Internal vs External Audit: What You Need To Know

Internal and external audits, while sharing some common elements, serve distinct purposes in an organization. In this blog, we will explain the key characteristics of each type of audit and examine how they overlap, as well as where they differ, to provide a greater understanding for our readers.

What is An Internal Audit?

An internal audit is an independent appraisal of a certain activity or department within an organization. It brings a systematic approach to evaluate and improve the functioning of an organization’s internal controls, management of risk, and governance processes. Internal auditors are employees of the organization. The internal audit function maintains its independence within the organization by reporting to the audit committee of the board of directors. They should have access to data and resources across the organization to carry out their audit plan.

The audit plan is approved by the audit committee and carried out by the internal audit function. The audit plan should be based on risk. Internal audit reports are for management and the organization’s board of directors, and are generally not shared outside of the organization. An exception to this may include vendor audits and joint venture audits, for example. Internal audits seek to continuously improve the organization’s operations and mitigate risk. Internal audits help management make informed decisions by identifying potential issues before they escalate, enabling a proactive approach to risk management. In some cases, an organization may outsource its internal audit function and, when this occurs, it should function no differently than if carried out by employees.

What Are the Types of Internal Audits?

The types of internal audits include financial, operational, compliance, and information technology. In accordance with the International Standards for the Professional Practice of Internal Auditing, an internal audit evaluates the adequacy and effectiveness of the internal controls over the governance, operations, and information systems that are in place by the organization to meet the following:

• Achievement of the organization’s strategic objectives;
• Reliability and integrity of financial and operational information;
• Effectiveness and efficiency of operations and programs;
• Safeguarding of assets; and
• Compliance with laws, regulations, policies, procedures, and contracts.

 

What is An External Audit?

An easy way to think of an external audit is that an external audit is performed by auditors external to the organization for independence. This is done to share the results with interested parties external to the organization. An external audit is an examination performed under specific regulations or guidelines that include an opinion on the results of the examination. The opinion given is either an unqualified opinion, meaning there were no material exceptions, or a qualified opinion, meaning that a material exception was noted.

An external audit is conducted primarily for users outside of the organization. A financial statement audit is what immediately comes to mind as an example of an external audit as it is widely performed for public entities. This type of external audit report is provided to investors, lenders, and other interested parties.

Other examples of external audits include system and organization controls (SOC) audits, including SOC 1 reports and SOC 2 reports. These types of audit reports are provided to current and prospective customers of the organization. There are also audits that are performed by external auditors, and for which reports are generated that are shared with users outside of the organization, who use external audit results to make decisions regarding the continuation of services. Examples of organizations that may utilize this type of audit are listed below.

• Health Insurance Portability and Accountability Act (HIPAA)
• HITRUST
• FedRAMP
• StateRAMP
• PCI DSS
• ISO/IEC 27001:2022 audits
• Cybersecurity Maturity Model Certification (CMMC)

An organization executes a contract with an external audit firm for the purpose of conducting an external audit. External auditors are required to be independent of the organization for which they are conducting the audit. They should have access to data and resources across the organization to achieve the requirements of the audit, otherwise, a scope limitation may result in qualifying the audit opinion. In some cases, the external audit may rely upon the work of internal auditors rather than performing all of the work themselves. In so doing, the external auditors perform steps to determine the independence and quality of work performed by the internal audit function to substantiate their reliance upon the work performed.

 

What Are Internal vs External Audit Similarities?

An internal audit and external audit are similar in that they both follow a similar audit process including 1) the planning phase; 2) the fieldwork phase, and 3) the reporting phase. An auditor, regardless of whether they are an internal auditor or an external auditor, must have independence of the process or company, respectively, that they are auditing. Below are some examples of similarities between an internal audit and an external audit.

Audit Similarities

• Independence: Internal auditors must be independent of the process, area, or department within the organization they are auditing in order to produce unbiased results. Similarly, external auditors must be independent of the organization for which they are providing audit services.
• Process: An internal and external audit will include:
  • A planning phase
  • A fieldwork phase
  • A reporting phase
• Report: A report will be issued based on the audit results for both internal and external audits.
• Access: Access to the data and resources needed to conduct the audit procedures should be unconstrained.
• Purpose: An internal audit and an external audit both provide assurance on the design and operational effectiveness related to the functioning of an organization’s internal controls.

 

What Are Internal vs External Audit Differences?

Differences between an internal audit and an external audit include who the audience is for the resulting audit report. The audience for internal audits is the organization’s management providing assurance over internal controls and adding value to improve operations. The audience for external audits is not only for the organization’s management, but also primarily for external parties such as investors, lenders, customers, prospective customers, regulators, etc.

