How Is Auditing Related to Accounting? A Look at Both

Accounting and auditing are distinct yet interconnected financial functions that support the reliability of financial information. Accounting systematically records, classifies, and summarizes an organization’s financial transactions, producing statements that reflect its financial health and performance. Auditing involves an independent examination of these financial records and statements to provide an objective opinion on their fairness and accuracy. This article explores their individual roles and shared purpose.

The Foundations of Accounting

Accounting functions as the language of business, systematically tracking all financial activities within an organization. Its purpose involves recording financial transactions, such as sales, purchases, and payroll. This record-keeping process, often called bookkeeping, includes maintaining journals for initial entries and ledgers for categorizing transactions.

The information gathered through recording and classifying is summarized into financial statements, the primary outputs of the accounting process. These statements include the balance sheet, which presents a company’s assets, liabilities, and equity at a specific point in time. The income statement, also known as the profit and loss statement, summarizes revenues, expenses, gains, and losses over a period, revealing the net income or loss. The statement of cash flows details cash inflows and outflows from operating, investing, and financing activities, providing insights into a company’s liquidity.

Various users rely on accounting information for decision-making.

• Investors use financial statements to assess a company’s profitability and financial stability.
• Creditors, such as banks, evaluate a company’s ability to repay loans by examining its financial position.
• Government agencies, including the Internal Revenue Service (IRS), use accounting records to ensure compliance with tax laws and regulations, such as those outlined in the Internal Revenue Code.
• Management utilizes this information for internal planning, performance evaluation, and strategic decision-making.

The Role of Auditing

Auditing serves as an independent verification process, examining an organization’s financial records and statements to ensure their reliability. The objective of an audit is for an independent auditor to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework. In the United States, this framework is Generally Accepted Accounting Principles (GAAP), established by bodies such as the Financial Accounting Standards Board (FASB). Auditors provide reasonable assurance that the financial statements are free from significant misstatement, whether caused by error or fraud.

Audits are performed by certified public accountants (CPAs) who operate independently of the organization being examined. This independence maintains objectivity and credibility in their opinion. For public companies, auditors adhere to standards set by the Public Company Accounting Oversight Board (PCAOB). Audits of private companies follow standards issued by the American Institute of Certified Public Accountants (AICPA). These standards provide a framework for conducting the audit, ensuring consistency and quality.

The audit process involves a systematic review of financial data, internal controls, and supporting documentation. Auditors gather evidence through procedures such as:

• Inspecting records
• Observing processes
• Confirming balances with third parties
• Recalculating figures

This evidence allows the auditor to form a professional judgment regarding the fairness of the financial statements. The resulting audit report, which includes the auditor’s opinion, is communicated to stakeholders.

The Synergistic Connection

The relationship between accounting and auditing is interdependent, with each function relying on the other to fulfill its purpose. Accounting is the process that systematically collects, measures, and reports financial information, resulting in financial statements like the balance sheet and income statement. These statements are prepared following established accounting principles, such as the revenue recognition guidance found in FASB Accounting Standards Codification 606. Auditing then steps in as the verification mechanism, examining these accounting outputs to confirm their accuracy and adherence to the applicable financial reporting framework.

Auditing relies on the accounting records and the principles applied in their preparation. Auditors must understand a company’s accounting policies and the specific entries made to revenues, expenses, assets, and liabilities. They scrutinize source documents, such as invoices, bank statements, and contracts, to trace transactions back to their origin and ensure they were recorded correctly.

Conversely, accounting benefits from the auditing process. An independent audit enhances the credibility and trustworthiness of the financial statements produced by the accounting function. When an auditor provides an unmodified opinion, it signals to users that the financial information is reliable, which can reduce uncertainty for investors and creditors. The audit process also identifies areas where accounting processes or internal controls can be improved, such as weaknesses in internal controls over financial reporting as required by Sarbanes-Oxley Act 404 for public companies. This feedback loop helps refine and strengthen the accounting system.

Why Their Relationship Matters

The distinct yet interdependent relationship between accounting and auditing is important to the integrity of financial reporting. Their combined functions foster public trust in financial markets and corporate transparency. Investors and other stakeholders rely on the assurance provided by an independent audit to make informed decisions about allocating capital, trusting that the financial data presented by companies is reliable. This trust is built upon the premise that accounting provides accurate data and auditing independently verifies it.

Their relationship also plays a role in ensuring regulatory compliance for organizations. Publicly traded companies, for instance, are required by the Securities and Exchange Commission (SEC) to file periodic reports, such as annual reports, which must include audited financial statements. This requirement ensures that financial information provided to the public adheres to established standards and regulations, promoting a fair and orderly market. Accurate accounting records, verified through auditing, are important for compliance with tax regulations enforced by the IRS, preventing potential penalties or legal issues.

The interplay between accounting and auditing enables more informed decision-making across various stakeholders. Lenders assess a company’s ability to repay loans based on audited financial statements, influencing credit availability and interest rates. Business partners evaluate potential collaborations by examining reliable financial data. This collaborative yet separate functioning of accounting and auditing provides a framework for financial governance, supporting economic stability and confidence in financial information.