Companies turn to auditors to test the integrity of their accounting procedures and the accuracy of their financial data. Auditing evolved alongside standardized accountancy as a way to identify and prevent fraud. Today, it is a critical step in the effort to ensure that the financial information companies release to the public is reliable.
Auditing concerns itself with assessing the internal financial status of a business and comparing it to the picture presented to the outside world. A company prepares its financial statements -- such as the balance sheet, income statement and cash flow statement -- and then submits them to auditors, who evaluate them according to industry standards for accuracy and relevance. Audits are extremely important to shareholders, potential investors, regulators, customers and others affected by the company's operations. A negative report from a firm's auditors can seriously damage that firm's reputation.
Auditing initially existed primarily for governmental accounting and was concerned mostly with record-keeping rather than accounting procedures. It wasn't until the Industrial Revolution, roughly from 1750 to 1850, that auditing began evolving into a field of fraud detection and financial accountability. As businesses grew to unprecedented sizes during this period, company owners couldn't directly oversee all their operations and had to hire managers to do so. Those owners recognized an increasing need to monitor managers' financial activities, both for accuracy and for fraud prevention.
The early 20th century saw the standardization of auditors' testing methods and reporting practices. Auditors developed a system for examining a representative sample of a company's transactions, rather than examining each transaction in detail, allowing audits to be completed in less time and at lower cost. Audit findings were also presented in a standard "Independent Auditor's Report" accompanying a firm's financial statements.
Sampling of transactions is now the industry standard for performing audits. It is only when gross errors or fraudulent activities are uncovered that comprehensive audits are performed. As business have increased in complexity, "risk-based" auditing has arisen to make auditing more efficient and economical. Risk-based auditing starts by assessing whether an audit is even needed, based on a review of information in the financial statements. If the review finds discrepancies, irregularities or suspicious activity, then a full-scale audit will follow.
Auditing today is seen not just as a process for verifying a company's financial statements, but also as a way for a firm to gain insight on its own activities. It is a labor-intensive job -- one that is in high demand. Audits are now performed in a more streamlined and efficient way and are intended to offer companies correction in their activities and to advise them on how to avoid the financial misreports in the future.