T.

RAMA KRISHANA RAO (8839271225)

B.COM 3 YEAR ST

AUDITING
(Paper Code-1156)
UNIT 1
DETAILED NOTES ,

T.RAMA KRISHANA RAO

(8839271225)
 T.RAMA KRISHANA RAO (8839271225)

UNIT 1
Introduction : Meaning and objectives of auditing;
Types of audit; Internal audit.

Audit Process : Audit programme; Audit note books;

Working papers and evidences.

Definition of Auditing
 T.RAMA KRISHANA RAO (8839271225)

Auditing means an examination of the accounts books and the relative documentary
evidence by an independent qualified person in order to ascertain the accuracy of the figures
appearing therein.

R. K. Mautz, “Auditing is concerned with the verification of accounting data

determining the accuracy and reliability of accounting statements and reports.”

Montgomery, a leading American accountant and author, has defined auditing as, “a
systematic examination of the books and records of a business or other organization in order
to ascertain or verify and to report upon the facts regarding the financial operations and the
results thereof.”

Essential Features:

From the close study of the definitions given above, the essential features of an audit can be
elaborated as follows:

i. It is an analytical and systematic examination of the books of accounts and other records of a
business.
ii. It is done by an independent person or body of persons qualified for the job.
iii. Examination is done with the help of vouchers documents, information and explanations
received from the authorities.
iv. The examination of records may be made throughout the year or periodically.
v. The auditor may satisfy himself with the authenticity of financial accounts and ultimately
report that:
 The balance sheet exhibits a true and fair view of the state of affairs of the business;
 The profit and loss account reveals the true and fair view of the profit or loss for the
financial period; and
 The accounts have been prepared according to the provisions of law.

Objectives of Audit

With a significant change in the scope of auditing, the objectives have also been changed.
In the early period, the audit was conducted with the sole object of finding out frauds and errors
committed by those incharge of reporting the affairs of business. But now the object is to
ascertain whether the financial statements show the true and fair view of earning capacity and the
financial position of the business.

The object of audit can be classified as follows:

1. Main object
 Examination of accounts
 Confirmations of truth and fairness of financial statements
2. Subsidiary objects
 Detection and prevention of errors
i. Clerical errors
 Errors of omission
 Errors of commission
 Errors of duplication
 Compensating errors
ii. Errors of principle
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 Detection and prevention of frauds

 Misappropriation of cash
 Inflating payments
 Suppressing receipts
 Misappropriation of goods
 Manipulation of accounts
 Inflating profits
 Suppressing profits

Examination of Accounts

The primary object of an audit is the examination of books of accounts and other appropriate
records so that the financial statements will exhibit a true and fair view of the states of affairs of
the business. An auditor is not only concerned with the determination of arithmetical accuracy of
the books of accounts but he is also required to satisfy himself about their substantial accuracy.
In order to achieve this objective, he is required to:

.
Confirmation of truth and fairness of financial statements

The main objective of audit is to confirm whether the financial statements fairly represent
the actual financial position and the working results of a firm in accordance with section 227 of
the companies Act, 1956. The auditor has to conduct an independent judgement and opinion
about the regularity and reliability of accounting records and truth and fairness of financial
statements.

Subsidiary or Secondary objects of audit

A. Detection and prevention of errors

An error may be defined as an unintentional mis-statement in the books of accounts or records

made by employees of the concern. Unlike fraud, errors are generally committed innocently.
Some times errors which might appear as innocent are the results of the fraudulent manipulation.
Therefore, the auditor must pay serious attention towards the errors. Errors may be committed
either due to ignorance of the principles of recording the transactions or due to the negligence of
those responsible to maintain records. The following are the various kinds of errors.

Clerical errors:

A clerical error may be committed in the course of recording a transaction in the books of
original entry such as cash book. Purchase book or Sales book, posting a transaction to the ledger
or totaling or balancing of a ledger account. It may be further divided as follows:

a. Errors of omission: Such type of errors arise when a transaction is wholly or partly omitted from
being recorded in the books of accounts. In case the transaction is totally omitted, it will not affect the
trial balance and it is more difficult to detect. For example, omission to enter purchases in Purchase
book. It means both the debit and credit aspect of the transactions are omitted and the arithmetical
accuracy of the trial balance is not affected. On the other hand, if a transaction has been partially
recorded in the course of its posting to the ledger, the error can be easily detected as it is disclosed by
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the trial balance. For example; where a credit sale has been credited to the sales account but not
debited to debtor’s account, the trial balance will show excess credit by the amount of sale and the
error will be detected.
b. Error of commission: When incorrect entries are made in the books of accounts either wholly or
partly, the errors are known as errors of commission. Errors in casting, posting, balancing and carry
forward are included in errors of commission. The following are the few example of such errors
 Where a transaction has been incorrectly recorded in books of original entry either wholly or
partly;
 Where a truncation has been incorrectly posted to the ledger;
 Where ledger accounts are incorrectly totaled and balanced;
 Where an error is made in entering balances in the trial balance.
c. Errors of duplication: An error of duplication occurs when the same truncation is recorded twice in
the books of original entry and also posted twice in the ledger accounts. For example: sale amounting
` 5000 may be recorded twice in the sale account. This may so happen due to failure of the account
assistance to mark the invoices or vouchers once they have been recorded in books of original entry
and some times confusion caused by duplicate invoices and vouchers. As these errors would not be
disclosed by trial balance, auditor should check the vouchers carefully.
d. Compensating errors: When there are two or more errors which exactly counter balance or
compensate each other, they are referred to as compensating errors. Such errors are difficult to detect
as they do not affect the agreement of the trial balance. It may also be possible that both errors may
not affect the profit and loss account. These errors can only be detected by detail checking of the
books of accounts.

