Even though external auditing and internal auditing have different scopes and objectives, they both complement each other, contributing to the work as a whole and generating credibility and transparency in the eyes of investors and shareholders, as well as managers.
The importance of external auditing and internal auditing is indisputable in the modern business context, as both play crucial roles in ensuring the transparency, integrity and efficiency of an organization's operations. Internal audit is responsible for evaluating and monitoring internal controls, operational and management processes, identifying areas for improvement, minimizing risks and promoting compliance with internal and external policies and regulations. On the other hand, the external audit is conducted by an independent entity and its main objective is to provide an impartial opinion on the company's financial statements, ensuring their compliance with applicable accounting standards and regulations.
While internal auditing is focused on improving internal processes and mitigating risks, external auditing provides credibility and trust to the financial information disclosed to external stakeholders, such as investors, creditors and regulatory bodies. The combination of these two forms of auditing is essential to guarantee the effectiveness of internal and external controls, promote corporate governance and ensure the organization's accountability to its internal and external environment. Together, these audit practices provide a comprehensive view of the company's financial and operational health, helping to make strategic decisions and maintain stakeholder trust.
RELATIONSHIP BETWEEN EXTERNAL AND INTERNAL AUDIT
Internal auditing is a means of evaluating the effectiveness of a company's internal controls. Maintaining an effective system of internal controls is vital to achieving a company's commercial objectives, obtaining reliable financial reports on its operations, preventing fraud and misappropriation of its assets and minimizing its cost of capital. Both independent auditing and internal auditing contribute to a company's auditing system in different but important ways.
Having an effective audit is important for a company as it allows it to achieve its various corporate objectives. Business processes need various forms of internal controls to facilitate oversight and monitoring, prevent and detect irregular transactions, measure ongoing performance, maintain adequate business records, and promote operational productivity. Internal audit reviews the design of internal controls and suggests informal improvements, as well as documenting any material irregularities and allowing for further investigation by management if warranted in the circumstances.
Internal audit helps an organization achieve its objectives through a systematic and disciplined approach to evaluating and improving the effectiveness of risk management, control and governance processes. This definition is globally recognized and accepted, being published by the Institute of Internal Auditors (IIA), represented in Brazil by IIA Brasil.
External auditing assesses the risk of material distortion in a company's financial reports. Without a system of internal controls or an auditing system, a company would not be able to create reliable financial reports for internal or external purposes. Therefore, you would not be able to determine how to allocate your resources or know which of your segments or product lines are profitable and which are not. Furthermore, it would not be able to manage its affairs as it would not have the ability to count the status of its assets and liabilities and would become non-dependent on the market due to its inability to consistently produce its goods and services reliably. Consequently, an independent audit system is crucial in preventing debilitating misstatements in a company's records and reports.
Internal audit plays an important role for companies in preventing fraud. Regularly analyzing a company's operations and maintaining rigorous internal control systems can prevent and detect various forms of fraud and other accounting irregularities. Internal audit professionals assist in designing and modifying internal control systems with the aim of including, among other things, fraud prevention. An important part of prevention can be deterrence, and if a company is known to have an active and diligent auditing system, reputation alone can deter an employee or vendor from attempting a scheme to defraud the company.
The cost of capital is important for all companies, regardless of their size. The cost of capital is largely made up of the risk associated with an investment, and if an investment has more risk, an investor will require a higher rate of return for investing. Strong independent auditing can reduce several forms of risk in a company, including its information risk (the risk of material misstatement in financial reporting), the risk of fraud and misappropriation of assets, as well as the risk of suboptimal management due to insufficient information about its operations.
IMPORTANCE OF AUDITOR INDEPENDENCE
The main objective of an independent audit is to provide the company's shareholders with an expert and independent opinion as to whether the company's annual accounts reflect a true and fair view of the company's financial position. Independence is the primary means by which an auditor demonstrates that he can perform his task objectively.
The auditor must be independent of the client company, so that the audit opinion is not influenced by any relationship between them. The auditor is expected to give an impartial and honest professional opinion on the financial statements to shareholders. It can be argued that unless appropriate corporate governance measures are implemented, an independent audit may reach audit opinions and judgments that are heavily influenced by the desire to maintain good relations with the client company. If this happens, auditors can no longer be said to be independent and shareholders cannot trust their opinion.
Accounting firms sometimes charge audit fees set at lower amounts than the market rate and make up the shortfall by providing non-independent audit services, such as management consulting and tax advice. As a result, some audit firms also have commercial interests to protect. This raises concerns that the auditor's interests in protecting a company's shareholders and their business interests may conflict with each other.
The independent auditing profession has recognized the following threats to auditor independence, many of which are linked to the provision of non-audit services:
- Self-interest threat: when an auditor is financially dependent on the audit client or when an auditor or someone closely associated with the auditor has a financial or other interest in the audit client. The auditor also depends on the company's management to ensure his re-election as auditor.
- Familiarity threat: The relationship between the auditor and the client is long-standing or otherwise so familiar that the auditor becomes involved in advising the client or acting in a management role.
- Danger of self-assessment: a judgment is required from the auditor that requires the company's previous work (whether audited or unaudited) to be questioned or re-evaluated.
