A Guide to Successful Financial Audit of Small Businesses
Audits provide invaluable information to a company. When the activity is carried out properly, it helps business owners to discover accounting issues related to the business. A proper audit ensures that the accounting information is accurate and without any errors.
Businesses of all sizes can benefit from an accounting audit. A thorough audit can help in identifying any issues regarding the internal controls and processes for recording accounting data.
What’s Involved in an Accounting Audit?
A lot of business owners are intimidated by the process involved in an accounting audit. The name of an audit brings stress to a lot of business owners.
But the fact remains that an accounting audit has nothing intimidating about it. An audit simply involves the examination of the accounting statements and records of a company.
Accountants who specialize in auditing accounts thoroughly examine the accounting records to ensure they comply with the generally accepted accounting principles (GAAP) and relevant regulations. Our outsourced bookkeepers can work with your auditors to complete the audit.
Knowing about the process of an audit will allow you to keep everything in order so that the process remains smooth and timely.
How Your Company Can Benefit from An Audit?
Your company can benefit from an audit in a number of ways. An audit of the company accounts will keep your company more productive. It will also provide a lot of other benefits that are briefly discussed below.
Gain Investor Confidence
An audit will allow you to gain the trust of potential investors. Most investors want to know about the financial aspects of the company before investing.
Investors make decisions based on bookkeeping and accounting records. You can gain their trust by having the accounts audited by an independent auditing firm.
Having the accounts audited will also help you gain the trust of lenders. They will be more likely to offer you credit if they are convinced about the exact financial position of your company.
Tax Submission
An audit of the financial accounts will also help in the accurate submission of tax reports. The IRS imposes a heavy fine on companies that submit wrong accounting data.
The process of auditing also helps in gathering documents required to prepare the tax return files. It will save the time of accountants in gathering information that must be entered into the tax files.
Identify Internal Fraud
An audit can also benefit a company in identifying fraud. It can help in the identification of any discrepancies in recording accounting information.
Business owners can know about the potential theft of company assets through an accounting audit. A regular audit will deter employees from misappropriating and wasting company resources. in.
Get Certifications
Companies can also meet the requirements of certification bodies through an accounting audit. The process of the audit will help a business to get certifications such as ISO 9001. The certification can allow businesses to gain the credibility and trust of customers, vendors, lenders, and investors.
An audit is a type of quality control of a company’s accounting records. It ensures that the accounting records comply with the relevant rules and regulations. The process of auditing helps in improving recording business transactions processes. Oftentimes, the audit leads to improved profitability.
How is An Audit of a Small Business Done?
An audit of a small business is easier as compared to auditing the financial records of corporations. But, the process involved in all types of audits is the same.
An auditor will go through the entire accounting records to evaluate if the entries in the books are accurate. The auditor will go through the financial statements, bookkeeping entries, and other information to make sure there are no discrepancies.
Auditors will inspect the physical records. They will also evaluate the accounting software to ensure that everything is in order. Typically, an auditor will look at one year of financial data. You need to ensure that the electronic and physical accounting records are properly organized to ensure a timely audit.
An auditor will prepare an auditor’s report at the end of the audit. The report will contain the name of the auditor, the scope of the auditing tasks, and important notes regarding the audited statements of the company.
All publicly traded companies must get their accounts audited by an external auditing firm. Moreover, some small businesses are also legally required to carry out regular audits. For instance, non-profit organizations with expenditures of over $750,000 must have their accounts audited by a professional. This is a mandatory requirement by the federal Office of Management and Budget (OMB).
In addition, insurance companies may also require their clients to get their accounts audited each year. The audit is required for the calculation of the premiums.
Types of Audits for Small Businesses
Small businesses can carry out different types of audits. Note that the different types of audits involve the same process in inspecting financial accounts. It is the auditor who is different in each type of audit.
Internal Audit
An internal audit is carried out by an auditor who is employed by the company. An internal auditor is usually a certified internal auditor (CIA) or a certified public accountant (CPA).
Small businesses must carry out an internal audit at least once a year. This is recommended to ensure that the books correctly represent the financial position of the company.
The report prepared by the internal auditor is only for internal verification. The reports are not submitted to external parties.
Most large companies have audit departments with upto five or more auditors. But generally, small businesses have just one auditor for internal auditing.
Public listed companies carry out an internal audit to assure the shareholders about the accuracy of the financial statements.
