External Audit – Concept, Practice, Framework, Purpose and Stakeholders
Defining External Audit:
An External Audit is an investigation and analysis of a business’s financial state performed by an Audit Firm not affiliated with the business being audited. This process usually begins with an analysis of the business’s accounting records to determine the accuracy of calculations and the recording processes used. One purpose of this investigation is to determine if the business’s accounting practices are valid and meet common accounting standards. The auditor’s interpretation of the business’s accounts is compared to the Financial Statements to determine if the company’s reporting accurately reflects the status of the business’s finances and overall fiscal well-being.
Why an External Audit is required:
In many cases, the external audit is required by business owners as a form of oversight of the business’s management. This is particularly true for large businesses where ownership and control are separate. Owners/shareholders seek reassurance that the management team is performing competently and that their investments in the company are secure. In other instances, external audits are required by governments or government agencies for businesses above a certain size. The primary intent of government required External Audits is to detect fraudulent practices by businesses. In Dubai and other Emirates of UAE, businesses are required to use accounting firms that have been approved by authorities.
Responsibilities of an Audit Firm:
An External Audit can be performed by an individual auditor but more commonly an Audit Firm specializing in external audits performs the audit. For audits required by government statute the qualifications of the auditor are normally specified in the statute. In the UAE, auditors in Dubai and other Emirates must be approved. External Audits are often required by an organization’s business plan or corporate by-laws. The qualifications of the auditor are customarily specified in the call for an audit.
International Professional Associations and Standards Setting Bodies:
There are some international organizations that certify accountants and auditors. The International Register of Certified Auditors (IRCA) offers training and certification of auditors. The International Auditing and Assurance Standards Board (IAASB) set standards for quality and consistency of audit practices worldwide. The Association of Certified Fraud Examiners (ACFE) establishes standards for auditors and provides certification credentials for qualified individuals. These professional associations and many others assure the auditors are knowledgeable in Generally Accepted Auditing Standards (GAAS) or International Financial Reporting Standards (IFRS). The actual certification required for an auditor or an Audit Firm is specified in the call for the audit. In all cases, some generally recognized certification will be required for both the Audit Firm and the Firm’s primary or lead auditors.
Values derived from an External Audit:
The value of an external audit is not easily quantified. It is not measured as a Return on Investment or a direct increase in profitability. CEOs, CFOs, and audit committee members often describe the value and benefits of an external audit in more intangible terms like comfort, confidence and security. There is comfort in knowing the issued audited Financial Statements are accurate and represent the company’s real financial status. There is comfort, as well, in knowing current and potential investors can have confidence in the company’s financial reports and company management. The same company officers often feel the external audit inspires confidence in the company’s own internal audit processes by imposing discipline on the internal audit staff. The security factor is expressed as a feeling that external audits demonstrate corporate management’s competence and good standing in respect to business statutes. External audits greatly reduce the managers’ vulnerability to legal actions by stockholders or government agencies. The transparency provided by the external audit gives consumers of the company’s financial reports a greater belief that the company is performing exactly as described in the reports.
The insights gained from an external audit can be enhanced by the auditors’ feedback concerning the competence of the management team and the cooperation of staff. Weaknesses in internal controls outlined by auditors can be important. Unfortunately, statutory limitations on non-financial activities by auditors often restrict the auditors’ ability to share this additional information. In strict terms, the auditors’ reports can be distilled down to a pass-fail decision about the company’s financial reporting. Any additional information and particularly auditors’ insights frequently is not passed on. There are ongoing efforts to loosen these limitations and permit auditors in Dubai and other Emirates of the UAE to make suggestions or recommendations to clients.
Scope for additional responsibilities of Audit Firms:
There is a movement among some Audit Firms calling for some revisions of the regulations constricting auditors’ contributions. These firms are promoting the concept that auditors have additional information of value to the audited company. The statutory restrictions should be loosened to allow auditors to provide analysis and advice in the audit report in addition to the pass-fail decision about the company’s financial reporting. The value of the external audit would be greatly enhanced by this additional information. We provide our clients with regular reports about the ongoing auditing process and we share any insights we have – within the legal limitations placed on auditors in Dubai.
External Audit in UAE:
In the UAE, audited Financial Statements have been mandatory since 1984 and the adoption of Commercial Companies Federal Law Number 8. The external audit conducted by auditors in dubai and other emirates of the UAE will fulfill this requirement and isolate the company from threat of fines or other penalties. The penalties were defined in a new commercial companies federal law issued in 2013.
