What is an audit?

We’re sure you’ve heard about Harshad Mehta. It’s possible some of you saw it first-hand, too. Maybe even lost money. In 1992, he was involved in a massive stock manipulation scheme. Do you know how he got exposed? Thanks to the audit process.

Auditors play a watchdog role in the business world. So, whether you’re a company owner or an employee, it’s important to understand what they do and how. Because you might need to hire one, too, someday.

Define Audit

Audits are like impromptu bag checks at school. The authorities aren’t looking at anything specific. They’re just trying to make sure you aren’t stowing away something that you shouldn’t be—like a smartphone. Audits involve an examination of company records to ascertain whether its financial statements are factually correct.

Company audits often include a physical examination of inventory and other assets as well. Documentation checked usually includes checkbooks, invoices, sales receipts, vouchers, bank statements, tax returns, cash records, and inventory records.

These book and inventory examinations can be conducted internally or externally, depending on the requirements and type of organization. In India, most audits are conducted by chartered accountants, either hired from an external agency or employed in-house.

Understanding audits better

The purpose of conducting audits is largely to ensure that companies or departments within them are correctly representing their financial data on the books. Audits look into the records to verify that none of the parties are engaging in fraudulent activities. All publicly-listed companies must get their books audited by an independent auditor before they publish their quarterly results.

The auditing process is based on the governance principles listed below.

• Independence, integrity, and objectivity: Any personal biases should be removed during the audit process.
• Skill and competence: This is meant to ensure the accuracy of the audit report
• Documentation: Record-keeping forms the basis of the audit process. Auditors go over all relevant documentation with a fine-toothed comb.
• Evidence: All claims made in the final audit report need to be backed by evidence.
• Accounting systems and internal controls: These are meant to make the process easier for everyone.
• Confidentiality: The auditor usually has access to a lot of confidential company information during the process. It is important that they respect the confidential nature of such information and documents. They cannot disclose any sensitive information to any third party unless it is required by law.

How are audits conducted?

In large corporations, audits are also done continuously by an internal auditing team. The team schedules inquiries and checks across departments on a quarterly, monthly, or yearly basis. Continuous audits are also assisted by technology that keeps track of company assets, liabilities, and resources to ascertain if they’re being used correctly.

Audits are usually conducted in the following manner. We’ve broken it down into three steps for simplicity.

Step 1: To start, an auditor’s role is defined by the client. The terms of engagement between the company and the auditor are laid out in a letter, which is then signed by both parties.

Sept 2: Next, the audit is planned. The duration of the examination depends on how many departments are under scrutiny and how big they are. Audits can last days or weeks.

Step 3: Information and data collected during the course of this audit are subsequently compiled in a systematic manner, forming a report. Conclusions drawn from an analysis of financial statements are also laid down in the report.

Almost all companies have to get their books audited every financial year. The audits usually include an inspection of the company’s balance sheets, income statements, and cash flow statements.

Lenders often demand audit reports or audited financial statements before giving out debt.

Why are audit reports important?

Audit reports are useful because they are meant to ensure the accuracy of financial reports, check the authenticity and validity of corporate transactions, confirm the existence of documented assets and liabilities, and examine the difference between the nature of transactions and capital and revenue.

The significance of an audit report is evident from the process followed during the inspection. To spell it out, audits serve three important functions:

• Preventative: Audits help highlight the responsibilities of a company and prevent any financial missteps.
• Detective: They simply point out flaws or discrepancies in the mechanisms used but no suggestions on how to fix them are offered.
• Corrective: Auditing can help detect problems and indicate potential solutions.

Types of audits

There are various different types of audits conducted by companies every year. They can be broadly put into two broad categories—internal audits and statutory audits—based on who conducts them.

Internal audit

Internal audits, as the name suggests, are conducted by the company. They can, however, be conducted either through an internal audit department or an independent contractor.

Such audits can serve various purposes:

• To check for compliance: Such audits determine whether the company is following the rules and regulations established by the government. These compliances are necessary for the company to stay in business, and periodical checks are sometimes required.
• To look into financial statements: Investigative or exploratory audits are conducted when there’s something wrong or suspicious about a company’s financial statements. Exploratory audits can also serve to identify potential threats to a company’s integrity and flag opportunities for improvement.
• To assess management, operations, or finances: Some audits are used to check the managerial, operational, and financial aspects of a company’s functioning in detail and list out discrepancies, if any.

Internal audits document the internal health of a company and help ensure longevity.

Statutory audit

Audits of this type are also meant to check the health of a company but they are conducted by an external entity, usually the Government of India. Qualified auditors are appointed by the government for this task. They follow government rules and regulations during the inspection.

Statutory audits are of multiple types. Here are a few:

1. Company audit: The details and provisions for this type of statutory are detailed in the Companies Act, 2013. The law says that every company, irrespective of its annual turnover or business type, has to get its financial accounts audited by a qualified professional.

2. Tax audit: This variety of statutory audits is compulsory for all businesses that have an annual turnover of more than ₹1 crore and for professionals earning more than ₹50 lakh per year, according to India’s income tax law. The core purpose of a tax audit is to confirm if the company is paying its taxes correctly and on time. A tax audit report makes it easier for tax officials to record the company’s taxes and process refunds when returns are filed.

3. Cost audit: The cost records of a company are examined in this type of audit. Such audits have to be conducted for as long as the company functions in the market. Efficient cost audits can reduce the incidence of fraudulent activities. Bigger companies themselves sometimes organize half-yearly cost audits to keep problems at bay. They track internal and external cash flows to ensure there are no discrepancies in data. They serve two main functions:

• Confirming arithmetic accuracy of data relating to cost, and
• Detecting errors, drawbacks, and frauds in accounts and correcting them immediately.

Conclusion

Since companies are the cornerstone of a functioning free market economy, it’s important that they play by the book and stay transparent.

Audits ensure that factual information represented in a company’s financial statements is true. They help companies stay on track in relation to fulfilling their obligations to the government and their shareholders.

While several governmental and statutory standards govern audit processes and auditors themselves, scams still happen. More regulation and stricter implementation are therefore required to make the audit process as efficient as possible.

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