What It Is:
In the tax world, an audit refers to the review of a taxpayer’s tax return for accuracy.
 
In the accounting world, an audit is the examination and verification of a company’s financial statements and records, and in the United States, examination for their compliance with Generally Accepted Accounting Principles (GAAP).
 
How It Works/Example:
Accounting professionals, usually Certified Public Accountants (CPAs), perform audits. These auditors must be independent, unbiased, and qualified to provide an auditor’s report (also called an opinion).
 
There are four major steps in the audit process:
·        Defining the terms of the engagement between the auditor and the client
·        Planning the scope and conduct of the audit
·        Compiling the audited information
·        Reporting the results of the audit
 
The terms of an engagement are usually set forth in an engagement letter that is written by the auditor and signed by the client. The letter documents the auditor’s role and addresses any specific issues. The audit plan defines the scope of the audit and key deadlines. Quite often the company’s audit committee (primarily composed of board members) reviews and approves the audit plan.

One of the goals of a financial audit is to find and correct any material misstatements, which are statements that are wrong, missing, or incomplete whether made deliberately or accidentally. This is why auditors must be able to drill down to the source of each piece of data (this is called the audit trail). To compile the information necessary to do this, an auditor does many things. For example, the auditor tests the transactions and account balances that make up the financial statements as well as the design and operation of the systems that generated those statements.

Auditors also employ sampling techniques, whereby they evaluate less than 100% of the items within an account or class of transactions as a way to understand the nature of the entire account or class of transactions. For example, an auditor will usually not check every expense report in a large company to make sure each has receipts attached. Instead, the auditor will pull a random sample of the reports, examine those, and draw conclusions about the quality of the information and controls related to expense reports. Auditors also analyze significant trends or ratios and question changes or variances from predicted amounts. Further, they investigate the reasonableness of management’s accounting estimates of uncertain events or events that are likely to occur (such as the outcome of litigation).

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