Auditing [5th Semester: Honours & Pass]

Contents:
S. No. Chapters Page
Number
1. Syllabus 01 - 02
2. Concept, need and purpose of audit (10 marks) (5 + 03 - 24
5)
3. Audit procedures and techniques (15 marks) (5 + 25 - 46
10)
4. Audit risk and internal control system ((10 marks) 47 - 54
5. Vouching, verification and valuation (10 marks) 55 - 71
6. Company audit (15 marks) (1 question of 15 72 - 92
marks)
7. Audit report and certificate (10 marks) 93 - 101
8. Other thrust areas (10 marks) 102 – 113
9. Audit 2019 Honours Question Paper 114 – 115
10. Audit 2019 General Question Paper 116 – 117
11. Audit 2020 Honours Question Paper 118 – 119
12. Audit 2020 General Question Paper 120 – 121
 5th Semester: Honours & General:

Auditing & Assurance

UNIT – I CONCEPT, NEED AND PURPOSE OF AUDIT (10 Marks) (5 + 5)

 Definition-Nature-Scope and Objectives of Independent Financial Audit

 Basic Principles Governing an Audit, Concept of Auditor’s Independence
 Errors and Fraud-Concepts, Means of doing Fraud, Auditor’s Responsibility towards Detection and
Prevention of Fraud, Difference between Audit and Investigation
 Classification of Audit- Organization Structure wise (Statutory, Non-statutory); Objective wise (Internal
and Independent Financial Audit); Periodicity wise (Periodical, Continuous, Interim, Final); Technique
wise (Balance Sheet, Standard, Systems, EDP);
 Standards on Auditing (SA)- Concept and Purpose

(This unit should be studied with SA 200 [REVISED] and SA 240 [REVISED])

UNIT – II AUDIT PROCEDURES AND TECHNIQUES (15 Marks) (5 + 10)

 Auditing Engagement-Audit Planning- Audit Programme (Concept)

 Documentation: Audit Working Paper, Ownership and Custody of Working Papers-Audit file
(Permanent and Current) – Audit Note Book- Audit Memorandum.
 Audit Evidence – Concept, Need, Procedures to obtain Audit Evidence
 Routine Checking, Test Checking and Auditing in Depth
 Concept of Analytical Procedure and Substantive Testing in Auditing.
 Audit of Educational Institutions, Hospitals and Hotels
(This unit should be studied with SA 210, SA 230, SA 300, SA 500, SA 520 and SA 530)

UNIT – III AUDIT RISK AND INTERNAL CONTROL SYSTEM ((10 Marks)
 Audit Risk – Concept and Types only.
 Internal Control- Definition, Objectives
 Internal Check- Definition, Objectives
 Internal Audit- Definition, Objectives, Regulatory Requirement, Reliance by Statutory Auditor on
Internal Auditor’s Work
(This unit should be studied with SA 610)

UNIT – IV: VOUCHING, VERIFICATION AND VALUATION (10 Marks)

 Vouching: Meaning, Objectives - Difference with Routine Checking – Factors to be Considered
during Vouching - Vouching of Following Items: i) Receipts: Cash Sale, Collection from Debtors,
Interest and Dividend from Investment, Sale of Fixed Assets. ii) Payments: Cash Purchase, Payment
to Creditors, Payment of Wages and Salaries, Advertisement Expenses, Travelling Expenses, Research and
Development Expenditure, Prepaid Expenses.
 Verification and Valuation: Concept, Objectives, Importance, Difference with Vouching, Difference
between Verification and Valuation, Verification of following items: i) Non- Current Assets:
 Goodwill, Patent and Copy Right, Leasehold Land, Plant and Machinery, ii) Investments iii) Current
Assets: Inventory, Loan and Advance, Cash and Bank Balances iv) Non-current Liability: Secured
Loan v) Current Liability: Trade Payables (Sundry Creditors).

UNIT - V COMPANY AUDIT (15 Marks) (1 Question of 15 Marks)

 Qualification, Disqualification, Appointment and Rotation, Removal and Resignation, Remuneration,
Rights, Duties and Liabilities of Company Auditor
 Branch Audit and Joint Audit
 Depreciation – Concept and Provisions of the Companies Act
 Divisible Profit and Dividend (Final, Interim and Unclaimed/Unpaid): Provisions of the Act, Legal
Decisions and Auditor’s Responsibility

UNIT – VI AUDIT REPORT AND CERTIFICATE (10 Marks)

 Definition – Distinction between Report and Certificate- Different Types of Report
 Contents of Audit Report (As per Companies Act and Standards on Auditing)
 True and Fair View – Concept
 Materiality – Concept and Relevance
(This unit should be studied with SA 700)

UNIT – VII OTHER THRUST AREAS (10 Marks)

 Cost Audit – Concepts, Objectives Relevant Provisions of Companies Act
 Management Audit - Concepts, Objectives, Advantages
 Tax Audit – Concepts, Objectives, Legal Provisions
 Social Audit – Propriety Audit – Performance Audit – Environment Audit (Concepts only)
Notes:
1) The provisions of the Companies Act, 1956 which are still in force would form part of the syllabus till
the time their corresponding or new provisions of the Companies Act, 2013 are enforced.
2) If new Laws or Rules are enacted in place of the existing laws and rules, the syllabus would include
the corresponding provisions of such new laws and rules with immediately following Academic Year.
3) Students are expected to develop analytical mind for answering problem based questions along with the
theoretical questions.

UNIT – I [5 + 5 = 10 Marks]
CONCEPT, NEED AND PURPOSE OF AUDIT
Definition-Nature-Scope and Objectives of Independent Financial Audit-Limitation.
Basic Principles Governing an Audit- Concept of Auditor’s Independence
Errors and Fraud- Concepts, Means of doing Fraud, Auditor’s Responsibility towards Detection and Prevention of
Fraud, Difference between Audit and Investigation
Classification of Audit- Organization Structure wise (Statutory, Non-statutory); Objective wise (Internal and
Independent Financial Audit); Periodicity wise (Periodical, Continuous, Interim, Final); Technique wise
(Balance Sheet, Standard, Systems, EDP);
Standards on Auditing (SA)- Concept and Purpose
 1. Define auditing.
Evolution of Auditing
The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days a person used
to listen to the accounts read over by an accountant in order to check them. He was known as auditor.
MEANING OF AUDITING
Earlier the term ‘adult’ was used to refer ‘hearing of accounts’. In other words, audit was restricted to
only verification of accounting and financial records. Thus, different celebrated authors defined audit
mostly in a narrower sense. A few of such important definitions are given below for further discussion.
DEFINTION BASED ON A NARROWER CONCEPT
Montgomery defined auditing as ‘a systematic examination of the books and records of a business or
other organizations in order to ascertain or verify and to report upon the facts regarding the financial
operations and the result thereof’.
The concept of audit as given by Spicer and Pegler is somewhat similar to that of Montgomery. However,
they elaborated the concept of audit as below : ‘ an audit may be said to be such an examination of books
of accounts and vouchers of a business as will enable the auditor to satisfy himself that the balance sheet
is properly drawn up, so as to give a true and fair view of the state of affairs of the business and whether
profit or loss account gives a true and fair view of the profit or loss for the financial period ,according to
the best of the information and explanation given to him as shown by the books and if not ,to report in
what respect he is not satisfied.’ Similarly, R.K. Moutz defined auditing as being ‘concerned with the
verification of accounting data, with determining the accuracy and reliability of accounting statements
and reports.’

AUDITING IN A BROADER SENSE

With the rapid change in social and economic environment, the concept of audit has been modified.
Auditing today is not confined to verification of financial and accounting records only. It now reviews
operations and performances of the organization apart from reporting on its financial statements. Thus,
according to General Guidelines on Internal Auditing issued by the ICAI, “Auditing is a systematic and
independent examination of data, statements, records, operations and performances (financial or other-
wise) of an enterprise for a stated purpose. In any auditing situation , the auditor perceives and recognises
the proposition before him for examination, collects evidences, evaluates the same and on this basis
formulates his judgement which is communicated through his audit report”

DEFEINITIONS:

According to General Guidelines on Internal Auditing issued by the ICAI, “Auditing is defined as a
systematic and independent examination of data, statements, records, operations and performances
(financial or otherwise) of an enterprise for a stated purpose. In any auditing situation, the auditor
perceives and recognises the propositions before him for examination, collects evidence, evaluates the
same and on this basis formulates his judgement which is communicated through his audit report.”

2. Discuss the scope of an audit?

Which aspects of the enterprise are to be covered in an audit will be determined by the auditor after
considering the terms of his engagement, the requirement of the relevant legislation and the pronouncements
of the Institute of Chartered Accountants of India. However, auditor should take care that no aspect of the
enterprise which are relevant to the financial statements is left unexamined.
According to SA200A Objectives and Scope of Financial Audit, the main aspects to be covered in an audit
are as follows:

i. Reliability and sufficiency of information: The auditor must satisfy himself that the financial
statements have been prepared on the basis of reliable and sufficient information.

In order to assess the reliability and sufficiency of the information contained in the underlying
accounts and other source data, the auditor will undertake following audit procedures.
 Compliance Procedures: Compliance procedures refer to study and evaluations of accounting
systems and internal control. Based on this evaluation, the auditor determines the nature, extend and
timing of other auditing procedures.
 Substantive procedures: Substantive procedure refers to testing the authenticity of information
contained in the accounting records. It involves checking arithmetical accuracy, vouching of receipts
and payments, verification of assets and liabilities etc.
ii. Disclosure of relevant information in a proper way: The auditor will examine to see whether
relevant information have been properly disclosed in the financial statements in conformity with
statutory requirements.
For ensuring disclosure of relevant information in the financial statements, the auditor will adopt
following course of action:
 Comparing source records and data: The auditor will compare the financial statements with
underlying accounting records. He will ensure that transactions and events as recorded in the accounts
are properly summarized in the financial statements.
 Assessing accounting policies: He will assess the selection and consistent application of accounting
policies and their adequate disclosure.
It is thus clear that audit of present day is not restricted to the verification of arithmetical accuracy of
the books of accounts. The auditor must go to root of transaction and examine its authenticity. He will
see that entries are recorded, posted and totaled correctly; The entries are properly summarized and
disclosed in the financial statements; the assets as reported belong to the company; liabilities are truly
owed by the company and so on. Finally, he will verify that financial statements have been drawn up
in conformity with the applicable statutory requirement and they reflect a true and fair view of state of
affairs of the business.

3. What is Independent financial audit? What are its

features/objectives?**

Independent financial audit is the audit conducted by a person who is ‘independent’ of the firm. He is an
outsider, usually a professional Chartered Accountant, who verifies books of accounts on the basis of
supporting documents and vouchers to form an unbiased opinion on the reliability and fairness of financial
statements. As the independent auditor is not an employee of the firm there is no interference in his work
from the management. So his report on the financial can be considered trustworthy and reliable.

Features/objectives of Independent Financial Audit:

The audit under broader concept has got the following features:
 i. Systematic and independent examination: Modern audit involves a systematic and independent
examination of accounts by a professional accountant. He will arrange the audit procedures in a logical
sequence and is required to be free from any bias in his work. He will not get influenced by any
kind of pressure while discharging his duties.
ii. Expression of opinion: The main purpose of audit is to express opinion by the auditor about the
reliability and fairness of financial statements. The auditor can never give absolute assurance about the
sanctity of financial statements.
iii. Determination of proportions: Audit starts with the determination of proportions to be examined
for achieving the audit objective. Haphazard examination without a clear idea about propositions leads
the auditor nowhere.
iv. Application of logic: The modern audit has its principal roots in logic and judgement. It is now
analytical and investigative. The auditor now pushes pencil less and pushes brain more.
v. Collective and evaluation of evidence: In order to examine the proportions, the auditor collects
evidences judiciously and evaluates them to arrive at a conclusion about the propositions.
vi. Formation of opinion: The audit requires the auditor to form an unbiased opinion on the assertions
made by the management in the financial statements.
vii. Communication of opinion: The process of audit ends with the communication of opinion by the
auditor through the audit report to client or shareholders.

4. Discuss the advantages of Auditing.

Advantages of Auditing:

(i) Satisfaction of Owner: It is because of audit that the owner will be satisfied about the business
operations and working of its various departments.
(ii) Detection and Prevention of Errors and Frauds: The errors whether committed innocently or
deliberately are discovered by the process of audit and its presence prevents their occurrence in
the future. No one will try to commit an error or fraud as the accounts are subject to audit and
hence they will have a fear of being detected. Just like errors, frauds are discovered by audit
and its presence minimizes future possibility if not eliminated totally.
(iii) Verification of Books: Another advantage of audit is the verification of the books of accounts,
this helps in maintaining the records up to date at all times.
(iv) Independent Opinion: Auditing is very useful in obtaining the independent opinion of the
auditor about business condition. If the accounts are audited by an independent auditor, the
report of the auditor will be true and fair in all respects and it will be of extreme importance for
the management of the company.
(v) Moral Check: The process of audit will establish a check on the minds of the staff working in the
business and they will not be able to commit any irregularity, as they will have a fear and will
also be aware that the accounts will be examined in the near future and that action would be
taken against them if any irregularity is discovered. Thus the audit prevents the happening of any
irregularity before it starts and the staff hence becomes more active and responsible. The fear of
their getting caught act as a moral check on the staff of the company.
(vi) Protection of the Rights and Interests of Shareholders: Audit helps in protecting the interests
of shareholders in case of joint stock company. Audit gives assurance to the shareholders that
the accounts of the company are being maintained properly and their interest will not suffer
under any circumstances.
(vii) Reliance by Outsiders: Outsiders like creditors, debenture holders and banks etc. will rely on
the books of accounts and financial statements of the business if they are audited by an independent
authority (external auditor).
(viii) Ensures Compliance with Legal Requirements: Audited statements are necessary to fulfill
certain legal requirements e.g. listing requirements of stock exchange etc.
(ix) Reinforce and Strengthen Internal Control: Since auditing exercise involves the review of
internal control system, an auditor will identify the gaps in internal control system and can suggest
the necessary changes in the internal control system.
(x) Loan Facility: Money can be borrowed easily on the basis of audited balance sheet from
financial institutions. If accounts are audited the true picture will be visible to banks and it will
be easy for them to issue loans as early as possible.

5. Do you agree with the view that there are inherent

limitations of Audit?

Besides having various benefits, there are some inherent limitations of auditing. These are as follows :

(a) Higher Cost Burden: Due to Higher Cost Burden, the auditor limits his scope of work to selective
testing or sampling thus in depth checking of books of accounts is not possible.
(b) Based on test checks. Generally an auditing exercise is based on test checking. Inferring a result
on the basis of test check always need not to be true.
(c) Insufficient Time: Generally an auditor needs to release the report up to a specified timeline.
Sometime this timeline become a constraint for an auditor in carrying out the auditing exercise
effectively. This time constraint may affect the amount of evidence that can be obtained concerning
events and transactions after the balance sheet date that may have an effect on the financial
statements. Moreover, there is a relatively short time period available for resolving uncertainties
existing at the financial statement date.
(d) Inconclusiveness of Evidences: The evidences obtained by an auditor are persuasive rather than
conclusive. For example, an architect’s certificate of valuation for a newly constructed building
of a client may not be conclusive evidence of the correct value of building.
(e) Based on Estimates: Estimates are an inherent part of the accounting process, and no one, including
auditors, can foresee the outcome of uncertainties. Estimate range from the allowance for doubtful
accounts and an inventory obsolescence reserve to impairment tests of fixed assets and goodwill. An
audit cannot add exactness and certainty to financial statements when these factors do not exist.
(f) Based on the Information provided by the Management: The audit opinion is based on the
information provided by the management. Hence, outsiders cannot fully rely on the auditor’s report.

6. What are the Basic Principles governing an Audit as laid

down in AAS - 1?
SA 200 describes the basic principles which govern the auditor’s professional responsibilities and which
should be complied with whenever an audit is carried out. Compliance with the basic principles requires the
application of auditing procedures and reporting practices appropriate to the particular circumstances. The
basic principles as stated in this guideline are:
(a) Integrity, objectivity and independence: The auditor should be straightforward, honest and sincere in
his approach to his professional work. He must be fair and must not allow prejudice or bias to override
his objectivity. He should maintain an impartial attitude and appear to be free of any interest which
might be regarded, whatever its actual effect, as being incompatible with integrity and objectivity.
(b) Confidentiality : The auditor should respect the confidentiality of information acquired in the course of
 his work and should not disclose any such information to a third party without specific authority or unless
there is a legal or professional duty to disclose.
(c) Skills and competence: The audit should be performed and the report prepared with due professional
care by persons who have adequate training, experience and competence in auditing.
(d) Work performed by others: When the auditor delegates work to assistants or uses work performed by
other auditors and experts he continues to be responsible for forming and expressing his opinion on the
financial information.
(e) Planning: The auditor should plan his work to enable him to conduct an effective audit in an efficient
and timely manner. Plans should be based on a knowledge of the client’s business.
(f) Audit Evidence: The auditor should obtain sufficient appropriate audit evidence through the
performance of compliance and substantive procedures to enable him to draw reasonable conclusions
therefrom on which to base his opinion on the financial information.
(g) Accounting System and Internal Control: Management is responsible for maintaining an adequate
accounting system incorporating various internal controls to the extent appropriate to the size and nature
of the business. The auditor should reasonably assure himself that the accounting system is adequate and
that all the accounting information which should be recorded has in fact been recorded.
(h) Audit conclusions and reporting: On the basis of the audit evidence, he should review and assess the
audit conclusions. He should ascertain:
a. As whether accounting policies have been consistently applied;
b. Whether financial information complies with regulations and statutory requirements; and
c. There is adequate disclosure of material matters relevant to the presentation of financial
information subject to statutory requirements.
The auditor’s report should contain a clear written opinion on the financial information.
 7. Accounting is a necessity while auditing is a luxury for a
business enterprise’ --- do you agree? Give reasons for
your
answer.***
A question often arises in the minds of businessmen whether audit is luxury or not. They say accounting is
necessity and auditing is a wastage of time and money. Auditing may be luxury from the point of view of an
ordinary businessman because of following reasons:-
(a) The remuneration paid to the auditor is an unnecessary waste of funds.
(b) Too many formalities attached to auditing create difficulties for an average businessman.
(c) The businessman feels that auditing means waste of time and disturbance in routine work of the
accountant and his subordinates.
(d) Audit is not perfect method of detecting errors and frauds.
Thus, auditing for a small business may be luxury but it is a necessity for a large business organization for
the following reasons:-
(a) Accounting data needs to be verified as to their reliability and accuracy.
(b) Public funds invested in the private sector of economy need to thoroughly examined as to their proper
utilization.
(c) Various social groups who are interested in affairs of a business entity need to be assured that the entity
functions are discharged efficiently and to the best advantage of social will-being.
(d) Absentee shareholders created out of widely dispersed ownership of management need to be provided
with sufficient assurance that the figures in the profit and loss account and balance sheet are fair
representations of the financial conditions of a business.
Thus, keeping in view the above, one can not say that auditing is luxury. Auditing is necessity of big
organizations. Auditing is compulsory in case of Private Limited Companies, Limited Companies, Charitable
Trusts, Societies, Banks etc. The partnership firms or proprietorship firms can also engage the auditors to
have the fair view of accounts. Auditing is not wastage of money because so many frauds can be detected
from auditing and the money paid to the auditors looks very petty amount in comparison of the frauds
detected. Auditing is not the wastage of time also. Normally, auditors do not disturb the accounting staff. The
do their own work. Very few interference is done by them with the accounting staff. The findings or benefits
of audit are more precious than wastage of little time of accounting staff. In my view, every business firm
whether it is small or big, must avail the services of the auditors.
 8. Accountancy begins where book-keeping ends &
accountancy ends where auditing begins. Discuss**
Book-Keeping, Accountancy and Auditing are the three aspects of the term `Accountancy' itself in its widest
sense.
Book-keeping:
Book-keeping is the art of recording the daily transactions in a set of financial books. It is concerned with
systematic recording of transaction in the books of original entry and their posting into ledger.
Accountancy
Accountancy begins where book-keeping ends." It means that an accountant comes into the picture only
when the book keeper has done his job. The functions of accountant can be classified as under :
(i) Checking the work of book-keeper.
(ii) Preparation of trial balance,
(iii) Preparation of Trading and Profit and loss Account.
(iv) Preparation of balance sheet,
(v) Passing entries for rectification of errors and making adjustments.
An accountant is supposed to be an expert in the accounting procedures as he has to examine analytically the
final accounts. But it is not necessary for him to pass the chartered Accountant's examination. He it's not
supposed to submit his report after the completion of work.
Auditing
It is said, "where accountancy ends, auditing begins." It is slightly said. An auditor has to verify the entries
passed by the accountant and the final accounts prepared by him. Thus, auditing is the checking of the
accounts of a business with the help of vouchers, documents and the information given to him and the
explanations submitted to him. An auditor has to satisfy himself after due verification and complete. Checking
of accounts as to whether the transactions entered into the books are accurate. An auditor is required to
submit his report to the effect whether or not the balance sheet is a true and fair representation of the existing
state of affairs of a business concern.
Thus, an auditor should have the proper knowledge of accounting principles. That is why he should be a
chartered Accountant. He has to express his impartial opinion in his report which he can not give unless he
satisfies himself completely with the proper recording of transactions. Thus, auditing is based on
accountancy and not accountancy on auditing. An auditor must be well familiar with the principles and
practical aspects of accountancy but it is not necessary for an accountant to be an expert in the audit work.
The following table makes the distinction clear among book-keeping accountancy and Auditing.
(a) Book-keeping :
(i) Journalizing.
(ii) Posting into Ledger.
(iii) Totaling of different accounts in the Ledger
(iv) Balancing,
(v) Checking the work of the Book-keeper.
(vi) Preparation of Trial Balance
Accountancy
(i) Preparation of Trading & Profit & loss account
(ii) Preparation of Balance sheet, (Theoretical part)
(iii) Passing entries for rectification of errors and making adjustments,
Auditing
Checking the work done by the accountant. (Examination of Records) (the Analytical part)
 9. “Auditing may be defined as ‘Accounting control”
Comment****
Accounting is concerned with measurement and communication of financial events based on some established
principles and procedures. Auditing, on the other hand deals with checking and confirmation of what are
recorded and to be communicated. It aims at ensuring that
(i) All transactions are undertaken in accordance with plans and procedures as laid down by the management,
(ii) Transactions are promptly and properly recorded so that financial statements is prepared timely and
presented in a fair way.
(iii) No fraud takes place so that assets of the business are safeguarded.
So, audit is the control of the accounting system of the organisation. It sees that accounting system has been
designed to prevent occurrence of errors and frauds and it can generate authentic and reliable financial
statements. Auditing is, therefore, appropriately defined as 'accounting control'.
However, the developments in the last few decades have extended the scope of audit beyond the accounting
system. The audit now a days is also concerned with operational efficiency and performance of the business.
It has now become control mechanism of all business activities. Accordingly the Institute of Chartered Accountants
of India has recently defined auditing as "a systematic and independent examination of data, statement,
records, operations and performances (financial or otherwise) of an enterprise for a stated purpose." So overall
control and monitoring of all business activities is now the object of audit. Hence it has been rightly said that
“The relationship of auditing to accounting is close, yet their natures are different, they are business
associates, not parent and child"

10. "An auditor is not an insurer" - Explain.****

SA 200A on “Objective and Scope of Audit of Financial Statements” states that auditor’s opinion is not an
assurance as to the future viability of the enterprise or the efficiency or effectiveness with which the
management has conducted the affairs of the enterprise. The auditor does not insures the interest of users of
accounts but only states his opinion after taking all reasonable care and skill, that the statements show a true
and fair picture. The ultimate responsibility is of the management. The audit of financial statements does not
relieve management of its responsibilities.
But According to Companies Act 2013: The financial statements shall give a true and fair view of the state of
affairs of the company or companies as at the end of the financial year [Sec. 129(1) of 2013 Act]. The
auditor’s report shall state that— to the best of his information and knowledge, the said accounts, financial
statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and
the profit or loss and cash flow for the year and such other matters as may be prescribed [Sec. 143(2) of the
2013 Act]. The aforesaid definition is very authoritative. It makes clear that the basic objective of auditing,
i.e., expression of opinion on financial statements does not change with reference to nature, size or form of
an entity. The definition given above is restrictive since it covers financial information aspect only.
However, the scope of auditing is not restricted to financial information only, but, today it extends to variety
of non-financial areas as well. That is how various expressions like marketing audit, personnel audit,
efficiency audit, production audit, etc. came into existence. But here we should study only financial audit
unless and until otherwise specified.
 11. Detection and prevention of errors are the main objects of
auditing- Discuss it fully and explain the duties of an
auditor in this regard*****
DETECTION OF FRAUD & ERRORS
The term fraud means the willful misrepresentation made with an intention of deceiving others. It is a
deliberate mistake committed in the accounts with a view to get personal gain. In accounting, fraud means
two things. a. Defalcation involving misappropriation of either cash or goods; and b. Fraudulent
manipulation of accounts not involving defalcation.
THE AUDITOR CAN SUSPECT FRAUD UNDER THE FOLLOWING CIRCUMSTANCES.

