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Nature of Audit 1st Chapter

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3 views18 pages

Nature of Audit 1st Chapter

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Rubayet Hosen
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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- - - - - - - - - - - - - - - - - - - . : . . . : . .

~ - - 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

tUDmNG DEFINED }1' -.YV 1: . , • 1i. ' • ..~~:.:;,,·.-,~ , ·1; /) :• • : r,_

~~:~ ;~~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 .

the greater complexity o 'tis required that ac i ssionasl bodies .


b y q u • ~I·'.~

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
•M-,- ~• ~_.•,_,,,_..I ...__ .. ~"' ,::;,,,,,.,J..;.•.t•:,..: ....- .. ;~~
.,. 4 _ ._

.. ••-::"_-; .. , •~ ~ 4 " ",,.... •-

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.

I .. ~
♦ Awliring: Princi~lcs arid Tcc hfl~

X: om the above it is dear that the au ditinS proce


are as follows:
ss involves three compon
el\ts. 'h
'\
• Books of accounts

• Auditor
• Techruques and procedures of audit
. t defines auditing as "a s
Montgomery, a leading Americ ccountan ,
an a ineSS or other orgaru•sation~, in . Yste
Order toll\~\
examination of the books and records of ab
~ ~
or verify and to report upon results.th ~r
eo f/ ~d As5urance ~tandard -1 (>.i\s.
The ICAI has defined auditing~ its ~u, 1
"the independent examination of finanoa ~ ~!ation of any entity, whether Pr t \
l
ented or not and irrespective of its size or uuOI f rJI\ when such an exanunation°'.11 \
lega . ~ ' . ' 1
st\
ducted with a view to express an opinion th
ereon :nor haS not only to 5ee the ilrithin
• From the above definitions, it is seen that
an
accuracy of the books of accounts but also has au ~e r and find out whether th eij~
to go tor not. It is possible to perf etr,
actions entered in the books of original entr
function b • y are ~on:ec scrutinising the vouchers 01'1ll this
y mspecti•ng, compan•ng, checking, revidewing,
ing the transactions in the books o~ acco~t mining the• corresp-ondenc sup!"'~~-
books of the shareholders' and directors s an ·.exa Memorandum of Assoei eijllliii"lt
~e_eting, 1 x--_ •• a 0nat\d
Articles of Associations etc. •
• .. :' • 'J>.... '_r,, ~ 1i ':~ ~- ••
\X /' •
·,
1.S ,/ ~ / •

ESSENTIAi.:. FEATURES OF AUi>llIN
- { •

~
,-:'- ......_
G,; : . ~ ,, • .,
'•,
t .,.......,,..:. •
/t. _-: ......: -:
• , -. I ..
-,. \ ,..,. l • \ - .• $,_ . • -- 1

· The following are the essential features I •


1 ..

of a1:1di~g: •'- = • ·;, : • • • • ~,


1

1.- Accounting.control ·· . . ........ •- . . . : .. ·.- -·.


.. ,,, ~ ... ; .. \ • • ' •• t

. Audit is an instrument of accountihg ~ont


. • information is controlled and checked ro_l.~ T~e I~~ ~~ fairness. ~f the a~counnn
g
I by auditing activities. , .~-. -
I • _ t "- ~
_~ 2. Safeguard · ··-. . . ": 1:
. , ' •
-" j • ..

·• · - . : . ,:' · . .·. -'. ,. . . . •


Audit acts as a safegtiard ·on behalf ~f the pro
prietor/ s(wh~ther an individu~ or agroup
; persons) against extravagance, carelessnes of
s or fraud on ,the part of the proprietors' agen
or servants in the realisation and utilisation ~
of his/their money and other assets.
3. Assurance
_Audit assures on the proprietors' behalf that
., • • ,. the accounts maintained truly represent facts
"· •

and expenditure has been incurred with.d -. • · -. I . . -1, .. •

I • • ue regularity and propriety.


