The Annual Audit: Why must we suffer this ordeal? kidding (Part 1)
Each year organizations try to comprehend the value, the cost and the issues of accountability encompassed in this darn Annual Audit. They have come to learn the importance of this document to outside parties like grantors and donors in their process of making funding decisions but for many the inner workings and true value remains a mystery.
In this primer on audits we will look at the following three items:
- What are you buying?
- What does an auditor do?
- What are the Board of Directors responsibilities with respect to an audit?
In this article, we answer the first two questions.
What Are You Buying?
An audit is a methodical and objective examination of accounts and items that support the financial statements. In a normal audit conducted in accordance with generally accepted auditing standards, a CPA firm's objective is to express an opinion on how fairly the financial statements present in all material respects the financial position, the results of operations, and cash flows in conformity with generally accepted accounting principles.
- The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor.
- In all matters relating to the assignment, independence in mental attitude is to be maintained by the auditor or auditors.
- Due professional care is to be exercised in the performance of the examination and the preparation of the report.
Standards of Field Work
- The auditing work is to be adequately planned and assistants, if any, are to be properly supervised.
- There is to be a proper study and evaluation of the existing internal control as a basis for reliance thereon and for the determination of the resultant extent of the tests to which auditing procedures are to be performed.
- Sufficient competent evidential matter is to be obtained through inspection, observations, inquires, and confirmations to obtain a reasonable basis for an opinion regarding the financial statements under examination.
Standards of Reporting
- The audit report shall state whether the financial statements are presented in accordance with generally accepted accounting principles.
- The report shall state whether such principles have been consistently observed in the current period in relation to the preceding period.
- Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.
- The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed.
The underlying premise of an audit is that the organization has internally prepared financial statements and provided supporting footnotes, upon which an auditor can ultimately issue an opinion on whether or not the statements are materially correct ? in essence, the financial statements are generally correct when compared to certain standards. So, while you can observe an auditor doing tests and looking at your books and records, what you are buying is an opinion as evidenced by a report.
The report in which the opinion is expressed is composed of at least four parts. The goal of every audit, the "gold standard" if you will, is a "clean" opinion. The parts of a clean opinion are as follows:
- Identification of the audited statements
- An express statement that the financial statements are the responsibility of management.
- Identification of the standards by which the audit was conducted and the basis upon which the auditor forms his opinion.
- The opinion
Additional information may be included in the report to describe significant items such as departures from the standards or what procedures, if any, were performed on supplementary information included with the financial report.
What Does An Auditor Do?
An auditor is engaged to render an opinion on whether the financial statements fairly present the financial position and activities of an organization in reference to a standard. Therefore, the organization must provide the auditor two things:
- Complete financial statements
- Standards by which the statements are evaluated against
The standards will determine what makes complete financial statements. For statements in accordance with generally accepted accounting standards (GAAP) in the United States, the following is included:
- Statement of Financial Position (similar to a Balance Sheet)
- Statement of Activity (similar to an Income or Profit/Loss Statement)
- Statement of Cash Flows
For Organizations receiving federal funding and subject to the Single Audit Act, the following additional statements are required:
- Schedule of Expenditures of Federal Awards
- Schedule of Findings and Questioned Costs
In order to develop an opinion, the auditor must perform tests on the financial statements. Tests may include:
- Examining cancelled checks,
- Examining invoices,
- Examining deposit slips
- Testing the procedures that form the system for recording the transactions of the organization
- Inquiry of responsible organization personnel regarding the relationship between the program activities the financial implications of those activities
- Confirmation from outside parties regarding balances
- In the bank and investment houses
- Pledges and accounts receivable
- Accounts and loans payable
- Amounts contributed
In an ideal audit situation, the auditor will limit his/her work to the examination of the financial statements and testing the underlying support for how they were created. In most cases however, the auditor is called upon to determine the need for all year end adjustments, including standard ones such as depreciation and the recording of separate activities such as fundraising events. Once year end adjustments are posted, the auditor drafts the financial statements and the footnotes. It is only then that the auditor is able to begin the testing necessary to determine that the financial statements are in accordance with the appropriate standards.
Auditors factor many things into the drafting of their report and the design of the tests of the financial statements. Organized books and records and the careful accounting of transactions contribute to the auditor?s ability to conduct an efficient and cost effective audit. Disorganized records require three things from auditors:
- the need to organize the records to determine what happened;
- an investigation to determine that all transactions were recorded; and
- testing or analysis to determine that the recording is appropriate.
In most cases of fraud and embezzlement, the records are disorganized, the financial statements are incomplete and too many adjustments are made than are warranted by the nature of the organization.
Once the report has been drafted, the auditor will meet at least with management, if not the board of directors to deliver the report and answer any questions regarding the financial position of the organization.
The auditor can be a valuable resource, not just at audit time, but also throughout the year. His/her education and experience with many different organizations and business models can be valuable resource to the organization. Sometimes, the only individual with history of the organization is the auditor. While it is tempting to not incur audit, accounting, or consulting fees, particularly in tough economic times, the involvement of an independent CPA can bring credibility to the public and donors.
In part two of this article, we will explain the responsibilities of the Board of Directors with respect to an audit.