Definitions and meanings:
External audit is a practice of examination and inspection of financial statements of a company by an external independent audit firm to obtain an opinion about the truth and fairness of these financial statements. An external audit is usually conducted under legal requirements on a yearly basis for public listed companies.
Difference between internal audit and external audit:
The main points of difference between internal audit and external audit are give below:
1. Legal Requirement:
External audit is mandatory by law for public listed companies because general public invests in these organizations. External audit must only be performed by independent external firms. Internal audit is not mandatory by law, however in accordance with the best practices of corporate governance it is highly recommended that larger organizations must have an internal audit department. This internal audit department must be reportable to audit committee.
2. Primary Objective:
The primary objective of an external audit is to verify and provide an opinion upon the truth and fairness of financial statements while the primary objective of internal audit is to identify the key risks that an organization is facing and provide solutions to mitigate those risks in order to help design management policies that could assist in long term development and growth of the company.
Internal Audit can be conducted either by an internal audit department or it can be outsourced to external firms. Internal auditors are appointed by the management of the company. On the other hand, external auditors are appointed by the approval of shareholders. If internal auditors are part of internal audit team they are paid salaries as employees of the company. If internal audit is outsourced to an external firm, it is paid a fixed fee for its services.
As internal auditors are usually employees of a company they are less independent in their opinion and have to work closely with the management of the company. This is because internal auditors cannot work unless they actively engage management of the company. External auditors are more independent as they are not dependent upon the company in any way. External audit is carried by external firms and charge a predetermined fixed fee for their service which must not be contingent upon audit results. External auditors are also restricted by the codes of corporate governance to accept any kind of undue favor or excessive gifts or hospitality from clients. This is the reason why management has less influence on external auditors.
5. Users and Application:
External audit reports are formulated for the use of shareholders. These reports show whether the financial statements of a company present a true and fair view about the financial affairs of that company or not. However, other internal and external stakeholders also use audit reports to make informed decisions about their respective dealings with the company. Internal audit reports are management reports and are prepared with a primary aim to strengthen the internal procedures and rectify errors in the internal controls of a company. These reports are only used by the internal audit department of the company and shared with other departments if deemed necessary.
Internal audit can be performed by management experts and there is no requirement for internal auditors to become chartered accountants. However, external audit can only be performed by professional chartered accountants. Almost every jurisdiction has their own chartered accountancy firms.
Internal audit versus external audit – tabular comparison
A tabular comparison of internal audit and external audit is given below:
|External Audit is binding by law for pubic listed companies||Internal Audit is highly recommended for large organizations|
|To check the accuracy of financial statements||To improve business processes|
|Appointed by the shareholders||Hired by the management|
|External Auditors are independent of company||Internal Auditors are not independent of company|
|Users and Application|
|External Audit Report is formulated for shareholders but also used by other stakeholders like creditors, supplier and potential investors||Internal Audit Reports are used by internal audit department or the management of the company|
Conclusion – internal audit vs external audit:
Although both external and internal audits have different focuses and the testing approaches used in both audits is usually the same. Now-a-days international auditing bodies especially IFAC (International Federation of Accountants) is considering to strengthen communication amongst internal auditors and external auditors and the implications of using the work of internal auditors to decrease detailed testing and time consumption required to complete external audit reports. This may provide an additional advantage to external auditors as internal auditors have more insight of the company if compared to external auditors. External auditors assess professional expertise and competence, educational background, independence of internal auditors, legal requirements of jurisdiction etc. before relying on the work done by internal auditors.