What is the importance of an Audit?
- 14 May 2021
- 5 minutes read
The word audit is originally derived from the Latin word Audiere, meaning "to hear".
Historically, auditors used to report on the accuracy of data based on oral representations.
In the early days, an individual had to listen to an accountant read through the accounts to audit them. He/she was then known as the auditor.
This blog post is divided into the following sections
- What is an Audit?
- Purpose of Audit
- Types of Audits
- Who requires an audit in the UK?
- Who qualifies for audit exemption?
- Advantages of an external audit
What is an Audit?
An audit is a crucial accounting concept that refers to reviewing and evaluating a company's financial statements.
It aims to ensure that financial data is presented reasonably and accurately. Audits also provide that financial statements are compiled in compliance with the applicable accounting principles.
An audit may apply to an entire organisation or a specific role, process, or manufacturing phase. Some audits are performed for administrative reasons, such as auditing records, risk, or results, or following up on completed corrective actions.
Auditing consists primarily of the following components –
- A critical review of the company's books of accounts
- Carried out by a trained independent practitioner known as the auditor
- Performed with the assistance of bills, records, details, and explanations
- The auditor is satisfied by the review of financial statements and their validity.
Purpose of Audit
The main purpose of an audit is to report to the owners that the records, financial statements, and profit or loss and cash flow for the year, as well as any other matters as may be prescribed, offer an true and fair view of the state of the company's affairs and financial performance for a given period.
Not sure why your small business needs an audit, check out our guide on Why your small business needs an audit.
Types of Audits
1. Internal Audits
Internal audits are carried out by a company's or organization's employees. These audits are not made available to anyone outside of the company. They are instead ready for use by management and other internal stakeholders.
Internal audits are used to enhance business decision-making by presenting managers with actionable items for improving internal controls. They also ensure that laws and regulations are followed and that financial reporting is timely, equitable, and reliable. The internal audit function usually reports to the audit committee.
Management teams can also use internal audits to find weaknesses or inefficiencies within the organisation before external auditors review the financial statements.
2. External Audits
External audits, which external agencies and third parties perform, offer an unbiased opinion that internal auditors may not be able to provide.
External financial audits are used to identify any significant misstatements or irregularities in a company's financial statements.
When an auditor issues an unqualified or clean opinion, it indicates that the auditor is particular that the financial statements are free from any material misstatements.
External audits are critical for allowing different stakeholders to make confident decisions about the business being audited.
Externals audit are not designed to detect or prevent fraud.
3. Government Audits
Government audits are conducted to ensure that financial statements are maintained accurately. So that a company's taxable income is not misrepresented. Audit choices provide that businesses are not overstating their taxable profits.
Tax fraud is the deliberate or unintentional misstatement of taxable income. A government audit can lead to the conclusion that there is:
- There has been no change to the tax return.
- A move that the taxpayer accepts
- A shift that the taxpayer does not embrace
The primary distinction between an external auditor and an internal auditor is independence. It means they will have a more unbiased opinion than an internal auditor, whose integrity can be harmed due to the employer-employee relationship.
Larger organisations can hire an accountant to conduct internal audits regularly. It ensures that the company employs someone to conduct an audit from inside, rather than having an audit performed by someone outside the organisation.
An external firm with specialised accountants will typically audit smaller businesses that are audited, and the results will be provided.
Who requires an audit in the UK?
- Your company is engaged in a regulated business, such as a financial services provider.
- Your shareholders have asked for an audit.
- A request is made by your bank or a big lender, an insurance company.
- For a complete list, see here
Who qualifies for audit exemption?
Not every company is required to have its books audited every year.
A company usually qualifies for an audit exemption if it has met at least two of the following conditions:
- An annual turnover of less than £10.2 million
- Assets less than £5.1 million
- The average number of employees is 50 or less
By this definition, most small and micro companies qualify for the exemption.
Advantages of an external audit
1. Educates the business owner
External auditors are appointed by shareholders in annual general meeting. So by default, they are answerable to the shareholders.
External audits may assist in educating company owners on the value of accounting information.
To strengthen their accounting process, business owners often collaborate closely with external auditors.
External auditors can provide information on current accounting issues to business owners.
Developing a personal partnership with a public accounting firm provides company owners with expert advice on potential accounting issues.
2. Compliance Assurance
An auditor ensures that the books of accounts are prepared in accordance with the applicable laws, regulations and accounting framework.
Since financial audits are performed on a yearly basis, they aid in keeping the accounting department in compliance with the specified rules and regulations.
The external auditor will also ensure that the company's accountants are up to date with any new government or authority regulations.
3. Errors are discovered
External audits can help business owners find errors in their accounting processes.
Accounting information errors can prevent business owners from making the right decisions. If there are mistakes, business owners will find it difficult to review historical financial data and identify patterns.
Trends allow business owners to forecast potential performance and sales for the coming months.
External audits also verify that company owners are documenting financial transactions in accordance with the rules.
4. A Different Point of View
Since the external auditors are a third party with no ties to the company, they would be objective against the company and would present his findings and corresponding opinions in this manner.
5. Boosts investor confidence
Since the audit report would include a comprehensive and reliable summary of both the company's past and current works, an investor will be able to make a more informed decision about investing in the company.
The investor will review the audit report, and if they believe that the company is on the road to profitability and that investing in the company is the right choice, they will invest in the business. As a result, it will make a potential investor's decision-making process easier.
The primary role of auditing is to verify the accuracy of the accountant's books of accounts. "Where the work of Accountant ends, the audit starts to decide the accurate and fair image of those accounts," as the old saying goes.
However, an audit is critical because it lends integrity to financial statements and provides shareholders with trust that they are accurate and reliable. It also aids in the enhancement of a company's internal controls and processes.