An audit is a process where independent accounting professionals perform verification of all material information in the financial statements through assessing financial and non-financial data. This process will end with the accounting professionals issuing an opinion on whether the information is true and fair. The opinion of auditors is expressed in the form of an audit report.
It is important to note that not all accounting professionals have the certification to issue an audit opinion. They usually have to be licensed or approved company auditors registered under specific regulatory bodies of the countries they are issuing the audit opinion in.
Why do businesses need audits?
There are various reasons that businesses engage auditors to check their financial statements, here are 7 main purposes of auditing that you should know about:
1) Compliance with statutory requirements
One of the main purposes an entity engages an auditor is to comply with legal and statutory requirements set by the Government. Without such compliance, the entity may lose its license to carry out its operations in the country.
Some countries require all businesses that operate as companies to be audited. At the same time, some allow those companies with certain financial statement line items below a specific threshold to be exempted from audit. However, this exemption does not apply to listed companies.
2) Application for external financing
Many entities obtain external financing in either equity or debt or a mixture of both to finance their business expansions. On many occasions, especially when the entities are looking for debt financing, the financier or an investor requests for the audited financial statements to ensure:
- The financial health of the entities that they are financing or investing in.
- That the entities would be able to repay their debts (specifically for financiers)
- That the entities would succeed in their business expansion and potentially bring capital growth (specifically for investors)
A set of audited financial statements would be more credible and reliable than those prepared and reviewed internally by the management. This is because auditors are third parties independent of the entities and have to abide by the professional code and ethics standards when performing an audit.
The auditors would review the accounts objectively to ensure they comply with the applicable accounting standards and lower the fraud or management manipulation risk. This helps the entities to build trust with their potential financiers and investors.
3) Internal check
The production of misleading financial statements can occur from misrepresentation of information, be it intentional or unintentional. As a result, audit processes are designed as an important element of transparent and comprehensive corporate governance to address the problem of understatement or overstatement in financial statements and avoid fraud and misrepresentation. (Although. It’s not the primary responsibility of auditors to detect fraud)
By right, every entity keeps financial records of all transactions that it is involved in. However, with the entity’s transactions and business becoming more complex, these transactions may become so voluminous that maintaining a paper record or audit trail becomes difficult. Due to a lack of knowledge, the financial statement prepared by the entity may not be fairly stated.
As a result, an audit is carried out to provide an audit trail of all financial transactions. It ascertains that every single number reported on the entity’s revenues and expenses is correct and that no material is omitted or left out.
What the auditors will do is that they would carefully examine the evidence supplied by the management, including invoices, records, vouchers, and relevant physical documents, to ensure that such evidence corresponds to the figures in the book of accounts or financial statements.
The auditing process also includes the verification and examination of non-financial data and information performance and operations. In addition, the preliminary auditing procedure aims to determine how the cash is used and distributed by the entity.
To summarise, the auditors would collect, gather samples, and evaluate all of the evidence before issuing an opinion on the financial statements. Aside from issuing an objective and independent opinion, the audit process also identifies operational inefficiencies in daily operations. A competent auditor would next provide appropriate recommendations on how to boost productivity and efficiency in the company.
Once all are reviewed, and the auditors are happy with the evidence gathered, they would then provide an independent report to the entity’s senior management. This report would then be used as a basis for management’s decision-making.
4) Competitiveness in a dynamic environment
When operating in an ever-changing and dynamic sector, auditing also helps to make sure that the entity maintains its competitiveness among its competitors.
5) Review of financial statements
The process of the audit also determines the quality of the financial statements. The auditor will highlight to the management whether the financial statements are up to par with the applicable accounting standards and whether any adjustments or improvements are required.
During the process, the auditors would also assess the experience of the management and determine if they are competent for their job. Any issues will be highlighted to those charged with governance for further discussion.
6) Tax filing
By performing an audit, the entity will have all the financial records and supporting documents it needs well kept, making it easier when it comes to filing tax returns.
7) Develop business efficiency and internal stakeholders’ trust
Having the internal controls and management’s expertise evaluated by auditors will help improve operational effectiveness. The entity can take the expert’s advice and improve on those areas that they lack, allowing the entity to make fewer mistakes that may impact business operation.
The purpose of auditing the financial statements is also to increase internal stakeholders’ trust, such as employees. The audited financial accounts should be made available to the entity’s employees. They may want to know how the entity is performing financially and how it affects their position within the entity.
Shareholders can also use it to calculate the return on equity that the entity has. The auditing process provides complete transparency in how the entity operates and keeps financial records.
However, there are certain limitations of the auditor. First of all, the design of the audit procedures is based on the concepts of materiality and sampling. It means the auditor may not be able to perform extensive testing. It may be due to time limitations or inadequacy of audit planning.