A financial statement audit may sound scary, but it shouldn’t be. The aim is simply to establish that the finances of an organization, individual, or department are all above board, fairly presented, and free of misleading statements.
In the case of an organization auditing one of its departments or branches, a financial audit may also hope to generally assess the state of the department/branch’s finances, locate any risks to your finances, and establish where (if anywhere) improvements could be made.
Assuming that your records are clear and up to date, a financial statement audit should not be too complicated. Let us take you through what you should expect and what you should do to prepare.
1. The preparation stage
The preparation stage consists of the following steps:
• Prepare financial statements and related documents
If you have digitized your records, this process will probably be much quicker and easier than if you have not. For example, payslip software allows you to pull up things like payroll reporting, tax calculations, and more with a simple click of a button. This saves you from having to trawl through drawers and drawers of paperwork during the audit itself.
• Communicate with the auditor
Communication is key during a financial statement audit. If you are able to work with the auditor, the audit will be a much smoother and more satisfying process for everyone concerned.
Keep clear and open communication with the auditor, and make sure that everyone is on the same page regarding what is going to happen and when.
• Schedule a date and time for the audit
Depending on the circumstances of your audit, you should be given a reasonable timescale within which to gather your financial statements and other relevant documents for the audit.
Work with the auditor to establish a date and time which allows you enough time to prepare and also lets the auditor do their job in a timely fashion.
2. The audit planning stage
The audit planning stage consists of the following steps:
• Understand the scope of the audit
During your communications, the auditor should have explained the scope of the audit and the kinds of things they will be looking for. They should also have told you the kinds of procedures they will be undertaking and what they expect from you in terms of documentation and cooperation.
Be sure that you thoroughly understand what the auditor has told you about the scope and objectives of your audit. If there’s anything you’re unclear about, don’t be afraid to contact the auditor and ask. Remember, they want to work with you, not against you, and it’s in their best interests for you to fully understand and participate in the audit.
• Identify risks and controls
Auditing comes with several risks, including:
- Inherent risk: This is an overall risk category that covers the basic risk of subjecting financial statements and accounts to scrutiny.
- Control risk: This occurs when financial misstatements happen due to a lack of proper controls within the accounting process.
- Detection risk: This involves auditors failing to notice something they should.
During the planning stage, your auditor will attempt to set the ‘risk’ level for your audit. This involves checking the controls within your accounting system and how complex your accounts are (greater complexity means a greater detection risk).
If any risk is deemed too high, the auditor will try to implement controls to bring the risk down. This could include increasing the document sample size, implementing cybersecurity measures, or targeting specific documents.
• Develop an audit plan
Working with you, your auditor will complete the planning stage by devising an audit plan. This will put together everything that’s been discussed above and outline how it will be used to conduct your audit.
Your audit plan should include:
- Information about the standards your auditors should uphold.
- The policies and procedures the auditors will be using.
- The scope and aims of the audit.
- The time frame over which the audit will be carried out.
- Specific information about who is being audited, by whom, and the responsibilities of everyone involved.
It will then go on to detail the audit procedure, including what will be looked at and when.
3. The fieldwork
The fieldwork consists of the following steps:
• Gather evidence and documentation
The first thing your auditor will want to do is to gather together your evidence and documentation. If you’ve understood the scope of the audit and prepared your documentation beforehand, this should not be a drawn-out process.
As the auditor goes through your documentation and evidence, they may find that they need a bit more from you, perhaps in order to bolster or support the documentation you have provided. For this reason, it’s a good idea to get all your documentation in order and easily accessible at the preparation stage.
• Test internal controls and transaction cycles
Having gathered your evidence and documentation, the auditor will proceed to test your internal controls and transaction cycles.
They may use several methods to do this, including:
- Inquiry: The auditor will ask staff about the controls they use to ensure accurate and reliable transactions.
- Observation: The auditor will observe the daily running of the department or branch to see how transactions are carried out, and controls are implemented.
- Examination: The auditor will use documentation and logs to test how controls are implemented and how effective they are.
- Re-performance: This involves the auditor trying to perform controls and transactions themselves to check that they really do work.
Many auditors will also use computer-aided audit tools (CAAT) to analyze your digital systems and controls. These tools can be used to run through your business data to quickly determine any risks, inaccuracies, or inefficiencies.
• Analyze and interpret financial data
Having studied your data, the auditor will analyze and interpret it.
There are six main ways auditors analyze data:
- Identify the economic norms of the industry: The industry you’re operating in has an impact on your finances and the way you process them. The auditor will establish industry norms in order to make sure that they are performing an analysis that’s fair to the characteristics of your industry.
- Identify company strategies: The auditor will look at company specifics like the nature of your product and your profit margins. This can extend across all areas of your business. For example, maybe you use some HR software for small businesses to analyze HR and recruitment expenses. This data can be cross-referenced with your financial statements to ensure that there are no discrepancies.
- Assess the quality of your financial statements: The aim of this stage is to establish whether or not your financial statements present an accurate picture of the company’s financial position.
- Analyze profitability and risk: This can involve things like examining statement ratios with respect to things like liquidity, asset management, debt management, profitability, and market valuation.
- Use analysis to prepare forecasted financial statements: At this stage, the auditor will attempt to predict future financial statements based on the data given.
- Value the firm: The auditor will use the data given to make a rough valuation of the firm.
All of this analysis and interpretation enables the auditor to establish a picture of the firm’s financial status, the way the firm handles its finances, and any discrepancies between what is presented and the financial reality.
4. The reporting stage
The reporting stage consists of the following steps:
• The initial draft of the auditor’s report
Having completed their analysis, the auditor will draft an initial version of their report. This normally contains three key areas:
- Outlining the scope and purpose of the report
- The main body of the report, including a statement of facts and findings
- Conclusions and recommendations
It may also contain appendices.
• Disclosure of findings and recommendations
The initial draft of the report will contain a disclosure of findings and recommendations. The auditor will share these with key stakeholders before finalizing the report.
Sometimes some of the auditor’s recommendations may not be practical to implement, for example, in the case of an internal audit. Similarly, stakeholders may feel that some of the auditor’s findings may be unfair, perhaps because the auditor has not fully understood something.
• Finalizing the audit report
After a discussion with key stakeholders, the auditor will produce a finalized version of the report. Key stakeholders will then sign the finalized report to affirm that they agree with the contents.
The finalized report will detail the audit process, scope, findings, and recommendations for improvement.
Following this, the company, department, or branch will be advised to follow the audit recommendations.
A financial statement audit is not a scary thing to face. If your accounts and documentation are all in order, and you have been doing everything aboveboard to the best of your ability, you have nothing to worry about.
In fact, a financial statement audit is often a very good thing. It can help you to improve your financial processes and controls, improve your compliance, and more. This helps to make your accounting more efficient and to generally optimize your operation.