Question

A friend knows that you are studying auditing and asks you what the difference is between internal and external auditing. Using what you learned in this chapter and from information from the AICPA website (www.aicpa.org) and the IIA website (www.theiia.org), compare and contrast the duties and characteristics of internal and external auditors.

Answer 1

Answer-

There are multiple differences between the internal audit and external audit functions, which are as follows:

• Internal auditors are company employees, while external auditors work for an outside audit firm.

• Internal auditors are hired by the company, while external auditors are appointed by a shareholder vote.

• Internal auditors do not have to be CPAs, while a CPA must direct the activities of the external auditors.

• Internal auditors are responsible to management, while external auditors are responsible to the shareholders.

• Internal auditors can issue their findings in any type of report format, while external auditors must use specific formats for their audit opinions and management letters.

• Internal audit reports are used by management, while external audit reports are used by stakeholders, such as investors, creditors, and lenders.

• Internal auditors can be used to provide advice and other consulting assistance to employees, while external auditors are constrained from supporting an audit client too closely.

• Internal auditors will examine issues related to company business practices and risks, while external auditors examine the financial records and issue an opinion regarding the financial statements of the company.

• Internal audits are conducted throughout the year, while external auditors conduct a single annual audit. If a client is publicly-held, external auditors will also provide review services three times per year.

In short, the two functions share one word in their names, but are otherwise quite different. Larger organizations typically have both functions, thereby ensuring that their records, processes, and financial statements are closely examined at regular intervals.

Comparison Chart

BASIS FOR COMPARISON	INTERNAL AUDIT	EXTERNAL AUDIT
Meaning	Internal Audit refers to an ongoing audit function performed within an organization by a separate internal auditing department.	External Audit is an audit function performed by the independent body which is not a part of the organization.
Objective	To review the routine activities and provide suggestion for the improvement.	To analyze and verify the financial statement of the company.
Conducted by	Employees	Third Party
Auditor is appointed by	Management	Members
Users of Report	Management	Stakeholders
Opinion	Opinion is provided on the effectiveness of the operational activities of the organization.	Opinion is provided on the truthfulness and fairness of the financial statement of the company.
Scope	Decided by the management of the entity.	Decided by the statute.
Obligation	No, it is voluntary	Yes, according to Indian Companies Act, 1956.
Period	Continuous Process	Once in a year
Checks	Operational Efficiency	Accuracy and Validity of Financial Statement

Definition of Internal Audit

By Internal Audit, we mean that an unbiased and systematic appraisal function, performed within the business organisation, with the purpose of reviewing the day to day activities of the business and providing necessary suggestions for the improvement.

Internal audit performs a wide spectrum of activities such as:

• Evaluating the accounting and internal control system.
• Examining the routine operational activities.
• Physical verification of inventory at regular intervals.
• Analysing financial and non-financial information of the organisation.
• Detection of frauds and errors.

The main aim of the internal audit is to increase the value of an organisation’s operation and to monitor the internal control, internal check and risk management system of the entity. An Internal audit is conducted by the internal auditors who are the employees of the organisation. It is a separate department, within the organisation where a continuous audit is performed throughout the year.

Definition of External Audit

The periodic, systematic and independent examination of the financial statements of the company conducted by a third party for specific purposes, as required by statute is known as External Audit. The main aim of external audit to publicly express an opinion on:

• The truthfulness and fairness of the financial statement of the company
• The accounting records are complete in all respects and prepared as per the policies outlined by GAAP (Generally Accepted Accounting Principles) or not.
• All material facts are disclosed in the annual accounts.

For carrying out an external audit, the auditor is appointed by the members of the company. He should be independent, i.e. he should not be connected to the organization in any way so that he can work in an impartial way without any influence. The auditor has the right to access books of accounts to obtain necessary information and provide his opinion to the members by way of the audit report. The report is of two types:

• Unmodified
• Modified
  • Qualified
  • Adverse
  • Disclaimer

If the report is modified, the auditor has to give reasons for the same.

Key Differences Between Internal Audit and External Audit

The following are the major differences between internal audit and external audit:

1. Internal Audit is a constant audit activity performed by the internal audit department of the organisation. External Audit is an examination and evaluation by an independent body, of the annual accounts of an entity to give an opinion thereon.
2. Internal Audit is discretionary, but the External audit is compulsory.
3. Internal Audit Report is submitted to the management. However, the External Audit Report is handed over to the stakeholders like shareholders, debenture holders, creditors, suppliers, government, etc.
4. Internal Audit is a continuous process while the External Audit is conducted on a yearly basis.
5. The purpose of Internal Audit is reviewing the routine activities of the business and give suggestions for improvement. Conversely, External Audit aims at analysing and verifying the accuracy and reliability of the financial statement.
6. Internal Audit provides an opinion on the effectiveness of operational activities of the organisation. On the other hand, External Audit gives an opinion of the true and fair view of the financial statement.
7. The scope of internal audit is decided by Those Charged With Governance (TCWG). As opposed to external audit, whose scope is determined by law.
8. Internal Auditors are the employees of the organisation as they are appointed by the management itself, whereas External Auditors are not the employees, they are appointed by the members of the company.

Conclusion

Internal Audit and External Audit are not opposed to each other. Instead, they complement each other. External Auditor may use the work of the internal auditor if he thinks fit, but it does not reduce the responsibility of the external auditor. Internal Audit acts as a check on the activities of the business and assists by advising on various matters to gain operational efficiency.

On the other hand, external audit is entirely independent in which a third party is brought to the organisation to carry out the procedure. It checks the accuracy and validity of the annual accounts of the organisation.