Why Financial Statements Are Audited?

The audit is an engagement held by independent auditors to review the financial statements of a company. The auditor expresses an opinion on whether the financial statements reflect a true & fair view. So, why is it necessary? Why businesses need to get their financial statements audited? Let me simply explain…

Why Financial Statements Are Audited?

Companies are owned by shareholders and run by managers. The shareholders, in most cases, are unaware of the day-to-day trading activities and heavily rely on reports generated by managers. These reports are called financial statements.

If the managers present a report, being unaware of the trading situation of the company, the shareholders will have no option but to accept the profit/loss and other data. But, what if the reports do not reflect the true position? What if the managers are involved in manipulating facts and figures? To add credibility to the financial statements, third-party professionals (Auditors) are hired to review the financial statements.

The need for an audit, however, is not solely giving confidence to shareholders. There are a number of other reasons that compel businesses to get their financial statements audited.

In some countries, like in the USA, publicly traded companies are required by law to get their financial statements audited while some countries have audit exemptions available to small businesses. For example in the UK, an audit exemption is available for companies if TWO out of the following THREE criteria are met.

1. No more than £10.2 million annual turnover
2. Assets worth no more than £5.1
3. 50 or fewer employees on average

Companies use different sources of funds including loans and other payables. In some cases, these amounts will be in millions or even billions of dollars. These suppliers and financial institutions will only be interested in reports that are reviewed by objective third-party professionals. The lenders could even include the requirement of an audit as part of the contract if significant borrowings are involved.

Simply put, companies having audited financial statements are more likely to get credits from suppliers & banks and that is one of the reasons that more and more companies are getting into the habit of auditing despite the availability of the exemption.

• An audit makes the financial statements more credible.
• In some countries, publicly-traded entities are required by law to get the financial statements audited.
• Companies having audited financial statements are more likely to get extended credit periods from suppliers and loans from banks.

Despite a lot of advantages, some companies do not get their financial statements audited. The primary reason for not conducting an audit is its expensive nature. Yes, audits can be expensive; way expensive for small businesses. In addition, it is time-consuming and can disrupt the day-to-day operations of the business.

Small businesses, however, will conduct other assurance engagements, that are much cheaper and quicker than audits and can provide helpful insights.