Audit in Nowadays Business: Managing the Expectation Gap - Essay Example

The of Greenwich Business School Audit and Assurance (ACCO 1125) work RELEVANCE OF AUDITS IN TODAY’S BUSINESS ENVIRONMENT; MANAGING THE EXPECTATION GAP Course Leader: Izette Kluever Table of Contents Table of Contents 2 1.0 Introduction 3 2.0 Aspects of Audits in Business Environment 4 2.1 Expressing an Opinion 4 2.2 Relevance of Expressed Opinion 5 2.3 Limitations of an Audit 6 2.4 Other Auditing Aspects 7 3.0 Conclusion 8 4.0 Bibliography 9 5.0 Appendix 1 10 6.0 Marking scheme 10 A Report on Relevance of Statutory Audits in Today’s Business Environment; Managing the Expectation Gap 1.0 Introduction It is no doubt that the expectations in the business environment across the world has increased in recent years; shareholders, government agencies, managers, and investors among other parties have high expectations in regard to transparency and accountability in business. Auditing plays a key role in meeting these expectations. The law entrusts auditors to conduct statutory audits in a bid to fulfil societal role in giving an opinion on whether the audited financial statements provides a true and fair representation of the financial position of a given entity (European Commission, 2010, p. 3). Basically, statutory audit can be defined as the legal requirement to review and determine the accuracy of the financial statements of a company or government (including its agencies). Kumar and Sharma (2005, p. 41) notes that for audit to be considered proper there are certain thresholds that should be attained key among them the independence of auditors and the presentation of the opinion in accordance with Generally Accepted Accounting Principles (GAAP). In the light of these thresholds, concerns have been raised by certain stakeholders as to the relevance of statutory audits in today’s business environment. Their concerns are informed by the argument that the independence of auditors is sometimes compromised and some of GAAP flouted to attain certain objectives by the entities’ management, resulting to untrue and unfair representation of financial statements (Drent, 2002, p. 50). It is for this reason that it is necessary to probe into the statutory audits’ true fulfilment of societal mandate of offering true and fair opinion of audited entities’ financial statements (European Commission, 2010, p. 3). In order to ascertain the relevance of audits in today’s business environment, this discussion will cover the following aspects: What does it mean to express an opinion on the truth and fairness of financial reports? How relevant is this expressed opinion in todays business environment? What are the limitations of an audit and to what extent, and how, are these limitations compensated for? In addition, the discussion will briefly discuss the following aspects: when are statutory audits required? What does “fitness for purpose” mean within the auditing realm? What is the expectation gap and how is this managed in practice? 2.0 Aspects of Audits in Business Environment 2.1 Expressing an Opinion What does it mean to express an opinion on the truth and fairness of financial reports? Auditing entails independent examination of the financial statements of public- interest entities with the view of expressing an opinion on whether those statements represent the true and fair view of the financial position of the audited entity (Gray and Manson, 1999, p. 8). Russel (2003, p. 25) states that the main purpose of statutory audit is to provide opinion that will inform the decisions made by the stakeholders and other interested parties regarding the audited entity. The recent financial crisis in Europe and other parts of the world increased the need to focus more on financial auditing in order to avoid losses in future to stakeholders and shareholders due to instability of financial systems of public- interest entities (Trompeter & Wright, 2010, p. 670). Expressing an opinion on the truth and fairness of financial reports ensures that statements fairly represent the performance and position of the entity to the shareholders, and other parties such as regulators, banks, and tax authorities among others (Kumar and Sharma, 2005, p. 117). Spencer-Wood (2010, p. 93) explains that expressing an opinion on the truth and fairness of financial reports entails several aspects. First, it means that the opinion must be factual and should conform to the financial reality of the audited organization; that is, the opinion should not be false. Besides, financial statements that informed the opinion should conform to the stipulated standards, that is, they should be in accordance with Generally Accepted Accounting Principles (GAAP). The financial reports should have been extracted from the organization’s books of accounts and other financial records and not from other sources (Gray and Manson 1999, p. 18). Secondly, it means that the opinion on financial reports is free from bias and discrimination and in compliance with set rules and standards. In addition, the financial reports should be a reflection of the organization’s commercial substance. The opinion expressed can be either ‘unqualified opinion’ or ‘qualified opinion’. Trompeter & Wright (2010, p. 676) states that an unqualified opinion is expressed when the independent auditor, after examining the financial reports, believes that they are sound and in accordance with GAAP accounting principles; they represent true and fair position of the organization since they are devoid of material misstatements, alterations, and falsehood. On the other hand, qualified opinion expressed when an independent auditor, after examining the financial records, deems that the information provided by the audited entity was incomplete and/ or the entity did not comply with GAAP accounting principles. Qualified opinion is usually written on the front page of the audit done and advises the reader to be aware of the suggestions made (Revsine et al, 2004, p. 54). 