Auditors Never Prepare or Compile Financial Statements - When Conducting an Audit

I am not sure what the controversy is surrounding auditors preparing financial statements on behalf of their audit clients. THEY NEVER DO.

If the external auditor conducts his or her audit in accordance with International Standards on Auditing they may never ever be accused of preparing or compiling the financial statements of their audit clients. This in my opinion is the very reason as to why Section 90 (2) of the Companies Act does not deal with this issue. This section deals with those persons who may not act as the auditor of a company in respect of a statutory external audit. The only mention that is made in respect of financial statements is in Section 90 (2) (b) (ii) which states - an auditor must not be an employee or consultant of the company who was or has been engaged for more than one year in the ...... the preparation of any of its financial statements. There is no debate that an external auditor is not an employee of the company however on many occasions the auditor does in fact act as a consultant to his or her audit client. The term consultant can be defined as an expert or a professional in a specific field and has a wide knowledge of the subject matter. However acting as a consultant to an audit client is not considered to be preparing financial statements in certain circumstances: Section 44 (5) of the Auditing Professions Act considers such a situation and states - a person must not be regarded as responsible for keeping the books, records or accounts of an entity by reason only of that person making closing entries, assisting with any adjusting entries or framing any financial statements or other document from existing records. Therefore where the external auditor assists her or her client with framing the clients financial statements this would not be considered to be an act of preparation. Also in IRBA’s Code of Professional Conduct for Registered auditors it is explained that - the [audit] firm may provide services related to the preparation of financial statements to an audit client that is not a public interest entity where the services are of a routine or mechanical nature, so long as any self-review threat created is reduced to an acceptable level. The Code provides an example - preparing financial statements based on information in the trial balance. The Code also suggests that the audit process necessitates dialogue between the firm and management of the audit client, which may involve the application of accounting standards or policies and financial statement disclosure requirements, the appropriateness of financial and accounting control and the methods used in determining the stated amounts of assets and liabilities, or proposing adjusting journal entries. The Code offers the view that these activities are considered to be a normal part of the audit process and do not, generally, create threats to independence. As Section 90 (2) has at is heart the legal enforcement of the external auditors independence the above would not be in law deemed to be acts of preparing financial statements where the external auditor is concerned. So the question arises as to what would the external auditor have to do to be considered preparing or compiling financial statements on behalf of his or her client. One has to turn to the definition of compiling - ISRS 4410 (Revised), Compilation Engagements defines compiling as an engagement in which a practitioner applies accounting and financial reporting expertise to assist management in the preparation and presentation of financial information of an entity in accordance with an applicable financial reporting framework. So could the external auditor in conducting an audit in terms of the ISAs ever be accused of compiling financial statements bearing in mind the exemptions granted by the Auditing Professions Act and the IRBA’s Code of Professional Conduct for Registered auditors? I would offer the view that this can never be the case.

The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. The responsibility for preparing a company's financial statements rests initially with the company's directors and is then subject to the opinion of the auditor. Therefore the external auditor must apply his or her financial reporting expertise to determine whether the financial statements are in fact prepared in terms of financial reporting standards. If the external auditor does not possess financial reporting expertise the auditor would be unable to determine the material misstatement in the financial statements. In other words the external auditor would not be able to discover those areas in the financial statements that do not comply with financial reporting standards. 

For example – An auditor would receive a trial balance from his or her client and it is upon this trial balance the auditor would basis his or her audit on. The auditor would conduct the audit in terms of the ISAs and would discover the areas where the client has not complied with financial reporting standards. If these errors or departures from financial reporting standards are material the auditor would report these to the client and explain that if the client does not adjust these errors then the auditor would have no alternative to qualify his or her auditors report. Larger clients have the skills to adjust the trial balance by themselves but what about those clients that do not have the skills. If the client then asks the auditor to make these adjustments then could this be considered to be preparing or compiling financial statements? The answer is no. This is okay provided the firm does not assume a management responsibility for the client. By taking instruction from the client the auditor is not acting as management. I would add that for the auditor to not to be perceived to be acting as management the auditor must explain the adjustments to the client so that when the client issues the instruction it is an informed one that is not based on the auditor’s expertise and no client understanding. The client must be able to understand the adjustments before issuing the instruction.

Now the trial balance is compliant with financial reporting standards from a measurement aspect. The client now says to the auditor that they do not know how to draft the financial statements from the trial balance – can the auditor help. Will this be considered preparing or compiling financial statements? The answer is no. Preparing financial statements based on information in the trial balance is a service that auditors can provide provided the audit client that is not a public interest entity where the services are of a routine or mechanical nature. But what about the disclosure? Surely assisting the client with disclosure is considered preparing or compiling? The answer is no. The IRBA code says that the application of accounting standards or policies and financial statement disclosure requirements are activities considered to be a normal part of the audit process. The Auditing Professions Act allows the auditor to framing financial statements on behalf of a client. Framing refers to the construction and presentation of facts or issues. Therefore the auditor will be able to construct these financial statements from the audited trial balance without having committed an act of preparing or compiling as contemplated by the law and professional standards.

No wonder Section 90 (2) does not mention the fact that auditors cannot prepare financial statements on behalf of their clients.