If you were asked to list the most valuable outside services your company receives, would you include a financial audit? Audits are an effective service and provide worth to your company in numerous ways. Assuring credible financial reporting, detecting and preventing fraud, improving internal controls, and providing best practices advice are among the four major benefits.
Assuring Credible Financial Reporting
An audit’s primary function is to produce credible financial reporting that offers assurance that your company’s financials are in accordance with generally accepted accounting principals (GAAP) as established by the American Institute of Certified Public Accountants (AICPA). Basically, it ensures your organization’s financial reporting is a reasonable representation of its financial condition.
Some think GAAP adherence is merely an academic exercise with no real impact on operations, but that’s not true. Properly recognizing and reporting financial transactions allows you to better understand the information presented. Also, many company bankers are accustomed to reviewing GAAP-compliant financials. Knowing the financial reporting meets industry-accepted standards helps confirm the report’s credibility.
Detecting and Preventing Fraud
The AICPA added several new procedures to the audit process that have significantly increased the auditor’s responsibility to search for material and nonmaterial fraud, as well as identify potential opportunities for it. They include:
• Brainstorming. Each company’s operations and work environment are reviewed to help identify possible ways employees might steal from your company or misstate financial information. Although a checklist of likely threats is used, each company’s specific operations are evaluated and discussed. Then, mitigating controls already in place—that determine areas of concern—are considered. Prior to conducting the actual audit fieldwork, the results are used to adjust the audit procedures and focus on any threat areas identified.
• Interviewing employees at varying authority levels. To help determine if employees are aware of fraudulent activities or opportunities to perpetrate fraud, interviews take place with all employees at various authority levels. As with brainstorming, interview results are used to tailor the audit procedures.
• Using an unpredictable audit approach. Unpredictability can thwart employees who may be considering engaging in fraudulent behavior. This can include auditing transactions that have occurred throughout the year, rather than in specific periods, and varying sampling types and thresholds.
• Identifying employee abuse. Focus attention on common patterns of financial abuse, such as where employees may be spending company funds for personal gain.
The mere fact an audit is being performed, especially by an experienced industry auditor, can be a deterrent to fraud in itself.
Improving Internal Controls
Proper internal controls help assure financial transactions are reported correctly and employees operate in an honest, ethical fashion. Audit procedures contain an investigation of few aspects: segregation of duties, administrative control of expenses, and the proper recording of revenues and expenses. Control of revenue is especially important to auditors, since diversion of revenues (theft) is generally the most harmful manifestation of employee fraud. Any weaknesses identified during the audit are reported to your company’s management with recommendations on how to tighten controls.
Providing Best Practices Advice
Having an industry expert look at your company’s financial statements can be a huge benefit. The expert’s ability to spot anomalies in how certain transactions are handled—and funds controlled—and how those transactions are reported adds greatly to financial operations. An auditor’s key responsibility is to gain an understanding of the client’s operations and to comment and make recommendations—not limited to financial matters—for improvement.
Materiality and Industry Expertise
A major factor in determining the relative seriousness of financial risk or reporting errors is materiality. Materiality verifies how large an error must be to affect the overall credibility of the financial reporting—in the case of risk, how considerable the risk must be to threaten the company’s financial wellbeing.
Legislation and the resulting AICPA audit requirements have emphasized the importance of focusing on not only quantitatively material issues, but also qualitatively material issues.
Review Vs. Audit
A review employs “analytical review procedures” that focus on information your company provides that doesn’t validate if the underlying transactions represented by your organization’s financial statements are correct. Instead, it’s more of a “30,000-foot view” of your company’s financials, based upon provided data, to assure financial information is presented in accordance with AICPA standards. No source documents testing is performed.
An audit uses detailed, independent testing procedures to verify that the underlying material transactions are recognized and certifies the statements to that effect. However, for most companies, the “audit vs. review” question is arguable simply because most bank covenants require an annual audit performed by an independent professional. IBI