What is an External Audit?
An external audit can be defined as an analysis or an investigation of a company’s financial state, which is performed by Audit teams that are unrelated to the company being audited. The process of auditing starts with analyzing the company’s accounting records which helps in determining the recording processes accuracy of information. One of the reasons why this investigation takes place is to check if a corporation’s accounting practices meet the standards set for accounting and to make sure that these practices are legal. The interpretation done by the auditor is compared with the company’s Financial Reports in order to determine the accuracy of the corporation’s reporting. This reflects on the position of the company’s overall finances.
Reasons Why External Auditing is Important
In a lot of cases, external auditing is seen as a required procedure that helps business owners in checking their company’s business administration. This is especially the case for large corporations where control and ownership are separate. Stakeholders/owners look for reassurance to make sure that the administration teams are playing their roles effectively and that the funds in the corporation are safe. In other cases, auditing is necessary because of government requirements on corporations of a certain level. The basic intention of external audits required by governments is to check for any illegal activities in a company.
Audit Firm – Responsibilities
External Audits can be conducted by a single auditor or an auditing team that specializes in external auditing. For audits that are implemented by the government, the specification of the accountant is stated in the law.
Standard Setting Entities and Global Professional Associations:
Auditors and accountants are certified by certain international organizations. The IRCA, International Register of Certified Auditors, offers certification and training of audit teams. The IAASB, International Auditing, and Assurance Standards Board sets standards for consistency and quality of audit processes on a global scale. Moreover, the Association of Certified Fraud Examiners, ACFE provides certifications to qualified individuals and sets standards for auditors. Associations like these and others reassure that the auditors selected are skilled and knowledgeable in International Financial Reporting Standards (IFRS) and Generally Accepted Auditing Standards (GAAS). In every auditing case, there are some general certifications needed for an audit team.
Values resulting from External Auditing:
The worth of external audits cannot be quantified easily. This is not weighed as a direct surge in profitability or as a Return on Investment. Audit committee associates, CFOs, and CEOs often define the benefits and value of audits in intangible terms like; security, confidence, and comfort. There is peace in knowing that the audited Statements are precise and embody the corporation’s real financial position. Moreover, it is comfortable to know that potential and the current investor can believe in the firm’s reports and Financial Statements. Also, a company that has gone through auditing makes its officers confident as well. The security aspect is conveyed as a form of reassurance that the company’s management is in excellent condition.
External audits also reduce the vulnerability of managers to lawful actions by government agencies or stockholders. Audits give transparency to companies that help customers in trusting them more. They see the corporation being completely honest in its actions, which promotes customer loyalty.
The insights that a company gains from an auditor can help companies better manage their internal affairs. The weaknesses highlighted by an auditor hold a lot of value. Unfortunately, the boundaries on actions that are not related to finances often confine the ability of the auditor to give this information to the company. In other words, the reports of the auditor can be refined to a fail or pass decision about a corporation’s financial reporting.
Scope of extra duties of Audit Companies:
Some Audit teams are going through a movement that calls for some changes in the regulations of narrowing auditors’ contributions. Such firms help in promoting the idea that accountants have extra information that is valuable for the business being audited. The statutory limitations should be relaxed in order to permit auditors to offer advice and analysis in the report while adding to the fail-pass decision revolving around the corporation’s financial reporting. Should this come to pass, the worth of an audit will be greatly increased.
Some countries make external auditing compulsory on the corporation of a certain size. This is done in order to reduce corruption within management. Some banks ask for Audited Financial Reports as well. This is required especially when a company needs credit approval, as the audited Financial Reports show the company’s reliability and transparency.
The basic point of an external audit is to build confidence in a corporation’s financial recording. This also provides some intangible advantages to business owners.
External Audit – Stakeholders:
Management and Owners:
Generally, stakeholders for audited Financial Statements are considered as any individual, government agencies, and organizations that have curiosity in the corporation and its management. Financial reports are considered as public documents that anyone can have access to. External audits take place for a narrower range of parties that are interested in the corporation’s operations. Large scale businesses owned by shareholders or privately owned have separations in management and ownership. It is essential that owners are aware of how their company is running. The audit boosts the confidence of owners in their company’s management techniques and they are reassured that the financial reporting they are seeing is real. Owners decide whether their company’s business managers are competent enough, which is why the auditing process of Financial Reports matters a lot to them.
Customers, Suppliers, Society, Employees, Banks and Government Authorities:
Other stakeholders are not directly troubled with a company’s Financial Statements condition but are interested in other operations of the company. Suppliers want to see whether products are affordable for customers. Customers, who buy expensive products like cars, need to be sure that the businesses they purchase from are able to deliver services in the upcoming times as well. In other words, customers are stakeholders of the business’s Financial Statement’s reliability. A corporation’s workers rely on the corporation to pay them their salary. They anticipate the company to do well, for an extensive period of time. Therefore, workers are investors in the business’s Financial Statements.
Many government agencies are concerned with the way businesses operate for taxation and legal reasons. They depend on Financial Reports of a corporation that show them how operations take place within the company. This makes the government an investor in the reliability and accuracy of Statements. Many companies depend on financial organizations like banks to give them long-term and short-term loans. Therefore, the consistency of Financial Reports is very significant in these matters, as it shows a company’s reliability to investors and banks.
Companies are considered as corporate citizens. As citizens, society expects certain behaviors from them. The transparency of a corporation is one method to improve your image and build trust.
Audited Financial Reports – Contents
After auditors are done with their job, they write an audit report. This report follows the specialized standard arrangement of every industry. It becomes easier to follow an already existing format and is easier for readers to understand as well.
