Financial audit - wikipedia Financial audit Financial audit This article has multiple issues. Please help improve it or discuss these issues on the talk page. ( Learn how and when to remove these template messages ) This article may require cleanup to meet Wikipedia 's quality standards. No cleanup reason has been specified. Please help improve this article if you can. ( May 2011 ) The examples and perspective in this article may not represent a worldwide view of the subject. You may improve this article, discuss the issue on the talk page, or create a new article, as appropriate. ( December 2010 ) Accounting Historical cost Constant purchasing power Management Tax Major types Auditing Cost Forensic Financial Fund Governmental Management Social Tax Key concepts Accounting period Accrual Constant purchasing power Economic entity Fair value Going concern Historical cost Matching principle Materiality Revenue recognition Unit of account Selected accounts Assets Cash Cost of goods sold Depreciation / Amortization Equity Expenses Goodwill Liabilities Profit Revenue Accounting standards Generally - accepted principles Generally - accepted auditing standards Convergence International Financial Reporting Standards International Standards on Auditing Management Accounting Principles Financial statements Annual report Balance sheet Cash - flow Equity Income Management discussion Notes to the financial statements Bookkeeping Bank reconciliation Debits and credits Double - entry system FIFO and LIFO Journal Ledger / General ledger T accounts Trial balance Auditing Financial Internal Firms Report People and organizations Accountants Accounting organizations Luca Pacioli Development History Research Positive accounting Sarbanes -- Oxley Act Business portal A financial audit is conducted to provide an opinion whether `` financial statements '' ( the information being verified ) are stated in accordance with specified criteria. Normally, the criteria are international accounting standards, although auditors may conduct audits of financial statements prepared using the cash basis or some other basis of accounting appropriate for the organisation. In providing an opinion whether financial statements are fairly stated in accordance with accounting standards, the auditor gathers evidence to determine whether the statements contain material errors or other misstatements. The audit opinion is intended to provide reasonable assurance, but not absolute assurance, that the financial statements are presented fairly, in all material respects, and / or give a true and fair view in accordance with the financial reporting framework. The purpose of an audit is to provide an objective independent examination of the financial statements, which increases the value and credibility of the financial statements produced by management, thus increase user confidence in the financial statement, reduce investor risk and consequently reduce the cost of capital of the preparer of the financial statements. In accordance with the US GAAP, auditors must release an opinion of the overall financial statements in the auditor 's report. Auditors can release three types of statements other than an unqualified / unmodified opinion. The unqualified auditor 's opinion is the opinion that the financial statements are presented fairly. A qualified opinion is that the financial statements are presented fairly in all material respects in accordance with US GAAP, except for a material misstatement that does not however pervasively affect the user 's ability to rely on the financial statements. A qualified opinion can also be issued for a scope limitation that is of limited significance. Further the auditor can instead issue a disclaimer, because there is insufficient and appropriate evidence to form an opinion or because of lack of independence. In a disclaimer the auditor explains the reasons for withholding an opinion and explicitly indicates that no opinion is expressed. Finally, an adverse audit opinion is issued when the financial statements do not present fairly due to departure from US GAAP and the departure materially affects the financial statements overall. In an adverse auditor 's report the auditor must explain the nature and size of the misstatement and must state the opinion that the financial statements do not present fairly in accordance with US GAAP. `` An auditor is not an insurer '' This question is taken from the famous law case London and General Bank. The honourable justice, Lindly. L. J said that `` An auditor is not an insurer ''. It is because Nowadays business world has become very complicated and technical and it is not possible for an auditor to be an expert of all subjects. Since an audit work in done after preparation of books of accounts, therefore auditor can not prevent errors and frauds. A book of accounts recorded at historical cost and can not present a true and fair picture of a business. If an audited account still contains errors and frauds, the client can not claim or recover compensation if the auditor works with reasonable care and honesty. Financial audits are typically performed by firms of practicing accountants who are experts in financial reporting. The financial audit is one of many assurance functions provided by accounting firms. Many organizations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organization. External