Top Auditing terms you should know

Before any financial statements are disclosed to the public, they are first reviewed by the auditors to ensure accuracy, reliability, unbiased, and presented in a true and fair view manner. Auditing is a process done to ensure that the financial statements’ information is not biased or manipulated since many users (internal and external) make important decisions based on these financial records. The following are some common auditing terms:-

ISA International Standard on Auditing:-

ISA is a professional standard that overlooks an independent auditor’s responsibility. They have been issued by IFAC and IAASB.

External Audit:-

External Audit is performed by a group of personal (they are the audit firm’s employees) who are responsible for analyzing the financial statements and ensuring that they have been prepared in compliance with the standards. An external auditor is more concerned about the entity’s financial situation and the accuracy of the accounts prepared.

Fun Fact: External Auditors exercise more independence as compared to Internal Auditor. Internal Auditing is done to enhance organizations’ decision-making process as they are the employees of the company.  

Internal Audit:-

It is performed by a group of people within the organization (employees of the client company itself) responsible for evaluating the statements and giving independent and unbiased opinions. It also considers the internal control of the company. They also focus on corporate governance and risk management. Therefore the focus can also be on non-financial information.

Management Assertions:- 

Audit Assertion is defined as the criteria or essential characteristics to ensure that the financial transactions, items, and disclosures are made correctly. It is done to ensure further that there are no manipulations involved.

Fun Fact:- The following are the assertions that are used in AuditingAuditing

• Existence/Occurrence
• Completeness
• Accuracy
• Cut-off
• Classification
• Rights and Obligations
• Presentation

Professional Skepticism:-

An auditor should approach the Auditing of a client with a professional mindset and exercise independence and objectivity. It is more of a behavior that an auditor should practice to ensure assurance of the financial statements.  

Example:- An expense payable (Audit Evidence) provided by a purchase manager regarding admin expense turns out to be not reliable and raises doubt. The Auditor needs to practice professional Skepticism to decide.

Fun Fact: In reality, an auditor does not verify all the transactions due to time constraints, and thus, an auditor uses a sample basis to evaluate the transactions. Therefore the Auditor should practice Professional Scepticism in deciding the sample.

Audit Risk:-

Audit Risk arises when the Auditor’s opinion is inappropriate when the financial statements are materially misstated. The risk exists even if auditors carry out a planned audit. The risk can be reduced by increasing the number of audit procedures. The formula for Audit Risk is

Audit Risk= Inherent Risk x Control Risk x Detection Risk

Audit Evidence:-

Audit Evidence is the data or information which is collected/used by the auditors to arrive at a conclusion on which the opinion is based, whether the financial statements are materially misstated on not.

Example:- The Auditors should ensure that the client’s receivables are correct by cross-checking them with the client’s customer and confirming the details. Apart from checking the internal sources, the auditors should also consider external sources.

Fun Fact:- The Audit Evidence should have two characteristics: It should be Sufficient and Appropriate. This evidence only helps the auditors to provide reasonable assurance.

Materiality:- 

In terms of Audit, it refers to a specific benchmark used by the auditors to obtain reasonable assurance that there is no material misstatement in the financial statements.

Example:- If the expenditure of $1 has not been recorded in the books, it will not impact the users’ decisions. Therefore it is immaterial. But in case an expense of $10,000 has been misstated, and the auditors think it will influence the users’ decisions; thus, it is Material.

Fun Fact: There is no standard threshold on what exact amount is considered to be Material. It is purely based on professional judgments.

Test of Control and Substantive Test:-

The two ways that the auditors check the evidence is through the Test of Control and Substantive Test. Tests of Control are performed to ensure that the client’s control system is working and ensures a true and fair representation of the financial statements. In contrast, Substantive Tests are performed by the Auditor to search for physical or supporting evidence for the figures represented in the financial statements and to ensure a true and fair view. Auditors use a mix of both.

Example:- Ensuring that the client performs reconciliations regularly and a senior employee overlooks it is a control test. Checking the figures and confirming that the cashbook and the bank statements reconcile is a substantive test.

Management Letter:-

The Auditor prepares the Management Letter and sends it to the client (audit committee of the client) reporting the weaknesses or faults in the control systems and recommends a remedy.

Audit Report:-

An auditor’s report is a written letter from the Auditor containing their opinion on whether a company’s financial statements comply with the accounting standards (IFRS or GAAP) and are free from material misstatement.

The independent and external audit report is published along with the company’s annual report. The Auditor’s report is vital because lenders (banks/creditors) require the organization’s audited financial statements before lending it to them.

Expectation Gap:-

The expectation gap is described as the difference between the public opinion of an auditor’s role and responsibilities regarding audit engagements and what the Auditor’s legal responsibilities actually are. The users of financial reports often believe that auditors are responsible for preventing and detecting all frauds. They test transactions and balances more comprehensively than what actual practice is.

Note: It is to be noted that the auditors only provide a reasonable assurance since it is not practical to check each area. Auditing is done on a sample basis. 

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