Audits - a waste of money?

The following story is courtesy of Fropki.com (http://www.fropki.com/real-talent-auditor-vt42816.html): “Once upon a time there was a shepherd looking after his sheep on the side of a deserted road. Suddenly a brand new Porsche screeches to a halt.

The driver, a man dressed in an Armani suit, Cerutti shoes and wearing Ray-Ban sunglasses a TAG-Heuer wrist-watch and a Pierre Cardin tie gets out and asks the shepherd, 'If I can tell you how many sheep you have, will you give me one of them?'

The shepherd looks at the young man, then looks at the large flock of grazing sheep and replies, 'Okay.' The young man parks the car, connects his laptop to the mobile-fax, enters a NASA Website, scans the ground using his GPS, and opens a database of 60 Excel tables filled with algorithms and pivot tables. He then prints out a 150-page report on his high-tech mini-printer, turns to the shepherd and says, 'You have exactly 1,586 sheep.' 

The shepherd cheers, 'That's correct, you can have your sheep.' The young man takes one of the animals from the flock and puts it in the back of his Porsche.  The shepherd looks at him and asks, 'If I guess your profession, will you return my animal to me?'  The young man answers, 'Yes, why not?'   The shepherd says, 'You are an auditor.'  'How did you know?' asks the young man. 'Very simple,' answers the shepherd. 'Firstly, you came here without being wanted. Secondly, you charged me a fee to tell me something I already knew. Thirdly, you don't understand anything about my business..... Now can I have my dog back?’

Whilst I know this story isn’t really funny (I wasn’t rolling on the floor laughing) yet it’s supposed to be; and I am pretty sure it’s not based on a true story (auditors have no idea what Cerutti shoes are), it does raise a valid question - is the money you pay for an audit justifiable or necessary?  Before you decide one way or the other, there are a few things you should bear in mind...

What is an audit?
A financial audit is defined as the verification of the financial statements of a legal entity, with a view to express an audit opinion. The audit opinion is a reasonable assurance that the financial statements are presented fairly, in all material respects, in accordance with the financial reporting framework. The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements.

Basically an audit is done to give the people who rely on an organisation’s financial statements comfort that they can rely on the financial statements to understand the organisation’s financial performance, to give them insights into the organisation’s viability and to allow them to draw comparisons with other organisations.

What an audit is not!
An audit is not a guarantee that ...

•  the financial records (and the financial statements in particular) are 100% correct;
•  the financial statements are free of misstatement;
•  fraud and theft have not taken place;
• collusion (two or more employees or parties related to the legal entity working together) with the intent to commit fraud and theft is not present in the organisation.

Furthermore:

• The generation of the annual financial statements for the legal entity is not an audit function - even though it is sometimes performed by the same persons who conduct the audit.
• Compliance with tax laws is also not an audit function.

This should tell you three things at least:

1. Any funnies performed by staff may never be detected by an audit - it’s your responsibility alone to ensure that this isn’t happening.
2. The job you’re paying your auditors for should be clearly understood and broken down into the various service offerings you are receiving - audit vs. financial statement drafting vs. tax compliance.
3. With a decent bookkeeper and practice management system, you should be able to reduce your audit costs - less work for your auditors to do should equate to you being charged a lower fee.

The audit process
Generally the audit process entails the following phases:

1. Engagement - this is where the auditor gets to understand your business.
2. Planning - during this phase the auditor determines what will be done and how.
3. Testing - here the auditor does his/her substantive and control testing.
4. Concluding - the final phase results in the audit opinion being formed.

If it’s the first time you are being audited or you have new auditors the room for negotiating audit fees down is small. If it’s not and your business has not changed much from the last time your auditors tortured you and your bookkeeping staff, you should be able to get them to reduce the fees, as the engagement and planning phase should take a lot less time.

Changes to the Companies Act have made it possible for some entities that were previously forced to have their books audited to now replace the audit with an independent review. The independent review will be conducted by an independent accounting professional who doesn’t have to be a registered auditor. In theory this should drive costs down. 

It is important to note that eligible entities can still choose to be audited. The benefits of being audited include:

• An audit should be more comprehensive and as such more likely to pick up issues.
• Resources doing the audit should be more skilled than those doing an independent review thereby offering greater value to the organisation. 
• Third parties relying on the financial statements may be more inclined to accept the audit opinion as opposed to the findings of an independent review.
• A review may also not necessarily be quicker or cheaper.

Given what you get from an audit vs. what you pay for it and the changes to the Companies Act, should you go through the pain of having an audit?

In my opinion - you should be honest with yourself in assessing:

• How actively involved you are in the management of your firm.  Looking regularly at the bank account is nowhere near enough involvement. If your management style is “hands-off” you should have an audit done
• Is there a distinction between owners and management of the firm (whilst there shouldn’t be it does happen) - if your firm’s day-to-day management isn’t done· by you, the owner or part owner, having an audit done is a good idea
• How accessible / readily available are reports and operational information to you as a manager? If it’s ad hoc or long after the fact you should have the audit done. Furthermore, with practice management solutions like GhostPractice available to you, you have no reason not to have access to reports and operational information at your fingertips - having such tools at your disposal and using them religiously could reduce your dependence on an audit and help you take real control of your firm.

I believe both audits and independent reviews offer benefits and have drawbacks, but at the end of the day neither absolves you of your duty to actively manage your firm or from employing tools like GhostPractice which will make those duties a lot easier.

If you would like to know more about GhostPractice or how GhostPractice is driving change in the legal industry feel free to call me on 084 586 6789 or email me on kubenn@korbitec.com.