External Audit

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.

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.

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.

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 reports 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 statements 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 company, 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.

• The main responsibility is to verify the company's general ledger and make all other essential inquiries from the company's management. It helps to determine the real picture of the company’s market and financial situation, which further provides the basis for managerial decisions.
• Examine the validity of financial records to find out if there is any misstatement in the company’s record because of fraud, error, or embezzlement. So, it increases the authenticity and credibility of financial statements as the financial statements of the company.
• If there are errors in the accounting process of the company, then it may prohibit the owner of the company is taking the decisions which are best for the company. An audit helps in overcoming this problem to a great extent as the procedures in the audit are designed in such a way that they help in detecting the errors in the system and the other fraudulent activity. The audits also ensure the recording of accounting transactions as per the generally accepted accounting principle. It helps the owner of the business to cover themselves when it comes to following the different rules and regulations which the registered entity needs to follow.

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.

• The audit is conducted by reviewing the sample data of the company, which the auditor thinks is material for his examination. An auditor does not assess and review all the transactions which occurred in the company. Thus, he merely expresses his audit opinion on the financial statements and data based on the sample data provided to him. Therefore, this does not give total assurance about the financial position of the company.
• Expenses involved in conducting an audit may be very high.
• In all stages of accounting, from preparation to finalizing the financial statements and expressing the audit opinion, there is the involvement of humans and thus making it prone to error. Also, if there is a lack of knowledge or experience of an auditor in the relevant field, then the purpose of the audit will not solve.

Importance

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

• The main purpose for which the external audit is conducted includes the determination of the completeness and accuracy of the accounting records of the client, to ensure that the records of the clients are prepared as per the accounting framework which applies to them and to ensure that the financial statements of the client present the true and fair results and the financial position. A statutory auditor can ask for the company’s financial books, records, or information in relation to that for which the management cannot deny him.
• After conducting the audit and gathering necessary information, the external auditor is supposed to give its audit report in writing, which will be based on the various evidence and data collected on the true and fair view of the financial statements provided to him to the concerned parties.
• Most commonly, an external audit is intended to get the certification of financial statements of the company. Certain investors and the lenders require this certification for their analysis. Also, all publicly traded businesses or the corporations which sell their shares to the public are legally required to get their financial statements audited and get this certification.

Frequently Asked Questions (FAQs)

Recommended Articles

This article has been a guide to what is External Audit. Here we explain the roles, responsibilities, examples, importance, and limitations. You can learn more about accounting from following articles –

• Internal Audit Functions
• Format of an Audit Report
• Contents of an Audit Report
• Types of Audit Report