In a majority of businesses, the owners and the management are different. It is because owners may not have the necessary knowledge and skills to run their business. Therefore, they appoint people with expertise and knowledge to run their business. In this relationship, owners provide the capital necessary for the business to run, while the management runs the business. In exchange, owners receive dividends or capital gains while the management gets salaries and bonuses. This relationship can be mutually beneficial for both parties if they act in one another’s best interests. However, there can be some problems with it as well.
While owners give control of their business to management, they also lose theirs. Therefore, they cannot dictate how the operations of the business occur. With their control, the management may manipulate the records of the business to present an unfaithful representation. It may occur due to many reasons, such as not meeting goals or bad performances. Usually, these records come in the form of financial statements. Therefore, owners need a system to help them verify whether the financial statements present a true and fair view. It comes in the form of auditing financial statements.
Definition
Statutory audit, also referred to as financial audit, is a type of audit that follows the statutes or laws of a specific jurisdiction. The primary goal of statutory audit, as with all other types of audit, is for auditors to obtain audit evidence and reach conclusions about the financial statements. The conclusions that auditors must reach relate to whether financial statement items present a true and fair view. Similarly, they must determine whether these items are free from material misstatement.
Based on the conclusions reached by auditors, they must conclude by forming an opinion about whether the financial statements as a whole present a true and fair view, and are free from material misstatements. Auditors then express their views in the form of an audit report. The audit report shows the opinion of auditors and any other observations they made during the audit.
The stakeholders of some businesses and companies may not require an audit due to their size or nature. However, some companies may still perform an audit voluntarily or an audit required by its stakeholders. For example, when a company applies for a loan with a financial institution, such as a bank, the bank may require them to perform an audit.
Statutory audits are the opposite of voluntary audits. With statutory audits, companies do not have an option to avoid audits. Most of the time, governments or accounting bodies require companies to perform an external audit under their laws. Therefore, the type of audit required by law rather than one that is voluntary or required by stakeholders is known as a statutory audit.
As mentioned above, auditing is necessary for owners to understand whether the records of their company or business are accurate and show a true and fair view. However, with this audit, the involvement of owners is not a requirement. For example, a company run by its owners in key positions may not need a voluntary audit. However, if they are subject to statutory audits, they must abide by the rules regardless of whether the owners want it or not.
Example of Statutory Audit
The government of the US and the UK require all public-listed companies to perform an audit. Usually, these statutory audits come with instructions as to what the government needs from the audit. In case governments don’t mention their requirements, the auditing standards have instructions as to how auditors should carry out these audits. Usually, the instructions are straightforward. Auditors need to reach conclusions about the financial statements to express an opinion and present it in the form of an audit report. For this purpose, auditors must check the underlying transactions and source documents for financial statement items.
It requires these from auditors because usually there are larger repercussions of any misstatements in the financial statements than just affecting a company’s stakeholders. For example, for public companies, any problems with their financial statements may affect the general public or even the economy of a particular country. Therefore, governments introduce statutory audit requirements to minimize these risks.
Similarly, for government organizations, the trust, and well-being of the general public are at stake. Therefore, most governments require these organizations to perform an audit. For the purpose of this audit, the general public is the stakeholder. These government organizations perform statutory audits to add to their transparency and show it to the public.
Statutory Audit vs Internal Audit
People often confuse statutory audit with internal audit. While in some jurisdictions, internal audit may also be a requirement of the law, they do not make statutory audits. There are many differences between statutory and internal audits. Given below are some of the fundamental differences between the two.
Requirements
As with statutory audit, some governments or regulatory bodies may also require internal audits for companies. Similarly, companies may also perform internal audits voluntarily without being required to do so. However, the requirements of both statutory and internal audits are different. For statutory audit, the law or auditing standards set the terms and provisions. For internal audits, while there are standards, the management of the company decides on the requirements.
Appointment
With both types of audits, who appoints the auditors is also different. In a statutory audit, the stakeholders of the company select an audit firm for the audit. With an internal audit, the management of the company selects auditors. Regardless of who appoints the auditors, both statutory and internal auditors should remain independent of the management of the company.
Timing
The timing for both audits is also different. Statutory audits occur after each accounting period, usually annually. However, the laws may require companies to perform audits even earlier or sometimes, later. Some companies may also perform audits quarterly or semi-annually. Statutory audits depend on the preparation of financial statements. On the other hand, the process of internal audit does not depend on financial statements at all. The internal audit process of a company is a continuous activity.
Role of auditor
The role of the auditor for both statutory and internal audits is different. In a statutory audit, the role of the auditor is to perform audit procedures to determine whether the financial statements are free from material misstatement, and present a true and fair view. With an internal audit, the role of the auditor is to examine the internal control systems and risk management process of a company.
Summary of Key Differences:
| Particular | Statutory Audit | Internal Audit |
|---|---|---|
| Requirement | Require by laws of government or regulatory bodies | It depends on the individual company or organization |
| Appointment | Appointed by stakeholders of the company | By management of the company |
| Timing | Normally at each accounting period; annually. In some cases, quarterly or semi-annually | It is continuous activities depends on risk assessments |
| Role of Auditor | The role is to express the true and fair view of financial statements from any material misstatements | The role is to determine the internal control system and risk management are carried out properly |
Advantage of Statutory Audit
There are many advantages that the statutory audit provides. First of all, it can help detect the reliability of the financial statements of a company. By performing a statutory audit, companies can increase the authenticity and credibility of their financial statements. In the absence of an audit report, stakeholders may not trust the financial statements.
Furthermore, a statutory audit helps determine whether the management of the company took all the steps necessary to ensure proper financial records were kept and used in the preparation of financial statements. It can also help in detecting any deficiencies in complying with relevant regulations.
While the primary purpose of statutory audits is to determine whether the financial statements of a company present a true and fair view, they can also help determine the effectiveness of its internal controls. Apart from sharing their opinion regarding the financial statements, auditors comment on the efficiency and effectiveness of the internal controls systems of the client as well.
Overall, it increases the value of the financial statements of the company to its stakeholders. In the absence of these reports, many stakeholders may refrain from continuing their relationships with the company.
Limitation of Statutory Audit
Statutory audit also has certain limitations aside from their advantages. First of all, for some companies, the benefits they get from performing statutory audit may be lower than the costs associated with them. Therefore, they may not get any gains from performing these audits. However, due to requirements by the law, they are forced to conduct statutory audit.
It also gives rise to additional administrative overheads. Performing statutory audits require companies to make time for auditors and cooperate with them. For some companies, this means paying employees overtime to do their job while also coordinating with auditors. Furthermore, statutory audit also come with other limitations such as time, internal controls, independence issues, etc.
While it can increase the trust in the financial statements of a company, auditors do no check all their aspects. For example, auditors use sampling or representations with some areas, which may not detect issues in those areas. In these cases, there is no guarantee that there aren’t any misstatements in the items.
Conclusion
Statutory audit is the type of audits required by the law. For example, some governments demand public-listed companies to perform an audit of their financial statements. In statutory audit, the goal of auditors is to provide an opinion on whether the financial statements of a company are free from material misstatements and present a true and fair view. Statutory audits are different from internal audits in their requirements, appointment, timing, and role of auditors. There are many advantages of statutory audits, but they also come with some limitations.
