Auditing & corporate governance B.

Com 6th Semester

B.COM 6TH SEMESTER

AUDITING AND CORPORATE GOVERNANCE

UNIT-1- AUDITING: Introduction, Meaning, Objects, Basic Principles and Techniques;

Classification of Audit, Audit Planning, Internal Control – Internal Check and Internal Audit;
Audit Procedure – Vouching and verification of Assets & Liabilities

INTRODUCTION TO AUDITING

The practice of auditing existed even in the Vedic period. Historical records show that
Egyptians, Greeks and Roman used to get this public account scrutinized by an independent
official. Kautilya in his book “arthshastra” has stated that “all undertakings depend on
finance; hence foremost attention should be paid to the treasury”.
Auditing as it exists today can be associated with the emerging a joint stock company
during the industrial revolution. The company’s act of 2013 gives regulations regarding the
audit work.

Meaning of Audit:
The word audit is derived from the Latin word “AUDIRE” which means to hear.
Initially auditor was a person appointed by the owners to check account whenever the
suspected fraud, he was to hear explanation given by the person responsible for financial
transactions. Emergence of joint stock companies changed the approach of auditing as
ownership was pestered from management. The emphasis now is clearly on the verification
of accounting date with a view on the reliability of accounting statement.

Definition:
Spicer and Peglar define auditing as “An examination of the books, accounts and
vouchers of a business’s shall enable the auditor to satisfy himself whether or not the balance
sheet is properly drawn up so as to exhibit a true and correct view of the state of affairs of the
business according to his best of the information given to him and as shown by the book.
Mautz: defines auditing as being “Concerned with the verification of accounting data
with determining the accuracy and reliability of accounting statements and reports.”

The international auditing practices committee defines auditing as “the independent

examination of financial information of any entity whether profit oriented or not and
irrespective of size/legal form when such an examination is conducted with a view to express
an opinion thereon”.

Scope of Audit
The scope of audit is increasing with the increase in the complexities of the business.
It is said that long range objectives of an audit should be to serve as a guide to the
management future decisions.

Today most of the economic activities are largely conducted through public finance.
The auditor has to see whether these larger funds are properly used. The scope of audit
encompasses verification of accounts with a intention of giving opinion on its reliability.
Hence it covers cost audit, management audit, social audit etc. It should be remembered that
an auditor just expressed his opinion on the authenticity of the account. He has no power to
take action against anybody, in this regard it’s said that “an auditor is a watch dog but not a
blood hound”.

Objectives of Auditing
Auditors are basically concerned with verifying whether the account exhibit true and fair
view of the business. The objectives of auditing depend upon the purpose of his appointment.

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 Auditing & corporate governance B. Com 6th Semester

Primary Objective
The primary objective of an auditor is to respect to the owners of his business
expressing his opinion whether account exhibits true and fair view of the state of affairs of
the business. It should be remembered that in case of a company, he reports to the
shareholders who are the owners of the company and not tot the director. The auditor is also
concerned with verifying how far the accounting system is successful in correctly recording
transactions. He had to see whether accounts are prepared in accordance with recognized
accounting policies and practices and as per statutory requirements.

Secondary Objective:
The following objectives are incidental to the main objective of auditing.
1. Detection and prevention of errors: errors are mistakes committed unintentionally
because of ignorance, carelessness. Errors are of many types:
a. Errors of Omission: These are the errors which arise on account of transaction into
being recorded in the books of accounts either wholly partially. If a transaction has
been totally omitted it will not affect trial balance and hence it is more difficult to
detect. On the other hand, if a transaction is partially recorded, the trial balance will
not agree and hence it can be easily detected.
b. Errors of Commission: When incorrect entries are made in the books of accounts
either wholly, partially such errors are known as errors of commission. E.g.: wrong
entries, wrong Calculations, postings, carry forwards etc. such errors can be located
while verifying.
c. Compensating Errors: when two/more mistakes are committed, which counter
balances each other, such an error is known as Compensating Error. E.g.: if the
amount is wrongly debited by Rs.100 less and Wrongly Credited by Rs.100 such a
mistake is known as compensating error.
d. Error of Principle: These are the errors committed by not properly following the
accounting principles. These arise mainly due to the lack of knowledge of accounting.
E.g.: Revenue expenditure may be treated as Capital Expenditure.
e. Clerical Errors; A clerical error is one which arises on account of ignorance,
carelessness, negligence etc.

Location of Errors: It is not the duty of the auditor to identify the errors but in the
process of verifying accounts, he may discover the errors in the accounts. The auditor
should follow the following procedure in this regard.
1. Check the trial balance.
2. Compare list of debtors and creditors with the trial balance.
3. Compare the names of account appearing in the ledger with the names of accounting
in the trial balance.
4. Check the totals and balances of all accounts and see that they have been properly
shown in the trial balance.
5. Check the posting of entries from various books into ledger.

2. Detection and Prevention of Fraud: A fraud is an Error committed intentionally to

deceive/ to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.
a. Misappropriation of Cash: This is one of the majored frauds in any organization it
normally occurs in the cash department. This kind of fraud is either by showing more
payments/ less receipt.
The cashier may show more expenses than what is actually incurred and misuse the
extra cash. E.g.: showing wages to dummy workers. Cash can also be misappropriated
by showing less receipt
E.g.: not recording cash sales. Not allowing discounts to customers. The cashier may
also misappropriate the cash when it is received. Cash received from 1st customer is
misused when the 2nd customer pays it is transferred to the 1st customer’s account.
When the 3rd customer pays it goes forever. Such a fraud is known as “Teaming and

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Lading”. To prevent such frauds the auditor must check in detail all books and
documents, vouchers, invoices etc.
b. Misappropriation of Goods: here records may be made for the goods not purchased,
not issued to production department, goods may be used for personal purpose. Such a
fraud can be deducted by checking stock records and physical verification of goods.
c. Manipulation of Accounts: this is finalizing accounts with the intention of
misleading others. This is also known as “WINDOWS DRESSING”. It is very
difficult to locate because it’s usually committed by higher level management such as
directors. The objective of WD may be to evade tax, to borrow money from bank, to
increase the share price etc. to conclude it can be said that, it is not the main objective
of the auditor to discover frauds and irregularities. He is not an insurance against
frauds and errors. But if he finds anything of a suspicious nature, he should probel it
to the full.

