Financial Audit – Definition, Features and Characteristics, and Procedure

In this article, we will discuss the features of Financial Audit, its Definition, and its procedure.

Accounting experts will say that a financial audit is an independent and objective evaluation of a company’s financial and reporting process.

Its main objective is to assure managers, directors, investors, and regulators that financial processes are accurate and by regulations. A financial audit acts as a guarantee to banks and investors that business finances are correct.

Financial auditing is a term that is heard mainly in the business world and is usually carried out by an individual entity.

Definition of Financial Audit

Financial audit basically means an examination of financial statements or other reports by an independent person or organization in which the opinion is expressed based on the facts of the review.

There are many types of audits and different levels of assurance provided by auditors.

For example, a financial audit is an audit of an entity’s financial statements by an independent audit firm and an internal audit performed by an internal audit team employed by the entity itself.

Auditors help users of financial statements, especially stakeholders or entity owners, to get better comfort over the financial reports they use.

Financial Audit – Definition, Features and Characteristics, and Procedure

On the other hand, auditors are supervisors who work on behalf of owners or shareholders to verify financial reports prepared by the directors (who run the company).

In general, to ensure that opinions are given are unbiased and reliable, audits need to maintain their main code of conduct and follow the mandatory guidelines of the professional bodies controlling them in that jurisdiction.

For example, external auditors who audit financial reports under applicable law need to follow the code of ethics of the Indonesian Institute of Certified Public Accountants (IAPI).

Internal auditors who follow the IIA are obliged to follow the IIA’s code of ethics. Auditors may use different auditing approaches and auditing strategies based on their professional judgment. Read this article for a full explanation.

Types of Audits

Following are types of audit you must know:

External Audit

An external audit is an audit conducted by independent parties from other companies. The external audit is not an employee of the company so it is not accountable to the company manager. External audits must be carried out by a public accountant.

In society, there is a misunderstanding or perception that audits are conducted to detect fraud by management. In fact, the findings of fraud are only a side effect of the audit process. The main purpose of an audit is to convince users of financial statements that the company’s financial transactions are recorded and reported by applicable accounting principles and standards.

When external auditors are done doing their job, they will report it to the owner or company owners. The report produced by the audit process is in the form of an opinion stating whether the company’s financial statements are presented fairly or not based on applicable accounting principles and standards.

To produce the audit report, the first carry out sampling checks on the recording of financial or accounting transactions. The audit report format consists of an opening paragraph, the scope or scope of the report, and the audit opinion.

Internal Audit

An internal audit is an audit carried out by internal company employees known as internal auditors. Internal auditors are appointed by company managers, so they are accountable to managers.

Internal auditors perform routine tasks and check the company’s accounting procedures. The work of the company’s internal audit includes checking the controlling and planning procedures.

Types of Audit According to the Examination

Audits are divided into several types based on their respective study angles. Some of them, namely based on the field and extent of the examination. Since audit activity can also be interpreted more shortly as an evaluation or examination process, the following are several types of audits based on the scope of the inspection field.

Audit of Financial Statements ( Financial Statement Audit)

A financial statement audit deals with the activities of collecting and evaluating evidence regarding the reports of an entity to provide an opinion or opinion about the report whether it is by generally accepted accounting criteria and principles or not.

Operational Audit (Management Audit)

This type of audit includes an examination of the operational activities of a company, such as accounting policies and management operational policies to ensure that operations are carried out effectively and efficiently.

Obedience Audit (Compliance Audit)

As the name implies, a compliance audit is none other than to ensure whether the company has complied with applicable regulations and policies, both policies set by internal parties and external parties of the entity or company. This audit plays a role in determining the extent to which the company complies with applicable government regulations, policies, and regulations and which must be complied with by the audited entity.

Performance Audit

Performance audits serve to test the level of the economy, efficiency, and effectiveness of using resources in achieving goals. This type of audit is qualitative and analytical using performance indicators, standards, and targets. Performance audits are intended to consider cost-benefit analysis as well as improve resource allocation optimally. As for other benefits, namely:

  •         Increase income
  •         Reducing costs or spending
  •         Improve efficiency and productivity
  •         Improve the quality of services provided
  •         Increase awareness of transparency and accountability in management for more efficient use of public resources

Types of Audit According to the Audit Area

Meanwhile, based on the extent or scope of the examination, the audit itself consists of 2 types, namely general inspection audits and special audit audits.

General Examination (General Audit)

A general audit covers financial reports conducted by an independent Public Accounting Firm (KAP) to assess and provide an opinion on the fairness and appropriateness of financial statements.

Special Investigation (Special Audit)

Meanwhile, a special audit is the opposite of a general audit, where the examination of the financial statements depends on the company. This type of audit only covers audit requests made by the Public Accounting Firm (KAP).

Why is a Financial Audit Necessary?

Financial audits were introduced to detect fraud and to enforce financial accountability. However, in the past, it was the internal manager who usually made the reports. It’s not very ethical.

Over time, physical inspection of inventory became mandatory to minimize illegal operations, and it became a regulation that companies appointed external companies to audit their finances.

