All businesses must uphold transparency, accuracy, and efficiency in their financial operations. Two important processes that help ensure that these standards are met are internal and external audits. While both aim to review and verify a company's financial activities, they differ significantly in their purposes, processes, and impacts.
Internal audits focus on evaluating and improving the effectiveness of risk management, control, and governance processes. While external audits provide an objective assessment of a company's financial statements.
Understanding the differences between internal and external audits is crucial for businesses in Malaysia. Each type of audit offers its benefits and plays a big role in maintaining financial integrity and stakeholder confidence. By leveraging both internal and external audits, companies can better manage risks, improve their internal processes, and ensure compliance with regulatory requirements.
Understanding Internal Audits
Definition and Purpose
An internal audit is a continual process conducted by a company's staff to assess and improve the effectiveness of risk management, control, and governance processes. It is designed to identify internal issues before they become external problems and provide solutions to enhance operational efficiencies.
Internal auditing is a key function within any organisation, designed to add value and enhance operations. The Institute of Internal Auditors (IIA) defines internal auditing as "an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations." This means that internal auditors work within the company, but independently from the departments they audit, to ensure they can provide unbiased evaluations.
The main purpose of internal auditing is to help your organisation achieve its goals. This is done by bringing a systematic and disciplined approach to assessing and improving the effectiveness of risk management, control, and governance processes. By identifying weaknesses in your organisation and suggesting improvements, internal auditors help management ensure that operations run efficiently and effectively.
Internal auditing is practised globally, both in the public and private sectors. Like in other parts of the world, the role of internal auditing in Malaysia is shaped by local factors such as laws, customs and governance practices, making it a dynamic and essential part of the corporate scene.
By regularly examining financial records, operational processes, and compliance with regulations, internal auditors provide ongoing feedback that helps prevent problems before they become significant issues. This proactive approach supports continuous improvement and helps organisations stay on track towards achieving their objectives.
Benefits for Business Owners
Internal auditing provides valuable benefits that increase operational efficiency and help your business thrive.
Credibility with Stakeholders: A positive external audit report can enhance the business's credibility with stakeholders, including investors, banks, and other financial partners.
Compliance Assurance: External audits help ensure that the business meets legal and fiscal responsibilities, reducing the risk of legal penalties.
Third-Party Insights: External auditors may provide impartial insights into the business’s financial practices, potentially highlighting areas for improvement that internal audits might overlook.
Exploring External Audits
Definition and Purpose
External audits are conducted by independent auditors not affiliated with the company. Their primary purpose is to provide an unbiased examination of the financial statements, ensuring they are free from material misstatement and compliant with statutory requirements.
External auditing ensures the accuracy and reliability of a company's financial statements. Malaysia’s National Audit Department oversees this function in the public sector, guided by the Federal Constitution and the Audit Act 1957.
External auditors are accountable to Parliament and other regulatory bodies, ensuring public accountability. Their evaluations help stakeholders trust the company's financial health and integrity. By confirming the accuracy of financial reports, external audits maintain transparency and confidence in the business environment.
Benefits for Business Owners
As with internal audits, external audit also brings a lot of benefits to business owners like you for operational efficiency and managerial improvements.
Credibility with Stakeholders: A positive external audit report can enhance the business's credibility with stakeholders, including investors, banks, and other financial partners.
Compliance Assurance: External audits help ensure that the business meets legal and fiscal responsibilities, reducing the risk of legal penalties.
Third-Party Insights: External auditors may provide impartial insights into the business’s financial practices, potentially highlighting areas for improvement that internal audits might overlook.
Example of an Audit Report
An audit report involves reviewing the company's financial processes to ensure accuracy and compliance. Be it an internal or external report, the format of writing is pretty much the same.
Audit reports usually include examining transaction records, assessing internal reporting, and identifying areas for improvement to improve efficiency and reduce risks.
The Malaysian Institute of Certified Public Accountants has prepared an example of auditor’s report for the public’s reference. You can read the whole document here.
Let’s take the example of a company with no subsidiaries’ audit report to further understand what internal reporting looks like for companies in Malaysia.
