Steps To Perform An External Audit

External Audit

An external audit is an independent assessment of a company’s financial performance, conducted by an external auditor appointed by the shareholders.

The auditor’s role is to provide an opinion on whether the financial statements are accurate and reflect the true state of the company’s affairs.

An external audit involves the examination of a company’s profit/loss and cash flow for the year.

The external auditor is required to review the company’s accounts and records, and make sure that they are in compliance with applicable laws and regulations.

The auditor will also assess the reliability and accuracy of the financial statements.

The auditor must also ensure that the company has maintained adequate internal controls to safeguard its assets and ensure accurate accounting records.

Finally, the auditor will provide a report on their findings to the shareholders.

External Audit Process

An external audit process is the systematic examination of an organization’s financial and operational performance, which is conducted by a qualified external auditor.

The process entails the auditor having a comprehensive understanding of the client’s business, performing a risk assessment, setting materiality, understanding internal controls, performing audit testing, and collecting evidence.

The external auditor’s objective is to express an opinion on the fairness of the financial statements and the effectiveness of the organization’s control environment.

Understand client business

Gaining a comprehensive understanding of the client’s business is essential for the successful completion of an external audit. To gain a better understanding of the client’s business, auditors should take the following steps:

Auditors should also take into account the external and internal factors impacting the business, including applicable regulations, tax clauses, industry information, and competition. It is important to note that auditors may need to hire external experts to fulfill their role in the audit. This will depend on the level of in-house expertise available.

Risk Accessment

Risk assessment is a critical component of the preliminary analytical review, which involves analyzing patterns and relationships in accounting figures to identify potential risks. The goal of this process is to determine the level of risk associated with a given business, which is known as the Risk Management Model (RMM).

To conduct the risk assessment, auditors must first gain an understanding of the client’s business. This includes analyzing financial statements, industry trends, and other relevant documents. The auditor then uses ratio analysis and examines patterns to identify any red flags. For example, if there is a large increase in receivables but only a small increase in sales, it may indicate an overstatement of receivables.

The results of the risk assessment are then used to plan and perform audit procedures. If the RMM is higher, more extensive audit procedures are planned, and vice versa.

The risk assessment process typically involves the following steps:

• Analyzing Financial Statements: Auditors review financial statements such as balance sheets, income statements, and cash flow statements to identify any discrepancies or potential risks.
• Analyzing Industry Trends: Auditors analyze industry trends to identify any changes that may impact the client’s business.
• Examining Patterns: Auditors examine patterns in the financial data to identify any red flags.
• Assessing RMM: Auditors assess the Risk Management Model (RMM) to determine the level of risk associated with the client’s business.
• Planning Audit Procedures: Auditors plan and perform audit procedures based on the results of the risk assessment.

Set Materiality

Based on the identified risks, auditors must carefully consider the appropriate materiality level to ensure the most effective audit procedures.

Materiality is a critical part of the risk assessment process as it determines the sample size and the extent of audit procedures.

Generally, higher risk leads to lower materiality and vice versa.

As materiality decreases, more extensive audit procedures are required to ensure accuracy and completeness of the audit results. Conversely, higher materiality requires less extensive procedures.

Therefore, it is necessary for auditors to determine the appropriate materiality level in order to effectively assess the identified risks.

Understand Control

An important aspect of the risk assessment process is understanding the internal control environment of the audit client.

This includes assessing the strength of the internal controls that have been established by the audit client and their ability to prevent errors and misstatements in the accounting records.

Internal control systems are generally created to ensure the accuracy and reliability of financial records, and also to detect and prevent fraud and other irregularities.

Auditors must evaluate the internal control environment to determine the level of risk associated with the audit engagement.

If the internal control environment is weak, the auditor may need to allocate more resources to perform the audit and may even decide to withdraw from the engagement.

Ultimately, strong internal controls are important for ensuring a successful audit.

Audit Testing and Collect evidence

Audit testing and the collection of evidence is an essential part of the audit process in order to assess the accuracy and validity of financial statements. Auditors must gather enough audit evidence through audit procedures in order to effectively evaluate the identified risks.

This evidence must be sufficient in quantity, as well as appropriate in quality. Generally, third-party documents are considered more reliable than internal business documents. The evidence gathered is then evaluated against the identified risks on the assertion level. Therefore, auditors must ensure they have sufficient evidence for relevant assertions, such as completeness and existence for inventory.

To effectively perform audit testing and collect evidence, the following should be considered:

• Understand the client’s internal control system
• Design audit tests to address any identified risks
• Analyze the evidence collected
• Evaluate the evidence to assess the accuracy and validity of the financial statements
• Document the audit procedures and the evidence collected
• Prepare and present an audit report summarizing the results.

Finalize

Once the audit testing and collection of evidence has been completed, the auditor must move on to the finalization stage of an external audit. This is the process of formally documenting the audit findings and forming an opinion on the financial statements.

During this stage, the auditor must review all of the evidence collected, assess the overall financial statement presentation and make a determination. The auditor will then communicate their opinion to the client in the form of an audit report.

The opinion expressed in the audit report is based on the evidence collected and whether sufficient and appropriate audit evidence has been obtained. If the evidence is sufficient and appropriate, a clean or unqualified opinion is issued. If the evidence is not sufficient and appropriate, the auditor may issue a qualified opinion. In certain circumstances, the auditor may also issue a disclaimer or adverse opinion.

Therefore, during the finalization stage, the auditor must take into consideration all of the evidence collected and determine the appropriate opinion to be expressed in the audit report. This is a key step that must be taken to ensure the accuracy and reliability of the financial statement information.

Conclusion

The external audit process is an important tool for businesses to ensure their financial statements and operations are in compliance with applicable standards and regulations.

The process includes a review of the company’s internal controls, a review of the company’s financial statements, and an analysis of the company’s compliance with applicable laws and regulations.

Additionally, the external auditor will often provide recommendations for improvement.

Ultimately, an external audit serves to provide a measure of assurance that financial statements and operations are accurate and reliable.

Through the external audit process, businesses can gain confidence in their financial statements and operations, and can ensure that they are meeting their legal and regulatory obligations.