What is Auditing? – Overview, Types, Opinions, Processes, And More

Overview:

The term Auditing generally refers to a financial statement audit. Auditing is the examination of records and reports of an organization by external specialists to ensure that financial statement is accurate and fair.

The audit is a legal requirement for some companies when there are possibilities to intentionally misstate financial statements. Public auditing by independent accountants is conducted to test whether the financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP).

Audit is an independent investigation of financial records and the results of the investigation is reported to shareholders of the organization.

Types of Audits

There are many types of audit according to the objectives, scopes and purposes.  Different types of audits are described here:

External Audit

External Audit is performed by external organizations to provide an unbiased opinion. The Big Four audit firms that provide external audit services are KPMG, PWC, EY, and Deloitte. External auditors are required to maintain the professional code of ethics and follow International Standards on Auditing.

External auditor’s unqualified opinion provides confidence that the financial statements are prepared and presented with accuracy and completeness. External audit assists stakeholders in making more informed and better decisions.

Internal Audit

Internal audits are conducted by the employees of the organization and the audit report is given to management and the board of directors. The objective of an internal audit is to make improvements to internal controls and to ensure compliance with laws and regulations.

Statutory Audit

Statutory Audit is required by law or local authority for the audit of financial statements of specific types of entities. The statutory audit report will be issued by the auditor and the entity will submit it to the government body.

Tax Audit

Tax audit is performed by the government’s tax department or tax authority. According to the tax law of a country, the entity needs to file its tax obligation properly. Entities are recommended to follow all the requirements set by tax law to minimize the penalty as a result of a tax audit.

Financial Audit

The most common type of audit is a financial audit that is an external audit. Financial auditors analyze the fairness and accuracy of a business’s financial statements. They review the transactions, procedures, and balances to conduct the audit.

Compliance Audit

Compliance auditors check if a business’s policies and procedures comply with internal or external standards. They help in determining whether the business is compliant with laws and regulations. A compliance audit is an entity’s part of the system used by management to enforce the implementation of government law and regulation.

Information System Audit

Information System Audit checks the controls over software development and data processing. This type of audit is for ensuring that the system provides accurate information to its users.

Technology is increasing nowadays and most of the entity’s financial reports are recorded by complex accounting software, so financial auditing also requires IT auditing.

Value for Money Audit

Value for money audit is the audit activities for assessing and evaluating three factors: Economy, Efficiency, and Effectiveness. It is a way of checking whether the resources are purchased at good quality at a low cost.

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Forensic Audit

A forensic audit is performed by forensic accountants who possess both the skill of accounting and investigation. The forensic investigation covers a number of areas including fraud investigation, crime investigation, a dispute among shareholders, and insurance claims. Forensic audit also requires a proper plan and procedure like other audit engagements.

Environmental Audit

Environmental Audit determines the resource availability in the environment and how does a large entity manages it. This type of audit ensures that the environment is not damaged to a certain level because of the entity.

Payroll Audit

A payroll audit examines an organization’s payroll processes to ensure accuracy. Payroll audits are internal and help to prevent possible external audits in the future. Organizations should conduct payroll audits annually to check for errors in their payroll process.

Agreed Upon Procedures

This is a negative engagement where auditors perform their reviews on the procedures that agreed with the client. Auditors are required to make sure that there is no conflict of interest between the audit team and the client management team.

Integrated Audit

The integrated audit is a type of audit that meets the requirements of two different areas of the audit. For example, in a social audit, there are some areas to be confirmed with the financial audit.

For NGO audit, there are expenses that need to be audited by the financial auditor and the number of technical reports needs to be audited by technical auditors. The integrated audit also happens when a company operates in many different countries and their financial statements are audited by different audit firms.

Special Audit

Special audit assignment is done by the internal auditor. Special audit happens for fraud cases, business cases,s or other special cases in the organization. This type of audit is done by the internal staff of the organization and it is a bit different from the forensic audit.

After completing the audit, the audit report is prepared by the audit team and submitted to the audit committee. Sometimes, the special audit report is submitted to the CEO of the company.

Operational Audit

An operational audit is a type of audit that is similar to an internal audit. This type of audit analyzes the company’s goals, planning process, procedures, and operational results. The goal of an operational audit is to improve a business by increasing efficiency and reducing costs.

Sales Audit

Sales auditing involves knowing about the sales process, review management’s target, and stock evaluation. Sales auditing plays an important role for organizations to determine whether the current sales practice is working or not and how it can be improved. Sales auditing helps in improving the sales process and profit of the organization.

The different types of audits are described above that a business can use. It is important for organizations to conduct audits regularly and the results of the audit can help the organization in many different ways. Organizations can conduct audits depending on which department is weak.

