It is an examination of an organization's financial statements by a third party, as detailed in the annual report

Author: Austin Anderson
Austin Anderson
Austin Anderson
Consulting | Data Analysis

Austin has been working with Ernst & Young for over four years, starting as a senior consultant before being promoted to a manager. At EY, he focuses on strategy, process and operations improvement, and business transformation consulting services focused on health provider, payer, and public health organizations. Austin specializes in the health industry but supports clients across multiple industries.

Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.

Reviewed By: Hassan Saab
Hassan Saab
Hassan Saab
Investment Banking | Corporate Finance

Prior to becoming a Founder for Curiocity, Hassan worked for Houlihan Lokey as an Investment Banking Analyst focusing on sellside and buyside M&A, restructurings, financings and strategic advisory engagements across industry groups.

Hassan holds a BS from the University of Pennsylvania in Economics.

Last Updated:November 9, 2023

What is Auditing?

Auditing is an examination of an organization's financial statements by a third party, as detailed in the annual report. It is a thorough review and evaluation of a company's financial accounts to guarantee that they are accurate. 

Audits can be divided into internal and external. Company employees can perform internal types, and a CPA can perform external types. A certified accountant will review the various books and perform a physical examination.

This is done to verify that the organization's financial reporting is accurate. They can be applied to the entire organization or, specifically, to audits, typically company inspections. They are often undertaken promptly after the fiscal year's books are closed. 

When performed by a Certified Public Accountant (CPA), the CPA can remark on the financial statements' accuracy. This declaration is sent to the investment community along with the annual financial accounts.

An audit is necessary because it lends credibility to a set of financial accounts and assures shareholders that the numbers are correct. It can also aid in enhancing a company's internal controls and processes.

Key Takeaways

  • Auditing is the meticulous examination of a company's financial records by an external party to confirm their accuracy and reliability, providing credibility to financial statements.
  • Audits can be internal (conducted by company employees) or external (by Certified Public Accountants), serving different purposes such as error detection, fraud prevention, and compliance verification.
  • Auditors aim to verify the accuracy of financial records, prevent errors, and detect fraud. Their goal is to provide an unbiased opinion on the company's financial statements.
  • Auditing is vital for maintaining financial transparency, complying with accounting standards, and building trust among shareholders and stakeholders. It helps in identifying errors, preventing fraud, and ensuring the accuracy of financial information.

Audit Purpose

The study and verification of a company's financial records are referred to as an audit in accounting. Its purpose is to guarantee that financial data is correct and accurately portrayed.

Auditing is the on-site examination and evaluation of a process or quality system.

It might focus on a specific function, process, or production stage, or it can cover the whole organization. For example, it's done to confirm the accuracy of a company's financial records. It can concentrate on a single function, process, or stage of production or span the entire company.

Preparers can readily falsify their financial condition without sufficient controls and standards. The criteria defined by a government authority while analyzing the financial report must be followed. They should keep the following two key points in mind:

Importance of Auditing

Auditing is necessary to ensure that organizations accurately portray their financial status. Financial statements reflect a company's operating, investing, and financing operations. 

They are also carried out to check that financial statements are produced in compliance with relevant accounting standards. The following are the three most important financial statements:

  1. Statement of Profit and Loss

  2. Statement of cash flow

  3. Balance sheet

Internally, financial statements are created using appropriate accounting rules such as the International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP). They were created with the following users in mind:

  • Shareholders

  • Creditors

  • Entities of the government

  • Customers

  • Suppliers

  • Partner

Auditing objectives

The objectives are:

1. Primary objectives

An auditor must verify the accuracy of the books of accounts, vouchers, and other records to certify that the Profit and Loss Account discloses a true and fair view of profit or loss. As a result, the auditor should take the following steps:

  • First, verify the presence and value of firms' assets and liabilities. 

  • Check if all legislative obligations for preserving the book of accounts have been met.

  • Finally, check the books of accounts for mathematical precision.

  • To Provide an Opinion on Financial Statements

2. Secondary objectives

a. Detection and Prevention of Errors, and 

b. Detection And Prevention of Frauds. 

An error is an unintentional mistake in the books of accounts, while fraud is the intentional or willful misrepresentation of transactions by dishonest employees to deceive somebody. 

