Auditing: What It Is and Why It Matters

What is auditing?

Auditing is the process of conducting a thorough review of all the financial data of a business entity. An audit ensures that the financial records and statements are accurate, up-to-date, and compliant. 

Audit may be conducted by an accountant employed by the business, an external Certified Public Accountant (CPA) firm, or an auditor. Auditors look at financial statements including the balance sheet, income statement, and cash flow statement once a year to prepare an audit report. 

Public companies are required to present their annual reports to their investors and shareholders every year, and the auditor’s findings are an important part of the report. 

Auditing standards

Lenders usually need an annual external audit report to understand the financial standing of a business and to understand whether it is representing itself fairly and accurately. 

Just like accounting principles, there are generally accepted auditing standards (GAAS) set by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA). Auditors use these auditing standards during company audits. 

Internationally, the auditing standards are called the International Standards on Auditing (ISA), which are set by the International Auditing and Assurance Standards Board (IAASB).

Types of audits

There are mainly two types of audits: external and internal. 

External audits, also called unqualified audits, are performed by auditors external to the company. Meaning, they are not employed by the company and are hired only for the annual audits. External audits are considered more reliable because they follow auditing standards different from those the company follows. External auditors check the company’s financial statements more objectively, looking for misrepresentations, missing information, or inaccuracies in their financial records. Stakeholders such as investors and even lenders can get a better picture of the company’s finances through external audits. 

Internal audits: Internal audits are usually performed by accountants employed within the company. These audits are usually meant for management and the board. Internal auditors use the company standards to perform the audits. Internal audits can also be conducted by consultant auditors when the company does not have the funds to employ someone full-time but needs audits. 

Internal audits are also called qualified audits and are meant to make internal, management-level changes. Internal audits help with legal compliance and can be done more than once a year. 

There is one other audit that doesn’t happen on a regular basis: 

Internal Revenue Service (IRS) audits: These are performed by the IRS to check if the taxpayer is paying their taxes fairly and accurately. Usually, if the IRS chooses to audit someone (company or individual), it is likely they may suspect fraud or some wrongdoing. But, this may not always be the case. The IRS may also randomly choose someone based on their tax returns. The IRS may choose to audit someone based on their association with another entity suspected of financial fraud. 

An IRS audit can either mean no change in a person’s tax return, a change that is accepted by the taxpayer, or not accepted by the taxpayer. In each case, they may have to pay a fine,  file an appeal, or need mediation. 

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