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Encyclopedia > Financial audit

A financial audit, or more accurately, an audit of financial statements, is the examination by an independent third party of the financial statements of a company or any other legal entity (including governments), resulting in the publication of an independent opinion on whether or not those financial statements are relevant, accurate, complete, and fairly presented. Image File history File links Gnome-globe. ... The term company may refer to a separate legal entity, as in English law, or may simply refer to a business, as is the common use in the United States. ... A legal entity is a legal construct through which the law allows a group of natural persons to act as if it were a single composite individual for certain purposes. ...


Financial audits are typically performed by firms of practising accountants due to the specialist financial reporting knowledge they require. The financial audit is one of many assurance or attestation functions provided by accounting and auditing firms, whereby the firm provides an independent opinion on published information. Assurance services have been defined by the American Institute of Certified Public Accountants (AICPA) as Independent Professional Services that improve information quality or its context. Such services are very broad and could include assessments of internet security and quality of health facilities. ... Accountancy (profession) or accounting (methodology) is the measurement, disclosure or provision of assurance about financial information primarily used by managers, investors, tax authorities and other decision makers to make resource allocation decisions within companies, organizations, and public agencies. ... An audit is an evaluation of an organization, system, process, project or product. ...


Many organisations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organisation. External auditors may choose to place limited reliance on the work of internal auditors. Internal Audit is an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations. ... The primary role of the external auditor is to express and opinion about whether or not the financials are free of material misstatements. ...

Contents

Purpose

Financial audits exist to add credibility to the implied assertion by an organisation's management that its financial statements fairly represent the organisation's position and performance to the firm's stakeholders (interested parties). The principal stakeholders of a company are typically its shareholders, but other parties such as tax authorities, banks, regulators, suppliers, customers and employees may also have an interest in ensuring that the financial statements are accurate.


The audit is designed to reduce the possibility of a material misstatement. A misstatement is defined as false or missing information, whether caused by fraud (including deliberate misstatement) or error. Material is very broadly defined as being large enough or important enough to cause stakeholders to alter their decisions.


The exact 'audit opinion' will vary between countries, firms and audited organisations.


In the US, the CPA firm provides written assurance that financial reports are 'fairly presented in conformity with generally accepted accounting principles (GAAP).' The measure for 'fairly presented' is that there is less than 5% chance (5% audit risk) that the financial statements are 'materially misstated'. For other meanings of CPA see CPA (disambiguation) Certified Public Accountants (CPAs) are accounting professionals of the United States who have passed the Uniform CPA exam, which was developed and is maintained by the American Institute of Certified Public Accountants (AICPA), and have subsequently met additional state requirements for licensure... This article or section does not cite its references or sources. ... Audit risk is a term that is commonly applied in relation to the audit of the financial statements of an entity. ...


In England and Wales, the Registered Auditors including Chartered Certified Accountant (ACCA) and Chartered Accountant (CA or ACA) provide 'reasonable assurance' that the financial statements are 'free from material misstatement', and that they give 'a true and fair view' of the state of the company's affairs as at a particular date, and of its profit/loss for the period then ended, and have been 'properly prepared in accordance with the Companies Act 1985' or other relevant legislation. The Association of Chartered Certified Accountants (ACCA) is a British chartered accountancy body with a global presence that offers the Chartered Certified Accountant (Designatory letters ACCA or FCCA) qualification worldwide. ... Chartered Accountant (CA) is the title of members of a certain professional accountancy associations in the Commonwealth countries and Ireland. ...


History

Audit of government expenditure

The earliest surviving mention of a public official charged with auditing government expenditure is a reference to the Auditor of the Exchequer in England in 1314. The Auditors of the Imprest were established under Queen Elizabeth I in 1559 with formal responsibility for auditing Exchequer payments. This system gradually lapsed and in 1780, Commissioners for Auditing the Public Accounts were appointed by statute. From 1834, the Commissioners worked in tandem with the Comptroller of the Exchequer, who was charged with controlling the issue of funds to the government. Elizabeth I redirects here. ...


As Chancellor of the Exchequer, William Ewart Gladstone initiated major reforms of public finance and Parliamentary accountability. His 1866 Exchequer and Audit Departments Act required all departments, for the first time, to produce annual accounts, known as appropriation accounts. The Act also established the position of Comptroller and Auditor General (C&AG) and an Exchequer and Audit Department (E&AD) to provide supporting staff from within the civil service. The C&AG was given two main functions – to authorise the issue of public money to government from the Bank of England, having satisfied himself that this was within the limits Parliament had voted – and to audit the accounts of all Government departments and report to Parliament accordingly. The Chancellor of the Exchequer is the title held by the British cabinet minister responsible for all financial matters. ... William Ewart Gladstone (29 December 1809 – 19 May 1898) was a British Liberal Party statesman and Prime Minister (1868–1874, 1880–1885, 1886 and 1892–1894). ...


