Accountability and why auditing is needed
Accountability means being able to explain how you used what was given to you. Shareholders give money; managers use it; managers must report back through financial statements.
The problem: managers write the report about their own work, so they may be tempted to show better results. Banks, investors and the tax office need a check by someone independent. That check is an audit.
Overview of auditing: how an audit works
An audit is an independent examination of financial statements to say whether they give a true and fair view.
- Plan: understand the business and find risky areas.
- Test internal control: are there good checks inside the company?
- Collect evidence: look at bills and contracts, confirm balances with banks and customers, watch a stock count, recalculate sums. Auditors test samples, not every entry.
- Form an opinion and write the audit report.
Independence is the key rule: the auditor must not be an employee, close relative or someone with a money interest in the company.
Audit opinions
| Opinion | Meaning |
|---|---|
| Unqualified | Statements are fair |
| Qualified | Fair except for one specific issue |
| Adverse | Statements are not fair |
| Disclaimer | Could not collect enough evidence to give an opinion |
Audit is different from internal audit (staff of the company checking its own operations) and from bookkeeping (recording).
Duties of professional accountants
Professional accountants have passed exams and joined a professional body. Common roles:
- Certified public accountant / chartered accountant: audits, advises on accounting and business.
- Tax accountant: prepares tax returns and advises on tax.
- Company accountant: prepares accounts, budgets and reports inside a company.
Their duties
- Honesty and fairness: no false statements.
- Independence (for auditors): no conflict of interest.
- Competence and care: keep learning, work with proper care.
- Confidentiality: do not leak client information, unless the law requires.
- Public interest: the profession serves not only the client but also investors, lenders and the public.
Breaking these duties can lead to fines, loss of licence and legal action.
Key formulas and definitions
- Key terms: Accountability = explaining use of resources
- Audit = independent check of statements
- Evidence = proof for audit opinion
- Independence = no conflict of interest
- Opinions: unqualified, qualified, adverse, disclaimer
- Professional accountant = trained, licensed, ethical
Worked examples
1. An auditor finds everything correct. Which opinion?
Unqualified opinion: the statements give a true and fair view.
2. An auditor finds a 5,000 loan not disclosed but everything else is correct and the amount is small compared with total assets. Which opinion?
Qualified opinion: fair except for the undisclosed loan.
3. Management refuses to show half of the records, so the auditor cannot check them. Which opinion?
Disclaimer of opinion: not enough evidence to say.
4. An auditor owns 10% of the shares of the company being audited. What problem arises and what should happen?
The auditor has a money interest, so independence is lost. The auditor should not accept the audit (or must give up the shares).
Common mistakes
- Thinking an auditor writes the accounts. Managers prepare them; the auditor checks and gives an opinion.
- Believing an audit checks every entry. Auditors test samples and use judgement.
- Mixing up adverse (not fair) with disclaimer (could not check).
- Thinking an auditor guarantees there is no fraud. An audit gives reasonable, not absolute, assurance.