Audit Explained

Article by Chloe Pearson

The purpose and meaning of audit

The term audit means the provision of assurance by an independent third party that the directors of a company have provided a “true and fair” view of the company’s financials within the financial statements that are created.

Subject to its status being dormant, every public company is required to have their annual accounts audited in a financial year as per section 475 of the Companies Act 2006 (the Act). Private limited companies, however, are not obliged to undergo audit in accordance with section 477 of the Act if they satisfy the small company exception under sections 382-384 of the Act, and to the extent that they are not members of a group nor a charity.

When undergoing an audit, it is important that this “true and fair” benchmark of accounting standards is met for many reasons. Such include:

• To ensure the company directors are adhering to their overriding duty to promote the success of the company for the benefit of the shareholders.
• To provide important information for stakeholders in the business such as guiding shareholders when voting on corporate matters in relation to their equity investments, and the economic decisions to be taken by outside investors.

Key roles in the audit process

Directors

The directors are responsible for the preparation of the financial statements for the audit which predominantly consist of the company’s balance sheet, income statement and cash flow statement. As part of the financial statements will also be the directors’ renumeration, the audit is therefore a key mechanism to oversee matters where the directors may have conflicts of interests.

Once the audit is the complete, the directors are then required to file the financial statements at Companies House and the Stock Exchange.

Auditor

Although the auditor will be appointed by the shareholders of the company, it is important that the auditor is a completely independent party to maintain an unbiased, objective view whilst exercising their professional opinion.

The auditor’s role is to report back to the shareholders directly or via the audit committee of the company on their findings in the form of an audit report. In 2015, the International Auditing and Assurance Standards Board introduced the requirement of the audit report to include ‘key audit matters’ with the aim to provide greater contextual information for outside investors to help differentiate between companies that receive a pass mark in their audit report. These matters are essentially areas of the audit that involve the most risk and therefore has required the most judgement by the audit, as well as explaining the approach of the audit in those areas.  This is important since audit is a statement of professional opinion and cannot provide a guarantee of a conclusion. Much of the information in the financial statements will possess a degree of uncertainty and this cannot always be removed through audit.

Shareholders

Once the audit is complete and the shareholders have received the financial statements alongside the auditor’s report, the shareholders will use these to determine the company’s value on the stock market. This results in market supervision which is the transparency and disclosure of the risks associated with that company

The regulation and supervision of audit in the UK

The Financial Reporting Council (FRC) is responsible for the regulation and oversight of registered auditors in the UK. This includes the power to monitor audit, to conduct investigations for any breach of audit regulations set by the FRC as well as sanctioning any breach. As well as registered auditors, the FRC also regulates and supervises the recognised supervisory bodies that have taken on the delegated regulatory functions from the FRC to ensure such bodies are doing so in the correct manner.

As stated, market supervision is created when the shareholders determine the value of the company on the stock market, and the overriding supervisory role of audit is taken through the FRC, a private company limited by guarantee. Accordingly, the supervisory role of audit is therefore taken by the private sector rather than a public body.

Useful links
Companies Act 2016
Financial Reporting Council