Audit Differences

• Frequency

• • Internal Audit: An internal audit plan is determined annually, however, the area being audited may be performed every 3-5 years depending upon the risk. Internal audits of the organization are conducted continuously throughout the year.
  • External Audit: Generally, an external audit is performed annually.

• Objective

• • Internal Audit: Provides feedback to management on the functioning of internal controls and areas with room for improvement and added value.
  • External Audit: Examines the organization’s compliance with guidelines or regulations (e.g., GAAP, SOC objectives, HIPAA compliance, etc.) to meet the objectives or criteria.

• Who

• • Internal Audit: Employees of the company (internal audit department) conduct internal audits or the function may be outsourced. Either way, the internal auditors must be independent of the function being audited in order to produce unbiased results.
  • External Audit: A third-party audit team, notably a CPA firm, conducts an external audit. The CPA firm and individual auditors are external to the organization and must be independent of the organization.

• Scope

• • Internal Audit: The board of directors or management of the company determines the internal audit plan which includes activities across the entire enterprise.

• • External Audit: The relevant authority, regulations, or guidelines determine the scope of the external audit which is specific to the regulation or guideline being measured against for compliance.

• Reporting

• • Internal Audit: Internal audit must be independent of the area being audited and generally reports to the audit committee of the board of directors and senior management.

• • External Audit: External auditors are responsible to the public and external users of the report generated along with the auditor’s opinion. They must be independent of the organization being audited.

• Users

• • Internal Audit: Users of internal audit reports are primarily internal to the organization such as management of the subject being audited. Some audit reports may be shared outside of the organization such as for vendor audits and joint venture audits.

• • External Audit: Users of external audit reports are primarily stakeholders external to the organization such as the public at large, investors, lenders, customers, prospective customers, regulators, etc., and are also used internally by management to provide assurance over the functioning of its internal controls.

• Requirement

• • Internal Audit: Having an internal audit function within an organization is not mandatory but is considered a good business practice.

• • External Audit: Having an external audit is dependent upon whether the organization is a publicly-traded entity, performs outsourced services, provides software as a service, etc., and whether lenders, customers, etc. are requesting the external audit to be performed to enter into or continue the relationship or services. External audits may not be discretionary if required for the entity to stay in business or be competitive or publicly traded.

• Main Purpose

• • Internal Audit: The main purpose of internal audit is improvement-oriented and focuses on identifying and evaluating risks, assessing internal controls, and helping management to improve operational efficiency.

• • External Audit: The main purpose of external audit is compliance-oriented and provides assurance to external stakeholders about financial credibility, operating effectiveness of internal controls, and compliance with regulatory requirements and security frameworks.

• Skills

• • Internal Audit: Certifications are not required for internal auditors, but interdisciplinary experience and certification designations are helpful, such as CPA, CIA, CISA, CFE, etc.

• • External Audit: Certified Public Accountants (CPA) firms are required when issuing opinions on financial statement audits, SOC audits, etc. CPA, CISA, and CISSP designations are beneficial for individual auditors performing the audit.

 

 Is An Internal Audit Better Than An External Audit, or Vice Versa?

There are similarities and yet differences between an internal audit an external audit. Though both types aim to improve the organization’s performance and accountability, they serve different purposes, operate under different frameworks, and have distinct scopes of work. While internal audits serve as an ongoing support mechanism for management and the board of directors, external auditors promote accountability to external stakeholders. At the end of the day, audits, whether they be internal or external, benefit an organization.

In the discharge of their management responsibility, the benefits of internal and external audits provide management assurance on the design and operational effectiveness of their internal controls and an understanding of where improvement opportunities exist. Together, they form a comprehensive system of checks and balances, contributing to the organization’s stability, sustainability, and growth.

Key Takeaways on An Internal vs External Audit

Internal audits and external audits complement each other – both require auditor independence and provide assurance over the functioning of internal controls. You may be wondering, what is the relationship between internal and external auditors and how does an internal audit help an external audit? In some cases, the external auditor may rely upon the work of the internal auditor rather than performing all the audit work themselves. Both types of audits provide assurance regarding the design and operational effectiveness around the functioning of internal controls and both provide feedback to management and the board of directors.

On the other hand, internal audits focus their efforts internally to add value and improve operations at the organization. The users of internal audit reports are the management of the organization. External audits focus their efforts on the regulations or guidelines prescribed by the authority under which the audit is being conducted to determine compliance by the organization. The users of external audit reports are primarily external to the organization.

Understanding how different types of audits serve your organization is crucial for compliance and growth. Linford and Company assists organizations with several audit compliance services such as SOC 1 audits, SOC 2 audits, and most recently StateRAMP Assessments, ISO/IEC 27001:2022, PCI DSS audits, and CMMC compliance audit services. Additionally, penetration test services are also provided. Contact us today to discuss your organization’s audit needs.

This article was originally published on 5/25/2021 and was updated on 11/6/2024.