An external audit is an independent examination of an organization’s financial statements, conducted by a qualified auditor who is not part of the company. The purpose of an external audit is to provide an objective opinion on whether the financial records present a true and fair view of the company’s financial performance and position. This process not only ensures transparency and accountability but also enhances the credibility of a business in the eyes of investors, regulators, and other stakeholders.
To achieve this, the external audit follows a systematic approach divided into five key stages. Let’s understand each stage of the external audit process in detail.
1. Planning and Risk Assessment
Planning is the initial step of the outsourced audit process. This is the stage where the auditor will have a clear picture of the business, operations, and internal controls of the client. The overall aim is to determine possible points of risks that might cause material misstatements in the financial statements.
The auditors scan the past reports of audit, trends in the industry, accounting policies, and internal control systems of the company. They also have meetings with the management to see what changes have taken place in business operation or any other financial practice. Using this information, the auditor comes up with an audit plan which defines the extent of the audit, the purpose of the audit and the schedule of the audit engagement. Proper planning makes it efficient and allows auditors to concentrate on the risk areas.
2. Internal Control Evaluation
Once planning is complete, auditors move on to evaluate the company’s internal control systems. Internal controls refer to the policies and procedures designed to ensure accurate financial reporting, safeguard assets, and prevent fraud.
During this stage, the auditor tests the effectiveness of internal controls related to accounting, data handling, and authorization processes. If the internal controls are found to be strong, the auditor may reduce the extent of detailed testing. However, if weaknesses are identified, additional audit procedures are planned to gather sufficient evidence. The evaluation of internal controls plays a crucial role in determining the reliability of the company’s financial data.
3. Substantive Testing
Substantive testing is the third phase, which implies the in-depth analysis of financial records and transactions. The auditor does different tests to ascertain the accuracy, completeness and validity of information contained in the financial statements.
This involves the analysis of invoices, bank statements, receipts, and ledger. Another form of analytical procedures that are carried out by the auditors is the ratio analysis and trend comparisons to identify abnormal fluctuations or inconsistencies. Substantive testing is aimed at gathering enough audit evidence to make a basis of the opinion of the auditor.
4. Audit Completion and Review
Once testing and verification has been done, the auditor is now taken to the stage of completion and review of the audit. In this case, the audit team will examine the results, assess the evidence obtained, and make sure all the actions have been performed properly.
In case of discrepancies, errors and irregularities, the same must be communicated to the management so that clarification or correction may take place. Post-balance-sheet events also show up in the audit where the auditor examines transactions or events that took place after the reporting period, and which may have an impact on the financial statements. This phase is also done to ascertain that the pre-final report is made with all the adjustments and disclosures that are needed.
5. Reporting and Opinion
The final stage of the external audit process is reporting. The auditor issues an official audit report that includes their opinion on the fairness and accuracy of the financial statements. There are four types of audit opinions:
- Unqualified (clean) opinion: Financial statements are presented fairly in all material respects.
- Qualified opinion: Financial statements are fair, except for certain issues.
- Adverse opinion: Financial statements are misleading or inaccurate.
- Disclaimer of opinion: The auditor could not obtain sufficient evidence to form an opinion.
This content is meant for information only and should not be considered as an advice or legal opinion, or otherwise. AKGVG & Associates does not intend to advertise its services through this.
Also Read: Audit vs Assurance: Clarifying Their Roles in Financial Reporting