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 a 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 the organization in any way. The importance of auditing can be described in the following points.
1) The credibility of financial statements
The regulatory body has made the auditor the only qualified person to carry out the assignment of audit and report on the true and fair view of the client entity’s financial statements so that users’ financial statements could rely on financial statements.
There are various stakeholders in the 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 a 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 the audit plan plays a huge role. Hence, requirements are there for auditors to be independent of influences that could cloud their professional judgment of auditors.
2) 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.
3) Assess the Risk of Misstatement
Auditors shall assess the risk of material misstatement in the audit of financial statements. The lack of proper internal control systems or audit mechanisms would create trouble and taint the image of reliable financial reports for internal or external purposes.
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 the 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.
4) Cost of Capital
The cost of capital is an important aspect of a company regardless of its size. The cost of capital consists of the 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 variety of risks 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.
5) 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 in 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.