As this area has developed over the years, experts in the field want it to continue to evolve and employ more sophisticated methods of maintaining financial accuracy. More regulatory control will emerge thanks to technological developments (particularly automation and outsourcing), and it is expected that regulation of the regularity of audit times will increase.

Auditors are likely to need to be more educated in technology and analytical methods if these changes are made.

As a rule, you need an audit if you own a company or intend to have one in the future. You will need audit documentation for the first year when your business has its own IPO or initial public offering, as well as for subsequent years.

In addition, if you receive funds from a bank or investor in the form of a refundable or non-refundable loan, you must have an audit and allow them access to the report. Some banks will require an audit if they think you are high risk. Lastly, you may want to make an audit voluntarily because it shows the persistence of your company and will facilitate future applications for loans or funding.

Characteristics and Features of Financial Audit

Here are the characteristics and features of financial audit:

Financial Reports Are Scorecards

Many investors judge a company from its financial statements which are used as a scoring record. A quality company will be judged on a solid balance sheet, positive cash, and potential profits. In other words, the performance of a company will be assessed by investors whether it is positive or not depending on what is said in the financial statements. For investors, of course, they must be observant in seeing every number that shows the condition of the company. For companies, it is at stake what they have been working on over the years.

Understand the Use of Financial Reports

Financial reports can be used for investment analysis such as income statements, cash flow statements, and balance sheets. In addition, there is shareholders’ equity or a report on the wealth of shareholders and retained earnings. Both of this information is rarely attached but needs to be known when making financial reports. In addition, understand that there are investors who tend to focus more on the income statement and balance sheet. Therefore, many think that cash flow is secondary.

Of course, this is not true. Therefore, from now on it is better to keep records that are permanent in nature in which it must be understood that the cash flow report or audit contains very crucial analytical data. Therefore, the use of financial reports must be understood correctly.

Know What’s Behind the Notes or Numbers

It is said that the numbers listed in the financial statements are a reflection of events that occur in the real world. Therefore, the figures and financial indicators or ratios that have been derived for the needs of investment analysis can make it easier to understand if then you can visualize the existing basis of reality from quantitative information. So, before writing or tinkering with existing numbers, you can try to understand what the company is doing, including its products and services, even the industry in which the company operates.

Know the Kinds of Financial Reports

There are many kinds of financial reports. Therefore, do not rely on just one reference. That is, if one sample financial statement does not match, then another can be replaced. Thus, the various activities of the company will also produce various financial report presentations. Usually, this diversity occurs on the balance sheet and not in the cash flow or income statement. So, be aware of the types of financial statements that are more suitable for the company’s style when managing finances.

Know the Two Accounting Conventions

Preparation of financial reports is familiar with generally accepted principles or GAAP (Generally Accepted Accounting Principles). For investors, of course, must understand two accounting conventions, namely historical cost, and accrual accounting. Under GAAP, an asset can be valued based on the purchase price (historical cost) which may differ significantly from the current market price.

Revenue will be recorded when services or goods are received, while expenses will be recorded when the event occurs. So, a company’s cash flow is very important because it can be used as a standard for assessment or audit. It is only natural for companies to know and make financial reports by standards. The audit party will certainly assess some of the company’s important records. That is why a company is not an easy type of investment because it has a more complicated concept so that the risk is also high.

Basic Procedures for Financial Audits

In general, four key phases are described for the financial audit process. These phases include planning the audit, determining how internal control works, testing significant assertions about data and evaluating compliance, and evaluation reporting.

These phases are described below for your reference:

1. Planning

The financial audit process begins with a plan that involves the method of collecting data to form an opinion about the organization or the company’s financial status. A way is devised to collect a sample that reflects a point in time in the life of a company or organization. The transactions and financial documents are then checked. It is noteworthy that the sample must demonstrate compliance with GAAP.

2. Internal control

The next step is to look at the internal controls. Auditors demand info, observe records closely, and oversee financial procedures in action. Without these steps, the auditor cannot provide a statement about the financial status of the organization.

3. Testing

Testing implies checking whether internal controls are functioning or not. The auditor asks for more info, returns to the company for further inspections, and oversees how financial procedures are performed. If the evidence shows GAAP compliance, the auditors determine that the company was successful in detecting and preventing errors.

4. Reporting

The final step in a financial audit involves providing a conclusion about how the company complies with accounting standards. An audit of a public accountant ( CPA: Certified Public Accountant ) provides an organization with approval without qualifications, qualifying approval, disclaimer, or adverse findings. Consent that does not meet the requirements is considered the best outcome and an adverse finding is considered the worst outcome.

Role of Financial Audit

Since its introduction, the need for the financial statements of certain companies to be audited by independent external auditors has been a cornerstone of confidence in the world financial system.

The benefit of an audit is to assure that management has presented a ‘right and fair’ view of the company’s performance and financial position. An audit underlies the trust and stewardship obligations between those who manage the company and those who own it or need a ‘right and fair’ view, the stakeholders.

Given the importance of their role, questions often arise about auditors, auditors, and the stakeholders they serve. This publication aims to provide useful background information on what financial statement auditing is and the role of the auditor.