What’s the purpose of a financial statement audit? Many professionals might answer, “To ensure compliance with IFRS,” while others might say it’s simply a legal requirement. While both are true, these answers don’t fully explain the bigger picture.
In this article, we’ll take a step back and look at the historical roots of financial statement audits to better understand their importance and why they matter today.
History of Financial Audits
The story begins with the South Sea Company and the infamous South Sea Bubble in Great Britain during the early 1700s. Here’s a summary of the events:
The South Sea Company was established in 1711 to trade with Spanish America.
In June 1720, the Bubble Act was passed, prohibiting the formation of joint-stock companies without a royal charter. This law aimed to limit competition with the South Sea Company, effectively granting it a monopoly over trade with South America.
The price of the South Sea Company’s shares soared, creating a speculative bubble. In January 1720, the shares were priced at £128. By August, they had risen to over £1,000. However, by
September, the bubble burst, causing the share price to plummet to about £150 and leaving many investors financially ruined.
Between late 1719 and mid-1720, leading up to the enactment of the Bubble Act, numerous companies were promoted and raised capital by promising incredible returns. While some of these ventures had legitimate purposes, many were fraudulent. Regardless of intent, investors were left devastated. One notable victim of the bubble was Isaac Newton, who reportedly lost an amount equivalent to £40 million in today’s terms.
During the bubble’s peak, South Sea Company shares were traded at absurdly inflated prices. A well-known anecdote from this era tells of a stock promoter endorsing “a company for carrying on an undertaking of great advantage, but nobody knows what it is.” While there is no concrete evidence of such an advertisement, it reflects the deceptive and speculative environment of the time, with many promotions designed to lure investors into fraudulent schemes.
By the 1760s, with the Industrial Revolution underway, there was a growing demand for associations and joint-stock companies. However, the prohibition on forming companies without a royal charter or Act of Parliament posed a significant hurdle.
Recognizing this need, the UK Parliament enacted the Joint-Stock Companies Act of 1844. Key features of this legislation included:
Allowing companies to be formed through registration, which became the primary method of incorporation. Incorporation by royal charter or Act of Parliament became rare.
Introducing audit requirements and financial disclosure.
The audit requirements introduced by the Act aimed to protect investors and were a direct response to the fraudulent practices seen during the South Sea Bubble era.
Financial Audits Today
It would be unfair to assume that investors from 300 years ago were any more gullible than those of today. Modern financial scandals, such as the $45 million fraud orchestrated by Nikola Corporation promoter Trevor Milton in 2020, the collapse of Theranos, the dot-com bubble of 1999, and the various cryptocurrency schemes, serve as reminders that financial markets remain susceptible to overconfidence and deception.
This brings us to the vital role of financial audits in today’s world. Independent third-party professionals, such as Onch & Co., provide the assurance investors and creditors need to trust where their hard-earned money is going. Audits of financial statements offer transparency, accountability, and peace of mind—safeguarding financial decisions and fostering confidence in markets.
Partner with Trusted Experts
At Onch & Co., we bring decades of experience in delivering reliable audit, advisory, and tax services. Established in 2004, we have a proud history, including 10 years as part of the Deloitte network. Since 2022, we’ve continued our commitment to excellence under the Onch & Company brand.
Trust us to provide the transparency and assurance your business needs. Browse our services today to learn how our expert team can support your financial goals and safeguard your investments.
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