(i) When vouchers, invoices, cheques, contracts are missing etc.

(ii) When control account does not agree with subsidiary books.
(iii) When the difference in trial balance is difficult to locate.
(iv) When there are greater fluctuation in G.P. and N.P. ratios.
(v) When there is difference between the balance and the confirmation of the balance by the parties.
(vi) When there is difference between the stock as per records and the stock physically counted.
(vii) When the explanation given by the client is not satisfactory.
(viii) When there is a overwriting of some figures.
(ix) When there is a contradiction in the explanation given by different parties.

PROCEDURE TO BE FOLLOWED TO DETECT ERRORS.

Following procedures may be adopted by the auditor to detect the errors.
(i) Check the opening balances from the balance sheet of the last year.
(ii) Check the posting into respective ledger accounts
(iii) Check the total of the subsidiary books.
(iv) Verify all the castings and the carry forwards.
(v) Ensure that the list of debtors and creditors tally with the ledger accounts.
(vi) Make sure that all accounts from the ledger are taken into accounts.
(vii) Verify the total of the trial balance.
(viii) Compare the various items from the trial balance with that of the previous year.
(ix) Find out the amount of difference and see whether an item of half or such amount is entered
wrongly.
(x) Check differences involving round figures as Rs. 1,000; Rs. 100 etc .
(xi) See where there is misplacement or transposition of figures that is 45 for 54; or 81 for 18 etc.
(xii) Ultimately careful scrutiny is the only remedy for detection of errors. 13. See that no entry of the
original book has remained unposted.

THE AUDITOR SHOULD PERFORM THE FOLLOWING DUTIES IN RESPECT OF FRAUD.

(i) Examine all aspects of the finance.
(ii) Vouch all the receipts from the counterfoils or carbon copies or cash memos, sales mart reports
etc.
(iii) Check thoroughly the salary and wages register.
(iv) Verify the methods of valuation of stocks.
(v) Check up stock register, goods inwards notes, goods out wards books and delivery challans etc
 (vi) Calculate various ratios in order to detect fraudulent manipulation of accounts
(vii) Go through the details of unusual items.
(viii) Probe into the details of the problems when there is a suspicion.
(ix) Exercise reasonable skill and care while performing the duty. 1
(x) Make surprise visit to check the accounts.

12. Distinguish between Accountancy & audit****

Or
“Auditor is not an accountant” – Explain****
Accounting is a systematic process of recording, classifying and summarizing transactions and economic
events which affect the business. At the end of this process, accounting prepares financial statements which
should contain information useful to the management and other stakeholders for decision making.
Auditing is concerned with verification of financial statements as prepared by the accountant and thereby
expressing opinion on their reliability and fairness. The auditor verifies the financial statements with help of
relevant documentary evidence and explanation and information given to him. So auditing begins, where
accounting ends. In other words, accounting is followed by auditing which confirms the accuracy and
fairness of the former. Unless auditing is carried out, the reliability of the financial statements will not be
ensured. Consequently, the management and other stakeholders will not find the financial statements useful
for decision making. So auditing and accounting are closely related although they are district disciplines.

Points of difference Accountancy Audit

(a) Scope
Accountancy is concerned with the Auditing is concerned with the
preparation of final accounts and verification and examination of those
other explanations which are helpful recorded in books of account.
to the management.
(b) Object The object of accountancy is to show The object of audit is to verify the truth
the financial position of the business and fairness of financial position and of
on a specific date and to determine the operating result of the concern and
the operating result for the specific at the same time to discover errors and
period of time. frauds if any, in accounts.
(c) Qualification There is no hard and first rule that an In order to acquire qualification, a
accountant should be a Chartered Ac- professional auditor must be a Chartered
countant. Accountant.
(d) Status The accountant is a paid employee of An auditor is not a paid employee of the
the concerned organisation and concern. The owners for a specific
performs his functions under the purpose appoint an independent person
control as an auditor.
of management
(e) Tenure The accountant is the permanent An auditor may not be appointed for
employee of the concern. long time in the same concern.
(f) Knowledge in the An auditor, having no knowledge in
An accountant may not necessarily
subject accountancy cannot perform his func-
possess the knowledge of auditing.
tions of audit well.
(g) Ranking After the work of accountancy ends, the
The work of accountancy has to be
work of audit begins. So, without
done at first. So, it is done before the
work of audit begins. performing the work of accountancy,
auditing can not start.
(h) Time period of work The work of accountancy continues The work of audit may be done at the
throughout the year. end of financial year or continuously
throughout the year.
(i) Control For the work of accountancy there is The work of audit is always regulated
no scope for professional control or by the rules and regulations of the
regulation. association.

(j) Type of work The accountant takes the responsibility The auditor does not prepare account,
of the preparation of accounts. As but reviews and analyses the accounts
such, its work is constructive in nature prepared by accountant. As such, his
work is analytical in nature.
(k) Submission of report The accountant after completion of The auditor after examining and
his preparation of account need not reviewing the accounts must have to sub-
submit report to the owner or to mit a report to the owner or to
management. management.
 13. Distinguish between Internal audit & statutory
audit.***** Or

"Internal Audit is no substitute for Statutory Audit."—Discuss.

Point of Difference Internal Audit Statutory Audit

(a) Appointment of The internal auditor is appointed by the The statutory auditor is generally
auditor directors of the company. appointed by the shareholders, but in
specific cases by die director or by the
government.
(b) Qualification of The directives of the companies act The statutory auditor must have the
auditor regarding qualification is not applicable qualification as prescribed by the
here companies act.

(c) Status of the Internal auditor has no independent status The statutory auditor is an independent
auditor as he is a paid employee of the under- and impartial person, not a paid
taking. employee of the company
(d) Removal of the The appointing authority i.e. the directors The shareholders in general meeting
auditor can remove the internal auditor can remove the statutory auditor.
(e) Remuneration The directors generally fix up the amount The shareholders in general meeting fix
of remuneration payable to the internal up the remuneration payable to the
auditor statutory auditor.
(f) Special right The internal auditor has no right to attend The statutory auditor has a right to attend
the general meeting of the company. the general meeting of the company
(g) Reasons for audit Internal audit is carried out to satisfy the The statutory auditor is earned out for
directors. preservation of shareholders' interest or
third party's interest.
(h) Legal obligation There is no legal obligation for Statutory audit is compulsory for the
conducting internal audit. It depends Joint Stock Company as per provisions
upon the intention of the directors. of the Companies Act.
(i) Object of audit The main object of internal audit is to In case of statutory audit apart from
detect the errors and frauds. detection of errors and frauds,
certification of final accounts of the
concern is the main object.
(j) Pervasiveness of The internal auditor has to examine all The statutory auditor may examine the
work the transactions of the business transactions thoroughly or may adopt the
thoroughly. test checking.
(k) Report The internal auditor is not appointed by As the shareholders appoint the
the shareholders. . So, he is not required statutory auditor, so, he is required to
to submit report to them. submit the audit report to them
 14. Distinguish between continuous audit & periodic
audit.

15. Distinguish between interim audit & Internal audit

Point of Difference Continuous Audit Periodical Audit
Point of Difference Interim Audit Internal Audit
(a) Definition Continuous audit is that system of The system of audit which is taken up
(a) Audit work done During the course of the financial Internal audit is a part of normal
audit under which the auditor or his after the books have been closed at the
year, interim audit is done at any time administrative routine work.
assistant makes a detailed examination end of financial or accounting period and
(b) Work carried on In case of interim audit, the work of Internal auditing work is performed by the
of all the transactions continuously thereafter carried on continuously until
audit is carried on by an outsider. persons of the concern itself.
throughout the year or at regular completed, is called the periodical audit.
(c) Objects of audit when thesay accounts
intervals, weekly,arefortnightly
prepared orfor Internal audit is a constant review of the
the partetc.
monthly, of die financial year, interim accounts carried on throughout the year.
(b) Features audit
The is meant
main featuretoofcheck the accounts
continuous audit In case of periodical audit, after the
as it has some interim purposes.
is that recording of transactions and completion of accounting for financial year,
(d) Work of audit In work
the interim audit, thethem
of verifying workare
of carried
audit is theInternal audit begins.
work of audit goes on continuously
pertaining to a period onrelating to certain date in a year
simultaneously. throughout the life-time of a concern.
(e)
(c)Submission
Nature of of
audit AsIn itcase of interim
is carried report, theat auditor
on regularly short AtThethequestion
close of of the
reporting does not
accounting arise
year, thein
report
work requires to submit his report.
intervals, all the transactions can be case of
work of internal
audit isaudit.
taken up. So, all the
(f) Purpose to be Interimthoroughly.
verified audit is always subjected to transactions in casepart
Internal audit is a of and parcel
large of the
concerns
fulfilled the need. That is, it is conducted organisational and
cannot be examined thoroughly. administrative
(d) Fairness Aswhenever
all the there are interim
transactions purposes
are verified Atprocedure
the end of of the
an undertaking.
financial year, the work
& correctness to be fulfilled.
minutely, so if any error or fraud is
begins. So, it will not be possible to verify
of accounts crept in account, that can be disclosed them minutely. As such, errors or frauds may
and timely steps, can beBalance
taken. creep in accounts. Final audit
Point16. Distinguish
of Difference between
Balance Sheet Audit sheet audit & Final Audit

(e) Case of necessity In case of large concerns and where Whatever may be the size of the concern
the number of transactions are and whatever may be the number of
numerous, the necessity of applying transactions, its necessity is felt everywhere.
the continuous audit is felt.
(f) Relationship of Under this system of audit, a close Under this system of audit, no close
the auditor with the relationship is formed between the relationship is formed between the auditor
(i) Scope of work
concern Here
auditortheand
audit work extends beginning
the firm Under
and thethis system examination begins from
firm.
(g) Scope of from
This balancesystemsheet involves
to examination of
much books of prime does
This system entry and
not related
involvevouchers
much
expendi- ture : books of prime
expenditure. So,entry and documents.
it cannot be applied to and documents
expenditure andcontinuous audited balance
as such is applicable to all
small concerns. sheet.
types of concerns.
(ii) Internal
(h) Certification of The
Underreliable internal
this system, control
it requires less timeand
to In thisthis
Under case it is it not
system, compulsory
required much time to
control
accounts : and internal check system are
prepare and submit the report relating not introduce internal control and
to prepare and submit report concerning internal
Internal check introduced. So, it ofisfinal
to the certification notaccounts.
possible to check system. of final accounts.
the certification
system run these system.
(iii) Verification There is no need of examining the In final audit examination of verification of
of vouching verification of transaction, transactions, determination of balance of
determination of the balance of accounts etc. are needed.
accounts etc
 17. Distinguish between statutory audit & non-statutory
audit?*

Point of Difference statutory Audit non-statutory Audit

(i) Legal obligation According to the companies act, the audit There is no legal obligation on the part of the
has been made compulsory sole-trader, partners to get their account
audited.
(ii) Nature and Scope The nature and scope of audit is The nature and scope of audit is determined
of audit governed by the provisions of the by an agreement with the proprietor in case
Companies Act and the Articles of of sole-trader and the partners in case of
Association. partnership firm.
(iii) Appointment of The auditor is appointed by the The sole-trader himself in the case of sole-
Auditor shareholders in the general meeting. trading business, appoints and in case of
But in specific cases, the board of partnership firm, the partners appoint an
directors or the Central Government auditor.
appoints an auditor.
(iv) Role of Auditor Whoever may be the appointing The auditor represents himself for the
authority, the auditor discharges his proprietor in case of sole-trading business
role as a representative of the and for the partners in case of partnership
shareholders. firm.
(v) Rights, Duties and The Companies Act lays down in The matters concerning qualification,
Liabilities of Auditor different provisions relating to rights, duties and liabilities of auditor are
qualification, rights, duties and dependent on the agreement made between
liabilities of auditor. No interference the auditor and the owner or partners. The
can be made on such provisions. conditions may be increased or decreased.
(vii) Power of Auditor According to the provisions of the The auditor is not entitled to enjoy
Companies Act, the auditor is entitled abundant power. He has to perform his
to enjoy enormous power. The share- functions subject to the conditions laid
holders/directors cannot curb them. For down by the employer.
performing this function, he can adopt
such measures as he thinks necessary.
(viii) Organisation of The auditor usually conducts his work The auditor conducts his work of audit
Audit Work of audit on the basis of Companies Act, according to the instructions given in the
Memorandum, Articles, Prospectus and agreement with the owner or the partners as
Directors' Minute Book, etc. the case may be.
(ix) Submission of The auditor is required to submit his The auditor submits his report to the
report written report to the shareholder employer.
 18. What is Interim Audit? What are the objectives of Interim
Audit?**
Interim audit is the audit which is conducted in between two annual audits. In other words, it is conducted for
a part of the accounting year say, for three months or six months as per requirement. This audit is conducted
for some specific purpose.
The main objectives of interim auditing are stated below:
(i) To get the half-yearly or periodic data of the sales, profit, net profit etc.
(ii) To get the profit for the period which may help the management to declare interim dividend.
(iii) With the help of interim audit, the management and the auditor can complete Final Audit early.
(iv) To detect errors and frauds at the earliest.
(v) To ascertain the interim profit or loss or state of financial affairs of the concern.
(vi) The introduction of interim audit is needed to save time in the final audit.
(vii) To gather some important points with regard to the concern which may be of help to him later while
conducting the final audit.
(viii) In the event of admission, retirement or death interim audited accounting data is needed in the middle
of the year.
(ix) Where an investigation becomes necessary covering an interim period.
(x) In the case of transfer, sale or change of ownership of a business, it becomes necessary to know the
true result of operation and the true financial position at the end of interim period.

19. What is standard audit? What are its advantages and

disadvantages?**
Standard audit, according to Irish, an Australian author, is “a complete check and analysis of certain items
and, contingent upon effective internal check, appropriate test checks on remaining items, the whole work
being in accordance with general auditing standards quite adequate to justify an unqualified opinion.”
Advantages of Standard Audit:
(i) Audit programme can be suitably designed based on standard audit principle.
(ii) It influences the nature and extent of documents and evidences to be obtained through audit procedure.
(iii) New auditing standards compatible with the changing socio-economic condition of the country can be
developed after the scrutiny of the existing auditing standard.
(iv) The criticism that collusion often exists between the management and the auditor leading to distortion of
financial statements can be stopped through the application of standard audit procedure.
Disadvantages of Standard Audit:
(i) Uniform application of standard audit is a remote possibility as it is very difficult to bring all the firms
under the same footing.
(ii) Application of standard audit may render some areas unaudited. So chance of undetected errors and
fraud cannot be ruled out.
(iii) Standard audit may bring rigidity in approach because of changing business environment.
(iv) Setting up standard is contrary to the development of creativity in audit.
 20. “It is no part of an auditor’s duty to give advice
either to directors or shareholders as to what they ought
to do”
Comment*
Or
“An auditor is not concerned with the proprietary of
business conduct” Comment*
Or
“It is nothing to auditor whether the business of company is
Being conducted prudently or imprudently, profitably or
unprofitably” Comment*
The objective of an audit of financial statements of an enterprise, according to SA 200A entitled ‘Objective
and Scope of the Audit of Financial Statements’, is to enable an auditor to express an opinion as to the
truthfulness and fairness of financial statements.
The auditor’s opinion helps to establish reliability of the financial statements. The auditors, however, does
not give opinion on the propriety of business conduct or its future prospects.
SA 200A has specifically pointed out that the user of the “financial statements should not assume that the
auditor’s opinion is an assurance as to future viability of the enterprise or the efficiency or effectiveness with
which the management has conducted the affairs of the enterprise”.
In pursuance of the role of the auditor in lending credibility to the financial statements the Companies Act,
1956, has provided that he should be concerned about propriety of some specific transactions.
Section 227(1A) of the Act requires the auditor to enquire into six specified matters and report by exception.
This section has been inserted into the Act to ensure that the funds of the company have not been siphoned
off by the directors.
Also under CARO, 2003 issued by the Central Government in pursuance of powers given to it by Section
227 (4A) of the Companies Act, 1956, the company auditor is required to examine the financial propriety of
some transactions.
Further, SA 570, ‘Going concern’ requires the auditors to evaluate whether the going concern concept is
applicable to the circumstances of the entity and whether it will continue for a foreseeable future i.e., a
period not exceeding one year after balance sheet. In other words, future viability for one year is to be
assessed. 93
To conclude, we can say that though, generally, an audit is neither concerned with propriety of business
conduct nor its future viability yet the auditor would be required to examine the former for the purposes of
Section 227(1A) and Section 227(4A) of the Act and the latter for assessing applicability of going concern
assumption as per the requirements of SA 570
 21. “Fraud does not necessarily involve misappropriation
of cash or goods.” Comment**
Any act committed with some mischievous objectives is called fraud. It includes not only misappropriation
of wealth but also misrepresentation of facts for misleading others. So far fraud in a business is concerned, it
involves either misappropriation of cash and goods or manipulation of accounts for false representation of
state of affairs of the business. Manipulation of accounts is done generally by responsible and trusted
officials of the business with motives like:
(a) Defrauding the state by not paying tax.
(b) Earning higher amount of commission on profit.
(c) Playing false with investors and creditors.
(d) Disposing of shareholding at inflated price etc.
By violating the realisation principle of revenue determination and by improper matching of costs with
revenue, accounts are manipulated. Some of the methods of falsification of accounts are as follows:
1. Manipulation of sales: Very often to show more profit in particular accounting year, finished stock are
shown as sold by preparing challans, gate passes and invoices before the last date of the accounting year.
Again actual sales within the year may not be credited to sales account for suppressing profit.
2. Depreciation: Systematic allocation of cost of fixed tangible assets over its estimated life to the
successive profit and loss A/c is known as depreciation. Very often this allocation is not done systematically.
Again lack of consistency in the method of charging depreciation is another way of falsification of accounts.
For example, if a Company following reducing balance method switches over to straight line method of
charging depreciation without any valid ground and without disclosing the impact on the working results, it
would be a case of falsification of accounts.
3. Stock valuation: It involves lot of calculation, approximations and estimation. For example there are
various methods of charging consumption of material viz, FIFO, LIFO, Average method etc. Valuation of
W-I-P and finished stock involves the question of absorbing a share of overhead. As there is a lot of
subjectivity in stock valuation, it is very often manipulated by management for some ulterior motive.
4. Sundry debtors: Sometimes old debtors are allowed to continue in accounts although there is no
possibility of their realisation. Again to suppress profit, provisions for bad debt may made unnecessarily.
Accordingly, actual profit and financial position of the business may be distorted.
5. Improper apportionment of revenue and capital expenditure: If capital expenditures are recorded as
revenue expenditures it will show less profit and create secret reserve. On the other and if revenue
expenditures are treated as capital expenditure it will show more profit artificially and results in window
dressing of balance sheet.
6. Recording of fictitious purchase and expenses: This practice will suppress the profit of the business.
It is, therefore, clear that manipulation of accounts is very often practiced by management to defraud the
various parties directly o indirectly connected with the business. So the statement that "fraud does not
necessarily involve misappropriation of cash or goods" holds good.
 22. What is system audit? What are its advantages and
disadvantages?**
The audit which is conducted to examine the suitability of various systems of accounting prevailing in the
firm is called system audit. It assesses the existing systems of accounting to determine whether they work
efficiently or not so that appropriate opinion can be formed on financial statements. It is an audit to explore
inside the systems and discover whether they produce desired results.
System audit is a kind of investigation of the system of accounts. Its purpose is to design appropriate system
of accounts suitable for the business or revise the existing system suitably. It is no denying the fact that the
business world is dynamic in nature. The information requirement of different stakeholders is constantly
changing. So, the accounting systems frequently need to be revised so that they provide the information
desired by the stakeholders as an aid to decision making. Therefore, companies should employ auditors to
analyze their accounting systems and business methods to ascertain whether accounting records and practices
are up to date and economical; and whether such records and practices may be changed so as to do the work
better, quicker and at less cost under the changing conditions.
Advantages:
(i) The accounting procedure can be revised or designed according to the changing business environment.
(ii) The users of financial statements are immensely benefited as the accounting system newly revised or
designed by this kind of audit can generate information useful to decision making.
(iii) The system does not allow opportunity to commit errors and fraud.
(iv) The profitability of the business is increased due to the introduction of system audit.
(v) The system audit is dynamic in the sense that old concepts and systems are subject to review in the
light of changing demand of the society.
Disadvantages:
(i) The introduction of system audit is likely to increase the overhead cost.
(ii) The introduction of system audit may be resisted by the accounting staff who may be prone to
orthodox ideas.
(iii) If the system fails to attain desired result, it will entail wastage of money, time and energy.

