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What is an accounting audit trail for small business?

What Is an Audit Trail?

When you maintain a complete and accurate audit trail, you can [theoretically] have a stress-free audit process.

Every day, your business records the transactions for that day. It is important to record the transactions correctly and have adequate documentation to support your entries. This documentation acts as an audit trail. There are multiple types of audit trails; this article is about audit trails in your accounting for small business.

What does an audit trail include?

An audit trail is the set of source documents that validate the transactions recorded on your business’s books. When you or your accountant records the business’s transactions, you base the entries on an event or activity of the business. An event can be anything from a daily sales transaction to a building acquisition to the disposal of equipment.

The documentation for an event or activity may involve one document or a series of documents that support the transaction. Examples of documentation include:

  • purchase orders
  • invoices
  • any correspondence that confirms the event

For example, valid correspondence (such as an email) might be communication between key personnel that states an event or transaction has been approved to move forward.

Audit trail example

Let’s say a floral shop needs to purchase a new delivery vehicle. The owner, or the person responsible for the delivery vehicles, might request a purchase order authorizing the type of vehicle as well as a price range for the purchase. If your business does not use a purchase order system, you may have a written estimate from the dealership.

Once the vehicle is purchased, the auto dealership gives you a vehicle bill of sale showing items like the vehicle type, purchase amount, and terms of the purchase itself.

These documents become part of the audit trail created for the vehicle’s purchase. Where will these documents be recorded or filed? In this case, they should be included in the fixed assets ledger along with any other vehicle purchases.

What about paperless recordkeeping systems?

While some businesses keep paper copies of this type of documentation in their files, more companies are now moving to a paperless system. With a paperless system, you can avoid the need for additional storage space for files. On the other hand, paperless systems call for caution when saving and labeling documents electronically. You want to be sure that tracking and locating particular documents is a simple process.

Are your records organized logically?
Are your files labeled consistently?
Can you find documents quickly?

The method of documentation and paper trails used requires consistency and efficiency to avoid any confusion or misinterpretation of the transaction in question. Regardless of how an audit trail is created, auditors and your authorized personnel will need to locate and view any documentation generated from a transaction at a moment’s notice.

Why is it important to have an audit trail?

Having a complete audit trail proves to auditors and investors that the information used to record the transaction is valid. It also follows with the government’s standards of recordkeeping for IRS tax purposes.

Prevent fraud

One main purpose of an audit trail is for the prevention of fraud. By having a trail of source documents that validate a transaction, a business can prove that a recorded transaction is valid.

In addition to proving the validity of a transaction, having an audit trail in place for all business activity also works to minimize the risk of fraud. When a business follows these strict standards, employees realize that any fraudulent activity won’t go unnoticed.

Enhance accuracy

Having an audit trail in place also further enhances the accuracy of a company’s financial records. Financial reports and records must contain accurate information to ensure that the business is operating efficiently. If these records are incorrect, not only will the business owners and managers not have a clear picture but investors and lenders will not have the correct information they need to make sound decisions.

For auditors

Another reason why audit trails are important is so that auditors and other key personnel can find or verify information. For example, if a transaction that is unusual or significant in nature appears on the books, an auditor may question its accuracy. By looking at supporting documentation such as a purchase order, invoice, bank statement reconciliation or even payroll accounting documentation, they can quickly determine whether or not the recorded transaction is valid.

In closing, having a series of documents to validate recorded transactions works to ensure the accuracy of financial records. An audit trail serves to prevent fraud and acts to meet recordkeeping requirements. Having an audit trail can also save time and money as it makes an audit go faster and easier for everyone involved.

avoid IRS audit

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