What does an audit do?
If a business breaks the rules of accounting and ethics, it can be liable for legal sanctions against it. It can deliberately deceive its investors and lenders with false or misleading numbers in its financial report. That's where audits come in. Audits are one means of keeping misleading financial reporting to a minimum. CPA auditors are like highway patrol officers who enforce traffic laws and issue tickets to keep speeding to a minimum. An audit exam can uncover problems that the business was not aware of.
After completing an audit examination, the CPA prepares a short report stating that the business has prepared its financial statements, according to generally accepted accounting principles (GAAP), or where it has not. All businesses that are publicly traded are required to have annual audits by independent CPAs. Those companies whose stocks are listed on the New York Stock Exchange or Nasdaq must be audited by outside CPA firms. For a publicly traded company, the expense of conducting an annual audit is the cost of doing business; it's the price a company pays for going into public markets for its capital and for having its shares traded in the public venue.
Although federal law doesn't require audits for private businesses, banks and other lenders to private businesses may insist on audited financial statements. If the lenders don't require audited statements, a business's owners have to decide whether an audit is a good investment. Instead of an audit, which they can't really afford, many smaller businesses have an outside CPA come in on a regular basis to look over their accounting methods and give advice on their financial reporting. But unless a CPA has done an audit, he or she has to be very careful not to express an opinion of the external financial statements. Without a careful examination of the evidence supporting the amounts reported in the financial statements, the CPA is in no position to give an opinion on the financial statements prepared from the accounts of the business.
What's in an Audit Report?
Most audit reports on financial statements give the business a clean bill of health, or a clean opinion. At the other end of the spectrum, the auditor may state that the financial statements are misleading and should not be relied upon. This negative audit report is called an adverse opinion. That's the big stick that auditors carry. They have the power to give a company's financial statements an adverse opinion and no business wants that. The threat of an adverse opinion almost always motivates a business to give way to the auditor and change its accounting or disclosure in order to avoid getting the kiss of death of an adverse opinion. An adverse audit opinion says that the financial statements of the business are misleading. The SEC does not tolerate adverse opinions by auditors of public businesses; it would suspend trading in a company's stock share if the company received an adverse opinion from its CPA auditor.
One modification to an auditor's report is very serious - when the CPA firm says that it has substantial doubts about the capability of the business to continue as a going concern. A going concern is a business that has sufficient financial wherewithal and momentum to continue it normal operations into the foreseeable future and would be able to absorb a bad turn of events without having to default on its liabilities. A going concern does not face an imminent financial crisis or any pressing financial emergency. A business could be under some financial distress but overall still be judged a going concern. Unless there is evidence to the contrary, the CPA auditor assumes that the business is a going concern. If an auditor has serious concerns about whether the business is a going concern, these doubts are spelled out in the auditor's report.