Financial Audits – Basic Tests

Financial audits are intended to provide some assurance to the public that a company’s financial statements are presented fairly and accurately, in accordance with the established or stated criteria.  The public may include the shareholders of the company, debtors such as bondholders, banks or other financial institutions and some government entities. In general, a financial audit will seek to confirm that the company used “generally accepted accounting principles” (GAAP) in the scope of the audit (all material information has been revealed), how the finances of the company have been managed and what are the kind and strength of the company’s internal financial control structures for reporting and protecting assets.  A proper audit will seek to confirm that all the financial data of the company has been reliably obtained, maintained and disclosed in the reports, and that the resources of the firm are properly protected against losses arising from fraud, theft, error or mismanagement.

There are three authoritative bodies for establishing accounting principles and financial reporting standards: the Federal Accounting Standards Advisory Board for the federal government, the Governmental Accounting Standards Board for state and local governments, and the Financial Accounting Standards Board (FASB) for nongovernmental entities.  GAAP has been developed by the American Institute of Certified Public Accountants’ (AICPA) to assure some uniformity in financial procedures; the audit process has a special section that applies to audit field work and reporting.

There are standard tests that are typically used in every audit. They will usually include:

Bank reconciliations are checked and confirmed, the reported balances in each account are confirmed with the banks, interest rates are confirmed, gains and losses from marketable securities are verified, and petty cash is inventoried.

The documents regarding equity are checked and any variation in equity or retained earnings is properly explained.

The outstanding debt with large debtors is confirmed to be in accordance with the books of the company and a review of the aged receivables account and bad debt receivable item is conducted to make sure it is realistic.

The outstanding credit with large creditors is confirmed to be in accordance with the books of the company, and notes and terms issued are reviewed.

Outstanding debt is reviewed for adherence to terms, payment track records.

Operating costs are analyzed and it is made sure they are properly reflected.

Fixed Assets
An examination of the schedule of capital additions and improvements is conducted to make sure they are properly reflected.

Tax returns are reviewed and verified.

Inter-company Operations
The treatment of any transactions between subsidiaries, affiliates, etc. are examined for proper reporting. Any consolidations are reviewed for accuracy and relevancy.

Payroll records are examined, including samplings of time sheets, payroll reports, payroll checks issued, etc.

Balance Sheet Review and Financial Results
The presentation of the profit and loss statement, balance sheet and cash flow statement are reviewed for compliance with GAAP and the financial results are deemed to be properly presented.

The financial audit is considered one of, if not THE most important tool in judging a company’s worth, and therefore is highly valued to all parties concerned with investing in, lending to or even just transacting business with the company.  The public relies on the integrity of audit, and needs to consider that one of the main problems in the audit process is the conflict between the objectivity an auditor should exhibit and the business relationship between the audit firm and the company being audited. On one hand, the audit firm should be ruthless in thoroughly checking the books, but on the other hand, it wants to keep its customer happy since it is a chief source of revenue.

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