UNIT -1

Meaning and objective of Auditing

Auditing is an examination of the books of accounts and vouchers of the business by an
independent person who should be qualified for the job, in order to ascertain their accuracy.

Objectives of Auditing:

The basic objective with which auditing is done are:

1. Verification of accounts and statements.

2. Detection of errors or frauds.
3. Prevention of errors or frauds.

The auditor is given a free hand to the books, accounts, statements enabling him to thoroughly
check them and if satisfied to certify that books have been properly drawn up and represent a
true view of the financial position of the business. He gives his special attention to the direction
of errors which may be innocently or intentionally committed.

In the case of former the auditor discovers the errors by vouching the transactions and by
comparing and tallying the balances between and amongst various books. But in the case of latter
such errors are classified as frauds as it leads to defrauding the proprietors. The frauds could be
detected by a thorough checking of the books and documents such as cash book, vouchers,
invoices, wage sheets, etc.

Advantages of Auditing:

1. It detects errors and frauds with suggestions for their prevention.

2. To avoid such mistakes being committed the accounts are kept up-to-date.
3. The parties feel confident of the audit report because it was done by an
independent person or body.
4. Accounts as audited stand authentic.
5. The auditors are competent persons in the fields of accounts and financial laws
so can render advice to management.
6. In case of joint stock companies the director has no chance of taking undue
advantages.
7. Auditing accounts facilitates settlement among partners.
 Accounting and Auditing
Accounting and audit have a pivotal role to play in the financial record keeping process of
any business though their roles are different in their focus. While accounting translates to a
much wider field, encompassing everything from the organization to the management of the
flow of money through the company, auditing is more of a specialized service.

Auditing is a part of the accounting world. It is an examination of accounting and financial

records that is undertaken independently. This is done to determine if the company or the
business undertaking has confirmed its operations to the laws and the generally accepted
accounting principles.

Whether you are a small business or a complex organization, keeping track of all your
financial activities can be a daunting task. And accounting does just that for you by keeping
track of your business. It reliably records every aspect of financial activities taking place,
which is a crucial piece of information for the management of your company. One key
function of accounting is keeping you updated about the company’s performance. This helps
in identifying the areas of underperformance and those that require corrective measures. The
information derived from accounting assist in the long term project planning of the business
as well.

You know that if your books are kept up-to-date in accordance with the generally accepted
accounting principles, it makes it possible for you to gauge your own performance and also
make peer to peer comparisons. This is an important aspect of creating and maintaining
credibility with your competitors and vendors. Your financial position determines how much
credit you may be allowed and at what rates, etc. Investors will get a clear picture of the risk
and opportunity your company could offer them. Keeping your accounts in place will serve
you well when it is time to pay your taxes, file your returns and claim deductions.

Difference between Accounting and Auditing

In terms of

(i) Definition

Accounting is keeping records of the financial transactions and preparing financial

statements; but auditing is critical examination of the financial statements to give an opinion
on their fairness.
(ii) Timing

Accounting is carried out on continuous basis with daily recording of financial transactions;
while auditing is basically a periodic process and carried out after the preparation of final
accounts and financial statements, usually on yearly basis.

(iii) Beginning

Accounting starts usually where book-keeping ends; while auditing always starts where
accounting ends.

(iv) Period

Accounting mainly concentrates on the current financial transactions and activities; while
auditing concentrates on the past financial statements.

(v) Coverage

Accounting covers all transactions, records and statements having financial implications;
while auditing mainly covers final financial statements and records.

(vi) Level of Detail

Accounting is very detailed and captures all details related to financial transactions, records
and statements; while auditing generally uses financial statements and records on sample
basis.

(vii) Type of Checking

Accounting involves checking and verifying details related with all financial statements and
records; while auditing may be carried out through test checking or sample checking.

(viii) Focus

The primary focus of accounting is to accurately record and present all financial transactions
and statements; while the primary focus of auditing is to verify the accuracy and reliability of
the financial statements, and to judge whether the financial statements provide a true picture
of the actual financial position of the entity.

(ix) Objective

Objective of accounting is to determine the financial position, profitability and performance;

while objective of auditing is to add credibility to the financial statements and reports of the
company.

(x) Legal Status

Accounting is governed by Accounting Standards with some degree of discretion; but

auditing is governed by Standards on Auditing and does not provide much flexibility.

(xi) Performed by

accounting is performed by accountants; while auditing is performed generally by qualified

auditors.

(xii) Status

Accounting is usually carried out by an internal employee of the company; but auditing is
carried out by an external person or independent agency.

(xiii) Appointment

Accountant is appointed by the management of the company; while the auditor is appointed
by the shareholders of the company, or a regulator.

(xiv) Qualification

Any specific qualification is not compulsory for an accountant; but some specific
qualification is compulsory for an auditor.

(xv) Remuneration Type

Accounting is carried out by a company employee who gets a salary; while a specific auditing
fee is paid to the auditor.

(xvi) Remuneration Fixation

Accountant’s remuneration, i.e., salary is fixed by the management; while auditor’s fee is
fixed by the shareholders.

(xvii) Scope Determination

The scope of accounting is determined by the management of the company; while the scope
of auditing is determined by the relevant laws or regulations.

(xviii) Necessity

Accounting is necessary for all organizations in the day-to-day or routine operations; while
auditing is not necessary in the day-to-day operations.

(xix) Deliverables

Accounting prepares financial statements e.g. Income Statement or P/L, Balance Sheet, Cash
Flow Statement, etc.; while auditing provides Audit Report.

(xx) Report Submission

Accounts are submitted to the management of the organization; while audit report is
submitted to the shareholders.

(xxi) Guidance

Accountants may make suggestions for the improvement of accounting and related activities
to the management; whereas auditor usually does not make suggestions, except in some cases
with specific requirements, e.g. improvement in internal controls.

(xxii) Liability
 Accountant’s liability generally ends with the preparation of the accounts; while auditor has
liability after preparation and submission of the audit report.

(xxiii) Shareholders’ Meetings

 Accountant does not attend the shareholders’ meeting; while an auditor may attend the
shareholders’ meeting.

(xxiv) Professional Misconduct

 An Accountant is not usually prosecuted for professional misconduct; whereas an auditor can
be prosecuted for professional misconduct as per the applicable legal procedure.

(xxv) Removal

Accountant can be removed by the management; while an auditor can be removed by the
shareholders.

Limitations of Auditing
1. Rely on Experts

An Auditor has to rely on experts like engineers, valuers and lawyers for estimation and
valuation of fixed assets and estimation of contingent liabilities.

2. Efficiency of Management

An Auditor does not comment on the efficiency of management working in client organization;
no comments on future performance of an organization can be made through audited financial
statements.

3. Checking of All Transactions

It is not possible for an Auditor to check all business transactions especially in big organizations
where the number of transactions is very high. An Auditor has to rely on sampling and test
checking.

4. Additional Financial burden

An organization has to bear additional financial burden on account of any fees and other such
expenses for conducting an audit.

5. Not Easy to Detect Some Frauds

It is not easy for an Auditor to detect deeply laid frauds like forgery, misstatements and non-
recording of transactions.

6. Cost Factor

A very thorough and detailed audit would be a costly affair. It is not cost effective. So the auditor
has to limit the scope of his audit and use techniques like sampling and test checking.

7. Time Factor

Auditors generally work on a very specific timeline. Sometimes this is due to statutory
requirements. This means he has to audit a whole year’s accounts in a few weeks. Hence
insufficient time is one of the main limitations of auditing.

8. Inconclusive Evidence

Generally, the audit evidence the auditor collects is persuasive in nature, not conclusive in
nature. So there is never cent percent conclusive evidence in most cases while auditing.

Concept of Auditing and Standards

Auditing standards provide minimum guidance for the auditor that helps determine the extent
of audit steps and procedures that should be applied to fulfill the audit objective. They are the
criteria or yardsticks against which the quality of the audit results are evaluated.
Detection and Prevention of Frauds
Detection and Prevention of Fraud: When something is being done with an intent to deceive,
to mislead or to conceal the truth, it is an art of fraud. It is done knowingly and intentionally to
defraud the owners of the business. Frauds are more difficult to detect than unintentional errors.
The detection of frauds is one of the objects of auditing.

Frauds may be divided into the Following categories:

1. Embezzlement Misappropriation of cash

Misappropriation of cash is usually done by theft of cash receipts, cheques, negotiable

instruments, showing fictitious payments to workers, creditors, purchases etc. When a person is
not subject to any form of check, such person has a number of opportunities and methods of
committing frauds in a small business, the possibility of such fraud remaining undetected is
remote. But with the increase in size of business, the opportunities of committing fraud also
increase because the owners of business have no direct control over receipts and payments of
cash. The transactions relating to the receipt of cash are omitted from the records or recorded
with the lesser amount in the cash book, thereby all such cash or a part of it is pocketed by the
cashier. Similarly, false payments of. cash or over -payment of cash is shown in the cash book. A
strict internal control system shall be adopted for receipts and payments of cash so that work of
one clerk is automatically checked by another. It may be a good practice to check
misappropriation of cash. The auditor should check cash transactions thoroughly.

2. Misappropriation of goods
This type of misappropriation is difficult to detect unless proper stock records are maintained. It
is easy to misappropriate goods which are less bulky and of high value. The goods may be
removed by a member of the staff for his personal benefit. The sales return may be
misappropriated before such goods are received by the stokeeper. Efficient system of record
keeping, periodical checking, internal check and adequate external security arrangements will be
helpful to avoid misappropriation of goods. Misappropriation of goods can be detected by
thorough checking of records and physical verification of stock.

3. Manipulation of Accounts

The accounts of a business can be falsified or manipulated by making false entries regarding
fictitious purchases, sales, expenses etc. Whenever such fraud is committed it usually involves
large amounts and is intentional. The information is manipulated to suit the intentions of persons
involved there in. Normally the intention is to increase or decrease the profits. This type of fraud
is usually committed by owners, managers, directors, board of directors etc. The object of
showing low profits than the actual ones may be as follows: (a) To purchase shares from the
market at’ a low price, (b) To reduce tax liability, and (c) To give wrong impression in the
market about success of business.

The object of showing more profits than the actual ones may be as follows:

 To increase market price of shares

 To mislead the competitors
 To mislead shareholders in the Annual General meeting
 To get more commission when it is paid on the basis of profits

The manipulation of accounts may be done e.g.

 Showing losses to avoid taxes and to deceive shareholdes,

 Falsification of accounts to deceive creditors, bankers etc
 Showing high profits than the actual to inflate the rate of dividends
 Increasing sales by fictitious entries by certain officers to earn more
commission

Window Dressing

The financial position is shown in such a way that it seems to be better than what it is. Window
dressing is more of misrepresentation than fraud. Window dressing may be done in any of the
following ways:

 Purchase of a year, may be shown as of next year

 Income of preceding year may be recorded in the current year.
 Expenses of current year may be shown as of next year
  Showing short-term liabilities as long-term liabilities
 Providing inadequate depreciation and bad debts
 Charging revenue expenditure as capital expenditure
 Over or under valuation of assets and liabilities
 Inflating the profits, or deflating losses by entering non- existent items of sales,
purchases returns.
 Utilizing secret reserves during the depression period without making the fact
known to shareholders

Detection and Prevention of Errors

Errors of Principle

When principles of book-keeping and accountancy are not followed such an error is error of
principle. For examples Treatment of revenue expenditure as capital expenditure or vice -versa
e.g., repair of plant and machinery debited to plant and machinery account, or purchase of Plant
and Machinery debited to purchase account.

Errors of Omission

When a transaction is omitted fully or in part from the books of accounts, such errors are known
as errors of omission. Where the transaction is totally omitted, it will not affect the Trial balance
and is more difficult to detect.

Following are its examples:

 Omission of purchases from Purchase Book or sales from Sales Book

 Omitting the entry for charging depreciation in the books

Omissions, which are completely omitted from the books, are difficult to locate. Thorough
checking of sequence of vouchers may help the auditor to locate such omission. Attention must
always be drawn if there is a big break in the series of vouchers. Omission of purchase vouchers
from the books is difficult to locate. But when payment is made to a supplier for which no
purchase entry appears in the account of such supplier, the omission can be located. Errors of
omission may be intentional or otherwise. But in both the cases profit or loss of the year is
affected.

