Audit Reports: What, Exactly, Are You Reporting?

I find that the auditing section of the CPA exam is a difficult area for many exam candidates. Auditing, more than any other topic on the CPA exam, is best explained with “real life” examples. I describe the audit section as more of a business law exam. That’s because audit reports and related disclosures read like legal documents. Real life examples can help the student break through this legal language and understand the topic.

What an audit report says:

If you were on an elevator and someone asked you what an audit report says, how would you respond? Keep in mind that you only have a minute or two.

Here’s my response: An audit report documents the auditor’s opinion that the financial statements are materially correct. By materially correct, the auditor is saying that they didn’t find any errors large enough that would change the financial statement reader’s opinion of the financial statements.

Let’s assume your considering buying a restaurant. As part of your due diligence, you read the audited financial statements. If the financial statements contained an immaterial error, that error would not change your view about the financial health of the restaurant.

What an audit report does not say:

·            An audit report does not say that the financial statements are free of all errors. You just learned that the report might contain immaterial error.

·            Fraud: Fraud is defined as “willful intent to deceive”. Fraud normally involves collusion. If two or more employees work together to commit fraud, they are colluding. An audit is not designed to detect fraud. If employees are attempting to defraud a company, typical audit procedures will not detect fraud.

A good example of fraud is creating a fictitious payee (which I have bogged about- search my blog for that particular posting). Say an employee creates a fictitious company and has the employer write checks to that firm to pay bogus invoices.

Typical audit procedures may not catch this fraud. That’s because an auditor assumes that the company’s internal controls over financial matters are used by employees. If workers are colluding to commit fraud, they certainly are not following the company’s internal controls!

What’s an audit- and what’s not an audit:

An audit is an opinion- in fact, the letter is called an “audit opinion”. Usually, the last paragraph of a standard audit report starts with: “In our opinion”…. You may hear the term that an auditor is “opining”…not sure if that’s a real word, but there you go.

Other work performed by CPAs are not audits. Reviews and compilations are not audits. In general terms, the CPA is verifying the “the numbers are in the right boxes”. By that I mean that the financial information is in the right format. For example, assets and liabilities are grouped into short term and long term categories. Important: an auditor is not giving an opinion in a review and compilation. Since there is no opinion provided, the auditor will likely do less work than they would in an audit.

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Thanks!

Ken Boyd

St. Louis Test Preparation

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