Speaker 1: Hi, my name is Garrett Watson, and I'm a senior business development representative at Flowcast. Prior to joining the Flowcast team, I spent the previous six years as a senior associate working in tax and audit. Today's video is all auditing financial statements. What a financial statement audit is, why it's important, and how it works. Now, what are audited financial statements? An audited financial statement is any financial statement that has been officially inspected by, tested, and opened by a certified public accountant or CPA that is independent of the organization. The purpose of a financial statement audit is to get an objective opinion on the organization's financial position. Auditors don't guarantee that every number on the financial statements is 100% accurate. Instead, they perform tests and analytical procedures that allow them to provide reasonable assurance that the financial statements are free of material misstatements and prepared following generally accepted accounting principles, also known as GAAP. Auditors work within an acceptable margin of error, known as materiality. Materiality depends on the size of the organization and its revenues and expenses. For a very small company, an error of a few hundred dollars might be significant. But for a company the size of Amazon or Facebook, a material misstatement might be hundreds of thousands of dollars. Providing reasonable assurance that the financial statements are free of material misstatements allows lenders, investments, government entities, and other interested parties to rely on those financial statements. Ensuring that the financial statements follow GAAP accounting standards ensures that companies can't pick and choose how they account for transactions or present financial information. Any financial statement can be subjected to audit procedures, but according to the Securities and Exchange Commission, or the SEC, most audits focus on four standard financial statements. So first we have the balance sheet. The balance sheet shows what a company owns and what it owes as of a certain date. Second, we have the income statement, or profit and loss, which shows how much the company made and spent over a period of time. Third, we have the statement of cash flows. The statement of cash flows shows how much cash flowed into and out of the company over a period of time. And then we have the statement of shareholders' equity. The statement of shareholders' equity shows changes in the interests of the company's shareholders or owners over a period of time. How do auditors verify financial statements? A financial statement audit begins when an organization signs an engagement letter from its audit firm. The audit engagement letter is the contract spelling out what each party agrees to. From there, the audit follows generally accepted auditing standards, which is a four-step process. Step 1. Assessing Risk Auditing rules require the auditor to assess general business risk and industry and company-specific risk. The assessment helps auditors determine where to focus their audit procedures and develop appropriate procedures to minimize the potential risk of material misstatement. The auditors may use various analytical procedures to test the company's internal controls and identify risky areas or obvious anomalies in the numbers. Step 2. Planning Based on the risk assessment, the audit firm develops a detailed audit plan to test the internal control environment and investigate the accuracy of specific line items within the financial statements. The audit partner then assigns audit team members to work on each element of the plan and works with the client to develop a timeline for getting the work done. Step 3. Gathering Evidence The next stage of the audit is field work, which may last anywhere from one day to several months, depending on the complexity of the organization. During field work, the auditors test and analyze internal controls. The exact procedures will vary depending on the type of account being audited and the organization's risk assessment, but usually include a mix of analytical and substantive procedures. Some examples of audit procedures include using analytical procedures to assess the reasonableness of expenses, make inquiries of management about contingent liabilities, observe employees performing a physical inventory count, recalculate depreciation to see whether there are any differences between the auditor's calculation and the client's calculation, tracing individual transaction to original financial records such as sales contractors, bank statements, or purchase orders, contacting third parties such as vendors, customers, or financial institutions to confirm account balances. Step 4. Communicating the Findings At the end of the audit, the audit firm develops an opinion about the accuracy and integrity of the company's financial statements. The firm then issues a report on whether the financial statements present a fair and accurate representation of the company's financial performance and to comply with generally accepted accounting principles. Four types of audit reports are possible, first being an unqualified opinion. This is also called a clean report and means the auditors are satisfied with the company's accounting and operations and didn't find any material problems. The second being a qualified opinion. This report indicates that the auditors found problems in some type of transaction or area and aren't confident that the accounting is correct for that specific area. The report will identify the problematic area and issues. The third is the disclaimer of opinion. In this situation, the auditors couldn't obtain enough evidence to determine whether the financial statements were presented fairly or not. This may happen if management doesn't provide the requested information or because management's explanation didn't make sense. Fourth is the adverse opinion. An adverse audit opinion means the auditors saw evidence of material misstatement or fraud or possibly both. This kind of opinion is a big red flag to stakeholders and investors. The auditors will also schedule an exit conference with management and the audit committee, if the company has one. At this meeting, they'll discuss the report and any issues or problems they encountered during field work. This can be an opportunity for a management to get insight into proving their business processes and financial reporting. Now let's review what we learned about an audit of financial statements. An audited financial statement is a financial statement that has been officially inspected by, tested, and opened by independent auditors. The purpose of a financial statement audit is to get an objective opinion on the organization's financial position. Auditors don't guarantee that every number on the financial statements is 100% accurate. Instead, they perform tests and analytical procedures that allow them to provide reasonable assurance that the financial statements are free of material misstatements and prepared following generally accepted accounting principles, also known as GAAP. Most audits focus on four main financial statements. The balance sheet, the income statement, the statement of cash flows, and the statement of shareholders equity. Financial statement audits generally follow a four-step audit process. First, risk assessment. Two, planning. Three, gathering evidence. And four, communicating the findings. And finally, at the end of the audit, the auditors will meet with management and the audit committee to discuss their auditor's report and any issues or problems they encountered during field work. This meeting is an opportunity for management to get insight into proving their processes and financial reporting. If you're interested in leveraging technology to make your audits flow smoother, check out Flowcast. With Flowcast's closed management software, your company is always audit ready because your reconciliations tie out and all your work papers are complete. When you grant your external auditors restricted access to Flowcast, they can find everything they need, saving you precious time and aggravation. This leads to a more productive audit and a better relationship with your auditor. And hey, if you found this video useful, hit that like button and don't forget to subscribe. That's all for today, and good luck with your month end close.