What Is a Financial Audit and How Does It Work

A financial audit is essentially an examination of a company's financial records and statements to ensure their accuracy and fairness. This process is usually conducted by an independent auditor, who reviews financial transactions, accounts, and other relevant documents.

The purpose of a financial audit is to provide an objective opinion on whether a company's financial statements present a true and fair view of its financial position. Audits can also help identify areas of financial risk and provide recommendations for improvement.

Auditors typically follow a standardized process, which involves reviewing financial statements, testing transactions, and evaluating internal controls. This process helps ensure that financial statements are accurate, reliable, and comply with relevant laws and regulations.

The audit process usually starts with a planning phase, where the auditor identifies the scope of the audit and gathers information about the company's financial systems and processes.

There are several types of financial audits, each with its own purpose and scope. External audits are performed by independent auditors who provide an impartial opinion on a company's financial statements.

External audits are conducted by parties who are not related to the company in any way, and they help stakeholders make better decisions by reviewing the transparency of a company's financial reporting. Internal audits, on the other hand, are conducted by internal employees or a third-party company hired for these tasks, and they help businesses identify areas for improvement and prepare for external audits.

The three main types of financial audits are:

Internal audits are conducted by employees of the organization, known as internal auditors, to provide management with an assessment of the effectiveness of financial reporting processes and internal controls over financial reporting.

Internal audits are typically used when an organization doesn’t have the in-house resources to audit certain parts of its operations. They're not employed internally but consultant auditors use the standards of the company they're auditing rather than a separate set of standards.

Internal auditors are employed by the company or organization for whom they're performing an audit. The resulting audit report is given directly to management and the board of directors.

Internal audits help an organization improve its processes and internal controls by performing projects and controls assessments to identify any areas of improvement or deficiencies in the controls and reporting process.

The results of an internal audit, along with the internal audit team’s recommendations for improvement, are recorded in a financial audit report provided to the organization’s management and board of directors.

Internal audits provide benefits to management by identifying flaws in internal control or financial reporting before its review by external auditors.

Here are the main objectives of internal audits:

In a financial audit, there are three main types of statements that auditors focus on. Each statement provides a unique perspective on a company's financial health.

An income statement is like a report card for a company's profitability, showing revenues and expenses. It helps auditors determine if a company is generating more cash than it's spending.

A balance sheet is a snapshot of a company's current financial position, listing assets, liabilities, and shareholders' equity. This helps external stakeholders make informed decisions about investing in the company.

A cash flow statement shows how a company is managing its cash, including revenue generation and spending. It's like a checkbook for the company, helping auditors identify areas for improvement.

Here are the three types of statements auditors review:

A financial audit is a thorough review of a company's financial statements and processes by an independent auditor. This process typically includes reviewing account balances and transactions, historical documents, internal documents, commitments, and financial statements.

The auditor will examine the company's financial statements, including the balance sheet, income statement, statement of cash flows, and statement of changes in equity. These statements provide a comprehensive picture of the company's financial health and performance.

The auditor will also evaluate the effectiveness of the company's internal controls over financial reporting and identify any material misstatements in the financial statements. This process is crucial in ensuring the accuracy and authenticity of the financial statements, which in turn shapes the company's reputation and guides investors' decisions.

An audit is the review or inspection of a company's accounts by an independent body. This review can be conducted internally or by an external third-party firm.

Almost all companies conduct a yearly audit of their financial statements, which includes reviewing statements like the income statement, balance sheet, and cash flow statement.

Lenders often require the results of an external audit annually as part of their debt covenants. This ensures that companies are financially sound and can meet their obligations.

Publicly traded companies must also receive an evaluation of the effectiveness of their internal controls as a result of the Sarbanes-Oxley Act (SOX) of 2002. This is to prevent companies from intentionally misstating financial information to commit fraud.

In the United States, external audits follow the generally accepted auditing standards (GAAS) set out by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA).

A financial audit considers every aspect of a company's financial process and documentation. This includes reviewing account balances and transactions, historical documents, internal documents, commitments, and financial statements.

Documentation of account balances and transaction history for each account covering the duration of the review period is a crucial part of a financial audit.

The IT department plays a crucial role in the financial audit process, ensuring that all financial data is accurately captured, stored, and retrieved. They are responsible for maintaining the integrity of the financial system, which includes identifying and resolving any technical issues that may arise.

IT staff must ensure that all financial software and hardware are properly configured and up-to-date, as outdated systems can lead to errors and inaccuracies in financial reporting. This includes regular backups and updates to prevent data loss.

