On Auditing: Fault-Finding vs Fact-Finding

Dr B K Mukhopadhyay

(The author is a Professor of Management and Economics, formerly at IIBM (RBI) Guwahati. He can be contacted at m.bibhas@gmail.com)

Dr. Boidurjo Rick Mukhopadhyay

(The author, international award-winning development and management economist, formerly a Gold Medalist in Economics at Gauhati University)

The term 'audit' is derived from the Latin term audire which means to hear. An Audit is fundamentally an instrument for exercising control over processes, systems, finances and individuals to make governments and governing bodies more responsible towards the public. In the early days, an auditor used to listen to the accounts read over by an accountant to check them. Auditing is as old as accounting. It was in use in all ancient countries such as Mesopotamia, Greece, Egypt, Rome, the UK and India. The Vedas also contain references to accounts and auditing. Arthasashtra by Kautilya detailed rules for accounting and auditing of public finances.

A) Understanding Auditing

Auditing is a means of evaluating the effectiveness of a company's internal controls. Maintaining an effective system of internal controls is vital for achieving a company's business objectives, obtaining reliable financial reporting on its operations, preventing fraud and misappropriation of its assets, and minimizing its cost of capital. Both internal and independent auditors contribute to a company's audit system in different but important ways.

An audit is an instrument, a tool of financial control, which is employed by the public or private sector, or an individual, to safeguard itself against fraud, extravagance, and more importantly, to bring credibility to the audited stuff. According to the International Organization of Supreme Audit Institutions, an audit is defined as "evaluation or examination of systems, operations and activities of a specific entity, to ascertain they are executed or they function within the framework of certain budget, objectives, rules and requirements". This is a modern definition of audit in the public sector and does not constrict itself with only cash audit.

B) An effective audit system

Evidently, for sound and effective functioning of government and also to ascertain that the benefits of public funds being used reach the lowest strata of society and to every individual, audit remains an indispensable tool. Whether it is public, private or joint enterprise, an audit helps to secure accountability of the executive to Parliament and towards the public in general. The legislature can exercise control over the executives and verify that the public resources have been utilized responsibly for the purpose intended and funds raised through various sources like taxes reach the government fully.

Having an effective audit system is important for a company because it enables it to pursue and attain its various corporate objectives. Business processes require various forms of internal control to facilitate supervision and monitoring, prevent and detect irregular transactions, measure ongoing performance, maintain adequate business records and promote operational productivity.

B) Audit and auditors

Auditors do shoulder big responsibilities. It is not fault-finding, but fact-finding. Auditing involves the review, analysis and evaluation of processes, products, services, systems, organizations and employees. Auditors have to assess the accuracy, validity, reliability, verifiability and timeliness of organizational information, plus the sources and processes by which that information is produced since management and external parties obtain an accurate assessment of the organization under their stewardship. Auditors are free, without fear or favour to inspect an organization's internal controls and the extent to which these controls manage an organization's risk exposures. An in-depth look into internal controls helps prevent the chance of theft of the company's assets and prevents any sort of data manipulation. Proper checking brings in reliability so far as financial and operational reporting is concerned.

An audit can be done internally by employees or heads of a department and externally by an outside firm or an independent auditor. The idea is to check and verify the accounts by an independent authority to ensure that all books of accounts are done fairly and no misrepresentation or fraud is being conducted. Internal auditors review the design of the internal controls and informally propose improvements, and document any material irregularities to enable further investigation by management if it is warranted under the ongoing facts and circumstances.

c) The 'to-do' list for internal audit

According to the Institute of Internal Auditors, "the role of internal audit is to provide independent assurance that an organization's risk management, governance, and internal control processes are operating effectively". Internal audit is conducted objectively and designed to improve and mature an organization's business practices. Internal auditing provides insight into an organization's culture, policies, procedures, and aid board and management oversight by verifying internal controls such as operating effectiveness, risk mitigation controls, and compliance with any relevant laws or regulations.

Internal audit programmes are critical for monitoring and assuring that all of the business assets have been properly secured and safeguarded from threats while verifying that the business processes reflect documented policies and procedures. The importance of internal audit can never be underestimated as much as the same refers to vital areas like providing objective insight, improving the efficiency of operations, evaluating risks and protecting assets, assessing controls, and ensuring compliance with laws and regulations.

The recent PwC report identifies eight groups of technology that internal audit needs to learn, and learn to leverage — artificial intelligence, deep learning, augmented reality, virtual reality, blockchain, robotics, drones, 3D printing, and the internet of things (IoT). The typical internal audit team may have access or exposure to a more limited range of technology, PwC says, such as enterprise resource planning systems, cloud, and perhaps big data and data analytics. That is why an internal audit is an important function of any information security and compliance programme and is a valuable tool for effectively and appropriately managing risk.

D) And, what about an external audit?

It has been the right practice that companies often hire external auditors in addition to auditing themselves. External auditors are accountants who work independently of a particular company and examine company records and operations to ensure that financial statements are accurate. External auditors are important to establishing business credibility while ensuring compliance with tax laws.

An audit system – either regulatory or operational in the form of financial audit, audit of legality concordance, audit of efficacy or programmes, audit of economy and efficiency, or in the form of audit of systems and procedures – is crucial to preventing debilitating misstatements in a company's records and reports. Auditors have to carefully assess the risk of material misstatement in a company's financial reports since without a system of internal controls or an audit system, a company would not be able to create reliable financial reports crucial for internal or external purposes. The company has to determine how to allocate its resources and should be able to know which of its segments or product lines are profitable and which are not, and should also possess the ability to tell the status of its assets and liabilities, as otherwise, it would be suffering from reputation risk in the marketplace due to its inability to consistently produce its goods and services reliably.

It has rightly been opined that though audit must be treated as an instrument for exercising control over processes, systems, finances and individuals to make governments and governing bodies more responsible towards the public and its resources, yet it cannot be considered as an end unto itself; it rather serves as one of the means to reach the end. Last but not the least, reference may be made to a few international bodies which recommend agreed upon auditing practices, reports and requirements such as the International Organization of Supreme Audit Institutions, International Federation of Accountants and Intervention General de la Administracion del Estado. For starters, movies such as Polka King, American Made, the Wolf of Wall Street, and All About Eve would create a good foundation to know the need for transparent, timely, and effective Auditing.