AU-C 510: Auditing Opening Balances
Understand the process auditors use to validate a company's starting financial figures, a key step that directly shapes the final audit report.
AU-C 510 is a professional standard that directs auditors in handling initial audit engagements. The focus of this rule is on “opening balances,” which are the closing financial numbers from a company’s previous fiscal year. These balances serve as the starting point for the current year’s financial records.
The standard applies when it is the first time a company has had an audit or if the company has switched to a new auditing firm. The integrity of the current year’s financial reporting depends on the accuracy of these beginning figures. AU-C 510 establishes procedures to ensure these starting numbers are reliable and have been brought forward correctly.
Core Objective of Auditing Opening Balances
A company’s current financial performance cannot be accurately reported without a verified beginning. If the opening balances of accounts like cash, inventory, or debt are incorrect, the entire financial picture for the current year will be skewed, including its net income and financial position.
AU-C 510 has two primary objectives. The first is for the auditor to obtain sufficient evidence that opening balances do not contain misstatements that could materially affect the current year’s financial statements. For example, if a company’s opening inventory was overstated, the cost of goods sold in the current year could be understated, leading to an overstatement of profit.
The second objective is to confirm that the accounting policies used for the opening balances have been consistently applied in the current year. If a company changes a policy, such as its method for depreciating assets, that change must be properly accounted for and disclosed. An auditor verifies this consistency to ensure that financial results are comparable from one year to the next.
Required Audit Procedures
An auditor performs several procedures to verify opening balances, beginning with a review of prior period information. The auditor will read the company’s most recent financial statements and, if audited, the report issued by the predecessor auditor. This review helps identify any issues from the previous year that could impact the current period’s opening numbers.
When a different audit firm handled the prior period, communication with the predecessor auditor is a standard procedure. The new auditor will request permission from the client to speak with the previous firm. This communication can provide insights into the prior audit, including areas of concern or disagreements with management.
Reviewing the predecessor’s audit documentation can also offer direct evidence for the opening balances. The auditor must then perform specific audit procedures on the balances themselves, with the nature of the tests depending on the account. For instance, an auditor might trace the opening cash balance to the prior year’s final bank statements or verify accounts receivable by confirming balances with customers.
For inventory, the auditor may observe the company’s current physical inventory count and reconcile it backward to the opening quantities. This involves reviewing records of purchases and sales that occurred between the beginning of the year and the count date. If the prior year’s financial statements were unaudited, the auditor must perform more extensive procedures, as there is no previous audit work to leverage.
Impact on the Audit Report
The findings from the audit of opening balances directly impact the auditor’s final report, which is the formal opinion on the company’s financial statements. The type of opinion issued signals the level of assurance the auditor can provide to investors and lenders. If the auditor is satisfied that the opening balances are free from material misstatement, they will issue an unmodified opinion, also known as a “clean” opinion.
A qualified opinion is issued if the auditor concludes the opening balances contain a material misstatement that affects the current period’s statements, but the effect is not pervasive. For example, if opening inventory is materially misstated, a qualified opinion would be appropriate. This opinion states that except for the effects of the specific matter, the financial statements are presented fairly.
A qualified opinion might also be issued if the auditor is unable to obtain sufficient evidence about the opening balances, but the potential effect is not deemed pervasive. This could happen if records are missing for a specific but isolated part of the business.
A disclaimer of opinion is issued when an auditor cannot obtain sufficient audit evidence regarding the opening balances, and the potential effect is both material and pervasive. For instance, if a predecessor auditor refuses to grant access to their workpapers and the company’s records are too poor to verify major opening balances, the auditor cannot form an opinion. A disclaimer of opinion explicitly states that the auditor does not express an opinion on the financial statements.