Auditing

MODULE: 1- INTRODUCTION
and
assurance
 MEANING, DEFINITION AND
NATURE OF AUDITING
The word audit is derived from the Latin word “audire” which means
‘to hear’.
It is the examination of the books of accounts of a business concern by an
independent person called auditor.
The work of an auditor begins on completing the accounting process.
Auditing is only a post- mortem analysis of the books of accounts.
It is an intelligent and critical examination of the books of accounts and
other documents through checking, vouching, and verification.
 DEFINITIO
N

Montgomery defines auditing as, “ a systematic

examination of the books and records of a business or
other organization, in order to ascertain or verify, and to
report upon the facts regarding its financial operations and
the result thereof.”
 NATURE/ FEATURES/ ESSENTIALS/ ASPECTS OF AUDITING

a. Systematic Examination: It is a systematic examination of the accounting records of the client.

b. Preparation of Accounts: The accounts are to be prepared by others, and not by the auditor.
c. Person conducting auditing: The auditing is to be carried on by independent and duly qualified
persons.
d. Examination of accounting: The examination of accounting records may be made throughout
the year or periodically.
e. Application of tools and techniques of audit: The auditor examines the accounting records with
the help of relevant records, vouchers, documents, information, explanation etc.
f. Report: The auditor has to satisfy himself and report with regard to the truth and fairness of
profit or loss of the period and financial position of the concern, as reflected in its balance sheet.
g. Scope of audit: The scope of audit is not limited only to the business concerns but it may be duly
extended to non- commercial concerns also.
 PRINCIPLES OF
GOVERNING Documentation
AN AUDIT : 5.
Audit principles are the basic rules according to
which the books of accounts of a business are to be Audit notebook- audit plan- audit files- audit
audited. Standards on audit (SA-200), describes the memorandum etc.
nine basic principles that govern the procedure of 6. Planning:
auditing.
 Audit plan- plan of action to be taken by the auditor while
1. Integrity, Objectivity, and independence: conducting the audit work.
 Honest-sincere- objective- without any prejudice- no
malpractice- impartial attitude – free from any personal interest. 7. Audit Evidence:
2. confidentiality: It is the information that the auditor uses in arriving at a
 Audit should be kept confidential. conclusion on the basis of which he forms his opinion.
3. Skill and competence: 8. Accounting system and internal control:
 Skill, training, experience, and competence in auditing. –
aware of new developments in accounting, auditing, and Adequate accounting system – internal control. – auditor
statutory rules and regulations as amended from time to time. has to determine the nature, timing, and extent of audit
4. Work performed by others: procedure to be applied.
 The auditor wil.vcl be fully responsible for the work done by 9. Audit conclusions and Reporting:
team.
Audit report- AAP- regulations- all material matters.
 SCOPE OF AUDIT- (RANGE OF ACTIVITIES & PERIODS OF
RECORDS)
1. Legal Requirements: Legal requirements 7. Comparison : check whether the same data
and regulations of relevant professional bodies. have been processed for preparing the final
accounts of a business concern.
2. Entity aspects: to cover all aspects relevant
for auditing. 8. Judgements: the auditor has to assess the
judgements made by the management regarding
3. Reliable information: Information contained the accounting policies followed and their
in the accounting records are reliable. consistent application.
4. Proper communication: all relevant
information are properly communicated in the
financial statements.
5. Evaluation: evaluating the accounting system
and internal control system.
6. Test: to assess reliability and sufficiency by
conducting test and other verification procedure.
 OBJECTIVES OF AUDIT
DETECTION OF
ERRORS

SUBSIDIARY/
DETECTION OF
SECONDARY/INCIDENTAL FRAUDS
OBJECTIVES.

OBJECTIVES OF PREVENTION OF ERRORS

AUDIT AND FRAUDS

VERIFICATION OF
MAIN / PRIMARY OBJECTIVES ACCOUNTS AND
FINANCIAL STATEMENTS
 MAIN / PRIMARY OBJETIVES
The main object of audit is to verify the accounts and to report whether the profit and
loss account and balance sheet are properly drawn up according to the companies act,
2013 and the exhibit a true and fair view of the state of affairs of the concern. For the
purpose he must:
Examine the system of internal check.
To check the arithmetical accuracy of the books of accounts.
Verify the authenticity and validity of the transactions with the relevant documents.
See that a proper distinction is made between the items of capital and revenue nature.
Verify and value the assets and liabilities.
 SUBSIDIARY /
SECONDARY/ INCIDENTAL
OBJECTIVES
1. Detection of
Errors

b) Errors of
a) Clerical Errors
principles

iv)
i) Errors of ii) Errors of iii) Errors of
Compensating
Omission Commission Duplication
Errors
 I ) ERRORS OF OMISSION
When the transaction is not entered in the books of original
entry or not posted from the books of original entry to the
ledger, an error of omission is caused.
The error of Omission may be complete or partial.
Error of complete omission happens when a transaction is not
at all recorded in the day book or subsidiary book.
It does not affect the agreement of trial balance.
Error of partial omission happens when a transaction is
partially recorded in the books of accounts.
 It affects the agreement of the trial balance.
 II) ERRORS OF
COMMISION
 Errors of commission are those errors committed by incorrectly
recording the transactions in the books of accounts.
 wrong posting, wrong balancing, wrong carry forwards etc.
These errors affect the agreement of trial balance
 III) ERRORS OF
DUPLICATION
 Are those errors occurred when transactions are
recorded twice in the books of original entry, and
hence posted twice in the ledger accounts.
Errors of duplication does not affect the agreement of
trial balance.
Clerical errors, confusions
Careful vouching is the only answer to detection of
such errors.
 IV) COMPENSATING
ERRORS
oAre those errors which are compensating each other.

oWhere two or more errors occur, but their effects

cancel each other out, resulting in a final result that is
closer to the true or expected value.
 B) ERRORS OF
PRINCIPLES
It is one in which happens when any accounting
principles is violated in recording a transaction.

