What is an Audit Trail?

An audit trail is a step-by-step record by which accounting or trade data can be traced to its source. Audit trails are used to verify and track many types of transactions including accounting transactions and trades in brokerage accounts. An audit trail is most often utilized when the accuracy of an item needs to be verified. Audit trails can be useful tools when determining the validity of an accounting entry, source of funds or trade.

Understanding the Audit Trail

Audit trails can be used in accounting when an examiner needs to verify figures such as revenue, net earnings or earnings per share. Transactions that are involved in computing a company's revenue, net earnings or earnings per share are reviewed and the calculations may be redone if figures were incorrectly classified. For example, cost of goods sold is an expense subtracted from gross revenue in computing net earnings. The cost of goods sold figure would be double-checked by verifying the transactions and data sources that went into calculating cost of goods sold. All elements of the final numbers are double-checked along the audit trail to verify the final figure. All public companies undergo a financial audit as part of their reporting responsibilities.

How Audit Trails are Used

Audit trails, or rather the process of following an audit trail, are found in many different areas of finance. When buying a home, for example, a mortgage lender may utilize an audit trail to determine the source of funds for a down payment. They may ask to see a bank statement showing the deposit of funds into the account and ask for additional 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 as to the validity or accuracy of trade data. This is to ensure that the trades taking place on major exchanges are in compliance with current regulations.

Of course, audit trails can also be used to track improper market activity. For example, if it is believed that a particular entity is trading large volumes of a thinly traded stock for the purpose of manipulating the share price, a regulator can utilize an audit trail to help identify the culprit. 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 might be the manipulator. Depending on the complexity of the trading scheme being used, reconstructing the trade history may require forensic accounting in addition to audit trail data.