Audit: What It Is, Types, Importance

What Is an Audit?

By Motley Fool Staff – Updated Dec 12, 2024 at 2:35 PM

Key Points

Audits validate a company's financial claims, essential for informed investing decisions.
Different audit types, like external and internal, offer varied insights into company operations.
High-profile failures like Enron highlight the critical need for rigorous audit practices.

An audit is an examination of the financial statements that are periodically issued by a company. It’s especially important for investors, who should use the information to study the company’s financial history and its prospects. Read on to find out more about audits and why they’re crucial to learning about potential investment.

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Types of audits

Although external financial audits are among the most commonly scrutinized documents for investors, you should be aware that there are different types of audits. Not all audits are public, but wise investors considering the prospects of a company should gather as many as available. Here are some of the most common types of audits:

External audits: These are the most well-known types of audits and verify the accuracy of a company’s financial statements. They’re designed to assure investors that the company’s financial performance is what the company claims. Independent examiners generally conduct external audits to avoid potential conflicts of interest.

Internal audits: An internal audit generally is performed by company employees. They ensure that internal controls and legal requirements are being followed. An internal audit is typically distributed to management and a board of directors.

Financial statement audits: Often, companies will be required to submit a financial statement audit to a bank or other creditor. Conducted by independent examiners, a financial statement audit is designed to catch any material misstatements about financial reporting. If made publicly available, these audits can be especially useful for investors.

Performance audits: Typically associated with companies or organizations that receive grants from governments or other sources, a performance audit is designed to ensure the effectiveness and results of a particular program. The gold standard for performance audits from local, state, or federal governments is the use of generally accepted government accounting standards (GAGAS), also known as the Yellow Book.

Operational audits: These audits review specific objectives of a company and often include recommendations that help a company improve its performance. Operational audits generally are conducted by employees but can also be done by external specialists, such as certified public accountants (CPAs) or consultants.

Information system audits: The growth of technology has created a booming market for information system audits that determine how well a company is managing its systems. An information system audit can determine if assets are being secured, data integrity is maintained, and systems are operating effectively. These audits usually are performed by Certified Information Systems Auditors.

Forensic audits: When individuals suspect fraud, theft, or inaccurate information being distributed by a company, a forensic audit may be performed. Forensic audits most commonly surface in litigation or shareholder disputes. A forensic audit is typically conducted by specialized accountants who can identify illegal or unethical conduct.

What Is an Audit?

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What is an audit?

Types of audits

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Importance of audits