Thus detection and prevention of fraud is of great importance and constituents an important duty of an auditor.

Detection and prevention of errors: Auditing mistakes are accidental faults in financial data caused by a lack of accounting knowledge. The auditor must complete his job to find mistakes.

Detecting and avoiding mistakes is a critical audit goal since the target cannot be accomplished until the points are gained. Therefore, an audit's primary goal is to offer a report based on correctness, performance, and dependability.

To discover errors, the auditor should do the following tasks:

  • First, examine the trial balance total.

  • Then, compare the previous year's balance to the current year's starting balance.

Detection and prevention of frauds: Money laundering, cybersecurity concerns, tax evasion, faked insurance claims, counterfeit bank checks, identity theft, and terrorist funding are all examples of fraudulent actions. There are commercial and open-source versions of fraud detection and prevention software available.

You'll need to incorporate as many of the following characteristics as feasible for fraud protection and detection. Pay-per-API pricing provides the most flexibility because you may scale your fraud protection use in accordance with your company's development. 

Make sure your solution is simple to use and intuitive.

Auditor Responsibilities

The auditor's job is, to be honest, which means he can't certify something he doesn't feel is real, and he has to use reasonable caution and expertise before presuming what he certifies is correct.

A basic investigation will be enough if there is no reason to suspect anything; nevertheless, once suspicion has been aroused, additional monitoring is specifically required. Even if there is reason to suspect, an auditor is perfectly appropriate to accept the advice of an expert where particular knowledge is required.

Unlike a bloodhound, the auditor's main job is double-checking the client's finances rather than looking for evidence. As long as sufficient audit processes are followed, auditors are not accountable for future fraud discovery. 

Because he is appointed in accordance with the law's provisions, a company auditor is a statutory auditor. An auditor isn't a cop or a worker for a firm. He isn't a bloodhound, but he has to keep an eye on the situation.

Despite the fact that an auditor is not a business employee, the Companies Act treats him as one in many ways. He cannot be held guilty for non-detection of misstatements unless he was careless in his approach.

An auditor isn't a detective or a company employee. He's more of a watchdog than a bloodhound. The auditor's job does not entail looking for well-planned and executed schemes. Instead, he may count on the honesty and high level of trust in the company of the company's employees. 

The fact that an auditor's judgment exists does not imply that the books of accounts are accurate.

Types of auditors

Some of the types are:

1. Internal

Who are they? 

The audited organization employs internal auditors. They work in government (federal, state, and local) and non-profit organizations.

What do they do?

The scope is determined by the Audit Committee or a director with equivalent authority. The company manager initiates the process and is run by the team.

2. External

Who are they? 

This type is an independent company that provides an opinion on whether a company's financial statements are free of material misstatement due to fraud or error.

What do they do?

An unqualified or clean auditor's opinion provides financial statement users with confidence that the financials are both accurate and complete. In addition, it determines any material misstatements or errors in a company's financial statements.

3. Consultant

Who are they? 

An independent person in a corporation engages in reporting in line with the company's criteria.

What do they do?

They perform all basic operational and financial, internal control audits and consulting projects.

4. Government

Who are they? 

Examine government agencies' budgets and practices. 

What do they do?

The results are reported to Congress, which utilizes them to establish and administer policies and budgets.

5. Cost / Statutory cost

Who are they? 

Cost Controller is a legal company that is self-contained. These are cost calculators and specialists from India who are recognized worldwide as CMAs.

What do they do?

Inspections of a company's financial accounts and spending report to ensure no major misstatements, whether due to fraud or error. The customer commissions the cost auditor to determine if the company's finances are solid.

6. Secretarial/ Statutory secretarial

Who are they? 

An independent company hired by a customer to review secretarial and other laws/compliances with other applicable laws.

What do they do?

They provide an opinion on whether the company's secretarial records are free of major misstatements and comply with applicable legislation.

