Why are Audit & Assurance Services in Demand?
What are Audit & Assurance Services and Who needs them?
Different Assurance Services
Financial Statement Audits
Financial statement audits are done to provide users of the financial statement with an opinion on whether the company’s financials are presented fairly in accordance with a suitable financial reporting framework, which augments the level of confidence that the intended users can assign to the financial statements. Public companies are required to have an annual financial statement audit by law while private companies are usually not required to have annual financial statement audits in most countries.
However, there are cases where other parties with interest in private companies request for audited financial statements from private companies. For example, a lender would request for audited financial statements in the event of lending money to a private company. Likewise, other trade contacts like customers could request for audited financial statements from suppliers to be assured that the suppliers would be able to provide goods for as long as they need it. Audited financial statements provide that level of confidence to make informed decisions about who to lend money to or who to contract as a supplier.
Internal Controls over Financial Reporting (ICFR)
The primary objective of ICFR is to express an opinion on the effectiveness of the company’s system of internal controls over financial reporting. Financial reporting being the recording, analysis, and summary of financial data. Doing an ICFR provides an appropriate level of assurance regarding how reliable the financial reporting and the preparation of the financial statements have been for external users. Additionally, to improve efficiency, financial statement audits and ICFR are performed at the same time. This is referred to as an integrated audit. The objectives of the audits are not identical, however, and the auditor must plan and perform the work to achieve the objectives of each audit.
Limitations of an Audit
A financial statement audit is conducted to augment the credibility and reliability of the information included in the financial statements. It is not a guarantee that the financial statements are free from error or fraud. Audit limitations are caused by:
- The nature of audit procedures
- The nature of financial reporting,
- The need for the audit to be conducted within a reasonable period at a reasonable cost.
The Nature of Audit Procedures
This refers to the dependence on all documentation of evidence received from clients and its management. Consider a scenario where client management decides to conceal or withhold salient documents from auditors. There is a chance the auditors may not be aware of this and may end up with an unsuitable conclusion established on insufficient information.
Furthermore, there is a possibility that perpetrators of fraud could modify or conceal appropriate evidence. Auditors can have difficulty discovering that fraud has occurred as those committing the fraud usually conceal any the evidence of the crime or at least do their best to. Besides this, sampling techniques are used to test some transactions and account balances. The sampling is not representative of all items available for testing and thus may lead to auditors arriving at incorrect conclusions.
Data Analytics in Audit could potentially solve undetected fraud by allowing auditors to test the entire population of transactions and account balances rather than sampling them. Anomalies and unexpected patterns in client-provided transaction data will be identified even faster.
Additionally, the nature of audit procedures also refers to the concept of materiality. The International Accounting Standards Board (IASB) defines materiality as follows: “information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general-purpose financial statements make on the basis of those financial statements, which provide financial information about a specific reporting entity.” Therefore, in planning an audit, the auditors choose audit procedures that are designed to discover material misstatements.
The Nature of Financial Reporting
The use of judgement in the preparation of financial statements due to the subjectivity required for arriving at accounting estimates is referred to as the nature of financial reporting. Judgment is also required when selecting and applying accounting methods. For example, depreciating a piece of equipment is an estimate that requires judgment in selecting a depreciation method and determining a useful life and salvage value.
The need for the audit to be conducted within a reasonable period at a reasonable cost.
Auditors face pressure to complete their audit within a specific time frame and at a reasonable cost. Although auditors must not omit procedures to meet time and cost constraints, they might face some pressure to do so. Clients may want to issue their financial statements by a particular date and even in the audit firm where there are pressures to complete the audit on time to avoid incurring irrecoverable costs.
Planning the audit properly can ensure that sufficient time is spent where the risks of a material error or fraud are greatest.
Compliance Audits
A compliance audit is essentially a process of gathering the necessary evidence to ascertain that the person or entity under review has abided by the policies, rules, procedures, regulations, and law they are expected to conform to. One of the best examples of a compliance audit is an income tax audit. Revenue Authorities such as the IRS, CRA and HMRC may conduct an audit of an individual or a company to determine if tax laws have been followed and the correct amount of tax paid.
Operational (Performance) Audits
Operational audits are concerned with the evaluation of a company’s day-to-day activities by the three E’s:
- Economy: This refers to acquiring the right inputs at the lowest cost.
- Efficiency: Deriving maximum benefits from the inputs acquired.
- Effectiveness: Getting expected results from the inputs.
It is necessary to perform properly in all three measurements and not allow one to dominate the others.
Internal Audits
Internal audits are performed to evaluate various aspects of an organization’s activities. It is usually conducted by employees of the organization but may also be outsourced to an external accounting firm. Those charged with governance and management within the organization determine the internal audit function. Governance being a system by which an organization is directed and controlled.
The internal audit is done to evaluate a company’s internal controls that ensure the company’s integrity in financial reporting.
Who Needs Audited Financials and Why?
The following are likely to be interested in financials of companies because of the following reasons:
- Managers: Managers need current and expected company financial to be able to run the company and make efficient and effective decisions.
- Shareholders: Shareholders want to evaluate how well a company is performing, how profitable its operations are and if they can withdraw from the business.
- Trade Contacts: These involve suppliers who want access to customer financials to assess their ability to pay for the products they supply. Additionally, customers would also want supplier financials to make sure the supplier is likely to remain in going concern (exist in the foreseeable future).
- Lenders: These include banks wanting to evaluate borrowers financials to make sure they would be able to pay off their debts.
- Tax Authorities: Tax authorities need to know the company’s financials to determine if the company is paying the tax required of them based on their earnings.
- Employees of companies: Employees need to know the financials of a company to ensure they will be getting paid for their work done.
- Financial Analysts: Financial Analysts need access to company financials to advise investors on whether to invest or not invest in a particular company.
- Government: They need access to company financials to provide a basis for national statistics.
