Difference Between Internal Audit and External Audit (or Statutory Audit)

Difference Between Internal Audit and External Audit

An audit can be of many types, of which internal audit and external audit are the most common ones. As is clear by the name, an internal audit is usually done by a company’s in-house team whereas an external audit is conducted by an independent outside firm.

Internal Audit

An internal audit is a controlling tool in the hands of a company that measures and evaluates the effectiveness of its affairs primarily in accounting, operational, and financial matters. The job of an internal auditor is to make sure that the company is working in a smooth and efficient manner and that all governing rules & regulations are adhered to. He seeks to ensure that a proper internal control system is in place in the company to prevent fraud and misappropriations.

The system of internal controls and its quality, the company’s operating policies & practices, and financial information are all checked by the internal auditor. Thus, in a way, internal auditors act as a supporting hand to management by assuring that company’s processes & systems are effective. They help the management in discharging its responsibility to mitigate the risks to the achievement of corporate goals.

External Audit

Now, we know that internal auditors serve the company’s management. But there is another set of auditors called the external or statutory auditors who independently conduct a financial audit to provide information to outside users, i.e., shareholders. External/statutory auditors perform a detailed review of the company’s financials to ascertain whether the Profit & Loss statement and Balance Sheet present a true and fair picture of the financial position and results of the company under audit.

The need for an external audit arises since the complete control of a company and its books of accounts are vested in the hands of its management. The shareholders, therefore, need assurance that the financial results prepared and disclosed by the management are reliable. This is where the role of an external auditor comes into play. He works as an independent expert and gives his opinion on the reliability of the company’s financials. Moreover, investors aspire to invest their hard-earned money in shares of different companies based on their profitability and financial position. They place greater reliance on financial statements if these have been audited by external agencies. Similarly, other users such as creditors, financial institutions, tax authorities, banks, etc. also value audited financial statements with greater credibility.

Sections 139 – 147 of Chapter X of the Companies Act of 2013 deal with the provisions of statutory audit. According to Section-139, at the first annual general meeting, each company must appoint an individual or firm as its auditor, who will serve office from the conclusion of that meeting until the end of the sixth annual general meeting. Further, Section 143 of the Act, which deals with the powers and duties of auditors, states that the statutory auditor must make a report to the company’s members on the accounts and financial statements he examines. In case of any qualifications or reservations in the audit report, the reason for the same should be stated in the report. If the auditor suspects any fraud, he should immediately report the same to the Central Government.

Relationship between Internal and External auditor

Both internal auditors and external auditors are independent parties. An external auditor of a company can in no case become the internal auditor of the same company. Despite this fact, there are cases where external auditors (commonly known as ‘statutory auditors’) often refer to the work done by internal auditors and vice versa. Each of the two often gives his/her opinion based on the report presented by the other. The relationship between them is evident from the following points:

  • Commenting upon internal audit system: While performing his audit, an external auditor assumes the responsibility to comment upon the suitability and efficacy of the client’s internal audit system in place. And to do so, the internal audit system laid down by the management must be evaluated by him. This is an essential step in the performance of a statutory audit. The external auditor must also evaluate the qualifications and experience of internal audit staff.
  • Using the work of an internal auditor: An external auditor has to make use of the work of an internal auditor. But he shall use it only when he himself puts faith in the work of the internal auditor. Thus, before using the internal auditor’s work, the external auditor evaluates the structure of the internal audit system and the actual work done by the internal auditor.
  • Relying upon internal auditor: To decide the extent of checking that the external auditor needs to do, he first needs to decide the extent of reliance to be placed on the work of the internal auditor. If he feels that the internal auditor has performed his work properly, he may put more reliance on his work. This in turn will minimize the extent of checking to be done by the external auditor himself.
  • Responsibility remains the same: Just because the external auditor relies upon the work of the internal auditor, it by no means reduces the responsibilities and duties of the external auditor. It can only reduce the burden or extent of checking. But for all his opinion and work, he would remain responsible on his own.

Comparison between internal audit and external audit

There are many differences between internal audit and external audit. The details of these differences are as follows:

1. Appointment:

The internal auditor is appointed by the organization’s management whereas the statutory auditor is appointed by owners or shareholders of a company. Moreover, the first statutory auditors of a company are appointed by its Board of Directors.

2. Report:

The internal audit report must be presented to the company’s Board of Directors or to the company’s management, which also serves as the appointing authority of internal auditors. On the other hand, a statutory auditor presents his report to the company’s shareholders at its annual general meeting.

3. Applicability:

Internal audit is addressed in Section 138 of Chapter IX of the Companies Act of 2013. There are certain specified classes of companies that are required to appoint an internal auditor under law. For others, it is a discretionary function. To know more about the applicability of internal audits, kindly go through this blog.

An external or statutory audit is compulsory for all companies. Every entity registered under the Companies Act, whether as a Private Limited or a Public Limited company, is required to have its books of accounts audited once a year.

4. Employment in the company:

The internal auditor of a company may or may not be its employee. However, a statutory audit has to be conducted only by external agencies.

5. Scope:

The Companies Act of 2013 specifies the scope of the statutory audit. It cannot be changed by a mutual agreement between the auditor and the management of the auditee’s business unit. Contrary to this, the scope of the internal audit is determined by the mutual agreement of the auditor and the management of the unit under audit. The company’s Audit Committee or the Board of Directors, in consultation with the Internal Auditor, shall define the scope, operation, frequency, and methodology for conducting internal audits.

6. Qualifications:

The Companies Act of 2013 specifies the qualifications of the statutory auditor. In the case of a corporation, only a practicing Chartered Accountant or a firm of practicing chartered accountants can be appointed as a statutory auditor. But there are no set qualifications for the position of internal auditor.

The internal auditor may be either a chartered accountant, whether or not in practice, or a cost accountant, or such other professional as the Board may determine to undertake an internal audit of the company’s functions and activities. In fact, it can be performed by the company’s in-house audit department or it may be outsourced.

7. Period:

Internal auditing is a continuous exercise designed to examine the operations of a business. Whereas, an external audit is performed yearly/quarterly and is usually concluded after the end of each financial year.

8. Purpose:

The primary goal of the statutory audit is to form an opinion on the organization’s financial statements. The auditor must state whether or not the financial statements present a true and fair picture of the organization’s affairs. On the other hand, the primary goal of internal auditing is to detect and prevent errors and fraud.

9. Removal:

The procedure for removing a statutory auditor before his tenure is very complicated. The statutory auditor can only be removed by the company in a general meeting. It must also obtain the permission of the central government. Internal auditors may be removed by the entity’s management at any time. No permission from the Central Government is needed.

10. Suggestions:

The internal auditor makes valuable recommendations to management in order to increase the efficiency of the business and keep it from failure. But normally, the statutory auditor does not make such suggestions.

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