Financial audit

The audit opinion is intended to provide reasonable assurance, but not absolute assurance, that the financial statements are presented fairly, in all material respects, and/or give a true and fair view in accordance with the financial reporting framework. The purpose of an audit is to provide an objective independent examination of the financial statements, which increases the value and credibility of the financial statements produced by management, thus increase user confidence in the financial statement, reduce investor risk and consequently reduce the cost of capital of the preparer of the financial statements.[2]

In accordance with the US GAAP, auditors must release an opinion of the overall financial statements in the auditor's report. Auditors can release three types of statements other than an unqualified/unmodified opinion. The unqualified auditor's opinion is the opinion that the financial statements are presented fairly. A qualified opinion is that the financial statements are presented fairly in all material respects in accordance with US GAAP, except for a material misstatement that does not however pervasively affect the user's ability to rely on the financial statements. A qualified opinion can also be issued for a scope limitation that is of limited significance. Further the auditor can instead issue a disclaimer, because there is insufficient and appropriate evidence to form an opinion or because of lack of independence. In a disclaimer the auditor explains the reasons for withholding an opinion and explicitly indicates that no opinion is expressed. Finally, an adverse audit opinion is issued when the financial statements do not present fairly due to departure from US GAAP and the departure materially affects the financial statements overall. In an adverse auditor's report the auditor must explain the nature and size of the misstatement and must state the opinion that the financial statements do not present fairly in accordance with US GAAP.[3]

Financial audits are typically performed by firms of practicing accountants who are experts in financial reporting. The financial audit is one of many assurance functions provided by accounting firms. Many organizations separately employ or hire internal auditors, who do not attest to financial reports but focus mainly on the internal controls of the organization. External auditors may choose to place limited reliance on the work of internal auditors. Auditing promotes transparency and accuracy in the financial disclosures made by an organization, therefore would likely reduce such corporations concealmeant of unscrupulous dealings.[4]

Internationally, the International Standards on Auditing (ISA) issued by the International Auditing and Assurance Standards Board (IAASB) is considered as the benchmark for audit process. Almost all jurisdictions require auditors to follow the ISA or a local variation of the ISA.

Financial audits exist to add credibility to the implied assertion by an organisation's management that its financial statements fairly represent the organisation's position and performance to the firm's stakeholders. The principal stakeholders of a company are typically its shareholders, but other parties such as tax authorities, banks, regulators, suppliers, customers and employees may also have an interest in knowing that the financial statements are presented fairly, in all material aspects. An audit is not designed to provide absolute assurance, being based on sampling and not the testing of all transactions and balances; rather it is designed to reduce the risk of a material financial statement misstatement whether caused by fraud or error. A misstatement is defined in ISA 450 as an error, omitted disclosure or inappropriate accounting policy. "Material" is an error or omission that would affect the users decision. Audits exist because they add value through easing the cost of information asymmetry and reducing information risk, not because they are required by law (note: audits are obligatory in many EU-member states and in many jurisdictions are obligatory for companies listed on public stock exchanges). For collection and accumulation of audit evidence, certain methods and means generally adopted by auditors are:[5]

1. Posting checking
2. Testing the existence and effectiveness of management controls that prevent financial statement misstatement
3. Casting checking
4. Physical examination and count
5. Confirmation
6. Inquiry
7. Observation
8. inspection
9. Year-end scrutiny
10. Re-computation
11. Tracing in subsequent period
12. Bank reconciliation
13. Vouching
14. Verification of existence, ownership, title and value of assets and determination of the extent and nature of liabilities

Financial audit is a profession known for its male dominance. According to the latest survey, it found that 70%-80% of the financial auditors are male, with 2% being female and the rest being a mixture of both (Bader, 2018).

Greenwood et al. (1990)[6] defined the audit firm as professional partnership which has a decentralized organization relationship between the national head office and local offices. Local offices can make most decision except for the drawing up professional standard and maintaining it.

The Big Four are the four largest international professional services networks, offering audit, assurance, tax, consulting, advisory, actuarial, corporate finance, and legal services. They handle the vast majority of audits for publicly traded companies as well as many private companies, creating an oligopoly in auditing large companies. It is reported that the Big Four audit 99% of the companies in the FTSE 100, and 96% of the companies in the FTSE 250 Index, an index of the leading mid-cap listing companies.[7] The Big Four firms are shown below, with their latest publicly available data. None of the Big Four firms is a single firm; rather, they are professional services networks. Each is a network of firms, owned and managed independently, which have entered into agreements with other member firms in the network to share a common name, brand and quality standards. Each network has established an entity to co-ordinate the activities of the network. In one case (KPMG), the co-ordinating entity is Swiss, and in three cases (Deloitte Touche Tohmatsu, PricewaterhouseCoopers and Ernst & Young) the co-ordinating entity is a UK limited company. Those entities do not themselves perform external professional services, and do not own or control the member firms. They are similar to law firm networks found in the legal profession. In many cases each member firm practises in a single country, and is structured to comply with the regulatory environment in that country. In 2007 KPMG announced a merger of four member firms (in the United Kingdom, Germany, Switzerland and Liechtenstein) to form a single firm. Ernst & Young also includes separate legal entities which manage three of its four areas: Americas, EMEIA (Europe, The Middle East, India and Africa), and Asia-Pacific. (Note: the Japan area does not have a separate area management entity). These firms coordinate services performed by local firms within their respective areas but do not perform services or hold ownership in the local entities.[8] This group was once known as the "Big Eight", and was reduced to the "Big Six" and then "Big Five" by a series of mergers. The Big Five became the Big Four after the demise of Arthur Andersen in 2002, following its involvement in the Enron scandal.