Errors of Commission

When entries made in the books of original entry or ledger are incorrect either wholly or
partially, such errors are the errors of commission. For example, posting from original book of
entry is wrongly made or made in wrong account on wrong side or of wrong amount is errors of
commission. Some of the wrong entries affect Trial Balance and some other do not.

Errors of Duplication

When a transaction is recorded twice and also posted twice in the ledger, such an error will not
affect the Trial balance. Sometimes the supplier sends the invoice in duplicate and both the
copies of the bill are recorded separately.It is more difficult to locate such errors. Only thorough
checking and comparing of vouchers with entries in the books of original entry will reveal such
errors. While going through an account, will reveal errors of duplication, if two entries on the
same side are appearing with same amount,

Compensating Errors

When an error offsets the effect of another error, such errors are known as compensating errors.
These errors do not affect agreement of Trial balance, hence can’t be located by the auditor
easily.

These errors can be located by checking the total, posting and casting. Some of these errors may
affect the profits of the year.

The auditor may take the following points into consideration while detecting an

Error:

 If various books are maintained on self -balancing system, errors can be located
by scrutiny of such books.
 If self balancing system is not used, then the trial balance should be checked
and ledger account balances shall be compared with those shown in the Trial
balance. It is possible that some balances in the ledger might not have been
transferred to trial balance.
 Check the totals of trial balance. It is possible that there may be totaling
mistake.
 In case there is any difference in trial balance, see if there is any account having
similar balance which is not taken to Trial balance. Check the difference in
Trial balance, and compare it with balance of an account, as the accounts
balance may be taken on the wrong side in trial balance.
 Ascertain the nature of account. Asset accounts, expense accounts, reserve for
discount to creditors always have debit balance;. ,ensure that these are shown in
the proper column of Trial balance Similarly, liabilities accounts, income
accounts, capital, account and reserves have credit balances and must be shown
in credit column of trial balance.
  Examine the totaling and balancing of each account in the ledger and see that
correct balances are carried forward to the next page.
 Total the list of creditors and debtors and compare it with the balance shown in
trial balance.
 Verify the totals of subsidiary books and their posting to ledger.
 Compare items of trial balance with the items of trial balance of previous year
to see if any account balance is omitted or shows abnormal balance.
 An error of Rs. 1, Rs. 10, Rs. 100, Rs. 1000 may be due to wrong totaling.
 See that all journal entries are posted to ledger.
 If self -balancing ledger system is maintained see that balances in control
account tally with total of balances of personal accounts of the ledger.
 Over and above all this, intensive and careful verification of subsidiary records,
vouchers and ledger is the only remedy for locating an error.

Basic Principles Governing an Audit

Auditing is a systematic and scientific procedure of inspection of the financial statements of an
organization. And like any scientific procedures, the audit also has certain principles and rules
that govern it. These principles are the Standards of Auditing or the Auditing and Assurance
Standards (AAS).

Basic Principles Governing an Audit

SA- 200 describes the nine basic principles that govern the procedure of auditing. It lists out the
roles and responsibilities of the auditor and his general code of conduct during an audit. We will
look into these principles in brief.

Basic Principles Governing an Audit

1. Integrity, Independence and Objectivity

The auditor has to be honest while auditing, he cannot be favoring the organization. He must
remain objective throughout the whole process, his integrity must not allow any malpractice.

Another important principle is independence. So the auditor cannot have any interest in the
organization he is auditing, which allows him to be independent and impartial at all times.

2. Confidentiality

The auditor has access to a lot of sensitive financial information of the organization. It is
important that he respect the confidential nature of such information and documents.
He cannot disclose any sensitive information to any third party unless it is a requirement by law.
And he must also be very careful with documents, certificates etc. that the organization entrusts
to him.

3. Skill & Competence

The auditor must be experienced and trained in the procedures of auditing, i.e. must be qualified
as an auditor. And as a professional, he must be up to date on recent changes, announcements,
rules etc.

If necessary he can undergo training and workshops to stay up to date with the recent auditing
and accounting procedures. For example, after GST was introduced, auditors had to update their
knowledge.

4. Work Performed by Others

The scope of audit at times can be very vast. So an auditor has employees, delegates and other
people who work under him.

However, the auditor will continue to be fully responsible for the work done by these people
working for him. So the auditor must carefully supervise and review such work and be
reasonably sure of the accuracy of such work.

5. Documentation

In most cases the auditor maintains an audit notebook, an audit plan and auditing file. It is
important the auditor keeps a record of important documents with respect to his audit work, as it
is evidence of the work the auditor has done. And the client is inclined to these documents and
files if he wishes to inspect the work.

6. Planning

An audit plan allows the auditor t plan out his work and enables him to be more efficient and
timely. Every audit plan is different as it has to be customized according to the type of
organization, the kind of business they conduct, the scope of the audit, the efficiency of the
internal controls etc.

7. Audit Evidence

The auditor must collect enough evidence to support his final opinion. This collection of such
evidence is done by compliance and substantive procedures. There are two sources of this
evidence internal and external. Also, external sources of evidence are always more reliable.
 8. Accounting Systems and Internal Controls

The auditor has to assure that the accounts of the organization are accurate and represent a true
and fair picture of the financial status of the company. Also, the auditor must ensure that all
material information has been recorded in the accounts. Testing the internal controls system is
also important as it helps determine the same.

9. Audit Conclusions and Reporting

After the auditor collects all evidence he must now form his opinion on the basis of the following
criteria,

 All relevant accounting standards were applied at all times

 Financial statements are in compliance with all regulations and statutory
requirements
 All material information has been disclosed

Types of Audit
Classification of Auditing:

1. Continuous or detailed.
2. Periodical or final audits.

1. Continuous Audit:

This is useful in case of big companies with larger business which have scope for keeping the
audit staff busy year round or auditors may attend to auditing at intervals fixed or otherwise, and
perform an interim audit. In this case, routine business goes on simultaneously with the audit
work.

2. Periodical or Final Auditing:

After the completion of the financial year audit work is undertaken which goes on continuously
till its completion. This system is the most satisfying from the auditors point of view.

Types

In general, an audit is an investigation of an existing system, report, or entity. There are a

number of types of audits that can be conducted, including the following:
  Compliance audit: This is an examination of the policies and procedures of an
entity or department, to see if it is in compliance with internal or regulatory
standards. This audit is most commonly used in regulated industries or
educational institutions.
 Construction audit: This is an analysis of the costs incurred for a specific
construction project. Activities may include an analysis of the contracts granted
to contractors, prices paid, overhead costs allowed for reimbursement, change
orders, and the timeliness of completion. The intent is to ensure that the costs
incurred for a project were reasonable.
 Financial audit: This is an analysis of the fairness of the information contained
within an entity’s financial statements. It is conducted by a CPA firm, which is
independent of the entity under review. This is the most commonly conducted
type of audit.
 Information systems audit: This involves a review of the controls over
software development, data processing, and access to computer systems. The
intent is to spot any issues that could impair the ability of IT systems to provide
accurate information to users, as well as to ensure that unauthorized parties do
not have access to the data.
 Investigative audit: This is an investigation of a specific area or individual
when there is a suspicion of inappropriate or fraudulent activity. The intent is to
locate and remedy control breaches, as well as to collect evidence in case
charges are to be brought against someone.
 Operational audit: This is a detailed analysis of the goals, planning processes,
procedures, and results of the operations of a business. The audit may be
conducted internally or by an external entity. The intended result is an
evaluation of operations, likely with recommendations for improvement.
 Tax audit: This is an analysis of the tax returns submitted by an individual or
business entity, to see if the tax information and any resulting income tax
payment is valid. These audits are usually targeted at returns that result in
excessively low tax payments, to see if an additional assessment can be made

Internal audit and Internal control

Internal Control
Internal Control can be understood as a system developed, implemented and maintained by the
company’s management, in order to ensure the achievement of objectives concerning:

 Effectiveness and efficiency of operations,

 Protecting assets,
 Prevention and detection of frauds and errors,
 Accuracy and completeness of financial reporting,
  Adherence to relevant laws.

It comprises of five elements, which are interconnected to each other and apply to all firms, but
their implementation depends on the size of the firm. The elements are control environment, risk
assessment, control activities, information and communication and monitoring.

Objectives of Internal Control

 Examining whether the transactions are executed as per the management’s

authorization.
 Checking prompt recording of transactions, in correct amount and account and
that too in the accounting period, to which it belongs.
 Ascertaining that assets are protected from unauthorized access and use.
 Comparing recorded assets with the existing ones, at various time intervals and
taking actions in case differences are discovered.

Review
The most important part of the internal control system is its review, for which the auditor can use
any of the methods: Narrative Records, Checklist, Questionnaire, and Flowchart.

Internal Audit
Internal audit is defined as an unbiased, rational assurance and consulting function, developed by
the management, to keep a check on the activities of the organization. It involves regular and
critical analysis of the functions of an organization, for the purpose of recommending
improvements. It is aimed at assisting members of the firm in discharging their responsibilities in
an effective manner.

Internal Audit Process

The task is performed by the internal auditor, who is appointed by the company’s management.
He/she reports the management regarding the analysis, appraisal, recommendation and all
relevant information relating to the activities under study.

Objectives of Internal Audit

 To check the accuracy and authenticity of the accounting records, which are
reported to those charged with governance.
  To identify whether the standard accounting practices, which are deemed to be
pursued by the entity, are complied with or not.
 To ensure detection and prevention of fraud.
 To examine that there is an appropriate authority for the procurement and
disposal of assets.
 To verify that the liabilities are incurred only for business causes and not for
any other purpose.
 To review the activities of the internal control system, so as to report
management regarding deviations and non-compliances.

Internal Control System Regarding Purchases, Sales, Salaries and Wages[not

available]

Unit 2
Audit Procedures
Audit procedures are used by auditors to determine the quality of the financial information
being provided by their clients, resulting in the expression of an auditor’s opinion. The exact
procedures used will vary by client, depending on the nature of the business and the audit
assertions that the auditors want to prove.

Here are several general classifications of audit procedures:

1. Classification Testing

Audit procedures are used to decide whether transactions were classified correctly in the
accounting records. For example, purchase records for fixed assets can be reviewed to see if they
were correctly classified within the right fixed asset account.

2. Completeness Testing

Audit procedures can test to see if any transactions are missing from the accounting records. For
example, the client’s bank statements could be perused to see if any payments to suppliers were
not recorded in the books, or if cash receipts from customers were not recorded. As another
example, inquiries can be made with management and third parties to see if the client has
additional obligations that have not been recognized in the financial statements.

3. Cutoff Testing
Audit procedures are used to determine whether transactions have been recorded within the
correct reporting period. For example, the shipping log can be reviewed to see if shipments to
customers on the last day of the month were recorded within the correct period.

4. Occurrence Testing

Audit procedures can be constructed to determine whether the transactions that a client is
claiming have actually occurred. For example, one procedure might require the client to show
specific invoices that are listed on the sales ledger, along with supporting documentation such as
a customer order and shipping documentation.

5. Existence Testing

Audit procedures are used to determine whether assets exist. For example, the auditors can
observe an inventory being taken, to see if the inventory stated in the accounting records actually
exists.

6. Rights and Obligations Testing

Audit procedures can be followed to see if a client actually owns all of its assets. For example,
inquiries can be made to see if inventory is actually owned by the client, or if it is instead being
held on consignment from a third party.

7. Valuation Testing

Audit procedures are used to determine whether the valuations at which assets and liabilities are
recorded in a client’s books are correct. For example, one procedure would be to check market
pricing data to see if the ending values of marketable securities are correct.

A complete set of audit procedures is needed before the auditor has enough information to decide
whether a client’s financial statements fairly represent its financial results, financial position, and
cash flows.

Audit Planning

Audit Planning
The audit planning is a major part of audit works for both internal and external audits. A good
audit planning will help the auditor to minimize its risks, improve audit efficiency, and meet its
objective at the minimum effort.

