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  The Audit Process

Introduction to the Audit Process

External audit

External audit forms an important element of corporate governance. To understand what it involves we must first be apparent about the roles and responsibilities of directors and auditors concerning the published financial statements.

As we saw earlier, company law requires that the directors prepare annual financial statements that provide a true and fair view of the state of affairs of the company. This will include

  • selecting appropriate accounting policies and applying them consistently;
  • making estimates and judgements which are prudent and practical;
  • stating whether suitable accounting standards have been adopted; and
  • applying the going concern convention in which it is suitable to do so.

The annual financial statements must be published and made available to shareholders, lenders and others. In addition to preparing the annual financial statements, the law also compels the directors to keep proper accounting records and to safeguard the assets of the company.

External auditors are appointed through, and report to the shareholders. They are generally an independent firm of accountants and their role is to examine the annual financial statements prepared by the directors. They must assess the reliability of these statements by examining the underlying accounting records and by reviewing the key assumptions and estimates used in their preparation. Following this, the auditors will provide shareholders with an independent opinion as to whether the financial statements provide a true and fair view of the state of affairs of the company and comply with legal and other regulatory requirements. This opinion is contained within an audit report, which becomes part of the published annual report.

The external auditors have to notify shareholders of any significant problems that have been unearthed during the audit process and so the audit report must include instances where

  • Proper accounting records must not been kept;
  • Information and explanations needed to undertake the audit have not been received;
  • Information specified by the law or by regulatory bodies, such as the UK listing authority, has not been disclosed; and
  • The directors' report contains information that is inconsistent with the financial statements.

For companies listed on the London Stock Exchange, the auditors must also review the corporate governance statement that is also prepared through the directors, to see whether it complies with the provisions of the UK Corporate Governance Code. Where the auditors have no concerns over the reliability and integrity of the financial statements, an 'unqualified' opinion is given that should lend credibility to the statements.

Internal audit

Many large companies have an internal audit function, although there is no legal requirement to have one. The main purpose of internal audit is to provide the directors with reassurance concerning the reliability of the company's control and financial reporting systems. Internal auditors are employees of the company and so do not have the same independence as external auditors. They will generally report to the directors, who will determine the nature and scope of the internal audit.

Although some variation will be found in practice, internal audit will usually involve a review of

  • Internal control systems to observe whether they are effective in safeguarding the company's assets and in preventing errors and fraud;
  • The accounting systems to see whether they provide reliable information, which meets the needs of management and complies with relevant regulations;
  • Internal processes and operations to observe whether they are efficient and provide value for money.

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