Why does an entity need to have an independent audit firm report on its financial statements?

Amendments: Amending releases and related SEC approval orders

Summary Table of Contents

.01        The objective of the ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations, and its cash flows in conformity with generally accepted accounting principles. The auditor's report is the medium through which he expresses his opinion or, if circumstances require, disclaims an opinion. In either case, he states whether his audit has been made in accordance with the standards of the PCAOB. These standards require him to state whether, in his opinion, the financial statements are presented in conformity with generally accepted accounting principles and to identify those circumstances in which such principles have not been consistently observed in the preparation of the financial statements of the current period in relation to those of the preceding period.

Distinction Between Responsibilities of Auditor and Management

.02        The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.1 Because of the nature of audit evidence and the characteristics of fraud, the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected.2 The auditor has no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud, that are not material to the financial statements are detected. 

.03        The financial statements are management's responsibility. The auditor's responsibility is to express an opinion on the financial statements. Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The entity's transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management. The auditor's knowledge of these matters and internal control is limited to that acquired through the audit. Thus, the fair presentation of financial statements in conformity with generally accepted accounting principles3 is an implicit and integral part of management's responsibility. The independent auditor may make suggestions about the form or content of the financial statements or draft them, in whole or in part, based on information from management during the performance of the audit. However, the auditor's responsibility for the financial statements he or she has audited is confined to the expression of his or her opinion on them. 

Professional Qualifications

.04        The professional qualifications required of the independent auditor are those of a person with the education and experience to practice as such. They do not include those of a person trained for or qualified to engage in another profession or occupation. For example, the independent auditor, in observing the taking of a physical inventory, does not purport to act as an appraiser, a valuer, or an expert in materials. Similarly, although the independent auditor is informed in a general manner about matters of commercial law, he does not purport to act in the capacity of a lawyer and may appropriately rely upon the advice of attorneys in all matters of law. 

.05        In the observance of the standards of the PCAOB, the independent auditor must exercise his judgment in determining which auditing procedures are necessary in the circumstances to afford a reasonable basis for his opinion. His judgment is required to be the informed judgment of a qualified professional person. 

Detection of Fraud

[.06-.09]        [Paragraphs deleted.]

Responsibility to the Profession

[.10]        [Paragraph deleted.]

.11 The auditor should be aware of and consider auditing interpretations applicable to his or her audit. If the auditor does not apply the auditing guidance included in an applicable auditing interpretation, the auditor should be prepared to explain how he or she complied with the provisions of the auditing standard addressed by such auditing guidance.

Note: The term "auditing interpretations," as used in this paragraph, refers to the publications entitled "Auditing Interpretation" issued by the American Institute of Certified Public Accountants' Auditing Standards Board as in existence on April 16, 2003, and in effect.

The purpose of an audit is to obtain an independent opinion on the financial statements of a business or organisation.

Specifically, auditors establish whether the financial statements are fairly presented and in accordance with generally accepted accounting principles.

Auditing promotes consistency and objectivity in financial reporting, and helps outside parties to be sure that the financial statements are true and fair.

Here are some examples of when an audit may be required:

As a regulatory requirement

Certain types of entities must have their financial reports audited by a registered auditor.

According to the Australian Securities and Investment Commission (ASIC), a company (other than a small proprietary company), registered scheme (managed investment scheme) or disclosing entity (a body that holds enhanced disclosure securities) must have its annual financial report audited.

Medium-sized charities with annual revenue of more than $250,000 must have their financial statements reviewed or audited, while organisations that fall under the Incorporated Association Act and large charities with annual revenue of more than $1 million must have their financial reports audited.

An audit may be required in certain industries due to regulation – for example, for manufacturers supplying products to the government.

When a company is deemed ‘large’

When a company becomes a large proprietorship, they must be audited, under the Corporations Act.

As of 1 July 2019, the Australian Securities and Investments Commission (ASIC) defines a proprietary company as being “large” if, at the end of the financial year, the company and any entities it controls meets two of the below three criteria:

• A consolidated revenue of $50 million or more
• Consolidated gross assets of $25 million or more, and
• 100 or more employees.

To obtain a grant or investment

If companies or charities are seeking a government grant, they may have to undertake an audit.

The government will need proof that the figures in their financial statements are true and fair.

If your business is seeking investment, an independent audit may also add credence to your proposal.

To qualify for a loan

Lenders require an audit of financial statements if a business wants a loan. This is to protect them and verify the figures within the financial statements are accurate.

If you plan to sell the business

If you’re planning to sell your business, potential buyers want to be able to rely on your financial data, so it’s a good idea to have your financial statements audited. Auditing adds value to your business.

Need help with an audit?

At LDB, we are experienced in providing audit advice to a broad range of clients, from public companies to large and small private companies and not-for-profits.

