What is an Audit?

An audit is an independent, systematic examination of a company’s financial statements and underlying records to form an opinion on whether the accounts give a true and fair view of the company’s financial position and performance. In the UK, the statutory audit framework is governed by the Companies Act 2006 and overseen by the Financial Reporting Council (FRC).

Section 1: The Purpose of an Audit

1.1 Building Trust

The primary purpose of an audit is to provide independent assurance to shareholders, lenders, regulators and other stakeholders that the financial statements are reliable. Without this assurance, users of the accounts would have to take the directors’ word at face value.

1.2 Public Interest

Audits serve a broader public interest function. They promote confidence in financial markets, help detect fraud and error, and encourage sound financial reporting practices. This is why certain companies are legally required to have an audit.

1.3 What an Audit Is Not

An audit does not:

• Guarantee the financial statements are free from all errors
• Provide assurance on the future viability of the business (though going concern is assessed)
• Detect every instance of fraud
• Express an opinion on the efficiency of management

The auditor provides reasonable assurance, which is a high but not absolute level of assurance.

Section 2: Who Needs an Audit in the UK?

2.1 Statutory Audit Requirement

Under the Companies Act 2006, all UK companies must have their accounts audited unless they qualify for an exemption.

2.2 Small Company Exemption

A company is exempt from audit if it qualifies as small, meeting at least two of the following thresholds for financial years beginning on or after 6 April 2025:

Even if a company qualifies as small, an audit is still required if:

• The company is part of a group that is not small
• The company is a public company (plc)
• The company is a regulated entity (e.g., financial services)
• 10% or more of shareholders (by number or voting rights) request an audit

2.3 Dormant Company Exemption

A dormant company (one that has had no significant accounting transactions during the year) is exempt from audit regardless of size.

2.4 Voluntary Audit

Any company may choose to have a voluntary audit, even if exempt. Reasons include:

• Lender or investor requirements
• Franchise or contractual obligations
• Enhancing credibility with customers and suppliers
• Internal governance and control

Section 3: The Audit Process

The audit process typically follows four main phases:

3.1 Phase 1: Planning and Risk Assessment

The auditor begins by understanding the business, its industry and its risk environment:

• Review the company’s activities, governance and internal controls
• Assess the risk of material misstatement in the financial statements
• Set materiality thresholds for the audit
• Design audit procedures that respond to identified risks
• Discuss with management any areas of significant judgement

Key areas of focus often include revenue recognition, management estimates and related party transactions.

3.2 Phase 2: Testing Internal Controls

The auditor evaluates the company’s internal control environment to determine how much reliance can be placed on it:

• Review the design of key controls (e.g., authorisation procedures, segregation of duties)
• Test whether controls have operated effectively throughout the period
• Assess IT controls over accounting systems
• Identify any control weaknesses

If controls are strong, the auditor may reduce the extent of detailed testing. If controls are weak, more substantive procedures are needed.

3.3 Phase 3: Substantive Testing

This is the detailed testing of transactions and balances:

• Tests of detail: Examining individual transactions, invoices and supporting documents
• Analytical procedures: Comparing figures to expectations, prior periods and industry benchmarks
• Bank confirmations: Obtaining independent confirmation of bank balances
• Receivables confirmations: Writing to customers to verify amounts owed
• Inventory observation: Attending physical stock counts
• Cut-off testing: Verifying that transactions are recorded in the correct period
• Review of the trial balance: Investigating unusual or unexpected balances

The auditor pays particular attention to:

• Depreciation and amortisation calculations and useful life estimates
• Accruals and provisions
• Going concern assessment
• Related party transactions and disclosures

3.4 Phase 4: Reporting

After completing the testing, the auditor:

• Evaluates all findings and accumulated misstatements
• Discusses adjustments with management
• Forms an opinion on the financial statements
• Issues the auditor’s report

Section 4: The Auditor’s Report

4.1 Components

The auditor’s report includes:

• Opinion paragraph: States whether the accounts give a true and fair view
• Basis for opinion: Explains the standards followed and scope of the audit
• Going concern: Whether a material uncertainty exists (see going concern)
• Key audit matters: The most significant issues addressed during the audit (for listed companies)
• Responsibilities of directors and auditor
• Report on other legal and regulatory requirements

4.2 Types of Audit Opinion

Most UK audits result in an unqualified opinion. Any other opinion is a serious matter that can affect the company’s reputation, banking relationships and share price.

4.3 Emphasis of Matter

An auditor may include an emphasis of matter paragraph to draw attention to a matter already disclosed in the accounts, such as a material uncertainty related to going concern. This does not modify the opinion but alerts users to an important issue.

Section 5: UK Regulatory Framework

5.1 International Standards on Auditing (UK)

UK audits are conducted in accordance with International Standards on Auditing (UK), also known as ISAs (UK). These are issued by the FRC and are based on international auditing standards with UK-specific additions.

Key standards include:

5.2 The Financial Reporting Council

The FRC oversees audit quality in the UK through:

• Setting auditing and ethical standards
• Inspecting major audit firms through the Audit Quality Review programme
• Investigating and disciplining auditors who fail to meet standards
• Monitoring compliance with the UK Corporate Governance Code

5.3 Auditor Independence

Independence is fundamental to audit quality. UK rules require:

• Auditors must not have a financial interest in the client
• Mandatory audit firm rotation for public interest entities (every 20 years, with retendering every 10 years)
• Restrictions on providing non-audit services to audit clients
• Annual independence declarations from all audit team members

Section 6: Audit and UK Accounting Standards

The auditor tests compliance with the applicable accounting framework, which for most UK companies is FRS 102 (see UK accounting standards). Specific areas scrutinised include:

• Correct application of revenue recognition policies
• Appropriate depreciation methods and useful life estimates
• Accurate amortisation of intangible assets
• Proper presentation of the cash flow statement
• Adequate disclosure in the notes to the accounts

Section 7: Cost of an Audit

Audit fees vary widely depending on the company’s size, complexity and industry. Typical ranges for UK companies:

The fee reflects the time required for planning, testing and reporting, as well as the risk profile of the engagement.

Section 8: Preparing for an Audit

8.1 What Directors Should Do

To ensure a smooth and efficient audit:

• Prepare complete financial statements and supporting schedules
• Ensure the trial balance is finalised and reconciled
• Perform bank reconciliations and resolve outstanding items
• Complete all period-end adjustments (accruals, prepayments, depreciation)
• Prepare a fixed asset register and an intangible asset register
• Document the going concern assessment with supporting forecasts
• Identify and disclose related party transactions

8.2 Common Causes of Audit Delays

• Incomplete or inaccurate accounting records
• Missing invoices and supporting documentation
• Unreconciled bank accounts or control accounts
• Late identification of year-end adjustments
• Insufficient going concern documentation
• Unresolved prior-year audit recommendations

Addressing these issues proactively reduces audit time and cost, and demonstrates strong financial governance to stakeholders.

Understanding the audit process is essential for directors, finance teams and advisors involved in UK financial reporting. A well-managed audit supports confidence in the company’s accounts and strengthens relationships with lenders, investors and regulators.