A firm informs its stakeholders about its revenues, operating expenses, interest and tax expenses, net profit, and other similar information through its financial statements. Suppose you had bought the stock of a firm based on a thorough analysis of its financial statements. A few years later, there is news that the firm had used fraudulent accounting to report fictitious revenue, which vastly overstated its profit. Following this, the firm goes bankrupt and you end up losing the money that you had invested in the firm’s stock. Wouldn’t it be awful to lose your hard-earned money just because you relied on information that you had expected to be accurate. It is therefore imperative that the users of financial statements feel assured that the information in the financial statements is accurate. How are financial statements assessed for reliability and accuracy? This is the “big picture” in the auditing and assurance course.
Financial statements would be accurate and reliable if firms prepared them in accordance with GAAP. There are, however, many different motivations and temptations for executives to cut corners and falsify accounts. Therefore, public firms are required to have their financial statements audited by an independent auditing organization. The auditing firm is somewhat like a detective agency. It snoops around, with the active cooperation of the firm though, to determine if there is a significant misstatement in the firm’s prepared financial statements.
In the auditing course, we studied the audit process; how it is initiated and its different stages and what should auditors look for during the audit and how should they conduct themselves. The topics included management fraud, assessing the quality of the firm’s internal control system, employee fraud, potential problems with respect to revenue collection, expenditures, production, and finance and investment, and the use of sampling for auditing.
Audits are performed in accordance with auditing standards known as GAAS (generally accepted auditing standards). Upon completion of the audit, the auditing firm offers an opinion on the financial statements. If the auditor issues an unqualified opinion, the users of the financial statements have reasonable assurance to rely on these statements. Note that auditors provide reasonable assurance, as opposed to absolute assurance.
Just because financial statements are audited and signed off by the auditor does not guarantee that all is well. Many firms are large and complex. Their financial statements reflect thousands of different transactions and activities; it is therefore not easy for an outside firm to come and spot problems in the financial statements of the firm. It is even more difficult to spot problems if the management of the firm makes a conscious effort to cover up any accounting shenanigans. Therefore, despite an auditor’s best efforts, it is possible that some problems go undetected. Furthermore, the auditor is supposed to be an independent organization but it not independent in the true sense. The auditor gets paid a fee for its auditing services and might not want to risk losing the client’s business should it incur the displeasure of the client.
There have been many cases where auditors have failed to spot blatantly fraudulent accounting. A number of high profile corporate frauds such as the ones at Enron and HealthSouth led to the passing of the Sarbanes Oxley Act in 2002. This Act, commonly known as SOX, established new standards and tightened existing standards for reporting and auditing of financial statements. For example, the Public Company Accounting Oversight Board (PCAOB) was created to oversee auditing firms. Likewise, several new standards were established to limit the conflict of interest between the client and the auditor. In our course, we discussed the auditing industry, the auditing profession, and the auditing environment post SOX.
Through this course, I experienced the “softer” side of accounting. Unlike the typical accounting course, the auditing course did not have number work; few accounting classes are this qualitative in nature. I found the course useful because it dealt with the human element of accounting and made me knowledgeable about a specific career path within accounting. I am, however, not planning a career in auditing. Therefore, I will not be taking any other auditing related courses.