INTRODUCTI

MODULE 1 ON TO
AUDITING
TOPICS COVERED
Origin
Meaning
Definition
Purpose and functions
Factors responsible for growth of auditing
Advantages and limitations of audit
Objectives (SA200)
Types of errors and location
Types of Audit
ORIGIN OF AUDIT
• The International Federation of Accountants (IFAC) was set up in
1977 with a view to bring harmony in the profession of accountancy on a
global scale.
• The IFAC Board has established the International Auditing and Assurance
Standards Board (IAASB) to develop and issue high-quality auditing and
assurance standards for use around the world.
• The Institute of Chartered Accountants of India is a member of the IFAC
and constituted the Auditing Practices Committee (APC) in 1982.
• The main function of the APC is to review the existing auditing practices
in India and to develop Statements on Standard Auditing Practices (SAPs).
• In July 2002, the Auditing Practices Committee was converted into an
Auditing and Assurance Standards Board (AASB), and the nomenclature
of SAPs has also been changed to Auditing and Assurance Standards
(AASs).
MEANING
Audit is derived from a Latin word, AUDIRE means to hear.

In the middle ages , an Auditor used to listen to the accounts

read over by an accountant in order to check them.

Auditing simply means Verification and examination of

accounts. It is done to ascertain the reliability and validity of
information.
 DEFINITION
According to R.K. Moutz, “ Auditing is concerned with the
verification of accounting data with determining the accuracy and
reliability of accounting statement and record”.

“An audit is an independent examination of financial information of

any entity , whether project oriented or not , and irrespective of its
size or legal form, when such an examination is conducted with a
view to expressing an opinion thereon.”
THE AUDITOR
 The person conducting an audit is known as the auditor. An auditor is a
trained professional who is responsible to review and verify the
accounting data of any business undertaking pertaining to its business
activities.
 He makes a report to the person appointing him after due examination of
the accounting records and the accounting statement in the form of an
opinion on the financial statements.
 The opinion that he is called upon to express is whether the financial
statement reflects a true and fair view.
 In India, under the authority of the Companies Act of 1956, only
Chartered Accountants are professionally qualified for the audit of the
accounts of companies.
 Objectives of Audit
(SA 200)
Objectives

Primary Secondary

Detection Detection
Express Verifying as and and
opinion per standards prevention of prevention of
Errors Frauds
Detection and prevention of Errors
Errors refer to unintentional misstatements in the records or books.
Clerical errors: Clerical errors refer to all types of errors committed on
account of clerical mistakes. They are -
a. Errors of Omission: - An error of omission is one which arises when a
transaction has been omitted to be recorded in the books of accounts either
wholly or partially.
b. Errors of Commission: - Errors of commission refer to errors committed in
the process of posting from the subsidiary books to the ledger accounts, casting,
carry forward and balancing of ledger accounts.
c. Compensating errors: - When the effect of one error is counter balanced,
set off or compensated by another error, the errors are known as compensating
errors or offsetting errors.
Detection and prevention of Errors

d. Errors of principle - An error of principle arises when the generally

accepted principles of accountancy are not observed, while recording a
transaction in the books of account. In other words, if a transaction is
recorded in the books of account against the generally accepted principles
of accountancy, the error is known as an error of principle.
Ex - Capital expenditure is recorded as revenue expenditure or vice versa,
and capital receipt is recorded as revenue receipt or vice versa.

e. Duplicating errors – Errors generating out of duplicate entries.

Detection and prevention of Frauds

Detection and prevention of frauds: - It is intentional or

willful representation or deliberate concealment of material
fact with a view to deceive, cheat or mislead somebody.
Fraud may be broadly classified into three types. They are
(1) Misappropriation of cash
(2) Misappropriation of goods
(3) Manipulation of accounts
Misappropriation of Cash

Due to the quality of cash being high in value and low in volume, it can be
embezzled easily. It might occur in the following ways:
1. Inflating purchase account by making false bills for the purchase of
goods and expenses.
2. Decreasing sales by not recording vouchers.
3. Making entries for false donations and charity.
4. Not showing a loan received in the books of accounts.
5. Embezzling wages by entering fictitious names in the wage sheets.
6. Making fictitious entries in the customer’s accounts relating to discounts,
returns, bad debts and embezzling the cash returned by them.
Misappropriation of Goods

The misappropriation of goods is more common in organisations where

goods are smaller in size but more expensive. It is also widespread in
government organisations. It might occur in the following ways:
1. Stealing goods from the store.
2. After entering purchases, embezzling the goods before it reaches the
godown or store.
3. Issuing fictitious credit notes in customers’ names but embezzling the
related goods.
4. Not entering goods received as sales returns.
5. Removing certain goods on account of purchase returns.
6. Using the organisation’s goods for personal use.
Manipulation of Accounts