This standard format includes Statement of Financial Position, Independent Auditors’ Report, Statement of Changes in Equity, Statement of Comprehensive Income, Statement of Cash Flows and Notes to the Financial Statements. Some readers only look at audit reports and have less attentiveness towards Financial Statements.
Independent Auditors Report
This type of report comes in the face of a letter that is written for the Board of Directors. The initial paragraph is an introduction. It talks about the Financial Statements that were under examination by the Auditors. There is also a declaration that the company’s management is accountable for the contents of the Financial Statements and not the auditors.
The 2nd paragraph is about the possibility of the audit. The basics of an audit, which are the accounting values, are specified. Moreover, the way auditors conducted the audit is thoroughly explained.
The 3rd paragraph holds the most significant information. This paragraph either discusses the opinions of the Auditors about the accuracy of the Financial Statements or discusses the motives for a competent opinion. The unqualified opinion gives assurance about the information within the Financial Statements. It is trustworthy enough to give accurate assessment of the financial status of the company. A qualified opinion interprets that there are issues in the Statements that have hindered in delivering an accurate calculation. If the auditor’s view is qualified, then the issues are discussed in a section after the usual opinion. This passage is the 1st thing that companies look for in the audit report.
The descriptive paragraph is typically the 4th one, which is included in the letter if the auditor needs to clarify some parts of the audit. This part is not considered as an explanation of the issue. It is just an explanation of the changes within the process of auditing. This paragraph is used as a means of highlighting changes in the auditing values.
The 5th paragraph, the control paragraph, expresses the opinion of an auditor about the corporation’s internal control. It can represent an unqualified judgment about the internal controls over the Financial Statements. This unqualified opinion is an important reason why readers rely on Financial Statements. If a qualified opinion is given, the reasons are discussed. Then, the corporation is supposed to improve its internal controls.
Components of Financial Statements as per International Standards
Other than the independent auditors report, auditors add Statement of Comprehensive Income, Statement of Financial Position, Statement of Changes in Equity, Statement of Cash Flows and Notes to the Financial Statements as part of the full Financial Statements. This comes under the rules of the International Financial Reporting Standards. Every statement represents the accounting data that is exposed to the auditors. Well-informed readers can understand a lot from these reports.
In the last section of Financial Statements, auditors write descriptions about the organization and its processes. This includes a breakup and overview of liabilities, assets, revenue, equity, expenses, and any other information.
Types of Audit Opinions:
When a report includes a qualified opinion, it means that the auditor faced problems such as missing documents. If an auditor fails to find signs for the verification of Financial Statements, they submit a qualified opinion. The report will include an explanatory paragraph that discusses the problems faced during the audit. This type of judgment does not imply that the Financial Statements are inaccurate. It just means that the information provided was not enough to meet the requirements of the auditors.
In this situation, the auditor will change the reporting strategy to rectify problems and errors.
This opinion is added when the audit did not face any problems in materials provided by the company. This suggests that the Financial Statements were completely accurate.
Another type of opinion is the adverse opinion. This specifies that the corporation’s financial accounts do not meet the criteria of International Financial Reporting Standards (IFRS). Moreover, it shows that the company’s records have been distorted.
Disclaimer of Opinion:
There are cases in which an auditor fails to complete the report in an accurate manner. This can happen due to different reasons, like missing financial documents substantially.
Why trust the work of Auditing Firms?
External Auditors are mandatory for auditing companies so that there is no connection between them and the corporation that is being audited. This avoids the chances of corruption. There are strict rules that auditors cannot have a stake in any result of the audit. They cannot have any investments in that company either. Certain international and national organizations give certification to auditing firms and individual auditors. These institutes follow set standards and give training to auditors as well. Some organizations also keep an eye on all auditing firms, even after they are certified. Due to these organizations, there is very little chance of problems arising. Certifications can be withdrawn if any suspicious activity takes place.
Reasons behind the requirement of Audited Financial Statements for a Company:
The role of a company’s management team is to reassure that the processes are being executed smoothly. Audited Financial Statements are the best way of showing this to shareholders and the owners. Since the management of a company is accountable for the Statements, there can be doubt about their accuracy. This is why it is best to get external auditors on the job.
Defense against lawsuits and litigations
External audits help in verifying that the corporation’s operations are legal and ethical. This helps companies in avoiding troublesome investigations and facing any problems with the government. In today’s society, people are fast to report a company if they feel any suspicious activity. Therefore, it is important to stay transparent.
Transparency in External Auditing:
External auditors cannot participate directly with the administration in order to make decisions nor can they accept any gifts from the company they are auditing. These rules enhance the transparency of an audit. A government must make sure that these rules are formed and implemented. Moreover, it is the duty of accountants to know about these rules and how to execute them.
While the auditing process develops, the auditors should keep reporting to the organization. The qualified standards of auditors include transparency in the whole process.
The best auditors include these services for their clients:
- Audit and Assurance: they can independently confirm the data you depend on for decision making with these services.
- Risky audits: they will thoroughly investigate the auditing process to make sure that any risks are handled effectively.
- Assurance services for regulators, lenders, shareholders, and banks: they can be assertive in the financial reporting of the company.
- Review and compliance services: they provide assistance in preparing for financial statements.
- Attestation services: they will examine the reports of your company and give detailed opinions on their validity.
- Management reports: they analyze the company’s performance and make detailed reports about it in order to guide you.
- Review on internal controls: they check your controls and give reviews accordingly.
- Assurance for lenders: their auditing services give confidence to lenders.
- Review of other processes: they will work on your audit team to make sure that proper procedures of auditing take place.
- Performance reporting: they can provide reports on a regular basis about the company’s performance.
- Assessing the Company’s Procedures and Policies: they examine how you form operations and what regulations you follow and accordingly, give you guidance and support.