The value of a good audit

How should a company go about choosing an external auditor? What factors must it consider in deciding whether a CPA would be able to perform a good audit?

The answer to these questions depends on the value that management and the other users place on the audited financial statements. Is audit just needed for regulatory compliance and submission to government agencies? Is it obtained because banks and creditors require it?

At face value, these maybe the obvious reasons why businesses undergo an audit. However, good governance and best practices on financial management requires for a good audit to be performed as it attests to the fairness of the information contained in the financial statements and disclosures issued by the company.

While the product of the auditor’s examination is the audit opinion, implicit in the audit report is the credibility of the auditors to whom the stakeholders (management, investors, government agencies, creditors) put their trust and reliance on.

Behind the audit report is actually a lot of hard work. There is the evaluation of the business risks. Businesses have been evolving and there are new ways of doing business (e.g., transactions are consummated via the internet), new business models (e.g., outsourcing and offshoring), and more complex contractual arrangements (e.g., joint ventures, multi-element contracts which include both sale of goods and services).

Auditors should be able to fully grasp the intricacies of these business developments so they can have a better basis for their judgment in identifying risks of material misstatements on the company’s financial statements. For example, auditors should understand the revenue-generation processes and relevant contractual arrangements of their clients so they can properly assess whether they will agree or not on the revenue recognition policy applied by the client, the amount of revenue reported for the period and even disclosure of such transactions on financial statements.

This business knowledge is important as it guides the auditors in making their judgment; and there are several areas where the auditors have to apply judgment on. The auditors have to apply judgment on the appropriateness of chosen accounting policies and the reasonableness of accounting estimates. The accounting policies can spell the difference between treating certain transactions as assets instead of expenses or recording a liability or just disclosing a contingency. The use of accounting estimates pertains to matters like impairment (e.g., collectability of receivables) and fair value measurements of financial assets and liabilities. Business knowledge of the auditors (good understanding of the clients’ business and its industry) is necessary to enable them to make good judgment on these areas.

The auditors’ evaluation and judgment of their clients’ internal control is also important as this will determine the nature of audit work, the timing of execution of audit procedures and the extent of audit testing and examination. Since audit is done on test basis, evaluation of internal control is critical. The processes and controls put in place by the clients’ management should be operating as designed to ensure the integrity of the clients’ financial reports.

Regulatory bodies are now routinely coming up with new regulations and requirements. Moreover, the accounting standards setting bodies are regularly issuing new standards and amendments and even amendments to amendments. The auditors should keep abreast of these developments and have a solid understanding of the implications of new regulations and standards to their clients and should ascertain proper compliance of their clients to the provisions of such regulations and standards.

Audit necessitates the timely and heavy involvement of the audit executives. These audit executives (i.e., managers and partners) have the experience and the business knowledge demanded by the auditing standards. And while newly-minted CPAs are hired by the hundreds by the larger auditing firms, the work that they handle are mainly verification of supporting documents and execution of certain audit procedures. The critical tasks are left to the managers and partners.

The tasks of the auditors are not outwardly manifested to the public; thus, to the question of a good audit (and good auditors), some questions need to be asked. Is the auditing firm known in the business community? Is it prominent enough or is it at least a member of professional organizations? Is it or are its partners known for thought leadership? Do they speak out about the latest issues—including regulatory matters—affecting the business community in general and the accounting and audit profession in particular?

It is also important to check on the professional capability of the team working on the audit. Does the audit firm have a set learning and development programs for its audit executives? How does it hire and train its people? What are its retention strategies? Does it have the tools and resources and methodologies to ensure the application of the auditing standards?

Good audit is inherent to good governance. In the end, the value of a good audit is achieved when the users of the financial statements believe that it is reliable because it is accompanied by an audit opinion performed by trustworthy auditors.

Jessie Carpio is the President of P&A Grant Thornton Outsourcing Inc. P&A Grant Thornton is one of the leading Audit, Tax, Advisory, and Outsourcing firm in the Philippines, with 20 Partners and over 700 staff members.

As published in The Manila Times dated 20 April 2016