What does your company’s auditor do and why is it so likely to be a Big 4 firm?

Nick Sundich Nick Sundich, May 30, 2023

Each and every ASX company will have auditor. But what do they do? And why is it almost always one of the so-called ‘Big Four’.

 

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What does an auditor do?

The purpose of a company’s auditor is to perform an independent evaluation of the company’s financial statements, ensuring that they are accurate and free from any fraudulent activities or misstatements. Specifically, they must verify that the company’s accounts provide a ‘true and fair’ view of the business’ position. This process involves examining the accounting records as well as testing internal controls and verifying documents.

The auditor will look at all areas of the business, including general ledger accounts, payroll, receivables and inventory. In addition they may also review debt covenants and legal contracts. The audit is generally conducted in accordance with the Australian Accounting Standards in order to provide assurance that the financial statements present a true and fair view of the company’s financial position.

If an auditor finds any material misstatement or potential fraud, they must disclose it to management so that correction or remediation can be taken if necessary.

Ultimately, the auditor’s opinion serves as a signal of trustworthiness for investors, creditors or other stakeholders who rely on the company’s financial reports for making decisions.

 

What are some of the auditing firms?

The vast majority of ASX companies employ one of the so-called ‘Big Four’ accounting firms as an auditor. The ‘Big Four’ are: Deloitte, PricewaterhouseCoopers (PwC), Ernst & Young (EY) and KPMG. These companies provide a range of services including auditing, consulting, taxation and legal advice to individuals and businesses.

The Big Four have been influential for many decades and are employed by many companies due to their global presence and strong market position. They audit about 80 percent of all publicly listed companies globally as well as many private companies. As such they are a source of trust for investors when assessing financial statements. In addition to auditing services they offer advisory services to listed companies (and private companies) on topics such as tax optimization strategies and investments plans. Nonetheless, a minority of firms hire non-Big 4 firms such as BDO.

 

The going concern

One of the key things auditors must verify is whether or not the entity should be regarded as a ‘going concern’. They also must disclose any events or conditions that ‘may cast significant doubt upon the entity’s ability to continue as a going concern’. An audit may be submitted with auditor doubts that an entity can continue as a going concern – something that’d raise eyebrows at the ASX.

 

Auditors are a safeguard, but not a guarantee

An auditor provides an important safeguard as an external entity that verifies a company’s statements are good. However, even though they provide a theoretical guarantee, the Enron scandal highlights that auditors can’t be perfect in practice. Enron had hired Arthur Anderson as its auditor, then one of the ‘Big Five’ auditors. Most investors should know what happened to Enron, but what specifically Arthur Anderson did (leading it to collapse) is a point of confusion.

By signing off on its audits, Arthur Anderson misrepresented the true value of the corporation and did not follow generally accepted accounting principals. It was also accused of destroying thousands of Enron documents that could’ve helped with the investigation. It wound down its operations barely months after Enron collapsed. Ultimately, after being convicted as a corporation, it was cleared in 2005 – too late to revive itself unfortunately.

This story illustrates that just because a company is audited, it doesn’t mean it is a safe investment and doesn’t excuse investors from doing their own “sanity check” on companies they want to invest in.

 

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