An external auditor performs an
audit
An audit is an "independent examination of financial information of any entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to express an opinion thereon.” Auditing ...
, in accordance with specific laws or rules, of the
financial statements
Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity.
Relevant financial information is presented in a structured manner and in a form which is easy to un ...
of a
company
A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members share a common p ...
,
government
A government is the system or group of people governing an organized community, generally a state.
In the case of its broad associative definition, government normally consists of legislature, executive, and judiciary. Government is a ...
entity, other
legal entity
In law, a legal person is any person or 'thing' (less ambiguously, any legal entity) that can do the things a human person is usually able to do in law – such as enter into contracts, sue and be sued, own property, and so on. The reason for ...
, or
organization
An organization or organisation (Commonwealth English; see spelling differences), is an entity—such as a company, an institution, or an association—comprising one or more people and having a particular purpose.
The word is derived from ...
, and is independent of the entity being audited. Users of these entities' financial information, such as investors, government agencies, and the general public, rely on the external auditor to present an unbiased and independent
audit report
An auditor's report is a formal opinion, or disclaimer thereof, issued by either an internal auditor or an independent external auditor as a result of an internal or external audit, as an assurance service in order for the user to make decisions ...
.
The manner of appointment, the qualifications, and the format of reporting by an external auditor are defined by statute, which varies according to jurisdiction. External auditors must be members of one of the recognised professional accountancy bodies. External auditors normally address their reports to the shareholders of a corporation. In the United States,
certified public accountant
Certified Public Accountant (CPA) is the title of qualified accountants in numerous countries in the English-speaking world. It is generally equivalent to the title of chartered accountant in other English-speaking countries. In the United Sta ...
s are the only authorized non-governmental external auditors who may perform audits and attestations on an entity's financial statements and provide reports on such audits for public review. In the
UK,
Canada
Canada is a country in North America. Its ten provinces and three territories extend from the Atlantic Ocean to the Pacific Ocean and northward into the Arctic Ocean, covering over , making it the world's second-largest country by tot ...
and other
Commonwealth
A commonwealth is a traditional English term for a political community founded for the common good. Historically, it has been synonymous with "republic". The noun "commonwealth", meaning "public welfare, general good or advantage", dates from the ...
nations
Chartered Accountants an
Certified General Accountantshave served in that role.
For
public companies
A public company is a company whose ownership is organized via shares of stock which are intended to be freely traded on a stock exchange or in over-the-counter markets. A public (publicly traded) company can be listed on a stock exchange (list ...
listed on stock exchanges in the
United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...
, the
Sarbanes-Oxley Act (SOX) has imposed stringent requirements on external auditors in their evaluation of internal controls and financial reporting. In many countries external auditors of
nationalized
Nationalization (nationalisation in British English) is the process of transforming privately-owned assets into public assets by bringing them under the public ownership of a national government or state. Nationalization usually refers to p ...
commercial entities are appointed by an independent government body such as the Comptroller and Auditor General. Securities and Exchange Commissions may also impose specific requirements and roles on external auditors, including strict rules to establish independence.
Organization & services
In some countries,
audit firms
An audit is an "independent examination of financial information of any entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to express an opinion thereon.” Auditing ...
may be organized as LLCs or corporate entities. The organization of audit firms has been a subject of debate in recent years on account of liability issues. For example, there are rules in EU member states that more than 75% of the members of an audit firm must be qualified auditors. In India, audit firms can only be partnerships of qualified members of
The Institute of Chartered Accountants of India
The Institute of Chartered Accountants of India (ICAI) is India's largest professional accounting body under the administrative control of Ministry of Corporate Affairs, Government of India. It was established on 1 July 1949 as a statutory ...
.
In the USA, the external auditor also performs reviews of financial statements and compilation. In review auditors are generally required to
tick and tie numbers to general ledger and make inquiries of management. In compilation auditors are required to take a look at financial statement to make sure they are free of obvious misstatements and errors. An external auditor may perform a full-scope financial statement audit, a balance-sheet-only audit, an attestation of internal controls over financial reporting, or other agreed-upon external audit procedures.
External auditors also undertake management consulting assignments. Under statute, an external auditor can be prohibited from providing certain services to the entity they audit. This is primarily to ensure that conflicts of interest do not arise. The independence of external auditors is crucial to a correct and thorough appraisal of an entity's financial controls and statements. Any relationship between the external auditors and the entity, other than retention for the audit itself, must be disclosed in the external auditor's reports. These rules also prohibit the auditor from owning a stake in public clients and severely limits the types of non-audit services they can provide.
