What Is an Audit? (With Definition, Types and Purposes)
Updated February 3, 2023
What is an audit?
An audit is an evaluation process that involves performing an inspection of documents to confirm the accuracy of an organization's or individual's financial statements. Following an initial examination of financial records, an auditor performs physical checks on inventory and makes sure that the professional or company records transactions correctly.Audits can serve a variety of purposes. For example, a company may request an internal audit to learn more about its financial situation, or an external financial contributor may request an external audit to ensure the organization reports information accurately. Related: Learn About Being an AuditorTypes of audits
Types of audits vary from organization to organization. For example, a construction company may conduct an audit to analyze project expenses or contractor costs. Here are some different types of audits:Internal audits
A company's employee conducts an internal audit and then reports their findings to an audit committee, made up of the board of directors. Internal audits can help a company define areas for improvement while providing necessary information to reach company goals.While an external audit usually focuses on financial matters, the scope of an internal audit is broad and can include anything that may impact achieving company goals. An internal audit often centers around key activities such as:- Investigating cases of fraud or theft
- Monitoring regulations and law compliance
- Checking the effectiveness of internal controls and advancing ideas for improvement
- Reviewing and verifying financial and operational information
- Examining the economy, efficiency and effectiveness of company processes and operations
- Evaluating company risk management procedures and policies
External audit
A third independent party who has no connection to a business, such as the IRS or an independent accountant, can perform an external audit. Generally accepted auditing standards regulate external audits, and determining the accuracy of accounting records is the main objective of completing them.Company law in most jurisdictions requires an annual external audit for companies over a certain size. The requirement for an external audit comes from the separation of control and ownership in a large company, where company leaders nominate directors to run the company on their behalf.These leaders, including external financial contributors, require assurance that the company's financial reports are accurate. An external audit provides reasonable confidence to the shareholders that the financial statements are free from material misstatements.Related: Learn About External vs. Internal Audits (Four Key Differences)Forensic audit
For situations involving legal implications, a forensic audit is necessary. Situations that require a forensic audit may include:- Fraud investigations involving tax evasion, insider trading, misappropriation of funds or money laundering
- Assessment of loss in the case of insurance claims
- Investigation and determination of claims of professional accountancy negligence
- Establishment of a business partner's profit share when there is a dispute
Tax audit
IRS tax audits assess the accuracy of company tax returns and the amounts paid or refunded. In some jurisdictions, certain companies are required to have regular tax audits, while in other jurisdictions, balloting systems randomly select companies for a tax audit. There are three primary types of IRS tax audits: mail, office and field audits.Related: 15 Types of Audits for Your Business (And When To Use Them)Public sector audit
In several jurisdictions, the law provides that a public sector auditor must audit state-owned companies or organizations. The auditor general, an institute that strengthens public sector accountability, supervises public sector audits.During a public sector audit, the financial affairs of state-owned enterprises are assessed for whether operations and standard procedures comply with good governance. This audit is more in-depth than a private organization's financial audit, which focuses on the reliability of a company's financial statements.Related: The 4 Types of Auditing ReportsInformation system audit
An information system audit assesses the controls relevant to an organization's infrastructure. This audit often forms part of the internal control assessment during an audit.An information system audit typically analyzes:- The system design and internal controls
- Information privacy and security
- Operational efficiency and effectiveness
- Data and information processing integrity
- System development standards
Social and environmental audit
This audit assesses the environmental and social impact of an organization on its economic activities. The need for environmental auditing is growing as many companies provide environmental and sustainability reports along with their annual report, detailing the impact of their business activities on the environment and their initiatives to reduce their footprint. To ensure the accuracy of business environment reports and claims, an environmental audit is conducted. For example, an environmental audit verifies a company's report on its CO² emissions.Related: Accounting vs. Auditing: What's the Difference?Showcase your skills with help from a resume expert
What is the purpose of an audit?
Audits perform a crucial role for organizations and can serve a variety of purposes depending on the company and its requirements. They can uncover financial issues or bookkeeping errors and help a company get back on track. An organization can use an audit when:- Maintaining compliance: One of the most important reasons for an audit is to ensure the company meets statutory industry requirements and regulations. An audit gives a business owner or shareholders confidence that the company is compliant with all its statutory obligations and doesn't run the risk of heavy fines or a tarnished reputation.
- Making system improvements: Since an audit looks closely at systems and controls, auditors will often suggest beneficial improvements to make an organization more efficient.
- Improving planning and budgeting: Since an audit confirms the accuracy of financial statements with income, expenses, assets and liabilities being carefully examined, the information gathered can help with future financial planning, decision-making and budgeting.
- Detecting and preventing fraud: Workplace fraud can go undetected and cause irreparable damage to a company. An audit is an effective tool to identify fraud or opportunities for fraud by pinpointing organizational system weaknesses and finding solutions and controls to prevent fraud.
Auditors & assurance occupations
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