A well-maintained IT system is essential for a smooth financial audit process, as it enables auditors to access and review financial data efficiently. This includes financial statements, ledgers, and other relevant documents.

IT staff must also ensure that all financial data is properly secured and protected from unauthorized access, as this is a key aspect of the financial audit process. This includes implementing robust security protocols and access controls.

In addition, IT staff must be able to provide auditors with the necessary data and documentation in a timely and efficient manner, which requires effective communication and collaboration.

During a financial audit, your auditor will review a wide range of financial information to ensure its accuracy and completeness.

Account balances and transactions are scrutinized, including documentation of account balances and transaction history for each account covering the duration of the review period.

Historical documents, such as articles of incorporation and bylaws, are also reviewed to verify the company's founding and governance structure.

Internal documents, like policies and procedures documentation, are examined to ensure they align with the company's financial reporting processes and accounting practices.

Financial commitments, including loans, lease agreements, employee benefits, and other liabilities, are evaluated to ensure they are properly recorded and disclosed in the financial statements.

The auditor will also review previous cash flow statements, balance sheets, and income statements to gain a comprehensive understanding of the company's financial performance and position.

Here's a breakdown of the key financial statements reviewed during an audit:

The auditor will carefully examine each number, figure, and disclosure in these statements to ensure they are accurate and authentic, and that they comply with established accounting principles.

There are several types of financial audits, each with its own purpose and objectives. One type is the external audit, which is performed by independent auditors who are not related to the audited entity.

The main objective of an external audit is to provide an impartial opinion on the financial statements. This type of audit benefits both external and internal stakeholders by reviewing the transparency of a company's financial reporting.

Internal audits, on the other hand, are carried out by the company's internal audit staff. They focus on the evaluation and improvement of financial management processes and risk control.

Government audits are performed by government entities to ensure that public organizations comply with regulations and use resources properly and effectively. This type of audit helps prevent waste and mismanagement of public funds.

Compliance audits focus on verifying whether the entity complies with applicable laws, regulations, and policies. This type of audit helps businesses identify areas for improvement and adhere to accounting standards.

Here's a breakdown of the different types of financial audits by purpose:

Financial audit vs accounting and bookkeeping are often misunderstood as the same thing, but they serve different purposes.

Auditing is a less frequent activity that ensures accounting policies are sufficient and error-free, obtaining an independent opinion on the company's financial statements.

Accounting is an ongoing process that records, classifies, and summarizes a business's financial transactions to ensure accuracy.

The purpose of accounting is to provide financial information accuracy, while auditing evaluates financial statements to determine their accuracy and compliance with accounting standards.

Auditing is conducted periodically, whereas accounting is an on-going process.

The obligation of accounting is to the company and its management, whereas auditing is to internal and external stakeholders.

Here is a comparison of accounting and auditing:

Financial audits rely on Generally Accepted Auditing Standards (GAAS), which provides a minimum set of standards for auditors to follow.

GAAS ensures consistency and uniformity in the auditing process, fostering a culture of integrity and objectivity that's crucial for establishing credibility.

GAAS focuses on principles that govern the audit process, including a comprehensive understanding of internal controls and a meticulous examination of financial statement evidence.

By following GAAS, auditors can dig into details while keeping the big picture in mind, ultimately bolstering the reliability of financial statement audits.

Most companies receive a yearly audit of their financial statements to satisfy debt covenants to lenders. Financial audits are a legal requirement for publicly traded companies under the Sarbanes-Oxley Act of 2002.

The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board to oversee the rules and standards for such audits. The PCAOB was created to ensure compliance with SOX.

For publicly traded companies, financial audits are a legal requirement under the Sarbanes-Oxley Act of 2002. Organizations planning for an initial public offering will usually perform audit readiness activities to ensure they can meet SOX compliance once required.

Financial audit procedures are built around the five audit assertions at the account or asset level, which include completeness, existence, disclosure, rights, and valuation.

To qualify as a substantive procedure, enough documentation must be collected so another qualified auditor can conduct the same procedure on the same documents and come to the same conclusion.

Substantive procedures are the procedures performed to support financial audits, and they may be a process, step, or test that creates conclusive evidence regarding the financial statements.

The five audit assertions are the foundation of financial audit procedures, and they are used to evaluate the financial statements.

Planning for a financial audit involves performing scoping and risk assessments before the audit project to understand areas that are material to the organization as well as evaluate areas of significant risk.

External auditors will usually determine their level of reliance on the work of the internal audit function in obtaining audit evidence ahead of the audit.

Here are the five audit assertions used in financial audit procedures: