CPA as Auditor

Independent auditing of financial statements is one of the best known services that certified public accountants provide; however, it is also the least understood.

Over 47 million investors own shares in more than 14,600 publicly held U.S. companies.  Such companies are required to issue financial statements.  CPAs are engaged to add credibility to management’s financial representations by giving assurance that the financial statements conform to generally accepted accounting principles.  The concept of the independent audit has been a key element in the growing number of shareholders willing to invest in the future of this nation’s businesses.

CPAs have acquired the expertise to give a professional opinion on the overall fairness of a company’s financial statements by having met the following requirements: obtained at least a college degree or its equivalent; passed a rigorous two-and-a-half day national examination; and obtained specific experience to qualify for the CPA certificate and a state license. CPAs are further guided by the accounting profession’s basic tenets of independence, objectivity, and integrity.

Before investors or other interested parties can determine how much they are able to rely on the auditor’s report, they must first gain a general understanding of what an audit is and what it is not.

What An Audit Is Not

The financial information upon which the audit is based is prepared not by the auditor, but by management.  An auditor does not express a judgment on the competence of management, advise on the desirability of investing in or lending to a company, nor assure that employees are honest and competent.

The CPA uses sophisticated testing techniques and professional judgment, within the parameters of established standards, to reach an informed opinion on the overall fairness of the financial statements in accordance with generally accepted accounting principles.

Although the purpose of an audit is not to uncover all fraud, the auditor is required to design the audit to provide reasonable assurance that material errors or irregularities that exist in the financial statements are detected.

Characteristics of an Audit

It is virtually impossible for a CPA to examine all transactions recorded in financial statements. The auditor bases his or her opinion on selective testing using sampling techniques. Audits provide an economical and reasonable level of assurance that the financial statements are free of material misstatements, rather than a guarantee of absolute accuracy.

Before forming an opinion, the auditor must consider the company’s internal control structure, which is divided into the control environment, accounting system, and control procedures. The auditor uses this knowledge to identify the risk of misstatement in the financial statements and then designs procedures to reduce that risk.

The auditor also is required to use analytical procedures, which are evaluations of financial information, in the planning and final review stages of all audits.

In addition, the auditor is obligated to consider whether the overall audit results raise substantial doubt about the company’s ability to stay in business. If there is doubt that the company can continue as a “going concern”, an explanatory paragraph must be included in the audit report.

The Auditor’s Standard Report

When an audit is completed, the auditor issues a report that states the CPA’s responsibility, the nature of the work performed, and the conclusions reached.

The auditor’s standard report consists of three paragraphs: an introductory paragraph, a scope paragraph, and an opinion paragraph. The introductory paragraph differentiates management’s responsibilities for the financial statements from the auditor’s responsibility to express an opinion on them.

The scope paragraph explicitly states that the audit was planned and performed to obtain reasonable assurance about whether the financial statements are free of material errors or irregularities. It also provides a brief description of what is involved in an audit and states that the auditor formed an opinion on the financial statements taken as a whole.

The third or opinion paragraph presents the auditor’s conclusions.

Recent Professional Developments

Quality control is a vital part of a CPA’s practice in that it helps ensure that appropriate standards are followed.  In 1988, AICPA members voted to require regular independent reviews of their accounting and auditing practices.

In April 1988, the AICPA Auditing Standards Board responded to the public’s concerns and misperceptions about what an audit is and what auditors do by issuing nine new statements on auditing standards.  These standards, most of which are effective for audits of financial statements periods beginning on or after January 1, 1989, are designed to improve auditor performance and auditor communications.

One of the new standards revised the auditor’s standard report so that it gives clearer descriptions of the auditor’s responsibility, the work the auditor does, and the assurance the auditor provides. This is the most substantial change in the auditor’s standard report in forty years.

Other new standards cover the detection of fraud and illegal acts, more effective audits, and improved internal communications.

In Summary

The auditor’s report is intended to communicate the auditor’s responsibility and conclusions reached. The report is set forth in standardized wording that has a specific meaning. At times, because of particular circumstances, the auditor may modify the report. In such cases, the reasons for any modification are noted. When CPAs affix their names to these reports, their opinions are not to be treated lightly. Their professional integrity and reputation are at stake.

The Purpose of an Audit

The primary objective of an audit is to provide reasonable assurance that the financial statements prepared by management are fairly presented in conformity with generally accepted accounting principles and do not contain material misstatements. These include errors-unintentional misstatements or omissions in financial statements-and irregularities-intentional misstatements or omissions. (Misstatements are considered material if they are significant enough to make a difference in the decisions of a reasonable financial statement user.)

This assurance, in the form of the CPA’s opinion, is obtained by testing the data underlying financial position, results of operations, and cash flows.  To do this, the CPA is guided by statements on auditing standards issued by the Auditing Standards Board of the American Institute of CPAs (AICPA).  Also, subjective professional judgment is involved.

The auditor then forms one of the following types of professional opinions:

• Unqualified (no significant limitations affected audit performance and no material deficiencies exist in the financial statements)
• Qualified (the scope of the auditor’s work is significantly restricted, or there is a material departure from generally accepted accounting principles)
• Disclaimer (restrictions in the audit’s scope are so pervasive that the auditor cannot form an opinion on the fairness of the presentation)
• Adverse (departures from generally accepted accounting principles are so significant that the financial statements do not fairly present the company’s financial position)

The basic point to remember is that an opinion is just that-an opinion indicating that a professional judgment, not a guarantee, has been given on management’s financial statements. Any user must carefully review such financial statements and all related footnotes, in addition to the auditor’s report.