Tuesday, December 1, 2009

Limitations of an audit

A financial statement audit is subject to a number of inherent limitations. One constraint is that the auditor works within fairly restrictive economic limits. Following are two important economic limitations.

Reasonable cost. A limitations on the cost of an audit results in selective testing or sampling, of the accounting records and supporting data. In addition, the auditor may choose to test internal controls and may obtain assurance from a well functioning system of internal controls.

Reasonable lenght of time. the auditor's report on many public companies is usually issued three or five weeks after the balance sheet date. This time constraint may affect the amount of evidence that can be obtained concerning events and transactions after the balance sheet date that may have an effect on the financial statements. Moreover, there is a relatively short time period available for resolving uncertaintes existing at the statement date.

Another significant limitations is the established accounting framework for preparing financial statements. Following are two important limitations associated with the established accounting framework.

Alternative accounting Principles. Alternative accounting principles are permitted under GAAP. Financial statement users must be knowledgeable about a company's accounting choices and their effect on financial statements.
Accounting Estimates. Estimates are an inherent part of the accounting process, and no one, including auditors, can foresee the outcome of uncertainties. Estimate range from the allowance for doubtfull accounts and an inventory obsolescence reserve to impairment tests of fixed assets and goodwill. An audit can not add exactness and certainly to financial statements when these factors do not exist.


Anonymous said...

Can anyone explain to me what aspect of auditing limitations permitted banks to hide the true risk level of their casino banking practices from their shareholders?

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