Auditing - Explained
What is an Audit?
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Table of ContentsWhat is an Audit?How is an Audit Used?Types of AuditorsOversight, Rules and RegulationAcademics Research on Audit
What is an Audit?
An audit refers to the area that analyzes and evaluates the financial reports of a company so as to ensure that it keeps an accurate record of its transactions and business activities, and it gets reflected in the financial statements. Either the employees who are already working in the organization, or the auditors outside can audit its activities. The IRS can also conduct audits in order to ensure that the returns of taxpayers and business transactions are reliable and accurate. Generally, audits take place when the IRS has a negative or suspicious feeling about the activities of the taxpayer.
Back to: ACCOUNTING, TAX, & REPORTING
How is an Audit Used?
When external auditors perform auditing services for a company, it makes sure that there is no favoritism, manipulation or bias involved. It is the objective of the auditor to seek material error in any elements of financial reports. This further enables companys stakeholders to have accurate information about its financial standing that ultimately helps them in making better investment decisions. Be it companys financial transactions, income statements, a specific aspect, or the whole organization itself, the auditing done by a third party can be transparent and authentic. Also, it doesnt have any impact on the companys internal relationships. Usually, every organization gets its auditing done on a yearly basis. There can be cases where huge organizations receive audits every month. It is important for a few organizations to get its financial statements audited at regular intervals because of their tendency to manipulate information and conduct fraudulent activities. There are some public organizations where auditors assess how effective the internal controls with regards to financial statements.
Types of Auditors
In case of external auditing, auditors are divided into two different categories. The first category involves external or statutory auditor who assesses financial statements and performs auditing independently. The second category involves external cost auditors that deals with cost accounting based reports, and analyzes errors, or fraudulent activities. These auditors, working externally, have their own set of policies and auditing standards which differ from the standards of the firm that hired them. Internal auditors, as the name suggests, already work in the organization for which they perform auditing. In spite of being a part of the company, they analyze the accuracy of internal books, and further ensure to offer relevant information based on their audit to the companys board of directors, stakeholders, and managerial committee. Though consultant auditors are not the internal part of the organization, they consider using the companys auditing policies and standards unlike the external auditors who use their own. A company hires consultant auditors when they are unable to audit specific elements of their transactions.
Oversight, Rules and Regulation
Similar to many other nations, in the U.S., an audit needs to be in compliance with a specific set of adopted standards and policies as provided by the concerned authorities. The American Institute of Certified Public Accountant regulate the Generally Accepted Auditing Standards (GAAS) that are the standards governing external audits. Also, the International Auditing and Assurance Board regulate the International Standard on Auditing that involves a distinct aspect of global standards. The Public Company Accounting Oversight Board (PCAOB), founded in 2002, set rules and regulations for audits conducted in public firms.
Academics Research on Audit
- Auditor size andauditquality, DeAngelo, L. E. (1981). Auditor size and audit quality.Journal of accounting and economics,3(3), 183-199. Regulators and small audit firms allege that audit firm size does not affect audit quality and therefore should be irrelevant in the selection of an auditor. Contrary to this view, the current paper argues that audit quality is not independent of audit firm size, even when auditors initially possesses identical technological capabilities. In particular, when incumbent auditors earn client-specific quasi-rents, auditors with a greater number of clients have more to lose by failing to report a discovered breach in a particular client's records. This collateral aspect increases the audit quality supplied by larger audit firms. The implications for some recent recommendations of the AICPA Special Committee on Small and Medium Sized Firms are developed.
- The effect ofauditquality on earnings management, Becker, C. L., DeFond, M. L., Jiambalvo, J., & Subramanyam, K. R. (1998). The effect of audit quality on earnings management.Contemporary accounting research,15(1), 1-24.
- Auditcommittee, board of director characteristics, and earnings management, Klein, A. (2002). Audit committee, board of director characteristics, and earnings management.Journal of accounting and economics,33(3), 375-400. This study examines whether audit committee and board characteristics are related to earnings management by the firm. A negative relation is found between audit committee independence and abnormal accruals. A negative relation is also found between board independence and abnormal accruals. Reductions in board or audit committee independence are accompanied by large increases in abnormal accruals. The most pronounced effects occur when either the board or the audit committee is comprised of a minority of outside directors. These results suggest that boards structured to be more independent of the CEO are more effective in monitoring the corporate financial accounting process.
- The pricing ofauditservices: Theory and evidence, Simunic, D. A. (1980). The pricing of audit services: Theory and evidence.Journal of accounting research, 161-190.
- Current affairs inaudit, Johnson, R., & Ravlic, T. (2002). Current affairs in audit.