By CPA William Waruingi
Beyond Financial Scrutiny
The rise of technology has interconnected the world like never before, yet corporate scandals persist, raising questions about the efficacy of traditional audit models. While post-scandal reviews rarely fault auditors for professional failure, stakeholders increasingly demand audits that proactively mitigate risks and enhance transparency. This has sparked global debate: Should audit scope expand to better serve management and shareholders?
Many in the business world have been concerned that the audit function has not done enough to forewarn stakeholders and prevent corporate scandals from occurring.
The issue of reviewing the role of audit and audit methodology has been discussed for a while now. The real problem for many professional bodies and other regulators has been whether the scope of an audit engagement should be reformed to provide more information relevant to the needs of management and shareholders. Quality annual audits are now a requirement in many jurisdictions. Different regulators now guide auditors on key areas to audit and report on. Modern-day audit is experiencing drastic changes at a very high rate.
“Audit” is derived from the Latin ” audire, ” meaning to hear. Financial auditing is the independent examination/ or review of an enterprise’s financial statements by an appointed auditor to give an opinion/ or assurance whether its financial statements comply with the relevant statutory obligations and applicable standards. This assurance is meaningful to external parties that rely on the financial statements, such as customers, investors, lenders, revenue authorities, regulatory authorities and suppliers. Many lending organizations require annual audits as part of their loan covenants. The balance sheet, income statement, and cash flow statement are the core three financial statements.
The Institute of Certified Public Accountants of Kenya (ICPAK) defines auditing as the independent examination of and expression of opinion on an enterprise’s financial statements by an appointed auditor in pursuance of that appointment and compliance with any relevant statutory obligation. According to the International Standard on Auditing (ISA) No. 200, Objective and General Principles Governing an Audit of Financial Statements, the objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, by an identified financial reporting framework. The phrases used to express the auditor’s opinion are “give a true and fair view” or “present fairly, in all material respects,” which are equivalent terms. This objective applies to auditing financial information prepared according to the appropriate criteria.
Auditing is designed to safeguard companies’ assets, resources, and capital from misuse by various parties. It is said that during medieval times, when books were maintained manually, auditors in Great Britain used to hear the financial reports read out to them to determine whether the organization’s personnel were not fraudulent or negligent. During the 18th century, auditing was viewed mainly as verification of bookkeeping.
The International Auditing and Assurance Standards Board (IAASB) is an independent standards body that issues standards, like the International Standards on Auditing, International Standards on Quality Management, and other services, to support the international auditing of financial statements. It was founded in March 1978 as the International Auditing Practices Committee (IAPC). The IFAC (International Federation of Accountants) Board established the IAASB to develop and issue, under its authority, high-quality standards on auditing, assurance, and related services engagements, related practice statements and quality control standards for use around the world. The leadership of the IAASB is appointed by the IFAC Board. The IAASB’s pronouncements govern audit, assurance, and related service engagements to which the International Standards on Auditing apply. The IAASB develops a set of international standards that are generally accepted worldwide.
In Kenya, the Companies Act Cap 486 gives guidelines on how the audit of public companies should be carried out. The Companies Act also gives guidelines on an auditor’s duties, rights, powers, qualifications for appointment, dismissal, remuneration, removal, and resignation. The current Companies Act was enacted in 2015. The new Act introduced modern company and insolvency laws, which were long overdue.
Audits are classified into two types: statutory and non-statutory. Statutory audits are compulsory under statute in the case of many undertakings. Independent auditors carry out non-statutory audits because the owners, proprietors, members, trustees, professional and governing bodies, or other interested parties desire them, not because the law requires them. Non-statutory audits are carried out at the mercy of management.
Due to the increasing number of regulations and the need for transparency, organizations are adopting risk-based audits that can cover multiple regulations and standards from a single audit event. This is a new but necessary approach in some sectors to ensure that all the required governance requirements can be met without duplicating effort from audit and audit hosting resources.
Auditing is a key part of good corporate governance; the directors are responsible for maintaining a system of control that safeguards the company’s assets. Thus, it gives guidelines for the facts that auditors must be aware of as part of their planning for carrying out an audit engagement. Governance and ethics in an organisation are also scrutinised during an audit engagement. Entities that adopt best corporate governance practices are believed to be industry leaders in their sectors.
