All About Audits: Everything You Need To Know About The Three Types of Business Audit
What is an audit?
Learn everything you need to know about the financial investigations into your business. We'll teach you about the 3 types of audits there are, how to properly prepare for an audit, how they can affect your business, how to find the right auditor, and more.
What is an internal audit?
An internal audit is an evaluation of a business’s internal controls and accounting processes. These audits help make sure your business remains in compliance with laws and regulations, and help maintain the accurate and timely reporting of financial data.
Regularly scheduled internal audits are essential in a wide range of industries. With them, business owners can figure out pain points in operations efficiently, allowing them to identify potential problems in workflow before they become evident in an external audit. Regular internal audits also provide risk management and safeguard against potential fraud, waste, or financial abuse in your business.
What is the process of an internal audit?
First, management will identify a department that they wish to audit. Next, an internal auditor will attempt to collect an understanding of the current internal control process and conduct fieldwork testing. This is where the actual auditing of the department begins.
Once they have concluded the evaluation, the auditor will follow up with management about the issues they have identified, prepare the official auditor’s report, review the report with management, and follow up with management to guarantee the suggested recommendations are in place.
What happens during an internal audit?
During an audit, the assigned auditor will observe, take notes, review documents and interview employees. Auditors will often ask questions and test employees’ knowledge of your company’s overall objectives, safety standards, training, and compliance rules and regulations.
Once the auditor is satisfied with their investigation, they will brief management on the results. During a meeting, an auditor will communicate the strengths and weaknesses of the department while offering their recommendations. They will also verify details with management for accuracy and ask for any disputes.
Once the details are satisfied, the auditor’s report is finalized and expectations are given to management on corrections to be made. Management and the auditor will both commit to a timeline to correct any issues. Once all agreed-upon issues are implemented satisfactorily, the audit is officially closed.
How often are internal audits conducted?
An internal audit can be conducted on a daily, weekly, monthly or annual basis depending on the circumstance and schedule which fits a business’s needs best.
Audits are tools that should be used by management to perform an overall assessment of their business and each department within. Generally, internal audits should be performed frequently enough to detect problems and to prevent compliance issues.
Internal audits may be scheduled in advance in order to give a department time to prepare documents and information, or they may be a surprise if unethical or illegal activity is suspected.
How to prepare for an internal audit:
- Prepare an internal audit plan.
- An internal audit plan is a list of all the audit tasks and obligations that will need to be conducted over the agreed-upon time period. This should be prepared with the auditor, and reviewed by the management team. It is important to determine specific steps, procedures, and the main focus of the audit.
- Prepare your employees.
- If the audit is regulatory, it is good practice to give departments notice so they can have any necessary financial documents and materials ready. Audited departments will also be involved in implementing the necessary changes recommended by the auditor such as new training requirements or revisions in compliance policies.
Who performs an internal audit?
Internal audits are typically performed by an internal auditor who is an employee of the company. Internal auditors don’t need to be certified public accountants (CPAs), but can earn a certified internal auditor (CIA) qualification, which requires them to follow agreed-upon standards governed by the Institute of Internal Auditors (IIA).
Why is an internal audit performed?
The main purpose of an internal audit is to assess and improve the effectiveness of administration and operations, provide risk management, and provide more control over the critical financial processes in your business.
A properly executed audit will identify the areas of concern in a department and present them to management in an understandable way. This allows management to make informed decisions on how to correct issues going forward and create necessary action plans for discrepancies.
What is an external audit?
An external audit is an examination that is conducted by an independent accountant or accounting firm. This type of audit results in a verified certification of the financial statements of a business. These certified statements are required for all publicly-held businesses and can be requested by shareholders, investors, and lenders if there is suspected discrepancy in the reports.
External audits are critical in the fact that their certified results remove any bias and question in the state of a company's financial status. All external audits performed in the United States follow the same standards called the generally accepted auditing standards (GAAS), which are set by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA).
What is the process of an external audit?
An external audit starts with either the appointment or hiring of an independent auditor. This means hiring someone external to the company that will be audited. In general, shareholders will appoint an auditor at the Annual General Meeting.
