Business owners need to conduct regular audits. This ensures accurate records. Honestly, many business owners do not like the auditing process; however, an audit can be extremely beneficial for a company. Audits examine the financial records as well as transactions to ensure they are all accurate. In most cases, audits involve looking at accounting books and financial statements to see how the information in each of them compares. A business owner may have an employee conduct an audit, or they may do it themselves. Businesses with accounting departments may have one of their accountants perform audits. Some businesses prefer to have a third party audit their records.
Some businesses conduct routine audits, usually at least once per year. When bookkeeping habits are not thorough or organized, audits take a lot longer to do. The types of audits may vary between businesses. For instance, a construction company may need to conduct an audit to determine how much was spent on a particular project. Overall, businesses benefit from audits as they ensure the business is operating smoothly.
There are many types of audits. Here are 11 types of audits, their purposes, and their differences.
- Internal Audit: Internal audits are initiated by the owner and take place within the business. Someone else in the business will conduct the audit.
- Financial Audit: This is a common type of audit, and most of them are external. An auditor will look at the financial statements of a business to determine their accuracy and fairness.
- Compliance Audit: This type of audit looks at the policies and procedures in a business to determine if they are in compliance with either external or internal standards. It can examine whether the business is compliant with worker’s compensation guidelines or IRS regulations.
- Operational Audit: Operational audits look at the company’s goals, procedures, and planning processes. It’s usually an internal audit that helps improve business operations.
- External Audit: A third party conducts external audits. A tax agency, the IRS, or an accountant with no connection to the company assesses financial records for accuracy.
- Payroll Audit: Businesses use a payroll audit to ensure their payroll processes are accurate. It assesses wages, employee information, tax withholdings, and pay rates.
- IRS Tax Audit: This type of audit is done by IRS tax auditors who check the accuracy of tax returns filed for the company. They will check tax liabilities to make sure there was no underpayment or overpayment of taxes.
- Information System Audit: Companies use this type of audit to detect issues related to data processing, computer systems, and software development.
- Employee Benefit Plan Audits: This type of audit takes a look at the finances of a company to determine if they are sufficient to cover employee benefits plans. It is conducted by a third party who provides statements to the Department of Labor.
- Forensic Audit: This audit evaluates financial records to find any evidence needed for a legal proceeding or a court case. It is an accounting specialization.
Pay Audit: This internal audit checks payroll. Its purpose is to find pay discrepancies among a company’s employees. Pay audits help ensure all workers are paid fairly.
Audits are designed to examine a company’s financial records as well as their transactions to ensure they are accurate. Most types of audits assess financial statements and accounting records to compare the information they contain. Many people can conduct an audit. An employee or company accountant may conduct internal audits. Other audits may be completed by a third party, such as an IRS agent or an accountant who does not work for your company. Most businesses conduct audits routinely, usually once each year. The types of audits vary between businesses based on the industry and the specific needs. Essentially, audits help to ensure that a business is operating smoothly.
1. Internal Audit
An internal audit takes place from within a business. Usually, the owner initiates the audit, but someone else in the business will conduct it. Businesses with board members or shareholders often use internal audits to keep them updated on their finances. Additionally, internal audits are great for checking in on financial goals. Financial audits are the most common business audits, and they are usually done by an outside third party. That means they are an external audit. This type of audit analyzes 2.
2. Financial Audit
financial statements for accuracy. An auditor will review procedures, balances, and transactions. Once the audit has been completed, the third-party auditor will release a statement to the business, creditors, investors, and lenders.
3. Compliance Audit
A compliance audit looks at the policies and procedures of a business to determine if they comply with both external and internal standards. For instance, is a business compliant and paying shareholder distributions? Do they pay workers’ compensation as they should? This audit can also determine if the business is compliant with relevant IRS regulations.
4. Operational Audit
An operational audit is very close to an internal audit. It is used to analyze the company’s planning processes, procedures, goals, and the results of business operations. It can be an internal audit or an external one. The main goal is to completely evaluate the business operations to learn ways of improving them.
