<img height="1" width="1" style="display:none;" alt="" src="https://px.ads.linkedin.com/collect/?pid=938154&amp;fmt=gif">

A Wise Choice: Audits and Agreed-Upon Procedures Explained



The word “audit” tends to give most business owners the shivers. The thought of an outsider learning the workings of your business can be a bit daunting unless you remember the benefits an audit provides.

Depending on the situation, an agreed-upon procedure (AUP) may be a better fit to meet your needs. Not familiar with AUP engagements? Below you will find a brief explanation of audits and AUPs, along with their benefits and drawbacks. You will also learn the factors businesses must consider when determining whether they need a full audit or an agreed-upon procedure.

(Download Video Transcript)

What is an Audit?

An audit is a comprehensive examination of a company's financial statements and underlying records. It's conducted by an independent auditor who provides an opinion on whether the financial statements present a true and fair view of the company's financial position and performance following the applicable financial reporting framework.

Benefits of an Audit

Enhanced Credibility

An audit provides an independent verification of a company's financial statements. This independent assurance enhances the credibility of the financial information presented, making it more reliable for investors, lenders, and other stakeholders.

Compliance with Legal Requirements

For many companies, particularly public companies and certain private entities, conducting an annual audit is a legal requirement. An audit ensures compliance with these regulatory obligations, helping to avoid legal repercussions.

Identification of Weaknesses in Internal Controls

Auditors assess the effectiveness of a company's internal controls during the audit process. This can help identify weaknesses or inefficiencies in financial reporting processes, enabling the company to address these issues and strengthen its controls.

Detection & Deterrence of Fraud

Although not primarily designed to detect fraud, the audit process can uncover instances of fraud and error. The mere presence of an audit can also act as a deterrent to fraudulent activities within the organization.

Improved Financial Management

Insights gained from an audit can lead to better financial management. Auditors may provide recommendations for improving financial processes, controls, and systems, leading to more accurate and timely financial reporting.

Facilitates Decision-Making

Reliable financial statements are crucial for internal management decision-making. Audits enhance the reliability of these statements, thereby supporting better strategic planning and decision-making processes.

Boosts Investor Confidence

Audited financial statements can boost the confidence of current and potential investors, as they provide a higher level of assurance about the accuracy of a company's financial position and performance.

Loan Approval and Better Terms

Banks and financial institutions often require audited financial statements before approving loans. Audited statements can also lead to more favorable loan terms, as they reduce the lender's risk.

Valuable for Tax Purposes

Audits can help ensure that financial statements are in compliance with tax laws, potentially avoiding issues with tax authorities. They can also be useful in efficiently handling tax planning and compliance.

Enhances Business Reputation

Regular audits can enhance the reputation of a business for financial integrity and transparency, which is beneficial in attracting customers, investors, and partners.

Supports Business Growth

For businesses looking to expand or attract new investment, audited financial statements can be a key requirement. They demonstrate a commitment to financial transparency and sound management, which can be attractive to potential investors or partners.

Drawbacks of an Audit

Cost

Audits can be expensive, especially for small to medium-sized enterprises (SMEs). The cost includes not only the auditor's fees, but also the internal costs related to preparing for the audit, such as staff time and resources.

Time-Consuming

The audit process can be lengthy, requiring significant time commitment from both the company's internal staff and the external auditors. This can divert resources and attention away from daily business operations.

Potential Disruption to Operations

The audit process may disrupt regular business operations. Auditors need access to records and personnel, which can interrupt normal workflow and productivity.

Limited Scope and Historical Focus

Audits primarily focus on historical financial data and compliance with accounting standards. They may not address forward-looking aspects of the business or operational efficiencies.

Risk of Over-Reliance

There's a risk that stakeholders might over-rely on the audit opinion. An audit provides reasonable assurance, not absolute certainty, about the accuracy of financial statements.

Subjectivity

Some aspects of auditing, such as assessing the adequacy of provisions or the valuation of assets, involve a degree of judgment and subjectivity, which can lead to differences in opinion.

No Guarantee of Fraud Detection

While audits can detect irregularities, they are not primarily designed to uncover fraud. An audit provides reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error, but it does not guarantee that all fraud will be detected.

Compliance Focus

Audits are often more focused on compliance with accounting standards and less on the broader business issues or operational effectiveness.

Potential for Conflict of Interest

If an auditing firm provides other services to the company being audited, there can be a perceived or actual conflict of interest, potentially impacting the auditor's independence and objectivity.

