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External Audits of Financial Statements

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  • 0:06 To Trust or Not to Trust
  • 1:04 The Audit and the Auditor
  • 2:13 Why an Audit?
  • 4:02 Lesson Summary
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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

Financial statements are one of the most heavily relied upon group of reports in the business world, and they must be accurate and reliable. In this lesson, you'll learn about financial statement audits, who performs them, and why they are important.

To Trust or Not to Trust

Jed owns a coffee shop. Business has been incredible in the first two years, and he wants to expand into other markets. He decides to have a meeting with his friend Sophie, and see how he can raise funds to branch out by offering stock options in his company.

Sophie, who is an accountant, tells him that there are several things that he must do before he can even offer stock for sale. 'The most important thing,' she says, 'is to be sure that he has an external audit done of his company's financial statements. Without that, investors may not trust that the financial statements are accurate.'

'An external audit,' Jed asks. 'What's that?'

Sophie shakes her head, realizing that Jed has a lot to learn. 'Ok, Jed,' Sophie replies. 'It looks like we have a lot to talk about.' Sophie sits back and begins to explain the concept of an external audit to Jed.

The Audit and the Auditor

'An external audit is an examination of a company's financial records by someone that is not an employee of the company itself. This person, known as an auditor, looks over the financial records of the company. The auditor has two main jobs.

His first job, and the most important, is to make sure that the financial statements of a company are in compliance with GAAP guidelines. GAAP guidelines are the generally accepted accounting principles that are established by the Financial Accounting Standards Board (FASB), which is the judge and jury in the accounting world. The second job that an auditor has is to attest to the truth and accuracy of information on the financial statements in both the notes to the financial statements and in audit reports.

There is another group of people that play an important role when it comes to audits and auditors. They are the Public Company Accounting Oversight Board (PCAOB). This group of people, under the direction of the FASB, sets the rules and regulations for performing audits. One important rule that they have set is that financial statement auditors must be certified public accountants (CPA).'

Why an Audit?

'So, you've told me what an audit is,' Jed says, 'and you've told me what an auditor is and who reigns over this type of thing, but what you haven't told me is why I need to have one done.'

'I was getting to that part, Jed. Just be patient,' Sophie replies. She continues on.

'There are three main groups of people that depend on financial statement audits. The first group is the investors. The investors are the people who have invested money into a company, as well as those who are considering making an investment into the company. They need to feel confident that the information on the financial statements is reliable.

The second group of people that depend on the financial statement audits is called regulators. Regulators are groups of people who spend their time reviewing practices of a company that are outlined in audit reports. The main goal of regulators is to ensure that company practices are legally compliant.

The third group of people that depend on financial statement audits are company leaders. Company leaders are those people in management that direct the actions taken by the company. Audits and audit reports allow company leaders to see how well their business is doing. They also tell company leaders where there may be room for improvement and where problem areas are.

Now, let's get to the burning question: Why have an audit done on company financial records? The answer is pretty simple. Investors, or those folks that you want to give you money to expand your business, need to know that you have taken every possible step to ensure the accuracy of the financial information that you have given them and that they have an auditor's opinion on the overall practices of the company. Having all that information makes it much easier for them to open their wallets to you. When they open their wallets, you expand your business. Do you see where this is going?'

Lesson Summary

'I do believe that I am getting a clearer picture of this whole auditing thing,' Jed says with a shake of his head. 'What you've told me, Sophie, is that an external audit is an examination of company financial records by someone outside of the company. You're also telling me that an auditor is the person who does the financial audit and that he must be a CPA. Am I right so far?'

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