Both internal and external audits play vital roles in safeguarding your organization’s financial integrity. They share the common goals of promoting reporting transparency and helping prevent errors and fraud, but they serve different functions and audiences. Here’s a closer look at some key distinctions to help your business develop a strategic audit approach.
Why they’re conducted
The purpose of an internal audit is to assess and improve a company’s internal controls, risk management and governance processes. Some companies have an internal audit department, but others outsource this function to external audit firms. Internal auditors — whether in-house or outsourced — work as an extension of the company’s management to ensure that internal processes align with organizational objectives and mitigate risk.
External audits must always be performed by an independent CPA firm. Under the auditing standards, an external audit aims to provide reasonable assurance about whether the company’s financial statements are free from material misstatement and to express an opinion on whether they’re presented fairly in accordance with U.S. Generally Accepted Accounting Principles (GAAP) or another relevant framework.
How far they reach
Internal audits can cover a broad range of topics. For example, auditors may evaluate operations, internal controls, company or industry-specific risks, and compliance with laws and regulations. You can tailor an internal audit’s scope to your company’s needs and modify it as new risks or business opportunities emerge. Outsourcing this function can be cost-effective for smaller organizations that don’t require a full-time internal audit department.
External audits are standardized, focusing solely on the financial statements and related disclosures. External auditors perform testing on account balances and transactions, evaluate financial reporting controls, and assess compliance with GAAP or other relevant frameworks. They also follow applicable regulatory guidelines, such as the U.S. Generally Accepted Auditing Standards issued by the American Institute of Certified Public Accountants and the Public Company Accounting Oversight Board standards.
Who stays independent
Internal auditors work under the direction of the company’s audit committee or management. Outsourced internal audit teams are also part of the organization’s internal audit function, so they may not be entirely independent. While internal auditors usually provide recommendations to the company, they can remain objective if they report directly to the audit committee or management.
On the other hand, external auditors must maintain independence, in fact and appearance, from the companies they audit to ensure objectivity and compliance with professional standards. This means they can’t have direct financial interests in the company or perform services that could create actual or perceived conflicts of interest. Independence is crucial for external auditors to provide an unbiased opinion that stakeholders can trust.
How the work gets done
Internal auditors use a risk-based, continuous-improvement approach, targeting specific areas of concern. They may also use internal control models — such as the Committee of Sponsoring Organizations of the Treadway Commission framework — to assess the company’s processes, identify potential risks, evaluate controls and make recommendations for improvement. Their role tends to be more consultative.
External auditors follow standardized methods to gather sufficient evidence to form an opinion on the fairness and compliance of the financial statements. After assessing the company’s risks, external auditors may perform substantive procedures, analytical reviews and sampling techniques to detect material misstatements. They verify the accuracy of accounts by conducting tests, reviewing source documents and confirming account balances with third parties.
What they produce
Internal auditors typically report directly to management or the audit committee. They provide detailed recommendations and action plans based on their findings, areas of risk and control weaknesses. Internal audit reports aren’t usually distributed to outside stakeholders; instead, they’re intended to guide internal improvements and decision-making.
External auditors issue an audit opinion on the organization’s financial statements. The audit opinion is a letter that serves as the front page of the company’s financials. Public companies file reports with the U.S. Securities and Exchange Commission, which are available to the general public. Many private companies share audited financial statements with lenders, franchisors, private equity investors and other stakeholders.
When they happen
Internal audit procedures are conducted throughout the year, typically in accordance with an annual audit plan approved by management or the audit committee. Internal auditors may evaluate different areas on a rotating or as-needed basis as risks evolve or emerge.
External audits are generally performed at year end. However, public companies and larger private organizations may also be required to issue audited financial statements quarterly. For an added measure of assurance, some companies have auditors conduct periodic “surprise” audits or agreed-upon procedures engagements that target high-risk accounts or areas of concern identified during year-end audits.
Choosing the right mix
When used together, internal and external audits provide a more complete picture of your organization’s risks, controls and financial reporting. As your business evolves, so should your audit approach. Periodically reassessing your needs can help ensure you’re getting the right balance of insight, assurance and strategic value. Contact us to learn more.
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