Nature of Audit 1st Chapter
Nature of Audit 1st Chapter
~ - - Nature of Auditing
♦
The In?ustriaJ Revolution was another landmark in the history of trade and commerce.
It resulted in !arge sc~J~ productio~ requiring huge amount of capital investment. Individu-
als ~ere ~ot. ma position to provide adequate capital, because of their limited finances. It
was at. this_ time that the company ~s. ~ ~orm of business organisation came into existence,
and ~s w1de_ned_ greatly, the fOssibih~es of raising capital for industry from the general
~ pu~hc b~ the issue of sh~res with a limite~ liability.
. In this type of or?arus~tion, the. s_ha~eholders delegated the management of the under-
taking to a board of directors and periodically the board submitted the accounts of the com-
., P~Y to the s~~reho~ders s~ !hat the shareholders were in a position to have a true and fair
. pictur~ of the fin~n~ial pos1~on.an~ the ~r~fi~ and loss·of the undertaking. .
in
• - • • "Yith the rapid growt~ 1n the number of companies, professional accountants came
the p1c~e. In ~8~0, the Queen of U~ted ~gdo m granted a charter, which incorporated
the v:arious s~1e~es of ~ccountants into.a single ~ody, the Institute of Chartered Account-
ants of ~nglan~ ~d Wales. By ~arly 1~9~s, the concept of audit had developed to a stage
where profession~! accountants became prominent as auditors. The objectives of audit
were also ~~n~~~ d~irig thi~ ml1:~·v·Apa!t from detecting frauds and errors, the·_auditors
1
ents
•_· • ··also ~ta~ed v~i:1~ ~ an~ rep~rting_~~ _the accuracy of the financial records and docum nts
as well as the financial statements. ··Th:e·verification and attestation ·of financial stateme
1
• • '
·., became'.the primary objective ·of coinpany·audit.·Detecfion of errors= and frauds became
incidental to the attainment of this objective. The Companies Act of 1948 in UK formalised
this position. · : • . ..
Being under the British rule; the deyelopments in the UK haq a prqfound effect on the
compariy legislation in India.' The Joint Stock Companies Act of 1857 contained provisions
for voluntary annual audit of company accounts. The Companies Act, 1913 made the audit
of company acco~ ts compulsory in India. The_Act also pr~sfrib~d, f~r the first time, the
p~wers ~n~. d~ties !)f ~~ aud_itors ~~~ the P.[~c~d~~~s ,o_f _t~ej~ appoi~tment. In 1949, the
Parliament of India passed the Ch~rte!ed ~cco~~t~nt~ Ac~, ~~~r whi:~ a _b~dy of p_rofes-
sional accountants, viz. The Institute of Chartered Accountants of India, was established.
t-
The Institute is an autonomous body, which regµlates the profession of chartered accoun
. ants throughout India. In 1956, a new ~omparµes Act replaceq the Act of 1913.•The Act now
s, the
,.. contains elaborate provisioll$ regarding qualificatio~s and disqualificatio~ of auditor
method of appointment of auditor~ and their powers anc;I duties. ,;-. • .. ; ,. . -,~
n.~· ;
-~ ., . . , . . . . . . ✓/ ~ v" po~ .,~~ r ~ .
''J
~~:~ ;~~di /~d~~ v'~ ~m the Latin wo:dtedaUdire'.'whiCh file~~ :to hear':-'1n olde~
fraud, they appointed cer~a1n persons
times, whenever the owners of a business suspec
• to check the accounts. ·such persons sent for the accountant and 'heard' wha_t they had to
• . .. ~ r. ► , r , , ,,
~
say in coMection with the accounts. · '. · • • -.
1 • .'
., - : , ; • •• • • ,. , •
The dictionary meaning of audit is official examination of accounts. Obv1o~Iy the per-
to
son who examines the accounts must be a perso~ who knows what to examine,_ how
examine and to whom his examination report and observations are to be s_ubnu tted. In
1 nd
brief it can be said that auditing is the process by which competent. n~epe the~t
eir
indiriduals collect and evaluate ~vid~ ce to ~orm an opinion and co~u_ru~ate
opinion to the ~ inte rest ed~ their audit rei> .°1/ • . •
J
r--
. les and ,r,,echni4l'es
♦ Auditing: PrinciP th of auditing profession
d we grow text of the enormous ~ ~
1.1 I NTRQDUCfJC:>N • ountancY an eettitl ~ec~~e Jttdustrial RevoJuij:~p~
f modefl\ ac; le rr11.1st t,e s tace s1ttce managed by their Pr n, ~
n,e developmethot :orld as aw ·cho has taketl Pll attd wereounting procedures ~op~J
• d d in e ' I x ace
an~, in ee ~od co!l'IJllerce, whiparativeIy sma f cofl\P e . joint stock companies• b ~
of industry rprises were co~ velopment o invested it1 panies, .it became nee ts
b~siness ~:le need for th~ a~d capital wa~ of such co~ regular intervals by:~~
the~ ~:perations increa~ the managemeiareftolders ~ unsuccessful comPanie e~~
::i:e~s who took no partt :Ccounts to the (~r direetorsth)\ companies from the s~ ~~
to presen
kof success of dais.
anagers et •
the managers wever, the rn Governmen ts thereforere
annual accoun~- H~t in hiding t~e tac d resultafl~ scan ersons ot~er than the dir ~
obvious vested in~uJent accountillg ~n to be repart~d byfse in the size of enter p~
ers; ~ led to ::cco unts of companie: contifluing incr\ e rnade increasing denian ~
pro~s1ons for diting was developed- procedures, all only be audited
In this way au . f their accoun
~ g
counts
h a h .
aI~
. •
the skill of auditors. Henceb, 1 f recognised pro e
accountants, who are mem ers o .. • .