Auditors are required to prepare a proper audit plan to ensure that all audit risks are identified
and correct audit strategies are deployed to detect all concerning risk areas.
It is essential for the auditor to prepare a good strategic audit plan. If the plan is well prepared,
all kind of audit risks is identified and detected.

This will help the auditor to minimize the audits risks of issuing the incorrect opinion to financial
statements.

Base of Audit Planning

Audit planning should be based on the following:

 Complete accounting knowledge of client’s business

 Reliability of internal control system
 Programming of audit procedures and
 Co-ordination of staff

Development of Audit Plan

The following points need to be considered at the time of preparation of an audit plan:

 Auditor Engagement terms

 Statutory responsibility of Auditor
 Co-ordination with other Auditors
 Internal control system of branches and subsidiaries
 Reliability of internal control system of an organization
 To mark important audit areas
 Impact of legal rules
 Nature and timing of reports

Audit Programme
An audit program is a set of directions that the auditor and its team members need to follow for
the proper execution of the audit. After preparing an audit plan, the auditor allocates the work
and prepares a program which contains steps that the audit team needs to follow while
conducting an audit. Thus, an auditor prepares a program that contains detailed information
about various steps and audit procedures to be followed by the audit.

Audit Programme
An audit program provides a basic plan for the audit team regarding the entity’s business, its
size, how to conduct the audit, allocation of work among team members and the estimation of
time within which it should complete the work.

It contains details regarding the relevancy of evidence, materiality level, risk tolerance, measure
of the sufficiency of the evidence. Thus, programs enhance the accountability of the audit team
and its members for the work performed by them.

An auditor may revise the audit program if he considers it necessary due to prevailing
circumstances. The size of the entity, type of business or services in which entity deals,
applicable laws, the effectiveness of internal controls, and various other relevant factors, also
affect an audit program.

Thus, an auditor prepares an audit program according to its scope of work. The minimum
essential work to be performed is the Standard Programme. However, there is no set audit
standard program applicable in all the circumstances.

Audit working papers document the activities that the audit program performs. Audit working
papers support the work performed by the auditor for providing assurance that the audit was
performed in accordance with all the applicable standards on auditing (SA’s). It helps the auditor
in the proper execution of audit work.

An audit program covers various steps of auditing in an audit program like the assessment of
internal control, ascertaining accuracy and reliability of books of accounts, inspection, vouching
and verification, valuation of assets and liabilities, scrutiny of accounts, presentation of financial
statements, and submission of reports and related disclosures.

Advantages

1. An audit program helps in ensuring that all-important areas are considered

while conducting the audit.
2. An audit program helps an auditor in the allocation of works among its team
members according to their skills and competency.
3. It enhances the accountability of audit team members towards work performed
by them
4. An audit program also reduces the scope for misunderstanding among team
members regarding the performance of audit work.
5. It helps the auditor in checking the status of audit work, its progress, how much
it is left for performance while conducting the audit.
6. Auditor prepares audit working papers which contains a record of various audit
procedure applied which serves as evidence against the charge of negligence.
 7. Audit program enables the auditor to keep a record of useful information
specifically for future audit and references.

Disadvantages

1. Rigidity: There is no set standard audit program that can be applied in the case
of every entity. However, programs differ for different types of entities. Every
entity has its own problems. Therefore, we cannot apply for a single audit
program in the case of all business
2. Reduces the Initiative of Efficient Staff: A program reduces the initiatives of
efficient and competent staff. Thus, staff members cannot make changes in
the audit plan and cannot make suggestions to it.
3. Audit Work becomes Mechanical: The program becomes mechanical when it
ignores other aspects like internal control.
4. Overlooking New Areas: A program may overlook the new areas. With the
change in time and technology, new problems may arise which an audit
program may not consider.

Audit Working Papers

Audit working papers are the outcome of the documentation process. Working papers are the
record of various audit procedures performed, audit evidence obtained, allocation of work
between audit team members etc. Audit working papers are the documents and evidence that an
auditor collects and retains with himself during the audit.

Audit working papers support the work that the auditor performs for providing assurance that he
conducts the audit in accordance with all the applicable standards on auditing (SA’s).

They constitute all the audit evidence that an auditor obtains. Also, it contains various procedures
that he applies to indicate that the audit is performed by him.

The auditor and his audit team members prepare the audit working papers while performing the
audit. Working papers are connecting link between the client’s records and
audited financial statements.

Working papers provide entity’s historical records as well as matters which should be taken care
and given due importance while performing future audit’s of such entity.

Audit working papers help auditor in audit planning and collecting evidence of the audit work
performed on which his opinion is based.
Working papers helps auditor in allocating the time required for performing various audit
procedures. The working paper helps auditor to maintain a record of various matters discussed
with management while conducting an audit.

Also, the working papers help audit team members to understand entity’s business, points which
they need to check on a priority basis, queries and actions against them in previous audits.
Working papers helps auditor in future cases to protect himself if the client files a suit against
auditor for auditor’s negligence while conducting the audit.

Working papers provide information on the following matters

 Information about audit team members and work allocated to them.

Information regarding unallocated work
 Whether he follows all the applicable standards on auditing (SA’s) or not
 He properly plans the audit or not
 Whether there was proper supervision over the work performed. Enabling the
audit team members to be responsible for the work performed by them
 An auditor undertakes an appropriate review or not
 Whether the evidence is relevant, sufficient and appropriate to support the
opinion of the auditor

We can divide the working papers into two parts

1. Permanent audit file

2. Current audit file

A permanent audit file contains information which is of continuous interest and is relevant in
future audits. Information like articles of association, loan agreements, leases, documents related
to internal control of the entity, record of accounting policies followed by the entity on a
continuous basis, significant observations of previous audits etc.

A current audit file contains information regarding audit conducted for the current period. It
includes information like financial statements and audit report of the entity, trial balance and
worksheets, records regarding internal control risk of an entity, external confirmations received,
queries of auditor and reply received from the management etc.

Audit Files

Audit Notebooks
Audit note book is maintained by the audit assistant ti note down to all those unclear matter
which he may come across in the course of audit and on which he requires further clarification
and explanation. It contains day to day work performed by the audit staff on any particular day.
Notes about all types of errors, difficulties and uncleared point, etc. are recorded in audit
notebook.

Audit notebook is a diary on which auditor scribble down all important inquiries to avoid the
possibility of unquestioned material facts.

Importance of Audit Note Book

Justice William throws light on the importance of audit notebook in the following words:

The audit notebook that contained detailed information proved to be very helpful to the auditor
in every critical moment. For preparing the audit report it is very useful for that auditor.

In case of negligence charge against the auditor, but note book good evidence can be presented.
It may be also used for future guidance and reference. It also enables to auditor to know that
what work his assistant at each audit has done.

Objectives of Audit Note Book:

1. To know about the nature of business.

Detection and prevention of frauds and errors effectively.

2. To make the future audit work easier.

3. To know the facts where clarification and explanation are essential.
4. To check the list of debtors and creditors.
5. To present as a proof by the auditor to clearance over the cases.

Contents of Audit Note Book:

1. A copy of audit program.

2. The nature of business and important documents relating to the business.
3. The name of the clients and audit year.
4. A list of books of accounts.
5. Name of principal officers, their duties and responsibilities.
6. Accounting and financial policies followed by the business.

Advantages of Audit Note Book

1. Audit Report
The audit notebook is helpful to prepare audit report. The auditor can record the weakness of
accounting records. The queries not properly answered are started in the audit report when the
auditor is satisfied he can submit a clear report.

2. Staff Honesty

The audit notebook is used to determine the integrity and honesty of audit clerks. The moral and
ethical value can be examined through audit work. When a person completes his work in time.
Time period auditor can appreciate him. If there is pending work after the expiry of time period,
he can be held responsible for it. The audit staff must be honest in his work.

3. Helpful For Memory

The audit notebook is help to keep things fresh in memory. The auditor can read the book on
daily basis. He can note the weakness on fingertips. The auditor can retain the data in his
memory for a longer period of time. He can ask the management to clear the doubtful points
before preparing audit report.

4. Reference

The audit notebook is useful for reference. In future it can provide information to the audit staff.
The past data gives an insight into business matters. The auditor can note the changes. He can
form an opinion about the changes in the nature and size of the business.

5. New Auditor

The audit notebook is useful for new auditor. They can see the weakness of previous years. The
old weak points may not be repeated this year.

6. Court Cases

The audit notebook is helpful to defend an auditor in court cases. The people can go to court of
law in order to fix liability for negligence of duty. The audit notebook is a written proof of work
performed by an auditor.

Audit Evidence: Methods of Obtaining Audit Evidence

Audit Evidences
An auditor applies various audit procedure to obtain audit evidence which enables him to form
an opinion whether the financial statements of an entity are free from material misstatement and
state a true and fair view or not.
Audit Evidence is the information that the auditor uses in arriving at a conclusion on the basis of
which he forms his opinion.

The auditor should obtain sufficient and appropriate evidence which enables the auditor to arrive
at a conclusion and supports his opinion. Audit evidence forms the basis for forming an opinion
whether the financial statements of an entity state true and fair view or not.

Evidence collected by the auditor should support the contents of its audit report. Sufficiency of
audit evidence is the measure of the quantity of audit evidence. Appropriateness of evidence is
the quality of the evidence, i.e., its relevance and reliability to support the auditor’s opinion.

Audit evidence includes information provided in books of accounts as well as information from

other sources. For Example – Purchase invoice and material received note prepared by the
store’s department are evidence to support the purchase.

Essentials of good audit evidence

1. Sufficient: Sufficiency is the measure of quantity. Audit evidence is sufficient

when they are available in adequate quantity. An auditor applies different audit
procedures to obtain sufficient audit evidence like test checking.
2. Reliable: Evidence obtained by the auditor is persuasive rather than
conclusive. We cannot consider such evidence 100% reliable for forming an
opinion. Reliability of audit evidence depends on its source and nature of such
evidence.
3. Source: Audit evidence obtained within the enterprise is known as the internal
source. Evidence obtained from an outside enterprise like confirmation from
the third party is known as the external source. We consider the external source
to be more reliable.
4. Nature: Can be documentary (like bills, vouchers), visual (like the physical
verification of fixed assets), or oral (confirmation from employees)
5. Relevant: Whether the audit evidence obtained by the auditor is relevant or not
depends on the purpose of audit procedures.

There are some thumb rules which helps in identifying the appropriateness of evidence

1. Written (documentary) evidence is better than testimonial evidence.

2. Evidence from external sources is more reliable.
3. Original documents are preferable over their photocopies.
4. The auditor should have a good understanding of internal control of the
organization as it enables him to obtain relevant evidence.
5. Evidence obtained by auditor through direct observation, inspection, physical
verification, and computations are better than the evidence obtained indirectly.
 Special Auditing Techniques
Audit techniques stand for the methods that are adopted by an auditor to obtain evidence.
Evidences are very important for an Auditor to form an opinion regarding financial statements. If
Auditor fails to collect proper evidence, it will reduce the reliability of audit report. The method
of collecting evidence is called audit technique. Following are a few important audit techniques:-

1. Inspection

(a) Documents and records

While verifying various transactions, the auditor examines the supporting documents and
records. This technique is otherwise called vouching. The purpose of examining the documents
and records is to

 Confirm the authenticity (genuineness) of the transaction.

 To find whether the transactions and the supporting document are appropriate.
 To ensure whether the transactions are authorized (approved).
 To ensure whether the classification of the transaction is proper.

The auditor goes through the accounting records and documents and if he comes across any
unusual transactions, he verifies the same thoroughly. This is called scanning of records, which
requires experience and expertise.

How for an auditor can rely on the documents depends on the origin (source) of the documents
and the efficiency of the internal control system in operation

Documents which have their origin in the hands of the third parties and held by third parties are
more reliable than the documents which have their origin in the organization itself and held by
the organization. One can classify the documents into 4 major categories according to their
origin and availability.

 Documents which have their origin in the hands of the third party and held by
them – Most reliable evidence.
 Documents which have their origin in the hands of the third party and held by
the organization – More reliable.
 Documents which have their origin in the hands of the organization and held by
the third party – Reliable.
 Documents which have the origin in the hands of the organization and held by
the organization – Reliable only if the internal control is effective.

