A fresh look at an old process

Intheblack, Mar 2008 by Bradley, Cameron

Audit: AN AUDIT IS AN IMPORTANT COMPONENT OF BUSINESS CORPORATE GOVERNANCE, AND CAN ADD REAL VALUE TO ANY ORGANISATION, SAYS CAMERON BRADLEY

AN INDEPENDENT AUDIT IS A KEY function of corporate governance. Corporate governance is the system by which organisations are directed and managed. It influences the achievement of business goals, it monitors risk and it achieves optimal performance.

In 2004 the CLERP 9 reforms focused on audit and corporate governance, which are now running smoothly in their second year of implementation. These legislative reforms demonstrated the importance that regulators place upon an independent examination of financial information. Regulators consider financial information is significant for economic decision-making, and therefore the quality of that information affects the calibre of the decisions made. First class decisions are considered good for the economy as a whole.

Whether an independent audit is viewed as adding value or simply a matter of compliance depends on the significance business managers and stakeholders place on the function.

Why have an audit?

Corporate governance processes are clearly defined for listed companies. They include audit committees, risk identification and mitigation and internal control sign-offs by management. These corporate governance processes are not necessarily implemented by growing proprietary companies.

Directors are often fully occupied in day-to-day operations and may not have sufficient time to step back and appraise the (sometimes ad hoc) development of internal processes.

An independent examination by a fresh set of eyes, with experience across a broad range of businesses, is often extremely useful.

An external audit will assist in identifying risk, providing recommendations for improvement, ensuring regulatory compliance, and will support sound decision-making through the provision of quality financial information.

An independent examination of business processes and financial information also provides far more than regulatory compliance. If there are material weaknesses in the internal control structure it is likely that related business processes are not operating at an optimal level, and control processes may not be effective or efficient. It is also likely that risks are not being adequately identified or controlled. All such deficiencies will contribute to less than optimal performance and results.

As the regulators increase their surveillance activity, with particular attention to directors' fiduciary duties, an independent review may be Important for identifying material deficiencies in the control environment that need to be considered and/or addressed.

A generally accepted view is that audited financial information is of higher quality than unaudited financial information. In my experience organisations that have their financial information audited have better internal controls and internal management reporting systems than those that don't. The discipline required to produce relevant and reliable external financial reporting information flows to the rest of the organisation's management means they must all work together to ensure the results are accurate and meaningful.

Independent audits add value

I have had several experiences of new clients who came with unaudited financial reports suggesting that they were reasonably profitable, but without a sense of success in their business dealings. When undertaking an audit on these clients, the audit has often revealed a lack of adequate provisioning, or an inappropriate revenue recognition policy, which has resulted in turning a perceived profit into a loss. Despite the disappointing outcome, the audit provided a timely opportunity for the clients to seek financial assistance, address loss-making activities and refocus efforts to generating sales.

The audit process also provides an opportunity for an independent review of internal controls, including an independent assessment of the risk of fraud.

Audited financial information is highly regarded by potential investors on when considering investment opportunities. An independent audit can add value when management is in the process of negotiating a business sale or raising equity funds by giving integrity to the business' performance and financial position.

Cameron Bradley is a partner at Pitcher Partners