High Power Business Assurance: The external audit

This month’s blog posts have been about compilations and reviews, both good tools to help a business get a grasp of its financial situation and practices.

This week, we examine the CPA audit and discuss its major differences from financial reviews. We’ll also analyze when a business can benefit from an audit and its pros and cons.

Let’s go!

Is an audit better than a review?

This is a common question business owners have, but it’s a little misguided because one isn’t better than the other based on their own merits.

It really comes down to what your business needs. Where audits excel is in their level of assurance.

Reviews are cheaper than audits but offer less assurance because they are more analytical and often narrower in scope.

Audits offer the highest level of assurance that financial statements are free from misstatement.

If creditors or investors require this level of assurance, an audit is your only real option.

So, let need, not cost be the deciding factor on whether to get an audit or review. If your business does require an audit, here’s what to expect and what you’ll get.

Planning, Preparation, and gathering evidence

The first thing that happens is that the business principals and the CPA firm agree on the scope of the audit. Then, they perform a risk assessment, identifying potential areas with a higher risk of material misstatement.

After the risk assessment, they start digging to learn everything possible about the business, the industry, and the internal control environment. The auditor will review financial records, contracts, invoices, and other relevant documentation.

Then, the testing begins.

Fieldwork

In this phase, the auditor assesses the effectiveness of internal controls over financial reporting. This is done by performing tests on transactions and account balances to verify accuracy.

This includes selecting a sample of transactions to test. The auditors look for inconsistencies or unusual patterns. They also verify information with third parties like banks and customers to gain confirmation on the documents inspected.

Depending on the business, a physical examination may occur to align inventory and equipment with financial statements.

Observation is often another part of the audit process.

This means the CPA will literally watch processes to find strengths and weaknesses. It also helps align what was said in interviews with what is happening.

Once that is done, it’s time for the next phase.

Review and Reporting

With fieldwork complete, the auditor will ensure all the audit procedures to ensure all procedures were completed and that the findings support the audit opinion.

Then, they issue the audit report, which includes their opinion on the financial statements. These reports come in several flavors.

They can issue an unqualified opinion, which means the financial statements are fairly represented in all material aspects.

A qualified opinion means statements are fairly represented, except for certain issues.

The next option is not good. That’s an adverse opinion, and it means just what it sounds like. The auditor found the financial statements were not fairly represented.

Finally, they can issue a disclaimer of opinion. That means the auditor can’t express an opinion due to limitations in the scope of the audit, which is also not ideal.

The auditor may also provide a letter recommending improvements for internal controls and operational efficiencies.

The Bottom Line

Audits are time-intensive and expensive. How much so depends on its scope and the amount of work required. However, it can be a worthwhile investment to provide insight and assurances that compilations and reviews cannot.