Limitations of External Audit
External audit is the process of independent examination of the company’s financial statements by external auditors, in which they give the reader a reasonable assurance on the truth and fairness of the financial statements.
The reasonable assurance is a high level of assurance, but it is not an absolute assurance. In this case, the auditor’s report does not guarantee that the financial statements are correct.
Auditors can only assure that the client’s financial statements are true and fair within a reasonable margin of error. This is one of limitation of external audit which is usually referred to as inherent limitation.
There are six common limitations of external audit which are included in the table below:
|Limitations of External Audit|
|Inherent Limitation||Auditors can only give reasonable assurance that the financial statements present fairly, in all material respects, not absolute assurance. Likewise, auditors can only assure that the financial statements are free material misstatements, not all misstatements.|
|Judgmental Areas||Auditors need to use professional judgment on many areas of audit, including determining materiality, assessing the risks, developing audit strategy, and interpreting the audit evidence. For example, estimation is made on the useful life of fixed assets by the client, so auditors need to use their professional judgment to evaluate whether it is appropriate or not.
In general, auditing is not objective, hence auditors need to make judgments on many subjective areas. As a result, it can never guarantee that auditors always make 100% right judgment and never overlook the misstatements that could occur on financial statements.
|Sampling Risk||Auditors usually cannot perform the audit test on all transactions and balances of client’s accounts as it would take a great deal of time and trouble to test the entire population of transactions and balances.
Hence, only a certain number of transactions and balances are selected for audit tests based on the sampling technique that auditors use. As a result, it creates a risk that auditors may fail to detect the material misstatements on financial statements, which is usually referred to as sampling risk.
|Fraud Risk||Auditors may fail to detect material misstatements due to fraud on financial statements even though auditors have the responsibility to do so. This is due to fraud is an intentional act, in which the individual or group that commits fraud would usually try their best to hide it.|
|Relying on Expert||Auditors may need to rely on experts like engineers, lawyers, or actuary, etc. in order to evaluate and estimate certain cases, events or transactions. For example, auditors have to rely on a lawyer to evaluate the court case that the client is facing in order to make an estimation of contingent liabilities.|
|Not up-to-date balance sheet||The audit report is usually issued at a time after the balance sheet date which usually is later than a month. As a result, the up-to-date financial position of the company and the audited one might be different.|