Category: Auditing & Tax

[vc_row][vc_column][vc_column_text]In today’s complex corporate governance requirements, the role of external auditors is quite important and significant. They act as a third party check and provide an independent opinion about the financial statements of the company.

However, there are some general misconceptions about the role of external auditors. It is essential to understand the limitation of an external audit. In the below points, we have listed ten misconceptions about the role of an external auditor and the respective reality.

 

Misconception 1: External auditors are responsible for the detection and prevention of frauds and errors:

Reality: External auditors are not responsible for the detection and prevention of frauds and errors. However, they may (or may not) come to know about any fraud in the organization. Once they know or suspect that there is a fraud, they have to get further details about it. However, depending upon the quantum of the fraud, they may still not report the same in their audit report. Further, it is the management of the company who is still responsible for the detection and prevention of fraud in an organization.

Misconception 2: External auditors are checking and reviewing all the transactions of a company

Reality: The external audit is carried out in a short period with a limited number of team. It is not practically possible to test and verify every transaction of the company. External auditors only validate a sample of the transactions. This sample of transactions is selected using statistical techniques or based on the past assessment of the auditor or the materiality (high amount or nature) of the transactions. It is still likely that a significant portion of the suspicious transactions remains unchecked.

 

 

Misconception 3: External auditors report all errors found in their audit report

Reality: External auditors work as partners of the companies. They do not intend to report errors in their audit reports. Instead, if external auditors find any mistake in the financial statements, they help the organization by suggesting to correct these errors. Often, both auditors and company’s management finalize the financial statements together, reducing the mistakes and miscalculations in the financial statements. Only in the case of a material and pervasive disagreement between auditors and the company’s management, the auditor would report such disagreement in their audit report.

Misconception 4: External auditors ensure that financial statements are free from errors and are accurate

Reality: Based on the limited time, selected sampling and limited staff, an external auditor can’t detect all the errors in the financial statements and make the financial statements accurate and free of errors. External auditors cannot ‘ensure’ that financial statements are free from errors. Instead, they provide their opinion about financial statements which they formulate by performing audit procedures.

Misconception 5: External audit is a guarantee that there is no financial fraud happening in the company

Reality: A well-carpeted scam may still go undetected even if well-reputed external auditors regularly audit the company. Techniques of collusion, window dressing, under-provisioning, overestimating revenues, undercharging depreciation, misleading interpretation, misuse of assets, weak internal controls, politics, reporting selected ratios in annual reports, may still not be detected and reported by external auditors.

 

 

Misconception 6: External audit is a confirmation that the operations of a company are being conducted most efficiently and effectively.

Reality: An external audit is not an efficiency check on the operations of the company. A statutory external audit is about providing an opinion on the financial statements. There are separate categories of operational audits which are available to assess operational efficiency. For example, how much material is being wasted during production? How much time is extra being consumed during the hiring process? What are the critical elements missed out in a strategy formulation? Which contracts were awarded to close relatives? Etc. Such instances are not usually reported in a statutory external audit report. A specific operational or fraud investigation audit may be used for such conditions.

Misconception 7: A good external audit report indicates a good management strategy of the organization

Reality: An external audit is not usually about checking the strategic direction of the organization. Did the organization select the best product mix? How successful was the innovation process during the year? What improvements are brought in the customer service? Has hiring and retaining employees improved? How well the company competed in the market? These items are usually not on the agenda of the external auditor.

Misconception 8: A clean audit report means that the company’s chances of success and future profits are high

Reality: Many companies go bankrupt or liquidated even after having a clean audit report. Does it mean that their auditors were not competent? Or they did not perform their responsibilities with honesty? No, it doesn’t say that. It’s because it’s not on the auditor’s part to ensure that a company remains successful and profitable.

Misconception 9: A clear external audit report from external auditors means that the company is paying its taxes correctly

Reality: Statutory audits are not detailed testing of the tax calculation of the company. Instead, external auditors would make a quick analytical assessment of the taxes and whether they seem to be correctly reported. It is not a detailed, line-by-line checking of the tax returns ensuring that all the items are correctly calculated and reported and that the tax laws have been correctly and fully interpreted in the preparation and submission of tax returns.

Misconception 10: External auditors claim that their report is a guarantee of accurate financial reporting.

