- The work is to be adequately planned and assistants, if any, are to be properly supervised.
- Independent auditors will carry out proper study and evaluation of the existing internal controls to determine their reliability and suitability for conducting all necessary auditing procedures.
- External auditors will make certain that they are able to review all relevant evidential materials, whether obtained through inspection, observation, inquiries, or confirmation, so that they can form an informed and reasonable opinion regarding the quality of the financial statements under examination.
Standards of reporting describe auditing standards relating to the audit report and its requirements. AICPA standards of reporting stipulate that the auditor indicate whether the financial statements examined were presented in accordance with generally accepted accounting principles; whether such principles were consistently observed in the current period in relation to the preceding period; and whether informative disclosures to the financial statements were adequate. Finally, the external auditor's report should include 1) an opinion about the financial statements/records that were examined, or 2) a disclaimer of opinion, which typically is included in instances where, for one reason or another, the auditor is unable to render an opinion on the state of the business's records.
THE EXTERNAL AUDITING PROCESS
The independent auditor generally proceeds with an audit according to a set process with three steps: planning, gathering evidence, and issuing a report.
In planning the audit, the auditor develops an audit program that identifies and schedules audit procedures that are to be performed to obtain the evidence. Audit evidence is proof obtained to support the audit's conclusions. Audit procedures include those activities undertaken by the auditor to obtain the evidence. Evidence-gathering procedures include observation, confirmation, calculations, analysis, inquiry, inspection, and comparison. An audit trail is a chronological record of economic events or transactions that have been experienced by an organization. The audit trail enables an auditor to evaluate the strengths and weaknesses of internal controls, system designs, and company policies and procedures.
The Audit Report
The independent audit report sets forth the independent auditor's findings about the business's financial statements and their level of conformity with generally accepted accounting principles. A check is made to verify that representations over a period of years are consistent. A fair presentation of financial statements is generally understood by accountants to refer to whether the accounting principles used in the statements have general acceptability. This includes such things as 1) the accounting principles are appropriate in the circumstances; 2) the financial statements are prepared so they can be used, understood, and interpreted; 3) the information presented in the financial statements is classified and summarized in a reasonable manner; and 4) the financial statements reflect the underlying events and transactions in a way that presents an accurate portrait of financial operations and cash flows within reasonable and practical limits.
The auditor's unqualified report contains three paragraphs. The introductory paragraph identifies the financial statements audited, states that management is responsible for those statements, and asserts that the auditor is responsible for expressing an opinion on them. The scope paragraph describes what the auditor has done and specifically states that the auditor has examined the financial statements in accordance with generally accepted auditing standards and has performed appropriate tests. The opinion paragraph expresses the auditor's opinion (or formally announces his or her lack of opinion and why) on whether the statements are in accordance with generally accepted accounting principles.
Various audit opinions are defined by the AICPA's Auditing Standards Board as follows:
- Unqualified opinion—This opinion means that all materials were made available, found to be in order, and met all auditing requirements. This is the most favorable opinion that can be rendered by an external auditor about a company's operations and records.
- Explanatory language added—Circumstances may require that the auditor add an explanatory paragraph (or other explanatory language) to his or her report. When this is done the opinion is prefaced with the term, explanatory language added.
- Qualified opinion—This type of opinion is used for instances in which most of the company's financial materials were in order, with the exception of a certain account or transaction.
- Adverse opinion—An adverse opinion states that the financial statements do not accurately or completely represent the company's financial position, results of operations, or cash flows in conformity with generally accepted accounting principles. Such an opinion is obviously not good news for the business being audited.
- Disclaimer of opinion—A disclaimer of opinion states that the auditor does not express an opinion on the financial statements, generally because he or she feels that the company did not present sufficient information. Again, this opinion casts an unfavorable light on the business being audited.
The fair presentation of financial statements does not mean that the statements are fraud-proof. The independent auditor has the responsibility to search for errors or irregularities within the recognized limitations of the auditing process. Investors should examine the auditor's report for citations of problems such as debt-agreement violations or unresolved lawsuits. "Going-concern" references can suggest that the company may not be able to survive as a functioning operation. If an "except for" statement appears in the report, the investor should understand that there are certain problems or departures from generally accepted accounting principles in the statements, and that these problems may call into question whether the statements fairly depict the company's financial situation. These statements typically require the company to resolve the problem or somehow make the accounting treatment acceptable.
