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What is an Audit?

Mary McMahon
Updated May 16, 2024
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An audit is an accounting procedure under which the financial records of a company or individual are closely inspected to make sure that they are accurate. Many American taxpayers fear an Internal Revenue Service audit, while dishonest companies fear independent audits of their business practices which may reveal embezzlement and other misuses of funds. This review keeps a company honest and also reassures employees and investors as to the financial status of the organization. There are two primary types: internal and independent audits.

Regardless as to the type of audit, it should be assumed that the procedure will be performed without bias. In the case of an internal audit, this can be difficult, because it is carried out by the accounting staff of the company concerned. Generally, this type can only successfully be carried out by a large accounting department, because auditors cannot audit records to which they contributed. Internal audits are usually carried out on a regular basis by large companies to ensure that their finances are in order, and if the company is publicly traded, the reports are available for inspection by stockholders.

An independent or external audit is carried out by a neutral third party, such as a professional accounting firm which specializes in the procedure. In both cases, all of the financial records of a company including ledgers, bank statements, payroll, tax information, internal financial reports, official published reports, accounts payable, and accounts receivable, will be examined. During the audit, these records are closely inspected for any discrepancies, and if an inaccuracy is uncovered, it must be addressed and repaired.

Commonly, an audit will reveal a simple accounting mistake. In other cases, more sinister issues may come to light. Companies that are struggling financially may choose to make unsound financial decisions in an attempt to salvage the company, and these decisions will be revealed by a close audit. Sometimes the review will reveal that a company is on the brink of bankruptcy due to gross misuse of funds by high ranking personnel, as was the case with many American corporations in the early twenty first century such as Enron and WorldCom.

When an inaccuracy is revealed by an independent audit, it is addressed by the auditors in the final report made to the company. In some cases, the review will be ordered by an external organization, such as the Securities and Exchange Commission, which will also receive a copy of the report. The issue must be repaired by the company. Common examples of repairable errors are failure to pay payroll taxes to the Internal Revenue Service, or misuse of pension plans. If the errors cannot be fixed because the company does not have the funds to address them, the company may face bankruptcy proceedings, and major creditors will be reimbursed after the company's assets are liquidated by an independent firm.

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Mary McMahon
By Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

Discussion Comments
By anon279641 — On Jul 13, 2012

I would like to know what time period should a city audit cover? Also, what audit work papers are needed by the auditor?

By anon158397 — On Mar 07, 2011

Audit is not necessarily related to finance. Many industrial processes can be audited, eg. to make sure health and safety procedures are being correctly implemented to ensure safety of workers.

By anon64786 — On Feb 09, 2010

I use a large, well-known tax preparer. With their prep I claimed my annual expense reports totaling $20,000 as not reimbursed, when if fact they were. What should I do to rectify or straighten this? I discovered this exactly one year later.

By anon26684 — On Feb 17, 2009

the information posted on your site is so easy to understand

thank you

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a...

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