What it means
The word statutory simply means required by statute, so a statutory audit is one imposed by legislation rather than requested by the board. Whether a company needs one usually depends on its size, its legal form and whether its shares or bonds are traded publicly.
The point of the exercise is to give outsiders a reason to trust numbers prepared by insiders. Shareholders who do not run the business, banks deciding on facilities and suppliers extending credit all lean on that independent opinion because none of them can inspect the ledgers themselves.
In practice the auditor plans the work around risk and materiality, tests a sample of transactions and balances, confirms items directly with banks and customers, and evaluates the accounting judgements management has made. The output is an audit report carrying an opinion that is unmodified, qualified, adverse or a disclaimer.
A statutory audit is not a fraud investigation and it is not a guarantee that every figure is exact. Auditors work to reasonable assurance within a materiality threshold, so small errors can and do survive an unmodified opinion.
Businesses below the statutory thresholds sometimes commission a voluntary audit anyway, usually because a lender, an investor or a large customer asks for one. The lighter alternative in many places is a review engagement, which gives limited assurance at a lower cost.
In practice
Real-world examples.
Example
A listed retailer with revenue of $2,100,000,000 undergoes its annual statutory audit. The auditor attends stocktakes at twelve sites, confirms bank balances directly and challenges the assumptions behind a $34,000,000 goodwill balance. The final report carries an unmodified opinion with a key audit matter on inventory valuation.
Example
A family manufacturing group crosses the statutory turnover threshold for the first time after a strong year. Management, used to unaudited accounts, spends three months building a fixed asset register and a proper cut-off process before the first audit begins. The first year fee is quoted at $95,000, higher than normal because the systems need remedial work.
Example
A charity with government grant funding faces a statutory audit under the rules governing its sector. The auditor tests whether restricted funds were spent only on their designated purposes and finds $60,000 of general overhead charged to a restricted grant. The finding is corrected before the accounts are filed.
Formula
Calculation
A statutory audit has no single formula, but the scale of the work is set using materiality:
Overall Materiality = Chosen Benchmark x Percentage
Take a distributor with revenue of $40,000,000. The auditor selects revenue as the benchmark and applies 1%, giving overall materiality of $40,000,000 x 1% = $400,000. A misstatement above that level could reasonably change a reader's view of the accounts.
Performance materiality is then set below that figure to leave room for errors the testing might not catch, commonly at 75% of the total: $400,000 x 75% = $300,000. Individual account balances are tested against this lower threshold.
A clearly trivial threshold is often set at 5% of overall materiality: $400,000 x 5% = $20,000. Differences below $20,000 are not even accumulated on the schedule of unadjusted errors.
If the engagement is planned at 900 chargeable hours at an average blended rate of $180 an hour, the fee comes to 900 x $180 = $162,000.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Crandell Packaging Group, an invented producer of corrugated boxes, grew from $18,000,000 to $46,000,000 of revenue in three years and became subject to a statutory audit for the first time.
The auditors set overall materiality at 1% of revenue, which is $460,000, and performance materiality at 75% of that, or $345,000. Testing of the revenue cycle showed the fictional company had recognised $610,000 of sales on goods still sitting in its own warehouse at year end, awaiting customer collection. Because the figure exceeded materiality, it could not be left uncorrected.
Management adjusted the accounts, which reduced reported profit for the year by $180,000 after allowing for the related cost of sales. The uncomfortable part was the effect on a bank covenant tied to profit, which the finance director had to renegotiate before signing. Crandell rebuilt its cut-off procedures the following year and the second audit finished three weeks faster.
Watch out
Common mistakes.
- Believing a clean audit opinion means the accounts are exact to the last dollar, when auditors only give reasonable assurance within a materiality threshold.
- Treating the audit as a search for fraud, when detecting fraud is management's responsibility and the audit is designed around material misstatement.
- Leaving preparation until the auditors arrive, which lengthens the fieldwork, raises the fee and increases the number of adjustments.
Questions
People also ask.
Who chooses and pays the statutory auditor?
Shareholders normally appoint the auditor at a general meeting and the company pays the fee, an arrangement that makes auditor independence rules so important.
What is the difference between a statutory audit and an internal audit?
A statutory audit is performed by an independent external firm for the benefit of outside stakeholders, while internal audit is an in-house function reporting to the board on controls and risk.
What does a qualified opinion actually mean?
It means the auditor found something material that is wrong or could not be verified, but the issue is not so pervasive that the accounts as a whole are unreliable.
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