January 26, 2022

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Four types of Audits (Auditing) you should know

Four types of Audits (Auditing) you should know
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Audit or as it is often called auditing is a job done by an auditor. Usually, the job requires care, rigorous knowledge of accounting, knowledge of the business environment under audit and so on. Audits are majorly three types, tax audit, external audit and internal audit. However, in this article, a fourth type is added. That is, performance audit.

The four types of Auditing

Internal Audit:

This is an objective examination of the books of accounts, financial reports and policy compliance by an internal auditor. The internal auditor may be an employee or group of the entity. It reports to the audit committee of the Board of Directors. Or simply to the Board. This enhances the independence of the auditor. However, they at times report to the chief executive officer and other managers of the company as the need arises.

A group of employees doing the audit job of a business are usually in a department referred to an internal control department. An entity may also outsource internal audits. This is especially true for small companies that need such service but cannot employ a full time staff.

The job of the internal audit is mainly to examine the books of accounts, financial statements, compliance of external regulators and internal policies of the entity by its employees. At the verge of their examination, they may locate errors or fraud committed by staff. Also, the department may comply with the advice of the external auditor writing in the engagement letter. The overall job, moreover, is to assess and manage risk within the entity. Note that government entities carry out internal audits.

External Audit:

This is the independence and objective examination of the books of accounts, financials and compliance issues by an external auditor. By external, it means that the auditor is not an employee of the company. This improves the reliability of the company financial reports that are made available to stakeholders.

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Note that it is mandatory by law for all limited liabilities companies to seek the service of an external auditor. Small businesses like sole proprietorship and partnership businesses don’t require such services. However, management of such entities may decide to audit the entity. Thereby employing an external auditor.

This audit examines the company based on its own assessments and not that of the internal audits. It ensures the business comply with International Financial Reporting Standards and other regulations relating to the entity. An external auditor of an Insurance company, for example, must ensure the entity complies with the Insurance Act and Bank and other Financial Institutions Act.

To be independent and objective means the audit is free from internal influence. The end report of the audit must state the true and fair view of the state of affairs of the entity. It means that the financial statement is free from material errors. And to be biased means to favour one stakeholder at the expense of another. To be reliable, the audit report must be a clean or unqualified report. If the auditor gives a qualified opinion or a disclaimer on the report, the audited entity may lose its reliability in the face of stakeholders.

Tax Audit:

An audit done by the tax administrators to examine if the tax returns paid by a taxpayer was not intended for tax avoidance. Tax audit usually arises when the internal revenue service or the federal inland revenue service believes that the tax paid was purported to avoid tax.

Sometimes, the audit may not be as a result of a suspected tax avoidance. The administrators of tax may believe that the taxes paid is lower than other companies in similar industries. Or by using sample size decides to handpick the company for such an audit.

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A tax audit assesses compliance with tax laws in the preparation and presentation of tax returns. The examination may be done for at most seven years of the company’s financials. If the result of the audit is negative, the taxpayer may end up paying penalties that will affect its profits.

Performance Audit

This is an audit exercise for government establishments. Ministries, Departments and Agencies (MDAs) may undergo performance audits from time to time. Also, nonprofits entities carried out this type of audit. The overall goal is to examine the economy, efficiency and effectiveness of government projects and processes.

Performance audit is done by an external auditor. The government of a state or country will engage an Audit firm to assess a certain process and project of the government. The audit report usually gives recommendations on where this process can be improved. The recommendations may include methods of cost reduction and how wastage of resources can be minimized.

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Another area examined by performance audit is if MDAs comply with government regulations and laws in the signing of contracts. There are lay down procedures in the procurement of supplies and the engagement of contractors for contracts. Through this audit, the government can know if MDAs comply with the procedures.

Conclusion

Finally, the four types of audits are internal, external, tax and performance audit. Each type is done based on different motives. Internal audit for internal control, external audit to examine true and fair view of the company’s financial reports. Tax audit assesses tax compliance and performance audit checks for compliance of government regulations as well as the economy, effectiveness and efficiency of processes and projects financed by the government.

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