Costs of audit services can vary greatly dependent upon the nature of the entity, its transactions, industry, the condition of the financial records and financial statements, and the fee rates of the CPA firm.[9][10] A commercial decision such as the setting of audit fees is handled by companies and their auditors. Directors are responsible for setting the overall fee as well as the audit committee. The fees are set at a level that could not lead to audit quality being compromised.[11] The scarcity of staffs and the lower audit fee lead to very low billing realization rates.[12] As a result, accounting firms, such as KPMG, PricewaterhouseCoopers and Deloitte who used to have very low technical inefficiency, have started to use AI tools. [13] Research has found that annual reports that convey optimistic tone are associated with lower audit fees, suggesting that annual report tone reflects factors that auditors consider in assessing audit risk.[14]

Seal of the United States Government Accountability Office[16]

In the United States, the SEC has generally deferred to the accounting industry (acting through various organisations throughout the years) as to the accounting standards for financial reporting, and the U.S. Congress has deferred to the SEC.

This is also typically the case in other developed economies. In the UK, auditing guidelines are set by the institutes (including ACCA, ICAEW, ICAS and ICAI) of which auditing firms and individual auditors are members. While in Australia, the rules and professional code of ethics are set by The Institute of Chartered Accountants Australia (ICAA), CPA Australia (CPA) and The National Institute of Accountants (NIA).[17]

Accordingly, financial auditing standards and methods have tended to change significantly only after auditing failures. The most recent and familiar case is that of Enron. The company succeeded in hiding some important facts, such as off-book liabilities, from banks and shareholders.[18] Eventually, Enron filed for bankruptcy, and (as of 2006) is in the process of being dissolved. One result of this scandal was that Arthur Andersen, then one of the five largest accountancy firms worldwide, lost their ability to audit public companies, essentially killing off the firm.

A recent trend in audits (spurred on by such accounting scandals as Enron and Worldcom) has been an increased focus on internal control procedures, which aim to ensure the completeness, accuracy and validity of items in the accounts, and restricted access to financial systems. This emphasis on the internal control environment is now a mandatory part of the audit of SEC-listed companies, under the auditing standards of the Public Company Accounting Oversight Board (PCAOB) set up by the Sarbanes-Oxley Act.

Many countries have government sponsored or mandated organizations who develop and maintain auditing standards, commonly referred to generally accepted auditing standards or GAAS. These standards prescribe different aspects of auditing such as the opinion, stages of an audit, and controls over work product (i.e., working papers).

Some oversight organisations require auditors and audit firms to undergo a third-party quality review periodically to ensure the applicable GAAS is followed.

The following are the stages of a typical audit:[1]

Corporations Act 2001 requires the auditor to:

• Gives a true and fair view about whether the financial report complies with the accounting standards
• Conduct their audit in accordance with auditing standards
• Give the directors and auditor's independence declaration and meet independence requirements
• Report certain suspected contraventions to ASIC[11]

One of the major issues faced by private auditing firms is the need to provide independent auditing services while maintaining a business relationship with the audited company.

The auditing firm's responsibility to check and confirm the reliability of financial statements may be limited by pressure from the audited company, who pays the auditing firm for the service. The auditing firm's need to maintain a viable business through auditing revenue may be weighed against its duty to examine and verify the accuracy, relevancy, and completeness of the company's financial statements. This is done by auditor.

Numerous proposals are made to revise the current system to provide better economic incentives to auditors to perform the auditing function without having their commercial interests compromised by client relationships. Examples are more direct incentive compensation awards and financial statement insurance approaches. See, respectively, Incentive Systems to Promote Capital Market Gatekeeper Effectiveness[21] and Financial Statement Insurance.[22]

• There are several related professional qualifications in the field of financial audit including Certified Internal Auditor, Certified General Accountant, Chartered Certified Accountant, Chartered Accountant and Certified Public Accountant.

Currently, many entities being audited are using information systems, which generate information electronically. For the audit evidences, auditors get dynamic information generated from the information systems in real time. There are less paper documents and pre-numbered audit evidences available, which leads a revolution to audit mythology.[23]