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Importance of Auditing

Auditing helps in verifying financial statements, accounts, and balances as per accounting standards, and conducting auditing regularly can help in understanding different aspects of the business. Auditing also helps in finding financial problems, cash errors, and other assets. The importance of auditing is described as follows:

1) Reliability of Financial Statements

Auditors report on the true and fair view of client’s financial statements so that users can reply to them. There are various stakeholders to a company’s financial statement who may not have sufficient knowledge to understand the financial statements.

They rely on the auditor’s independent opinion that reflects the books of account. Auditor’s opinions can create a relationship of trust between auditors and stakeholders.

2) Fraud Prevention and Detection

Internal audit plays an important role for companies to prevent fraud. A rigorous internal control system can help in preventing and detecting various types of fraud.

If the auditor helps in developing an effective audit system, the reputation of the system can help in preventing employees from attempting the scheme of fraud in the company. One important part of fraud prevention is deterrence.

3) Risk of Misstatement

Auditors should assess the risk of misstatement in the audit of financial statements. Lack of proper internal control systems would create trouble for financial reports. The audit methodology helps in determining which segments require attention of management.

4) Cost of Capital

Cost of capital is an important aspect of a company as it consists of risk associated with investment. When there are more risks in an investment, the rate of return is high. Strong audit systems helps in reducing various types of risk in an enterprise.

An effective audit assists companies in achieving goals and objectives by measuring overall performance. Audit protects organizations from financial misstatements and fraud. An audit provides trusted information to investors and shareholders about a company’s financial statements. The audit helps financial analysts in determining the value of an organization’s shares.

Auditing Standards

The Public Company Oversight Board (PCAOB) maintains external auditing standards for public companies registered with the Securities and Exchange Commission (SEC).

Auditing standards which are called Generally Accepted Auditing Standards (GAAS) helps to measure the quality of audits. GAAS outlines auditing standards that companies might follow. GAAS helps in ensuring the accuracy and verifiability of an audit report.

According to general standards, the auditor should have adequate training to perform the audit, the auditor should maintain independence in all matters relating to audit and the auditor should exercise due professional care in the preparation of the audit report.

The auditor should state in the auditor’s report that the financial statements are presented as per GAAS and the audit report should express an opinion regarding the financial statements.

Audit Processes

The audit process generally starts from the appointment of auditors and ends with the issuance of audit report. The audit process is descried below:

1) Appointment

The first step in the audit process is the appointment of auditors. Auditors are appointed to perform the audit work on their client’s financial statements.

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2) Plan the Audit

After appointment auditors start the initial planning of the audit. At this step compliance and ethical matters are evaluated and audit team is formed.

3) Understanding the Client

This is where auditors obtain an understanding of the client’s business and control environment. At this stage, auditors also need to know whether there is any risks that the client’s accounts is exposed to.

4) Risk Assessment

At this stage the risk of material misstatements is assessed that can occur on the client’s financial statements. This step also includes how auditors respond to the assessed risks.

5) Test of Controls

At this stage test of control is performed. If the client’s internal controls are ineffective the substantive procedures are performed directly.

6) Substantive Audit Procedures

This is where audit evidence is gathered by testing various audit assertions of the client’s accounts. Substantive audit procedures involve substantive analytical procedures and tests of details.

7) Overall Review of Financial Statements

After obtaining sufficient appropriate audit evidence an overall review of financial statements is performed.

8) Audit Report

This is the final audit process where audit report is issued by giving auditors opinion on financial statements. Audit opinions may be qualified, adverse or disclaimer.

4 Types of Audit Opinions

The audit opinion is the statement expressed by independent auditors to their client’s financial statements. The audit opinion is very important for shareholders because they can use the information for decision-making.

ISA 700 is used by auditors to issue an unmodified opinion and ISA 705 is used to issue a modified opinion. The different types of audit opinions are described below:

Unmodified Opinion

When the financial statements are prepared in all material respect and complying with the applicable framework, an unmodified opinion is expressed. Once auditors obtain sufficient appropriate audit evidence, this opinion is issued. The auditor does not provide absolute assurance but reasonable assurance on the financial statements.

Qualified Opinion

When material misstatement is found in the financial statements qualified opinion is issued. However, the misstatements are not pervasive. Pervasive means the misstatements are not affecting the financial statements and user’s decision-making.

Adverse Opinion

When auditors examined and concluded that the financial statements are materially misstated and pervasive, an adverse opinion is issued. This opinion provides the message that financial statements are not reliable for decision-making.

The difference between adverse opinion with qualified opinion is that the misstatements found in the qualified opinion are not pervasive but in adverse opinion, the misstatements are both material and pervasive.

Disclaimer of Opinion

Disclaimer opinion is different from both adverse and qualified opinion. When auditor could not obtain and unable to access the audit evidence, they issue a disclaimer opinion.

This happens when the auditor tries to convince the client to obtain all important information but the client still rejects it intentionally or unintentionally. Auditors believe that for those items they are unable to access or obtain information could be materially misstated and pervasive.