Role of Auditor in entrepreneurship and small business management

1. Entrepreneurship+and++
Small+Business+Management+
Role+of+the+Auditor+in+Small+Business+Organization+
Ayush&Parekh&
&
! !

2. & 2&
Index
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& &
Sr.&No.& & & Topic& Page&No.&
1.& Introduction& 3&
2.& Attributes&of&Entrepreneurs& 4&
3.& Factors&affecting&Entrepreneurship& 7&
4.& Small&Business&Management&& 11&
5.& Importance&of&Small&Business&in&economy& 11&
6.& How&can&Small&Business&Survive?& 12&
7.& Auditors&is&Small&Businesses& 14&
8.& Role&of&Auditors& 14&
9.& Management’s&responsibility&in&an&Audit& 16&
10.& Conclusion& 18&

3. & 3&
Introduction
We often hear that so and so is an entrepreneur who has
started his or her own business. It is also the case that
when we hear the term entrepreneur, we tend to associate
it with a person who has or is starting their own ventures
or in other words, striking it on their own. This is
indeed the case as the formal definition of
Entrepreneurship is that it is the process of starting a
business or an organization for profit or for social
needs. We have used the phrase for profit or for social
needs to delineate and separate the commercial
entrepreneurship from social and charitable
entrepreneurship. After defining entrepreneurship, it is
now time to define who an entrepreneur is and what he
or she does.
An entrepreneur is someone who develops a business
model, acquires the necessary physical and human
capital to start a new venture, and operationalizes it
and is responsible for its success or failure. Note the
emphasis of the phrase responsible for success or failure
as the entrepreneur is distinct from the professional
manager in the sense that the former either invests his or
her own resources or raises capital from external sources
and thus takes the blame for the failure as well as reaps
the rewards in case of success whereas the latter or the
professional manager does the job and the work assigned
to him or her for a monetary consideration. In other
words, the entrepreneur is the risk taker and an innovator
in addition to being a creator of new enterprises whereas
the professional manager is simply the executor.

4. & 4&
Attributes of Entrepreneurs
Moving to the skills and capabilities that an entrepreneur
needs to have, first and foremost, he or she has to be an
innovator who has a game changing idea or a potentially
new concept that can succeed in the crowded
marketplace. Note that investors usually tend to invest in
ideas and concepts which they feel would generate
adequate returns for their capital and investments and
hence, the entrepreneur needs to have a truly innovative
idea for a new venture.
Leadership Qualities
Apart from this, the entrepreneur needs to have excellent
organizational and people management skills as he or she
has to build the organization or the venture from scratch
and has to bond with his or her employees as well as vibe
well with the other stakeholders to ensure success of the
venture.
Further, the entrepreneur needs to be a leader who can
inspire his or her employees as well as be a visionary and
a person with a sense of mission as it is important that
the entrepreneur motivates and drives the venture. This
means that leadership, values, team building skills, and
managerial abilities are the key skills and attributes that
an entrepreneur needs to have.
Creative Destruction and Entrepreneurship
We often hear the term creative destruction being spoken
about when talking about how some companies fade
away whereas others succeed as well as maintain their
leadership position in the marketplace. Creative
destruction refers to the replacement of inferior

5. & 5&
products and companies by more efficient, innovative,
and creative ones wherein the capitalist market based
ecosystem ensures that only the best and brightest
survive whereas others are blown away by the gales
of creative destruction. In other words, entrepreneurs
with game changing ideas and the skills and attributes
that are needed to succeed ensure that their products,
brands, and ventures take market share away from
existing companies that are either not creating values or
are simply inefficient and stuck in a time warp wherein
they are unable to see the writing on the wall. Therefore,
this process of destroying the old and the inefficient
through newer and creative ideas is referred to as
creative destruction which is often what the entrepreneur
does when he or she launches a new venture.
An Entrepreneur is a Risk Taker
We have discussed what entrepreneurship is and the
skills and attributes needed by entrepreneurs along with
how they engage and indulge in creative destruction.
This does not mean that all entrepreneurs are successful
as the fact that they can become victims of creative
destruction as well as due to lack of the other traits
means that a majority of new ventures do not survive
past the one year mark of their existence. Now, when
ventures fail, the obvious question is who takes the
blame for the failure and whose money is being lost. The
answer is that the entrepreneur puts his or her own
money or raises capital from angel investors and venture
capitalists which means in case the venture goes belly up,
the entrepreneur and the investors lose money. Note that
as mentioned earlier, the employees and the professional
managers lose their jobs and unless they are partners in