(b) Physical Verification

If an item can be measured in physical term, the same may be verified for quantity and quality (if
possible). By physical examination, the auditor ensures the availability of the item. However, the
ownership of the items cannot be verified through this method.

2. Observation

The auditor observes a particular procedure being carried by the organization. Examples are
observation of the internal control measures that are adopted in transactions involving cash,
procedures followed on receipt or issue of material, etc. The auditor makes his observations to
evaluate the efficiency and effectiveness of the system followed by the organization.

3. Inquiry and Confirmation

 Inquiry: Seeking information from persons belonging to the organization or

from outside organization is called inquiry.
 Confirmation: Confirming the information available with the records of the
organization or with the persons mostly from outside the organization through
an inquiry is confirmation.

Inquiry and confirmation can take place either orally or in writing. The best example for inquiry
and confirmation is confirming the balances of debtors shown in the accounting records with the
debtors of the organization.

4. Computation

An auditor makes appropriate calculations and verifies the accuracy of the accounting records.
For example, the auditor computes the depreciation to be charged for the year, by taking into
consideration. the value of the asset (cost), the date of purchase, the rate of depreciation, etc., to
verify the accuracy of the depreciation charged by the organization. The auditor also traces a
particular transaction from the origin to check the book keeping procedure.

5. Analytical Procedures

The purpose of analysis is to ensure consistency of accounting methods and also to evaluate the
efficiency of the management by comparing the results of several years. The several analytical
procedures are

 Reconciliation
 Ratio Analysis; and
 Variance Analysis

The auditor also applies the analytical procedures to help the management in decision making.
Such analytical techniques are
  Marginal Costing
 Standard costing etc

The auditor studies the nature of the business and also the prevailing circumstances and selects
the techniques to be applied. While conducting the audit, he may change his technique according
to the changes observed in the circumstances. The suitable audit techniques adopted by the
auditor helps him to carry on the audit efficiently.

Unit 3
Vouching- Meaning and Importance

Vouching
Accounting entries made in the books must be supported by documentary evidence and
inspection of that evidence is called vouching. The Auditor judges the authenticity, of the
accounting entries using the technique of vouching. In case of unavailability of proper supporting
documents, the Auditor may have all reasons to doubt about errors or fraud or manipulation.

Thus, auditing is incomplete without vouching.

In auditing process, based on evidence, there are two main functions

 Collection of evidences: Through observation, confirmation, inspection,

inquiry.
 Evaluation of evidences: With relevance, adequacy and validity.

Objective of Vouching

Following are the main objectives of vouching:

 To check whether all the business transactions are properly recorded in the
books of accounts or not.
 To see whether recorded transactions are duly supported by documentary
evidence or not.
 To verify that all the documentary evidence is authenticated and related to
business transactions only.
 To verify that transactions are free from errors or frauds.
 To verify whether voucher is processed through all the stages of Internal Check
system properly.
  To verify and confirm that the entries are recorded according to the capital and
the revenue nature or not.
 To check the accuracy of accounting transactions.

Importance of Vouching

Vouching forms the base for auditing and has an important part of Auditor’s duty. In case of
negligence in vouching, the Auditor will be held responsible; he cannot escape from his duty, if
he has done vouching carelessly. Following points show the importance of vouching:

 Vouching is equally important as passing of original entry in the books of

accounts. If, original entry is wrong, it will affect every process of accounting
entry and its impact will be till the end result. Similarly, vouching is base of all
auditing process.
 Efficiency of vouching will decide the success of audit.
 Any errors and frauds are easily detectable if vouching is conducting in
searching and intelligent manner.
 Intelligent and faithful vouching will establish reliability on financial
statements, i.e., Profit and Loss account and Balance Sheet of any organization.
 If adequate internal control system exists, the Auditor may choose to do test
checking instead of complete vouching.

Vouching and Routine Checking

Routine checking covers the checking of every carry forward, posting to ledger account and
balancing of account. Vouching includes routine checking which is a mechanical checking,
whereas vouching is made on the basis of documentary evidence.

A voucher may be a sales bill, purchase bill, payment receipt, pay-in slip, etc. All such types of
documentary evidence are known as vouchers.

Types of Voucher

There are two types of vouchers:

 Primary Voucher: Original copy of written supporting document is called

primary voucher. Like purchase Bill, cash memo, pay-in-slip, etc.
 Collateral Voucher: Copies of supporting documents which are not available
in original are collateral voucher like duplicate or carbon copy of sale invoice.

Example of Vouchers
 Transactions Vouchers

Sales order, sales invoice, goods outward register, cash

Sales
receipt, bank pay-in-slip, etc.

Quotations, purchase orders, purchase bills, goods inward

Purchase
register, etc.

Cash Payments Demand note, cash receipt, cash memo, etc.

Duplicate or carbon copy of cash receipt, contracts and

Cash Received
correspondence with payee, etc.

Bank Payments Cheques, counterfoils, bank statements, etc.

Payment received through

Bank deposit slip, bank statements, etc.
Banking Channels

Important Points Regarding Vouching

Following points need to be considered regarding vouching:

 Accuracy of transactions.
 Authenticity of transactions.
 Proper classification of accounts.
 Voucher should be properly numbered serially and arrangement of vouchers
accordingly.
 Every checked voucher should be tick marked with sign.
 Amount of receipt should be same in words and in figure.
 Period of payment should be there on receipt.
 Receipt should clearly mention “advance payment” if it is do.
 To check and investigate the books of accounts if they are in the name of
Director, Manager, Partner or any other employee of the company.
 To verify that proper certification of voucher should be there by any
responsible officer of the company.
 Investigation about missing vouchers in file if any.
  Every alteration in voucher must be authenticated by concerned officer.
 Vouching should be complete at once in one sitting for a particular period of
time.
 All the expenses should be examined by the Auditor.
 Without existence of adequate internal control system in organisation, an
Auditor should not opt for test checking.
 Checking the classification of account must be done.
 Cash purchase should not be recorded twice, once in cash purchase and second
one in credit purchase.
 An Auditor should refer the resolution as passed at the meeting for certain
transactions.
 An Auditor should verify that accounting entries are done on the basis of
capital and revenue items.
 An Auditor should verify that every payment voucher of above Rs. 5,000/-
should bear the revenue stamp.

Vouching is the act of reviewing documentary evidence to see if it properly supports entries
made in the accounting records. For example, an auditor is engaged in vouching when examining
a shipping document to see if it supports the amount of a sale recorded in the sales journal.
Vouching can work in two directions. For example, an auditor can trace actual inventory items
back to the accounting records to see if the items are properly documented, or start with the
inventory records and trace back to the warehouse shelves to see if the inventory exists.

When engaged in vouching, an auditor is looking for any errors in the amount recorded in the
accounting records, as well as ensuring that the transactions are recorded in the correct accounts.
The auditor is also verifying that transactions have been properly authorized.

When vouching uncovers an error, the auditor may need to increase the sample size being audited in order
to gain assurance that a system operates properly. An alternative is to engage in different auditing
procedures.

Voucher of Cash and Trading Transactions

Vouching of cash receipts (debit side of cash book)

We will discuss the cash receipt which are placed on the debit side of cash book for following
items:

(i) Opening Balance of Cash Book

Opening balance of cash book represents cash in hand at the start of the year and should verified
from the balance sheet of last financial year.
(ii) Cash Received from Debtors

Consider the following points for verification of cash received from debtors:

 The carbon copies or counterfoils of cash receipt book should be verified.

 Cash receipt should be serially numbered.
 Cash received should be entered on the same date when the cash is actually
received.
 The discount allowed to customers should be properly authorized by a
responsible officer.
 Correspondence with customer and ledger account should be tallied.

Following are the different ways used for misappropriation of cash −

 Cash received from customer not recorded in books and no cash receipt may be
issued.
 Issuance of receipt for lesser amounts than amount actually received.
 Using teeming and lading method; it is a very common method to
misappropriate the money, in which the cash received from any customer not
recorded in the books and the cash received from same customer at a later
instance or another customer recorded in the books and so on.

(iii) Repayment of Loan by Others

Repayment of loan by others may be verified in the following ways:

 Calculation of interest received and interest should be credited to interest

received account.
 Verification from bank statement if directly deposited by party into bank.
 Checking of carbon copies or counterfoils of cash receipts.
 To ensure that there should be no violation of Income Tax rules as payment of
loan exceeding Rs. 20,000/- cannot be repaid in cash. It should be through
Cheques, Demand Draft, NEFT, RTGS or any other available banking
channels.

(iv) Rent Received

 To check rental agreement or lease deed

  In case where the rental income is received from more than one property,
separate account for each property should be maintained.
 The Auditor should verify that the rent for all the twelve month is received or
not.
 The amount of rent should be verified from the rent deed or the lease deed.
 If TDS (Tax Deducted at Source) is deducted by the party, there should be
proper accounting of TDS.

(v) Sale of Investments

 To check bank statement if the sales proceeds have reached the bank account.
 To verify broker commission, note or debit note, if investments are sold
through broker.
 To ensure separate accounting is being done for capital receipts and revenue
receipts. Dividend or profit or loss on sale of investment is a revenue receipt
and the sales proceeds of the investment cost should be booked as capital
receipt.

(vi) Subscription

Subscriptions are received from the members of a club and the following points need to be
considered by the Auditor while vouching subscription:

 Subscription register should be verified.

 Verification of subscription received during the year and the subscription
receivable.
 Counterfoil of cash receipt should be verified.

(vii) Sale of Fixed Assets

 To check minutes of the meetings of the Board of Directors.

 Sale agreement or sale contract.
 Verification of agent account if sale is made through an agent.
 Profit or Loss on sale of fixed assets should be booked to revenue account.
 Authorization of sale of fixed assets.
 Sale proceed of fixed assets should be credited to fixed assets account after
deducting expenses on sale of fixed assets if any.

(viii) Interest and Dividend Received

  Verification of the dividend warrant letter along with the covering letter for
verification of dividends in case of dividends received through cheque.
 Verification of bank statement, if the dividend is directly credited to the bank
account
 Interest on security can be vouched from the securities schedule.
 Interest on fixed deposit can be verified from bank statement and TDS
certificates
 Interest received from outsiders to whom company has granted loan could be
verified from statement of account of party along with TDS certificates.
 Provision should be made for interest accrued but not due
 All interest received and accrued should be properly accounted for in the books
of accounts

(ix) Commission Received

 Verification of agreement on the basis of which the commission is received

 Calculation of the commission receivable
 The commission received should be verified from counterfoils, bank
statements, cash receipts, etc. and the provision for commission receivable
should be rightly accounted for in the books of accounts
 Commission receivable on “sale of goods sent on consignment” should be
verified from sale account

(x) Installments Received on Hire-Purchase Sale

 Study of the Hire-Purchase agreement for hire-purchase-sale price, number of

installment, rate of interest etc.
 Segregation of principle amount and interest amount should be done and both
should separately account for
 Profit on sale on hire-purchase should be duly calculated on the basis of
installment received during the year

Vouching of cash payments (credit side of cash book)

All the payment made to creditors, expenses incurred in cash and all other payments done appear
on the credit side of cash book and the Auditor is required to vouch cash payments because
chances of cash misappropriation are very high.

Following points need to be considered for different types of cash payment:

(i) Opening Balance

The opening balance of cash book can never be credited because cash of company cannot be in
negative but the credit bank balance represents the overdraft account from bank or utilization of
cash credit limit as sanctioned from bank.

(ii) Payment to Creditors

Payment to creditors may be examined by the following:

 Receipt issued by the creditors

 If the creditor is paid amount as full and final settlement, the balance amount, if
any stands in the ledger account of the creditor; this amount should be credited
to discount received
 If any advance payment is made to creditor that should be clearly mention
 Statement of account of creditor

(iii) Payment of Salaries

Depending upon the adequacy of internal control system in an organization Auditor will decide
his audit Program. It is very important for Auditor to check the following:

 Attendance record of employee and salary register

 Appointment letter of new employees
 Comparison of current month salary with last month’s salary and if there is any
abnormal change in amount, Auditor should verify the same
 Alteration in amount of deductions on account of advance, loan, fine, funds,
insurance, TDS, etc.

