What Is the Need for an External Audit
The need for an external audit in the case of companies arises primarily from the existence of split-up of ownership from control. When control is shared an audit report will be needed in order to ensure that all the partners or be it shareholders are on the same page as the managers (the ones who will be controlling the company) and know what has been happening in the company, what is happening at present and what can be expected to happen in the future in order to increase returns in the company.
The case of an owner controlled company is different as usually the manager will be working in the company and will be aware of everything that will be taking place and will not need an audit report to find out what is going on. Since the owner is alone in decision making, he knows about all the decisions that need to be made and will not find out through an audit report that maybe the company has decided to expand and open a new branch using the accumulated or retained profits.
The audit involves the client’s staff and management in giving time to providing information to the auditor. The auditors need part of the staff’s time as they will not know where the proprietary’s accounts are kept and in which way they are filed. To gather all the information that the auditor will use in making his audit report he has to get it through staff.
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Since most owner controlled companies are very small and the staff members are few, it will make it difficult for the Professional auditors to plan their audit to minimize the disruption which their work will cause.
The audit might end up inconveniencing other stakeholders such as customers because service can become slow as one of the staff members will be assisting the auditor, giving him all the documentation that he needs and accompanying him around as he investigates the internal control measures that have been created in the company to see how effective they are. Application to lenders/financial institutions for finance may be strengthened by the submission of audited accounts.
However some financial institutions, a bank, for instance, is likely to be far more concerned about the future of the business and available security, than by the past historical accounts, audited or otherwise. Audited accounts cannot predict the performance of the company in the future, which is the information that the Bank will be trying to find out. Therefore; audit reports are not an issue of paramount importance, especially in owner controlled companies.
Not all owner controlled companies need to be audited. Auditing of companies does not depend on the type of ownership (that is, sole trader, partnership or co-operative), but it mostly depends on the size of the company at hand. There are laws that have been made in the U. K that exempt certain companies especially the small ones and the owner controlled ones from being audited. Instead of following all audit requirements, the owner controlled companies can submit shortened accounts.
The main differences that can be produced under the banner of abbreviated accounts basically mean that an owner controlled company does not have to include a full balance sheet, profit and loss account or directors report which would normally be required by Companies House. The owner controlled company is still required to submit a shortened balance sheet together with notes that explain the year end balances shown in the balance sheet. Under the audit exemption rules the year end accounts for an n owner controlled company do not have to include an auditors report.
When an auditor has prepared the accounts and submits a special audit report that report should state that in the auditor’s opinion the abbreviated accounts are being submitted in accordance with the appropriate section of the Companies Act. To qualify for being able to file shortened accounts a small company should satisfy at least two of three conditions. The three exemption conditions prior to April 2008 were that annual turnover is less than 5. 6 million pounds, balance sheet total is less than 2. 8 million pounds and the average number of employees is less than 50.
Where the financial year started after April 2008 the parameters increased to, annual turnover less than 6. 5 million pounds, balance sheet total less than 3. 26 million pounds and average number of employees less than 50. When an owner controlled company satisfies the audit exemption parameters it can maintain that audit exemption for a full financial year afterwards even if the parameters were exceed in that following financial year. There are benefits in submitting abbreviated accounts as simpler and easier accounting records can be maintained reducing time spent on accountancy work.
In addition although potential suppliers and financial institutions may require details of the year end financial accounts it is acceptable not to publish full details. In China, Owner controlled companies have an exemption from the audit and this gives management for smaller companies some newfound flexibility, Alyssa Martin says. Companies may not have to produce as much documentation or perform as much testing to produce management’s assertion as they might have had to produce for the sake of the audit, she says. They can use other measures, like ongoing monitors or their own personal experience, to assess internal controls when they don’t have to have the external auditor auditing their process or leveraging their process in performing the audit of internal control,” notes Weaver’s Martin. Yong Xu, CFO for Jingwei International, says he was grateful to see the audit requirement lifted, even though the company voluntarily produced the audit for its 2009 financial statements and is planning to have the audit again in 2010. Jingwei International is a China-based technology services provider listed on the stock exchange and is owned controlled.
However while the recent legislation exempts smaller companies from the audit of internal control, it doesn’t relax any of the requirements for companies to establish and maintain an effective control environment or to report on the effectiveness of controls, says Alyssa Martin, an executive partner with audit firm Weaver. That’s because the Dodd-Frank bill does not exempt smaller companies from Section 404(a), which is the requirement for management to produce its own report on the effectiveness of controls to mitigate errors in financial statements. “It doesn’t really change the role of management,” says Alyssa Martin. They still have to understand the design of internal control and assess the effectiveness. ”“It’s not a cake walk. If you’re not documenting anything or doing anything, you’re not following the SEC’s guidance. ”—Jim DeLoach, Managing Director, Protiviti. Owner controlled companies should audit their accounts as this reduces the Risk of Fraud. A number of factors affect the risk or exposure to loss from fraud, and some organizations suffer more fraud than others. The incidence of fraud in books of account is distributed unevenly. Some industries, some companies, some occupations, and some persons are higher risks than others.
If accounts are being constantly audited, employees will comply with the regulations and do the correct thing; on the other hand, this can become a motivating factor in the case of employees as they know that changes in the company for better that have been initiated by them will be recognized. Many companies have embraced voluntary environmental audits, commonly known as self-audits, as a valuable business resource. Consultants and experts agree that the practice can be of enormous benefit to enterprises in all types of industries, for it addresses so many facets of a company’s operations.
For example, Barbara Ceizler Silver, author of Environmental Self-Audit for Small Businesses, described the self-audit as a valuable “diagnostic tool” that can be used by companies seeking to identify and address compliance problems relating to air, water, land use, solid waste, and hazardous materials prior to submitting formal permit applications or other business processes. The practice of voluntarily checking compliance with environmental regulations through the practice of self-auditing has garnered considerable support from state lawmakers as well. As of 2000, environmental self-audits receive significant legal protections in 26 states.
The body of law in these states maintains that companies can voluntarily test for violations and correct all previously undetected problems without legal penalty. Companies that report violations avoid financial penalties and receive additional time to rectify problems. Most significant of all, the results of self-audit tests and programs in these states receive significant legal protections from public disclosure The advantages of an audit report in owner controlled companies may be there, but the disadvantages far outweigh the advantages and therefore I agree with the statement that owner controlled business should not have audit reports.
This is because this will be a large and unnecessary expense to the company and will result in the company spending large amounts on auditing which could have been diverted to expanding the business. There are cheap alternative methods that owner controlled companies can use to manage their companies than auditing their accounts and getting audit reports every year. (1503 words)
References Abdel-Khalil A. R. (1983). Why do private companies demand auditing? A case for organizational loss of control. Journal of Accounting, Auditing ;amp; Finance, 8(1), 31-52 Proviti Flash Report on SOX 404(b) July 17 2004.
Accounting and Audit Exemptions for Small Companies in the U. K-Terry Cartwright Environmental Self-Audit for Small Businesses: A Quick and Easy Guide to Environmental Compliance. New York Department of Environmental Conservation, Empire State Development, March 1998. Geltman, Elizabeth Glass. A Complete Guide to Environmental Audits. ABA, 1997. Power, Michael. “Expertise and the Construction of Relevance: Accountants and Environmental Audits. ” Accounting, Organizations, and Society. February 1997. Environmental Self-Audit for Small Businesses- Barbara Ceizler Silver