Many companies engage public accounting firms to perform audits on their financial statements. They outsource this responsibility to add an independent review of their financial reporting and to add credibility. An external audit of the annual financial statements assures investors and creditors that all financial data appears accurately and fairly on the statements. Occasionally public accounting firms face a work overload and lack the capability of serving all of their customers. At these times, the firm may outsource the external audits it has been hired to perform. Several disadvantages exist for accounting firms who outsource their external audits.
The External Audit
A company contracts with an outside accounting firm to perform the external audit. The accounting firm sends an audit team to visit the company’s location and meets with the accounting staff. During this visit, the team learns about the company’s process for recording financial transactions and what software package the company uses. After the initial visit, the external auditors divide their time between working at their office or at the company site. The team identifies risk areas, reviews sample transactions and issues an opinion on the company’s financial statements.
One disadvantage of outsourcing external audits considers the financial cost incurred by the original accounting firm. The company enters into an agreement with the original accounting firm. This firm then contracts with another firm to perform the audit. The accounting firm maintains responsibility for paying the external auditors. The accounting firm may incur expenses that surpass the money it receives from the company.
Another disadvantage of outsourcing the audit function involves the external auditors’ lack of history with the company. The first accounting firm maintains a history of working with the company which the external auditors lack. Employees with the original firm know the employees and their processes. The outsourced audit team needs to gain this knowledge.
The original accounting firm faces potential liability, another disadvantage, if the outsourced auditors act unethically. The original accounting firm made the agreement with the company. If the external auditors perform an incomplete review or disregard the confidentiality necessary when completing audits, the original firm remains liable to the company.