Auditing is a means of evaluating the effectiveness of a company’s internal controls. Maintaining an effective system of internal controls is vital for achieving a company’s business objectives, obtaining reliable financial reporting on its operations, preventing fraud and misappropriation of its assets, and minimizing its cost of capital. Both internal and independent auditors contribute to a company’s audit system in different but important ways.
Having an effective audit system is important for a company because it enables it to pursue and attain its various corporate objectives. Business processes need various forms of internal control to facilitate supervision and monitoring, prevent and detect irregular transactions, measure ongoing performance, maintain adequate business records and to promote operational productivity.
Internal auditors review the design of the internal controls and informally propose improvements, and document any material irregularities to enable further investigation by management if it is warranted under the circumstances.
Risk of Misstatement
Auditors assess the risk of material misstatement in a company’s financial reports. Without a system of internal controls or an audit system, a company would not be able to create reliable financial reports for internal or external purposes. Thus, it would not be able to determine how to allocate its resources and would be unable to know which of its segments or product lines are profitable and which are not.
Additionally, it could not manage its affairs, as it would not have the ability to tell the status of its assets and liabilities and would be rendered undependable in the marketplace due to its inability to consistently produce its goods and services in a reliable fashion. Accordingly, an audit system is crucial in preventing debilitating misstatements in a company’s records and reports.
Internal audit serves an important role for companies in fraud prevention. Recurring analysis of a company’s operations and maintaining rigorous systems of internal controls can prevent and detect various forms of fraud and other accounting irregularities. Audit professionals assist in the design and modification of internal control systems the purpose of which includes, among other things, fraud prevention.
An important part of prevention can be deterrence, and if a company is known to have an active and diligent audit system in place, by reputation alone it may prevent an employee or vendor from attempting a scheme to defraud the company.
Cost of Capital
The cost of capital is important for every company, regardless of its size. Cost of capital is largely comprised of the risk associated with an investment, and if an investment has more risk, an investor will require a higher rate of return to invest.
Strong audit systems can reduce various forms of risk in an enterprise, including its information risk (the risk of material misstatement in financial reporting), the risk of fraud and misappropriation of assets, as well the risk of suboptimal management due to insufficient information on its operations.