Basic Principles Governing an Audit

Auditing is a systematic and scientific procedure of inspection of

the financial statements of an organization. And like any scientific
procedures, the audit also has certain principles and rules that
govern it. These principles are the Standards of Auditing or the
Auditing and Assurance Standards (AAS). Let us now take a look
at some basic Basic Principles Governing an Audit

SA- 200 describes the nine basic principles that govern the procedure of
auditing. It lists out the roles and responsibilities of the auditor and his
general code of conduct during an audit. We will look into these
principles in brief.

principles governing an Audit.

1] Integrity, Independence and Objectivity

The auditor has to be honest while auditing, he cannot be favoring the

organization. He must remain objective throughout the whole process,
his integrity must not allow any malpractice.

Another important principle is independence. So the auditor cannot

have any interest in the organization he is auditing, which allows him to
be independent and impartial at all times.

2] Confidentiality

The auditor has access to a lot of sensitive financial information of the

organization. It is important that he respect the confidential nature of
such information and documents.
He cannot disclose any sensitive information to any third party unless it
is a requirement by law. And he must also be very careful with
documents, certificates etc. that the organization entrusts to him.

3] Skill & Competence 

The auditor must be experienced and trained in the procedures of

auditing, i.e. must be qualified as an auditor. And as a professional, he
must be up to date on recent changes, announcements, rules etc.

If necessary he can undergo training and workshops to stay up to date

with the recent auditing and accounting procedures. For example, after
GST was introduced, auditors had to update their knowledge.

4] Work Performed by Others

The scope of audit at times can be very vast. So an auditor has

employees, delegates and other people who work under him.

However, the auditor will continue to be fully responsible for the work
done by these people working for him. So the auditor must carefully
supervise and review such work and be reasonably sure of the accuracy
of such work.

5] Documentation

In most cases the auditor maintains an audit notebook, an audit plan and
auditing file. It is important the auditor keeps a record of important
documents with respect to his audit work, as it is evidence of the work
the auditor has done. And the client is inclined to these documents and
files if he wishes to inspect the work.

6] Planning
 An audit plan allows the auditor t plan out his work and enables him to
be more efficient and timely. Every audit plan is different as it has to be
customized according to the type of organization, the kind of business
they conduct, the scope of the audit, the efficiency of the internal
controls etc.

7] Audit Evidence

The auditor must collect enough evidence to support his final opinion.
This collection of such evidence is done by compliance and substantive
procedures. There are two sources of this evidence – internal and
external. Also, external sources of evidence are always more reliable.

8] Accounting Systems and Internal Controls

The auditor has to assure that the accounts of the organization are
accurate and represent a true and fair picture of the financial status of
the company. Also, the auditor must ensure that all material information
has been recorded in the accounts. Testing the internal controls system
is also important as it helps determine the same.

9] Audit Conclusions and Reporting

After the auditor collects all evidence he must now form his opinion on
the basis of the following criteria,

i. all relevant accounting standards were applied at all times

ii. financial statements are in compliance with all regulations and
statutory requirements
iii. all material information has been disclosed

Solved Question for You

Q: What is a clean audit report?

Ans: After the auditing procedure, the auditor must give his opinion via
an audit report. A clean audit report means the auditor is fully happy
with the accounts. He thinks they are a true and fair representation of
the financial status of the organization. The opposite of a clean report is
an adverse or qualified report or a disclaimer.

Audit Meaning
The word “audit” is a very generic word; it essentially means to
examine something thoroughly. But we will be learning about auditing
as it relates to accounting and the finance world. So audit meaning is the
thorough inspection of the books of accounts of the organization.

This involves the examination of vouchers and the verification of

various assets of the organization. And the person who carries out such
an audit is known as the auditor.

The International Federation of Accountants has given the following

definition of an audit, “audit is an independent inspection of the
financial information of any organization, whether profit-oriented or not
profit-oriented, irrespective of its legal form, status or size when such
examination is conducted with a view to express an opinion thereof”.

The one important thing to remember is that an audit is a close

inspection of the books of accounts, but it does not absolutely guarantee
error-free books. The auditor only expresses his opinion on the accuracy
of the books, he does not give his opinion on the financial status of the
company or predict its future.
If he is satisfied with the examination then he will state that the
financial accounts are true and fair, which means they are absent of any
material misstatement. But this is not an opinion about the financial
status of the company.

Features of an Audit
 Auditing is a systematic process. It is a logical and scientific
procedure to examine the accounts of an organization for their
accuracy. There are rules and procedures to follow.
 The audit is always done by an independent authority or a body of
persons with the necessary qualifications. They have to be
independent so their views and opinions can be totally unbiased.
 Once again, an audit is the examination of all the books of accounts
and financial information of the company. So it is essentially a
verification of the final accounts of the organization, i.e. the profit
and loss statement and the balance sheet at the end of the financial
year.
 Auditing is not only the review of the books of accounts but also
the internal systems and internal control of the organization.
 To conduct the audit we need the help of various sources of
information. This includes vouchers, documents, certificates,
questionnaires, explanations etc. He may scrutinize any other
documents he sees fit like Memorandum of Association, Articles of
Associations, vouchers, minute books, shareholders register etc.
 The auditor must completely satisfy himself with the accuracy and
authenticity of the financial statements. Only then can he give the
opinion that they are true and fair statements.

