Businesses that use independent auditors do not need the use of internal auditors.

What is an Internal Audit?

Internal audit refers to the department located within a business that monitors the efficacy of its processes and controls. The internal audit function is especially necessary in larger organizations with high levels of process complexity, where it is easier for process failures and control breaches to occur.

What is an External Audit?

An external audit is an examination that is conducted by an independent accountant. This type of audit is most commonly intended to result in a certification of the financial statements of an entity. This certification is required by certain investors and lenders, and for all publicly-held businesses.

Comparing Internal and External Audits

There are multiple differences between the internal audit and external audit functions, which are as follows:

• Internal auditors are company employees, while external auditors work for an outside audit firm.

• Internal auditors are hired by the company, while external auditors are appointed by a shareholder vote.

• Internal auditors do not have to be CPAs, while a CPA must direct the activities of the external auditors.

• Internal auditors are responsible to management, while external auditors are responsible to the shareholders.

• Internal auditors can issue their findings in any type of report format, while external auditors must use specific formats for their audit opinions and management letters.

• Internal audit reports are used by management, while external audit reports are used by stakeholders, such as investors, creditors, and lenders.

• Internal auditors can be used to provide advice and other consulting assistance to employees, while external auditors are constrained from supporting an audit client too closely.

• Internal auditors will examine issues related to company business practices and risks, while external auditors examine the financial records and issue an opinion regarding the financial statements of the company.

• Internal audits are conducted throughout the year, while external auditors conduct a single annual audit. If a client is publicly-held, external auditors will also provide review services three times per year.

In short, the two functions share one word in their names, but are otherwise quite different. Larger organizations typically have both functions, thereby ensuring that their records, processes, and financial statements are closely examined at regular intervals.

What Is an Internal Auditor (IA)?

An internal auditor (IA) is a trained professional employed by companies to provide independent and objective evaluations of financial and operational business activities, including corporate governance. They are tasked with ensuring that companies comply with laws and regulations, follow proper procedures, and function as efficiently as possible.

Key Takeaways

• An internal auditor (IA) is a trained professional tasked with providing independent and objective evaluations of company financial and operational business activities.
• They are employed to ensure that companies follow proper procedures and function efficiently.
• Final reports are presented to senior management and can include recommendations.

Understanding an Internal Auditor (IA)

The main job of an internal auditor (IA) is to identify problems and correct them before they are discovered during an external audit by an outside firm or regulatory agencies, such as the Securities and Exchange Commission (SEC). One of the roles of the SEC is to regulate how companies report their financial statements to help ensure that investors have access to all of the necessary information before investing.

An internal audit generally performs the three tasks outlined below.

• Assess any risks and the internal controls within a company
• Ensure that a company and its employees are in compliance with federal and state laws and regulations
• Make suggestions as to what needs to be done to rectify a failed audit or issues that were identified as problematic during the audit

Internal Auditing Process

To achieve this goal, internal auditors will typically perform a multitude of tasks, including examining financial statements, expense reports, inventory, financial data, budgeting and accounting practices, as well as creating risk assessments for each department. Detailed notes are taken, interviews with employees are conducted, work schedules are supervised, physical assets are verified, and financial statements are scrutinized to eliminate potentially damaging errors or falsehoods and find ways to boost productivity.

Once an internal auditor has completed the examination, the findings are presented in a formal report. The audit report describes how the audit was done, what it discovered and, if necessary, suggestions for what improvements could be made. It is usually presented to senior executives at the company. If changes are recommended, it's common for an internal auditor to be asked to complete a follow-up audit to determine how well the advised changes have been executed.

Properly-managed publicly-traded companies also carry out internal audits to ensure that the company is complying with federal and state regulations, including those mandated by the SEC. However, companies must also ensure that their accounting practices follow the accounting guidelines as laid out by the Generally Accepted Accounting Principles (GAAP).

Requirements for Internal Auditors

The Institute of Internal Auditors (IIA), established in 1941 and headquartered in Florida, is the international professional organization that sets standards, guidance, best practices, and code of ethics for practitioners. On its website, the IIA defines internal auditing as: “an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.”

Internal Auditor vs. External Auditor

Sometimes the role of internal and external auditors can be confused. The main difference between the two is that internal auditors (IA) work on behalf of company management. Internal auditors are hired by the company, while external auditors are appointed by a shareholder vote.

Internal auditors are employed to educate management and staff about how the business can function better. External auditors, on the other hand, have no such obligations. They are responsible for reviewing financial statements to ensure that they are accurate and conform to GAAP. Their findings are then reported back to shareholders, rather than management.

According to the Association of Certified Fraud Examiners, the role of the external auditor is to: “inspect clients’ accounting records and express an opinion as to whether financial statements are presented fairly in accordance with the applicable accounting standards of the entity, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). They must assert whether financial statements are free of material misstatement, whether due to error or fraud.”  

It is a legal requirement for all financial statements from public companies to be audited by a third-party accountant, in accordance with the Securities Act of 1933 and the Securities Exchange Act of 1934.  

Benefits of an Internal Auditor (IA)

Many companies choose to employ an internal auditor, despite not being legally obligated to do so. Robust internal audits are viewed as a key way to correct issues quickly, maintain a good reputation, and prevent money from being wasted. Reports filed by internal auditors (IA) can help companies to prosper and operate at maximum efficiency. For this reason, many executives view them as a necessary expense.

Many companies choose to employ an internal auditor, despite not being legally obligated to do so. Robust internal audits are viewed as a key way to correct issues quickly, maintain a good reputation, and prevent money from being wasted. Reports filed by internal auditors (IA) can help companies to prosper and operate at maximum efficiency. Internal auditors also set the company up for success when it's annual external audit comes around. The job of an internal auditor is essentially to help catch and fix issues before an external auditor has the chance to so do. For this reason, many executives view them as a necessary expense.

How the internal auditor's work may be used by the independent auditor?

Is it compulsory for every company to have an internal audit system?

Which company is required for internal audit?

Can external auditors rely on internal audit?