6. & 6&
the venture, their money is not at stake. Therefore, this
means that the entrepreneur is the risk taker in the
venture which means that the success or failure of the
firm reflects on the entrepreneur.
Some Famous Entrepreneurs
Given this basic introduction to entrepreneurship, we can
now turn to some famous examples of entrepreneurs who
have succeeded despite heavy odds because they had
game changing ideas and more importantly, they also
had the necessary traits and skills that would make them
legendary. For instance, both the founder of Microsoft,
Bill Gates, and the late Steve Jobs, the founder of Apple,
were college dropouts though their eventual success
meant that they had not only truly innovative ideas, but
they were also ready to strike it out for the longer term
and hang on when the going got tough. Even the founder
of Facebook, Mark Zuckerberg, as well as Google’s
Larry Paige and Sergey Brian can be considered as truly
revolutionary entrepreneurs. What all these legends have
in common is that they had the vision and the sense of
mission that they were going to change the world and
with hard work, perseverance, and a nurturing
ecosystem, they were able to self actualizes themselves.
Entrepreneurship Needs a Nurturing Ecosystem
Finally, note the use of the term nurturing ecosystem.
This means that just as entrepreneurs cannot succeed if
they lack the necessary attributes, they cannot succeed
even having them but living in an environment or a
country that does not encourage risk or tolerate failure
and more importantly, is unable to provide them with the
monetary and human capital needed for success. This

7. & 7&
means that the United States remains the preeminent
country for entrepreneurship as it has the ecosystem
needed for these entrepreneurs to succeed whereas in
many countries, it is often impossible or difficult to find
funding, work through red tape, and ensure that the
environmental factors do not inhibit entrepreneurship.
Factors affecting Entrepreneurship
Political Factors
Political factors play a huge role in the development of
entrepreneurship in a given geographical area. This is
because politicians decide the type of market that is in
place. The market could be capitalistic, communist or
some countries have adopted a mixed economy. Each of
these three markets has very different implications for
the way in which entrepreneurs are required to function.
Capitalism requires breakthrough innovation whereas
communism requires entrepreneurs to be well connected
with the political class. Therefore, it has been observed
that the more capitalistic any country is, the more
entrepreneurship flourishes in the region.
Legal Factors
Entrepreneurs are dependent upon law for a wide variety
of factors. The strength and fairness of the legal system
of a nation affect the quality of entrepreneurship to a
large extent. This is because entrepreneurs require a wide
variety of legal services to function. For instance,
entrepreneurs would require the courts to enforce the
contracts that were entered to between parties. In many
countries such contracts are not enforceable and
therefore the resultant risk prohibits the development of

8. & 8&
entrepreneurship. Then again, the entrepreneurs are
dependent on the courts for the protection of their
property rights. Also, many advanced countries have
noticed that the provision of declaring bankruptcy has
been positively associated with the development of
entrepreneurship. Entrepreneurs do fail a few times
before they find the right innovation that leads to their
success. The United States is amongst the countries with
the highest rate of entrepreneurial development and it is
also known to have one of the most advanced bankruptcy
laws! Even business legends like Henry Ford had
declared bankruptcy in their early days.
Taxation
The government can also influence a high degree of
control on the market through provisions of taxation.
Some amount of taxation is necessary for the government
to maintain the legal and administrative systems in place
for the entire economy. However, a lot of times
governments resort to excessive taxation. They usually
adopt the policy of beggaring the rich and giving it off to
the poor. This goes against the basic tenets of
entrepreneurship which believes in survival of the fittest.
Therefore, countries where tax regimes are restrictive
find an outflow of entrepreneurs. In short, entrepreneurs
want to set up shop in places where there is minimal
interference from the government.
Availability of Capital
The degree to which the capital markets of a nation are
developed also play a huge role in the development of
entrepreneurship in a given region. Entrepreneurs require
capital to start risky ventures and also require instant

9. & 9&
capital to scale up the business quickly if the idea is
found to be successful. Therefore, countries which have a
well developed system of providing capital at every stage
i.e. seed capital, venture capital, private equity and well
developed stock and bond markets experience a higher
degree of economic growth led by entrepreneurship.
Labor Markets
Labor is an important factor of production for almost any
kind of product or service. The fortunes of the
entrepreneurs are therefore dependent on the availability
of skilled labor at reasonable prices. However, in many
countries labor has become unionized. They demand
higher wages from the entrepreneurs and prohibit other
workers from working at a lower price. This creates an
upward surge in the costs required to produce and as
such has a negative effect on entrepreneurship.
With the advent of globalization, entrepreneurs have
witnessed the freedom to move their operations to
countries where labor markets are more favorable to
them. This is the reason why countries like China, India
and Bangladesh have witnessed a huge rise in
entrepreneurial activity in their countries.
Raw Materials
Just like labor, raw material consisting of natural
resources is also an essential product required for any
industry. In some countries this raw material is available
through the market by paying a fair price. However, in
some countries seller cartels gain complete control over
these natural resources. They sell the raw materials at
inflated prices and therefore usurp most of the profit that
the entrepreneur can obtain. Therefore, countries where