Auditing ensures that organizations present stakeholders with an accurate and fair view of the financial statements. The mandatory audit engagement acts as a means of control. An audit makes stakeholders comfortable working with a company as it assures that its financial statements are accurate and provide a true and fair view of the company’s economic performance. Also, a company being audited shows that it upholds transparency and financial integrity, making it easy for customers and suppliers to have confidence in doing business with the audited company.
An audit helps ensure that a company complies with the requirements of all applicable regulators. Non-compliance tarnishes a company’s reputation with its relevant stakeholders. It can also attract heavy fines and penalties, negatively affecting an enterprise’s going concern. Conducting an audit can identify any inefficiencies in a company and recommend proper ways to handle the inefficiencies, which will improve the company’s performance. This results in operational efficiency, which is every company’s goal. Companies that operate optimally guarantee maximum returns to their shareholders.
Auditors play a crucial role in identifying opportunities for a company to enhance its accounting operations. Through their objective assessment, auditors provide actionable recommendations to improve accuracy and the choice of accounting software that is good for the organization. Auditors will also advise on best practices for maintaining robust accounting records.
Audits assess the effectiveness of a company’s internal controls and recommend improvements in areas with weaknesses. Strong internal controls prevent fraud and help prepare financial statements that present the proper and correct position of the business. It is common for financial audits to review internal controls and assess their efficiency.
Although every audit engagement is unique, the process is similar for most engagements. Usually, it consists of four phases: planning (survey or preliminary review), fieldwork, audit report and follow-up review. Client involvement is critical at each phase of the audit exercise. Auditors review the accounting data using substantive testing, within the context of materiality and risk assessed during the planning phase, as well as the overall effectiveness of the control environment. Substantive testing involves sampling transactions and gathering evidence to support the accounting data. Substantive testing is the review of events and transactions. Evidence from third parties is preferred, such as bank statements, confirmation letters from customers and suppliers, invoices, receipts, and statements.
At the end of the audit process, the auditor can give four opinions. The nature and content of the report will be determined by the information provided during the audit exercise. The auditor will use his judgment and apply applicable standards before issuing his report. Before issuing his report, any matters, questions, and explanations to the management of a company that he deemed necessary for the audit must be answered or explained.
An unqualified opinion means that the financial statements are correct and give a true and fair view of an enterprise’s financial position. It is sometimes called the “clean” opinion. The financial statements present fairly the correct position in all material respects. The auditor is satisfied that an entity has complied with accounting standards and other relevant guidelines.
A qualified opinion means that the financial statements are fairly presented to a large extent. However, there are specific discrepancies, which could include an incorrect accounting policy, unrecoverable debts, misstated inventories, or a discrepancy that does not recur in the financial statements. Due to the discrepancies, the auditor is unable to give a “clean” report.
An adverse opinion means that the financial misstatements are material and pervasive to the financial statements. Simply put, the report is bad. The report is given where material misstatements exist and the financial statements do not conform to applicable accounting standards and other guiding principles. An adverse opinion is more serious than a qualified opinion.
Disclaimer of opinion means that the auditor was unable to obtain sufficient audit evidence on which to base an opinion. In short, the available financial statements and accounting records could not be relied upon to warrant an opinion. This is the worst form of opinion an auditor can give. It is issued after the auditor has exhausted all avenues to obtain the evidence needed to form an opinion on the financial statements.
Annual audited reports and financial statements, which auditors registered and approved by ICPAK prepare, are a requirement for every company listed in the Nairobi Stock Exchange. The report must disclose all matters that different regulators and other applicable standards set.
Auditors must ensure that the audited report discloses all issues as per the guidelines of the IFRS (International Financial Reporting Standards) and IAS (International Accounting Standards). The two standards are major accounting standards that guide the preparation of financial statements. Companies’ reports that comply with these standards are awarded at the annual Fire awards. The coveted award is presented to companies that adopt best practices in financial reporting and other disclosure requirements.
The author is an audit associate at CGA CONSULT CPA(K). He is also an associate member of ICPAK.
