An external auditor is a third-party professional who performs an independent review of an organization's financial records. Generally reporting to an audit committee of company executives, he evaluates accounting, payroll, and purchasing records, as well as anything related to financial investments and loans, searching for any mistakes or fraud. Afterwards, he provides an accurate, unbiased report of the company’s financial condition to management or those responsible for corporate ethics. External and internal auditors typically perform similar work, though an internal review is generally more focused on risk management and internal control procedures.
Internal vs. External Auditors
An independent financial professional performs work for an organization, but he is not employed by it. An internal auditor, on the other hand, works for the organization he reviews. Both parties provide similar services, including the evaluation of financial statements, business operations, and compliance with regional rules as well as offering their opinions on efficiency and finding fraud. Internal examiners generally have the advantage when it comes to understanding industry or company-specific characteristics, but knowing the people being audited can interfere with their judgment.
Advantages and Disadvantages of Using Outside Auditors
An external auditor doesn't have developed relationships within the organization he's reviewing, which helps him avoid bias. There are strict requirements about this: external auditors generally can't be a friend or relative of any owner, manager or employee. Those reviewing publicly traded companies must not hold stock in them or have any equity stake in any of their subsidiaries or holdings.
While an outside auditor may specialize in a particular field of business, he often has to learn the ins and outs of a specific industry before conducting an audit. Although this can be a disadvantage, it also means that he is unlikely to come into the job with any set ideas about how things should be done. This can make it easier for him to recognize problems.
Choosing an Auditor
An organization may rely on an internal or external auditor or use a combination of both services, depending on its needs and the law. In the U.S., the Securities and Exchange Act of 1934 requires publicly traded companies to hire an outside party. Chosen by a committee, this professional has to ensure that financial statements accurately depict a company's financial performance, since public investors often rely on this information when purchasing stock. Private companies may or may not use an outside professional, but when they do, it's usually only in situations in which they are required to do so by the law or because of a major event, like a merger.
In some instances, a third-party's services are required by a regulatory agency or shareholders that believe that a company's financial claims are questionable. If the auditor finds evidence to support their suspicions, he is usually required to report them. The company is generally given the opportunity to defend its position either in writing or orally.
Audit planning is a formal process that an auditor must perform before the actual examination begins. First, he must prove that he has a working knowledge of the business and its operations. Next, he must identify the risks associated with misreporting financial statements for this particular entity and then develop an approach based on the results of the previous two steps. The entire review process can take anywhere from weeks to months, depending on things like an organization's size and reporting risks.
Most countries have organizations that establish the standards for financial auditors. Professionals typically follow the Generally Accepted Auditing Standards (GAAS), which attest to their training, independence, and diligence. The International Standards on Auditing (ISA), released by the International Auditing and Assurance Standards Board (IAASB), are enforced in many countries as well, including all members of the European Union. In the U.S., the Public Company Accounting Oversight Board (PCAOB) oversees the auditing industry and sets standards.
Despite having these guidelines, there are times when the auditor needs to rely on his own experience to draw some conclusions. He is trained to challenge the truth of the material he encounters to find mistakes and fraud, and to identify areas that need improvement. For instance, he might notice that a company could be more efficient in its accounting, internal controls, or spending habits. He may suggest solutions like reducing overhead through staff reductions or better inventory control.
More problematic are irregularities, which are misstatements or lies from client. They can happen in many ways, including when a company manipulates its financial performance. This may mislead investors and can force a company to admit wrongdoing, recalculate past profits, and delay the disclosure of future financial performance if discovered. Another type of irregularity is related to the classification assigned to company positions, which affects the way employees are paid.
To find irregularities and to avoid oversights, independent reviewers create tests during the planning to locate mistakes or fraud. The higher the risk for errors in financial reporting, the greater the depth of the test and the less an outside partner will rely on a company's official input for accuracy.
Once the job is completed, an external auditor will present his findings to the company's executives or board. His report normally covers the state of accounts payable and receivable as well as his opinion of the company's record-keeping systems and financial health. His comments on these topics are expected to be constructive and include recommendations for improvements.
An auditor's findings strongly influence the company’s reputation. There can be serious consequences if his conclusions about assets, debts, tax responsibilities, and payments do not match the company's. In the U.S., the auditor must assign a rating to the client, ranging from "unqualified," which means acceptable, to "adverse," which suggests that the company is misrepresenting its financial performance. These ratings often influence whether a company can stay in business.
Most jobs in this field require the applicant to be a Certified Public Accountant (CPA), which in the U.S. indicates that he passed the Uniform CPA Examination and is a licensed professional. In other countries, this job is done by a chartered accountant. Experience in auditing, financial analysis, or business administration is also valuable for anyone planning to go into this field.