Auditing of UK government expenditure is now carried out by the National Audit Office and Audit Commission. Please wikify (format) this article as suggested in the Guide to layout and the Manual of Style. ... The Audit Commission is a non-departmental public body in the United Kingdom which is responsible for auditing local government in England, National Health Service Trusts and other local agencies in England and Wales. ...


Audit of companies and regulation of auditors

In the US, prior to the 1930s, corporations were required neither to submit annual reports to government agencies or shareholders nor to have such reports audited. In the United States, the Securities Exchange Act of 1934 required all publicly traded companies to disclose certain financial information, and that financial information be audited. The establishment of the Securities and Exchange Commission (SEC) created a body to enforce the audit requirements. Face The 1930s (years from 1930–1939) were described as an abrupt shift to more radical and conservative lifestyles, as countries were struggling to find a solution to the Great Depression, also known in Europe as the World Depression. ... The Securities Exchange Act of 1934 was a sweeping piece of legislation in the United States regulating the participants in the financial markets. ... The Securities and Exchange Commission, commonly referred to as the SEC, is the United States governing body which has primary responsibility for overseeing the regulation of the securities industry. ...


In the United States, the SEC has generally deferred to the accounting industry (acting through various organisations throughout the years) as to the accounting standards for financial reporting, and the U.S. Congress has deferred to the SEC. The Congress of the United States is the legislative branch of the federal government of the United States of America. ...


This is also typically the case in other developed economies. In the UK, auditing guidelines are set by the institutes (including ACCA, ICAEW, ICAS and ICAI) of which auditing firms and individual auditors are members. The Association of Chartered Certified Accountants (ACCA) is a British chartered accountancy body with a global presence that offers the Chartered Certified Accountant (Designatory letters ACCA or FCCA) qualification worldwide. ... Abstract The Institute of Chartered Accountants in England & Wales is the main English accountancy body for chartered accountants and auditors, having over 150,000 members. ...


Accordingly, financial auditing standards and methods have tended to change significantly only after auditing failures. The most recent and familiar case is that of Enron. The company succeeded in hiding some important facts, such as off-book liabilities, from banks and shareholders. Eventually, Enron filed for bankruptcy, and (as of 2006) is in the process of being dissolved. One result of this scandal was that Arthur Andersen, then one of the five largest accountancy firms worldwide, lost their ability to audit public companies, essentially killing off the firm. Enron Creditors Recovery Corporation, formerly Enron Corporation, is a defunct America energy company based in Houston, Texas. ... 2006 is a common year starting on Sunday of the Gregorian calendar. ... Arthur Andersen, see Arthur Andersen LLP v. ...


A recent trend in audits (spurred on by such accounting scandals as Enron and Worldcom) has been an increased focus on internal control procedures, which aim to ensure the completeness, accuracy and validity of items in the accounts, and restricted access to financial systems. This emphasis on the internal control environment is now a mandatory part of the audit of SEC-listed companies, under the auditing standards of the Public Company Accounting Oversight Board (PCAOB) set up by the Sarbanes-Oxley Act. MCI logo MCI, Inc. ... The Public Company Accounting Oversight Board, or PCAOB, is a private-sector, non-profit corporation created by the 2002 Sarbanes-Oxley Act to oversee the auditors of public companies. ... The Sarbanes-Oxley Act of 2002 (107 H.R. 3763), signed into law on 30 July 2002, is considered the most significant change to federal securities laws in the United States since the New Deal. ...


Stages of an audit

A financial audit is performed before the release of the financial statements (typically on an annual basis), and will overlap the 'year-end' (the date which the financial statements relate to).


The following are the stages of a typical audit:


Planning and risk assessment

Timing: before year-end


Purpose:

  • to understand the business of the company and the environment in which it operates.
  • to determine the major audit risks (i.e. the chance that the auditor will issue the wrong opinion). For example, if sales representatives stand to gain bonuses based on their sales, and they account for the sales they generate, they have both the incentive and the ability to overstate their sales figures, thus leading to overstated revenue. In response, the auditor would typically plan to increase the rigour of their procedures for checking the sales figures.

Internal controls testing

Timing: before and/or after year-end


Purpose:

  • to assess the internal control procedures (e.g. by checking computer security, account reconciliations, segregation of duties). If internal controls are assessed as strong, this will reduce (but not entirely eliminate) the amount of 'substantive' work the auditor needs to do (see below).

Notes: Separation of duties (SoD) is the concept of having more than one person required to complete a task. ...

  • In some cases an auditor may not perform any internal controls testing, because he/she does not expect internal controls to be reliable. When no internal controls testing is performed, the audit is said to follow a substantive approach.

