An audit adjustment is a correction to the financial statements proposed by the auditor during or after audit fieldwork. Adjustments arise when the auditor identifies errors, omissions or misstatements that need correcting before the accounts can be signed off. Some are straightforward (a missed invoice, a cut-off error), others involve significant accounting judgements.
This guide explains what audit adjustments are, why they happen, how the process works, and what directors should expect.
What is an audit adjustment?
An audit adjustment is a journal entry or correction proposed by the auditor to bring the financial statements into line with the applicable accounting framework (FRS 102, IFRS, or the Charities SORP). The adjustment corrects a material misstatement – an error or omission large enough to affect the decisions of someone reading the accounts.
Audit adjustments can affect the profit and loss account, the balance sheet, or both. They’re recorded in the audit working papers and discussed with the client’s finance team before being posted to the accounting records.
Common types of audit adjustments
Revenue and cost cut-off errors
The most frequent audit adjustment. Sales invoices or purchase invoices recorded in the wrong accounting period. If a December year-end company records January sales in December (or misses December costs), the auditor proposes an adjustment to move those transactions into the correct period. Cut-off testing is a standard part of every statutory audit.
Accruals and prepayments
Missing or incorrect accruals for expenses incurred but not yet invoiced (utilities, professional fees, bonuses). Prepayments not released correctly over the period they relate to (insurance, rent, software licences). These adjustments correct the matching of income and expenditure to the right financial year.
Bad debt and expected credit loss provisions
Where trade debtors include balances that are unlikely to be collected, the auditor may propose an increase to the bad debt provision. Under FRS 102 Section 11 and IFRS 9, companies must also consider expected credit losses on financial assets – a forward-looking assessment that often requires an adjustment at year end.
Stock and work-in-progress valuation
Stock counted at year end but valued incorrectly – using selling price rather than cost, failing to write down slow-moving or obsolete items, or applying overhead absorption rates that don’t reflect actual production costs. For construction and manufacturing companies, WIP valuation adjustments are particularly common.
Fixed asset depreciation and impairment
Assets depreciated over the wrong useful life, assets not written down after impairment indicators arise, or capital expenditure incorrectly treated as revenue expenditure (or vice versa). The auditor checks that the depreciation policy is consistent, reasonable, and correctly applied.
Deferred revenue
Particularly common for SaaS companies, subscription businesses and any company billing in advance. Revenue received but not yet earned must be deferred to the period it relates to. If the finance team hasn’t set up a deferred revenue schedule, the auditor will propose one.
Related party transactions
Transactions with directors, shareholders, group companies or connected parties that haven’t been properly disclosed or recorded at arm’s length. The adjustment might be to the accounting treatment, the disclosure note, or both.
Prior period adjustments
Corrections to errors that originated in a previous accounting period but were only discovered during the current audit. Prior period adjustments require restating the comparative figures in the financial statements – they can’t simply be corrected through the current year’s profit and loss.
How the audit adjustment process works
The process is collaborative, not adversarial. Here’s how it typically runs:
- The auditor identifies the issue. During fieldwork, the audit team finds a misstatement through substantive testing, analytical review, or control testing.
- The audit team quantifies the adjustment. They calculate the impact on the profit and loss, balance sheet, and any disclosure notes. Every proposed adjustment is documented in the audit working papers with a clear explanation of why it’s needed.
- Discussion with the finance team. The auditor discusses the proposed adjustment with the client’s finance director or financial controller. Sometimes the client agrees immediately. Sometimes there’s a professional disagreement about the accounting treatment, which gets escalated to the audit partner.
- The client posts the adjustment. If agreed, the finance team posts the correcting journal entry to the accounting system. The auditor then re-tests to confirm the adjustment has been made correctly.
- Unadjusted differences. If the client disagrees with a proposed adjustment and the amount is below materiality, the auditor may accept it as an “unadjusted difference” – a known error that isn’t corrected because it’s not material enough to affect the audit opinion. All unadjusted differences are reported to the directors in the management letter.
What are the 4 types of adjusting entries?
In accounting, the four main types of adjusting entries are:
- Accrued expenses – costs incurred but not yet recorded (e.g. audit fees, utility bills received after year end)
- Accrued revenues – income earned but not yet invoiced or recorded
- Deferred expenses (prepayments) – costs paid in advance that relate to future periods
- Deferred revenues – income received in advance for services not yet delivered
In the context of a statutory audit, the auditor tests all four categories to check that amounts are correctly calculated, consistently applied, and supported by appropriate evidence.
How to reduce audit adjustments
Audit adjustments aren’t a sign of failure – they’re a normal part of the audit process. But a high volume of adjustments does suggest that the finance team’s year-end procedures need tightening. Practical steps that reduce the number of audit adjustments:
- Complete monthly reconciliations. Bank, debtors, creditors, intercompany, VAT. If these are done properly every month, year-end errors are caught before the auditor arrives.
- Get cut-off right. Run a proper cut-off procedure at year end – match sales and purchase transactions to the correct period using delivery dates and invoice dates, not just when the entry hits the system.
- Prepare an accruals schedule. List every known cost that hasn’t been invoiced at year end. Include audit fees, legal fees, bonuses, commissions, utility estimates, and any other amounts you know are coming.
- Review deferred revenue. If you bill in advance, set up a deferred revenue schedule that releases income monthly. Don’t leave it for the auditor to calculate.
- Document accounting judgements. Stock provisions, bad debt provisions, useful economic lives for fixed assets – write down how you arrived at the figures and what evidence supports them. The auditor will ask.
Do audit adjustments affect the audit opinion?
If all material adjustments are agreed and posted, the auditor issues an unqualified (clean) opinion. The adjustments have done their job – the financial statements now give a true and fair view.
If the client refuses to post a material adjustment, the auditor may issue a qualified opinion – stating that the accounts are correct except for the specific matter that wasn’t adjusted. This is rare, because most directors prefer to make the correction rather than have a qualification on their audit report.
Unadjusted differences below materiality don’t affect the opinion, but they’re accumulated and reported. If the total of unadjusted differences approaches materiality, the auditor will insist that some or all are corrected.
Talk to us
If your company is preparing for an audit and you want to minimise the number of adjustments, preparation is everything. See our audit readiness guide for a practical checklist, or get in touch to discuss your specific situation.
