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

Overview:

The term auditing generally refers to a financial statements audit. Auditing is the examination of an organization’s records and reports by an independent auditor (generally called an external auditor or CPA firm) to ensure that the financial statement is accurate and fair.

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

The audit is an independent investigation of financial records and the investigation results are reported to the organization’s shareholders.

Types of Audits

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

External Audit

External organizations perform external audits to provide an unbiased opinion. The Big Four audit firms that provide external audit services are KPMG, PWC, EY, and Deloitte. External auditors must maintain the professional code of ethics and follow International Standards for Auditing.

An 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

The organization’s employees conduct internal audits and the audit report is given to management and the board of directors. An internal audit’s objective is to improve internal controls and 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 auditor will issue the statutory audit report and the entity will submit it to the government body.

Tax Audit

A tax audit is performed by the government’s tax department or tax authority. According to a country’s tax law, the entity must 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 which 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 several areas, including fraud, crime, disputes 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 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 prevent possible future external audits. 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 agreed upon with the client. Auditors are required to ensure 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 audits, some expenses 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 different audit firms audit its financial statements.

Special Audit

The internal auditor does special audit assignments. Special audit happens for fraud cases, business cases,s or other special cases in the organization. The organization’s internal staff does this type of audit, which 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 company’s CEO.

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. An operational audit aims to improve a business by increasing efficiency and reducing costs.

Sales Audit

Sales auditing involves knowing the sales process, reviewing management’s target, and evaluating the stock. Sales auditing plays an important role for organizations to determine whether the current sales practice is working 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. Organizations need to conduct audits regularly; the audit results can help the organization in many different ways. Organizations can conduct audits depending on which department is weak.

Importance of Auditing

Auditing helps verify financial statements, accounts, and balances per accounting standards, and regular auditing can help understand different aspects of the business.

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Auditing also helps find 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 clients’ financial statements so users can reply. Various stakeholders in a company’s financial statement may not have sufficient knowledge to understand the financial statements.

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

2) Fraud Prevention and Detection

Internal audit plays an important role in companies preventing fraud. A rigorous internal control system can help prevent and detect fraud.

If the auditor helps develop an effective audit system, the system’s reputation can help prevent 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. A lack of proper internal control systems would create trouble for financial reports.

The audit methodology helps in determining which segments require the attention of management.

4) Cost of Capital

The cost of capital is an important aspect of a company as it consists of the risk associated with the investment. When there are more risks in an investment, the rate of return is high. Strong audit systems help 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 about a company’s financial statements to investors and shareholders. The audit helps financial analysts determine 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 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 the 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 with the appointment of auditors and ends with the issuance of the audit reports. The audit process is described 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.

2) Plan the Audit

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

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3) Understanding the Client

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

4) Risk Assessment

At this stage, the risk of material misstatements can be assessed 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. The substantive procedures are performed directly if the client’s internal controls are ineffective.

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 an audit report is issued by giving auditors’ opinions 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 comply 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, a qualified opinion is issued. However, the misstatements are not pervasive. Pervasive means the misstatements are not affecting the financial statements and users’ decision-making.

Adverse Opinion

When auditors examine and conclude 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 opinions. When auditors cannot obtain and cannot 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 those items they cannot access or obtain information could be materially misstated and pervasive.

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