Difference Between Internal and External Audit

Auditing, a prevalent practice in the corporate realm, serves to evaluate the performance and adherence to standards, regulations, and best practices of an organization, process, or project. Two primary types of audits, internal and external, are commonly employed by companies. While these audits bear resemblances, they also diverge notably in terms of their respective roles, responsibilities, objectives, and methodologies.

What is an Internal Audit?

The internal audit department is responsible for overseeing and evaluating the efficiency of a company's processes and controls. This function becomes particularly crucial in large organizations, where processes are intricate, making it easier to detect process failures and control breaches.

In contrast to external auditors, internal auditors are primarily company employees. They are tasked with assessing the company's operations to ensure compliance with internal standards and procedures, thereby ensuring integrity, transparency, and adherence to regulations in the company's activities.

Internal auditors review financial documents, internal policies, and operational procedures to verify the legality of all company activities and their compliance with current standards. They also evaluate the risks associated with these activities and suggest strategies to mitigate them.

To be effective, internal auditors must have a comprehensive understanding of the company's standards and procedures, as well as possess financial analysis and risk management skills. They should maintain objectivity, independence, and integrity to ensure the accuracy and truthfulness of their findings.

What is an External Audit?

An external audit is an examination conducted by an independent Certified Public Accountant (CPA). Typically, this audit aims to provide a certification of an entity's financial statements, a requirement for certain investors, lenders, and all publicly listed companies.

The external auditor, unlike the internal auditor, is an independent professional hired by the company to review its financial statements for accuracy and compliance with current accounting and tax standards. This auditor scrutinizes the company's financial records, invoices, and documents to ensure that all transactions are accurately recorded. Additionally, the external auditor evaluates the effectiveness and reliability of the company's internal control processes as well.

The main objective of the external auditor is to offer impartial and objective assurance that the company's financial statements accurately reflect its financial position, performance, and cash flows. This assurance is crucial for shareholders, creditors, suppliers, and other stakeholders, who rely on this information to make informed financial decisions.

To be effective, the external auditor must be impartial, objective, and possess a strong background in accounting and finance. They must also collaborate closely with the company to understand its operations, risks, and challenges.

Internal or External Audit: Which is better?

To start, there are several key distinctions between internal and external audit functions:

• Nature of Employment: Internal auditors are company employees, whereas external auditors are employed by external auditing firms and are appointed through a shareholder vote.
• Accountability: Internal auditors report to the management of the company, while external auditors are accountable to the shareholders.
• Usage of Reports: Internal audit reports are utilized by the management for improving business practices and managing risks. In contrast, external audit reports are used by investors, creditors, and lenders for evaluating the financial health of the company.
• Scope of Examination: Internal auditors focus on issues related to the company's business practices and risks. External auditors, on the other hand, scrutinize financial documents and provide an opinion on the accuracy of the company's financial statements.
• Frequency: Internal audits are conducted throughout the year, whereas external audits typically occur once annually. For listed companies, external auditors also provide review services three times a year.

It's important to note that neither audit type is inherently "better" than the other. Rather, they serve different yet complementary purposes in ensuring a company's compliance and transparency. Internal audits assess compliance with internal policies and enhance operational processes, while external audits verify adherence to accounting and tax standards. The choice between internal and external auditing should be based on the specific needs and objectives of the company's audit requirements.

What is the Auditor's Role?

The primary duty of an auditor is to conduct fair and unbiased evaluations to ensure that a company's financial and accounting practices adhere to current regulations. Auditors can be categorized as either internal or external. Internal auditors operate within the company and are responsible for continuously monitoring internal processes. Conversely, external auditors are engaged by an independent entity to review processes and offer an impartial evaluation of performance.

In both scenarios, auditors utilize various tools and methodologies to evaluate a company's risks and weaknesses while also identifying areas for enhancement. They also scrutinize the company's internal controls to guarantee that its assets are adequately safeguarded against fraud, errors, and misuse.

The primary goal of an audit is to provide a reasonable level of assurance that the company's financial statements and information are accurate and comply with relevant standards. As such, auditors play a critical role in safeguarding the interests of the company's investors and stakeholders.

Difference Between Internal and External Audit

Conclusion

In essence, internal audit plays a crucial role in enhancing companies' operations and processes from within, focusing on improving internal controls, risk management, and operational efficiency. On the other hand, external audit ensures that the financial statements and other disclosures presented by companies to external stakeholders accurately reflect the true financial position and performance of the organization.