What is an Audit?
In a nutshell, an audit is an official inspection of a business’s operations, processes, or financial records. There are two types of audits, namely internal and external. While both share similarities in how they are approached and conducted, they are quite different in terms of their objectives, scope, methodologies, and outcomes.
According to The Institute of Internal Auditors, internal auditing is an independent and objective assurance and consulting activity designed to add value to and improve a company’s business operations.
Barring exceptions, internal audits are discretionary, and generally small to medium-sized businesses tend to carry out internal audits on an ad hoc or annual basis.
The frequency of internal audits depends entirely on the process complexity of the business. As a general rule, the more complex the business, the higher the chances of risks that need to be addressed.
An external audit is an inspection of the business’ financial statements and its compliance with regulatory standards. External audits are performed by external auditors who are professional accountants with public accounting experience and are designed by the applicable corporate law to undertake such assurance engagements. In the US, external audits are commonly performed by Certified Public Accounting (CPA) firms.
External audits are mandatory, and their frequency depends on local laws and regulations. For example, publicly-held businesses must undergo external auditing at least once a year. Ageras provides detailed insight into the frequency of audits.
Key differences between internal and external audits
The objective of the audit
Internal audits are proactive inspections that seek to identify and address any risks or deficiencies in a business’ processes and operations. They are performed to ensure future success for the business. External audits on the other hand are performed to gain a reasonable degree of assurance on whether the financial statements of a company present a true and fair view, i.e., these financial statements are free from material misstatements regarding the company’s financial performance and position.
Scope of the audit
Internal audits tend to inspect all matters of governance, risk management, business processes and strategy. Since the objective is to thoroughly analyze and improve the business operations, all key aspects of the processes governing these operations are inspected in detail. Internal auditors not only identify deficiencies within and vulnerabilities around the business processes, but they also suggest ways in which these issues can be addressed.
External audits are much more limited in scope, with the focus primarily on establishing the true and fair view of the financial statements.
The auditing teams
Internal audits are performed mostly by employees of the company, although the services of a third-party service provider can also be hired for this purpose, whereas external audits are performed by individual professional accountants or firms of professional accountants designated by the applicable corporate laws within the local jurisdiction to act as external auditors. Typically, large businesses tend to establish a dedicated internal auditing department to perform internal audits. External auditors are generally hired by the company’s board of directors.
To be a member of the internal auditing team, it is preferred but not mandatory to hold a certain type or level of qualification. However, as stated earlier, only legally designated professional accountants may act as external auditors of a company.
The objectivity of the internal auditing team may be questionable to the layman as they are hired by the business itself; however, the Institute of Internal Auditors addresses this concern in their code of ethics, encouraging internal auditors to be honest and objective in their assessment. This is typically why auditing committees – which are subcommittees of the board of directors – are formed to oversee the internal audit function.
Reports generated by the internal auditors are presented to the company’s management, which could be the board of directors or any of its subcommittees – usually the audit committee. The audit report issued by the external auditors is presented by the board to the shareholders during the company’s annual meeting in case of public or listed companies. Technically, the external audit report is presented to the owners or the shareholders of the company.
On a concluding note, an internal audit examines the efficiency and effectiveness of a company’s processes and operations, whereas an external audit examines whether a company’s financial statements present a true and fair view of its financial affairs.
Auditing, whether internal or external is not easy. It is resource-intensive in terms of the skills, finances, and manhours required. For SMEs, maintaining an in-house internal audit department or frequently undertaking internal audits is far from easy, even though its importance cannot be emphasized enough.
Expertise Accelerated as your audit facilitator
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Internal and external audit support is part of the EA’s comprehensive service portfolio. EA publication “Why Is Staff Augmentation Vital for US Companies Today?” highlights the importance of staff augmentation for US businesses today. This is doubly true for SMEs that should leverage such solutions to stay afloat in the competitive landscape.