Companies can employ two different types of audits, internal and external. Each is carried out to ensure business operations are not violating any laws and adhering to a sense of ethical business practices. An external audit shows an unbiased and objective view of the financial stability of a business.

an audit checklist document

External Audits

The process of an external audit is to provide a board of directors, management personnel, or company shareholders with an unbiased accounting of a company’s financial status. They are never handled by individuals employed by the business, or organization. External audits have the purpose of understanding and accurately interpreting financial statements. So, accounting firms usually conduct them, sometimes in conjunction with law offices.

Definition of an External Audit

There are two types of audits.  Auditors perform each of these a transparent independently of one another. This happens because they serve different purposes. An audit staff handles internal audits within the company. This team does not usually have any departmental ties. External audits, on the other hand, are examinations of the company’s financial records and policy. An outside auditing firm usually conducts them.

An internal audit may consider monetary aspects of the company. Its main objective revolves around managing risk factors, legal compliance, and ethical procedures. External audits deal almost exclusively with the financial ramifications of the company’s business ventures.

Shareholders of large corporations are frequently the beneficiaries of the audit process. Also, final reports primarily focus on any financial risk associated with the company. Companies perform external audits on a yearly basis. They schedule these audits at the end of the fiscal year. External auditors assess all financial reports and fiscal statements to determine if they accurately reflect the company’s actual financial position.

Compliance policy and general internal operations are not usually areas that an external auditor will focus. However, these aspects of a company’s business policy can be a part of an external audit. This may be the case when there is a need to evaluate internal controls from a financial risk standpoint. Auditors design this aspect of the report in order to improve controls and compliance policy. The main focus of all this process is to improve a business’ financial stability.

Purpose of an External Audit

a diagram showing how an audit cycle happens

The principle behind an external audit is the verification of a company’s annual financial standing. An external audit’s results do not focus on uncovering fraud or illegal activity. They present an accurate financial accounting situation. Then, the company’s management can use them to formulate their fiscal policy.

When the auditors detect any illegal activity, they immediately report it to the board of directors. Moreover, they usually do this before the issue becomes public. External auditors are not hired to incriminate. On the contrary; they provide expert financial analysis. This way, the company can assess how well their team follows policies and procedures. Also, they will discover whether or not their staff members apply their guidelines and foresee the financial outcomes.

Appointment of an External Auditor

It is imperative for an external audit to become a truthful and accurate assessment of any company. For that reason, certified accountants are the only satisfactory people to create an external auditing team.

All certified external auditors must have one of the following three professional certifications – Certified Public Account, Association of Chartered Accountants, or the Association of Certified Chartered Accounts. These are three distinct entities, and many accountants belong to more than one. To legally provide an external audit, the team of auditors must belong to one of these certifying entities.

Auditors are selected by the Board of Directors, Shareholder executive board, or upper management for privately owned business. A donor can coordinate external audits of private organizations such as non-profits. He/she can do that during an annual meeting.

Specialists call these special audits and are independent of any connection with the organization, or its employees. To meet the requirements of an independent external auditor, the auditor must not be associated with company record keeping and can never have a personal connection to the organization. There are four primary steps to appointing an external auditor.

The 4 Steps of Selecting an External Auditor

  • Research potentially qualified firms by consulting with other similar businesses that have conducted external audits. Members of upper management or the board of directors will usually be willing to offer suggestions. A list of qualified auditing accountants is also on record at a local or regional accountancy regulatory board. Non-profit organizations can consult a donor’s list of certified auditing firms.
  • Accounting firms that offer external audit services will customarily supply a written estimate of costs. Besides this, they will also meet any special requirements a client may require. Still, these requirements need to be pertinent to the type of business that goes through the auditing process.
  • First, the company chooses at least two qualified auditors. Then, they schedule a time for the audit. One should include both start date and estimated completion time. Furthermore, the estimate should contain any acclaimed credentials of the agency, plus the actual cost of the audit.
  • The last step is an engagement of services letter. The auditing firm will issue this. The letter will include all the previously mentioned particulars and constitutes a binding agreement to perform an unbiased financial accounting of the company. The letter will also allow a full disclosure of all the necessary financial documents. This will be guaranteed under privacy laws of fair accounting practices.

Application of an External Audit

looking at a graph through a magnifying glass

Applying an external audit involves four stages.

  • Stage one is the actual preparation of the audit. This includes requests for all financial documentation. The auditing staff usually requires certain documents. As part of the final agreement letter, company management will have given the audit team the right of full disclosure. All staff must answer audit related questions and provide individual department records if requested.
  • Once the company provided all the data and financial documentation, the audit team will then conduct what is referred to as audit performance. This involves the fieldwork done by the auditors. Most of the fieldwork involves working onsite, using financial records and files available within the company accounting department.
  • After experts complete the performance work, the audit team will begin composing an official audit report. They use this report to communicate the results of the audit to management, the board of directors, or shareholders.
  • The experts finalize an external audit with a follow-up and disclosure meeting. There are federal and state regulations that govern specific types of external audits. At the time of the disclosure meeting, the audit team will verify the results of the report and make expert recommendations to management.

Putting It All Together

External audits establish a clear and trustworthy accounting of a company’s financial stability. While they can be used to reveal violations of company fiscal policy, their primary focus is only the accurate reporting of the current financial status. Businesses, who regularly engage in scheduled external audits, can establish public credibility. Moreover, they can quickly correct internal policy to enhance the profitability of their operations.

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