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Auditing

A detailed examination of financial reports

What is Auditing?

Auditing is the detailed examination of the financial reports of an organization and is used to provide confidence for all stakeholders that the organization’s accounting reports are accurate.

In accounting, we look at the different accounting rules, journal entries, financial statements, and other bookkeeping duties. All these tasks are important because, with these skills, accountants can then be involved in an engagement team to perform an audit on both internal or external clients. The most common audits are performed by the Big Four accounting firms for large publicly-traded companies around the world. To summarize the auditing process, see the diagram below:

 

Auditing process

 

The financial statements in the first box, which include the balance sheet, income statement, statement of cash flows, and note disclosures, are evaluated against some form of accounting criteria known as GAAP. Different regions around the world adhere to different GAAP rules. Some common GAAP criteria may be IFRS or US GAAP. The bottom line is that these are established criteria that are known publicly. Finally, the work culminates in an audit report where the findings are communicated to the users.

 

Formal Definition

More formally, auditing is referred to as the accumulation and evaluation of evidence to determine and report on the degree of correspondence between the information presented (i.e., the financial statements) and the established criteria. Auditing should be done by a competent, independent person or entity.

 

Accounting vs Auditing

Overall, auditing is a more specialized field of accounting but the two go hand in hand. This means that auditors cannot be totally unaware of accounting rules. In fact, auditors must be qualified and competent in accounting in order to properly conduct an audit. Let’s take a look at the following table to compare the two topics:

 

AccountingAuditing
Recording, classifying, summarizing transactions in accordance with GAAPAccumulating and evaluating evidence
Bookkeeping, financial statement preparation Determines if the financial statements are prepared in accordance with GAAP

 

External Auditors vs Internal Auditors

There are basically two types of auditors: external auditors and internal auditors.

External auditors refer to public accountants who take on different clients and perform the audit together with an engagement team. As mentioned before, these are the usual public accounting firms such as the Big Four firms that audit large public companies in addition to large private companies. External auditors are employees of the accounting firm they are associated with and only interact with their clients through the audit process.

Internal auditors, on the other hand, are actual employees of the company. Their role is to perform general auditing procedures all year to ensure that all accounting and record-keeping are being done properly so that the external audit becomes more feasible. Internal auditors usually exist only in large companies.

 

Different Types of Assurance Engagements

Auditing falls under a broader umbrella of assurance. An assurance engagement refers to those performed by an auditor to enhance the reliability of the situation. Other than audit engagement, there are other forms of assurance that a public accountant can provide. The types of assurance may differ in terms of levels and tasks. In all these scenarios, the public accountant should obtain a contract from the client before starting any work.

 

Type of EngagementCommunicationDescription
AuditIndependent Auditor’s ReportProvides a high level of assurance.
Provides a clear statement regarding whether the financial statements are prepared in accordance with GAAP.
ReviewReview Engagement ReportKnown to assess plausibility of the financial statements.
Moderate level of assurance.
No accumulation of evidence.
CompilationNotice to ReaderProvides zero assurance.
Simply a compilation of the financial statements and a check for arithmetical accuracy.

 

Related resources

This has been CFI’s guide to auditing. We hope you found it educational. For more information on auditing and accounting, the following resources will be helpful:

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