Introduction of

Auditing
Course: Auditing
Outline
• Meaning and definition
• Important features of audit
• Objectives of auditing
• Distinction between accounting and auditing,
 MEANING AND DEFINITION
• The word Audit is derived from Latin word “Audire” which means ‘to
hear’.
• Auditing is the verification of financial position as disclosed by the
financial statements.
• It is an critical examination of the records and books of account of a
business by a independent qualified person for ascertaining the
authenticity and the accuracy of entries appearing in the books of
account and financial statement
• “Auditing… is a systematic and independent examination of data,
statements, records, operations and performances (financial or
otherwise) of an enterprise for a stated purpose. In any auditing
situation, the auditor perceives and recognizes the propositions before
him for examination, collects evidence, evaluates the same and on
this basis, formulates his judgment which is communicated through
his audit report.”
“ A careful and critical examination of books of accounts
by a properly qualified person on the basis of proper
evidence so as to express an opinion (i.e. views) about
the truth and fairness of financial statements”.
“Auditing is concerned with the verification of accounting data
determining the accuracy and reliability of accounting statements and
reports.” - R.K. Mautz

“Auditing is the systematic examination of financial statements,

records and related operations to determine adherence to generally
accepted accounting principles, management policies and stated
requirement.” - R.E.Schlosser

“Auditing is an examination of accounting records undertaken with a

view to establishment whether they correctly and completely reflect
the transactions to which they purport to relate.”- L.R.Dicksee
Important Features Of Audit
Examinations of books, statements: An audit is a critical examination of
the books of account and the financial statements drawn from them, including all
operations and performances, whether financial or otherwise.

By a properly qualified person … An audit examination can only be made

by a person (or group of persons) who is duly competent for the purpose. Only a
person who possesses the prescribed qualifications and who is wholly independent of
the client will be deemed as competent.
on the basis of proper evidence … An audit examination is to be made on
the basis of evidential documents such as invoices, money receipts and other
records, including information and explanations supplied by authorized
representatives of the client. It is the duty of the auditor to carefully assess and
evaluate every piece of evidence relevant for his examination.
to express his opinion as to the truth and fairness of assertions in
statements, financial accounts. The object of the audit examination is to enable the
auditor to express his opinion as regards the truth and fairness of the financial
statements prepared by his client.
Continue…
• To this end, be must ensure –
a) that the books of account have been maintained as
required by law, if any;
b) that the Profit and Loss Account (or Income and
Expenditure Account) gives a true and fair view of the
profit or loss of the business for the period under review,
c) and the Balance Sheet (or the statement of Affairs) gives
a true and fair view of assets and liabilities of the
business on the closing date.
Objectives of Auditing
1. Primary : To examine the reliability and validity of
the financial statements so as to render an opinion
of the truth and fairness of the presentation in
those statements.
2. Secondary: Detection and prevention of errors, and
fraud.
 Primary objectives
• The main objective of the auditing is to find reliability of financial
position and profit and loss statements.
• The objective is to ensure that the accounts reveal a true and fair
view of the business and its transactions.
• The objective is to verify and establish that at a given date balance
sheet presents true and fair view of financial position of the
business and the profit and loss account gives the true and fair view
of profit or loss for the accounting period.
• It is to be established that accounting statements satisfy certain
degree of reliability.
Thus the main objective of auditing is to form an independent
judgement and opinion about the reliability of accounts and truth and
fairness of financial state of affairs and working results
 Secondary objectives
• The subsidiary objectives of the auditing are:
1. Detection and prevention of fraud: the one of the
important subsidiary objective of auditing is the detection and
prevention of fraud. Fraud refers to intentional
misrepresentation of financial information. Fraud may involve:
a. Manipulation, falsification or alteration of records or documents
b. Misappropriation of assets.
c. Suppression of effect of transactions from records or documents.
d. Recording of transactions without substance.
e. Misapplication of accounting policies
2. Detection and prevention of errors: is another important
objective of auditing. Auditing ensures that there is no mis-
statement in the financial statements. Errors can be detected
through checking and vouching thoroughly books of accounts,
ledger accounts, vouchers and other relevant information.
Importance of Auditing
1. Audited accounts help a sole trader in knowing the value of the business for the
purpose of sale.
2. Dispute over correctness of profits can be avoided.
3. Shareholders, who do not know about day-to-day administration of the company , can
judge the performance of management from audited accounts.
4. It helps management in detecting and preventing errors and frauds.
5. Management gets advice on financial affairs from the auditors.
6. Long and short term creditors depend on audited financial statements while taking
decision to grant credit to business houses.
7. Taxation authorities depend on audited statements in assessing the income tax, sales
tax and wealth tax liability of the business.
8. Audited accounts are useful for the government while granting subsidies etc.
9. It can be used by insurance companies to settle the claims arising on account of loss by
fire.
10. Audited accounts serve as a basis for calculating purchase consideration in case of
amalgamation and absorption.
11. It safe guards the interests of the workers because audited accounts are useful for
settling trade disputes for higher wages or bonus
Comparison Table Between
Accounting and Auditing
Parameter of Accounting Auditing
Comparison
Accounting is the process by Auditing is the process of a
which day-to-day monetary comprehensive evaluation of
records of the organizations are the financial statements or
maintained and are further records prepared under the
utilized to prepare the financial accounting process. The main
Definition statements. These financial purpose is to verify the
statements give a true picture reliability of the financial
of business health. statements.