(iv) Payment of Wages

At the time of vouching of wages paid, the Auditor should verify the following points to avoid
misappropriation of cash:

 Adequacy of Internal Control System

 Payment of wages at higher rate than allowed
 Payment shown to ex-workers in the current month
 Lower or non-deduction of advance or other deductions due
 Payment to fictitious workers
 Payment to workers who were absent from duty
 Wages sheet should compare with wages register
  Comparison of current month wages with last month’s wages and proper
verification should be there for extra ordinary changes
 Detailed verification for payment to casual workers
 Vouching and verification of treatment accounting treatment for unpaid wages

(v) Purchase of Plant and Machinery

The Auditor should pay attention to the following:

 Purchase invoice of machinery

 Freight inward charges, installation charges, erection and commissioning
charges should be capitalized
 Treatment of Excise duty according to the excise rules

(vi) Purchase of Land & Building

 Study of Lease hold agreement, if land is purchased on lease hold basis

 Payment should be as per lease term
 All the expenses incurred to acquire lease hold property should be debited to
respective property account
 Auditor should study the conveyance deeds in case property is purchased under
free hold basis
 For verification of payment, the Auditor can check the payment receipt and the
conveyance deed

(vii) Rent Paid                   

Consider the following points for the verification of rent by the auditor:

 Rent Deed
 Rent receipt from Land lord
 Provision for un-paid rent at the end of the year

(viii) Insurance Premium

Consider the following points for the verification of Insurance Premium:

 Insurance policy issued by the Insurance Company

 Insurance premium receipt
  Insurance premium should not be related to any official of the company

(ix) Income Tax

Consider the following for the verification of Income:

 Advance Tax Challan

 Self-Assessment Tax challan
 Income Tax demand notice
 Assessment order

(x) Excise Duty

Consider the following for the verification of Excise Duty:

 Rate of Excise Duty

 Excise records and sale invoice for verification of excise duty

Routine Checking and Test Checking

Routine Checking

Routine checking means checking of arithmetical accuracy of books of original entry the ledgers
with a view to detect clerical errors and frauds of a very simple nature so first time when a
candidate goes for doing the auditing he has to go for checking the routine checking so first step
to be followed is to check the arithmetical accuracy of the data being entered so whatever data
input has been done we need to ensure whether the totals are being matching up the debit sides
and credit side are being tallied there is no difference in the ledger posting which is being done
for the books of original entry so this is a very simple exercise but yet with lot of detail analysis
and meticulation such routine checking is to be done.

Advantages

What are the advantage of going for the routine checking thorough checking of transactions can
be done so that there cannot be a chance of any fraud there cannot be duplicacy of the data if a
data is being entered twice whether intentionally or unintentionally it can be detected there can
be lesser chances of doing any mis-statement of the information when thorough checking of
transaction is being done while following the routine checking. It constitutes important base
because it is being known to the organization that routine checking’s will be done they will be
much particular about the fact that clerical errors or the errors manager of fraud should not be
done. It facilitates the verification of arithmetical accuracy of transections and it’s very easy to
perform.

Disadvantages

First one is it is a mechanical process because it is very monotonous and regularly and on a daily
basis arithmetical accuracy of the transaction are to be done it is repetitive in nature. Complex
errors and fraud remain undiscovered so again when the substantive test are being implemented
on a larger scale and in an extensive manner such complex errors and frauds can be determined
but in the routine checking only ordinary errors can be traced out. It is expensive because its time
consuming the labour is being employed to do routine checking and its tends to be boring
because every time we have to find out the same sort of errors we have to do the calculation
aspect so that the debit and credit side may not be mismatched there cannot be any omission or
duplication of the data so in a way it tends to be repetitive so it amounts to a certain level of
boredom for the staff who is doing it on a regular basis. Of course there is a method of reducing
the boredom under this work there on a circular basis or on a rotational basis staff can be
changed then redundent in certain cases.

What’s difference between routine checking and test checking let us understand it. Under routine
checking we need to verify each and every book of accounts, while test checking is the
examination of selected number of items it is not that elaborative as that of routine checking.
Under routine checking, check transection verification without exception that means entire
transaction which are being recorded in the original books of accounts and subsidiary books are
to be checked without any deficiency or without leaving anything out while under test checking
it avoids immaterial items only significant items or material items are being examine under test
checking.

Routine checking is done on a daily basis while test checking can be done on a weekly, monthly
or quarterly basis depending upon the size of an organization and quantum of transaction which
need to be analyzed and examined.

Test Checking
Test checking is an accepted audit procedure wherein an audit is conducted on the basis of part
checking. We are not going for a complete checking but part checking is being done for example
there are a bulk of sales transaction so we will take up certain transaction of certain suitable basis
and partly we will do the checking of such items in detail. In adopting this technique the auditor
must take care to see the proportion of the transaction tested to the total number of transaction is
reasonable so here we want to say that where there are number of transactions we can go for test
checking but the test checking should not be so small that we cannot derive any information of it.
If out of hundred transactions we are going to vouch only 50% of the transaction then we should
setup a limit that each of these bundles last 25 or first 25 transaction would be verified randomly
and they would be verified in the detail. So under test checking what we are doing is that we are
not totally secluded the entire range of the accounting data’s but we are doing it in a partial
manner. Only on the basis of a reasonable base we are doing the test checks. Test checks cannot
be carried out in the case of size of the entity is very small and or there is no effective internal
control system so we have two important things are there if the size of the organization is so
small that there are only limited number of transaction there is no use of going for the test
checking entire routine checking is to be done as well as vouching is to done and one more
feature is there that if organization might be medium term organization or a large one but if the
internal control systems are week and there are lot many errors in the transactions which we have
noticed under that case it is advisable not to go for the part checking or to go for a detailed
procedure of auditing here we are going to extend the audit checking we will avoid the test
checks where internal control systems are week.

Company Auditors: Appointment

After incorporation of a company in the first annual general meeting, an Auditor must be

appointed by the Board of Directors. The Auditor will typically hold term till the conclusion of
6th AGM or 5 years. The appointment of an Auditor can also be made for a period of 1 year,
renewable at each annual general meeting.

Before the appointment of the Auditor, a written consent along with Certificate must be obtained
from the CA, that he/she is eligible for appointment as Auditor of a company and that
the proposed appointment is in accordance with the Companies Act.

The appointment of First Auditor of the Company must be completed by the Board of Directors
within 30 days of incorporation. In case the Board of Directors fail to appoint an Auditor, the
members of the company must be informed. The members will then be required to appoint an
Auditor within 90 days at an Extra Ordinary General Meeting. An Auditor so appointed will hold
office until the conclusion of 1st Annual General Meeting.

Rotation of Auditors
While re-appointing Auditors for a limited company or specified company, it is important to be
aware of the regulations pertaining to rotation of auditors. Individuals as an Auditor cannot be
appointed as an Auditor for a term of more than 5 years. A firm of Auditors cannot be appointed
as Auditors for more than two terms of 5 years. An Auditor who has completed his/her term of 5
years will also not be eligible for re-appointment for 5 years from completion of his/her term.

While rotating Auditors of a company, the following points must be taken in to account by the
Board of Directors:

 In case of an auditor, the period for which he has held office as auditor prior to
the commencement of the Act shall be taken into account for calculating the
period of five consecutive years or ten consecutive years, as the case may be.
 The incoming auditor or audit firm shall not be eligible if such auditor or audit
firm is associated with the outgoing auditor or audit firm under the same
network of audit firms
  Break in the term for a continuous period of five years shall be considered as
fulfilling the requirement of rotation.
 If a partner, who is in charge of an audit firm and also certifies the financial
statements of the company, retires from the said firm and joins another firm,
such other firm shall also be ineligible to be appointed for a period of five
years.

Casual Vacancy of Auditor

Any casual vacancy of the auditor must be filled by the Board of Directors within 30 days. If the
casual vacancy is on account of a resignation of an auditor, then the appointment of the auditor
must be approved at an Extra-Ordinary General Meeting convened within 3 months of the
recommendation of the Board.

Re-appointment of Retiring Auditor

Retiring auditor can be re-appointed at an Annual General Meeting if:

 The auditor is not disqualified for re-appointment.

 The auditor has not given the company a notice in writing of his unwillingness
to be re-appointed.
 A special resolution has not been passed at that meeting appointing some other
auditor or providing expressly that he shall not be re-appointed.

If at any Annual General Meeting, no auditor is appointed or re-appointed, the existing auditor
will continue to be the auditor of the company.

Company Auditors: Removal

Removal of auditor as per provision of the companies Act 2013

An audit means an examination of the financial reports which include a balance sheet, statement
of changes in equity, income statements, cash flow statements, and notes providing a summary
regarding significant accounting policies and such other explanatory notes which are required to
be presented in the annual report of the Company, by an independent individual or an
organization. Here we will discuss the Auditor Removal Procedure as per Companies Act 2013.

The main objective of the audit is to provide a true and fair view of the Financial Information
presented in Annual report thereby reflecting the financial position of the Organization of the
Financial Year.

An auditor is an independent person who is qualified to conduct an audit. From an accounting

point of view, an auditor is an independent person who evaluates the authenticity and reliability
of the company’s financial statements. The auditors are required to follow the auditing
standards which are set by a governing body.
Eligibility & Qualifications for Appointment as Auditor
Only a person who is a qualified chartered accountant can be appointed as an auditor of a
company. In case, a firm is appointed as an auditor, only the partners who are qualified chartered
accountants are authorized to act and sign on behalf of the firm.

A person is disqualified to act as an Auditor under the following circumstances:

 Any person who is an officer or an employee of the company

 Any person whose relative is a director of the company or who is a position of
key managerial personnel in the company.
 Any person convicted by the court of any offense involving fraud and tenure of
ten years has not elapsed from the date of his conviction.

Roles & Responsibilities of Auditor

The following are the roles and responsibilities of an auditor:

 Ensure that all the auditing standards have properly complied.

 To access all records of subsidiaries, if required.
 Ensure that desired information is obtained and have a backup for the same in
certified copies.
 Should report qualifications, reservations, or adverse remark after auditing the
records, if any.
 Should Report fraud or disqualifications in the company’s records, if any,
within 30 days along with the substantial evidence. Failure to report and if it is
discovered later by the authorities, the auditor is liable to pay a fine up to Rs.
25 lakh.
 No services like internal audits, bookkeeping, investment or banking services
should be provided by a person to the company where he has been appointed as
an ‘Auditor of annual financial records’.
 The Act prescribes several such essential responsibilities for auditors and
thereby giving enough liability and the role of the auditors to perform as per the
rules set by the Act.

Appointment of Auditor
A Company’s first auditor is required to be appointed within 30 days of incorporation in a
general meeting or within 90 days at an Emergency General Body Meeting. The first auditor
appointed shall hold the office from the conclusion of such meeting in which
the auditor appointment has been being confirmed until the conclusion of a fifth annual general
meeting.

Written consent from the auditor along with the necessary proof of qualifications under Section
141 of the Companies Act, 2013 are required to be submitted prior to such appointment.
A notice of such appointment is required to be sent to the auditor by the company and Form
ADT- 1 is required to be filed with the ROC within 15 days of the meeting in which such
appointment is confirmed.

The Auditor for Government companies shall be appointed by CAG.

Auditor Removal Procedure

Section 140 of the Companies Act, 2013 provides for Removal of Auditors. The procedure for
removal of Auditor in a Private Limited Company and a Public Limited Company are one and
the same.

An Auditor may be removed under the following scenarios:

 Before the expiry of a term

 After the expiry of a term

Removal before the expiry of a term

A special resolution & prior approval of Central Government is required to be obtained for
removing an auditor from the office before the expiry of his term.

The application for Central Government approval for removal of auditors is to be made in Form
ADT-2, within 30 days of the passing of the Board Resolution.

A general meeting (EGM) is required to be held by the company within 60 days of receipt of
Central Government’s approval for the passing of Special Resolution.

The section also provides that, the auditor must be given a reasonable opportunity of being heard
at the meeting.