Errors of principle are committed in those cases where

a proper distinction between revenue and capital items
is not made.

Capital expenditure is taken as a revenue expenditure

or vice versa.
 DUTIES OF AN AUDITOR
WITH REGARD TO
DETECTION OF ERRORS
 check and re-check the total of the trial balance He should checkup the totals of the lists of
to ensure that there is no mistake in totaling it. debtors and creditors and compare them with
 When there is a difference in the Trial Balance, the debtors' and creditors' balances entered in
the auditor should see whether there is any the Trial Balance.
account or item, having the same balance, which He should compare the names of ledger
is not included in the Trial Balance.
accounts, its balances.
When there is a difference in the Trial Balance,
he should divide the amount of difference by 2, To checkup the debit and credit balance of
and see whether any debit item equal to that accounts have been entered on the correct
sum has been wrongly entered on the credit columns or side of the balance sheet.
balance column of the Trial Balance or any credit
item equal to that sum has been wrongly  to check total of ledger accounts, carry
entered on the debit balance column of the Trial forwards, opening balances, closing balances ,
Balance total of the books of original entry
 auditor should check up with the casting or  compare the items in the trial balance of the
totaling of the various ledger accounts. current year with the items of the previous year.
 DETECTION OF FRAUDS
A fraud is an intentionally created mistake committed or defraud
the proprietors of the concern. Fraud may be of three types;
Misappropriation / embezzlement of
cash

Misappropriation of goods

Falsification / manipulation of
accounts
 MISAPPROPRIATION OF CASH
it means that fraudulent appropriations of cash belonging to another person by one who
handles it.

A) suppression or non- disclosure of cash B ) Inflating the payments or showing false cash
receipts payments
 omitting to record the full cash sale proceeds. Inflating the payments or showing false cash
payments.
 recording the cash sale proceeds at a figure
 Recording fictitious or false cash purchases.
lesser than the actual cash sale.
 omitting to record the credit sale.  recording cash purchases at a figure higher than the
actual amount and pocketing the difference.
 teeming and lading: - the money received from
Recording payment to fictitious creditors for purchases
the first customer is misused or misappropriated
by the cashier. The money received from the Recording payments to creditors at a figure higher
second customer is credited to the account of than the actual amount.
the first customer, The money received from the Not recording the purchase returns, discount and
third customer is credited to the account of the allowances from suppliers or creditors, and pocketing
second customer. This practice is continued till the amounts by showing them as payment to creditors.
such fraud is detected. This is called teeming
and lading.  Recording payments to dummy workers and pocketing
the money.
 cash received from sale by V.P.P may be
Recording fictitious payments of expenses, such as
pocketed, making fictitious or false entries in the
refreshments and pocketing the money.
 MISAPPROPRIATION OF GOODS
 Its detection is not easy.
Goods can be misappropriated by;
the actual theft of stock
 the issuing of fictitious credit notes to customer
detailed checking is necessary to detect misappropriation of goods. There
must be strict control over the issue of materials, records of sale,
purchases and stock
 MANIPULATION OR
FALSIFICATION OF
ACCOUNTS
Manipulation of Accounts is the falsification of Reasons for understatement of profit are:
accounts, intentionally committed by managers, to reduce tax liability
directors or other responsible officials to overstate
or understate the profit and financial condition of  to deceive the competitors by creating wrong
the business to serve their ulterior motives. impression about the performance of the business.
Reasons for overstating profit are: to induce a fall in the price of shares with a view to
to earn more commission, if it is based on profit. buying them in bulk at lower prices.

to get better prices for the shares owned by to avoid payment of higher bonus to workers and
them. commission to managers.

to win the confidence of members by claiming Different methods of manipulation of accounts:
that the higher profits are the results of higher  window dressing : it is the practice by which the
efficiency of the management. balance sheet is made to show state of affairs that is
to make more persons subscribe to the shares of rosier or far better than the actual state of affairs.
the concern.  by creation or utilization of secret reserves
to get better credit terms from the creditors, Undervaluation or over valuation of stock or other
financiers etc. assets etc..
 PREVENTION OF ERROR AND
FRAUDS
Besides detection of errors and frauds, auditor has to take steps to prevent their occurrence. It
is possible only by the application of sound system of internal check and efficient management
of the concern. The auditor simply puts a moral check on the client's staff. They will be very
alert as any dishonest transactions carried on by them would be sooner or later detected by
the auditor.
The auditor has to do the following in connection with detection and prevention of errors and
frauds.
1. Check the internal check system
2. Ensure how far accounting principles have been followed.
3. Preparation of accounts:
4. Checking of Balance Sheet.
If a fraud is detected after the completion of audit, the auditor cannot be blamed in all
circumstances. If in the best of his knowledge, skill and care, he certifies the account as
correct, he cannot be held responsible for an error or fraud which is still in their accounts.
Auditor cannot do any thing directly for the prevention of errors and frauds. He can give only
suggestions for the prevention of recurrence of errors and frauds in future.