15 Mar What to Expect in a Financial Statement Audit

 

If you are required to obtain an audit on your financial statements for the first time, you may be scratching your head as to what this entails, or what will happen behind the scenes. Regardless of your previous experience with audits, if you are looking for a better idea of what happens during a financial statement audit, then this article is for you.

 

 

Audits vs. Reviews and Compilations

 

Audits are the most detailed examination of financial statements that a CPA firm can perform, providing the most assurance but also having the highest cost. The rules for how to perform an audit are laid out in the Canadian Auditing Standards (CAS), and they’re typically performed on financial statements that are prepared in accordance with Canadian Generally Accepted Accounting Standards (GAAP).

 

Review engagements are also conducted on GAAP financial statements but there is less work to be performed than with an audit. Thus, reviews provide less assurance than an audit and also cost less.

 

Compilations are the simplest form of engagement that we perform on financial statements. These engagements are very limited in scope and thus they provide no assurance but are much less costly than reviews and audits.

 

For more information on the differences between audits, reviews and compilations, you can read our article called Financial Statement Reporting – What Are Your Options? that explores the differences in more detail.

 

 

Understanding Your Organization

 

One of the first things we are required to do on an audit is obtain a detailed understanding of your organization—what it does and how it tracks financial and other information. We are required by CAS to update this understanding each year, which is why we will typically ask similar questions year after year.  This process tends to be much more work in the first year an organization is audited and then less onerous in subsequent years unless the organization has gone through substantial changes.

 

 

Evaluating Your Control Environment

 

In addition to better understanding your organization, we are also required by CAS to document our understanding of your control environment. Your control environment is made up of all the policies and procedures that your organization puts in place to ensure financial and other data is appropriately captured and recorded in your accounting and other records systems. It is also comprised of the measures that you put in place to ensure fraudulent activity does not occur or is caught quickly if it does occur.

 

A common misconception is that a smaller organization is easier to audit than a larger one. While it may be true that smaller organizations have less complex financial statements, they also tend to have less sophisticated control environments. Organizations that have better control environments are more efficient to audit. There are many aspects of creating a better control environment, including management and director oversight, payment approval measures, regular inventory counts, etc. We will explore this subject further in a future piece.

 

 

Details Testing

 

Details testing is the most basic procedure performed in an audit. Here, we simply verify transactions by matching them to supporting documentation such as receipts, invoices, bank statements, cheques, wire transfer documents, etc. Because it is usually impractical to test all of an organization’s transactions over a whole year, most detail testing is performed using a sample of transactions.

 

 

Analytical Procedures

 

Another form of audit testing is analytical procedures. This is where we develop an expectation and compare your organization’s data to it. As a simple example, if we have verified that you pay rent at $10,000 a month for a premise that you rented for 10 months of the year, then our preliminary expectation of your rent expense would be $100,000. We would then compare this to the actual rent expense account in your records and investigate any significant differences from our expectation.  Analytical procedures can be quick and simple like this example or they can be quite complex with lots of assumptions and calculations.

 

 

Confirmations

 

An important concept in audit testing is that third-party evidence is considered more reliable than internal evidence. Confirmations are an efficient process where we can obtain direct third-party evidence from an entity that your organization works with, such as a bank, a customer or a supplier.

 

For example, you may have a client that you sold a significant amount of product to during the year. We could perform detailed testing by looking at order request forms, invoices and payments. Alternatively, we could send a confirmation to the customer asking them how much they purchased from you during the year. Not only is it likely faster and more efficient to do the confirmation rather than the detail testing, it is considered better audit evidence.

 

We usually perform confirmations with banks on account balances and loan balances at year end. If we deem it more efficient or necessary, we also perform confirmations with suppliers and customers.

 

 

Fraud Testing

 

We are required by CAS to consider how fraud could occur in your organization. We are also required to understand and document your controls to prevent and detect fraud. Lastly, all audits are required to include specific tests to see if there is any evidence of fraud.

 

So while we look for fraud as part of our audit, it is not the main focus of a financial statement audit.  Further, individuals who perpetrate fraud are highly incentivized to cover up their tracks so fraud is inherently difficult to detect. We will explore fraud testing in a financial statement audit further in a future piece.

 

 

Estimates

 

Not all figures in a set of financial statements are known amounts—some of the figures are based on estimates. Common examples of estimates in a small organization are allowances for bad debts, inventory obsolescence, useful life of capital assets, certain accrued liabilities, etc. The CAS requires all auditors to look at the estimates and question whether or not they appear reasonable. Recent changes to audit standards also require us to look at management’s track record for estimates and consider that in our assessment of their reasonability.

 

 

Summary

 

We hope the above gives you a better idea as to what is going on in a financial statement audit. As noted above, we will continue to publish pieces to help you better understand what we do and how it impacts you. Our hope is that this information puts you more at ease and helps you get the most out of the work that we perform for you. As always, if you have any questions on this or any other subject, please reach out to your key contact at Clearline.