstatements or errors
8. The audit report and the management’s response are discussed in a closing meeting
9. The final audit report goes to all the departments and the board of directors of the company
10. The auditing firm may conduct a follow-up

2. A Three-Component Relationship

In compliance with the International Standard on Assurance Engagements (ISAE), an audit process is a three-party relationship. This triad involves the auditor, the manager of the department or the area under the financial statement audit, and the company’s board of directors.

3. Subject Matter

The subject matter for an audit engagement can vary considerably. It can be for financial information, operations, data, systems, or processes. It is an important feature of an audit, as it should be identifiable and measurable against a certain criterion. The subject matter of a financial audit helps clearly define the scope of the audit.

4. Evidence

An auditor has sufficient and reliable evidence to examine and audit a certain subject matter and give an opinion on the objective of the financial audit. Important financial evidence includes bank statements, receipts, payroll, invoices, and management accounts. Here are the two important characteristics of good evidence:

• It comes from a reliable source
• Contains relevance to the subject matter

5. Established Criterion

An audit criterion is a set of standards against which a process’s financial accuracy or performance and effectiveness are evaluated. Standard accounting policies, audit procedures, laws and regulations, published standards, client agreements, and generally acknowledged best practices help establish a dependable audit criterion.

6. Opinion

An audit opinion is an honest and professional report on the reasonable assurance of a company’s financial statements, whether they carry misstatements. There are four main types of audit opinions:

1. Unqualified opinion: A clean report indicates that the auditors are satisfied with the company’s financial reporting.
2. Qualified opinion: The auditor is not confident enough to give a clean audit report.
3. Disclaimer of opinion: The auditor provides a disclaimer with an audit report when the company limits its access to sufficient evidence and financial statements.
4. Adverse opinion: According to the GAAS protocol, adverse comments on the audit report indicate misstatements and errors.

Conclusion

The conclusion of a financial audit typically includes the following elements:

1. Summary of the audit objectives and scope: The conclusion will summarize the objectives and scope of the audit, outlining what the audit was intended to accomplish and the areas that were examined.
2. Summary of findings: The conclusion will summarize the key findings of the audit, including any issues or concerns identified and any recommendations for improvement.
3. Opinion of the auditor: The conclusion will include the auditor’s opinion on the organization’s financial statements, based on the evidence gathered during the audit. The opinion may be either unqualified, meaning that the financial statements are found to be accurate and presented in compliance with relevant accounting standards, or qualified, meaning that the financial statements are found to be partially accurate and presented in compliance with relevant accounting standards, or adverse, meaning that the financial statements are found to be not accurate and presented in compliance with relevant accounting standards.
4. Management’s response: The conclusion will include the management’s response to the findings and recommendations of the audit, outlining any actions that have been taken or planned to address the issues and concerns identified.
5. Next Steps: The conclusion will outline the next steps for the organization, including any follow-up audits or monitoring that may be required to ensure that the recommendations have been implemented and that the organization’s financial statements continue to be accurate and presented in compliance with relevant accounting standards.

The conclusion of a financial audit is an important document that provides valuable insights and recommendations for improving the organization’s financial reporting.