B. Detection and Prevention of Frauds

Fraud is a false representation which is made intentionally with some mischievous

objectives. Frauds are ore serious than innocent errors because of the intention to deceive or to
conceal the truth. Thus, detection and prevention of fraud is of great importance and constitute
the most important duty of an auditor. Frauds may be classified into three types.

Misappropriation of cash

Misappropriation of cash means embezzlement or defalcation or fraudulent application of

cash. In big business houses, where the owner has no direct control over the receipts and
payments of cash, the chance of misappropriation is more than small business. Misappropriation
of cash may be committed (a) by inflating payments, (b) by suppressing receipts:

i. Inflating payments: inflating payments may be made when purchase invoices are overcharged,
making payments against false vouchers, the totals of wage sheets manipulated by adding fictitious
names of workers etc.
ii. Suppression of receipts: Suppression of receipts may be done by
 Cash sale not being fully accounted for;
 Adjusting unauthorized rebates, allowances, discounts etc. in debtors’ account and
misappropriating amounts paid by them;
 Writing off as bad debts of those debtors’ balances against which cash has been received;
 Not accounting for miscellaneous receipts like sale of scrap, rent of quarters allotted to employee
for a temporary period etc.,
 Writing down asset value wholly, subsequently selling them and misappropriating the money;
 Misappropriating money received for the sale of goods on ‘sale or return basis’ or ‘VPP’ by
showing such goods as returned in the books;
 “Teeming and Lading Process” which means concealing of money received from one customer
and entering in his account the money received form another customers.
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Misappropriation of goods

Misappropriations of goods are easy in those businesses which produce or deal with
goods which are less bulky and of higher value. Such frauds may be committed by way of
recording purchases of larger quantities than are actually received, or entering sales of larger
quantities than are actually supplied and the balance is misappropriated for personal gain. Further
such types of frauds are also committed by persons who are responsible for keeping physical
custody of goods.

Manipulation of accounts

Such type of frauds are pre-determined and preplanned which are usually committed by
the top management. The accounts are so prepared that they present a picture of states of affairs
of the business which is not actual. As a result, profits may be inflated or suppressed. The object
of manipulation of accounts may be to avoid payment of taxes, mislead a prospective buyer,
getting higher amount of commission, securing more capital to attract shareholders and
prospective investors, giving a wrong notion of its financial position to intending competitors,
withholding the declaration of dividend etc.

 Inflating profits: Inflating profits may be done by way of proving less or no depreciation on the
business assets, over valuation of assets or under valuation of liabilities, showing revenue expenditure
as capital expenditure, omitting purchases and other items of expenses, taking into account past or
future years’ income as current years’, using secret reserves etc.
 Suppression of profits: Suppression of profits may be done by way of providing higher depreciation
charges than actual, under valuation of assets or over valuation of liabilities, transferring capital
expenditure to revenue expenditure, omitting sales and other items of income and taking into account
past or future years expenses as current year’s etc.
Manipulation of accounts may also take the shape of window dressing it makes the
presentation of financial statements more favourable than what is actual. Sometime, this is done
to collect money from debtors or to attract prospective investors. This need not necessarily be
fraudulent. What is important for auditor is that he should judge the intention behind such
window dressing.
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Advantages of an Audit

The following are the advantages accruing from an audit:

i. Audited accounts are more readily accepted as a correct and authentic record of the
transactions.
ii. Errors and frauds are detected and rectified in time.
iii. A regular audit would exercise a great moral influence on the client’s staff and thus prevent
frauds and errors. At the same time the staffs will also keep the books of accounts up-to-
date.
iv. An auditor possesses practical knowledge of business finance, contract laws, tax laws and
other financial and legal matters. He can always advise on these matters and this opinion
can be helpful to his clients.
v. An auditor acts as a trustee of the shareholders in the case of a joint stock company and
safeguards their financial interests. Shareholders are assured that the accounts have been
properly maintained and the directors and managers of the company have not taken any
undue advantage of their position and have conducted the company affairs in the interest of
the whole body of shareholders.
vi. Audited accounts arise considered more reliable for taxation purposes i.e., sales tax,
income tax and other taxes.
vii. Audited accounts are helpful in claiming reasonable compensation from the insurance
company in respect of loss by fire or burglary, etc.
viii. Audited accounts facilitate the settlement of accounts between the partners, at the time of
retirement or death or death of a partner.
ix. Comparison can be made between the accounts of the current year and other years.
x. Audited accounts can be very useful whenever it is desired to secure a loan; to obtain
extended credit, to admit a partner, to sell the business or to convert it into a company and
to absorb or amalgamate different business or to determine the purchase consideration for a
business and for the purposes of obtaining licenses from the government,
xi. As an appraisal function, audit reviews the existence and operations of various controls in
the organization and points out the weaknesses and inadequacies, in them.
Audit safeguards the interests of the owners, creditors, investors and workers. For
example, it is generally seen that the audited accounts are useful for settling trade dispute for
higher wages or for payment of bonus to the workers.

Nature of Auditing

i. An audit is a systematic examination of books, accounts, documents and vouchers of a

business with a view to determine the accuracy and reliability of accounting statements.
ii. It is to see the arithmetical accuracy of the books of accounts. It finds out whether the
transaction entered in the books of original entry are correct or not.
iii. The purpose of auditing lies in ascertaining whether the working results and financial
position as shown by the Profit and Loss Account and the Balance Sheet for a particular
period are truly determined and presented those responsible for their compilation.
iv. Auditing does not mean the preparation of accounts. It is the verification of accounts by an
independent person who examines and checks them and makes best use of the information
supplied to him.
v. The auditor is required to prove and establishes the authenticity of the transactions by
vouching all the relevant documentary evidence at his disposal.
 T.RAMA KRISHANA RAO (8839271225)

Thus auditing primarily involves testing the reliability, competency and adequacy of evidence
in support of monetary transaction of an organization.