BASIC PRINCIPLES OF AUDITING

Planning: An Auditor should plan his work to complete his work efficiently and well within
time. To plan work accordingly, an Auditor handles the following −
 Accounting system and policies.
 Internal control system of organization.
 Determination of audit procedures and coordinating audit work.
Honesty: An Auditor must have impartial attitude and should be free from any interest. He
should be honest and sincere to his work and he should do his work without any bias and
prejudice.

Secrecy: An Auditor should keep confidential all the information acquired by him during his
audit. He should not share the information with anyone without the permission of the client
and that too the information can be shared with the client’s permission only when it is bound
to be so.

Audit Evidence: An Auditor should adhere to substantive and compliance procedure for
collecting audit evidences before conducting an audit. Through substantive procedures, an
Auditor may collect evidences regarding accuracy, completeness and validity of data; and
through compliance procedure, he may collect evidences regarding internal control system as
used in the client’s organization.

Internal Control System: It is the primary responsibility of a company to keep adequate

internal control system in his organization. On the basis of such internal control system, an
Auditor can determine the nature, timing and audit procedure to be applied to conduct his
audit.

Skill and Competence: Audit should be done by trained, experienced and competent persons
and audit staff should be updated with all the developments in accounting, auditing and legal
rules and regulations as amended from time to time.

Work Done by Others: An Auditor is permitted to rely on work done by others but he
should exercise due diligence when referring to it. He should mention the source of reference
thereof in his report.

Working Papers: An Auditor should prepare and preserve all the necessary documents as
obtained during his audit. These documents can be used by him as audit evidences.

Legal Framework: All business activities should be run adhering to the rules and regulations
stipulated in the legal framework. This is to safeguard the interests and rights of the interested
parties.

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Audit Report
On the basis of the review and assessment of the audit evidences, Auditor should express his
opinion regarding financial statements of an organization −
 Financial statements are prepared using acceptable accounting principles.
 Financial statements comply all relevant statutory requirements.
 All material matters are disclosed and proper presentation of financial statements are
done subject to statutory requirements.

TECHNIQUES OF AUDITING
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 −

Vouching
When the Auditor verifies accounting transactions with documentary evidence, it is called
vouching. Through vouching, the Auditor verifies authority and authenticity of records.

Confirmation
Confirmation is a technique used by an Auditor to validate the correctness of the transactions;
for example, an Auditor obtains written statement directly from debtors to confirm the
debtors balance as appeared in the books of client.

Reconciliation
Reconciliation is a technique used by an Auditor to know the reason of differences in
balances. For example, to know the difference in the bank book of the client and the bank
balance as appeared in the bank statement or pass book, the Auditor prepares the
reconciliation statement. The same method may be used for debtors, creditors, etc.

Testing
Testing is a technique of selecting representative transactions out of whole accounting data to
draw a conclusion about all items.

Physical Examination
Physical examination requires verification and confirmation of the physical existence of
tangible assets as appears in the Balance Sheet like cash in hand, land and building, plant and
machinery, etc.

Analysis
Analysis technique is used by an Auditor to segregate important facts and to further study
their relationship.

Scanning
By scanning of books of accounts, an experienced Auditor can identify those entries which
would require his attention. It is also called scrutiny of accounts.

Inquiry
This method is used to collect in-depth information about any transaction.

Verification of Posting
To verify posting from books of original entry to ledger account and confirm the balance, an
Auditor is required to verify the postings; for example, to verify a sale book, an Auditor may
verify postings from the sale register to the sale ledger. He may further calculate balances of
the sale register and the sale book.

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 Auditing & corporate governance B. Com 6th Semester

Flow Chart
The Flow Chart technique is used by an Auditor to determine the stages of transaction and the
generation of documents at all levels of transactions.

Observations
Through observation, an Auditor get an idea about reliability of the process and the procedure
of an organization.

ADVANTAGES OF AUDIT:
1. Audited accounts are detected as an authentic record of transaction.
2. Errors and frauds are detected and rectified.
3. It increases the morale of the staff and thus it prevents frauds and errors.
4. Because of his expertise the auditor may advise on various matters to his clients.
5. An auditor acts as a trustee of his shareholders. Hence he safeguards their financial
interest.
6. For taxation purpose auditing of account is a must.
7. In case of any claim is to be made from the insurance company only audited account
should be submitted.
8. Even in case of partnership firm auditing of accounts helps in the settlement of claim at
the time of retirement/death of a partner.
9. Auditor account helps in managerial decisions.
10. They are useful to secure loan at the time of amalgamation, absorption, reconstruction etc.
11. Auditing safeguards the interest of owners, creditors, investors, and workers.
12. It is useful to take certain financial decisions like issuing of shares, payment of dividend
etc.

TYPES OF AUDIT:

1. Statutory Audit: any audit carried on as per the requirement of law is called as a
statutory audit. e.g.: all companies have to get their accounts audited as per the provision
of the company’s Act of 2013.
2. Periodical/ Annual Audit: it is a kind of audit where the auditor verifies the account at
the end of the financial year. He starts the audit work after the closure of financial year.
This is a common audit and is mostly used by small organizations.
3. Interim audit: it’s an audit conducted in the middle of the accounting year before the
accounts are closed. In other words, any audit conducted between two financial audits is
known as interim audit. The objective is to get periodical results, to declare interim
dividend.
4. Partial Audit: when an auditor is asked to audit only a part of the account system. It’s
called partial audit. E.g.: he may be asked to audit only the payment side of cash book.
5. Balance sheet audit: it’s a kind of partial audit and is concerned with the verification of
only those items appearing in the Balance Sheet. It is more popular in the USA. In fact
while verifying BS items the auditor verifies/ checks all related items/accounts.
6. Cost audit: cost audit is defined as the verification of cost accounting records. Data and
techniques for its accuracy and authenticity. It gets as effective managerial tool for the
detection of errors and frauds in cost accounting records. The companies act implies the
central government to order cost audit in case of specifies companies.
7. Management audit: Management audit may be defined as a comprehensive examination
of an organizational structure of a company, institution/government and its plans and
objectives it means of operations and use of human and physical facilities. The main
objective of management audit is to see how far the objectives of management are
fulfilled. It aims to ascertain whether sound management prevails throughout the
organization and evaluates its efficiency in the system of its operation.

