What Are the Differences Between In-House Audits and External Audits?
The word audit can be enough to elicit worry and consternation from business owners and employees alike. For most people, having their work double- and triple-checked by someone else is nerve-wracking. Not many people relish the idea of someone else looking over every detail of their work, poking and prodding for mistakes.
Of course, the purpose of an audit is not to poke and prod at one individual’s work. Rather, audits are a method for reviewing the accuracy of a company’s financial statements. Often, they also serve to test the company’s financial controls and processes.
But is conducting an audit using internal employees or bringing in an outside party more effective? Let’s explore some of the key differences between internal vs. external audits.
What Is an In-House Audit?
Put simply, an in-house audit is conducted by the business’s employees. In-house audits are a tool businesses can use to test their financial processes and procedures.
While external audits are mandatory for certain companies, internal audits are usually discretionary. Businesses conduct in-house audits for various reasons, from ensuring compliance with financial laws and regulations to identifying issues with financial reporting systems.
Why In-House Audits Are Needed
No matter how small, every business has financial procedures and controls that help ensure its finances are handled properly. For some businesses, these procedures can be as simple as separating business accounts from personal accounts to prevent the commingling of funds or ensuring that more than one person counts all cash deposits. Larger businesses are likely to have more robust controls in place, like regular account reconciliation or segmenting transactions, so that no one employee handles a particular transaction from start to finish.
Regardless of the size of your business or the specifics of your financial procedures, an in-house audit is an effective way to review those procedures. Doing so lets you ensure that your financial controls work as they should.
Advantages of In-House Audits
While in-house audits don’t involve opening your books to an outside entity, they can be as robust as an external audit. Some of the primary advantages of conducting an internal audit include the following:
Flexible Process: A business can choose to conduct an In-house audit at any time and also has wide latitude to decide on the specific focus of the audit. For example, a business could conduct an audit solely focused on its petty cash system to ensure money is being handled properly.
Opportunity for Improvement: After compiling their findings, internal auditors can work with business owners and managers to improve any areas of weakness identified by the audit. While external auditors often need to maintain objectivity to give a neutral opinion about a company’s finances, in-house auditors face no such restrictions.
Trial Run: An in-house audit can be used to prepare for an external audit. If your business needs to have financial statements independently audited, an in-house audit can serve as a trial run for that process.
Disadvantages of In-House Audits
While there are advantages to conducting in-house audits, it’s important to be aware of the potential downsides.
Significant Disruption: As mentioned, there aren’t very many employees who look forward to an audit. Conducting a voluntary, in-house audit can make employees feel their work isn’t trusted. And even if they don’t feel that way, preparing for an audit will pull them away from their other duties.
Use of Resources: Internal audits can impose significant costs on your business. Choosing to do an in-house audit means allocating resources to the audit at the expense of day-to-day operations. Because staff are responsible for the audit, in-house audits often take up more staff time than external audits.
What Is External Audit?
An external audit consists of a review of a business’s financial statements conducted by a third-party auditor. Generally, external audits are conducted by Certified Public Accountants (CPAs). The most common external audit type involves reviewing a company’s financial statements, including balance sheets, cash flow statements, and income statements. External auditors check the accuracy of these financial statements, noting any errors or discrepancies.
Why External Audits Are Needed
Often, external audits are mandated by financial regulators. For instance, publicly traded companies must have their financial statements audited regularly. Many businesses and nonprofit organizations that receive funding from government agencies are also required to undergo external audits.
While many private companies are not required to undergo external audits, businesses often choose to do so to build trust with customers, investors, and potential creditors. Presenting externally audited financial statements lends legitimacy to a business’s financial claims.
Advantages of External Audits
While external audits can be stressful, they can also provide significant advantages for your business. A few of the most important include:
Legitimacy: A successful external audit of your company’s financial statements proves that you are accurately portraying the business’s financial situation. Audited financial statements signify the legitimacy of your company’s finances to others, from customers to potential investors.
Better Controls: Preparing for an external audit is a strong motivator for ensuring your business’s financial controls work well. Having good financial controls and procedures will continue to help your business as you progress and grow.
Outside Opinion: No matter how smoothly your business seems to be functioning, letting another pair of eyes check your work is always useful. Getting an external audit can help you be confident that your business is doing things as it should.
Disadvantages of External Audits
External audits have some disadvantages as well, including:
Negative Findings: There’s always a possibility that an outside auditor may look at your financials and provide a negative opinion. This is more of an issue for prominent or publicly traded companies, but it isn’t a good thing from a perception standpoint to have an auditor come to a negative conclusion.
Cost: External audits are often expensive. As noted, external audits are usually conducted by CPAs, meaning that their time is likely more costly than that of an internal auditor who doesn’t necessarily have the same level of qualification.
Factors to Consider When Deciding Between In-House and External Audit
If you’re considering conducting an audit for your business, identifying the specific goals of the audit will help you decide whether you should go with an in-house or external audit. Is the primary purpose of your audit to test your business’s financial controls and ensure that you have robust accounting procedures in place? In that case, you might be better served by conducting an internal audit, allowing employees to test your systems. Upon completion of the audit, you can use their findings to improve any areas found deficient.
Alternatively, you may have a growing business and want to ensure that your financial reporting is adequate and accurate before you present your numbers to a new group of potential investors. If the primary purpose of your audit is to have confidence in your public-facing numbers, you’re likely better off conducting an external audit.
How Remote Quality Bookkeeping Can Assist With Audits
At Remote Quality Bookkeeping, we provide outsourced bookkeeping and accounting services to ensure your books are up-to-date and accurate. Our team of professionals includes CFOs and CPAs with expertise in assisting franchises and small and medium-sized businesses.
If your business is considering conducting an audit, consider consulting with Remote Quality Bookkeeping first. Our team can help you decide what type of audit is most appropriate for your circumstances and ensure that you and your books are ready.
And if it’s accurate financial reporting you’re after, we can also help with that. At RQB, we work with clients to ensure all your financial statements are done on time and meet all your regular reporting deadlines. Reach out today and schedule a demo of our services to see what we can do for you.