Removal after the expiry of a term

The Company may not reappoint the Retiring Auditor at its AGM if such auditor has served
consecutively for a term of 5 years or 10 years, as provided by Section 139 and may appoint
another entity to act as its auditor. In such cases, a Notice is required to be sent for considering
the Resolution for an appointment at the AGM for-

 Appointment of a person to act as an auditor other than the auditor who is

retiring
 Expressly stating that the retiring auditor is not eligible for re-appointment

The company is also required to send the copy of a notice to the retiring auditor.

The Retiring auditors are eligible for making a Representation.

Where the retiring auditor makes a representation in writing and requested the company to notify
the same to its members of the company, the company shall state the fact in the notice given to
members that representation has been made by the retiring auditor.

A copy of the representation made will be sent to all those who are entitled to receive the notice
of the meeting. In Case, the Company is unable to send the same, then the auditor’s
representation may be read out at the meeting.

Company Auditors: Rights[not available]

1. Auditor Powers & DutiesEvery auditor has a right of access to the books
of accountand vouchers of the company at all times, whether they are at the
registered office of the company or at any other place.
2. The auditor of a holding company also has a right of access to the records of
the subsidiary company if they are necessary for the purposes of
the consolidation.
3. An auditor also has a right to receive notice of any general meeting. He may
attend it himself or through his authorized representative who is also qualified
to be an auditor. He also has a right to be heard on any part of the business
which concerns him.
4. The auditor also has a right to receive information and explanation regarding
the matters which are necessary for the performance of his duties. He needs to
know whether:
5. The company makes loans and advances against proper security and the terms
of these are prejudicial to the interests of the company.
6. Transactions that merely represent a book entry are prejudicial to the interests
of the company.
7. In the case of a company which is not an investment or banking company, it
sells the assets.  They are in the form of shares, debentures, and other securities
at a price less than their purchase price.
8. The company shows the loans and advances that it makes as deposits.
9. It charges the personal expenses to revenue account.
10.It states in the books and documents that where it has allotted the shares
in cash, it has received the cash or not. Also, whether the position in the books
and Balance Sheet is correct and not misleading.

Company Auditors: Liabilities

Auditor Liabilities
Due care generally implies four things:
 1. The auditor must possess the requisite skills to evaluate accounting entries
2. The auditor has a duty to employ such skill with reasonable care and diligence
3. The auditor undertakes his task(s) with good faith and integrity but is not
infallible
4. The auditor may be liable for negligence, bad faith, or dishonesty, but not for
mere errors in judgment

If a person suffers a loss or damage due to professional negligence of the auditor, an action can
be initiated by such person against the auditor. Moreover, it is known that a report of an auditor,
issued by him is considered to be that of an ‘expert’.

For example, His consent in writing, is included in the prospectus issued by the companies
inviting public to subscribe in share or debentures. If the report is found to be misleading in its
form and content, and a person has sustained a loss or damage as a result of subscription to the
shares or debentures, on the strength of the prospectus, such person can succeed in taking action
against the auditor, only if

1. The auditor has not withdrawn his written consent before any copy of
the prospectus was delivered for registration; or
2. Failed to withdraw his consent in writing and to give reasons thereof after the
registration of prospectus but before any allotment was made there under; or

 That he is not competent to make the statement and that he had reasonable
ground to believe at the time of registration of prospectus and / or up to the
allotment of shares or debentures, that the statement made by him is untrue.

The auditor is liable for such loss or damages suffered by the person who has relied upon his
statement.

Liabilities of an auditor for misfeasance

The term ‘Misfeasance ”means ‘breach of duty or trust‘.

1. If a company has suffered any loss or damage due to negligence or misfeasance

on the part of the auditor, direct action can be taken by the company, against
him under law of contract.
2. Action can be taken even during the course of winding up of the company.
Such action can be taken within 6 years from the date of order of winding up or
from the first appointment of the liquidator. The liability may
be civilor criminal.
3. If the auditor appeals to the court, claiming that he was reasonable and honest
in performing his duties, the court may relieve him totally or partially from
such liability with or without any condition.
 4. The auditor may also apply to court to grant relief against any proceedings that
might be brought against him, relating to negligence or misfeasance or breach
of trust. The court is competent to grant relief.
5. Action can be brought against the auditor only if his negligence has resulted in
any loss or damage to the company.
6. No contract with the company or provision in the Articles of Associationcan
indemnify the auditor against any liability on account of negligence,
misfeasance or breach of trust.
7. However, if the court acquits or discharges the auditor from such liability (civil
or criminal) and the judgement was given in favor of the auditor, the company
may indemnify the auditor against any liability incurred by him, defending the
proceedings.

Auditor’s Report

Auditor’s Report: Clean report and Qualified Report

An audit report is a written opinion of an auditor regarding an entity’s financial statements. The
report is written in a standard format, as mandated by generally accepted auditing standards
(GAAS). GAAS requires or allows certain variations in the report, depending upon the
circumstances of the audit work in which the auditor engages. The following report variations
may be used:

 A clean opinion, if the financial statements are a fair representation of an

entity’s financial position, being free of material misstatements. This is also
known as an unqualified opinion.
 A qualified opinion, if there were any scope limitations that were imposed upon
the auditor’s work.
 An adverse opinion, if the financial statements were materially misstated.
 A disclaimer of opinion, which can be triggered by several situations. For
example, the auditor may not be independent, or there is a going concern issue
with the auditee.

The typical audit report contains three paragraphs, which cover the following topics:

1. The responsibilities of the auditor and the management of the entity.

2. The scope of the audit.
3. The auditor’s opinion of the entity’s financial statements.

An audit report is issued to the user of an entity’s financial statements. The user may rely upon
the report as evidence that a knowledgeable third party has investigated and rendered an opinion
on the financial statements. An audit report that contains a clean opinion is required by many
lenders before they will loan funds to a business. It is also necessary for a publicly-held entity to
attach the relevant audit report to its financial statements before filing them with the Securities
and Exchange Commission.

CLEAN AUDIT REPORT OR UNQUALIFIED REPORT: If the auditor is satisfied that the
accounts and balance sheet and profit & loss accounts do present a true and fair picture as per
accounting principles and statutory requirements, he will give an unqualified or clean opinion.

Thus, if the auditor makes a statement in his report that “in our opinion and to the best of our
information and according to the explanations given to us, the balance sheet and profit and loss
account give a true and fair view of the state of affairs and the results of operations”, he will be
said to have given an unqualified opinion and his report will be known as unqualified or clean
report.

QUALIFIED REPORTS: Whenever the auditor of a company is not satisfied with any

information or explanation given to him or if he thinks that the profit and loss account and the
balance sheet do not exhibit a true and fair view of the state of affairs of the company or if the
accounts presented by the directors call for further clarification, he must ask the directors to do
so. He must mention that fact in his report. This type of report is known as qualified report as
distinct from a clean report.

Before the auditor gives a qualified report, he should discuss the points with the directors. They
may give such information in light of which it may be found unnecessary to qualify the report. It
should be specified and to the point. A qualified report may be in respect of the following
matters and the auditors should use appropriate words:-

1. The stock in trade has been valued at the market price which has been more
than the cost price.
2. If there is any contingent liability the extent of which has not been given.
3. Inadequate provisions for depreciation has been made.

Keeping the above in view we must consider the following also:

An Auditor is a Watchdog and Not a Bloodhound

 An auditor is not bound to be a detective or

 To approach his work with suspicion or
 With the foregone conclusion that there is something wrong.

He is a watch dog not a bloodhound. He is justified in believing the tried servants of the
company and is entitled to rely upon their representation provided he take reasonable care.

An auditor is not an insurer. He does not guarantee that the books do correctly show the true
position of the company’s affair.
The Auditor is to give information, not means of information: The auditor is required to
make a report to the members of the company:-

 On the accounts examined by him

 On every balance sheet and profit and loss account which are laid before the
company in general meeting during his tenure of office
 On every document declared to be a part of or annexed to the balance sheet and
profit and loss account.

The auditor’s report must state whether in his opinion and to the best of his information, and
according to the explanations given to him, the said accounts give the information required by
this act in the manner so required, and give a true and fair view:

 In the case of the balance sheet, of the state of the company’s affairs as at the
end of the financial year and
 In the case of the profit and loss account, of the profit or loss for the financial
year.

If the report is not clean, it is qualified and the auditor expresses qualified opinion, then he is
supposed to give the source of information otherwise not.

Unqualified Report

This is also known as a clean report and is considered to be the most common type of audit
report. In this report, an auditor assigned in an audit simply states that a company’s financial
statements that have been audited are fairly and correctly presented on their records. It is also
stated there that important facts are not hidden and it complies with the accounting standards.

This is a report that shows an auditor’s assumptions that your business has followed conformity
with accepted accounting principles and legal requirements. However, this report does not reveal
anything about your business is in good standing economically. The unqualified report only
states that your financial statements are correct and do not have any important details hidden.

Qualified Report

This is a kind of report that states that a company’s financial records are fairly presented aside
from certain area/s. It means that most things related to audit have been dealt with except for a
few matters at hand. It is basically saying to anyone who needs to know that the company in
question has accounting methods that do not follow the accounting standards.

An audit report can be unqualified if there is a limitation of scope in the work of an auditor.
Aside from that, it is also possible that there is a disagreement between two parties (auditor and
management).
However, it should be noted that having a qualified audit report is a sign that a business is deteriorating as
it only means that a company’s financial statements are not found to be transparent.

Cost Audit

Nature and significance of cost audit

It is an audit process for verifying the cost of manufacture or production of any article, on the
basis of accounts as regards utilisation of material or labour or other items of costs, maintained
by the company. In simple words the term cost audit means a systematic and accurate
verification of the cost accounts and records and checking of adherence to the objectives of the
cost accounting.

As per ICWA London’ “cost audit is the verification of the correctness of cost accounts and of
the adherence to the cost accounting plan.”

The ICWAI defines cost audit as “system of audit introduced by the government of India for the
review, examination and appraisal of the cost accounting records and attendant information
required to be maintained by specified industries”

From above definition of cost audit, it is clear that cost audit is a systematic examination of cost
accounts to verify correctness of cost accounting records.

As per the section 233 B of Company Law 1956, there is the provision for cost audit. Under this
section, cost audit is compulsory for all the public and govt. companies which are associated
with the processing and production. If there aggregate value of net worth exceeds 5 crores or
total sale exceeds 20 crores, the cost audit is must.

Objectives of Cost Audit

The following are some of the objectives for which cost audit is under taken:

1. To establish the accuracy of costing data. This is done by verifying the

arithmetical accuracy of cost accounting entries in the books of accounts.
2. To ensure that cost accounting principles are governed by the management
objectives and these are strictly adhered in preparing cost accounts.
3. To ensure that cost accounts are correct and also to detect errors, frauds and
wrong practice in the existing system.
4. To check up the general working of the costing department of the organization
and to make suggestions for improvement.
5. To help the management in taking correct decisions on certain important
matters i.e. to determine the actual cost of production when the goods are
ready.
 6. To reduce the amount of detailed checking by the external auditor if effective
internal cost audit system is in operation.

Advantages of Cost Audit: 

To The Management

1. Cost audit helps in detection of errors and frauds.

2. The management gets accurate and reliable data based on which they can make
day-to-day decisions like price fixation.
3. It helps in cost control and cost reduction.
4. It facilitates the system of standard costing and budgetary control.
5. It helps the management in inter-unit / firm comparison.
6. It enables the management to identify loss making propositions.

To The Government

1. Cost audit ensures efficient functioning of the industry. This in turn, nurtures a
healthy competition among the different companies and paves a path for fast
progress.
2. It helps in identification of sick units and enables the Government to make
relevant decisions.
3. It helps in fixing prices in the case of essential commodities and checking
undue profiteering.
4. It enables to take decisions as to granting of subsidies, incentives and
protection to various industries.
5. It helps to take decisions as to levies, duties and taxes.

To the Society

1. Cost audit enables the Government to fix prices of essential commodities. This
safeguards the interests of the society.
2. Cost audit enables the Government to keep a check on undue profiteering by
the manufacturers and avoids artificial price rise due to monopolistic
tendencies.

