The audit is simply a process by which auditors check the company’s math and application of accounting rules. Most of the investors take audited financial statements as major consideration to invest in a company. But by doing so it leads them to false sense of security when examining the audited frauds. Following are some of the common issues to say why a audited financial statement could not be true.
- Auditors only examine small samples of transaction
The heart of an audit is testing transactions. The auditors select a sample and test those transactions to ensure that they were properly recorded in the accounting system. The inherent limitation in sampling is that all transactions are not tested. And of course, it would not be possible for the auditors to examine all transactions a company enters into in a year.
There is always a good chance that a key transaction will not be part of the auditors’ sample, and therefore will not be examined. So many transactions are untested by the auditors, and that means there is a very good chance that a fraudulent item will not be part of the testing.
2. Auditors may be inexperienced
The current business model for audit firms (and the one that has been in place for decades) relies on relatively inexperienced auditors to do the bulk of the field work. While this may make economic sense in terms of controlling the costs of audits, it is a terrible practice from a quality control standpoint.
Most of the inexperienced auditors tend to not ask difficult questions because of their lack of experience. Those who have the knowledge to identify problems and ask difficult questions spend very little time in the field. They are best equipped to zero in on fraud, yet they provide little hands-on supervision of the inexperienced auditors.
3. Audit process are lagging with the dynamic nature of business
Given the dynamic nature of a business through mergers and acquisitions, development of new products and services, and constant strategic planning all mean that business is changing faster than ever. Comparing the financials of a company from year to year becomes nearly impossible because of all the changes. Therefore audit process has to catch up with the dynamic nature of frauds risks.
We can point out many of such similar issues surrounding why a audited financial should not be a major consideration in investing on a company, but what we need to understand is that traditional financial statement audits were never designed to detect fraud. However, sometimes fraud is detected by auditors, and they can increase their chances of finding fraud if they are so inclined and diligent.
Source: http://www.sequenceinc.com/fraudfiles/2013/06/escaping-detection-why-auditors-do-not-find-fraud/
An unqualified Audit Report by a reputable Auditor carries tremendous importance to an investor. Yes, there are other factors that will play into the decision whether or not to invest, but that 3rd party opinion in the Audit Report and the work that goes into it provide a great deal of security. I do agree that Auditors have no guarantee in detecting fraud in their work, but scrapping the Audit report in my opinion would be a big mistake.
I agree with dthomas that we can’t scrap the Audited Financial Statement because that at least require companies to uphold certain rules by law. However, investors should not reply 100% on audited financial statement as we have seen many frauds which was made by the cooperation of independent auditors and company’s executives. Investors should analyse the financial statements themselves and make a call if the auditors’s opinion makes sense to them.