- The Confidence Threat: The auditor becomes too trusting of directors and managers, thereby preventing adequate testing of management information and representations.
- The threat of intimidation: the auditor is intimidated by real or potential pressure from the client or other party.
- The defense threat: the auditor becomes involved in promoting or defending the client's interests.
The need for independence arises because, in many cases, users of financial statements and other third parties do not have sufficient information or knowledge to understand what is contained in a company's annual accounts. Thus, they depend on the assessment of independent auditors. Public confidence in financial markets and the conduct of public interest entities depend in part on the credibility of auditors' opinions and reports in relation to financial auditing.
ASPECTS ABOUT THE OPINION OF THE INDEPENDENT FINANCIAL AUDIT
Financial auditing is usually carried out by firms of accountants and auditors, specialists in financial reporting. Financial auditing is one of many assurance functions offered by accounting and auditing firms. Many organizations hire internal auditors, who do not attest financial reports but focus primarily on the organization's internal controls. External auditors may choose limited dependence on the work of internal auditors. Independent auditing promotes transparency and accuracy in the financial disclosures made by an organization.
An independent audit is conducted to provide an opinion on whether the financial statements are stated in accordance with specified criteria. Typically, the criteria are international accounting standards, although independent auditors may perform audits of financial statements prepared using a cash basis or other basis of accounting appropriate to the organization. In providing an opinion on whether the financial statements are reasonably stated in accordance with accounting standards, the independent auditor gathers evidence to determine whether the statements contain material errors or other misstatements.
The independent audit opinion is intended to provide reasonable assurance, but not absolute assurance, that the financial statements are presented fairly, in all material respects, and/or give a true and fair view in accordance with the financial reporting framework.
The objective of an independent audit is to provide an objective examination of financial information, which increases the value and credibility of the financial statements produced by management, increasing users' confidence in the financial statement and reducing investor risk.
In accordance with Brazilian and international auditing standards, the independent auditor must disclose an opinion on the general financial statements in the auditor's report. The independent auditor can release three types of statements in addition to an unqualified/unmodified opinion.
A qualified opinion is that the financial statements are presented fairly in all material respects in accordance with Brazilian and international accounting standards, except for one material misstatement which, however, does not generally affect the user's ability to to trust the financial statements.
A qualified opinion provided by independent auditors may also be issued for a scope limitation that is of limited significance. Additionally, the auditor may instead issue a legal warning because there is insufficient adequate evidence to form an opinion or because of a lack of independence. In a disclaimer, the auditor explains the reasons for withholding an opinion and explicitly indicates that no opinion is expressed.
Finally, an adverse audit opinion is issued when the financial statements do not present reasonably and materially affect the overall financial statements. In an adverse auditor's report, the independent auditor must explain the nature and size of the misstatement and state the opinion that the financial statements do not comply with Brazilian and international accounting standards.
THE IMPORTANCE OF EXTERNAL AUDIT IN FRAUD DETECTION
External auditing, also known as independent auditing or accounting auditing, is seen as an extremely important service within companies, mainly because fraud is growing at the same speed as technology.
The object of the external audit (independent audit or accounting audit), which comprises the examination of assets elements, based on standards and procedures approved by regulatory bodies, has as one of its main functions to promote analysis of fraud.
Due to several factors, from the ease of document fraud to the lack of supervision, companies of all sizes are targets of some type of fraud every day. As the external audit investigates in depth and understands the facts that occurred, hiring an audit professional has become a common practice within company management.
Therefore, some experts in the field consider fraud detection to be one of the main objectives of an external audit process. In this context, the professional who will carry out the external audit needs to obtain various information to be sure of the opinions and conclusions that will emerge from their work. Basically, he will check the accounting records to confirm their veracity.
Through this process, the external audit, in addition to checking the company's accounts and financial records, also guarantees the correct accounting of assets. If fraud is discovered, it checks its size and suggests improvements in controls to prevent other frauds from occurring in the future.
Currently, the factors mentioned above are exposing public and private companies to the occurrence of fraud, which requires serious work from professionals in the area, making external auditing increasingly focus on detecting and preventing them.
The relationship between external and internal auditing is fundamental to ensuring the transparency, integrity and effectiveness of an organization's processes. While internal audit focuses on the assessment and ongoing monitoring of internal controls, risks and operational processes within the company, external audit is conducted by an independent entity, usually an external accounting firm, and aims to provide an impartial opinion on the company's financial statements. organization, ensuring its compliance with applicable accounting standards and regulations. These two forms of auditing are complementary, as internal auditing provides valuable information to improve internal processes and minimize risks, while external auditing provides credibility and confidence in financial information disclosed to external stakeholders, such as investors, creditors and regulatory bodies. Together, these audit practices play an essential role in promoting corporate governance and ensuring the organization's accountability to its internal and external environment.
Please contact TATICCA Allinial Global, which operates throughout Brazil and globally, with integrated services auditing, accounting, taxes, corporate finance, technology, risk advisory, business consultancy and training. For more information, visit www.taticca.com.br or email taticca@taticca.com.br and find out more. Our company has professionals with extensive experience in the market and has certified methodologies for carrying out activities.