Financial Statements Auditing – Definition, Purpose, And Phases


Financial statements auditing is the review of an entity’s annual financial statements for the purpose of allowing an independent auditor to express their opinion over the true and fair view in preparing and presenting financial statements again the specific accounting standard and framework.

The financial statements that auditors will review are the balance sheet, income statement, statement of change in equity, statement of cash flow, and related noted to financial statements.

That means the auditor will assess the preparation and presentation of financial statements again the accounting standards like IFRS, US GAAP as well as local GAAP.

Audit scope, fees, and other important information are normally included in the audit engagement letter.

Financial statements auditing is normally performed annually and it could help to improve the quality of financial information used by key stakeholders.

CPA firm is the one that offers and performs this financial statements auditing.


  • Required by Law: Audit of financial statements is normally perform as the requirement of law and other related authority. For example, the most financial institution is required by law and central bank to have their financial statements audited by an authorized CPA firm. You may also note that most of the security and commission authorities also required the corporation listed in the stock exchange to have their financial statements audited.
  • Required by Shareholders or Board of Directors: Some entity is not enforced by law to have their financial statements audited, but it is the requirement of its shareholders, owners, and board of directors. This is to ensure that the financial statements that submit to them correctly prepare and no material misstatements. It also improves the integrity of management to the shareholders especially the minority shareholders that do not have their own key personal work in the entity.
  • Improve Financial Statements Credibility: The credibility of financial statements is generally crease from bankers, suppliers, creditors, and other related parties’ points of view. Because they believe that these financial statements have an independent party perform a technical review on their behalf.
Related article  What is the Mail Tax Audit? (Explained)

4 Importance Phases:

Financial statement auditing normally involved four important phases:

1) Engagement:

Before auditor could perform their work, auditors need to agree on the key term and conditions with its client first.

Those key terms and conditions include the scope of audit, objective, fee, reporting requirement, reporting timeline, auditors’ responsibilities, and entity’s responsibilities.

These things are included in the audit engagement and they should be done before they execute the audit plan.

In this phase, auditors should also perform pre-analytical reviews and client due diligence to assess whether the firm could handle the audit or not.

That includes resources and technical expertise. Client due diligence helps the auditor to assess if the client involves money laundering or not.

2) Planning:

Planning an audit engagement is important. At this stage, the auditor might consider which audit approach should they follow, resources allocation, and obtain an understanding of the client’s environment and internal control.

At this phase, the auditor also performs a risks assessment to identify the possibility of risks of material misstatements that could possibly happen in the financial statements.

Setting materiality also performs in this planning stage. But the auditor could change the materiality amount in case there is a new situation happen.

3) Execution:

At this stage, auditors perform their detailed testing on the areas, transactions, accounts, or events related to financial statements.

For example, auditors inspect the inventories that store in the client’s warehouse and join in annual inventories count observation.

The procedures that they normally use are including inspection, observation, analytical review, vouching, recalculation, interview, re-performance, etc.

Related article  Statutory Audit and Non-Statutory Audit (Explained)

4) Reporting:

Reporting is the final stage of the audit process. Once the audit completes their detailed testing as per requirement from the international standard on auditing, they will conclude the result and issue the opinion.

The opinion that they will issue could be unqualified, qualified, adverse, or disclaimer.

Auditor’s opinion is very important for the entity. This is because the credibility of their financial statements significantly depends on this.

For example, if the opinion is unqualified, then that means the financial statements are true and fair view.

If the opinion is qualified, part of the financial statements is not correctly prepared or presented. Adverse on the other hand could mean that the financial statements are materially misstated and pervasive.

Financial Statements to be review:

In a financial statement audit, auditors will review the five statements including balance sheet, income statement, statement of change in equity, statement of cash flow, and noted to financial statements.

Auditors might also review the significant sales or purchase contracts that the entity made during the years as well as accounting policies along with internal control over financial reporting.

In addition to financial statements, auditors will also review other related information like annual reports. This is the requirement of ISA 720.

The five elements of financial statements that auditors normally focus on are Assets, Liabilities, Equity, Income, and Expenses.

In practice, auditors delegate audit works to a team member based on this element and sometimes break them down into sub-elements like current assets and fixed assets.

Management and auditor’s Responsibilities:

Management is the one responsible for preparing financial statements. They are also responsible for setting up proper internal control over financial reporting to ensure that the financial report is prepared on time, and any finding of fraud or error risks is minimized.

Related article  Tax Audit: Definition, Example, Explanation, and Types

Physical control and segregation of duties are the key internal control that is normally placed in most entities.

The auditor is responsible for reviewing the financial statements that prepare by management and expressing their opinion on whether those statements are correctly prepared and present based on accounting standards.

The auditor needs to work independently from management to avoid conflict of interest that could impair audit independence.

The auditor is not primarily responsible for detecting fraud that happened or could happen in the entity.

However, during their audit, auditors need to assess the risks of material misstatements whether they are from error or fraud.

In case auditors detect fraud, the auditor should seriously review what are the safe communication channel that they should communicate to, whether they should report to management, the board of directors, or the authority.