Audit trails are an important part of any accounting, as they provide a record of all financial transactions and help to prevent fraud.
“Because audit trails are often a regulatory requirement for companies, or, at the very least, a business best practice for tracking transactions, processes, and more, you’ll want to establish a suitably rigorous audit trail,” said Riley Adams, a certified public accountant (CPA) and senior financial analyst at Google.
Having a full record of events can provide valuable insight into where something might have gone wrong or confidence in your business' financials, believes Adams.
What is an audit trail in accounting?
An audit trail summarizes changes to your financial data, which can include invoices, bills, contacts, inventory items, and fixed assets. They also:
- Provide a record of who accessed what information and when.
- Act as a register of every transaction or activity that an employee or software did with financial data.
The daily volume of transactions can vary from hundreds, for small organizations, to hundreds of thousands in large organizations, making financial data complex to track.
“It’s challenging to start implementing a system to meticulously document everything, and on top of that, monitor people to make sure it’s followed regularly. There is always resistance to change. It’s human nature. In the beginning, creating audit trails is by no means fun, especially when your company is newer. Once it’s set up, however, things naturally pick up and run smoothly. As long as the system is consistently followed, audit trails provide security, legal protection, accountability, and support.” — Armine Alajian, CPA and founder of the Alajian Group
When is an audit trail needed?
Audit trails are useful whenever you need to provide a record of your organization’s financial transactions.
- Internal auditors use audit trails to assess the accuracy of financial statements and to identify potential areas of fraud or waste.
- External auditors can use audit trails to verify that an organization's financial statements are accurate and that investors, regulators, and creditors are not being deceived.
- For accounting teams, an audit trail can make the ongoing task of reconciling accounts and preparing tax returns a little easier.
In short, an audit trail is an essential tool for anyone who needs to track or verify financial transactions.
Audit trails vs. transaction logs: what’s the difference?
A transaction log is a specific part of an audit trail that records all changes made to a database. This includes creating, updating, and deleting records. Transaction logs are often used by developers IT to track any changes to a database during development and testing.
“Relying on erroneous—or worse, fraudulent—data to understand financial performance can prove disastrous for companies. Audit trails verify transactions and the build-up of financial statements. Further, they can ensure all items are correctly classified and reported properly, further improving financial performance analysis.” — Riley Adams, CPA, and Senior Financial Analyst at Google
The 3 main benefits of comprehensive audit trails
There are three main reasons why an audit trail is crucial for any organization.
- To comply with legal requirements: You are required to have an audit trail, according to many regulations and standards. For example, a company may be required to maintain an audit trail of all financial transactions to comply with Sarbanes-Oxley.
- To prevent internal fraud: Are there too many systems or too many users accessing your data? In this case, it is quite challenging to keep track of all the activities happening. It's time and resource-consuming. Not to mention the hidden risks if it's not done in the right way, but malicious actors can tamper with data and keep digital evidence.
- To prevent data breaches: The cliche is true: cybercriminals are getting more active and more inventive. When you work with sensitive data, the risk of a data breach remains high.
Common challenges of creating audit trails
However, creating effective audit trails can pose a challenge for accounting teams, finance departments, and important external stakeholders.
- Internal audit teams may be unfamiliar with the latest accounting software and financial automation technologies needed to generate audit trails
- External auditors may not have access to the necessary data when there is insufficient receipt and invoice management.
As a result, CFOs, financial controllers, and accounting teams must take care to ensure their organizations have the tools and expertise required to create robust audit trails.
“It’s challenging to start implementing a system to meticulously document everything, and on top of that, monitor people to make sure it’s followed regularly,” said Armine Alajian, CPA and founder of the Alajian Group, which provides accounting for startups.
“There is always resistance to change, it’s human nature. In the beginning, creating audit trails is by no means fun, especially when the company is newer. Once it’s set up, however, things naturally pick up and run smoothly. As long as the system is consistently followed, audit trails provide security, legal protection, accountability, and support.”
How to create an audit trail
To create an audit trail, you need to understand the information needed, the parties involved with creating, specifying and verifying the information—and the chain of custody, according to Adams.
From there, you'll map out a process and begin establishing requirements like chronological ordering of events, time stamping, the chain of custody, reviewers and approvers, and the segregation of duties.
“Critically, no single party can own oversight and administration of duties, as this can obscure information and possibly result in errors, or worse, fraud,” Adams said.
There are a number of different ways to create an audit trail, but some common methods include maintaining ledgers for all cash movements, payables and receivables, and invoices and receipts. At the very least, you need to follow these steps to prepare an effective audit trail:
- All invoices and receipts should be scanned and saved electronically. This will provide a paper trail in case of any disputes, and will also make it easier to search for specific transactions.
- All transactions should be recorded in a ledger. This ledger should include all relevant information, such as the date, amount, and type of transaction.
- More specifically, both your payables and receivables should be tracked separately. This will help to ensure payments are that there are no instances of issues such as double-charging.
- All ledgers should be reconciled on a regular basis, once the previous steps are in place. This will ensure that all cash movements are accounted for across both your accounts receivable (AR) and accounts payable (AP) processes.
- Finally, businesses should periodically review their audit trail to identify any areas of improvement. By taking these steps, businesses can ensure that their audit trail is accurate and efficient.
Startups and other small businesses with tight-knit finance functions might also consider working with a certified public accountant (CPA), especially when establishing a company’s first audit trail.
“A CPA can assist with establishing these audit trails through employing business best practices for internal controls,” said Adams.
“A CPA specializes in establishing audit trails, working with systems integration, compliance, record-keeping, and reporting functions. Bringing in a CPA early on can ensure the company takes the correct steps to establish an audit trail with the appropriate checks put in place during setup,” he said.
Tools to generate audit trails
Audit trails can also be created by tracking changes to financial records or by using financial management software that records all transactions. “Accounting software like QuickBooks, NetSuite, and Xero help streamline the audit trail process,” said Alajian.
“Additionally, automation tools for accounts payable, accounts receivable, and expense reimbursement also helps make the process more efficient. Little things like writing memos that state the policy, having individual logins, using electronic documents and signatures, and storing documents online keep things neat and organized.” she added.
How QuickBooks supports audit trails
QuickBooks records all transactions in your chart of accounts, while the software’s audit log records every user sign-in, settings change, edit to your contacts, and payroll submission.
How Xero supports audit trails
Similarly, Xero’s ‘History and Notes’ report serves as the software’s audit trail. The report records the history of all changes to transactions and any attached notes. Changes are date-stamped to indicate when they took place, and also show which user made the change.
How Netsuite supports audit trails
NetSuite’s search capabilities allow users to access system notes for auditing purposes. Its stored data includes all users involved in the history of a transaction, their actions, their roles, the date and time of that action, and whether an account was affected.
How Ramp supports audit trails
At Ramp, we integrate with the software above that an accounting team like yours use to maintain a ledger of all financial transactions for internal and external auditing. Ramp capabilities around invoice and receipt matching and automatic logging and categorization of transactions support cleaner audit trails.