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Financial Audits Explained

The accountancy industry is the realm of the financial audit. A career as an auditor is a popular one for those interested this area of finance, and it could lead to international travel opportunities and very healthy salaries in more senior roles. Here’s a little explanation of the bread and butter of an auditor role: financial audits…

Why are audits necessary?

An audit is essentially a kind of MOT for a company or organisation. Whether they’re public sector or private sector, there is firstly a legal obligation for companies to display transparency in their books and prove that they are upholding official accounting standards and procedures in the running of their business. This is referred to as ‘compliance’. Each jurisdiction has its own Generally Accepted Accounting Principles (GAAP), and the company has to make sure these are met. An external audit will tick this legal obligation box.

Companies also run internal audits with the aim of assessing how accounting processes are running. These checks are equally as important from a business planning perspective as they can often highlight weaknesses and identify areas in the company which could be made more efficient and cost-effective. It’s an opportunity to refine processes to ensure the company or organisation is making the best out of their money and resources.

The auditing process…

A financial audit conducted by an external auditor will roughly follow these stages:

Planning & risk assessment

A solid plan must be put together in the initial stages to ensure a thorough and effective audit that pertains to all standards. During this stage, the auditor determines the best way to go about collecting the necessary data they need in order to conduct the audit and figures out which areas need to be covered in order to fulfil the order purpose (it may be an overall external audit for example, or a focus on one particular department).

The auditor will also identify any potential risks which may crop up during the process and result in an inaccurate opinion of the company’s financial information.

Internal controls testing

This stage most often takes place at the client’s site. This is the auditor’s chance to observe and dissect the inner workings of the company’s accounting processes. This includes everything from the authorisation of transactions to ‘segregation of duties’ (how the company splits up responsibilities amongst staff in order to reduce the risk of things like fraud). 

Testing

The testing stage builds on the findings of the internal controls testing. The auditor compares findings with further financial documents from the company, and then carries out more observations and checks. The purpose is to make sure that all the figures provided match up with the company’s financial statement. The extent of this stage depends on the results of the internal controls testing stage: the more discrepancies and evidence of weak internal procedures there are, the more in depth testing will be.

Report production

The auditor’s report is the culmination of the audit findings throughout the testing stages, complied by the auditor.   

Within this report, auditors will present their ‘opinion’; basically whether they think the company’s accounts are accurate or whether there seems to be something amiss in upholding accounting standards.

There is a particular format an official audit report must follow. If the auditor thinks that everything’s shipshape, accurate and above board (‘true and fair’) in the company’s financial documentation, and that official accounting standards are met, they will grant an ‘unqualified approval’.

Qualified approval, disclaimer or adverse findings all denote other grades of the auditor’s opinion.

Differences between internal audits & external audits…

Here are some key differences in a nutshell:

  • The auditor’s report will be passed onto the company’s senior management team and board members accordingly in an internal audit. External audit reports will be provided to the company’s shareholders and necessary government bodies.
  • An internal audit will usually have a key objective, with the aim of helping to improve efficiency and effectiveness of processes in a particular department for instance. External audits fulfil a legal obligation and also add to a company’s credibility.
  • Internal auditors will often provide additional recommendations and advice to a department’s/company’s managers on how to make improvements based on their audit findings; an external audit is simply descriptive and does not involve any level of consultation services.

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