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8. Continuous audit: a continuous audit is one in which the auditor visits his client’s office
at regular intervals throughout the year to verify the account. The objective of CA may
be-
a. To get final account audited immediately after the closure of accounting year.
b. When the business is very large.
c. When interval control system is into effective.
d. When regular final accounts are required.

ADVANTAGES:
1. Errors and frauds are discovered and rectified quickly.
2. The chances of fraud are reduced.
3. The workers will be careful in their work.
4. Continuous audit acts as a valuable morale check on the staff.
5. Final audit becomes easier and faster.
6. If the company wants to declare interim dividend it’s easier to prepare interim
account.
7. It increases the efficiency and accuracy in the accounts.

DISADVANTAGES:
1. After the auditor’s visit is over, alternative may be made.
2. It affects the regular work.
3. It’s not suitable for small organizations.
4. The auditor may loose the line of work if he does not complete his work in a visit.

Precautions to be taken for continuous audit:

1. He should record important balances; totals etc. and verify the same in his next visit.
2. Strict instructions should be given prohibiting the alteration of figures after checked
by the auditor.
3. For each visit special ticks should be used.
4. It’s always better to verify the nominal account at the end of the year.
5. An exhaustive audit programme must be prepared.
6. He should ensure that normal working is not affected.
7. As far as possible, he should pay surprise visits.

Preparation before commencement of the audit:

An auditor after receiving the appointment letter should communicate his
acceptance/otherwise in writing to the company. The following steps are necessary to
commence the audit work:

1. If it is not a statutory audit, he should find out the exact nature and scope of his duties i.e.,
whether he has to audit the account/prepare accounts also.
2. He should inform his clients to close all the books of account and keep them ready for
verification.
3. He should acquaint himself with the nature of his client business.
4. He should examine the efficiency of the internal control system.
5. He should obtain the names of directors their power duties etc.
6. He should obtain a complete list of all books and documents maintained by the clients.
7. He should obtain a copy of previous year’s audit report.
8. He should go through various documents like MOA, AOA, prospectus etc.

Audit Programme: before commencing the audit, he should plan his work so that is over
without delay. For this purpose, the auditor chalks out a detailed programme explaining the
procedure to be followed for audit. It explains the work to be done by the audit staff. An audit
programme is defined as “a detailed plan of the auditing work to be performed, specifying the

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 Auditing & corporate governance B. Com 6th Semester

procedure to be followed in verification of each item in the financial statements, and giving
the estimated time required’.
Hence an audit programme is a statement giving instructions and guidance to the audit staff
as to the audit procedure. It arranges and distributes the work among the audit staff.

ADVANTAGES:
1. It provides the audit staff clear instructions about their duties.
2. It promotes division of work in a well-organized manner.
3. It helps the auditor to monitor the progress of the work.
4. It will be easier to fix responsibilities for omissions and commissions.
5. It serves as a valuable evidence for the work done.
6. It serves as a guide for future audit.
7. It ensures that audit process in a systematic manner.
8. It eliminates inefficiency and saves time.
9. Incase if any audit assistant goes on leave, his work can be easily continued by others.
10. It avoids duplication of work.

Disadvantages of Audit Programme

1. The audit work becomes mechanical.
2. It kills the creativity of the audit staff.
3. Chances of work not done properly/ high as the scope are to be completed within a
scheduled time.
4. A rigid programme may not be suitable for all kinds of business.

The above disadvantages can be minimized if the audit programme is made more flexible and
audit staff encourages to go beyond the work mentioned in the audit programme. The
auditors should also periodically review the programme in the light of experiences gained in
the previous year. He should impress upon the audit staff. The audit programee is only
guidance and they should use their initiatives, intelligence and common sense at all times
during the course of the audit.

Audit Note Book: an audit note book is one of the most important documents maintained by
the auditor. It is defined as a record used mainly in recording audit, containing data on work
done and comments made. Audit Note book contains information regarding the day to day
work performed by the audit staff, notes about errors, explanations required etc. the auditor
can use it as an authentic evidence in the court if there is any case against him.

Contents of Audit Note Book:

1. Nature of business and important documents such as MOA, AOA, Partnership deed etc.
2. List of books of accounts.
3. List of officials, their duties and responsibilities.
4. Copy of the audit programme.
5. Information on missing receipts, vouchers etc.
6. Details of errors discovered.
7. Explanations sought from the officials.
8. Points to be included in the audit report.

An audit note book should be preserved by the auditor as it contains valuable information in
respect of the work done by its staff.

Audit Working Papers:

 Audit working papers are those papers which contain essential facts about accounts,
which are being audited. It’s defined as the file of analysis, summaries, comments and
correspondence build up by the auditor during the course of audit.

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 The auditor maintains papers as supporting evidence to the audit work. The institute
of chartered accountants of India states that “an auditor is expected to maintain
evidence of work done by him and his staff”.
 Usually, audit working papers contains a copy of the trial balances, schedule of
debtors and creditors, reconciliation statements important correspondence etc.
 Working papers should be clear complete, and contain the necessary information so
that they may be of maximum utility. They should be properly organized, documented
and signed. In this regard it’s said that “an auditor is often judged by the quality of the
working paper prepared by him under his guidance”.
 Working papers are confidential documents hence he should not disclose the facts to
others. Doing so results in professional misconduct. Working papers should be
preserved properly because they are important documents.

Purpose of maintaining working paper:

1. They show the extent to which accounting principles and auditing standards have adhered
to.
2. They provide the required support for the auditor’s report.
3. They also reveal the efficiency with which the audit work was done.
4. They can be used as evidence in the court to defend himself against negligence in his
duty.
5. They help the auditor in finalizing his report quickly.
6. They help the auditor to understand the efficiency of the accounting system, internal
check system etc.