auditors may choose to place limited reliance on the work of internal auditors. Auditing promotes transparency and accuracy in the financial disclosures made by an organization, therefore would likely reduce such corporations concealmeant of unscrupulous dealings. Internationally, the International Standards on Auditing ( ISA ) issued by the International Auditing and Assurance Standards Board ( IAASB ) is considered as the benchmark for audit process. Almost all jurisdictions require auditors to follow the ISA or a local variation of the ISA. Contents 1 Audit overview 2 The Big Four 3 Costs 4 History 4.1 Audit of government expenditure 5 Governance and oversight 6 Stages of an audit 6.1 Phase I Plan and Design an Audit Approach 6.2 Phase II Perform Test of Controls and Substantive Test of Transactions 6.3 Phase III Perform Analytical Procedures and Tests of Details of Balances 6.4 Phase IV Complete the Audit and Issue an Audit Report 7 Responsibilities of an Auditor 8 Commercial relationships versus objectivity 9 Related qualifications 10 See also 11 References Audit overview Financial audits exist to be 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. 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 knowing that the financial statements are presented fairly, in all material aspects. An audit is not designed to provide absolute assurance, being based on sampling and not the testing of all transactions and balances ; rather it is designed to reduce the risk of a material financial statement misstatement whether caused by fraud or error. A misstatement is defined in ISA 450 as an error, omitted disclosure or inappropriate accounting policy. `` Material '' is an error or omission that would affect the users decision. Audits exist because they add value through easing the cost of information asymmetry and reducing information risk, not because they are required by law ( note : audits are obligatory in many EU - member states and in many jurisdictions are obligatory for companies listed on public stock exchanges ). For collection and accumulation of audit evidence, certain methods and means generally adopted by auditors are : Posting checking Testing the existence and effectiveness of management controls that prevent financial statement misstatement Casting checking Physical examination and count Confirmation Inquiry Observation inspection Year - end scrutiny Re-computation Tracing in subsequent period Bank reconciliation Vouching Verification of existence, ownership, title and value of assets and determination of the extent and nature of liabilities The Big Four Greenwood et al. ( 1990 ) defined the audit firm as professional partnership which has a decentralized organization relationship between the national head office and local offices. Local offices can make most decision except for the drawing up professional standard and maintaining it. The Big Four are the four largest international professional services networks, offering audit, assurance, tax, consulting, advisory, actuarial, corporate finance, and legal services. They handle the vast majority of audits for publicly traded companies as well as many private companies, creating an oligopoly in auditing large companies. It is reported that the Big Four audit 99 % of the companies in the FTSE 100, and 96 % of the companies in the FTSE 250 Index, an index of the leading mid-cap listing companies. The Big Four firms are shown below, with their latest publicly available data. None of the Big Four firms is a single firm ; rather, they are professional services networks. Each is a network of firms, owned and managed independently, which have entered into agreements with other member firms in the network to share a common name, brand and quality standards. Each network has established an entity to co-ordinate the activities of the network. In one case ( KPMG ), the co-ordinating entity is Swiss, and in three cases ( Deloitte Touche Tohmatsu, PricewaterhouseCoopers and Ernst & Young ) the co-ordinating entity is a UK limited company. Those entities do not themselves perform external professional services, and do not own or control the member firms. They are similar to law firm networks found in the legal profession. In many cases each member firm practises in a single country, and is structured to comply with the regulatory environment in that country. In 2007 KPMG announced a merger of four member firms ( in the United Kingdom, Germany, Switzerland and Liechtenstein ) to form a single firm. Ernst & Young also includes separate legal entities which manage three of its four areas : Americas, EMEIA ( Europe, The Middle East, India and Africa ), and Asia - Pacific. ( Note : the Japan area does not have a separate area management entity ). These firms coordinate services performed by local firms within their respective areas but do not perform services or hold ownership in the local entities. This group was once known as the `` Big Eight '', and was reduced to the `` Big Six '' and then `` Big Five '' by a series of mergers. The Big Five became the Big Four after the demise of Arthur Andersen in 2002, following its involvement in the Enron scandal. Costs Costs of audit services can vary greatly dependent upon the nature of the entity, its transactions, industry, the condition of the financial records and financial statements, and the fee rates of the CPA firm. A commercial decision such as the setting of audit fees is handled by companies and their auditors. Directors are responsible for setting the overall fee as well as the audit committee. The fees are set at a level that could not lead to audit quality being compromised. History Audit of government expenditure National Audit Office Logo ( United Kingdom ) 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 issuance of funds to the government. 