Purpose of an Audit
An audit is a systematic and independent examination of books, accounts, statutory records, documents, and vouchers of an organization to determine how far the financial statements present a true and fair view of the concern. The primary purposes of an audit include:
- Verify Accuracy of Financial Statements: One of the main purposes of an audit is to ensure the accuracy and validity of financial information provided by an entity. Auditors examine the entity’s financial statements and ensure that they are free of material misstatements, whether due to fraud or error.
- Ensure Compliance: An audit checks compliance with relevant laws, regulations, and accounting standards. For example, a tax audit verifies compliance with tax laws, while an environmental audit checks compliance with environmental laws and regulations.
- Improve Internal Controls: The auditing process often helps to identify weaknesses in an entity’s internal controls or systems. Auditors provide recommendations to strengthen these controls and improve efficiency and effectiveness.
- Increase Credibility: For public companies, an audit can increase the credibility and reliability of financial statements. This makes the financial statements more trustworthy for shareholders, potential investors, lenders, and other stakeholders.
- Detect and Deter Fraud: Audits can help to uncover fraudulent activity. By doing so, they act as a deterrent to individuals who might consider engaging in fraudulent behavior.
- Facilitate Decision Making: By ensuring the accuracy and completeness of financial information, audits help stakeholders make informed decisions. These stakeholders can include management, investors, lenders, and regulators.
- Risk Management: An audit can reveal areas of higher risk within an organization. This can assist in developing strategies and plans to mitigate those risks.
In summary, the purpose of an audit is to provide an objective independent examination of the financial statements, which increases the value and credibility of the financial statements produced by management, thereby increase user confidence in the financial statement, reduce investor risk and consequently reduce the cost of capital of the preparer of the financial statements.
Example of the Purpose of an Audit
Let’s consider an example using a hypothetical publicly-traded company, “TechEase Inc.”
TechEase Inc. is required by law and stock exchange regulations to have an annual audit of its financial statements. The company hires an independent external auditing firm to perform the audit.
- Verify Accuracy of Financial Statements: The auditors systematically go through TechEase’s financial records to ensure that the financial statements accurately represent the company’s financial position and performance. They ensure that revenue, expenses, assets, and liabilities are recorded correctly.
- Ensure Compliance: The auditors also check to make sure TechEase is in compliance with generally accepted accounting principles (GAAP) and any relevant laws or regulations.
- Improve Internal Controls: While performing the audit, the auditors find that TechEase does not have an adequate system in place to approve expense reports. They make a recommendation in their audit report for TechEase to improve this control to prevent possible fraud or errors.
- Increase Credibility: After a successful audit, the auditors issue an audit report stating that TechEase’s financial statements present a true and fair view of the company’s financial position. This increases the confidence of investors, customers, and other stakeholders in the company’s reported financial results.
- Detect and Deter Fraud: During the audit, the auditors use various techniques to detect potential fraudulent activities. Knowing the company is regularly audited also serves as a deterrent for individuals within the company who might be tempted to commit fraud.
- Facilitate Decision Making: The audited financial statements provide reliable information that TechEase’s management, board of directors, and shareholders can use to make informed decisions, such as whether to invest in a new project or how much dividend to declare for the year.
- Risk Management: The auditors identify areas of higher risk, such as reliance on a single supplier for a critical component. The company then uses this information to plan risk mitigation strategies.
In this example, you can see how the audit provides value to TechEase Inc. and its stakeholders by ensuring the accuracy of its financial information, improving its internal controls, increasing the credibility of its financial statements, detecting and deterring fraud, facilitating decision-making, and assisting with risk management.