OWNERSHIP OF WORKING PAPERS:

The auditor, who collects information through working papers for his audit work,
usually claims that he is the owner of the working papers. On the other hand the company
claims that the auditor was appointed by and he only acts as its agent. Hence, all the
documents that the auditor had collected should belong to the company several cases have
been referred to the courts regarding the ownership in one of the cases it was decided that the
working papers belong to the auditor because he was an independent professional and not an
agent of the client. In another case also, it was held that the working papers belong to the
auditor.
Auditors Lien:
The auditors if has into been paid his audit fees has the right to keep the books of accounts
and other related documents in his possession till his dues are paid. Such a right is known as
Auditors Lien.
Differences between Accounting and Auditing

Accounting Auditing
1. It’s a continuous process carried out throughout 1. It’s a onetime activity after the closure of
the year. accounting year.
2. No prescribed qualification is required to be an 2. He must be the member of Institute of Chartered
accountant. Accountants of India to become an auditor.
3. An accountant is an employee of the company. 3. An auditor is an independent professional.
4. An accountant gets regular salary for his work. 4. He gets remuneration for his professional work.
Audit fees.
5. Accounting is concerned with recording of 5. It concerned with verification of accounts
business transactions systematically. prepared by the accountant.
6. Accounting precedes, auditing. 6. Auditing succeeds accounting.

Usually an auditor confines his work only to the verification of accounts. In small
organizations he may also be asked to finalize accounts. In this case he acts both as an
accountant and as an auditor but the audit work commences only when the accounting work
is over. Hence, it’s said that “Audit begins where accounting ends”.

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 Auditing & corporate governance B. Com 6th Semester

INTERNAL CHECK
The term internal check implies that the work of various members of the staff is
allocated in such a way that the work done by one person is automatically checked by
another. It is defined as “such an arrangement of book keeping routine where in errors and
frauds are likely to be prevented or discovered by the very occupation of book keeping itself’.
Internal check is a system under which accounting methods and details of an establishment
are laid out that the accounts and procedures are not under the absolute and independent
control of any one person or the contrary the work of one employee is complementary to that
of another.

The system of IC is based upon the principle of division of labor, where in

performance of each individual is automatically checked by another. This is possible by
properly allocation the work and integration of function of the employees in such a manner
their work complements each other.

OBJECTIVES OF INTERNAL CHECK:

1. Eliminates frauds and errors to prevent misappropriation of goods in cash.
2. To encourage specialization of labor.
3. To reduce the time spent on a particular work.
4. To exercise moral pressure over staff members.
5. To make accounting system more reliable.

Points to be Considered in Framing a Good Internal Check.

1. No single employee should have independent control over any important aspect of the
business. In other words, the work of employed should be automatically received by
another.
2. The duties of the employees should be changed from time to time without prior notice.
3. Employees who control physical assets should not have assets to goods of account.
4. It’s better to follow a system of self-balancing ledger.
5. Account must be periodically verified.
6. The allocation of work must be carefully done and the position must be reviewed
periodically.
7. While stock taking the pricing and evaluation of stock should be done by the people who
are not connected to stores department.
8. A cashier should not be in charge of maintaining accounts complete bank transactions etc.

Internal check and the Auditor:

The auditor before starting audit work evaluates the system of internal check. If it is
efficient, he may avoid detailed checking of the transactions and he can carry out a few test
checks of the transactions to what extent should an auditor rely upon the system of internal
check will depend upon the degree of effectiveness with which, the system is followed as
well as the size of the business. If the internal check system is inefficient, he had to check in
detail all transactions. It should be remembered that even if the internal check system is
efficient, he should still test its existence and efficiency.
Efficient internal check system reduces his work but not his responsibility. If in the
process of examination of accounts if he finds any weakness in his system, he should report it
to his client. Thus, the existence of a good internal check system may help an auditor to a
great extent, but does not reduce his legal liability. If any fraud is discovered subsequently, he
may be held quietly of negligence. He can’t defend himself saying that he relied upon the
efficient internal check system that existed in the business.

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Internal check regarding CASH SALES

Sales over the counter
The following is the internal check system regarding sales over the counter.
1. Each counter should have a separate salesman.
2. Each salesman should be given a separate sales memo book. Usually different color is
used for different counters,
3. Sales memo should be prepared by the salesman in 4 copies.
4. The sales memo is checked by another clerk before being handed it over to customer. A
copy is retained by the clerk.
5. Payment is made at the cash counter.
6. One copy of cash memo is returned to the internal duly stamped as cash paid 2 copies are
returned to the cashier.
7. The cashier records days total sales in cash sales register.
8. Every salesman should prepare total sales summary of the respective counters. At the end
of the day total sales as recorded by salesman, total cash received and total sales as per
register must agree with each other.

Postal Sales:
A separate register should be maintained to record details of postal sales. Cash may be
received either with order (C.W.O) or at the time of delivery (C.O.D). Proper records will be
made in this regard for cash received and due. Usually, goods are sent by V.P.P (value
payable post). The sales register must be checked in detail by a senior officer.

Sales by Traveling Agents:

1. Traveling salesman should not be allowed to issue final receipts to customers.
2. Amount received must be remitted to H.O. account on daily basis.
3. Salesman should not be allowed to deduct their expenses or commission from the sale
proceeds.
4. The salesman should submit periodical sales report which must be examined in detail.

Internal check regarding Wages:

In a large organization, expenses on wages with form one of the major portions of expenses.
The chances of frauds are also high in this regard. In this background, a good system of
internal check assumes significance.
a. Frauds might be in the form of recording more wages than actually paid.
b. Payment of wages to dummy/ghost workers.
c. Recording wages for which no payment has been made etc.

The design of internal check system should try to prevent the above fraud. The following
internal check system is suggested in this regard.

1. Maintaining Time Records: A department is in charge of recording the time spent by

the workers should be constituted as far as possible. Manual system of time keeping must
be avoided. This brings down the fraud regarding the payment of wages for which no
work is done.
The time keeping check and the foremen should separately prepare the time recorded
sheet recording the name of the worker, time of entry, names of absentees etc.
In case if the workers are paid on piece rate system proper system of time booking
must be followed each worker should be given a job and counter assigned by the
supervisor.
In case if workers work overtime, the overtime slips must be issued, which is
authorized by the concerned official. No worker should be allowed to work Over Time if
he is not authorized to do so.

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2. Preparation of Wage Sheets:

Large scale organizations should evolve in an internal check system in such a manner
that the chances of over payment, under payment, wrong payment to workers are
minimized and prevented. Preparation of wage sheets should be the responsibility of a
separate department. Separate wage sheets should be maintained for workers under time
rate system and price rate system.
Two clerks should examine the time and price wage records. Over time records etc.
another clerk should be in charge of preparing wage sheets of individual works. The 4 th
clerk checks the calculations deduct amount for PF, IT, etc. to arrive at net amount to be
paid to workers. All officials involved in the process, should sign the statements which
will be approved by the work manager/ the production manager.