Accounting takes the input from Auditing starts when

the books of account or accounting work is completed.
bookkeeping i.e. daily The financial statements
Initiation transactions that involve sale
or purchase of something and
prepared by the accounts
function are verified to check
then utilize them to prepare the accuracy, completeness,
financial statements of the and trustworthiness.
 Mode of Operation Daily i.e. continuous process Periodic i.e. quarterly or yearly

Current: The scope of work Past: The scope of work

Scope involves the creation of current involves validating the past
year financial statements. financial statements.

The main objective of The main objective of Auditing

Accounting is to assess whether is to verify the correctness of
a company has earned profits the organization’s account and
Objective or suffered losses, thus financial statements, thus
establish the current financial certain or certify that they
position of the organizations for exhibit the true view.
that particular period.
Very detailed as every financial Sample-based
Level of Detail transaction need to be
captured
Financial statements e.g. Audit Reports
Income Statement or statement
Key Deliverables of Profit & Loss, Balance Sheet,
Cash Flow Statement, etc.

Carried by Bookkeepers and Qualified Auditing agency or

Performed By Accountants (internal auditors (external &
 WHY IS THERE A NEED FOR AN
AUDIT?
• 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 disclose 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.
ERRORS AND FRAUDS IN
ACCOUNTING
Errors
• Generally errors are the result of carelessness on the part
of the person preparing the accounts.
• Errors can be described as unintentional mistakes.
Accounting errors, which are possible to be detected
through auditing, can be of the following types:
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.
Examples
(a) Omission of purchases from purchases day book.
(b) Ignoring depreciation on fixed assets completely.
Errors of commission
When entries made in the books of original entry or ledger are either
wholly or partially incorrect, they are known as errors of commission.
Some of these errors may not affect the trial balance.
Examples
(c) Wrong amount recorded in the books of original entry, e.g. sale of
goods of Rs. 15,000 recorded as Rs. 1,500 in sales day book. This
error will not affect trial balance.
(d) Posting to the wrong side of an account. In place of debiting, e.g. an
amount of Rs. 150 is credited. This error will affect the trial balance
• Compensating errors
When an error offsets the effect of another error, it is known as a
compensating error. These errors do not affect the agreement of
the trial balance, hence cannot be located by it. Examples
(a) A debit balance is undercast by Rs. 100 and credit balance is
undercast by the same amount.
(b)Sales return of Rs. 500 is posted to the Return Inward A/c as Rs.
5,000 and similarly purchase return of Rs. 500 is posted to the
Return Outward A/c as Rs. 5,000.
• Errors of principles
When principles of book-keeping and accountancy are not
followed, the error is known as error of principles.
Such errors may be committed intentionally to understate asset
and to overstate liability and to inflate and deflate profit as and
when the circumstance dictates.
Examples
(a) Treatment of capital expenditure as revenue expenditure, e.g.
purchase of machinery treated as purchase of goods.
(b)(b) Valuation of stock on the basis of wrong principle
Fraud
Fraud means false representation or entry made
intentionally or without belief in its truth with a view to
defraud somebody. Detection of fraud is considered to be
one of the important duties of an auditor
The following are the main ways in which fraud may be
activated:
Embezzlement of cash Defalcation of cash is possible
irrespective of the size of the business small or large.
Misappropriation of goods Misappropriation of
goods is another type of fraud.
It may happen that the valuable goods of an organization may be
stolen by the employees or workers.
It may also happen that the storekeeper in collusion with the works
manager may sell the goods illegally to some third party.
Such frauds are very difficult to locate or identify
Manipulation of accounts Accounts are manipulated
through falsification of accounts.
These are fraudulent manipulations through accounts and arise
generally through passing of false entries with the motive of
misappropriating funds slowly and steadily.
Unlike misappropriation of cash and goods, this type of fraud is done
by the sophisticated personnel of an organization.
ROLE OF AUDITORS IN DETECTING
ERRORS AND FRAUDS
• The auditor sees his duty as: “The independent
examination of, and expression of opinion on, the
financial statements of an enterprise by an appointed
auditor in pursuance of that appointment and in
compliance with any relevant statutory obligation.”
• 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 analyzed 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.
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.
SCOPE AND PROCEDURES OF
AUDIT
• The scope and procedures of audit for a particular
organization will be determined by the auditor on the
basis of the terms of engagement, the requirement of
relevant legal formalities and the pronouncement of
the Institute.
• The principal areas to be covered in an audit include
the following:
1. Accounting and internal control
• An examination of the system of accounting and internal control to
ascertain whether it is adequate and appropriate for the concerned
organization or not.
2. Arithmetical accuracy
• An overall checking of the arithmetical accuracy of the books of
accounts by the method of posting, casting and balancing procedures.
3. Authenticity of transactions
