A. what is the main objective of the audit of an entitys financial statements?

An audit is defined as an official inspection of an organisation’s accounts, typically by an independent body. Many companies within the UK are likely to require an audit, but are unsure what an audit is and when is it needed.

So when does an entity require an audit?

A company is legally required to have an audit if they breach two of the following thresholds:

• Turnover greater than £10.2m;
• Total assets greater than £5.1m; or
• Greater than 50 employees.

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Even if a company is below these thresholds it will be required to have an audit if it is part of a group which breaches certain size thresholds. Additionally, sometimes the company’s articles or the shareholders will require an audit. Therefore, even small companies can be required to have an audit.

The objective of an audit

The objective of an audit is to form an independent opinion on the financial statements of the audited entity. The opinion includes whether the financial statements show a true and fair view, and have been properly prepared in accordance with accounting standards.

A misconception is that auditors are required to identify all misstatements. However, they are responsible for identifying material misstatements, not all misstatements.

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What does an audit involve?

An audit must be performed by a registered auditor and must comply with certain standards. It involves performing procedures on the numbers disclosed in the financial statements. These procedures are designed to identify material misstatements and regularly involve testing a sample of transactions and balances.

Additionally, the auditor performs a detailed review of the financial statements, including disclosures, to check they comply with accounting standards and company law.

After all the work has been completed the audit opinion is communicated in a standard report which is included in the financial statements of the audited entity. Any weaknesses the auditor has identified in internal controls will also be communicated to management.

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More about Menzies audit and compliance services

As well as meeting your statutory reporting obligations, Menzies’ audit and compliance services are the proactive way to reduce risk and drive forward your business strategy. Our pragmatic, hands-on approach helps you improve your business performance – by challenging assumptions and resolving commercial issues that could be holding your business back.

Our audit and compliance team will help you to:

• Add value to your business by using the audit as a basis to identify and resolve commercial issues and to improve your business processes.
• Use the understanding and insight gained from the audit as a basis for helping you develop strategies to drive your business forward.
• Reduce risk and improve your organisational performance by challenging existing assumptions and practices.
• Secure peace of mind from knowing your statutory obligations are met, accounts are true and potential problems have been identified early on.

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A financial statement audit is the examination of an entity's financial statements and accompanying disclosures by an independent auditor. The result of this examination is a report by the auditor, attesting to the fairness of presentation of the financial statements and related disclosures. The auditor's report must accompany the financial statements when they are issued to the intended recipients.

The purpose of a financial statement audit is to add credibility to the reported financial position and performance of a business. The Securities and Exchange Commission requires that all entities that are publicly held must file annual reports with it that are audited. Similarly, lenders typically require an audit of the financial statements of any entity to which they lend funds. Suppliers may also require audited financial statements before they will be willing to extend trade credit (though usually only when the amount of requested credit is substantial).

Audits have become increasingly common as the complexity of the two primary accounting frameworks, Generally Accepted Accounting Principles and International Financial Reporting Standards, have increased, and because there have been an ongoing series of disclosures of fraudulent reporting by major companies.

What are the Stages of an Audit?

The primary stages of an audit are noted below.

Step 1. Planning and Risk Assessment

This step involves gaining an understanding of the business and the business environment in which it operates, and using this information to assess whether there may be risks that could impact the financial statements.

Step 2. Internal Controls Testing

This step involves the assessment of the effectiveness of an entity's suite of controls, concentrating on such areas as proper authorization, the safeguarding of assets, and the segregation of duties. This can involve an array of tests conducted on a sampling of transactions to determine the degree of control effectiveness. A high level of effectiveness allows the auditors to scale back some of their later audit procedures. If the controls are ineffective (i.e., there is a high risk of material misstatement), then the auditors must use other procedures to examine the financial statements. There are a variety of risk assessment questionnaires available that can assist with internal controls testing.

Step 3. Substantive Procedures

This step involves a broad array of procedures, of which a small sampling are:

• Analysis. Conduct a ratio comparison with historical, forecasted, and industry results to spot anomalies.

• Cash. Review bank reconciliations, count on-hand cash, confirm restrictions on bank balances, issue bank confirmations.

• Marketable securities. Confirm securities, review subsequent transactions, verify market value.

• Accounts receivable. Confirm account balances, investigate subsequent collections, test year-end sales and cutoff procedures.

• Inventory. Observe the physical inventory count, obtain confirmation of inventories held at other locations, test shipping and receiving cutoff procedures, examine paid supplier invoices, test the computation of allocated overhead, review current production costs, trace compiled inventory costs to the general ledger.

• Fixed assets. Observe assets, review purchase and disposal authorizations, review lease documents, examine appraisal reports, recalculate depreciation and amortization.

• Accounts payable. Confirm accounts, test year-end cutoff.

• Accrued expenses. Examine subsequent payments, compare balances to prior years, recompute accruals.

• Debt. Confirm with lenders, review lease agreements, review references in board of directors minutes.

• Revenue. Examine documents supporting a selection of sales, review subsequent transactions, recalculate percentage of completion computations, review the history of sales returns and allowances.

• Expenses. Examine documents supporting a selection of expenses, review subsequent transactions, confirm unusual items with suppliers.

Types of Financial Statement Examinations

An audit is the most expensive of all the types of examination of financial statements. The least expensive is a compilation, followed by a review. Due to its cost, many companies attempt to downgrade to a review or compilation, though this is only an option if it is acceptable to the report recipients. Publicly held entities must have their quarterly financial statements reviewed, in addition to the annual audit.

Audits are more expensive for publicly-held firms, for auditors must adhere to the stricter audit standards of the Public Company Accounting Oversight Board (PCAOB), and so will pass their increased costs through to their clients.

What is the main objective of an audit?

What is the main objective of financial statements?