Payment of Wages:
A person is not involved either in maintaining time records preparation of wage sheets
should be in charge of payment of wages. Usually the cashier in the accounts department
will allot the wages, according to the information given by the wage sheet. As far as
possible wages should be distributed personally to the workers who sign the Wage
Register. Absentee workers should be paid through others workers only after written
authorization is received. A list of unpaid wages should be prepared after the distribution
of wages. If there are casual workers, payment should be made to them separately on a
different day.

Internal Check as Regards Purchase

The purchase department will be responsible for proper control over purchases as far as
possible. Purchases must be centralized for the purpose of internal check. The purchase
process may be divided as:
1. Purchase.
2. Storage.
3. Issues of Materials.

1. Internal Check regarding Purchase of Materials:

The concerned department, head will send requisition letter to the purchase
department, for each department, a separate file must be maintained for requisitions.
Based on the requisition the purchase committee, purchase department, calls for
tenders from approved suppliers. These tenders must be opened by the purchase
committee and the least bidder will be chosen.
Purchase order has to be sent to the selected suppliers. Usually, purchase order
will be prepared by the purchase department, a copy of which will be sent to the
supplier, second to the stores, third to the accounting department, and the fourth is
retained by the purchase dept.
When goods are received the storekeeper inspects them and compared with the
purchase order. If goods are acceptable, he enters them in goods inward book and
issues the acceptance letter. A copy of the acceptance letter will go to the accounts
department, which will again compare goods approved letter with the purchase order.
The accounts manager if satisfied authorizes for its payment.
2. Internal Check over Storage of Goods: The stores keeper should maintain proper
records, regarding storage of goods. He usually maintains bin cards and stores ledger
surprise.
3. Internal Check as regards to issue of Materials: Materials should always be issued
against material requisition note. After each issue, and purchase proper record must be
made in bin cards and stores ledger.

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Internal Control:
Internal control is a broad term which is normally used to control financial and non-
financial activities. It involves a number of checks and controls exercised in a business to
ensure efficient and economic working.

Definition:
Internal Control is defined as “the whole system of controls, financial and otherwise
established by the management in the conduct of a business including internal check internal
audit and other forms of control.

Advantages of Internal Control:

1. From the client’s point of view.
a. Internal control system provides authentic and reliable data useful to take business
decisions.
b. It safeguards the physical and non-physical assets in the form of records,
documentation etc.
c. It promotes operational efficiency, by preventing waste, duplication of work and
inefficient use of resources.
d. A good system of internal control provides that the company follows the procedures
and rules as required by the law.

2. From auditors’ point of view.

An auditor evaluates a system of control before commencing an audit work his work
becomes easier if the control system is efficient. He can also decide whether detail
verification is necessary or not.

Disadvantages of Internal Control:

1. It involves expenditure which may not be affordable by the small organizations.
2. Internal control is concerned with routine transactions many times unusual transactions
may be over looked.
3. The system of internal control may be weakened due to inefficiency in handling of the
system.
4. There are chances of diverse objectives among employees in the departments and staff in
charge of internal control.
5. Management may manipulate the operation of internal control system.

Elements, features characteristics principles of a good Internal Control System:

An effective internal control system should have the following factors:

1. Competent and trust worthy staff: people in charge of internal control system must be
reliable and highly competent about the work. Lack of knowledge and dishonesty will
spoil the efficiency of the system.
2. Records of financial and other organizational plans: A good internal control system
must have good documentation system. Filing, recording, classifying, etc will help in this
regard.
3. Segregation of duties: normally, there should be a separate department for internal
control this reduces frauds, bias etc. normally; a clerk in charge of accounting function
should not be in charge of assets also.
4. Supervision: proper reviewing of the operations of the company regularly makes the
control system effective.
5. Authorization: all transactions must be properly authorized. In other words, the authority
of each person should be well defined.
6. Sound practices: the company should have well established procedures, policies,
delegations’ organizational manuals etc.

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7. Internal Audit: it’s a part of internal control and it should be independent of internal
check.
8. Accounting Controls: proper accounting information systems should be established so
that the information relating to accounts is properly collected, recorded and accounts
prepared.

Scope of Internal Control or Areas of Internal Control:

1. General financial Control: It’s concerned with control over all finance functions i.e.,
planning, acquiring and investing funds and management of profits. It deals with
accounting supervision recording etc. of the finance department.
2. Cash Control: it’s concerned with proper control over receipts payments and balance of
cash. The control system must ensure that misappropriation of cash is prevented.
3. Control over wages: this includes maintenance of time records, wage records, and
payment to workers. The main area of concern in this regard is the check payment to
wages for the work not done and misappropriations of cash.
4. Control over purchases: the system of internal control regarding purchases should be
developed in such a manner that purchasing accounting, handling and issuing of goods
are properly controlled.

INTERNAL AUDIT:
Large scale organizations usually develop a system to review their activities to identify areas
of non-performances. Internal audit is a tool used in this regard.

Definition:
Internal auditing involves a continuous critical review of financial and operating activities by
a staff of auditors functioning as full-time salaried employees.

Objective of Internal Audit:

1. To comment of the effectiveness of the internal control system in force and means of
improving it.
2. To verify correctness accuracy and authenticity of the records presented to management.
3. To facilitate early detection of errors and frauds.
4. To ensure that standard accounting practices are followed.
5. To ensure that assets are properly acquired, safeguarded and accounted for.
6. To investigate in the areas as requested by the management.
7. To see that exhibited liabilities are valid.

Advantages of Internal Audit:

1. Internal Audit makes the system of internal control more effective and efficient.
2. It makes the auditor’s work simpler.
3. Errors and Frauds are detected early.
4. It increases the morale of the employees.
5. Employees will be more careful as their work will be audited immediately.

Disadvantages of Internal Audit:

1. Small organizations cannot afford to have internal audit system as it’s expensive.
2. The regular work of the organization will be affected.
3. Internal auditor acts as a staff manager hence there are chances of differences of opinion
between the internal auditor and the employees of the company.

