The Role of an External Audit

Written by marquis codjia
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The Role of an External Audit
An external audit process helps a company evaluate its internal controls and operating procedures. (currencies market image by luka from Fotolia.com)

An external audit process ensures that an organisation internal operations are adequate, functional and comply with regulations and corporate policies. This process also helps a company evaluate mechanisms around its financial reporting procedures and detect potential weaknesses. Various users read audit reports, including regulatory agencies, corporate trading partners, senior management and investors.

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Function

An external audit helps an organisation evaluate its internal controls, processes or policies and ensures that such policies agree with regulatory standards and industry practices. An organisation hires an external auditor---typically a certified public accountant (CPA)---to review its operations and issue a report. An external audit expert ensures that a business entity's controls around financial reporting mechanisms are adequate, functional and in compliance with generally accepted auditing standards (GAAS). An audit expert also verifies that financial statements are accurate, complete and in agreement with generally accepted accounting principles (GAAP).

Time Frame

An external audit process spans 12 months, although auditors test financial statement sections at year-end, when a corporation closes its books and accounting records. An external auditor partners with internal audit employees to review "key" areas or mechanisms and detect potential operating issues ("key" means "significant" or "important" in audit parlance). For instance, an external auditor could test accounts receivable balance at year-end and compare it with prior years' amounts.

Significance

An external audit is important for a company under review because various groups read audit reports. Trade partners---such as lenders, suppliers and customers---may read them to learn about a company's financial standing. Regulators and investors also use reports to gauge industry trends, corporate operating data and profitability. A company's management and employees also use an audit report to evaluate corporate activities.

Types

There are five types of audit reports: unqualified, unqualified with explanation, qualified, adverse and disclaimer. An unqualified reports means a "clean" report---that is, no major problem was detected. An unqualified report means auditors have not found any major problem but want to highlight a specific situation---such as a risk of bankruptcy---to investors and regulators. A qualified report arises from an accounting inaccuracy or a limitation in the auditor's work. An adverse report---the opposite of a "clean" report---means that auditors believe there are significant problems in internal controls and financial statements are not accurate. A disclaimer of opinion means auditors do not wish to issue a report because they were unable to review major parts or segments within a company.

Misconceptions

An external auditor does not work for investors, company senior managers or regulators even though these groups use audit reports. A company's directors are the auditor's direct employers and they receive and review reports prior to publishing. An external auditor also does not test for illegal or fraudulent activities---such as tax evasion or money laundering schemes---but only ensures that financial statements are accurate and complete.

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