The value added by external auditing

An external audit provides reasonable (but not absolute) assurance that the financial statements of the entity being audited are free from material misstatement. However, external auditing is often seen as costly and of no practical value to businesses. This is particularly prevalent in small to medium-sized businesses. The change in the Companies Act has also removed the requirement for all companies to be audited which resulted in a number of companies choosing to save costs and rather opt for an independent review or less (if owner managed).

How can external audit perform its mandate and still add value?

External auditors are appointed by the shareholders and as such report to them when issuing their audit report. They are however required by the auditing standards to report deficiencies in internal control to those charged with governance and management. The auditor may consider matters such as the susceptibility of the related assets to loss or fraud or the likelihood of deficiencies leading to material misstatement of the financial statements in the future. This is especially valuable to smaller entities who have fewer employees and segregation of duties are thus impractical. The auditor can assist by suggesting certain controls to improve management oversight of the finance function.

Business owners and managers tend to align themselves with people who choose their side and agree with them all the time. This is not ideal for business as it creates an atmosphere where new ideas are discouraged or a process that is not serving the business well is not questioned. External auditors can be valuable to uncover fraudulent or inefficient practices and make suggestions for improvement. They can add value to a company in this instance as they are tasked to find areas where certain risks are not addressed and will not be afraid to approach a client with potential bad news.

The auditor is required to obtain a very good understanding of the laws and regulations applicable to the business in order to provide an audit opinion. This puts the auditor in a position to be able assist with compliance or determine certain potential issues with non-compliance, which could avoid possible penalties.

Furthermore audited financial statements assure management that their current numbers are not materially misstated, which makes it easier to budget and forecast the future performance of the entity as they have assurance about the starting point. The audited financial statements are thus not just a record of what happened in the past but could assist to plan for the future.

For the reasons mentioned above the items discussed in the management report issued by the auditor to those charged with governance should be considered the most important communication received from the auditor. Therefore it is important to align your business with someone who realises the power behind understanding your business in order for it to realise its full potential.

Rudolph Harms

Audit Manager | Cape Town

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