What Is Auditing? Definition and Types

Auditing involves closely reviewing business processes and documents, such as financial statements to ensure accuracy in reporting. Individuals, small businesses, and large corporations go through audits, which auditors conduct either internally (by auditors employed by the company itself) or externally (by accounting firms). 

What Is an Audit?

Auditing means investigating — audits can be simple reviews of specific company processes or large-scale independent examinations of an organization’s finances. In accounting, an audit usually involves looking at an individual’s or company’s financial records and determining if they’re accurate. 

For large corporations and public companies, proving accurate financial reporting is vital — investors, lenders, and government entities rely on a company’s financial statements to make informed decisions. If a company lies about its situation, the consequences can be far-reaching: investors lose money, and the company may face legal action for committing fraud. Additionally, if a highly influential public company commits fraud, it can sway the market as a whole.

Who Handles Audits?

An auditor conducts an audit, though the type of auditor differs depending on the type of audit. For example, auditors and accountants who are employees of the company itself often conduct internal audits. On the other hand, certified public accountants (CPAs) complete external audits through accounting firms like EY and KPMG. These external auditors are independent of the client they’re investigating. 

However, clients are encouraged to participate in the audit — the auditing process can run smoothly if companies and individuals cooperate with the auditing team, regardless of if the audit is internal, external, or through the Internal Revenue Service (IRS). Companies, clients, and individuals typically know about audits before they begin, so preparing the necessary documentation beforehand can make the auditors’ lives easier. Additionally, clients should always ensure accuracy when initially creating and filing financial statements to avoid messy or complicated audits.

Types of Audits

The three main types of audits are internal, external, and IRS tax audits. 

Internal Audits

An internal audit reviews a company’s structure and accounting processes to ensure accurate collection and reporting of financial data. During an internal audit, companies can also look at how effectively areas of the business are performing. 

Internal audits are performed by a team selected by the company, which can lead to more fluid communication about the auditing process, findings, and recommendations. A company will most often use an internal audit for internal purposes: assessing the company’s corporate structure, business goals, strengths, and weaknesses.

External Audits

External audits involve investigating similar aspects to internal audits. However, independent auditing teams perform external audits. These auditing teams are typically financial services firms like PwC or Deloitte. While companies can choose which firm to work with, they can’t control who’s on the team, ensuring an unbiased approach to the auditing process. 

External audits are often required for public companies and to show investors and lenders that the organization is accurately reporting its financial information. A certified public accountant (CPA) conducts an external audit to verify all documentation.

IRS Audits 

In an IRS audit, government-employed auditors review a company’s or individual’s tax filings. Although being audited by the IRS may sound like a bad thing, the IRS often randomly selects people and companies to audit. These random selections help the IRS set baselines for what a “normal” tax return looks like. 

However, the IRS may audit some individuals and organizations because of discrepancies or red flags found during the filing process. Additionally, if a company is audited, any business partners of that company will likely be audited too.

Other Types of Audits

Because an audit is simply an investigation, countless processes are up for auditing within a company. For example, a company can audit a specific department to ensure everything works as it should. 

Certain companies may face compliance audits, too, which determine how well a company is adhering to government regulations and standards. For instance, a large farming company may need to be audited by the U.S. Department of Agriculture to ensure the farm’s processes follow standards set by the department. 

Forensic audits are a special class of audits performed by forensic accountants that seek to determine if intentional fraud, theft, or inaccuracies exist in a client’s financial records. 

>>MORE: What Is Forensic Accounting?

What Is the Auditing Process?

Each audit is slightly different — no two clients are the same, so the exact process for one client may differ from another. However, audits generally follow a four-step process: research and planning, fieldwork, summarizing and reporting, and follow-up. In an audit, the term client describes the company or individual being audited, regardless of the audit type. 

Research and Planning

In this stage, auditors notify the client about the audit and explain the general plan. The auditor also begins gathering information about the client, such as their internal control design — how the company operates and what risk areas exist. 

Meetings between the auditor and relevant client employees help the client understand what’s happening and give the auditor a clear picture of the company as a whole.

Fieldwork

Fieldwork involves diving deep into a client’s documentation. The auditor tests these documents to make sure the information is correct and that the company’s system for recording and reporting transactions (and its internal control design) is working correctly. 

Some of the key documents auditors review include:

• Financial statements like balance sheets and cash flow statements
• Organization charts
• Questionnaires filled out by the client
• Flowcharts detailing the client’s transaction reporting processes 

Auditors document fieldwork findings in working papers, which detail the information reviewed to support an auditor’s final recommendations to the client.

Summarizing and Reporting

Once auditors complete their fieldwork, they summarize their findings, detailing any major concerns and recommendations for improvement. The client receives an audit report explaining the results, and both the auditing team and the client meet to discuss the report’s details. The report also includes guidance for resolving any issues.

Clients should respond to the report explaining plans to fix the problems found in the audit and giving an approximate time frame for this process.

Follow-Up

Auditors periodically review their final reports to ensure clients are appropriately addressing any issues. An auditor creates follow-up reports that include any unresolved issues and the client’s plans to fix them. 

>>MORE: Accelerate Your Career With the Top Audit Job Simulations on Forage

Showing You Understand Auditing on Resumes

The first place you can mention your experience with auditing is in the skills section of your resume. Here, you can list skills like: 

• Performance of internal audits
• Financial auditing
• Tax auditing 
• Financial account analysis
• Knowledge of federal, state, and local tax regulations

In the description of relevant work or internship experiences, highlight key instances that show your auditing skills. For example, you can mention if you participated in an external audit that resolved a company’s reporting issues before any big problems arose. You can also explain a school project or internship that involved completing mock audits and ensuring adherence to federal tax regulations. 

Related Skills for Finance Careers

Accountants, auditors, and finance professionals need to be familiar with financial statements, especially to conduct and help with audits. Other skills that can make auditing an easier process include: 

• In-depth knowledge of the generally accepted accounting principles (GAAP)
• Understanding how assets and liabilities work in a company’s finances 
• Knowing the types of expenditures
• Familiarity with vital formulas, like the accounting equation

Check out more accounting skills you need for your resume.

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