Importance of Auditing

Audit is an important term used in accounting that describes the

examination and verification of a company’s financial records. It is to ensure
that financial information is represented fairly and accurately.

Also, audits are performed to ensure that financial statements are prepared
in accordance with the relevant accounting standards. The three primary
financial statements are:

1. Income statement
2. Balance sheet
3. Cash flow statement

Financial statements are prepared internally by management utilizing

relevant accounting standards, such as International Financial Reporting
Standards (IFRS) or Generally Accepted Accounting Principles (GAAP). They
are developed to provide useful information to the following users:

 Shareholders
 Creditors
 Government entities
 Customers
 Suppliers
 Partners

Financial statements capture the operating, investing, and financing

activities of a company through various recorded transactions. Because the
financial statements are developed internally, there is a high risk of
fraudulent behavior by the preparers of the statements.

Without proper regulations and standards, preparers can easily

misrepresent their financial positioning to make the company appear more
profitable or successful than they actually are.
Auditing is crucial to ensure that companies represent their financial
positioning fairly and accurately and in accordance with accounting
standards.

Types of Audits

There are three main types of audits:

1. Internal audits

Internal audits are performed by the employees of a company or

organization. These audits are not distributed outside the company.
Instead, they are prepared for the use of management and other internal
stakeholders.

Internal audits are used to improve decision-making within a company by

providing managers with actionable items to improve internal controls.
They also ensure compliance with laws and regulations and maintain timely,
fair, and accurate financial reporting.

Management teams can also utilize internal audits to identify flaws or

inefficiencies within the company before allowing external auditors to
review the financial statements.

2. External audits

Performed by external organizations and third parties, external audits

provide an unbiased opinion that internal auditors might not be able to
give. External financial audits are utilized to determine any material
misstatements or errors in a company’s financial statements.

When an auditor provides an unqualified opinion or clean opinion, it

reflects that the auditor provides confidence that the financial statements
are represented with accuracy and completeness.
External audits are important for allowing various stakeholders to
confidently make decisions surrounding the company being audited.

The key difference between an external auditor and an internal auditor is

that an external auditor is independent. It means that they are able to
provide a more unbiased opinion rather than an internal auditor, whose
independence may be compromised due to the employer-employee
relationship.

There are many well-established accounting firms that typically complete

external audits for various corporations. The most well-known are the Big
Four – Deloitte, KPMG, Ernst & Young (EY), and PricewaterhouseCoopers
(PwC).

3. Government audits

Government audits are performed to ensure that financial statements have

been prepared accurately to not misrepresent the amount of taxable
income of a company.

Within the U.S., the Internal Revenue Services (IRS) performs audits that

verify the accuracy of a taxpayer’s tax returns and transactions. The IRS’s
Canadian counterpart is known as the Canada Revenue Agency (CRA).

Audit selections are made to ensure that companies are not

misrepresenting their taxable income. Misstating taxable income, whether
intentional or not, is considered tax fraud. The IRS and CRA now use
statistical formulas and machine learning to find taxpayers at high risk of
committing tax fraud.

Performing a government audit may result in a conclusion that there is:

1. No change in the tax return

2. A change that is accepted by the taxpayer
3. A change that is not accepted by the taxpayer

If a taxpayer ends up not accepting a change, the issue will go through a

legal process of mediation or appeal.
Definition of 'Audit'
Definition: Audit is the examination or inspection of various books of accounts by an auditor
followed by physical checking of inventory to make sure that all departments are following
documented system of recording transactions. It is done to ascertain the accuracy of
financial statements provided by the organisation.

Description: Audit can be done internally by employees or heads of a particular department

and externally by an outside firm or an independent auditor. The idea is to check and verify
the accounts by an independent authority to ensure that all books of accounts are done in a
fair manner and there is no misrepresentation or fraud that is being conducted.

All the public listed firms have to get their accounts audited by an independent auditor before
they declare their results for any quarter.

Who can perform an audit? In India, chartered accountants from ICAI or The Institute of
Chartered Accountants of India can do independent audits of any organisation. CPA or
Certified Public Accountant conducts audits in USA.

There are four main steps in the auditing process. The first one is to define the auditor’s role
and the terms of engagement which is usually in the form of a letter which is duly signed by
the client.

The second step is to plan the audit which would include details of deadlines and the
departments the auditor would cover. Is it a single department or whole organisation which
the auditor would be covering. The audit could last a day or even a week depending upon
the nature of the audit.

The next important step is compiling the information from the audit. When an auditor audits
the accounts or inspects key financial statements of a company, the findings are usually put
out in a report or compiled in a systematic manner.

The last and most important element of an audit is reporting the result. The results are
documented in the auditor’s report.
What Is an Audit?
The term audit usually refers to a financial statement audit. A financial
audit is an objective examination and evaluation of the financial
statements of an organization to make sure that the financial records are a
fair and accurate representation of the transactions they claim to
represent. The audit can be conducted internally by employees of the
organization or externally by an outside 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 commonly performed by Certified Public
Accounting (CPA) firms and result in an auditor's opinion which is
included in the audit report.
 An unqualified, or clean, audit opinion means that the auditor has not
identified any material misstatement as a result of his or her review
of the financial statements.
 External audits can include a review of both financial statements and
a company's internal controls.
 Internal audits serve as a managerial tool to make improvements to
processes and internal controls.