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Internal vs External Audit: The Basics

An audit can be carried out either internally by the employees or organization itself, or externally by a third party not affiliated with the firm. Essentially, an audit involves an independent evaluation of an organization's financial statements, separate from its internal financial records, in order to provide an opinion on their accuracy.

There are various types of internal and external audits, each with its own specific focus. Here are some commonly encountered ones:

• Compliance audits verify that a company or organization adheres to regulations and meets the legal requirements of their country, state, province, city, and industry.

• Financial statement audits, conducted by an external auditor, ensure the accuracy of a company's accounting records. The outcomes of these audits are significant to regulators, lenders, and investors.

• Risk management audits analyze current internal operations, identify areas of risk, and propose methods to mitigate those risks.

• Operational audits, performed by internal experts, examine business spending and budgets to identify areas where potential improvements can be made.

What is Internal Audit?

Internal Audit involves an unbiased and systematic evaluation conducted within a business organization. Its aim is to assess the day-to-day operations of the business and provide recommendations for improvement.

The activities carried out by internal audit cover a broad range, including:

• Performing regular physical verification of inventory.

• Evaluating the accounting and internal control systems.

• Examining routine operational activities.

• Identifying and investigating instances of fraud and errors.

• Analyzing financial and non-financial information pertaining to the organization.

The primary goal of internal audit is to enhance the value of the organization's operations while overseeing the effectiveness of internal controls, internal checks, and risk management systems.

Internal audits are conducted by internal auditors who are employees of the organization. They operate as a separate department within the organization, conducting ongoing audits throughout the year.

What is External Audit?

External Audit refers to the scheduled, methodical, and impartial examination of a company's financial statements by an independent third party for specific purposes, as mandated by regulations.

The primary objective of an external audit is to publicly express an opinion on the following aspects:

• The accuracy and fairness of the company's financial statements.

• The completeness and adherence to Generally Accepted Accounting Principles (GAAP) of the accounting records.

• The disclosure of all significant information in the annual accounts.

To conduct an external audit, the auditor is appointed by the company's members. It is crucial for the auditor to be independent, meaning they should have no affiliations with the organization, enabling them to work objectively and without any influence.

The auditor has the right to access the company's financial records to gather necessary information and provide their opinion through an audit report to the members of the company.

What are Key Differences Between Internal and External Auditing?

Internal and external audits share the goal of providing an independent assessment of a company's finances and practices. However, they differ significantly in terms of the auditor, purpose, and scope of the audit. Let's delve deeper into these distinctions:

• Purpose

Internal audits primarily aim to evaluate current performance, identify areas for improvement, and enhance internal processes. On the other hand, external audits primarily focus on substantiating the accuracy and reliability of financial statements for external stakeholders.

• Scope

Internal audits typically concentrate on specific areas within a company, whereas external audits encompass a comprehensive examination of all relevant financial information and practices to verify the accuracy of financial statements.

• Auditor

External audits are conducted by independent third-party auditors who are not affiliated with the company being audited. Internal audits, in contrast, are performed by auditors who are part of the company's own staff and work on behalf of the organization.

Internal auditors can play a supportive role in preparing for external audits. For instance, they may utilize automated systems for preparation, compilation, and review of financial data to facilitate the external audit process or assess internal performance.

The Final Word

Internal Audit and External Audit are not in opposition to each other; rather, they work in harmony and complement one another. The External Auditor has the option to utilize the work performed by the Internal Auditor if deemed appropriate, although this does not diminish the responsibility of the External Auditor.

Internal Audit serves as a mechanism to review and monitor the activities of the business, offering guidance on various matters to enhance operational efficiency. It acts as a check on the organization's operations and provides valuable insights.

On the other hand, External Audit is an entirely independent process in which a third party is engaged by the organization to conduct the audit. Its primary purpose is to verify the accuracy and validity of the organization's annual financial statements.

While Internal Audit focuses on internal controls and operational effectiveness, External Audit concentrates on providing an objective assessment of the financial statements from an external perspective. Both audits serve important roles in ensuring transparency, accountability, and confidence in the organization's financial reporting.