What Is an Audited Financial Statement?

An audited financial statement represents a formal review of a company’s financial records and reports. This process is undertaken by an independent third party, typically a Certified Public Accountant (CPA) firm. The primary goal is to provide an objective assessment of whether the financial statements accurately reflect the entity’s financial position and performance in accordance with established accounting principles.

Core Elements of an Audited Financial Statement

An audited financial statement comprises several distinct financial reports that collectively offer a comprehensive view of a company’s financial health. These include the balance sheet, income statement, statement of cash flows, and statement of changes in equity.

The Balance Sheet

The balance sheet, also known as the statement of financial position, presents a snapshot of a company’s assets, liabilities, and equity at a specific moment. Assets are resources owned by the company, such as cash, accounts receivable, inventory, and property. Liabilities represent obligations to others, including accounts payable, loans, and deferred revenue. Equity reflects the owners’ residual claim on the assets after deducting liabilities.

The Income Statement

The income statement, or profit and loss statement, summarizes a company’s financial performance over a period, such as a quarter or a fiscal year. It details revenues earned and expenses incurred, ultimately reporting the net profit or loss.

The Statement of Cash Flows

The statement of cash flows tracks the movement of cash and cash equivalents into and out of a business. It categorizes cash flows into operating, investing, and financing activities, providing clarity on how a company generates and uses cash.

The Statement of Changes in Equity

The statement of changes in equity details the changes in the owners’ equity over an accounting period. This includes net income or loss, dividends paid, and any new capital contributions or withdrawals.

Notes to Financial Statements and the Auditor’s Report

Accompanying these statements are the notes to financial statements, which provide additional details and explanations about the information presented. These notes clarify accounting policies, significant estimates, and other relevant disclosures. The auditor’s report presents the independent auditor’s professional opinion on whether the financial statements are fairly presented in all material respects and conform to Generally Accepted Accounting Principles (GAAP).

The Role of the Independent Auditor

The independent auditor enhances the credibility and reliability of financial statements. An auditor is a qualified professional who performs an objective examination of a company’s financial records to provide an unbiased opinion on whether the financial statements are presented fairly and accurately.

Auditor independence is a foundational principle, meaning the auditor must be free from any financial or other relationships that could compromise their objectivity or impartiality. This includes avoiding direct investments in the audited client, certain loan agreements, or employment relationships that could create a conflict of interest. For instance, PCAOB rules require registered public accounting firms and their associated persons to be independent of the client during the audit and professional engagement period.

Maintaining independence in both fact and appearance is essential to preserving public trust in the audit process. Independence in fact means the auditor holds no actual conflicts of interest, while independence in appearance means that external parties perceive the auditor as unbiased. Professional standards from the American Institute of Certified Public Accountants (AICPA) and state boards of accountancy, along with Securities and Exchange Commission (SEC) and PCAOB rules for publicly traded companies, establish strict guidelines to ensure this independence.

Overview of the Audit Process

The audit process involves a series of structured steps undertaken by an independent auditor to examine financial statements. The initial phase is planning, where the auditor gains an understanding of the client’s business, industry, and operating environment. This helps identify potential risks that could lead to material misstatements.

Auditors then assess and test internal controls, which are the processes a company uses to safeguard assets and ensure the accuracy of financial data. This involves performing walkthroughs to observe how controls are applied, such as reviewing authorization procedures, segregation of duties, and record-keeping. A strong internal control system can influence the nature, timing, and extent of further audit procedures.

Substantive testing gathers evidence directly supporting financial statement balances and transactions. This includes procedures like confirming bank balances, verifying accounts receivable, and observing physical inventory counts. Auditors also examine various documents, such as sales invoices, purchase orders, and expense reports, to ensure accuracy and proper classification.

The final stage is reporting, where the auditor forms an opinion on the fairness of the financial statements and issues the auditor’s report. There are generally four types of audit opinions:

• An unqualified (or unmodified) opinion, which indicates that the financial statements are presented fairly in all material respects according to GAAP.
• A qualified opinion, which suggests minor issues or scope limitations.
• An adverse opinion, which means significant misstatements exist.
• A disclaimer of opinion, which indicates insufficient evidence to form an opinion.

Importance for Stakeholders

Audited financial statements hold substantial value for a diverse range of stakeholders, providing transparency and fostering trust in financial information.

Investors

For investors, these statements offer a reliable basis for informed investment decisions, helping them assess a company’s financial health and future prospects. The verified data reduces investment risk by providing a clear picture of performance and position.

Lenders and Creditors

Lenders and creditors rely heavily on audited financial statements when evaluating loan applications and creditworthiness. Banks often require audited statements before approving loans, and the thoroughness of the audit can lead to more favorable interest rates for businesses. These statements assure lenders that the financial data used for credit assessments is accurate and dependable.

Regulatory Bodies

Regulatory bodies, such as the SEC for publicly traded companies, mandate audited financial statements to ensure compliance with laws and regulations. This oversight protects the public interest and maintains orderly financial markets. Audited reports demonstrate adherence to accounting standards and legal requirements, reducing the risk of disputes with tax authorities and potential penalties.

Management and Boards of Directors

Management and boards of directors utilize audited financial statements for internal oversight, strategic planning, and performance evaluation. While involved in preparing the statements, the independent audit provides external validation that strengthens their internal decision-making processes. It can also highlight inefficiencies or areas for improvement within financial operations.

The General Public and Employees

The general public and employees benefit from audited financial statements through increased transparency and accountability. For example, not-for-profit organizations often publish their audited statements to assure donors and the public that funds are managed responsibly. This transparency builds confidence and reinforces ethical financial practices.