You are the audit manager of an audit firm where the purpose of an external audit and its role are not well understood. You have been asked to write some material for inclusion in your firm’s training materials dealing with these issues in the audit of large companies.
Required:
In your paper explain the purpose of an external audit and its role in the audit of large companies, for inclusion in your firm’s training materials. (10 marks)
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Purpose and role of external audit
Basic definition
The objective of an audit of financial statements is to enable the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable accounting framework. The opinion is often worded as …………… give a true and fair view.
The nature of the audit is to give reasonable (but not absolute) assurance that the financial statements are free from material misstatement. This should add to the credibility of the financial statements.
Regulatory framework
In a large company, the owners of the business, the shareholders, are unlikely to be involved in the management of the business.
They therefore, depend on the information provided to them by the directors to let them assess the performance of the business and to make decisions such as whether to stay invested in that business or how to cast their votes in respect of the director’s appointment.
The directors have a duty of stewardship of the company on behalf of the shareholders and the preparation of annual financial statements is part of their accountability towards the shareholders.
An unmodified audit opinion should reassure the shareholders that the information is free from any significant misstatement, whether due to fraud or error.
Although it is the directors who are responsible for prevention and detection of fraud, the auditors must consider the risks that a material misstatement may arise from fraud, and maintain professional skepticism when carrying out the audit. Because of this an audit may act as a fraud deterrent even though this is not the primary audit objective.
The role of the auditor is that of an independent expert who gathers evidence and issues an opinion that will indicate, to shareholders and other third parties who may use the financial statements, the degree of reliance that should be placed on the information.
Third parties who may benefit from the assurance given in the auditor’s report could include lenders, potential investors or potential suppliers. Large companies often raise funds through capital markets and high quality auditing is therefore integral to capital market confidence.
Under the legal framework, and the rules of recognised professional bodies such as the ICAG, there are strict requirements as to who may carry out audits to ensure that only properly qualified people can perform this service.
The ICAG also issues ethical rules to ensure that auditors are genuinely independent. This regulatory framework should maintain the credibility of the role of the audit.