Internal vs. External Auditing

Internal vs. External Auditing

Here is a look at what you can expect from internal and external audits and the advantages and drawbacks of each.

Audits, whether internal or external, gauge the performance of a company or organization in a specific area. When bolstered by auditing software, new levels of collaboration and data visualization are unlocked. There are different types of internal and external audits, each of which has a distinct focus. Here are some of the most common: 

  • Financial statement audits, conducted by an external auditor, ensure the correctness of a company’s accounting records. The results are important to regulators, lenders and investors. 
  • Compliance audits ensure that a company or organization is abiding by regulations and meeting the legal requirements of their country, state, province, city and industry. 
  • Operational audits, performed by in-house experts, look at business spending and budgets and find areas for potential improvement. 
  • Risk management audits look at current internal operations, define areas of risk, and suggest ways to mitigate the dangers. 

An audit is the most detailed of three related activities that organizations can perform. Included in this group are: 

  • Compilations, which provide basic financial data without any additional analysis, fact-checking or insight. 
  • Reviews, which offer limited insights. An accountant performing a review will compare the numbers to expected figures to see if there are any inconsistencies or unexpected values. 

Internal and external audits can be time-consuming. Digitized records and automated accounting software can help your company streamline the process, automatically find inconsistencies, and visualize data to inform executive decisions. 

With these systems in place, you can focus on the results of audits rather than the process. Here is a closer look at what you can expect from internal and external audits and the advantages and drawbacks of each. 

What is internal auditing?

The overall goal of internal auditing is to make a company more efficient, more profitable and better at making key decisions. 

For example, a company could order an internal audit of its inventory system. The auditor would look at the system for tracking inventory and see if it accurately reflects the supplies that a company has on hand and if there are any delays or discrepancies. 

Internal auditors are employees of a company who provide objective and independent reports on a company’s finances, operations and management practices. Their goal is to accurately assess performance and provide insights that aren’t affected by office politics or other influences within the company. 

One way to streamline internal audits is to have an audit trail. This is a collection of chronological events, time and date-stamped financial records, and details about operational decisions. If data gets organized in this way, it is easy for an auditor to find patterns or call up specific information that can help them pinpoint a problem or see exactly where a mistake happened.

Here is a closer look at the advantages and disadvantages of having internal auditing for your organization. 

Pros of internal auditing

When supported by well-organized data and skilled auditors, internal auditing can bring specific advantages to an organization. 

  • Enhance decision-making: Internal audits can define specific problems and give decision-makers data to help inform their strategies and assess solutions.  
  • Improve operations and efficiency: Internal audits can identify operational problems and inefficiencies. Because audits look at specific areas in-depth, they provide insights into the source of the issue. After the company makes changes, they can run another internal audit to see if the new practices and procedures have delivered the desired results. 
  • Define and mitigate risks: Internal audits can look at the consequences of potential events and the odds that such an event will take place. Once decision-makers are aware of the risk, they can take steps to mitigate it, lower the odds of it taking place, and reduce the potential consequences. 
  • Ensure compliance and success in external audits: Internal audits can mimic the process of external audits and find issues with reporting or compliance. By finding these problems and making corrections, a company can avoid potential penalties or punishments. 

Cons of internal auditing

Internal auditing brings advantages, but there are also some drawbacks to consider. 

  • Cost: Internal auditing costs money. The most efficient auditing departments only cost their companies $0.13 per $1,000 in revenue. However, expenses can be as much as $3.06 per $1,000 if you aren’t careful. 
  • Disruptions to operations: Sometimes, audits may disrupt business processes. Work stoppages due to audits can harm a company’s bottom line. 
  • Negative employee reactions: Employees may feel that an audit is unjust, that their department is being unfairly singled out, or that the review focuses on their performance rather than the department’s overall efficiency. 
  • Poor use of digital accounting systems: Internal audits may be inaccurate or time-consuming because of poor record-keeping, a lack of an automated accounting system, and disorganized financial data. 