Scope of Audit

The scope and dimensions of auditing greatly increased in the seventies. The evolution of
new concepts such as Tax Audit, Management Audit and Operations Audit further laid emphasis
on its adoption on a wider scale. The primary audit objective of detection of fraud now shifted to
the determination of the fairness and authenticity of reported financial position together with the
detection and prevention of errors and fraud. This vastly enhanced the scope of auditing.
Exhaustive rules and regulations were framed in all the countries of the world for conduct of
independent and professional audits.

An auditor certifies the correctness of the books of accounts and detects errors committed
by the clerks and accountants in the preparation of financial records. If this verification is not
conducted in a proper and satisfactory manner, the results would be wholly unreliable. There may
be various ways and reasons due to which the financial books may be incorrect and inaccurate.
The auditor should bring them to light and report them to the owners of the business.

The scope of audit is clear from the following duties of an auditor:

i. Checking the arithmetical accuracy of the accounts;

ii. Checking the books of accounts with the help of all the relevant, vouchers, invoices,
correspondence, minute books etc;
iii. Verifying the assets and liabilities shown in the Balance Sheet, and
iv. Reporting to the client on the basis of his findings.

Advantages to the Business

i. Care and Systems: Employees in charge of maintenance of books of accounts and other
records remain regular, careful and systematic in their work.
ii. Moral Check: Errors and frauds, if any, committed by employees of the business are
promptly detected. In any case, knowledge of an impending audit exercises a moral check
on the employees who may otherwise be tempted to commit defalcations and
embezzlements.
iii. Loans and Credit: Loans and credit may be obtained on the basis of audited accounts
which are regarded as reliable index to the state of affairs of the enterprise.
iv. Determination of Liability: Liability of the enterprise as to income-tax, wealth-tax, sales-
tax., can easily be determined on the basis of audited accounts as these are readily believed
by the tax authorities. The Income-tax Act contains a provision for holding tax audit.
v. Determination of Sale price: In case a running business is proposed to be sold, purchase
considerations can easily be determined on the basis of audited accounts.
vi. Settlement of higher wages and bonus: Audited statements of account provide a mutually
satisfactory basis for the resolution of disputes about higher wages and bonus payments to
workers.
vii. Determination of claims: In case of loss or damage to business property, audited accounts
facilitate the determination of claims against the insurers.
viii. Detection of weaknesses of control: Weaknesses of the existing system of internal check
and internal control may be detected so that remedial steps may soon be initiated.
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ix. Ascertaining maintenance of accounts: Audit is an easy means to ascertain whether the
undertaking is in fact maintaining the registers and books of account as required under the
law.
x. Suggestions of Improvements: The enterprise can benefit from the professional
competence and experience of the auditor who is always at hand to apprise the efficacy of
various control measures, and to suggest improvements therein.

Advantages to the owners

i. Sole Ownership: If the business is owned by a sole trader, he can rely well on the audited
accounts and on his accounts clerk who are responsible for the maintenance of accounts.
ii. Partnership firm: If the business is organized as partnership firm, its partners can utilize
the audited accounts to settle their disputes in regard to adjustment of capital and valuation
of goodwill at the time of admission, retirement and death of a partner.
iii. Joint stock Company: If the business is constituted as a joint stock company, its
shareholders who reside at places distant form the head office of the company relay on the
audited accounts and can be sure of their investment being sage with the company.
iv. Trusts and Cooperative: In case of trusts, cooperative societies etc, auditing serves as an
evidence for the beneficiaries, members etc. that their interests are being properly and
efficiently looked after.

Advantages to Management

i. Comparison of accounts: Audit enables comparison of accounts of different departments

from one period to another and the fluctuation if any, may be analyzed in detail.
ii. Help in decision making: Audited accounts are relied upon for the purposes of decision
making by the management.
iii. Advantages to others
iv. Banks: In case of banks, audited statements of a business serve as a reliable guide to make
decisions about loans to that business.
v. Insurance of companies: Insurance companies also rely on audited accounts to settle
claims in respect of damage or loss of business assets.
vi. Tax authorities: For determination of liability under Income-tax, sales tax, wealth tax etc.,
tax authorities unquestioningly accept the audited statements.
vii. Purchaser: The purchaser of a business can easily calculate the amount of purchase
consideration on the basis of audited final accounts.
viii. Court: The audited accounts of a business are readily accepted as evidence before the
court.
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Types And Conduct Of Audit

Audit may be of different types but the broad classification of audit is:

i. Classification on the basis of organizational structure of the business; and

ii. Classification as to the Conduct of Audit.
iii. On the basis of Functions and objective

Classification on the basis of organizational structure of business: The following are the
different types of audit under their category:

 Statutory Audit
 Private Audit
 Government Audit
 Internal Audit
On the basis of conduct

 Continuous Audit or Detailed Audit;

 Periodical Audit or final Audit;
 Interim Audit;
 Partial Audit;
 Balance Sheet Audit;
 Occasional Audit.
On the basis of functions and objective

 Cost audit
 Management audit
 Social audit
 Propriety audit
 Propriety audit
 Performance audit
 Efficiency audit
 Cash audit
 Special audit
 Joint audit
 System audit
 Operational audit

Statutory Audit:

Audit by independent qualified persons, which is compulsorily required by any Statute or

Law is called “Statutory Audit”. In these case the nature, scope and extent of audit, qualification,
appointment, rights, duties and liabilities of auditors are governed by the provisions of the
concerned laws. In India, the audit of the following institutions is compulsory according to their
respective statute.

