In this lesson we are going to do a high level run through of the audit process so that you get a feel for what an audit is and how it is conducted.
The rest of the course will take a deeper look at each of these audit procedures.
Let’s pretend our client is Lakeview Hotels.
It’s a small capitalization public company that operates a small portfolio of hotels across the country.
We work for Early and Youth Public Accountants. Here is a bit of background.
Lakeview has been a client for the past four years.
The company has been negatively impacted by the slow recovery in the economy and older properties.
Two years ago, Lakeview outsourced the management of the hotels to external managers.
Lakeview’s corporate staff are responsible for oversight of the managers, strategic decisions, financing decisions, and public reporting.
Lakeview’s CEO is a seasoned veteran of the hotel industry.
The CFO has been with the company for the past three years, and does not have a background in hotels.
The company is faced with significant maturity of a debenture.
So with that background in mind, let’s walk through the high level audit process.
Let’s start with the end in mind, an audit is the expression of independent opinion on the fairness of presentation of the...
financial statements as prepared by management.
Two important points to make here.
First, management is responsible for the preparation of the financial statements, not the auditors.
Second, the auditors are responsible for their opinion, which is based on the evaluation of the audit evidence they gather.
So let’s put this into the simplest terms possible...
An audit is intended to ensure that every number and every disclosure contained within the financial statements is valid and supported.
So for instance, let’s just flip to the Statement of Financial Position (also known as the Balance Sheet).
Management represent that there is $1.4 million of cash in the company as at December 31st.
As auditors, we need to gather evidence to support that this is in fact true.
Think about this for a moment and consider the types of evidence you would expect the auditor to request to support this assertion.
[PAUSE: YOU ARE SUPPOSED TO BE THINKING!]
Here are some examples of the sorts of evidence should have in mind.
A bank reconciliation.
A bank statement.
Talking to the bank about how much cash is in the account as of that date.
Count the cash on hand.
The idea is to gather what is called, sufficient appropriate audit evidence to support management’s representation that...
there is $1,436,789 of cash on the balance sheet.
This audit process and evidence gathering activity goes on and on
for everything you see in the financial statements until everything has been validated.
That’s auditing in a nutshell; however, as you can imagine, there is a bit more to it than that.
Why?
Well first and perhaps most importantly, you need to realize we can’t practically look at every piece of evidence that exists,
that would be cost prohibitive and in most cases unnecessary for the users.
So what auditors do instead, is they use a “risk based approach” to auditing.
That is to say, they identify where the greatest risks exist for a material misstatement,
and then focus their audit procedures to ensure one or more of these so called "material misstatements" does not exist.
Notice I use the word “material” misstatement and not just misstatement.
Material implies a misstatement in the order of magnitude that it would change a user’s decision when using the financial statements.
We will discuss this in much greater depth in a later lesson.
So, let’s go back to the beginning once again, and this time go through the audit process step