. ~- . -~ • .
.------..---~-- .. WO-R
. 1.2 ORl'G~N OF THE ____D 'AU!i>. __ , _,
IT' i -
.. ;-~··• , . , which means
'
to
, ......
hear.
.- - ~ . .___..~ • • Laf word audire '
TheOti •
· · fOrm was tab · ~
The word 'audit' is derived _from the . ~ but auditing as its existin
of'audit' can be traced back to olden ~ime .'
g . es lis~
·
only in the middle of the 19th century.·~:· • .. • • crude and the number of transat
• In olden times •the methods of'acco~tin_g ~ereps0osition to check all the
transactiora
tions were so _small' that- ev~ry
• • d·vidu
1 al ·was ma th b ·
m . .- . . WheneYer the owner of e usmess sus~
recorded by himself or by his employees. . t d an official to check the accounts. Such,
frauds or misappropriation of funds, h~ appom : hear whatever they had to say in connec.
person would meet the concerned emp ~yees an • the accounts came to be knowna1
tion with the accounts. The person appointed to examin e -
the 'auditor'.
. . -
1.3 EARLY HISTORY OF AUDIT
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Hi~torical evidence reveals Iha t soon after the ancient states and empires acquired a coher·
ent organisation, systems of checks were applied to their public accounts ~s testified
by
ancient records. The ancient Egyptians, the Greeks and the Romans utilised system
s ~f
checks and counter checks aµlong the various financial officials. The duties of the audttor
ancient times were thus limited. .. in
1
• ,· I
..
I
The last decade of the 15th century, witnessed a great impetus in trade and commerce,
inspired by ~e Renaissance in Ital.y. This led to the evolution o_f a system of accounts capa·
ble of recording compl~tely ~11 kmds _of bus!t'ess transactions. The principles of double
entry system were published m 1494, m Veruce by Luca Pacioli although the system
had
already been in existence in the preceding century. The author offue principles also defined
and described, for the first time, the duties and responsibilities of, d·tor' in detail.
• th th d ti.
Smce en, e u es and respons1"bill.ties• f
o an auditor have inaeased an au 1
enormously.
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♦ Awliring: Princi~lcs arid Tcc hfl~
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r • •Audit assesses the ade
quacy of the accounting system: in order to ..
in maintaining accounting records ascertain its effectivene!
of an organisation.'- .
' • • . 5. Review • : ..
0 .
Audit carries out a review· of the financia
-·records are in agreement with those stat l statements to know whether the accounting
. •• ' ements.
&. Reporting tool
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. 1 I
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7. Practical subject
Auditing is a practical subject. It is something that people do. How it is done today is a
result of long history of marginal changes and responses to new commercial and legal
developments over the centuries with the most rapid progress in the last few years.
.,.
1.& WHY IS THERE.A NEED FOR AN AUDIT?'
t ·• I •~~~-~•-•----L---.,,. I _ . . . . ._ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __
The problem that has always existed when the managers report to owners is the credibility
of the report.
The report may
• contain errors • be deliberately misleading
• not d_isclose frauds • fail to disclose relevant information
. • be inadvertently misleading • fail to conform to regulations
The solution to this problem of credibility in reports and accounts lies in appointing an
independent person called an auditor to investigate the report and submit his findings.
A further point is that mod~m companies can be very large with multi-national activi-
ties. The preparation of the accounts of such groups is a very complex operation involving
the bringing together and summarising of accounts of subsidiaries with different conven-
tions, legal systems and accounting and control systems. The examination of such accounts
_. :- by. in~ependent experts trained in ~e assessment of financial information is of benefit to
• • those who control and operate such organisatlons as well as_to owners and outsiders..