Manipulation of accounts is done by managers, owners or the higher level

officers, while the rest is done by lower level employees. It may be
manipulated with the following objectives:
1. Saving of income and sales tax.
2. Hiding the true picture of the business from competitors.
3. Enhancing profits with the aim of earning a higher commission payable
on the basis of profits.
4. Declaring lower profits in order to declare lower dividend payouts and
paying lower employee bonuses.
5. Obtaining loans.
Manipulation of Accounts

Accounts may be manipulated in the following

manner:
1. Not claiming depreciation on assets, or claiming
depreciation at lower or higher rates.
2. Under or over-valuing assets or liabilities.
3. Showing fictitious expenses.
4. Not recording income in the books.
5. Creating secret reserves.
“AUDITING BEGINS
WHERE ACCOUNTING
ENDS ”
Accountancy Auditing
1. It is constructive in nature. 1. It is analytical in nature.
2. Scope is restricted to preparation of 2. It is determined by the agreement
financial statements. between auditor and his client.

3. No formal professional 3. Must be qualified Chartered

qualification required. Accountant.

4. Main object is to find operating 4. Main object is to ascertain truth and

fairness of statements.
results.
5. It starts where accounting ends.
5. It starts where book-keeping ends.
6. Auditor gets a fixed amount known as
6. Paid monthly salary. Audit fees.
7. Accountant is employee of the 7. Might be internal or external person-
business. independent outsider.
CLASSIFICATION
OR
TYPES OF AUDIT
CLASSIFICATION OF AUDIT
OR TYPES OF AUDIT
Classification of Audit on the basis of Organization
structure.

Classification of audit on the basis of Degree of

independence of the auditor

Classification of Audit on the basis of method or approach to

audit work or on the basis of extent of work to be performed
or on the basis of conduct of audit.

Classification of audit on the basis specific objectives

CLASSIFICATION ON THE
BASIS OF ORGANIZATION OR
ORGANIZATION STRUCTURE
1. Statutory audit – The audit of an organisation which is legally mandatory
under any enactment is known as a statutory audit. Certain organisations which
are established under specific legal enactments, are legally bound to have a
mandatory audit. Also known as compulsory audit, it is mandatory for the
following companies:
1. Joint stock companies registered under the Companies Act of 2013 or previous.
2. Banking companies under the Banking Companies Act, 1949.
3. Insurance companies governed by the Insurance Companies Act of 1968.
4. Public and charitable trusts registered under various enactments related to law.
5. Local government and local authorities.
6. Co-operative societies registered under the co-operative societies acts of
various states.
2. Private audit – The audit of accounts of organisations which are not
under any legal compulsion to get audited is known as a private audit. It
is also known as voluntary audit because whether or not to get the audit
done, depends upon the organisation. In this audit, the duties and rights
of the auditor are determined on the basis of the audit agreement.
• Sole Traders
• Partnership firms
• Individuals and institutions
3. Government Audit – The audit of accounts of government
departments and institutions is known as a government audit. The
Comptroller and Auditor General of India is the chief officer of the
accounts and duty department and is appointed by the President of India
under Article 148 of the constitution of India. Article 149 states the rights
and duties of the auditor. Under Article 151, the comptroller and auditor
general submits his report on accounts of the central government to the
President.
CLASSIFICATION OF AUDIT
ON THE BASIS OF DEGREE
OF INDEPENDENCE:-
External auditors are the persons who practise the profession of
accountancy having qualified in the professional examination and are
external to the organization of which they audit the accounts. They
are appointed by the owners of the organisation, say, shareholders of
the company and thus they are treated external to the organisation in
which they have been appointed.
Internal auditors, on the other hand, may also be professionally
qualified and are internal vis-a-vis the organisation in which they are
appointed to perform specific work. They are considered internal
because their appointment is done by the management and the scope of
work is also specified by it. They may be appointed either on a contract
basis or as employees to undertake auditing of the books and records
as a part of management control and appraisal system.
ON THE BASIS OF CONDUCT
OF AUDIT OR METHODS OR
APPROACH TO AUDIT WORK
Continuous Audit