1. Joint stock companies incorporated under the Companies Act, 1956 or any of the previous
Companies Act.
2. Banking companies governed by the Banking Companies Regulation Act, 1949.
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3. Insurance Companies governed by the Insurance Act, 1938

4. Co-operative Societies registered under the Co-operative Societies Act, 1912
5. Public and Charitable trust registered under the Indian trust Act, 1882
6. Local Authorities and Government Undertakings

Essential Features

1. It is compulsory by nature
2. The auditor must be an independent person.
3. He must be a qualified Chartered Accountant.
4. He is appointed according to the norms laid down by the Act.
5. The auditor is a trustee of the shareholders interest. So he is to submit his report to the
shareholders.
6. The statutory audit is always a complete and final audit. It can never be partial audit.

Private Audit or Voluntary Audit

Where audit of a business enterprise is not compulsory by law, and is voluntarily opted by
the proprietors due to several benefits, it is called private audit. In India, sole trading concerns,
partnership firms and joint Hindu Family businesses are not obliged under law to get their
financial accounts audited. but due to a recent amendment in the Income Tax Act audit by a
professional auditor has been made compulsory in case of an businesses whose gross turnover
exceeds Rs. 40 lakhs and all professional persons whose gross receipts exceed Rs. 10,00,000.

Essential features

1. In case of private audit, the nature and scope of audit is determined by the client.
2. The duties, liabilities and appointment of the auditor are made on the basis of agreement
with the client. Sometimes, the auditor is appointed only to prepare accounts and not to
audit them.
3. Such audits may not be regular and may not continue in future. It comes to an end when the
purpose is fulfilled.

Government Audit

Government audit may be categorized as :-

 Audit of government Departments

 Audit of Statutory Corporations and
 Audit of Government companies.
The government maintains a separate department known as Indian Audit and Accounts
Department whose main function is to audit the different departments and organizations of the
government. This department is headed by Comptroller and Auditor General (CAG) of India.
CAG is the guardian of Public Finance and he is to see that not even a paisa is spent without the
authority of parliament. He is responsible for auditing the accounts of Government of India and
those of the States. He is to ascertain whether money as shown in the accounts as having been
disbursed was legally available for and applicable to the purpose to which it has been applied.
The Comptroller and Auditor General has a headquarter organization in Delhi and there are
offices of Accountant General in each State.
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Internal Audit

Internal audit is a review of operations and records undertaken within a business by

specially assigned staff, it is a post-transition review to evaluate the correctness of records and
the effectiveness of operations on a continuous basis in an organization by the salaried staff.

The term internal audit has been defined as “the independent appraisal of activity within
an organization for the review of accounting, financial and other business practices as a
protective and constructive arm of management. It is a type of control which functions by
measuring and evaluating the effectiveness of other types of controls.”

Thus, internal audit is the examination of books of accounts which is conducted by the
salaried staffs of a business known as internal auditors the scope of the work of the internal
auditor is determined by the management. The objects of an internal auditor may be stated as
follows:

1. To study the adequacy of the existing control system.

2. To verify accuracy and integrity of financial accounting records and reports.
3. To ascertain the degree of compliance with pre-determined plans, policies and procedures.
4. To ascertain that the business assets are properly accounted for,
5. To confirm the true liability of business;
6. To prevent and detect errors and frauds;
7. To ascertain the authenticity of accounting data;
8. To make investigation to meet special requirements of management;
9. To analyze and improve the system of internal check;
10. To review the operation of internal control system and to bring material departures and non-
compliances to the notice of the appropriate level of management.

The following are the basic requirement of internal audit:

 Independent status,
 Freedom form executive function,
 Freedom for investigation,
 Clear understanding of assignment and
 Proper selection of audit staff.
It deals primarily with accounting and financial matters, but it may also properly deal
with matters of an operating nature.”
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Difference Between Internal Check and Internal Audit

BASIS FOR
INTERNAL CHECK INTERNAL AUDIT
COMPARISON

Meaning Internal Check is a system, wherein Internal Audit is the ongoing

division of work and allocation of critical examination of the
responsibilities are organized in such a financial and operational
manner that the work of one employee is activities of the concern, by an
spontaneously looked over by another. internal auditor.

Method Work of one person is automatically Work performed by the

checked by another person. employees is examined by a
separate group.

Commencement of Commences from the moment a transaction Once the transaction has been
Work is entered. recorded in the books.

Involved Accounting and clerical accuracy Effectiveness of management

evaluation of control

Performed by Existing staff A specially dedicated team of

auditors

Cost Involvement Economical Comparatively Expensive

Thrust of System Prevention of errors and frauds Detection of errors and frauds

Tool for Arrangement of the work Examination of the work

Time of Checking Checking is performed simultaneously Examination of the work takes

when the work is performed. place after the work is completed.

Report Summary of day to day transactions acts as Submits his/her report to the
a report to the supervisor. management.

Continuous Audit:

A continuous audit is one in which the external auditor’s staff is occupied in a detailed
examination of the books of accounts of the client the whole year round or at regular intervals
say weekly, monthly and quarterly. It is a system of audit in which the audit work is carried on
almost simultaneously with the recording of transactions.
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Continuous audit becomes imperatives in the following types of business:

i. Where it is desired that the audited final accounts should be ready immediately after the
close of the accounting period.
ii. Where business is very large and there are numerous transactions to be checked.
iii. Where there is no satisfactory and effective system of internal check in force.
iv. Where monthly final accounts are required.