Internal auditing involves checking not just the accounting records but also internal controls, policies, and processes. The internal audit aims to identify operational issues and ensure compliance with relevant accounting standards and rules.
Independent Audit
An independent audit is different from an internal audit in that the audit is performed by another firm. An external party carries out the independent audit. The auditor who carries out the external audit is not employed by the firm that is being audited.
An external audit has no association with the audited company. That’s why they are more trusted by external agencies such as investors, lenders, and vendors. The independent auditor has no responsibility that can create a conflict of interest.
Generally, an external audit is required to comply with regulations. The OMB and the SEC require public companies to carry out an external audit.
The format of the external audit report is typically different from the internal audit report. The external audit report is more detailed. It contains one of the following judgments regarding the accounting records of the company.
Qualified Opinion
A qualified opinion means that the auditor thinks that the audit could not come to a definite conclusion. There might be some slight issues regarding the company’s accounting records. This opinion is usually given when the auditor does not have complete access to the accounting records. The remarks are also given when the scope and time of the audit are short.
Clean opinion
The auditor gives a clean opinion when the financial statement and records of the company are accurate. A clean opinion is given when the information presented in the accounting statements accurately depict the financial position of the company.
Negative opinion
An auditor gives an adverse opinion when the financial records of the company contain a misrepresentation. This opinion is given when the accounting record does not accurately represent the financial position of a company.
Disclaimer of opinion
Disclaimer of opinion means that the auditor cannot give an opinion regarding the accounting information. The disclaimer of opinion is stated for records that don’t fall within the scope of the audit.
IRS Audit
An IRS audit is a type of external audit. The audit is required when the IRS finds significant discrepancies in the given information. The audit is typically carried out for accounting records of the past three years. But the IRS audit can go further if it deems it necessary to determine the correct financial position of the company.
Companies will be required to undergo an IRS audit for different purposes. The audit will be required if a claim is made regarding significant deductions.
IRS Audits are also different. The two main types of audits by the taxation authority are discussed below.
Correspondence audit
A correspondence audit is a common type of IRS audit. The taxation authority will send you a letter asking you for clarification regarding the information in the tax return file. You will be required to reply to the request by submitting relevant accounting documents for verification.
The audit is carried out electronically. Physical visits are not normally done with this type of IRS audit. This type of audit involves electronic communication with the taxation body.
Field audits
Field audits are more comprehensive and detailed than correspondence audits. It involves an IRS officer visiting the company’s registered office to audit and verify the accounts.
The IRS officer will examine the records to look for any discrepancies. This type of audit aims to make sure that the information entered in the tax records is correct.
3-Steps Involved in a Business Audit
You need to get acquainted with the steps involved in a typical audit. Here are the main activities that are carried out in an external and internal audit.
1. Gather Accounting Records
The process of audit starts with the presentation of the accounting information required by the auditor. The auditor will request the accounting department to gather all the accounting records such as:
- Receipts
- Invoices
- Bank reconciliation statements
- Financial statements (Profit and Loss report, balance sheet, cash flow statement)
You will be asked to present the past two to three years of accounting data to the auditor. This requires that you have a system for the record of accounting documents. Auditing cannot be done if you don’t have a proper record of accounting-related data.
2. Inspect the Accounting Information
The next step in an audit involves the review of the accounting information to make sure there are no errors. The step involves looking at the financial statements, ledger entries, and electronic and manual records.
The auditor will closely examine each record to ensure that there is no mistake in entering accounting information. The documents will be reviewed to ensure that ledger entries have been made correctly and promptly.
The important accounting records that are reviewed during an audit are briefly discussed below.
Financial reports
An auditor will look at the financial reports of the company. All the reports that show the income, expenses, assets, and liabilities of a company will be reviewed.
Sales invoices
The auditor will review the sales invoices to ensure there are no errors. The auditing professional will look at the invoices sent to the customers and tally the information with the accounting entries.
Vendor receipts
During the audit, vendor receipts will also be examined. The audit aims to make sure that the information about vendor payments is correctly entered into the ledger.
Transaction related documents
An auditor will also look at the documents about financial transactions. The auditor will look at the purchase requisition order, warehouse inspection reports, and other necessary documents to ensure that all transaction entry is done correctly.
Trial balance
A trial balance shows the summary of various accounts. The statement shows an aggregate of different accounts. An auditor will loom at the trial balance to verify the transactions.