Reality: External auditors never claim that their report on the financial statement is a guarantee that the financial affairs of the company have been correctly and accurately reported. In fact, they mention in their description that it is the responsibility of the management to prepare and present financial statements correctly. External auditors only provide an opinion about the financial statements, whether, in their opinion, the financial statements of the company are presenting a true or fair view or not.

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[vc_row][vc_column][vc_column_text]Trade receivables are one of the risky areas in an audit assignment, and it should be tackled professionally and tactfully. There might be a high risk for the overstatement of trade receivables to enhance current assets and the corresponding growth in sales.

As an auditor, first, you need to identify what are the audit risks in trade receivables (debtors) balances and then devise suitable audit procedures to handle these audit risks.

 

Identification of audit risks on trade receivables

Let’s list out possible audit risks in trade receivables as follows, remember to use ‘what could go wrong’ (WCGW) methodology and generate as many risks as possible in the given circumstances:

1. Trade receivables stated in the balance sheet may be fictitious and non-existent in reality.
2. Trade receivables balance provided by the management may be artificially increased to show higher current assets and higher revenue.
3. Party-wise break-up of receivables might not be available.
4. Sum of closing balances of individual accounts might not be reconciled with the debtors’ control account total.
5. The ageing of the trade receivables may not be provided at all.
6. Ageing of trade receivables figures may not be calculated correctly or maybe deliberately distorted.
7. Other receivables and prepayments might have been wrongly classified as trade receivables.
8. Some expenses might have been incorrectly classified as trade receivables instead of booking in profit & loss.
9. Opening balances in the current year may not be matching with the closing balance of the previous accounting period.
10. A payment made to a creditor’s account might not have been correctly booked in the creditor’s account; rather, it might have been booked as a receivable debit balance.
11. The receivable balances might be outstanding for long, and thus provision is required.
12. A receivable related to the next accounting period may be booked in the current accounting period or a receivable pertaining to the current accounting period may be booked in the next accounting period.
13. Provision for doubtful and bad debts might not be correctly calculated and booked.
14. There is a risk that the amount received from receivables is not recorded in the company’s books and the accounts receivables still show outstanding balances.
15. A consistent methodology is not used for calculation of the provision for bad and doubtful debts.
16. Certain long outstanding old receivables might have been netted off against trade payables.
17. Proper segregation of duties may not exist. For example, if the same person is performing any two or more of following responsibilities, i.e., receipting money, preparing bank reconciliation statement, issuing invoices to the customer, depositing money in the bank accounts etc.
18. There might be some logical error in the system, and the ageing report is not correctly generated.
19. Receivables might have been booked before conditions of revenue recognition are met in compliance with applicable accounting standard (like IFRS 15 or IFRS 17).

 

 

Audit procedures on trade receivables

Well, once you have identified what could go wrong, i.e., audit risks on trade and accounts receivables, it would be relatively easy to devise suitable audit procedures to tackle these risks. Audit procedures should be designed to target audit risks. Each audit procedure should help in catering one or more audit risks, partially or fully.

Below are possible audit procedures for auditing trade receivables:

1. Obtain a list of trade receivables, party-wise balances and their respective ageing.
2. Obtain a schedule of provision for bad and doubtful debts, broken down into party-wise provisions.
3. Review the increasing or decreasing trend of the receivables with previous accounting periods and assess if it is in line with the general economic environment and the company’s financial performance.
4. Perform substantive analytical procedures to understand the trends and critical movements in the balances of trade receivables.
5. Inquire with the management on the significant variances (if any) in the movement of trade receivables.
6. Send balance confirmation letters to a selected sample of receivables.
7. Check subsequent positioning of the receivables, i.e., check the movement in the balance after the reporting date but before audit report issuance.
8. Keep a sharp eye on any reversals passed after the reporting period.
9. Check for any dishonoured cheques of material amounts subsequent to closing period.
10. Propose adjustment entries in the receivables balance to the management of the company.
11. Critically analyze the assumptions used for the calculation of the provision for doubtful receivables. Use the historical trends, industry practice and subsequent collection details in your assessment.
12. Perform cut-off procedures to ensure that receivables are reported in the correct accounting period.
13. Critically inquire the reasoning of the change of the provisioning policy, ensuring that the management duly approved the policy.
14. Carefully review the movement of any long outstanding balances ensuring that the collection is made and the balance is not just netted off against any payable balance.
15. Perform a system check on the ageing report generated from the system, take help of I.T team if required to ensure that the system is calculating ageing correctly.
16. Check if receipts are daily reconciled with the amounts collected in cash and bank.
17. Check if the cash collection option is limited to authorized individuals only, and a proper reconciliation is prepared.
18. Inquire if a receipt is issued against each collection ensuring that no collection remains unaccounted in the books of the accounts of the company.
19. Check that opening balances of receivables and provision for doubtful debts are correctly brought forward in the current accounting period.
20. Match the balances of the trade receivables break-up and the provision break-up with the financial statements and the notes to the financial statements.

