The primary job of an auditor is to ensure that the financial statements of a company are free from “material misstatement”. But what does this actually mean?
The basic meaning of “free from material misstatement” means that the accounts do not contain any incorrect information that would cause a significant impact to the viewer of the financial statements. They do this by determining a “materiality” before carrying out their work. This materiality differs from company to company and is a benchmark figure used to determine if an error is actually going to affect the accounts in a significant way.
The reason that materiality is actually useful is that auditors do not actually perform testing on every single item that make up the accounts. Instead they perform samples in order to get a picture of what the overall figures look like. If the auditor tests 10 random fixed asset additions out of 50 in the year and find no issues, they can likely conclude that all 50 of the additions were treated correctly. However if they were to find an error it is important for them to be able to evaluate the error by using the materiality they decided on.
If you take a huge company such as Mcdonald’s with billions of pounds of revenue in the year, the revenue figure being “misstated” by £5,000 is going to make practically no difference to the financial statements end result and would thus be classed as immaterial. However if you were to take a small company with just £6,000 of revenue in the year a mistake like the one above would have huge implications on the accounts and would therefore be a material error meaning the auditor would have to adjust the figures within the financial statements.
Who Uses the Financial Statements?
There are many different users of financial statements and these users are known as stakeholders. While the stakeholders might not actually own a share of the business they are may be interested in how the business is performing for other reasons.
Some common examples of these are:
- Banks – The bank needs to review the business’ profitability and underlying assets before making a decision to lend to it.
- Potential Investors – Anyone looking to invest in a company should review how the business is performing before doing so.
- Suppliers – Anyone who supplies to the business and is owed money from them needs to be sure the business is able to repay their debts.
While these are just some of the many groups that want to ensure the financial statements are accurate, the main beneficiary of audited accounts are the shareholders. In large businesses it is common for the shareholders/directors of the company to not actually be involved in the day to day running of the finance team and thus, they need absolute confidence that the figures being presented to them are accurate.
How do auditors do their job?
Auditors normally work in teams that are made up of both senior and junior members. They spend a period of time at their client’s offices in order to speak with the finance team and will use the initial stages of the audit to get an understanding of how the finance team operates. They can do this by performing “interviews” known as audit walkthroughs.
Once the team understand how the finance team operates they begin their testing. They normally pick samples of certain balances and then agree these back to supporting documents which help to prove the legitimacy of the amounts to go in the financial statements.
Once the testing has provided sufficient assurance that the amounts are correct, a senior member of the audit firm (normally a director or partner known as a “responsible individual”) will sign odd the audit reports and the accounts can now be finalised and submitted to companies house.