Understanding Business Accounting For Dummies, 2nd Edition (115 page)

Bentley Jennison

These guys bob up and down and, on occasion, even dip out of the top spots in this list. Accountancy Age (
www.accountancyage.com/resource/top50
) keeps tabs on their movements each year.

Though these ten are pretty big bears, their combined fee income is less than that of Ernst & Young, the smallest of the Big Four.

The firms are legally organised as limited liability partnerships, so you see LLP after their names. The big four international accountancy firms and a handful of those in the second tier audit almost all of the large, public corporations in the UK and the US. For these corporations the annual audit is a cost of doing business; it's the price they pay for going into public markets for their capital and for having their shares traded in a public marketplace - which provides liquidity for their shares.

Banks and other lenders to closely held businesses whose ownership shares are not traded in any public marketplace may insist on audited financial statements. We would say that the amount of a bank loan, generally speaking, has to be more than £5 million or £10 million before a lender will insist that the business pay for the cost of an audit. If outside, non-manager investors - for example venture capital providers or business angels - have much invested in a business, they will almost certainly insist on an annual audit to be carried out by a substantial firm such as those listed earlier.

Instead of an audit, which they couldn't realistically afford, many smaller businesses have an outside accountant come in regularly to look over their accounting methods and give advice on their financial reporting. Unless an accountant has done an audit, he or she has to be very careful not to express an opinion of the external financial statements. Without a careful examination of the evidence supporting the account balances, the accountant is in no position to give an opinion on the financial statements prepared from the accounts of the business.

In the grand scheme of things, most audits are a necessary evil that do not uncover anything seriously wrong with a business's accounting system and the accounting methods it uses to prepare its financial statements. Overall, the financial statements end up looking virtually the same as they would have looked without an audit. Still, an audit has certain side benefits. In the course of doing an audit, an accountant watches for business practices that could stand some improvement and is alert to potential problems. And fraudsters beware: Accountants may face legal action if they fail to report any dodgy dealings they discover.

The auditor usually recommends ways in which the client's
internal controls
can be strengthened. For example, an auditor may discover that accounting employees are not required to take holidays and let someone else do their jobs while they're gone. The auditor would recommend that the internal control requiring holidays away from the office be strictly enforced. Chapter 2 explains that good internal controls are extremely important in an accounting system. Also, in many audits that we've worked on, we caught several technical errors that were corrected, and we suggested minor improvements that were made - the end result being that the financial statements were marginally better than they would have been without the audit.

What an Auditor Does Before Giving an Opinion

An auditor does two basic things:
examines evidence
and
gives an
opinion
about the financial statements. The lion's share of audit time is spent on examining evidence supporting the transactions and accounts of the business. A very small part of the total audit time is spent on writing the auditor's report, in which the auditor expresses an opinion of the financial statements and footnotes.

This list gives you an idea of what the auditor does ‘in the field' - that is, on the premises of the business being audited:

Evaluates the design and operating dependability of the business's accounting system and procedures.

Evaluates and tests the business's internal accounting controls that are established to deter and detect errors and fraud.

Identifies and critically examines the business's accounting methods - especially whether the methods conform to generally accepted accounting principles (GAAP), which are the touchstones for all businesses.

Inspects documentary and physical evidence for the business's revenues, expenses, assets, liabilities, and owners' equities - for example, the auditor counts products held in stock, observes the condition of those products, and confirms checking account balances directly with the banks.

The purpose of all the audit work (examining evidence) is to provide a convincing basis for expressing an opinion of the business's financial statements, attesting that the company's financial statements and footnotes (as well as any directly supporting tables and schedules) can be relied on - or not, in some cases. The auditor puts that opinion in the auditor's report.

The auditor's report is the only visible part of the audit process to financial statement readers - the tip of the iceberg. All the readers see is the auditor's one-page report (which is based on the evidence examined during the audit process, of course). For example, Deloitte & Touche spend thousands of hours auditing General Motors, but the only thing that GM's shareholders see is the final, one-page audit report.