Next, the external auditing will begin to take place. The auditor will collect, assess, and interpret data to gain full understanding of all of the company’s activities. This includes examining the business’ accounting records, looking through financial statements in order to obtain evidence, verifying compliance with standard accounting policies, and confirming the assets that have been purchased.
Once they feel their investigation is satisfactory, the auditor will submit their report and state their objective opinion. An external audit’s findings and auditor’s opinion can seriously influence the reputation and future of a company. An auditor’s opinion and rating can mean whether or not a company stays in business.
What happens during an external audit?
During an external audit, an auditor will thoroughly review your financial and according records. This involves checking for the accuracy and completeness of these records, whether these records have been prepared in accordance with the generally accepted principles, and whether your financial statements are correctly representing your company’s financial position.
The auditor’s process includes going through the records used to create each financial statement and re-creating them to see if they were created correctly. They will also compare your business to others in the same industry to attempt to identify differences and irregularities that potentially be a sign of incorrect financial reporting.
At the end of the external audit, the auditor will prepare and deliver an auditor’s report to your business, including the details and findings from the audit. This will include the discrepancies found in the financial reporting and any non-compliance of rules and regulations relevant to your business.
How often are external audits conducted?
Generally, a company will not have more than one external audit per year.
Publicly-held companies are legally obligated to annual external audits due to the regulations of the Securities Act of 1933 and the Securities Exchange Act of 1934. The results of this audit must be submitted to the U.S. Securities and Exchange Commission.
Nonprofit companies are also often legally obligated to perform annual external audits due to federal and state regulations. Nonprofits that receive $500,000 or more in federal government funding per fiscal year must conduct an A-133 Audit.
An external audit also occurs at random request of an entity to confirm that the accounting records are following standard practices. For example, an external audit may occur when a governmental entity is questioning a part of the financial statements of a company. Some instances where an audit may be ordered are when the IRS detects tax fraud, when shareholders feel that the company is not producing GAAP compliant financial statements, or when there is court suspect of illegal activities due to the spending of business funds.
Who performs an external audit?
An external audit is performed by an external auditor, who works for an independent accounting firm. Generally, an external auditor must be a Certified Public Accountant (CPA) and must follow the U.S. Generally Accepted Auditing Standards (GAAS).
How to prepare for an external audit:
- Prepare your team.
- In preparation for your audit, it is wise to designate an “audit liaison” or “audit manager” within your team who will act as the main contact for the auditor. This will the process of the audit run smoothly and prevents miscommunications between the team and the auditor. Whenever the auditor has a question or request, they should be referred to the audit manager. When picking an audit manager, a wise choice is an experienced team member who has very strong project management and communication skills.
- Prepare your records.
- During the audit process, you should expect to receive requests from the auditor for additional information and documents. These may range from evidence supporting a specific transaction, such as receipts, to more thorough descriptions of your company’s process and controls. It is wise to maintain a detailed list of all records that you provide to the auditor during the process, and keep track if any of your documents are taken off-premises.
Why is an external audit performed?
The main purpose of an external audit is to validate a company’s financial statements and to provide assurance of the accuracy of financial reports. The results of an external audit assure third-parties that the financials of the company are correct and secure.
While external audits are oftentimes required, some businesses find it beneficial to perform them voluntarily due to the asset of a verified auditor’s report. When a small business or nonprofit applies for financing, having verified and accurate financial statements can come in handy. Audit results may also be a prerequisite for certain contract bids or grant proposals. Many companies also find that conducting an external audit is a way to help build public confidence in their company.
Internal Audit vs External Audit
What is an IRS audit?
An IRS audit is a formal investigation conducted by the Internal Revenue Service in order to verify that the information entered your business’ tax return is accurate and correct.
These tax audits can be triggered by unusual or unordinary deductions and forms of income listed on your tax return, or you can also be selected at random.
How often are IRS audits conducted?
Your tax return is subject to an audit at any time within six years of initial filing, though in general the IRS only includes tax returns filed within the last three years.
It is very important to note that if the IRS determines that you are subject to an audit, you will be notified only via U.S. postal mail.
