Why Is An Audit Trail Important In Bookkeeping?

One of the most important aspects in bookkeeping is a clear and accurate audit trail. Find out why in today’s article. RELATED: 11 Common Small Bookkeeping Mistakes And How To Avoid Them In this article:

1. What Is an Audit Trail?
2. Why Are Audit Trails Important?
3. Practical Tips for Maintaining a Clear and Accurate Audit Trail

Audit Trail: Why All Bookkeepers Need It

What Is an Audit Trail?

An audit trail is a system of recordkeeping that ensures all steps of a financial transaction are documented both digitally and physically. An audit trail typically includes physical source documents like:

• Purchase orders
• Sales invoices
• Official receipts
• Issued and received checks
• Bank deposit slips
• Bank withdrawal slips
• Vouchers
• Other internal documents used for recording and executing financial transactions

Why Are Audit Trails Important?

An audit trail is a crucial part of bookkeeping for several reasons.

1. Accuracy

The first reason why audit trails are crucial for bookkeeping is they help ensure accuracy of financial transaction records. Financial statements and reports require accurate information to:

• Give owners and managers an accurate picture of their businesses’ true financial health and performance
• Help owners and managers make well-informed decisions that will positively impact their businesses
• Provide external stakeholders, like lending institutions, potential investors, and regulatory agencies, with the necessary information when transacting with their business

Without a good audit trail in place, the accuracy of financial information can be compromised. As a result, the accuracy of financial statements may also be compromised.

2. Fraudulent Transactions

An audit trail can also help minimize or even prevent fraudulent financial transactions. How? Source documents comprise an audit trail. These provide evidence that a financial transaction has really taken place and spent on the intended purpose of the business. Thus, an audit trail establishes the validity of a business’ financial transactions. On the other hand, lack of a clear and accurate audit trail means a financial transaction is at best, suspect. At worse, it can mean a financial transaction didn’t happen and fraud was committed. Because of strict documentation requirements for financial transactions, those with bad intentions will find it hard or impossible to commit fraud. And even if they try, auditors will figure out these actions through the audit trail.

3. For Financial Auditors

Finally, a good audit trail is crucial for bookkeeping because it can help auditors validate or invalidate questionable financial transactions they uncover during audits. For example, an external auditor comes across a significant purchase of items that aren’t related to that particular business. This may either be a legitimate or illegitimate transaction for the business. With a good audit trail established by supporting documents, such as purchase orders signed by the owner, the auditor can determine with certainty if the transaction was legitimate. Without them, the auditor can flag it for lack of compliance for being invalid or worse, fraudulent.

Practical Tips for Maintaining a Clear and Accurate Audit Trail

1. Keep Personal and Business Accounts Separate

Commingling a business’ accounts and transactions with those of its owner’s is a surefire recipe for a poor audit trail. When a business owner courses personal payments through a business’ accounts and vice versa, accountants and auditors may be burdened.

• For the accountant, it can be hard to prepare financial statements that accurately present a business’ true condition. Also, if the commingling is rampant, it may become almost impossible to segregate the owner’s finances from the business’.
• For auditors, commingling may keep them from doing their jobs well. They may be forced to render a qualified opinion or report, which can negatively impact a business’ external dealings.

For example, a qualified opinion citing issues with internal controls, such as, the owner using the business’ money for personal transactions. When applying for a business loan, a bank may turn a business down out of concern that the business owner may use loan proceeds for personal purchases. The unqualified report, on the other hand, states that there are no anomalies or no important details hidden, which renders the audit of the financial statement fairly and correctly presented on the records. RELATED: The 9 Bookkeeping Basics Every Bookkeeper Should Know

2. Always Ask for Receipts and Invoices for All Payments

Many make the mistake of thinking account statements are enough to validate payment transactions. No, they’re not. Account or billing statements only validate financial obligations of a business to suppliers, lending institutions, utility companies, etc. They don’t validate payments made by the business to settle those financial obligations. Without an official receipt or invoice, there’s no evidence of payment. No one can validate a recorded payment in a business’ books if it doesn’t have a supporting receipt or invoice. Regardless of the transactions’ amounts, always ask for and keep receipts and invoices to avoid audit issues. Having these systems in place can avoid any issues in the future.

3. Use Journals as Alternatives to Receipts and Invoices

Unfortunately, not all transactions are supported by receipts or invoices. Take for example, parking meter tickets. For transactions like these, maintain journals instead and keep related documents as support for proper audit trail.

4. Use Numbered Documents

These refer to source documents like checks, receipts and invoices, among others. And more importantly, it’s important to use or issue them in a sequential order instead of in random. Why? Having these systems in place can make looking for specific source documents during audits much easier.

5. Keep a Mileage Log for Official Business Travels

One of the areas of any business’ operations that’s vulnerable to fraud is business travel-related expenses, especially gas costs. Fraudsters can use a business’ funds for personal gas purchases and get away with it for since it’s supported by official receipts. With a mileage log file, bookkeepers, accountants, and auditors can identify a fraudulent or questionable gas expense or reimbursement. A mileage log file is a record of a business’ vehicles’ actual activity, which is mileage, based on odometer readings. Through odometer readings in a mileage log, a business can have objective bases for validating business-related gas expenses. For example:

• A business’ vehicle has an average gas mileage of 26 miles-per-gallon.
• An employee presents a receipt for a 10-gallon gas purchase and the odometer reflects an increase of 100 miles only since the last fill-up.
• At 26 miles-per-gallon, traveling 100 miles only requires 3.85 gallons of gasoline. The 10-gallon purchase then is a red flag for a possible fraud.

With information on a mileage activity log, it’s easy to catch red flags like these. But without these log entries, catching red flags like these is impossible. An audit trail is key to ensuring accurate book entries and financial statements. It also helps minimize or prevent fraudulent acts by making potential fraudsters think twice about getting caught. For these reasons, bookkeepers must ensure there’s a proper audit trail for all financial transactions. And because they’re the “gatekeepers” of a business’ books, they’re responsible for ensuring audit trails for the transactions they record. For you, what’s the biggest reason for having a clear and accurate audit trail in any business? Let us know in the comments section below. Up Next:

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