What Is Audit: Meaning, Process, Types & Importance In Accounting

Key Highlights

1. Investors and regulators value audit reports more than the net profit presented by the company.
    
2. There are different types of audits, like internal, external, finance, operations, IT and more.
    
3. The company becomes more trustworthy if the numbers in the audit reports match the ones presented by the company.

Auditing means checking a company’s accounts to see if they are correct and follow the rules. Investors and lenders review audit reports before investing or lending.

For example, XYZ Pvt. Ltd. shows a profit of ₹10,00,000. An independent auditor reviews invoices, bank statements, and ledgers to confirm that sales are genuine and expenses are properly recorded.

The table summarises the activities performed by the auditor.
 

Now investors and lenders can rely on the ₹10,00,000 profit shown by the company. Let’s learn more about audition, from the process, types, to its importance in accounting. 

How is an Audit Prepared?

Auditors follow a step-wise approach to check the financial records of the company. Each step depends on the previous one. Let’s see what these steps are in this section.

1. Planning & Risk Assessment

Auditors begin by understanding the company and identifying risky areas that may cause errors or fraud. This step helps them focus time and effort on what matters most.

For example, at ABC Electronics Ltd, total revenue is ₹100,00,00,000, out of which ₹30,00,00,000 is from cash sales. The auditor marks cash handling as high-risk because it is prone to errors or theft.

2. Testing Controls & Substantive Procedures

Next, auditors check whether internal controls work properly and verify a sample of transactions. This ensures the system prevents mistakes and that the records are reliable.

For example, from the ₹30,00,00,000 cash sales, the auditor tests 50 payment vouchers. He finds that 4 vouchers worth ₹40,00,000 had no manager approval, showing weak controls in cash handling.

3. Analytical Procedures & Detailed Testing

Auditors compare financial data, trends, and ratios to spot unusual results. They then test unusual items in detail with supporting evidence.

For example, ABC Electronics’ revenue increased from ₹80,00,00,000 last year to ₹100,00,00,000 this year, a ₹20,00,00,000 jump. But marketing spend only grew 2%, which looks unusual and triggers a deeper review.

4. Audit Reporting

Finally, auditors form an opinion based on their findings. The opinion can be clean (unqualified), qualified, adverse, or a disclaimer.

For example, after completing tests, the auditor finds errors of ₹2,00,00,000. Since this is significant but not huge compared to ₹100,00,00,000 revenue, he issues a qualified opinion instead of a clean one.

Do you know that, across non-Big 4 audits, around 18.75% of companies receive qualified or modified opinions (discrepancies are present)? This shows how important it is to follow these steps. 

What are the Types of Audits?

Under the Companies Act, 2013 and the Income Tax Act, 1961, companies undergo multiple audit types in India. Let’s see the different types of audits that companies undergo with the table given below.

1. Internal Audit

Internal audits are done by a company’s own employees or audit team. They focus on internal controls, compliance, and spotting weaknesses.

For example, Riya, an internal auditor in a textile firm, checks stock records. She finds that out of ₹10,00,000 worth of inventory, ₹2,00,000 is unused spare fabric. This shows inefficiency in purchases.

2. External Audit

External audits are conducted by independent auditors to give shareholders confidence in financial statements. They ensure accounts are reliable and fairly presented.

For example, Bharat Ltd hires an external auditor to review its annual revenue of ₹50,00,00,000. The auditor detects a 2% mismatch, which equals a ₹1,00,00,000 reporting error.

3. Government or Statutory Audit

These audits are required by law, like tax audits or regulatory checks. They ensure businesses follow rules and pay the correct taxes.

For example, Priya’s manufacturing unit with ₹5,00,00,000 turnover undergoes a statutory tax audit. The audit reveals irregularities worth ₹50,00,000, which could lead to penalties.

4. Operational Audit

Operational audits check if business processes are efficient and cost-effective. They highlight delays or waste in day-to-day operations.

For example, at Company ABC, auditors find 100 hours of machine downtime in a month. Since each hour costs ₹1,000, the firm lost ₹1,00,000 due to inefficiency.

5. Cost Audit

Cost audits examine whether cost accounting records are accurate and whether product pricing is correct.

For example, A shoe factory claims it spends ₹100 per pair, but the audit shows the actual cost is ₹80. For 1,000 pairs, the cost was overstated by ₹20,000.

6. Information System (IT) Audit

IT audits review data security, system integrity, and whether IT controls protect financial information.

For example, Deepa checks her company’s billing system and finds 5 unencrypted databases. These hold ₹10,00,000 worth of transaction records, putting sensitive data at risk.

7. Forensic Audit

Forensic audits investigate fraud or misconduct and provide evidence for legal cases.

For example, A forensic auditor examines a missing ₹5,00,00,000 fund. By tracking invoices, they uncover a false billing of ₹50,00,000, proving fraud within the company.

The table below summarises each type with the examples given:

In 2019, audit firms in India spent about 150–200 hours per client for conducting financial statement audits. This number rose to 200–500 hours
or more for large companies. The time frame shows the intricacies present in the entire process and the need for it to be accurate.  

Importance of Audits in Accounting

In this section, let’s see how audits are helpful in accounting with the help of the table given below.

Audits detect fraud and maintain integrity. When reliable, audited data is presented before shareholders, their trust and investment in the company grow. 

Conclusion

When someone audits financial statements, they are basically double-checking all the numbers present there. It is necessary for all the data to be accurate, comply with regulations, and have no fraud, etc. 

This is done so that investors can build their trust and investments accordingly. Timely and independent audits lead to better decisions, reduce risk and improve long-term sustainability.

Frequently Asked Questions

What determines audit fees?
Audit fees depend on company size, industry complexity, assessed risk, required hours, travel, and the auditor’s reputation.

What is audit sampling, and how is sample size chosen?
Auditors use statistical or judgmental sampling; the size depends on risk, population variability, and desired confidence level.

How do auditors use data analytics in modern audits?
Analytics automate testing, detect anomalies, test entire populations, and focus auditors on high-risk transactions for efficient procedures.

What tools help automate audits?

Modern tools like Workiva, Inflo, and Datasnipper use AI, analytics, and workflows to check large amounts of data fast and spot errors.

What is the role of the audit committee?

It selects auditors, reviews their work, and ensures independence and strong internal controls.

How is auditor independence maintained?

By limiting non-audit work, rotating partners, and using cooling-off periods to avoid conflicts.

How do auditors set materiality levels?

They base it on company size and risks, focusing only on errors big enough to affect decisions.

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