Difference between Internal and Independent Audit:

Internal Independent.
1. An internal auditor is a regular employee 1. He is a professional auditor appointed by
of the company. the company who is not an employee.
2. His duties, rights and responsibilities are 2. The scope of audit work liabilities, duties

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determined by management. etc. are explained by concerned statutes.

3. He is appointed by the management. 3. He is appointed either by shareholders or
by govt.,
4. It’s not compulsory. 4. It is compulsory for all companies.
5. Internal auditor acts as an advisor to the 5. He is independent of the management.
management.
6. To become an internal auditor professional 6. An independent auditor must have
qualification is not necessary. professional qualification as per the act.
7. Internal Auditor ensures that the system of 7. the internal auditor comment on the true
accounting is efficient. and fair view of business.
8. An internal auditor reports to the 8. The Internal Auditor reports to the
management. shareholders.
9. Internal audit is a continuous process. 9. It’s a periodic process.

To conclude, it can be said that “the internal auditor’s responsibility is to the

management and he is not a servant of the independent auditor. His scope will be decided by
the management and eh should be free to communicate to the external auditor but should not
involve himself with the work of independent auditor.

Difference between internal checks and internal audit:

Internal Check Internal Audit.
1. It is an arrangement of duties allocated in 1. It is independent appraisal of operation and records
such a way that the work of one person is of the company.
automatically checked by another.
2. The purpose of Internal Check is to prevent 2. The purpose is to detect errors and frauds that are
minimize possibilities of errors and frauds. already committed.
3. Internal Check doesn’t require separate staff. 3. It requires separate staff employed only for this
It represents only the arrangement of duties. purpose.
4. Internal Check is a continuous process. 4. The Internal auditor has to report periodically
about various inefficiencies and suggest
improvements.
5. Internal Check begins along with the 5. It begins when the accounting process ends.
recording of transactions.
6. It is devices of doing the work. 6. It is a device for monitoring the work.
7. Scope of Internal Check is limited especially 7. The scope of internal audit goes on beyond
to the accounting department. accounting department.

Internal check in a Department Store:

A department store is a large-scale retail organization working on self-service basis selling
the daily requirements of the customers. These are centrally located and attract customers.

Operation of Department Stores:

As the name itself suggests a dept., store is divided into many small departments, each
department offering a specific product line. These depts., are headed by supervisors assisted
by stock assistants. While the accounting departments, takes care of recording all
transactions, in the cash department, will be in charge of receipts and payments of cash. As it
operates on self-service basis cash is paid by the customer at the counter.

Internal Check as regards Purchase

Goods are to be purchased as per the order of the G.M. The General Manager prepares
purchase order based on the requisition notes sent by the supervisor. No supervisor should be
given independent charge of purchase. A copy of the purchase order is sent to the accounting
department and stores dept., when once the goods are received the store keeper verifies them

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with the order and approves for payment. The accounts department makes the payments after
verifying the Purchase order and goods.

Internal Check regarding Cash Receipts

Usually the cash counters are computerized which brings down the human errors. The
customers make the payments directly at the counter. The counter clerk prepares the bill and
receives the cash. Chances of error and fraud are less as goods are coded and price is
mentioned against codes. As far as petty cash expenses are concerned, the cashier should be
in charge of petty cash expenses, which are recorded on daily basis. The goods are delivered
after verifying the bill.

Vouching and verification of Assets & Liabilities

Verification:
Verification is a process carried out to confirm the ownership valuation and existence
of items at the balance sheet date. Spicer and Pegler define verification as, “the verification
of assets implies an inquiry into the value, ownership and title, existence and possession and
the presence of any charge on the assets.
It is also defined as a process by which the auditor substantiates the accuracy of the
right-hand side of Balance Sheet and must be considered as having 3 distinct objects, i.e.,
verification of the existence of assets, the valuation of assets and authority of their
acquisition.
The auditor is required to report whether the Balance Sheet exhibits the true and fair
view of the business. For this, he has to examine and ascertain the correctness of money value
of assets and liabilities as shown in the Balance Sheet. In the case of London Oil Storage
Company Ltd, it was held that it is the duty of the auditor to verify the existence of assets,
stated in the Balance Sheet and that he will be liable for any damage suffered by the client, if
he fails in this duty.
The Institute of CA of India, states that the verification of assets should be aimed at
establishing there:
a. Existence
b. Ownership
c. Possession.
d. Free from Encumbrance.
e. Proper recording and proper verification.

Difference Between Verification and Vouching

Vouching Proves the accuracy of book entries but certification on balance sheet can be made
only after verification.
Vouching Verification
1. Vouching examines the entries relating to 1. Verification examines the assets and
transactions recorded in books of liabilities appearing in the Balance Sheet.
accounts.
2. Vouching is done throughout the year. 2. It takes place at the end of the year.
3. Vouching is bases on only documentary 3. Verification is based on personal as well
examination. as documentary examination.
4. It does not include verification. 4. It includes valuation.
5. Vouching is normally done by audit 5. It1 is done by the auditor himself.
assistant.

Valuation:

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The accuracy of B.S depends on the correctness of estimation of value of assets. A

company’s BS is not drawn for the purpose o showing what the capital would be worth if the
assets were realized and liabilities paid off. But to show how the capital stands invested. It’s
the responsibility of the auditor that items in the BS are neither over valued nor undervalued.

Auditor Position Regarding Valuation:

 An auditor can obtain the certification of valuer and other competent persons. Usually,
the assets are valued by responsible officials.
 An auditor audits many types of companies and he can’t be an expert to value all
kinds of assets.
 An auditor is not a valuer, and can’t be expected to act as such. All that he can do is to
verify the original cost price and to ascertain as far as possible the current values are
fair and reasonable and are in accordance with accepted principles.
 It must be borne in mind that the actual valuations are made by officials who have a
practical knowledge of such assets and that an auditor’s duty is confined to testing the
valuations as far as he can and, in this way, satisfy himself with correctness of the BS
position.
 However, he can’t guarantee the accuracy of valuations.
 In simple words, in the absence of suspicious circumstances he can rely on the trusted
officials of the company but this will not relive him from his responsibilities if assets
are incorrectly valued.
 He should exercise reasonable care and skill, analysis critically all the facts and satisfy
himself that generally accepted. Accounting principles are followed.
 He should not certify what he believes to be incorrect.