 

Ageing of receivables

Ageing of trade receivables is the break-up of balances by the number of days with which it is outstanding. For example, if a customer purchased goods worth $1,000 one year ago, and then he purchased another goods of $500 three months ago and did not pay both of these amounts as at the closing date, in that case the ageing of this receivable would $1,000 above 365 days and $500 above 90 days and the total outstanding would be $1,500.

 

 

Audit documents related to trade receivables

Below is the list of documents which are usually standard in the process of auditing trade receivables:

1. Process document detailed understanding of the receivables cycle
2. Management’s policy document containing policy for receivables collections and provisioning
3. Confirmation letters for debtors
4. Post-dated cheques received from customers
5. Bank reconciliation statements and bank statements
6. General ledgers of receivables and bank accounts
7. Cut-off testing document

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[vc_row][vc_column][vc_column_text]Auditing is a vast subject, has a massive impact on our society and plays a pivotal role in regulating the economy. It is a broad field, and some people in the profession of accounting & finance spend their entire life performing audits — others who don’t still spend plenty of time for auditing or related items. Auditing is so popular that even non-finance people also come across this subject from time to time, during their work.

Mastering the art of auditing would require years of experience, deep learning passion, and spending numerous hours concentrating on the audits. You need to stay away of all distractions and always keep thinking about “what could go wrong” or “what is the audit risk” or “what is the control risk” related to this assignment. If you are choosing the auditing as a profession, you have to question every item and assess that item’s impact on financial statements.

 

 

An auditor would assess the impact of transactions on the underlying financial statements. He/she will do it by trying to link a transaction with the financial statements. For example, how sales impact financial statements? What will be the impact of renovation going on the office on the financial statements? What is the audit risk in the new car purchased by the CEO? What is the control risk in selecting a supplier for awarding construction of new office building? What is the inherent risk in the outsourcing of call center?

The mind of an active and ambitious auditor would always seek clarifications. He would question every transaction, every process, every deal, every event and every system, all with scepticism. He would link all these items with the financial statements of the organization and vice versa. Does he see the building of the audit client on the balance sheet of the company? Can he trace back the rental income in the profit and loss account? Can he link the increase in the staff with the increase in the payroll cost during the year?

Many people enjoy auditing as it would provide the opportunity to visit different companies. An audit manager would be handling around 30-40 clients in a year, depending upon the size of the firm and the economy in which he operates. Visiting different companies, meeting with a variety of people, reviewing multiple accounting systems and assessing business risks of different sectors is a fascinating, challenging and skillful job. Auditing will expose you to various industries like real estate, retail, FMCG, manufacturing, oil & gas etc. This variety is quite fantastic and exciting.

 

 

To commence the career as an auditor, you usually need to join as an audit trainee or audit associate in an audit firm. Mostly audit firm provides three years or five years of training programs. You can also continue your studies during this training period.  The hierarchy in an audit firm would be something like audit associate, semi senior associate (or associate 2) and senior associate (or associate 3), audit supervisor, audit manager, senior manager, audit director and then audit partner.

Many external auditors prefer to stay in the audit firm for an extended period and seek to become audit partners in the audit firm. Usually, an audit partner is the highest rank in the field of external auditing. Some partners are further promoted later to the level of the senior partner or managing partner. Many people choose to move out of an audit firm during different stages of their audit career. The move is usually into some company. If a person moves from audit practice to join a company in their accounts/finance team, they call it a ‘career in the industry’.

Auditing as a career is quite promising; it provides a career ladder, a stable job and a continuous learning curve. General public considers auditors as people of high integrity and excellent ethical standards. A career as an external auditor would lead to respect in society and would strengthen your network.[/vc_column_text][/vc_column][/vc_row]