23. What is EDP auditing? **

The principal object of an audit is to ensure that the accounts on which the auditor is reporting to show a true
and fair view of the state of affairs at a given date and of the results for the period ended on that date.
The overall objective and scope of an audit does not change in an EDP environment. However, the use y a
computer changes the processing and storage of financial information and may affect the organization and
procedures employed by the entity to achieve adequate internal control. Accordingly, the procedures
followed by the auditor in his study and evaluation of the accounting system and related internal controls and
nature, timing and extent of his other audit procedures may be affected by an EDP environment.
Essential requirement of EDP audit
(a) Skills and Competence: When auditing in an EDP environment, the auditor should have an
understanding of computer hardware, software and processing systems sufficient to plan the
engagement and to understand how EDP affects the study and evaluation of internal control and
application of auditing procedures including computer-assisted audit techniques. The auditor should
also have sufficient knowledge of EDP to implement the auditing procedures,
(b) Work Performed by Others: The auditor is never able to delegate his responsibility for forming
important audit conclusions or for forming and expressing his opinion on the financial information.
Accordingly, when he delegates work to assistants or uses work performed by other auditors or
experts, the auditor should have sufficient knowledge of EDP to direct, supervise and review the work
of assistants.
(c) Planning: The auditor should gather information about the EDP environment that is relevant to the
audit plan, including information as to how the EDP function is organized and the extent of
concentration or distribution of computer processing throughout the entity.
24. Distinguish between investigation & audit?******

Points of distinction Audit to ensure that

The auditor is required The investigatorInvestigation
does not bother about
1. Objective accounts have been
Audit is undertaken prepared
to ascertain in
whether the complianceisofundertaken
Investigation generally accepted
for some
conformity
accounts havewithbeengenerally accepted
properly drawn up accounting principles.
specific purpose, He is not
say, to ascertain:
accounting practices
and whether they discloseand
a truerelevant
and fair concerned
i. Financialwith whether
position accounting
of the firm
accounting standard. He is required
view of financial position and results to be
of policy of the company is being
ii. Earning capacity of the firm followed
well versed in accountancy and generally
the business. iii. Extent
or not. He mayof fraud committed
belong etc.
to accounting
2. Scope becomes
It deals awith
Chartered
entireAccountant.
area of books of profession or other profession.
As it is conducted for some specific
accounts. So the auditor has no alter – purpose, it involves thorough
native but to resort to test – checking examination in some selected areas.
or sample checking.
3. Nature The auditor is required to express his The investigator proves into the matter
opinion about generally reliability and and looks for substantive and conclusive
fairness of accounts. He, therefore, relies evidence to establish the fact. He is a
on persuasive or prima – facie evidence blood hound and takes everything as
to support his findings. He is only a suspicious unless proved otherwise.
watch dog and takes everything as
correct in the absence of suspicion.
4. Time Span Time span of audit is generally financial It has got no fixed time span. It is
year which may extend to 15 months undertaken covering any time period
in some special cases. It is a regular depending upon cases. It is not regular
matter undertaken compulsorily in case but occasional.
of joint stock company.
5. Interested party Audit is conducted on behalf of the An investigation is done
owners or shareholders and in some i. On behalf of owners;
cases for Central Government. ii. On behalf of prospective buyers
or would be owners;
iii. On behalf of incoming partners;
iv. On behalf of Central Govt. at
the request of shareholders.
6. Adjustment of profit An auditor is not required to adjust the The investigator may have to adjust the
net profit as ascertained by accountant. net profit as calculated by accountant to
arrive at the actual profit earning
capacity.
 7. Use of GAAP
8. Reporting The report of auditor is stereotyped and as The report of the investigator is made
per format prescribed by the Companies in detail and refers to (a) the
Act and SA700, ‘Forming an Opinion instructions given to him; (b) method
and Reporting on Financial Statements’. of approach followed by him; (c)
documents relied upon; (d) his
findings and observations;
and (e) his recommendation to his client.

25. What do you mean by auditor’s independence? Why is it

so important?*

Auditor’s independence means ability of the auditor to express opinion on the financial statements without any
influence from parties that have an interest in the results published in the financial statements of the entity. It
implies that the auditor’s judgement on the authenticity of the financial statements is not subordinate to the
wishes of directors or other parties, more specifically company managers/directors or to his own self interest.
Independence is characterized by integrity and an objective approach to the audit process. The concept
requires the auditor to carry out his or her work freely without any pull and pressure.
Real Independence and Perceived Independence:
There are two aspects of auditor’s independence – independence in fact (real independence) and independence
in appearance (perceived independence). Together, both forms are essential to achieve to goals of
independence. Real independence refers to independence of mind. It determines how the auditor is going to
deal with a particular situation. It enables him to make independent decisions even if he is under some
pressure from company directors. Independence in appearance, on the other hand, implies that the auditor
should act in a manner that other people consider him independent.
It is essential that the auditor not only acts independently, but appears independent too. If an auditor is in fact
independent, but one or two factors suggest otherwise, people will be led to conclude that financial statements
do not reflect a true and fair view. For example, if the auditor renders any consultancy service to the client
apart from conducting statutory audit, his independence is likely to be suspected.
Types of Independence:
The statutory auditor should have three types of independence. These are as follows:
1. Programming independence: It implies that the auditor should be at liberty to select the most appropriate
strategy while conducting an audit. It is he who will decide his audit plan without being influenced by
wish or direction of another person.

2. Investigate independence: It indicates that the auditor should be able to implement his audit strategy in
whatever manner he considers necessary. He should have unlimited access to all company information. He
must have right to get answers to all queries he makes regarding company’s business and accounting
treatment.
3. Reporting independence: This independence implies that auditors should have ability to disclose any
information relevant to the users for taking decisions.

Importance of Auditor’s Independence:

The stakeholders of the company take various economic decisions based on the audited financial
statements. But since 2000 a number of scams and accounting scandals in many globally reputed
companies like Enron, World Com etc. could not be brought to light by auditors. In India the recent
accounting scam in Satyam Company is a glaring example of audit failure. So the perception of the
people about the integrity of audit profession is now gradually changing. It is being thought that
there is a wide-spread collusion between auditors and management which results in drainage of
public money.
In this background the question of auditor’s independence has assumed a special significance. It is now being
considered as the cornerstone of the auditing profession. The auditor should carry out his work freely and in an
objective manner. He should express an unbiased opinion on the financial statements so that stakeholders can
rely on his opinion and can safeguard their interest. This will lead to economic development of the country by
bringing prosperity to business.

26. What do you mean by standards on auditing (SA)?

Discuss the importance/Purpose of standards on
Meaning:
auditing.*******
Standards on auditing refer to a set of systematic guidelines used by auditors while conducting audit of
company’s accounts. These guidelines are generally prescribed by the professional bodies of accountants
based on collective deliberation and views of different segments of society and interested groups such as
regulators, industry and academies. These standards provide principles and techniques of auditing which help
the auditors ensure performing his duties most efficiently and effectively. They are a set of ideas which serves
as a framework for auditing.
Importance/Purpose:
The importance of standards of auditing can be summarized as below:
1. Guidance for audits: Standards on auditing provide high quality auditing standards and guidance for
financial statement audits and other types of assurance services. Thus, quality of audit is much improved.
2. Reducing audit risk: By rely on standards on auditing auditors can minimize the probability of missing
material information. So the extent of audit risk is reduced. The auditor can defend himself against
allegation of negligence by establishing that he has performed audit according to standards.
3. Prevention of scams and accounting scandals: The standards on auditing educate the professional
auditors about their role and responsibility in performing audit. So they always remain careful and
cautious while performing audit. This mindset of auditors goes a long way towards detection of scams and
accounting scandals.

4. Public confidence in the auditing profession: As standards on auditing enhance the quality of audit, the
public confidence on audit profession which has been shattered due to recent wide spread scams and
accounting scandals, will be strengthened.
5. Reduction of investor’s risk: If there is any discrepancy between what the audit report states and the
actual situation, it will have a disastrous impact on the risk perception of the investors. The cost of capital
will then rise and the firm will find it difficult to raise finance. It is expected that standards on auditing can
play a significant role in reducing the risk perception of the investors as they can rely on audit conducted
in a fair and uniform manner.
 Unit II: (10 + 5 = 15 Marks)
Auditing Procedures and Techniques
Auditing Engagement-Audit Planning- Audit Programme (Concept)
Documentation: Audit Working Paper, Ownership and Custody of Working Papers-Audit file (Permanent and
Current) – Audit Note Book- Audit Memorandum.
Audit Evidence – Concept, Need, Procedures to obtain Audit
Evidence Routine Checking, Test Checking and Auditing in Depth
Concept of Analytical Procedure and Substantive Testing in Auditing.
Audit of Educational Institutions, Hospitals and Hotels

27. What do you mean by the term of audit engagement?

Why is it necessary to issue an engagement letter?**
Audit engagement
When a company has to go through the audit process, an auditor may use the term "audit engagement." This
can mean different things, so it is important that the auditor clarify what he means when he uses the term.
Regardless of which definition the auditor follows, however, the auditor always follows specific procedures
and guidelines for handling the engagement.
Accepted Definitions
An audit engagement very loosely refers to an audit that an auditor performs. More specifically, it refers only
to the initial stage of an audit during which the auditor notifies the client he has accepted the audit work and
clarifies his understanding of the audit's purpose and scope. Even more specifically, the term audit
engagement can refer to the written letter by which the auditor formally notifies the client he will engage in
audit services.
Full Engagements
When referring to the audit as a whole, audit engagements encompass several distinct steps, which are
organized into planning, testing of controls, substantiation or fieldwork and exit or finalization.
The first is sending a letter to the client alerting him of the audit.
After this initial contact, the client and auditor meet to pinpoint further how, when and why the audit will
happen, as well as the resources the auditor will have at his disposal. The auditor then conducts primary
surveys to understand the company and the controls in place.
The next step is testing the controls and gathering as much information as possible. Based on the results, the
auditor constructs a draft of the formal audit report, which he shares with the client. Auditors complete the
audit by following up with the client, normally within six months.
Initial Audit Step
Viewed as only as the first step of the audit process, the intent of an audit engagement is to get the client and
the auditor on the same page. The client describes exactly what he needs the auditor to do. This helps the
auditor decide whether the audit is feasible and how to approach it. The audit engagement by itself does not
produce any viable results or findings -- auditors do this during fieldwork -- but it allows the auditor to know
how, when and why to get those findings. During this initial stage of the audit, the auditor is concerned with
understanding the client and the risks that might produce inaccurate audit results.
Why is it necessary to issue an engagement letter?
Auditors generally provide audit engagement letters as one of the final steps in the audit planning stage. The
letter summarizes all the information the auditor has gained about the client, the client needs and audit
objectives, as well as the scope of the audit and what the client is responsible for doing. Additionally, audit
engagement letters clearly indicate the auditor assigned to the audit. They also may indicate additional
information the auditor will need during the audit,, the auditor's fees, people with whom the auditor will need
to speak and how much time the auditor has to finish his work. Also sometimes included are relevant
financial and accounting regulations to which the auditors must adhere. A good audit engagement letter also
recognizes that not all clients are familiar with audit procedures and therefore outlines those procedures for
clarification. Audit engagement letters are very similar to work contracts in the way they are constructed in
that they define duties and relationships, but based on their wording, they are not necessarily legally binding
the way a formal contract is.

28. What is audit planning? What are the benefits of Audit

Planning?***
Audit planning refers to establishing the overall audit strategy to conduct an effective audit in an efficient
and timely manner. As per SA 300 ‘Planning an audit of Financial Statements’, audit planning involves
following activities:
(i) Acquiring knowledge of the client’s accounting system, policies and internal control procedures.
(ii) Establishing the desired degree of reliance that can be placed on internal control.
(iii) Setting the scope, timing and extent of audit procedures to be applied.
(iv) Deciding the analytical procedures to be applied.
(v) Obtaining a general understanding of the legal and regulatory framework applicable to the entity and
how the entity is complying with that framework.
(vi) Determining the resources to be deployed for specific audit areas, such as the use of appropriately
experienced team members for high risk areas or involving of experts on complex matters.
(vii) Determining the amount of resources to be allocated to specific audit areas.
(viii) Deciding how such resources are managed, directed and supervised.
(ix) Setting of materiality levels for audit process SA300, “Planning an Audit of Financial Statements” states
that audit planning is a continuous process that often begins shortly after the completion of the previous
audit and continues until the completion of the current audit engagement.
Advantages of Audit Planning:
SA 300 points out the following benefits of audit planning:
(i) It helps the auditor to devote appropriate attention to important areas of the audit.
(ii) The potential problems can be identified and resolved on a timely basis.
(iii) The auditor can properly organize and manage the audit engagement so that it can be performed in an
effective and efficient manner.
(iv) Audit planning can assist in the selection of engagement team members with appropriate levels of
capabilities and competence to respond to anticipated risks.
(v) It facilitates the direction and supervision of engagement team members and the review of their work.
(vi) It assists, where applicable, in the co-ordination of work done by other auditors and experts.
 29. What is audit programme? Discuss the advantages****
Before starting an audit, a programme of the work to be done on the audit, known as audit programme, is
generally drawn by the Chief Auditor. He outlines a programme according to the requirement of each case as
to what work is to be done by senior and junior staff and the time by which the work is to be finished. While
preparing the audit programme of each audit, the auditor should keep in mind the nature of internal control
and its extent as well as the size and composition of the business.
According to Professor Meigs, "An Audit Programme is a detailed plan of the auditing work to be
performed, specifying the procedures to be followed in verification of each item in the financial statements
and giving the estimated time required."
Therefore an audit programme provides a guide in arranging and distributing the work and in checking
against the possibility of omissions.
Advantages of Audit Programme:
A pre-determined audit programme has the following advantages:
(a) Balanced distribution of work: With the help of audit programme, it will be possible to distribute the
work in an orderly way according to the qualification, experience and efficiency of the assistants of the
auditor.
(b) Consciousness about the work accomplishment: In view of allocating the work in a scientific way
among the staffs of the auditor, they are well conscious and alert about their own duties. No one will
show any grievance.
(c) Knowing the progress of the work: The auditor can know about the progress of the work done by his
assistants. As a result, the whole work can be completed timely, methodically and honestly.
(d) Immediate start of the work: As the work can be planned and phased beforehand with the help of
audit programme, it will start immediately without any loss of time.
(e) No work left unexamined: Since the programme takes into consideration all the details involved in the
work to be undertaken during the course of audit, no portion of the work is left from checking. There is
less chance of its being over – looked or omitted.
(f) No possibility of dislocation of work: Division of work among the junior clerks is done in such a way
so that there will be minimum dislocation of work if any junior goes on leave or leaves the work
(g) Specifying the responsibility: In case, any fraud or error remains undetected, the responsibility for
negligence or mistake on the part of a clerk can be easily located as the work allotted to him is already
fixed and he has to put his signature in the programme every day against the work performed by him.
(h) Proof of evidence: If charge is made against the auditor in future, he can produce it as evidence and can
defend himself that the work has been done with due course and competence. Because, the programme
will indicate what has been done by him or his assistants.
(i) Maintenance of uniformity: It may result in uniformity in the work done if similar programme is
followed from time to time. Moreover, it serves as a ready check list of the procedures to be applied and
the work already finished.
(j) Supervision and control of the work: Supervision and control of the work can be undertaken easily
and conveniently as the work is performed in a planned and systematic manner.
(k) Facilitating the final review: Before signing his audit report, it is easily possible for him to have a final
review of the work done by him. At this juncture, it may be explored whether every work has been
completed or not.
(l) Basis for preparation of next audit programme: It may be considered as a useful basis for planning
the programmes for the years to come. Thus, it will save time and labour.
 30. What is audit working papers? Discuss its objectives***
Audit Working Papers
Working papers are those papers which consist of details about accounts which are under audit so that the
auditor may not have again to go over the accounts of his client if he wants to refer to them later on during
the course of audit. Working papers consist of working trial balances, adjusting entries, account analysis,
schedules of debtors and creditors, particulars of investment and of depreciation, copies of correspondence
between auditors and debtors, creditors, and banks etc. -previous audit reports, important quarries with
explanations completed audit programme etc.
According to SA 230 “Audit Documentation”, audit working papers are written records of evidence obtained
by the auditor in the course of audit. They also document methods and procedures followed by the auditor
and the conclusions he has arrived at. The summary of important matters identified by the auditor which
require exercise of judgement together with the auditor’s conclusions are included in working papers.
Objects of working Papers :
(a) To show the extent to which accounting principles and auditing standards have been followed.
(b) To support the audit report.
(c) To serve as an evidence in case of any suit against the auditors for negligence in the performance of
his duties.
(d) To enable the auditor to know the weaknesses of the internal control system and give advise to his
client to avoid such weaknesses.
(e) To serve as a means to provide training to the audit clerks about the ways of summarising the work
done by them.
(f) To help the auditor to plan for the subsequent years.
(g) To enable the auditor to prepare the report to be issued without any dealy.
(h) To assign the unfinished work of one clerk to another without dislocation, duplication and omission of
any work in case changes and transfer of staff are very frequent.
Characteristics of good working papers
(a) They should be complete in all respects. In other words, they should contain all the essential
information so that they may be of maximum utility.
(b) Working papers should be properly organised and arranged so that one may not find any difficulty in
locating a particular matter.
(c) Paper used for working papers should be of good quality and of convenient and uniform size so that it
may not be damaged by frequent handling.
Protection and ownership or Working Papers
The working papers are highly confidential papers and therefore, must be kept in safe custody. They are not
to be shown to any party which might make misuse of them. With regard to the ownership of these papers,
there is a controversy as to whether these papers belong to the client or to the auditor. The client claims that
since the auditor is his agent, he has no line on these papers. On the other hand, the auditor claims these
papers to be his property on the basis that he has collected the information for the purpose of discharging his
duties. Actually these papers come to the help of the auditor in future in case the client files a suit against the
auditor for negligence etc. it is also argues that the outgoing auditor should hand over these papers to
incoming auditor but he should not do so if there is some kind of suspicion or doubt in his mind. In many
cases, it was held that these papers belonged to the auditor and not to the client.
 31. What is Audit File? What are the contents of Audit
File?****
The File in which the auditor preserves audit papers is known as audit file. So it is the archive of audit papers
which are generated and obtained by the auditor in the cause of audit. To the auditor, the importance of audit
file is enormous. In the subsequent audit of the same client, he can use it as reference. He can also use it as
proof of defence, if any charge of negligence is levelled against him in future. For the sake of convenience,
the audit file should be classified into permanent audit file and current audit file.
(1) Permanent Audit File:
A permanent audit file normally includes
(a) Information concerning the legal and organisational structure of the entity. In the case of a company,
this includes the Memorandum and Articles of Association. In the case of a statutory corporation, this
includes the Act and Regulations under which the corporation functions.
(b) Extracts or copies of important legal documents, agreements and minutes relevant to the audit.
(c) A record of the study and evaluation of the internal controls related to the accounting system. This
might be in the form of narrative descriptions, questionnaires or flow charts, or some combination
thereof.
(d) Copies of audited financial statements for previous years.
(e) Analysis of significant ratios and trends.
(f) Copies of management letters issued by the auditor, if any.
(g) Record of communication with the retiring auditor, if any, before acceptance of the appointment as
auditor.
(h) Notes regarding significant accounting policies.
(i) Significant audit observations of earlier years.
(2) Current audit file.
The current file normally includes
(a) Correspondence relating to acceptance of annual reappointment.
(b) Extracts of important matters in the minutes of Board Meetings and General Meetings, as are relevant to
the audit.
(c) Evidence of the planning process of the audit and audit programme.
(d) Analysis of transactions and balances.
(e) A record of the nature, timing and extent of auditing procedures performed, and the results of such
procedures.
(f) Evidence that the work performed by assistants was supervised and reviewed.
(g) Copies of communications with other auditors, experts and other third parties.
(h) Copies of letters or notes concerning audit matters communicated to or discussed with the client,
including the terms of the engagement and material weaknesses in relevant internal controls.
(i) Letters of representation or confirmation received from the client.
(j) Conclusions reached by the auditor concerning significant aspects of the audit, including the manner in
which exceptions and unusual matters, if any, disclosed by the auditor’s procedures were resolved or
treated.
(k) Copies of the financial information being reported on and the related audit reports.
 32. What is audit note book?****
Audit Note book:
Audit note book is a diary or register maintained by audit staff to note errors, doubtful quarries and
difficulties. The purpose is to note down the various points which need to be either clarified with the client or
the chief editor. The Audit note book is used for recording important points to be included in the auditor’s
report.
Contents of an Auditor’s Note Book:
(a) A list of books of accounts maintained.
(b) The names, duties and responsibilities of principal officers.
(c) The particulars of missing receipts and vouchers.
(d) Mistakes and errors detected.
(e) The points which need clarifications and explanations.
(f) The points deserving the attention of the auditor.
(g) Various totals and balances.
(h) The Points to be a part of auditor’s report.
Advantages of Audit Note book:
Some of the advantages of the audit note book are.
(a) It ensures the uniformity and helps in knowing the amount of work performed.
(b) Important matters relating to the audit work may be easily recalled.
(c) Facilities and preparation of the audit report.
(d) In case of the assistant in charge is changed, no difficulty is faced in continuing the incomplete work.
(e) The responsibility of the errors undetected can be fixed on clerk concerned.
(f) The audit note book shows the extent of the interest and pain taken by the audit staff. It helps in their
appraisal.
(g) It ensures that the audit programme has been sincerely followed. Deviations can be noticed.
(h) It is reliable evidence in the court of law, If an auditor has to defend himself.

33. What is Audit Memorandum?****

An audit memorandum a Statement containing all useful information regarding the business of the client. It
indicates the method of operation, policies as to the different aspects of the business. It should also contain
all the conditions in respect of audit. The object of preparing the memorandum is to record the general
information of the business which may be of real use to him while carrying on the work of audit.
If it is a first audit, it will have to be prepared thoroughly so that it covers the various aspects of the concern.
But where the audit work was carried out earlier, only changes, if any, concerning various items should be
noted. The term 'audit memorandum', though not commonly used, covers different aspects, like audit
manual, audit programme, audit file and internal control questionnaire, etc.
The contents of audit memorandum as prescribed by Eric. L. Kohlar are as follows:
i. The plant and office location.
ii. Ownership and control and the nature of re-organization having taken place in recent year.
iii. Adequacy of manufacturing facilities, various products manufactured and their market
potentiality.
iv. Sources of raw-material and their price trend.
v. Names of responsible officers and nature of their responsibility.
 vi. The adequacy of books of account maintained by the client.
vii. A brief resume of net worth of the firm.
viii. Types of subsidiary companies and how they are operated and controlled.
ix. Different policies of the company as to advertisement, costing methods, effectiveness of
internal control system.
x. Investment policy, adequacy of reserve and the purposes of contingency reserve.

