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External Audit

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What is External Audit?

External Audit is defined as the audit of the financial records of the company in which independent auditors perform the task of examining the validity of financial records of the company carefully in order to find out if there is any misstatement in the records due to fraud, error or embezzlement and then reporting the same to the stakeholders of the company.

External-Audit

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The objective of an external audit report includes the determination of the completeness and accuracy of the accounting records of the client, ensuring that the records of the clients are prepared as per the accounting framework which applies to them, and ensuring that the financial statements of the client present the true and fair results and the financial position.

Key Takeaways

  1. The term “external audit” refers to an examination of a company’s financial records by independent auditors tasked with determining the records’ accuracy.
  2. They are focused on identifying any misstatements that may have resulted from fraud, error, or embezzlement before informing the relevant parties.
  3. It aids in establishing the true picture of the company’s financial and market status, which further serves as the foundation for managerial decisions.
  4. Auditors examine the accounting books, purchase records, inventories, and other financial information to ensure that the business operates properly. They arrange their audits and base their work on them. They assess the company’s compliance with GAAP as well.

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External Audit Explained

External audit is the process of examination and analysis of the company’s financial documents by an auditor or a team of auditors, external to the company. These audits are conducted to ensure there are no cases of fraud, embezzlement, or genuine errors from individuals within the company.

Auditors examine the accounting books, purchasing records, inventory, and other financial reportsFinancial ReportsFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more to check that the company is functioning in the right manner. They conduct the external audit process based on these parameters.

Moreover, They also determine whether the company following GAAP standards or not. They perform the test and then submit a detailed report to the authorities. It conducted with the purpose to gather different information so that the auditors can give their opinion on the true and fair view of the company’s financial position as on the balance sheet date. External audit increases the authenticity and credibility of financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more as the financial statements of the company are being verified by an independent external party.

Examples

Let us understand the external audit process with the help of a couple of examples as discussed below.

Example #1

XYZ ltd manufactures garments and is listed as a publicly-traded companyPublicly-traded CompanyPublicly Traded Companies, also called Publicly Listed Companies, are the Companies which list their shares on the public stock exchange allowing the trading of shares to the common public. It means that anybody can sell or buy these companies’ shares from the open market.read more, i.e., sell their shares to the public. The company wants to know whether they are liable to get its financial statements audited by an external auditor or not.

As per the law, all the company publicly traded businesses or corporations which sell their shares to the public are legally required to get their financial statements audited by an external auditor. The objective includes the determination of the completeness and accuracy of the accounting records of the client, ensuring that the records of the clients are prepared as per the accounting framework and ensuring that the financial statements of the client present the true and fair financial position. Hence, the company will appoint an auditor who will conduct the external audit of the company and give its audit report in writing, which will be based on the various evidence and information gathered on the true and fair view of the financial statements provided to him to the concerned parties.

Example #2

Gold Resource Corporation reported the results of its yearly operations in December 2022. In the report, they declared net losses of $6.3 million and EBITDA of $19.5 million.

They also clarified that their external audit firm, BDO USA, LLP was yet to finish their audit. Once their external audit report was procured, they would be able to confirm the net results of the company’s performance.

Roles & Responsibilities

Let us understand the roles and responsibilities of an external audit process through the discussion below.

Limitations

Even though an external audit report increases the credibility of a company’s financials, there are a few factors that prove to be a hassle. Let us understand them through the explanation below.

Importance

Let us understand the importance of an external audit process through the discussion below.

Frequently Asked Questions (FAQs)

What makes external auditing crucial?

An unbiased analysis of the financial accounts can show shareholders that the business is being operated in their best interests and can draw their attention to any problems that may not have been brought to their attention.

What is the goal of an external audit?

An external audit of financial statements aims to determine whether, in the auditor’s judgment, they present information about the company’s financial status honestly and fairly in all material ways.

What does an external audit cover?

An external audit allows the government and the company to examine the organization’s financial operations. An external audit guarantees that the company’s financial statements are substantially accurate and fair to investors, lenders, and other stakeholders.

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