Updated July 19, 2023
Introduction of Statutory Audit
Statutory Audit (also known as financial audit or external audit) is an audit required under by the statute governing the entity, performed by an independent person with the end objective to provide opinion whether the financial statements give a true & fair view of the company & whether the same are free from material misstatements whether arising due to fraud or error during the year.
- The word “Statutory” means something which forced to be done by a statute. The law governing the entity is called statute. So, the word “Statutory audit” means an audit required under law.
- The statutory audit is performed by an individual auditor or a firm of auditors, who are eligible for appointment as auditor in the company.
- In the United States of America, statutory audit is performed by Certified Public Accountants (CPA). CPA can be an individual or a firm of such individuals.
- The Sarbanes-Oxley Act (SOX) enacted in 2002, requires the public companies to submit an annual report of the company. As per SOX, such annual report should include the effectiveness of internal controls. SOX is also known as Public Company Accounting Reform & Investor Protection Act.
- SOX applies to public listed companies of US as well as those non-US public companies which have presence in the United States.
- In & around, SOX enforces the public companies to appoint an external auditor who shall report on the effectiveness of the internal controls of the company, disclosures placed in the financial statements as well as reporting on the non-compliances of various laws which are applicable to the said company.
How Does it Work?
- A statutory audit is an audit required under the statute. However, the statutory requirements can at federal, state or municipal level.
- The shareholders in the Annual General Meeting (AGM) of the company, appoint a person as statutory auditor. The shareholders cannot vouch or verify each transaction of the books of accounts. They only have right for obtaining financial statements. Thus, they need the financial statement should be reliable & free from misstatements.
- A statutory audit means an independent examination of the financial records held by the entity. The purpose of audit is generally to provide an opinion on the true & fair view of financial statements. Auditor can also provide opinion on the utilization of the funds of the entity.
- The entity has to provide all information, explanations, records & reports as & when required by the auditor. If the auditor does not get information, he has the right to specify the same in his audit report.
- As a statutory auditor, he has to ensure compliance with auditing standards while performing the audit.
- The statutory Auditor needs to work independently i.e. without getting influenced by any factor.
- His end objective is to provide an opinion through the audit report.
- However, one should note that the applicability of statutory is a sign of inherent misstatements in the financial statements. It is usually required under the statute. In some cases, it is done to enhance the confidence of the reader of financial statements. Even a few charitable institutions are required to conduct the statutory audit in exceptional circumstances.
Example of Statutory Audit
ABC Inc is a public limited company incorporated under US laws. The statutory auditor appointed by the shareholders, get information about the prevalent fraudulent transactions in the entity. However, he is not provided with all the information & explanation in respect such suspectable transactions. Management is of the view that auditor can not ask for secret information about the company. We need to check the impact of this, on the audit report of the entity.
- No information is secret, when the statutory auditor asks for the same.
- Since, the management is not providing the information & explanation asked for, the statutory has right to report the same in his audit report.
- Auditor needs to consider whether the suspected transactions are material in nature. Only if yes, he can demand the information.
- Further, he can provide “Qualified Opinion” in the audit report. However, he needs to have strong evidence of the existence. In case, he does not have evidence, he can provide “Disclaimer of Opinion” due to lack of information or evidence.
Statutory Audit Limit
- Statutory Audit is generally required to be done by public listed companies of US as well as those non-US public companies which have presence in US. SOX emphases the public companies to get the accounts audited by an independent CPA or firm of CPAs.
- On the other hand, for private entities or other types of non-corporate entities, the audit is generally not mandatory. Reason is that, their information is not publicly available & not required to be reported to general public. However, financial institutions may ask the entities to get their records audited by an independent person. Also, potential investors may require the private entity to get the accounts audited by a person appointed by such individual.
- In case a firm to which statutory audit is not mandatory, can consider getting the accounts reviewed by an independent person. Under limited review, no assurance opinion is provided.
Advantages of Statutory Audit
Some of the advantages are:
- It enhances the reporting quality of the company.
- It reduces the likeliness of probable chances of occurrence of financial frauds on the company by its officers or employees.
- The credibility of the financial statements is enhanced due to independent examination. Thus, it enhances the confidence for the readers.
- The financial statements become more authentic to the reader of financial statements.
- Since the audit report specifies the responsibilities of the management as well & management has to sign the financials, the management also ensures that due & sufficient care has been taken in presenting the financial statements.
- The audit report also comments on the effectiveness of the internal controls of the entity. In case of deficiencies in the internal controls, the auditor has to specify its impact on the opinion of the auditor.
- For the entities to whom statutory audit is not mandatory, they can also get the accounts audited voluntarily. Such voluntary audit also enhances the confidence of financial institutions who are considering to provide finance to such entities.
- Organisation becomes more active in complying with the norms & regulations applicable to it.
Disadvantage of Statutory Audit
Some of the disadvantages are:
- There are inherent limitations to a statutory audit. Statutory auditor cannot verify the 100% records of an entity given the time, money & resource constraints at his end.
- He cannot give assurance that the financial statements are true & correct in all respects. The audit is done on a materiality basis, which means 99% of things are checked through substantive audit procedures. For the remaining 1% check the auditor cannot be held liable if he could not detect the frauds occurring within the entity.
- In case of frauds within the entity are discovered, the entity is first held liable to the consequences & then the auditor. Also, the auditor can be relieved if he proves that he has done his job appropriate following the relevant audit procedures in place. Secondly, it’s not his job to detect frauds. Auditors are therefore said to be watchdogs (i.e. just observe &report) and they are not blood-hounds (i.e. they should not investigate in minute details).
- For few cash-crunch companies, the cost of the audit may be very high. Audit firms charge fees based on turnover achieved by the company & not according to the cash reserves.
- Audit opinion is subjective in nature & vary from one person to another. So, it may happen that a company gets a clean report in one year & a modified opinion in the next year due to a change of auditor & change in his judgements.
- The normal operations of the entity may get disrupted due to time allocated for solving audit queries. Hence, big firms normally have a separate team to help the auditor.
Has the responsibility of the management ended once the audit is done? The answer is no. The management is answerable to the shareholders for any qualification in the audit report. In case the report specifies the material deficiencies, the management has to consider the facts on ground to resolve the deficiencies so that next year, the same point is not raised. No doubt that the statutory audit increases the authenticity & credibility of financial records & statements of the entity. However, there are many areas in which the statutory auditor has to rely on the management for its stand. The auditor comments on the going concern viability of the entity but it nowhere assures the survival of the entity in near future.
This is a guide to Statutory Audit. Here we also discuss the introduction and how does it work? along with advantages and disadvantages. You may also have a look at the following articles to learn more –