What are the three stages of an external audit?

Statutory external audits play a key role in making sure companies are compliant, secure and, ultimately, healthy. While it’s true that the external audit process can be involved and time-consuming, the goal is to bring value to your business and safeguard its future, especially at times of heightened risk.

Kapil Davda explains the main steps of the external audit process, the roles that owners and advisors play in making the experience valuable and how you can streamline the process to limit business disruption.

What circumstances require an external audit?

An external audit is a legally required review of the accuracy of a company's or organisations financial statements and records, tied to specific circumstances. However, the term is often misused.

While many think of audits as a penalty or something that arises when there are issues, but statutory audits are a specific process with set steps, goals and outcomes. The triggers for them are prescribed, along with the methodologies used.

Broadly, statutory audits fall into two major categories:

1.  Voluntary

2.  Required

What’s a voluntary audit?

A business of any size can choose to commission an audit for their own benefit, using the process to gather key information, set benchmarks and assess risk. Given that the audit process provides an independent assessment of financial statements, management and controls this can be useful in certain circumstances, including:

• Shareholder-instigated investigations into the company’s financial health, which is mandatory if proposed by shareholders who own at least 10% of shares.

• Owner-reviews of core financial processes and controls within the business

• Preparing to raise investment and making the business more attractive for investors

What’s a required audit?

There are certain circumstances where an audit is a legal obligation for the business, or may be externally mandated by a third-party. These include:

• Reaching a certain size, and meeting two of the following three criteria: an annual turnover over £10.2 million, balance sheets assets worth more than £5.1 million, over 50 employees on average during the relevant review period.

• Public companies

• Working in an FCA-regulated field, such as insurance, banking or securities

• Raising funding - where the audit plays a role in due diligence, checking the relevant assets, controls and records are as they have been presented.

In either situation, the process of the audit is the same.

What are the stages of the statutory audit process?

Once a licensed statutory auditor has been appointed it involves three main stages:

• Planning

• Audit and field work

• Finalisation and presentation of results

Stage one: planning

The first stage of the audit is to determine the scope of the project and areas to examine. This is done in collaboration with the business owner and financial leaders within the organisation.

Since going through every single invoice in a business’s history is long, tedious and expensive for all involved, statutory audits are designed to test controls and records via a representative sample. The initial stage will guide the range and depth of samples that will be gathered.

Through initial meetings, the auditor will gather information about recent business activities to determine the key data to investigate. The more risk-relevant activities present, the wider the sample and the deeper the checks will be. This also takes into account any concerns of the owner themselves.

Examples of risk factors include:

• Significant changes in staffing, ownership structures, products or services

• Instances of fraud and theft in the business

• A lack of proper accounting records

• High turnover, particularly within the accounting team

• Condition of management accounts

• High lending-levels

• Missed filing deadlines

• Significant levels of outstanding bills owing to suppliers

Stage two: audit & field work

Once the scope of the audit has been determined, the audit team will begin work on reviewing the business. This may be done on-site or virtually, depending on the financial systems in place.

The goal of this stage is to compare the existing accounts of the business with original source documentation, including:

• Invoices

• Legal documents such as contracts

• Bank statements

• Inventory records

The size of the team will depend on the scale of the work to be undertaken. Input from the owner is still necessary at this stage, answering queries and helping guide ongoing work. If preliminary work during this stage indicates systems are not working as they should, errors or missing records, this can affect the scope of the work.

Stage three: finalisation

Once a representative sample of the records has been conducted, the audit has to determine to what extent the accounts as they currently sit correspond with the reality of the examined records.

This will involve a review by the manager of the onsite audit followed by confirmation from a partner at the firm in question. The goal of this stage is to assess whether the accounts in question are materially correct.

In practice, very few businesses have perfect accounts – the nature of systems, people and change in organisations can let small errors and discrepancies slip through. The job of the auditor is to assess the materiality of any errors or required adjustments – to what extent would the owner’s, or users’ perception of the accounts change in light of the required amendments.

A clean, unmodified audit report will be produced if any errors or adjustments identified are not considered to be material, or if they are material, the necessary adjustments have been made in the accounts. If there are material changes to be made, this will be noted in the audit report along with the degree of qualification.

Some auditors, including us at Haines Watts, will also produce a management letter to help leaders make use of the information discovered through the audit, summarising the findings, commenting on the relevant systems and controls, as well as what they can be done to improve processes. This letter is not filed, but exists purely to provide the owner value.

Driving value from the audit process

Collaboration between the auditor and the business owner is key to a successful audit process. The end goal of a statutory audit is to leave a business in a better place than before. The more the owner is involved, the more the auditor can focus on the areas that matter for the business.

At Haines Watts, we take a human-focused approach to statutory audits, building trust between our teams and the businesses we assess. For regular audits, we endeavour to use the same teams year on year to streamline the process and create better outcomes for both sides.

Get in touch with us to find out how we can maximise value for you throughout the external audit process.