1
·' .; &. •
Many financial statements ~~st cqnf~rm to statutory a~d other requirements. The
most notable is that all company accounts have to conform to the requirements of the Com-
panies Act. In addition, all accounts should conform to ~he requirements of accounting
• standards. It is essential that an audit should be carried out on financial statements to
,,,..
ensure that they conform to these requirements. i, •-· • \•
hf»l1"~
Awlitint Principles ¢id Tee
f the trUe and fair Vi
ew of --'irtariort O
. . hclJ'S deter"..... rprise•
2. The ,uditor's ~~gresults of art ente ort whO is t~I!
appointed to . • \
posilioll ,tld opcratitl rt irtdepertdertl pe~ repared
from thell\ a IJ:\vl!s. ~
The auditor stiould be (irtandal staterrte; a~dal state
organisalioll, its records~ ~e ss of thtsh:w a trUe
J
ments. lhe p~d tl\11~~\
opinion on the accur3CY that the aceounts
and fair ~iew or,~tn.qt/ !l'ii: i
.ciency and
audit is to enable to confirm d"tis to prorrtoteefft - cura accurac • at ti\~~~
, ilnof anau 1 te info~atiy lr\ ace~· ~y q~
So, the pruna1Y a re}toldetS artd rnartagernen t ac
aid to overall administra ~f tl\l!¾~.:,. ~
on
to place before the ~ha hich rnay serve as ~
condition of th e~ • w f the prirnar)' ob)e Of an audit the f0 u•ti0ri of !iii~
ness entity. For the fulfilhnertl O cts •' O\vii\g 8 ¾
: •• • - 11~.~
objects are to be realised: • prevention of ~rroi-s ,
• Detection of errors , Preventio~ of frauds
• Detection of fra1:1ds , . • artd ~re1ess~e$5, are of thr
.
gain , errors, which arise out of iJ\1\ocence . ..
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• Oerical errors ••
• Compensating errors · , . • ' • ,. 1 . ·_ • • , . •.
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• Errors of principles . ·· · .~ ' •: ·: • ..,... · _.... _. .·.: . ·~ . •
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Also, clerical errors may be of two, typ~: ' . • .. • • • . ', • ; . • .
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• Errors ofomission • . · ' • • • :. '. t,. ~rr?rs ~ 0
~~~ 1o n . : .
On the ~ther hand, fraudS which.arise ~~t ()f..~~ll\e.lll1-~~
o~ to ga~ ~methin •
some ~p ula ~g dev~c~ are of~ ~ ~s : : .· : ,.: f
, • Misappropriati~n· or embezz!~I!le~t ~f-~~~~-, ,:1·:· _....•.• _•-'.
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---w--:--"7" .;;.._--,-\-,-------:.: :___ _ _ _ _ _ _ Nature of Auditing ♦
1.8 ERRORS AND FRAUDS IN ACCOUNTING
1.8.1 Errors
Generally errors are the result of carelessness on the part of the person preparing the
accounts. During the course of auditing, errors may be detected, though auditing does not
ensure detection of all errors. Errors can be described as unintentional mistakes. Errors can
occur at any stage in business transaction processing i.e. transaction occurrence, documen-
tation, record of prime entry, double entry record, summarising process or financial state-
ment production. Errors can be of any of a multitude of kinds i.e. mathematical, clerical or
in the application of accounting principles.
Accounting errors, which are possible to be detected through auditing, can be of the
fo~lowing typ~s: . .
1. Errors of omission ·
When a transaction is omitted completely or partially from the books of accounts, it is
known as an error of omission.. This type of error is not reflected in the trial balance and
hence are more difficult to detect.
•• • • " r •
.
- • • I
Examples .'
(a)_ Omissiqn of purchases from pu_rchases day book.
. _ (b) Ignoring depreciation on fixed assets com'pletely.
• • p " • ' ' •
~ : • (a). W~ong. a~otinf recorde·d· in the books ~f original entry, e.g. sale of goods of Rs~ 15,000
. as· Rs.· 1,soo in· sales day book: This . error will not affect trial balance:; ~
·,,,recorded
•
(b) •Posting to the wrong side of an account. In place of_ debiting, e.g. an ~mount of Rs. 150 is
. ... credited.; This error .will affect the trial bal~nce.
,. '. .. \ . .
~• ... . I •
I , •
3. Compen~ting erro~
When an error offsets the effect of another error, it is known as a compensating error. These
errors do not affect _the ~greement of the trial balance, hence cannot be located by it.
'
- Eiamp~is · ·•1 • ·.- • •• ' •• • ••• • • •
(a) . A debit balance is undercast by ·Rs. 100 arid credit balance is underc'ast by the same
• · . amount. . · • ·•• ' ·: · · ·· _.-. 1 · • • • • ·_ - : . · \ • .- •. , ,
(b) Sales return of Rs. soo·is ·posted to· the Return Inward Ale as Rs. 5,000 and similarly pur-
chase return of Rs. 500 is posted to the Return Outward Ale as Rs. 5,000.
