What is an audit?
3 minute read
| Name | What is an audit? |
|---|---|
| Publication date | 20 May 2025 |
| Type | Information sheet |
| Format | PDF, 253.3 KB |
An audit is a professional services engagement in which an auditor expresses a reasonable assurance opinion on whether the financial statements of an entity are true and fair, or free from material misstatement.
Reasonable assurance is not absolute assurance; it is obtained when the auditor has reduced the risk of not identifying a material misstatement to an acceptably low level. This is accomplished by first assessing where risks of material misstatement are more likely to arise, and then designing and performing procedures to obtain sufficient appropriate audit evidence to address these risks.
The level of risk that a material misstatement is not identified that might be deemed “acceptable” is not, and can not be, quantitatively defined. It is a matter of professional judgement.
What do we mean by ‘materiality’?
The concept of materiality is central to audit. A material misstatement is one that could reasonably be expected to influence the economic decisions of the intended users of the financial statements. The auditor is not, therefore, attempting to identify all misstatements of any size that may be present in the financial statements, only those that are material. It is important to note, however, that a misstatement can be material by nature as well as by value. For example, a fraudulent misstatement may be deemed material even if it is below quantitative materiality.
What is the purpose of an audit?
The purpose of an audit is to enhance the confidence of the intended users in the financial statements. The audit should also enhance their understanding of the financial position and performance of the audited entity. Though the auditor may be engaged by the entity whose information they are expressing an opinion on, they are acting for the benefit of the intended users and the broader public interest. The public interest benefits of an audit stem from the intended users having increased confidence in, and understanding of, the financial statements. Shareholders, potential investors and creditors benefit from the increased transparency over how the audited entity’s management have stewarded the assets entrusted to them; this reduces the risk of investing in, or lending to, the entity and lowers the cost of capital. Employees, suppliers and other stakeholders may use the financial statements to learn more about the stability and long-term viability of the entity. All of this helps facilitate a better functioning economy, which benefits the wider public beyond the intended users.
What value does an audit bring to the audited entity?
For the audited entity, the primary benefits of an audit stem from the enhanced trust and confidence that can be provided to users of the financial statements. For many banks, lenders and investors, audited financial statements will signify robust business practices and may inform their decisions to allocate capital. In practice, an audit may result in lower risk premiums on investments, be a precondition as part of a loan agreement or be a requirement as part of a contractual arrangement. In each of these cases, the audit provides accountability and transparency for the users of financial statements. In addition, an auditor can provide an informed perspective on the controls and processes, which can in turn can support management in enhancing them. It is important to emphasise, however, that the auditor must abide by ethical and independence standards. While the auditor may provide an opinion and feedback on judgements made by management, it is not their role to play a part in management decision taking.
What are the principles common to all audits?
Every audit is different, as every audited entity is different. However, there are some principles that are foundational to all audits.
Independent
To fulfil its primary purpose of enhancing confidence in the financial statements, the auditor must be, and be perceived to be, independent. This gives the intended users confidence that the auditor will have the willingness to challenge management where appropriate, and conduct a robust audit.
Professional scepticism
Professional scepticism is a core part of an auditor’s mindset. It is characterised by a willingness to challenge and inquire, to look for contradictory as well as corroborative evidence and to critically assess information.
Risk based
Audits are fundamentally risk based. This means that the auditor will allocate more time and resources to transactions, balances and disclosures that have a higher risk of material misstatement. This principle is the source of most of the proportionality that is inherent in an audit.