Financial audit

Basic definition

Audit is the examination of records and reports of a company, in order to check that what is provided is relevant, and closest to the reality. That is to say, all assets and liabilities are properly recorded in the balance sheet, and, all profits and losses are properly assessed. This assessment is done through 2 methods, by assessing internal control procedures and by checking the consistency of items in the books. (cf hereunder)

History

• 2001 : Enron case. The company succeeded in hiding some important risks from banks and shareholders. Eventually, Enron filed for bankruptcy.

Steps

Main elements of the accounts to be audited

Audit is usually done annually through 3 main steps.

Interim review

This is the first approach of the company. It usually occurs in the middle of the financial year. For instance, a company closes its accounts yearly on December 31, 2000. The interim audit will starts on June 2001.

The purpose is

• to understand the business of the company, its market, what its main issues are
• to figure out what risks are from an audit point of view. This means, auditors will have to find what kind of mistake (on purpose or not) could be done in this company. For instance, if the income of sales representatives is directly linked to the sales they generate (it's of course never the case), they could try to overstate their figures, leading to an abnormally high income.
• to assess the internal control procedures actually in place. This is an important step as it will allow later to determine if one should carry out basic or advanced investigations. Indeed, if the internal control procedures seem to be reliable, this means there is no need to check accounts further.

Hard Close

This audit precedes the closing date. For a company closing on December 31, 20xx, the Hard Close would typically occur using numbers as of November 30, 20xx. Note: some hard closes are performed using the numbers as of the preceding quarter end (i.e. in the above example as of September 30, 20xx. The purpose is to audit all movements year to date.

This audit step is not mandatory, but is generally performed on larger companies to reduce the amount of time spent on the audit during Final.

Final

This is the latest step of the audit, usually some weeks after the closing. For a company closing on December 31, 2000, the Final would occur on January 30, 2002. Thanks to the work already done during the Hard Close, only the remaining range between the date of the Hard Close and the closing has to be audited.

Stakes

Audit has some specificities throughout the world but has some mains components. One of the main problem in audit is the conflict between the need to control a company and the business relatioship. On one hand, the audit company has to check thoroughly the books, but on the other side, it has to keep its customer that is its source of revenue. In practical terms, this means that the audit company will try to protect itself by carrying out the minimum checks, but if it has a slight doubt, it won't go further if the client is a bit reluctant to give out information. The power of the auditor is limited by its appeal for revenues.

Biggest audit companies (often called Big Four)

• KPMG
• PricewaterhouseCoopers
• Ernst & Young
• Deloitte