Internal Audit Vs. External Audit: Key Differences You Should Know

Overview

The internal audit function relates to an organization’s internal control and risk management. It ensures a company follows the adopted accounting standards.

The external audit function provides a fair and independent opinion about an organization’s financial statements. They report independently to the shareholders of the company.

Both internal and external auditing functions provide valuable services and fulfill the regulatory requirements in their respective context.

Let us discuss key perspectives of internal and external audits.

What is an Internal Audit?

The internal audit function is to evaluate a company’s internal controls and corporate governance. It also ensures the company follows the accounting standards.

The internal audit ensures that a company follows accounting standards, compiles reports, and prepares financial statements promptly.

Thus, its mandate is to confirm internal controls and compliance with accounting regulations.

The internal audit function can also be used to identify and control different types of business risks. A company may also use special internal audits such as forensics to detect and control fraud, theft, and misconduct.

The role of the internal audit mainly focuses on internal controls and governance. It also coordinates with the external audit to ensure that the company follows the regulatory requirements.

What is an External Audit?

The external auditor evaluates a company’s financial records according to the applicable financial reporting standard and local law and regulation.

The main objective of the external audit is to analyze the fairness and correctness of an organization’s financial statements. The external audit function is a statutory requirement for organizations of every type and size.

The external audit scope also includes identifying and controlling financial embezzlement, misconduct, theft, and fraud.

The external audit function is mainly concerned with the accuracy of the financial statements of the organization. However, the scope of the audit includes comprehensive functions of the organization.

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Roles and Responsibilities of Internal Audit

Broadly, the roles and responsibilities of the internal audit include internal controls, corporate governance, and statutory compliance.

The internal audit can be conducted through the employees of the organization. However, many companies outsource the task to external auditing service providers to avoid conflict of interest.

Internal Audit Process

The internal audit process begins with the evaluation of existing internal control measures. It then identifies any loopholes and prepares recommendations for improvements.

The detailed process may include fieldwork testing, report writing, and report presentation to the board of directors. The internal audit also ensures follow-up with the management for effective control.

The internal audit can be conducted daily, monthly, or yearly, depending on the nature and requirements of the organization.

Internal Auditing Methods

Internal auditors can use several techniques and methods to implement internal controls effectively.

Internal auditing methods can start with reviewing policies, procedures, and rules. Then, the function can use special audit techniques such as sampling, fieldwork testing, forensics, etc.

Reporting Responsibilities

The internal auditors report to the board of directors of the company. The company may present interim and comprehensive reports as and when needed.

The comprehensive audit report will include an overview of existing internal controls, policies, procedures, and the effectiveness of these measures. The report includes suggestions and findings of the internal auditors as well.

Internal Auditing and Risk Management

A key aspect of internal auditing relates to risk management. Internal auditing can help an organization identify and manage the business and financial risks.

The internal auditing function evaluates the internal controls to mitigate financial risks. It can also comment on the effectiveness of the policies to reduce business risks.

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Roles and Responsibilities of External Audit

All public and non-public entities must conduct external auditing. The scope of external auditing relates to the accuracy and fairness of the financial statements.

The external audit’s primary responsibility is to ensure that an organization has presented the true picture of its financial performance. It means ensuring the figures stated in the financial statements are correct.

External auditing will evaluate the accuracy of financial records. It means ensuring that the organization follows its adopted accounting standards, such as GAAP rules.

The external audit also analyzes the financial statements for misreporting, financial misconduct, embezzlement, and other malpractices.

The external auditors report to the audit committee. The report includes a comprehensive evaluation of the existing internal controls, adopting accounting standards, and presenting the financial statements.

The audit committee then reports to the BOD and shareholders. Public companies publish their external auditing reports and audited financial statements.

Internal Audit v External Audit – Key Differences

Let us now discuss some key differences in the internal and external audit functions.

Appointment

The audit committee approves the external auditors and board of directors members. The audit committee ensures no conflict of interest when appointing external auditors.

The top management of the company appoints internal auditors. They can be the employees of the company with qualifications as auditors. The company may outsource internal auditing as well.

Duties

The main duty of external auditors is to offer a fair and independent opinion about an organization’s financial statements. Their roles, rights, and stature are governed by law.

The main duty of the internal audit is to provide an opinion about the organization’s internal controls, risk management, and corporate governance.

Reporting

The audit committee is answerable to the shareholders of the company. The audit committee works independently of the company management and does not report to the company’s employees.

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The internal audit reports to the audit committee. However, as internal auditors can also be the company’s employees, they must not hold any operational duties to avoid any conflict of interest.

Reporting Format

The external auditors’ reports should be published for all listed companies by law. Public companies must also publish their audited financial statements that accompany external auditors’ fair and independent opinions.

Internal auditors report to the audit committee and the BOD. They do not need to publish the report. Hence, they can follow a reporting format prescribed by the BOD of the company.

However, the regulators can demand the internal auditors’ report at any time.

Auditing Perspective

The external auditing perspective is based on the company’s past performance, as their main task is to evaluate the financial statements based on historical results.

However, they can also form an opinion about the company’s prospects in terms of future performance forecasts.

On the other hand, the internal auditing perspective is future-centric. They analyze the risk management, internal controls, policies, and procedures that ensure the organization’s performance.

Professional Qualification Requirements

External auditors must hold membership in one of the professional accounting bodies such as the ACCA, ICAEW, ICPA, etc. These bodies require practical work experience from these professionals as well.

Contrarily, there are no regulatory requirements about the professional qualifications of internal auditors. However, their expertise and knowledge of the field are often mandatory requirements.

Final Thoughts

The internal and external audit functions ensure that an organization is run fairly and complies with the statutory requirements. Both functions differ drastically in their approach, duties, and reporting formats.