UAE Free Zone requirements of External Audit
UAE authorities will request audited Financial Statements as part of the license renewal process. Free Zone Authorities will always request audited Financial Statements for license renewal. Having the audit report ready will make license renewal quick and relatively painless.
Banks and Financial Institutions requirements of External Audit
When most UAE banks are approached for credit approval, they will require audited Financial Statements to help determine the company’s credit-worthiness. The same requirements must be met for most other bank facilities approvals.
The primary purpose of an external audit, in the UAE or elsewhere, is to establish confidence in the company’s financial reporting. This provides some important but intangible benefits to all business owners and top managers. In the UAE, these intangible benefits are equally applicable. Just one of these benefits is that audited Financial Statements can be major evidence in any legal disputes involving the company. Another benefit is that the audit can help interested parties accept the reliability of company’s financial reports.
Stakeholders of an External Audit:
Owners and Management
In general terms, the stakeholders for audited Financial Statements are any persons, organizations, and government agencies with an interest in the company and its operations. Financial Statements are by and large considered public documents available to anyone. External audits are performed for a more narrow range of interested parties with specific concerns about the business. Large businesses, whether privately owned or owned by shareholders, have some separation between ownership and management. It is important that the owners/shareholders know the business is being operated competently. The external audit gives the owners confidence that the managers are reporting the business’s financial status accurately. Business managers’ positions are subject to the judgments of the owners so they have a very important stake in the audited Financial Statements. These are the primary stakeholders in the process.
Suppliers, Customers, Employees, Government Authorities, Banks and Society
Other stakeholders are less directly concerned with Financial Statements quality than the owners and managers but still have significant interest in company operations. Suppliers need to know their customers are financially able to pay for the products and services they supply. Customers that purchase high-ticket products like automobiles need to know the company will be able to provide service for the products in the future. This means the customers are stakeholders in the company’s Financial Statements reliability. A company’s employees depend on the company for income. They expect the company to be around for a long time and to have the resources to pay them for their work. Thus, employees are stakeholders in the company’s Financial Statements.
There are government agencies concerned with businesses’ operations for legal reasons and for taxation. These agencies rely on Financial Statements for some insight into companies operations, making the government another stakeholder in the accuracy and reliability of Financial Statements. Most companies rely on financial institutions for short-term and long-term loans to finance purchases, day-to-day operations and capital improvements. The reliability of a company’s Financial Statements is very important for the banks, investors or other lenders in making lending decisions. These financial institutions and investors definitely have a stake in the company’s Financial Statements reliability. Businesses are corporate citizens. Society has certain expectations from member/citizens for appropriate behavior in society and community. The reliability of a business’s financial reporting is one way a business exhibits its compliance with society’s rules and expectations, making society in general another stakeholder in the Financial Statements.
Contents of an Audited Financial Statements:
When financial auditors complete an audit, an audit report is generated. This audit report follows an industry and professional standard format for content and layout. Following a known format makes the report easier to understand and allows readers to quickly find the information that interests them.
The standard format of an audited Financial Statements includes the Independent Auditors’ Report, Statement of Financial Position, Statement of Comprehensive Income, Statement of Changes in Equity, Statement of Cash Flows and Notes to the Financial Statements. Some readers may never look beyond the auditors’ report and have no interest or understanding of the Financial Statements.
Independent Auditors’ Report
The independent auditors report takes the form of a letter addressed to the Board of Directors of the audited company because the audited company pays the auditors’ fees and the report is what the company has paid and asked for. The first paragraph is introductory in content. It describes the Financial Statements that were examined by the auditors and specifies the time frame covered by the examined Financial Statements. There is a statement that the company management – not the auditors – is responsible for the content in the Financial Statements. The auditors’ responsibility is limited to an opinion about the reliability of the information contained in the Financial Statements.
The second paragraph describes the scope of the audit. The accounting standards that were the basis of the audit are specified and the way the auditors interpreted and followed the standards is explained.
The third paragraph is the most important. The opinion paragraph either expresses the opinion of the auditors concerning the “true and accurate” status of the audited Financial Statements or describes the reasons for a qualified opinion. An unqualified opinion provides assurance that the information in the audited Financial Statements can be trusted to present an accurate assessment of the company’s financial status. A qualified opinion means that there were problems in the Financial Statements that prevented an accurate assessment or that material misstatements were found. If the auditors’ opinion is qualified, the problems are described in a paragraph inserted ahead of the normal opinion paragraph. The very existence of a problem paragraph before the opinion paragraph is the first thing experienced readers of audit reports look for. If the problems described were primarily a lack of sufficient evidence the ramifications are less than if the auditors discovered some material misinformation in the Financial Statements.
