Audit adjustment is the adjustment proposed by independent external auditors to correct the misstatements on financial statements before they sign off the audit report. In this case, the adjustments proposed by auditors indicate the gap between the financial statements prepared by the client and the applicable accounting standards, such as US GAAP, IFRS, or Local GAAP.
Auditors need to form the basis of opinion on the financial statements based on the evidence they obtained. As a result, if financial statements contain material misstatements and proposed adjustments based on those misstatements are rejected by the client’s management, auditors are unlikely to give a clean audit opinion on financial statements. In this case, auditors may issue a modified audit opinion based on the severity of misstatements.
A misstatement occurs when something has not been treated correctly in the financial statements, in accordance with the applicable accounting standards. Auditors usually accumulate misstatements they identify during the audit work.
Auditors should communicate on a timely basis with the client’s management and request them to correct misstatements that they have found, especially those that are material.
Timely communication of audit adjustment to the client’s management is very important as the management may refuse some or all of the adjustments proposed by auditors. This may be due to the negative effect on management’s bonus payment or breaching of loan covenant if the audit adjustments are made to the company’s accounts.
In this case, auditors need to understand the management’s reasons of not correcting misstatements and evaluate whether the financial statements a whole are free from material misstatement and still present fairly.
If the company has the audit committee, auditors will communicate to them those audit adjustments to correct misstatements that they identified during their audit works. In this case, the three parties, including auditors, management and audit committee, may need to discuss and come to an agreement on which proposed adjustments they must make in order for the financial statements to present fairly, in accordance with applicable accounting standards.