Why Do We Need Auditing – UAE

FIRST: Types & Contents of Financial Audit

A financial audit is reviewing accounts or financial statements of any entity being natural persons or legal entities of all types and sizes from the smallest sole proprietorship company to the biggest multinational corporation.

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A – Types

1 – Internal Audit

This is a part of the internal control procedures installed by entities appointing a person or a department within the same company but completely separate from the finance department to review the entity’s financial transactions and records to report to the top management of the entity of all its findings regularly and to assist the management in all its requirements. Many companies use the services of independent Chartered Accountants Firms to perform internal audit work which naturally is completely different from any assignment for External Audit

Occasionally entities make use of internal audit departments to check some specific transactions even before expenditure or agreements signed, in addition to their normal work of checking work already done by the finance departments. Naturally the work of the internal audit departments assists the external audit done by outside parties, normally firms of Chartered Accountants in the United Arab Emirates.

2 – External Audit

In this article we shall cover this type of audit rather than internal audit as external audit is governed by many regulations in the United Arab Emirates, both in local and federal laws and also at most departments at nearly all registering authorities like Departments of Economic Development in each emirate has its own rules & regulations while federal laws apply to all emirates.

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B – Contents

Financial Audit is concerned with checking or reviewing the financial statements issued by the entity to provide an audit report for the benefit of the reader and users of those financial audit reports. Naturally such work is regulated by international auditing standards issued by regulatory authorities.

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SECOND: Financial Statements Contents

In order to understand what is an audit & the audit report, one must know the contents of the financial statements:

1 – The Statement of Financial Position (Balance Sheet)

This statement shows all the assets of the entity both current (short term) and fixed (long term) assets owned at a certain day or point of time. It also shows the liabilities of that entity (assets owed to outside parties). The excess of assets over liabilities, shows the owners (shareholders) equity which means what the shareholders own in this entity. If the liabilities exceed the assets, then there is a deficit of shareholder equity.

Current (short term) assets normally means assets to be converted into cash or liabilities to be settled within one year after the reporting date of the financial statements which is the date of the Statement of Financial Position (Balance Sheet).

Fixed (long term) assets means assets which are held for more than one year to be used by the entity. Examples are vehicles, furniture, long term loans, machinery, buildings, etc.

Long term liabilities are liabilities to third parties to be settled after more than one year from the date of the Statement of Financial Position (Balance Sheet).

2 – Income Statement (Profit and Loss)

This statement shows the results of operations of the entity during a specific period e.g. a year. If the entity is a trading company, then the P&L (Profit & Loss) A/C (Account) shows its sales and costs of sales to arrive at the margin which we call Gross Profit or Gross Loss.

After deducting the administrative and general expenses, and adding other miscellaneous income we then have Net Profit earned or Net Loss incurred during that period. That is the reason we normally call the Income Statement: Profit and Loss Account.

3 – Cash Flow Statement

This statement shows cash received & cash paid during a period (like a year). This statement is normally very difficult to understand by most readers of the financial reports.

However, in recent & present times it may be the most important statement of all as it depicts the liquidity of the entity which has become extremely important for a useful study of the entity’s affairs because cash and liquidity of the entity. Many professors say now “cash is king” which shows the importance of managing cash and necessity of cash forecasting as to know the past should enable us to forecast cash position of the future

It is now extremely important as though some companies are otherwise profitable, but because there is no cash available to settle its debts to outside parties, it could have problems and creditors could possibly cause problems to the company and may even reach liquidation or insolvency according to the laws of the country. The United Arab Emirates has over the past few years introduced bankruptcy laws and many other commercial laws dealing with such instances.

4 – Other Schedules & Notes

The set of financial statements also contain many other schedules like:

1. Details of fixed assets which shows the original costs of the fixed assets and depreciation thereon and the book values which are shown in the Balance Sheet .

2. Costs and industrial expenses for industrial companies, while trading companies show costs of purchasing the goods and the direct costs on those goods till they become ready to be sold.

The sales or total revenue less costs and factory expenses shows what we call the Margin or Gross Profit during the period of the statements. Finally the General and Administrative Expenses which are deducted from the Gross Profit to reach the final Net Profit of the entity earned during that period or the Net Loss incurred during the period.

Nowadays as the multinational companies operate in many countries and as the financial statements are very important for all stakeholders of the entities, institutes and boards have issued many financial standards. Those standards issued for a particular country like the United Kingdom and United States of America ( US GAP ) are normally mandatorily applied in those countries and may also be applied at other countries

In the United Arab Emirates, most audit firms make sure the application of International Financial Reporting Standards (IFRS) issued by certain boards which are actually guidelines for all countries to be followed in preparing the financial statements. The United Arab Emirates does not yet have a standard setting institute except the Union of Auditors and Accountants, and we are following the international financial standards in auditing the accounts of our clients’ accounts.

This shows the basis of preparation of the financial statements and also explains many parts of the main financial statements stated above. Notes to financial statements have become a very important part of the financial report as a whole as they show and explain many matters relating to the financial statements.

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THIRD: Benefits of External Financial Audit

A – Shareholders

Though all stakeholders of any entity derive benefits from the external financial audit done by a registered auditor at the MoE (Ministry of Economy), the the first and most important part are the owners / shareholders. The MoE (Ministry of Economy) is the federal authority which regulates and registers auditors all over the United Arab Emirates

The shareholders have invested considerable funds and efforts in the entity so naturally need to know what is happening to their investment, the return expected, and future viability or otherwise of that entity. This is in order to decide what action to take on their shares (keep, sell, etc.) and also to decide on appointment or change of management.

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B – Government Departments

The Federal Commercial Companies Law of the U.A.E. No. 2 for the year 2015 stipulates keeping of accounts and audit for most types of companies. Most local laws & regulations require accounts and audited financial statements to be presented.

Most Free Zones in the United Arab Emirates have very strict regulations and requirements for their companies to present audited financial statements within a certain period e.g. DMCC stipulates a three months period after The Statement of Financial Position (Balance Sheet) date and should present the audited financial statements, otherwise fines are imposed. Similarly JAFAZ and nearly all other Free Zones all over the United Arab Emirates stipulate such requirements. In repeated delays or none submission of audited accounts many Free Zones have stricken off those violating companies from their records.

Same is followed by many Departments of Economic Development (DEDs) at most emirates which require audited accounts upon renewal of the license annually.

Therefore, the laws and regulations stipulate on entities to present audited financial statements.

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C – Other Stakeholders

Banks insist on having audited financial statements of the companies they deal with especially essential for entities they provide finance or loans to. In addition, lenders always require audited financial statements regularly in order to study those financial statements and decide accordingly whether to approve providing facilities to those applicants.

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D – Large Conglomerates

Other large conglomerates like ADNOC insist on audited financial statements of their suppliers before allowing them to supply goods and services to them.

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FOURTH: Summary

We have showed that in United Arab Emirates and possibly all over the world all entities of all kinds must keep financial records and have those records audited by independent auditors so that all stakeholders can know, analyze, and understand the financial position of those entities so that they can forecast its future position and take important decisions in dealing with the shares, loans, trading, investing in those Companies accordingly.

Munem Rubaie, B.Com (Hons.), Leeds England , FCA, ICAEW – London
Founder & Managing Partner ARCA