Auditing: definition, process, content

Definition: What is auditing?

Because the larger industrial and commercial enterprises that emerged in the course of industrialization from the beginning of the 18th century could no longer be managed by their owners, managing directors were hired locally. In addition, capital investors – shareholders in stock corporations – also took stakes in companies that did not participate in the operating business of the companies. Thus, an increasing asymmetry formed between the operationally active managing directors and the investors.
To ensure that investors were nevertheless correctly and fully informed by the management, independent experts were commissioned to audit the management. After serious accounting crimes had occurred around 1930, these initially voluntary audits became mandatory for stock corporations in England in 1900, Germany followed in 1931, the USA in 1934 and Switzerland in 1936. In particular, the realization had matured that until then assets had been overvalued and fictitious accounting transactions had hardly been discovered due to different accounting practices. On September 10, 1931, the classification schemes for the balance sheet and income statement were prescribed, the profession of auditor was created, and stock corporations were required by law to have their annual financial statements audited.

In 1969, an amended Disclosure Act in Germany (PublG) made it mandatory for larger partnerships to prepare, audit and disclose their annual financial statements. In 1985, the Accounting Directive Act in Germany (BiRiLiG) made it mandatory for all medium-sized and large corporations, in particular limited liability companies (GmbHs), to have their annual financial statements audited, and in 1990, this also applied to consolidated financial statements. In 2000, the Capital Companies & Co. Directive Act in Germany (KapCoRiLiG) also brought limited liability partnerships, in particular GmbH & Co. KGs, were included in the audit and disclosure obligation. The size criteria are set out in the German Commercial Code (HGB).

The mandatory audits are divided into the compliance audits of the annual financial statements and the management report, and the management audits, which include the assessment of the effectiveness and efficiency of the management’s fulfillment of social and competitive tasks.

What is the process of an audit?

The audit of financial statements includes the balance sheet, the income statement, the notes to the financial statements, including the management report, as well as the accounting and corporate planning. The responsibility for correct accounting and financial statements lies with the company’s management, even if the management delegates the execution of the financial statements to a tax advisor. The tax advisor will seek confirmation from management that management has provided all information to the tax advisor completely and accurately.

The audit is usually started by reviewing the formal documents, which include the articles of association and the extract from the commercial register. This is followed by a review of the current accounting records based on account movements and supporting documents, with inspection of material contracts. On the closing date of the annual financial statements, the auditor accompanies the inventory of materials and goods. The auditor then assesses the appropriateness of the valuation method applied and the valuation of the material and goods inventories. Then, an audit of the accounts receivable and accounts payable items is performed on the basis of the lists of totals and balances provided to the auditor by the company.

If the audit shows that the accounting and the annual financial statements have been properly prepared, the auditor gives an unqualified opinion. If the audit reveals any deficiencies, the auditor shall make recommendations for correcting the bookkeeping or the annual financial statements. If management follows and implements these recommendations, the auditor issues an unqualified opinion.

Legal requirements: Who is subject to the audit requirement in Germany?

The legal basis in Germany is the German Commercial Code (Section 316 (1) sentence 1 in conjunction with Section 267 HGB). For corporate groups, Section 316 (2) in conjunction with Sections 290-293 HGB also apply. With regard to publication, the basis in Germany is Section 6 PublG in conjunction with Section 1 PublG. In corporate groups, Section 14 PublG in conjunction with Section 11 PublG applies. According to this, the annual financial statements of all medium-sized and large corporations (GmbH, AG) are subject to an audit by an auditor. These are companies with a balance sheet total of > 6 MEUR, sales exceeding 12 MEUR and a workforce of more than 50 employees. As soon as two of these three conditions are met, a company is subject to mandatory auditing. In addition, there is an audit requirement for consolidated financial statements and the annual financial statements of capital market-oriented companies.

Different principles apply to credit institutions and companies in the insurance sector (credit institutions: § 340 HGB, §§ 1,2,28 and 29 KWG and insurance companies: § 341k HGB and §§ 1, 2, 55-64 and 83 VAG).

In addition to these mandatory audits, there are voluntary audits, which include the following audits:

  • Audits of the internal monitoring system
  • creditworthiness and credit protection audits
  • Insolvency audits
  • Restructuring eligibility audits
  • Audits for subsidies
  • Prospectus audits
  • Audits of interim reports required by stock exchange law

Conclusion on auditing

The audit of accounting records and financial statements by an independent auditor protects market participants and the state from deviations of annual reports prepared by companies from the factual economic situation in which companies find themselves.

The audit required by law for medium-sized and large corporations includes a standard audit scope. Management is required to provide the auditor with the documents, evidence and information to be audited. The auditor’s unqualified opinion exonerates the management.


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