Better understanding the financial statement audit.

• Author: Gauthier, Stephen J.

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For most local governments, the annual financial statement audit is as much a part of the yearly round of public finance as the approval of the operating budget. Despite its routine character, however, the financial statement audit appears to remain something of mystery to most outside the auditing profession. This article will attempt to dispel the cloud of mystery by first briefly reviewing the nature and purpose of the financial statement audit and then examining ten specific points of misunderstanding commonly encountered in practice.

NATURE AND PURPOSE

Anyone entrusted with responsibility for managing financial resources on behalf of others should provide a full accounting of that stewardship. For state and local governments, such an accounting ideally takes the form of financial statements prepared in conformity with generally accepted accounting principles (GAAP).

It is easy, of course, to imagine circumstances where those giving an accounting of their stewardship might be tempted to be less than forthcoming, or worse, Accordingly, those who must rely on financial statements to make decisions have traditionally sought the assurance of a disinterested third party to justify that reliance. That third party, of course, is the independent auditor.

Role of Management. Since management is responsible for the stewardship of financial resources, it is also primarily responsible for preparing the financial statements that give an accounting of that stewardship. Even when management seeks outside help to prepare the financial statements, it remains responsible for their contents, just as taxpayers remain responsible for their tax returns, even if the returns are prepared by paid tax professionals. Thus, managers must take ownership of their financial reporting. Generally accepted auditing standards (GAAS) require that managers do so explicitly in the form of a management representation letter.

Role of Internal Control. It would be hard to place confidence in an approval process that amounted to little more than affixing initials to documents without first examining them. So too, it would hardly be meaningful for management to assume responsibility for the data presented in financial statements if management did not have some reasonable basis for doing so. That reasonable basis can be provided only by a comprehensive framework of internal control.

Role of the Governing Body. While management is primarily responsible for financial reporting (including the comprehensive framework of internal control used to generate the financial statements), the governing body remains ultimately responsible for ensuring that management meets its responsibilities in this regard. Typically, an audit committee, comprising members of the governing body, provides the necessary oversight.

Objective of Fair Presentation. Precision comes at a price. That price can be justified only if the resulting benefits exceed their cost. In real life, few decisions require that amounts in financial statements be exact "down to the penny." Thus, the goal of financial...