• , l • , ~
4. Assessment . ,
, .• J : • t ' • ', -' I

. . .
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
l
. 1 I
w _

•Audit is a tool for rep or~ ~n ~e ~c ' 1 . • •

ia l statements as required by the tennS


auditors' appointment and in compliance of~
with the relevant statutory obligations.
- ~ - - - - - - -_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Nature of Auditing ♦

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, •-· • \•

1.~ECTivE OF.AN AUDlfl. ·_ -~r('/\ P


--~a.J . , . .. A ...... ~ !.· .. ,.>:J'u.;_.1,.Jh- .. ~· .,_.!.,,.__!.
.
0
~
"' .. ! \ . ! ~ U - - - - - - - - - - - - - - - - - -
. . .. -· ...
The original objective of an audit was principally to see whether the personnel involved in
accounting had properly accounted for the receipts and payments of cash. In other words,
the objective of audit was to find out whether cash had been embezzled and if so,. who em-
bezzled it and what amount was involved. Thus, it was only an audit of cash boo~. _But, ~t
•present, the main aim of audit is to find out, after going through the books of accounts,
whether the balance sheet and profit and loss account are drawn up accordingly and
• whether they represent a true and fair view of the state of the affairs of the concern. This is
possible when the auditor verifies the accounts and the statements. While performing his
duties, the auditor also has to discover errors and frauds.
'
The ICAI · in its "statement on •objective and scope of the audit of financial
statements"AAS-2 enumerates the 'following as the objectives of auditing the financial
statements:
1. The objective of an audit of financial statements, prepared within a framework of
recognised accounting policies and practices and relevant statutory requirements, U
any, is to enable an auditor to express an opinion on such financial statements.
I I I - 11 ""'- '

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 . ..
A. • •• ee . ~-
. .. (.
. ....,~ , ..,...' ,, ...,· .. . .
. .
. •-J ~ ·'
• Oerical errors ••
• Compensating errors · , . • ' • ,. 1 . ·_ • • , . •.
• . t I " , I , • ,

'·:
i
• Errors of principles . ·· · .~ ' •: ·: • ..,... · _.... _. .·.: . ·~ . •
I l ·' • I I • • ·.J • • ... ~ ' • -

1
Also, clerical errors may be of two, typ~: ' . • .. • • • . ', • ; . • .
j •
"• ' • ; • # • •

f • . :.--;· . ~ \·
• 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·:· _....•.• _•-'.
_i . -.&. ~
Mi • • :. •. . . .
'•,1 i •
I ·sappropriation of iZOOdS: :.. r -~ ~-:·~~ ·,... :, ,,· \ : • >,· . ,·, ... :. .,._' .,,•·•t'''·. ~IJ.••,/.1 • • L ,, •

• Marup · ulation p
· of acco•unts• : -

t ';: • • .
I I ' .J • ,lJ ,l I~• I ,,1 ( ,· •• • ~ •

~ · ,·. · ::.• ~- ·
t, I ,. ,_ .,.

•.
It.

• • . • •. . t.,, \ .'
r;
I l
• ,
' .. _
,;

•• \
I
••• ··: •
• " ..
: •• • -

The objectives of audifulg ~~-presented in the follOwing


,,. ••

' ,

.
chart. '

. •. Ob'ectlves of Au It,, ;
• ••
. ,
I
~ .. • a - • •

'Seco
. . ncla.ry

Prevenoond
frauds
i .
. ' .. : . Cledral ,, ... Compensati I • "':• I

• ••• ••. .i : .- • • • ..
; -· '!"'0" . , . errors. ng •• • E~ of •. S:fflha....____ ,.
·· . ·.... · · •' ,.. pnna
. ' .. ""es -of· ~ Misappropriation Manipulatiat
.,. C'.llh .
. 1 , ,. . '\
,
of goods d aa,,,,ts
• " t •• f I I,,.- • • • I ...
. • .. • J
• •

' ..
of ;, .. . .
El'l"ftM
: • -•·_.
~~ ·_· • =•.-· ··Errors of • ..
j

. •. ~ - ..
---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 " • ' ' •

2. Errors ~f c~~missio~ xi'


When entries rriade in .the books of 9riginal entry or ledger are either wholly or partially
incorrect, they are knowri as errors of commission. Some of these eqors may not affect the
· trial balance. ~ • •• • ' ·- • · · • I
• • . . ·1 •.