2.2 Relevance of Expressed Opinion How relevant is this expressed opinion in today’s business environment? As has been noted, statutory audit seek to provide the stakeholders and other interested parties of an audited entity with an opinion on the financial records’ truth and fairness so as to inform their decisions regarding the entity. Spencer-Wood (2010, p. 11) says that auditors have been entrusted by law to carry out statutory audits with the purpose of fulfilling the societal role in giving an opinion on whether the financial records of an organization represent true and fair position (Gray and Manson, 1999, p. 60). This opinion relies greatly on the independence of the auditor. However, in recent past there have been concerns about this independence whereby the concerned parties are concerned with the reliability and credibility of audit opinions (Shrives, 1996, p. 26). Consequently, certain stakeholders have also raised concerns about audit’s relevance in present business environment. The concerns are further compounded by the fact that some of the stakeholders are not aware of an audit limitation, thus engendering expectation gap (European Commission, 2010, p. 4). That notwithstanding though, the relevance of expressed opinion in today’s business environment cannot be dismissed. Drent (2002, p. 52) observes that increased expectations on the part of stakeholders, regulatory requirements, and the need to stabilise financial systems across the world has made expressed opinion more relevant in today’s business environment. Expressed opinion is relevant in today’s business environment in the following ways: one, expressed opinion is important to any given company’s shareholders as it helps them know whether the financial reports represent the true and fair view of the company’s position at a given period(financial period) (Gray and Manson 1999, p. 39). Also, they are interested to have assurance that the accounts have complied with statutory requirements and are in accordance to GAAP accounting principles (Kumar and Sharma, 2005, p. 80). Since the main intention of shareholders holding shares in a company is to gain returns after certain period of time, expressed opinion helps them decide on whether to continue holding their shares in the company or not (Trompeter and Wright, 2010, p. 683). Secondly, tax authorities usually demand to know whether the financial reports they use in ascertaining the amount of tax represents the true financial status of the company. As such, expressed opinion is vital and relevant in today’s business environment because taxation is inevitable (Drent, 2002, p. 54). Additionally, other parties such as employees, customers, suppliers, and banks in most cases have interest in the accuracy of financial statements so as to ascertain the creditworthiness, financial stability, and other business aspects of a company (Smieliauskas, Craig and Amernic 2010, p. 463). In today’s business environment transacting with these parties may prove difficult without the expressed opinion on the truth and fairness of financial reports, thus making expressed opinion relevant (Spencer-Wood, 2010, p. 85). Lastly, expressed opinions are not only required by law but also add value to the company by reducing the information asymmetry costs. The fact that audit will be conducted at a given time ensures that certain information in the financial statements are provided on time; for example, up- to- date information on income statement, valuation of assets, capital, acquisitions and mergers, and provisions and reserves are provided (Drent, 2002, p. 55). 2.3 Limitations of an Audit What are the limitations of an audit and to what extent, and how, are these limitations compensated for? Gray and Manson (1999, p. 75) notes, financial reports audit is subject to several limitations; some of them internal in the audited entity while others are due to external factors. To begin with, an audit often involves getting information from the company’s management and staff which requires that they use time in giving the information hence causing disruption to their work. These limitations can be compensated by ensuring that the auditor(s) plan their audit carefully and in a manner that will cause minimal disruption to the company (Trompeter and Wright, 2010, p. 673-4). The second limitation involved in audit is the audit fee which may be relatively; this explains the reason why most partnerships and sole proprietorships prefer not to have their financial reports audited. Companies compensate for this limitation by ensuring that they have the accountant who prepare the financial reports, financial advisers, and the tax adviser; this ensures that auditing work becomes easier and relatively cheaper (Spencer-Wood, 2010, p. 24). In addition, established accounting framework is a limitation of an audit; as such, most companies are confined to use the framework which may not really fit in the companies’ accounting needs. Besides, the established framework do not clearly provide for accounting estimates hence not making auditors unable to foresee the uncertainties outcome (Kumar and Sharma, 2005, p. 233). These limitations are compensated by alternative accounting principles that are allowed under the GAAP accounting principles. Also, due to lack of certainty and exactness in accounting estimates, auditor has discretion of making a decision on whether the estimates were reasonable or not. 2.4 Other Auditing Aspects Moreover, it is important to emphasize that statutory audits are very important in today’s business environment. George (2009, p. 24) Statutory audits are required at certain