Audit simply refers to examine and give comments on the items verified. Financial audit implies examination of the books of accounts and other relevant records. This will provide the auditor necessary information to give his opinion whether the accounts are properly maintained and complied with necessary statutory, accounting or financial reporting and auditing standards.
A Financial Statement Audit is an independent appraisal of the financial statements prepared by the organization. The basic objective of a financial statement audit is to provide an independent or third-party assurance that the management has, in its financial statements, presented a “true and fair” view of a company’s financial performance.
The result of this examination is a report by the auditor, attesting to the fairness of presentation of the financial statements and related disclosures. The auditor’s report must accompany the financial statements when they are issued to the intended recipients or stake holders.
Importance of Audit is increasing with the passage of time – as there is always more and more things to review and whistle, when things are deviating. The businesses become more complex and the management of the companies are playing different methods to beat the market. When the countries or societies are progressing at greater speed with technological developments, new ways of doing things are arising. In order to cover such activities accounting and auditing has to cope up with the market movements and ensure that stake holders’ interests are well protected. There have been an ongoing series of disclosures of fraudulent reporting by major companies, this will also point out the need for an effective audit.
Having an expert opinion independently from the management of the company is highly essential to ensure that what is reflected through balance sheet / statement of financial position or Profit or Loss Account is reliable or not. The purpose of a financial statement audit is to add credibility to the reported financial position and performance of a business. Tax authority need the confirmation of sales and income, Lenders typically require an audit of the financial statements of any entity to which they lend funds. Suppliers may also require audited financial statements before they will be willing to extend trade credit.
A well planned verification is necessary to cover all financial items with audit materiality. Audit involves collection and evaluation of evidence in support of conclusions arrived. The procedures which will assist the auditor in this direction are.
• Planning and risk assessment Involves gaining an understanding of the business and the business environment in which it operates, and using this information to assess whether there may be risks that could impact the financial statements.
• Internal controls testing Involves the assessment of the effectiveness of an entity’s suite of controls, concentrating on such areas as proper authorization, the safeguarding of assets, and the segregation of duties.
• Substantive procedures Involves a broad array of procedures, of which a small sampling.
Depending upon the nature of engagement and the purpose it demands the level of assurance provided by the auditor varies from Audit to Compilation. An audit provides high level of assurance. But a review engagement gives a reasonably lesser degree of assurance than audit. As in a review, the auditor does not carry out all those procedures that are carried out in an audit. Publicly held entities must have their quarterly financial statements reviewed, in addition to the annual audit.
Sometimes the requirement is only to report on individual items of financial data or on a set of financial statements to report on the factual findings, say to certify only the turnover of the company. The level of assurance in such agreed upon procedures is again lower than a review engagement. In the case of a compilation engagement, the auditor is called upon to prepare the financial statements – where his expertise in collecting, classifying and summarizing the financial information only demanded and not designed to give any assurance on the financial statements.
Normally the external audit is conducted annually. In the case of new entities, the audit period can be extended to 18 months from the date of incorporation. At the same time, it may not be less than 6 months as well. Subsequent audit period will be for a period of 12 months and this period can be extended up to 15 months in case of certain Free Zones. In case where management of the companies need special purpose audits it can be carried out for a different period or even number of years.
The manner of appointment, the qualifications and the format of reporting by an external auditor is defined by statute which varies according to jurisdiction of different countries.
The auditors must be a member of one of the recognized professional accountancy bodies. The auditors normally address their reports to the shareholders of a corporation or to the owners of the business entity. The auditors are subjected to strict rules to uphold their integrity and to establish independence.
Audits have become almost mandatory in the UAE both in the free zones and in the main land. In the free zones, authorities insist filing of audit reports as mandatory requirement for renewing the license of the company. In the main land, as per UAE commercial company law annual audit is required to be done. Moreover wherever bank has financed materially, they will insist filing of audit report for continuing the finance facilities. Sometimes, suppliers or customers or other stake holders ask financial audit report, time to time. With the implementation of UAE VAT, additional responsibility will be there most probably to the management of the company to confirm the turnover through the audit report .
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Internal Audit Service is an independent, objective assurance and consulting activity intended to add value and develop an organization’s operations. Internal Audit helps business to achieve its objectives by bringing a methodical, meticulous and disciplined approach to assess and enhance the effectiveness of risk management, control, and governance processes.
Internal Auditing is an activity carried on by the internal auditor to meet the management requirements of information. It is an independent appraisal activity within an organization for the review of operations as a service to organization.
Internal Auditor’s role is to provide Management with independent assurance on organization’s internal controls, risk management strategies and governance are operating effectively. Internal Auditors’ function includes supervising, evaluating, investigating and analyzing the risks & controls; checking and ensuring information and compliance with policies, procedures, and laws. Internal Auditor will assess for the achievement of goals and objectives set by the Senior management. In case of short of stated goals, the auditor will identify process gaps and make suggestions for improvement for bridging the same.
