Nov 10, 2021Learning the Pros and Cons of In-House and External Audits
To examine the fairness and accuracy of their operations, companies will conduct audits. There are two main types of audit: in-house (or internal) and external audits. This article details the differences between in-house and external audits, including their purpose, focus, and the parties that they involve.
Companies conduct audits to check their financial statements as well as their operating processes. These audits, whether done in house or externally, allow companies to root out issues and improve efficiency. The purpose of any audit is to ensure that a company is progressing appropriately, while maintaining established laws and regulations.
In-house or internal auditing is simply company-conducted auditing. The main purpose of in-house auditing varies from external auditing. In-house auditing examines the overall performance of its own company to safeguard the company’s wellbeing. On the other hand, external auditing focuses more specifically on a company’s financial statements.
Companies hire internal auditors to perform in-house audits. These internal auditors are normally company employees or a consultant internal auditor. Whether they are a company employee or a consultant, their process is the same. These internal auditors use company resources and standards to perform their audit.
Internal auditors evaluate several company elements, including the following:
- Internal controls
- Corporate governance, and
- Accounting processes
Within these elements, internal auditors look for different things. They evaluate any potential risks existing within a company and its operations. They make sure that the company is complying with federal and state laws. And they make recommendations to correct any issues.
After the audit, the internal auditors report their findings back to company management. Sometimes, these reports will be completed and delivered in multiple stages. These reports capture any flaws in the organization and make recommendations for improvement. The company’s management can use this information to make decisions to course correct if necessary.
The frequency of internal audits often depends on the department in question. Some departments may require frequent—weekly or even daily—audits. Other departments might only need one audit a year. Management determines whether or not an audit will be a scheduled audit or a surprise audit. Surprise audits can be helpful in discovering fraud or other illegal activity.
Companies are not required to hire an internal auditor, but many do to promote company efficiency. Often, internal auditors can identify potential problems before an external auditor. Internal auditors who catch problems first can help resolve issues more quickly, which also helps the company maintain a better reputation.
One of the biggest differences between in-house auditing and external auditing is that external auditing is conducted by an outside auditor. External auditors usually work for a third-party organization, like a government agency. Since they work apart from the audited company, they can conduct unbiased evaluations.
External auditors are subject to public standards, such as the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS). They need to be trained and certified to become Certified Public Accountants (CPA). An external auditor’s primary purpose is to inspect the fairness and legality of a company’s financials.
The regulations that external auditors have to abide by deter companies from misrepresenting their financial position. In this way, companies are held accountable for maintaining fairness and accuracy.
Since the main purpose of external auditing is to examine a company’s financial records, these audits provide a public representation of a company’s financial health. The resulting external auditing report provides clarifying financial information to investors, creditors, and other stakeholders. Of course, these external audits are also helpful for in-house use.
Even if a company does not employ internal auditors, they are required to have external auditors. Thanks to laws governing financial security, public companies are required to have their financial statements externally audited (see “Internal Auditor”). These laws necessitate company transparency and discourage fraud.
Another type of external auditing that exists is government audits, which is just another term for Internal Revenue Service (IRS) audits. IRS audits are conducted to examine the accuracy of taxpayer reporting. The IRS randomly selects individuals and companies to audit. If an individual or company is selected for an IRS, this is not necessarily an indication of erroneous reporting. As a result of these IRS audits, the IRS will inform audited taxpayers of any changes that need to be made to their returns (see “Audit”).
The Bottom Line
While in-house and external audits vary in their purpose and execution, both types of audit allow for a clearer sense of company performance. If a company does not currently employ an internal auditor, they may consider it worth the added expense. Ultimately, in-house and external auditing promotes company progress through encouraging fairness and accuracy.
(See also, “The Difference Between Internal and External Audits,” “External Auditor Definition,” and “Auditing.”)