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An auditor investigates a company's finances and operations to determine whether the company's records are accurate. In most cases, a CPA or certified auditor conducts an audit. If you are a business owner facing an audit, understanding how audit evidence is gathered can help you prepare for your upcoming audit. If you go through your records and company operations before the auditor arrives, the audit process may run more smoothly.[1]
EditSteps
EditExamining the Records
- Review records for completeness. All spaces of a financial ledger or form should be filled in, and each entry should have a verifiable date. If any spaces are blank, there should be some notation or explanation as to why the information wasn't filled in.[2]
- For records of meetings or interviews, the entry should include the action that was taken as a result and any other follow-up actions that were taken later.
- Include the names of anyone involved in an entry, and their role in the company, if applicable. For example, if you have a list of deposits made into an account, each entry should include the names of the managers or employees who made the deposit.
- Compare account balances and transactions to banking records. Financial ledgers are attached to a business banking or investment account. The company's ledgers should reconcile against the bank's records.[3]
- In some cases, further investigation may be required. For example, if the company's records note a $1,000 sale to a client, but only $500 was deposited into the company's account, the auditor might contact the client to find out how much money the client paid and when.
- Get recent bank statements and compare the company's records to the bank's records. If there is a discrepancy, mark the transaction and determine why the records are different. If you can identify the reason for the discrepancy in advance and correct your records if necessary, it will save the auditor some time and effort.
- Test the effectiveness of internal financial controls. Inadequate controls leave room for error as well as an increased risk for theft or fraud. Make sure all financial software is up-to-date, and use complex passwords that are unique to each user. Make sure passwords aren't left lying around for anyone to use.[4]
- The auditor will keep an eye out for any holes in the company's financial security that could be exploited. When information about these type of security risks show up in an auditor's report, it is an opportunity for the company to take steps to close those gaps to protect the company as well as its customers.
- Reconcile debt computations with lenders. If your company is carrying debt, pull statements from the lenders and make sure the interest rates and principal owed match your company's books.[5]
- The auditor will also evaluate who approved the debt, any mention of the debt in company meetings, and whether all debt payments are made in full and on time. Make sure these records are clear and available to the auditor.
- If the company leases work or office space, the auditor will also evaluate the lease agreements and make sure those obligations are being fulfilled according to the terms of the contract.
- Recompute and evaluate expenses. Pull receipts, expense reports, and other expense records and determine their accuracy and legitimacy as business expenses. Unusual items or overly large transactions may be subject to additional scrutiny.[6]
- For example, if a company usually has $800 in utility expenses each month, and one month the expense report notes $8,000 for utility expenses, the auditor would reach out to the utility companies for confirmation of the amount and determine why that month was excessive or if the amount was listed in error.
EditSeeking Confirmations of Transactions
- Send letters to customers and vendors for repeat transactions. For particularly large or out-of-the-ordinary transactions, write or call and confirm the amount and details of the transaction. Ask the customer or vendor what their records say rather than simply reading your record and asking for confirmation.[7]
- For example, if the company pays $2,500 to a particular vendor every month, and then in February the company's records show it paid that vendor $7,500, you could contact the vendor and ask what their records showed your company paid in February. If the amount is correct, ask for a detailed statement that could help you figure out why the bill was so high. If the amount is incorrect, adjust your books.
- Verify supporting information for complex account balances. For some transactions, it makes more sense for the auditor to verify supporting information, such as rates, and then recalculate the total that should be there.[8]
- For example, suppose there's a question about 401(k) withdrawals from employee paychecks. You can verify the rate of those withdrawals from employees, then recalculate the amounts that should have been withdrawn. Compare those calculations to the balances in the employees' 401(k) accounts.
- Analyze market data to confirm financial statements. Particularly if the company trades securities on the open market, look at market data to determine whether your valuation in company financial statements is accurate.[9]
- For example, if the company has invested in securities and plans to sell them in 2 years, you could analyze the prevailing market price and performance of those securities to determine their book value.
- Check the terms of unusual transactions. Confusing or unusual transactions may raise flags for auditors, since they indicate a higher risk of fraudulent activity taking place at the company. Identify these transactions in your books and talk to customers or vendors to figure out what was going on.[10]
- For example, a transaction for the purchase of a large amount of products, followed nearly immediately by a return of the proceeds of that sale to the customer without a return of product, might raise audit flags.
- Use intermediaries for related-party transactions. If two managers, company officers, or employees are involved in a transaction, the auditor typically uses third-party records, if available, to confirm the transaction was above board. If you know those records exist, you can go ahead and request them to justify the transaction.[11]
- The auditor will seek out audit evidence from any intermediaries, such as banks, agents, or attorneys, to confirm the business rationale and terms of the transaction.
EditInspecting the Premises
- Verify the existence of assets through physical inventory. Something may be listed in the books, but that doesn't mean it's actually present. Particularly in a retail sales environment, regular inventory enables you to correct the books through the auditing process.[12]
- Notes and photos, as well as inventory records, help document this evidence.
- Observe how broken or expired product is disposed of, and which employees have responsibility for marking down that product for the records.
- Interview employees about policies and procedures. Employees may be questioned generally about policies and procedures, or asked specific questions about particular transactions that have raised red flags. While an employee interview on its own may not constitute objective, reliable audit evidence, it may point to other evidence or information.[13]
- Employees in financial and managerial roles in particular should expect to have conversations with the auditor throughout the auditing process.
- In more serious situations, the auditor may submit written questions to employees so that their responses are preserved in writing.
- Look for uncontrolled documents or nonconforming products. Random documents or notes posted on walls or machines may indicate an alternate procedure that doesn't exactly follow policy or that presents security concerns. The same is true for products that aren't kept or stored where they're supposed to be.[14]
- For example, if an auditor of a retail store found piles of product hidden behind a desk in the office rather than out on the sales floor, they would want to determine the status of those products and why they were being segregated from the rest of the inventory.
- Notes taped to machines may indicate that something isn't working properly and needs to be repaired, or that staff members have not been properly trained on how to operate the machine. These random notes become a part of basic policy and procedure, even if their message isn't communicated through standard channels.
- Note poor cleaning or improvised repairs. Walk through the workplace and look for machines or fixtures that have been temporarily "repaired" by employees using duct tape or shims. Implement proper maintenance procedures before the audit to make sure everything is clean and in working order.[15]
- If a workplace is messy, it may indicate that there's a larger issue, or that a problem isn't being adequately addressed. This can raise red flags for auditors.
- Machines and fixtures are business assets that require regular maintenance to live out their service life. If these assets aren't being cleaned, repaired, and maintained properly, the company could lose money.
EditTips
- It's a good idea to stay on top of these processes even when you're not facing an audit. This will help you maintain good operational safeguards that will protect you in the event of an audit and make the process go smoothly.
- Actively look for positive evidence of things the company is doing right. The audit report will be better received if the auditor can point to practices or policies that are working.[16]
- Make notes in audit reports as specific as possible, so the company can implement new policies and procedures to address the problem.[17]
EditReferences
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