Auditors play a crucial role in financial regulation. Most people have heard the term "audit" or "auditors," but many don't actually know what auditors do and why their role is so important in the economy of today.
What Are Auditors?
Auditing is a type of accountancy function, so auditors are actually a type of accountant. There are two types of auditors: external auditors and internal auditors. External auditors are hired on behalf of the shareholders of a company to assess whether the company's accounts represent a "true and fair view" of the company's actual position in reality. Usually when the term "auditors" is used in newspapers and other media, it refers to external auditors.
Accountancy firms which provide professional services are usually hired to act as external auditors. Examples of accountancy firms which provide these services are The Big Four: PricewaterhouseCoopers, Ernst and Young, KPMG, and Deloitte. These are the four largest accountancy firms and they have a large share of the audit industry.
The role played by auditors is a very important one for a smooth functioning economy. Shareholders don't have an active role in a company's everyday business affairs. It is therefore impossible for them to be able to assess whether the company's accounts are an accurate representation of the business' true financial position. They have no access to the internal accounts of the organization, and only have access to the financial statements released in the public domain. But how can they ascertain whether these accounts are an accurate representation of the company?
This is where auditors come into the picture. Auditors are hired to assess whether the accounts represent a true and fair view, and report their opinion in the financial statements. External auditors are a third party and therefore are able to deliver an unbiased opinion on the company's accounts. This is very important because when auditors assess accounts and deliver their opinion that the accounts represent a true and fair view, they are providing assurance to the shareholders. Shareholders and others who use the accounts can therefore be assured that the accounts are trustworthy, and can base their decisions on this.
The auditors carry out various tests on the accounts to determine their opinion on them. They test how the figures in the accounts were reached by examining the figures used to generate them. They can do this by randomly checking if numbers used to generate those figures correspond to the documentation. For instance they may check some of the numbers used to generate the sales figure by checking in the files to see if these sales were carried out. They also test the internal accounting controls of the company to assure that they are adequate. Auditors can then give their opinion on the accounts, which is given in the financial statements of the respective company. As auditors cannot give an opinion with absolute certainty, all audits come with a risk attached; this is the audit risk.
Enron Scandal
An example of how accounts do not always represent a true and fair view, is that of the Enron Scandal. The Enron Scandal was when fraudulent accounting techniques such as "mark to market" accounting were used to make Enron's accounts look "healthier" by falsely representing the company.
For instance they grossly overvalued assets, and committed many other false representations. This scandal actually highlighted failings on the auditor's part as well. The auditing company was Arthur Andersen and it was found to not have been forceful enough in its investigations, whilst at the same time ignoring the fact that the company had a conflict of interest in their affairs with Enron. The conflict of interest was that whilst being the auditors (and effectively working for the shareholders), they were also providing business services to Enron. In the aftermath, new legislation attempted to correct these shortcomings. An example of such legislation is the Sarbanes-Oxley Act of 2002.
What are Internal Auditors?
Internal auditors differ from external auditors in that they are hired by the company's directors and not the shareholders. They therefore report to the directors and not the shareholders. The job of the internal auditors is to ensure that the company's accounts represent a true and fair view. This is important for various reasons.
First, it ensures that the accounts are accurate, reduces the work of the external auditors (and therefore their interference), and it protects the company from unknowingly committing fraud (and therefore being subject to preventable litigation). Unlike the external auditors, the internal auditors have a direct duty to look for fraud, whilst the external auditors only have to keep an eye out for it. The internal auditors carry out their duties by ensuring that the company's controls are operating effectively and by doing testing similar to that of external auditors.
Elliot Abraham - Elliot Abraham lives in London and is a freelance writer. He has a Bachelor of Science degree from City University of London in Economics ...