• f I 1 -- ,
advantage
(b) Inte ntio nal mis -sta tem ents in, or . . •
omi ssio ns O '
~m oun ts or dis clo sur es frol l\ f
enti ty's accounting records or financial stat eme
nts
. an
. f • . •
•
(c) Theft, whe the r or not acc omp anie
d by mis -s tate rne .
nts o acc oun ting record
. .
financial stat eme nts ..,. ' i'. · •·· ··: ·:·~ ' •"- : • • • • • • •• . s or
.r. n · g are the
· mai·n way·s m
The .ro owm · w • hich frau.. d. may . . . be acti
_ vat
: ed:
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.; · Defalcati~n of ca~h_· is possi~le ii:r~spe~~~e
. ~~.. fu.e ~~~e of ~e bu~mess sm a~ or .larg
. •
pos sibi lity of the mis app rop riat ion of cash is e. The
sma ll ma small bus ine ss orgarusation, wher
the pro prie tor has a dire ct contro~ over the cash e
receipts and dis bur sem ent . The chances are
greater in case of !arge business organisatio
ns. There are diff ere nt me tho ds of misappro-
. p,riation of cash def alca tio~ , out .of _whi~~-
. "Te e~n g a~d Lad ing " pro ced ure in usua
fol low ~ by the ~pl oye es invo~ve.<f ~ the ~sa lly
.. . ppr opr !ati on of cash. -.,>-~~~iii.,.
• ' •· • 2. .- ~lsapproprlatlon of goOds •. .
..... ~
.· ·-.. •.. -· : -~ • ·. , . .. .
Mi sap pro p~~ on of goods is another' type of fr.iU
:d. it lllay ~p pe n that. the valuable goods
• of an or g~ tio n ~y be ~tolen by the employ
. . . . storekeeper m collus1on with the works ma ees or workers. It ma y als o hap pen that the
•• , ·_. p~ : S~~ frauds ~re ~ery difficult to loca nager may 5ell ·the goo d ill all t
te or identify. . . . -. ~ eg y o some third
3. M~nlpulatlon of accounts •' ✓
~
• • • • • • • • • • • •
1.10.1 Book-keeping
It is concerned with systematic recording of transactions in the books of ol'iginal entry and
their posting to the concerned ledger accounts. In fact, book-keeping involves the following
activities:
• Journalising the transactions
• Posting them into respective ledger accounts
• Casting the total of ledger accounts and
• Finding the balances
• Akditing: Principles and Techniques - - - - - - - - -
1.10.2 ~ccountancy •
•tt..ff'letical accuracy of ledgera
. . h h k'ngo f art
concerned with t ec ec 1
iu,,
Accountancy 1s . I balance from the halan Cco4
p~pared by the book-keeper and preparing t~e trl:s profit and loss accoun~e avail~~~l
different ledger accounts. Finally from the ba ;ncnd financial position of th anq b~l 1~
sheet are prepared to know the financial res.u _t .:5. e colle;e i\~
short, accountancy involves the following activilt • . tit, j
• Preparation of trial balance . entries for rectificat·ion
• d passing
• Incorporation of adjustment entnes an .
• Preparation of profit and loss account
• Preparation of balance sheet
1.10.3 Auditing . . . .. .
· 1 is 1nv1ted to check the a
d'tor 1
When the a~countancy work is comple~e~, an_ au "Auditing begins where cco'llilts
pared by the accountants. That is why, 1t 1s said tha! , , d verify the acco accoll!\ta~
~~ds". It is the duty of the auditor to critically exarrt_u,le an ·ietin his work unts. In no c"'l)
th
1t 1s the duty of the auditor to prepare accounts. Afte~ com/ioss !count exhi ~ auditor~
to submit a report of the fact whether or not the profit anth b 1 h bits a!rue '
fair financial result of the organisation and also whether e a ance s eet reflects the~
and fair financial picture _of the organisa~on. .-, • 1
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•
•
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, .AAS-1 descri~s the basi~ princ!ple~ which ~~vern ~e ~ll~itor's responsibilities and IVhic!
' : .should be._co~pl_ied wi~ ~h~rteyer ai:i a~d1t.1s ~arned o~t. They are as follows:
1. Integrity, objectivity and independence .
The auditor should be straight forward, honest and sincere in his approach to his prot
an i~p~rtial attitude. _· .
. ma~~ain
siona1 work and should '~
· ••.
'
2 C fid t· Ii ~ .. • ~ . .
.- .· "~ .. ~~!', .,, ~~ 18 ,tvr.". ., •:, .'' •
The auditor should respect the confi~entiality of information acquired in the course of his
audit work.
: r ~ ~- 3. >· Skills and competence· : ... :• . . . - •
-~ , 1 • :
:> :r,-\·::<The ·audit should be .performed and the report should be prepared with due prof~ional
care by persons who have a~equate training, experience and competence in auditing.
· 4. Documentation I • •
'.fhe auditor should maintain documents which are important in providing evidence tf'wt
the audit was carried out in accordance with the basic principles.
5, Planning
The auditor should plan his work t9 enable him to conduct an effective audit in an effiri4li
and timely manner. j
-------- -------- ---.1... ,___ Nature of Auditing ♦
W _ \yt1 ?cr,X :;,--.r--Y.-,~-
TABl~ 1J Accountancy vs auditing
Points of difference Accountancy Auditing
• 1. Scope The scope of accountancy is limited to In auditing, the auditor is concerned with
the preparation of financial statements. the checking of accounts.
2. Objectives The objective of accountancy is to know The objective of auditing is to verify the
the financial result and financial position. truth and fairness of the accounts.
'· 3. Status • An accountant is an employee of the An audjtor is an independent outsider.
organisation.