34. Explain the concept of audit evidence.*****

Evidence in Auditing
Auditing is concerned with the verification and examination of accounting data. In this process an auditor
collects and evaluates evidence to establish facts and to draw conclusions and inferences. It is an accepted
standard of auditing that "sufficient competent evidential matter is to be obtained through inspection
observation, inquiries and confirmation to afford a reasonable basis for an opinion regarding the financial
statements under examination". There an auditor should understand the nature and type of evidence available
in various auditing situations. Further he should" be able to evaluate the sufficiency which refers to adequacy
of such evidence and the competency which refers to the quality or reliability of evidence.

Concept of audit evidence

The concept of evidence is fundamental to auditing. All audit techniques and procedures are derived from it.
It helps the auditor in perceiving the types of evidence available in an audit situation, collecting it through
the various audit techniques and evaluating its sufficiency and competency to support accounting data.
According to Mautz and Sharaf development of this concept contains the following steps :-
(a) Recognition of the Propositions to be Proved First of all, the auditor is to perceive and recognise
what he is trying to prove. In other words, he must be clear about the propositions in support of which
evidence is required. The accounting statements, which an auditor reviews, consist of a series of
propositions. For example one of the propositions in balance sheet is that the enterprise has fixed assets,
debtors cash etc.
(b) Evaluation of Propositions After the propositions behind accounting data being identified they must be
evaluated according to their significance or materiality. In other words, various propositions may be
classified into those which are very significant, those which are moderately material, and those which are
not so material. Materiality is a relative concept and depends upon the size and nature of an item. It is
natural that an auditor must collect quantitatively more compelling evidence in case of significant
propositions, than in case of propositions which are not so material. Therefore, there is a direct link
between the materiality of a proposition and the quality of evidence required to support it.
(c) Collection of Evidence By applying various audit techniques an auditor collects different types of
evidence to support the propositions made in the accounting data. The audit programme lists the manner
in which such evidence is to be collected within the constraints of time and cost.
(d) Evaluation of Audit Evidence After the evidence being collected the auditor must evaluate it critically
with regard to its usefulness. Auditor, like historians and mathematicians must develop professional
standards to such an extent that they can be used to evaluate audit evidence.
(e) Formation of judgement: The last steps is to form an opinion about the various propositions by the
auditor after he has identified the propositions behind the accounting data, evaluated them according to
their significance, collected evidence through the audit techniques, critically reviewed the evidence as
regards, it validity. In forming his judgemnt the auditor is not looking for absolute proof. He has to find
 evidence which assures that the accounting data under report fairly represent the reality as far as it can be
determined.

35. What are the various methods of obtaining Audit

Evidence? Discuss the principles which are useful
in
assessing
SA 500 has prescribed the ofreliability
following methods obtaining audit of audit evidence ****
evidence:
1. Inspection: Inspection consists of examining records, documents or tangible assets. Whether the
inspection can be a reliable means of obtaining audit evidence will depend upon the nature and source of
documents and effectiveness of internal control of their processing. Inspection of tangible assets is one of
the methods to obtain reliable evidence with respect to their existence but not necessarily as to their
ownership or value.
2. Observation: Observation consists of witnessing a process or procedure being performed by others. For
example, the auditor may observe the counting of inventories by client’s staff.
3. Inquiry: Inquiry consists of seeking appropriate information from knowledgeable persons inside or
outside the entity. It may range from formal written inquiries addressed to third parties to informal
inquiries addressed to client’s staff.
4. Confirmation: It refers to the substantiation by a knowledgeable third party, in response to specific
enquiry/request by the auditor.
5. Computation: Computation consists of checking the arithmetical accuracy of source documents and
accounting records or performing independent calculations.
6. Analytical Review: Analytical review consists of studying significant ratios and trends and investigating
unusual variation in the amount of an item.
7. Reperformance: It involves the auditor’s independent execution of procedures or controls that were
originally performed as part of the entity’s internal control.
Reliability of Audit Evidence:
The reliability of audit evidence depends upon the source from which it is obtained. However, following
generalization as per SA 500 may be useful in assessing the reliability of audit evidence:
1. Evidence obtained from external source (e.g. confirmation of balance received from a third party)
becomes usually more reliable than evidence obtained internally.
2. Internal evidence is more reliable when the related internal control is sound.
3. Evidence in the form of documents and written representations is usually more reliable than oral
representations.
4. Evidence obtained directly by the auditor himself is more reliable than obtained indirectly or by
interference.
5. Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles or documents that have been filmed or digitized.
 36. What is routine checking? Discuss the objectives of
routine checking?**
The checking of books which are carried on by the auditor as a matter of routine work is known as routine
checking. In other words, the work performed by auditor in order to see whether the transactions recorded in
the books of account are proper and whether scientific method has been followed in recording the
transactions, is called the routine checking.
It involves the consideration of the following functions:
Following works are included in the scope of routine checking:
i. Whether correct amount has been recorded from voucher.
ii. Whether appropriate accounts have been debited and credited for each transaction in the books of
original entry.
iii. To check the casting, sub-casting, carry forward, extension and other calculations in the books of
original entry.
iv. To check the posting from the books of original entry to ledger.
v. To check the opening balances of all personal accounts and real accounts.
vi. To check the total and carry forward to next page of the ledger account.
vii. To check whether balancing in all accounts have been correctly done.
viii. To see that whether all balances have been transferred to appropriate column in the trial balance.
ix. To check whether balances of all nominal accounts have been transferred to Income Statements.
x. To see whether balances of all real and personal accounts have been properly recorded in the respective
site of Balance Sheet.

Objectives of Routine Checking

(a) Detection of errors and frauds : Detection of errors and frauds can be easily done. They can be
prevented with ease.
(b) Examining the correctness of figures : The correctness of the figures of transactions which are
recorded in the books of original entry are examined.
(c) Examination of posting to ledger accounts : It requires to examine whether the transactions have been
posted to the respective ledger accounts from the books of original entry.
(d) Examining the balances of different ledger accounts : It needs to examine whether the balances of
different ledger accounts have been properly drawn up.
(e) Verifying the ledger balances in trial balance : It certainly requires to verify whether the different
ledger balances have been correctly shown in the trial balance and examining the state of affairs, as
revealed by the profit and loss account and the balance sheet prepared from the trial balance.
(f) Not to alter the figures in the books : Provision should be made for not altering the figures in the
books of original entry and ledgers after once audited.

Advantages of Routine Checking

Advantages derived from routine checking are as follows:
1. Detection of error: Since all the aspects of recording transactions are checked thoroughly, there
is at least possibility of error being left undetected.
2. Detection of fraud: Fraud of minor nature committed by the accounting clerk can be detected by
routine checking.
 3. Moral pressure: Since routine checking involves thorough checking, the accounts clerk become
more cautious and careful while recording transactions. Their venture to commit fraud is also
minimized.
4. Increasing reliability and fairness of financial statements: By keeping the books of accounts free
from errors and frauds as far as possible, it makes significant contribution towards increasing the
reliability and fairness of financial statements.
5. Economy: Routine checking can be got done by ordinary clerks. So it is not much expensive.

Disadvantages of routine Checking

Disadvantages of routine checking are as follows:
1. Monotonous: Routine checking is a mechanical process of comparing entries with vouchers and
ticking the figures. So audit clerks may get bored with his job.
2. Inability to detect all types of errors and frauds: Errors of principle or compensating errors are
unlikely to be detected by mere routine checking.
3. Inability to detect planned fraud: Routine checking cannot detect the planned fraud committed by
the top management.

37. What is test checking? What are the Precautions to

be taken in Adopting Test Checking Techniques?**
Or
Test checking is based on presumption. What is that
presumption?**
TEST CHECKING
Test checking refers to the process of selection and examination of a few sample transaction out of large
number of similar transaction. It is presumed that selected transaction represent other transaction not
considered for verification. It is selective verification of transaction. An auditor can form his opinion on
financial statement by conducting verification of either cent percent transaction or only a few representative
transactions from each category. However, his opinion is unlikely to differ even if he verifies only a few
transactions provided his selection of transaction is judicious and rational.
As per SA 530 “Audit Sampling”, the auditor should select sample item in such a way that the sample can be
expected to be representative of the population. It should be ensured that all items in the population have an
equal opportunity of being selected. Test checking is adopted to avoid unnecessary exercise of going through
each and every transaction. Based on the result of verification of a few representative transaction only, the
auditor forms his opinion about the fairness of financial statements.
Precautionary measures before the application of test checking
As the adoption of test checking is fully dependent on the judgement of the auditor, he should be very careful
in this respect. The following are the precautionary measures to be taken by the auditor before he applies test
checking for audit.
(a) Covering every book of prime entry: Representative transactions should be so selected as far as
possible, as to cover the whole of the period under audit. It should cover every book of prime entry and
ledger.
(a) Clerks of organisation checked: The selection of transactions should be distributed in such a way that
the work of almost all the clerks of the organisation is checked.
(b) Reviewing the internal control system etc: The auditor must review the system of internal check,
internal control and internal audit thoroughly. If he views that the prevalent internal control system is
either defective or ineffective, he should not apply it.
(c) Items be representative: The selection of the items should be made at random and should be as far as
possible be representative in character.
(d) No element of biasness: There should be no element of biasness or arbitrariness in the selection of
sample.
(e) Number of transactions pre-determined: The number of transactions to be selected for each test
check should be pre-determined.
(f) Transactions selected to be large number: The transactions selected for test checking must include a
fairly large number of transactions for the period.
(g) Entries for first and last months be checked: The entries pertaining to the first and the last months of
the year should be thoroughly checked as fraudulent manipulations are usually made during these
months.
(h) Test checking not to be applied for Cash Book and Pass Book: Test checking should not be applied
for Cash Book and Pass Book which are to be thoroughly checked.
(i) Review the results of test checking: The auditor must always review the results of test checking for
determining whether there is any further scope of checking records. The nature of errors detected
throughout test checks may reveal this if they are reviewed carefully and thoroughly.
(j) Checking the different portions of the work: In case of selection of entries and accounts for applying
test checks, proper care should be taken to check the different portions of the work at each audit
(k) No consultation with the staff of the client: No consultation should be made with the staff of the client
as regards the selection of transactions for test checking. This is absolutely his job and is to be treated
with utmost secrecy.

38. What do you mean by auditing in depth?********

Meaning:
Audit in depth refers to the step by step examination of selected transactions from their beginning to their
conclusion. Under this technique the auditor reviews all operational and accounting aspect of the
representative transactions from origin to end. Based on his findings of thorough examination of a few
selected transactions of a particular category he forms his opinion about the propriety and correctness of rest
of the transactions of that category. This technique is adopted by the auditor when the number of transactions
is numerous and it is not possible for him to check each and every transactions. Therefore, he select a few
representative transactions of a particular category and starts checking vertically step by step
For example, audit in depth of purchase will involve following steps:
i. Selecting a few purchase invoices of material importance.
ii. Verifying that they are backed by purchases orders.
iii. Examining that purchase orders have been raised as per established procedure and norms of
propriety.
iv. Checking that invoices have supporting challans duly certified by receiving Deptt. and stores Deptt.
v. Ensuring that purchases have been recorded correctly in the books.
vi. Seeing that payments have got the approval of competent authority and have been correctly recorded
in the book.
If the auditor is sure that there is no irregularity at any stage of those transactions, he can presume that there is
also no irregularity in any stage of other transactions of this category left unchecked.
One thing that should be carefully noted is that audit in depth is not the substitute of test checking. Rather, it makes
the Test Checking more effective.

Advantages:
Following are the advantages of audit in depth:
i. Effectiveness of audit: Audit in depth makes the audit more effective. In fact in depth review of some
representative transactions provides the auditor with better audit evidences than superficial examination
of all transactions.
ii. Timely completion of Audit: It is possible to complete audit very quickly.
iii. Reduction of cost of Audit: Cost of Audit can be reduced as only a few representative transactions of
each category are thoroughly checked.
iv. Avoidance of monotony: The audit staff do not feel monotonous as they are to check only
representative transactions of varied nature.
v. Creating moral pressure: There is moral pressure on accounts clerk, in as much as any transaction
may be selected for in depth study.
vi. Assessment of propriety: This technique is very suitable for propriety study with regard to transaction
of material importance.
vii. Fair assessment of Position: Since only items of material importance are selected for verification,
there is least possibility off any error on the part of auditor in assessing position of the company.
viii. Scope of development: Since audit in depth is conducted analytically, the auditor finds scope to
develop new thoughts and techniques for future improvement of audit.

Disadvantages:
Following are the disadvantages of audit in depth:
i. Risk: The auditor cannot avoid risk since all transactions are not considered for in-depth
examination.
ii. Chance of improper selection of Transactions: This technique will not be very effective, if the
transactions are not properly selected for verification.
iii. Inappropriate audit opinion: If some errors and frauds remain in transaction not selected for
examination, the financial statement will not reflect a true and fair view. So, there will be
inappropriate audit opinion.
iv. Chance of Brand: Since only items of material importance are selected, the accounts clerk may
become prone to commit fraud in less important transactions the cumulative effect of which may be
enormous.
 39. What is analytical procedure in the audit?****
Very often there may be some complex error or ingeniously made fraud in the books of accounts which do
not come to the notice of the auditor in the course of routine checking or even carefully conducted vouching.
This omission on the part of the auditor may also occur due to sample based checking undertaken by him. To
eliminate or reduce the possibility of such omissions, the auditor is required to apply certain other
procedures. So, with the passage of time, analytical procedure has assumed a lot of significance as a
substantive audit procedure. Analytical procedure means the study of the relationship among relevant
financial and non-financial data, observing the trend of data and inquiry into the reasons of some unusual
fluctuation in the amounts of some items which are not consistent with other relevant information or which
deviate from predicted amount.
As per SA520, ‘Analytical Procedures’, “analytical procedure means evaluations of financial information
through analysis of plausible relationships among both financial and non-financial data. Analytical
procedures also encompass such investigation as is necessary of identified fluctuations or relationships that
are inconsistent with other relevant information or that differ from expected values by a significant amount.”

40. Discuss how the application of analytical procedure is

done in audit?***
Or
What are the methods of analytical procedure?***
Analytical procedure may be conducted in the following ways:
i. Comparison with last year data: Comparison of entity’s financial information with comparable
information of last year can enable the auditor to identify some serious mistakes or frauds in
accounts. For example, by inquiring into the reasons of fall of gross profit ratio from that of last year,
it may be possible to detect pilferage of stock or overcharging of consumption of material or
misappropriate of a part of sale proceeds.
ii. Comparison with budgets: Comparison of actual results with anticipated results such as budgets or
forecasts. If the differences are found to be material, the auditor will investigate the reason of the
difference.
iii. Comparison with Industry average: Comparison of entity’s financial information with that of the
industry may help the auditor unearth fraud and error. For example the investigation into the unusual
difference of the entity’s ratio of sales to accounts receivables from that of entities of comparable
size in the same industry or industry average may probably enable the auditor to detect ‘paper’ book
debt.
iv. Examination of relationship among data: The auditor may look into the relationship among
financial data that are expected to conform to a predictable pattern based on the entity’s experience.
The study of sales to raw material consumption ratio may reveal under charging of raw- material
consumption.
v. Study of relationship between financial and non-financial data: The study of relationship
between financial and non-financial information, such as employment cost to number of employees
may throw some light about the veracity of the employment cost shown in the income statement.
 41. Discuss the Tools and Techniques of Analytical
procedure?**
As per SA 520 Analytical procedure can be conducted with the help of following tools and techniques:
1. Trend Analysis: This technique is used for analyzing the fluctuations in the amounts of important
accounts over two or more years.
2. Testing of Reasonableness: Reasonableness testing is done by reviewing the relationship of certain
account balances to other balances. Examples of accounts that may be reasonable tested are:
(a) Raw material consumption to production quantity.
(b) Interest expenses against interest bearing obligations.
(c) Wastage & scrap % against production and raw-material consumption (quantity)
(d) Work-in-progress based on material issued.
(e) Sales discounts and commission against sales volume.
(f) Rental revenues based on occupancy of premises.
3. Ratio Analysis: This technique is used for studying the relationship between financial statement
amounts. Commonly used ratios are:
(a) Income or loss as a percentage of sales
(b) Gross profit ratio
(c) Accounts receivable turnover
(d) Inventory turnover
(e) Leverage ratios
(f) Liquidity ratios
4. Sources of Information: Following sources of information may be used for analytical review:
(a) Interim financial information
(b) Budgets
(c) Non-financial information e.g., employee morale, Government policy, threat from other products
etc.
(d) Confirmation from bank, debtors and creditors
(e) VAT return
(f) Board minutes
5. Common size Analysis: Common size analysis which is done by expressing each item of balance
sheet as a percentage of total assets and each item of income statement as a percentage of total sales is an
useful tool of analytical procedure.

42. Discuss the extent of reliance on analytical

procedures?***
Analytical procedures have now assumed a special significance as a method of testing the validity of
different data in the financial statements. It is applied by the auditor with the expectation that relationships
among data exist and will continue to exist. By reviewing these relationships the audit can assess the
completeness, accuracy and validity of the data. However, the reliability of analytical procedures depends
upon several matters some of which, as per SA 520, are as follows:
1. Sources of information: Analytical procedures will be more reliable when it is applied to information
obtained from independent sources outside the entity such as bank, Excise authority, etc.
2. Materiality of items: When the items, say inventory balances, are material, the auditor should not rely
on analytical procedure in forming conclusion. The test of details should also be carried out.
3. Comparability of the information: Analytical review based on cross-sectional analysis (comparing data
 with that of the industry or another firm) will be more reliable when the industry data or data of
competitors are comparable.
4. Nature and relevance of the information: For effective analytical review, the benchmark used for
comparison should be relevant and logical. For example, budgets against which financial data are
compared for analytical review must be established as results to be expected rather than as goals to be
achieved.
5. Predictability of data: When the financial data are expected to have a greater degree of predictability,
analytical review becomes more reliable. For example, the auditor can expect greater consistency in
comparing gross profit margins from one period to another than in comparing discretionary expenses
such as research or advertising.
6. Control over preparation of data: When there is a strong control over preparation of information, the
auditor will have greater confidence in the reliability of the information and, therefore, in the results of
analytical procedures. For example, controls over the preparation, review and maintenance of budgets.

43. What factors are to be considered in analytical

procedures for substantive testing?*****
Substantive testing refers to the test of the validity and propriety of the information produced by the
accounting system. This can be carried out either by test of details (i.e., vouching and verification) or by
analytical procedure or by both. Analytical procedure means evaluations of financial information through
analysis of plausible relationships among both financial and non-financial data. While designing and
performing analytical procedure for substantive testing, the auditor should consider the following matters in
accordance with SA330 “The Auditors’ Responses to Assessed Risks”
1. Suitability of the procedure: He should determine the suitability of particular substantive analytical
procedures for given assertions. He should take into account the assessed risks of material
misstatement and the results of test of details, if conducted for these assertions.
2. Reliability of data and information: He should evaluate the reliability of data and information to
be used for analytical procedure. For this the auditor is to take into consideration the source,
comparability, and nature and relevance of information available and control over their preparation.
3. Development of expected values: The auditor shall develop an expectation of recorded amounts of
ratios. For developing expectation of recorded values, the auditor should consider the following:
i. The degree of accuracy with which the expected results of substantive analytical procedures
can be predicted. For example, the auditor may expect greater consistency in comparing
gross profit ratio from one year to another than discretionary expenses like travelling or
advertisement.
ii. The degree of which information can be disaggregated. For example, substantive analytical
procedure is more effective when applied to segment information than composite
information.
iii. The availability of the information both financial and non-financial. For example, if financial
information such as budgets and non-financial information such as number of units produced
or sold is available, analytical procedure for substantive testing can be effectively designed.
4. Necessity of further investigation: The auditor will determine whether the difference between
recorded amounts and expected values is material enough to warrant further investigation.
 44. What special steps are involved in conducting the audit
of an Educational Institution?********
Educational institutions like school, colleges are usually run under the Societies Registration Act, 1960 or
Public Trust Act of the state, if any. The audit of accounts of an educational institution is carried out
according to the provisions of the Regulation or Trust Deed or the Act governing the concerned educational
institution. The audit process of an education comprises of the following aspects:
A. Preliminary Matters
1. Study the Trust Deed or Regulations in the case of school or college and note all the provisions
concerning the accounts of the institution. In case of a university, the Act of Legislature and the
Regulation framed there under should be carefully studied.
2. Evaluate the internal control system involving maintenance of records and documents, safeguarding
of assets, acquisition of assets, authorization of transactions, segregation and rotation of duties etc.
3. Go through the minutes of the meetings of the managing committee or governing body and note
down resolutions concerning accounts. See that they have been duly complied with.
B. Income
1. Check names entered in the Student’s Fee Register with respective class registers and verify that
there operates a system of internal check ensuring that defaulting students are identified and served
with notice in time.
2. Check fees received by comparing counterfoils of fees book with the collection recorded in the Fee
Register and trace the entries in the Cash book to confirm that revenue under this head has been
properly accounted for.
3. Examine whether all concessations have been granted as per rules.
4. See that arrear fees which are irrecoverable have been written off under the sanction of appropriate
authority.
5. Check admission fees with the admission forms duly signed by the head of the institution or other
authorized person and see that the amount has been credited to Capital Fund unless the other
decision is taken in this regard by the Managing Committee or Governing Body.
6. Confirm that late fines have been either collected or waived under proper authority.
7. If the Institute is having hostel facility, then examine the statement reconciling the total hostel
charges recoverable with the amounts actually received.
8. Verify receipts of rent for premises let out by the institute with reference to copies of agreements
with the relevant parties.
9. Examine the entries in the cash book in respect of donations and legacies with reference to the
counterfoils of receipts issued to doners.
10. Verify interest and dividends received during the year with reference to the securities in which
investments have been made.
11. Verify the grants received with reference to the sanction letters and examine whether conditions
specified therein have been duly complied with.
C. Expenditure
1. Examine whether salaries and allowances paid are as per the terms and conditions of appointment of
each category of staff.
2. Check the computation of gross salary payable and deduction in respect of provident fund, income
tax etc. See that income tax and provident fund deducted from salaries have been deposited with the
authorities in time.
3. Vouch the payment of salaries with reference to acknowledgement from employees and entries in
 the bank statement.
4. Examine that scholarships to students have been granted as per rules and under proper authorization.
5. Vouch all capital expenditures confirming that established norms have been followed in their
incurrence and they have the sanction of competent authority.
6. Vouch in the usual manner all establishment expenses and enquire into any heavy expenditure under
any head.
7. Examine the payments on account of expenditure on hostel facilities including those on repairs,
maintenance, electricity, water charges etc. in the usual manner. Similarly, examine the payment
relating to purchase, consumption, stock of food grains etc.
8. Examine payments made out of various grants received from Government/U.G.C. with reference to
supporting vouchers, entries in the cash book, minutes of the Governing Body and utilization
certificates, if any, furnished to authorities.
D. Assets and Liabilities
1. Conduct physical verification of fixed assets as shown in the assets Register.
2. Examine whether adequate depreciation has been properly charged on fixed assets.
3. Carry out physical verification of investments.
4. Examine arrear student fees by reconciling total fees received during the year and total fees
receivable as per the applicable fee structure.
5. Confirm that the refund of taxes deducted from the income from investment has been duly claimed
since the institutions are generally exempted from payment of income tax.
6. See all the liabilities in respect of purchase of assets, maintenance expenses, food grains and
provisions have been duly provided.
E. Statement of accounts
The annual statements of accounts of an Educational Institution generally consist of Income &
Expenditure Account and Balance Sheet. Confirm that they have been prepared as per generally accepted
accounting principles. Also see that separate statement of accounts have been prepared as regards Poor
Boys Fund, Games Fund, and Capital Fund etc.