Final Audit or Annual or periodical audit

Interim Audit

Balance sheet audit

Occasional Audit

Complete Audit

Partial Audit
1. Continuous Audit- The examination of the books of accounts
by the auditor throughout the year or at irregular or regular
intervals is known as a continuous audit. Such an audit is also
known as a detailed audit or a running audit. The auditor’s staff
keeps on auditing the accounts at fixed intervals – like weekly,
fortnight or monthly, and the auditor gives the report at the end of
the year.
2. Complete Audit – If the books of accounts of an organisation
relating to a specified person are examined in detail so that no
transaction or other related document remains unexamined, then
such an audit is known as a complete audit. In such an audit, every
transaction, entry, book, total, balance, vouchers are examined.
3. Partial Audit – when, instead of examining all books of
accounts of a particular organisation, only a specific part of the
books are examined, it is known as partial audit. Ex- examining
only purchase book, sales book, cash book, etc. This type of
auditing is not practical as the auditor has to examine only partial
books.
INTERIM AUDIT
It is an audit conducted between two annual audits. In other words, it
is the audit conducted in the middle of the financial year. It is carried
out for some specific purpose for declaring interim dividend,
ascertaining interim profit.
Advantages:
1) Quick discovery of errors and frauds.
2) Imposes moral check on client staff.
3) Helpful for speedup the final audit.
4) Useful for publication of interim figures.
5) Audit becomes easy and can be completed without lapse of time.
Balance sheet audit: - Balance sheet audit is a
type audit which concentrates mainly on the
verification of the items in the balance sheet such
as capital, reserves, profit and loss account
balance, liabilities and provisions and all the
assets of the business.
Occasional Audit:- An occasional audit is an
audit which is conducted once a while, whenever
the need arises. In other words , it is a kind of
audit which is not conducted on regular basis, but
is conducted for a special event, time or purpose.
Complete Audit:- Complete audit is a kind of
audit under which all the records and books of
accounts are audited by an auditor.
CLASSIFICATION OF
AUDIT ON THE BASIS OF
SPECIFIC OBJECTIVES:
Cash Audit
Special Audit
Operational Audit
Proprietary Audit
Efficient Audit
Tax Audit
Cost Audit
Management Audit
Social Audit
ADVANTAGES OF
AUDITING
 ADVANTAGES OF
AUDITING
1. Audit ensures the accuracy or correctness of the books of accounts
2. Audit ensures the authenticity and reliability of the financial statements.
3. Audit helps in the detection and rectification of errors and frauds.
4. Audit helps the enterprise and management to ascertain whether the legal
requirements are complied with.
5. Audit point out the weakness of the existing system of internal check and
internal control.
6. Audit examination makes the employees in charge of accounts and
records vigilant, regular and up- to –date in their work.
 ADVANTAGES OF
AUDITING
7. Liability of an enterprise as to income tax and GST can be easily determined
on the basis of audited accounts.
8. A business can enjoy better reputation, if its accounts are audited by an
independent professional auditor.
9. Audited accounts are more reliable as evidence in courts of law.
10. The insurance claim can be easily determined on the basis of audited accounts
11. Audited accounts serve as a basis for solving the disputes as to higher wages.
12. Comparison of accounts from year to year becomes easier since the accounts
are uniformly prepared.
13. Loans and credit facilities can be easily obtained by a concern on the basis of
audited accounts
DISADVANATAGES OF
AUDITING
1. Non-detection of errors or frauds: - Auditor may not be able to detect certain
frauds which are committed by the clients.
2. Dependence on explanation by others: - Auditor has to depend on the
explanation and information given by the responsible officers of the company.
Audit report is affected adversely if the explanation and information prove to be
false.
3. Dependence on opinions of others:- Auditor has to rely on the views or opinions
given by different experts viz Lawyers, Solicitors, Engineers, Architects etc., he
cannot be an expert in all the fields
4. Conflict with others: - Auditor may have differences of opinion with the
accountants, management, engineers etc. In such a case personal judgement
plays an important role. It differs from person to person.
5. Effect of inflation : - Financial statements may not disclose true picture even
after audit due to inflationary trends.
6. Corrupt practices to influence the auditors: - The management may use corrupt
practices to influence the auditors and get a favourable report about the state of
affairs of the organisation.
DISADVANATAGES OF
AUDITING
7) No assurance: - Auditor cannot give any assurance about future
profitability and prospects of the company.
8) Inherent limitations of the financial statements: - Financial
statements do not reflect current values of the assets and
liabilities. Many items are based on personal judgement of the
owners. Certain non-monetary facts cannot be measured. Audited
statements due to these limitations cannot exhibit true position.
9) Detailed checking not possible: - Auditor cannot check each and
every transaction. He may be required to do test checking.
10) Auditing is a post mortem examination of accounts.