Internal Audits vs External Audits
In my years in the financial arena, I have found that the word audit causes some turmoil among business professionals. In many cases, the concern is entirely unwarranted.
In basic terms, internal audits are conducted by a company’s own staff to improve business operations and focus on specific areas, while external audits are performed by independent firms to verify the accuracy of the company’s financial statements.
Leveraging my years of experience, I’ve broken down differences between the two as well as the pros and cons to help you better understand.
Key Takeaways
- Internal Auditing: Conducted by company employees, internal audits focus on improving operations, identifying risks, and ensuring compliance.
- External Auditing: Carried out by independent auditors, external audits aim to verify financial statements’ accuracy and improve business credibility and transparency.
- Pros of Internal Auditing: Include enhancing operations, risk mitigation, and compliance preparation.
- Cons of Internal Auditing: Potential work disruptions, adverse employee reactions, and high costs.
- Pros of External Auditing: Increased credibility, stronger controls, and improved transparency.
- Cons of External Auditing: Negative publicity and increased costs.
Differences Between Internal vs External Audits
Essentially, both types of audits are attempting to state independent opinions regarding a company’s finances and practices. The variations show up in who performs the audit, its overall purpose, and its scope.
A closer look will explain the differences between the two types of audits.
1. Who Conducts the Audit
The internal auditor is employed by the company being audited. An external auditor is an employee of a separate company.
2. The Reason for the Audit
When a company has an internal audit, they are typically seeking ways to improve or measure how the company is performing. An external auditor is searching for ways to prove the accuracy of financial statements.
3. The Scope of an Audit
An internal auditor is looking at a specific area of the company. The external auditor looks for useful information that can confirm the budget statements.
Internal Auditing Pros and Cons
| Pros of Internal Auditing | Cons of Internal Auditing |
|---|---|
| Improve operations and efficiency: By identifying operational problems, internal auditors suggest changes to improve. After implementation, another audit checks the effectiveness of these changes. | Potential work disruptions: Internal audits may cause work interruptions depending on their execution. |
| Define and eliminate prospective risks: Internal auditors mitigate issues by assessing potential problems and their likelihood. | Adverse employee reactions: Departments might feel unfairly targeted during an internal audit. |
| Ensure compliance: Internal audits align with external audit principles, aiding in preparations for external audits and compliance. | Cost: Without careful management, internal audits can become excessively expensive. |
External Auditing Pros and Cons
| Pros of External Auditing | Cons of External Auditing |
|---|---|
| Increased credibility: Businesses appear more credible when they open their books to a third party. | Negative publicity: Unfavourable external audit results could lead to negative public perception. |
| Stronger controls: Learnings from external audits can be used to enhance business operations. | Increased costs: External audits can be expensive, ranging from tens of thousands to millions. |
| Improved transparency: Shareholders and potential investors appreciate insights into a company’s financials. |
Examples of Internal vs External Audit Processes
I’ve written the below examples to help clarify the differences between internal and external audit processes. These examples are general and have been created for illustrative purposes only.
Internal Audit Example
- Scenario: Consider the case of an Australian retail company, ‘Kangaroo Kicks’, which specialises in sports footwear. The company has been experiencing discrepancies in inventory levels and wants to improve its operational efficiency.
- Initiation: Kangaroo Kicks’ management decided to conduct an internal audit of their inventory system.
- Planning: The internal audit team, employed by Kangaroo Kicks, plans the audit. They aim to identify the causes of inventory discrepancies and suggest improvements.
- Execution: The team examines the inventory tracking system, comparing electronic records with physical stock in warehouses across Australia. They interview staff and analyse procedures for recording inventory movements.
- Findings: The audit reveals that discrepancies are due to outdated scanning technology and human error in manual entries.
- Report and Recommendations: The team prepares a report highlighting issues and suggesting solutions, such as upgrading scanning technology and training staff on accurate data entry.
- Follow-up: After Kangaroo Kicks implements these changes, a follow-up audit is conducted to ensure the improvements have effectively resolved the issues.
External Audit Example
- Scenario: ‘Outback Energy’, an Australian energy company, is preparing its annual financial statements for shareholders and regulatory compliance.
- Initiation: As a publicly traded company, Outback Energy is required by Australian law to have its financial statements independently audited.
- Selection of Auditor: An external auditing firm with no ties to Outback Energy is chosen to conduct the audit. This ensures objectivity and compliance with regulatory standards.
- Planning and Preparation: The external auditors plan their approach, focusing on areas of high financial risk and compliance with accounting standards.
- Execution: The auditors examine Outback Energy’s financial records, assess the accuracy of financial statements, and evaluate compliance with accounting standards and regulations.
- Findings and Report: They identify any discrepancies or non-compliance issues. The final audit report is prepared, providing an independent assessment of Outback Energy’s financial health and compliance.
- Follow-up: Based on the audit findings, Outback Energy may need to adjust its financial statements or improve certain practices to ensure future compliance.
FAQs
Why are the results of audits posted?
These are posted to help understand the processes involved, to explore the actual effectiveness of audits, and to increase accountability.
Which type of audit is conducted by the company’s choice?
Internal audits are completely voluntary.
Do all businesses need to have yearly external audits?
Only publicly listed companies in Australia are required to have yearly external audits.
Is there a way to streamline the auditing process?
For decades, I have been cautioning clients to keep meticulous records. With cloud-based software, you can relax knowing things are nicely organised.
Conclusion
I have seen numerous instances where both internal and external audits have vastly improved the position of businesses.
Enhancing transparency to build stakeholders’ confidence, finding ways to enhance profitability, and guiding direction for growth are just a few of the many ways audits can improve your company.
If you would like to learn more, please get in touch with us. Our helpful staff can answer your questions and explain various solutions to help your company flourish.
