Purpose and scope of an audit - Accounting records and prope...

Learning Outcomes

After reading this article, you will be able to explain why keeping proper accounting records is critical to an effective audit, describe what constitutes proper records under company law, outline the scope of auditor and director responsibilities for those records, and identify potential risks and audit implications when record-keeping is inadequate.

ACCA Foundations in Audit (FAU) Syllabus

For ACCA Foundations in Audit (FAU), you are required to understand how the maintenance of proper accounting records relates to the purpose and process of an external audit. In particular, you should be able to:

• Explain the nature of accounting records and define proper records.
• Outline the legal and regulatory requirements for maintaining accounting records.
• Distinguish between the responsibilities of directors and auditors relating to accounting records.
• Describe the implications if proper records are not maintained.
• Relate the maintenance of records to the 'true and fair view' assertion in audited financial statements.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which party is responsible for ensuring a company maintains proper accounting records?
   1. The shareholders
   2. The directors
   3. The external auditors
   4. The audit committee
2. What does 'proper accounting records' mean in the context of a limited company audit?
   1. Records covering only cash transactions
   2. Records sufficient to show and explain all transactions and financial position
   3. Records kept for tax purposes only
   4. Only copies of bank statements

3. True or false? If a company fails to keep proper accounting records, the external auditor must qualify the audit opinion.

4. List two items usually found in proper accounting records under company law.

Introduction

Accurate financial information is the basis for decision-making by shareholders, creditors, and other stakeholders. The directors of a company are required by law to keep accounting records that allow the preparation of financial statements giving a true and fair view. Auditors, in turn, examine whether such records exist and if they provide a reliable basis to express an audit opinion. A company's failure to maintain proper records increases the risk of errors and fraud, and may directly impact the audit outcome.

Key Term: accounting records
Documents and entries maintained by an entity to consistently record all financial transactions and balances throughout the accounting period.

Purpose of Proper Accounting Records

Proper accounting records serve three main purposes:

• Enable directors to fulfill their duty to prepare financial statements giving a true and fair view.
• Allow auditors to obtain sufficient, appropriate audit evidence.
• Ensure stakeholders can rely on the reported financial position and performance of the business.

Accounting records should be complete, accurate, and maintained on a timely basis.

Key Term: proper accounting records
Records sufficient both to show and explain all company transactions, disclose financial position with reasonable accuracy, and allow financial statements to comply with the legal framework.

Legal Requirements for Accounting Records

Most jurisdictions require all companies to maintain accounting records adequate to:

• Record, day by day, all sums received and spent and the matters for which each was received and expended.
• Record the assets and liabilities of the company.
• Ensure that, at any time, the financial position can be determined with reasonable accuracy.
• Allow the preparation of annual financial statements in accordance with the applicable framework.
• Where relevant, include details of inventory holdings, goods bought and sold, and sufficient information to identify buyers and sellers.

Directors must retain accounting records for a minimum period—typically three or six years, depending on company type and national law.

Key Term: directors’ responsibility
Directors are legally required to maintain adequate accounting records and to safeguard the assets of the company.

Implications for the Audit Process

An external audit relies on robust supporting records. Without them:

• Auditors may not obtain sufficient appropriate evidence.
• There is increased risk of undetected errors or fraud.
• Auditors must consider modifying the audit opinion if proper records are missing or incomplete.

Arrangements for accounting records affect the efficiency, cost, and scope of the audit. When there are deficiencies, more audit work and judgment are needed, and the risk of qualification rises.

Key Term: audit opinion
The formal statement by the auditor as to whether the financial statements give a true and fair view and are properly prepared according to the relevant framework.

Responsibilities: Directors and Auditors

• Directors: Must establish controls and processes for proper record-keeping, oversee regular preparation of management accounts and financial statements, and ensure records are routinely updated and secured.
• Auditors: Review whether proper records have been kept, determine if records agree with financial statements, and, if necessary, report when records are inadequate or explanations from management are insufficient.

Consequences of Improper Records

Failure to keep proper records can lead to:

• Regulatory penalties or prosecution of directors.
• Inability for auditors to express an unmodified (clean) opinion.
• Shareholders and other stakeholders being misled.
• Increased exposure to fraud and operational mistakes.

If auditors identify record-keeping failures, they must state this in the audit report and may have to qualify their opinion or even disclaim it if appropriate evidence cannot be obtained.

Worked Example 1.1

A company operates several branches where cash sales and expenses are managed manually, and records from two branches are found missing during the audit. The directors inform the auditor that summaries were prepared but the supporting receipts were not kept.

Question: What auditing and reporting actions should the auditor take in this case?

Answer:

• The auditor should evaluate the impact of the missing records on the ability to form an opinion.
• If alternate procedures cannot provide sufficient evidence, the auditor will need to qualify the opinion for limitation of scope or issue a disclaimer if the impact is pervasive.
• The audit report should clearly state that proper records have not been maintained as required by law.

Worked Example 1.2

During an audit, it is found that a company's directors have failed to keep inventory records required by law, although sales and purchases are recorded in the general ledger.

Question: Is the company complying with the duty to maintain proper accounting records? What implications does this have for the audit?

Answer:

• No, inventory records detailing levels and movements are typically part of legal requirements for companies dealing in goods.
• Lack of inventory records impairs the company’s ability to show its true financial position.
• The auditor may not be able to verify the completeness or valuation of inventory and should consider qualifying the audit opinion.

Exam Warning

Many candidates think that if some records are missing, auditors can always compensate with extra procedures; however, if critical records are missing, the auditor must consider modifying or disclaiming their opinion, not just increasing testing.

Revision Tip

Prepare a checklist of all documents and records required by law for audited entities—use it to assess case study scenarios in past exam questions.

Summary

Maintaining proper accounting records is a legal duty for directors and a precondition for a credible audit. Auditors must report any shortcomings in records that can affect the audit opinion and may be unable to obtain sufficient evidence where records are inadequate. In such cases, a qualification or disclaimer may follow.

Key Point Checklist

This article has covered the following key knowledge points:

• The legal and practical definition of proper accounting records
• Why proper records are necessary for both management and auditing
• Key legal obligations of directors regarding record-keeping
• Auditor actions when proper records are missing
• The impact of inadequate records on the audit opinion and reporting

Key Terms and Concepts

• accounting records
• proper accounting records
• directors’ responsibility
• audit opinion