What Is an Accounting Audit? A Complete Guide
An accounting audit is conducted to check whether financial statements prepared by organizations such as companies, public interest groups...
An accounting audit is when an auditor checks the financial statements prepared by a company to make sure there are no errors. There are legal provisions for a company’s accounting procedures, and undergoing an accounting audit can provide confidence that “accounting procedures are being carried out in accordance with the law.”
Here we will explain the process of an accounting audit, its specific contents, and key points for preparation.
What is an accounting audit?
An accounting audit is conducted to check whether financial statements prepared by organizations such as companies, public interest groups, and government agencies are prepared in compliance with laws and regulations. By undergoing an accounting audit, a company can demonstrate to third parties the reliability of its financial statements, which are prepared based on correct accounting procedures.
First, let us explain the purpose and timing of accounting audits.
Why Are Accounting Audits Important?
Accounting audits are conducted to prove to the public that a company is conducting accounting procedures correctly. The opinions of accounting auditors are made public as “independent auditor’s audit reports,” and the contents of these reports can be viewed by stakeholders such as business partners, financial institutions, and investors.
For example, when an investor acquires shares in a company, he or she will always check the financial statements to see if the company’s financial situation is sound. However, simply checking the published financial statements does not guarantee that accounting procedures are being carried out correctly or that figures have not been falsified.
Therefore, by obtaining the opinion of the auditor who conducted the accounting audit, you can confirm that the company is “performing accounting correctly.” In other words, accounting audits are essential for demonstrating the reliability of an organization to third parties such as stakeholders.
When Are Accounting Audits Conducted?
Accounting audits are often conducted in conjunction with the closing of financial statements, but depending on the size of the company, they may also be conducted during the fiscal year, such as at the half-year or quarterly closing.
In addition, listed companies and other companies that are required by law to conduct accounting audits must report the audited financial statements to shareholders at the general shareholders’ meeting. If the financial reports are not submitted in time for the general shareholders’ meeting, the company will lose the trust of shareholders and, in the worst case scenario, may be delisted.
Since accounting audits take a certain amount of time, it is important to plan the audit schedule in advance to coincide with the financial statements and general shareholders’ meetings. Preparations for accounting audits are described in detail below, so please refer to that as well.
Types of Accounting Audits
Although accounting audits are generally referred to as such, they can be divided into three types depending on who carries them out: “external audits,” “internal audits,” and “auditor audits.” What are the differences between the people who carry out the audits and what is checked? Let’s take a look at each one.
External Audit
An “external audit” is an accounting audit conducted by external experts independent of the organization . It is required by the Companies Act and the Financial Instruments and Exchange Act, and is conducted by certified public accountants or auditing corporations.
Under the Companies Act
A “Companies Law Audit” is an accounting audit stipulated in Article 436 of the Companies Law, and is mandatory for companies that fall under the category of “large companies under the Companies Law.”
- In a Corporate Law audit, the auditor will check whether the “financial statements” and their supplementary schedules have been prepared properly. The “financial statements” referred to here include the following four points:
- Balance Sheet
- income statement
- Statement of changes in shareholders’ equity
- Individual Notes Table
Since large companies have a large impact on stakeholders, if inappropriate accounting practices are carried out, it could cause significant damage to shareholders and creditors. Therefore, the purpose of making accounting audits a legal requirement is to protect shareholders and creditors.
Under the Financial Instruments and Exchange Act
Companies listed on the stock exchange are required to undergo accounting audits under the Financial Instruments and Exchange Act (Article 193-2).
Financial Instruments and Exchange Act audits are conducted for the purpose of protecting investors, and two audits – a “financial statement audit” and an “internal control audit” – are carried out by certified public accountants or auditing firms.
A financial statement audit is a check on whether a company’s financial statements have been prepared in accordance with laws and regulations, and whether there are any errors or falsehoods in the accounting treatment. On the other hand, an internal control audit is an investigation into whether a company’s internal control reports have been prepared according to the correct standards.
