Introduction

Financial audits are a crucial process for businesses of all sizes, ensuring the accuracy and reliability of their financial statements. While the idea of an audit may sound complex, understanding what auditors check in your financial statements can demystify the process.

In this article, we’ll explore the key components of financial statements and dive into the specific areas auditors examine to verify a business’s financial health, compliance, and overall performance.

What Are Financial Statements?

Financial statements are formal records of a company’s financial activities. They provide insights into the business’s operations, profitability, and financial position, helping stakeholders such as investors, creditors, and regulators make informed decisions.

There are four primary types of financial statements that auditors typically review:

1. Income Statement (Profit and Loss Statement)
2. Balance Sheet
3. Cash Flow Statement
4. Statement of Changes in Equity

Each of these statements serves a distinct purpose, but auditors scrutinize all of them to ensure accuracy, transparency, and compliance.

1. Income Statement (Profit and Loss Statement)

The income statement shows a company’s revenues, expenses, and profits over a specific period, usually quarterly or annually. Auditors closely examine this statement to ensure that revenue and expenses are recorded accurately, and that profit figures are not manipulated.

What Auditors Check in the Income Statement:

• Revenue Recognition: Auditors verify that revenues are recognized according to the applicable accounting standards (e.g., IFRS or GAAP). They check that revenues are reported in the correct period and are supported by appropriate documentation (e.g., sales invoices, contracts).
• Expense Classification: Auditors review the classification of expenses to ensure they are categorized correctly, and they investigate any unusual or unexplained costs. For example, they check whether non-operating expenses, such as interest or depreciation, are correctly accounted for.
• Profitability: Auditors assess the reported profit or loss to ensure it’s consistent with other financial data and industry standards. They may investigate significant discrepancies or unexpected swings in profitability.

2. Balance Sheet (Statement of Financial Position)

The balance sheet provides a snapshot of a company’s assets, liabilities, and equity at a given point in time. It follows the fundamental accounting equation:Assets = Liabilities + Equity.

What Auditors Check in the Balance Sheet:

• Assets: Auditors examine the company’s assets to confirm they are recorded at the correct value and reflect the true financial standing of the business. They check whether assets like property, inventory, and receivables are appropriately valued and supported by documentation (e.g., purchase invoices, appraisals).
• Liabilities: Auditors review the company’s liabilities (debts and obligations) to ensure they are properly disclosed and categorized. This includes checking for accurate accruals for expenses and ensuring that long-term liabilities are appropriately distinguished from short-term liabilities.
• Equity: Auditors evaluate the company’s equity to confirm that changes in retained earnings, stock issuance, and dividends are properly accounted for. They also verify that the equity reported aligns with the company's overall financial health.

3. Cash Flow Statement

The cash flow statement details how cash moves in and out of a business during a specific period. It helps stakeholders understand how well the company manages its cash to fund operations and meet obligations.

What Auditors Check in the Cash Flow Statement:

• Cash from Operating Activities: Auditors review the cash flows generated from the core business activities. They verify that operating cash flow accurately reflects the company’s ability to generate revenue and cover operating expenses.
• Cash from Investing Activities: Auditors check cash flows from buying or selling long-term assets like equipment or investments. They ensure that these transactions are accurately classified and documented.
• Cash from Financing Activities: Auditors assess cash flows related to the company’s financing decisions, such as issuing new equity, repaying debt, or paying dividends. They confirm these transactions align with other financial records and comply with accounting principles.

4. Statement of Changes in Equity

This statement outlines changes in a company’s equity over a given period. It includes information on issued shares, retained earnings, and other equity-related items such as dividends.

What Auditors Check in the Statement of Changes in Equity:

• Retained Earnings: Auditors review the company’s retained earnings to ensure that net income is correctly transferred to this account after dividends are paid. They also check whether prior period adjustments are properly reflected.
• Dividend Payments: Auditors verify that dividend payments to shareholders are accurately recorded and that the amounts paid align with the board’s declarations and the company’s profitability.
• Share Issuance and Buybacks: Auditors check for any new share issuances or repurchase of shares, ensuring these transactions are correctly documented and comply with relevant regulations.

What Else Do Auditors Check?

In addition to examining the four main financial statements, auditors also perform a detailed review of supporting documents and business practices to ensure compliance and accuracy.

1. Internal Controls

Auditors evaluate the strength of a company’s internal controls to ensure there are mechanisms in place to prevent errors and fraud. They check if policies are followed, and whether segregation of duties and proper authorization procedures are in place for financial transactions.

2. Accounting Policies and Procedures

Auditors review a company’s accounting policies to ensure they align with the applicable financial reporting standards. They verify that the company uses consistent and appropriate methods for recognizing revenue, valuing assets, and reporting expenses.

3. Compliance with Laws and Regulations

Auditors check whether the company is compliant with relevant laws and regulations, such as tax laws and industry-specific rules. They verify that the business has filed all required tax returns and that its financial reporting adheres to local accounting standards (e.g., IFRS in South Africa).

Why Auditors Perform These Checks

Auditors perform these checks to ensure that financial statements are free from material misstatement, whether caused by error or fraud. They aim to provide stakeholders with an independent, objective, and accurate picture of the company’s financial health.

An auditor’s goal is not to examine every transaction, but to assess whether the financial statements, taken as a whole, give a true and fair view of the company’s financial position.

Conclusion

Understanding what auditors check in your financial statements can help you prepare for the audit process and ensure the accuracy of your financial reporting. By focusing on areas like revenue recognition, expense classification, cash flow, and equity changes, auditors assess whether your financial statements are compliant, accurate, and reliable.

Regular audits are an essential tool for businesses seeking to maintain transparency, build trust with stakeholders, and stay compliant with financial regulations. With proper internal controls and accounting practices in place, businesses can pass audits smoothly and gain valuable insights into their financial performance.

💡 Tip: Regularly reviewing and updating your financial statements will not only help your audit go smoothly but also improve the overall financial health and transparency of your business.