For business owners and key management staff, an audit is often seen as a necessary evil, a box to be ticked in order to satisfy compliance. In fact, an independent audit can add real value to your company. It can help you spot weaknesses in your infrastructure, expose fraudulent behaviour, and refine your accounting processes. In this article, we’ll explore the finer points of auditing and discover how an independent audit can help your business become more efficient and more profitable.
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:
- Income statement
- Balance sheet
- 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:
- Government entities
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 behaviour by the people preparing these statements. Without proper regulations and standards, these people 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.
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 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:
- No change in the tax return
- A change that is accepted by the taxpayer
- 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.