5. External Audit
External audits are conducted by someone outside the company. The third party can be an accountant, a tax agency, the IRS, or another qualified individual who is not part of the company. An employee cannot conduct an external audit since they are connected to the business. They are similar to an internal audit in that they are looking at the accuracy of the accounting records. Oftentimes, lenders and investors will require an external audit to ensure the financial information is fair and accurate.
6. Payroll Audit
A payroll audit is a type of internal audit that assesses the payroll processes of a business to ensure accuracy. An auditor looks at all the factors involved in the payroll process, such as employee information, wages, pay rates, and tax withholding. Doing an internal payroll audit usually prevents an external audit later. To ensure there are no errors in payroll processes, businesses usually conduct an annual payroll audit.
7. IRS Tax Audit
A tax audit is conducted to check for accuracy in the company’s filed tax returns. An auditor will look for any discrepancies in the tax liabilities to make sure there wasn’t an overpayment or an underpayment when the taxes were computed. A tax auditor also reviews tax returns to ensure there were no errors committed during the filing process. An IRS audit is usually random and can be in person or through the mail.
8. Information System Audit
IT and software companies are the most impacted by an information system audit. Businesses often use information system audits to find problems in their data processing, computer system, or software. The audit is important to ensure accurate information for users and to make sure unauthorized parties have no access to private information. Non-software businesses need cybersecurity audits to make sure their systems are not accessed by hackers.
9. Employee Benefit Plan Audits
The employee benefit plan audit takes a look at a company’s employee benefit plans. It can be a very complex process as there are many factors to consider. Auditors gather information about employee benefits and pass the information on to the DOL. The audit helps determine whether or not financial statements contain anything that could be fraudulent or misleading in any way.
10. Forensic Audits
A forensic audit is usually conducted when a party is being prosecuted for fraud or other types of financial crimes. However, they may also be used in situations like bankruptcy disputes, divorces, and business closures. An auditor goes through financial records to find the evidence they need to present in court. Most large companies have an entire forensic audit department. The auditor can be called to serve as an expert witness in a trial.
11. Pay audit
Pay audits help identify discrepancies in pay among employees. It is useful for finding unequal pay practices in a company. During pay audits, an auditor will look at possible disparities due to gender, age, religion, or race. This type of audit helps ensure all workers are paid fairly.
What is an Audit?
Audits are an examination and evaluation of different financial documents. It’s a way to physically check to make sure processes and documentation of recorded transactions are done accurately. The audit looks at the documented system of a company and how they record transactions. And the purpose is to verify the accuracy of all financial statements of the organization.
What is the Goal of Auditing?
The primary goal of auditing is to assess financial records and statements and ensure they are accurate. Secondly, the audit reveals if the company is conforming with the appropriate accounting principles. Auditors look at all the financial statements and determine if there are any useful policy recommendations they can make on ways the company can improve its accounting methods. Some audits have specific goals such as risk management, tax matters, or forensic accounting.
How is the Audit Conducted?
An audit will take some time and may involve personnel in the company and auditors outside the company. It’s essential to determine what the auditor’s role is in the process as well as the desired outcome and purpose of the audit. One of the main keys to a successful audit is communication which is part of each step in the auditing process. Listed below are the basic steps taken to conduct an audit.
- Planning: All types of audits require planning. During this phase, the scope and objective will be determined as well as the steps the auditor will take to meet the objectives. Planning includes both management and auditors who will discuss risk factors, the purpose of the audit, and other logistics as needed.
- Notifications: Notifications include notifying appropriate personnel and departments about the upcoming audit as well as its purpose. This step in the auditing process helps everyone understand what is going on, who is involved, and how long it may last.
- Opening Meeting: This first meeting will include all administrative and management personnel who will be involved in the auditing process. The audit will be discussed in detail. During this informational meeting, there may be some adjustments made to the auditing program.
