Today's lesson we are going to jump right into the financial statement audit. We've set the table by looking at other context for you to think about the value of audits conceptually, but we're going to focus on what is a financial statement audit? Talk a little bit about, how does the auditor plan the financial statement audit? And then how does the auditor perform this financial statement audit? So let's talk about who is the auditor. Who does this auditing? Well, the audit is conducted by a registered public accounting firm, that's for public companies in the United States. If it's not a publicly held company, and of course what I mean by a publicly held company it's those companies whose common shares are traded over big exchanges, like NASDAQ or the New York Stock Exchange. But you have a lot of big companies that are private companies, and they need not be audited by a registered public accounting firm. They do, however, need to be audited by a firm whose signing partners are certified public accountants. And we talked about a certified public accountant way back at the very beginning of the course. So when someone comes in to do a financial statement audit, they do, at the financial statement level, a very similar set of activities to what a very skillful mechanic or a skillful physician would do in examining automobiles, if it's an auto mechanic, or humans, if it's a physician. What they do though, is that they examine the financial statements and the underlying support for these financial statements. So, what are the assets that are really in place in an organization? What obligations, liabilities, does that organization have? And what are these assets and liabilities evidenced by? This often will be in the form of documentation. Sometimes it will be in the form of physical evidence. Other times it will be in the form of quantifiable analytical evidence. So the auditor's going to examine this evidence, and evaluate this evidence. A lot of what you see in the financial statements are not precise concrete numbers. And what you often have is estimates that are subjective to a very high degree. What the auditor will do in such cases is evaluate the reasonableness of the assumptions that management uses to derive its estimates. The auditor also will assess the accounting principles that management is using. It's important for the auditor to make sure that the accounting principles management is using to make its financial statements comply with, in the United States, generally accepted accounting principles, or in many parts of the globe, IFRS, International Financial Reporting Standards. The auditor also is taking a step back and they're trying to examine the overall financial statement presentation. Are the financial statement themselves and the notes that accompany the financial statements, are they being presented in a way that is representationally faithful and relevant to users? So that at a very, very high level is what a financial statement audit is. It is also called an examination, okay? An audit is not called a review, okay? That's a technical term for a limited assurance engagement. And it's not called a compilation. That's even less assurance, that's a no assurance engagement. It is an examination. Now, why do all of these procedures? Why undertake this examination? And the auditor does this because he or she is trying to form an evidenced based opinion about whether the financial statements represent, in all material respects, that organization's balance sheet. Is the statement a financial position? The income statement would be that organization's financial performance, and its cash flows, would be that organization's statement of cash flows. And you want to make sure as an auditor that all three of those financial statements are free of material misstatement. The ultimate goal here is to provide anyone who relies on these financial statements with reasonable assurance that the financial statements prepared by management are fairly stated. And the most important evidence for fair statement is compliance in all material respects with general accepted accounting principles. In some parts of the world, the auditors need to go beyond just saying in compliance with generally accepted accounting principles. For example, if you're in the UK, you will opine as an auditor that the financial statements present a fair and true view of the financial statements. But we need to understand that two big threads over the audit are reasonable assurance and materiality. In a public company audit, the auditor is also looking at the strength of the internal control over finance reporting by management. And in fact, they give a dual opinion. The opinion is going to be that the internal controls were working, as of a specific date, and that they're working and they're in compliance with an internal control framework. Often that will be COSO, Committee Of Sponsoring Organizations, have a framework for internal control. So there's an opinion on the controls, but then there's also the opinion on the financial statements themselves.