While internal auditing can bring good results, it is not a requirement. External audits, however, are sometimes mandated by law. 

What is external auditing?

An external audit looks at the accuracy of a company’s financial statements and whether its accounting practices comply with all applicable rules and regulations. The auditor also verifies that the financial reports and records offer an accurate picture of the company’s performance. 

All publicly-traded businesses have to publish financial statements for investors. These records need to be independently audited to ensure they provide a full and accurate picture of a company’s financials. Additionally, nonprofits have to undergo audits to retain their tax-exempt status. 

Private companies do not have to undergo external audits as a matter of routine, but some still choose to do so. Typically, external audits help them build trust with their customers or furnish them with additional proof to show lenders when applying for credit. 

External audits are performed by a third-party auditor who has no ties to the organization and no stake in the outcome of the audit. Qualification requirements for external auditors vary, but they must be certified accountants with qualifications and professional accreditations. 

There are advantages and disadvantages to external audits. 

Pros of external auditing

When a company is required to have an external audit, it can enjoy certain advantages. 

  • Improved transparency: An outside auditor gives a company a chance to prove their finances are in order and their statements are accurate. This extra proof is necessary for shareholders, but lenders and people who want to support honest, transparent businesses will also appreciate it. 
  • Stronger internal controls: A business can establish strong internal policies and practices to ensure a positive outcome of an external audit. These policies can also help with accounting, record-keeping and overall efficiency within the company. 
  • Increased credibility: Whether public or private, a company can increase its credibility by letting a third party examine its financial records. The audit can show that the firm is operating honestly and not trying to manipulate its finances or engage in any unscrupulous practices. 

Cons of external auditing

External audits can also come with drawbacks, some of which can be significant if you aren’t prepared for them.

  • Increased costs: The cost of an external audit depends on the size of a company and the details of its financial records. The Financial Education & Research Foundation found that the average audit expense for publicly traded companies in 2020 was $2.52 million. Nonprofits, which lack the complex finances of a corporation, can still spend $10,000 to $20,000 on audits
  • Negative publicity: If your audit produces negative results, it could generate damaging stories in the media. This could be disastrous for public companies, which could lose shareholders. Even smaller firms could suffer if the audit turns up financial reporting or compliance issues. 
  • Compliance concerns: An impending external audit could lead to concerns about meeting regulatory requirements. Companies may worry about accounting practices or systems missing necessary data or reports not complying with industry requirements. 

An internal audit can help your company see how prepared it is for an independent external audit.

Key differences between internal and external auditing

Internal and external audits both seek to provide an independent opinion about a company’s finances or practices. However, they differ significantly when it comes to who performs the audit, its overall purpose, and its scope. 

Here is a closer look at these differences: 

  • Scope: Internal audits usually focus on a specific area of a company, while external audits look at all relevant financial information and any other practices that could confirm the veracity of budget statements. 
  • Purpose: Internal audits focus on measuring current performance and finding areas for improvement. External audits focus on proving the accuracy and veracity of financial statements. 
  • Auditor: External auditors are from a third party while internal auditors work on a company’s behalf. 

Internal auditors may help prepare for external audits. For example, they can use automated systems for preparation, compilation and review to organize for an external audit or assess internal performance. 

How to streamline the audit process

Auditing software can help you create a more efficient process leading to more accurate results. These systems decrease internal auditing costs, reduce compliance worries and help auditors organize their reports more easily. Cloud-based software also improves communication, makes reports more accessible, and facilitates coordination between different accounting professionals. The software also reduces the workload by automatically filling important reports and creating financial documents that are ready for an employer, external auditor or client.
Meanwhile, analytical tools assist internal auditors with new insights from financial or operational data, which they can then visualize for clear reports to present to decision-makers. With a centralized platform for all auditing activities, you’ll find it’s simple to drive engagement and ensure the necessary contributions.