Auditing

Auditing typically refers to financial statement audits or an objective examination and evaluation of a company’s financial statements – usually performed by an external third party.

Audits can be performed by internal parties and a government entity, such as the Internal Revenue Service (IRS).

Importance of Auditing

Audit is an important term used in accounting that describes the examination and verification of a company’s financial records. It is to ensure that financial information is represented fairly and accurately.

Also, audits are performed to ensure that financial statements are prepared in accordance with the relevant accounting standards. The three primary financial statements are:

Income statement,Balance sheet,Cash flow statement

Financial statements are prepared internally by management utilizing relevant accounting standards, such as International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP). They are developed to provide useful information to the following users:

Shareholders,Creditors,Government entities,Customers,Suppliers,Partners

Financial statements capture the operating, investing, and financing activities of a company through various recorded transactions. Because the financial statements are developed internally, there is a high risk of fraudulent behavior by the preparers of the statements

Without proper regulations and standards, preparers can easily misrepresent their financial positioning to make the company appear more profitable or successful than they actually are.

Auditing is crucial to ensure that companies represent their financial positioning fairly and accurately and in accordance with accounting standards.

Types of Audits

1. Internal audits

Internal audits are used to improve decision-making within a company by providing managers with actionable items to improve internal controls. They also ensure compliance with laws and regulations and maintain timely, fair, and accurate financial reporting.

Management teams can also utilize internal audits to identify flaws or inefficiencies within the company before allowing external auditors to review the financial statements.

2. External audits

Performed by external organizations and third parties, external audits provide an unbiased opinion that internal auditors might not be able to give. External financial audits are utilized to determine any material misstatements or errors in a company’s financial statements.

When an auditor provides an unqualified opinion or clean opinion, it reflects that the auditor provides confidence that the financial statements are represented with accuracy and completeness.

External audits are important for allowing various stakeholders to confidently make decisions surrounding the company being audited.

The key difference between an external auditor and an internal auditor is that an external auditor is independent. It means that they are able to provide a more unbiased opinion rather than an internal auditor, whose independence may be compromised due to the employer-employee relationship.

There are many well-established accounting firms that typically complete external audits for various corporations. The most well-known are the Big Four – Deloitte, KPMG, Ernst & Young (EY), and PricewaterhouseCoopers (PwC).

3. Government audits

Government audits are performed to ensure that financial statements have been prepared accurately to not misrepresent the amount of taxable income of a company.

Within the U.S., the Internal Revenue Services (IRS) performs audits that verify the accuracy of a taxpayer’s tax returns and transactions. The IRS’s Canadian counterpart is known as the Canada Revenue Agency (CRA).

Audit selections are made to ensure that companies are not misrepresenting their taxable income. Misstating taxable income, whether intentional or not, is considered tax fraud. The IRS and CRA now use statistical formulas and machine learning to find taxpayers at high risk of committing tax fraud.

Performing a government audit may result in a conclusion that there is:

No change in the tax return
A change that is accepted by the taxpayer
A change that is not accepted by the taxpayer

Accounting

Accounting is a term that describes the process of consolidating financial information to make it clear and understandable for all stakeholders and shareholders. The main goal of accounting is to record and report a company’s financial transactions, financial performance, and cash flows.

Accounting standards improve the reliability of financial statements. The financial statements include the income statement, the balance sheet, the cash flow statement, and the statement of retained earnings. The standardized reporting allows all stakeholders and shareholders to assess the performance of a business. Financial statements need to be transparent, reliable, and accurate.

Importance of Accounting

1. Keeps a record of business transactions

Accounting is important as it keeps a systematic record of the organization’s financial information. Up-to-date records help users compare current financial information to historical data. With full, consistent, and accurate records, it enables users to assess the performance of a company over a period of time.

2. Facilitates decision-making for management

Accounting is especially important for internal users of the organization. Internal users may include the people that plan, organize, and run the organization. The management team needs accounting in making important decisions. Business decisions may range from deciding to pursue geographical expansion to improving operational efficiency.

3. Communicates results

Accounting helps to communicate company results to various users. Investors, lenders, and other creditors are the primary external users of accounting information. Investors may be deciding to buy shares in the company, while lenders need to analyze their risk in deciding to lend. It is important for companies to establish credibility with these external users through relevant and reliable accounting information.

4. Meets legal requirements

Proper accounting helps organizations ensure accurate reporting of financial assets and liabilities. Tax authorities, such as the U.S. Internal Revenue Service (IRS) and the Canada Revenue Agency (CRA), use standardized accounting financial statements to assess a company’s declared gross revenue and net income. The system of accounting helps to ensure that a company’s financial statements are legally and accurately reported.

Types of Accounting

Accounting can be classified into two categories – financial accounting and managerial accounting

1. Financial Accounting

Financial accounting involves the preparation of accurate financial statements. The focus of financial accounting is to measure the performance of a business as accurately as possible. While financial statements are for external use, they may also be for internal management use to help make decisions.

Accounting principles and standards, such as US GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards), are standards that are widely adopted in financial accounting. The accounting standards are important because they allow all stakeholders and shareholders to easily understand and interpret the reported financial statements from year to year.

2. Managerial Accounting

Managerial accounting analyzes the information gathered from financial accounting. It refers to the process of preparing reports about business operations. The reports serve to assist the management team in making strategic and tactical business decisions.

Managerial accounting is a process that allows an enterprise to achieve maximum efficiency by reviewing accounting information, deciding on the best next steps to follow, and then communicating these next steps to internal business managers.

An example of managerial accounting is cost accounting. Cost accounting focuses on a detailed break-up of costs for effective cost control. Managerial accounting is very important in the decision-making process.