Stress and Pressure on Staff

The audit process can create stress and pressure for the company's staff, particularly in areas under scrutiny or where discrepancies are found.

Delayed Reporting

The time taken to complete an audit can lead to delays in the publication of financial statements, which might impact decision-making or investor relations.

Cultural and Communication Barriers

In multinational companies, auditors may face challenges due to cultural differences and language barriers, potentially impacting the effectiveness of the audit.

What is an Agreed-Upon Procedure (AUP)?

AUP engagements involve an auditor performing specific procedures that have been agreed upon by the entity and any third parties involved. The auditor then reports on the factual findings of these procedures, without expressing an opinion or assurance.

Benefits of AUPs

Customization and Flexibility: One of the primary benefits of AUP is the ability to tailor the procedures to meet specific needs. Businesses can focus on particular areas of concern or interest, such as specific financial transactions, internal processes, or compliance with certain regulations. This level of customization ensures that the engagement is highly relevant to the specific requirements of the business or the requesting party.

Cost-Effectiveness: AUP engagements can be more cost-effective than full-scale audits. Since AUPs are focused on specific areas, they often require less time and resources, making them a more affordable option for many businesses, especially small to medium-sized enterprises.

Targeted Information and Insights: AUPs provide detailed insights into specific areas of a business. This targeted approach can yield valuable information that might not be as easily discerned in a broader audit, helping businesses address very specific concerns or questions.

Reduced Disruption to Business Operations: Because AUP engagements are more focused and generally shorter in duration than comprehensive audits, they tend to cause less disruption to day-to-day business operations. This is particularly beneficial for businesses that cannot afford the time and resource commitments required for a full audit.

Enhanced Credibility with Third Parties: The findings from AUP engagements can enhance credibility with third parties, such as lenders, investors, or regulatory bodies, especially when these parties have requested or agreed to the specific procedures. The factual findings provide a level of independent verification that can build trust and confidence.

Facilitates Compliance and Risk Management: AUPs can be used to verify compliance with regulatory requirements, contracts, or internal policies. They can also help in identifying risks in specific areas of the business, contributing to better risk management practices.

Supports Decision-Making: The insights gained from AUP engagements can support strategic decision-making. By providing clarity on specific aspects of the business or financials, AUPs can help management make informed decisions.

Rapid Resolution of Specific Issues: If a business faces a particular issue or challenge, AUP can provide a rapid and focused examination, leading to quicker resolution compared to a full audit.

Confidentiality: AUP reports are typically confidential and intended only for the use of the parties who agreed to the procedures. This can be advantageous when dealing with sensitive information.

Useful for Contractual or Transactional Purposes: In situations like mergers, acquisitions, or contractual agreements, AUPs can be used to verify specific financial information or operational details that are critical to the transaction.

 

Drawbacks of AUPs

No Assurance or Opinion Provided: One of the primary drawbacks of AUP is that the auditor or practitioner does not provide any assurance or opinion on the financial information or processes being reviewed. The report consists only of factual findings based on the specific procedures agreed upon.

Limited Scope: The scope of an AUP engagement is confined to the procedures that have been explicitly agreed upon by the involved parties. This means that significant areas of potential concern might not be examined if they are not part of the agreed procedures.

Potential for Misinterpretation: Since the AUP report only presents factual findings without interpretive analysis or conclusions, there is a risk that users of the report might misinterpret the results. Without the context of an auditor's opinion, stakeholders might draw incorrect conclusions from the findings.

Not a Substitute for an Audit: AUP engagements are not a substitute for a full audit and do not satisfy statutory or regulatory requirements for an audit. This is particularly relevant for public companies and certain private entities that are required to have their financial statements audited.

Limited Use of Report: The AUP report is intended only for the parties who agreed upon the procedures. It may not be suitable or sufficient for other stakeholders or external parties who did not participate in defining the scope of the AUP.

Dependence on Accurate Information: The effectiveness of an AUP engagement is highly dependent on the accuracy and completeness of the information provided by the client. If the information is flawed or incomplete, the findings of the AUP may be misleading.

No Holistic Evaluation: AUP engagements do not provide a holistic evaluation of a company's financial position, operations, or systems. They are focused only on the specific areas covered by the agreed-upon procedures.

Cost Considerations: While often less expensive than a full audit, AUP engagements can still be costly, especially if the procedures are extensive. Businesses must weigh the benefits against the costs involved.

