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Most small business owners are intimidated at the thought of an audit, but an audit can actually help your business to be more productive and plan better for the future. An audit is an independent examination of financial statements of an entity or business, whether profit oriented or not, and irrespective of its size, to ensure the accuracy of your financial records.
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Although, audits are generally considered stressful events, a lot of valuable information can be gained from these financial exercises, and also internal and external audits are performed for a variety of reasons. Both can help pinpoint areas where a small business is lacking in internal controls, operational efficiency or regulatory compliance. Small businesses can gain a lot from having a better understanding of their financial position. Benefits of regular audits include improved interest rates, increased protection from risk and legal liabilities and access to more capital. A financial review or audit can also give a business owner a better understanding of how their business operates, uses cash and assumes risk. However there are dangers or risks involved in auditing small business and they are:
  • Inherent risk
It is the risk posed by an error or misleading information in a financial statement due to a reason other than a failure of internal control, and it represents a worst case scenario, because all internal controls in place have nonetheless failed. This type of risk is common in financial statements and is often present when a business releases forward looking financial statements, either to internal investors or the public as a whole. This forward looking financial statement is gotten when management has to use a substantial amount of judgement and approximation in recording transactions. External factors also influence inherent risk. For example, technological developments might make a particular product obsolete, thereby causing inventory to be more susceptible to overstatement. 
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  • Control risk
This is the risk that occurs when a financial misstatement results from a lack of proper accounting controls in the firms, and this is likely to surface in the form of fraud or lazy accounting practices. Some control risk will always exist because of the inherent limitations of any system of internal accounting control. And keeping control risk at an acceptably low level is the responsibility of management. Assessment of control risk may be higher for instance in a small business in which segregation of duties is not well defined, and the financial statement is prepared by individuals who do not have the necessary technical knowledge of accounting and finance.
  • Detection risk
This is the risk that the auditor simply fails to detect; an otherwise easy to notice error in the financial accounts. Normally, this risk is countered by increasing the number of sampled transactions during testing. This is the responsibility of the auditor, and he can lower the detection risk by tolerating less misstatement. Detection risk is a function of the effectiveness of auditing procedures and of their application by the auditor, and it arises partly from uncertainties that exist when the auditor does not examine 100 percent of an account balance, and partly because of other uncertainties that exist, even if 100 percent of the balance has been examined. Other uncertainties arise because an auditor might select an inappropriate auditing procedure, misapply an appropriate procedure or misinterpret audit results, and these other uncertainties can be reduced to a negligible level through adequate planning and supervision, and conduct of a firm’s audit practice in accordance with appropriate quality control standards.  The inherent risk and control risk differ from detection risk in that they exist independently of the audit of the financial statements and, inherent risk and control risk are functions of the client and its environment, regardless of whether an audit is conducted or not. Detection risk, on the other hand, relates to the auditor’s procedures and can be changed at the auditor’s discretion, and when all these risks are properly evaluated, the auditor can issue a proper and accurate advice to the business owners.  Featured image source: okcredit
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This article was first published on 5th February 2022

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Grace Christos Is a content creator with a proven track record of success in content marketing, online reputation management, sales strategy, and so much more.

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