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An audit is an examination of the financial statements that are periodically issued by a company. It’s especially important for investors, who should use the information to study the company’s financial history and its prospects. Read on to find out more about audits and why they’re crucial to learning about potential investment.
At its heart, an audit is a financial investigation. Companies periodically release audits that contain material information about their financial history and future prospects. Audits generally are performed by independent experts who can verify that the information they contain is accurate.
Audits generally are required by the Securities and Exchange Commission (SEC) for publicly traded companies. Although they vary slightly, all audits generally contain information about a company’s income statement, cash flow statement, and balance sheet.
Independent auditors generally provide an opinion on the accuracy of the financial statements contained in the company’s audit. This is crucial for investors, who rely on verifiable information before making a decision to invest in the company.
Although external financial audits are among the most commonly scrutinized documents for investors, you should be aware that there are different types of audits. Not all audits are public, but wise investors considering the prospects of a company should gather as many as available. Here are some of the most common types of audits:
For an example of the importance of audits, look no further than the spectacular 2001 collapse of Enron, a major player in the electricity, natural gas, and communications markets that claimed revenues topping $100 billion in 2000. The Houston-based company was described by Fortune as one of the nation’s most innovative companies for six consecutive years.
Enron’s true innovation, however, lay in the area of accounting fraud. The company used special-purpose vehicles and offshore accounts to hide liabilities and keep a strong credit rating. Meanwhile, it inflated or invented assets and profits.
When the magnitude of the company’s corruption surfaced in 2001, Enron filed for bankruptcy. The company’s auditor, Arthur Anderson & Company -- one of the former Big Five of accounting firms -- was found guilty of obstruction of justice for destroying important audit records and lost its ability to audit publicly traded companies, effectively dissolving it.
The fallout wasn’t just limited to Enron and Arthur Anderson. Estimated losses hit $74 billion, making it the largest U.S. bankruptcy at the time. The scandal resulted in the 2002 passage of the Sarbanes-Oxley Act, major legislation that set tighter auditing and disclosure standards for publicly traded companies.
