Understanding Audits in Finance and Accounting: Types and Importance
Defining an Audit
An audit typically refers to a financial statement audit. This is an impartial examination and evaluation of an organization’s financial statements. The goal of an audit is to ensure that the financial records accurately represent the transactions they purport to show. Audits can be conducted internally by the organization’s employees or externally by a Certified Public Accountant (CPA) firm.
Key Insights
- Audits are divided into three main categories: external audits, internal audits, and Internal Revenue Service (IRS) audits.
- External audits are usually conducted by Certified Public Accounting (CPA) firms, leading to an auditor’s opinion incorporated into the audit report.
- An unqualified or clean audit opinion indicates that no material misstatements have been found during the review of the financial statements.
- External audits can encompass both financial statements and a company’s internal controls.
- Internal audits act as a managerial instrument for improving processes and internal controls.
Decoding Audits
Most companies undergo an annual audit of their financial statements like income statements, balance sheets, and cash flow statements. Lenders often mandate an external audit’s results yearly as part of their debt covenants. In some cases, audits are a legal requirement to deter intentional misstatement of financial information for fraudulent purposes. Following the Sarbanes-Oxley Act (SOX) of 2002, publicly-traded companies must also receive an evaluation of their internal controls’ effectiveness.
The standards for external audits performed in the United States, known as the generally accepted auditing standards (GAAS), are established by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA). Furthermore, additional rules for the audits of publicly traded companies are dictated by the Public Company Accounting Oversight Board (PCAOB), formed as a consequence of SOX in 2002. The International Auditing and Assurance Standards Board (IAASB) has established a separate set of international standards, the International Standards on Auditing (ISA).
Categories of Audits
1. External Audits
Audits conducted by external entities can effectively eliminate bias in evaluating a company’s financial status. Financial audits aim to discover any material misstatements in the financial statements. An unqualified or clean auditor’s opinion provides users of financial statements with the assurance that the statements are accurate and complete. Hence, external audits enable stakeholders to make informed decisions about the audited company.
External auditors abide by a different set of standards from the company or organization employing them. The primary difference between internal and external audits lies in the external auditor’s independence. When third parties conduct audits, the auditor’s opinion expressed on the audited items (such as a company’s financials, internal controls, or a system) can be honest and candid without affecting daily work relationships within the company.
2. Internal Audits
Internal auditors are hired by the company or organization for which they are conducting an audit. The audit report is then given directly to management and the board of directors. Consultant auditors, while not employed internally, use the company they’re auditing standards instead of a separate set. These auditors are employed when an organization lacks the in-house resources to audit certain aspects of their operations.
The internal audit results are used to implement managerial changes and enhance internal controls. The aim of an internal audit is to ensure compliance with laws and regulations, maintain precise and timely financial reporting, and data collection. It also provides a benefit to management by pinpointing weaknesses in internal control or financial reporting before its review by external auditors.
3. IRS Audits
The Internal Revenue Service (IRS) also routinely conducts audits to verify the accuracy of a taxpayer’s return and specific transactions.
Further Resources for Enhanced Understanding
Dive deeper into the world of finance and accounting audits with these comprehensive resources:
Websites and Online Resources:
- American Institute of Certified Public Accountants (AICPA): An extensive resource offering a wealth of information on audits, audit standards, and the role of CPAs.
- The Internal Revenue Service (IRS): Contains valuable information on IRS audits, their process, and implications.
Books:
- Audit and Assurance Essentials: For Professional Accountancy Exams by Katharine Bagshaw: A comprehensive guide that breaks down audit and assurance concepts.
- Auditing For Dummies by Maire Loughran: An easy-to-understand guide on auditing for beginners and non-specialists.
Academic Journals and Research Papers:
- The Accounting Review: A highly respected academic journal publishing research on auditing and accounting.
- Auditing: A Journal of Practice & Theory: A scholarly journal that publishes research specifically about auditing.
Reports and Studies:
- Public Company Accounting Oversight Board (PCAOB) Reports: Offers a range of reports on audits of public companies.
- Audit Analytics Trends Reports: Provides extensive reports on trends in the audit industry.
Professional Organizations and Associations:
- Information Systems Audit and Control Association (ISACA): A professional association focused on IT governance, risk management, and cybersecurity.
- Institute of Internal Auditors (IIA): A global professional association for internal auditors offering a wealth of resources and professional certifications