11
4.'· aual~ication
• ••• Accounti.ng work requires . no formal To be a company auditor, one should be a
qualification. . qualified chartered accountant.
; 5. Tenure of service .~ Accountant is usually a· permanent· "'Auditor can be changed from year to year.
l _ • employee of the organisation.
~ •6. ,Kno~i~ge ln o~~er, •·.-, , Ari_ account~nt is not expected to have • An auditor must have good knowledge not
r s~bjects.. ;
• •·, • ,. . ... ·; knowledge in other ~ubjects.
•. t ( . • .
•:' • only in accountancy, but also in other
- • ' . • related subjects.
f • 7. RankinQ of ~~iviti~s . , Accountancy i~ ~-~~ d~p~~-dent C)n audi~-' ,; A·ud.iting ;~an be started only after the
_· .•• '·. .• ••. • : •. :·/ •• ing work.. . ' . •.i' ;' • completion of accountancy work. I •• -~- '; • . :· . J
:, 8. l)me pe~~'. of -~~r,< ·:·__·:. '.i Acc~un_ting wqrk is ·c~rried 9ut through•· ~ Auditing is ·usually cairied out at the end of
1
• .. ~- ....•. . :·. •.~j>~theyear:~ •; .·-,,.· ••;. ,. :·, . .'/··.'..the year..
1
-_·:_- •. _·: ..:. • _
\- ;•·'•,...,_; -:_,,._ •. ~...~~'~-Ai.:,.:·~.' .. " r '--,~;·-·_••~ ~:.,~·:•!~t,r., .....• :~2~~: ~; '. ::~ . ~: ...~' • 1
_ ... , • ..
• t ..~rof~sional contro~ _,- -~ ·/ There is _no. professional .control over ; There are professional rules and regula-
.. • • • '•- • ~ : , ,., ~ , • ., ...... I 4" __, •· -., _. J • '/ "I-, -. , •. • •-·
... - ••• _. _..• ·: -_- .._. -•-, J• .: : ~:t, 1a~9untancy.._ .. ;·!->·-- ., ..- .:·~ ~, .,.· , >
t :: tions oyer t~e ~uditing work. ~}<· l :·
.;. • •
• ~
• • • ,, I • t o _:- • ;,.
• 10. Nature of work. • ~- - .,. The nature of accountancy work Js '.·:,Auditing work, on the other hand, is mostly
.- ,.· - : - ;. :~,. ,_..·:.._: {.· ·,: ,. _constru~iye•. t- ·: .: <·r' -~ •... ~. .. - ... .\~,.·-:analytical. ..
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~ 11. Submission of report . ~ No report ·is required to be submitted at ; f. A report on · the -final . accounts are
1
• _ . -: ;; ....._'j _:...~., 3 . :.· --.:.,:·? ,:, .• t~e en~ ~f the accoupting work. ;: r~. ~ .: requi~ed to be $Ubmitted by the audttor at
..,._.. _ ·:··._:·. :_/:-'·.--~:-:-.-,·_.,._.\,:~;~~~•;.:~,.~. ->:· .·q·~ :, • ..- _ .· ·-~·:_.-i-th_eendof_hiswork. -~ ,
•12: Accountabil1ty· :.J : ,•r··~ .P { The· accountant is accountable to the :;. The auditor is 'accountable to the share-
>-·::~:-· .• >:~'·; ·:·'. •:.:.. _;j}management.
,•j .. ,·.r ;_- .'• ·:· • ·._::.--holders.·. ' -~· '. -· .
.. .. . , :-
. . .. ..
6. Audit evidence •-
. .
' .. . .. . . • . ' ~ •
,
I
~
•
r.
•
I '
.The auditor should obta~ sufficient appropriate audit evidence to enable hi~ to draw rea-
• • - •sonable co~ch.isions therefrom on which he can base his opinion on the financial informa-
.. I • •. ~
· tion. ; - •. · , t , .
' · ·
.
· ·
. ... • • ... , ' .. , .
tem, 1
by fraud or other irregula_rities b\l~ coll~sive f~au 15en~ m , . anoa .;te m~ ts ca'¾!
d o ten lDlpossi e to d1~over ~
auditing procedures. If there were a requirement to
uncov~r ~uch frauds ~e audit wou1a
become impossible or, ·af the least, req~re many mor
e ~e~ailed and expensive proced~
thanare~entlype~formed.... :,:: ~- ·,··,;'·.':-.:, 1·' :' •• ·, ..... ~_ • •
•
th •
I
.. .
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Namreo{ AHditing ♦
7. When ~xamining financial data, the auditor acts exclusively in the capacity
of auditor
This is .tied
. .
up Wt'th no t·ions l'k • dependence, useful economic function and social
1 e 1n
responsib~hty_ to the public. This postulate is fundamental and yet the necessc1ry independ-
ence of nund 1s still a difficult problem for many auditors. .
8. The professional status of an independent auditor imposes commensurate
professional obligations
This mean~ t~at members of the professions have higher duties than economic self-interest.