To find out more about how we can help your business with an audit, call on (03) 9875 2900 or fill in the contact form below.

Editor’s note: This article was originally published in March 2017 but has since been updated to include new information.

There is flexibility in the order of the remaining sections of the Auditor’s Report.  The Australian Auditing Standards provide guidance on the order with the overall principle being to give prominence to the matters of most importance.  The order of content in ASA 700 Forming an Opinion and Reporting on a Financial Report and the illustrative Auditor’s Reports are structured to achieve this, and it is advisable that this order is followed.  Refer to question 5 for further details.

Auditor’s opinion

The auditor’s opinion no longer includes an opinion on compliance with IFRS.  This requirement was considered redundant in view of changes to the Corporations Act 2001 which now requires that the director’s declaration includes a statement of compliance with IFRS (Corporations Act 2001 section 295 (4)).

Key Audit Matters (KAMs)

- Auditors of listed entities now include information in respect of those matters which in their judgement, were of most significance in the audit of the financial report in the current year.
- Auditors of non-listed entities can elect to include KAMs but are not required to do so.

Refer to questions 8-17 for further details.

Other information

More detail is provided on the director’s and auditor’s responsibilities in respect to other information, and on the status of the auditor’s consideration of other information, at the date of the Auditor’s Report.  Other information is financial and non-financial information included in the Annual Report (excluding the financial report and Auditor’s Report thereon).  This is included in the Auditor’s Report under a heading ‘Other Information’ or other appropriate heading.

For listed entities, the Auditor’s Report now details the other information received and information that has not yet been received at the date of the Auditor’s Report.
For non-listed entities, the Auditor’s Report details the other information received at the date of the Auditor’s Report.  There is no requirement to detail other information not received at the date of the Auditor’s Report.

For non-listed entities, if at the date of the Auditor’s Report no other information has been received, the Auditor’s Report does not include an ‘Other Information’ section.  As the other information includes the Director’s report, it is unlikely to be common that some other information has not been received at the date of the Auditor’s Report.

Refer to questions 21-25 for further details.

Management’s responsibilities

This is reported using the heading ‘Responsibilities of Management (ASA 700, paragraphs 33-35 The heading is modified to reflect who is responsible for the preparation of the financial report, and the oversight of the financial reporting process.  This may be management, those charged with governance and / or directors.  If the individuals responsible for the oversight of the financial reporting process are different to those responsible for the preparation of the financial report the heading includes both parties.) for the Financial Report’ (or for Corporations Act 2001 entities this would refer to ‘Directors’).

There are additional details on the responsibility of management/the directors for assessing whether the use of the going concern basis of accounting is appropriate, and whether any relevant disclosures are adequate.  These responsibilities are not new, but are now described in the Auditor’s Report.

Auditor’s responsibilities

The auditor’s responsibilities section has been expanded to provide more information about the key features of an audit.

This section is no longer ‘boiler plate’ across all audits and is amended depending on whether or not:

- the entity is a single entity or a group- the entity is a listed entity or non-listed entity- the auditor is communicating KAMs- the entity uses a fair presentation or compliance framework in the financial report- the audit is a group audit

- the auditor is issuing a qualified opinion.

New options are now available to present parts of the auditor’s responsibility section (ASA 700, paragraph 41):

- within the body of the Auditor’s Report (as is current practice)- within an appendix to the Auditor’s Report with a reference in the Auditor’s Report to the appendix

- or by including a reference within the Auditor’s Report to the relevant page on the Australian Auditing and Assurance Standards Board (AUASB) website (www.auasb.gov.au/Home.aspx). 

ASA 700 stipulates that the Australian Auditing and Assurance Standards Board website is the only website to which reference can be made (ASA 700, paragraph Aus A57.1).

Refer to questions 19-20 for further details.

Going concern

There is an expanded description of the responsibilities of directors/management and the auditor in relation to going concern which is mandatory for all Auditor’s Reports.  These responsibilities are not new, but are now included for the first time in the Auditor’s Report.

If there are events or conditions that cast significant doubt on an entity’s ability to continue as a going concern, there are changes to the way this is reported:

- If the auditor concludes that a material uncertainty exists and disclosure within the financial report is adequate, the auditor expresses an unmodified opinion and the Auditor’s Report includes a separate section headed ‘Material Uncertainty Related to Going Concern’ instead of the previous ‘Emphasis of Matter’ paragraph.  In this scenario it is not described in the KAM section if a listed entity.
- If the auditor concludes a material uncertainty does not exist and there is adequate disclosure in the financial report, in the case of a listed entity this is likely to be reported as a KAM as it is likely that it was a matter of most significance to the audit.  This is often referred to as a ‘close call’ situation.  If the entity is not listed and the auditor is not communicating KAMs, the matter is not reported in the Auditor’s Report.

Refer to questions 26-27 for further details on going concern.