Top 3 Biggest Dilemmas With Your Auditors
Companies are very watchful when it comes to an audit of their financial statements. How to deal with our auditors? Do they know everything? Should we listen to them? Can they force us to do something we don’t want?
I worked as an audit assistant, audit senior and audit manager for some years and I can relate. The relationship between a client and an auditor is very delicate and sometimes, we (as a client and as an auditor) simply don’t know what we can afford to do or say to each other.
As many audit-related questions pop out in my mailbox these days, I dedicate this article to 3 biggest dilemmas you may experience during audit of your financial statements.
Please, bear in mind that the answer is never clear yes or no, black or white. The life is full of colors.
Warning and disclaimer: Throughout this article, I avoid a professional audit terminology and I don’t recall or cite any professional rules or guidelines, such as International Standards of Auditing (ISAs). I just wanted to give you my opinion based on my own past experiences. Also, I want you to have some fun, too!
So, let’s go through 3 biggest dilemmas. Plus, I could not resist adding a bonus question in the end.
#1: Can we rely on our financial statements prepared by our auditor? Can we trust them?
In short – yes, you can, because:
- Auditors are very smart and they know what they do (in most cases);
- They issue their audit opinion on those financial statements.
Auditors should NOT prepare your financial statements.
This is YOUR responsibility to prepare your own financial statements. Auditor’s task is to examine them, verify them and issue their opinion in their audit report.
Frankly speaking, officially, no auditor can audit his own work. An auditor must be independent.
What does it mean?
You cannot really hire one company to prepare your financial statements (or even maintain bookkeeping) and the same company to audit those financial statements.
Hmmm, but what about the situation when auditor take your trial balance and prepares the statement of financial position, statement of comprehensive income, cash flows, etc.?
In an ideal world, this should not happen. Indeed, it’s an audited company who should do it, not an auditor.
But in the real world, it happens. It happens A LOT.
When I worked as an audit assistant, I remember preparing lots of cash flow statements (it was the biggest nightmare for any client), notes to the financial statements and other components of the financial statements instead of my clients.
The main reasons were:
- I did not need to wait for the client to prepare it;
- I did not have to search for errors, differences, balancing figures, shady numbers, etc.;
- We saved a lot of time and effort.
Of course, auditor’s name will never appear on the financial statements as an “author’s name” (due to independency, remember), but the truth is as it is.
Just bear in mind that even when auditors make financial statements for you, you are still responsible for them.
#2: Can our auditor force us to book something we don’t want?
In short – NO, he/she CANNOT.
Auditor’s task is not to force you book anything, because auditor is not doing your books.
So no, don’t worry, auditor will not hold a knife to your neck.
Auditor’s task is to express his opinion on what you have booked.
So what can happen?
Auditor finds out that you booked something and he disagrees with your entries, for whatever reason.
Auditor will propose you some adjustment to your books.
Now, there are 3 basic scenarios:
- You will accept auditor’s proposed adjustments and book them. Auditor will issue clean (unqualified) audit report.
- You will try to support your numbers with some arguments, additional information, estimates, calculations, whatever. If you are lucky and persuasive enough, your auditor may accept it and issue a clean opinion.
- You refuse to book proposed adjustments and leave the books as they are. Auditor will issue an opinion with qualification.
And of course, something in between.
Once I experienced very painful story with that.
I was an audit manager at the time and we performed an audit of a company whose core business was to sell machines for recharging mobile phone credits.
Let’s say you want to recharge your credit, so you pay EUR 50 to the recharging machine. Our client received EUR 50 via the machine, and needed to pay EUR 48 to the mobile operator. Our client’s revenue was EUR 2 being the commission for helping to make a sale via the machine.
The main accounting issue in this company was the incorrect accounting for revenues.
Our client recognized revenue of EUR 50 and the cost of sales of EUR 48.
Wrong, wrong, wrong.
The reason is that when you assess an agent/principal relationship, you find out that in fact, our company was only an agent mediating the sale, as it was a mobile operator who provided a service to the end customer.