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. Auditing of UK government expenditure is now carried out by the National Audit Office. The Australian National Audit Office conducts all financial statement audits for entities controlled by the Australian Government. Governance and oversight Seal of the United States Government Accountability Office 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. 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. While in Australia, the rules and professional code of ethics are set by The Institute of Chartered Accountants Australia ( ICAA ), CPA Australia ( CPA ) and The National Institute of Accountants ( NIA ). 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. 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. Many countries have government sponsored or mandated organizations who develop and maintain auditing standards, commonly referred to generally accepted auditing standards or GAAS. These standards prescribe different aspects of auditing such as the opinion, stages of an audit, and controls over work product ( i.e., working papers ). Some oversight organisations require auditors and audit firms to undergo a third - party quality review periodically to ensure the applicable GAAS is followed. Stages of an audit The following are the stages of a typical audit : Phase I Plan and Design an Audit Approach Accept Client and Perform Initial Planning. Understand the Client 's Business and Industry. What should auditors understand ? The relevant industry, regulatory, and other external factors including the applicable financial reporting framework The nature of the entity The entity 's selection and application of accounting policies The entity 's objectives and strategies, and the related business risks that may result in material misstatement of the financial statements The measurement and review of the entity 's financial performance Internal control relevant to the audit Assess Client 's Business Risk Set Materiality and Assess Accepted Audit Risk ( AAR ) and Inherent Risk ( IR ). Understand Internal Control and Assess Control Risk ( CR ). Develop Overall Audit Plan and Audit Program Phase ii perform test of controls and substantive test of transactions Test of Control : if the auditor plans to reduce the determined control risk, then the auditor should perform the test of control, to assess the operating effectiveness of internal controls ( e.g. authorisation of transactions, account reconciliations, segregation of duties ) including IT General Controls. If internal controls are assessed as effective, this will reduce ( but not entirely eliminate ) the amount of ' substantive ' work the auditor needs to do ( see below ). Substantive test of transactions : evaluate the client 's recording of transactions by verifying the monetary amounts of transactions, a process called substantive tests of transactions. For example, the auditor might use computer software to compare the unit selling price on duplicate sales invoices with an electronic file of approved prices as a test of the accuracy objective for sales transactions. Like the test of control in the preceding paragraph, this test satisfies the accuracy transaction - related audit objective for sales. For the sake of efficiency, auditors often perform tests of controls and substantive tests of transactions at the same time. Assess Likelihood of Misstatement in Financial Statement. Notes : At this stage, if the auditor accept the CR that has been set at the phase I and does not want to reduce the controls risk, then the auditor may not perform test of control. If so, then the auditor perform substantive test of transactions. This test determines the amount of work to be performed i.e. substantive testing or test of details. Phase iii perform analytical procedures and tests of details of balances 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 of Balance ( 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 31 December, the hard close may provide the auditors with figures as at 30 November. The auditors would audit income / expense movements between 1 January and 30 November, so that after year end, it is only necessary for them to audit the December income / expense movements and 31 December balance sheet. In some countries and accountancy firms these are known as ' rollforward ' procedures. Phase iv complete the audit and issue an audit report After the auditor has completed all procedures for each audit objective and for each financial statement account and related disclosures, it is necessary to combine the information obtained to reach an overall conclusion as to whether the financial statements are fairly presented. This highly subjective process relies heavily on the auditor 's professional judgment. When the audit is completed, the CPA must issue an audit report to accompany the client 's published