Introduction:
Internal and external audits are both essential components of a company’s financial management and control processes. While they share some commonalities, such as the goal of evaluating the effectiveness of a company’s internal control system, there are fundamental differences between the two that are important to understand. This article will discuss the differences between internal and external audits.
Definition of Internal and External Audit:
An internal audit is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.
On the other hand, an external audit is an independent evaluation of a company’s financial statements and financial reporting practices by a qualified, external auditor. External audits are conducted to provide reasonable assurance that the financial statements are free of material misstatements and conform to Generally Accepted Accounting Principles (GAAP).
Purpose:
The primary purpose of an internal audit is to help an organization achieve its objectives by providing insights into the effectiveness of the organization’s internal control system. The internal audit is designed to identify areas where the company’s control environment can be improved, identify risks that the company faces, and make recommendations on how to improve the organization’s risk management and control processes.
The primary purpose of an external audit, on the other hand, is to provide an independent and objective evaluation of the company’s financial statements. The external audit is designed to provide assurance to stakeholders that the financial statements are accurate, reliable, and prepared in accordance with GAAP.
Reporting Line:
The internal audit function generally reports to the audit committee of the board of directors or the chief executive officer. The internal audit team is part of the company’s management team and provides ongoing assurance to management and the board of directors on the effectiveness of internal controls and governance processes.
The external audit function, on the other hand, is typically conducted by an external auditor who is independent of the company. The external auditor reports to the company’s shareholders or other external stakeholders and provides an opinion on the accuracy and reliability of the company’s financial statements.
Scope:
The scope of an internal audit is determined by the internal audit team and is designed to provide a comprehensive evaluation of the organization’s internal control system, risk management processes, and governance processes. The scope of the internal audit can be tailored to the specific needs of the organization and can focus on specific areas of risk, such as fraud prevention, cybersecurity, or financial reporting.
The scope of an external audit is determined by auditing standards and regulations and is focused solely on the company’s financial statements. The external auditor is responsible for evaluating the accuracy and reliability of the financial statements and ensuring that they conform to GAAP. The external auditor may also evaluate the effectiveness of the company’s internal controls as they relate to financial reporting.
Expertise:
Internal auditors are typically employees of the organization and are selected for their knowledge of the company’s operations and control environment. Internal auditors are expected to have a broad range of knowledge and skills, including accounting, risk management, and internal controls.
External auditors, on the other hand, are typically independent firms that are contracted by the organization. External auditors are selected for their expertise in auditing and accounting standards. External auditors are expected to have a deep understanding of accounting principles and auditing standards, as well as knowledge of the company’s industry and specific risks.
Responsibility:
Internal auditors are responsible for providing assurance to the organization’s management and the board of directors on the effectiveness of internal controls, risk management, and governance processes. Internal auditors also make recommendations for improving the company’s control environment and risk management processes.
External auditors are responsible for providing an independent and objective evaluation of the company’s financial statements. External auditors are responsible for evaluating the accuracy and reliability of the financial statements, ensuring they conform to GAAP, and providing an opinion on the financial statements to external stakeholders, including shareholders, creditors, and regulatory bodies.
Frequency and Timing:
Internal audits are conducted on an ongoing basis and can be scheduled at any time throughout the year. The frequency of internal audits can vary depending on the company’s size, complexity, and risk profile. Internal audits can be conducted monthly, quarterly, semi-annually, or annually.
External audits, on the other hand, are typically conducted once a year and are scheduled at the end of the company’s fiscal year. External audits are required by law for public companies and are voluntary for private companies. In some cases, external audits may be conducted more frequently if there are concerns about the accuracy of the company’s financial statements.
Level of Independence:
Internal auditors are part of the company’s management team and are not independent of the organization. While internal auditors are expected to maintain objectivity and independence in their work, they do not have the same level of independence as external auditors.
External auditors are independent of the company and are not affiliated with the company in any way. This level of independence ensures that external auditors can provide an objective and unbiased evaluation of the company’s financial statements.
Reporting Format:
The results of an internal audit are typically presented in a written report that is distributed to the audit committee of the board of directors, senior management, and other relevant stakeholders. The report includes findings and recommendations for improvement, as well as a plan for corrective action.
The results of an external audit are presented in an audit report, which includes the auditor’s opinion on the accuracy and reliability of the financial statements. The audit report is included in the company’s annual report and is available to external stakeholders, including shareholders, creditors, and regulatory bodies.
Cost:
Internal audits are conducted by the organization’s internal audit team, which is part of the company’s management structure. Notwithstanding, some company may outsource their internal audit functions especially if the audit is just for a particular purpose. The cost of conducting internal audits is included in the company’s operating budget.
External audits are conducted by an independent audit firm that is contracted by the organization. The cost of external audits is typically higher than the cost of internal audits due to the additional expertise required and the level of independence provided by the external auditor.
Conclusion:
In conclusion, internal and external audits serve different purposes and have different scopes, reporting lines, levels of independence, and reporting formats. Internal audits are designed to provide ongoing assurance to management and the board of directors on the effectiveness of the organization’s internal control system, while external audits are designed to provide assurance to external stakeholders on the accuracy and reliability of the company’s financial statements.
While there are some similarities between internal and external audits, it is important to understand the fundamental differences between the two in order to effectively manage risk and maintain financial integrity. Both types of audits are important components of a company’s overall risk management and control processes, and both can help identify areas for improvement and promote better financial management practices.