The objective of Internal Audit is to evaluate and improve the effectiveness of governance, risk management and control process. The overall objective of internal auditing is to assist all members of the management in exuding their responsibilities. Also, to help them with objective analysis, recommendations and relevant comments concerning with any phase of business activity wherein they can be of service to management. In short, Internal Audit will help the management for: –
Operational Audit is systematic process of evaluating an organization’s operational efficiency and effectiveness. On completion of Operational Auditing, the results of the evaluation and the recommendations for improvements will be reported to the management for action. It means that the internal auditor goes beyond financials controls into operating areas. It is focused to strengthen Organization’s operations and control mechanism for day to day operations. Operational Audit will help to identify points of non-conformity in procedure implementation. It will help the management to take corrective actions.
Some of the objectives of Operational Auditing are:
There is no statutory compliance for a company to conduct the operational audit. Operational Audit is conducted when Management desires to evaluate the company’s operational efficiency and effectiveness. It helps Management in improving the economic savings of financial processes, where operations are based on financial statements.
The primary responsibility for managing the day-to day operations is of CEO and/or General Manager. But for every individual function/process covered under Operational Audit, the responsibility will be of the Process Owner/Line Manager responsible to handle that process or operation.
In a programme of operational auditing, the auditor is capable of appraisal activity with particular reference to the following aspects:
This depends completely on the size of Operations. Unlike financial audit which focuses on the financial controls as they relate to reporting, Operational audit focus on review and assessment of a business process. So, the time taken for completion of operational audit will purely depend on the number of processes related to operations of business.
The reporting should be very helpful and accommodating to the Management. Operational Audit report provides in detail the observations, auditor’s recommendations to the reported observations, actions to be taken by the Management, responsibility of the process owner and the target date for the closure of the observation. This report is to be discussed with the Management and process owner in detail, so as to help Managers to evaluate and analyze the current effectiveness of a company’s operations while identifying areas of potential improvement.
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Compliance Audit is the process of verifying the business function to ensure the regulatory requirements and contractual obligation as per the law. There are specific rules and regulations defined for particular set of business or in particular to a specific function/ process in a company. These requirements are either enforced by the law/ statute or the agreed terms or conditions between parties to the contract/ agreement. These requirements are mandatorily required to be adhered to carry on the business or a particular function/ operation. Compliance audit is done on a company to assure that the company is following the defined rules or requirements.
An organization can have compliance audits to review adherence to regulatory requirements in various department like finance, IT, manufacturing, human resources, and others. It also depends upon types of financial firms, marketing and sales.
The main purpose of having Compliance audit is to assess the overall effectiveness of a compliance practices and protocols adopted by a business. A compliance auditor determines whether the item being examined complies with established standards while examining processes and transactions. To ensure that the compliance requirements of the statute are complied. Whether the terms and conditions are adhered to while carrying on day-to-day operations will be evaluated.
The procedures of the compliance audit may be done internally but many times are usually initiated by the certifying organization. In cases, where the compliance audit is not a mandatory requirement by law or statute, the Management may initiate a compliance audit to assure that the company’s compliances are effective and adhered as required at any given point in time. The ideal procedure is as below:
• Initial Meeting : The first procedure included in Compliance audit is meeting between the Auditor and the Management.
• Employee Review : To review employee’s performance & ascertain the level of individual compliance.
• Department Review : To review operational, financial & other paperwork from business departments/ function.Auditors will draft report on the non-compliance with the mandatory regulatory requirement, non-adherence to the stated terms & clauses of law/ statute/ act or contract. The report will also include all the mathematical errors, posting problem, authorized payment which is not paid, any discrepancies and other audit concerns etc. Non-compliance of regulatory requirements, if any and deviations from agreed contracts also be included.
• Draft Report : Auditors will draft report on the non-compliance with the mandatory regulatory requirement, non-adherence to the stated terms & clauses of law/ statute/ act or contract. The report will also include all the mathematical errors, posting problem, authorized payment which is not paid, any discrepancies and other audit concerns etc. Non-compliance of regulatory requirements, if any and deviations from agreed contracts also be included.
• Final Report : Auditors will have a final meeting with company management upon completing the compliance audit.
Many times, the management fails to measure the risk appetite of the business. Risk appetite is the risk-taking capacity of a business. Non-compliance with the defined rules, regulations or non-adherence to the terms and conditions may turn out to be riskier for the business. Non-compliance may result in penalties, fines or sometimes even the liquidation of the company or surrender or termination of license or registration.
A compliance audit is different from an external audit since under compliance audit, the auditor is not forming an opinion on the financial report, but on the client’s compliance with specified clauses as per provisions of the law or contract.
Financial Control Audit focuses on accounting, recording, and reporting of financial transactions, as well as reviewing the adequacy of internal financial controls. Financial Audit also emphasizes analysis of financial performance of a business. It aids management in its decision-making process by providing right kind of information through analyzing variability in profitability of business, unusual increase in cost, unexpected fall in Revenue, etc. Financial Control Audit helps to ensure optimum utilization of resources available within the organization.
