PKF-FPM Senior Manager Debbie Mullen highlights information that must be included in audited financial statements and explains the role of the external auditor.
Unless they qualify for audit exemption, companies are required by law to produce audited financial statements. The company’s board of directors is responsible for producing the financial statements and must ensure that they are prepared in accordance with generally accepted accounting principles (GAAP).
What to Include in Audited Financial Statements
Key elements in the financial statements include:
- Strategic Report (if applicable) – This sets out what the business does, what it is looking to achieve, and how well it is progressing.
- Directors’ Report – This includes the names of the company directors, a summary of the company’s trading activities, future prospects, principal activities, dividend recommendation for the period in question, and details of financial events which could affect the company that occurred after the balance sheet was prepared.
- Auditor’s Report – where the auditors report their expression of opinion on the financial statement (discussed in more detail below)
- Profit and Loss Account – This shows the performance of the company during the accounting period. It shows the revenue earned and the expenses incurred.
- Balance Sheet – This shows the financial position of the company at the end of the accounting period. It records the value of the company’s assets, liabilities, and equity.
- Cash Flow Statement – This shows the cash inflows and outflows for the period. It provides an insight into the company’s ability to meet its short- term obligations.
- Statement of Changes of Equity – a reconciliation between the opening and closing balances of shareholder’s equity.
- Notes to the Financial Statements – these are notes used to explain the assumptions and accounting policies used to prepare the primary statements. These are essential to help the user fully understand the financial statements.
External Auditor’s Report
Audited financial statements include an independent external auditor’s report. This is based on work carried out by the auditor to verify that the financial statements present a ‘true and fair view’ of the company’s financial position and have been prepared in accordance with GAAP.
There are three stages in the audit process:
- Planning and Risk Assessment – This is where the auditor develops an understanding of the company and the environment in which it operates. The auditor then uses this knowledge to identify risks and plan the audit.
- Fieldwork – This involves testing the company’s internal controls and procedures. Internal controls are controls used by the business to ensure the integrity of financial information. Auditors test these controls to determine their strength so that they can plan the level of substantive testing required. Auditors use substantive procedures to verify the validity and accuracy of all material financial line items.
- Completion and Forming an Opinion – Auditors use the evidence obtained in their planning and fieldwork to form an opinion which is then included in the audit report.
Types of Audit Opinion
An audit opinion can either be modified or unmodified. An unmodified report means that the auditor gives an unqualified opinion. This is the best possible opinion as it states that the financial statements are a fair representation of the financial condition of the business and follow Generally Accepted Accounting principles.
There are three types of modified opinions–qualified, adverse and disclaimer.
- Qualified Opinion – This is where the auditor concludes that the effects of misstatements, individually or in aggregate, are material but not pervasive to the financial statements or where the auditor has been unable to obtain sufficient appropriate audit evidence on which to base the opinion. Auditors may issue a qualified opinion if the company’s accounting policies are not in line with GAAP or if the disclosures are not deemed adequate. However, these issues are not serious enough for the auditor to issue an adverse opinion.
- Adverse Opinion – This is where the auditor concludes that the effects of misstatements individually or in the aggregate are both material and pervasive to the financial statements. Pervasive effects are those that in the auditor’s judgment is not confined to specific elements or line items in the financial statements or are in relation to disclosures that are fundamental to the users’ understanding of the financial statements. This may be when the accounting policies applied by the business are significantly different from GAAP and so mislead the users.
- Disclaimer of Opinion – This is where the auditor states that they were unable to obtain sufficient audit evidence on which to base an opinion of the financial statements. It means that the possible effects of undetected misstatements could both be material and pervasive.