The Limitations of Audit: All you need to know about!

We all know that audit is an independent appraisal activity in an organization. It is a process of carefully checking and examining financial matters according to standardized policies and practices. Auditing is advantageous to the management and all persons interested in the organization as it is an effective tool for the detection of frauds, errors, or inconsistencies. Once accounts are audited, greater reliability can be placed on financial reports, and hence, decision-making can be done more confidently. However, even though auditing offers many advantages, it comes with certain limitations too. In fact, there are some limitations in auditing which cannot be overcome and which are with the subject since its evolution. These are often referred to as inherent limitations of an audit.

According to SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”:

“The auditor is not expected to, and cannot, reduce audit risk to zero and cannot, therefore, obtain absolute assurance that the financial statements are free from material misstatement due to fraud or error. This is because there are inherent limitations of an audit.”

What are the inherent limitations of an audit?

An auditor checks the books of accounts for one whole year within a specific time limit. He or she employs various audit procedures such as test checking, sampling, observation, etc. to gather evidence in support of business transactions. With a limited time, not all transactions can be checked, and moreover, the evidence obtained through these audit procedures is persuasive and not conclusive. The auditor’s capacity to collect audit evidence is restrained by practical and legal limitations. And thus, an audit does not completely assure that financial statements have zero misstatements.

Mentioned below are some of the main Limitations of Audit:

Limitations of Audit due to the Nature of Financial Reporting

1. Examination on prepared accounts

Auditing begins where accounting ends. When the accounts are being finalized, the auditor may nowhere be around. Therefore, he might not be able to identify well-planned manipulations in the books of accounts that are discoverable at the planning stage only. As a result, even after the books have been audited, several questionable facts may go undetected.

2. Accounts involve estimates

The financial statements of a client are always based on certain estimates made by the management in accordance with the financial reporting framework. Since management estimates are an inevitable part of financial statements be it making allowances for receivables or estimating the life of fixed assets, the auditor cannot ascertain their accuracy & correctness with conclusive proof. He can only exercise his judgement to assess their reasonableness.

Limitations of Audit due to the Nature of Audit Procedures

3. Not access to full information

For example, it is possible that management or others will not disclose the entire information that is necessary to the production and presentation of the financial statements or that has been requested by the auditor, either intentionally or accidentally.

4. Not an expert

Fraud can take the form of complex, well-planned strategies intended to keep it hidden. As a result, audit processes used to acquire audit evidence may be inefficient in detecting an intentional misstatement, such as a conscious attempt to manipulate documents, which may lead the auditor to feel that audit evidence is genuine even when it’s not. The auditor is not trained in the authentication of documents and is, therefore, not expected to be an expert.

5. Different from an investigation

An audit isn’t the same thing as a formal investigation into fraud or wrongdoing. As a result, the auditor is not given specific legal powers, such as the power of search, that may be required for an investigation of this nature.

It is critical that we recognize the difference between audit and investigation. A critical study of the accounts for a specific reason is known as an investigation. For example, if fraud is suspected and it is specifically requested to verify the accounts to see whether fraud is indeed present, it takes on the form of an investigation.

The goal of audit, on the other hand, is to get reasonable certainty that the financial statements as a whole are free from material misstatements, whether due to fraud or error, thus allowing the auditor to give an opinion.

As a result, audits are never initiated with preconceived notions about the state of affairs; about wrongdoing; or about some wrong act being committed. The auditor’s goal is to report on what he discovers during the routine examination of the books. However, it is possible that the auditor’s preliminary findings may lead to an investigation. It’s possible that the auditor found something important to be concerned about. Such findings may necessitate calling for a formal investigation.

6. Dependence on inside information

A company’s books of accounts, no matter how complete they are in every way, do not tell the whole story of the transactions that are recorded in them. As a result, an auditor is required to solicit extra information, clarifications, and explanations from a variety of individuals in the company. The reliability of such information, etc., is generally in doubt, especially if the people giving it are themselves involved in the manipulation of accounts. Therefore, even audited financial statements or accounts may not present an accurate or full picture.

7. Faulty or Inadequate External Evidence

Though the auditor is perfectly within his or her rights to seek information from external sources to support the assertions made in the financial statements, such evidence may not be entirely reliable. A business debtor, for example, may offer incorrect information regarding the debt that he owes. The company’s lawyer may distort the facts in order to argue that there are no claims against the company. Similarly, when valuing an asset, the evaluator may make a mistake. Hence, even audited accounts may lack credibility in these circumstances.

8. Inconclusiveness of evidence

The evidence that an auditor obtains is generally persuasive rather than conclusive. For instance, an architect’s certificate to support the valuation of the client’s newly constructed building might not be conclusive proof of the correct value of the building. Thus, the conclusions drawn by the auditor from such evidence are only reasonable. They are not fully conclusive.

9. Exercise of judgement

Every auditor uses his or her professional judgement to decide the nature, timing, and extent of auditing procedures required to be performed for a client’s business. Further, the auditor exercises judgement to evaluate the appropriateness of various estimates used by management in the financial statements. As a result, there isn’t always a scientific reason behind every conclusion made by the auditor.

Limitations of Audit due to Timeliness of Financial Reporting

10. Limited time

There is a need for the audit to be conducted within a reasonable period of time as well as at a reasonable cost. This puts pressure on the auditor to complete the audit within the deadline and hence, thorough checking of each and every transaction is not possible.

Limitations in the scope of an audit

Sometimes the management, before engaging an auditor, puts a limitation on the scope of the auditor’s work in the terms of a new audit engagement. In such a situation, if the auditor thinks that such limitation will result in the auditor disclaiming an opinion, he should not accept the audit engagement, unless required by law or regulation to do so. If he accepts the engagement, he might end up issuing a disclaimer of opinion on the financial statements due to his inability to collect sufficient & appropriate audit evidence.

The subsequent discovery of misstatements

Because of the disadvantages or limitations of an audit, there is an inherent risk that some major misstatements of financial statements will go undetected, even if the audit is properly planned and done in compliance with Standards on Auditing (SAs). As a result, the subsequent discovery of a major inaccuracy in the financial statements due to fraud or error does not in itself demonstrate a failure to undertake an audit in compliance with SAs.

It should, however, be borne in mind that the inherent limitations of an audit do not justify that the auditor should be satisfied with less-than-persuasive audit evidence. He must perform his audit in compliance with SAs and by using the audit procedures necessary to suit the circumstances of each case.

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Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

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