45. Draft a suitable audit programme to conduct the audit of

an College Hostel.***
A college hostel provides boarding and lodging facilities to the students of college. It is run by the college
authority on no profit no loss or subsidised basis. Generally a cash book is maintained to record daily
receipts and disbursement of cash. At the end of the year a Receipts and Payments statement is prepared and
in case of a big hostel an Income and Expenditure Account is also prepared to know the results of operation.
The programme of auditing the accounts of big College hostel will cover following special points..
1. Study the rules and regulations of hostel.
2. Check the number of seats in the hostel and verify whether only eligible students are. accommodated
in the hostel.
3. Vouch the receipt of hostel fees with the register of students.
4. See whether arrear hostel fees have been properly recorded and reflected in Income and Expenditure
Account.
5. See that advance hostel fees have been properly recorded and reflected in accounts.
6. Check that suitable action is taken against students who are regular defaulter in payment of hostel fees.
 7. Check the system of internal control for procurement of foodstuff. If it is procured through contractor,
see that selection procedure is appropriate.
8. Vouch the payment against contractor's invoices. See that bill is duly certified by the storekeeper and
hostel superintendent.
9. Check the stock register of various main items of foodstuff like rice, wheat, mustard oil etc. See that all
entries of issue are supported by stores requisition duly signed by head cook and authorised by hostel
superintendent.
10. Vouch the petty expenses and see all vouchers are duly sanctioned by hostel superintendent.
11. Check the asset register and see whether there is any discrepency in physical verification.
12. See that adequate depreciation is being provided on all items of assets in the Income and expenditure
Account,

46. Draft a suitable audit programme to conduct the audit of

an Medical College.***
A medical College is run with the twin objectives of imparting medical education and rendering medical
services to general public. It is generally established by the Government and run with budget allocation out
of Government exchequer. Now a day, however, Corporate bodies are also coming forward to establish
Medical College with the main object of earning profit. Whatever may be the nature of Medical College, the
auditor must consider the following points:
1. The rules, regulations and bye-laws of institution should be studied by the auditor to acquaint himself
with its functioning.
2. The internal control system for procurement of food, medicine etc. and their issue should be studied to
determine its adequacy or otherwise.
3. The minute book containing resolutions of Governing Body should be studied.
4. The system of procurement of assets, medical equipment and other accessories should be studied and it
should be examined whether the system as prescribed is being duly complied with.
5. See that proper stock register is maintained and issue of medicine is based on requisition duly
approved by doctor. He should physically verify the stock of some high value medicine to compare the
same with book balance.
6. Monthly fee from students should be vouched from fee register and carbon copies of receipt issued. If
fee collection is entrusted with a bank, the same should be confirmed from bank statement. He should
note that —
(a) Fees received in advance is duly carried forward.
(b) Outstanding fees have been duly adjusted.
(c) Fee other than tution fee have been duly credited to respective heads.
7. Income from endowment if any should be vouched separately and the auditor will see that income is
used for the purpose for which the endowment is made.
8. Check the charges and collection received from patients with Register of patients, copies of bills and
cash book.
9. Check donation from public if any and see it is used for the purpose for which it is received.
10. Vouch the payment of salaries in usual manner.
11. Grants from Governments, if any, should be properly verified. This should be classified as capital
grant, maintenance grant etc.
 12. See that expenditure have been properly classified as revenue and capital and methods and rates of
depreciation on capital assets are reasonable.
13. Ensure that wage payment system is sound and there is no loophole for defalcation.

47. Prepare an audit programme in respect of a Nursing

Home/Hospital.****
A hospital is established with the objective of providing service to the society. There are some hospitals
which are run and funded by Government or Local Authority. They are usually non – profit seeking.
Hospitals established and run by private bodies are mostly profit seeking. Now a days many hospitals are
found to be running on the basis of public – private partnership. So, keeping in mind the nature of hospital to
be audited, the auditor will look into the following matters:
A. Preliminary Matters:
1. Enquiry about the nature of hospital: The auditor should first study the relevant
documents to ascertain its ownership pattern, nature i.e., whether profit seeking or not,
capacity, different types of activities performed etc.
2. Evaluation of internal control: The auditor will evaluate internal control system involving
maintenance of records and documents, safeguarding of assets, purchase of assets,
authorisation of transactions, division and rotation of duties etc.
3. Study of the minute book: He should go through the minutes of meetings of Board of
Directors or the Managing Committee and note down resolutions concerning financial
matters such as acquisition of assets, engagement of staff, investment, fees, expansion of
facility for treatment etc.
4. Study of accounting system: The accounting system maintained should be studied and audit
procedure to be followed should be decided.
B. Receipts:
1. Vouching of collection from patients: The auditor should check the collection from
patients as entered in the cash book with reference to Patient Register, receipt counterfoils
and other evidences. The auditor will check the bill register to see whether all charges have
been computed correctly as per rate chart, period to stay of patient, category of bed,
medicine used, time taken by patient in the operation theatre, medical materials used etc.
2. Free bed facility: The auditor will see that free bed facility has been provided to deserving
patients as per rules and regulations.
3. Reimbursement from Insurance Company: The auditor will vouch the reimbursement of
medical expenses from the insurance company in case of cash less admission health
insurance. He will also vouch the collection from patient over the limit sanctioned by TPA
with reference to necessary supporting documents.
4. Legacies and donations: All the legacies and donation will be vouched with reference to
letters, counterfoil of receipts etc. the auditor will also see that donations received for some
specific purposes have been utilised accordingly.
5. Receipt of Grant: The auditor will verify grants received from Government with reference
to the sanction letters and examine whether conditions specified therein have been duly
complied with.
 6. Other incomes: The auditor should check collection of other income by way of rent from
properties, dividend, interest on securities etc. with reference to agreements, Properties and
Investment Register etc.
C. Expenditure:
1. Vouching of salaries: The auditor should vouch salaries and allowances with references to
terms and conditions of appointment of each category of staff namely doctors, nurse,
medical staff, administrative staff and other categories of employees of the hospital.
2. Accounting of various deductions: The auditor will see that deductions from salary
towards provident fund, income tax, group insurance etc. have been properly accounted and
deposited with the concerned authorities in time.
3. Capital Expenditure: Vouching of all capital expenditures should be done confirming that
established norms have been followed and they have the sanctions of competent authority.
4. Established Expenses: He will vouch in the usual manner all establishment expenses.
He will compare the different heads of expenses with budgets and figures of last year. Any
unusual variation should be enquired into.
5. Purchase of Provisions: Examine the payment relating to purchase of medicines, foodstuff,
and different medical items etc.
D. Assets and liabilities:
1. Verification of cash and investment: The auditor will carry out physical verification of
cash and various investments as laid down in the investment register.
2. Verification of fixed assets: The auditor will conduct physical verification of fixed
assets as shown in the assets register.
3. Depreciation: The auditor will see that depreciation at appropriate rate has been written
off against all fixed assets.
4. Examination of stock: He will see whether the stock of medicine, foodstuff and other
materials are properly maintained. He will ensure that any difference found in physical
verification from stock records has been properly adjusted.
5. Provisioning of liability: The auditor will ensure that all the liabilities in respect of
purchase of assets, medicines, maintenance expenses, foodgrains etc. have been duly
provided.
6. Verification of capital: Capital introduced during the year by partners or by
shareholders by way of subscribing shares should by checked based on various
documents like agreement, board’s meeting etc.
E. Financial statement:
The auditor will see whether financial statements comprising of income and expenditure account
or statement of profit and loss, balance sheet and cash flow statement have been prepared
properly and according to the generally accepted accounting principles.
F. Submission of audit report:
At the end, the auditor will submit his report expressing opinion about the reliability and fairness
of financial statements.
 48. Prepare an audit programme in respect of a Hotel***
An Auditor should consider the following points while conducting Audit of Hotels −
(A) Detail of Applicable Law
For audit of hotels, it is very crucial and important for an Auditor to go through the laws normally applicable
to the hotel industry .
The Companies Act, 2013 may also be applicable to hotels in case if the status of hotel is like a company.
Whereas, the Income Tax Act, 1961 will be levied in all the cases irrespective of whatever the status of that
hotel is.

(B) Preliminary Matters:

 An Auditor should determine the scope of his audit from his letter of appointment. It should be seen
whether he is asked to express his opinion on financial statements only or some additional
responsibility being assigned to him.
 An Auditor should obtain list of books of accounts, documents and registers maintained by hotel.
 He should see whether relevant hotels have independent status or a part of chains of hotels.
 An Auditor should study the Memorandum of Articles and the Memorandum of Association.
 He should obtain the title deed and other related documents to verify the land and building.
 He should also obtain Minutes of meeting of the Board of Directors to note down the important
decisions relating to accounts, finance and audit.

(C) Receipts:
In order to conduct audit of a hotel, an Auditor should study, verify and vouch books of accounts, keeping in
mind the different points of sale.
(a) Revenue from Room Rent
(b) Revenue from Food & Beverages (Restaurants)
(c) Revenue from Food & Beverages (Room Service)
(d) Food & Beverages Revenue from Minibar
(e) Revenue from Banquets
(f) Revenue from Business Centre
(g) Arcade Revenues
(h) Revenue from Car Hire
(i) Revenue from Telephone & Internet
(j) Revenue from Housekeeping
(k) Revenue from Laundry
(l) Revenue from Beauty Parlors and Health Clubs
(m) Revenue from Sale of Scrap and Disposal of Empties

(D) Audit of Expenses

An Auditor needs to consider the following points and verify the Revenue from Expenses −
(a) An Auditor should verify the appointment letter, policy of increment, time record, salary register,
cash book and bank book to verify the salary payments of employees.
(b) He should verify all purchases through requisition slip, quotations, purchase order, inward register,
quality control verification record and stock ledger.
 (c) Every purchase should be passed by appropriate authority in this regard.
(d) Vouching should be done properly and should be verified with documentary evidences.
(e) At times, there may be a contract between a seller and a buyer (hotel) to sell a particular product at
the same rate for a specific period like a week or a month, especially in case where the supply of
material is done on daily basis like milk, bakery products, fresh vegetables, etc. The Auditor should
verify purchases on the basis of such agreement.
(f) An Auditor should apply all other precautions and experience to audit the expenses as he does in any
other industries.
(g) Verification of purchases, consumption and stocking is very crucial in hotel industry and it is a real
challenge for an Auditor to verify all these very carefully. An Auditor should apply all his
experience and knowledge to do audit of it.

(E) Assets and liabilities:

(a) Verification of cash and investment:
(b) Verification of fixed assets:
(c) Depreciation:
(d) Examination of stock:
(e) Provisioning of liability:
(f) Verification of capital:

(F) Financial statement:

The auditor will see whether financial statements comprising of income and expenditure account or
statement of profit and loss, balance sheet and cash flow statement have been prepared properly and
according to the generally accepted accounting principles.

(G) Submission of audit report:

At the end, the auditor will submit his report expressing opinion about the reliability and fairness of financial
statements.
 Unit III: (10 Marks)
AUDIT RISK & INTERNAL CONTROL SYSTEM
Audit Risk – Concept and Types
only. Internal Control- Definition,
Objectives Internal Check-
Definition, Objectives
Internal Audit- Definition, Objectives, Regulatory Requirement, Reliance by Statutory Auditor on
Internal
Auditor’s Work

49. What is Audit risk? What are its different types?****

What is Audit risk?
Risk is a fundamental concept when performing an audit. It forms the basis for how the auditor will complete
the audit engagement and drives the amount and type of work that will be performed.
The definition of ‘audit risk’ is the risk that the auditor gives the wrong opinion on the financial statements
and so, ultimately, this is what the auditor is trying to avoid.
To support this, audit risk should be reduced to an acceptably low level. To help actually achieve this when
completing an audit, we split audit risk into three components, as shown below:
Audit Risk = Inherent Risk x Control Risk x Detection Risk
Inherent Risk
Inherent risk is the susceptibility of a financial statement account to a material misstatement, irrespective of
related internal controls. Therefore, this risk is assessed by understanding the entity and is the driver behind
much of the work performed at the acceptance and planning stages of the audit.
To effectively complete an audit, the auditor must thoroughly understand the entity that they are to give an
opinion on. This understanding will allow for the inherent risks to be identified, which means the auditor can
focus their attention towards areas more likely to contain errors.
Control Risk
This is the risk that the entity’s controls will not prevent / detect and correct a material misstatement in the
financial statements on a timely basis.
In order to assess this risk, the auditor must understand the key business processes in place at the client and
whether the controls over these processes are designed effectively, as well as assessing the overall control
systems at the entity.
The auditor can then test the controls to assess whether they have operated effectively during the year, and
therefore, will reduce the likelihood of a misstatement occurring in the financial statements.
This work will be completed after the planning work, as part of the systems and controls analysis stage of the
audit.
Detection Risk
Detection risk is the risk that the auditor’s procedures will not detect a material misstatement that exists in
the financial statements. It is the only risk that can be controlled by the auditor as it will depend on the level
of procedures performed by the auditor.
The level of detection risk will depend on the inherent risk and control risk that the auditor has already
assessed, and it will drive the amount of work that is performed at the substantive testing stage of the audit.
 50. What do you mean by internal check system? What are its
objectives?**
Meaning and Definition:
Internal check is the valuable part of the internal control. It is an arrangement of the duties of members of staff
in such a manner that the work performed one person is automatically and independently checked by the other.
Spicer and Pegler have defined a system of internal check as "an arrangement of staff duties whereby no
one person is allowed to carry through and record every aspect of a transaction such that without collusion
between two or more persons., fraud is prevented and at the same time possibilities of errors are reduced to a
minimum".
Objectives
The objects of internal check system can be set forth as below:
(a) To exercise moral pressure over the staff.
(b) To ensure that the accounting system produces reliable and adequate information.
(c) To provide protection to the resources of the business against fraud, carelessness and in efficiency.
(d) To distribute work in such a manner that no business is left unrecorded.
(e) To allocate duties and responsibilities of each clerk in such a way that he may held responsible for
particular fraud or error.
(f) To increase the efficiency of clerks because the allocation of duties is based on the principle of division
of labour.
(g) To detect errors and frauds easily if it is committed, because in an efficient internal check system, there
is a provision for independent checking.
Advantages of Internal Check:
(a) Proper division of work: internal check entails a proper and rational distribution of work among
the members of staff of the enterprise keeping in view their individual qualifications, experience and area
of specialization.
(b) Detection of errors and frauds: since no individual worker is allowed to handle a job completely
from the beginning to the end, and the work of each clerk is automatically checked by the other, this
helps in the early detection and discovery of errors and frauds.
(c) Increased efficiency coupled with economy: A good system of internal check increases the efficiency
of work among the staff and leads to overall economy.
(d) Convenience to auditor: where an organization is operating the system of internal check, the statutory
auditor may conveniently avoid detailed checking of the transactions. He may apply a few tests here
and there and can relieve himself from detailed checking.
(e) Accuracy of the accounts can be relied upon: If there is a good system of internal check the owner of
the concern may rely upon the genuineness and accuracy of the accounts.
(f) Increase in Profits: overall efficiency and economy in operations result in more profits- thus
ensuring larger dividends for the owners or shareholders.
 51. What do you mean by internal control? What are its
objectives?***
Internal control
Internal control has been defined as being "not only internal check and internal audit but the whole system
of controls, financial and otherwise, established by the management in order to carry on the business of
the company in on orderly manner, safeguard its assets and secure as far as possible the accuracy and
reliability of its records."
Therefore internal control is a broad term with a wide coverage. Its scope extends beyond those matters
which relate directly to the functions of accounting and financial records. In its modern sense, audit control
includes two types of controls:
(a) Accounting Controls : These comprise primarily the plan of organization and the procedures and records
that are concerned with and directly related to the safeguarding of assets and reliability of financial
records. These include budgeting control, standard costing, control accounts, bank reconciliation, self
balancing ledgers and internal auditing etc.
(b) Administrative Controls : These comprise the plan of organization that are concerned mainly with
operational efficiency. They may include controls, such as time and motion studies, quality controls
through inspection, performance reports and statistical analysis.
Objectives of Internal Control :
(a) Providing reliable data: Business decisions require accurate information o run the business
efficiently. Examples of significant areas where management requires reliable information are fixation
of selling prices production directives depending upon requirements etc. with the efficient internal control
in place the accurate, required and reliable information can be provided for taking the important
decisions and efficient performance of the activities.
(b) To promote operational Efficiency: the controls within an organization are meant to prevent
unnecessary duplication of efforts, protect against waste in all aspects of business and discourage other
types of inefficient use of resources so as to promote the operational efficiency.
(c) To encourage adherence to the prescribed policies: the system of internal control is meant to
provide reasonable assurance that procedures and rules of various institutes are followed by company
personnel.
(d) Safeguarding assets and records: the physical assets of the company can be stolen, misused or
accidently destroyed if not properly protected by adequate controls. The internal control helps to
safeguard the physical assets and to secure the accuracy and reliabilities of the records of the company.
 52. Distinguish between internal control system & internal
check system.******

Points of Distinction Internal Control Internal Audit

1. Meaning Internal control is the whole system Internal audit is an independent
of control instituted in the continuous and critical appraisal and
organization for the purpose of review of accounting, financial and
running the business in an orderly other operations of the undertaking.
manner, safeguarding its assets,
increasing the productivity and
ensuring reliability and fairness of
financial records.
2. Scope The coverage of internal control is Internal audit is an important part of
vast. It is the accounting and the internal control system. Its function
administrative devices controlling all is to see that organization’s system of
the areas of the organization so that internal control is maintained
the ultimate objective of the appropriately and management
organization is attained. instructions and policies in relation to
various operations are being carried
out correctly.
3. Existence Internal control system exists in all To carry out internal audit, a separate
the departments of the organization. department is formed. The internal
All the employees of each auditor who heads this department is
department are responsible for responsible for continuous and
proper implementation of internal independent review of books of
control system. accounts and appraisal and evaluation
of effectiveness of other controls.
4. Responsibility To implement the internal control is To carry out internal audit is the
the responsibility of the management responsibility of the internal auditor
staff who work according to who works independently.
established policies and procedures.
5. Nature Internal control system runs It does not work automatically. It is
automatically and concurrently with undertaken after the transactions take
the execution of transactions. place.
6. Reporting system It involves regular reporting of daily The internal audit reports about the
transactions and operations of the operational efficiency and reliability of
department to the departmental financial records and reports are sent
manager. to the top management.
 53. In a good system of Internal check, the work of one is
checked indirectly by the work of another" — Explain and
discuss the statement with examples.******
Internal Check
Internal check is a method of organising the accounts system of a business concern or a factory where
the duties of different clerks are arranged in such a way that the work of one person is automatically
checked by another and thus the possibility of fraud, or error or irregularity is minimised unless there is
collusion between the clerks. For example, the receipt of cash is entered by the cashier on the debit side
of the cash book; this entry is carried to the ledger by another clerk; the statement of account relating to
this transaction is sent to the customer by a third clerk and so on. Thus the same transaction has passed
through three different hands and the work of one is checked automatically by the other. It is a kind of
division of labour. This minimises the possibilities of frauds and errors unless all the three join hands in
defrauding their employer.
According to the special committee on Terminology, American Institute of Accountants, 1949 "Internal check-
a system under which the accounting methods and details of an establishment are so laid out that the
accounts procedures are not under the absolute and independent control of any person - that, on the contrary,
the work of one employee is complementary of that of another, and that a continuous audit of the business
is made by the employees."
The essential elements of an internal check are :
(a) Instituting of checks on day-to-day transactions.
(b) These checks operate continuously as a part of routine system.
(c) Work of each person is made complementary to the work of another.
The objective of such allocation of the duties is that no one has an exclusive control over any transaction.
An example of internal check is the system of encashment of cheque in bank. When a cheque is
presented to bank for encashment, one person issues a token, then he verifies the balance in the ledger book
and makes entry. One officer then verifies the signature and authorises payment. The cashier then makes
payment. Thus the entire system is so designed that no single person can verify record and make payment.
Sometimes to enhance the efficacy of Internal check system duties among staff members are
interchanged. They are also encouraged to go on leave so that in the absence of an individual frauds and
errors, if committed by him, can be brought to light.
On the basis of the above, it may be concluded that the internal check means a system by which the work is
divided among the employees in such a manner that not a single individual is allowed to carry on the whole
function from the beginning to the end and the work of an individual is automatically checked by another.
 54. What is meant by internal audit? State its objectives.****
INTERNAL AUDIT
Internal audit is the review of operations and records undertaken within a business by specially assigned
staff on a continuous basis. Internal audit has been defined as "the independent appraisal of activity
within an organization for the review of accounting, financial and other business practices as a protective
and constructive arm of management. It is a type of control which functions by measuring and evaluating
the effectiveness of other types of controls." Therefore it is clear that internal audit not only includes the
verifications of accounting matters but also financial and other matters.
Objects of Internal Audit
(a) To verify the correctness of the financial accounting and statistical records presented to the
management.
(b) To comment on the effectiveness of the internal control system and the internal check system in force
and to suggest means to improve them.
(c) To facilitate the early detection and prevention of frauds.
(d) To ensure that the standard accounting practices to be followed by the organization are strictly followed.
(e) To confirm that the liabilities have been incurred by the organization in respect of its legitimate activities.
(f) To examine the protection provided to assets and the uses to which they are put.
(g) To undertake special investigation for the management.
(h) To identify the authorities responsible for purchasing assets and other item as well as disposal of assets.