The Financial Control Audit is different from the Financial Statement Audit. Some of the difference are as below:
|Financial Statement Audit||Financial Control Audit|
|It is examination of entity’s financial statements and accompanying disclosures by an independent auditor.It is assessment of financial controls as they relate to Management reporting.||It is assessment of financial controls as they relate to Management reporting.|
|Auditor expresses an opinion on the state of affairs of the company.||Auditor identifies the gaps in the controls and recommends the solution to bridge the gaps.|
|Financial Statement Audit is done at the end of the year after finalization of books of accounts.||Financial control audit is done monthly or quarterly as decided by the Management.|
|Financial statement audit is done by external auditors.||Financial/ control audit is performed by the internal auditor|
The key accounting and financial issues addressed under financial control audit are:
The Financial Control Audit is generally effective in identifying and mitigating the risk that the departmental financial statements may be materially misstated. Improvements will be provided proactively to involve Management through effective communication & also to ensure they understand the risk involved.
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There are many reasons why a business owner or company need to know the value of a business – to sell or buy a business, settlement on litigation, capital restructuring, expansion of business etc.
Business valuation demands high level financial analysis that should be undertaken by a qualified valuation professional with the appropriate credentials. Business owners who seek a low-cost business valuation are seriously missing out on the important benefits received from a comprehensive valuation analysis and valuation report performed by a valuation expert. These benefits help business owners negotiate a strategic sale of their business to get a fair price, minimize the financial risk of the management in a litigation etc.
How to price a company? Business valuation refers to the process of determining the current worth of a company and there are many techniques used to determine value. The typical standard of value utilized is fair market value. The fair market value is the price at which a business would change hands between an independent buyer and seller having the requisite knowledge and facts, not under any undue influence and having access to all of the information to make an informed decision. An analyst placing a value on a company looks at the company’s management, the composition of its capital structure, the prospect of future earnings and market value of assets etc.
It’s a common misperception to say that the company is worth these many times EBITDA (earnings before interest, taxes, depreciation and amortization) simply, as that doesn’t take into consideration the industry, business risks, cash flow expectation, debt and more. So, it is always advisable to do the business valuation by a valuation expert. Not knowing the actual fair market value of the business could cause the business owner to sell the business for a lesser price or buy a business at a high price than it actually worth. For these reasons, the cost to do the business valuation can be an excellent investment. Sometimes it may be a savings in millions by paying a right price or by taking a right decision not to invest in an unworthy business.
While there are numerous valuation models and metrics around, there are only three valuation approaches:
• Intrinsic valuation : It relates the value of an asset to its intrinsic characteristics: its capacity to generate cash ﬂows and the risk in the cash ﬂows. In its most common form, intrinsic value is computed with a discounted cash ﬂow valuation, with the value of an asset being the present value of expected future cashﬂows on that asset – in cases where cash flows are more predictive in the business.
• Relative valuation : It estimates the value of an asset by looking at the pricing of ‘comparable’ assets relative to a common variable like earnings, cashﬂows, book value or sales.
• Contingent claim valuation: It uses option pricing models to measure the value of assets that share option characteristics.
There are Four fundamental ways and other methods to measure the value of a business practice based on the above three approaches:
Under each approach, a number of methods are available which can be used to determine the value of a business enterprise. Each business valuation method uses a specific procedure to calculate the business value.
The asset approach to business valuation considers the underlying business assets in order to estimate the value of the overall business enterprise. This approach relies upon the economic principle of substitution and seeks to estimate the costs of re-creating a business of equal economic utility, i.e. a business that can produce the same returns for its owners as the subject business.
The business valuation methods under the Asset Approach include:
Under the Market Approach to business valuation, one consults the market place for indications of business value. Most commonly, sales of similar businesses are studied to collect comparative evidence that can be used to estimate the value of the subject business. This approach uses the economic principle of competition which seeks to estimate the value of a business in comparison to similar businesses whose value has been recently established by the market.
The business valuation methods under the Market Approach are:
The Income Approach to business valuation uses the economic principle of expectation to determine the value of a business. To do so, one estimates the future returns the business owners can expect to receive from the subject business. These returns are then matched against the risk associated with receiving them fully and on time.
The returns are estimated as either a single value or a stream of income expected to be received by the business owners in the future. The risk is then quantified by means of the so-called capitalization or discount rates.
The methods which rely upon a single measure of business earnings are referred to as direct capitalization methods. Those methods that utilize a stream of income are known as the discounting methods. The discounting methods account for the time value of money directly and determine the value of the business enterprise as the present value of the projected income stream.
The methods under the Income Approach include:
There are some other methods of business valuation which are as follows:
All the above approaches can yield different estimates of value for the same asset at the same point in time. To truly grasp valuation, we have to be able to understand and use all the approaches. There is a time and a place for each approach and knowing when to use each one is a key part of mastering valuation. There is no single business valuation approach or method which is definitive. Hence, it is common practice to use a number of business valuation methods under each approach. The business value then is determined by reconciling the results obtained from the selected methods. Typically, a weight is assigned to the result of each business valuation method. Finally, the sum of the weighted results is used to determine the value of the subject business.
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