In this course we are going to tackle auditing. More specifically financial statement auditing.
Let’s get started with what we mean by an audit.
Take these financial statement.
If you look at the front of most financial statements, particularly those of publicly listed companies for which an audit is required,
you’ll find a report called the Auditor’s Report.
In later lessons, we will get into what the report is telling the reader and the basis of the opinion.
At this point, realize than an audit is an independent opinion over all the financial information and disclosures that follow.
Basically, the audit report says that the financial information is pretty much accurate and prepared in accordance with defined criteria.
And because it’s the opinion of someone other than the company who issues the financial statements,
hopefully readers who use the financial statements feel just a little better knowing that someone is checking the numbers.
That’s auditing in a nutshell.
Audits are necessary because readers of financial statements need to rely on this information to make decisions.
Banks use financial statements to extend credit.
Investors use financial statements to invest in the company. Government uses financial information to levy taxes
In the absence of an audit, questions would arise about the relevance and reliability of the information being presented.
This is called Information Risk, the risk that the financial statements are inaccurate.
Users would otherwise worry about such things as: - the information that hasn’t been disclosed
-the bias and motives of management
-the sheer mass of information
-the complexity of the information
So instead of having management deal directly with all these users on an individual basis,
it’s generally accepted that having an independent party give an opinion on the financial statements is sufficient.
Let’s identify the components of an audit, after all, not just anyone can slap one of these audit reports...
on a set of financial statements.
First we need something to audit, in this case a set of financial statements.
But behind these financial statements you need to recognize that there are likely thousands, millions, or possibly billions of transactions.
Financial statements are a summary of all business activity that goes on during a period,
and a snapshot of the entities asset and liability position as at the year end date.
This information is compiled by management- not the auditors.
Auditors are usually professional accountants, like Chartered Accountants or Certified Professional Accountants,
but they do not prepare the financial information.
To do so, would impair their objectivity.
That is, their appearance of being unbiased.
The second component of an audit is that we need criteria against which we evaluate the information.
If management were free to make the rules about the accounting policies,
readers would have one heck of a time understanding what it is they are reading.
So in the case of financial statement audits, the criteria is normally General Accepted Accounting Principles.
However, different types of audits can have different criteria, so don’t think of criteria in a narrow sense.
Tax auditors have tax rules and regulations.
Internal auditors have companies policies and procedures.
External auditors may be engaged to express an opinion on criteria other than GAAP, such a compliance with a loan agreement.
The third component of an audit is the auditor needs to do something to support their opinion.
Every single number, every disclosure, every policy you read in a set of financial statements must be evaluated, tested, and supported.
The same way as a legal prosecutor gathers evidence to build a case against the defendant,
the auditors builds a case to support or refute management’s presentation of the financial information.
We will spend a number of lessons on how this is done most efficiently.
An audit does not look at every single piece of