Substantive procedures

Timing: after year-end (see note regarding hard/fast close below)


Purpose:

  • to collect audit evidence that the actual figures and disclosures made in the Financial Statements are reliable and in accordance with required standards and legislation.

Methods:

  • where internal controls are strong, auditors typically rely more on Substantive Analytical Procedures (the comparison of sets of financial information, and financial with non-financial information, to see if the numbers 'make sense' and that unexpected movements can be explained)
  • where internal controls are weak, auditors typically rely more on Substantive Tests of Detail (selecting a sample of items from the major account balances, and finding hard evidence (e.g. invoices, bank statements) for those items)

Notes:

  • Some audits involve a 'hard close' or 'fast close' whereby certain substantive procedures can be performed before year-end. For example, if the year-end is 31st December, the hard close may provide the auditors with figures as at 30th November. The auditors would audit income/expense movements between 1st January and 30th November, so that after year end, it is only necessary for them to audit the December income/expense movements and the 31st December balance sheet. In some countries and accountancy firms these are known as 'rollforward' procedures.

Finalisation

Timing: at the end of the audit


Purpose:

  • to compile a report to management regarding any important matters that came to the auditor's attention during performance of the audit,
  • to evaluate and review the audit evidence obtained, ensuring sufficient appropriate evidence was obtained for every material assertion and
  • to consider the type of audit opinion that should be reported based on the audit evidence obtained.

Significant audit firms

These firms are the 'Big 4' multinational accountancy firms which audit the majority of large quoted/listed companies. In addition to providing audits, they also provide other services including tax advice and IT consultancy. The Big 4, sometimes written as the Big Four, is a group of international accountancy and professional services firms that handles the vast majority of audits for publicly traded companies as well as many private companies. ...

Firm 2005 global revenue (US dollars)
PricewaterhouseCoopers (corporate website) 20.3bn
Deloitte (corporate website) 18.2bn
Ernst & Young (corporate website) 16.9bn
KPMG (corporate website) 15.7bn

Other significant audit firms are listed here: A PwC office building (Southwark Towers) in London, England. ... Deloitte Touche Tohmatsu is one of the Big Four auditors. ... Ernst & Young is one of the largest professional services firms in the world, and one of the Big Four auditors, along with PricewaterhouseCoopers (PwC), Deloitte Touche Tohmatsu (Deloitte) and KPMG. Ernst & Young is a global organization consisting of many member firms. ... KPMG is one of the largest professional services firms in the world. ...

Commercial relationships versus objectivity

One of the major issues faced by private auditing firms is the need to provide independent auditing services while maintaining a business relationship with the audited company. The auditing firm's responsibility to check and confirm the reliability of financial statements may be limited by pressure from the audited company, who pays the auditing firm for the service. The auditing firm's need to maintain a viable business through auditing revenue may be weighed against its duty to examine and verify the accuracy, relevancy, and completeness of the company's financial statements.


Related Qualifications

Chartered Certified Accountant (Designatory letters ACCA or FCCA) is a United Kingdom chartered accounting designation awarded by the Association of Chartered Certified Accountants (ACCA) The term Chartered Certified Accountant was introduced in 1996. ... Chartered Accountant (CA) is the title of members of a certain professional accountancy associations in the Commonwealth countries and Ireland. ... Certified Public Accountants (CPAs) are qualified accountants in the United States who have passed the Uniform Certified Public Accountant Examination and have met additional state education and experience requirements for certification as a CPA. In most U.S. states, only CPAs who are licensed are able to provide to the...

See also

Following is a list of accounting topics. ... Categories: | ...

External Link

  • Why Didn't Our Auditors Find the Fraud?

  Results from FactBites:
 
Financial audit - Wikipedia, the free encyclopedia (1340 words)
A financial audit, or more accurately, an audit of financial statements, is the examination by an independent third party of the financial statements of a company or other organisation, resulting in the publication of an independent opinion on whether or not those financial statements are relevant, accurate and complete.
Financial audits are typically performed by firms of practising accountants, due to the specialist financial reporting knowledge they require.
A financial audit is performed before the release of the financial statements (typically on an annual basis), and will overlap the 'year-end' (the date which the financial statements relate to).
Greek Financial Audit, 2004 - Wikipedia, the free encyclopedia (916 words)
New Democracy's government then accused Costas Simitis and PASOK, who was the prime minister and president of PASOK at that time, of having falsified Greece's macroeconomic statistics, on the basis of which the European institutions accepted Greece to join the Eurozone.
As a result of that financial audit, Greece fell in the list of the loan creditability and now pays more taxes on the loans it has with other countries.
This caused criticism of the Financial Audit of 2004 and the New Democracy government by PASOK and parts of the press.
  More results at FactBites »

 
 

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