Why does a company choose to have an independent auditor report on its financial statements?

Amendments: Amending releases and related SEC approval orders

Summary Table of Contents

.01        The objective of the ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations, and its cash flows in conformity with generally accepted accounting principles. The auditor's report is the medium through which he expresses his opinion or, if circumstances require, disclaims an opinion. In either case, he states whether his audit has been made in accordance with the standards of the PCAOB. These standards require him to state whether, in his opinion, the financial statements are presented in conformity with generally accepted accounting principles and to identify those circumstances in which such principles have not been consistently observed in the preparation of the financial statements of the current period in relation to those of the preceding period.

Distinction Between Responsibilities of Auditor and Management

.02        The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.1 Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected.2 The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements are detected. 

.03        The financial statements are management's responsibility. The auditor's responsibility is to express an opinion on the financial statements. Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The entity's transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management. The auditor's knowledge of these matters and internal control is limited to that acquired through the audit. Thus, the fair presentation of financial statements in conformity with generally accepted accounting principles3 is an implicit and integral part of management's responsibility. The independent auditor may make suggestions about the form or content of the financial statements or draft them, in whole or in part, based on information from management during the performance of the audit. However, the auditor's responsibility for the financial statements he or she has audited is confined to the expression of his or her opinion on them. 

Professional Qualifications

.04        The professional qualifications required of the independent auditor are those of a person with the education and experience to practice as such. They do not include those of a person trained for or qualified to engage in another profession or occupation. For example, the independent auditor, in observing the taking of a physical inventory, does not purport to act as an appraiser, a valuer, or an expert in materials. Similarly, although the independent auditor is informed in a general manner about matters of commercial law, he does not purport to act in the capacity of a lawyer and may appropriately rely upon the advice of attorneys in all matters of law. 

.05        In the observance of the standards of the PCAOB, the independent auditor must exercise his judgment in determining which auditing procedures are necessary in the circumstances to afford a reasonable basis for his opinion. His judgment is required to be the informed judgment of a qualified professional person. 

Detection of Fraud

[.06-.09]        [Paragraphs deleted.]

Responsibility to the Profession

[.10]        [Paragraph deleted.]

.11 The auditor should be aware of and consider auditing interpretations applicable to his or her audit. If the auditor does not apply the auditing guidance included in an applicable auditing interpretation, the auditor should be prepared to explain how he or she complied with the provisions of the auditing standard addressed by such auditing guidance.

Note: The term "auditing interpretations," as used in this paragraph, refers to the publications entitled "Auditing Interpretation" issued by the American Institute of Certified Public Accountants' Auditing Standards Board as in existence on April 16, 2003, and in effect.

An audit is essential as it provides credibility to a set of financial statements and gives the shareholders confidence that the accounts are accurate and fair; it can also help to improve a company’s internal controls and systems. A financial statement audit examines an entity’s financial statements and conducting disclosures by an independent auditor. The consequence of this examination is a report by the auditor demonstrating the fairness of the financial statements and associated disclosures. The auditor’s report must convoy the financial statements when they are issued to the intended recipients.

The cause of the financial statement audit is to add credibility to a business’s reported financial position and performance. Audits have become increasingly common as the complications of the two primary accounting structures, Generally Accepted Accounting Principles and International Financial Reporting Standards, have enlarged and because there has been an ongoing series of disclosures of fraudulent reporting by significant companies.

Financial statement audits are a compliance exercise and a chance to gain knowledge to initiate positive business consequences. In many cases, though, companies are not taking full advantage of the intuition that audits provide, according to a recent survey report:

• More than three-fourths (79%) of executives and 91% of audit committee members say financial statements audits identify chances to enhance business performance.
• Almost half (46%) of executives and even more audit committee members (62%) say it’s at least rather likely that they would have forfeited essential insights if the audit had not occurred.
• Companies that regularly maximize the audit’s information are more likely to have attained growth over the past three to five years.

Through audits, companies may learn new information about their industry and market, locate limitations in processes and policies, and recognize inefficiencies and risks. In addition, expanded use of data analytics is helping auditors look at vast pools of data in a range of areas to find information that could be benefited to clients.

Enhancing audit committee effectiveness

Effectiveness often hinges on the chair’s point. The crucial characteristics of a strong audit committee chair are often personal attributes. They should be recognized for their leadership and vision and be perceived by other committee members and management to set and supervise the audit committee’s members and management to set and control its agenda. For enhancing audit committee effectiveness in business, the following are ways to improve audit committee effectiveness:

Increased clarity on how an audit committee has discharged its duties is crucial and enables a more illuminated assessment of its performance and effectiveness. As a result, many corporate governance codes and regulations include requirements around audit committee disclosure. In addition, voluntary disclosures continue to grow, emulate that audit committees respond to evolving expectations of investors and other stakeholders.

The importance of fruitful communication flows to and from the audit committee cannot be overstated. It comprises written and formal and informal, presenting with management, internal and external audit, the CFO and finance function, and the board. The audit committee is also required to transmit with the board how it has discharged its responsibilities. It is not requisite for the board to simply ‘rubber stamp’ reports from the audit committee; there needs to be complete discussion and deliberation on key aspects of the audit committee’s work and any important issues they have identified that warrant the full board’s attention.

• Committee composition- including appropriate skills, competencies and expertise

Ensuring the correct composition of the audit committee is vital but can be demanding. Requirements vary across jurisdictions, but usually, there must be at least one financially literate member. It can put a significant burden on one individual if they are the only person on the audit committee to have reporting and accounting expertise. While the audit committee can depend on outside expertise, an effort must be made to provide continuing professional training to understand emerging issues and develop an awareness of best practices.

• Strength of finance function

The finance function is responsible for producing dependable and auditable information for external disclosure. Therefore, the strength of the finance function is critical in supporting the oversight role of the audit committee, which can be severely hesitated by a weak finance function that lacks capacity, expertise, or effective CFO leadership. Therefore, considerations for the audit committee include whether the finance function is appropriately staffed and resourced, has suitably qualified people in a critical position, and whether it has support for its continued development.

Today it is straightforward to choose the best audit firms in India. Financial statement audits are helping companies improve their performance; according to a survey, around three-quarters of the top executives and 91 per cent of the audit committee members said audits of financial statements recognize opportunities to improve business performance. The auditor should review and access the conclusions drawn from the evidence obtained through the implementation of procedures.

Leave a comment about what are your opinions on the effectiveness of financial statement audit over the business.