5 Hidden Problems which can be solved with the Help of the Audit

The owner of the business is unable to ensure full personal control over activities of managers’’ and direct performers of business-tasks. Furthermore, it’s quite possible that the part of employees expects to gain benefits from the business not foreseen by the official rules. That’s why the informational needs of the company’s owner are not limited by the periodical overview of financial reports and also include management papers. Such reports provide all the necessary information related to the direct management of the company which is more valuable than other official reporting.

Regardless of the effectiveness of the management accounting and reporting system in the company, from time to time the business requires independent evaluation. Auditors are the best in providing such services.   

An entrepreneur, who decides to conduct an audit of his business, has a precise list of questions which he expects to be answered by auditors. These questions can be very different, but as a rule, there are always some related to risky areas of a company’s operation.

The list of problems which can be identified in course of the audit is borderless, though the description of risk areas provided below encompasses most of them.

Issue № 1. Over- or under-estimation of the financial result

Managers can manipulate the net profit figures in order to get higher bonuses. Audit procedures for the verification and validation of financial reporting are not sufficient for the identification of such behavior of managers. A comprehensive and detailed overview of accounting and reporting is required in such case.  

If a company’s policy suggests the provision of bonuses to managers the size of which depends on the profit, they can revert to overestimation of revenues or underestimation of expenses in order to get larger paychecks. If there the culture of bonuses is absent in the company, managers may be tempted to understate the amount of profit which is to be distributed among shareholders, in order to appropriate the difference between the real revenue and figure in the report.

Issue № 2. The absence of the well-functioning system of internal control  

Auditors who have higher experience in evaluation of internal control systems of companies can easily identify “blind spots” in the management of performers of routine tasks. As a rule, this is achieved through:

• the testing of paperwork plans and deadlines observance. It helps to establish to which extent the information passed from ordinary tasks performs and junior managers to higher management is timely, credible and complete.  
• the review of the interdependence between senior managers and their junior peers  in order to identify whether representatives of the higher management cover the activity of their subordinates;
• the overview of tools used for the evaluation of the volume of performed tasks by concrete employees.

According to the results of the audit disintegration, ineffectiveness (lack of the workflow transparency) or complete absence of the operations supervision system at all functional levels in the company can be identified. All these make employees more reluctant and encourage them to seek fraudulent ways of satisfying their own interests at the company’s expense.

Issue № 3. Ineffective use of company’s resources

This problem is tightly connected to a previous one. Several factors can lead to the abuse of resources by the company’s employees:

• the absence of resources usage standardization system;
• absence of human and other resources valuable for shareholders usage system;
• tools for the verification of the validity of information provided in different reports are absent or aren’t applied properly;
• the responsibility for the poor performance of work duties, excessive usage or unreasonable saving of resources with the purpose of its further theft, etc., isn’t established.   

For example, if the company doesn’t track the time used for the performance of certain tasks, it allows employees to take care of their personal affairs during working hours. If there is no system of check measurements of production resources, or the video surveillance system is absent in places where the control over tasks performs can’t be established in any other way, the probability of resources theft is very high.      

Another dimension of this issue is the absence of payment discipline as well as the low efficiency of the retail system: untimely payment of accounts’ receivables by contractors, and disregard of low volumes of products turnover. It washes out the turnover funds from the company’s budget which could have been directed to the business development in case of more effective management practices were in place. Ineffective and unprofitable products manufactured by the company also fall within this dimension.

The third part of this issue is the absence of comprehensive price planning – both internal and external. Specialists can identify that resources used by the enterprise are purchased at unreasonable prices. It’s the outcome of negligence to find cheaper resources or purposeful purchase of resources at higher prices arising from fraudulent preliminary agreements between the company’s employees and contractors.

The same is related to the downsizing of prices for products manufactured by the company. These products can be sold at lower prices for some clients without evident reasons. In the worst case, it can result in fake contracts when the payment is disbursed for resources which never actually supplied to the enterprise.

Issue № 4. Fake budgets and absence of expenses planning

This issue explains the previous one. Not always when the company’s budgets and plans are absent or vague the resources are used irrationally. Though, it’s the first step towards managerial, economic and financial chaos in the company. Plans, limited expenses, and reasonable budgeting are effective tools for the control and optimization of the business processes.

Issue № 5. Improper approach to financial liabilities

It happens when the management adopts commitments related to loans and other financial liabilities which are disadvantageous to the company. The same concerns problems emerging from non-compliance with financial liabilities - i.e. sale of resources at lower prices for the immediate repayment of loans, as well as payment of fines and fees resulting from the violation of agreements with banks and other contractors.

It’s worth remembering about the simple consistency: the further are the owners from the operational management of the business, the wider are opportunities for fraud for top-managers. The higher is the need for audit as well, as it’s the best way for owners to be sure about the effectiveness and competence of managers or to identify risks or even facts of fraud.