To the Shareholders

1. Cost audit reveals whether any of the products of the company are making
losses. Thus though the company making an overall profit, a loss making line
may eat up the company’s profits. This is brought to the notice of the
 shareholders and the management is forced to take remedial measures, thereby
making optimum utilisation of resources.
2. Cost audit ensures that the shareholders get a fair return on their investments.

Disadvantages of Cost Audit: 

1. Holding a Cost Audit can be expensive. This is because a company will often
bring in an independent auditor who are normally charging higher price.
2. A Cost Audit can be a long process which will likely involve more time. This
extra time and effort can impact an employee’s day to day routine work.
3. If a Cost Audit is carried out in order to find fraudulent activity it can take a
long time by which time people stealing could have covered their tracks.
4. Cost Audits involve a large amount of estimation and so there is the possibility
that figures will be incorrect and if record keeping from the company is not
good to start with then inaccuracies will be arises

Social Audit

Social Audit and Social Responsibility of Business

Social Audit
A social audit is a formal review of a company’s endeavors in social responsibility. A social
audit looks at factors such as a company’s record of charitable giving, volunteer activity, energy
use, transparency, work environment, and worker pay and benefits, to evaluate what kind of
social and environmental impact a company is having in the locations where it operates.

Social audits are optional. Companies can choose whether to perform them and whether to
release the results publicly or only use them internally.

A social audit is an internal examination of how a particular business is affecting a society. It

serves as a way for a business to see if the actions being taken are being positively or negatively
received and relates that information to the company’s overall public image.

A social audit examines issues regarding internal practices or policies and how they affect the
identified society. The activities included tend to pertain to the concepts of social responsibility.
This can include activities affecting the financial stability of a region, any environmental impact
resulting from standard operations and issues of transparency in reporting.

There is no standard regarding what must be considered as the society during the audit. This
allows a business to expand or contract the scope based on its goals. While one company may
wish to understand the impact it has on a small-scale society, such as a particular city, others
may choose to expand the range to include an entire state, country or the world as a whole.
Social Responsibility of Business
Social responsibility of business implies the obligations of the management of a business
enterprise to protect the interests of the society.

According to the concept of social responsibility the objective of managers for taking business
decisions is not merely to maximize profits or shareholders’ value but also to serve and protect
the interests of other members of a society such as workers, consumers and the community as a
whole.

Thus, Sachar Committee on Companies and MRTP Acts appointed by Government of India
states, “In the development of corporate ethics we have reached a stage where the question of
social responsibility of business to the community can no longer be scoffed at or taken lightly. In
the environment of modern corporate economic development, the corporate sector no longer
functions in isolation. If the plea of the companies that they are performing a social purpose is to
be accepted, it can only be judged by the test of social responsiveness shown to the needs of the
society”.

But in today’s world the interest of other stakeholders, community and environment must be
protected and promoted. Social responsibility of business enterprises to the various stakeholders
and society in general is considered to be the result of a social. Responsibility of Business
Enterprises towards Stakeholders and Society in General contract.

Social contract is a set of rules that defines the agreed interrelationship between various elements
of a society. The social contract often involves a quid pro quo (i.e. something given in exchange
for another). In the social contract, one party to the contract gives something and expects a
certain thing or behaviour pattern from the other.

In the present context the social contract is concerned with the relationship of a business
enterprise with various stakeholders such as shareholders, employees, consumers, government
and society in general. The business enterprises happen to have resources because society
consisting of various stakeholders has given them this right and therefore it expects from them to
use them to for serving the interests of all of them.
Though all stakeholders including the society in general are affected by the business activities of
a corporate enterprise, managers may not acknowledge responsibility to them. Social
responsibility of business implies that corporate managers must promote the interests of all
stakeholders not merely of shareholders who happen to be the so called owners of the business
enterprises.

1. Responsibility to Shareholders

In the context of good corporate governance, a corporate enterprise must recognise the rights of
shareholders and protect their interests. It should respect shareholders’ right to information and
respect their right to submit proposals to vote and to ask questions at the annual general body
meeting.

The corporate enterprise should observe the best code of conduct in its dealings with the
shareholders. However, the corporate Board and management try to increase profits or
shareholders’ value but in pursuing this objective, they should protect the interests of employees,
consumers and other stakeholders. Its special responsibility is that in its efforts to increase profits
or shareholders’ value it should not pollute the environment.

2. Responsibility to Employees

The success of a business enterprise depends to a large extent on the morale of its employees.
Employees make valuable contribution to the activities of a business organization. The corporate
enterprise should have good and fair employment practices and industrial relations to enhance its
productivity. It must recognise the rights of workers or employees to freedom of association and
free collective bargaining. Besides, it should not discriminate between various employees.

The most important responsibility of a corporate enterprise towards employees is the payment of
fair wages to them and provides healthy and good working conditions. The business enterprises
should recognise the need for providing essential labour welfare activities to their employees,
especially they should take care of women workers. Besides, the enterprises should make
arrangements for proper training and education of the workers to enhance their skills.

However, it may be noted that very few companies in India follow many of the above good
practices. While the captains of Indian industries generally complain about low productivity of
their employees, little has been done to address their problems. Ajith Nivard Cabraal rightly
writes, “It should perhaps be realised that corporations can only be as effective and efficient as
its employees and therefore steps should be taken to implement such reforms in a pro-active
manner, rather than merely attempting to comply with many labour laws that prevail in the
country. This is probably one area where good governance practices could make a significant
impact on the country’s business environment.”

3. Responsibility to Consumers:
Some economists think that consumer is a king who directs the business enterprises to produce
goods and services to satisfy his wants. However, in the modern times this may not be strictly
true but the companies must acknowledge their responsibilities to protect their interests in
undertaking their productive activities.

Invoking the notion of social contract, the management expert Peter Drucker observes, “The
customer is the foundation of a business and keeps it in existence. He alone gives employment.
To meet the wants and needs of a consumer, the society entrusts wealth-producing resources to
the business enterprise”. In view of above, the business enterprises should recognise the rights of
consumers and understand their needs and wants and produce goods or services accordingly.

The following responsibilities of business enterprises to consumers are worth mentioning:

1. They should supply goods or services to the consumers at reasonable prices and
do not try to exploit them by forming cartels. This is more relevant in case of
business enterprises producing essential goods such as life-saving drugs,
vegetable oil and essential’ services such as electricity supply and telephone
services.
2. They should not supply to the consumers’ shoddy and unsafe products which
may do harm to them.
3. They should provide the consumers the required after-sales services.
4. They should not misinform the consumers through inappropriate and
misleading advertisements.
5. They should make arrangements for proper distribution system of their
products so as to ensure that black-marketing and profiteering by traders do not
occur.
6. They should acknowledge the rights of consumers to be heard and take
necessary measures to redress their genuine grievances.

Unit 4
Verification and Valuation of Assets, Liabilities
The verification of assets and liabilities involves the consideration of the following points:

1. That each asset/liability is correctly stated in the balance sheet.

2. That each asset/liability is correctly valued according to the generally accepted
valuation principles.
3. That the assets actually exist on the date of balance sheet, and are the property
of the company.
 4. That the assets are free from any charge except that disclosed on the balance
sheet.
5. That no liabilities on the date of balance sheet have been omitted.

The verification of assets and liabilities achieves two main objects:

1. Propriety of transactions recorded.

2. Expressing an opinion on the financial statements, i.e., whether the balance
sheet reflects a true and fair view of the state of affairs of the company.

1. Where Stock Records are Maintained:

(a) applying test checks to ensure proper maintenance ;

(b) comparing quantities as per stock sheets with those of the balances in the stock records;

(c) checking consistency in their valuation ;

(d) comparing ‘gross profit on turnover’ (%) with that of previous years, including the explana-
tions for material variations, if any ; and

(e) ensuring separate disclosure of the value of the various components of stock-in-trade in the
balance sheet.

2. Where Stock Records are not Maintained:

(a) Inquiring into the system of stock-taking and stock sheets, preparation by reference to counts,
pricing, extensions and totals;

(b) Inquiring into the system of internal accounting and administrative controls and evaluating its
adequacy;

(c) Verifying the stock movements (i.e., receipts, issues, etc.) during the count, the listing of
items in the stock sheets ;

(d) Determining the obsolete, slow-moving, non-moving, and damaged items and ascertaining
their treatment in accounts ;

(e) Ensuring that the stock sheets include the goods sent on consignment but not yet sold,
and do not include any goods:

(i) held on consignment,

(ii) sold but not dispatched, and

(iii) received but not purchased ;

(f) Examining that the quantities and corresponding values have neither been over-stated nor
under-stated, and that the valuation has been done as per the company’s policy in accordance
with the generally accepted accounting principles;

(g) Testing the appropriateness of allocation of costs of materials and labour, and of the propor-
tion of overhead charges (if any) relating to the goods-in-process ;

(h) Comparing ‘gross profit on turnover’ (%) with that of previous years and ascertaining the
reasons for material variations ;

(i) Obtaining a certificate from the management to the effect that the stock sheets are accurate,
and confirming that the stock sheets have been signed by a partner or director or a responsible
officer, and

(j) Finally ensuring that the various components of stock have been separately disclosed in the
balance sheet with their mode of valuation.

The verification steps for various assets of a company include:

1. Loans Against Security of Landed Property:

(1) Examining the documents like: Memorandum and Articles which empower the company to
lend money, security papers, mortgage deeds, title deeds of properties, insurance policies, etc.

(2) Vouching the date and amount of loan, the rate of interest, and the date on which due.

(3) Examining the value’s certificate for sufficiency or otherwise of the securities held.

(4) In case of land and property having been mortgaged, seeing that:

(i) The mortgage has been properly executed.

(ii) The mortgager is empowered to do so.

(iii) The mortgage is registered with the Registrar of Companies in the case of a company.

(iv) The first mortgagee is aware of the second mortgagee (if any) and the title deeds are with the
first mortgagee.
(5) Scanning the loan accounts in the ledger and obtaining confirmation from the borrowers as to
the loan amounts on the date of balance sheet.

2. Loans Against Security of Stocks and Shares:

(1) Obtaining the list of stocks and shares held as securities and ascertaining that these are trans-
ferred in the client’s name.

(2) Examining the status of shares as fully or partly paid as because the transferee will have to
pay the uncalled amount whenever the company makes a call.

(3) Checking the valuation of securities held to ascertain its sufficiency or otherwise against the
amount of loan.

(4) Examining the terms of agreements, viz., rate and amount of interest payable by the
borrower, etc.

(5) Verifying whether such securities have been lodged with the bank for safe custody and
obtaining a certificate from the bank.

(6) Confirming from the borrowers as to the loan amounts on the date of the balance sheet.

3. Loans Against Security of Goods:

(1) Examining the documents like:

(i) Go-down-keeper’s receipt/Warehouse receipt/Dock warrant against which a loan has been
advanced.

(ii) Railway receipt/Bill of Lading/Letters of Hypothecation/Insurance policy/Invoice on the

basis of which a loan has been advanced for the goods-in-transit.

(iii) Inspection Reports to ascertain the quantity of goods which have been held as securities.

(2) Ensuring that the above documents have been duly endorsed in favour of the client.

(3) Ascertaining the value of the goods from the invoices, market quotations, etc., in order to
determine the value of securities.

(4) Confirming/inspecting the turnover of the stock, where the goods are of perishable mature.

4. Loans Against Personal Security of the Borrower:

(1) Making an inquiry as to the financial solvency of the surety, if any.

(2) Examining the validity periods of the Securities e.g., promissory notes.

(3) Ensuring that the terms, on which a loan has been advanced, have not been changed during
the repayment period of the loan.

(4) Vouching of repayments and enquiry as to steps for recovery.

5. Loans Against Insurance Policy:

(1) Examining whether the insurance policies:

(i) Are running policies;

(ii) Have been assigned in favour of the client , and

(iii) So assigned have been notified to the insurance company.

(2) Seeing that the amount of loan advanced is within the surrender value of such policies.

(3) Checking the premiums paid by the borrower by reference to the last receipts.

(4) Ascertaining whether the client has paid any premiums to prevent the policies lapsing and
whether amounts so paid have been debited to the concerned loan Account of the borrower.

