Warning: Is Your Auditor Documenting Correctly?

When it comes to a financial statement audit, timing is critically important.

 

Auditors must perform a certain amount of audit procedures, and the timing of those procedures can impact the accuracy of the audit opinion.

 

This article defines a financial statement audit, discusses some key audit procedures and assertions, and explains why timing is so important.

What Happened

 

I was spurred to write this post after reading about a former BDO audit manager who backdated audit work papers. As explained in Accounting Today, the BDO audit team fell behind while auditing AmTrust Financial Services, a publicly traded company. Some audit procedures were not completed by the time that AmTrust filed its annual report with the SEC.

 

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An audit senior manager instructed audit staff to backdate audit work papers. This decision made it appear that the work was completed before the annual report was filed.

 

And it’s a huge problem. Here’s why:

 

What’s An Audit?

 

An audit is an opinion as to whether or not the financial statements are free of material misstatement, and an audit is performed by a CPA firm. The term materiality refers to a dollar amount of error that is judged to be meaningful for a financial statement reader.

 

Assume, for example, that a CPA firm is auditing a $5 million inventory balance and notes a $50 error in the balance. A $50 error in a $5 million balance may not change the financial statement reader’s opinion- but a $20,000 error may be a red flag.

Auditors use judgment to determine materiality.

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Assertions

 

Management is responsible for creating the financial statements, and accounting rules assume that management is making assertions regarding the statements they issue. The valuation assertion, for example, states that the dollar value assigned to assets is correct- usually based on the historical cost of the asset.

 

Auditors plan the audit procedures to address these basic assertions.

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Timing Is Everything

 

Now, here’s where the rubber meets the road.

 

When procedures are performed is critically important. In fact, if the date of some procedures is altered, the accounting information is largely worthless- it doesn’t support the audit opinion. Here an example:

 

For many companies, particularly retailers and manufacturers, inventory is the biggest asset balance on the balance sheet. The best audit evidence for auditing inventory is perform a physical inventory count as close to the balance sheet date as possible.

 

An inventory count requires the auditor to compare each inventory item listed in the accounting records to a physical item in the company warehouse. During the count, the auditor compares the number of items, the cost per item, and a description to the inventory listing.

 

Assume that the audit work papers state that the inventory count was performed on December 30^th– the day before the 12/31 balance sheet date. In reality, however, the count was perform on December 5^th– and the date listed on the inventory count was altered to state 12/30.

 

The Impact

 

Well, do you think a great deal of inventory count be purchased, manufactured, or sold between the 5^th and the 31^st?

 

Of course.

 

Now, there are other procedures that can be performed to audit inventory, but no step is as reliable as an inventory count to confirm the existence assertion.

 

Existence: Is the inventory in the warehouse?

 

The bottom line: few, if any, auditors would rely on an inventory count 26 days before a 12/31 balance sheet date. Sure, the company may have great internal controls, but 26 days is too much time to account for by using other audit procedures.

 

Food for thought. This post is for educational purposes only.

 

Ken Boyd

Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies

Co-Founder: accountinged.com

(email) ken@stltest.net

(website and blog) https://www.accountingaccidentally.com/

(you tube channel) kenboydstl

 

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