Companies both small and large, need to have frequent examinations and evaluations to predict if the company is performing up to the industry’s standards and have all the required legal documentation. Audits are legal processes that inspect the company’s policies, accounts, and day-to-day operations to mitigate any kind of redundancy, resource wastage, or embezzlement.
Internal Audit vs External Audit
The main difference between an internal audit and an external audit lies in who performs such audits and the requirement the same. Internal auditors are those who work in the same organization i.e., employees of the organization whereas external auditors are those who are not related to the organization and thus are independent of it i.e., third parties. Internal audits are not compulsory whereas external audits must be compulsorily performed for every legal organization.
Difference Between An Internal Audit and An External Audit in Tabular Form
|Parameters of Comparison
|Internal audits are done within the organization by the employees of the company.
|External audits are done by some third-party entities that are independent of the organization.
|Analyze and review all the routine, day-to-day activities, and operations to provide space for suggestions and improvement.
|Review the financial condition of the organization to predict any kind of potential risks.
|Internal audits can be conducted multiple times throughout the year.
|External audits are conducted on an annual basis.
|Auditors examine the company’s business practices and the relevant risks to evaluate its efficiency.
|Auditors examine the company’s financial records and the relevant risks to evaluate its integrity and fairness of the same.
|The internal auditors are appointed by the management of the company.
|The external auditors are appointed by the stakeholders through a voting system.
|Internal audits are not necessary to be performed but are taken up voluntarily.
|External audits must compulsorily be organized for every legal entity annually.
|The internal auditors need interdisciplinary skills to perform audits.
|The external auditors need expertise in accounting, finance, and taxes.
What is Internal Audit?
Internal audits are legal processes, appointed to be performed at any legal entity by the employees of the same organization, to check the efficiency and performance of the business and close any gaps to improve the same factors. These are conducted multiple times a year as required by the organization. While not necessary to be performed, internal audits assess a company's routine operations and business practices frequently to look for improvement.
Types of Internal Audits:- The types of audits available are categorized based on the range of parameters they assess and analyze in an organization.
- Operational Audit: Auditors that perform operational audits check the efficiency of the business by analyzing their operational strategies. This also evaluates the company’s reliability and also provides advice on bettering the same.
- Performance Audit: A performance auditor is appointed to ensure that the company meets certain standards set by the management, based on the closest competitors the organization deals with. These standards are set by considering the human resources, performance, and policies of the same.
- Compliance Audit: These auditors help analyze whether the company is a legal entity that lawfully complies with all the regulations and the policies that fulfill the industry standards. All the legal entities must follow the General Data Protection Regulation(GDPR) and Foreign Corrupt Practices Act(FCPA).
- Environmental Audit: As the name suggests, environmental audits are performed to check whether the organization maintains policies that promote eco-friendly environments or in turn, harm nature. Thus, the auditors must verify that the company does not violate any environmental laws when conducting its operations or even merely existing.
- IT Audit: IT auditors assess the technological infrastructure that supports the company to check whether it is up-to-date and protected appropriately against any possible risks. These IT controls can include system backup, switch management, recovery, etc.
Advantages of Conducting An Internal Audit:- Internal audits help establish a sort of an early warning system that distinguishes whether an opportunity promotes the business or rather brings it down.
- Improved efficiency and performance: When conducting an internal audit, the business strategies and practices that a company follows are looked at closely and analyzed if they fit the organization the best. Their techniques are carefully audited to predict any kinds of risks due to small or big factors that might be harmful to the company, even in the long run. Thus, any kind of wastage or redundancies is mitigated to improve efficiency.
- Strong control condition: When certain business practices can compromise the company’s systems, operations, and other such processes, they might not come to light easily. However, internal audits perform intricate evaluations to check whether all the above-mentioned actions are well designed and up-to-date.
- Ensures compliance: Internal audits help in checking whether the company follows all the rules and obligations stated by the law and the standards of the industry i.e., verifying whether the organization complies with legal obligations. In case of any deviations concerning the standard, the auditors can also help suggest helpful remedies.
- Enhanced security: Businesses, when developed to the stage of reaping profits, are always prone to cyberattacks. Thus, internal audits find such gaps in the company’s digital systems, policies, or networks to close them with appropriate policies and security policies. Therefore, internal audits take care of such vulnerabilities that might arise, making the system digitally secure.
- Better staff: Similar to how a justice system helps keep the citizens in check by implementing a punishing system, internal audits too, raise fear in the minds of employees. This is because any mistake will be immediately caught and demanded compensation for the same. Thus, the employees of the organization always remain attentive and active, eventually improving their efficiency and morale to work harder.
- Division of work: When analyzing all the operations in a company without any divisions or departments, it is quite tedious to check and verify every activity with a high possibility of confusion and miscalculation. Internal audit supports the division of labor as it is easier to check all the activities and operations of a company through different departments and all the included subdivisions.