10. & 10&
the supply of raw material faces such issues witness
depletion in the number of entrepreneurial ventures over
time.
Infrastructure
Lastly, there are some services which are required by
almost every industry to flourish. These services would
include transport, electricity etc. Since these services are
so basic, they can be referred to as the infrastructure
which is required to develop any business. Therefore, if
any country focuses on increasing the efficiency of these
services, they are likely to impact the businesses of
almost all entrepreneurs in the region. Therefore,
countries which have a well developed infrastructure
system witness high growth of entrepreneurship and the
opposite is also true.
Of course, the above list of factors is not exhaustive.
Entrepreneurship is far too complex a subject to capture
in a few bullet points. However, the above list does
provide an indication towards the type of factors that can
play an important role.

11. & 11&
Small Business Management
A small business is a business that is independently
owned and operated, with a small number of
employees and relatively low volume of sales.
Different countries have slightly different description for
a small business.
For example, in United States a business have less than
100 employees is considered as a ‘small business’,
whereas it is under 50 employees to qualify as a ‘small
business’ in European Union.
In Australia, a small business is defined as 1-19
employees.
Small businesses are normally privately owned
corporations, partnerships, or sole proprietorships.
Apart from number of employees other criteria for
classifying a business as ‘small’ are:
Amount of capital employed
Annual Sales turnover
Value of assets
Profits
Importance of small business in the
economy
As we all know that small firms are important for the
economy.
Small businesses employees majority of the
workforce in any country.
Every business starts small.
Small businesses are flexible and respond easily to
changes in demand.
Small firms often cater to local demands.

12. & 12&
In difficult economic times, such as a recession,
small business can be an important source of
providing employment.
Small firms provide competition to larger firms
through providing customised goods and services.
Small firms provide niche products and services,
which a larger firm might overlook.
Small businesses face the following
problems
Under capitalization
Poor debt management
Lack of managerial skills of the owner
Cannot retain experienced staff
Usually find it difficult to attract skilled staff
Poor stock management
How can small business survive?
Small firms survive by being different (product
differentiation). They can survive by
• Segmenting the market by income. They can target
niche market segments of high income customers,
position their product as a ‘premium brand’ at a
high ‘premium price’ eg Morgan sports cars
• Small firms have the advantage of being able to
respond quickly to change - they do not have the
bureaucratic procedures often a feature of large
firms where decisions are made only after endless
meetings. This means they can be quick to exploit
new market trends.
• The Internet also allows small firms direct access to
consumers, by passing intermediaries. The web

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gives small firms the opportunity of international
marketing.
• Small independent firms can join together to form a
buying group to negotiate discounts on joint orders.
• Small firms can survive by selecting a premium
niche and offering an exclusive brand’ that exactly
meets the customer requirements of their target
segment. They will need to be totally customer
orientated.

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Auditors in Small Company
In the past, companies often relied on accountants from
their audit firms to assist in reconciling accounts,
preparing the adjusting journal entries and writing
financial statements.
Small companies, in particular, often lacked the level of
accounting sophistication necessary to carry out these
tasks. Relying on the audit firm often made sense from
the perspective of efficiency and cost containment.
But an increased focus on auditor independence has
come about during the last decade in new requirements
by the American Institute of CPAs and a host of related
regulatory guidance issued by the Securities and
Exchange Commission, the General Accounting Office
and the U.S. Department of Labor.
The standards generally restrict the nonattest services –
such as tax or consulting services – that auditors may
perform and the circumstances under which those
services may be allowed. The increased regulations serve
to muddy an already often-misunderstood set of
expectations.
Role of Auditors
The outside, independent auditor is engaged to render an
opinion on whether a company’s financial statements are
presented fairly, in all material respects, in accordance
with financial reporting framework. The audit provides
users such as lenders and investors with an enhanced
degree of confidence in the financial statements. An
audit conducted in accordance with GAASand relevant
ethical requirements enables the auditor to form that