Solved Question for You

Q: What are the main types of functional audits?

Ans: The main types of functional audits are,

 Propriety Auditing
 Efficiency Auditing
 Operational Auditing
  Voucher Auditing
 Statutory Auditing
 Social Auditing
 Cost Auditing
Principle Aspects Covered by Auditing

It is very important to accurately determine the financial position of an

organization. This is why auditing is done to double check the accounts
system, and gain assurance of the accuracy of the financial statements
of an organization. Now, let us take an in-depth look o what is auditing
and the principle aspects covered by it.

What is Auditing?

Auditing, specifically financial auditing is the examination of a

business’s financial records to determine their accuracy and their
adherence to the accounting standards and other applicable rules.

In India, the ICAI (Institute of Chartered Accountants of India) has a list

of Standards of Auditing that lay out the rules, procedures, methods etc
about auditing, both internal and external. In all, there are 35 of these
Auditing and Assurance Standards (AAS) as of now.
Browse more Topics under Concept Of Auditing

 Meaning and Definitions of Auditing

 Basic Principles Governing an Audit
 Advantages and Limitations of Audit
 Investigation vs Auditing

Principle Aspects Covered by Auditing

1] Review of all Systems

The primary objective of any audit is the review of all systems and
procedures that relate to the accounting and financial processes. The
auditor must first understand the system and its functionality before he
started with the audit of the final statements of accounts. It will be the
base of the entire auditing exercise.

2] Review of the Internal Controls

The effectiveness of the organizations internal control system will

dictate the scope of the audit. If the internal controls of the company are
in place and very effective, then the auditor can rely on the system.
Then he need no go through the accounts very minutely.

However, if on the other hand the internal controls are not effective, the
auditor has to go through the accounts with a fine tooth comb. And as
per CARO 2003, it is compulsory for the auditor to review the internal
control system.

3] Arithmetical Accuracy
The auditor must also routinely check the accuracy of the books of
accounts. This includes checking the arithmetical accuracy of the books,
by ensuring the posting of the entries is perfect.

4] Accounting Principles

The auditor must ensure that proper distinction is made between the
capital and revenue transactions. All financial transactions must be
properly categorized as either revenue or capital transactions. The
auditor must also check the items of both income and expenditure for
their accuracy.

5] Verification of Assets

The auditor must physically verify all the assets of the company. So he
must check all the legal documents, certificates, official statements etc.
to analyses the ownership of all assets. The auditor will also have to
ensure no assets have been left out of the balance sheet either.

6] Verification of Liabilities

The auditor must also verify all the liabilities of the organization. Again
he will inspect all documents, letters, certificates etc. If necessary he can
ask third parties for confirmation as well.

7] Vouching

Ever financial transacting leaves a paper trail. The auditor has to

examine these supporting documents to check the existence and
accuracy of these transactions. This is known as vouching. For example
the organization has shown an electricity expense of 12,000/-. Then the
auditor must inspect the electricity bill to cross check this transaction.
8] Statutory Compliance

It is the duty of the auditor to check that the financial records of the
company are in compliance with all the laws, rules and regulations in
effect at any given time. So he must make sure that the accounts are in
compliance with the Companies Act 2003, Income Tax Act 1961 etc.

Solved Question for You

Q: If the company has a very strong internal control system, then ____
checking is necessary.

a. less
b. more
c. both
d. none of the above
Ans: The correct answer is A. If there is already a strong internal
controls system, then the auditor may rely on it and stringent checking
of accounts is unnecessary.

Advantages and Limitations of Auditing

Auditing is the process of inspecting the books of accounts to
authenticate their accuracy and reliability. It is an important process to
the company itself, the government, the investors, creditors, shareholder
etc. They all rely on audited accounts to make important decisions. Let
us now take a look at the advantages of auditing and the disadvantages
of auditing in some detail.

Advantages of Auditing
1] Assurance to the Owners/Investors

One of the biggest advantages of auditing is that it offers assurances to

the owners, investors, shareholders etc. The owners of the business will
be assured about the accuracy of their books of accounts.

They will be satisfied with the workings of their various departments

and the overall efficiency and profitability of their business operations.
It is the same case with investors, who will find assurance in the books
of accounts after auditing.

Browse more Topics under Concept Of Auditing

 Meaning and Definitions of Auditing

 Basic Principles Governing an Audit
 Principle aspects covered by auditing
 Investigation vs Auditing

2] Errors and Frauds

An error is something that is done without the intention to fraud the

company, it is an innocent mistake. Fraud, on the other hand, is
deliberate. During the process of auditing, both errors and frauds are
discovered. Auditing also helps prevent such errors and frauds. It
creates a fear of being detected.

