What is the Purpose of an Audit?

For many of us, the thought of an audit strikes a feeling of fear. We become fraught with images of an Internal Revenue Agent with beady eyes, sporting a dark three-piece suit, auditing our last tax return to determine if we owe additional income taxes. Despite our worries, an audit of our local government should be welcomed rather than feared. Unlike an audit we may undergo as individuals, an audit of our local government has an entirely different purpose. The objectives of an audit of our local government include:

1. Are the government’s financial statements fairly presented in accordance with Generally Accepted Accounting Principles?
2. Did the government comply with applicable laws and regulations?
3. Does the government have an adequate system of internal controls?

The auditor’s primary objective is to determine if the government’s financial statements are fairly presented. A favorable opinion does not mean that the government’s financial statements are free of errors. The term fairly presented means that the financial statements are not so materially misstated or misleading that they do not present fairly the government’s financial information. The auditor’s conclusions are presented as an opinion, rather than a statement of absolute fact or guarantee. Despite this lack of certainty, government officials should welcome an audit, look forward to passing all of the auditor’s tests, and gain assurance that the government’s financial records are reasonably accurate.

Governmental audits are often referred to as “financial and compliance” audits because governmental auditing standards require auditors to test both financial and compliance requirements. The financial portion of the audit is meant to determine if the financial statements are fairly presented in accordance with accounting standards. The compliance portion of the audit refers to whether the government followed applicable laws and regulations. A listing (a "Compliance Supplement") of many city/town's compliance requirements can be found on the Montana Department of Administration's website http://sfsd.mt.gov/LGSB/Audit-Financial-ReviewResources/4_ComplianceSupplement.

Auditors are required by their auditing standards to evaluate the government’s system of internal controls. Internal controls (also referred to as a system of checks and balances) are intended to provide reasonable, but not absolute, assurance that the government’s assets are protected. Guaranteed protection is impossible. Segregation of duties is one of the most powerful aspects of internal control. The overriding principle is: no one person should ever be placed in a situation to carry out or conceal an error or irregularity without timely detection by others in the normal course of their responsibilities.

Many mistakenly believe that an audit is designed to detect fraud, if it exists. This is simply not the case. While the detection of fraud could possibly be an outcome of an audit, fraud is rarely detected by an audit. The system of checks and balances that governments implement serve to prevent these problems from occurring, which is obviously far better than discovering problems after the fact through an audit or other means. Governing bodies are responsible for ensuring auditor’s recommendations for improvements in internal controls are implemented and should also consider an even stricter system of checks and balances than the auditors may recommend. Many audit firms will provide specialized engagements at a reasonable cost designed solely for the purpose of improving a government’s system of internal controls. Given the public’s expectation of a frugal and efficient government, it is difficult for elected officials to expend additional money to prevent problems, when most feel no problems exist. However, there are a multitude of government officials who have experienced fraud and embezzlement and have wished they had expended a relatively small amount of money to improve their system of internal controls. Problems of this nature, regardless of severity, serve to erode the public’s trust in government.

Montana Municipal Officials Handbooks 3rd Edition, Section 5.501