The internal audit function relates to the internal control and risk management of an organization. It ensures a company follows the adopted accounting standards.
The external audit function provides a fair and independent opinion about the financial statements of an organization. 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 Internal Audit?
The function of the internal audit is to evaluate the internal controls and corporate governance of a company. 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 on a timely basis. Thus, its mandate is to confirm the internal controls as well as compliance with the accounting regulations.
The internal audit function can be used for the identification and control of different types of business risks as well. A company may use special internal audits such as forensics to detect and control fraud, theft, and misconduct as well.
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 External Audit?
The external audit function is the evaluation of a company’s financial records according to the local and internal accounting standards. It also ensures that a company follows regulations and laws.
The main objective of the external audit is to analyze the fairness and correctness of the financial statements of an organization. The external audit function is a statutory requirement for organizations of every type and size.
The scope of the external audit also includes the identification and control of 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.
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 on a daily, monthly, or yearly basis depending on the nature and requirements of the organization.
Internal Auditing Methods
Internal auditors can use several techniques and methods to ensure the effective implementation of internal controls.
Internal auditing methods can start with evaluations of policies, procedures, and rules. Then, the function can use special audit techniques such as sampling, fieldwork testing, forensics, and so on.
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 in the identification and management of 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.
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 primary responsibility of the external audit is to make sure that an organization has presented the true picture of its financial performance. It means to ensure the figures stated in the financial statements are correct.
External auditing will evaluate the accuracy of financial records. It means to ensure that the organization follows the accounting standards it has adopted such as the GAAP rules.
The external audit also analyzes the financial statements for any 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, adoption of accounting standards, and presentation of 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.
The external auditors are approved through the audit committee and members of the board of directors. The audit committee ensures there is no conflict of interest when appointing external auditors.
The internal auditors are appointed by the top management of the company. They can be the employees of the company with qualifications as auditors. The company may outsource internal auditing as well.
The main duty of the external auditors is to offer a fair and independent opinion about the financial statements of an organization. Their roles, rights, and stature are governed by law.
The main duty of the internal audit is to provide an opinion about the internal controls, risk management, and corporate governance of the organization.
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 employees of the company.
The internal audit reports to the audit committee. However, as internal auditors can be the employees of the company as well, they must not hold any operational duties to avoid any conflict of interest.
The external auditors’ reports should be published for all listed companies by law. Public companies must also publish their audited financial statements that must 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.
The external auditing perspective is based on the past performance of the company. As their main task is to evaluate the financial statements that are based on historic results. However, they can form an opinion about the prospects of the company in terms of future performance forecasts as well.
On the other hand, the internal auditing perspective is future-centric. They analyze the risk management, internal controls, policies, and procedures that ensure the performance of the organization.
Professional Qualification Requirements
External auditors must hold the membership of 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 the internal auditors. However, their expertise and knowledge of the field are often a mandatory requirement.
The internal and external audit functions ensure that an organization is run fairly and in compliance with the statutory requirements. Both functions differ drastically in their approach, duties, and reporting formats.