What is an external audit?

An external audit is a process of reviewing the financial record of the business. It’s a regulatory requirement and is conducted by a professional accountant. The local regulator must license these accountants. For instance, the external audit profession in the UK is monitored and regulated by the Institute of Chartered Accountants of England and Wales – ICAEW.

Detailed explanation of external audit

Companies raise finance from shareholders and use it in business activities. The shareholders invest their hard-earned money to generate profits and grow financially. So, companies are required by law to present financial performance and status to the shareholders, which is done via financial statements.

However, management prepares financial statements, which is responsible for managing business operations. Hence, there is a significant self-interest threat, and management might show inflated profits or window dress financial statement. Hence, the law requires management to hire an auditor and get a certificate of accuracy in an audit report.

It’s important to note that multiple stakeholders use financial statements that include but are not limited to customers, suppliers, employees, government, creditors, debtors, and any other person/entity.

Purpose of external audit

An external audit helps to obtain the following purposes.

  1. Accuracy of the financial statement – auditors perform different procedures to ensure accounting record is free from material misstatement.
  2. Compliance with regulatory provisions – auditors need to ensure that the company’s financial statement has been prepared in line with the applicable regulatory framework. For instance, auditors need to ensure that companies in the United States follow GAAP issued by the financial accounting standard board.
  3. Fair presentation – Auditors need to ensure that all financial and related non-financial information has been presented in a material aspect.

Auditor perspective for external audit

From an auditor’s perspective, it is an engagement to perform the following tasks.

  1. Understand the business of clients, including internal and external market conditions.
  2. Set the scope of performing audit-related activities.
  3. Assess the risk of material misstatement.
  4. Design audit procedures to obtain sufficient and appropriate audit evidence.
  5. Collect audit evidence.
  6. Issue audit report to be used by the company.

However, auditors need to ensure that they only accept an engagement if they have sufficient resources. For instance, a potential audit client may have a significant risk of material misstatement, and the firm is unable to perform an audit. So, an auditor must not engage in such a situation.

Final thoughts

The external audit is an assurance-based activity conducted by a professional accountant. Local regulators license these accountants to issue audit reports.

The purpose of performing an audit is to ensure that financial statements present a true and fair view, and have been prepared in compliance with applicable directives with an accurate presentation.

Further, the audit report is used by shareholders, creditors, customers, banks, and Government to ensure their dealings with the company is based on factual financial information.

From an auditor’s perspective, external audit engagement is about risk assessment, designing audit procedures, performing audit procedures, collecting sufficient and appropriate audit evidence, forming opinions, and issuing reports.

Frequently asked questions

Steps to perform an external audit

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