• A proper verification of the validity and authenticity of the transactions
entered into by checking the entries with the supporting documents.
4. Distinction between capital and revenue items
• An effective scrutiny over the distinction between the items of capital
and of revenue nature of income and expenditure correspond to the
accounting period.
5. Verification of assets
• A detailed verification of the ownership, existence and value of the
assets appearing in the balance sheet.
6. Verification of liabilities
• A proper verification of the liabilities of the organization as stated in the
balance sheet.
7. Comparison of the financial statements
• A comparison of the balance sheet and profit and loss account or other
statements with the available records in order to see that they are in
accordance therewith.
8. Truth and fairness of financial statements
• An effective checking of the results as shown by the profit and loss
account to see that the results shown are true and fair.
9. Statutory requirements
• A concrete confirmation about the fulfilment of the statutory
requirements and legal formalities in recording the financial
transactions and in preparing the financial statements.
10. Appropriate reporting
• An appropriate reporting to the concerned persons to explain whether
the statements of accounts examined do reveal a true and fair view of
the state of affairs and of the profit and loss of the organization
 ADVANTAGES OF AUDITING
• From Legal Point of View
1. Filing of income tax return
Income tax authorities generally accept the profit and loss account that has been
prepared by a qualified auditor and they do not go into details of the accounts.
2. Borrowing of money from external sources
Money can be borrowed easily on the basis of audited balance sheet from
external sources. Most of the financial institutions sanction loan on the basis of
audited financial statements.
3. Settlement of insurance claim
In case of fire, flood and the like unexpected happenings the insurance company
may settle the claim for loss or damages on the basis of audited accounts of the
previous year.
4. Sales tax payments
The audited books of accounts may generally be accepted by the sales tax
authorities.
5. Action against bankruptcy
The audited accounts serves as a basis to determine action in bankruptcy and
insolvency cases.
• From Internal Control Point of View
1. Quick discovery of errors and frauds
Errors and frauds are located at an early date, so that in future no
attempt is made to commit such frauds as one is rather careful not to
commit an error or a fraud as the accounts are subject to regular audit.
2. Moral check on the employees
The auditing of accounts keeps the accounts clerks regular and vigilant
as they know that the auditor would complain against them if the
accounts are not prepared up to date or if there is any irregularity.
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 accounts have been prepared on a uniform basis, accounts of one
year can be compared with other years and if there is any discrepancy,
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 business 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 independent
person.
3.Future trend of the business
The future trend of the business can be assessed
with certainty from the audited books of accounts.
 LIMITATIONS OF AUDITING
• Auditing suffers from the following shortcomings:
1. Want of complete picture
The audit may not give complete picture. If the accounts are prepared with
the intention to defraud others, auditor may not be able to detect them.
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. There is no use of such
examination when events have already been occurred.
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 organization. As a result, there may be error in the
audited accounts even after the checking by the auditor.
5. Lack of expertise
Auditor has to seek opinion of experts on certain matters on
which he may not have experts knowledge. The auditor has to
depend upon such reports which may not always be correct.
6. Diversified situations
Auditing is considered to be a mechanical work. Auditors may not
be in a position to frame audit programme, which can be followed
in all situations.
7. Quality of the auditor
Success of audit depends on the sincerity with which the auditor
has performed his duties. The same audit work can be done by
two different auditors with difference in sincerity.
8. Existence of defective policies
The auditor can only report on the truth and fairness of the
financial statements. But other defects, i.e. defects relating to
management and control may not be possible to be covered by
the auditor
 QUALITIES OF AN AUDITOR
• Only a chartered accountant can be appointed as an auditor of a limited company.
Besides the statutory requirement about the qualification of an auditor, he must
possess the following qualities:
• An auditor must possess the necessary technical ability and knowledge to
audit accounts.
• He must be conversant with the relevant provisions of the companies and
other regulations and with both best current accounting practices and current
auditing practices.
• He must be objective both in formulating his opinions and in expressing them
without bias.
• He must have integrity. Once he has formed his opinion, he must be prepared
to express it clearly without fear and favour.
• He must be methodical in his work. An auditor who leaves loose ends will find
himself open to allegations of negligence.
• He should have an inquiring mind. An auditor must recognize suspicious
circumstances, and once his suspicion has been aroused, he has a duty to
probe matters to the bottom.
• He also needs to be tactful and practical in his dealings with his clients.
• An auditor must be independent and must be careful not to compromise his