What Is an External Audit?

An external audit is a review of the financial statements or reports of an entity, usually a government or business, by someone not affiliated with the company or agency. External audits play a major role in the financial oversight of businesses and governments because they are conducted by outside individuals and therefore provide an unbiased opinion. External audits are commonly performed at regular intervals by businesses, and are typically required yearly by law for governments.

Function

External audits are performed to verify that the financial statements of an entity are correctly presented. They do not involve an actual accounting of a business' or company's financial accounts, but rather external audits are an independent review of financial documents provided to the auditor.

For a private-sector business, an external audit will typically include a review of the company's quarterly or monthly financial reports as well as statements on revenues and expenditures to ensure they are correctly tabulated and reported.

For governments, an external audit will include a review of the budget, the allocation of funds and the actual expenses to ensure the budgeted revenues and expenses were correctly compiled and used.

Time Frame

External audits are typically conducted once a year at the end of the company's or government's fiscal year. They are performed after the entity's in-house bookkeepers prepare a year-end financial report, which is one of the documents verified in an external audit.

Companies and governments will typically issue quarterly financial reports throughout; however, these are usually by internal accountants and bookkeepers, and have not been externally reviewed for accuracy.

Significance

Because external audits are performed by third-party accountants, they represent an unbiased view of an entity's financial standing. For governments, this independent review will ensure taxpayers that budgeted funds are being appropriately spent and the revenues are not being under- or over-projected.

In the private sector, external audits are valuable to stockholders as they provide an independent assessment of the company's financial holdings and can be used to determine investment levels in the business.

Features

An external audit will feature a report outlining the auditor's findings. This will generally be a summary of the overall validity of the financial statements and documents as presented by the company or government.

Should the external auditor uncover discrepancies between the statements presented by the company and his findings, these will be noted in the report as well. The audit will often include financial suggestions for the entity as ways to improve its overall financial standing and accounting practices.

The more important feature of an external audit is the conclusion of the auditor. A favorable conclusion is unbiased evidence that the entity is reporting financial data correctly while a negative conclusion is a red flag for poor accounting practices.

Misconceptions

An external audit is not related to an inquiry conducted by the Internal Revenue Service. The role of an external auditor is not to investigate fraud or tax evasion, but rather to ensure the financial documents presented by a business are an accurate reflection of its financial standing.

External auditors are not employed by the IRS or any government agency. They are generally certified public accountants hired by the entity.