55. Can a statutory auditor rely upon the internal audit

system in carrying out the statutory audit? Give reasons
for your
The relationship of the internal auditor and statutory auditor can be summed up as follows: -
1. comment upon the effectiveness and suitability of internal audit system: As per manufacturing and
other companies order 1988 issued under section 227 of the companies act the statutory auditor has to
comment upon the effectiveness and suitability of internal audit system laid down by the management.
2. To discharge this responsibility: statutory auditor should evaluate the internal audit system he should
evaluate the strength of the internal audit staff, their qualification and experience.
3. Evaluation of the actual work of internal auditor: After studying the internal audit system and
structure actual work of the internal auditor should also be evaluated. Statutory auditor has to make use of
the work of internal auditor. This he can do only when he himself puts faith in the work of internal
auditor.
4. Relying on the work of internal auditor: Statutory auditor has to decide that up to what extant he can
rely upon the work of the internal auditor. This will decide the extent of his own checking. If he feels
that internal auditor has properly done his work he can reduce the extent of his checking.
5. No reduction in responsibility: “ Relying on work of internal auditor in no way reduces the responsible
for the discharge of his duties as statutory auditor.
Relying on the internal auditor can only reduce the burden of the statutory auditor. For all his works statutory
auditor would remain responsible.
 56. Internal audit can not replace internal check-Explain.
*** Or
Distinguish between internal check system & internal audit
system.***
Internal audit is an independent and continuous appraisal and review of accounting, financial and other
operations of the undertaking.
Internal check on the other hand is the division of work amongst various staff members in such a way that work of one
person is instantly and automatically checked by the work of other staffs. So, their difference can be summarised as
follows
Points of Distinction Internal check System Internal audit System
(i) Nature It is an inbuilt system and once introduced It does not work automatically. It is under
it runs automatically and con- currently taken after the transaction takes place.
with the execution of transaction.

(ii) Function It is an arrangement of allocation of duties It is an independent and continuous review

in such a way that work of one employee is of operations and records.
automatically checked by
the work of another employee.

(iii) Results It prevents occurrence of errors and frauds As it is undertaken after the work is
or if they are committed, it can detect them complete, it cannot prevent occurrence
almost instantaneously. of error or fraud..

(iv) Formation To run the internal check system, no To carry out internal audit, a separate
separate set of staff is required. It only department is formed. This department
represents arrangement of duties among consists of people both of accounting
staff. and technical profession.

(v) Objective The objective of this system is prevention Detection of errors and frauds is the
and early detection of errors and frauds. secondary objective of internal audit,
Its thrust mainly is, on operational
efficiency.
(vi) Subject matter An internal check system is concerned with It is concerned with the appraisal of work
carrying out work efficiently and done and ascertaining the reliability of
effectively. records and reports.

(vii) Reporting system It involves regular reporting of daily The internal audit report about the
transactions of the department to the operational efficiency and reliability of
departmental manager. financial records and report are sent to
the top management.
 57. Distinguish between internal Control & internal audit
system.***

Points of Distinction Internal Control Internal Audit

1. Meaning Internal control is the whole system of Internal audit is an independent
control instituted in the organization for continuous and critical appraisal and
the purpose of running the business in review of accounting, financial and
an orderly manner, safeguarding its other operations of the undertaking.
assets, increasing the productivity and
ensuring reliability and fairness of
financial records.
2. Scope The coverage of internal control is vast. It Internal audit is an important part
is the accounting and administrative of the internal control system. Its
devices controlling all the areas of the function is to see that organization’s
organization so that the ultimate objective system of internal control is
of the organization is attained. maintained appropriately and
management instructions and policies
in relation to various operations are
being carried out correctly.
3. Existence Internal control system exists in all the To carry out internal audit, a separate
departments of the organization. All the department is formed. The internal
employees of each department are auditor who heads this department is
responsible for proper implementation of responsible for continuous and
internal control system. independent review of books of
accounts and appraisal and evaluation
of effectiveness of other controls.
4. Responsibility To implement the internal control is the To carry out internal audit is the
responsibility of the management staff responsibility of the internal auditor
who work according to established who works independently.
policies and procedures.
5. Nature Internal control system runs automatically It does not work automatically. It is
and concurrently with the execution of undertaken after the transactions take
transactions. place.
6. Reporting system It involves regular reporting of daily The internal audit reports about the
transactions and operations of the operational efficiency and reliability
department to the departmental manager. of financial records and reports are
sent to the top management.
 Unit IV (10 Marks):
VOUCHING, VERIFICATION & VALUATION
Vouching: Meaning, Objectives - Difference with Routine Checking – Factors to be Considered during
Vouching - Vouching of Following Items: i) Receipts: Cash Sale, Collection from Debtors, Interest and
Dividend from Investment, Sale of Fixed Assets. ii) Payments: Cash Purchase, Payment to Creditors,
Payment of Wages and Salaries, Advertisement Expenses, Travelling Expenses, Research and Development
Expenditure, Prepaid Expenses.
Verification and Valuation: Concept, Objectives, Importance, Difference with Vouching, Difference
between Verification and Valuation, Verification of following items: i) Non- Current Assets: Goodwill,
Patent and Copy Right, Leasehold Land, Plant and Machinery, ii) Investments iii) Current Assets: Inventory,
Loan and Advance, Cash and Bank Balances iv) Non-current Liability: Secured Loan v) Current Liability:
Trade Payables (Sundry
58. What is vouching? What are the objectives of vouching?*
Vouching is the act of authenticating a transaction recorded in the books of accounts with reference to its
documentary evidence. It is the essence of auditing and in fact, the whole structure of auditing rests upon it. It is
not routine checking. In other words, it is not mere comparison of entries recorded in the books of accounts with
relevant vouchers. Rather, the auditor has to go beyond the books to substantiate propriety of transactions. So,
vouching requires intelligence and tactfulness on the part of the auditor. He will apply professional skepticism
i.e., alertness and judgement in his work. While conducting vouching, he will collect evidence judiciously in
support of transactions, evaluate credibility and truthfulness of evidence and then form his judgement about the
propriety of transactions.
According to Spicer and Peglar, “Vouching may be defined as the examination by the auditor of all
documentary evidence which is available to support the authenticity of transactions entered in the clients’
records”.
According to Dicksee, “vouching consists of comparing entries in books of account with documentary evidence
in support thereof”.
Objectives of Vouching
The objectives of vouching may be discussed in the following way:
(a) Correction of vouchers: The work of vouching involves correction of vouchers and related evidences.
(b) Evaluation of evidences and voucher: Its involves the evaluation of collected evidences and vouchers.
(c) Examination of vouchers: It is concerned with the examination of vouchers or documents in such a manner
the auditor may satisfy himself as to the authenticity and validity of the recording of transactions.
(d) Nothing unrecorded : It refers to finding out that nothing pertaining the business has been left unrecorded,
(e) Finding out the transactions recorded: It involves finding out whether entries relating to transactions
have been properly recorded in the books of account or not.
(f) Recording of transactions not concerned with: It refers to finding out that no transaction which is not
concerned with the business has been recorded in the books of account.
(g) Recording of transactions in the books: It is concerned with examining whether all the transactions relating
to the business have been recorded in the books and whether those transactions are pertaining to the period
under audit.
(h) Basis for final conclusion: It forms the basis for final conclusion to be drawn by the auditor.
 59. Vouching is the essence of audit – Discuss.*
Vouching is the process of examination of all available documentary evidences to verify the genuineness,
authority and authenticity of transactions entered in client’s books. Vouching is the essential part of auditing. In
fact, “it constitutes the foundation upon which the superstructure of auditing is erected.”
The factors that make vouching the essence of auditing can be brought out as under:
1. Basic Evidence: Vouching is a substantive audit procedure designed to obtain evidence to verify the
accuracy and validity of data produced by the accounting system.
2. Assurances: Through couching, the auditor tries to obtain the reasonable assurance on the following
assertions:
(a) The transaction is recorded in the proper account and revenue or expense is properly allocated to
the accounting period;
(b) The transaction recorded pertains to the organization;
(c) All transactions which were actually taken place have been recorded;
(d) There is proper authorization for all transactions;
(e) Transactions have been classified and disclosed according to generally accepted accounting
principles.
3. Genuineness of transactions: The transactions do not take place in the presence of auditor. So, the
auditors, through vouching, try to establish the genuineness of transactions.
4. Propriety of transactions: Through vouching, the auditor goes to the root of transactions to substantiate
their propriety. It helps him determine whether transactions have been carried out in the best interest of the
entity.
5. Substantial accuracy: Substantial accuracy as opposed to arithmetical accuracy of transactions is
determined by vouching. It is applied by the auditor to test the authority, regularity and truthfulness of
entries in the accounts.
6. Detection and prevention of frauds and errors: Vouching is an analytical exercise; it is critical and
investigates. It requires application of professional skepticism and judgement on the part of the auditor. So
complex error and ingeniously made fraud can be detected by vouching.
7. Successful and logical completion of audit: The success of audit depends upon the efficacy of vouching.
A casual and careless conduct of vouching will expose the auditor to legal action if he fails to detect
material errors and fraud. In Armitage V. Brewer and Knott (1932) case the auditor was held guilty of
negligence for not conducting vouching properly.
8. Basis for verification: Vouching is also the basis of verification of assets and liabilities stated in the
balance sheet. For verification they are traced from underlying books of accounts and relevant source
documents. Examination of these source documents constitutes vouching.
9. Basis of expression of opinion on financial statements: The auditor satisfies himself about the accuracy,
validity and authenticity of transactions recorded in the books of accounts through the process of vouching.
After being satisfied, he can emphatically state that the financial statements reflect a true and fair view of
the business. Thus, vouching is the basic requirement to achieve the primary objective of audit.
10. Internal control cannot make Vouching redundant: In an organization with sound internal control
system, the auditor can rely on the internal control and can reduce the extent of vouching. But under no
circumstances the auditor can escape his responsibility for not conducting vouching on the plea that he has
relied on internal control.
Hence, it is said that vouching is the backbone of audit. Without vouching, financial audit remains incomplete.
 60. Are routine check and vouching complementary to each
other?*
Routine checking and vouching are not the same thing. They are not complementary to each other. They
have different purposes and they vary in approaches. Following points will justify this assertion:
i. Purpose: Routine checking is done for ascertaining the arithmetical accuracy of books of
original entry and ledger. Vouching is done for determining the authenticity and propriety of
transactions.
ii. Checking compliance with GAAP: Routine checking cannot ensure the compliances with
generally accepted accounting principles. Proper vouching ensures that all transactions have
been recorded as per accounting standards and generally accepted accounting principles.
iii. Importance: By conducting routine checking only, the auditor cannot report on fairness of
financial statements. It is only vouching by which the auditor reports on the reliability and
fairness of financial statements,
iv. Fraud detection: The auditor cannot detect irregularities and frauds by conducting routine
checking only. Proper vouching only enables the auditor to detect and prevent frauds and
irregularities.
So from the above discussion it is clear that routine checking and vouching are not complementary to each
other.

61. How do you vouch the following items**********

(i) Director’s remuneration****
This refers to the amount paid to directors for their services rendered to the company and for attending Board
meeting. While checking this term of expense, the auditor should have the following information:
i. Total number of Executive Directors and Non-executive Directors.
ii. Types of remunerations and perquisites to which directors are entitled and other terms and
conditions of their appointment.
iii. Whether directors are entitled to get fees for attending Board meeting and if executive directors
get any such fess, whether specific approval has been taken from Department of company
Affairs, Govt. of India.
iv. Whether director’s remuneration has been separately shown in the profit & Loss A/c as required
under the Companies act.
v. Whether the net profit on which commission is paid or payable to Directors has been computed
in pursuance to sec. 309 of the Companies Act, 1956.
vi. Whether the ceiling of maximum managerial remuneration as stipulated under section 198 of the
Companies Act, 1956 has been adhered to.
vii. Whether any increase in remuneration is as per sec. 310 of the Companies Act.
Following documents should be examined for the above information:
i. Articles of Association to know the details of remuneration payable to Directors.
ii. Agreement with directors or appointment letters,
iii. Directors’ minute book or attendance register to vouch the director fees.
iv. Statement showing details of calculation of commission.
v. Directors’ receipts etc.
(ii) Travelling Expenses****
For vouching of traveling expenses, the auditor should have following information:
i. business travel rules as formulated by management,
ii. Whether every tour has got approval of competent authority.
iii. Whether the tour expenses are within the prescribed limit.
iv. Whether personal A/cs of the employees taking business travel advance have been correctly
debited.
v. Whether debit balances of personal A/cs of employees have been duly regularized through
submission of travelling vouchers.
vi. Whether foreign travel has got Reserve Bank of India’s permission, if necessary for withdrawing
foreign exchange. The auditor should also check whether the amount of foreign exchange spent
has been separately disclosed in the accounts as per requirement of Part I of Schedule VI to
Companies Act.
To satisfy himself with the above information, the auditor should go through following documents:
i. Business Travel Rules of the company.
ii. Business Travel Vouchers as submitted by employees.
iii. Personal accounts of employees.
iv. Board’s Resolution etc.

(iii) Preliminary Expenses

Expenses incurred in connection with the promotion of a new company are known as preliminary expenses.
This expenditure includes stamp duties, registration fees, legal cost, accountant’s fees, cost of printing, etc.
while vouching these expenses, the auditor should require following information:
i. Whether the expenses shown as preliminary expenses are actually connected with the
formation of the company.
ii. Whether the expenses incurred have got due sanction from the competent authority.
iii. Whether the amount of expenses is justified from propriety angle. In other words, the auditor
should enquire into the rightness of the amount of expenses.
iv. Whether the amount of expenses is within the sanctioned limit. If it exceeds the limit, the auditor
should enquire into whether approval from shareholders has been obtained in this regard.
v. Whether preliminary expenses have been written off in the year in which they are incurred as
required under AS 26, Accounting for Intangible Assets.
In order to gather the above information, the auditor should go through following documents,
(a) Invoices, bills etc. to ensure that expenses pertain to formation of the company,
(b) Contracts, agreement, purchase order etc. to ensure authorisation of expenses.
(c) Correspondence with various suppliers, their quotations, price comparative statement etc. to ensure Tightness of
expenses,
(d) Board's Resolution, Prospectus etc. to see that amount is within limit,
(e) Agreement with promoters to see the terms and conditions of reimbursement of expenses to them.
(iv) Payment of dividend
The following points must be considered while vouching the payment of dividend in case of a public company
and private company which is a subsidiary of a public company –
(a) Examine special provisions, if any, in the Memorandum and Articles of Association regarding payment of
dividends.
(b) See that in declaring dividends, provisions of the Companies (Transfer of Profits to Reserves) Rules, 1975
have been complied with.
(c) Examine the Board’s minutes regarding rate of dividends.
(d) Examine the company’s procedure for payment of dividends including unclaimed dividends and ensure that
they are not paid without adequate safeguards as to identification of the payee, checking of the payee’s claims
etc. In this connection, internal control of the company should be examined.
(e) Verify the shareholders’ register and ensure that the names of all shareholders who are entitled to receive
dividends have been included.
(f) Check the computation of dividends with reference to rate of dividends and number of shares held.
(g) See counterfoils of cheques for amounts paid to shareholders.
(h) Examine, whether all the conditions for payment and source of dividend as specified on section 205, 205A and
205B, have been complied with. It may be noted that the Institute has issued a Guidance Note on Audit
of Payment of Dividends.

(v) Interest & dividend received

The following points must be considered while vouching the receipt of interest & dividend in case of a public
company and private company which is a subsidiary of a public company –
(a) The auditor should examine the separate ledger accounts kept for each investment or loan given.
(b) The dates on which dividends or interest payments generally fall due should also be noted.
(c) The counterfoil of dividend warrants should be seen. These should be tallied with the records of investment.
(d) Where investments are sold ex-dividend, it should be seen that the dividends are subsequently received.
(e) Similarly when a purchase is on cum dividend basis, the receipt of dividend should be checked.
(f) In case of interest on deposit with banks, verification should be done by reference to the bank’s statement and
the agreed rate of interest.
(g) The receipts of dividends and interest should be addressed to the bank statement for encashment.
(h) It should be ensured that the interest and dividend received are credited to the respective account in full i.e.,
before deduction of tax at source and the tax deducted at source should be debited to an appropriate account.
(i) It should be further seen that the certificate for tax deducted at source exists in each case.
Documents to be verified:
(a) The documents to be verified for interest received are (a) Loan agreement (b) Fixed deposit or debenture
certificate (c) Interest warrant for debenture (d) Mortgage deed (e) Bank pass book etc.
(b) The documents to be verified in connection with dividend are (a) Dividend warrant (b) Investment Register
(c) Bank pass book. For checking the interest, the auditor should
(vi) Rent received: -
The following points must be considered while vouching the rent received:
(a) Before proceeding to vouch rental receipts, copies of bills issued to tenants should be test checked by reference
to copies of tenancy agreements and bills of charges paid by the landlord on behalf of the tenants, i.e.,
house tax, water tax, electricity consumed, etc.
(b) The entries in the Rental Register in respect of rents accrued afterwards should be verified by reference to
copies of rental bills.
(c) The amounts collected from tenants on account of rent should be checked by reference to receipts issued to
them. These afterwards should be traced into the Rental Register.
(d) At the end, the register should be scrutinized to find amount or rents which have not been recovered and
are considered bad or irrecoverable, for deciding whether these should be written off or as provision against the
same should be made.
(e) An overall check over rental receipts is also necessary. For this purpose, particulars of total accommodation
available for being let out, in different buildings, belonging to the client, should be ascertained.
(f) It should be verified that every available accommodation has been let out and rental income has been
duly accounted for.
(g) If it is reported that one or more tenements have remained vacant a certificate in respect thereof should be
obtained from the client.

(vii) Vouching of cash sales

Fraud frequently occurs in the areas of cash sales. So the auditor should be very careful while vouching cash
sales. He will adopt following procedures for this purpose:
i. To check the internal check to assess its efficacy in preventing fraud.
ii. To verify each sale with copies of cash memos. If the number of transactions is large, a cash
sales summary book is maintained from which the daily total of cash sales is recorded in the cash
book. So cash memos will be traced in cash sales summary book and daily totals of summary
book are traced in the cash book. He will see that dates of cash memos tally with the dates of
entry in the cash book.
iii. To verify the calculations of price of goods sold on selective basis and to check the price with
reference to the price list.
iv. To ensure that there is proper authorization of discount and rebate.
v. To see that cancelled cash memos have signature of responsible officer.
vi. To make sure that total cash sales of the day is deposited into bank next day. Pay-in-slips should
be verified in this respect.
vii. To see that proper sales tax declaration forms have been obtained from customers for charging
sales tax at reduced rate.
62. “In vouching payments, the auditor doe not merely seek
proof that money has been paid away.”—Critically
examine
the statement.*
Vouching is the act of authenticating a transaction recorded in books of accounts with reference to its
documentary evidence. Vouching is called the essence of auditing. In fact, the whole structure of
auditing rests upon vouching. The correct assessment of financial statements to determine their reliability
and fairness depends upon intelligent conduct of vouching on the part of an auditor. It is so important in
audit of accounts that some people have compared it with the backbone of human structure. It is to be
noted vouching should not be construed as mere comparison of entries recorded in the books of accounts
with the relevant vouchers. If the auditor restricts his work to mere comparison, he is likely to be
deceived as the very document itself may be fake. So, the entire exercise of auditor will be futile and the
very purpose of audit i.e. ensuring fairness and reliability of accounts will then be frustrated. Therefore,
the auditor will have to go beyond near comparison of entries with vouchers; rather, he will go to the
source of transactions to substantiate its propriety. For example, while vouching the payment against
suppliers invoice, he will not merely tick the entry in the Bought Ledger and Cash Book with payment
voucher but will also check that
i. The payment voucher is based on some purchase invoice. If the payment voucher is for some
advance or ad hoc payment, approval of competent authority must exist.
ii. The invoice is supported by purchase order.
iii. The P.O. has been duly raised by the responsible purchase officer after following the
established purchased procedures.
iv. The invoice has been duly certified by the Receiving Deptt., Inspection Deptt., and store Deptt.
v. The invoice has been duly checked by the accounts staff with reference to purchase order and
certification of other departments as mentioned.
vi. Proper classification between capital expenditure and revenue expenditure has been made.
vii. The payment has been sanctioned by the competent authority in the Accounts Deptt.
viii. Proper acknowledgement of receipt of payment as given by the supplier remains attached with
payment vouchers
The success of editor in vouching depends upon his intelligence and tactfulness. He will select
the audit technique and method very carefully and methodically. He need not be thorough and
meticulous in vouching all transactions as audit will then be an endless job. After satisfying
himself with the internal control system existing in the organization, he will select only those
items which are of material importance. Circumstances of cases will guide him to determine the
materiality of item. He will then collect evidences judiciously in support of those items,
evaluates credibility and truthfulness of evidences and then form his judgment about the
propriety of transactions. So vouching has ceased to be a mere comparison and ticking. Clever
fraud can only be detected by proper vouching. So the auditor should be careful, cautious and
very methodical while conducting vouching, otherwise he will be held responsible for
negligence as was held in the case Armitage v. Brewer & Knott (1932).
 63. What do you mean by Verification of Assets?
Distinguish between vouching & verification.*
MEANING OF VERIFIACTION OF ASSESS
According to Spicer and Pegler, verification of asses to an “enquiry into the value, ownership and title,
existence and possession and the presence of any charge on the assets”.
Verification is a process by which an auditor satisfies himself about the accuracy of the assets and liabilities
appearing in the Balance Sheet by inspection of the documentary evidence available. Verification means
proving the truth, or confirmation of the assets and liabilities appearing in the Balance Sheet.
Difference between Vouching and Verification
Points of distinction Vouching Verification
1. Meaning It refers to the examination of all Verification refers to the examination
documentary evidences in support of disclosure of assets and liabilities in
of transactions recorded in the the balance sheet.
books of accounts.
2. Objective Vouching is carried out with the Verification is done for confirming the
objective of establishing the ownership, existence, possession and
authenticity, genuineness and valuation of assets as stated in the
correctness of transactions recorded balance sheet.
in the primary books of accounts.
3. Level of Enterprise Vouching is usually done by junior Verification is done by senior level
level audit clerks with sound audit clerks or the auditor himself as it
knowledge in accounting requires expertise not only in account-
principles. ting principles but also in various
compliance and substantive audit
procedures and statutory requirements.
4. Point of Review Vouching involves examination Verification of assets and liabilities is
of transactions at their point of carried out at the Financial Statements
origin. stage.
5. Nature of Items Vouching is concerned with all Verification is concerned only with
items of Statement of Profit and items of Balance Sheet.
Loss and with those Balance sheet
items undergoing change during
the year.
6. Aspects under Review Vouching verifies— For Assets: It involves enquiry into the
(i) Date of voucher; value, ownership, existence, charge
(ii) Existence of proper and proper disclosure in Financial
authorization of the Statements.
transactions; For Liabilities: To see whether they
(iii) Supporting evidence are truly owed by the entity and
i.e., Bill, challan, disclosed at correct amounts.
inspection report, etc.;
(iv) Propriety of
transactions;
(v) Completeness;
(vi) Proper accounting
 64. Distinguish between verification & valuation of Assets?*
Verification
Verification means `proving the truth' or `confirmation'. One of the most important duties of an auditor in
connection with the audit of the accounts of a concern is to verify the assets and liabilities appearing in the
balance sheet.