'¼ '=J''• ~,,..,I;~.~•.,..... ,,:--,,.,, ..., ,·.•1•;- ~. , •


' Examples . -' ~ ~ •'; ;•t"
.... p .'I.'.:
••I c~ •
a•' • . •• ~ • • ', • • I •

~ : • (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 -- ,

♦ Awliring: Principks and TechnJ4un


- -------------~ ot foll owe d, the erro
4. Errors of prfn dpl es . nd acco unta ncy ~re :Oti ona lly to und erst r is kn.
Wh en prin cipl es of boo k-ke eptn g a be com ate asseto\vt\
as erro r of principles. Such_errors m7 d flate mitt ed ;.nt d whe n the circ ums tanc e diet c\t\ct
to ove rsta te liab ility and to infl ate an e pro fit as an . . c\~.
.- • .
, •
Enm plN • • , enditure~ e.g. purcha~e· ?f mac
. revenue exP hine
(a) Treatment of capital expenditu .- . , • • : ~: _. _,_.. .· _ ~
re as , •• - .. . : . • . _.
treated as purchase of goods. ; , ·. . .
. {b) Valuation of stock on the basis of wron
rinci ple .. · ,i. -· , " ; ; . ,~, -., ,,, .... ,~ ~- ~--~
~ ~- ., . • ••·' · ·" - ····--·· ~
., i '!' -
I
j

1.8 .2 Fraud .. . intentionally or ~ith<.?,Ut beli ef in its tru


Fraud means fals e representation or entr
y m~de of frau d is con sid ere d .to ~e one of
wit h a view to def rau d somebody. Det :
ec~on d' is use d for sev era l sin s incl udi ng
imp orta nt dut ies of an aud itor . The term frau the
.: , e J : • _
following: . ., • ~ • . ' ; , ... -~ t~ ~bt ain an unj ust or ille
• , •

(a) Fraud, which involves the use of deceptt gal finan.


~n : . !, . Clal tJ j • ,

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:
• #- ... ".". . . . . . ;

.. , _ 1.. Embezz•e~e~t of_cash .


,I_ - • ""

l ··, • ~ •, .'.
,J. ,,:.
r ... • •_• ! _ ~;·- --~
.; · 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 •' ✓
~
• • • • • • • • • • • •

Accounts are manipulated through falsifi ti


lations through accounts and arise en ca n
motive of misappropriating fundS-slg ta1 ~ •
f
of accounts. Th ese are fra udu len t manip1I"
thr ou ~ pas sin g of fal se ent rie s with Iii
·1 and go od s,~ type of fraud is do ne~ ;lea n
:a. dil y. Un like mis app rop ria tio n of ~
. • _- . . · · .. • . sop . tic a~ per son nel of an ~rganisatic JI.
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Nature of Auditing ♦

1,9 ROLE OF AUDITORS IN DETECTING ERRORS AND FRAUDS


There is a difference of perception between the public and the auditing profession in rela-
tion to an auditor's duty regarding errors and frauds.
The auditor sees his duty as:
"The independent examination of, and expression of opinion on, the financial state-
ments of an enterprise by an appointed auditor in pursuance of that appointment and in
compliance with any relevant statutory obligation."
While certifying the final accounts of the concer:n, the auditor, has to face a specific
problem. He has to certify in his report as to whether the profit and loss account reflects the
true profit or loss for the financial year concerned and the balance sheet exhibits a true and
fair view of the state of affairs at the end of the financial year. The emphasis is on financial
statements. However, the public, including much of the business community, tends to see
an auditor's duties in terms of the detection and possibly prevention of error and fraud.
. Accordingly, he has a duty to ascertain frauds and errors to justify the correctness of the
accounts. This duty of detecting and preventing errors and frauds can be analysed in the
following ways:
Detection of errors and frauds
It is desirable that the auditor should exercise reasonable care and skill, so that he may
detect errors and frauds. If he carries routine checking and vouching more carefully and
checks the books of accounts thoroughly; he may be successful in his duty. Whereas, in
doing so, if he is not successful but he himself feels that he has not shown any negligence in
his duty, then he cannot be held responsible for any error or fraud which remains undetec-
ted in accounts. Hence, an auditor is not an-ins~er. .
Prevention of errors and frauds
The auditor has no authority to introduce remedial measures for the prevention of errors
and frauds. All that he can do is to advise his client and suggest the ways and means to
prevent them.

1,10 RELATic;>N BETWEEN BOOK-KEEPING;


ACCOUNTANCY AND AUDITING

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
., J , '·

. , r .., ' ., -. .r.

1.JJ0,4 Accountancy vs auditing -~ .• • . , , - .