The explanatory paragraph, typically the fourth, is included when the auditors feel the need to explain some aspect of the audit process. This is not the description of a problem, it is only a description of changes in the audit process employed in the audit. This is normally used to highlight changes in regulatory requirements or auditing standards.
The control paragraph, typically the fifth, expresses the auditors’ opinion of the company’s internal controls. This paragraph can present an unqualified opinion about the company’s control over financial reports. An unqualified opinion about the company’s internal controls is another reason for readers to rely on the company’s Financial Statements. In the event of a qualified opinion concerning internal controls, the reasons will be described. The company is expected to take steps to improve these controls.
Other Components of Audited Financial Statements as per International Accounting Standards
In addition to the Independent auditors’ report, the auditors include Statement of Financial Position, Statement of Comprehensive Income, Statement of Changes in Equity, Statement of Cash Flows and Notes to the Financial Statements as part of complete audited Financial Statements as per International Accounting Standard, IAS 1. Each of these individual statements in a Financial Statements represents the actual accounting information revealed to the auditors separated into specific categories. Knowledgeable readers can derive a lot of specific data about the company’s operations from these statements.
In the final section of the audited Financial Statements, the auditors provide a description of the company’s organization and accounting processes. An overview and breakup of assets, liabilities, equity, revenue, expenses and other pertinent information is presented.
Types of an Audit Opinion:
Unqualified Opinion
An external auditors’ report will contain one of four types of opinions. An unqualified opinion is issued in an auditors’ report when the audit has revealed no material misstatements in the company’s Financial Statements. This is a favorable opinion that assures readers that the company’s Financial Statements accurately present the company’s financial status.
Qualified Opinion
When an auditors’ report contains a qualified opinion the auditors encountered material misstatements with the examination of the company’s Financial Statements or found substantial wrong or misleading information.
If the auditors were unable to find evidence to verify the company’s Financial Statements and records, the auditors will issue a qualified opinion. In this case the qualified opinion will usually include a description of the problems encountered. Such a qualified opinion does not mean the Financial Statements are inaccurate – it means the available information did not meet the auditors’ requirements for reasonable assurance.
When an auditor discovers information in the company’s reports that does not conform to the approved standards for financial reporting the audit report will contain a qualified opinion. In this case, the audited company will ordinarily make adjustments to the reporting to rectify the errors and problems. The auditors’ report is a warning to readers that such errors and mistakes were identified.
Adverse Opinion
A third type of audit opinion is called an adverse opinion; which indicates that the Company’s financial records do not conform to International Financial Reporting Standards (IFRS). In addition, the financial records provided by the management have been grossly misrepresented.
Disclaimer of Opinion
On some occasions, an auditor may be unable to complete an accurate audit report. This may occur for a variety of reasons, such as an absence of appropriate financial records. When this happens, the auditor issues the fourth type of audit report with disclaimer of opinion, stating that an opinion of the Company’s financial status could not be determined.
Reasons for trust on the work performed by Audit Firms:
Independent External Auditors are required by law to be completely independent from the company being audited. There are rules forbidding auditors having any stake in the outcome of the audit. Auditors should have no investment in the company being audited. There are some national and international organizations that offer certification of auditors and auditing firms (such as in the United States, the SEC, PCAOB, and AICPA serve this purpose). These professional associations express the standards of auditor independence and provide education for auditors. There are some organizations that provide a watchdog function over auditors. In order to remain licensed or certified as auditors, individual audit professionals and audit firms must maintain both the appearance and fact of independence. Questions about an auditor’s independence are investigated and licenses or certifications may be withdrawn. When a stakeholder in an audit verifies the certification of the auditor, that stakeholder is encouraged to trust the auditors’ work.
Reasons for Banks and Free Zones in UAE to require Audited Financial Statements of a Company:
UAE authorities will request audited Financial Statements as part of the license renewal process. Free Zone Authorities will always request audited Financial Statements for license renewal. An audited Financial Statements shows authorities the company is active in the activities allowed by the business’s license and not doing any non-licensed activities. A reliable audited Financial Statements helps authorities detect illegal or inappropriate activities and the audit requirement encourages companies to avoid illegal actions. Having the audit report ready will make license renewal quick and relatively painless.
When most UAE banks are approached for credit approval, they will require audited Financial Statements to help determine the company’s credit-worthiness. The same requirements must be met for most other bank facilities approvals.
