Evaluating financial statements

The primary role of a statutory or external auditor is to provide the members of a company, typically the shareholders, with an independent opinion as to whether the financial statements of the company (or any other type of organisation) give a true and fair view of the assets, liabilities and financial position at the year end, as well as the results or performance for the year then ended.

While the independent opinion and report of an external auditor is made to a company's shareholders, the reality is that information produced by companies and reported upon by external auditors is used by a wide range of other stakeholders in making economic decisions. These include regulators, banks, suppliers and customers. It is also common that a company's shareholders don't manage it day to day, and as such these owners take comfort from the independent assurance that an external auditor provides. All of this explains why having a company's financial statements audited by an independent external auditor is so fundamental to maintaining trust, confidence and market stability in the world's financial systems.

So how do independent external auditors evaluate an organisation's financial statements? What are they looking for?

Firstly, they look at the numbers. Auditors start by verifying the accuracy and completeness of financial records. They examine transactions, ensuring they're properly recorded, classified and summarised within the financial statements. Auditors validate the existence and valuation of assets – what assets does an entity own, what is it owed and by who. Similarly, auditors verify the existence and accuracy of liabilities – who does an entity owe money to and what does it owe. They ensure that all obligations, including debts, loans and contingent liabilities, are accurately recorded and disclosed. Any discrepancies or inconsistencies raise red flags and typically prompt further investigation.

Secondly, they look at disclosures. While the numbers are an important part of the picture, without the context that disclosures provide, the numbers are just… well, numbers. Auditors meticulously evaluate disclosures within financial statements as part of the audit process, ensuring they are comprehensive, transparent, clear and aligned with accounting standards and legislation.

But what do the disclosures within financial statements actually consist of? They primarily include:

1. Details of an entity's accounting policies. These explain how an entity has recorded its income, expenses, assets and liabilities. This is important context for understanding the numbers that are presented in financial statements.
2. Details of any areas of judgement or estimation used by an entity. As these areas are inherently uncertain and open to subjectivity or bias, they can have a significant impact on the “true and fair view” of an entity's financial position and performance. Part of the auditor's role is to evaluate judgements and estimates made by the entity and the transparency and clarity of disclosures made around them.
3. A statement in respect to whether the financial statements are prepared on a going concern basis – i.e., whether the entity expects to be in a position to continue operating for the foreseeable future. An external auditor's report will typically refer specifically to this. In certain cases where there is uncertainty as to whether an entity can continue operating or where an entity does not actually intend to continue operating, additional disclosures are typically required to meet the true and fair view test. These would set out the board's views as to why they believe the entity can continue operating or, where the intention is to cease operating, why the entity is ceasing to operate and how it is expected to be wound up. The external auditor's report concludes as to the appropriateness of those disclosures.
4. Information about subsequent events. These are events that have occurred after the reporting date of the financial statements that have or could have an impact on the company's financial position. Again, in meeting the true and fair view test, the auditor evaluates whether such events if not disclosed would lead users of the financial statements to make different economic decisions.

From the above, it is easy to see why the adequacy of disclosures is so vitally important when external auditors are evaluating financial statements and providing their opinion as to whether they give a true and fair view. It is easy to imagine the potential impact the omission or misstatement of certain disclosures can have on how a company's performance or financial position are perceived, and the decisions taken as a result.

How we can help

Crowe's audit team works with a broad range of clients, covering a variety of sizes, industries and sectors. This breadth of experience ensures that we can guide our clients through the audit process, particularly in preparing and evaluating your financial statements to ensure they reach the highest quality without undue stress or inconvenience.

If you are considering conducting an audit or have any queries in regard to financial reporting, please do not hesitate to contact a member of our team.