The Advantages and Disadvantages of a Financial Audit

by Patrick Gleeson, Ph. D., Registered Investment Adv; Updated September 26, 2017

There are obvious advantages to performing a financial audit on a business and several different reasons for doing so. The downside is less obvious, but there may be good reasons to delay an audit or to substitute a less rigorous bookkeeping procedure.

What Is a Financial Audit?

A financial audit -- sometimes called a financial statement audit -- is the detailed report that results from an examination of a company's books by a qualified auditor -- usually a certified public accountant or a financial accountancy firm employing qualified professionals. The report confirms that the financial statements and disclosures presented are honest and fair.

Advantages of an Audit

A professional audit benefits several different parties. For the officers of a company, the audit provides an external confirmation of the company's financial health that confirms their good management. For stockholders, the financial audit is a critical means of establishing the worth of the company. For the business community, regular audits enhance the company's reputation and make it a desirable business partner. For the company's lenders, financial audits are a prerequisite for almost any kind of business loan.

Disadvantages of an Audit

In most circumstances, the advantages of an audit far outweigh any disadvantages, which is why most companies conduct regular audits and audits are a legal requirement for any public company. Nevertheless, audits are not in any sense free. A survey conducted by the Financial Executives Research Foundation (FERF) concluded that 2013 audit costs for public companies averaged more than $7 million. This is not the only cost. An audit constitutes a necessary but significant disruption of the company's workplace and may lower productivity for the period of the audit as employees defer other tasks to support the auditor's needs.

Limitations of an Audit

An audit is not an assurance that the company is actually viable going forward -- only that it is in the represented condition at the time of the audit. Even then, the auditors only state that they used accepted accounting methods and made their best efforts to assure the accuracy of the audit statement. Every audit statement contains language making clear that the audit statement represents professional opinion and is not a guarantee.

In fact, according to The National Council of Nonprofits, only 3.3 percent of workplace fraud is discovered in the process of an independent audit.

Another problem for stockholders and others who rely on audits to identify the financial status of a company is that keeping bad managers and bad auditors apart isn't easy. The fraudulent audit prepared by a colluding auditor does not come with an identifying sign. Waste Management reported $1.7 billion in imaginary earnings in 1998; the audit report was fraudulent, largely because senior managers were dishonest. But Arthur Andersen, the company's auditor, was also to blame and paid $7 million in fines. Arthur Andersen auditors were also held partly responsible for the Enron scandal that defrauded stockholders of $74 billion. Ultimately, Arthur Andersen went out of business.

About the Author

Patrick Gleeson received a doctorate in 18th century English literature at the University of Washington. He served as a professor of English at the University of Victoria and was head of freshman English at San Francisco State University. Gleeson is the director of technical publications for McClarie Group and manages an investment fund. He is a Registered Investment Advisor.