1: 0 wever, it is not ~lways clear to whom professional duties are owed. Are they to the pub-
l~c at large, to t~e chen! co~pany or the shareholders? However, it is certain that the profes-
sional accounting bodies impose very onerous duties on their members.
. • t>. .\ r,,Y--
1,13 •SCOP~_ ~N_D P~OCEPURES .OF AUDIT · \;(/,~~ /y() f ~
0""
40
,, '
. • . ..
L., ... .. ! ': .. - . l : 'l ~ . . ... . • ";.. ,. .. r
The scope and procedures of audit for a particular organisation will be determined by the
auditor on the basis of the terms of engagement, the requirement of relevant legal formali-
ties and the pronouncement of the Institute. The term of engagement cannot, however, in
any way reduce the scope and pr~edures of audit which are prescribed by the legal provi-
sions or by the pronouncement of the Institute.
To express an opinion on the financial statements of an organisation, the auditor should
satisfy himself first whether the information contained in the given accounting records is
authentic, reliable and adequate as a basis for the preparation of the financial statements.
The audifprocedure should be designed in such a manner to cover sufficiently all aspects of
.the organisation as far as they are relevant to the financial statements. In forming his
. opinion, the auditor should also decide whether the relevant information is properly dis-
closed in the financial statements on th~ basis of ~ts statutory requirements.
. The principal areas to be covered in an audit include the following:
1~ - ACC0unting ~nd inte~nal co~trol • · .• _ •• •. . : _-
An ~xamination of the system of accounting and ~temal coritro~ to ascert~in whether it is
'i adequate and approp~ate for th~ ~~nce~e~ organisation 0~ not. , .,
• .
• ~ ' • • ,..· ' • l
2, Arithmetical accuracy • -. • •. ,i • • . . •- ..
• An overall checking of the arithmetical accuracy of the books of accounts by the method of
posting, casting and balancing procedures. •__. • •
' j I
• 3. Authenticity of transactions . . . . .
A proper verification ~f, th~ validity _an~ authe~ticity o~ the transactions entered into by
checking the entries with the supporting doc~ments. . _. -
4. Distinction between capital and revenue items . _
An effective scrutiny over the distinction between the ite~s of c~pital and of revenue na-
ture of income and expenditure correspond to the accounting period.
s. Verification of a ~
of the assets
· in the
appeanng
A detailed \·erification of the ownership, existence and value
balance sheet.
I ..._ ,
,
• Audit111r ~ and Tt c~ tS
6. V.lflcMIOn of lllbllltles l
_. .
A pro,,,pe~r,-m'fication of the liabilities of the orgarusa t',on as stated in the balance sheet.
tA . ,.
7. Cofflpl·.. rtscM---n lfle ftnandal sta tements
A comp • fthebalancesheetan d pro fit and loss account or other statements wt'th th~
an son o . rd to see that they are in acc th
a,·ailab1e records m O er .. ordance erew1'th• '
I. lNth and fairness of ftnanda · '
An effecti\'e checking of the l statements • . acc
results as shown by the profit an_ ount to see that th
results shown are true and fair. d loss .: '
9. Slabll'Ory requirements
•
A concrete confirmation about ~e
malities in recording the finanaa ful film~ t of th~ sta
•
tut
l transactions and in prepanng or r
·• em~ts- and legal for
financial statements.•
.
re:r
10• A -late reporting
~ ' -. · •· • •~. • . : .
An appropriate reporting to , •• 1 • h •ther the sta
accounts examined do reveal a tru the co nc ern ~ ~ersons to exp amf wff ~ d of tements of
e and £arr view of the sta the profit ilnd
km of the organisation. te o a airs an .
, . ..
-l
~ ~ • ••
",
go ing
" f 1 ; "- • ' ~ • i
its
• .. I,._..
• •• •• I .. : ~
• I,..
• • •
• • P I
., I '
- - - - - - - - - - - - - - - - - - - - - - - - Nature
of Auditing ♦
of audit also covers the following:
1. Checking cost accounting records and to verify whether costing princip
les
are fol-
lowed while preparing and presenting costing data.
2. C_omprehensive
examination and review of managerial policies and operational effi-
ciency.
3. Checking the perfo~mance ~f the _organisation and comparing it with the overal
l
performance of the industry 1n which the organisation belongs.
.
4. C~itical examination and analysis of the contribution of the organisation for the
efit of the society. ben-
5. Evaluation and measurement of efficiency of human resources in the organi
sation
. and comparing it with the expected utilisation of the human resources as a whole.
which are
responsible for capital erosion. In order to stop capital erosion of the business,
_different
system of audit should be introduced. Capital erosi?,n is very dangerous, becaus
e it tends to
liquidate the business. So, the function of an audit from social point of view is to
stress and
scrutinise those aspects, which are responsible for capital erosion.
4. Meisurement of fair wages
Measurement of fair wages does not come under the purvie~ of general ·a~dit.
It ~hould ~
the social objective of an audit to see whether the wages for workers are
fa~r and in
conformity with the general price index. ••
s. Falrprices for consumers • •
As a part of the society, the business organisation should charg~ fair pri~es from
the con~
sumers. It not only creates goodwill of the organisation but also e~sure~ its future grow~
.