The table below depicts the Types of Auditors:

Type of Auditor Description
Internal Auditor Employees of the audited organization, conducting internal audits to improve processes, ensure compliance, and detect errors or inefficiencies.
External Auditor Independent Certified Public Accountants (CPAs) hired externally to audit a company's financial statements for accuracy, credibility, and compliance with accounting standards.
Consultant Auditor Independent professionals engaged by a company to conduct operational, financial, and internal control audits, offering consulting services to improve various aspects.
Government Auditor Examines government agencies' budgets and practices, reporting findings to authorities for policy-making and budget decisions.
Cost/Statutory Auditor Certified Cost Accountants evaluating a company's financial accounts and spending reports to ensure accuracy and compliance with statutory requirements.
Secretarial Auditor Independent entities hired to review secretarial records and ensure compliance with applicable laws and regulations regarding corporate governance

Types of audits

Some of the types are:

1. External

The external type is carried out by an independent party, such as a tax agency or the IRS

  • The key difference between an external and an internal is that an external is independent, and an internal is dependent. 

  • They determine any material misstatements or errors in a company's financial statements.

2. Internal

The internal type is used to help businesses make better decisions. 

  • They also guarantee that rules and regulations are followed and that financial reporting is correct. 

  • Before enabling external, auditors need to analyze the company's financial accounts; management teams might employ internal audits to detect defects or inefficiencies.

3. Internal Revenue Service (IRS)

These types ensure that a taxpayer's return and specific transactions are accurate.

  • When the IRS examines a person or a group, it usually has negative consequences and is seen as evidence of some form of wrongdoing.

  • There are three possible outcomes: no change to the tax return, a change accepted by the taxpayer, or a change the taxpayer disagrees with.

  • The selection formula is based on random statistics assessing and comparing a taxpayer's returns to similar ones.

4. Quality

These types are conducted to ensure the criteria are met by reviewing objective evidence. 

  • They are necessary to ensure objective evidence of compliance with the required process. 

  • You also need to provide evidence of the reduction and elimination of problem areas. It is a practical management method that helps companies achieve continuous improvement.

  • Other departments can exchange knowledge and thereby change their work process.

5. Project

This type allows you to find issues, concerns, and obstacles that arise during the project's lifetime. It provides the project manager, sponsor, and team with an intermediate assessment of what went well and what needs to be improved on future projects.

Regular and regulatory are available for projects.

  • A regular health check's goal is to understand the project's present situation to improve project success

  • Regulatory ensures that a project follows all applicable rules and requirements. 

  • Formal is when the sponsor agrees that an audit is necessary, the sensitivities are high, and findings must be supported by evidence. 

  • Informal ones can use the same criteria as formal ones, but no detailed or official report is required.

6. Performance

A government or non-organization's program, function, operation, or management system audit.

Security, information system performance, and environmental issues are all being scrutinized more and more. Security and information system are currently the focus.

7. Energy

Visual inspections, investigations, and analyses of energy flow inside a building, process, or system to lower energy use. The objective is to lower the amount of energy used in the system while maintaining the performance of a certain source (such as a gas or oil burner).

8. Operations

These look into anything that may be considered commercially unsound. The goal is to look at the three E's: effectiveness, efficiency, and economy.

9. Forensic

This type examines and confirms the financial records of an individual or company and collects evidence of the legal action. 

The expert witness may be a forensic inspector in a trial. Corruption, asset misappropriation, and accounting fraud allegations are examples of situations that require forensic investigation.

10. Process

This type examines compliance to established instructions or standards, as well as the efficiency of the instructions while evaluating an operation or procedure.

11. Product

This type is a thorough study of a product or service to see if it complies with specifications and performance criteria.

12. System

This one tests a management system's compliance with business rules, contractual obligations, and regulatory requirements. An existing quality management program is evaluated during a quality management system audit. 

Food safety system audits look at the food safety management system, whereas the environmental system looks at the environmental management system.

Phases in audit processing

The phases are:

Step 1:  Notification to the company or department

It begins with the firm or entity being reviewed and receiving notice. The aim, date, and time of the first meeting between the auditor and corporate management are frequently included in notices. In addition, articles of incorporation, recorded board minutes, organizational charts, postal orders, and other documents may be included.

Step 2: Planning and defining the objectives

Every review requires a strategy, beginning with defining the scope and objective and progressing through the creation of the processes to achieve the goal.