What is the process of an IRS audit?
The process of an IRS audit will depend on the type of audit you are selected for. There are three types of tax audits that are conducted by the IRS.
- Mail Audit
- Mail audits are documentation requests from the IRS that a taxpayer will receive and respond to via mail. Typically, these requests will be so benign that you may not even realize that you have been audited at all. The IRS may request additional information about certain items or issues, or suggest specific changes be made to your return.
- Office Audit
- Office audits are in-depth, in-person interviews conducted by an audit officer at your local IRS office. During these interviews, you will review bank statements, past tax returns, and other relevant documents in order to legitimize the suspect items on your audited tax return.
- Field Audit
- Field audits are very in-depth, in-person interviews conducted by IRS agents at your home or business. During a field audit, an IRS agent will not only review financial statements and past returns, but also make assessments based off of observations about your place of business and the processes occurring there.
What happens during an IRS audit?
During an IRS audit, an agent will ask questions and ask you to present them with specific documentation. This will include evidence to back up tax deductions, forms of income, and tax credits that you have claimed on your tax returns.
The length of the tax audit will vary depending on the type of audit that is conducted, how complex it is, and the taxpayer’s willingness to cooperate with the IRS agent’s findings.
Once the investigation is complete, the agent will conclude the audit with one of three findings.
- The result of the audit determines that changes need to be made, and you agree to make the proposed amendments.
- The result of the audit determines that changes need to be made, and you do not agree to make proposed amendments. As a result, you can either file an appeal or meet with an IRS manager for a dispute mediation.
- No Change
- All information on your tax return is reviewed and confirmed, and you do not need to make any changes.
How to prepare for an IRS audit:
Organize, organize, organize!
The best preparation for an IRS audit is to get your records and files organized. If you are selected for an in-person audit, promptly collect and organize the records needed of you. Having tax returns and records such as receipts, bills, loan agreements, and account statements organized by year will allow for a smoother experience when dealing with the questions and concerns of an IRS audit agent.
What is an auditor's report?
After both an internal or external audit, you will receive the auditor’s report. This consists of a written letter from the auditor that is attached to your company’s financial statements that expresses the auditor’s opinion on the compliance with standard accounting practices.
The report is typically published within the company's annual report. A report usually consists of three paragraphs. The first paragraph will describe the responsibilities of the auditor and directors. The second paragraph describes the focus, scope, and set of standard accounting practices held for the audit. The third paragraph states the auditor's opinion.
The auditor's opinion is arguably the most important and critical part of the auditor's report. There are four common opinions issued for companies in an auditor's report.
- Clean or Unqualified Report
- This opinion means that the auditor believes that the company's financial records are correct and in compliance with the guidelines set out by GAAP. Most of the time, an audit will conclude with this opinion.
- Qualified Opinion
- This opinion means that the auditor found that the company did not follow the proper accounting standards. However, the company did not technically break any laws or compliances. The auditor will state the specific reason and areas where each issue is present so that the company can make the necessary adjustments.
- Adverse Opinion
- This opinion means that the auditor found that the company did not follow acceptable accounting practices and also found discrepancies in the company’s financials. The auditor will list any suspicions of misstatements or misrepresentations in the company’s financial statements. This opinion is the worst outcome and can have very severe legal consequences if not corrected quickly.
- Disclaimer of Opinion
- In this opinion, the auditor could not complete the given audit or has chosen not to provide their opinion. This can happen when the auditor cannot remain impartial to the business or cannot access the needed information.
Finding the right auditor
The auditing process and its results are crucial and critical to your business, so finding and choosing the right professional for the job is essential. An auditor is responsible for maintaining an unbiased opinion throughout the scope of the project and needs to remain independent from your business. It is important to remember that audit firms also should not have any sort of financial interests in your business’ industry.
At Ageras, we specialize in helping business owners find the right auditor for their needs. Whether you need an auditor with industry knowledge or an auditor with a unique specialty, it is important that you choose one with a good reputation. We can match you with 3 auditors from our network, 100% free of charge, where you can easily compare price, qualifications, customer reviews, and more before making your choice.
Posted: 05 Mar, 2020