An external audit is an independent examination of a company’s financial records and business transactions. This audit is conducted by an outside organization or a certified public accounting (CPA) firm not affiliated with the company being audited.
The primary purpose of an external audit is to provide an objective assessment of the company’s financial statements. The auditors verify the accuracy and completeness of the information presented in the financial statements, assess the company’s internal controls, and ensure the company is in compliance with accounting standards and regulatory requirements.
At the end of the audit, the external auditors issue an audit report. This report provides an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework (e.g., Generally Accepted Accounting Principles, International Financial Reporting Standards).
If the auditors conclude that the financial statements are fair and free from material misstatements, they will issue a clean or unqualified audit opinion. However, if they find significant discrepancies, errors, or signs of fraud, they might issue a qualified opinion, adverse opinion, or a disclaimer of opinion, each of which reflects varying degrees of concern about the financial statements.
External audits are essential for maintaining trust and transparency between a company and its stakeholders, which include shareholders, creditors, investors, and regulatory bodies. The auditors’ independent and objective perspective helps ensure the reliability and integrity of the financial information provided by the company.
Example of an External Audit
Suppose there’s a company called “TechNovel Inc.” that manufactures computer hardware. At the end of its financial year, TechNovel decides to undergo an external audit, as required by law for publicly traded companies or due to requirements set by its creditors or investors.
TechNovel hires an independent Certified Public Accountant (CPA) firm, “Audit Masters,” which is not affiliated with TechNovel in any way, to conduct the audit. The primary aim of this audit is to examine TechNovel’s financial statements, including the balance sheet, income statement, and statement of cash flows.
The auditors at Audit Masters perform the following tasks:
- Review the financial statements : They check if the financial statements have been prepared according to an accepted accounting framework, like Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).
- Verify Transactions: They randomly select a sample of transactions and match them with the relevant supporting documents like invoices, receipts, or contracts to verify their authenticity.
- Test Internal Controls: They evaluate the company’s internal control procedures to determine if they are robust and effective in preventing errors or fraud.
- Assess Inventory: They may physically count the inventory to verify that the quantity matches what’s reported in the financial statements.
- Speak with Third Parties: They may independently confirm the company’s account balances by contacting third parties like customers or suppliers.
After the audit is complete, Audit Masters will issue an audit report. If they found that TechNovel’s financial statements are a fair and accurate representation of its financial position, they would give an “unqualified” or “clean” opinion. If there were significant issues, they would explain these in their report.
The completed audit and audit report provide assurance to stakeholders such as investors, creditors, and regulators that TechNovel’s financial statements are reliable. This helps maintain confidence in the financial integrity of the company.