In recent years, there have been many instances of financial fraud and mismanagement in public companies. These scandals have resulted in significant financial losses for shareholders and a loss of trust in the financial markets. To prevent these occurrences, public companies need to be audited regularly.
Here are 5 reasons why:
1. Compliance with Regulations
Public companies are required to comply with various financial regulations, and auditing ensures that they are meeting these requirements. An auditor can identify any potential issues or noncompliance with financial reporting standards and help the company address them before they become a problem.
The financial services company, Wells Fargo, was fined $3 billion in 2020 for creating millions of fake accounts without customers' consent. The company's failure to comply with regulations led to the scandal and an audit could have detected the issue earlier, preventing the financial loss and reputational damage suffered by the company.
2. Detection of Fraud
One of the primary reasons for auditing is to detect and prevent fraud. Auditors can spot abnormalities in financial transactions and assist the organization in investigating them. This is crucial in preventing fraudulent activities, such as embezzlement, from occurring.
In 2018, the South African retailer, Steinhoff International, announced that it had uncovered accounting irregularities, which led to a drop in its share price. A subsequent audit found that the company had overstated its profits by over $7 billion. An earlier audit could have detected the fraud and prevented the financial loss and damage to the company's reputation.
3. Improved Financial Reporting
Auditing can help companies improve their financial reporting practices. By conducting regular audits, companies can identify any weaknesses in their accounting practices and make improvements. This can lead to more accurate financial statements, which can improve investor confidence and potentially increase the company's stock price.
The multinational energy company, Enron, filed for bankruptcy in 2001 after it was revealed that it had engaged in accounting fraud to conceal losses. The company's financial statements were inaccurate and unreliable, leading to significant financial losses for investors. An audit could have identified the weaknesses in the company's accounting practices and improved its financial reporting.
4. Assurance to Investors
Auditing assures investors that the company's financial statements are correct and credible. This can help attract more investors and improve the company's overall reputation in the financial markets.
The pharmaceutical company, Valeant, was accused of fraudulent accounting practices in 2015, leading to a drop in its share price. An audit could have provided investors with assurance that the company's financial statements were accurate and reliable, potentially preventing the financial loss suffered by shareholders.
5. Risk Management
Auditing can assist businesses in identifying and managing financial risks. Companies can detect possible hazards and mamanage them by performing frequent audits. This can help prevent financial losses and protect the company's assets.
The ride-hailing company, Uber, was fined $148 million in 2018 for covering up a data breach that affected 57 million customers and drivers. An audit could have identified the potential risks associated with the company's data management practices and helped it take steps to mitigate them, preventing the financial loss and reputational damage suffered by the company.
In conclusion, auditing is essential for public companies to ensure compliance with regulations, detect fraud, improve financial reporting, provide assurance to investors, and manage financial risks. Recent events have highlighted the importance of auditing in preventing financial scandals and protecting investor interests.
