External audit is a type of assurance service that provides an independent and objective assessment of the financial statements and internal controls over financial reporting and associate processes. The purpose of an external audit is to verify a company's conformance to accounting rules and regulations to ensure that the financial statements are presented without material errors. Public accounting firms, like the big four in the United States (Deloitte, PWC, E&Y, KPMG), as well as smaller regional and local firms, perform external audits. External audits must adhere to the Generally Accepted Auditing Standards (GAAS), which provide requirements and guidance for performance of external audits. These standards are set by national or international organizations, such as the American Institute of Certified Public Accountants (AICPA) in the United States. Auditing standards endure the quality and consistency of assurance engagements, which is important considering the various uses and audience of audit reports. The GAAS pertains to three key areas:
- General standards, which relate to auditor competencies, independence, and professional care.
- Standards of field work, which require that audits are appropriately planned and performed.
- Standards of reporting, which relate to audit report format, disclosures, and communication of audit conclusion (opinion).
There are several types of audit opinions issued by external auditors, as listed below:
- Unqualified opinion – “the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with generally accepted accounting principles.”
- Explanatory language added to the auditor's standard report – certain situations that do not affect the auditor's overall opinion may require additional explanations (explanatory language) in the report.
- Qualified opinion – “except for the effects of the matter(s) to which the qualification relates, the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with generally accepted accounting principles.”
- Adverse opinion – “the financial statements do not present fairly the financial position, results of operations, or cash flows of the entity in conformity with generally accepted accounting principles.”
- Disclaimer of opinion - the auditor does not express an opinion on the quality of the financial statements.
External audit requirements
Certain companies are subject to annual independent audit requirements for various reasons. Companies publicly traded on one of the U.S. stock markets under the Securities Exchange Act of 1934 are required by the U.S. Securities and Exchange Commission (SEC) to submit annual and quarterly audited financial statements. National banks in the United States are subject to regulatory audit requirements. The Federal Deposit Insurance Company (FDIC) requires in Part 363 that banks with total assets exceeding $500 million submit audited financial statements to the primary regulator within 90 days for public companies or 120 days for private companies from the fiscal year end.
- American Institute of Certified Public Accountants (1989). on Audited Financial Statements, AU Section 508. Independent Auditor's Report, 2153.
- American Institute of Certified Public Accountants (2001). Generally Accepted Auditing Standards, AU Section 150. Auditing Standards, 1599-1600.
- Federal Deposit Insurance Corporation (2018). 2000 – Rules and Regulations, Section 363.2 Annual reporting requirements, 1.
- U.S. Securities Exchange Commission (2018). Financial Reporting Manual. Topic 4, Independent Accountant's Involvement. Section 4200 Accountant's Reports, 1.
- American Institute of Certified Public Accountants (2001)
- American Institute of Certified Public Accountants (1989).
- U.S. Securities Exchange Commission (2018)
- Federal Deposit Insurance Corporation (2018)
Author: Urszula Szydłowska