Financial Audit Process: Compliance, Working Papers, and SOX Requirements

The Financial Statement Audit Process

Financial statements represent several key assertions regarding the entity's financial position. These assertions ensure the reliability of the reported data:

• Existence and Occurrence: Reported assets and liabilities exist, and recorded transactions occurred during the particular accounting period.
• Completeness: The financial statements present all transactions and accounts.
• Rights and Obligations: Listed assets represent the enterprise's rights, and reported liabilities show the business's obligations.
• Valuation and Allocation: Financial statements record the enterprise's assets, liabilities, revenues, and expenses at appropriate amounts.
• Presentation and Disclosure: Proper classification, description, and disclosure are provided for all financial statement components.

The Role of the Auditor and Internal Controls

Auditors rely on internal controls and sampling techniques. Internal controls are the systems, procedures, and policies which ensure that appropriate individuals authorize, execute, and record all transactions.

Professional judgment is crucial. Auditors conduct an audit to obtain reasonable assurance that the financial statements do not contain any material misstatements or omissions.

Defining Audit Risk

Audit risk (maintained at a low level) is the probability that an auditor will unknowingly fail to modify appropriately the audit opinion on materially misleading financial statements (FS).

The Three Phases of an Audit

The audit process consists of three primary steps:

1. Planning
2. Implementing
3. Reporting

Working Papers and Documentation

Working papers are the documents auditors prepare to support the audit of the financial statements.

Implementing the Audit Program

After gathering information, the auditor develops the Audit Program. This program outlines the detailed procedures the auditor will perform to test transactions and account balances to establish reasonable assurance that the financial statements fairly represent, in all material respects, the business's financial condition and operating results.

A lawyer reviewing working papers can expect to find documentation such as audit programs, confirmation letters, and management representation letters.

Sarbanes-Oxley Act (SOX) Record Retention Rules

The Sarbanes-Oxley Act (SOX) was enacted following the destruction of various documents by Arthur Andersen. SOX requires accountants to retain records relevant to audits and reviews of an issuer's financial statements.

SOX Section 103 Requirements

Section 103 requires the preparation and maintenance of work papers and other information related to any audit report for a period of not less than seven years. This documentation must be sufficient to support the conclusions reached in the report.

SOX Section 802 and Criminal Penalties

Section 802 establishes criminal penalties, including imprisonment for not more than 10 years, for failing to maintain all audit or review work for a period of five years from the end of the fiscal period in which the audit or review was concluded.

Note: 18 U.S.C. 1501, Rule 2-06, mandates a seven-year period for retaining such records.