Therefore, the correct accounting should have been revenue of EUR 2, and payables of EUR 48.
Why does it matter, when profit or loss effect is still the same EUR 2?
Wow, it makes a HUGE difference.
Our client took some loans and one of the covenants was to maintain certain level of revenues. And, while the revenue of EUR 50 per transaction meets the covenant, the revenue of EUR 2 does not.
Plus, the management bonuses were derived from revenues (not the profit!). You do your math. As you can see, our client had all great reasons to account for these transactions in gross amounts (not in a net amount as a commission revenue only).
So you can imagine the fight!
It was exactly the situation when an auditor strongly disagreed with the numbers. We could not force the client to make it right.
How did it end?
The client refused to book the adjustment and we issued a qualified opinion.
And this can happen to you, too.
#3: Do we need to hire the same auditor as our parent company hires?
In short – NO, unless your shareholder or group policy requires that.
It can be more practical and cost effective from the group’s point of view.
Don’t get me wrong here.
I can understand very well why small local branch of a multinational group wants to select local audit firm and not a Big4 branch. Sure, Big4 can cost much more than a local auditor.
However, think about it from the parent’s point of view.
Parent’s auditor needs to audit consolidated financial statements.
Therefore, he will need to audit subsidiaries’ financial statements, too.
In practice, auditors often rely on the work of experts, including other auditors.
If subsidiary’s financial statements are audited by the same auditor (e.g. Big4’s local office), then a parent’s auditor can rely on them, because it’s the same group, using the same audit procedures and policies, known for extensive training of their audit personnel, high audit standards, etc.
However, if subsidiary’s financial statements are audited by the local firm, a parent’s auditor needs to decide whether he can rely on this audit or not.
In some cases, parent’s auditor may decide to perform his own audit of a subsidiary – which can be more expensive in total. Why? Because:
- A subsidiary pays an audit fee to its local auditor;
- A parent can pay an extra audit fee to its group auditor to re-perform an audit of a subsidiary.
So what can you do?
If you work for a company that is a part of a group and you are deciding whether to select an (expensive) group auditor or a (cheaper) local auditor, think about the group’s materiality level.
Is your local company big enough to cause material error in the consolidated financial statements?
If yes, then it’s maybe worth to hire group auditor.
But if your local company is of a size of a “rounding difference” in the group’s financial statements, then leave it to the local auditor.
Bonus Question: We pay audit fees and therefore, our auditor has to issue the opinion in line with our desire, isn’t it?
Actually, I’m not kidding here, it was a real requirement from the real client.
I was just promoted to an audit senior and assigned to my first audit engagement in my new role. It was like a trial by fire and I thought I was doomed.
Mess everywhere I looked. Even trial balance did not balance.
Even coffee was terrible. David Lynch once said “Even bad coffee is better than no coffee at all.” After that audit, I strongly disagree!
When we had a final meeting with the client, we told him that based on what we saw, the report could not be clean.
He looked at me with his blue eyes and said: “ I pay you the audit fees. You HAVE TO issue a clean report, because that’s what I pay for!!!”
Man, he meant it!
The client pays an audit fee for auditor’s job that is to examine the financial statements and express his independent opinion.
Independent opinion does NOT mean an opinion in line with the client’s desires. That would not be independent.
I know, I know.
It’s a kind of oxymoron – how can auditor be independent from a client if that client pays him an audit fee? How is this different from a tax inspection that is for free?
The answer to the first question: It’s a well-suited and valid argument and therefore, there’s a whole bunch of rules about auditor’s independence in International Standards on Auditing. You know, nothing is perfect.
The answer to the second question: Except for issuing an audit report, auditor is here to help you and giving you good advice about your accounting. Tax inspection is here to impose penalties (edit: although some exceptions do exist, not to offend any helpful tax inspector).
I would absolutely LOVE to read some of your stories, whether you’re an auditor or a client. Please, leave me a comment below this article. Thank you!
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