With external audits, auditors examine a client's financial statements. These financial statements primarily include the balance sheet and the income statements. Usually, auditors employ an audit approach such as substantive procedures or a system-based approach for these audits. Sometimes, however, auditors may focus on the balance sheet only. In that case, they may utilize the balance sheet audit approach.
What is the Balance Sheet Audit Approach?
The balance sheet audit approach is a strategy that auditors use within audit engagements to focus on a client's balance sheet. This approach prioritizes balance sheet items, which primarily involve account balances. With the balance sheet audit approach, auditors usually perform little testing on other financial statements. However, they do not ignore the other statements completely.
The balance sheet audit approach primarily focuses on testing assertions related to account balances. These include occurrence, completeness, accuracy, classification, presentation, and cut-off. Therefore, auditors don't put a substantial amount of work toward testing transactions. This approach is particularly beneficial when the client's balance sheet includes significant balances.
How does the Balance Sheet Audit Approach work?
Like any other audit approach, auditors decide on using the balance sheet approach during audit planning. Usually, auditors investigate the client's balance sheet and the account balances on it. As mentioned, when the account balances on the balance sheet are significant, auditors may decide on using this approach.
However, auditors still use their professional judgement to determine if the account balances are substantial enough. Similarly, auditors also consider other financial statements and how they will contribute to users' decisions. If a client's income statement contains critical transactions, the balance sheet audit approach may not be practical.
Auditors must also consider the materiality set for the audit to check the balance sheet items. If most balances on the balance sheet are material, then the balance sheet approach will be effective. Once auditors consider these factors, they may decide on using this approach to focus on the client's balance sheet.
The balance sheet audit approach also works on the assumption that transactions also affect account balances. For example, it assumes that sale transactions also affect the account receivable balances on the balance sheet. Therefore, testing account receivable balances from the balance sheet can also help investigate sale transactions.
What are the advantages and disadvantages of the Balance Sheet Audit Approach?
The primary advantage of the balance sheet audit approach is that it reduces the amount of work that auditors perform. Instead of testing two or more separate financial statements, auditors only focus on a single financial statement. For capital-intensive clients, where the balance sheet includes substantial balances, this approach is usually the best.
However, the balance sheet audit approach also plays down the significance of other financial statements. By focusing on the balance sheet or account balances, auditors may miss material misstatements in transactions. Therefore, this approach may not be the best when the other financial statements also have substantial items.
Conclusion
The balance sheet audit approach is a strategy used by auditors that primarily focuses on testing account balances. It assumes that transactions also affect account balances. Therefore, by investigating those balances, auditors also test transactions. This approach works best when a client's balance sheet consists of large account balances while other statements aren't as critical.
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