What is an Audit
Audit. Do you panic when you hear that five-letter word? You might think an audit is the last thing your business needs, but they aren’t always bad. Regular audits can be more like a routine maintenance check than an invitation for IRS penalties.
As a business owner, you always need to be ready for them—this means having your company’s financial house in order. As a small business owner, you are responsible for maintaining clear accounting books that show your business’s income and expenses. If your records are disorganized or missing, audits will be especially drawn out and difficult.
What’s an Audit’s Purpose?
The purpose of an audit is to form a view on whether the information presented in the financial report, taken as a whole, reflects the financial position of the organisation at a given date, for example:
- Are details of what is owned and what the organisation owes properly recorded in the balance sheet?
- Are profits or losses properly assessed?
When examining the financial report, auditors must follow auditing standards which are set by a government body. Once auditors have completed their work, they write an audit report, explaining what they have done and giving an opinion drawn from their work. Generally, all listed companies and limited liability companies are subject to an audit each year. Other organisations may require or request an audit depending on their structure and ownership.
Auditors don’t do everything, though. Audit’s don’t:
- Audit other information provided to the members of the organisation, for example, the directors’ report.
- Check every figure in the financial report – audits are based on selective testing only.
- Judge the appropriateness of the organisation’s business activities or strategies or decisions made by the directors.
- Look at every transaction carried out by the organisation.
- Test the adequacy of all of the organisation’s internal controls.
- Comment to shareholders on the quality of directors and management, the quality of corporate governance or the quality of the organisation’s risk management procedures and controls.
Types of Audit
It’s not just audits conducted by the IRS (or your country’s central tax authority) that you need to know about, though. There are other types.
1. Internal audits
An internal audit is initiated by you and conducted by someone within your business. You might have someone conduct an internal audit to prevent financial mistakes and check in on company goals.
Internal audits don’t just look at your business’s finances. They can examine business operations and management to make sure everything is functioning efficiently.
If you have board members or shareholders, you might conduct an internal audit to update them on your finances.
2. External audit
An external audit is performed by a third party, like an insurance company, local tax agency, or the IRS. External auditors must follow auditing standards known as generally accepted auditing standards (GAAS).
Some external auditors might want to look at the complete picture of your business’s financial records while others may examine specific aspects of business operations.
Audit reports prepared by external auditors are written using generally accepted auditing standards.
3. Tax authority audits (e.g. IRS, HMRC, etc.)
A tax authority audit might take place due to a discrepancy on your small business tax return. Or, your business might randomly be selected for an audit.
If you are being audited by a central tax authority, you will first receive a notice in the mail. Tax authority audits are conducted either by mail or through in-person interviews. In the event of a tax authority audit, you should respond promptly and seek the guidance of a tax professional.
Preparing for an Audit
So, what happens if you get audited? Before an audit, you need to get your financial records in order. Theoretically, you should always be prepared for an audit. You should have an audit trail so you can prove where your numbers come from and auditors can easily trace your transactions.
Organize your financial documents so the auditors can easily access records and get a clear view of your business. Organize records chronologically.
Bring financial records like bank statements, credit card statements, receipts, invoices, and journal entries. Your auditor will use the records to test for accuracy and discover errors. The more information you provide and the more organized you are, the faster the audit process.
Proper financial management, e.g. by using a robust accounting tool such as Holded’s, will always ensure that you are prepared.