- Fieldwork: During fieldwork, auditors will carry out all the steps outlined collaboratively in the planning and opening meeting phases. Steps may include interviews, reviewing transactions and records, conducting surveys, analyzing data, or looking at policies. Auditors meet with management regularly during the fieldwork phase to discuss how the audit is progressing, any preliminary observations, and possible upcoming recommendations.
- Reporting: After completing the audit, auditors will have a formal meeting with management. The results will be discussed along with specific findings, observations, and official recommendations. These will be communicated to management, who will be asked to provide a response that includes any corrective action plan, including when and how it will be implemented. Management can also provide feedback at this point.
- Management Response: Management will look at the audit and provide careful consideration before providing their response to the auditor’s recommendations. Their response will include their plan for making any corrections or changes. The plan of action will also include a timeline for completion, and a follow-up date will be scheduled.
- Closing Meeting: At the closing meeting, the auditor and department management will gather to discuss all the details. The audit report as well as the management response will be reviewed. During the discussions, questions may be asked and answered so that any clarification that is needed can be made. Any other audit procedures that were not discussed during the final report will be presented during the closing meeting.
- Final Audit Report: A final audit report will be prepared and distributed following the closing meeting. It will include the auditor’s findings as well as any management responses. Once it’s prepared, it is distributed to any department personnel who were involved in the auditing process.
- Follow-up: Approximately six months after the audit has been completed, a follow-up interview will be held. The purpose of the follow-up is to determine if corrective actions were implemented appropriately and carried out.
These are the steps involved in the auditing process. Each audit will be different depending on its purpose and whether it is assessing financial statements or policies. Ultimately, the result is corrective actions that improve the business processes and outcomes.
How to Classify Audit Types
Audits are classified based on the desired outcome and the type of assessment an auditor is making. Auditors may assess financial records, documentation, policies, or tax records. Ultimately audits will fall into one of three primary classifications. Companies typically perform a yearly audit, and sometimes lenders will require them. Some companies are legally required to perform an annual audit. Here are the three ways audits are classified:
- Internal Audit: An internal auditor works for the company. Sometimes, they are employed and work in the accounting department. Larger companies often have an auditing department that conducts ongoing audits. The purpose of an internal audit is to make improvements to internal controls or make changes in management.
- External Audit: An external audit is performed by a third party. They look for misstatements or misrepresentations in the company’s financial statements and documentation. External audits help stakeholders make informed decisions pertaining to the company. An external auditor follows independent standards and can perform an unbiased assessment.
- IRS Audit: An audit by the Internal Revenue Service verifies tax return information and accuracy. Being selected for an IRS audit in no way indicates any wrongdoing on the part of the business.
Each of the types of audits mentioned above will fall into one of these three main classifications. They will be internal, external, or an IRS audit. Audits are classified based on who is conducting the process and the desired outcome of the auditing process.
What are the Auditing Stages?
The size of the company and its complexity determine how an audit is conducted. Even though there are many steps involved in the auditing process, an audit has only four basic stages. The first stage is the planning stage, where all the details are worked out. The second stage is an internal controls stage where all records and documents are gathered to conduct the audit. The third stage is the testing stage, where auditors determine the accuracy of financial statements and other documents. And the final, fourth stage of the auditing process is the reporting stage. The final stage occurs after all tests and assessments have been completed, and the auditors prepare their reports and recommendations.
When Should an Audit be Performed?
The frequency of audits depends on a number of different factors. Minimally, audits should be conducted annually. Based on the size and complexity of a business and its financial structure, audits can be performed monthly, quarterly, or twice a year. Sometimes, internal controls are audited weekly. High-risk processes need to be audited more often. Audits should be a regular practice to help reduce risks and ensure compliance.
What is the Difference Between an External and an Internal Audit?
The primary difference between an external and internal audit is who conducts the audit. Internal auditors come from within the company. They may be an accountant or other company employee. External auditors come from outside the company and usually work for an outside auditing firm. Internal auditors report to management, and external auditors report to shareholders. Internal auditors examine issues pertaining to the company’s business practices and specific risks. An external auditor looks at financial records and provides a professional opinion about them.