Why is it important for the external auditor to have an appropriate understanding of the clients business?

Published: 20 Aug 2018 By CareersinAudit.com

The current business landscape exists within a tougher regulatory climate which has, since the inception of the EU GDPR, further elevated the threshold for companies to suffer financial losses. As a result, many organisations are likely operating under loss versus the profit they’re imagining. This is where the importance of external audit proves its worth to an organisation.

An external audit provides an impartiality that the in-house internal audit team cannot. While internal auditors can’t help but be personally invested in the outcome of their findings, there are no concerns over repercussions for the external auditor if the organisation is unhappy with their report. This absence of bias is hugely important for reinforcing the credibility of a company’s financial statements and general financial health.

Key business stakeholders as well as relevant revenue and review committees can be assured of a thorough investigation into an organisation’s finances and accounting processes, with an external auditor on board. This credibility is particularly important to small and start-up companies, as well as companies that may have suffered a data breach and thus be working to repair their reputation and restore faith in customers, shareholders and the public.
 

In light of increasing regulation, employing an external auditor serves to strengthen company practice within the remit of government compliance. It is the job of an external auditor to identify areas of non-compliance, as well as any issues with fraud or abuse within the organisation. An external auditor is likely to dig deeper to unearth these vulnerabilities because they are removed from the business and can cast a fresh and objective eye over it.
 

In addition to pinpointing areas where compliance efforts may be lacking, the role of external audit will also highlight other areas for improvement. It is the external auditor’s job to locate any factions of the business where processes could be tightened in order to reduce waste and inefficiency. They will make recommendations to key decision makers within the organisation to enhance internal controls or perhaps implement automation in order to streamline business and accounting practices.
 

The job of external audit can also incorporate training for a company’s internal audit team. Comparing modes of analysis between the internal and external auditor can improve the former’s performance moving forward and ultimately strengthen the audit capabilities of the organisation.
 

External auditors provide important and valuable insight into the information that exists within an organisation. Their findings and audit processes give businesses the confidence and reassurance that their information and the way they conduct business is suitably kosher.

James Hadfield – Audit Partner

Aside from the importance of the legal requirements for a statutory audit, the undertaking of the audit itself provides important and valuable insight.

An audit determines whether an organisation is providing a true and fair view of its financial performance and position, which on its own is something any organisation wants to achieve.

Providing comfort over the accuracy of management accounts, or revealing systematic errors occurring throughout the year, a year end audit is critical to decision making for an organisation placing reliance on management information. The process through which an audit is undertaken challenges the robustness of the internal controls and processes an organisation has in place, giving an external perspective and valuable feedback.

With more and more companies falling out the audit regime following the increase in the audit thresholds, what are the benefits of having a voluntary audit?

Auditors do not just focus on the numbers but will gain an understanding of the businesses overall systems and controls environment. This will enable them to identify deficiencies in the accounting systems or controls for which recommendations can be made, making your business more efficient and less prone to fraud or error.

Having your financial statements verified by an external auditor can lead to more credibility in the business marketplace than those that have not. Should you be seeking to raise finance or sell your business in the future, providing audited accounts gives security that your accounts are free from material error or malpractice, making you more likely to be successful in achieving your goals.

Many business are run by a small board of directors on behalf of the shareholders who can be remote and have little involvement in the day to day operations. An independent review of the financial statements can provide transparency to the shareholders that the company is being run within their best interests and can highlight any issues that have occurred which may not have been brought to their attention.

More Audit FAQs

More about Menzies audit and compliance services

As well as meeting your statutory reporting obligations, Menzies’ audit and compliance services are the proactive way to reduce risk and drive forward your business strategy. Our pragmatic, hands-on approach helps you improve your business performance – by challenging assumptions and resolving commercial issues that could be holding your business back.

Our audit and compliance team will help you to:

• Add value to your business by using the audit as a basis to identify and resolve commercial issues and to improve your business processes.
• Use the understanding and insight gained from the audit as a basis for helping you develop strategies to drive your business forward.
• Reduce risk and improve your organisational performance by challenging existing assumptions and practices.
• Secure peace of mind from knowing your statutory obligations are met, accounts are true and potential problems have been identified early on.

Contact Menzies Audit & Compliance team

To speak to a partner or for more information about the audit and compliance services we offer please contact one of the Menzies LLP offices or complete our contact from below.

Business understanding is important for auditors in the following way,

• Auditors will be able to assess the risk of material misstatement more precisely.
• It helps the auditor to identify potential business risks.
• It enables auditors to understand if they can cover the risk and issue a clean audit report.
• It enables auditors to understand market and competition.

Let’s understand the detailed aspects of the above.

1-Auditors will be able to assess risk of material misstatement more precisely.

The audit approach is dependent on risk identification, designing for audit procedures, obtaining sufficient and appropriate audit evidence, forming an opinion, and issuing the audit report.

It’s important to note that risk identification is the first step towards audit processing. In fact, auditors need to assess risk when accepting audit engagement. If the overall risk of the potential client is higher than the audit firm’s competence to cover the risk, they must withdraw from the engagement.

Further auditors identify risk from the following three main sources,

• Business/operations understanding
• Internal controls (operational and financial)
• Financial reporting

Business understanding is one of the most important sources for risk assessment. Some businesses have sensitive operations. For instance, banking operations are sensitive in terms of finance, authorization, regulations, approval etc. It means the industry is highly regulated and there is a higher risk while engaging.

On the other hand, a retail store has comparatively lower risk as their operations are not very sensitive. Hence, the risk brought by operations is lower. And even small audit firms can enter into audit engagement with them.

2-Business understanding helps the auditor to identify potential business risks.

The auditor needs to identify business risks. These risks can be identified by analyzing business operations, business model, production analysis, distribution network, supplier management, etc. Auditors need to cover identified business risks with sufficient and appropriate audit evidence. This enables them to form an opinion and issue an audit report.

3-Business understanding (BU) enables auditors to understand if they can cover the risk and issue a clean audit report.

It’s simple science that if auditors obtain sufficient and appropriate audit evidence to cover the risk, based on the audit evidence, they form an audit opinion that is not qualified and vice versa.

Sufficient audit evidence refers to the quantity of audit evidence. On the contrary, appropriateness refers to the quality of audit evidence.

4-BU will enable auditors to understand market and competition.

Business understanding enables an auditor to understand about products/services of an audit client. This further leads the auditor to research market competition and product performance.

Logical understanding of how business understanding increases audit quality

Business understanding enables an auditor to,

1. Assess risk brought by business operations, products, services, marketing, distribution etc.
2. Design audit procedures based on identified risk of material misstatement.
3. Perform audit procedures and collect sufficient and appropriate audit evidence.
4. Make an audit opinion and issue an audit report.

Frequently asked questions

Why is an understanding of the control environment essential for the auditor?

Auditors need to understand the control environment because they need to decide,• If they would place reliance on the controls implemented by management.

• If they would reduce their sample by placing reliance on the implement controls.