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Chapter 4

Need for external audit

 Shareholders provide the finance for a company and may or may not be
involved in the day to day running of the company.

 Directors manage the company on behalf of the shareholders in order to
achieve the objectives of that company (normally the maximisation of
shareholder wealth).

 The directors must prepare financial statements to provide information on
performance and financial position to the shareholders.

 The directors have various incentives to manipulate the financial statements
and show a different level of performance.

 Hence the need for an independent review of the financial statements to ensure
they give a true and fair view - the external audit

Benefits of an audit

 Improves the quality and reliability of information, giving investors faith in and
improving the reputation of the market.

 Independent scrutiny and verification may be valuable to management.

 May reduce the risk of management bias, fraud and error by acting as a
deterrent.

 May detect bias, fraud and error.

 Enhances the credibility of the financial statements, e.g. for tax authorities or
lenders.

 Deficiencies in the internal control system may be highlighted by the auditor.

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