External Audit and Its Role in Large Companies
The purpose of external audit and its role are not well understood yet. Although it does have the drawbacks, such as confidentiality issues or audit failures, those are rare; besides, external audit brings many advantages to large corporations and their stakeholders, which an internal one can never provide.
What is External Audit?
External audit (also known as independent or statutory audit) is a financial assessment conducted by particular auditors or firms that are not dependent on the company, which financial statements they examine (Jones & Pendlebury 2000, p. 229). Many jurisdictions nowadays require large and medium organizations to be submitted to such an assessment regularly, most commonly once a year. So, unlikely internal audit, which is regulated only by the company’s management, the work of external auditors are determined by statute (Millichamp 2002, p. 352). In many countries, the stakeholders also have the right to ask the company’s directors to conduct the external audit on their behalf (Walton & Aerts 2006, p. 46). Therefore, independent auditors are usually answerable to the law, the stakeholders and ‘arguably to an even wider public’ (Millichamp 2002, p. 352).
The Purpose and Role of External Audit
The main purpose of the external audit is to verify the adequateness and fairness of the organization’s financial accounts and check whether they comply with the company’s policy and constitution (Handling an external audit 2015, par. 6). Since such auditors are not personally connected to the corporation, which financial statements they examine and do not participate in keeping records, they are able to show an accurate and fair picture of the company’s financial state. External audit is aimed to verify the fairness, not reveal the fraud, although it inevitably happens sometimes. The auditors are ‘watchdogs not bloodhounds’ (Handling an external audit 2015, par. 7).
So, why do large companies need external auditors? First of all, conducting the audit regularly, organizations can protect themselves from serious mistakes emerging in the financial system. Auditors can catch and reveal small problems so that they will not grow into big ones. Someone may ask why the external audit is necessary here – the internal one may be enough. However, it is not. Internal audit is fraught with many mistakes, made both on purpose or accidentally. People who conduct it work in this particular company and are answerable to its managers. They are too close to business, which is why their acts and decisions can be influenced by this fact (Ori 2015, par. 5). For example, they can find out about the committed fraud but because of the risk to lose their job in case they report about it, they decide to keep silent. There are also many other disadvantages of internal audit.
As a prime example, people who are responsible for it do not always have a lot of experience in accounting and can simply do the job inaccurately, which is less likely to happen if independent auditors are in charge. Additionally, external and internal audit overlap (Millichamp 2002, p. 349). That is why independent auditors have the right to both request the data of internal audit and check its accuracy by their own. Therefore, external audit double-checks internal one. Finally, the independent audit is more credible. And that is essential for large companies since it helps to maintain their reputation, make people trust the organization, and attract more investors and stakeholders. For the same reason, from the point of view of stakeholders, investors and creditors, the independent audit matters since it can show whether they can rely on this particular company or now. Based on the results of the examination, they decide if they should buy or sell the company’s shares, make loans, and so forth (Friedlob & Plewa 2006, p. 700). They can not rely on internal audit in this matter since they can never be sure that it has been conducted in accordance with ‘generally accepted accounting principles’ (Friedlob & Plewa 2006, p. 700).
The Drawbacks of External Audit
Still, even the external audit has its drawbacks. Firstly, the independence of auditors from the company can be threatened, which deprives external audit of its main advantage. The prime reason for that to happen is a financial interest in clients that appears when auditors begin to provide non-audit services to them (Alabede 2012, p. 120). Unfortunately, that can lead to unpredictable consequences. As the proof of it, there was the Enron scandal when the auditor concealed the fact that the company had huge debts and then was accused of negligence and an attempt to get financial gain (The Fallout of Arthur Andersen and Enron 2015). In another case, regarding Re London and General Bank, the auditor found out about the fraud but did not reveal it to the stakeholders (External and internal audit n.d., p. 12). One more great concern of external audit is confidentiality (Brandenberg 2015, par. 4). Such auditors are not tied to the company, and providing them with the information about the employees’ salaries or logins to the databases requires extra precautions. Admittedly, this list can be greatly expanded, but the truth is that the majority of those drawbacks can be eliminated by choosing decent auditing companies and taking extra precautions.
To conclude, the advantages of external audit outweigh its drawbacks. While small businesses can manage without it relying only on internal audit, that is absolutely impossible for large corporations, which regularly need to reaffirm their credibility according to generally accepted principles and attract new stakeholders, investors, and creditors.
Reference List
Alabede, JO 2012, ‘The Role, Compromise and Problems of the External Auditor in Corporate Governance’, Research Journal of Finance and Accounting, vol. 3, no. 9, pp. 114-126.
Brandenberg, D 2015, The Disadvantages of Using an Independent Auditor.
External and internal audit: Chapter 2 n.d., Web.
Friedlob, GT & Plewa, FG 2006, Financial and Business Statements, 3rd edn, Barron’s Educational Series, Hauppauge, New York.
Handling an external audit 2015, Web.
Jones, R & Pendlebury, M 2000, Public Sector Accounting, 5th edn, Pearson Education, Harlow, England.
Millichamp, AH 2002, Auditing, 8th edn, Thomson Learning, London, England.
Ori, J 2015, Importance of an External Audit.
The Fallout of Arthur Andersen and Enron on the Legal Landscape of American Accounting 2015.
Walton, P & Aerts, W 2006, Global Financial Accounting and Reporting: Principles and Analysis, Thomson Learning, London, England.