Question

Need help covering financial information and the role of outside auditors in the financial reporting process. To this end, you are required to discuss the importance of the financial statements and the significance of outside auditors to the financial reporting process.

Answer 1

Features of Financial Statements:

1. The Financial Statements should be relevant for the purpose for which they are prepared. Unnecessary and confusing disclosures should be avoided and all those that are relevant and material should be reported to the public.

2. They should convey full and accurate information about the performance, position, progress and prospects of an enterprise. It is also important that those who prepare and present the financial statements should not allow their personal prejudices to distort the facts.

3. They should be easily comparable with previous statements or with those of similar concerns or industry. Comparability increases the utility of financial statements.

4. They should be prepared in a classified form so that a better and meaningful analysis could be made.

5. The financial statements should be prepared and presented at the right time. Undue delay in their preparation would reduce the significance and utility of these statements.

6. The financial statements must have general acceptability and understanding. This can be achieved only by applying certain “generally accepted accounting principles” in their preparation

7. The financial statements should not be affected by inconsistencies arising out of personal judgment and procedural choices exercised by the accountant.

8. Financial Statements should comply with the legal requirements if any, as regards form, contents, and disclosures and methods. In India, companies are required to present their financial statements according to the Companies Act, 2013.

Importance of Financial Statements:

The importance of financial statements lies in their utility to satisfy the varied interest of different categories of parties such as management, creditors, public, etc.

1. Importance to Management:

Increase in size and complexities of factors affecting the business operations necessitate a scientific and analytical approach in the management of modern business enterprises.

The management team requires up to date, accurate and systematic financial information for the purposes. Financial statements help the management to understand the position, progress and prospects of business vis-a-vis the industry.

By providing the management with the causes of business results, they enable them to formulate appropriate policies and courses of action for the future. The management communicates only through these financial statements, their performance to various parties and justify their activities and thereby their existence.

A comparative analysis of financial statements reveals the trend in the progress and position of enterprise and enables the management to make suitable changes in the policies to avert unfavorable situations.

2. Importance to the Shareholders:

Management is separated from ownership in the case of companies. Shareholders cannot, directly, take part in the day-to-day activities of business. However, the results of these activities should be reported to shareholders at the annual general body meeting in the form of financial statements.

These statements enable the shareholders to know about the efficiency and effectiveness of the management and also the earning capacity and financial strength of the company.

By analyzing the financial statements, the prospective shareholders could ascertain the profit earning capacity, present position and future prospects of the company and decide about making their investments in this company.

Published financial statements are the main source of information for the prospective investors.

3. Importance to Lenders/Creditors:

The financial statements serve as a useful guide for the present and future suppliers and probable lenders of a company.

It is through a critical examination of the financial statements that these groups can come to know about the liquidity, profitability and long-term solvency position of a company. This would help them to decide about their future course of action.

4. Importance to Labour:

Workers are entitled to bonus depending upon the size of profit as disclosed by audited profit and loss account. Thus, P & L a/c becomes greatly important to the workers. In wages negotiations also, the size of profits and profitability achieved are greatly relevant.

5. Importance to the Public:

Business is a social entity. Various groups of society, though directly not connected with business, are interested in knowing the position, progress and prospects of a business enterprise.

They are financial analysts, lawyers, trade associations, trade unions, financial press, research scholars and teachers, etc. It is only through these published financial statements these people can analyze, judge and comment upon business enterprise.

6. Importance to National Economy:

The rise and growth of corporate sector, to a great extent, influence the economic progress of a country. Unscrupulous and fraudulent corporate managements shatter the confidence of the general public in joint stock companies, which is essential for economic progress and retard the economic growth of the country.

Financial Statements come to the rescue of general public by providing information by which they can examine and assess the real worth of the company and avoid being cheated by unscrupulous persons.

The law endeavors to raise the level of business morality by compelling the companies to prepare financial statements in a clear and systematic form and disclose material information.

This has increased the confidence of the public in companies. Financial statements are also essential for the various regulatory bodies such as tax authorities, Registrar of companies, etc. They can judge whether the regulations are being strictly followed and also whether the regulations are producing the desired effect or not, by evaluating the financial statements.

signifinace of an External Audit in Financial Reporting process

As a business owner, it’s vital that you conduct frequent internal audits to determine whether or not your business is operating at peak efficiency. You can limit these audits to examinations of your financial health, or you can also order an extensive audit that takes a deep dive into all the risks and challenges facing your business and how you can prepare for those risks in the future. An internal audit is undertaken by members of your own staff who have a vested interest in the success of your company. An external audit, on the other hand, is an audit conducted by an independent agency or firm that has no connection to your business. Business owners can order an external audit for the same reason they conduct an internal audit. However, there are several important advantages of having an audit conducted by an independent firm to determine your company’s financial status and reputational strength.

Ensures Tax Compliance

When you order an external audit, you are opening your business up to a critical and bias-free assessment of whether your company is in compliance with all applicable Internal Revenue Service rules and regulations. One of the advantages of having an audit of this kind is that an external auditing firm is not affiliated with your company and can evaluate your business without the fear of repercussions if you don’t like what it has to say. For example, an internal auditor who has been working within your company for years may not want to deliver bad news about tax non-compliance and may decide to delay fixing the problem, which could make things worse.

Provides Independent Credibility

Another of the advantages of having an audit from an outside firm is that your financial statements will be more credible if a company with no stake in your success or failure vets them. The importance of independence in auditing is that it provides credibility that is one of the keys to the success of your small business, especially when you’re in the process of building a strong reputation within your industry. Because external auditors don’t work directly for your company, they’re not going to be swayed by any pressure you may use to obtain a favorable audit. As a result, an external auditor’s approval of your financial statements is much more credible than that of an internal auditor.

Allows Critique of Your Internal Processes

The importance of independence in auditing also includes the fact that internal auditors can’t effectively critique your company’s internal processes because they are part of your company. External auditors, however, can observe operations with a steely eyed gaze and determine in which areas your business is wasting time and money. External auditors often critique accounting practices and general operations, and develop an action plan for you to reduce waste and implement strategies for greater efficiency.

Allows Quality Control of Internal Audit

Another factor that confirms the importance of independence in auditing is that, in many instances, internal auditors are too close to your business because of their positions within your company. Some internal auditors also don’t have sufficient accounting experience to properly audit their company’s financial statements. External auditors can look at the same factors as internal auditors and double-check their work. They can ensure that the internal audit was comprehensive, accurate and reflective of your company’s financial status and tax compliance. External auditors typically have expertise in a variety of financial areas that often exceeds the knowledge of your internal auditors. That means external auditors can also train your internal auditors in accounting principles by explaining how their analysis differs from the analysis the internal auditors performed.