So auditing helps us minimize the risks of errors and frauds in our

books of accounts but does not eliminate the risk entirely. There is
always the chance that the error may go unnoticed, and the fraud is very
cleverly hidden so may go undetected.
                                     Learn the difference between auditing
and investigation here. 

3] Independent Viewpoint

If the auditor is an external auditor, the business can get a second

opinion on their financial statements and their financial standing as
well.

An external auditor will closely inspect the books and be completely

true and fair in his opinion as he has no hidden agenda. If he says the
accounts are true and fair, it has a lot of weightage with the company
and the investors.

4] Moral Check

One of the other advantages of auditing is that the staff and the workers
of the company do not try to steal or defraud the company. They are
under constant scrutiny since they know that the accounts will be
audited. Any irregularities can be identified during such an audit, and
they will be caught eventually. This helps the staff in being honest and
responsible at all times.

5] Stakeholders Confidence

After auditing stakeholders like creditors, investors, banks, debenture

holders etc. can rely on the books of accounts with more confidence.
And so after auditing by an independent authority, the financial
statements have more credibility.

Limitations of Auditing
1] Cost Factor

A very thorough and detailed audit would be a costly affair. It is not

cost effective. So the auditor has to limit the scope of his audit and use
techniques like sampling and test checking.

2] Time Factor

Auditors generally work on a very specific timeline. Sometimes this is

due to statutory requirements. This means he has to audit a whole year’s
accounts in a few weeks. Hence insufficient time is one of the main
limitations of auditing.

3] Inconclusive Evidence

Generally, the audit evidence the auditor collects is persuasive in nature,

not conclusive in nature. So there is never cent percent conclusive
evidence in most cases while auditing.

This is one of the major limitations of auditing. There also a lot of use
of estimates in accounting. The auditor cannot measure or comment on
the exact accuracy of these estimates. He has to rely on his knowledge.

                                  Understand the Principle aspects covered by

Auditing here. 

Solved Question for You

Q: Auditing helps in securing loans from banks. True or False?

Ans:  This statement is in fact, true. Audited statements are a necessity

when availing loan or credit facilities from banks. The banks are more
assured about the financial position of the company and can sanction
loans accordingly.

Investigation vs Auditing
Auditing is the general check to verify the accuracy of the accounts. But
in certain cases, a more in-detail look is required into specific areas.
This is what we call an investigation which forms a part of forensic
accounting. So let us further study the concept and differences of
auditing and investigation.

Sometimes a business needs to find out all the facts behind a particular
situation or scenario, and thus conducts a thorough investigation into the
matter. When the issue is related to finance or accounting in any way,
we use forensic accounting process of investigation. It basically entails
a critical examination of the books of accounts.

For example let us say in the process of auditing, the company has
discovered the possibility of fraud. Then we will call a qualified
accountant to conduct an investigation.

He then will try and investigate the character of the fraud, the level of
breach, the amount of the loss, the source of the fraud etc. Then the
company can work on closing any loopholes for future security,

There are various methods to conduct an investigation. These include

many of the same techniques involved in auditing such as searching,
research, observations by the investigator, inquiries, inspections etc.

Browse more Topics under Concept Of Auditing

 Meaning and Definitions of Auditing

 Basic Principles Governing an Audit
 Principle aspects covered by auditing
 Advantages and Limitations of Audit

Differences between Auditing and Investigation

Often many people confuse the terms auditing and investigation and use
them interchangeably. However, they are two very distinct terms.
Learning about the points of differences between auditing and
investigation will help us understand both the concepts better.

 In auditing, we will inspect and audit the entire books of accounts

and subsequently write a report on it. In an investigation, however,
the focus is on the critical examination of a specific fact to learn the
whole truth about the matter.
 Another point of difference between auditing and investigation is
their nature. Auditing is more of a general and basic examination of
the accounts. An investigation, on the other hand, is more of in-depth
scrutiny. In fact, the investigation starts with a negative outlook, i.e.
they acutely look for frauds and errors.
 In most cases, auditing occurs annually, once a year. An
investigation is only done when a situation calls for it.
 The evidence is auditing is always persuasive in nature. But in an
investigation, the evidence must be conclusive and decisive. There
can be no doubt about its surety.
 In some cases, auditing is compulsory or mandatory according to
the law. This is known as a statutory audit and is done according to
the standards of auditing. It is performed by external auditors.
However, the investigation is never obligatory.
 As per the rules of the ICAI, only by qualified Chartered
Accountants can perform an audit. And in case of a company, the
appointment of the auditor can only be done by shareholders. But any
qualified accountant can perform an investigation. He must be an
expert in his field. Shareholders/management appoint the auditor.

Solved Question for You

Q: Is the scope of auditing and investigation the same? 

Ans: No, the scope of auditing and investigation is very different. The
scope of auditing is for the auditor to examine the financial accounts
and give his opinion on them. The scope of the investigation is to seek
answers and explanations for specific questions or problems.