Difference Between Internal Audit and External Audit

Audit refers to the process of independent examination or checking of the financial statements and records of an organization, so as to give an unbiased opinion on their accuracy and integrity. Audit has evolved to encompass the non-financial areas and operational matters in its ambit e.g. management audit, risk audit, performance audit, etc.

Audit has two main categories viz. Internal Audit and External Audit. 

Internal Audit:

Internal audit refers to the critical examination of the financial statements and records of a business or organization, by its own employees. These employees are called internal auditors and appointed by the management of the organization. The scope of work is determined by the management of the organization, particularly the audit committee.

Internal Audit is not compulsory by nature. It is carried out almost continuously. Of late, internal audit often involves the critical review of the non-financial and operational aspects or activities of the organization, for example, management audit, performance audit, IT audit, etc.

External Audit:

External audit refers to the independent critical examination of the financial statements and records of a business or organization.

External Audit is obligatory for every separate legal entity. It is carried out after the preparation of the financial statements of the entity.

A third party or independent auditor, called external auditor, is appointed to carry out the process of audit and give an unbiased opinion on the financial statements and records of the company. The external auditors carry out the audit under the provisions of an applicable law on behalf of shareholders or a regulator. The scope of work is determined by the applicable law or regulation.

The main responsibility of external auditor is to carry out the statutory audit of the final accounts, and give an unbiased opinion on whether they provide a true and fair reflection of the actual financial position of the entity. 

Similarities between Internal Audit and External Audit:

The basic auditing process of both of the internal audit and external audit is almost same. Both are based on the sound principles and techniques of accounting and auditing. Both the audits aim at finding out the errors and detecting the frauds. Both want to judge the accuracy of the financial statements and records. Both are required to give an unbiased opinion on whether the financial statements and records provide a true and fair reflection of the actual financial position of an organization or business.

Key Differences between Internal Audit and External Audit:

• Legal Status: Internal audit is discretionary or not compulsory; but external audit is obligatory or compulsory by law.
• Nature of Audit: Internal audit is carried out on continuous basis; while external audit is carried out after the preparation of final accounts and financial statements usually on yearly basis.
• Objective: Objective of internal audit is to evaluate and improve the effectiveness of accounting, financial activities, governance, risk management and other control processes of the company; while objective of external audit is to add credibility to the financial statements and reports of the company.
• Coverage: Internal audit covers financial statements and records, various risks, and other operational activities; while external audit covers financial statements and records.
• Type of Checking: Internal audit involves the checking of almost all the financial statements and records; while external audit may be carried out through test checking or sample checking.
• Scope: The scope of internal audit is determined by the management of the company; while the scope of external audit is determined by the relevant law or a regulator.
• Focus: The primary focus of internal audit is to find out errors and frauds; while the primary focus of external audit is to verify the accuracy and reliability of the financial statements, and to judge whether the financial statements provide a true picture of the actual financial position of the entity.
• Report Submission: Internal audit report is submitted to the management of the company or organization; while external audit report is submitted to the shareholders, or in some cases, to a regulator.
• Guidance: Internal audit involves making suggestions for the improvement of financial statements, accounting and related activities to the management of the organization or the company; whereas external audit usually does not involve making such suggestions, except in some cases with specific requirements.
• Audit Activity: Internal audit is usually carried out by an employee of the company; but external audit is carried out by an independent person or agency.
• Appointment: Internal auditor is appointed by the management of the company; while the external auditor is appointed by the shareholders of the company, or a regulator.
• Qualification: Any specific or prescribed qualification is not compulsory for internal auditor; but some specific or prescribed qualification is compulsory for an external auditor.
• Remuneration Type: Internal audit is carried out by a company employee who gets a salary usually on monthly basis; while a specific audit fee is paid for the external audit, usually based on the audit assignment.
• Remuneration Fixation: Internal auditor remuneration, i.e., salary is fixed by the management of the company; while fee for external audit is fixed by the shareholders of the company.
• Shareholder Meetings: Internal auditor does not attend the meetings of the shareholders of the company; whereas external auditor may attend the shareholder meetings.
• Removal of Auditor: Internal auditor can be removed by the company management; whereas external auditor can be removed by the shareholders of the company.
• Professional Misconduct: Internal auditor is not prosecuted for professional misconduct; while external auditor can be prosecuted for professional misconduct as per the procedure prescribed under the relevant law or statutes.

Internal Audit and External Audit:

Criterion	Internal Audit	External Audit
Legal Status	Discretionary or not compulsory	Obligatory or compulsory by law
Nature of Audit	Continuous	After the preparation of financial statements usually on yearly basis
Objective	To evaluate and improve the effectiveness of accounting, financial activities, governance, risk management and other control processes of the company	To add credibility to the financial statements and reports of the company
Coverage	Financial statements and records, various risks, and other operational activities	Financial statements and records
Type of Checking	Checking of almost all the financial statements and records	May use test checking or sample checking
Scope	Determined by the management of the company	Determined by the relevant law or a regulator
Focus	To find out errors and frauds	To verify the accuracy and reliability of the financial statements
Report Submission	To the management of the company	To the shareholders, or in some cases, to a regulator
Guidance	Suggestions for improvement of accounting and related activities to the management	No such suggestions
Audit Activity	Carried out by an employee of the company	Carried out by an independent person or agency
Appointment	By the management of the company	By the shareholders of the company, or a regulator
Qualification	Any specific or prescribed qualification is not compulsory	Some specific or prescribed qualification is compulsory
Remuneration Type	Company employee gets a salary usually on monthly basis	Specific audit fee, usually based on the audit assignment
Remuneration Fixation	By the management of the company	By the shareholders of the company
Shareholder Meetings	Does not attend the meetings of the shareholders of the company	May attend the shareholder meetings
Removal of Auditor	Removed by the company management	Removed by the shareholders of the company
Professional Misconduct	Not prosecuted for professional misconduct	Can be prosecuted for professional misconduct as per the procedure prescribed under the relevant law

Summary:

Internal audit and external audit are carried out separately by the different persons: internal employees and independent third party respectively. But, they are not opposed to each other. Instead, they are complementary.

External auditors may get help from the internal auditors for the in-depth knowledge of the accounting system of the entity and better understanding of the technical aspects of the business. On the other hand, internal auditors may learn from superior professional knowledge of the external auditors; and implement the best practices in the internal audit.

Though, the external auditors may rely on the work of the internal auditors; but they cannot shift their responsibility. If any error or fraud remains undetected; the external auditors will solely be held responsible.

Internal audit is continuous; and focuses on finding out the errors or frauds and improving the processes in the organization. External audit is independent; and focuses on critical evaluation of financial statements and providing an unbiased opinion on their accuracy.

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