Financial reports should give an organization’s external stakeholders fair and accurate financial information about economic entities that is useful for economic decision-making. Inaccurate financial reporting will cause current and potential investors to form erroneous opinions about a company. The provision of an impartial evaluation and review service to ascertain and document the level of control exercised over financial systems is one of the internal audit’s key responsibilities. An internal audit of financial statements validates the quality of a firm’s financial reporting standards. Implementing a comprehensive internal audit positively affects the quality of financial statements by detecting fraud activities and reducing errors and misstatements that affect financial reporting credibility.
Acute and careful oversight of the financial reporting process, enforced by internal auditors’ controls, helps organizations detect and deter fraud. High-quality internal auditor functions create better internal control systems that prevent misstatements and fraud. Internal controls offer a reasonable assurance that transactions are recorded as required to prepare financial statements per generally accepted accounting principles (Chang et al., 2019). In addition, internal audits ensure company receipts and expenditures are only being carried out in accordance with management and board of directors’ approvals.
Fraudsters can manipulate financial statements to mislead investors and business owners. Bonuses for management are frequently based on the company’s success, and dishonest executives may change account balances to boost their pay. Internal controls are implemented to prevent management from falsifying financial statements and misleading investors. Superficial performance in difficult economic times when businesses are struggling is a sign that there might be a problem with the financial accounts, such as during the COVID-19 period. Fraud and accounting irregularities can be uncovered with the aid of internal auditors. The internal auditor is accountable for assessing the risks relating to the accuracy and integrity of financial information (DeSimone, 2021). The basic responsibilities of an internal audit include advising the board and management that internal controls, including controls to prevent and detect fraud, are adequate for the risks identified and confirming that the controls are operating as intended.
Errors and Omissions
Reducing mistakes and omissions in financial reports is made possible by an internal auditor’s obligation to evaluate that impact on the financial statements, particularly in the context of disclosures and internal controls over financial reporting in the event of a material breach. Errors in financial statements are still possible and more likely to arise without an internal control mechanism. Account balances may not match up with bank statements or accompanying schedules if reconciliations, which are a type of control, are not carried out regularly by internal auditors. Internal controls implemented by internal auditors reduce the risk of substantial misstatements to the minimum. Stakeholders can assess and make the best decision by minimizing financial statement errors. Users of financial statements may be impacted in their financial decision by serious misstatements.
Misrepresentation of Assets in Financial Statements
The quality of financial statements is viewed based on relevance, faithful representation, understandability, comparability, and timeliness. These components of financial reporting entail maintaining records that fairly and accurately depict the company’s asset transactions and dispositions in reasonable detail. In addition, a reasonable assurance should be given in the financial report regarding the avoidance or prompt discovery of any improper purchase, usage, or disposition of the company’s assets that could materially affect the financial statements. When issues develop, an internal audit has direct functional reporting to the financial accounts and acts independently of the organization.
General ledger accounts can be altered to misappropriate assets and hide the theft. Petty cash and inventory are two examples of company assets constantly at risk of misrepresentation. Internal auditors’ division of responsibilities strengthens internal control and increases the accuracy of financial reporting (DeSimone, 2021). Company employees are required to keep the custody of assets apart from keeping records and approving transactions. Internal controls reduce the risk to assets and cash accounts from internal and external sources to tolerable levels. Internal auditors examine the data backing up management claims about assets in the financial accounts to ensure there is no managerial interference.
Employee dishonesty can completely devastate a company, especially if supervisors conspire to manipulate account balances to hide illicit activity. These unethical activities may distort the financial reports, misleading stakeholders. The internal audit committee can reduce these risks by submitting crucial inquiries and maintaining comprehensive supervision of an issue during the audit process to identify misconduct (DeSimone, 2021). Internal audit may be involved in overseeing the program for reporting unethical behavior, determining whether the entity’s code of ethics is being followed, and other actions that support the company’s ethical culture. These internal auditor’s responsibilities positively influence the quality of financial statements generated by a company.
Lack of accuracy in financial reporting can mislead stakeholders and investors to make wrong decisions regarding an organization’s financial performance. Implementing a comprehensive internal audit positively affects the quality of financial statements by reducing errors and misstatements and detecting fraud activities that are crucial indicators of doctored financial reports. The various factors that help internal auditors achieve high-quality financial reporting entail the implementation of controls that reduce mistakes and omissions, assess the risks relating to the accuracy and integrity of financial information, ensure correct assets registry and reinforce ethical morals regarding illegal acts.
Chang, Y.-T., Chen, H., Cheng, R. K., & Chi, W. (2019). The impact of internal audit attributes on the effectiveness of internal control over operations and compliance. Journal of Contemporary Accounting & Economics, 15(1), 1–19.
DeSimone, S. (2021). Internal audit and quality of financial reporting in the public sector: The case of the university for development studies. Finance & Accounting Research Journal, 3(1), 1–23.