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 statement, income statement, balance sheet, reports of changes in equity and notes containing a description of principal accounting policies and other supplementary records.
Objectives of an Audit
An audit is performed to:
- To verify whether an organisation is following the legally established system of recording transactions or not.
- 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.
The objective of such audits is to maintain accurate financial records and to ascertain that the rules and regulations of the concerned organisation 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.
The purpose of these audits is 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.
With an unqualified or clean audit report, the shareholders’ confidence in the organisational operations is retained.
3. Compliance Audits
In countries like India, companies are required to undergo independent audits other than financial audits to assure the government that their businesses are running in compliance with the clauses of specific laws and agreements.
How is an audit conducted?
The auditing process as a whole primarily comprises of 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 it is financially or operationally, conducting periodical audits, have always proved to be beneficial for the health of organisations. The following are some significant advantages of executing an audit.
- An audit provides an objective and unbiased assessment of an organisation’s overall health.
- It provides an accurate valuation of assets and expenses.
- An audit entails several steps related to evaluation and verification. Consequently, 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 and comprehensive audit is always an expensive affair. Organisations spending on periodical audits often considers 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 have to verify an entire year’s accounts within just a few days or weeks, which is in actuality not enough at all.