In two weeks, I will be teaching a graduate course on audit concepts and methods to accounting students at Fairleigh Dickinson University. I’ve taught this previously and certainly know the material. However, my role is not just to teach the material but to excite them about accounting as a profession and auditing in particular and share my pride in the vital role auditors play in our ecosystem.
In its simplest form, auditors provide an opinion on an organization’s financial statements. Most people who receive a financial statement look first to see what the auditor’s report and opinion say. That report is about two pages and, in some respect, is the only part of the financial statement that the auditor prepared. The remaining five financial statements and extensive notes to financial statements are prepared by accountants, but not independent auditors. The only role of the independent auditor is to express its opinion on whether the financial statements present fairly, in all material respects, the financial position of the organization and the results of its operations and cash flows as of a specific date and for a specific period. Without such independent assurance, investing, banking, extending credit and many other seemingly easy business functions would be much more difficult.
While auditing is a multifaceted process, it is also a work discipline that is transferrable to almost any endeavor the student heads toward. While the specifics are for accountants and auditors, the discipline is for anyone, anywhere, doing anything. The following are some of the transferrable techniques auditors acquire.
- Obtain a thorough understanding of how organizations function. Note that I use organization rather than business. Businesses are not the only organizations that need audited financial statements. Many charities, not-for-profits and governmental agencies also need these services. However, in here, I use organization or business interchangeably. Businesses receive revenues, pay expenses, overhead, rent, salaries and related taxes, and many other functions. How each part is done varies and needs systems, procedures and controls and auditors get inside views of each of these functions. Understanding these processes provides an overview of how things really get done.
- Auditors understanding a client’s systems, procedures and controls means just that. This is usually done with the assistance of the people performing each task. There is a decided trend for the manual work being overtaken quite rapidly by digitization and auditors also need to understand the technology used. Understanding where controls are or should be, adds to the overall performance in any position the auditor might hold.
- Part of the systems and controls review is the documentation of what the auditor sees. This is then compared to the organization’s procedure manuals and training material to see if what is supposed to be done is being carried out. Additionally, this is also compared to what would be considered best practices for such controls. This provides an understanding of how business procedures, in general, should be conducted and how the client’s organization adapts them to its specific needs. Documentation means that the observations are written in a manner that a reviewer would easily understand what was done. Auditors learn through what they do to be able to clearly write what they are trying to communicate. And people think we are just numbers people!
- Ethics is not a buzzword. It is something auditors and everyone should live by.
- Independence is important to meet professional responsibilities and gain the public’s trust. The purpose of the audit is to have someone unrelated in all respects to the issuer of the financial statements review them in a way they could be able to express their opinion about the fairness of the statements. The underpinning of independence provides a warning against conflicts of interest.
- Materiality is part of the determination of the fairness of the statements. A business with $5 billion in sales might not be affected in any meaningful manner by a theft of $200,000 by an employee, so in that regard, that amount is not material. However, if that theft is by the controller, it might be an important amount that requires further investigation. These are not easy things to uncover, and the concept of materiality is an important one. Otherwise, the auditor might be tasked to look at every transaction to make sure they are all properly recorded. A line needs to be drawn and the materiality of errors, defalcations, or embezzlements is that line. This concept works well in any setting.
- Part of the planning process is to assess the areas where there might be a greater risk of error or a material misstatement. While checklists are used for this and all audit procedures, this is not cookie-cutter stuff, and the planning and execution must be done with deliberate care. The importance of planning carries over to anything you might be doing.
- Sometimes a certain amount of professional skepticism, judgment or awareness is needed. What that is, is a vague issue, and again, the materiality of the effect of such deviations is what is considered. Organizations can provide against such eventualities by having an internal audit group or engaging an outside accounting firm to look for such unacceptable or abhorrent activities or even engage a forensic accountant to occasionally perform such services. This is also a discipline that is portable.
- Forensic engagements that are part of litigation are done by many accountants who started as auditors and who transitioned into this work. This is something an auditor can move into if they enjoy this type of work.
- The scope of the engagement must be clearly defined and then planned to accomplish the objectives in a timely and cost-effective manner. Defining and planning any project in advance is essential and is a skill transferrable to any endeavor.
- Sampling is a method of selecting some transactions to determine if they are properly recorded and will reflect the overall performance of the client for those functions. Sampling techniques have been elevated into a duplicable process that could determine the reliability of how all of the transactions from which the sample was chosen are recorded, within a given error rate. This not only requires a special skill but also awareness that the sample size was not unjustly limited or biased or that the universe from which it was chosen was not compromised in any manner. This teaches awareness of details and how to use some micro activities to consider the macro.
- Reviewing subsequent events is also a skill that is acquired. There is a natural gap between the time the financial statements are completed, and the audit is performed and the balance sheet and ending period date. The auditor would review such transactions during that gap period to determine if anything material occurred that would affect the results the opinion is based on. This is a “subjectively determined objective” process. This means two auditors might do the work the same way but might have different conclusions. This is an awareness consideration that always is useful.
- Sufficient appropriate evidence of the transactions and data reviewed must be obtained during the audit process and this must be documented appropriately. The work of the people in the CPA firms that perform audits is always reviewed internally by a quality control department and a second time by an internal oversight group and thirdly by the PCAOB for adherence to the firm’s sound professional standards and procedures. The results of the first internal review will cause the work to be corrected or updated before being issued. The second review is after the fact and could cause considerable added quality control procedures within the practice. The PCAOB results are done considerably after the reports were issued and are made available publicly. Failure to adhere to proper standards could result in sanctions, fines or the banning of the firm from performing audits of public companies under the jurisdiction of the PCAOB. That is a big deal.
Whew! This is plenty and I tried to shorten the steps here. To get a further understanding of the audit process you should read the auditor’s report. You can choose any report from any public company you own stock in. The auditor’s report with its opinion is usually not more than two or three pages, and if you read it deliberately, you should get a good overview of the auditor’s role. I posted a prior blog about this that is not fully current, but I think good enough to provide you with a good understanding of the audit report and process.
This is a quick outline of what auditors do and what I will be teaching to my students, some of whom will become future leaders in my profession.
I hope you enjoyed this background information.
P.S. My autobiography, Memoirs of a CPA / The Growth Development and Rise of One of America’s Most Successful CPAs, was just published. It is available on Amazon. Enjoy!
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