What Is Auditing? Common Types and Steps to Perform an Audit

By Indeed Editorial Team

Published 27 April 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Every organisation depends on the integrity and accuracy of its financial records to operate effectively and profitably. Regular auditing helps companies keep track of their financial transactions. Internal or external teams can perform audits as a control process or government agencies may perform audits if they notice suspicious financial activity. In this article, we discuss what auditing is, list the main types of audits and audit reports and describe how auditors usually prepare an audit plan.

What is auditing?

If you're considering a career in finance, you might wonder "What is auditing?" Auditing is the act of reviewing, inspecting and verifying a process or quality system to ensure compliance with requirements. In certain situations, an audit refers to a review of financial documents, but sometimes, companies also perform audits to evaluate the efficiency of their procedures. Other commonly audited areas include quality management, secretarial and compliance, project management, internal controls, water management and energy conservation.

Internal accounting teams, approved external agencies and government entities, such as the Inland Revenue Department (IRD), can perform auditing. The primary aim of auditing is to ensure that a company's financial statements are accurate and adhere to the regulatory guidelines. Auditing also offers investors, creditors and other key stakeholders assurance about the company's integrity and trustworthiness.

Related: How to Become an Internal Auditor

Types of financial audits

There are four main types of financial audits. They include:

Internal audit

Organisations employ internal auditors who don't have a vested interest in the company to conduct an unbiased audit. Companies perform internal audits to measure their strengths and weaknesses against their own procedures, processes or external standards adopted or those imposed by third-party organisations. These audits ensure compliance with laws and regulations and help maintain accurate data collection and financial reporting.

Related: What Is an Internal Audit and What Are Its Primary Objectives?

External audit

Independent, third-party agencies or companies specially tasked with evaluating and assessing an organisation's compliance with the regulatory norms perform external audits. Through their investigation, these auditors determine if financial and other records are accurate and in accordance with the law. These audits are also mandatory due to compliance and regulatory reasons and shareholder requirements.

Government audit

The Inland Revenue Department initiates and performs this type of audit to ensure accuracy in bookkeeping and compliance with tax laws. Since government agencies initiate these audits, it's different from the previous audits mentioned above. Such audits may result in certification, registration, license approval, a fine or a penalty issued by the department.

Strategic, operational and IT audits

There are other types of audits, such as operational, strategic and IT audits that are increasing in popularity due to the complex nature of organisational processes and IT infrastructure. Such audits evaluate whether organisations are aligning their internal procedures with the standard protocols. In addition, IT audits can assess and evaluate the readiness of an organisation's IT infrastructure to meet the stated goals. Such audits can also help organisations withstand security breaches.

Importance of auditing

Here are some benefits of auditing:

Provides credibility

Performing internal or external audits can lead to more credibility in the business marketplace. Regular auditing helps shareholders trust the company's accounts and are more comfortable investing in the business. Providing regular audited accounts ensures that business accounts are free from material error or malpractice, helping the company achieve their goals more successfully.

Improves internal controls and systems

Auditors aren't just focused on finances and reports, but they also seek to understand the company's overall operating environment. This helps them identify flaws in accounting systems and what recommendations to make. This ensures the organisation is more efficient and less prone to fraud.

Prevents fraud

Audits help prevent fraud in businesses. Regularly analysing an organisation's operations and maintaining rigorous internal control systems can help detect and prevent various kinds of fraudulent activities and accounting irregularities. A company with a functioning and comprehensive audit system may prevent employees or suppliers from attempting schemes to defraud the company.

Related: 18 Top Skills of an Auditor (Plus Examples of How to Use Them)

How to create an auditing plan

Whether you're an internal or external auditor, it's essential to create and follow a concise auditing plan. Here are some steps to help you build an effective auditing plan:

1. Perform a risk assessment

Before performing the audit, research the industry and operating environment of the organisation you're investigating. Determine if any factors may threaten management's ability to perform their best. After leveraging internal and external resources to identify relevant risks, build an audit programme that tests for these risks.

2. Research the organisation's policies

When designing an audit plan, auditors investigate the company's auditing protocols. Accounting policies include procedures related to revenue recognition, capitalisation, consolidation, accounting for inventory, impairment and valuation. The company may also provide flowcharts and other documentation that help auditors understand the various accounting policies implemented in the organisation.

3. Identify areas of special audit consideration

Auditors give special consideration to areas with a high likelihood of error or unregulated sections of the company. Auditors can review their assessment of the organisation's risks and accounting policies to determine areas of special attention. Ensure to note such special audit considerations in the risk assessment report.

4. Develop audit procedures

After auditors understand the processes and risks, they develop an audit programme. A well-defined audit program ensures that the auditor considers all the important areas while auditing. It can also enhance the accountability of the audit team members and each team member can focus on areas based on their skills and competencies. An audit programme details the following information:

  • name of the client

  • nature of business and operation of the client

  • date of commencement of audit work

  • duration of audit

  • process objectives

  • accounting systems used in the client's organisation

  • business risks

  • testing procedures for controls during the audit, such as inquiry, observation, inspection and re-performance

5. Reassess your plan

Auditors reassess their procedures throughout the audit programme. This ensures that their plans are adaptable to changing situations. For instance, auditors may adopt more rigorous testing methods if they observe extra risks, due to the complexity of the client's business or transactions.

Related: What Does an Auditor Do? (With Career Steps and Skills)

Types of audit reports

A company can receive four types of audit reports. These reports communicate to companies and investors the status and validity of a company's financial standing. While these reports are similar in structure, each emphasises different results. Here's an overview of the four major types of audit reports:

1. Clean report

A clean report, also called an unqualified opinion, is an audit report that indicates the business's financial records are free of any misrepresentations. It suggests that the company doesn't require meeting any further qualifications to improve its financial status. An organisation receives a clean report when its financial records adhere to the Generally Accepted Accounting Principles (GAAP) standards. This type of report is the best and most desired one an organisation can receive.

2. Qualified report

A qualified report represents an auditor's opinion of a company's financial standing. This indicates that an organisation doesn't adhere to all the standards set by the GAAP, but isn't operating its business in an illegal or misrepresenting way. This report helps financial management teams recognise what parts of the company require greater attention to improve its financial status.

3. Disclaimer report

Sometimes an auditor is unable to perform an audit accurately. This may occur due to various reasons, such as the absence of appropriate financial records or errors in financial statements. In such situations, the auditor can issue a disclaimer report stating that they can't determine the firm's financial status. A disclaimer report helps auditors distance themselves from a company if required and maintain their reputation as fair and professional auditors.

4. Adverse opinion report

An adverse opinion report is the most negative report an auditor issues to a business. Such a report indicates that the firm's financial records don't adhere to GAAP standards. These financial records may have been misrepresented, which is often an indication of fraudulent activities. These reports allow an organisation to improve its practices and correct its financial statement before re-auditing.

Please note that none of the companies, institutions or organisations mentioned in this article are affiliated with Indeed.

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