An audit is an objective inspection or examination of various financial reports and accounts of an organisation, regardless of its legal form and size, by an auditor.
The organisation may or may not be profit-oriented, and the financial statements include cash flow statements, income statements, balance sheets, reports of changes in equity and notes containing a description of principal accounting policies and other supplementary records.
- Audit systematically examines a company’s financial records, accounts, and operations.
- An independent auditor conducts it to ensure that the financial statements provide a true and fair view of the company’s financial performance.
- The auditor provides an audit report that includes an opinion on the financial statements and identifies any areas of concern.
Objectives of an Audit
An audit is performed to:
- To verify whether an organisation follows the legally established system of recording transactions.
- To confirm the exactitude of the financial reports provided by an organisation.
Types of Audit
There are primarily three kinds of audits.
1. Operational Audits or Internal Audits
These are conducted in an organisation (profit or non-profit) by the auditors employed by that organisation.
Such audits aim to maintain accurate financial records and ascertain that the concerned organisation’s rules and regulations are complied with sedulously.
The resultant audit reports are sent to the managers and board of directors, who then make appropriate decisions related to organisational changes and enhancement of internal controls.
2. Financial Audits or External Audits
Also known as statutory audits, these are conducted by outside parties, primarily the auditors of Certified Public Accounting (CPA) firms in the USA and the chartered accountants of the Institute of Chartered Accountants of India in India.
These audits aim to have an independent viewpoint regarding the accuracy of a company’s financial statements.
As the reports of such audits come from a third-party organisation, stakeholders expect an unbiased opinion.
An unqualified or clean audit report retains the shareholders’ confidence in the organisational operations.
3. Compliance Audits
In countries like India, companies must undergo independent audits other than financial audits to assure the government that their businesses comply with the clauses of specific laws and agreements.
How is an audit conducted?
The auditing process as a whole primarily comprises four steps:
- Describing the auditor’s role and the audit engagement terms. It must be done in the form of a letter signed by the client in a due manner.
- Planning the audit. It involves defining the scope of the audit (departmental or whole organisation), duration of the audit (day, week and so on) and other similar details.
- Compiling the collected information. It involves gathering, inspecting and analysing all the necessary financial statements and systematically assembling them.
- Reporting. It entails documenting the results found in the form of a report.
Advantages of Audit
Whether financially or operationally, conducting periodic audits has benefitted organisations’ health. The following are some significant advantages of executing an audit.
- An audit provides an objective and unbiased assessment of an organisation’s health.
- It provides an accurate valuation of assets and expenses.
- An audit entails several steps related to evaluation and verification. Consequently, the detection of frauds, errors and inefficiencies becomes relatively easy.
- A clean audit report helps in retaining the confidence of an organisation’s stakeholders.
- Periodical audits enhance an organisation’s operational efficiency.
Disadvantages of Audit
Despite their varied advantages, audits do exhibit some limitations.
- Costly affair: A thorough audit is always an expensive affair. Organisations spending on periodical audits often consider them an additional financial burden. Consequently, most of the time, the scope of an audit is restricted, and techniques like test checking and sampling are used.
- Time-bound: Auditors are required to work within a specific timeline. Consequently, they must verify an entire year’s accounts within a few days or weeks, which is insufficient.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.