times in the period of existence of business entities. They are required when there are Annual General Meetings for shareholders of any given company. They are essential in informing the shareholders the performance and position of their company, and also to confirm to them that the directors and management of their company have complied with the statutory requirements (Brigham and Houston, 2009, p. 503). Also, they are required during remitting of tax to tax authorities. Kumar and Sharma (2005, p. 308) argues that they are needed to satisfy the tax authorities that the financial reports truly fairly represent the company’s financial position hence ascertaining the amount of tax payable. Also, statutory audits are required by other parties such as suppliers, banks, and customers when in order to inform their decisions when dealing with the audited entity in deals such as loans (Spencer-Wood, 2010, p. 29). Furthermore, “fitness for purpose” within the auditing realm means that the process of auditing and the opinion given is good enough to achieve its intended purposes (George, 2009, p. 20). This phrase seeks to ensure that there is no misrepresentation which can cost the audited entity. Basically, “fit for purpose in auditing mean that auditing should be organized in the appropriate manner, the subject matter in auditing should be specified, all the details of auditing should be covered, and there should be structures that connect the audit contents and can be traced. Lastly, Alvarado (2007, p. 16) explains that the expectation gap in auditing relates to the difference between stakeholders’ awareness of audit limitations and the ability of the auditors to ensure the material soundness and reasonableness of financial statements. Expectation gap is managed through creation of awareness to stakeholders about limitations of audit and by auditors making efforts towards ensuring that auditor reports and financial statements are “fit for purpose” (Alvarado, 2007, 18). 3.0 Conclusion In conclusion, it is evidently clear from the analysis that statutory audits are very relevant in today’s business environment; it is nearly impossible to delink statutory audit from business. In today’s business environment, deals and transactions are conducted formally and legally and accuracy of financial statements is very critical. This is because; business entities are making efforts to make sure they have minimized potential financial risks that may arise. Therefore, statutory audits play very crucial role by giving an opinion on whether the audited entities’ financial reports are true and fair, thereby, facilitating informed decision- making of the users of such an opinion. Also, it is evident in the analysis that there is expectation gap and it is necessary to manage this gap. As noted by Alvarado (2007, p. 18), this gap can be managed through creation of awareness to stakeholders about limitations of audit and by auditors making efforts towards ensuring that auditor reports and financial statements are “fit for purpose”. 4.0 Bibliography Alvarado, K 2007, “Auditors face great expectations”, The Internal Auditor, 64(6), 16-16,18. Brigham, E and Houston, J 2009, Fundamentals of Financial Management, Cengage Learning. Drent, D 2002, “The quest for increased relevance” The Internal Auditor, 59(1), 49-55. European Commission, 2010, Audit Policy: Lessons from the Crisis. COM (2010) 561 final. Brussels, Available at: http://ec.europa.eu/internal_market/consultations/docs/2010/audit/green_paper_audit_en.pdf [Accessed 28 January 2012]. George, C 2009, THE NECESITY FOR AUDITING THE FINANCIAL-ACCOUNTING ACTIVITY, Young Economists Journal, 7, 13, pp. 20-28 Gray, I and Manson, S 1999, The Audit Process: Principles, Practice and Cases, Routledge. Kumar, R and Sharma, V, 2005, Auditing: Principles and Practice, PHI Learning Pvt. Ltd. Revsine, L et al 2004, Financial Reporting and Analysis, Prentice Hall. Russel, J 2003, The Process Auditing Techniques, ASQ Quality Press. Shrives, P, 1996, “The new face of auditing” Financial Management, 74(5), 26-26 Smieliauskas, W, Craig, R and Amernic, J 2010, Auditing, Reasoning Systems, Reporting Frameworks, and Accounting Policy Risk: A Response to Alexander, Abacus, 46, 4, pp. 455-463 Spencer-Wood, J 2010, Audit and Assurance Coursework – 2010-11, London, University of Greenwich. Trompeter, G and Wright, A 2010, The World Has Changed-Have Analytical Procedure Practices?, Contemporary Accounting Research, 27, 2, pp. 669-700 5.0 Appendix 1 Word Count- 2158 6.0 Marking scheme Name: .................................................................. Student ID: ......................................................... Indicative mark Actual marks Have the cover, contents page, introduction, reference list, headers and footers & word count all been included as required by the question? Is each satisfactory? Is the word count within the given range? 5% Is the presentation and language indicative of business reports? 5% * Has Harvard referencing been used? Properly? (minor infringements – see note below*) In body of report? References section? 10% 10% The Introduction (rules, reasons, concepts, introduces the reader to the main ideas to follow). Use of professional journals, academic journals, web-based sources, textbooks (NOT SET TEXT)? 10% The data collected and analysed Topicality? Relevance? Sufficiency? Well researched data – research covers numerous viewpoints and includes an element of criticality. Data is structured in a logical manner. Use of professional journals, academic journals, web-based sources, textbooks (NOT SET TEXT). Data collated to form a strong argument and is thoughtfully structured and analysed. 50% Conclusion Links title to analysis (main body) & conclusions are reasonable in light of cited evidence. 10% TOTAL % Read More