An audit is an essential element to build trust between the management and the stakeholders of the company. But what is an audit? And what’s all the hype behind the importance of auditing?
What is Audit?
Simply put, an audit is where the financial position and performance of the company is evaluated by an independent third party (the auditor) to provide a realistic level of assurance that what is reported in the financial statements is true and fair.
This activity generally takes place annually after management has prepared accounts in line with prevalent standards and regulations.
The auditor comes in, gains an understanding of the company and the environment is which it operates and then begins to cross-check whether the accounts are free from material error or omission and not subject to any malpractices.
The purpose of an audit is simple. For the average stakeholder, an audit is when financial statements of a concern are subjected to an independent check. This is needed to satisfy the many stakeholders that large entities have like shareholders, lenders, suppliers, government regulators, etc. most of whom do not have unrestricted access to the books of accounts and daily workings of the company.
For specific companies, an annual audit is legally required by the regulatory authorities.
However, a lot of stakeholders consider it a burdensome expense with no real benefit. Consider the situations below for better clarity.
The stewards of the company (the management and the directors) may take bonuses when certain profit targets of the concern are met. The requisite profit is achieved and the bonuses earned.
However, the same company has approached a lending bank for another loan. On top of that, the industry situation has not been great either and other similar companies have not been able to earn such a stellar profit.
In such a situation how can the lender and the shareholders ensure the results have not been window-dressed to show a rosy picture? This is where a reputable auditor steps in, who is unbiased towards all parties and held to high ethical and regulatory standards to analyze the financials. They hear management’s side of the story including information that is sensitive (trade secrets) and may not be acceptable to be shared with the wider public, analyze and verify the facts in light of industry understanding and issue a report of their findings.
When owners of a company wish to pass on the business to another person; this other person needs some sort of confirmation that what they are buying is as it appears on paper.
They would logically put more trust in accounts that have been audited by an unbiased independent party rather than unaudited accounts that may not conform to industry standards and thus have to be restated at the last time.
In other words, the transaction would be quite easy if the company is already in the habit of getting audited accounts periodically rather then having to scramble when the need to transfer ownership arrives.
Importance of Audit
Keeping in view the purpose and the goals of an audit activity, we can now deliberate the possible advantages that lend importance to auditing.
The distinction between the stewards of a business and the shareholders and other stakeholders means that not everyone has access to the same amount of information. The latter have to rely on the former for a fair and balanced picture of the affairs of the company.
An audit heralds more trust between these two groups because a professional third party, unrelated to either provides their opinion on the representations made by the caretakers of the company. Auditors are bound by their professional bodies to maintain ethical standards that do not compromise their judgement so their opinion remains unbiased and dependable by all.
Complying with Laws
As already mentioned, certain entities have an obligation imposed by regulators to carry out an auditing activity yearly. However, all businesses have to adhere to the law in regards to preparation of accounts in matters such as following certain international (IFRS and GAAP) and local frameworks and regulations.
These regulations maybe subject to changes from time to time and a professional auditor is required to stay ahead of all these and carry out their audit in light of the most recent and applicable amendments. So, even if your accountant misses out on any requirement, an auditor will help by pointing out the shortcoming and keeping you legally compliant.
An organization that opens itself up to regular appraisals by a third-party is viewed as open and more responsible. People are more inclined to engage in business that is transparent and reliable then one that indulges in secrecy and media censure.
Importance of auditing is not always demonstratable but it does have intangible benefits which promote better business and business relations in the financial ecosystem that profit all the players
Confidence in Systems and Processes
Those outside the company are not the only beneficiaries of the audit process. Management will have in place internal controls and systems to ensure the smooth flow of operations without mistakes and opportunities for deception by outsiders and employees.
It is within the scope of an audit to understand the process in place in context of not only the company but the industry as a whole and assess their effectiveness. This relates to financial and non-financial areas of an entity. So, once management has received a clean bill of health from the auditors about their internal controls, they can rest easy relying on the strength of a good system.
Benefitting from Auditor Expertise
As professionals governed by strict regulations and with a wealth of experience from dealing with many organizations, auditors have a unique value proposition over regular accountants. They bring with them a fresh perspective and knowledge about global best practices.
When management works with auditors to bring about positive change, it might have some monetary and time expense in the short run, but in the long run it works wonders for the organization by bringing them in line with international standards.
The importance of auditing is not just in its ability to catch fraud or errors in financial matters, but as we have considered, there are manifold advantages to all stakeholders which auditing professionals can bring to the table.