The primary role of external auditors is to express an opinion on whether an entity's financial statements are free of material misstatements.
Difference from internal auditor
Internal auditors who are members of a professional organization would be subject to the same code of ethics and professional code of conduct as applicable to external auditors. They differ, however, primarily in their relationship to the entities they audit. Internal auditors, though generally independent of the activities they audit, are part of the organization they audit, and report to management. Typically, internal auditors are employees of the entity, though in some cases the function may be outsourced. The internal auditor's primary responsibility is appraising an entity's risk management strategy and practices, management (including IT) control frameworks and governance processes. They are also responsible for the internal control procedures of an organization and the prevention of fraud.
Internal and External Audits; Comptrollers Handbook
Detection of fraud
If an external auditor detects fraud, it is their responsibility to bring it to the management's attention and consider withdrawing from the engagement if management does not take appropriate actions. Normally, external auditors review the entity's information technology
Information technology (IT) is the use of computers to create, process, store, retrieve, and exchange all kinds of data . and information. IT forms part of information and communications technology (ICT). An information technology system (I ...
control procedures when assessing its overall internal controls. They must also investigate any material issues raised by inquiries from professional or regulatory
Regulation is the management of complex systems according to a set of rules and trends. In systems theory, these types of rules exist in various fields of biology and society, but the term has slightly different meanings according to context. For ...
authorities, such as the local taxing authority.
External Auditors' Liability to Third Parties
Auditors may be liable to 3rd parties who are damaged by making decisions based on information in audited reports. This risk of auditors' liability to third parties is limited by the doctrine of privity
Privity is the legal term for a close, mutual, or successive relationship to the same right of property or the power to enforce a promise or warranty. It is an important concept in contract law.
Contract law
{{main article, Privity of contract
The ...
. An investor or creditor, for instance, can not generally sue an auditor for giving a favorable opinion, even if that opinion was knowingly given in error.
The extent of liability to 3rd parties is established (in general) by 3 accepted standards: Ultramares, restatement, and foreseeability.
Under the Ultramares doctrine, auditors are only liable to 3rd parties who are specifically named. The Restatement Standard opens up their liability to named "classes" of individuals. The foreseeability standard puts accountants at the most risk of liability, by allowing anyone who might be reasonably foreseen to rely on an auditor's reports to sue for damages sustained by relying on material information.
While the Ultramares doctrine is the majority rule, (to the relief of many new and budding accountants pursuing an auditing career!) the restatement standard is preferred in several states and is growing in popularity. The foreseeability standard will not likely be widely adopted anytime soon because the cost (time and financial) of litigation would be enormous.
CFOs, company accountants, and other employees are not provided the same luxuries of the doctrine of privity. Their material actions and statements open them (and their companies) up to liability from third parties damaged by relying on these statements.
See also
* Audit
An audit is an "independent examination of financial information of any entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to express an opinion thereon.” Auditing ...
* Auditor's report
An auditor's report is a formal opinion, or disclaimer thereof, issued by either an internal auditor or an independent external auditor as a result of an internal or external audit, as an assurance service in order for the user to make decisions ...
* Attestation (disambiguation)
Attestation may refer to:
* Attestation clause, verification of a document
* Oath of Allegiance (United Kingdom)#Armed forces The date from which the service of a member of the armed forces begins is the date of ''attestation'', on which the oath ...
* Financial audit
A financial audit is conducted to provide an opinion whether "financial statements" (the information is verified to the extent of reasonable assurance granted) are stated in accordance with specified criteria. Normally, the criteria are internat ...
* Single Audit
In the United States, the Single Audit, Subpart F of the OMB Uniform Guidance, is a rigorous, organization-wide audit or examination of an entity that expends $750,000 or more of federal assistance (commonly known as federal funds, federal grants, ...
* Board of Audit (Japan)
The reviews government expenditures and submits an annual report to the Diet. Article 90 of the Constitution of Japan and the Board of Audit Act of 1947 give this body substantial independence from both cabinet and Diet control.
In 1968, it hos ...
* International Organization of Supreme Audit Institutions
The International Organization of Supreme Audit Institutions (INTOSAI) is an intergovernmental organization whose members are supreme audit institutions. Nearly every supreme audit institution in the world is a member of INTOSAI. Depending on t ...
References
External links
Typical organization standards for external auditors
Discussion of the Sarbanes-Oxley Act in relation to external auditors
{{DEFAULTSORT:External Auditor
Auditing
Financial reporting