Reasons for Management to require Audited Financial Statements of a Company:
Company management is expected to assure company operations are being managed competently and the company’s resources are properly implemented. One of the primary tools available to parties interested in a business is the audited Financial Statements issued by the company. Since the company management is responsible for these Financial Statements, there is sometimes a degree of doubt that the Financial Statements are legitimate. An External audit will prove the accuracy and reliability of the Financial Statements and inspire confidence in the company management. This confidence makes the managers’ positions in the company more secure.
Defensive against litigations and law suits
External audits can also serve to verify the company’s operations are ethical and meet any legal requirements. This can help the company avoid any expensive investigations by government agencies or possible penalties. In today’s litigious environment, some people and groups are quick to file suit at any hint of management misbehavior or incompetence. External audits will defuse any such actions or provide a valuable defensive tool in case action is pursued.
Transparency maintained in External Audit:
External auditors are limited in the non-audit activities they can perform in relation to an audit. This means the auditors cannot engage with the Management directly for making management decisions nor they can accept any significant gifts or offerings from the company’s management such that it impairs the objectivity of auditors. These rules serve to enforce the independence of the auditors and therefore enhance audit transparency. It is a role of government in developed countries to adopt rules and guidelines that promote audit transparency. It is a role of auditors to be aware of the rules and the intent as well.
As an audit progresses, the auditors should regularly report to the management about the current auditing activities and any problems faced in accessing required documents. This gives the client company a view into the transparency of the audit process.
The professional standards for auditors include the notion of transparency and professional auditors work hard to follow the standards. In the audit report provided to the client, the auditors will reference the standards the auditors maintained during the audit process.
We are one of the leading and reputed auditors in dubai and we are privileged to offer the following services to our clients:
• Audit & Assurance: We can independently verify the information you rely on for business decisions with our audit and assurance services.
• Risk based audits: We will investigate your internal audit process to determine if potential risks are being managed effectively with our risk-based audit services
• Assurance services to shareholders, regulators, bankers and lenders: Shareholders, lenders and regulators can be confident in company financial reports thanks to our assurance services.
• Compilation & review services: We will assist you in preparing standards-based financial statements and report our opinions about the content of those statements with our compilation and review services.
• Attestation services: We will examine your financial reports and express our opinion on the validity of information in the reports with our attestation services.
• Statutory audit services: As approved Auditors in Dubai we are qualified to perform statutory audits.
• Compliance with IFRS: We can ensure that your financial statements are prepared according to International Financial Reporting Standards (IFRS).
• Attestation of Financial Statements: We can examine and attest your company’s financial statements with our formal external audit services.
• Management reports: We can analyze company performance and provide you with in-depth management reports of business performance.
• Internal controls review: We can investigate your company’s internal controls and report on their effectiveness.
• Assurance to lenders: Our auditing services can provide assurance to the shareholders, bankers and lenders regarding the performance of the company.
• Assurance to relevant authorizes: We are familiar with the regulatory financial landscape in UAE and we are authorized to perform auditing services. We can provide assurance to authorities that your financial statements are valid.
• Review or reporting and other processes: We will work with your designated audit personnel to assure proper internal audit procedures and reporting are being used.
• Performance reporting: We can provide regular reports on on-going performance of the company.
• Company’s policies & procedures: We can examine transactions and report compliance with the company’s policies & procedures.
In addition to Financial Auditing services we also help with business set up in Dubai, company formation in Dubai and company incorporation in dubai. We are a full service accounting firm in dubai offering a wide range of services to our clients in Dubai and other Emirates of the UAE. Arqaam Global services make doing business in Dubai much easier and profitable.
How Arqaam Global can help in getting your External Audit done efficiently and effectively:
Arqaam Global is a Partnership owned by Professionally Qualified Chartered Accountants who have a wide experience in the areas of External Audit, Internal Audit, Accounting, Business Advisory, Financial Consultancy and Management Consultancy. Arqaam Globalhas a strategic alliance with a well known reputed Audit Firm of UAE, NUF Chartered Accountants and our experienced Partner, Farhan Aqil also serves as an Audit Partner at NUF Chartered Accountants.
Our Group of Firms for Audit, Accounting and Consultancy Services means that we can serve you with a wide range of services, all from a single platform, executed by well trained and experienced Audit and Accounting Professionals. The External Audit service provided by our Group Firm NUF Chartered Accountants is accepted and recognized by all Government Authorities, Free Zone Authorities and Banks of UAE.
As one of the top Auditing firms in Dubai, we are qualified to help your company meet any audit needs, whether required by government agencies, company by-laws or other institutions.
Contact us:
For more information on how we can serve you with the best External Audit services for your Company, please contact our Audit Partner, Farhan Aqil at farhan@nufca.ae or +971 50 3958931