The first part of the document starts with a report on the company’s financial statements that includes the director and auditor’s responsibilities. Followed by the opinion of the auditor on the assessed information as shown below.
The second part of the document contains the report on other legal and regulatory requirements and other matters that are worth mentioning.
Key Differences
While both types of audits are crucial, they serve different purposes and offer unique benefits:
Scope: Internal audits focus on operational and strategic management, whereas external audits concentrate on financial accounts and compliance with legal requirements.
Objective: Internal audits aim to improve the business internally, whereas external audits strive to validate the financial statements to externals.
Periodicity: Internal audits are usually conducted throughout the year, while external audits are annual.
Internal and external audits both serve different purposes and report to different authorities.
In the public sector, external audits are conducted by the National Audit Department, led by the Auditor General, whose authority comes from the Federal Constitution and the Audit Act 1957. These auditors are independent and report to Parliament. This is for public accountability.
Internal audits, however, are part of the organization's management control system. Our accountants at Douglas Loh are equipped with the skills and knowledge to help with our organisation's needs.
They are overseen by the head of that particular organisation, and internal auditors report directly to this head. Internal audits focus on improving internal controls, risk management, and governance processes to help the organization meet its objectives.
We have put the key differences of internal and external audits in the table below:
Feature | Internal Audit | External Audit |
Purpose | To reassure an organization’s management and stakeholders that its operations are running smoothly, and efficiently, and comply with all laws and regulations | To give an unbiased opinion on whether the organisation’s financial statements are accurate and follow accepted accounting standards |
Scope | Wide - covers all aspects of an organisation’s operation | Narrow - covers only the organisation’s financial statement |
Frequency | Throughout the year | Once a year |
Reporting | Organisation’s senior management | Parliament, shareholders and stakeholders |
Independence | Independent within organisation | Independent of the organisation |
Cost | Borne by organisation | Borne by organisation’s shareholders |
Conclusion
Both internal and external audits are essential for businesses in Malaysia. They help meet compliance, enhance operational efficiency, and instil confidence among external stakeholders regarding the reliability and soundness of business operations.
By understanding and leveraging the strengths of both auditing processes, business owners in Malaysia can significantly improve their organisation’s profitability, sustainability, and reputation.
Book a free consultation call with us and we’ll sort out your audit needs. At Douglas Loh, we will approach auditing with a deep understanding of your business, your industry and of the latest regulatory standards.
FAQs
What is the difference between internal and external audits in ACCA?
In ACCA, internal and external audits are different in their purpose and focus. Internal audits check and improve all parts of an organisation's operations, including both financial and non-financial areas. They report to management to help the organisation run better.
External audits, on the other hand, focus on making sure the financial statements are accurate and follow the rules. These auditors are independent and report to shareholders or regulatory bodies such as Parliament to ensure that the financial information is reliable.
Who performs an external audit?
External auditing is performed by independent auditors who are not affiliated with the company.
In the public sector of Malaysia, the external audit function is specifically carried out by the National Audit Department, led by the Auditor General, whose authority is established by the Federal Constitution and the Audit Act 1957. These external auditors report to Parliament to ensure public accountability.
Who requires an external audit?
External audits are typically required by various entities to ensure the accuracy and reliability of financial statements. These entities include:
Publicly Listed Companies: Companies that are publicly traded are generally required to undergo external audits to ensure transparency and protect investors.
Large Private Companies: Certain large private companies may be required by law to have external audits.
Government Agencies: Public sector organisations often require external audits to ensure public accountability and compliance with laws and regulations.
Financial Institutions: Banks, insurance companies, and other financial institutions often need external audits to comply with regulatory requirements.
Non-Profit Organizations: Many non-profits are required to have external audits to ensure proper use of funds and maintain donor confidence.
Regulatory Bodies: Regulatory authorities may mandate external audits for businesses within specific industries to ensure compliance with industry standards and regulations.
Investors and Stakeholders: Companies seeking investment or those with significant external stakeholders may be required to provide audited financial statements to demonstrate financial health and reliability.
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