An audit involves an examination of financial and non-financial information to form an opinion on the financial statements of an entity.
The primary purpose of an audit is to ensure that the management of an organization is carrying out its fiduciary duty in the shareholder-management relationship.
The Evolution of Audits
Audits have a very long history, but the current auditing practices are a consequence of more than a century of evolution in auditing profession. Auditing first became mandatory in the US after the stock market crash of 1929 which, in part, caused the great depression.
Subsequent developments in reporting frameworks have resulted in evolving techniques for performing audits. The widespread use of computers for accounting in the 1960s resulted in the development of AUDITAPE, the first widely used auditing program.
Frauds as a Catalyst for Audit Development
Major financial scandals throughout recent history have resulted in significant strides in the development of audits. Consequently, the quality of audits has improved, but simultaneously the costs of performing audits has skyrocketed.
In the Enron scandal, the CEO and their auditors were involved in covering up millions of dollars in losses. The management of Enron confessed to having inflated close to $586 million in profits. All this occurred after the auditors Arthur Andersen were signing off on corporate reports for years.
The Enron bankruptcy highlighted the lack of legislation for accounting and corporate fraud. The Sarbanes-Oxley act was passed shortly after the Enron scandal.
The edicts of the Sarbanes-Oxley Act include:
- Increased accountability of those charged with corporate governance
- Increased responsibility of auditors
- Prohibition of non-audit services to audit clients.
- Increase in disclosure requirements
Subsequent corporate scandals have also impacted audits but none so much as Enron. The general trend has been to increase transparency in reporting, while simultaneously requiring more disclosures. The auditor’s responsibilities have also increased significantly with the following areas added to the scope of a regulatory audit:
- Issue opinions on internal controls of management
- Audit the IT systems for security and probability of misstatements
The work of an auditor has therefore increased, deadlines have become shorter, and complex businesses have further driven the cost of auditing upwards.
To better manage tight reporting deadlines most popular approaches are as under:
- Hard close audit
- Rolling forward interim period work
- Reducing substantive testing by increasing extent of control testing procedures
- Relying on work of internal audit department
Exercising judgement on these critical areas is subsequently even more important than in prior times. However, despite all the additional work, bankruptcies, accounting irregularities and frauds have continued.
Despite hefty investment in audit resources, auditor still ends up producing a report with the delay and not reflective of the current company position.
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