What is Statutory Audit? Its Types, Advantages, Disadvantages
Understand the importance of statutory audit, its objectives, types, and step-by-step procedure to ensure accurate financial reporting, compliance, and fraud prevention in organizations.
Izhar Ahmad15 Jan, 2025
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A statutory audit is a required examination that examines the accuracy of a corporation's or governmental entity's financial accounts and paperwork. The primary goal of this audit is to discover whether a company shows a true and exact picture of its financial standing, achieved through the study of details such as bank funds, accounting records, and financial deals.
We must understand why a statutory audit is necessary. For a corporation, the shareholders form the company’s ownership. Nevertheless, they do not run or conduct the daily operations of the company. The management through the board of the directors does this.Statutory Audit Meaning
Statutory audit also known as financial audit entails going through the final financial statements such as profit and loss account and balance sheet. This audit aims to ensure that these accounts reflect the true picture of the company’s current financial state as of the balance sheet date.Objectives of Statutory Audit
The objectives of an audit, particularly in financial statement audits like statutory audits, involve auditors scrutinizing financial statements prepared by a company's management.Identifying and Preventing Errors
Auditors look for any mistakes or discrepancies in financial statements, such as incorrect entries or miscalculations.Identifying and Preventing Fraud
Auditors assess the company's financial processes to identify potential fraudulent activities and safeguard the organization.Addressing Clerical Errors
Auditors check for manual errors that may impact the financial records.Managing Compensating Errors
The audit aims to detect any compensating errors that might be obscured in the company’s financial records.Resolving Errors of Principles
Auditors identify errors in accounting principles and recommend corrections to ensure compliance with financial reporting standards.Types of Statutory Audit
There are two primary categories of statutory audits:Tax Audit
This involves a thorough examination of the tax return by the Internal Revenue Service (IRS) to verify the accuracy of reported income and deductions. The IRS conducts a tax audit when a closer inspection of the tax return is deemed necessary to ensure precision in income and deduction reporting.Company Audit
According to section 183(3) of the Company Act 1994, a company audit entails the examination of a company's balance sheet, profit and loss account (or income and expenditure account), or cash flow statement by the company's appointed auditor.Provisions Regarding Auditor
The Companies Act 2013 outlines the provisions concerning statutory audits and auditors in sections 139 to 147. Key provisions include:Auditor’s Right to Access Financial Records
It has unrestricted access to all financial books, records, and other relevant information. They can also request any additional information required for the audit.Auditor’s Report
The auditor is responsible for providing a report that clearly states whether the company’s financial statements represent a true and fair view of its financial position.Qualified Report
If the auditor determines that the financial statements do not reflect the true financial status, they must provide clear reasons for this qualification.Fraud Detection
If the auditor identifies fraud during the audit, they must report it to the appropriate authorities.Compliance with Auditing Standards
Auditors must adhere to the auditing standards established by the Institute of Chartered Accountants of India (ICAI).Steps in Statutory Audit Procedure
The steps in the statutory audit procedure include:Understanding the Operating Environment
The auditor gains insight into industrial guidelines and regulatory criteria to assess their ethical adherence. This step encompasses the use of questionnaires, checklists, surveys, and formal notifications.Understanding Controls
The auditor learns about a business entity's operational controls by engaging with employees, external auditors, and reviewing industry publications, as well as previous audit reports and working papers of the company.Testing Controls
This phase of the statutory audit involves evaluating corporate procedures conducted by a specialist performing regulatory audits. The focus is on operational mechanisms for fraud prevention or error mitigation. The auditor ensures that these controls align with industry practices and regulatory standards, are adequate, executed properly, and are well-understood by all relevant employees.Testing Account Balances
Auditors conduct tests on account balances to verify the accuracy of financial reports. This ensures compliance with regulatory standards, statutory principles, and industry practices.Testing Account Details
The auditor further performs tests on specific account details, such as those related to banks, insurance companies, or hedge funds, to ascertain the accuracy and completeness of the audited statutory financial statements.Advantages of Statutory Audit
The statutory audit offers several benefits, such as:Credibility of Financial Reports
The audit ensures that the company’s financial reports are accurate, providing credibility to stakeholders.Enhanced Management Efficiency
The process helps identify areas for improvement in internal controls and operations.Improved Reputation
A company that undergoes a statutory audit builds trust among shareholders, investors, banks, and regulatory authorities.Fraud Prevention
Statutory audits help detect and prevent fraudulent activities by scrutinizing financial records thoroughly.Better Access to Financial Resources
Companies opting for statutory audits gain easier access to bank loans and other financial resources.Disadvantages of Statutory Audit
Despite its benefits, a statutory audit has a few disadvantages:Sampling Method Issues
Audits often rely on sampling methods, which may not guarantee absolute accuracy.Cost
Statutory audits can be costly, especially for smaller companies, which may impact their financial resources.Potential Conflicts of Interest
If audit personnel have conflicts of interest, it could affect the quality of the audit.Time Constraints
Tight deadlines may lead to rushed audits and reduce accuracy.Dependence on Auditor’s Judgment
The quality of the audit can vary based on the auditor's expertise and judgment. A statutory audit is an essential process for ensuring the transparency and integrity of a company’s financial statements. It verifies the accuracy of financial records, helps prevent fraud, ensures compliance with legal standards, and builds trust among stakeholders. While there are certain challenges and costs associated with statutory audits, their benefits far outweigh the drawbacks, making them a critical part of any organization’s financial operations. Join PW Commerce Online Course now and excel in your academic and professional pursuits!What is Statutory Audit<span style=
What are the roles of statutory audit?
Statutory audit verifies financial statements for accuracy, ensuring a true and fair representation, detects fraud, and assesses internal controls.
Who needs statutory audit?
Entities like companies, as mandated by regulatory authorities, often with certain turnover or capital thresholds, require statutory audits.
Is statutory audit compulsory?
Yes, for certain entities, statutory audit is compulsory, particularly when they meet specified criteria related to turnover and capital.
Who appoints a statutory auditor?
The company's shareholders appoint the statutory auditor based on recommendations from the Board of Directors.
What is statutory audit also known as?
Statutory audit is also known as financial audit or external audit.
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