Method of Valuation:
Assets may be valued in any 1 of the following methods.
1. Cost Price: Its price paid to purchase an asset including installation and other expenses
incurred to make the asset into workable condition.
2. Market Value: Its value of which an asset can fetch in the market when it is sold.
3. Replacement Value: It’s the price at which a particular asset can be replaced.
4. Book Value: It’s the value of an asset, as shown in the Balance Sheet.

Differences between Verification and Valuation

Verification. Valuation.
1. Verification is done to prove the 1. It certifies the correct value of the asset at
existence, ownership and title to assets. the date of the BS.
2. Verification is done or both assets and 2. Usually only values of assets are
liabilities. certified.
3. Verification is done by the auditor. 3. It’s done by the experts and responsible
officials.
4. Verification is made on the basis of 4. it is based on the certificate issued by the
evidence. officials

Verification and Valuation of Assets

A. Intangible Assets:
i) Goodwill:
a. Goodwill is an intangible asset representing the value of the reputation of
the firm which enables it to earn more than normal profit. The value of
goodwill varies with the earning capacity of the business.
b. When a business has been purchasing and goodwill is paid for the auditor
should verify the agreement with the vendors. Whenever a business is

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acquired, goodwill is the difference between the value of acquisition and

cost of acquisition.
c. Sometimes, goodwill may also be created by spending huge amounts to
innovate new products. Such goodwill is known as Deferred Goodwill. It’s
capitalized over a period of time. Goodwill is shown in the books at cost less
the written off amount.

ii) Patents:
a. Patent rights should be verified with the certificates granting such rights. If a
patent is purchased, he should verify the assignment deed. He should see
whether the deed is registered in the name of his client and patents are the
property of the client.
b. The auditor should also examine whether fees paid to purchase patents are
treated as capital expenditure. If renewal fees are paid, it should be treated as
revenue expenditure.
c. If the client has number of patents, he should get the list of patents with
details such as the date of acquisition, the period of which it acquired etc.
d. Patents are written off over the period of which they are acquired. Hence,
they are shown in the BS at cost less written off amount.

iii) Copy Rights:

a. Copy rights are those rights to produce or reproduce any creative work. The
auditor should verify the agreement between the holder of the copy right and
his client.
b. Copy right is shown is BS at cost price less written off amount.

iv) Trademarks:
a. They are registered brands. It gives the holder exclusive right to own the
brand and protect it from imitation.
b. An auditor should verify the certificate issued by the concerned authority;
the fees paid for renewal etc. trademarks are valued at cost price less written
off amount.

B. Fixed Assets.
i) Land and Building:
a. For verifying land and building the auditor should differentiate between free
hold and lease hold properties.
b. In case of free hold land and building, the auditor should verify with the title
deeds to ensure that the property is in the name of the client. He should check
the other documents like the life encumbrance certificate etc. to see whether
the property is free of any charge.
c. If it is mortgaged, he should verify the mortgage deed. As long as the title
deeds are in order the auditor can’t be held liable for frauds. However, the
auditor should obtain a certificate from the client’s legal advisor confirming
the validity of ownership.
d. Land is valued at cost price which includes purchase, price, commission pay
registration and legal charges, etc. it should be remembered that the land is not
depreciable assets.
e. On the other hand, building is always valued at cost less depreciation. It
should be remembered that is to be charged even if the building is not used
during the year. In case of building under construction valuation is made based
upon the architect certificate.
f. Lease Hold Property: In case if the property is held in lease, he should verify
the lease agreement and see whether its registered or not it is valued at cost
less depreciation.

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ii) Plant and Machinery:

a. He should obtain a schedule of plant and machinery certified by responsible
official. It gives all details about each machine.
b. He should compare the schedule with the plant register. If machinery is
acquired under hire purchase, he should verify the hire purchase agreement.
c. If the machinery is imported, he should verify the export license copy of
invoice, permission of RBI from foreign exchange payment.
d. Plant and Machinery is valued at cost less depreciation. Depreciation rate is
decided by the management. The only duty of the auditor here is to see
whether depreciation is charged as per the provision of the IT Act.

iii) Furniture and Fixtures:

a. Furniture is a movable asset whereas a fixture becomes a part of another asset.
It any addition is made during the year, he should verify the invoice and pass
book.
b. He should also verify the schedule of furniture and see whether they are
properly numbered and proper accounts are maintained. Repairs to furniture
should be treated as revenue expenditure and hence debited to P&L a/c.
furniture is always valued at cost less depreciation at a reasonable rate.
c. He should verify the method of depreciation. The amount of depreciation
varies with the usage.
d. E.g.: Furniture used in Canteen requires more depreciation than furniture used
in office. Hence the auditor must verify carefully to satisfy himself about the
adequacy of depreciation.

iv) Motor Vehicle:

a. If the company has a greater number of vehicles, he should verify the schedule
of vehicles. He should verify the registration book of each vehicle.
b. He should check the insurance paid on the vehicle etc. motor vehicles are
valued at cost less depreciation. He should see that reasonable depreciation is
provided.

C. Current Assets.
i) Cash in Hand:
a. Cash in hand is verified by actually accounting it on the date of Balance Sheet.
The counting must be done in front of the cashier.
b. To avoid frauds the auditor must ask the cashier to deposit all the cash except
petty cash into bank account. This makes verification easier.
c. In case of temporary advances, enough care must be taken in verifying the
delays. Auditor will be held responsible for any negligence in this regard.
d. In the case of the London Oil Storage Co., Ltd it was found that the auditor
had committed breach of duty in not verifying the petty cash balance properly.
e. The institute of CA of India had clearly stated that the auditor should actually
count the cash.
f. Its further states that verification of cash should be of surprise nature and if
cash in hand doesn’t agree with the balance as shown in the Balance Sheet, he
should qualify his report by mentioning the same.

ii) Cash at Bank:

The following steps are taken in verifying cash at bank:
a. Comparison of B.S as shown in the cash book and the pass book.
b. Preparation of Reconciliation Statement.
c. Obtaining a letter of confirmation from the bank.

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iii) Bills Receivable:

B/R is the acceptances given by Debtors. The objectives of verifying bills
receivable are:
a. To establish the accuracy of amounts.
b. To know the validity of the bills.
c. To know whether they are reliable and to see whether there is a fair
disclosure in the BS.

