An audit is an inspection of a company’s financial records and statements. This inspection can be either internal or external. A regular internal audit is useful for generating verified reports for management decision-making. Regular internal audits help the company course correct and reinforce internal controls over processes. External audits are not as frequent as internal audits, and they are usually conducted on an annual basis. An auditor studies the company’s books and publishes an auditor's report. Annual financial statements that have been audited reassure the shareholders, investors, financial institutions and other stakeholders that the company is following the correct accounting practices and that the financial reports are true and verified. If there are any malpractice or compliance issues, they will be uncovered by an external audit. Some authorities require audited reports for submission for official purposes.
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External audit
While an internal audit is performed by people who are a part of the company, an external audit must be performed by an external body or person. Some companies call in an external company for their internal audit purposes.
Purpose of internal vs external audit
An internal audit is purely for the use of the company's internal management. It is used to evaluate and judge the business performance and identify risks and opportunities for growth and improvement. A company also uses internal audits to identify problem areas and correct their controls or processes. So, internal auditors are also advisors to the management. Internal audits are not always purely financial. They also cover the business policies, objectives and risks. Internal audits may lack objectivity because the auditors are part of the processes in the company. Since they may also have been involved in the preparation and recording of the financial transactions, they may lack objectivity.
An external audit is an objective examination by an auditor to examine the company’s books of accounts and determine if the company's financial statements are fair and true. An auditor also determines if the company follows accounting standards and systems. An independent auditor reviews the accounts and provides the company's shareholders with transparency and reassurance about the correctness of the accounts. It makes the company and its financial statements more credible and respected.
An external auditor is a person who is not connected to the business in any way. The auditor is appointed by the board of directors of the company.
The process of an external audit
After the auditor has been appointed, a meeting may be held between the auditor and the top company management. The auditor may ask for a set of documents required for the audit. Based on the study of the documents and the meeting with the management, the auditor will be able to estimate a timeframe for the audit. The auditor may also want to personally interview people involved with specific processes if there are any queries. It is essential to keep all the financial documents at hand to present to the auditor if there are any queries. An auditor may have questions with regard to transactions that will have to be answered with supporting documents if required.
Since it would be impossible to verify every company transaction in a short period, the auditor would usually examine random samples. The selected samples will be examined, and the auditor may decide to probe deeper into the transactions if required. The audit will also check the internal controls, processes and procedures. The purpose of the audit is to check the company's processes and see if there are any financial aberrations. Auditing is easier when the company approaches it as an exercise in reviewing their systems and finding room for improvement rather than looking for fraud.
After the investigation of the reports and on-site, an auditor releases a report that states the auditor’s opinion. In an ideal situation, the auditor would have found that all the company’s processes and books of accounts are in order. If the auditor states that the financial reports are true, the transactions listed occurred and that the stated assets exist. A report that says that the statements are fair means that the listed assets, liabilities, and transaction values are all fair.
A fair and true report is the optimal auditor’s report. However, an auditor may also give a negative report. A disagreement report may state that all the transactions are fair and true except for certain issues. These issues could be fraud, unrecoverable debts or unsuitable accounting methods. A report that states limited scope indicates that certain documents have not been made available to the auditors or that the recording methods are at fault. An adverse report is given for accounts that are neither fair nor true. An inconclusive report may be given if the auditor feels that they have not been given enough information for a conclusive report.
The advantages of an external audit
External audits take time and cost money. Yet, they have benefits for a company. An external audit improves the credibility of the company and its financial reports. This is especially useful in a company looking for a buyer or an investor. Audited reports show that the company maintains accounts properly and that the reports are free from errors or malpractices. It raises the respectability of the company in comparison to other companies that do not have external audits.
Audited reports give the shareholders confidence in the management of the company and how it is run. Since an independent auditor performs an external audit, there is added transparency. External auditing builds the trust of the investors and shareholders. If there are any issues in the company, the external audit highlights these issues and brings them to the notice of the shareholders.
The process of auditing studies the books of accounts and also the processes in the company. So, if there are any issues or room for improvement in these systems, an audit will highlight them. Wastefulness, operational inefficiencies, inadequate controls and non-compliance are issues that are highlighted by an external audit. Every external audit is a chance for a company to improve itself, become more efficient and protect itself from fraud. While internal audits are performed by people familiar with the company and its processes, an external audit is objective and has a new perspective.
External audits also throw up areas where the company can become more cost-efficient. If the company is having cross-functional issues that are too complex for the internal auditors, an expert external auditor may be able to identify a workable solution. The company's shareholders benefit by knowing if the company’s finances are being managed well. The managers and process owners in the company benefit by getting insights into operational inefficiencies and identifying exactly where and how to improve. Some regulatory bodies and financial institutions also require audited reports.
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