What is an External Audit? Everything you need to know

Definition

External audit – This is an independent examination of an organization’s financial statements to determine whether they represent a true and fair view in all material respects and whether they comply with relevant financial reporting requirements.

A statutory audit is a requirement under the law for some companies. Others may be legally exempt from this need, but they frequently elect to undergo an audit for sensible commercial reasons. Which includes:

  • To ensure that a company complies with its legal and regulatory requirements, it is important to identify risks and or highlight opportunities.
  • To get ready for due diligence while organizing a transaction like merger or business sale
  • To give owners, lenders, investors and other important stakeholders of a business information that has been independently vetted.

External Audit Process

  1. Audit planning: Here the primary duty of the auditor starts; preparation of an audit plan so as to determine the procedures to undertake in terms of risks, materiality, tests etc. This may take up to 40% of the entire audit process.
  2. Audit Execution: At this stage, the auditor executes the audit programs, collection and documentation of audit evidence to aid in forming opinion in the audit report. These documentations need to be corroborative in nature i.e., Convincing evidence-reliable and sufficient. The auditor obtains this evidence through, performing inquiries with the relevant management teams, inspection and review of records, obtaining third party confirmations and other procedures. Any matters identified during the audit is communicated those charged with governance in a timely manner.
  3. Audit Completion: A report is drafted after the execution. The report includes such areas as the purpose and extent of the audit, relevant background, the findings and recommendations for correction or improvement. This stage of the audit is of crucial importance. It is during this stage that the auditor reviews the documentations obtained during the audit together with the final version of the financial statements with the intention of forming the auditor’s opinion.
  4. Audit Reporting: The written audit report includes a discussion with the management or directors about the particular audit area and the audit observation both positive and negative. The audit findings are noted in the report along with recommendations to management and management’s action plan.

Purpose and Importance of External Audit

  • By attesting to a company’s financial stability, the main goal is to increase its credibility.
  • Verification of the of the entity’s financial statements.
  • Verification of the company’s compliance with laws and regulations and the relevant reporting frame works.
  • Checking to see if the company is accurately represented in the financial statements.
  • Ascertain that the entity adheres to all pertinent accounting standards.
  • The objective is to boost stakeholder’s faith about the financial status of the company.

Internal Audit Vs External Audit

  • Internal Audit– According to IIA, ”Internal Auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations”. The internal auditor can be an employee of the company or outsourcing can be done from a CPA firm.
  • External Audit– is an independent examination of an organization’s financial statements to determine whether they represent a true and fair in all material respects and comply with relevant financial reporting requirements. This must be done by an independent audit firm.

Comparison between external & Internal Audit

  • Frequency: Internal audit is carried out continually throughout the year, as opposed to the yearly external audit
  • Objective: An internal audit attempts to give the management feedback on how internal controls are operating, areas for development and areas of added value while the external audit’s goal is to assess an organization’s compliance with rules or guidelines.
  • Scope: The internal audit plan, which covers the entire organization is determined by those in charge of governance, whereas the external audit’s scope, which is particular to the regulation or guideline being checked for compliance is determined by the relevant authority, regulations or guidelines.
  • Reporting: The internal audit must be independent of the area being audited and typically reports to the audit committee of the board of directors. While the external auditors are accountable to the general public and external users of the report produced. They must be impartial toward the company being audited.
  • Purpose: The internal audit is focused on improvement, whereas the external audits are focused on compliance.
  • Users: Internal audit reports are primarily used by the management and other internal stakeholders of the company whereas the external audit reports are primarily used by the regulators, customers, lenders and general public, they are also used by the management internally to ensure that internal controls are operating effectively.

Related: Internal Audit and Corporate Governance

Related: ESG: What Is It and Why Should Your Firm Care?

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