What is Auditing in Accounting?

Trying to prepare for an audit? An auditing accountant can help.

The specter of an audit often dangles over the heads of small to midsize business (SMB) leaders. Many decide to pursue external solutions instead of waiting for the blade to drop: 44% of decision-makers use service providers because they lack the bandwidth even though they have the talent in-house. 

But the process of hiring the right accountant can be easier said than done, especially when it comes to managing the auditing process. To start, what are the differences between auditing and accounting, and what does an audit accountant actually do?

What is an audit?

In some cases, however, an audit can be conducted in-house to check if operational or financial procedures are being followed as intended.

Your business can also be audited as part of a merger or acquisition process. The other party may want to ensure that your cash flow, debts, accounts payable and receivable, and other financial factors are sound before moving forward.

An audit can be a powerful tool for an SMB because it can reveal issues that may have gone unnoticed. This is especially true when a company decides to conduct internal audits on a regular basis. For instance, you can perform an audit to check the soundness of your accounting procedures and whether expenses and revenues are being properly incorporated into accounting or business management software.

Regardless of what happens during an IRS audit or any other kind, the result is visibility—into important financial information for you or an external entity.

What does an auditor do?

What does an audit accountant do? An auditing accountant assesses the accuracy of financial information. This applies to both internal and external audits. But their process typically breaks down into the following steps:

• Planning for the audit: During the planning phase, the auditor investigates the company's operations and figures out what the audit's objectives should be. They will also determine the scope of the audit and plan out execution.

• Collecting artifacts: Auditors then proceed to collect evidence. These typically include financial statements and other documents, such as receipts and order information.

• Verification of financial information: The auditor will then test and verify whether the documentation or previous claims, such as those made on tax returns, are accurate. This may involve comparing stated revenue with what records show or checking whether depreciated assets are actually held by the organization.

In some cases, however, an auditor can dig deeper. For instance, they may assess the internal financial controls the company has in place. They may examine how sales are entered into the accounting system using automated or manual means. They might also inquire about how the company collects receipts of purchases made by employees or managers.

During an internal audit, the auditor will also perform a risk assessment. This focuses on elements in the organization's business environment that could negatively impact its financial performance.

For example, if the audit reveals that a large portion of sales come from a product built with an expensive natural resource, the auditor may surface this as a potential risk.

Auditing vs. accounting

Even though accountants frequently perform audits, auditing and accounting are very different. Accounting involves generating financial records, while auditing involves checking them. This is also why accountants often make good auditors—they know what to look for and when something appears problematic.

But auditing and accounting have a lot in common as well. They both deal with the accuracy of financial records and how a business incorporates financial data into its other systems.

This is why, for some companies, it's feasible to turn an internal accountant into an auditor. In this way, your business can avoid the expenses associated with teaching an external auditor the ins and outs of your financial system.

At the same time, by using an internal person to perform your audits, you may be flirting with a conflict of interest. In other words, an internally-sourced auditor may have a personal investment in the success of your organization or some of its employees. So they may hesitate to reveal important information—or they may choose to minimize problems caused by a friend of theirs.

Types of auditing in accounting

The importance of auditing in accounting cannot be understated, especially because a thorough audit can reveal major issues. But there are different types, including government audits for the IRS, internal audits, and external audits.

IRS audits

IRS audits involve examining a taxpayer's records and returns to make sure they abide by tax laws. The objective is to ensure the taxpayer reports all income, deductions, and credits accurately. Here's how an IRS audit works, step by step:

1. Notification: The IRS sends a letter to you or your business regarding what they plan to audit.

2. Examination: The IRS reviews your financial records and any evidence you have to support them. This involves looking at bank statements, invoices, receipts, and other documentation.

3. Additional information request: The IRS may ask for additional information from you as well, giving you a timeframe in which to provide what they're looking for. This may include additional receipts, bank statements, or sales orders.

4. Interviews: You may be asked to explain what the auditor found. For instance, if there's a discrepancy where sales orders far outpace your reported income, the auditor may ask for clarification. Perhaps it's due to pending payments or some other legitimate reason.

5. The proposal of adjustments: After concluding the investigation, the IRS will recommend adjustments to your tax liability, if necessary. They may require that you pay additional taxes as well as a penalty and interest. The investigation may also reveal that you're entitled to a refund.

Internal audits

The importance of auditing from an internal perspective can't be overstated. Internal audits may be less daunting but are often no-less formal or thorough. Sometimes businesses use an internal audit to dig deeper into an issue they noticed. In other cases, an internal audit is a pre-emptive step to prevent a more costly or embarrassing IRS or external audit.

As mentioned above, a merger or acquisition may also trigger an internal audit. The company may need to get a better understanding of what they are worth, its obligations, and its assets, and an internal audit can produce reliable data the organization can use during negotiations.

External audits

External audits follow many of the same steps that the IRS undertakes—at least at a high level—but the objectives are usually very different. Here are some things an external auditor may look for:

Accurate accounting records to ensure there's no fraud happening in your organization.

Records of investments and their returns so investors can evaluate the performance of your assets.

Discrepancies in complying with financial record-keeping requirements, such as for publicly traded companies.

Effective internal financial controls. For example, an auditor may be hired to examine how the company spends discretionary income or purchases components used for manufacturing.

The information external audits reveal is often valuable to the company itself, which may order an audit just to be sure the results aren't tainted by internal bias. In many cases, an external audit is part of the business purchasing process when one entity is considering acquiring another. This helps verify the value of the company they're interested in.

What triggers an audit?

Tax audits are among the most common kinds of audits that companies hire accountants to manage—and avoid. What triggers tax audits? A tax audit may be triggered by a company appearing to underreport its tax obligations. For example, if your tax returns indicate a refund that doesn't align with expected revenues or expenses, the IRS may decide to audit your company to check the accuracy of your tax filing.

Is it worth it to hire an auditor?

As you can see, an audit accountant can be a powerful tool in helping your company prepare for, execute, or manage an audit. By hiring an audit accountant and having them oversee your accounting department, you can improve your chances of passing an external audit or one issued by the IRS.

But an audit accountant can be equally valuable when assessing your organization's financial health. You get a thorough investigation into the accuracy of your records, financial performance, or anything else you'd like to see under a microscope.