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Home > Auditing Checklists > The Key Components of an Audit Report

Auditing Checklists

The Key Components of an Audit Report


Checklist Description

This checklist outlines the key components of an audit report.

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Definition

An audit is the examination and verification of an organization’s financial statements and records. Audits provide independent and impartial opinion as to whether the information is presented objectively. Most organizations—privately held businesses, publicly owned corporations, and nonprofit organizations—have to prepare financial reports, which are audited. These reports assist owners and managers to make decisions, and help to show the company’s financial status to stockholders, employees, regulators, and the public.

When reviewing an audit report on a company, key questions include: What is the source of its revenue? Where, and on what, does it spend its income? How much profit is it earning?

The answer lies in the company’s financial statements, and, by law, all public companies have to make these statements freely available to everyone.

These financial statements can be broken down into two key components: the profit-and-loss statement (or income statement) and the balance sheet.

The profit-and-loss statement tells us whether the company is making a profit. It indicates how revenue is transformed into net income. Profit-and-loss statements cover a period of time—usually a year or part of a year.

The balance sheet is a snapshot of a business’s financial health at a specific moment in time—usually the close of an accounting period. A balance sheet shows assets, liabilities, and stockholders’ equity/capital. Assets and liabilities are divided into short-term and long-term obligations. The balance sheet does not show the flows into and out of the accounts during the period. A balance sheet’s assets should equal liabilities plus owners’ equity.

There are two kinds of audit: internal and external.

Internal audits ensure that the management of the business is meeting internal goals such as productivity, quality, compliance controls, consistency, and cost, as well as external goals such as customer satisfaction and market share.

External audits are carried out by outside auditors, who do not have any ties to the organization or its financial statements. The outside auditor checks the financial statements prepared by management for balance, and also to see whether the company is adhering to professional standards and Generally Accepted Accounting Principles (GAAP).

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Advantages

  • External audits improve understanding of underlying business trends and provide an objective opinion as to whether the information is presented fairly.

  • Internal audits let managers know whether a business can expand or needs to adopt a more conservative approach. Can it deal with the normal ebbs and flows in revenue, or should it take immediate steps to bolster cash reserves?

  • Internal audits focus on processes within the business, and can identify and help to analyze trends, particularly in the area of receivables and payables, i.e. is the receivables cycle lengthening? Can receivables be collected more aggressively? Is some debt uncollectible?

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Disadvantages

  • Results sometimes depend on the accounting methods used. Measuring and reporting give management considerable discretion and the opportunity to influence an audit’s results.

  • Internal audits are not always carried out rigorously and the figures may not reflect the true financial position of the company. Salaries for internal audit staff are paid for by the organization. This can lead to questions about objectivity.

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Action Checklist

  • Carefully analyze any profit-and-loss statements for differences during the reporting period. Anomalies might be due to seasonal or other variations, or may indicate deeper problems.

  • When reviewing internal audits, be prepared to be involved in a long and detailed process of analysis. Some areas will need clarification by experts.

  • Check which GAAP are used in the internal audit of the business in which you are interested.

  • Internal audits are not infallible. If you are unsure about specific areas or numbers, don’t hesitate to ask for clarification.

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Dos and Don’ts

Do

  • Make sure that you take the time and effort to analyze the audit. If in doubt, consult an independent auditor.

  • Use your judgment when reviewing internal audits; results do not always tell the whole story.

Don’t

  • Don’t assume that all audits truly reflect a company’s financial position; they only reflect the auditor’s opinion.

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Further reading

Books:

  • Cardwell, Harvey. Principles of Audit Surveillance. Philadelphia, PA: R. T. Edwards, 2005.
  • President’s Council on Integrity and Efficiency, US General Accounting Office. Financial Audit Manual. Darby, PA: DIANE Publishing, 2000.
  • Wealleans, David. The Quality Audit for ISO 9001:2000: A Practical Guide. Burlington, VT: Gower Publishing, 2005.

Websites:

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