15. & 15&
opinion.
To form the opinion, the auditor gathers appropriate and
sufficient evidence and observes, tests, compares and
confirms until gaining reasonable assurance. The auditor
then forms an opinion of whether the financial statements
are free of material misstatement, whether due to fraud or
error.
Some of the more important auditing procedures include:
✎ Inquiring of management and others to gain an
understanding of the organization itself, its operations,
financial reporting, and known fraud or error
✎ Evaluating and understanding the internal control
system
✎ Performing analytical procedures on expected or
unexpected variances in account balances or classes of
transactions
✎ Testing documentation supporting account balances or
classes of transactions
✎ Observing the physical inventory count
✎ Confirming accounts receivable and other accounts
with a third party
At the completion of the audit, the auditor may also offer
objective advice for improving financial reporting and
internal controls to maximize a company’s performance
and efficiency.
What auditors don’t do?
For a clear picture of the role of external auditors, it
helps to understand what you should not expect auditors
to do. The emphasis is on “independent.”
First and foremost, auditors do not take responsibility for
the financial statements on which they form an opinion.

16. & 16&
The responsibility for financial statement presentation
lies squarely in the hands of the company being audited.
Your external auditor may perform some of these duties
under guidelines of the American Institute of CPAs,
Department of Labor, Government Accountability
Office, Securities and Exchange Commission or Public
Company Accounting Oversight Board. However, these
same guidelines may preclude the auditor from
performing some of these functions.
Management’s responsibilities in an audit
The words, “The financial statements are the
responsibility of management,” appear prominently in an
auditor’s communications, including the audit report.
Management’s responsibility is the underlying
foundation on which audits are conducted. Simply put,
without management having responsibility for the
financial statements, the demarcation line that determines
the auditor’s independence and objectivity regarding the
client and the audit engagement would not be as clear.
It is important for a company’s management to
understand exactly what an audit is – and what an audit
does and does not do. The auditor’s responsibility is to
express an independent, objective opinion on the
financial statements of a company. This opinion is given
in accordance with auditing standards that require the
auditors to plan certain procedures and report on the
results of the audit, while considering the
representations, assertions and responsibility of
management for the financial statements.
As one of their required procedures, auditors ask
management to communicate management’s

17. & 17&
responsibility for the financial statements to the auditor
in a representation letter. The auditor concludes the
engagement by using those same words regarding
management’s responsibility in the first paragraph of the
auditor’s report.
Auditors cannot require management to do anything or to
make any representation. However, to conclude the audit
with the hope of a “clean” unqualified opinion issued by
the auditor, management has to assume the responsibility
for the financial statements.
Auditing standards are very clear that management has
the following responsibilities fundamental to the conduct
of an audit:
1. To prepare and present the financial statements in
accordance with an applicable financial reporting
framework, including the design, implementation and
maintenance of internal controls relevant to the
preparation and presentation of financial statements that
are free from material misstatements, whether from error
or fraud
2. To provide the auditor with the following information:
✎ All records, documentation and other matters relevant
to the preparation and presentation of the financial
statements
✎ Any additional information the auditor may request
from management
✎ Unrestricted access to those within the organization if
the auditor determines it necessary to obtain audit
evidence objectivity.
It is not uncommon for the auditor to make suggestions
about the form and content of the financial statements, or
even assist management by drafting them, in whole or in
part, based on information provided by management. In

18. & 18&
those situations, management’s responsibility for the
financial statements does not diminish or change.
Conclusion
An auditor must act honestly and with reasonable care
and skill; otherwise he may be sued for damages.
Further, it is the duty of an auditor to verity with skill,
care and caution which a reasonably competent, careful
and cautious auditor would use. What is reasonable skill,
care and caution must depend on the particular
circumstances of each case. An auditor is not bound to be
a detective or to approach his work with a foregone
conclusion that there is something wrong. He is a watch-
dog but not a blood hound. He is justified in believing
tried servants of the company and in assuming that they
are honest provided he takes reasonable care.
On the other hand if there is anything calculated to excite
suspicion, he should probe it to the bottom, and he must
not confine himself merely to the task of verifying the
arithmetical accuracy of the balance-sheet but should
ascertain by comparison with the books of the company
that it was properly drawn up so as to show the correct
financial position.
An auditor must satisfy himself that the securities of the
company in fact exist and are in safe custody. This duty
is discharged by their making personal inspection of the
securities in question.
Auditors are not concerned with the policy of the
company or whether the company is well or ill managed.
It is not his duty to give advice, either to directors or
shareholders, as to what they ought to do.