Limitations of Audit of Financial Statements
Due to the inherent limitations of audit, auditors are only able to offer 'reasonable assurance' over the truth and fairness of the financial statements rather than absolute assurance. Inherent limitations of audit are discussed below.
Use of Professional Judgment
Audit involves the use of judgment in the identification of audit risks, selection of appropriate auditing procedures and the interpretation of audit evidence. Although auditing standards provide guidelines to assist auditors in forming sound professional judgments, it is inevitable that an auditor may at times misjudge a situation which may cause the auditor to overlook a misstatement in the financial statement.
Use of Sampling
Auditors apply sampling techniques to limit the number of transactions and balances selected for audit testing in order to perform the audit efficiently and cost effectively. The results derived from the selected transactions and balances may not however be representative of the entire population. There is therefore an inherent risk that the audit procedures may fail to detect a material misstatement in the financial statements due to the inability of auditors to perform detailed testing of the entire population of transactions and balances.
Generally, external evidence is considered to be a more reliable form of audit evidence than internal evidence produced by the management. Although auditors collect audit evidence from a range of sources, too often they have to rely on the representations of management in order to assess the reasonableness of the matters concerning financial statements. This is particularly the case in matters that involve the use of judgment by the management as it is usually difficult to corroborate management representations about the appropriateness of their judgments with external evidence.
Risk of Fraud
By their very nature, frauds are intended to be concealed by the perpetrators and therefore pose a very high risk of remaining undetected by the auditors even in spite of the application of sound audit methodology and procedures.
In practice, auditors face strict time constraints within which they have to provide their opinion on the financial statements. Auditors tend to prioritize tasks that are essential for the effective performance of the audit. In some cases, particularly where there is legal requirement for companies to publish their financial reports within a certain time frame, the auditors may, in a bid to meet the assignment deadlines, fail to consider an important matter in the finalization of the audit report.
Whereas the ethical guidelines issued by IFAC and other professional bodies attempt to minimize the instances of loss of objectivity of auditors, certain level of conflicts of interest are inevitable in practice. The perceived independence of an auditor is for instance impaired where a client accounts for a significant portion of the revenue of the audit firm.
Audit procedures are designed to detect material misstatements in the financial statements and focus on the financial aspects of transactions and events. Non financial matters are generally not considered in the performance of the audit unless they have relevance to the financial statements. Stakeholders often misinterpret the role and scope of an external audit.