Internal audits and external audits are the two types of audits that can be performed. They complement each other and may often need to collaborate to attain their objectives. The two functions do not contradict or compete with one another; instead, they contribute to good governance.
So what are the key differences between internal and external auditing?
Key differences: Internal audit vs. external audit
1) Who is it for?
Internal audit is not a must for all entities, although it can examine an entity’s operational activities. External audit, on the other hand, is required of every company or independent legal body. Different countries may have different rules on the type of companies that need to undergo an external audit.
2) What is the purpose of the audit?
The internal audit focuses on assessing the entity’s controls and performance and recommends ways to improve them. The internal auditors will primarily look at the entity’s non-financial information such as risks, governance, and control systems as a whole.
On the flip side, an external audit is to provide an opinion on the entity’s financial status and risks associated with the controls and financial system and examine the entity’s adherence to relevant general or industry-specific laws, rules, and regulations.
The main difference is that other than reporting internal control concerns or indicating corrective measures needed to resolve non-compliance issues that may arise during their audit work, external auditors have no duty to evaluate governance, operations, or recommend changes.
3) Who performs the work?
Internal audit can either be performed by a third party or the entity’s own employees. It is important to note that although internal auditors may be the entity’s own internal staff and may have a vested interest, they still have to maintain their objectivity and independence when performing an audit on the entity’s operations.
A third-party audit team that is independent of the entity being audited is brought in to carry out the audit procedures for external audit.
4) Who determines the scope?
The scope of work for internal audit is usually determined by the entity’s management in this form of auditing whereas the scope of work for external audit is usually determined by the regulatory authority based on the applicable laws and regulations.
5) What is the audit focus?
For internal audit, it is mainly to improve and safeguard the value of the entity. Internal auditors examine the overall health of an entity, assessing if controls and processes in place are sufficient to support the entity’s strategic goals. It will also focus on detecting risks and threats that might jeopardise those goals.
For external audit, the auditors will focus on verifying compliance with applicable laws and regulations and are concerned about the true and fair representation of financial statements. That means they will gather evidence to ensure the entity’s financial performance is correctly and fairly represented in the entity’s financial accounts while government or regulatory agency auditors will check for any compliance flaws or breaches based on the evidence collected.
In other words, an internal audit is more proactive and forward-thinking whereas an external audit examines the entity’s past records and documents to perform a verification of compliance.
6) What is the audit scope?
Internal audit targets the entity’s operations. It is proactive and is a continuous process. Its existence allows management to obtain the insights they need and recommendations for all risks, governance, and control processes. It helps the entity’s to maintain its competitiveness and sustainability.
External audit targets the financial records and assesses all compliance requirements. Unlike an internal audit, external audits are only conducted on an annual basis, although the timeframe between each audit might be different for different entities and might vary based on the requirements in the country that the entity resides in.
7) What are the skills required of the auditor?
Internal auditors are usually interdisciplinary. That means they might come from a range of professional or academic backgrounds.
External auditors are usually qualified accountants who have the necessary knowledge to perform financial audits. They could also be compliance specialists or government personnel if the audits are about compliance, such as tax auditors who check the entity’s compliance with tax laws. There might also be customers, whether potential or current, who may seek an audit to ensure that an entity meets its prerequisites before they decide whether to work with it.
8) What are the reporting requirements?
The internal audit function must be a standalone department that is separate from the entity’s management. It should report directly to the audit committee, which comprises certain members of the board of directors.
On the other hand, external auditors have a duty to report to the company’s shareholders. They are also ultimately answerable to a legislative body such as the Parliament in the public sector. Unlike internal auditors, external auditors have no responsibility towards the entity’s management or the audit committee since the scope of their work is not dictated by the entity’s management.
9) Who are the primary users?
The primary users for the report of an internal audit are those within the entity. This includes the board of directors, senior management, the audit committee, and/or other groups within the entity’s own governance structure. They are required to provide assurance to these groups of people.
External auditors report to various groups of audience, which may include the public, the customers, the shareholders, the members, potential investors or the regulators. A lot of times, the users are people who are not involved in the entity’s governance process.
Internal and external auditors should frequently communicate and share the information obtained to enhance audit coverage and prevent duplication of work. This is despite the fact that the goal, focus and outcomes of their fieldwork differ.
The work performed by internal auditors may also be useful to external auditors as it may help ensure that risk assessments, reports, work papers, and other documents are created in a manner that is easy to understand.