A third-party professional who performs an independent review of an organization’s financial records is known as an external auditor. He examines accounting, payroll, and purchasing records, as well as anything related to financial investments and loans, for any mistakes or fraud, and reports to an audit committee of company executives. After that, he gives management or those in charge of corporate ethics an accurate, unbiased report on the company’s financial condition. Internal and external auditors typically do similar work, with the exception that an internal audit is more focused on risk management and internal control procedures.
Internal vs. External Auditors: What’s the Difference?
An independent financial professional works for a company but is not one of its employees. An internal auditor, on the other hand, is employed the company he audits. Both parties offer similar services, such as evaluating financial statements, business operations, and regional rule compliance, as well as providing advice on efficiency and fraud detection. Internal examiners have an advantage when it comes to understanding industry or company-specific characteristics, but knowing the people who are being audited can sway their judgment.
The Benefits and Drawbacks of Hiring Outside Auditors
An external auditor has no established relationships within the company he’s auditing, which helps him avoid bias. There are strict guidelines in place: external auditors cannot be friends or relatives of any owner, manager, or employee. Those conducting research on publicly traded companies must not own stock in them or have any equity stake in their subsidiaries or holdings.
While an outside auditor may specialize in one area of business, he must often learn the ins and outs of a particular industry before conducting an audit. Although this can be a disadvantage, it also means he is unlikely to arrive at work with preconceived notions about how things should be done. This will make it easier for him to spot issues.
Selecting an Auditors
Depending on its needs and the law, an organization may hire an internal or external auditor, or a combination of the two. The Securities and Exchange Act of 1934 in the United States mandates that publicly traded companies hire an outside party. This professional, who is chosen a committee, is responsible for ensuring that financial statements accurately reflect a company’s financial performance, as public investors frequently rely on this information when purchasing stock. Private companies may or may not hire an outside consultant, but when they do, it’s usually only when the law requires it or when a major event, such as a merger, necessitates it.
A regulatory agency or shareholders who believe that a company’s financial claims are questionable may require the services of a third-party. If the auditor finds evidence to support their suspicions, he is usually required to report them. In most cases, the company is given the opportunity to defend its position in writing or orally.
Before the actual examination, an auditor must go through a formal process called audit planning. He must first demonstrate that he understands the business and its operations. The next step is for him to identify the risks of misreporting financial statements for this specific entity, and then develop an approach based on the results of the previous two steps. Depending on factors such as an organization’s size and reporting risks, the entire review process can take weeks to months.
Financial auditors’ standards are set organizations in almost every country. Generally Accepted Auditing Standards (GAAS) are used professionals to demonstrate their training, independence, and diligence. Many countries, including all members of the European Union, have adopted the International Standards on Auditing (ISA) issued the International Auditing and Assurance Standards Board (IAASB). The Public Company Accounting Oversight Board (PCAOB) regulates and supervises the auditing industry in the United States.
Despite these guidelines, there are times when the auditor must draw conclusions based on his own experience. He’s been taught to question the veracity of the information he comes across in order to spot errors and fraud, as well as areas that could be improved. For example, he might notice that a company’s accounting, internal controls, or spending habits could be improved. He might suggest cost-cutting measures like reducing staff or improving inventory control.
Irregularities, which are misstatements or lies from the client, are more problematic. They can occur in a variety of ways, including when a business manipulates its financial results. This can deceive investors and force a company to admit wrongdoing, recalculate past profits, and postpone the disclosure of future financial results if discovered. Another type of irregularity concerns the classification of company positions, which has an impact on how employees are compensated.
Independent reviewers create tests during the planning process to locate mistakes or fraud in order to find irregularities and avoid oversights. The deeper the test, and the less an outside partner will rely on a company’s official input for accuracy, the greater the risk of financial reporting errors.
An external auditor will present his findings to the company’s executives or board of directors once the job is completed. His report usually includes his assessment of the company’s record-keeping systems and financial health, as well as the state of accounts payable and receivable. His thoughts on these subjects are expected to be constructive, with suggestions for improvement.
The findings of an auditor have a significant impact on a company’s reputation. If his conclusions about assets, debts, tax responsibilities, and payments do not match the company’s, there could be serious consequences. In the United States, the auditor must give the client a rating ranging from “unqualified,” which means acceptable, to “adverse,” which indicates that the company is lying about its financial performance. These ratings can have a significant impact on a company’s ability to stay in business.
Most jobs in this field demand that the applicant be a Certified Public Accountant (CPA), which means that he has passed the Uniform CPA Examination and is a licensed professional in the United States. A chartered accountant performs this task in other countries. Anyone interested in this field should have prior experience in auditing, financial analysis, or business administration.