- Optimum resource usage: Any organization will come across some amount of resource wastage where the resources need not be just raw materials but also human resources, time, money, and technology. Redundancies in the business practices can lead to overspending of the resources whereas some cases might lead to underutilization of the same. All these are rectified by making better budgetary decisions and cutting unnecessary costs spotted by the internal audit.
Disadvantages of Conducting An Internal Audit
- Time Delay: To conduct any audit, one must always finish accounting. Thus, both cannot be done parallelly. In case of any delay when finishing accounting, the audit must also be delayed.
- Fewer Staff with Expertise: Internal audits must be conducted by people who have enough qualifications to do the same. Companies may or may not have sufficient staff to do this and this can prove to be a huge limitation.
- Ignorance of Higher Authorities: When redundancies, immoral practices, or gaps in policies are pointed out and reported to the higher authorities or management of the company, the management may choose not to act on rectifying these errors due to immoral intermediaries. There will not be any use for such internal audits if the higher authorities choose to ignore the shortcomings of the company.
- Expensive Option: An internal audit requires an extravagant set up to organize and progress through such processes. Thus, there are large expenses that the organization might need to cover to afford such audits.
What is an External Audit?
External audits are legal processes that would examine the financial records of the organization to test for any kind of false accounts, embezzlements, or frauds that might land the company in jeopardy. External audits are conducted by independent organizations that are appointed by the company themselves. They are compulsory and cannot be ignored by the company to avoid costs or exposure of shortcomings.
Advantages of Conducting An External Audit
- Impartial Analysis: Sometimes, internal audits can be biased towards their organizations, and thus external audits are far more unbiased than internal audits. This is because the external audits are conducted by third-party organizations that have no relation with the company whatsoever and thus can easily verify if there are any false accounts.
- Easy Comparison to Competing Companies: Reports made from conducting internal audits can differ in formats from company to company. However, this is not the case with external audits. External audits all have a certain format and procedure that when formed can be compared with different companies. Thus, external audits provide us with a common, universal tool that can help compare the efficiencies and performances of other companies that pose competition.
- Stricter evaluation: External audits will conduct a more exhaustive investigation than internal audits and thus leave very less space errors. Since any faults from the company’s side, irrespective of their intention, will be exposed and compensated for the same. Due to such strict and tight assessments, employees would be scared to commit any error and think twice before any decision. This helps them remain active and alert all the time.
- Different Point of View: When working at an organization for a considerable amount of time, employees will be habituated to that perspective, making it harder for them to think outside the box. Thus, when a third party is appointed to assess a business’s strategy and tactics, we gain a fresh perspective of the company since they view the company differently. This not only allows us to gain innovative ideas but also helps us realize the gravitas of the shortcomings of a company.
- Quicker Identification of Problems: Owing to the fact mentioned above, it is easy to spot all the problems and potential risks the company might face. It is this new pair of eyes that helps bring such errors to light.
- Helps in Managerial Decisions: When there are gaps in the management style and system of a company, external auditors will make a report of it and provide suggestions on how to rectify the same. Thus, by providing such financial advice, managers get to make better budgetary decisions.
Limitations of Conducting An External Audit
- Confidentiality: The discretion of the external audit report can be put at stake as the auditors appointed may or may not be completely moral to keep the results and the analyses confidential. The auditors can easily gain access to business secrets that might prove to be a hazard.
- Unaffordable for Small businesses: Audits are generally expensive to conduct and external audits are more expensive than internal audits. This can be quite strenuous for small businesses that cannot afford such compulsory processes.
- Time-consuming: External audits are more formal and official and consume more time than internal audits. It is not possible to examine every nook and corner of the company’s financial records since they have a lot of expenses and purchases that cannot be scaled down easily.
- Violation of Auditor’s independence: The auditor will need to sort it out with the company and its management as to how much freedom and space they have with a given assignment. This means they will have to ask the client about how independent they can be when operating on a given assignment. There are generally 5 threats that an auditor can be prone to that may lead him to suffer. They are intimidation, advocacy, self-review, self-interest, and threats of familiarity.
- Sampling: As mentioned previously, auditors cannot examine every portion of the population. Thus, they consider only a small portion of the population that is considered and sampled. This can lead to a gap in the expected results and pose a sampling risk.
Main Differences Between Internal Audit and External Audit In Points
- Internal audits are performed by the employees of the organization itself whereas external audits are performed by third-party organizations who are not related to the company in any way.
- Internal audits can be conducted multiple times in a year, whenever the company desires so whereas external audits are conducted only once a year.
- Internal audits are not required to be performed i.e., they are not necessary. On the other hand, external audits must be conducted for every legal entity.
- Internal auditors need to have interdisciplinary skills whereas external auditors require expertise in accounting, finance, taxes, and relevant skills.
- Internal audits are conducted to examine the routine tasks and business practices in a company whereas external audits are conducted to examine the financial records of the company to predict any potential risks.
From the above discussions, we can summarize that internal audits are not compulsory whereas external audits are. However, we can safely conclude that both of these are quite necessary, especially for large companies as the limitations in one kind will be rectified and overcome in the other.