The General Ledger Audit Process and Preparation

A company’s general ledger (GL) is the master record of all its financial transactions, functioning as a central repository for every sale, purchase, and payment. A general ledger audit is a systematic examination of these transactions to verify that the financial statements are accurate and reliable. This process provides assurance to investors, lenders, and management that the company’s reported financial position fairly represents its performance.

Auditor Objectives in a GL Review

An auditor’s review of a general ledger is guided by objectives tied to financial statement assertions, which are management’s claims about the figures in their reports. Auditors design tests to gather evidence that supports or contradicts these claims. This process ensures the final statements are free from significant errors by addressing different risks of potential misstatement.

A primary objective is to test for completeness by verifying that all transactions for a period have been recorded in the general ledger. For example, an auditor might review shipping logs and cash receipts to ensure all sales were recorded. This verification prevents a company from understating its revenues or concealing liabilities.

Another objective is to confirm accuracy by checking that the amounts and other data for transactions are recorded correctly. This could involve matching the amounts on vendor invoices to the accounts payable ledger. An error in a transaction’s value can have a cascading effect on the financial statements.

Auditors also focus on the cutoff assertion, confirming that transactions are recorded in the correct reporting period. To test this, an auditor examines invoices and shipping documents for transactions recorded near the end of the accounting period. This ensures transactions are assigned to the proper timeframe.

Finally, auditors test for existence and classification. Existence confirms that assets and liabilities on the books actually exist, which an auditor might test by physically inspecting equipment. Classification ensures transactions are posted to the correct accounts, such as distinguishing between a repair expense and a capital improvement.

Preparing Key Documents and Schedules

Preparation for an audit begins with assembling specific documents from the accounting system. The general ledger detail report is a primary document, providing a complete, transaction-level listing of every entry for the period. Auditors use this report to select transactions for detailed testing.

A trial balance is also required, which lists every general ledger account and its final balance for the period. It serves as the starting point for creating the financial statements. Auditors use it for a high-level overview of the company’s financial position before beginning detailed testing.

Companies must provide complete bank statements for every account for the audit period, along with corresponding bank reconciliation reports. These reports match the company’s cash balance to the bank’s, explaining differences like outstanding checks or deposits in transit.

Manual journal entries receive close scrutiny because they occur outside of automated systems and can be a source of error. For every manual entry, such as for accruals or corrections, detailed supporting documentation must be available. This backup should explain the entry’s purpose and provide evidence for the calculation.

Companies must also prepare reconciliation schedules for major control accounts supported by sub-ledgers. These reports tie the general ledger’s summary balance to detailed listings in a subsidiary system. Examples include the accounts receivable aging report, the accounts payable aging report, and the fixed asset schedule.

The Audit Examination Process

The examination phase begins with a risk assessment, where auditors identify accounts susceptible to misstatement. Using their understanding of the company and industry, they focus on high-risk areas. Accounts relying on complex calculations or significant judgment, like a warranty liability or an allowance for doubtful accounts, receive more extensive testing.

Based on the risk assessment, auditors use audit sampling to select transactions for testing, as examining every item is impractical. A representative sample is selected from the general ledger detail using either statistical methods for a random selection or non-statistical methods. Non-statistical sampling allows an auditor to use professional judgment to select large or unusual transactions.

Auditors then perform detailed testing procedures on the selected sample. One procedure is vouching, where a transaction in the general ledger is traced backward to a source document to verify it is valid. The opposite procedure, tracing, follows a source document forward to the general ledger to ensure it was properly recorded, which tests for completeness.

Auditors also use analytical procedures to evaluate financial information by comparing current balances to prior periods, budgets, or industry averages. This helps identify unexpected fluctuations or unusual trends that require investigation. For example, an auditor would investigate if revenue grew by 30% while the cost of goods sold only increased by 5%.

Throughout the process, auditors will also make inquiries of management and staff. These questions help them understand business processes and clarify any irregularities found during testing.

Understanding Audit Findings and Reports

The audit concludes with formal reports communicating the auditor’s findings. The primary output is the audit opinion, which states whether the company’s financial statements are presented fairly in accordance with generally accepted accounting principles (GAAP). An “unqualified” or “clean” opinion is the most desirable outcome, indicating the financial statements are free of material misstatement.

Another deliverable is the management letter, a less formal report provided to company management and its audit committee. The management letter focuses on specific issues identified during the audit rather than the overall fairness of the financial statements.

The management letter details internal control weaknesses, specific errors, or recommendations for process improvements. For example, it might point out a lack of segregation of duties where one person can both approve and issue payments. It may also list non-material errors found during testing and suggest ways to prevent them in the future.