Question

Think about this: assets equal liabilities plus equity. This is the balance sheet and if it balances, and you’ve audited it, then the income statement must be reasonably stated. Right? What’s the point in auditing the income statement if you’ve audited everything else on the balance sheet – and it all balances. In fact, you’ve probably noticed that the focus of all the audit work we’ve studied has been on the balance sheet. Please consider and discuss the reasons why we perform audit procedures on the income statement. Please write an articulate, thoughtful response to the question above. This response should be 200-250 words in length

Answer 1

To answer the question asked, let me start with the definition of a financial statement audit. "A financial statement audit is the examination of the financial statement of a company, audited by internal and/or any external independent auditor, who is responsible for the accuracy and fairness of the financail statements."

This definition clearly explains your query, why is it necessary to audit income statement, if the balance sheet is already following the accounting equation and is in tally. Audit is carried out not only to ensure that the financial statements are prepared fairly and accurately. Even if the Balance Sheet's both sides tally, it doesnt mean that the books are fair and in compliance with the accounting standards of the country. One of the strongest reasons why Financial Statement Audit is mandated by the government, is to make sure the management reports correct and true picture of the financial health of the organisation to the shareholders and other stakeholders. There are many reasons why the management may try to manipulate the financial statements, even if the Balance Sheet's Accountng equation tally, still it would be an inaccurate statement of Financial Health of the Company. All the expenses and income heads under income statement should be supported by relevant documents. Also there are ways when the books of accounts could be manipulated by showing fictitious expenses, like wages, payment of raw materials cost, etc for the transactions, which never occured. And similarly, fake income could be shown as revenues from the sale of goods, or other incomes, which actually never happened. Also the depreciation charging methods could be wrongly charged intentionally to inflate profit or reduce profit reporting in the financial statements, so is the case with inventory valuations.

Enron is an exampe, where the management was able to report all fake expenses and fake income to the stakeholders, where the Investors got fooled by the wrongly crafted financial statements, and thought company is making good profit, when actually company was into deep trouble.

Hence Financial Audit is required both at internal level and also to be externally audited by an independent auditor, so as to make sure that the books of accounts is accurate, and in compliance with the financial standards. All the red-flags have to be reported by the Auditor in the Audit Report, and his Opinion on the financial statements is also very important.