.~ · The diffe~ces ~~ee~ acc~~'t~cy.and ~~diting·ar~ outlined in Table 1.1. \ .....
'
< / •/ •
.VV'- •
. . . '.: · :- . : t ·: , •• r .• • ~ •tJ\
r:J •"~ -· 1
i, • • •.
1
, - • ;. •
l ••


., '
• • f • •

-,
#

1.11: • BiS1c PRl~dP1.E~-GOVe~NiNG AN:Auo1r·' ~y{)~ ,,,~-/-


- .. .._..,_ -~ • ... 1. 'w 11~ .,,.., ,...,_, • ..... ·•· :~- -~ : •• • ... l j .i· ':.~•. ..,,;;;.,.,. ~•· ,,.:-,.:. . /,; ,....,...-,, ... ;, :," • . ~ ~ ., ··: ":-" ,.

, .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. ..
..,z_ •·~' ,-~:., ~· :i·.,--1.-Lr»· .a..~ 4,.t•~,,..!1,t."' •.,;. .. 1-.--tA--.:,. J\·,
1
\~• .,J .r. .t; J-:,"":, j " ' ~"'· .<l'j~..... •~· • ....., .. .. •

~ 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 , .
' · ·
.

· ·
. ... • • ... , ' .. , .

7. Accounting system and internal control


The·a~ditor.sh~uid ·reasonably assu~e himself.that the accounting system ~s adequate and
that all the accounting information ·which should be recorded has been recorded intact.
• • • • ,, • 4 : • • • • ,. '. : • "

8. Audit conclusions and reporting


The auditor should review and assess the conclusions drawn from the audit evidence and
submit a report that contains a clear written opinion on the financial information of the
organisation. •
I •

• Awliting; Princil>fes and Tcchni4Ues

l,12 POS1ULA1t5 Gf Al:JDITING d to be trt1e and are taken for


hi h are assurne . r e and to see what • 8?~?\t
~: =~ ~= t~ :
postulates. This was done by Mautz an w
:~:::~!
t~ e~a;:ar:;;i:i ir~ ook The Philosophy~} ~di~~-1
1961. Their eight postulates are given J,elo •
re ver
:
ifiable 1
'~i
'
1. Flnandal statements and flnancIaI data ho a •
otherwise would not atternp
This is an unspoken assumption · bYa11 auditors w · es facts are t 8 • t to
the assertions in the accounts they are aud1.ttng,. 5ornettm no trict1y ~~
ts of the circumstances, Whi vheri~j
and auditors content themseve 1 s wi•th staternen. .•. ~ ._. .... _ c ci
~~
verified. . . nthe auditor and the manage111
2. T:here Is no confhct of interest betwee
•.. .·., ·.. el\t~
~· entity . ' .
H this was not so, auditors w~uld ~ot believe 'ilie· answers giy~n to their questio
Id find conducting an audit itn ~ ~
given the complexity of modem busme~es, wou
is this basic assumption which leads auditors to cons•idef whether they should ac~08s1h~.l
client where the integrity of the client is s~spe~te~~ - epta\
. .. .' ..- • . .• ..
3.. The finaricial statements·are·,ree tl'Oin COiiusive and·0ther unu
sual
Irregularities . . . . . - ,,
Auditors are expected tJ itnco~er mai~ri~l miS~sta fin . .v • • •

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·' :' •• ·, ..... ~_ • •

4. The existence ·of a satisfactory system of inte


· probability of irregularities·,;.-, : •., :'.. •·._. • _. •mal control eliminates the
; ··-... •. ·. - •.
•. ·· · ·Auditors ·ue. entitled to rely on satisfactory
internal controls a·s evidence of many asser.
tions. If this ·j,ostulate· was :not a fund~mental prin
ciple of auditing they would not do so
·• . Regarqless of, the as·sessed level of risk, au4itors
sho~d
dures for financial statements· assertions of materia perform some substantive proce-
,

classes. , l account balances and transaction

5. Consistent applicition of generally accepte


d accounting principles results
-f,1· • ~ -.. :·. ,.1~,~~lr P~~~~~
~~n 1~he ~tul':5 ~n~.-~sltl~ns . _~--. •. . ~~! •.
··i_ I :.-~udit?~~-~d some .cri.~erion for th~ir_ ~-s~essm
::

._ financial statements and the GAAPs supply it.


en~ of the.faiI'lless of the view given DJ
• which fairness could be judged. Otherwise there would be no standard bJ
.• )· ... . . i
, : .•. : .. ~- .: In the absence of dea
0 r evidflnce to ;~ ~r y; whit has held true In tlie
, P.I~ ~~ t~.• ~n~lty ~Ill ~ol~ true In the futu
•· • •
' ,- ' • • - - ' ..
re •.
H this were not so the auditor would be unable
• I

th •
I

fixed assets, the saleability of stock, the effectiYe acce t


to' I f debts the vatue ~ ,.

