Financial Statements - The Auditor and Audit Opinion
An audit is a process for testing the accuracy and completeness of information presented in an organization's financial statements. This testing process enables an independent Certified Public Accountant (CPA) to issue what is referred to as "an opinion" on how fairly a company's financial statements represent its financial position and whether it has complied with generally accepted accounting principles.
Note: Only independent auditors (CPAs) can produce audited financial statements. That is, the company's board members, staff and their relatives cannot perform audits because their relationship with the company compromises their independence.
The audit report is addressed to the board of directors as the trustees of the organization. The report usually includes the following:
- a cover letter, signed by the auditor, stating the opinion.
- the financial statements, including the balance sheet, income statement and statement of cash flows
- notes to the financial statements
In addition to the materials included in the audit report, the auditor often prepares what is called a "management letter" or "management report" to the board of directors. This report cites areas in the organization's internal accounting control system that the auditor evaluates as weak.
What Does the Auditor Do?
The auditor will request information from individuals and institutions to confirm:
- bank balances
- contribution amounts
- conditions and restrictions
- contractual obligations
- monies owed to and by the organization.
To ensure that all activities with significant financial implications is adequately disclosed in the financial statements the auditor will review:
- physical assets
- journals and ledgers
- board minutes
In addition, the auditor will also:
- select a sample of financial transactions to determine whether there is proper documentation and whether the transaction was posted correctly into the books
- interview key personnel and read the procedures manual, if one exists, to determine whether the organization's internal accounting control system is adequate
The auditor usually spends several days at the organization's office looking over records and checking for completeness.
Auditors are not expected to guarantee that 100% of the transactions are recorded correctly. They are required only to express an opinion as to whether the financial statements, taken as a whole, give a fair representation of the organization's financial picture. In addition, audits are not intended to discover embezzlements or other illegal acts. Therefore, a "clean" or unqualified opinion should not be interpreted as assurance that such problems do not exist.
The standard auditor's opinion contains three parts and states that:
• the preparation of the financial statements are the responsibility of management, and that the auditor has performed an independent review.
• Generally accepted auditing procedures were followed, providing reasonable assurance that the statements do not contain any material errors.
• The auditor is satisfied that the statements were prepared in accordance with accepted accounting procedures and that any assumptions or estimates used are reasonable.
An unqualified opinion indicates that the auditor believes that the statements are free from any material errors or omissions
The Qualified Opinion
A qualified opinion is issued when the accountant believes the financial statements are, in a limited way, not in accordance with generally accepted accounting principles. A qualified option may be issued if the auditor has concerns about the going-concern assumption of the company, the valuation of certain items on the balance sheet or some unreported pending contingent liabilities.
An adverse opinion is issued if the statements are not presented fairly or do not conform to generally accepted accounting procedures.
Under U.S. GAAP, the auditor must provide its judgment about the company's internal controls, or the processes the company uses to ensure accurate financial statements.
Under the Sarbanes-Oxley act, management is supposed to make a statement about its internal controls including the following:
• A statement declaring that the financial statements are presented fairly;
• A statement declaring that management is responsible for maintaining and executing effectual internal controls;
• A description of the internal control system and how it is evaluated;
• An analysis of how effective the internal controls have been over the last year;
• A statement declaring that the auditors have review management's report on its internal controls