I keep hearing this term from my accountant friend and have absolutely no idea what it means. I tried googling it but that just left me even more confused than I was.
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Making sure the financial statements are free from material misstatements due to error or fraud, but they are not specifically looking for fraud. Also, making sure the financial statements are prepared using the generally accepted accounting principles (GAAP).
Example of poor auditing: [Adani had a handful of auditors as young as 23 years old signing off on companies worth $100 billion, Hindenburg says](https://markets.businessinsider.com/news/stocks/adani-young-auditors-23-years-old-100-billion-companies-hindenburg-2023-2)
With any kind of submission the people who receive it basically just look at the cover and go, “okay this guy owes this much tax, we trust him.” And there’s auditing for all sorts of things (efficiencies, safety, harassment, etc.). And with a regular report they just look at it and say “okay we trust that this is accurate.”
What an audit is, is looking in depth to make sure that everything adds up. They get copies of all invoices and receipts and do an independent calculation. If the two amounts add up everything is fine. If the two amounts don’t add up, there’s problems. Typically when an audit goes bad for the audited it’s because they tried to claim an expense that they aren’t allowed.
For example my sister-in-law was told by a friend of hers that she could claim her personal vehicle as a business expense if she leased it instead of buying it. It turns out, that’s not exactly true. The vehicle has to be used for business purposes and if it’s mixed use you need to break down the differences between work travel and non-work travel into the overall leasing cost, maintenance and use of the vehicle…. which she didn’t do (although I did tell her about it she just chose to ignore me).
At it’s most simple, making sure that money in matches money out. If there’s a mismatch, then an explanation is needed.
It means checking that things happened the way that you say they did.
At a high level, accounting audits check that you spent the money you said you spent, on the things that you said you spent it on, for the purpose you said you spent it for.
So, if I said “I spent $300 on print outs to advertise my new products”, and I spent $300, and it was on those print outs, and those print outs were to advertise my new products? That’s fine. It’s a business expense, there’s no problem here.
But if I said “I spent $300 on print outs to advertise my new products”, but the reality was that I spent $250 on print outs to advertise my new products, and pocketed $50? That’s a problem. It probably means that I claimed too many expenses for my business and I could wind up in trouble for expensing more than what’s reasonable on top of some minor accounting fraud.
If I said all that, and I spent the $300 on my personal car payment and there were no printouts? That’s also a problem.
If I said all that, and there were printouts, but the printouts were invitations to a party unrelated to my business? That’s also a problem.
Audits are there to confirm the truth of these sorts of claims. So the auditor might pick an expense, we show them the receipt, and if they have a reasonable need to dig further we might show them evidence of the product that the receipt was for.
Say you bought shares in a company. This means that when that company makes a profit, they give you a small part of it as dividends
This year, the company tells the shareholders that they didn’t make any profit and that they won’t be paying dividends. They release a report showing how their expenses are greater than their revenues as an explanation
Now, you’re astute and notice in the report that the company pays way more in salaries this year than it did in its previous reports despite seemingly not having more employees. That’s when you might want to ask for an audit to be done, to clear up why that is.
The auditors go in the company, dig in all of its documents to find the cause of the discrepancies, and maybe notice that the guy in HR is creating fake employees and pocketing the profits that should be going to you. Or maybe they find out that the cost of labour has just increased a lot this year, who knows until the audit is done.
That’s what an audit is in a nutshell : a fact checking process to make sure there’s no funny business, especially to enforce legal obligations (ex : the IRS will audit you if your tax declarations look suspicious).
In business (and in life), a fundamental problem is determining whether you can trust that a person and what they say is the truth.
An audit is an additional voice attesting to the truth, on the simple notion that the odds of two untrustworthy folks is lower than odds of just one person, particularly in the case where an auditor’s reason for being and reputation is trustworthiness.
You sit in a room while someone scrutinises errors and discrepancies, you explain that it was your fault and die a little inside. In my experience, anyway.
Another aspect I haven’t seen so far, is also the regulatory aspect of auditing, especially within accounting. It is often mandated by law, and a regulatory mechanism for the benefit of the government and broader society. At least in the EU, given the size of a company are required to be audited. Furthermore this audit have to be done from someone that has a license to perform audits. I also think accounting firms that do audits have to either educate their auditors or even be licensed to be an firm that can do auditing.
Companies have to report on various financial numbers and auditors make sure everything is correct. And if they report that their audit isn’t correct, then there can be major consequences for the company that doesn’t show healthy financial numbers.
And even more interestingly is that being audited is actually a service(expensive too) you pay for, but auditors have to comply with the law, so they can sometimes act not in the best interest of the client.
A few years ago, there was a major corporation that was technically insolvent, despite actually being profitable. The company disagreed with the auditors opinion, and kinda hired every major auditing firms, which in turn all came to the same conclusion, and the company was made insolvent due to the audit.
Auditing means someone is going to look at your math and check to see that you have filled in all the right forms and that you have receipts for everything you said you bought, and receipts for everything you said you paid for.
It basically means someone is going to check over your paperwork searching for mistakes because they think you either slipped up, or are cheating.
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