Audit reports for financial statement audits and internal control audits are to be submitted together with securities reports and are available for viewing by general investors.
Other legally required audits
Accounting audits required by law are not limited to those stipulated by the Companies Act and the Financial Instruments and Exchange Act that we have introduced so far.
In addition, independent administrative institutions and social welfare corporations are also required by law to undergo accounting audits.
In addition, even organizations that are not required by law can voluntarily undergo accounting audits. Because accounting audits are effective in increasing trust from outside, it is not uncommon for companies to voluntarily request accounting audits from certified public accountants or auditing corporations.
Internal Audit
An internal audit is an audit conducted independently within an organization. While external audits are conducted by certified public accountants or auditing corporations, internal audits are generally conducted by the company’s auditors or personnel within the organization.
Although internal audits are not required by law, organizations voluntarily conduct them with the aim of strengthening organizational governance and preventing the risk of fraud.
However, as mentioned above, large companies and listed companies are required by law to conduct internal controls, so they inevitably conduct both external and internal audits.
Audit by Auditors
An auditor’s audit is an audit conducted by auditors and there are two types: an “operational audit” and an “accounting audit. “
An operational audit covers all business operations other than accounting and checks whether the directors’ business operations are in compliance with laws and regulations or the articles of incorporation. On the other hand, an accounting audit checks whether the financial statements prepared by an organization are prepared in accordance with laws and regulations and whether correct accounting procedures are being carried out.
Not all companies are required to appoint auditors, but companies with a board of directors and companies with an accounting auditor are required to appoint auditors.
What Do Auditors Check During an Audit?
Contents of the balance sheet and income statement
The format and item arrangement of the balance sheet and income statement, which are the most representative financial statements, will be checked. It will also be checked whether the amounts recorded on the balance sheet and income statement match the general ledger balance.
Cash, deposits and loan balance
For companies that have cash in their offices or stores, a “cash audit” is conducted to check whether the balance matches the cash ledger. In addition, the balance of deposits and loans other than cash is also subject to audit. A balance certificate is issued by the financial institution with which the company does business, and it is checked whether it matches the balance in the cash ledger.
Accounts receivable and accounts payable balance
The accounts receivable and payable will be checked to see if they match the balance certificate received from the business partner. If there are any accounts receivable that are delayed in collection or accounts payable that are in arrears, the status of those payments will also be checked.
Provisions
Companies prepare “reserves” to prepare for future expenses and losses. Typical examples are “bonus reserves,” “retirement benefit reserves,” and “bad debt reserves.” The accounting treatment of reserves varies depending on the purpose of the reserve, but since it is easy to make incorrect accounting treatments, it is a point that is often checked during accounting audits.
Fixed asset accounting and disposal
Fixed assets owned by a company are also subject to audits. The main checks are to see whether fixed assets are recorded correctly and whether depreciation calculations are correct.
In addition, if fixed assets are sold during the period, the accounting treatment of those assets will also be checked. Since fixed assets cannot always be determined by bookkeeping alone, auditors may also conduct on-site inspections as necessary.
Accounting system and bookkeeping, accounting practice survey
Since financial statements are prepared based on processing by the accounting department, it is necessary to check what system is being used for accounting work and whether there are any errors in the handling of the books.
In addition, accounting audits do not only check the books, but also sometimes involve direct interviews with employees working in the organization. Since accounting department employees are particularly involved in accounting work, it is not uncommon for auditors to directly ask them questions such as “how much knowledge they have about accounting work” and “are they sufficiently aware of compliance?”
Account
There are various account items for accounting, and the account items to be processed are determined depending on the content of the transaction. An accounting audit checks whether each transaction is processed using the correct account items.
Another point that is checked during an accounting audit is whether there are any suspicious points in the balance of account items. For example, if the amount of a particular item is significantly large, or if the balance has changed significantly compared to the previous period, the cause of this will also be checked.
