Why Do Companies Get Audited? Key Reasons Explained

Companies undergo financial audits to ensure their financial information is accurate and reliable. An audit is an independent examination of a company’s financial records, operations, and internal controls by professional accountants. The process involves reviewing financial statements, such as income statements, balance sheets, and cash flow statements, to confirm their accuracy and compliance with established standards. This independent examination provides assurance to various parties that the company’s financial position is fairly represented. Audits support transparency and integrity in financial reporting.

Meeting Regulatory and Public Requirements

Publicly traded companies are required to undergo annual financial audits. The Securities and Exchange Commission (SEC) requires public companies to file financial statements that comply with Generally Accepted Accounting Principles (GAAP). This ensures financial reporting is consistent, accurate, and transparent for investors. Independent auditors verify this compliance, providing an unbiased opinion on the financial statements.

Regulatory audits foster investor confidence and ensure market transparency. Audits provide assurance that financial statements are free from material misstatement and are presented fairly according to GAAP. This process helps maintain public trust in financial markets and protects shareholder interests. The Sarbanes-Oxley Act (SOX) introduced reforms to improve corporate governance and financial transparency. SOX also established the Public Company Accounting Oversight Board (PCAOB) to oversee and regulate auditors of public companies, setting auditing and quality control standards.

Satisfying External Financial Stakeholders

Audits are a prerequisite for companies seeking financing or engaging in significant transactions with external parties. Lenders require audited financial statements to assess a company’s financial health and creditworthiness before extending loans or credit lines. This independent verification helps lenders mitigate risk by providing a reliable picture of the borrower’s financial standing. The Federal Housing Administration (FHA) requires mortgage lenders to submit audited financial statements.

In mergers and acquisitions (M&A), audits are important for due diligence, as potential buyers rely on audited financials to accurately value the target company, identify potential risks, and understand its financial health. This assessment helps uncover hidden liabilities, assess regulatory compliance, and support the target company’s valuation. Private equity firms and venture capitalists also require audits before making significant investments. These audits assure limited partners (LPs) that the fund’s financial statements are accurate and that valuations of portfolio companies are reliable. The SEC now requires all SEC-registered private fund advisers to have an annual audit.

Ensuring Internal Financial Reliability

Companies conduct internal audits for reliable financial information to support sound decision-making. An internal audit helps management verify the accuracy of financial statements, which are used for strategic planning, budgeting, and operational management. This process provides insights that lead to more informed business decisions.

Internal audits detect and deter fraud or significant errors within a company’s financial systems. Auditors assess the effectiveness of internal controls, which are policies and procedures designed to safeguard assets and prevent financial misconduct. By evaluating these controls, audits can identify weaknesses that might lead to discrepancies or fraudulent activities, protecting company assets. Regular internal audits also help identify inefficiencies, leading to operational improvements and cost savings.

Responding to Government Oversight

Government agencies initiate audits to ensure companies comply with laws and regulations, particularly concerning taxes. The Internal Revenue Service (IRS) conducts audits to verify that businesses accurately report income, deductions, and tax liabilities. These audits aim to ensure adherence to federal tax laws and maintain the integrity of the tax system. The IRS can audit returns filed within the last three years, and sometimes up to six years in cases of substantial error.

Beyond tax compliance, government bodies may conduct audits related to other regulatory areas. This can include audits for adherence to environmental regulations, labor laws, or the proper use of government funds in industry grants. These governmental compliance audits ensure that companies receiving public funds or operating in regulated sectors meet legal requirements. The process ensures accountability and verifies that companies are operating within established legal frameworks.