·;, l management and many other matters. :., . l\eSS Ji n~ ue o 1• ~ integri!Y~


' -
controc,,
,. • • . t~ • ' l I.. • J

.. .
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 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
~ ~ • ••
",

~: 1~14 _~~~ I~_~E C oN


~~ ~- ~! U .e !! !~ ~J ....·'...'
The auditing profession has, at ...· · ~ - - - - -
present, revised its method of wo
the early part of ~e 20th century, rk from the_las~ century. In
the e~phasis in auditing was on
fraud by D\aSSive checking of en the de t~ on _of ~rror and
. b ~ entities, and the mech tries in the books of a~c~unts. The grow~ m the SlZe of the
anisation and computerisation of
made this approach increasingly accounting records, have
realistic.. The profession has respo
emphasis of· its auditing pro nded by switching the
ce~ure fron;t massive -c}:leckin
establishing whether the organ g of in~ividual items ·to
isations have a reliable system:
inaeasingly concerned itself ~t The modem audit has
h establishing that the annual
pared from a reliable accounting accounts have been pre-
. reliance and then with thorough
sy ste ~ on ~h ich a pru~e n~ au dito~
• ly testing and reviewing the final c~ reasonably place
accounts them5elves.
, ,

Moreover, the profess_i~n is ~ow


,J
• • ~. J "
• •

~y~n~ th~ duties_p~e~


, "' I

go ing
" f 1 ; "- • ' ~ • i

panies Act in that it is initiating its bed on it by the Com-


own accounting standards and
guidelines. At present, it ~as so au diting regulations and
.• •- - manda~ry acc~unting sta ught to standardise the accoun
ting procedure by issuing
ndards and also issuing standard
conducting audit work. ised au ing guidelines for
. · ."'_· 1 • . , . • ••• ••• • ( • dit • •. - •
In addition to that, auditing in •

its
• .. I,._..

~ approach. At _present, the scope mo de m fo ~ ~as adopted a multidim


• • • ., f

~~ auditing is not only restricted ensional


• ! _ :
1

the Co~paru~ ~ct. Th~ purpo


se of ~uditing -~as ~een ex
to financial audit under
~ ge na l po~o~, operationa ten
l efficiencies, system a'.ppliQtion ded .to cost accounts,
business organisations and envir s, so
ail the • f ualifi on
. mental aspects too. Even non-- cial implicitions of
av · L•-mess· -
se ~c es o q
.
ed audit ors an d ge t their aceotmts ~u~ted. f.t presorg
~w , aru·sa0•005
'"'
! ..... / ent;_the field
• • • . .. J \ l 1•

• •• •• 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.

1.1s. ·socltd::-'OBJEcr1VES' (>F AuDIT VV' j



i
""---"-''
:.. ~ II.
41.~-- ~ -~ '
,
~ r' n;~ ·~b
~ audit is a social science. So, audit has certain social objectives. It should make
contribu-
tions towards the fulfilment of social purposes. Auditing work to be effectively
performed
·has to function for the following purposes:
1. Protection of shareholders' interest
Auditors are the representatives'of the shareholders; naturally it is the duty of an
auditor to
see whether the interest of the shareholders are protected or not. The· shareholders
' interest
can·be protected by ensuring stable solvency; profitability and efficiency positio
n of the
company form of organisation. .. . , _ ,
.., 1.1

2. Protection of national interest .:, ~- .


Another vital social object-of an audit is to see that the national interest is protec
ted. The
national interest can be protected only when cases of evasions of taxes are preven
ted. So,
tax evasion should be discou!aged for 11:ational interest as there is no denying the
fact that
' raising revenue through taxation is a 'm:ust for the development of the c·ountry.
3. Safeguarding capital erosion
t
I •
.
Mere examihation of the books of accounts will not help to locate those factors
'

