External Auditor03/09/2022 1 By indiafreenotes
An external auditor performs an audit, in accordance with specific laws or rules, of the financial statements of a company, government entity, other legal entity, or organization, 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.
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 accountants 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 and other Commonwealth nations Chartered Accountants and Certified General Accountants have served in that role.
For public companies listed on stock exchanges in the United States, 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 commercial entities are appointed by an independent government body such as the Comptroller and Auditor General. Securities and Exchange Commission’s may also impose specific requirements and roles on external auditors, including strict rules to establish independence.
External auditors are appointed by corporate shareholders with the intent of carefully examining the validity of the organization’s financial records. Like internal auditors, external auditors will pore over accounting books, payroll, purchasing records, and other financial reports to spot red flags. Getting to know the organization and its operations comes first for audit planning. Then, it’s their job to determine whether the company is fairly following the Generally Accepted Accounting Principles (GAAP), according to the Financial Accounting Foundation. Finding financial misstatements due to error, fraud, or even embezzlement is what external auditors do. After performing their tests, external auditors prepare detailed, unbiased reports on corporate ethics for management executives.
The Difference between an External Auditor and Internal Auditor
Internal auditors are employees of a company, and so are not independent from it, as is the case with an external auditor. Further, internal auditors are more concerned with investigating whether processes are functioning properly, while external auditors are more concerned with whether an entity’s financial statements are fairly stated. In addition, internal auditors are more likely to obtain the Certified Internal Auditor designation, while external auditors obtain the Certified Public Accountant designation.
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 control procedures when assessing its overall internal controls. They must also investigate any material issues raised by inquiries from professional or regulatory 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. An investor or creditor, for instance, can not generally sue an auditor for giving a favourable 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.