Audits assure investors, stakeholders, and customers that a company’s financial statements are error-free. Companies need audits to sustain investor’s trust and help maintain a robust and transparent investment climate. Investors trust auditors’ professional expertise, discernment, and independence and usually rely on audit reports to determine a company’s financial performance.
Auditors must consider different factors and requirements when auditing companies. The complexity of internal processes and investment opportunities vary based on the size and business nature of the company. For instance, a small startup in its infancy would have a limited financial history compared to a large, well-established company. Auditors need to understand the company’s background and adjust their expectations accordingly.
This article explores the differences in audit requirements for small vs. large firms. It also explains the importance of tailoring accounting processes to fit a company’s scale of expansion, using the Hyflux vs. KPMG case as an example.
Role of Audits in Investors’ Financial Due Diligence
There is a difference between audits and financial due diligence. They may overlap in scope but ultimately investigate different things.
Audits help complement investors’ financial due diligence (FDD) process. FDD refers to investigating a company’s financial performance to make an investment decision. It includes gathering knowledge on historical sales figures, earnings, and operating expense trends. This specialised information is usually not included in an audit report. As such, investors are usually advised to use audit reports as supplementary information or as a starting point to begin their FDD process.
Investors may conduct a special FDD exercise that caters to their special interests and needs. FDD exercises alter the scope of investigation to focus on specific areas. This yields more personalised information compared to regular audits adhering to legal requirements.
Auditing Startups and Small Companies
First-time audits are known to be challenging. Some issues that auditors might face when auditing startups and small companies are:
Disorganised, Irregular, or Incomplete Financial Records
Small companies may not have the budget to invest in sophisticated accounting software to track their finances. They may rely on manual bookkeeping and accounting, which is more prone to human error. For instance, smaller firms may not have the expertise to set up a professional accounting system that matches their accounting line items. It could lead to missing information, incorrect figures, and disorganised records.
Limited Financial History
Startups usually have a limited financial history. This restricts the amount of information that auditors can check for evidence. As such, audits for startups may focus on more cash flow management and risk assessment instead.
Small firms with limited financial history may also not have enough data, e.g., recurring revenue, to back up their early projections. Investors tend to trust actual financial statements instead of projections.
● Combined Personal and Business Financial Accounts
Small companies may lack awareness and knowledge of professional accounting standards. They may combine personal and business financial accounts for convenience. This makes it difficult for auditors to check through company financial records.
Despite the challenges, audits significantly help startups build a clean reputation and attract investors. Startups usually do not have the clout and track record to win over investors when starting. A clean audit from an independent auditor will improve investor and stakeholder confidence.
Auditing Established Companies
While well-established companies might have good financial performance track records and extensive history, their complex business operations may present more challenges to auditors. Some issues that auditors might face when auditing large and well-established companies are:
● Complex Automation Processes
Large, well-established companies usually have more sophisticated automation processes, and conducting audits in a highly automated environment can be challenging due to greater IT-related risks.
Highly automated accounting systems generate and process data without much human intervention. Auditors usually depend on these system-generated financial reports to conduct the audit. The high reliance on automation means that any IT disruptions to the system could affect financial records and accounting processes.
Some areas where IT disruptions could affect an audit:
- Automated computation and calculation.
- Automated accounting entries posted to ledgers.
- Automated application of internal controls.
- Automated access granted to specific users for the segregation of duties. Auditors must account for IT system risks when conducting audits in highly automated business environments.
Diverse and International-Scale Operations Well-established big companies may also have more diverse business segments and international-scale operations, greatly expanding the audit scope. Auditors may face information delays when collecting financial information from various parties due to coordination issues in large-scale companies. They may also need to consider international tax laws and audit regulations.
Could Hyflux’s Ambition Have Affected Accounting and Audit Processes?
Hyflux was a Singapore-based water treatment firm that liquidated in 2021 due to financial problems. In 2022, it alleged that KPMG, its audit partner, had been negligent in auditing its financial records. KPMG refuted the allegations by explaining that Hyflux’s management and board were obliged to prepare their financial statements in compliance with corporate regulatory and accounting standards.
According to The Online Citizen, Singapore’s Energy Market Authority (EMA) noted that Hyflux’s commercial decisions exacerbated its financial issues. Persistently depressed wholesale energy prices in 2016-2018 caused Tuaspring severe profit losses. According to research by the National University of Singapore, Tuaspring’s power plant project did not generate profit since starting operations in March 2016.
Hyflux initially offered low-price bids but did not anticipate that energy prices would drop drastically in future. According to analysts, the low wholesale energy prices were the main reason the company went under.
According to the Monetary Authority of Singapore, Hyflux’s management allegedly failed to disclose crucial information relating to Tuaspring, and its directors were charged with disclosure-related offences in 2022.
Conclusion
Companies are duty-bound to ensure fair and transparent internal processes. Strong corporate governance increases investor confidence and helps companies adapt to increasing demands for transparency from stakeholders and regulatory authorities. They should work with auditors to improve business processes and enhance corporate governance processes for the benefit of all stakeholders.