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

6, Fair retum for Investors


th ..
·tal of a company is not utilised . . • th m any will n~t b~·able
If e car1 eff1c1ently, e co p to
h hand the row th of the business may be Wl.thheld• BOth higheq
:air =~ ~~ ot: ;:ta ~rs tan d ~nth! wa a
0 y to fair retum. This rate of tu~retryrsh
a~ with tumover tate of other compan rul: be c~
ies
P estors depends on the solvency and probelfita
onging to th~ ~ame in
bili
us •. us ce to~
inv ty position of the .~usi_ness, Whit~
. ff . tu
becomes favourable through the earrun .
g o air re m.
,
1.16 ~DVANiAG~S OF AUDITING
vz/ The tasks of an audi~o~ a~e of great im~
his audit report impartially and effectiv
~rtance to all conce~ed. The ~uciitor
~r ;J
·' .,
{F~t
ely based on facts and actual figures.
the following advantages can be expect t! s 1s d~
~ I'
ed fro.m auditing: , ._ ,. ~ . y

. ~, ...
.~ I From ~a l Point of ~-lew '

. : ._,.
r •
.:. ,

~~ l· _1. Fl~l~g of ln~ome tax return . _:


J · j, • Income tax authorities generally accept the pro . . .. . i •

// 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

I e;ally b~ accep'ted by'the,saies tax' author


,._ ' I _J - 1
ities.
I , _, 4,. ,.

5. Action against bankruptcy



I •

. _ . •
. , . .
~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
' .. ' - . • . ') '

Auditing is a post-mortem examination. Tuer~ is no u~e of such e~amination when events


have already been occurred. 1 ' • 1
• •
1

,
1
• , ' ,

4, Existence of errors in the audited accounts


It is not possible for the auditor in all cases, to check each and every transaction. of an
organisation. As a result, there may be error in the audited accounts even after the checking
by the auditor.
"~

5. lad e of ep &t lll rts


a

Auditor has to seek ~o n of edxpe don rt . matters on whichhemaynothaveexp~


knowledge. The auditor has to epen ce a~ reports which may not always
upon su be corr~
_ ,~ 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

The auditor can only report on the truth • .• . , .·


and fairriess of the financial sta t~~ ts-
, bdefectsthe, i.de: defects rel~ting t~ m~age ~~ut othet
• ,v au 1tor.. .·, •
me nt w,d control m,ay ~ot ~~ ~~~c~ ~ covereq,
1
J : ., · · · •. .. • ;) ••· · ·•~ • .
. . 1 i l •.;:, rl
f •
rt ....
, ... ~ --
. ..~ . #"' .~ ..
- ....;, ..._ ,. ,.

; 1. 18 . QUIUTIES 8FAN AlllDl;fQ~;i


- . • ~ ... '
... <l • .., ... t; ' ·• 4',. '.
~
,a•' • .... :
• •

·:! • •
.•
.!

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 .- • ,
,

• :•· He must be objective b~~~ ~ formu~~ :j I ' '· , , ·, • ' •


;t ·.··- ~ ~-.·
..
1'

911g hi~Jopinioi:ts ~~din express~g them with


• r

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 ' :. , ..

~e ~_ls~ ~eeds to be ~a c~ ~d practical iJ:t 1 'I> -4 I f T ! .:,., ; •


1 • ••

• An auditor mUst be independent and


his dealings with his clients.
pendence. II\USt be carefµl DOt to C:Ompl'O~·his incle-
• • .. 1
.. ., \

.'
.. t
• • l
t
, .. t
1
l

-• .
' 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

.' Knowledge about the


: 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
' •. • ~· • ·, • :· : • :- ~·· •:

•• •Balancing books· • · 1 •• •• ·' • • • • • • • • • • : Liquidation arid receivership work


• • Preparing final accounts
• I
• Investigations
, •• • • • • .-, • , • • I • • : • • ,r. \•; • • t • • ~ #• • • • \.
1 •

• . ·•; • ~eg~tiatio~ •;; '~- ,. '. ' - ' , ;


I _ -~ ; ' ~ ~
-~: •• Risk m.anag~ment
•••• Goveriunent fonn fillirig ~ Corporate governance I ~. • - .• • • ,· • •
J • l. . • ~ ~ ~. .' l ·. , ... . • ; \ ~ # t •

. • 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

'• • ' •• • • 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.

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