An audit is the most objective way to ensure that your financial statements match up with what they represent. It can be conducted internally by employees of an organization or externally by a Certified Public Accountant firm (CPA). The term audit typically refers to a financial statement audit. It is a crucial step in the accounting process because the objective examination and evaluation of the company’s finances are required to understand the overall financial situation of the company rather than specific transactions or events during the year. 

The audit could be conducted internally by employees of the organization or externally by an outside Certified Public Accountant (CPA) firm every three years to spot possible problems, if any, before it becomes too late. It will also ensure that the financial records are a fair and accurate representation of the transactions they claim to represent.

Understanding Audits

Nearly all companies obtain a yearly audit of their financial statements like income statements, balance sheets, and cash flow statements. Lenders usually need the results of an external audit every year as part of their debt covenants. And for some companies, audits are a legal requirement because of the compelling incentives to twist financial information to commit fraud deliberately. The Sarbanes-Oxley Act (SOX) of 2002 requires publicly traded companies to receive an evaluation of the effectiveness of their internal controls.

The standards for external audits performed are called “generally accepted auditing standards (GAAS)” in the United States. They are set by the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants (AICPA). 

The additional rules for the audits of publicly traded companies are set by the Public Company Accounting Oversight Board (PCAOB), which was established after SOX in 2002. Another set of international standards was set up by the International Auditing and Assurance Standards Board (IAASB), known as the International Standards on Auditing (ISA).

Types of Audits

There are three main types of audits: internal audits, external audits, and Internal Revenue Service (IRS) audits.

External Audits

Audits performed by external squads are considered to be the most reliable as they remove any inclination or favors while reviewing the condition of a company’s financials. Financial audits aim to pinpoint any material misstatements in the financial statements if any. An unbiased or clean auditor’s opinion gives confidence — that the financials are both accurate and complete — to financial statement users. Thus, external audits help stakeholders to make informed decisions with confidence.

External auditors have standards different from the company hiring them. The most noticeable difference between an internal and external audit is obvious — the external auditor has more independence, and, thus, is hoped to be unbiased. 

Internal Audits

The company employs internal auditors to perform an audit, and the final resulting audit report is presented straight to management and the board of directors. 

Consultant auditors use the company’s standards they are auditing instead of independent standards, even though they are not employed internally. These types of auditors are employed if a company doesn’t have enough in-house resources to audit specific parts of the operations.

The internal audit results are used for making managerial changes and revisions to internal controls. The objective of an internal audit is to guarantee the company’s adherence to laws and regulations and also maintain punctual financial reporting and data collection. Using the results, the management can identify internal control or financial reporting flaws before external auditors can review them.

Internal Revenue Service (IRS) Audits

The Internal Revenue Service (IRS) also performs audits to verify the accuracy of a taxpayer’s return and other specific transactions. The IRS auditing of a person or company is usually viewed with a negative connotation as it creates a general perception that some type of wrongdoing is evident by the taxpayer. But being chosen for an IRS audit doesn’t confirm that there is wrongdoing.

IRS audit selection is generally made by random statistical formulas that examine a taxpayer’s return and compare it to other identical returns. A taxpayer might also be selected for an audit if they had dealt with another person or company with tax errors on their audit.

An IRS audit has three possible outcomes: 

1. No change in the tax return;

2. A change that is agreed by the taxpayer;

3. A change that is disagreed with by the taxpayer. 

The taxpayer might owe extra taxes or penalties if the change is accepted. If the taxpayer disagrees, a new process begins, including mediation or an appeal.


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