What Is a Vertical Audit?

The word "audit" throws fear into many people's minds because they automatically associate it with an audit from the Internal Revenue Service. Auditing, though, is a tried and true business practice that helps companies, processes and individuals perform better, cheaper and more efficiently. Especially useful are in-depth audits like vertical audits.

An audit is an evaluation. It can be an evaluation of financial records -- e.g., a company's accounting books or an individual's tax return, a process or procedure -- e.g., how blood samples are taken and then tested, a report -- e.g., fact checking, a department -- e.g. how well or poorly the account receivables department in a company is doing, or even of an individual -- e.g., how well or poorly a particular sales rep is doing.

There are two basic types of audits: horizontal and vertical. Horizontal audits are used particularly for processes and typically span several departments. For instance, if a business were to audit their retail procedure starting with the point at which a customer orders a product online and finishing when the customer received the product in the mail, the audit would look at the web department, the fulfillment department, the shipping department and customer service. Vertical audits, though, look not at a process but at all aspects of a single department, from top to bottom.

Vertical audits can be internal or external. In an internal audit, an individual or company evaluates itself, simply for the purpose of betterment. In an external audit, a neutral party not paid by the individual or company makes the evaluation. In most cases, external audits are done to insure compliance or for certification or accreditation. For instance, when a private college is being audited by a regional collegiate association, it is for the purpose of maintaining their accreditation with the association. And when the IRS performs a vertical audit on a company, it is to insure that the company complied with tax reporting regulations.

Most of the background checking the IRS does is horizontal auditing. For instance, if a company reports a 1099 form for an outside contractor, the IRS might check the independent contractor's return to make sure the 1099 income was reported. When anomalies are found, typically the IRS sends a letter asking about the specific discrepancy. However, when the IRS calls in an individual or company for a face-to-face or onsite audit, they are performing a vertical audit. They are checking every line of the tax return from top to bottom.