What is a financial audit?
A financial audit is when an auditor looks very carefully at a company’s financial statements and records. The auditor wants to make sure the company is following all the rules about how to keep track of its money. These rules are called accounting standards.
The auditor checks that the amounts in the financial statements are right, and that the company didn’t hide or forget anything important. This helps people trust that the financial statements are accurate and complete.
Two types of financial audits
There are two main kinds of financial audits:
- An internal audit is done by the company’s own employees. They are called internal auditors.
- An external audit is done by auditors from outside the company. They are called external auditors or independent auditors.
Why financial audits are important
Financial audits are super important because they help make sure companies are being honest about their finances. Without audits, companies might try to trick people about how much money they have or how well their business is doing.
For the company
Audits also help the company. The auditors might find ways the company can improve how it handles money. Maybe the company is wasting money somewhere or maybe there’s a smarter way to keep financial records.
For people outside the company
People who don’t work at the company really care about audits too. Like if you want to invest money in a company, you want to know its financial statements are true. Or if a bank is going to lend money to the company, the bank wants an audit to make sure the company can pay the money back.
The government also uses audits to check if a company paid the right amount of taxes. If there was no audit, the company might try to cheat on its taxes!
How an external audit works
An external audit is a big project with a bunch of steps. Here’s how it usually goes:
Planning the audit
First, the external auditors make a plan. They talk to the bosses at the company to understand how the business works. They figure out which parts of the financial statements need the closest look.
Testing the numbers
Next, the auditors do a bunch of tests. They might pick some numbers from the financial statements and trace them back to where they came from to make sure they’re right.
They also test the company’s internal controls. “Internal controls” are the ways the company tries to prevent mistakes or fraud with its money. The auditors want to see if those controls are working.
Finishing the audit
After all the testing, the auditors write a long report. This audit report says if they think the financial statements are right or if they found big problems. The report also suggests ways the company can get better at handling its finances.
The auditors have a big meeting with the company’s top bosses to explain what they found. Then the company publishes the final financial statements and the audit report where everybody can see them.
Internal audits vs. external audits
Even though internal and external audits both look at the company’s finances, there are some key differences:
Who does the audit
Internal auditors work for the company, but external auditors don’t. External auditors are independent. This independence is vital because it means the external auditors aren’t afraid to report problems. They don’t worry that the company’s bosses will get mad at them.
Why they do the audit
Internal audits help the company improve itself. They happen pretty often, maybe even every month. But external audits are mainly to give outsiders confidence in the company’s financial statements. They usually happen just once a year.
What rules they follow
External auditors have to follow super strict rules set by the government and professional groups. Internal auditors still follow rules, but the company gets to decide those rules.
The importance of auditor independence
For an external audit to mean anything, the auditors have to be truly independent. They can’t have any special money ties to the company. They shouldn’t be friends with the bosses.
If the auditors aren’t independent, they might ignore problems or help the company fool people with false financial statements. When that happens, it’s a huge scandal!
There have been some scary cases where auditors messed up bad. Like the Enron scandal in 2001. The auditors were too cozy with Enron’s bosses and let the company lie about its finances. When the truth came out, a lot of people lost money and the auditing firm shut down. It was a big disaster!
So audit independence is a big deal. Governments and audit professional groups have strict rules to make sure auditors stay independent. Breaking these rules can land an auditor in serious trouble.
