Have you ever wondered what your auditor is talking about?
Rest assured you’re not alone. While most auditors are diligent in their quest for clarity, the lingo trap can sometimes rear its ugly head.
Here’s a bit of a primer on that crazy audit – and accounting – language.
Clarifying Financial Statement Terms
Analytical procedure – This procedure applies analytical analysis as a method of auditing an assertion. Auditors compare financial statement amounts with their expectations.
Audit committee – This group is responsible for oversight of the financial reporting process, selection of the independent auditor and receipt of audit results.
Audit risk – Audit risk is a combination of the risk that material errors will occur in the accounting process and the risk that audit tests won’t uncover the errors.
- Deficiency – A deficiency is an internal control shortcoming or an opportunity to strengthen internal controls.
- Control deficiency – This deficiency exists when the design or operation of a control does not allow employees, in their assigned functions, to prevent or detect misstatement on a timely basis.
- Significant deficiency – This deficiency in internal control is less severe than a material weakness, yet important enough to merit attention by those charged with governance.
- Dual-purpose test – This procedure, or test, provides evidence for both substantive tests and tests of controls.
- Material weakness – A deficiency in internal control exists such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented or detected and thus corrected on a timely basis.
- Test of controls – Auditors use these procedures to evaluate the design of controls and determine whether the controls are in operation – and operating effectively when reliance is going to be placed on controls.
- Adverse opinion – The presentation is not in accordance with U.S. generally accepted accounting principles (GAAP).
- Disclaimer of opinion – The auditor is unable to express an opinion as to the presentation of financial statements in conformity with GAAP.
- Unqualified opinion – This is a personal favorite. “Unqualified” does not mean the auditor is lacking the qualifications required to render an opinion. It does mean that the opinion of the independent auditor has not been qualified in any way. This is often referred to as a “clean opinion.” The unqualified opinion is the one you want.
- Qualified opinion – In certain circumstances, an auditor cannot render a clean opinion on a portion of the financial statements. When the auditor feels that – except for the effects of the matters to which the qualification relates – the financial statements are fairly presented in conformity with GAAP, a qualified opinion is issued.
Random sample – A random sample is determined under conditions in which each item has an equal chance of being selected.
Relevant assertion – A relevant financial statement assertion has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated.
Segregation of duties – When a company segregates duties, it assigns different people the responsibilities of authorizing transactions, recording transactions and maintaining custody of assets.
Substantive audit procedure – This procedure is a direct test of a financial statement balance.
Those charged with governance – These individuals are responsible for overseeing the entity and obligations related to the accountability of the entity.
Trace – The auditor follows a transaction through the steps of a system.
Deciphering Other Audit Lingo
A discussion of audit terminology would be incomplete without noting a few items that are not limited in applicability to a financial statement audit but are important nonetheless. Read on for more exciting information.
Accounting estimate – Estimates are necessary when amounts are uncertain pending the outcome of future events. An accounting estimate refers to an approximation of a financial statement element, for example, depreciation. The owners of a depreciable asset estimate the useful life of the asset in question. There is no precision involved, although the auditor can assess the reasonableness of the factor considered.
- Financing activities – This refers to borrowing money or repaying amounts borrowed, or otherwise settling obligations.
- Investing activities – This refers to making and collecting loans, and acquiring and disposing of debt or equity instruments or property.
- Agreed-upon procedures – Not an audit. In this case, the clients or another user, such as a bank, specifies what procedures the accountant will perform.
Basis of accounting
- Accrual basis of accounting – An organization recognizes, or records, a transaction when an obligation to pay or be paid arises, not when payment is consummated.
- Cash basis of accounting – An organization records transactions when cash is increased or decreased.
- Comprehensive basis of accounting – A complete set of rules, other than GAAP, is applied to all items in a set of financial statements, for example, income tax basis or cash basis.
Cash equivalents – Cash equivalents are short-term and highly liquid investments that convert readily to cash and carry little risk of change in value at maturity.
- Balance sheet or statement of financial position – This is an inventory of assets and liabilities at a particular moment in time. Assets represent what an organization owns. Liabilities represent obligations owed to other parties.
- Income statement or statement of activities – This statement summarizes revenues and expenses occurring during a given time period.
- Statement of cash flows – This statement reconciles changes in cash and cash equivalents with changes in income between two consecutive periods.
- Trend analysis – Trend analysis examines the change in something over time, for example, comparisons of one year to another.
If you find yourself still lost in the terminology, have a conversation with your CPA, who is your most valuable resource in achieving financial literacy.