What is audit? Types, benefits and limitation of Audit

Origin of Audit and assurance services

 Since the industrial revolution in the 18th-century, businessmen started forming joint-stock companies to do business. In the most situation, people who manage the company (called management and directors) were separated from who owned the company (called shareholders). To judge the performance of Management and director, shareholders ask them to prepare and present the financial statements. Soon after it was recognized that the financial statements prepared by the management present the best view of the business instead of true and fair view due to some incentive or pressure faced by management. The credibility of the financial statement was questioned. So, to enhance the credibility of the financial statements an expert person is hired by the shareholder to verify the financial statements. This person is independent of both management and shareholders and this person was called an auditor. 

What is audit

An audit is an official inspection of an organization’s account. The audit is usually done by an independent auditor or a firm of auditors.

An auditor is not liable to detect every fraud and misstatement in the financial statements.

Types of audit

 There are usually two types of audit

1. 1.      Statutory 
2. 2.      Non-statutory 

Statutory Assurance engagement

 They are required by law. Most companies in Pakistan and all over the world are required by law to get their annual financial statements audited before they are given to shareholders.

Non-statutory Assurance engagement

They are not required by the law but are voluntarily performed because of its advantage. For example, sole proprietorship partnerships and small companies are not required audit by law In Pakistan.

You must be thinking that what can be the benefits of the audit? When a business has to pay a big amount to the auditor as his fee. So, there are many benefits of audit and some benefits are listed below

 Benefits of audit

I will divide the benefits of an audit into two major categories

 Benefits for shareholders

1.      Most of the misstatements in the financial statements are identified during the audit.
2.   If you ask Bank for the loan, then the bank will ask for audited financial statements and this will increase the confidence of the bank on your business. So, audited financial statements will assist you in a grant of loan by Bank.
3.      The confidence of the debtor and creditors of the business is also increased with audited financial statements. So, it will assist in the sale purchase of businesses.

 Benefits for management

1. 1.      The auditor inspects financial statements by performing a test of controls and substantive procedures. The test of control identifies deficiencies in the entity's internal control system. So, the auditor helps the management to prevent, detect and correct the internal control of the entity.
2. 2.      Auditor also confirmed that management is performing its statutory and non-statutory duties.

Limitations of audit

1. 1.      It is not the duty of the auditor to detect and correct the fraud by management, but the auditor must perform procedures to detect the fraud.
2. 2.      The auditor does not inspect all the transactions in the financial statements. he inspects the transactions in financial statements on a sample basis.
3. 3.      There are some audit risks so that the auditor cannot provide an absolute (100%) level of assurance but he can provide a reasonable level of assurance.
4. 4.      The auditor does not verify the financial statements. He just draws an opinion based on procedures performed.
5. 5.      The auditor can not inspect all the transactions due to the limitation of time in a statutory type of audit.

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