Question

You and your best friend are both majoring in accounting, and the two of you have had several courses together throughout your studies. Due to a scheduling conflict, you're on your own in the auditing class, and loving the content so far! As you try to explain the class to your friend, it becomes clear that he doesn't really understand the audit process. He asks you the following questions:

1. Isn't it the auditor's job just to check the numbers and calculations on financial statements and find all kinds of fraud?
2. Why do you need to understand the client's business? Isn't the CPA there to audit financial statements?
3. What is the purpose of auditing an entity's financial statements?

How should you respond to your friend's questions?

Answer 1

The audit is the process of obtaining reasonable assurance that the financial statements are free from material misstatements and they reflect true and fair view of financial results and position of the enterprise. Checking the numbers and calculations on financial statements and finding out frauds are part of audit procedure, but the scope of audit is far beyond these three activities. To ensure that the financial results i.e. Income statement and financial position i.e. Balance Sheet reflect true and fair view, the auditor has to draft the audit plan determining the level of materiality of a transaction. The auditor needs to check that the accounting has been done in compliance with relevant Accounting standards and compliance with laws of the land. Auditors are also required to report whether the company has adequate internal control policies in place, the director's independence report.

In order to understand the accounting of business transactions, through understanding of the business, business processes and flow of activities in the organisation is mandatory.If the auditor does not understand the business of the client, he wont be be in a position to audit the results also because he would not have the required knowledge to comment on the internal control system, any control lapses, any errors in accounting flow. Hence, understanding the client business and then preparing the audit plan to conduct the audit is of utmost importance. The CPA as the auditor of the company needs to express an opinion on the true and fair view of the financial statements. The audit plan assesses the internal control system, reviewing the accounts, provisions, asset and liabilities balance, test checking of flow of journal entries in the ERP software, physical verification of assets, inventories, cash and bank balances. Thus, all material items in which chances of errors or frauds exists are covered in audit procedure.

The preparation and presentation of financial statements is the responsibility of the Board of Directors of the company. The directors are also responsible for implementing and reviewing the internal control mechanism. Since, the company has lot of stakeholder's like owner's, suppliers, lenders, financial institutions and they have various kind of interest in the business of the company.An auditor has to express an opinion on the financial statements whether they represent true and fair view and on the internal control systems of the entity. This third party opinion provides reasonable assurance to the various stakeholders that financial statements are free from material misstatements.