What Is an Audit?
An audit typically refers to the objective examination and evaluation of financial statements to ensure their accuracy and fairness. These financial audits can be conducted internally by employees or externally by a certified public accountant (CPA) firm.
Key Takeaways
- There are three main types of audits: external audits, internal audits, and Internal Revenue Service (IRS) audits.
- External audits are performed by Certified Public Accounting firms and result in an auditor’s opinion included in the audit report.
- An unqualified, or clean, audit opinion indicates no material misstatement in financial statements.
- External audits may review both financial statements and a company’s internal controls.
- Internal audits serve as a managerial tool for improving processes and internal controls.
Understanding Audits
An audit entails the review or inspection of accounts by an independent body. Auditors may be hired internally or work externally through third-party firms. Annual audits typically review major financial statements like the income statement, balance sheet, and cash flow statement.
Lenders often require external audit results annually to comply with debt covenants. Some companies face legal mandates for audits to prevent fraud. Publicly traded companies are compelled by the Sarbanes-Oxley Act to evaluate their internal controls.
United States standards for external audits (generally accepted auditing standards or GAAS) are set by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA) and for publicly traded companies, additional rules are set by the Public Company Accounting Oversight Board (PCAOB). International standards are managed by the International Auditing and Assurance Standards Board.
Importance of Audits
Audits play a significant role in ensuring a company’s financial health by promoting honest and accurate accounting. Regular audits help maintain standards, provide assurance to stakeholders, and prevent fraud. They also contribute to operational efficiency by identifying areas for improvement.
Key Benefits of Audits
- Identifying inefficiencies
- Enhancing production and operations
- Ensuring compliance requirements
- Establishing monitoring procedures
- Preventing fraud
Types of Audits
Audits can inspect financial accounts of both companies and individuals. These can be executed by external or internal auditors, or even tax agencies such as the IRS.
External Audits
Performed by third parties, external audits eliminate bias and provide stakeholders with confidence in the financials. An unqualified auditor’s opinion reflects accurate and complete financial statements, enabling informed decision-making.
Internal Audits
Internal auditors, employed by the designated company or organization, perform audits to provide findings to management and the board. Often used when in-house resources are insufficient, results from internal audits assist in managerial decisions and internal control improvements.
IRS Audits
The IRS conducts audits to verify tax return accuracy. While audits may suggest errors or inconsistencies, their selection is frequently random. Potential outcomes include no change, acceptance of suggested changes, or disputes.
What’s the Purpose of an Audit?
Audits aim to ensure transparency and accuracy in financial reporting. They help corporations remain compliant with standards and verify honest representation of financial health. Tax audit triggers include specific credits, deductions, or income types.
Are Audits a Bad Thing?
While often perceived negatively due to tax connotations, audits can be beneficial. They ensure legal compliance, truthful disclosures, and help organizations represent their financial realities accurately.
How Do I Prepare for an IRS Audit?
Preparation involves maintaining easily accessible records, including receipts and tax documents, for at least three years. This approach helps simplify the audit process and demonstrates compliance.
The Bottom Line
Although audits may incite apprehension, their intent is to validate honest financial practices and uphold accurate reporting. Whether for corporations or individuals, audits ensure compliance and trustworthiness in financial representations.
Related Terms: financial statements, income statement, balance sheet, cash flow statement, certified public accountant.
References
- Securities and Exchange Commission. “SEC Implements Internal Control Provisions of Sarbanes-Oxley Act; Adopts Investment Company R&D Safe Harbor”.
- AICPA. “Generally Accepted Auditing Standards”, Page 1599.
- Securities and Exchange Commission. “Public Company Accounting Oversight Board (PCAOB)”.
- IAASB. “International Auditing and Assurance Standards Board”.
- IRS. “IRS Audits”.
- IRS. “How long should I keep records?”