Advantages of Continuous Audit

i. Errors and frauds are discovered quickly because the auditor’s staff attends the work at a
regular interval. Such errors and frauds can also be rectified at an early stage.
ii. The opportunities for fraud are reduced because of the frequent attendance of the auditor.
iii. The constant attendance of auditors will have the effect on the staff of the client to keep the
work up-to-date. This also acts as a valuable moral check on the client’s staff.
iv. As the auditor frequently visits the client’s office, he remains constantly in touch with the
technical details of the business. It helps him in performing his duties efficiently.
v. Where the directors of a company desire to declare an interim dividend, it will help them in
preparing interim accounts without much delay.
vi. Regular supervision of the auditor on the client’s affairs would bring about increased
efficiency and accuracy in the accounts of the business.

Disadvantages of Continuous Audit

i. Figures maybe altered either innocently or deliberately by the client’s staff after the auditor
has checked the books for a particular period.
ii. The auditor or his clerks are likely to loose the link of the work in some way or other and
will fail to clear up outstanding queries.
iii. If the size of the concern is small, a continuous audit may involve waste of time, effort and
money.
iv. The frequent attendance of the auditor’s staff may be inconvenient to the client and may
affect the efficiency of the client’s staff.

Periodical or Final or Annual Audit:

A system where the auditor takes up his work of checking the books of accounts and
other related documents, only at the end of the accounting period when the transactions for the
whole financial year are completely recorded, balance, the trial balance is drawn out and the final
accounts have been prepared, is known as periodical or final or annual audit. The auditor will
normally start routine checking of the books and other audit procedures only after the close of the
financial year. He would complete his audit work in one continuous session or without any
interval.

In other words, the auditor visits his client only once a year and goes on checking the
accounts and other related documents until the audit work for the whole of the period is
completed.
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The chief advantage of this audit is that it is not expensive and there is less danger of
fraudulent manipulation of the books after audit is completed. Its execution also involves less
organization on the part of the auditor. But, it lacks the advantages of continuous audit.

Difference between Final audit and Continuous audit

Continuous Audit Periodical Audit

i. It is conducted throughout the year. i. It is conducted at the end of the accounting
ii. It permits detailed checking of books of year.
accounts. ii. It does not permit detailed checking.
iii. It exercises moral influence on client’s staff. iii. No such moral pressure is exercised.
iv. There is no delay in presentation of final a/c iv. It involves delay in the preparation and
presentation of final accounts.
v. There is danger of alteration of figures. v. There is no such danger.
vi. It is more expensive.
vii.It facilitates preparation of interim accounts. vi. It is less expensive.
viii. There is early detection of errors and vii.It does not provide such facility.
frauds. viii. Early detection is not possible.
ix. The audit work becomes mechanical and boring. ix. It is not mechanical and boring.
x. It requires large audit staff. x. It does not require large audit staff.
xi. Frequent visit of auditor reduces the change of xi. There is no such chance.
errors and frauds.

Interim Audit

An audit which is conducted in between the two annual audits for some interim purpose is
called interim audit. For instance, to enable a company to declare an interim dividend or to get
the periodical data of the turn over or gross profit etc. This kind of audit involves a complete
checking of the accounts prepared by a company for a part of the accounting year. It is a kind of
audit which is done between the two balance sheet audits. The work of the final audit becomes
much easier if there has been an interim audit.

Continuous Audit Interim Audit

i. It is conducted throughout the year at certain i. It is conducted for a period which is up to
or uncertain intervals according to the a definite date according’ to the
convenience of the auditor. instruction of the client.
ii. Verification of assets and liabilities is done at ii. Verification of assets and liabilities is
the close of the year. done at the time of audit
iii. Trial balance is not prepared at intervals. iii. Trial balance must be prepared and
iv. Audit report is prepared at the close of the checked at the time of such audit.
financial year. iv. Audit report is prepared after the
v. It is costly. completion of interim audit.
vi. It facilitates detailed checking of transactions. v. It is less costly.
vii.Figures may be altered after they are vi. It does not permit detailed checking.
checked. vii.The scope for alteration of figures is less.
viii. It acts as a moral check on the staff of viii. No such check is there in interim
the client. audit
ix. Errors and frauds can be detected earlier and ix. Errors and frauds are discovered of the
steps can be taken in advance to prevent end of the period for which audit is
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their recurrence in future. undertaken. Hence remedial action is not

x. The object is not to know the profit or loss. possible.
x. The object is to find the profit or loss for
a given period.
Cost Audit

The term cost audit means an audit of cost records. The cost accountant is appointed to
check the cost accounting records in order to ascertain their accuracy and also to ensure that cost
accounting plan as laid down by the company is carried out.

According to the Institute of Cost and Work Accountants of England, ‘Cost Audit’ has
been defined as “the verification of the correctness of cost accounts and of the adherence to the
cost accounting plan.”

Smith and Day defined cost audit as, “the detailed checking of the costing systems,
techniques and accounts to verify their correctness and to ensure adherence to the objective of
cost accounting.”

From the above definitions, it would be clear that

 Cost audit examines the correctness of cost accounts, and

 It verifies the adherence of cost accounts to the cost accounting plan.

Objects of Cost Audit

1. To verify the correctness of cost accounting records.

2. To certify that the cost accounting principles applied in cost ascertainment and cost reporting.
3. To find out the adherence of cost accounts to the established systems and procedures.
4. To ascertain how far the cost accounting system is helpful for cost control and managerial
decision making.
5. To check the reconciliation of costing profit or loss with the financial profit or loss.
6. To reduce the volume of work of the external auditor, if the internal cost audits system is in
vogue.
7. To cast a moral check on the cost accounting staff for improvement of the system.
It is an audit of actual performances. It acts as an effective managerial tool for the
detection of errors, frauds, inconsistencies and irregularities in cost accounting records.

