Meaning

Auditing means evaluating the effectiveness of the company’s internal controls and to assess the transparency of the entity to its stakeholders. To achieve the company’s business objectives, the management must maintain an effective system of internal controls.

This helps in obtaining reliable financial reporting on its operations, preventing fraud and misappropriation of its assets, and minimizing its cost of capital.

The internal and external auditors have different objectives and work in tandem to achieve the objectives of the business. Auditing is a tool in the private or public sector undertaking to safeguard against fraud, extravagance, etc. Audit brings more credibility to the business being audited.

“Evaluation or examination of systems, operations, and activities of a specific entity, to ascertain they are executed or they function within the framework of certain budget, objectives, rules, and requirements.”

– International Organization of Supreme Audit Institutions

This is a modern definition of audit which also includes the scope of cash audit. This was not the case in the past, however. The audit is necessary for the sound and effective functioning of the government. It also safeguards public funds being used.

Importance of auditing

Audit scope is depicted to verify financial statements, accounts and balances as per governing accounting standards. It is also helpful in cash verification and other assets.

The audit is in fact intended to verify all transactions and make sure all processes are in full accordance with the law of land and do not cause harm or influence organization in any way. The importance of auditing can be described in the following points.

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Credibility of financial statements

The regulatory body has made auditor only qualified person to carry out assignment of audit and report on true and fair view of client entity’s financial statements so that users’ financial statements could rely on financial statements.

There are various stakeholders to company’s financial statements. They may not have sufficient knowledge of financial shenanigans. They rely on the auditor’s independence and objectivity to ensure that audit opinion has been expressed to reflect the books of account.

The auditor’s opinion creates the relationship of trust between the auditor and the stakeholders which leads to the credibility of financial statements.

The opinion shall be credible and for this to happen, the independence and objectivity aspects of audit plan plays huge role. Hence, requirements are there for auditor to be independent of influences that could cloud the professional judgement of auditor.

Fraud Prevention and Detection

Internal audit plays a critical role for companies in fraud prevention. Recurring analysis of the company’s operations and maintaining internal controls is able to prevent and detect various fraud based activities at the initiation point.

Audit professionals help in the design of an internal control system to prevent fraud. The important part of prevention is deterrence.

If the auditor has helped the company to have an effective audit system in place, the reputation of such a system can alone prevent employees or vendors from attempting the scheme of fraud in the company.

Assess the Risk of Misstatement

Auditors shall assess risk of material misstatement in the audit of financial statements. The lack of proper internal control systems or audit mechanism would create trouble and taint the image of reliable financial reports for internal or external purposes.

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Hence, it won’t be able to determine how to allocate the resources. The audit mechanism helps in identifying which products or segments are most profitable and which would require attention of management.

Further, the auditor has to produce the status of assets and liabilities. The audit, therefore, helps to reduce misstatements in a company’s records and reports.

Cost of Capital

The cost of capital is important aspect of company regardless of its size. Cost of capital consists of risk associated with the investment. If the investment assumes more risk, the investor has to cough for more rate of return to invest.

The employment of a strong audit mechanism reduces the varieties of risk of an enterprise including its information risk, the risk of fraud, and misappropriation of assets. Further, it reduces the risk of underperforming management due to a lack of sufficient information on its operations.

Enables the Pursuit of Business Objectives

The use of an effective audit system helps in the proper implementation of internal control. It enables the company to pursue and achieve its various objectives for the business. The company needs various types of internal controls.

This is to facilitate supervision and monitoring and prevent and detect irregular transactions. This also helps to maintain adequate business records. In turn, it increases the operational productivity of the business.

Internal auditors regularly review the design of the internal controls suggesting improvements all around it. They document any material deficiencies in the internal control by thorough investigation and report to the appropriate level of management as and when required.