Brendan and I have been going to the gym 2-3 times a week and lifting weights. He is starting to learn how to control free weights and he is enjoying charting his progress. The other day, while we were between sets, he asked me, “What do you do as an accountant?”
One of those exciting moments every parent of a pre-teen lives for!
So I explain to him that I am an auditor, which is not really an accountant but a scientist. He seemed puzzled but I pressed on.
“Do you remember learning about the scientific process?” I asked, he replied yes and then started to explain that you first set a hypothesis, test the hypothesis, and then draw a conclusion from your test.
I told him that is what makes an auditor a scientist. We follow the exact same pattern.
Whenever an auditor begins work, we start by creating a hypothesis. We changed it around a bit to state we test assertions but in reality we create the hypothesis about management’s assertions. Ok, that is a little wonkish so perhaps an example.
The books show that the company has $100,000 in a bank account. Management has made several assertions:
- That the $100K Exists
- That the Company has a Right to the money
- That the $100K is Complete and all transactions are recorded
- That it is actually Valued at $100K
- That it is actually Classified as a bank account
- And that management Cutoff all transactions on the right date
Six assertions on one little bank account but any one of them being an incorrect assertion possibly means that the $100K isn’t really. So, as an auditor/scientist, the first thing we do is form the hypothesis; and our hypothesis is always a negative. For instance, some of the hypotheses for this bank account could be
- There really isn’t a bank account with $100K in it (it doesn’t Exist)
- The bank account is in the name of another business (There is no Right to it).
- Management failed to get checks signed and mailed by year end (The transactions are not Complete)
- The account is in Peso’s in a Mexican bank (the Value is not $100K dollars but 100K Pesos)
- The account is an investment account (it is not Classified correctly)
- Management recorded deposits that were actually received later (they didn’t get a good Cutoff)
We create these hypothesis and then test them. For a bank account, we have a ready-made solution – the bank confirmation. We send out a letter to the bank and ask them to say they agree, or confirm, managements assertions. The bank writes back and says, “Yes, there is $100K in the bank, it is actually in US Dollars and it is a demand deposit business checking account in the Company’s name.
One confirmation and poof, four assertions are taken care of. Our hypotheses were disproven and we can safely say that, as far as those assertions go, management was correct. As a matter of fact, one of the best forms of evidence for an auditor is when a third party can provide evidence that a transaction exists. We can confirm a lot and prefer it whenever possible as it can help us with more than one assertion – other tests typically only go after one assertion at a time – which means we can spend hours trying to prove the remaining assertions.
Oh yes, by the way, I lost him at the six assertions – he is only 13 after all. And, to be honest, he is far more curious about the times we catch people making poor choices and how we deal with it.
I told him to read my blogs. No, he prefers Star War’s books. But someday he will. In the meantime, I hope you begin to have an appreciation of what steps we take as auditors to ensure that management is recording transactions to your books accurately.
An audit is designed to prove that the financial statements being presented are fair and accurate. Management makes those six assertions on every account and ever dollar reported. So, the next time you are meeting with your auditor, ask him about management assertions and how they design their hypothesis. If nothing else, it is a great way to find out if they pay attention to their checklists!
Have a great day. If you are looking for a firm to perform a review or audit of your financial statements, we would love the opportunity to be of service to you. Go to our website, look us over and then click the Get a Quote tab. We are a little wonkish but love to get the job done right and on budget.