Valuation
Valuation of assets means determining the fair value of the assets shown in the Balance Sheet on the basis of
generally accepted accounting principles.
The valuation of the assets is the primary duty of the officials of the company. The auditor is required to
verify whether the value ascertained is fair one or not. For this, he may rely on the technical certificate issued
by the experts in the field.
Valuation of assets means not only checking value of the assets owned by an organization as on Balance
Sheet date, but also critical examination of the value of these assets (comparative analysis of different
assets).

Distinction between verification and valuation :

Point of Distinction Verification Valuation

(i) Meaning Apart from the examination of Valuation means the examination of
determined value of different adequacy of determined value of
assets, verification means the different assets and liabilities
examination of the existence,
ownership and title etc. This is a
whole process.
(ii) Scope In such a case, the scope of work Since valuation is a part of
is comparatively extensive. verification, its scope of work is
comparatively little.
(iii) Performance of The work of verification is The function of valuation is
work accomplished by the auditor. performed generally by the manager,
director or responsible employee or
value determiner.
(iv) Object The object of verification is to
The scope of valuation is to justify the
verify the existence of the asset, propriety of the determined values of
its ownership, valuation and to assets and liabilities.
examine the existence of liability
and proper valuation.
(v) Liability of an The auditor may be responsible The auditor can depend on the
auditor for negligence in case of information of responsible employee for
verification. proper valuation. If any mistake is crept
on that information, the auditor cannot be
responsible
 65. “Verification includes valuation” - Comment**
Valuation of assets is an important part of their verification. The correct profits can not be calculated unless
the assets are properly valued. Only then the balance sheet will reveal the true and fair position of the
financial affairs of the business. The valuation as such is to ensure the correct valuation of the assets while in
verification, the auditor has to verify the authority, and the existence of the property also besides
its valuation. Thus valuation means to test the exact value of an asset on the basis of its utility. Normally,
valuation is done after deducting the depreciation for the value of an asset. If proper depreciation on assets is
not provided for, the profits will be overstated or understated which will have adverse effect on the
company's solvency. The auditor should consider the following points while valuing the assets:
(a) Original cost of the assets.
(b) Expected working life of the assets.
(c) Wear and tear of the assets.
(d) Break-up value of the assets.
(e) The chances of the assets becoming obsolete.

66. Do you think that verification of Assets and Liabilities is

necessary when vouching has been done properly?
Discuss*
Verification means `proving the truth' or `confirmation'. One of the most important duties of an auditor in
connection with the audit of the accounts of a concern is to verify the assets and liabilities appearing in the
balance sheet. The fact that there is an entry regarding the purchase of an asset and has been be correctly
recorded, is not a proof that the asset is in the possession of the concern at the date of the balance sheet. It is
possible that after purchase and passing the entries, the asset might have been disposed of or pledged and no
entry has been made concerning this before the closing of these books. Therefore, he has to see whether a
particular asset as recorded in the balance sheet on the day of the closing of the books of account exists or
not. If he fails to verify the asset, he will be liable for any damage suffered by the client as it was decided in
the case of London Oil Storage Co. Ltd. Vs. Sear Haslock and Co. (1904).
Thus we can say that verification is a process by which the auditor satisfies himself not only about the actual
existence, possession, ownership and valuation but also ensures that the assets are free from any charge or
lien. The verification of assets involves the following points :
(a) Comparing the ledger accounts on the date of the balance sheet.
(b) Verifying the existence of the assets on the date of the balance sheet.
(c) Satisfying that they are free from any charge of mortgage.
(d) Verifying their proper value.
(e) Assets were acquired for the business.
 67. How would you verify the following assets
& liabilities*******************
(a) Stock
As the correctness of the profit of a business depends to a great extent on the accuracy of the valuation
placed on the closing stock, it will be readily appreciated that the verification of this asset forms one of the
most important part of an auditor’s duty. While verifying the stock-in-trade the auditor has the following
duties –
(a) Ascertain the method of stock-taking and the basis of valuation.
(b) Ensure that the stock-sheets have been subjected to a good internal check, e.g. they are certified as to
have taken prices, extension and additions while determining the stock and also generally approved as
correct by managing director.
(c) Check calculations and additions.
(d) Check a few of the important items with actual invoices as to prices.
(e) Examine some of the quantities in stock-sheets with those shown by the stock books, if such stock
books are kept.
(f) Ascertain that the stock is valued on the same basis as in the previous year.
(g) Ascertain that obsolete and unsalable stock is shown at fair market prices.
(h) Compare the percentage of gross profit on turnover with that of the previous period and also
enquire into the cause of any notable fluctuation.
(i) Ensure that the goods entered as sold and not delivered are not included.
(j) Ensure that the goods bought and not entered in the invoice book are included.
(k) (i) Ascertain that the value of unfinished goods is taken at actual cost and the basis of valuation is the
cost of the materials consumed and the wages spent thereon upon the date of the Balance Sheet.
Sometimes a percentage is added in the above to cover the factory cost, such as foreman’s wages, fuel,
power, lighting, heating, depreciation of plant etc. (ii) In case of finished goods, a reasonable
percentage in respect of office cost has also to be added to the works cost.
(l) See that the goods sold on approval basis are properly included in closing stock.
(m) See that the stock held does not include goods held on consignment as an agent.
(n) Examine carefully the stock sheets and ensure that the stock includes only the goods dealt with by the
client and does not include any asset purchased.
(o) Confirm that stock has been valued at cost or market price, whichever is less.
(p) Obtain from a responsible officer of the organization a certificate regarding the procedure followed
in valuation of stock.
(q) Obtain a certificate from client certifying that :
i. Physical verification of stock is done.
ii. All goods included in the stock are property of the company.
iii. Cut off procedure is properly followed. (Cut off is a transaction which separates one accounting
year from the next accounting year. Last document nos. of goods 193 received notes, goods
accepted notes, debit and credit notes etc. should be obtained at the time of stocktaking).
iv. The basis of valuation is the same as was followed in the previous year.
(b) Investment
Investment may be a share certificate, government bond certificate, government loan certificate, debenture
certificate, etc. For verification of such securities, the following procedure is adopted.
(a) Obtain a schedule of investments in hand at the beginning of the audit period. Obtain the details of
description of investments together with distinctive number of face value, date of purchase, book value,
market value, rate of interest, date of payment of interest or, date around which dividend is declared,
etc., with also the details of interest or dividend received along with tax deducted at source.
(b) Add to the above list, purchase made during the year and delete the investments sold during the year
with all the above details.
(c) Balance this schedule and compare the balance with general ledger and Balance sheet.
(d) Check the market value of investments with reference to stock exchange quotations or other suitable
method, on Balance Sheet date and see that the values are disclosed in the Balance sheet.
(e) Inspect the certificates or securities physically on the Balance Sheet date.
(f) Compare the income received with amount due and adjust the accrued income.
(g) Confirm the uncalled liability on partly paid shares held as investment shown as contingent liability by
way of a note to the Balance Sheet.
(h) See that adequate provision is made for any shortfall in the book value of investment shown in the
Balance Sheet.
(i) See that, regarding the investment in subsidiaries, disclosure requirement of the Companies Act, 2013
are complied with.
(j) For investment in the capital of partnership, the partnership deed and copy of accounts of partnership
firms, is to be verified. Also adjust the share of profit and loss for the partnership period.
(k) Investments which stand in the name of persons other than that of the company are to be confirmed
with appropriate sanction.
(l) For investment lodged with others as security or lying with banks or share brokers, obtain a certificate
from the parties concerned.
(m) In case of application money paid for shares which are still to be allotted, that fact is to be specially
disclosed in the Balance Sheet.
(c) Debtors:
Sundry Debtors represents the amount recoverable from the customers for sale of goods or rendering of
services.
(a) The under mentioned procedure should be applied for verification of `Book Debts’ or `Sundry
Debtors’ after receiving a schedule or list of debtors from the client.
i. Direct confirmation of balances from debtors by sending confirmatory letters.
ii. Year-end Scrutiny of ledgers.
iii. Verification of the position of debts considered bad or doubt ful. (d) Compliance with
legal requirement or presentation.
(b) The auditor should arrange to send the letter of confirmation of balances by the client as per client’s
records and see that the reply of confirmation is forwarded to his office directly. Usually this
should be sent within 15 or 20 days of close of the year under the supervision of the audit staff. After
the reply is received, the same should be tallied with the balances shown in the Debtors Ledger and
difference properly reconciled.
 (c) After the said procedure is carried out, he should carry out a thorough scrutiny of the debtor’s
individual accounts. Wherever the number of debtors is very large, Test Checks can be applied.
(d) While scrutinizing the ledger, the auditor should focus the light on discounts, returns, cash received,
rebates allowed, goods returned etc.
(e) On ascertaining the balances of the debtors as genuine and correct, the auditor has to verify the
debtors to find out bad or doubtful debts to make a provision for the same.
(f) After ascertaining the position of bad or doubtful debts, he should see that the legal requirements of
Schedule III to the Companies Act, 2013 are complied with. For this purpose, the debtors are to be
classified as : (a) Outstanding for a period of more than six months ; and (b) Other debts.
(g) Over and above this, other requirements like debts considered as good and which are fully secured,
debts due from the officers, directors, managers of the company, etc., are to be ascertained for
disclosure.
(h) If the customers have purchased the goods on hire purchase system and some of the instalments are
not due, the same is not to be shown as `stock out on hire purchase’.
(i) Likewise, if the goods are sold on `return or approval’ basis, such customer cannot be shown as a
debtor at the close of the year.
(j) Further, whenever there are credit balances in some debtors account, the same are not to be deducted
from other debtors debit balances and net balance is not to be shown in the assets side, but former is
to be shown as Sundry Creditors.

(d) Leasehold Property :

Normally the lease or right to use the property is granted for certain number of years. At the expiry of the
period of lease, the rights go back to the original lessor. Various steps involved in the verification of
leasehold rights are stated below.
(a) Inspect the lease agreement to ascertain the amount of premium paid, period of lease, other terms
and conditions, like maintenance, insurance, etc.
(b) See that the lease is properly registered with the Registrar because a lease for a period exceeding
one year is not valid unless it has been granted by a registered document.
(c) Ascertain those conditions, the failure of which might result in the forfeiture or cancellation of lease,
and see whether they have been properly complied with.
(d) See whether sub-lease is valid as per lease agreement, in case if it is granted, by referring to sub-
lease agreement.
(e) See that the premium paid and acquisition expenses of lease are being amortised (written off) over
the period of lease adopting a suitable basis.
(f) In case, any provision is to be made under the dilapidation clause for payment on the expiry of the
term of lease, see that the same is properly and continuously provided.
(g) In case of leasehold land, if any building is constructed by the lessee, see the position and ascertain
the correct method of presentation of such expenditure for disclosure in the Balance Sheet
(e) Plant & Machinery****
(a) Now-a-days as per provision of the Companies Act, 2013 every company is required to maintain a
Fixed Asset Register showing full particulars including cost, location, depreciation, details of purchase,
expenses capitalised, etc. Therefore, the auditor should ask for such a register maintained by the client
and see that all items of plant and machinery are recorded properly giving full details.
(b) As per the provision of the same section, all fixed assets are required to be physically verified by the
management. Therefore, the auditor should enquire whether such physical verification was undertaken
or not. If yes, he should ask for necessary papers pertaining to the same. If there is any discrepancy,
reasons for the same should be asked.
(c) Any new purchase made during the year are to be verified with reference to purchase invoice and other
papers regarding installation of the same.
(d) Total value of plant and machinery as shown by Fixed Asset Register should tally with ledger account
maintained in the financial books.
(e) Where any item of plant and machinery is sold, scrapped or transferred the auditor should check
relevant entries for the same and verify that they are removed from the Fixed Assets Register.
(f) The auditor should verify that adequate depreciation is provided on all items of plant and machinery and
method of depreciation is consistently followed from year to year.
(g) Auditor should see that the entire plant and machinery stands in the name of the client and are free from
any charge or encumbrances. If plant and machinery is mortgaged, then he has to verify that the
documents are properly executed and mention of mortgage is made in the Balance Sheet.
(h) He will ensure that plant & machinery have been disclosed under Non-Current assets as Fixed Assets as
per Schedule III Companies Act, 2013.

(f) Goodwill*
The duty of an auditor regarding verification of goodwill is stated below:
(a) Whenever the company has purchased or acquired a running business and has paid for it an amount, in
excess of the book value of its net assets, the excess is called `Goodwill’. It can be verified from the
vendor’s agreement and the auditor has to see whether there is a specific sum which is paid or whether it
is the excess of price paid over the tangible assets and see that it is properly recorded.
(b) When the company has written up the values of all its assets on a revaluation and has raised a Goodwill
Account in the books, the Goodwill appears in the Balance Sheet. In this case, the auditor has to see the
basis of valuation and get satisfied about the same. If he is not satisfied, the fact should be reported to the
shareholders.
(c) He has to see that such excess is credited to a Capital Reserve or Revaluation Reserve and no dividend
is being declared from it.
(d) He has also to see the disclosure requirement of Schedule VI and ensure that the fact are disclosed for 5
years subsequent to the date of revaluation.
(e) Sometimes, Goodwill which is written off earlier may be brought back in the books of account to adjust
the debit balance of Profit and Loss account. In this case, the auditor should investigate the fact and
satisfy in full before approving such method of creating Goodwill. He should also refer to the board
resolution. In case he is not satisfied, the fact should be reported to the shareholders.
(f) If Goodwill has been created by any other means, the auditor should see that all relevant facts are
properly disclosed and are supported by documentary evidence.
(g) Patent and Trade Mark:**
(a) The ownership of patent rights is verified by inspection of certificate issued for grant of patent, by the
prescribed authority.
(b) If it has been purchased, the agreement surrendering it in favour of the client should be examined.
(c) If there are a number of patents held by the client, obtain a schedule giving the full details thereof or
verify with reference to the register maintained by the client.
(d) It must be verified that patent rights are alive and legally enforceable and renewal fees have been paid on
due dates and charged to Revenue Account. The last renewal receipt should be examined to ascertain
that the patent has not lapsed.
(e) See that the patents are properly registered in the name of the client only.
(f) See that the cost of patent is being written off over its useful period of life.
(g) In case the patent is acquired, cost paid for the same and all relevant expenses are to be capitalized.
(h) If the patent is created by the client by the research experiments and laboratory work, only the actual
expenses incurred for it in the process are to be capitalised.

(h) Copyright:**
(a) The auditor has to examine the written agreement of assignment along with the royalty paid to the
authors etc., for such copyrights.
(b) He has to see that such assignments are properly registered.
(c) If the client is the owner of many copyrights, the auditor should ask the client to prepare a schedule of
copyrights and get the detailed information to confirm that the same is shown in the Balance Sheet.
(d) Regarding the value of copyrights, it should be remembered that this asset has no value in the long run.
Hence, value is determined on revaluation basis and period of copyrights.
(e) If any copyrights does not command the sale of any books, then the same should be written off in such
year. The auditor has to verify the same in detail.

(i) Cash in hand :

(a) Special care is necessary with regard to verification of cash balances. There can be no certainty that the
cash produced for inspection was in fact held by the custodian.
(b) For this reason, the cash should be checked not only on the last day of the year, but also checked again
sometime after the close of the year without giving notice of the auditor’s visit either to the client or to
his staff.
(c) If there is more than one figure for cash balance e.g. when there is a cashier, a petty cashier, a branch
cashier and in addition, there are imprest balance with employees, all of them should be checked
simultaneously, as far as practicable, so that the shortage in one balance is not made good by transfer of
amount from the other.
(d) It is desirable for the cashier to be present while cash is being counted and he should be made to sign the
statement prepared, containing details and the cash balance counted. If he is absent at the time the cash
is being verified, he may subsequently refute the amount of actual cash on hand which may put the
auditor in an embarrassing position.
 (e) If the auditor is unable to check balance on the date of the Balance Sheet, he should arrange with his
client for all the balance to be banked and where this cannot conveniently be done on the eve of the
close of the financial year, it should be deposited the following morning. The practice should also be
adopted in the case of balance at the factory, depot or branch where cash cannot be checked at close of
the year.
(f) Should this not be possible, the auditor should verify the receipts and payments of cash upto the date he
counts the cash. This should be done soon after the cash balances have been counted. The cash book of
the day on which the balance is verified should be signed by the auditor to indicate the stage at which
the cash balance was checked.
(g) If any cheques, or drafts are included in cash balance the total there of should be disclosed.
(h) If there is any rough Cash Book or detail of daily balance are separately kept, the auditor should test
entries from the rough Cash Book with those in the Cash Book, to prove that, entries in the Cash Book
are correct.
(i) If the auditor finds any slip, chit or I.O.U’s in respect of temporary advances paid to the employees,
included as part of the cash balance, he should have them initialed by a responsible official and debited
to appropriate accounts.

(j) Bank Balance:

(a) To verify cash at bank, the auditor should examine the bank pass book and compare it with the balance
as shown by the bank column of the cash book.
(b) Check bank reconciliation statement with bank statement / pass book of subsequent period.
(c) The auditor should get a certificate regarding the balance at the bank directly from the bank.
(d) Ensure that the balance as shown by the cash book is brought into the balance sheet as `Cash and Bank’
and not `Balance as shown by the pass book’.
(e) The auditor should also see that the `cheque outstanding’ and `cheques not yet collected’ are genuine
and not made up in order to conceal the deficiency. If some of these cheques are more than six months
old, he should make inquires, and have them reversed in the books of accounts.
(f) Cash in Fixed deposits with the bank can be verified by examining the deposit receipt, or getting a
certificate from the banker.
(g) If there are more than one bank account such as `Dividend Account’. “Interest Account’ etc. all such
accounts should be checked and the balances should be verified upon the same date. Information
regarding their balance should also be obtained from the bank directly.
(h) If the bank account shows an adverse balance and the client has deposited any security for the overdraft,
the auditor should enquire from the bank the particulars of the security and the amount of the interest
charged.

(k) Secured loan**

Verification of secured loan may be carried out by employing the following procedures:
i. The auditor should examine the Article of Association and Memorandum of Association to
know the power of the company to raise loan and its limit.
ii. He is required to go through the minutes of Board to see whether there is authorization of
raising loan.
iii. The auditor should enquire into the purpose of taking loan and whether the amount of loan has
been utilized for that purpose.
 iv. The loan agreement entered into between the client and borrower should be examined to know
whether terms and conditions are in the interest of the company.
v. The auditor will see whether there is fixed charge or floating charge on assets for taking secured
loan. In case of fixed charge, the particular asset placed as security for loan should be clearly
stated in the balance sheet.
vi. He will verify whether terms and conditions of taking loan have been duly complied with.
vii. The auditor will obtain certificate from lenders to confirm the validity of the amount of loan
standing on the balance sheet data and any outstanding interest thereon.
viii. He will see that secured loan has been properly disclosed in the balance sheet as per Schedule III
of the Companies Act, 2013.

(l) Creditors
(a) The auditor should ask for a schedule of creditors and check the same with the purchase ledger as that is
already examined by him.
(b) He should ensure that all purchase made during the year especially at the end of the year are included in
the accounts of the creditors.
(c) In case of suspicion about any creditors, the auditor with the consent of the client can ask the statement
of account to be sent and verify the same by scrutinizing ledger accounts.
(d) He should see the various debits given for discount, goods returned etc, and confirm that the same are
genuine.
(e) The auditor should ask for the reason for not paying any overdue creditors.