As an auditor of the organisation, everyone should take care of this social aspect
. of audit-
mg.
f.
♦
. . g·. Principles and Techniques
Audiun
. ~, ...
.~ I From ~a l Point of ~-lew '
. : ._,.
r •
.:. ,
// by a qualified auditor and they do not fit ~d los s acc ount that has ~ prepa_red
II go into det ~tls _of the
' ' ,acc ~unts~.. . _..·
. 2. Borrowing of money from:· ext.ern '
',' . ~ •
. ' ... • ~ {,
al sou~~~s.. . -- , . · · . .
Money can b~ b~~rowed ~asily, on the bas ! . .,
is of audited balance sheet from extern
Most of the fina
. ncial institutions s~ction loan. on the bas al sourcesi
is of audited financ . ial stat ements
3. Settlement of insurance claim
. - , .,
In case of fire, flood and the like une
xpected happenings the insurance· com
· \ the claim for loss or damages on pany may settle
. the l;,asis of audited accounts of the pre
.
•. · ~ •.4.. Sales tax payments ~ 1 ~ • ·: .
vio us year.
::. • : • ' , - • .. , ! ' . - •; .
• The aucii~ed books of acc'ount~ ~ay g~n 1
. _ . •
. , . .
~e audited aCC(?~t~ ~~rves a_s a basis ' ' • I • • • •
~~~
•
~n ~ bankruptcy ~d insolvency
•
cases. • :· t~ de ter ~e I
. •
'I .-' ,•_• t •, , ,•
1 f f I l \ •
~ ~
• f •
• ,\ ~ I' ..
0
J •
•• • I f • '
\ •
I , • f ' • • ' • J , t .
.Fro~ Internal Controt'Point of Vie '
.. ~ ~ • ,
W "J • i ; , t •. ·'' I' ; ' . :, . r
.• I.
: • , ! ••
" " ~ •· .
1. Quick discovery of errors and ! ' , . •
.
frauds
i
, .. . . . . . .
Errors. and frauds are loc~ted at an ear
_, ... comnu~.s~c~ 6:~ud~ as on~ 1~ rath ly dat~_, so .that in _future no. ~tt~mp
t is made to
.a~e subJ~t.to regular a~dit.' • er car
•
eful not to commit an error or a fraud as
the accounts
• ·. •· • ◄
2. ·Moral ·check On the em~loy~
•
•
•
• ••• ..
The auditing of accounts keeps the acc
th d.1t0 uld ounts clerks regular ~d,vt'gilan.t th
~ a~ . r ~o compIam . . . kn
ey ow that
t~~re 1s any llTegularity. _against them if the accounts are not preparas ed upto date or~ 1
••• . • • • .• - • • •
, ,
.I
. '
------- :------ ------- ----..;. ......-- Nature of Auditing ♦
3. Advice to the management
The management may consult the auditor and seek advice on certain technical points
although it is not the duty of the auditor to give advice.
4. Uniformity In accounts
If the ac~ounts have been prepared on a uniform basis, accounts of one year can be com·
pared With other years and if there is any discrepency, the cause may be enquired into.
From External Affairs Point of View
1. Settlement of accounts
The audited accounts would facilitate the settlement of accounts of a deceased partner.
'
. . 2. Valuation of assets and goodwill
If the busines~ is to be sold as a going concern, there may not be much difficulty regarding
the valuation of assets and goodwill as the accounts have already been audited by an inde-
pendent person.
3. Future trend of the business
The future trend of the business can be assessed with certainty from the audited books of
accounts. .,,.... - - . . •; - . . \ . .. '
•
1.11 ~~tiONS-OF.AUDIT~~-G
• .: ·t:, ~·· ... ;._ ··-'!s. '-~~:.. :....~·· ... ,,. ·~ 1••'::.~..::
i:,J. \I •~:F}~ ~l: / . pj
' : _ t • : -. . . . . . . . .- - - - . . . . . - - - - - - - - - - -
. Truly speaking, ~ audit should have no limitations of its own. It is designed to protect the
1
_ ~ interest of all parties who are interested in the affairs of the business. If there be any short-
coming arising therefrom, it may be· due to its narrow scope ·of application in its related
field of operation and unextended definition of the concept.
'. • Auditing suffer~ from the following shortcomings: )
1. Want of complete picture • . ,
•
}1 ' I• •• • • • I • \. 1' •
The audit may not give complete pie~~~- If the.~ccpunt_s are prepared with the intention to
defraud ~thers, ~uditor m~y no~ be able t~.d~t~ct them., .
I lt.r. .' ~· .. ,.. ... , . l J. "' ' .. -~ • ... •
2. Problems of dependence •• • ,
• Sometimes the auditor has to depend on explanations~ clarification and information from
staff and the client. He may or may not get correct or complete information.