financial statements. Responsibilities of an auditor Corporations Act 2001 requires the auditor to : Gives a true and fair view about whether the financial report complies with the accounting standards Conduct their audit in accordance with auditing standards Give the directors and auditor 's independence declaration and meet independence requirements Report certain suspected contraventions to ASIC 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. This is done by auditor. Numerous proposals are made to revise the current system to provide better economic incentives to auditors to perform the auditing function without having their commercial interests compromised by client relationships. Examples are more direct incentive compensation awards and financial statement insurance approaches. See, respectively, Incentive Systems to Promote Capital Market Gatekeeper Effectiveness and Financial Statement Insurance. Related qualifications There are several related professional qualifications in the field of financial audit including Certified Internal Auditor, Certified General Accountant, Chartered Certified Accountant, Chartered Accountant and Certified Public Accountant. See also Auditor 's report Center for Audit Quality ( CAQ ) Comfort letter Comparison of accounting software Computer Assisted Audit Tools Forensic Accounting International Standards on Auditing ( ISA ) List of accounting topics References Library resources about Financial audit Resources in your library ^ Jump up to : Arens, Elder, Beasley ; Auditing and Assurance Services ; 14th Edition ; Prentice Hall ; 2012 Jump up ^ `` Auditing Standard No. 5 ''. pcaobus.org. Retrieved 2016 - 04 - 07. Jump up ^ `` AU 508 Reports on Audited Financial Statements ''. pcaobus.org. Retrieved 2016 - 04 - 07. Jump up ^ CALCPA. ( 2010, November ). Report : Auditing Missteps During the Economic Crisis. News & Trends, p. 4. Jump up ^ Auditing and Assurance Vol. 1. The Institute of Chartered Accountants of India. 2011. p. 3.4. ISBN 978 - 81 - 8441 - 135 - 5. Retrieved 27 August 2012. Jump up ^ Greenwood, Royston ; Hinings, C.R. ; Brown, John ( 1990 - 12 - 01 ). `` '' P2 - Form '' Strategic Management : Corporate Practices in Professional Partnerships ``. Academy of Management Journal. 33 ( 4 ) : 725 -- 755. doi : 10.2307 / 256288. ISSN 0001 - 4273. Jump up ^ Mario Christodoulou ( 2011 - 03 - 30 ). `` U.K. Auditors Criticized on Bank Crisis ''. Wall Street Journal. Jump up ^ Ernst & Young. `` Legal statement ''. ey.com. Jump up ^ Denlinger, Craig. `` Audit Costs ''. Retrieved 27 January 2014. Jump up ^ `` Audit Costs ''. Retrieved 15 April 2015. ^ Jump up to : Commission, c = au ; o = Australian Government ; ou = Australian Government Australian Securities and Investments. `` Audit quality - The role of directors and audit committees ''. asic.gov.au. Retrieved 2016 - 05 - 17. Jump up ^ `` National Audit Office ( NAO ) ''. www.nao.org.uk. Retrieved 2016 - 05 - 17. Jump up ^ Office, Australian National Audit ( 2016 - 05 - 12 ). `` Auditor - General and the Office ''. www.anao.gov.au. Retrieved 2016 - 05 - 17. Jump up ^ `` U.S. GAO - Our Seal ''. Gao.gov. 2008 - 09 - 29. Retrieved 2013 - 09 - 02. Jump up ^ `` Part 2 ''. archive.treasury.gov.au. Retrieved 2016 - 05 - 17. Jump up ^ `` A Look Back at the Enron Case ''. FBI. Retrieved 2016 - 04 - 07. Jump up ^ International Standard on Auditing 315 Understanding the Entity and its Environment and Assessing the Risks of Misstatement Jump up ^ Stef, Scott,. `` Tests of control & substantive tests ''. www.icas.com. Retrieved 2016 - 05 - 17. Jump up ^ `` Carrots for Vetogates : Incentive Systems to Promote Capital Market Gatekeeper Effectiveness by Lawrence A. Cunningham : : SSRN ''. 2007 - 04 - 17. SSRN 980949. Missing or empty url = ( help ) ; access - date = requires url = ( help ) Jump up ^ `` Choosing Gatekeepers : The Financial Statement Insurance Alternative to Auditor Liability by Lawrence A. Cunningham : : SSRN ''. 2004 - 06 - 03. SSRN 554863. Missing or empty url = ( help ) ; access - date = requires url = ( help ) NDL : 00564569 Retrieved from `` https://en.wikipedia.org/w/index.php?title=Financial_audit&oldid=821079820 '' Categories : Auditing Financial accounting Accounting terminology Types of auditing Hidden categories : Pages using web citations with no URL Pages using citations with accessdate and no URL Use dmy dates from October 2013 Articles needing cleanup from May 2011 All pages needing cleanup Cleanup tagged articles without a reason field from May 2011 Wikipedia pages needing cleanup from May 2011 Articles with limited geographic scope from December 2010 Articles with multiple maintenance issues Articles containing potentially dated statements from 2006 All articles containing potentially dated statements Pages using div col without cols and colwidth parameters Talk Contents About Wikipedia Български Čeština Deutsch Español فارسی Français 한국어 Bahasa Indonesia Italiano עברית ಕನ್ನಡ Қазақша Lietuvių Magyar Bahasa Melayu 日本 語 Polski Português Shqip Slovenčina Suomi தமிழ் Türkçe Tiếng Việt Edit links This page was last edited on 18 January 2018, at 07 : 41. 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Question: what is the basic purpose of an audit
Answer: to provide an opinion whether "financial statements" (the information being verified) are stated in accordance with specified criteria