The Companies Act, 1956, empowers the central government to order an audit of cost
accounts in the case of specified companies. Cost audit is different from the financial audit as the
later is an examination of financial books and records in order to see whether or not the financial
statements represent a true and fair view of the state of affairs of the organization while the
former is the verification of cost accounts and a check on adherence to the cost accounting plans.

Types of Cost Audit:

1. Non-statutory: Non-statutory cost audits are those which are voluntarily conducted either for a
specific purpose or for a general purpose. Cost audit on behalf of customer’s cost audit by trade
associations, cost audit by labour tribunals falls on the specific purpose category on the other hand.
Cost audit done on behalf the management is under the general category
2. Statutory: Statutory cost audit is conducted according to the provisions of law as required by the
statute. Under the Companies (amendment) Act, 1965, two new amendments haves been added to the
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Companies Act, 1956 i.e., clause (d) to sub section (1) of section 209 and 233B of section 233 have
provided for the audit of cost account in certain cases. Section 209 (1)(d) of Companies (Amendment)
Act 1965 requires certain class of companies engaged in production, processing, manufacturing or
mining activities to keep at its registered office books of accounts with respect to such particulars
relation to utilization of material or labour or to other items of cost as may be prescribed, if such class
of companies is required by the Central Government to include such particulars in the books of
account. The Central Government has from time to time brought different industries under the
purview of this clause and also empower to frame cost accounting records rules application to the
respective industry.
According to section 233B of the Companies Act, the Central government is empowered to order
cost audit to be conducted in nay company required to maintain cost accounting records as per the
rules under the provision of section 209(1)(d).

Management Audit

The term management audit is a new concept in the sphere of auditing. As its name
signifies, management audit means the audit of management processes and functions.

According to W.P. Leonard “The management audit may be defined s a comprehensive

and constructive examinations of an organizational structure of a company, instituting or
branch of government, or of any component thereof, such as a division or department, and its
plan and objectives, its means of operation and use of human and physical facilities.”

Features of the Management audit:

i. It makes a review and appraisal of entire organization or a part there-of;

ii. It involves the checking of operations of management.
iii. The appraisal or checking should be based on commonly accepted professional standards.
iv. The study is to be carried on independently by experts.
v. It involves a detail study or plans, policies, practices, systems and procedures and
management control.
vi. The objective of such study is to see whether operations of management are being carried
on in accordance with plan etc, or not.
vii. Find out the weakness and make suggestions and recommendations for improvement of
management performance.
Thus the auditor examines the policies and the actions of the management to ensure that
there is proper and maximum utilization of the available resources.
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AUDIT PROCESS : AUDIT PROGRAMME; AUDIT

NOTE BOOKS; WORKING PAPERS AND
EVIDENCES

Audit Programme

Programme means a plan of action. An audit programme is a written scheme prepared by the
auditor to distribute work to be followed during audit.

According to Prof. Meigs, “An audit programme is a detailed plan of the auditing work
to be performed, specifying the procedures to be followed in verification of each item in the
financial statements and giving the estimated time required.”

The preparation of audit programme involves mainly three things:

 How much work is to be done?

 Who is going to do a particular portion of the work?
 What is the duration of time by which the work is to be finished?

Objects of an Audit Programme:

i. To ensure that no part of routine checking and verification has been omitted;
ii. To provide the assistants with clear instructions as to what and how much work they have to
do and also to fix the extent of checking so that unnecessary time is not lost.
iii. To get the audit work conducted by several assistants by allocating the different portions of
work to them.
iv. To identify the assistants responsible for each section of the work and then to fix the
responsibilities for any errors.
v. To enable the chef auditor to exercise proper control over the whole of his business by
having full knowledge about the progress of various audits.
vi. To serve as an evidence of the extent of checking carried out and work performed.
vii. To serve as a guide in succeeding years and a basis for future planning.
viii.To complete the audit work in time.
ix. To evaluate the cost of audit.

Types of Audit Programme

Audit programmes may be classified as:

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 Fixed, pre-determined or standardized; and

 Flexible, progressive or special.

i. Fixed audit programme contains general or standardized instructions and procedures to be

followed while conducting audit. Since it incorporates all edit procedures irrespective of their
applicability, the auditor is required to edit the applicable procedures for individual members
of the audit staff as they proceed with their work. Though fixed audit programme is the
product of organized thinking, the main disadvantage is that it lays down a rigid frame work
which is not suitable in case of enterprises where conditions may vary from year to year.

ii. A flexible audit programme only outlines the general scope, character and limitations of the
audit engagement. It gives much discretion to the auditor in developing and adapting it with
the progress of the audit work. But the main draw back is that it may overlook certain
important audit procedures in conducting the examination.

Advantages of Conducting an Audit According to a Pre-determined Audit Programme

i. It provides audit assistants with a set of clear instructions about their duties. The audit
assistants will be careful in the performance of their duties. It promotes the division of
work over the audit staff in a well organized manner.
ii. It enables the auditor to keep constantly in touch with the work done and the general
progress of the audit.
iii. It is possible to fix the responsibility on the audit assistants as regards items of checking
carried on by them; if subsequently it transpires that their checking has been inadequate.
This stops scamping.
iv. It serves as a valuable evidence (as regards the extent of checking and other functions
performed in relation to an audit) if at any time thereafter an action is brought against the
auditor alleging negligence in the performance of his duties. He can produce the audit
programme in defense as a proof of his having carried on the work with reasonable skill
and care.
v. It serves as a guide for audit to be carried out by the auditor in the succeeding years.
vi. It provides a check against the possibility of certain important items requiring verification
being omitted, and thereby ensures that the audit shall proceed in a systematic manner.
vii. It provides for systematic audits routine and thus eliminates inefficiency and saves time.
viii. Last but not the least the auditor is saved from the botheration of issuing instructions to his
senior and junior staff time and again.
ix. It assures adherence to the principles of auditing and accounting.

