Sunday, May 11, 2014

Advantages and Limitations of Auditing

Adavantages of Auditing

A. Benefits of Business: Business may get many advantages of conducting audit by a qualified auditor. The advantages are discussed below:

(a) True and Fair view: With the help of audit of accounts, it is possible get a true and fair view of the financial position of the business.

(b) Detection of errors and frauds: If books of accounts are audited, errors and frauds can be detected and necessary action can be taken to prevent it.

(c) Moral pressure on the employees: If audit is conducted by the organization, employees should be cautions and there should be a moral pressure on them. As a result, chances of errors and frauds will be minimized.

(d) Proper accounting control: A system of regular audit helps the organization to maintain proper books of accounts regularly and books of accounts are kept up to date.

(e) Acceptable evidence: Audited accounts are very strong financial document acceptable to many interested parties e.g. taking loan from financial institution, determination of income tax, sales tax, amalgamation of companies, determination of purchase consideration, admission, retirement, death of a partner etc.

(f) Increase in goodwill: Audit of business on a regular basis increases confidence to the interested parties and general public. As a result goodwill of the business increases.

B. To the Owner: The owners of the business are also interested to know the financial position of the business. There are discussed below:

(a) Benefit to the sole proprietor: In case of large business, the proprietor can get a true and fair view of the accounts maintained by his employees and also able to know the state of affairs and profit made by him. The proprietor is also benefited for getting loan from financial institutions, to pay income tax etc.

(b) Benefits to the partners: Shareholders are the owners of a company. With the help of audited accounts help to the partners to settle their unsettled disputed, for taking loan from financial institutions, to get off the books of accounts maintained by the employees etc.

(c) Benefits to the shareholders: Shareholders are the owners of a company. With the help of audited accounts they get a real picture of the financial position of The company and they can assure that business is running efficiently.

(d) Benefit to the non-profit seeking organizations: There are different non-profit seeking organizations e.g., charitable institution, club, religious institute, school, college etc. This organization run with public money. Whether public money is properly utilized or not can be revealed from the audited accounts.

C. To the third parties: Besides business and the owners, there are different outside interested parties who required audited accounts for different purposes: These are:

(a) Government may be interested to get the audited accounts to show the deficiency of the business for giving grant and subsidy.

(b) Financial institutions sections loan to the organization on the basis of verification of financial soundness form the audited accounts.

(c) Tax authorities may depend on audited accounts for determination of income tax, sales tax, excise duty etc.

(d) Prospective buyers who want to invest money in shares and debentures of a company may rely on audited accounts.

(e) Creditors who supply goods to the business may asses the solvency and liquidity position of the business on the basis of audited accounts.

(f) For settlement of insurance claim, insurance companies can barely on audited accounts.

Inherent Limitations of Auditing
                The objective of an audit of financial statements is to enable an auditor to express an opinion on such financial statements which helps in determination of the true and fair view of the financial position and operating results of an enterprise. But such expression by the auditor is neither an assurance as to the future viability of the enterprise nor the efficiency or effectiveness with which management has conducted affairs of the enterprise. Further, the process of auditing is such that it suffers from certain inherent limitations, i.e., the limitation which cannot be overcome irrespective of the nature and extent of an audit procedure. The inherent limitations are:

                I. First of all, auditor’s work involve exercise of judgment, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgment and estimates made by the management in preparing the financial statements. Further much of the evidence available to the auditor can enable him to draw only reasonable conclusions there from. The audit evidence obtained by an auditor is generally persuasive in nature rather than conclusive in nature. Because of these factors, the auditor can only express an opinion. Therefore, absolute certainty in auditing is rarely attainable. There is also likelihood that some material misstatements of the financial information resulting from fraud or error, if either exists, may not be detected.

                II. The entire audit process is generally dependent upon the existence of an effective system of internal control. Further, it is clearly evident that there always be some risk of an internal control system failing to operate as designed. No doubt, internal control system also suffers from certain inherent limitations. Any system of internal control may be ineffective against fraud involving collusion among employees or fraud committed by management. Certain levels of management may be in a position to override controls; for example, by directing subordinates to records transactions incorrectly or to conceal them, or by suppressing information relating to transactions. Such inherent limitations of internal controls system also contribute to inherent limitations of an audit.

Generally following are the Limitations of auditing

1. Non-detection of errors/frauds:- Auditor may not be able to detect certain frauds which are committed with malafide intentions.

2. Dependence on explanation by others:- Auditor has to depend on the explanation and information given by the responsible officers of the company. Audit report is affected adversely if the explanation and information prove to be false.

3. Dependence on opinions of others:- Auditor has to rely on the views or opinions given by different experts viz Lawyers, Solicitors, Engineers, Architects etc. he can not be an expert in all the fields

4. Conflict with others: - Auditor may have differences of opinion with the accountants, management, engineers etc. In such a case personal judgement plays an important role. It differs from person to person.

5. Effect of inflation : - Financial statements may not disclose true picture even after audit due to inflationary trends.

6. Corrupt practices to influence the auditors :- The management may use corrupt practices to influence the auditors and get a favourable report about the state of affairs of the organisation.

7. No assurance :- Auditor cannot give any assurance about future profitability and prospects of the company.

8. Inherent limitations of the financial statements :- Financial statements do not reflect current values of the assets and liabilities. Many items are based on personal judgement of the owners. Certain non-monetary facts can not be measured. Audited statements due to these limitations can not exhibit true position.

9. Detailed checking not possible :- Auditor cannot check each and every transaction. He may be required to do test checking.