Why the Planning Phase of a Financial Statement Audit is Important

The word audit is often dreaded by many companies. However, if properly prepared, a financial statement audit can provide many benefits to a company.

An audit consists of the evaluation of company information to express an opinion on whether the financial statements are fairly presented and conform to generally accepted accounting principles (GAAP) without material misstatement. In other words, an audit helps the users of the financial statements determine the overall financial health of a company and its operations. The users of the audited financial statements may include lenders, investors, government regulators, management, and owners.

The planning phase of a financial statement audit is arguably the most important step. Clients must understand this step and why it is crucial for a successful and efficient audit.

What Does Audit Planning Consist of?

There are multiple steps an accounting team takes to prepare for an audit. A few of the main steps in planning include the following:

Understanding the Entity, its Environment, & Internal Controls

• This step is particularly important for new clients. As part of understanding the entity, the auditor will likely require information on the operations of the business, ownership structure, investments in other entities, the overall goal and strategy of the company, and other relevant information related to business operations.
• Understanding the entity’s environment includes internal and external factors. Externally, the auditor must understand any regulatory requirements or factors, how the economy affects the operations of the business, any potential or ongoing litigation, and current competition. Internally, the auditor must gain an understanding of the involvement of owners/management in day-to-day operations, organizational structure, roles performed by employees, and the integrity and ethics of key employees. Topics auditors may ask questions about could relate to qualifications for employees who are in charge of preparing the company's financial statements, management’s tone at the top, reporting lines of communication, etc.
• Lastly, understanding the entity’s internal controls over financial reporting includes identifying whether the entity has processes and procedures in place to mitigate the risk of a possible material misstatement. Examples of these procedures include segregation of duties, preparation of bank reconciliations, approval of invoices, etc.

Assessing the Risk of Material Misstatement

• This step includes obtaining an understanding of the entity’s business processes associated with certain transactions, account balances, and disclosures. The audit team will likely ask the client to walk them through its major transaction cycles, such as cash, accounts receivable, accounts payable, revenue, etc., as well as the entity’s overall financial reporting processes. Understanding these processes helps the audit team identify the audit risks of the entity and ultimately helps determine what procedures will be performed for the audit.

Audit Strategy, Scope, & Timing

• Audit strategy involves determining what procedures will be performed based on the audit risks identified, planning the overall audit approach, ensuring the audit team is staffed sufficiently, scheduling fieldwork, and documenting deadlines and deliverable dates.

Why Are These Steps Important to the Client?

The steps described above involve multiple inquiries with management and, at times, can feel overwhelming or unnecessary. However, providing all the necessary information to fulfill these steps can save the client time and money in the long run. Conversely, if the auditor does not get enough information upfront to appropriately plan for the audit and assess risks it could result in the following:

• Performance of unnecessary audit procedures resulting in inefficiencies
• Information identified late in the audit requiring additional procedures
• Improper staffing of an engagement- too few or too many team members
• Insufficient time scheduled for fieldwork resulting in fieldwork needing to be rescheduled or extended
• Issuance of a qualified or disclaimer opinion (unclean opinion)

Each of the scenarios listed above results in additional time and money required by the client and audit team. On the other hand, if the planning phase of an audit is completed thoroughly, it will most likely result in gained efficiencies, less time, and less money. If you have any questions, please contact us or read more about related topics on our blog.