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Finance glossary

What is an audit trail?

Bristol James
5 Min

Au audit trail is a record of the adjustments, transactions, and details within your accounting system. Audit trails are useful for tracing back inputs to the source. Most accounting systems create an audit trail in the background, which can be accessed when you need to verify a transaction or the validity of the source. 

Audit trails are commonly used in accounting by auditors or other examiners to double-check important numbers, such as revenue, expenses, or earnings per share. Let’s say an auditor needs to determine if travel expenses were legitimate. First, they would obtain data from your accounting system (usually a list of expenses). Then, they would request supporting documentation, like receipts or invoices, for each line item. For public companies, an audit trail might be mandatory.

One of the main components of an audit is analyzing internal controls. When an auditor is testing the segregation of duties or the flow of transactions, they may request an audit trail. If your company doesn’t have the necessary controls in place to track transactions and adjustments in your accounting system, your internal controls could fail.

How are audit trails used?

Audit trail data can provide comprehensive information, including who is making changes, when changes are made, and what transactions are impacted. In addition, audit trails give regulators the ability to verify transactions and numbers. This information is crucial to running a successful business, regardless of size. Here are some of the benefits of audit trail records:

Reduce fraud

The reduction of fraud risks is one of the most important benefits of a comprehensive audit trail. Audit trail analysis provides an overview of transactions with time stamps. When there is detailed information showing the movement of money or transactions, there is less opportunity to commit fraud.

Additionally, if fraud was committed, regulatory agencies and members of management can easily trace back to the culprit with audit trail data. With detailed audit trail information, it’s not if fraud will be caught but when, making it less appealing to fraudsters.

Compliance with regulatory agencies

In some cases, audit trails are required. For example, healthcare agencies are required to follow the Health Insurance Portability and Accountability Act (HIPAA), which manages the way information is stored and accessed. An audit trail provides insights into this function, capturing data and information that regulatory agencies might request.

Outside of the healthcare realm, companies that are subject to audit procedures should have a detailed audit trail to support the movement of transactions and verify internal controls. Audit logs help prove that your accounting system is following the proper protocol.

Protect restricted areas

Audit logs also help safeguard your data from external parties. When you lock down your internal controls, your risks of external hacks and attacks are minimized. There are defined policies and procedures that employees follow when processing transactions and adding information to your accounting system.

Any type of request outside of normal procedures will raise concerns, thwarting external attacks. For example, let’s say that your audit trail processes require employees to have an invoice before issuing a payment. If a fraudulent vendor sends a payment request through email with no attached invoice, your employees will not pay the amount without proof. Having audit trail requirements in place adds an extra layer of protection for your business.

Confirm accuracy of financial information

The transparency an audit trail provides confirms the accuracy of your financial information. Without a detailed log of each transaction, regulatory agencies, investors, and other third parties have no reason to believe your financial information is accurate. Audit trail records provide the necessary transparency in your accounting system, facilitating smooth investing and lending decisions.

Not to mention that accurate insights into the financial health of your organization are crucial for business growth. By proving that the numbers on your financial statements are valid, you can make more informed business decisions surrounding growth and scalability. This might entail precise budgeting, tackling new markets, or securing capital for expansion initiatives.

Types of audit trails

Audit trails are designed to fit the needs of your business. As a result, audit logs have many different use cases, but are predominately found in the business realm. For example, a mortgage lender might take advantage of an audit trail to pinpoint the source of funds used as a down payment. This process might involve tracing the amounts from your paystub to your bank statement, and even back to your employer.

Moreover, the Securities and Exchange Commission (SEC) and stock exchanges will use audit trails to reconstruct trades. By following the transaction trail, the SEC ensures that the trade is in compliance with regulations. Any suspicious or unusual behavior will be flagged during audit logging, allowing regulators to catch fraudulent or non-compliant activities. Publicly listed companies will be subject to the SEC’s Consolidated Audit Trail*, which helps the SEC track trading activities.

Implementing audit trails

The implementation of audit trails will look different for each business and is heavily dependent on your goals. For example, if you are required to comply with Generally Accepted Auditing Standards (GAAS), you would need to design your audit trails around effective internal controls. This might include separating duties or ensuring proper documentation for each expense.

Public companies also have expanded audit trail requirements when undergoing audits by the SEC and other regulators. This makes it important to check with your regulatory agencies on the expected requirements before reworking your audit trail processes.

Even if you aren’t required to have an audit, implementing audit trail analysis into your accounting processes proves beneficial. For large expenses and income items, be sure your accounting staff verifies the legitimacy of each transaction with proof. This is commonly done with a receipt or invoice.

Next, be sure each accounting user has a unique login. If you are concerned about fraud or need to look up who processed a transaction, having individual logins will be indispensable. Furthermore, when implementing audit trail best practices, place restrictions on certain areas of your accounting system.

For example, your accounts payable clerk should not be the one completing bank reconciliations. Separation of duties is not only important to reduce fraud, but it may also be required if your business gets audited. Using a comprehensive accounts payable verification system, like Eftsure, can eliminate the number of verifications steps required to confidently pay invoices and suppliers.

Materiality in Audit Trails

It’s also important to understand how materiality thresholds factor into the audit trail implementation process. When auditing your company, the auditor will determine a materiality threshold, which is a dollar amount that will impact your financial statements. This is generally based on a percentage of sales or assets.

Materiality comes into play when determining which transactions need an audit trail. For example, if your materiality is $1,000, your team would not worry about compiling receipts for expenses under that threshold. Internal materiality is at the discretion of your management team. However, outside auditors will compute their own materiality.

Summary

  • An audit trail is a detailed record of the history and events related to your accounting system or a specific transaction.
  • Audit trails are commonly requested by accountants and financial regulators to verify the validity of financial data.
  • Reduced fraud risks, compliance with regulatory agencies, protection of restricted areas, and verification of accurate financial information are four benefits of a comprehensive audit trail function.

 

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