Disadvantages of Audit Programme

i. The work may become too mechanical. An efficient audit assistant cannot show his
intelligences and also losses his initiative because he has to follow the directions as given
in the predetermined audit programme. Thus inefficiency increases and the incentive to
work is taken away.
ii. Sometimes work may be hurried in order to complete it within the required schedule.
iii. A rigid and inflexible programme cannot be laid down for each type of business because
each business may have different problems and procedures.
iv. The audit programme may be followed mechanically year after year through the business
may change in its operation or conduct.
v. Inefficient audit assistants may take shelter behind the programme.
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Audit Note Book

Meaning

Audit Note Book is a register maintained by the audit staff to record important points observed,
errors, doubtful queries, explanations and clarifications to be received from the clients. It also
contains definite information regarding the day-to-day work performed by the audit clerks. In
short, audit note book is usually a bound note book in which a large variety of matters observed
during the course of audit are recorded. The note book should be maintained clearly, completely
and systematically. It serves as authentic evidence in support of work done to protect the auditor
against any legal charge initiated against him for negligence. It is of immense help to the auditor
in preparing audit report. It also acts as a valuable guide for conducting audit for future years.

Contents of Audit Note Book

The following matters should have been incorporated in an Audit Note Book.

 A list of the account books normally used and maintained.

 Names of the principal officers, their duties and responsibilities.
 Nature of business carried on and important documents relating to the constitution of
business like
 Memorandum of Association, Articles of Association, Partnership deed etc.,
 Extracts of minutes and contracts affecting the accounts.
 Extracts of correspondence with statutory authorities.
 Copy of audit programme.
 Accounting methods, internal control and internal check system in operation.
 Routine queries like missing receipts and vouchers etc.
 Details of errors and frauds discovered during the course of audit.
 Points to be included in audit report.
 Details of all important information to be used as reference for future audits.
 Date of commencement and completion of audit.

Advantages of Audit Note Book

1. Facilitates Audit Work: It facilitates the work of an auditor as all important details about the
audit are recorded in the note book which the audit clerk cannot remember everything at all the
time. It helps in remembering and recalling the important matters relating to the audit work.

2. Preparation of Audit Report: Audit note book helps in providing required data for preparing
the audit report. An auditor examines the audit note book before preparing and finalizing the
audit report.

3. Serves as Documentary Evidence: Audit note book serves as a documentary evidence in the
court of law when a suit is filed against the auditor for his negligence.
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4. Serves as a Guide: When a audit assistant is changed before the completion of audit work,
audit note book serves as a guide in completion of balance work. It also acts as a guide for
carrying on subsequent audits.

5. Evaluating Work of Audit Staff: It helps to assess the work performed by the audit staff and
helps in evaluating their level of efficiency.

Disadvantages of Audit Note Book

1. Fault-finding Attitude: It leads to development of a fault-finding attitude in the minds of the

staff.
2. Misunderstanding: Very often maintenance of audit note book creates misunderstanding
between the client’s staff and the audit staff.
3. Improper Preparation: Since it serves as evidence in the court of law, it needs to be prepared
with great caution. When the note book is prepared without due care it cannot be used as
evidence against the auditor for negligence.
4. Adverse Effects on Subsequent Audits: Since audit note book is used in performing
subsequent audits, any mistakes in the note book may have adverse impacts on the next audit.
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Audit Working Papers

Audit working papers are those papers which contain essential facts about accounts which
are under audit. “The term designates the file of analyses, summarizes, comments, and
correspondence built up by him (auditor) during the course of the field work of an audit
engagement.” It is the duty of an auditor to maintain his working papers as they support the audit
report.

Purpose of Working Papers

The purposes served by working papers are:

i. They show the extent to which accounting principles and auditing standards have been
adhered to;
ii. They provide essential support for the auditor’s opinion including evidence that the
examination was conducted in accordance with generally accepted auditing standard;
iii. They also reveal how the work was performed by the audit staff and thus helps the auditor
in forming an opinion about their efficiency;
iv. They assist the auditor in justifying his opposition against criticism and can be used as an
evidence if a legal action is brought against the auditor alleging negligence in the
performance of his duties;
v. They help the auditor in finalizing his audit report without much delay;
vi. They enable the auditor to know the weakness of the internal check system in operation,
and the inefficiency of the accounting system, if any. He may advice his client the ways
and means to improve these inefficiencies;
vii. These working papers serve as guide to the auditor for audits of the same client in the
succeeding years.
Working papers should be carefully prepared as they are the basis of conclusions and
summarizations shown by the auditor in his report. As such they should be clear, complete and
contain all essential information in regard to accounts and audit so that they may be of maximum
utility. Each completed work paper should be signed and dated by the persons performing the
work. This will help in fixing responsibilities. They should be properly organized and arranged
so that one may not find difficulty in pinpointing a particular matter. It has been rightly said that
“An auditor is often judged – and quite properly so – by the character of the working paper
prepared by him or under his direction.”

Working papers are of a confidential nature, therefore, the information collected by the
auditor or his staff should not be divulged.

Preservation and Filing of Working Papers

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It is necessary that the working papers should be preserved as they are important and
invaluable documents for the clients as well as for the auditor. It is therefore suggested that they
should be filled systematically, and kept in an orderly fashion at all times. They must be
preserved by a responsible officer for a reasonable time .for convenience; the working papers
may be sub-divided between current and permanent files.