Auditors must also identify the primary areas of inquiry and concern and the precise data they want to review. Audit and management advisory services (AMAS) handle the pre-planning and information-collecting phases. 

In addition, the auditor looks into applicable rules and legislation and creates a basic program to follow. Finally, the planning phase involves management, with information documented in planning and scoping notes.

Step 3: Opening meeting

The client describes the unit or system to be examined, as well as the organization and resources available (people, facilities, equipment, and funds). The client must identify any issues or areas of concern. 

This meeting will be attended by management and any administrative personnel involved in the report. If more information is gathered, the analysis may be adjusted.

Step 4: Fieldwork

AMAS collects data and conducts evaluations to better understand internal controls. For example, we may conduct detailed transaction testing during the fieldwork. The fieldwork concludes with a list of key findings from which the auditor will draftreport'sort's the final draft.

Step 5: Drafting report

AMAS produces a formal report. This report is designed to advise top university administrators and managers about concerns and administrative flaws that have been detected. 

The aim and scope, as well as pertinent background, results, and recommendations for corrections or improvements are all included in this report. It might also include a list of open issues.

Step 6: Response from the management 

A draft report is sent to the administrator in the area for evaluation and response. The corrective action plan should be part of the management's response. Undeveloped corrective action plans are submitted annually to the President, Executive Committee, and Audit Committee. 

The final paperwork is handed over to management for review and response after the team makes final adjustments to the report.

All results and conclusions may be addressed in the document by indicating whether you agree with the expressed concerns, plans to fix any problems or defects found, and the date on which all problems will be fixed. 

Step 7: Closing meeting

AMAS will meet with the management informally once the fieldwork is completed to discuss observations and suggestions. This conference will include findings from various procedures not covered in the final report. Closing meetings are arranged to address any client issues or concerns.

Step 8: Final report

The final report will be sent to the university's president. Management is responsible for checking the integrity and correctness of concerns and recommendations. 

The Fiduciary Security, Risk, and Compliance Committee receive reports in distinct. To help, you could be requested to conduct a post-audit inquiry.

Step 9: Follow-up

Approximately six months after the report is produced, the Internal Audit Office will undertake a follow-up. Interviewing personnel and examining processes or records are examples of follow-up actions. 

A quarterly Institutional Audit Committee meeting will provide a summary of all outstanding findings.

First-party, Second-party, And Third-party audits

These are:

1. First-Party Audit

Internal audits are another term for first-party type. They are one of the most effective methods for a company to find areas where it can improve.

  • Internal audit, internal-EMS, operational, and incident are all related terms.

  • Someone from your company audits a procedure or collects processes in an environmental management system.

2. Second-Party Audit

A second-party audit is when a supplier is reviewed by an entity with which it already has a connection, such as a client.

  • Depending on the client's demands, the customer can review all or sections of the contract. They can be performed on-site by analyzing the supplier's procedures or records.

  • Suppliers, contracts, compliance, due diligence, and external stakeholder are all examples of second-party types.

3. Third-Party Audit

Audits conducted by third parties are fully independent of the firm.

  • They're just there to see if a business fits specific requirements.

  • They are conducted on an organization with whom the external organization has no direct contact.


The auditors examine financial statements such as income statements, cash flow statements, and balance sheets. In addition, investors and regulatory agencies use these reports to ensure the integrity of a company's financial reports.

When analyzing the financial report, auditors must conform to auditing criteria established by a government entity. Auditors complete their work by writing an audit report that summarizes their findings and expresses their opinion. All publicly traded and limited-liability corporations are audited once a year.

Other organizations may require or seek a review depending on their form and ownership. The scope is discussed with the organization, and the board of directors or management may request additional procedures.

Auditors retain their independence from management and directors to conduct objective tests and judgments. Based on the risks and controls identified, auditors determine the type and scope of processes to be performed.

Auditing extracts the auditor's independent opinion, which is vitally important for a company's management. The audit aids in the discovery and avoidance of mistakes and fraud. It also aids in the maintenance of records and the verification of books of accounts.

Audit FAQs

Researched and authored by Manal Fatima LinkedIn

Reviewed and Edited by Savan Sabu | LinkedIn

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