What investors need to know

A sound understanding of financial statements (FS) is crucial for investors because these reflect a true and fair view of the financial position and financial performance of a company as well as providing a base for forecasting the financials. Investors need reliable FS in order to make their investment decision. In addition, National Board of Revenue (NBR) requires FS to be prepared in accordance with Bangladesh Accounting Standards (BAS) and Bangladesh Financial reporting Standards (BFRS) with a view to determining the correctness of tax declared in the tax returns, as corporate tax is a function of net profit made by a company. Auditors add value to the FS by increasing the credibility and reliability of the numeric figures and thus play an important role to the users of FS.
However, there are some misconceptions about the role of auditors, which give rise to expectation gap. The American Institute of Certified Public Accountants (AICPA) defined expectation gap as "the difference between what the public and financial statement users believe auditors are responsible for and what auditors themselves believe their responsibilities are." The most common expectation gap is that "Auditors inspect every small detail". It is possible for an auditor to inspect each and every item of a FS, but it costs timeliness and cost effectiveness. So, auditors most often follow a risk based audit approach. In this approach, key risk areas, which mean items having high probability of manipulation, are identified by conducting analytical procedure and focus is given on these areas. For example, key risk areas of a manufacturing company FS are inventory, property plant and equipment, creditworthiness of receivables, sales recognition etc. Immense care is taken in auditing these areas. However, less risky areas are not left unaudited; rather these are audited on a sample basis to the extent of satisfaction. Contrary to this, sensitive transactions like directors fee, related party transactions, transfer pricing etc. requires a detailed check.
Another expectation gap is that "Auditors give an absolute assurance". Absolute Assurance is the highest level of assurance an auditor can give if each and every transaction is audited. The reason why auditor is unable to obtain absolute assurance is not because auditor's do not conduct audit activities with enough care rather there are limitations and these limitations restricts the auditor to obtain only reasonable assurance. Some of these limitations are use of judgments in making accounting estimates, concealment of important financial information by management, legal restriction in obtaining some evidences, human error etc.
Most naive investors cherish a misconception that "Auditors prepare the FS and should accept the primary responsibility for the FS". It is actually the management of a company who prepares the FS. Auditors are just provided with a full set of FS and they express an independent opinion on these FS, even the opinion does not become a part of the FS prepared by the company management. However, a company may outsource its FS preparation function from an accounting or audit firm. In this case, the same audit firm should not prepare and audit the same FS, and in case of Stock Exchange listed companies, it is strictly prohibited by Bangladesh Securities and Exchange Commission.
Over the last decade, the media and courts have been overflowing with corporate collapses and bankruptcies due to fraud. Clients, judges, shareholders, bankers and other parties expect auditors to take steps to detect fraud during the audit. When undetected fraud is uncovered without warning, by accident, or other, the users of the financial statements and the courts look first to the auditor to place blame. The actual scenario is different.  In a standard audit, the auditor may well discover a fraud through the procedures performed. On the other hand, in a forensic audit the auditor identifies that there is a potential fraud and will perform steps and procedures to uncover this fraud. That is the distinction which is missing in the public's perception of the auditor's role to identify fraud in a standard audit.
In order to reduce expectation gap, the users of FS need to read and understand the auditor's report, which specifically mentions both management's and the auditor's responsibilities. Discussion and understanding of the auditor's perception of the business and its risks are also important. Finally, users have to trust that auditor is adhering to professional standards, but they should not do so blindly and should, at least, understand what those standards are.

The writer is Audit Assistant,Hoda Vasi Chowdhury & Co. Email: mosarraf33@gmail.com