Voucher
The invoices that record each and every transaction are also subject to audits. They check whether invoices are issued based on actual transactions. The approval flow for invoices is also checked, and a thorough check is made to see whether approval is being properly carried out in accordance with company rules.
Checking inventory, physical inventory
The audit also covers physical inventory work, where the amount of stock is measured and confirmed at the actual site at the end of the fiscal year. In accounting audits, auditors also attend the inventory work carried out by the company. By directly attending the actual inventory work, they can check whether the inventory is being carried out appropriately.
Preparation for an audit
Accounting audits check a wide range of aspects, including the organization’s internal books, management systems, and business processing procedures, so it is not uncommon for other work to be disrupted during the audit. In order to reduce the burden on both the auditor and the auditor and to ensure the audit proceeds smoothly, it is important to prepare books and related forms in advance.
In particular, for organizations with separate accounting and finance departments, each department should work together to make preparations.
Preparation of books and documents
Since the documents required for an accounting audit are diverse, it will take time and effort to prepare them after the audit has begun. In order to start the accounting audit smoothly, it is important to prepare the books and documents in advance.
Documents and books to be submitted for accounting audit
- Organization Chart
- Minutes (shareholders’ meeting minutes, board of directors’ meeting minutes)
- Registers (shareholders list, business partner list)
- Financial statements and accounting documents
- General ledger
- Various contract documents (rental, loan, etc.)
- Invoices, receipts, cash slips
- Fixed asset ledger, etc.
How to Prepare for an Accounting Audit
In accounting audits, the nine items mentioned above are checked with particular emphasis to ensure that “financial statements have been prepared correctly in accordance with laws and regulations” and “accounting procedures have been carried out correctly.” Various documents are submitted for accounting audits, but it is particularly important to have a good grasp and understanding of the contents of the following books and documents.
Books and documents you need to understand
- Balance Sheet, Income Statement, General Ledger
- Accounts receivable and accounts payable balance
- Cash, deposits, loans, and various reserve balances
- Balance comparison with the previous period
In accounting audits, you may be directly questioned about submitted documents and book contents, unclear monetary movements, and accounting processes. In order to answer questions from auditors without delay, it is important to have a good understanding of the contents of the books and documents. If you are unable to answer properly, you may be asked to submit additional documents.
Be sure to share the contents of the records within your department so that you will be able to handle detailed questions from the auditors. In particular, areas that have changed significantly from the previous period are likely to be checked, so it is important to have a good understanding of the causes.
Conclusion
Accounting audits are essential to prove that accounting procedures are being carried out correctly. In order to reduce the burden on both the auditing and audit recipient parties, it is important to deepen your knowledge of accounting procedures and carry out correct administrative procedures on a regular basis.
In addition, to prevent mistakes caused by busy work schedules and work becoming dependent on individual staff, consider using accounting software to improve work efficiency.
FAQ
What is the purpose of an accounting audit?
Accounting audits are conducted to prove to the outside world that a company is conducting accounting procedures correctly. After an accounting audit, the auditor’s opinion is made public, so it is possible to prove to third parties that the company is conducting accounting procedures correctly. Accounting audits are essential to demonstrate the reliability of a company’s financial statements to third parties such as stakeholders.
What are the types of accounting audits?
There are three types of accounting audits: “external audits,” “internal audits,” and “auditor audits.” Each type has different auditors and forms and materials to check. External audits are conducted by certified public accountants or auditing corporations, and some companies are legally required to conduct them. On the other hand, internal audits and auditor audits are conducted independently by organizations, by in-house staff or auditors.
What is the process for an accounting audit?
Accounting audits are generally conducted in the following order: (1) preliminary investigation → (2) submission of audit plan → (3) implementation of audit → (4) submission of audit report. Accounting audits check whether the contents of financial statements and accounting procedures are correct. In particular, they focus on checking “balance sheets and profit and loss statements,” “accounts receivable and accounts payable balances,” and “cash, deposits, and loan balances.”