Auditor’s Report: Clean report and Qualified Report

An audit report is a written opinion of an auditor regarding an entity’s financial statements. The
report is written in a standard format, as mandated by generally accepted auditing standards
(GAAS). GAAS requires or allows certain variations in the report, depending upon the
circumstances of the audit work in which the auditor engages. The following report variations
may be used:

 A clean opinion, if the financial statements are a fair representation of an

entity’s financial position, being free of material misstatements. This is also
known as an unqualified opinion.
 A qualified opinion, if there were any scope limitations that were imposed upon
the auditor’s work.
 An adverse opinion, if the financial statements were materially misstated.
  A disclaimer of opinion, which can be triggered by several situations. For
example, the auditor may not be independent, or there is a going concern issue
with the auditee.

The typical audit report contains three paragraphs, which cover the following topics:

1. The responsibilities of the auditor and the management of the entity.

2. The scope of the audit.
3. The auditor’s opinion of the entity’s financial statements.

An audit report is issued to the user of an entity’s financial statements. The user may rely upon
the report as evidence that a knowledgeable third party has investigated and rendered an opinion
on the financial statements. An audit report that contains a clean opinion is required by many
lenders before they will loan funds to a business. It is also necessary for a publicly-held entity to
attach the relevant audit report to its financial statements before filing them with the Securities
and Exchange Commission.

CLEAN AUDIT REPORT OR UNQUALIFIED REPORT: If the auditor is satisfied that the
accounts and balance sheet and profit & loss accounts do present a true and fair picture as per
accounting principles and statutory requirements, he will give an unqualified or clean opinion.

Thus, if the auditor makes a statement in his report that “in our opinion and to the best of our
information and according to the explanations given to us, the balance sheet and profit and loss
account give a true and fair view of the state of affairs and the results of operations”, he will be
said to have given an unqualified opinion and his report will be known as unqualified or clean
report.

QUALIFIED REPORTS: Whenever the auditor of a company is not satisfied with any

information or explanation given to him or if he thinks that the profit and loss account and the
balance sheet do not exhibit a true and fair view of the state of affairs of the company or if the
accounts presented by the directors call for further clarification, he must ask the directors to do
so. He must mention that fact in his report. This type of report is known as qualified report as
distinct from a clean report.

Before the auditor gives a qualified report, he should discuss the points with the directors. They
may give such information in light of which it may be found unnecessary to qualify the report. It
should be specified and to the point. A qualified report may be in respect of the following
matters and the auditors should use appropriate words:-

1. The stock in trade has been valued at the market price which has been more
than the cost price.
2. If there is any contingent liability the extent of which has not been given.
3. Inadequate provisions for depreciation has been made.
Keeping the above in view we must consider the following also:

An Auditor is a Watchdog and Not a Bloodhound

 An auditor is not bound to be a detective or

 To approach his work with suspicion or
 With the foregone conclusion that there is something wrong.

He is a watch dog not a bloodhound. He is justified in believing the tried servants of the
company and is entitled to rely upon their representation provided he take reasonable care.

An auditor is not an insurer. He does not guarantee that the books do correctly show the true
position of the company’s affair.

The Auditor is to give information, not means of information: The auditor is required to

make a report to the members of the company:-

 On the accounts examined by him

 On every balance sheet and profit and loss account which are laid before the
company in general meeting during his tenure of office
 On every document declared to be a part of or annexed to the balance sheet and
profit and loss account.

The auditor’s report must state whether in his opinion and to the best of his information, and
according to the explanations given to him, the said accounts give the information required by
this act in the manner so required, and give a true and fair view:

 In the case of the balance sheet, of the state of the company’s affairs as at the
end of the financial year and
 In the case of the profit and loss account, of the profit or loss for the financial
year.

If the report is not clean, it is qualified and the auditor expresses qualified opinion, then he is
supposed to give the source of information otherwise not.

Unqualified Report

This is also known as a clean report and is considered to be the most common type of audit
report. In this report, an auditor assigned in an audit simply states that a company’s financial
statements that have been audited are fairly and correctly presented on their records. It is also
stated there that important facts are not hidden and it complies with the accounting standards.
This is a report that shows an auditor’s assumptions that your business has followed conformity
with accepted accounting principles and legal requirements. However, this report does not reveal
anything about your business is in good standing economically. The unqualified report only
states that your financial statements are correct and do not have any important details hidden.

Qualified Report

This is a kind of report that states that a company’s financial records are fairly presented aside
from certain area/s. It means that most things related to audit have been dealt with except for a
few matters at hand. It is basically saying to anyone who needs to know that the company in
question has accounting methods that do not follow the accounting standards.

An audit report can be unqualified if there is a limitation of scope in the work of an auditor.
Aside from that, it is also possible that there is a disagreement between two parties (auditor and
management).

However, it should be noted that having a qualified audit report is a sign that a business is deteriorating as
it only means that a company’s financial statements are not found to be transparent.

Disclaimer of Opinion
A disclaimer of opinion is a statement made by an auditor that no opinion is being given
regarding the financial statements of a client. This disclaimer may be given for several reasons.
For example, the auditor may not have been allowed or been able to complete all planned audit
procedures. Or, the client restricted the scope of the examination to such an extent that the
auditor was unable to form an opinion. If the client allows the auditor to complete planned work,
or rectifies an underlying irregularity, then the auditor may be able to issue a clean opinion. Until
the auditor issues a replacement opinion, the disclaimer remains in force.

Disclaimer of opinion is basically a statement provided by the auditor that doesn’t lay down any
sort of opinion with regard to the financial position and condition of the company. Disclaimer of
opinion is provided by certified public accountant wherein he clarifies that an audit related
opinion/statement cannot be provided owing to limitations of the examinations conducted.

This kind of an opinion/statement makes it evident that the auditor isn’t in a position to provide a
particular opinion with regard to the company’s overall financial status based on its financial
statements or records. Such a statement is issued if there is any sort of irregularity, which the
auditor fails to reconcile based on his/her satisfaction.

A disclaimer once provided by the auditor remains effective till the time the client incorporates
the required adjustments to the financial records, which further ensures that the documents fully
comply with the accounting related statements. Once the adjustments have been made the auditor
can consider re-evaluating the financials and find out whether all the outstanding matters have
been appropriately resolved or not. The moment the auditor issues an opinion, the disclaimer of
opinion issued by him/her previously is considered to be null and void.

Using Disclaimers

As per GAAS (Generally Accepted Auditing Standards), the auditors are required to either issue
a disclaimer of opinion after an audit or provide an opinion with regard to the financial condition
and statements as a whole.

In fact a disclaimer of opinion doesn’t really implicate that the auditor is suspecting some kind of
impropriety happening with the financial statements and records. If required, the documents
aren’t provided for the purpose of justifying the line related items registered in the accounting
statement/records and the auditor may in such a case come to the conclusion that it isn’t possible
to provide an opinion around that time. Similarly, if enough documents are available but the
financial record maintenance doesn’t comply with the GAAS, then in such a case the auditor is
most likely to provide a disclaimer of opinion. In addition to this, the auditor will also look at
encouraging his/her client and suggest him/her to seek advice and services from a professional
and reputed accountant so that the records can be put in order.

Audit Certificate, Company Auditor Report

Auditor’s Report: Clean report and Qualified Report

An audit report is a written opinion of an auditor regarding an entity’s financial statements. The
report is written in a standard format, as mandated by generally accepted auditing standards
(GAAS). GAAS requires or allows certain variations in the report, depending upon the
circumstances of the audit work in which the auditor engages. The following report variations
may be used:

 A clean opinion, if the financial statements are a fair representation of an

entity’s financial position, being free of material misstatements. This is also
known as an unqualified opinion.
 A qualified opinion, if there were any scope limitations that were imposed upon
the auditor’s work.
 An adverse opinion, if the financial statements were materially misstated.
 A disclaimer of opinion, which can be triggered by several situations. For
example, the auditor may not be independent, or there is a going concern issue
with the auditee.

The typical audit report contains three paragraphs, which cover the following topics:

1. The responsibilities of the auditor and the management of the entity.

2. The scope of the audit.
 3. The auditor’s opinion of the entity’s financial statements.

An audit report is issued to the user of an entity’s financial statements. The user may rely upon
the report as evidence that a knowledgeable third party has investigated and rendered an opinion
on the financial statements. An audit report that contains a clean opinion is required by many
lenders before they will loan funds to a business. It is also necessary for a publicly-held entity to
attach the relevant audit report to its financial statements before filing them with the Securities
and Exchange Commission.

CLEAN AUDIT REPORT OR UNQUALIFIED REPORT: If the auditor is satisfied that the
accounts and balance sheet and profit & loss accounts do present a true and fair picture as per
accounting principles and statutory requirements, he will give an unqualified or clean opinion.

Thus, if the auditor makes a statement in his report that “in our opinion and to the best of our
information and according to the explanations given to us, the balance sheet and profit and loss
account give a true and fair view of the state of affairs and the results of operations”, he will be
said to have given an unqualified opinion and his report will be known as unqualified or clean
report.

QUALIFIED REPORTS: Whenever the auditor of a company is not satisfied with any

information or explanation given to him or if he thinks that the profit and loss account and the
balance sheet do not exhibit a true and fair view of the state of affairs of the company or if the
accounts presented by the directors call for further clarification, he must ask the directors to do
so. He must mention that fact in his report. This type of report is known as qualified report as
distinct from a clean report.

Before the auditor gives a qualified report, he should discuss the points with the directors. They
may give such information in light of which it may be found unnecessary to qualify the report. It
should be specified and to the point. A qualified report may be in respect of the following
matters and the auditors should use appropriate words:-

1. The stock in trade has been valued at the market price which has been more
than the cost price.
2. If there is any contingent liability the extent of which has not been given.
3. Inadequate provisions for depreciation has been made.

Keeping the above in view we must consider the following also:

An Auditor is a Watchdog and Not a Bloodhound

 An auditor is not bound to be a detective or

 To approach his work with suspicion or
 With the foregone conclusion that there is something wrong.
He is a watch dog not a bloodhound. He is justified in believing the tried servants of the
company and is entitled to rely upon their representation provided he take reasonable care.

An auditor is not an insurer. He does not guarantee that the books do correctly show the true
position of the company’s affair.

The Auditor is to give information, not means of information: The auditor is required to

make a report to the members of the company:-

 On the accounts examined by him

 On every balance sheet and profit and loss account which are laid before the
company in general meeting during his tenure of office
 On every document declared to be a part of or annexed to the balance sheet and
profit and loss account.

The auditor’s report must state whether in his opinion and to the best of his information, and
according to the explanations given to him, the said accounts give the information required by
this act in the manner so required, and give a true and fair view:

 In the case of the balance sheet, of the state of the company’s affairs as at the
end of the financial year and
 In the case of the profit and loss account, of the profit or loss for the financial
year.

If the report is not clean, it is qualified and the auditor expresses qualified opinion, then he is
supposed to give the source of information otherwise not.

Unqualified Report

This is also known as a clean report and is considered to be the most common type of audit
report. In this report, an auditor assigned in an audit simply states that a company’s financial
statements that have been audited are fairly and correctly presented on their records. It is also
stated there that important facts are not hidden and it complies with the accounting standards.

This is a report that shows an auditor’s assumptions that your business has followed conformity
with accepted accounting principles and legal requirements. However, this report does not reveal
anything about your business is in good standing economically. The unqualified report only
states that your financial statements are correct and do not have any important details hidden.

Qualified Report

This is a kind of report that states that a company’s financial records are fairly presented aside
from certain area/s. It means that most things related to audit have been dealt with except for a
few matters at hand. It is basically saying to anyone who needs to know that the company in
question has accounting methods that do not follow the accounting standards.

An audit report can be unqualified if there is a limitation of scope in the work of an auditor.
Aside from that, it is also possible that there is a disagreement between two parties (auditor and
management).

However, it should be noted that having a qualified audit report is a sign that a business is
deteriorating as it only means that a company’s financial statements are not found to be
transparent.

Computer Aided Audit Techniques and Rules[not available]

Auditing Standards[not available]