Can you explain three limitations of external audits?

1. The historical nature of reporting. The audit can take place from 3 months upto a year or more after the financial year end. This impacts on the relevance of the information gathered in an audit.

2. Use of sampling. It is impractical to attempt to test 100% of transactions therefore sampling is used, the downfall of this is that it cannot provide 100% assurance as to whether there are errors contained in the information which was not contained in the sample.

3. Information collected during an audit is persuasive rather than conclusive. Evidence is gathered from more than one source in order for the auditor to gain understanding of the business. This information is evaluated in order to form an opinion. Lack of information can lead to an incorrect opinion.

Some of the important limitations of external audit are as follows:

Use of estimation and judgement by the management of the entity in numerous values reported in the financial statements e.g. depreciation, provision for doubtful debt etc. This is one of major limitations of financial accounting

Historic nature of reporting – audit opinion is expressed on historic information which is most of the time pertains to period 3 months to 1 year old and this information may not be true by the time user actually uses such information and similarly the audit report is also expressed on information that is 1 year old in case of annual audits and such information may not be relevant anymore. This seriously questions the relevance of audit report and the financial statements for the purpose of decision making.

Use of sampling basis to extract conclusions regarding population of large sizes that cannot be examined 100% by the auditor. May be because of cost-benefit woes or simply not much resources are available

Humans – from preparation of accounting records to finalizing financial statements to planning audit to expressing audit opinion, humans are involved and they are prone to error. Also lack of knowledge, experience and failure to identify misstatements cause effectiveness of audit to reduce.

Nature of evidence – many a times evidence collected by the auditor is of persuasive nature rather than conclusive i.e. it is left on the auditor to decide what conclusion should be drawn or what steps should be taken further. Conclusive evidence help us reach conclusion with complete authority whereas in case of persuasive evidence we have to seek additional evidence to corroborate our understanding and support our conclusion and this may not be possible because of lack of resources or just because it is not possible given the situation.

Nature of audit – Audit provides assurance regarding accuracy of assertions or in simple words whether financial statements reflect true state of affairs of the entity. External auditor’s opinion in no way help users to derive conclusions regarding managerial effectiveness or future viability of the entity and thus limited only to provide assurance regarding preparation and presentation of financial statements according to specific accounting framework.

here are the limitations of the external auditor:time lapse: lapse of time between balance sheet date and the presentation of the audit report may be up to 4 months.audit testing and selective samples: has limitations due to sampling riskAssessment of materiality: the assessment of materiality with both quantitaive and qualitative requires high degree of professional judgementHighly specialised areas: forming professional judgement in highly specialised areas can often result in disagreements between auditors and clientsReport format limitations: the standard format of the audit report may not reflect fully the complexities involved in the audit process and the decision of the audit opinion.despite these limitations an audit of the financial statements adds credibility to the financial information

limitations

1. Sampling - it is not practical for an auditor to test  all  the transactions and so they have to apply sampling in selecting balances or transactions to test

2.Subjectivity - financial statements include judgmental and subjective areas and as such the auditor is required to use their judgment in assessing  whether financial statements show a true and fair view.

3.Evidence is  persuasive and not conclusive

4 Historical information- the report is issued some time after the year end and so the financial information can be quite different to the current position.

5 Inherent limitations of internal control systems - an internal control is operated by people and so  liable to human error.

The reasons why auditors are unable to provide total assurance is because the assurance given by auditors is governed by the fact that auditors use judgment in deciding what audit procedures to use and what conclusion to draw, and also because of the inherent limitations associated with the every audit work. The main inherent limitation of audit are, limitation of cost and use of sampling, limitation of time, reliance on experts work, the use of materiality concept, and last but not least the possibility of management fraud.Limitation of Cost: Limitations on the cost of an audit results in selective testing or sampling, of the accounting records and supporting data. For the fact that auditors cannot and do not attempt to check the entire transactions in the financial statements. Because, there is vast number of transactions in the financial statements of large companies, it would be impossible and extremely expensive to check all these transactions and there is no company prepared to pay for the auditors to do so.

Limitations of Time: the auditor’s report on many public companies is usually issued three or five weeks after the balance sheet date. This time constraint may affect the amount of evidence that can be obtained concerning events and transactions posy the balance sheet date that may have an effect on the financial statements. Moreover, there is a relatively short time period available for resolving uncertainties existing at the statement date.