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why an audit is still the highest level of surety for businesses
11 March 2020
You may recall the judgement following the audit scandal of Tesco in 2014 which resulted in them inflating their reported profits by over £325m. Once the largest retailers in the UK and a shining example of British business, the company was fined £129m and forced to compensate select shareholders to the tune of nearly £90m.
Since then, there have been several more accounting scandals involving high street names such as Patisserie Valerie, Ted Baker and BHS, which have come into the spotlight, and it’s alleged that auditing errors even contributed to the demise of Thomas Cook.
This has all raised some uncomfortable questions for auditors. Where were they in all of this? Isn’t it their responsibility to ensure this doesn’t happen? Should they be held accountable?
is it right to recognise income related to supplier rebates?
Unfortunately the answers are not always straightforward. If we look back to 2014, the accounting ‘error’ centered on when it was right to recognise income related to supplier rebates.
The problem with this type of income is that there is often a fair amount of judgement involved. For example, if the company hit a particular level of sales they may have been entitled to a rebate of say £1m. However if they’d sold 5% more, then this may have increased to say £2m. At the time, the company wouldn’t have known exactly how much it was going to sell over the course of the year. Therefore, they would have needed to estimate the value of this income.
Despite the grey area around estimation, what was clear is that they didn’t exercise the level of judgement expected of them.
So what about the auditors?
Well, if we look back at the audit report issued before the scandal, the auditors had raised this very topic as an area of risk due to the high level of judgement involved, highlighting in the audit report to the user of the accounts that this was an area they felt was subject to a degree of estimation.
Which leads us to question whether Tesco simply ignored the advice of the auditors to ensure this area was robustly managed or whether something was indeed missed.
What is clear, however, is the importance of sound and robust financial controls, as well as the level of reliance both current and future stakeholders place on a company’s financial statements.
Audits still have many advantages for businesses
Improving the credibility of financial information to external stakeholders, providing a solid financial platform on which to base commercial decisions and increasing efficiencies through improvements to systems and controls. A focused and proportionate audit can still provide peace of mind for many business owners so they can focus on decision-making and growing their business.
An audit is still the highest level of assurance a company can obtain over their financial statements and the reason so many companies choose to have this voluntarily, outside of those who are required to have one. However, the process is by no means infallible. The level of testing performed by the auditors is centered on risk and often conducted on a sample basis.