3. Post-mortem examination
' .. ' - . • . ') '
,
1
• , ' ,
6. Divel di ed sftWltlonS
Auditing is considered to be a mechanical . •~ •.
work. ~ud1_tors ma~ ~ot e ~ ·~ pos ition to fr
, ~ .~ . . ~
audit programme, which can be followed
in all situations. •
7. Quallty of the auditor
•
. .. . •
Success of audit depends on the sincerity
• • • : •• ••• ·, ••~ d
with which th~ audi~r ~~s pe_rf~~~ 8
hi .
The same audit work can be done by two .
different auditors with d~~erence ~ s~c d~ti~.
• I enty.
8. Existence of defective policies • •
. \ I
•
•• ' : -
'
•
• • ; • t' ?. f
·:! • •
.•
.!
r.·~~- · • .•·.·.,.. , .:. ...·,,, •• • ~--· ~•• ''•• -·· '••• • ~..' ~
I
........ . ..... _ ....... ... - ..... ·~-~-
.,,__. A;,_:,. .•·~--u .....,A, ,., .• , ...
, . , __ ,,•••.,.,,._,_ ·."t"·~
~ .
• Only a charte~ed acco~ta~! ~~· .app~i b~
, , . • ,1 j.
1 ,; '
nted ;~: a~--;~dit~r 0f a Iktlted ~oµtpany.
the statutory requirement about the qua Besides1
lification of a~ auditor, he must posses
ing qualities: .. s the follow:
. . •. - . •. . ., . ., .• ,.;. . . . . .
• ~ auditor must pos~ess the necesi~ry 1 J • • . , •
·4 • I ii 'I
, accoun
tec hni cafabi lity and kn ow led ge to aud
1
it'
r, •• ..
ts. . .. ., . . - ;
, , ,
· .
, r .) · ~ ~
._ . ,
., ..
; ., • • • • • •. '! I ~ J
• He must be. ~onversant.with the rele
""J
' ',,
I
·(
Jl1 , ·' '\ , ' r •., •• .. ' ... '"", .
-i •, , •
1 •J • .. ~ •'.. ' .; • ..l-l , .._ ..
' • l
vant provisions ~f ~~ co mp ~e ~ and
,.
'
1
;. . . . regula~o~. ~nd: with. ~~th ·~est. c1:1 other
rrent_ a~co~ting practi~e~ and Curren~
Practices.• . ~, • ~
auditingr
~ ,,·.
, • f •, I I J .,,,
J,.:; , • • • ,• . ., •~ .J .- • ,
,
out bias.
. • He m~st hav~ inte ty. Once h.e has
. . ·' ., . expres~ it clearly wigri fol'IJl~d hi~
• •
~, he ~ust~~ prepared to
.
-I
I
thout fear and favour; •., .:. ~-. 'Jp:)•iniO
•. d • : ,· \.. ! ).
• He must be methodical in' hls.'wdrk. An
~uditor ~hJ lea~es loose ends will find him
seH open to allegations of negligence. -
•· ... ••, : •· ·; , , ::,. =· . : ~.
• He should have an inquiring 'mind. An
auditor
stances; and once his suspicion has been aro must recognise suspicious circum-
the bottom. used, he has a duty. to probe matters to
• • •
r ' :. , ..
-• .
' Nature of Auditing ♦
I \I. ' •).J V"~ f)
'?
,) I'-·~ l' ,.,:;;
• • .-·,.,
,. .
~J •✓ - \ r
~ In the following chart, the qualities needed to become an effective auditor are shown:
Qualltles of an Auditor
Educational
Other qualities
Professional
* General Inherited
i * i
Acquired
(As prescribed • Knowledge about • Honesty and • Caution and vigilance
by the statute) . accountancy intelligence • Impartial attitude
·• Idea about various • Patience and • Man of personality
techniques of auditing •reasonableness • Strategic and
• Knowledge about • Sincerity in conscious approach
different laws profession • Common sense
• Knowledge about the
.. . - ., principles of economics
1
: organisation . •
J : .• .~ • • Knowledge about
: ••
computerised accounting •
• Knowledge about different
·:: .. common languages .·, · : ·: •. • • '
Auditing ·firms do not describe themselves as auditors. They describe themselves as Char-
tered Accountants or in ·some cases just as accountants. Auditing firms are ~omposed of
' ··accountants· who perform audit fc;,r their clients. They also perform other services. The
small firms especially' may spend more time on other services than on auditing.
Other services may include the following:
~
:.r • Writing· up books <--1 ·_.:, •
• • Financial advice • • . : · · • 1
' •. • ~· • ·, • :· : • :- ~·· •:
. • JManagement and
t , I:. ,.
system
. '
ad~i~e I. I • • I ' .
o: ... o t I
, • '• • 1 °,. ; o
O
I # 0 o .• • .o \ '
.. . . . .
• •
. . I t • I
# • l I • ... ~ : f •. - ,. ' •
'
t
. ,. ' • I
Arun, Badal and Cl)avan are partners in a firm of constructions business. Since commenc-
ing in business in 15 months ago they have been fairly successful. Arun who has a Diploma
in Business Management as well as in building constructions has kept the books and Aron
has also prepared the first year's accounts.