What is an Audit?
An audit is a term that refers to the process of auditors examining a company’s financial statements. Through this process, auditors aim to evaluate the financial statements to ensure accurate and fair presentation. Similarly, it seeks to ascertain that these statements meet the criteria set by the applicable financial reporting framework.
The word audit usually refers to the external audit of a company’s financial statements. However, some companies may also employ their internal audit function for better corporate governance. Regardless of the type of audit, the primary objective remains the same. However, there are some differences between both of these audits.
Internal Audit Vs External Audit: What Are the Differences?
There are several differences between how internal and external audits work. Primarily, external audit comes from external sources while the internal audit is client-sided. Usually, both types don’t rely on each other and can operate independently of each other. In some cases, a company’s external and internal auditors may interact with each other. However, it is not mandatory to do so.
Some of the top differences between internal and external audits are as below.
Definition
The primary difference between both types of audits comes from their respective definitions. An internal audit is a process in which a company employs auditors. While internal auditors may analyze a company’s financial statements, they also have other roles. These roles usually relate to the company’s internal controls.
An external audit is a process through which a company contracts an external auditor to assess its financial statements. The outcome of an external audit process is the report provided by the external auditor.
Purpose
The primary purpose of an internal audit is to assess and analyze a company’s internal controls and performance. Beyond this purpose, the internal audit function also evaluates a company’s risks and controls systems. Generally, internal auditors ensure internal controls and risk management effectiveness.
On the other hand, the primary purpose of an external audit is for auditors to provide an opinion. This opinion comes in an audit report. In this report, external auditors specify whether the financial statements meet the required conditions set by the applicable financial reporting frameworks. External audits also comment on the company’s internal controls. However, that is not its primary purpose.
Focus
Based on the above definition and purpose, the focus for each type of audit also differs. Internal audits mainly focus on enhancing and protecting organizational value. Internal auditors determine whether a company’s practices are supporting its strategic objectives. Similarly, it focuses on identifying risks that could impact a company’s objectives.
On the other hand, external auditors focus on whether a company’s financial statements show an accurate and fair representation of its financial matters. On top of that, it seeks to ensure that the company complies with all regulatory requirements.
Users
Both auditors perform tasks that are crucial for their users. However, the end-users for each of their works differ. For internal auditors, the users include the company’s management and the board. Being employees of the company, internal auditors report to the management. In some cases, it may also impede their independence.
External auditors, in contrast, provide a report to a company’s stakeholders. It primarily includes investors and shareholders. However, it may also include customers, suppliers, employees, the government, etc. It also implies that the work that external auditors perform has more impact compared to internal audits.
Scope
The scope for both audits also differs. Internal audits are an ongoing process. Due to the nature of their work, internal auditors have to provide continuous services. It includes constantly identifying risks and limitations to internal controls.
External audits, on the other hand, are a one-off process. Companies may perform these audits after a specific period. The scope of external audits comes down to financial reports and compliance requirements. Apart from these, external audits may also make observations on internal controls. However, that is not compulsory.
Relationship with the Company
In an internal audit process, the internal auditors have an employment relationship with the company. Therefore, both parties are directly related. In some circumstances, it implies that internal auditors may not be independent of the company’s management.
External auditors are independent of the company and its management. They have a business relationship with the client. However, they are more independent and objective compared to internal auditors. In this relationship, external auditors and the company are equals.
Perspective
Internal auditors look at the company’s historical performances. Using that information, they contemplate the future. Similarly, they analyze historical information to identify any weaknesses in internal controls. It implies that internal audits take both a historical and a future perspective.
External audits take a wholly historical view. These audits do not consider any future implications. As mentioned, external auditors only look at a company’s financial statements. These statements reflect the company’s financial matters in the past.
Summary of Internal Audit Vs External Audit: Key Differences
| Description | Internal Audit | External Audit |
|---|---|---|
| Definition | It is a process in which a company employs auditors. | It is a process through which a company contracts an external auditor to assess its financial statements. |
| Purpose | To assess and analyze a company’s internal controls and performance. | To provide an audit opinion. |
| Focus | Mainly focus on enhancing and protecting organizational value. | Focus on whether a company’s financial statements show an accurate and fair representation of its financial matters. |
| Users | The company’s management and the board. | The company’s stakeholders; include investors, shareholders, customers, suppliers, employees, the government, etc. |
| Scope | Provide continuous services; mainly on internal controls | Comes down to financial reports and compliance requirements. |
| Relationship with the Company | Employment relationship with the company. | Independent of the company and its management. |
| Perspective | Look at the company’s historical performances and future perspective. | Take a wholly historical view. |
Conclusion
An audit is a process in which an auditor examines a company’s financial statements. There are two types of audits that companies may use, which include internal and external audits. Both of these are different in various regards. These include their definition, purpose, focus, users, scope, relationship with the company, and perspective.