BLOG 4 # INTERNAL VS EXTERNAL AUDIT

INTERNAL AND EXTERNAL AUDIT

Hi Friends!!!

In this article, we are going to discuss the role and objectives of Internal audit and External audit; and also a comparison and contrast between the two.

PART 1: INTRODUCTION

You might have seen dozens of pages and hundreds of tables which differentiate between the role of internal auditor and the role of external auditor.

Right from your graduation where the subject Audit is introduced till the pinnacle of professional courses CA CMA ACCA CS CMA(USA) etc., this is a hot and never ending topic.

After reading hundreds of paragraphs, student again ends up in square one with the same question: What is the exact difference between this two. 

Let me put it in its simplest way.

Remember: Internal Auditor is a POLICE where as External Auditor is a JUDGE

Observe Traffic system. You can see various things over there.

1. An act (Law) - Motor Vehicles Act, Traffic rules and regulations made there under.
2. Police - a mechanism / system which oversees that the Act, Rules and Regulations are complied with (with an objective of reducing the risk of accidents, crime etc)
3. Judicial System - Which takes care of situations when something goes wrong by determining whether the crime has happened? What are the consequences? and adjudging the offence, penalty, prosecution etc.

1   Now it’s pretty simple to understand it right. Exactly!

PART 2: ROLE OF EXTERNAL AUDITOR.

Definition:

External audit is a Systematic and Independent examination of data, statements, records, operations and performance (financial or otherwise) of an enterprise with a view to expressing an opinion thereon.

The purpose of external audit engagement is to enhance the degree of confidence of intended users in financial statements.

The financial statements of the entity are used by various stakeholders for different purposes.

For example

1. Bankers use them to evaluate the creditworthiness of the entity
2. Government uses them to assess the taxes and grant licences
3. Customers use them to evaluate the financial position of the entity to enter into long term contracts
4. Employees use them for calculation of Bonus and ESOP etc.
5. And most importantly, Shareholders and Potential Shareholders use the financial statements of the entity to make investment decisions.

All these users who use financial statements for a purpose or to make a decision or other; need an assurance that the financial information provided in the financial statements is accurate, reliable, genuine and complete. So they look for some professional opinion which increases their confidence levels by adding credibility of financial information.

External auditor provides such assurance.

The external auditor expresses an opinion on whether the financial statements;

a) Give a true and fair view (or present fairly in all material respects)

b) Are prepared, in all material respects, in accordance with an applicable financial reporting framework.

c) are free from material misstatements due to fraud or error.

PART 3: ROLE OF INTERNAL AUDIT FUNCTION

Definition:

Internal auditing is an independent, objective, assurance and consulting activity designed to add value and improve an organisation’s operations. It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.

The role of internal audit varies depending on the requirements of the business and the management.

Internal audit function includes

1. Assessing whether the company is demonstrating best practice in corporate governance.
2. Evaluating the company’s risk identification and management processes
3. Testing the effectiveness of internal controls
4. Assessing the reliability of financial and operating information
5. Assessing the economy, efficiency and effectiveness of operating activities (value for money audit)
6. Assessing compliance with laws and regulations applicable to the entity
7. Providing recommendations on the prevention and detection of fraud. 

PART 4: DIFFERENCE BETWEEN INTERNAL AND EXTERNAL AUDITS

While the external auditors conduct audit from the point of view of legality for shareholders, the internal auditors conduct audit from the point of view of compliance for management.

They might apply same audit procedures at times but there is a difference in the scope of the work, objectivity and reporting. The table shows it clear.

Sl No	Point of Difference	External Audit	Internal Audit
1	Objective	Express an opinion on the truth and fairness of the financial statements in a written report.	Improve the company’s operations by reviewing the efficiency and effectiveness of internal controls.
2	Scope of work	Verifying the financial statements and expressing an opinion thereon	Wide in scope and depends on the management’s requirements.
3	Coverage	Primarily on Accounts and financial statements	Broader in scope. It transcends to every department which incurs expenses and generates revenue
4	Appointment and removal	By the shareholders of the company	By the audit committee or board of directors
5	Relationship with company	Must be independent of the company.	Internal audit can be performed by the employees duly qualified (which limits the independence) of can be outsourced (which increases auditors independence)
6	Report	Reports to Shareholders	Reports to the management or to those charged with governance.
7	Availability of Report	Publicly available	Not publicly available. Usually an internal document which is used by management or TCWG.
8	Standards	International Standards on Audit issued by IAASB or the standards issued by a regulatory authority of profession in a specific jurisdiction.	The standards issued by the institute of internal auditors (IIA)

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