Permanent Files:

These files usually contain the following information:

i. History of the company, the nature of its products, places of business, etc;
ii. Constitution and important documents lime Memorandum of association, Articles of
Association, Partnership Deep, Trust Deed, etc;
iii. Copy of appointment letter together with the terms and conditions of appointment, specially
the limitations imposed on the audit work.
iv. Details of accounting policies and the system of internal check in force;
v. Copies of previous audited final accounts along with audit notes.
vi. Organization charts, workflow charts, lists of senior officials and their specimen signatures,
personal details of senior business executives, etc;
vii. A list of important books maintained by the client;
viii.Records of all documents or information of continuing importance.
Current Files

The current files normally include the following documents which have a bearing on the gear of
audit.

i. A copy of the annual accounts under review.

ii. A copy of the audit programme and audit tests performed
iii. A check list concerning the compliance with the provisions regarding statutory disclosure.
iv. Minutes books of the directors and share holders’ meetings or the board of trustees or
partners.
v. Quarries raised during the audit and the official comments.
vi. Letters from clients and other sources confirming account, certificate for valuation of stock
and provision for bad debts etc.
vii. A list of missing vouchers.
viii.Bank and branch reconciliation statements.
ix. Tax, bonus and gratuity computation sheets.

An auditor is a ‘Watch Dog’ and not a ‘blood hound’.

This quotation is an extract from the decision given by the learned judge in the case of
Kingston Cotton Mills Company (1896). This decision clearly makes an indication of the
auditors’ duty as regards detection and prevention of errors and frauds. There are tow important
parts in the judgment.

First, an auditor is a watch dog which implies that he is appointed to look after the interest
of the owner of the business. The duty of a watch dog is to look after the interest of his owner
because it is kept and fed by the owner. That is why, a watch dog is bound to bark and also chase
if necessary, to safeguard owners’ interests. Similarly the auditor should detect errors and frauds
so that he can protect the interest of his client sincerely, honestly and tactfully.
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Second part of the judgment is, an auditor is not a blood hound. This signifies that an
auditor is not bound to a detective who always starts his work with suspicion. It is not his duty to
take the task of finding guilty for committing errors and frauds. He should not be malicious
towards the persons responsible for any act of negligence or falsification. He is to be sincere,
honest and methodical in his approach of work without causing any harm to the staffs whose
work he has to certify. This is the actual meaning of the above quoted statement.

Case: Kingston Cotton Mills Company, 1896

Fact:

The fact of the case were, that stock in trade was overvalued for a number of years, as a
result of which profits were inflated and dividends were paid out of capital. The auditor was
charged with negligence for relaying upon the stock sheets certified by the management of the
company.

It was contended by the auditors that there was nothing to arouse his suspicion and
therefore he relied upon the stock sheets which were signed by a responsible official of the
company. Further, he put the remark “as per managers’ certificate” while signing the Balance
Sheet.

It was held that it was not the duty of an auditor to take stock and in the absence of
suspicious circumstances he could accept the certificate of a responsible official.

Judgement

In the course of the judgment justice Lopes observed that ‘an auditor is not bound to be a
detective or approach his work with suspicion or with foregone conclusion that there is
something wrong. He is a watch dog but not a blood hound. An auditor need not necessarily be
suspicious in his attitude”. But when there is anything that arouses his suspicion, he must probe
into the matter to satisfy himself that all is in order. Thus he should be alert like a watch dog but
not aggressive like a blood hound.

The decision in the Kingston cotton mill case was given more than hindered year ago.
Since then, much improvement has taken place both in the standards of accountancy and
auditing. In the United States it is now the practice for the auditor to be present at the time of
stock taking. But in India and England, stock taking is still not considered to be part of an
auditors’ duty. So, an auditor has to rely upon the certificate given by the management in regard
to stock in trade. But before accepting such a certificate, he should exercise reasonable care and
skill to satisfy himself that he procedures laid down and followed by the management in regard to
stock taking are give such as would enable it to honestly a certificate. Where ever practicable, the
auditor should be present for at least a part of the time, when the stock verification is being
carried out to observe the method of verification.

However, Lord Justice Lindley said in the same case, that an auditor need not be
suspicious, but he should be reasonable careful. It is no part of an auditors’’ duty to take stock.
He must rely upon other people for details of stock in trade.
 T.RAMA KRISHANA RAO (8839271225)

International Laboratories Ltd. vs. Dewar case:

In this case it was held that “while the auditor may be only a watch dog, he will not have
performed the functions of his office. If, after one howl, he retreats under the barn or if he
confines his protest to a fellow watch dog.” It can not be said that the auditor is altogether free
from liability about frauds and errors in the books of account or the financial statements of the
enterprise under audit. An auditor is a professionally competent person and he owns a duty of
reasonable care and skill in the conduct of his examination.

Duty reasonable care requires the following on the part of the auditor:

i. To make an intensive check of the system of internal control and devise his audit and testing
procedures accordingly.
ii. To make all verifications personally or through an experience representative.
iii. To ensure that the financial statement fully conform to the generally accepted accounting
procedures and legal requirements.
iv. In case the financial statements disclose a situations even remotely hinting at a fraud, to
pursue the lead to its logical conclusion.
Thus so long as an auditor acts honestly, takes reasonable care and skill, and conforms to
generally accepted auditing standards and procedures, he will not be liable for any error,
irregularity or fraud, which has remained undiscovered despite his following the prescribed
standards and procedures, to quote, De Paula “It is very unlikely that an auditor will be held
personally liable if he is possessed of the requisite professional skill and exercises such skill
honestly taking care to satisfy himself on every point before he certifies the accounts. An
auditor’s position will indeed be intolerable if he is to be made liable for the tracking out of
ingenious and planned scheme of fraud, when there is nothing to arouse suspicion.”