[vc_row][vc_column][vc_column_text]You might be wondering which audit is better, internal audit or external audit. Which audit is more efficient, effective and cost-effective? Or Which audit is more productive for the owner and the company?
Well, there is no one right answer here. Both internal audit and external audit are unique and do not compete with each other. Both complement each other, and both of the audit types serve their own purposes.
In the below table, we’ll have a comparison of internal audit and external audit and evaluate their respective strengths and unique features.
| External Audit | Internal Audit | |
|---|---|---|
| Purpose | The purpose of an external audit is to provide an opinion on the financial statements of the company. | Purpose of internal audit is to have an independent check on different internal controls of the organization, identification of control weaknesses and suggesting improvements. |
| Who performs it | Third-party auditors, known as external auditors, perform an external audit.
An external audit cannot be done by the company, or by its employees. |
Most of the times, companies have a separate department where it employs internal auditors. So, internal auditors are the employees of the company, but these employees are not involved in the operations.
Sometimes, internal audit function can be outsourced as well to some audit firm, however, not to the same audit firm, which is the external auditor of the company. |
| Deliverable | Once an external audit is complete, the external auditors of the company will issue an external audit report. The title of this report is ‘independent auditors’ report on financial statements’. | Depending upon the nature of the assignment, there are different kinds of reports issued by the internal audit team. Mostly, the title of these reports is “internal auditor report on [subject]”. |
| Frequency | The external audit is usually performed once a year. Once annual financial statements are prepared, the annual audit is conducted by external auditors.
However, some companies prepare and publish quarterly summarized financial statements as well. In such cases, a quarterly review of the financial statements is also performed by external auditors. However, a review is not as detailed as a full-fledge annual audit. |
Internal audit team keeps working throughout the year in the company. They work on different account heads from time to time. Usually, the annual internal audit plan will define a schedule of which areas will be testing during a particular year.
For example, in year 1, the internal audit team may review internal controls systems of revenue, receivables, cash and bank. In year 2, they may decide to review operations of accounts payables, inventories and production etc. |
| Independence | The external auditor is always a third party. Therefore, the opinion of the external auditor is considered an independent view, free of bias. | Internal auditors are not involved in the routine operations of the company. They are not engaged in sales, production or accounting operations of the organization. Therefore, internal auditors are also independent up to a reasonable extent. |
| Appointment and Removal | The owners of the company appoint external auditors. Owners select external auditors to review financial statements of the company which are prepared by the management of the company. If owners and management are same, then auditors are appointed either for regulatory purposes or for submission of financial statements to third parties like banks etc.
Since external auditor is appointed by shareholders only, the removal of the auditor or the change of external auditor is also done by shareholders only. |
Board of Directors of the company appoint internal auditors. As part of good corporate governance practices, head of internal audit (or chief internal auditor) is supposed to report directly to the board of directors.
Board of the Director (or top management) of the company can change internal audit staff or the outsourced internal auditor. |
| Time-line | External auditors usually have a tight timeline to provide their report after the closing period. This timeline varies but typically ranges from 1 month to 4 months.
Deadline for the review reports of quarterly financial statements is usually less at 15 to 45 days. |
Internal auditor’s timeline is governed based on the nature of the assignment on which they are working. Further, since they are working throughout the year on the same company’s audit, they will have rolling deadlines. |
| Requirement/ Regulation | Conducting an external audit is usually a statutory requirement for many registered companies, depending upon local legislation. Most of the times, all public companies, listed companies, regulated companies and private companies above a certain limit of revenue are compulsorily required to have it’s annual accounts audited from an external auditor. | Internal audit is mostly a voluntary activity. However, in certain jurisdictions, corporate governance rules require an internal audit to be mandatory for listed companies and public companies. Many private companies have also started to build and enhance their internal audit teams as an additional check. |
| US GAAP / IFRS and IAS | External auditors have to check compliance of financial statements with US GAAP or IFRS. Further, external auditors are required to perform their audit procedures as per International Accounting Standards. | Internal auditors have to work under IIA’s International Standards for the Professional Practice of Internal Auditing (Standards). |
| Objective | The objective of an external audit is to enhance reliance by introducing a third party check, on the financial statements of the company. | The objectives of internal audit may include identification of control weaknesses, finding instances of internal controls violations, reducing operational losses, introducing efficiencies, finding fraud, detailed investigation, ensuring correct recording of accounting entries and true and fair view of the financial statements. |
| Scope | The scope of external audit is limited to providing an opinion on the financial statements of the company.
The scope of the work of an external audit is usually defined in the statutory laws or company laws of the respective jurisdiction. |
The scope of internal audit is much bigger and may include various additional items such as detailed investigation, finding fraud, identifying weaknesses, suggesting improvements etc. |
| Conflict of interest | External auditors have to be necessarily independent of the organization’s performance and profitability. Therefore, they cannot work on any business assignment or investment advisory function, in addition to being the external auditor. | The internal auditor (whether employed in-house or outsourced) can provide additional business services like investment advisory, mergers & acquisitions, business development, business setup, deal negotiation etc. |
| Fee | External auditors charge a fee in consideration of their audit services. | If the internal auditor is in-house, they are paid salaries. In the case of outsourcing, the company will pay an agreed fee to the third party to whom internal audit is outsourced. |
| Qualifications | The signing partner of the audit report has to be a qualified member of an IFAC member body. Usually, partners of external audit firms are Certified Public Accountants or Chartered Accountants. | In some jurisdictions, it is now mandatory for the head of internal auditor to be a Certified Internal Auditor. |
| Cooperation | External auditor usually takes input from internal audit reports issued by the internal auditor of the company. Based on these reports, the external auditor may enhance or decrease the extent of its audit procedures. | Internal auditors may take note of the points raised by external auditors in their management letter. |
| Report format | The external auditors’ reports are highly regulated and are in a particular format. There is minimal scope available to the external auditor to amend it’s report. | The reports of the internal auditor may vary in length, size and structure, depending significantly upon the nature of the assignment being reported. |
| Users | External auditor’s reports are mostly for external users. This report is shared usually with regulators, banks, stock exchanges, potential investors, fund managers, tax authorities etc. | Internal audit reports are usually confidential and are not shared externally.
However, external auditors may require to review reports issued by internal auditors. |
| Terminologies | The external audit is also referred to as ‘statutory audit’ or ‘annual audit’ or ‘regulatory audit’ or just ‘audit’.
|
Internal audit is referred as ‘internal audit’. |
| Assurance level | External audit provides a moderate level of assurance in their audit report. | The internal auditor may provide a high, medium or low level of assurance, depending upon the extent of the work done by the internal auditor. |
[/vc_column_text][/vc_column][/vc_row]