While verifying the BS the auditor

a) Should examine bills receivable book.
b) To see whether any bill is honored after the BS is prepared but before
auditing for this, he should vouch the cash book.
c) If bills are discounted; he should vouch the cash book and should see
whether it is shown as a contingent liability in the BS with proper provision.
d) He should see that bills receivable dishonored and not renewed are not
shown in the bills receivable book.

iv) Book Debts/ Sundry Debtors:

a. Book debts are to be classifies as good, bad and doubtful. The auditor should
see the accuracy, validity, and collectability and confirmation letters directly
from the debtors.
b. For any balance for which no confirmation is received, he should carefully
verify the account. He should see that proper provision is made for bad debts.
Failing to do so the auditor will be held guilty for negligence.

v) Stock/ Inventories:
a. Stock is the life blood of the business. It consists of stores and spares, raw
materials, work in progress, and finished goods. If stock is incorrectly
recorded, verified or valued, the P&L a/c doesn’t show correct balances.
b. It also affects the BS if stock if overvalued profit is inflated and if it’s
understated it encourages creation of secret reserves.
c. The objective of verifying stock is to see that it exists and is correctly valued.
It may not be possible to verify the entire stock.
d. Hence, he has to go for the checks to ascertain the accuracy of stock. In the
case of Kingston cotton mills co., ltd the judge observed that, “it is no part of
the auditor’s duty to take stock; he must rely on other people for details of
stock in trade.”
e. It was further observed that “an auditor is not bound to be a detective. He
should not start his work with a foregone conclusion that there is something
wrong. He is a watch dog and not a blood hound to be a detective.
f. He is justified in believing in trust worthy servants of the company provided it
takes reasonable care”.
g. In another case it was decided that ‘it is certainly not the duty of the auditor to
take stock. He should check the calculation with proper care’.

While verifying stock:

a. He should review the procedure for maintenance of stock and records.
b. Examine the efficiency of internal check and control system.
c. See whether stock verification process contains adequate safeguards against
possible errors and frauds.
d. Test checks the physical existence of a part of the stock. Stock is valued at cost
price/ market price whichever is lower/less.

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vi) Investment:
a. It may consist of govt., bonds, shares, securities etc. The auditor should
examine whether the company is authorized to make investments. He should
see whether the legal formalities have been completed.
b. If the investments are larger in number, he should obtain the schedule of
investments certified by a responsible official. The statement should include
name of the investment date of purchase, book value, market price, rate and
date of interest, tax deducted etc.
c. It is advisable to verify all investment at a time. It is always advisable that the
auditor should personally inspect the investments in the case of city equitable
fire insurance company limited.
d. Where the investments were in the possession of brokers who had pledged
them, the judge observed that “had the auditors not depended on the certificate
form, their brokers and had demanded the actual production of securities, the
fraud might have been detected.
e. Dividend received on investment should be examined by checking the counter
foils of dividend warrants. Investments are valued depending upon the purpose
for which they are held.
f. If they are held as fixed assets (e.g.: trusts) they are valued at cost price, if
they are held as current assets, they are valued at cost price or market price
whichever is less.

Miscellaneous expenses and losses:

1. Preliminary expense: all expenses incurred in the formation of a company are
called preliminary expenses. The auditor should vouch the payments made and see
whether these expenses are written off regularly. The portion of preliminary
expense not written off will be shown in the balance sheet on the assets side.

2. Discount on issue of shares and debentures : whenever shares and debentures are
issued at discount, the company shows discount amount of the asset side till it is
written off. The auditor should verify the relevant accounts and documents and see
whether discount on the issue in particular on the re issue of forfeited share is as per
the provision so act.

Verification and Valuation of liabilities

If liabilities are not properly exhibited account do not show fair view of the business.
While verifying liabilities the auditor should ensure that:
a. All the liabilities in the Balance Sheet are actually payable.
b. They are actually recorded.
c. They have arisen out of natural business operation.
d. There is a proper disclosure.
He should obtain a certificated from the responsible official of the company about the
existence of liability. In the case of West Minster Road Construction Company limited, it was
held that the auditor must take reasonable care to satisfy himself that all liabilities have been
brought into account. It was further observed that “If the auditor finds that a company in the
course of its business was incurring liabilities of a particular kind it becomes his duty to make
specific inquiries as to the existence of such liability before he signs his report.

i) Verification of Share Capital: Share capital constitutes the amount contributed

by the owners. He should verify the MOA, AOA, and Minutes Book of board
meetings, cash book and pass book. If the shares are issued for 1 st time (IPO) he
should go for detailed checking of all transactions. He should also verify records
regarding calls in arrears, forfeiture of shares and their re-issue.

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ii) Debenture: A debenture is a certificate issued by a company acknowledging its

debt to the authorized holder. It carries a fixed rate of interest. Usually paid once
in 6months. The auditor should verify the minutes of directors meeting the
authorizing the issue. He should also verify cash book, pass book etc.

iii) Loans: Loans may be either secured or unsecured. The auditors should verify
the MOA and AOA and verify the borrowing powers of the company. In case of
mortgage loans, he should see that the assets are mortgaged as per the provisions
of the law. It’s advisable to get confirmation from lending institution with a
respect to amount of loan, security, interest etc.

Current Liabilities
i) Creditors: The auditor should obtain the confirmation statement from the
creditors and compare this with the statement of creditors as sent by the
company. He should verify purchase ledgers, invoice etc. It is advisable to
have a test check of all purchase’s made during the year.

ii) Outstanding Expenses: The auditor should obtain a statement of all

outstanding expenses signed by a responsible official. He should see whether
these expenses have been properly disclosed. He should ascertain the
accuracy of the accounting records.

iii) Bills Payable: Bills Payable is negotiable instruments acknowledging the

debt. He should get a statement of bills payable and compare it with the bill
payable book. If any bills payable has been paid after the balance sheet date
but before the audit, he should verify cash book and pass book. Such bills
should not be included in the balance sheet.

iv) Contingent Liability: A future uncertain liability which is dependent on the

happening of some event is called Contingent Liability. It may or may not
arise in future. E.g.: Bills receivable discounted claims against the company
etc. the auditor should see whether all contingent liabilities are disclosed in
the Balance Sheet.

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