The auditor will look at the balance of accounts receivable, accounts payable, and other important information. The bonuses, commission agreements, sick day policies, loan conditions, and property values will be evaluated and validated to ensure that the correct information is entered into the accounts.
Minutes of meetings
In case of an audit of a publicly listed company, an auditor will also look at the bylaws prepared by the company founders and directors. The minutes of the meeting will also be reviewed to find out any area of concern regarding the record of financial transactions.
Electronic records
An audit of a company also involves looking at the electronic or digital records of a company. The auditor will look at the digital records to ensure that the correct information is recorded.
The accounting and bookkeeping software used for recording transactions will also be reviewed. In addition, the auditor will inspect the scanned copies of records to verify information entered in the accounting application.
Taxation documents
An audit of a company also involves a review of the company records. The tax returns submitted to the IRS will be reviewed. The auditor will make sure that the company has entered the correct information when submitting the returns.
The tax receipts will be reviewed and compared with the tax payments made to the IRS. The deductions and credits that are claimed by a company will also be examined. The auditor will be on the lookout for suspicious entries such as inflated expenses and deductions.
Internal policies
A professional auditor will also look at the internal policies of a company. The policies of the companies for the prevention of theft and fraud will be reviewed. The auditor will examine the protection measures taken by the company to protect financial resources such as separation of accounting duties, locks for securing cash, policies for verifying checks, and encryption of financial data.
3. Compare the Records
The auditor will compare the records of the company with the information submitted to third parties. Wrong entries submitted by a company will be flagged by the auditor. The auditor will look for wrong expenses entered in the tax form.
During the inspection, the auditor will also look at the salvage values of assets and compare them with the gain or loss from the sale of the asset. The auditor will closely inspect and compare the gains and losses of the previous years.
A common mistake that is caught during the audit is fewer sales or inflated expenses reported in Form 1099. The mistake will be flagged during an external and internal audit.
The auditor will also highlight math errors that result in inflated figures. For example, adding an extra digit to the revenues or expenses can result in significantly different results.
An error can also be identified by using the accounting formula. The auditor will screen for outliers that are likely errors in recording transactions.
Helpful Tips for Handling an External Audit
You need to prepare beforehand to ensure that the auditing process goes smoothly. You will face a lot less trouble if errors in bookkeeping are identified before the audit. This will ensure that you don’t have to pay a hefty fine for the wrong submission of accounting information.
Carefully Review the Audit Letter
If you receive an audit letter, you should carefully review the content of the letter. You should read the issues that have been identified in the letter.
You must also reply to the audit letter promptly. This is important as the auditor will become suspicious about the intention of the company.
But you should also make sure that the letter for an audit is authentic. Scammers sometimes send fake audit letters to solicit confidential company information. You should consider calling the party that has sent the audit letter to verify the authenticity of the same.
Get your Records in Order
You must prepare records that will be required during an audit beforehand to ensure that the auditing is completed promptly. Before meeting the auditor, you must collect all the records of the past year.
Gather all the invoices and receipts, bank statements, ledgers, canceled checks, tax statements, leases, titles, and other accounting-related information. Make sure that the electronic data is easily accessible by the auditor.
Address the Auditor’s Requests
During the audit, you must address all the concerns of the auditor. It is also important that you only limit the information requested by the auditor.
Avoid giving information that is not material or relevant for auditing the accounts. You should not give information about previous years’ returns and statements if not asked specifically by the auditor.
Keep Your Bookkeeper Involved
The auditor will ask for detailed information about the method of recording bookkeeping entries. So, you must let the auditor talk with the bookkeeper. This will ensure that the correct information is provided to the auditor.
You should also consider giving a power-of-attorney agreement to the auditor to let a professional talk on behalf of your company. This brings a professional in the loop that will ensure that the audit of your small business goes without any issues.
Lastly, you should not be defensive during an audit. Don’t act aggressively toward the requests of the auditor. This is important otherwise the auditor may give a negative opinion even when everything is in order.
Key Takeaway
Accounting audits investigate the financial and accounting reports of a company. They probe into the financial records to ensure an accurate representation of the financial position of a company. Professional auditors inspect accounting and bookkeeping records to make sure they are without any errors or other discrepancies.
Small and large businesses should carry out audits regularly. They need to prepare for an external audit through the proper record of accounting information. The bookkeeping records should be organized and preserved for an audit. Knowing the process will help you prepare for a possible audit of the accounts.
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