What Is an Audit Trail?
An audit trail is a step-by-step record by which accounting, trade details, or other financial data can be traced to their source. Audit trails are used to verify and follow many types of transactions, remembering accounting transactions and trades for brokerage accounts.
An audit trail is most frequently utilized when the precision of an item needs to be verified, as it very well may be on account of a audit. Audit trails can be useful tools when determining the legitimacy of an accounting entry, source of funds, or trade.
Understanding an Audit Trail
Audit trails can be used in accounting when an auditor or examiner needs to verify figures like revenue, net earnings, or earnings per share (EPS). Transactions that are involved in computing a company's revenue, net earnings, or earnings per share are reviewed and the computations might be redone assuming that figures were incorrectly classified.
The cost of goods sold (COGS), for example, is an expense item subtracted from gross revenue that is used when working out net earnings. The COGS figure would be double-checked by verifying the transactions and data sources that went into working out the cost of goods sold. All elements of the last numbers are double-checked along the audit trail to verify the last figure.
All public companies undergo a financial audit as part of their reporting responsibilities.
Types of Audit Trails
Audit trails, or rather the process of following an audit trail, are found in various areas of finance. When buying a home, for example, a mortgage lender might utilize an audit trail to determine the source of funds for a down payment. They might ask to see a bank statement showing the deposit of funds into the account and ask for extra verification regarding the source of the deposit.
The Securities and Exchange Commission (SEC) and NYSE will use audit trails for the explicit reconstruction of trades when there are questions about the legitimacy or precision of trade data. This is done to ensure that the trades occurring on major exchanges are in compliance with current regulations.
Of course, audit trails can likewise be used to follow improper market activity. Assuming that it is believed, for example, that a particular entity is trading large volumes of a thinly traded stock to manipulate the share price, a regulator can utilize an audit trail to help identify the guilty party.
A regulator will then document and analyze all houses and brokers involved in specific trades for the offending security to determine whose activity is abnormal and who may be the controller. Depending on the complexity of the trading scheme being used, reconstructing the trade history might require forensic accounting notwithstanding audit trail data.
Advantages and Disadvantages of Audit Trails
Audit trails are a crucial tool used by accountants to hold corporations accountable for their actions. Without the use of audit trails to confirm financial data, there would be no great explanation to believe in the legitimacy of a company's financial reports. Along these lines, audit trails not just protect consumers from fraudulent reporting, they additionally help to stabilize the overall economy.
Audit trails likewise force entities to keep an intensive and updated audit log and trail system, which further cuts down on fraud and other types of financial crime. In industries, for example, healthcare, the meticulous keeping of audit logs helps ensure that sensitive data, for example, HIPAA-protected data, must be accessed by the appropriate parties.
While audit trails provide financial data that is absolutely necessary for the smooth flow of business, there are challenges to keeping up with and implementing the practice.
The biggest issue faced by corporations is the time and money it takes to keep a sufficiently consistent audit log, especially when the audit log is automated. Logs likewise might be challenging to navigate and store as they increase in size. Furthermore, access might be too broad, which can compromise the integrity of the data.
At last, as on account of banks hoping to approve loans to their members, sometimes the requirements of audit trails are unnecessarily inflexible. On the off chance that, for example, a consumer neglects to keep appropriate financial records, they might be unreasonably rejected for loans for which they would otherwise be approved.
The Order Audit Trail System (OATS) is an automated trade entry system established by the Financial Industry Regulatory Authority (FINRA) that is used to record data relating to orders, quotes, and other trade-related data from all equities traded on the National Market System (NMS). This system simplifies an order's progression from its initial receipt to its eventual execution or cancellation, for easy tracking or auditing purposes.
One of the purposes of OATS is monitoring for suspicious behavior and giving an audit trail to investigators. Because of the data that is recorded, anyone involved in suspicious activity is easier to find.
A critical case occurred on May 6, 2010, when an informal investor "spoofed" the S&P 500 E-mini market. He used an automated program that started a cascading type of influence of sell orders which led to a flash crash that day. The man responsible, a London resident, was gotten and arrested in 2015. In 2016 he pleaded liable to spoofing and wire fraud.
While a number of parties were involved in giving testimony and evidence, and this case involved futures, not stocks, it shows the importance of order audit trails and financial oversight. The regulators were able to see that Navinder Singh Sarao, the man responsible, put out hundreds of huge orders without any intention of filling them, yet rather for the sole purpose of controlling the market in his preferred direction.
Another popular example of fraud discovered by auditing practices in recent years was the case of Enron. In the late 1990s, Enron was praised for its innovation and was one of the dears of Wall Street. However, the company had huge exposure to some of the hardest-hit sectors of the dotcom bubble crash in 2000. Instead of eating its losses and moving forward honestly, the company concealed its losses from investors and inflated profits in other sectors to appease shareholders.
The firm tasked with auditing the company, the now-defunct Arthur Andersen, signed off on Enron's reports even however they knew the documents were fraudulent. Eventually, the losses were too big to hide and Enron was forced to file for bankruptcy.
Even however Arthur Andersen's CEO ordered auditors to destroy all Enron documents that revealed fraud, eventually the truth came out and employees at both Enron and Arthur Andersen were charged criminally.
The Enron case presents one of the most persuading arguments regarding the need for accurate and intensive audit logs.
In response to the Enron scandal, President George W. Bush signed into law the Sarbanes-Oxley Act. The Act heightened the consequences for destroying, altering, or manufacturing financial statements and attempting to defraud shareholders.
What Are Auditing Standards in the United States?
Companies in the United States are required to abide by generally accepted accounting principles (GAAP).
What Is Internal Auditing?
Internal audits evaluate a company's internal controls, including its corporate governance and accounting processes. This report provides management with the tools necessary to achieve operational efficiency by identifying problems and correcting lapses before they are discovered in an external audit.
What Is Materiality in Auditing?
As indicated by the U.S. GAAP, materiality is described along these lines: "The oversight or misstatement of an item in a financial report is material if, in the illumination of encompassing circumstances, the magnitude of the item is to such an extent that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item."
How Might I Know If the IRS Is Auditing Me?
Assuming you are being audited by the IRS, you will be notified via mail. The IRS does not tell people by means of telephone. For more data, counsel the IRS website on audits.
What Should a General Ledger Audit Trail Include?
A general ledger audit trail ought to record a company's all's transactions and the documents as a whole — whether paper or electronic — related to those transactions. This could include invoices, purchase orders, and expense reports, as well as whatever other data that can confirm the source and contents of the transaction.
What Documents Are Included in a Payroll Audit Trail?
A payroll auditing trail ought to include all employees' identification data, expense reports, tax documents, and any documentation related to changes in their salary as well as to bonuses or extra compensation.
- Order audit trails provide evidence and data for regulators in cases of suspected fraud or illegal financial activity.
- The use of audit trails helps to stabilize the overall economy by confirming the data corporations release to the public.
- An audit trail is a sequential record detailing the history and events related to a specific transaction or ledger entry.
- Keeping an audit trail is often a regulatory requirement in numerous financial spaces, as well as an accounting best practice.
- Regulatory institutions, for example, the SEC and the NYSE will use audit trails for the explicit reconstruction of trades when there are questions concerning the legitimacy or precision of trade data.