What is Auditing? Four Phases Of The Audit Cycle

Definition

The examination of the financial records of your business to verify their accuracy is called auditing. Auditing is performed by a systematic review of all the transactions of the business, and it looks at the financial statements, accounting books, and all the financial transactions that are made during the current fiscal year. Most of the businesses have one routine audit once a year.

As a business owner, you may be responsible for keeping a clear history of accounts in the accounting books which depict the income and expenses of your business. Audits are also useful in spotting problems within the company. Audits can help you find errors in the accounts, transactions which can also help you with decision-making. In the long run, an audit is expected to bring the business on track and improve the bottom line of the business.

The acceptable accounting standards are the ones that are compared with the transactions of the business. It is with them that the finances are examined and determined if they are within limits or not.

There are individual auditors for performing business audits. Some companies have internal auditors who are nothing but internal employees of the organization who keep the record of all the financial transactions while other companies may hire external auditors for performing the auditing.

In many countries, the law mandates to have external auditors for public companies. External auditors have a reputation of giving unbiased auditing reports and remain uninfluenced.

Types of Auditing

There are mainly three types of audit:

1. Process Audit

This is the type of audit that is concerned with the verification of processes and their workings. The process audit determines whether the processes are working within limits or not. It helps to establish and evaluate the operations and methods which are predetermined or the standards which are used to measure the conformance.

The process audit may check the process for different variables like accuracy, time, pressure, temperature, responsiveness, etc. anything related to the process.

The process audit also examines the available resources like people, equipment, materials that are applied to transform the raw material into finished material that is inputs into outputs, the related environment, and the procedures that are followed.

The process audit may also check the effectiveness and adequacy of the processes that are established by the company, including the instructions for work, the standard operating procedures, flowcharts, and training processes.

2. Product audit

This is the type of audit in which the examination is done of a specific product or a service that can be hardware, the end material, or software. This audit is done to determine if it conforms to the specifications and the performance standards set out by the company.

The expectations of the company are documented initially before starting the production. All the specifications regarding the product like its color, height, weight, consistency, and all other measurable parameters are determined before the production process. After the production process, a random product selected and compared with the given standards and checked if it passes the test or not.

3. System Audit

The audit, which is conducted at the management level, is called a system audit. It is a documented activity done to verify evaluation and examination of the elements of the system that are adequate and appropriate and are documented, developed and implemented according to the specified requirements.

A quality management system audit is the one that refers to and evaluates the existing quality management program.

On a similar basis, an environmental audit is conducted which examines and evaluates the environmental management system, a food safety system audit is the one which examines food safety management system, a sales audit examines sales procedures.

The different types of audit can also vary on who conducts the audit

4. First Party Audit

This audit is performed within the organization to measure its strengths and weaknesses. It is done against its methods of procedures against the external standards which may be imposed by or adopted by the organization.

Internal audit is also classified as a first-party audit in which the audit is conducted by the auditors who are on the payroll of the organization. Although they are on the payroll of the organization, they have no interest in the audit results.

5. Second-party audit

Usually, an external auditor performs is the second party audit like a customer or supplier. The organization contacts him. There is usually a contract, and the goods and services are delivered. The contractual rules are strict in case of second party audits as they provide the contractual direction to the supplier from the customer.

Usually, the second party audits are more formal than first-party audits because the results of second party audit can influence the entire decision of customer purchasing.

6. Third-party audit

A third-party audit is usually performed by an organization that is entirely independent of the customer-supplier relations. It is free of any conflict of interest and is independent. The independence of the auditing firm is one of the primary features of a third-party audit.

There is a formal registration, certification, recognition, license approval, and many other steps or even a penalty for the audit reports issued by third-party organizations.

To read more, you can see our complete article on Types of Audits

Four phases of Audit

An audit cycle usually goes through four stages and is standard for most of the industries. However, few steps may change or differ or be modified based on the company or requirement of the auditors. Following are four typical phases of an audit cycle:

1. Audit planning

This is the first step of the audit cycle in which the preparation consists of planning everything. This is usually done in advance by the interested parties. This can be done by an auditor, the lead auditor, the audit program manager, the client himself or a combination of any of these so that the audit compliance with the objectives of the client.

The necessary approvals, if any, are taken, and the information is provided to the party being audited. Sometimes no information on auditing is provided to the party being audited, and a surprise audit will be conducted.

However, these incidences are very less and are usually third-party audits. This stage of audit planning begins with the necessary approvals and decision to conduct an audit and ends with the beginning of the audit itself.

2. Audit Execution

The execution of an audit is often referred to as fieldwork. It is the phase in which there is the data gathering for audit and covers the entire period right from arrival at the audit location up till the exit meeting.

Many activities are included in audit execution, like meeting with the auditee, understanding the requirements and Processes, and verifying the process against the standard operating procedure. It also provides communication with other team members and the party being audited

3. Audit report

Audit reports and is one of the crucial steps in which the results are communicated. The results may be communicated to the person expecting the audit or requesting it. The report is usually issued in the name of the lead auditor after a few follow up processes are completed.

The audit report must be sent to whoever has requested the audit, including the third-party auditors.

4. Audit follow-up

The audit is only completed when all the planned activities during auditing are completed. This or if the client agrees the audit is completed, then the audit is declared as completed.

The final step of audit follow up is to have a proper closure in which the corrective action as suggested, and improvement or plan of action is also given.

Advantages of Auditing

Following are a few types of audit which are based on who conducts it

The audit can be external or internal or even the company audit, but it has many advantages. Following are a few of the benefits of performing a business audit:

1. The primary function of an auditor is to check the audit for its accuracy. As a result, there could be many errors that can be found out by the auditor in your daily accounting processes.
2. The auditor may be able to spot a tiny mistake and help you fix it before it turns out to be a big one, which could cost your company a lot of money. Non-IRS audits can help you catch and correct errors in your audit before filing tax returns.
3. New accounting processes can be implemented because of auditing. If the auditor is not able to understand your account is clearly, then he can help you to maintain and improve the auditing records for the next audit.
4. The incorporation of new accounting software is will also help you to prevent many errors and complete the incomplete records.
5. Most of the businesses follow the procedures of relying on financial statements like balance sheet, cash flow, fund flow, and other financial reports to help them with business decisions. But there could be a possibility in which the errors have crept down into the statements. The auditors help you to find and fix these recording errors so that your reports can be straightened out, and your decisions can be reliable.