Audit adjustment definition
/What is an Audit Adjustment?
An audit adjustment is a proposed correction to the general ledger that is made by a company's external auditors. The auditors may base the proposed correction on evidence found during their audit procedures, or they may want to reclassify amounts into different accounts. Such an adjustment should only be for a material amount; otherwise, the client could potentially be buried under an avalanche of minor adjustments that have no material impact on its financial statements.
An audit adjustment may not be accepted by the client, especially if the adjustments will negate bonus payments that would otherwise have been paid to management, or when the effect could cause the company to breach a loan covenant. If so, the auditor must decide whether the non-inclusion of the audit adjustment has a material impact on the accuracy of the client's financial statements, which could in turn impact whether the auditor is willing to give a clean audit opinion on those statements.
A different situation is that the auditor proposes several audit adjustments, which essentially offset each other. If so, the net impact on the financial statements may be immaterial, so the client may be justified in not recording the entire group of adjustments. However, the net effect of ignoring these changes could be the reporting of amounts in the wrong line items in the financial statements, which could be misleading to the users of those statements. In most cases, the client approves the proposed adjustments and records them as requested by the auditors, making it much easier for the auditor to justify a clean audit opinion.
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If a company has an audit committee, the auditors will typically discuss the more material adjustments with the committee. By hearing about them, committee members learn about potential control problems or other issues regarding the effectiveness of the accounting department in correctly recording transactions. This may lead to changes in the management of the accounting department.
A final issue for the auditors is to examine the beginning account balances at the start of the following year's audit to ensure that the client recorded all audit adjustments properly. If not, these adjustments must be made.
Example of an Audit Adjustment
Henry is the outside auditor for the Excalibur Shaving Company. He has reviewed the firm’s financial statements, and notes during his examination of the prepaid expenses account that the firm’s controller neglected to charge $15,000 of prepaid insurance to expense during the reporting period. To correct the situation, Henry proposes an audit adjustment that will charge $15,000 of prepaid expenses to the insurance expense account. By doing so, Excalibur’s financial statements will now more accurately show the firm’s expenses and assets, specifically its insurance expense and prepaid expenses line items.