Lack of Standardization: Since AUP engagements are tailored to specific needs, there is a lack of standardization, which can make comparisons across different engagements or periods challenging.

Not Designed to Detect Fraud: AUPs are not specifically designed to detect fraud or errors. While such issues might be incidentally discovered during the process, uncovering these is not the primary objective of AUP.

 

Factors in Deciding Between an Agreed-Upon Procedure and an Audit

There are several factors that businesses need to consider when determining which approach is more suitable for their specific needs:

Purpose and Objectives

Audit: If the primary objective is to provide assurance about the accuracy and fairness of financial statements as a whole, an audit is appropriate. Audits are often required for regulatory compliance, especially for public companies.

AUP: If the need is for specific information or verification of particular aspects of financial statements or business operations, AUP might be more suitable.

Regulatory and Compliance Requirements

Certain businesses may be legally required to have their financial statements audited, particularly public companies and certain types of private entities.

Stakeholder Requirements

Consider what external stakeholders (like investors, lenders, or partners) require. An audit provides a higher level of assurance, which might be necessary for these stakeholders. AUP might be sufficient for internal purposes or when specific third-party stakeholders request it.

Scope and Focus

Audits are broad in scope, covering the entire set of financial statements. AUPs are narrow in scope and focus on specific areas or issues.

Cost and Resource Allocation

Audits are generally more expensive and resource-intensive than AUPs. Consider the budget and whether the additional cost of an audit is justified. AUPs can be more cost-effective for addressing specific concerns.

Levels of Assurance Required

An audit provides a high level of assurance, whereas AUP provides no assurance – only factual findings based on the agreed-upon procedures.

Risk Management

If the goal is comprehensive risk management and an understanding of internal controls, an audit is more appropriate. For targeted risk assessment in specific areas, AUP might suffice.

Time Constraints

Audits are time-consuming. If time is a constraint, and the information needed is specific, AUPs can be quicker to perform. With audits taking more time, this can put an additional strain on employees and the day-to-day operations during the audit.

Nature of the Business and Industry Practices

Some industries have specific requirements that might make an audit more necessary. For unique or non-standard inquiries, AUP might be more adaptable.

Future Plans

If the company plans to go public, seek significant investment, or engage in major transactions, an audit might be more beneficial for providing the required level of assurance to potential investors or partners.

Confidentiality and Sensitivity of Information

AUP reports are typically restricted in their use to the parties who agreed upon the procedures, which might be preferable in sensitive situations.

Previous Financial History

If there have been issues in the past like fraud or significant errors, an audit might be necessary to restore credibility.

Which to Choose?

Both audits and AUPs offer distinct benefits as well as drawbacks. The decision should align with the business’s strategic goals, operational needs, and the expectations of its financial stakeholders. Professional guidance is advised to ensure the chosen approach best serves the company’s interests.

Request More Information

© 2023 SVA Certified Public Accountants

Share this post:


Biz Tip Topic Expert: Shawn Miller, CPA

Shawn Miller, CPA

Shawn is a Senior Manager at SVA Certified Public Accountants with focused expertise in the real estate and nonprofit industries. He oversees and performs audit and tax services for owners of a variety of affordable multifamily housing projects.

Awards and Affiliations

milwaukee-business-journal-largest-milwaukee-area-accounting-firms-2022-logo2
sva-certified-public-accountant-affiliation-wicpa
SVA_2023_Certification_Badge-white
accountingtoday-white
sva-award-logo-inside-public-accounting-top-200-firms-2023
sva-certified-public-accountant-affiliation-m-power-business-champion-program
sva-certified-public-accountant-affiliation-aicap-ebpaqc-member
2023ECA_Finalist-white
sva-certified-public-accountant-affiliation-aicpa

Locations

Madison, WI
1221 John Q Hammons Dr, Suite 100
Madison, WI 53717
(608) 831-8181

Milwaukee, WI
18650 W. Corporate Drive, Suite 200
Brookfield, WI 53045
(262) 641-6888

Colorado Springs, CO
1880 Office Club Pointe, Suite 128
Colorado Springs, CO 80920
(719) 413-5551

SVA BBB Business Review Man Standing

Contact

(888) 574-4782
info@SVAaccountants.com
BizTips

Are you in the know on the latest business trends, tips, strategies, and tax implications? SVA’s Biz Tips are quick reads on timely information sent to you as soon as they are published.

Connect With Us

Copyright © 2024 SVA Certified Public Accountants | Privacy Policy | Cookie Policy | CCPA