(m) Contingent liability:**

Contingent liabilities are those liabilities which may or may not arise in the future for payment. The auditor’s
duty is to see that all known and unknown liabilities have been brought into the accounts at the date of the
Balance Sheet and have been shown in the Balance Sheet separately as such.
Examples:
(a) Liabilities on Bills Receivable discounted and not matured
(b) Liabilities for calls on partly paid shares :
(c) Liability under a guarantee :
(d) Liability for cases against the company not acknowledged as debts :
(e) Liability in respect of arrears of Dividend on Cumulative preference Shares :
Auditor’s duty :
(a) The auditor should very carefully check the various contingent liabilities named above. There may be
some such liabilities for which no provision has been made in the books but merely a note has been
made at the foot of the Balance Sheet, e.g. Bills Receivable which have been discounted and which have
not matured at the date of the Balance Sheet, arrears of fixed cumulative dividends, etc.
(b) For liabilities in respect of which provision has to be made in the Balance Sheet, viz a suit, etc., the
auditor should examine such cases and ascertain the amount to be specifically reserved for the purpose.
(c) The auditor should examine the Director’s Minute Book, correspondence made with the legal advisers
and the information obtained from the officials of the business.
(d) He has to ensure that proper provision has been made for all such liabilities and if he is not satisfied,
he should mention the fact in his report.
(e) It is to be remembered that the requirements of the Companies Act regarding the contingent liability
should be complied with in the Balance Sheet on the liabilities side.
 Unit V:
Company Audit (Marks 15):
Qualification, Disqualification, Appointment and Rotation, Removal and Resignation, Remuneration, Rights,
Duties and Liabilities of Company Auditor
Branch Audit and Joint Audit
Depreciation – Concept and Provisions of the Companies Act
Divisible Profit and Dividend (Final, Interim and Unclaimed/Unpaid): Provisions of the Act, Legal Decisions and
Auditor’s Responsibility

68. What are the qualifications & disqualifications of an

auditor?*
Qualification
(a) According to Provisions of Section 141(1) of the Companies Act, 2013 “a person shall be eligible for
appointment as an auditor of a company only if he is a chartered accountant within the meaning of
Chartered Accountants Act, 1949 and holds a valid Certificate of Practice.
(b) It has been further provided that the firm shall also considered to appointed by its firm name whereof
majority of partners practising in India are qualified for appointment as auditor of a company.
(c) According to Provisions of Section 141(2) of the Companies Act, 2013, a firm including limited
liability partnership who are chartered accountants shall be authorised to act as auditor and sign on
behalf of the such limited liability partnership or firm.
Disqualification
As per section 141(3), following persons shall not be eligible for appointment as an auditor of a company:
1. A body corporate other than a limited liability partnership registered under the Limited Liability
Partnership Act, 2008;
2. An officer or employee of the company;
3. A person who is a partner, or who is the employment, of an officer or employee of the company;
4. A person who, or his relative or partner—
i. Is holding any security of or interest in the company or its subsidiary, or if its holding or
associate company or a subsidiary of such holding company, of face value exceeding
rupees one lakh;
ii. Is indebted to the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, in excess of rupees five lakhs;
iii. Has given a guarantee or provided any security in connection with the indebtedness of
any third person to the company, or its subsidiary, or its holding or associate company or
a subsidiary of such holding company, in excess of rupees one lakh;
5. a person or a firm who, whether directly or indirectly, has business relationship with the
company, or its subsidiary, or its holding or associate company or subsidiary of such holding
company or associate company of such nature as may be prescribed;
 6. a person whose relative is a director or is in the employment of the company as a director or key
managerial personnel;
7. a person who is in full time employment elsewhere;
8. a person or a partner of a firm who holds appointment as auditor of more than twenty
companies;
9. a person who has been convicted by a court of an offence involving fraud and a period of ten
years has not elapsed from the date of such conviction;
10. a person whose subsidiary or associate company or any form of entity is engaged on the date
of appointment in consulting and specialized services as provided in section 144 of the 2013 Act.
(1) Appointment of 1st auditors [Section 139]:

69. State the provisions of the companies act regarding

the appointment of an auditor? [Section 139]****
Subject to the provisions of this Chapter, every company shall, at the first annual general meeting, appoint an
individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the
conclusion of its sixth annual general meeting and thereafter till the conclusion of every sixth meeting and
the manner and procedure of selection of auditors by the members of the company at such meeting shall be
such as may be prescribed:
(a) Provided that the company shall place the matter relating to such appointment for ratification by
members at every annual general meeting:
(b) Provided further that before such appointment is made, the written consent of the auditor to such
appointment, and a certificate from him or it that the appointment, if made, shall be in accordance
with the conditions as may be prescribed, shall be obtained from the auditor:
(c) Provided also that the certificate shall also indicate whether the auditor satisfies the criteria
provided in section 141:
(d) Provided also that the company shall inform the auditor concerned of his or its appointment, and
also file a notice of such appointment with the Registrar within fifteen days of the meeting in which
the auditor is appointed.

(2) Reappointment of auditors

No listed company or a company belonging to such class or classes of companies as may be prescribed, shall
appoint or re-appoint—
(a) an individual as auditor for more than one term of five consecutive years; and
(b) an audit firm as auditor for more than two terms of five consecutive years:
Provided that—
(a) an individual auditor who has completed his term under clause (a) shall not be eligible for re-
appointment as auditor in the same company for five years from the completion of his term;
(b) an audit firm which has completed its term under clause (b), shall not be eligible for re- appointment
as auditor in the same company for five years from the completion of such term:
(c) Provided further that as on the date of appointment no audit firm having a common partner or
partners to the other audit firm, whose tenure has expired in a company immediately preceding the
financial year, shall be appointed as auditor of the same company for a period of five years:
 (d) Provided also that every company, existing on or before the commencement of this Act which is
required to comply with provisions of this sub-section, shall comply with the requirements of this
sub-section within three years from the date of commencement of this Act:
(e) Provided also that, nothing contained in this sub-section shall prejudice the right of the company to
remove an auditor or the right of the auditor to resign from such office of the company.

(3) Casual vacancy:

Any casual vacancy in the office of an auditor shall—
in the case of a company other than a company whose accounts are subject to audit by an auditor appointed
by the Comptroller and Auditor-General of India, be filled by the Board of Directors within thirty days, but if
such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved
by the company at a general meeting convened within three months of the recommendation of the Board and
he shall hold the office till the conclusion of the next annual general meeting;

70. State the provisions under companies act 2013 regarding

removal of an auditor****
Removal of auditor before expiry of term as per Companies Act, 2013 [sec. 140(1)]
An auditor appointed under section 139 may be removed from his office before the expiry of his term if
following conditions are fulfilled:
i. An application to the Central Government for removal of auditor shall be made;
ii. The application shall be made to the Central Government within thirty days of the resolution
passed by the board;
iii. The company shall hold the general meeting within sixty days of receipt of approval of the
Central Government for passing the special resolution;
iv. The auditor must be given a reasonable opportunity of being heard.

Appointing a new auditor in place of the retiring auditor as per companies act, 2013 [sec.140(4)]
Section 140(4) of the Companies Act, 2013 has laid down following provisions for appointment of new
auditor in place of retiring auditor at an annual general meeting:
i. Special Notice: A special notice has to be given for a resolution at the annual general meeting
for appointing as auditor a person other than a retiring auditor or providing expressly that a
retiring auditor shall not be reappointed.
This provision is not obviously applicable where the retiring auditor has completed a
consecutive tenure of five years or ten years as the case may be.
ii. Intimation to auditor: On receipt of such notice, the company shall forthwith send a copy
thereof to the retiring auditor.
iii. Representation by the auditor: The retiring auditor proposed to be replaced by a new auditor
has right to make a representation to the company against his removal.
The representation shall be in writing with a reasonable length. He may request the company
to circulate the representation to the members of the company.
Removal of auditor by tribunal [sec.140 (5)]
i. Removal for Fraud: The Tribunal may, either suo motu or on an application made to it by the
Central Government or by any person concerned, directs the company to change its auditors if
it is convinced that the auditor has acted fraudulently.
ii. Appointment of New Auditor by Central Government: If the application is made by the
Central Government and the Tribunal makes an order removing the existing auditor for fraud,
the Central Government may appoint another auditor in his place.
iii. Liability of the Auditor being removed: An auditor, whether individual or firm, against
whom final order has been passed by the Tribunal under this section, shall not be eligible not
be appointed as an auditor of any company for a period of five years from the date of passing
of the order and the auditor shall also be liable for action under section 447.

71. How is the remuneration of a company auditor

determined?**
Remuneration of auditors [Section 142]—
1. The remuneration of the auditor of a company shall be fixed in its general meeting or in such manner
as may be determined therein:
Provided that the Board may fix remuneration of the first auditor appointed by it.
2. The remuneration under sub-section (1) shall, in addition to the fee payable to an auditor, include
the expenses, if any, incurred by the auditor in connection with the audit of the company and any
facility extended to him but does not include any remuneration paid to him for any other service
rendered by him at the request of the company.

72. What are the right (Power) and duties of an auditor under
the companies act?**
Rights of an Auditor
1. Right of access to books and vouchers: Section 143(1) of the Companies Act, 2013 states that an
auditor of a company has a right of access at all times to the books, account and vouchers of the
company whether kept at the head office or anywhere else. The term ‘vouchers’ include any
document supporting the transactions in the financial statements. Similarly ‘books’ means financial,
costing, statutory and statistical books.
The right of access ‘at all times’ implies that the auditor can inspect the books and accounts and
vouchers at any time during the tenure of his appointment and during normal business hours. The
proviso to sub-section(1) of section 143 has also, given right to the auditor of a holding company to
have access to the records of all its subsidiaries in connection with consolidation of its financial
statements.
2. Right to obtain information and explanations: As per section 143(1) of the Companies Act,
2013, the auditor can ask for any information and explanation which he consider necessary for the
performance of his duties as auditor.
3. Right to get a report on branch accounts: According to section 143(8) of the Companies Act, 2013,
the branch auditor shall send a report on the account of the branch of the Company’s auditor who
shall deal with it in his report in such a manner as he considers fit.
 4. Right to receive notices and to attend General Meeting: Section 146 of the Act, 2013 has given
right to the auditor to have notice of and to attend every general meeting. He has also right to be
heard in the meeting on matters concerning himself.
5. Right to have audit report read at AGM: As per section 143 of 2013 Act, the auditor has the right
to have the audit report read before the company in the General Meeting and the same shall be open to
inspection by any member of the company.
6. Right to be indemnified: The auditor has right to be indemnified for any expenses incurred by him in
defending himself while the Court’s judgement goes.
7. Right to take legal and technical advice: According to judgement in London and General Bank
(1895) case, an auditor can take legal, expert or technical advice while conducting audit. However,
he must always give his own opinion in the report.
8. Right to remuneration: On completion of the job he is assigned with, the auditor has right to get his
agreed remuneration. If his service is terminated by the client before the expiry of the term, he will be
entitled to remuneration of the full term.
9. Right to sign the audit report: Under Section 145 of Companies Act, 2013 the auditor has right to
sign the audit report and the balance sheet and profit & loss account including the documents
annexed.
10. Right to attend the meetings of Audit Committee: The auditor shall have the right to attend the
meetings of the Audit Committee and right to be heard in the meeting when the Committee considers
the Auditor’s report. But he shall not have right to vote [Sec. 177(7)]

Duties of An Auditor
According to Companies act, 2013, the duties of an auditor may be described as below:
1. Duty to make report on financial statements: According to Sec. 143(2) of the Companies Act,
2013 the statutory auditor is required to submit a report on the accounts audited by him to the
shareholders of the company. It is to be noted that he might have been appointed by directors. But
he is always required to submit his report to shareholders and not to the directors.
2. Duty to make enquiry: The auditor shall also inquire, under section 143(1), into various matters
such as:
i. Whether loans and advances made by the company are properly secured and whether
the terms of loans and advances are against the interest of the company.
ii. Whether the transactions which are merely represented by book entries are prejudicial to
the interest of the company.
iii. Whether shares, debentures and other securities have been sold of a price less than cost
price.
iv. Whether personal expenses have been charged to the revenue A/c.
v. Whether loans and advances made by the company have been shown as deposits.
vi. Whether cash has actually been received in respect of shares allotted for cash as stated in
the books and if no cash has actually been so received, whether the position as stated in
the account books and balance sheet is correct, regular and not misleading.
3. Matters to be stated in the report: According to Sec. 143(3), of Companies Act, 2013 he has to
clearly state in his report that
 i. Whether he has sought and obtained all the information and explanations relating to
the accounts which to the best of his knowledge and belief were necessary for the
purpose of audit.
ii. Whether proper books of account as required by law have been kept by the
company.
iii. Whether proper returns have been received from the branch not visited by him.
iv. Whether the report on the accounts of any branch office of the company audited
by the branch auditor has been sent to him and the manner in which he has dealt
with it in preparing his report.
v. Whether the Company’s balance sheet and profit and loss account dealt within the
report are in agreement with the books of account and returns.
vi. Whether applicable accounting standards have been followed in the preparation and
presentation of financial statements.
vii. Observation or comments on financial transactions or matters which have any
adverse effect on the functioning of the company.
viii. Whether any director is disqualified from being appointed as a direction under sub-
section (2) of section 164.
ix. Any qualification, reservation or adverse remark relating to the maintenance of
accounts and other matters connected therewith.
x. Whether the company has adequate internal financial controls system and whether it
is effective in operation.
4. Reasons for negative remark/Qualification: In case of negative remark or qualification in any
reporting matters, the auditor should state the reasons therefore in his report.
5. Compliance with C & AG direction: In case of a Government Company, the auditor’ report
include:
 The direction, if any issued by the C & AG regarding manner of audit of accounts;
 The action taken on such direction and the impact thereof on the company’s financial
statements=0. [Sec. 143(5)]
6. Duty to intimate the Central Govt. about fraud: If the auditor, in course of audit, comes across
any fraud involving such amount as may be prescribed, he shall immediately report the matter
to the Central Government within such time and in such manner as may be prescribed. In case
of fraud involving lesser than the specified amount, the auditor shall report the matter to the Audit
Committee or the Board within such time and in such manner as may be prescribed. [Sec.143
(12)] as amended by Section 13 of the Companies (Amendment) Act, 2015. Section 13 of the
Amendment Act has not been notified till 31.07.2015.
7. Duty of cost accountant and company secretary: The provisions of section also apply to the
cost auditor conducting cost audit under section 148 of 2013 Act and the Company secretary
conducting secretarial audit under section 204 of 2013 Act. [Sec. 143 (14)]
8. Duty to pay penalty: If the auditor fails in his duty to report any fraud he shall be punishable
with fine which shall not be less than one lakh rupees but which may extend to twenty-five lakh
rupees. [Sec.143(15)]
9. Mandatory Compliance with auditing standard: It is the duty of the company auditor to
comply with auditing standards in course of audit. [Sec. 143(9)]
10. Duty to make comments as sought by Audit Committee: It is obligatory on the part of the
auditor to make comments about internal systems, the scope of audit, including his observation
and review of financial statements, if sought by the Audit Committee. [Section 177(5)].
 73. Discuss the status of an auditor in a company.*
STATUS OF AUDITOR
A company auditor is viewed by different persons in different ways. Shareholders may think him as their
agent while to many others he is an officer of the company. Again many are inclined to consider him as the
employee of the company. Now let us discuss how far it will be justified to treat him as agent of shareholders
or an officer or even an employee of the company.
(A) As an agent of the shareholders:
The auditor is appointed by shareholders barring in few cases when he may be appointed by the Board of
Directors or Central Government. Who ever appoints him, his main objective is to protect the interest of
shareholders in the company. The auditor will see whether the company is being managed by the Board on
behalf of the shareholders efficiently and effectively and whether accounts as prepared by the management reflect
the actual financial position and operating results of the business. Moreover his audit report is always meant for
shareholders. Because of' this role, the auditor is treated by the shareholders as their agent.
However, according to law of Contract, an agent is required to submit accounts to his principle 'On demand'.
In actual practice no such accounts are submitted by auditor as he is not entrusted with the task of
maintaining any property. What the company auditor is required to do is to submit, whether demanded or not,
his report on accounts as prepared by the management to the shareholders.
Again according to the Law of Agency "he who does through another does by himself." It means that any act
of agent will be purported to be the act of principal. But this relationship does not exist between shareholders
and auditors. If the auditor distorts any fact in collusion with directors, this must not be taken as an act of
shareholders. Under the same law, the knowledge of an agent regarding a matter is also taken as the knowledge
of the principal. But so far as company auditor is concerned he is not supposed to intimate the shareholders
any information other than the actual results and financial position through financial statements.
Therefore, a company auditor can not be treated as an agent of shareholders. He can be at best treated as
representative of shareholders under certain circumstances.
(B) As an officer of the company:
There are many legal decisions where a company auditor has been termed as an officer of the company : For
example, the London and General Bank case it was held by Lord Justice Lindley that it seems impossible to
deny that for some purposes, and to some extent, an auditor is an officer of a company. In the famous
Kingston Cotton Mills Co. Ltd. case, it was also held that "auditors are officers of the company."
But an officer is an employee of the company who is entrusted with the task of implementing the plans and
policies of the management. He is bound by the service rules of the company and is required to work as per
directions given to him. Even the may have to surrender to boss wishes and whims which may be against the
interest of the company. But independence in the work of auditor is a well established principle. He needs to be
independent of management in order to make his report reliable to shareholders and other interested parties like
bankers, creditors, employees etc. Therefore, the auditor must work according to his own judgement and
independent thought even though that may not suit the desire of management and may render his assignment
ceased. So to treat the auditor as an officer of the company is contrary to the basic philosophy of audit.
(C) As a servant of the company:
Sometimes an auditor is treated as a servant of the company as he is paid for. But if payment to auditor by the
company makes him a servant of the company, it will create lot of confusion.
Then the doctor who is paid by the patient is to be treated as servant of the client. So it would not be logical to
treat auditor as servant of the company.
An auditor is an independent person rendering professional service to the company in return of fees. He can neither
be an agent of the shareholders nor be an officer of the company, nor is he a servant of company.
74. What are the liabilities of an auditor under the
companies act?**
A. Civil Liability
1. Liability for negligence in relation to prospectus: As per corresponding section 35 of 2013
Act regarding civil liability for misstatement in prospectus, the auditor will be held liable if he as
an “expert” gives written consent to the issue of prospectus which is misleading and where a
person has sustained any loss or damage by subscribing for securities of the company acting on
such prospectus.
2. Liability for misfeasance: As per corresponding section 340 of 2013 Act, Misfeasance means
breach of trust or willful negligence in the performance of duty. The company auditor may be
charged with misfeasance only at the time of liquidation if it appears that he has
 Misapplied or retrained or become liable or accountable for any money or property of
the company, or
 Been guilty of any misfeasance or breach of trust in relation to the company.
B. Criminal Liability
The circumstances in which an auditor may be criminally prosecuted under the Companies Act are:
1. Misstatement in Prospectus [Sec. 34]: As per section 34 of 2013 Act relating to the
criminal liability for misstatement in prospectus, the responsible person shall be liable under
section 447 which stipulates that any person who is found to be guilty of fraud, shall be
punishable with imprisonment for a term which shall not be less than six months but which
may extend to ten years and shall also be liable to fine which shall not be less than the
amount involved in the fraud but which may extend to three times the amount involved in
the fraud. The auditor can escape liability under this section if he proves
 The statement was immaterial;
 He had reasonable grounds to believe that the statement was true.
 He had not authorised the issuance of the prospectus.
2. Fraud and Deception [Sec. 336]: If an auditor destroys, mutilates, alters, falsifies, secretes
or is privy to any manipulation in books of accounts or documents of a company under
winding up, he shall be punishable with an imprisonment for a term which shall not be less
than three years but which may extend to five years and with fine which shall not be less
than one lakh rupees but which extend to three lakh rupees.
3. Penalty for non compliance by auditor any of the provisions of sections 139, 143, 144
and 145 [Section 147]:
a) If the auditor makes any falsification in connection with his appointment u/s 139, default
in discharging powers and duties as imposed u/s 143, renders certain services as
prohibited u/s 144 or fails to sign the audit report or certify any other documents as
required u/s 145, he shall be punishable with a fine which shall not be less that Rs.
25,000 and which may extend to Rs. 5 lakh.
b) If the contravention is willful with the intention to deceive the company or its
shareholders or creditors or tax authorities, he shall be punishable with imprisonment for
a term which may extend to one year and with fine which shall not be less than one lakh
rupees but which may extend to twenty five lakh rupees.
 c) The convicted auditor has to refund remuneration to the company and pay for damages
to the company, statutory bodies or authorities or to any other person for loss
suffered due to misleading audit report.
4. Refusal or failure to produce document [Sec. 217]: In case of refusal or failure to produce
documents or evidence as sought by the inspector appointed by the Central Government to
investigate the affairs of the company, the auditor shall be punishable with an imprisonment
for a term which may extend to six months and shall be liable to fine which shall not be less
than twenty-five thousand rupees but which may extend to one lakh rupees and also with a
further fine which may extend to Rs. 2000 for every day during which the failure continues.
5. False statement [Sec. 448]: If any person, including auditor, deliberately makes a statement
in any return, report, certificate, balance sheet, prospectus, statement or other documents
which is false in any material respect or deliberately omits any material fact, he shall be
punishable with imprisonment for a term which shall not be less than six months but which
may extend to ten years and shall be liable to fine which shall not be less than the amount
involved in the fraud but which may extend to three times the amount involved in the fraud.

75. State the provisions of companies act 2013

regarding declaration & payment of
The important provisions of company law pertaining to dividend are described below:
1. Source of Dividend: As per section 123(1), dividend can be paid out of following sources:
i. Current profit after providing for depreciation;
ii. Past reserves created out of profits of credit balance in the profit and loss account brought
forward after providing for depreciation.
iii. Money provided by the Central Government or a State Government.
2. Mode of payment: Section 123(5) has expressly allowed a company to make payment of dividend
through electronic mode along with the conventional mode of payment by cheque or dividend
warrant as usual.
3. Provision for Depreciation: Section 123(1) has also made it mandatory for the company to make
provision for depreciation before declaration of dividend out of profit.
However, unlike 1956 Act, the new Act has not given any power to the Central Government to
permit declaration of dividend without providing for depreciation.
4. Arrear of Depreciation: The Companies (Declaration and Payment of Dividend) Amendment
Rules, 2014 has stipulated that no company shall declare dividend out of profit unless depreciation
not provided in previous years or years are set off against profit of the company of the current year.
5. Setting the past loss: The Company is required to set off the entire amount of accumulated loss
against the current profit before declaration of dividend as per the Companies (Declaration and
Payment of Dividend) Amendment Rules, 2014.
6. Transfer of profit to Reserve: The Company may before declaration of dividend in any financial
year, transfer such percentage of profit as it may consider appropriate to the reserve of the company.
 7. Use of the past Reserve: As per the second proviso to subsection (1) of Section 123 in the event of
inadequacy or absence of profit in any year, a company may declare dividend out o free reserves
subject to fulfillment of prescribed conditions.
i. Restriction on rate: The rate of dividend shall not exceed the average of the rates at which
dividend was declared by the company in the three preceding years.
The rule has further stated that it will not be applicable to the company which has not
declared any dividend in each of the three preceding financial year.
ii. Restriction on amount: The total amount to be drawn from the past reserve shall not
exceed one-tenth of the sum of its paid-up share capital and free reserve.
iii. First utilization of amount drawn: The amount drawn from the past reserve shall first be
utilized to set off the loss incurred in the financial year before declaration of dividend on
equity shares for that year.
iv. Maintenance of minimum reserve: The balance of reserves after such withdrawal shall not
fall below fifteen percent of paid up share capital.
8. Debenture Redemption Reserve: The Companies (Share Capital and Debentures) Rules, 2014
requires a company which has issued debentures to create a Debenture Redemption Reserve out of
profit available for dividend for an amount not less than 25% of the value of debentures issued.
9. Failure to comply with provisions of acceptance or repayment of deposits: As per Section
123(6) of 2013 Act, if accompany fails to comply with provisions of sections 73 and 74 regarding
acceptance and repayment of deposits, it shall not declare any dividend on equity shares so long such
failure continues.
10. Unclaimed dividend: Section 124(6) of 2013 Act states that all shares in respect of which unpaid or
unclaimed dividend has been transferred to the Investor Education and Protection Fund shall also be
transferred by the company to the fund along with a statement with certain specified details.
11. Deposit in a separate account in a Scheduled Bank: Subsection 4 of section 123 has mandated
that the company shall deposit the amount of dividend including interim dividend in a separate
account in any schedule bank within five days from the date of declaration of such dividend.

76. Can dividend be paid out of Capital? Justify***

Payment of dividend out of capital means return of capital to shareholders in disguise. In other words, a part
of the capital invested by the shareholders is paid back to them in the form of dividend.
The legality of payment of dividend out of capital can be discussed under the following heads:
1. Judicial Announcement: It was decided in the case of Verner Vs. General and Commercial
Investments Trust Ltd. (1894) that dividend cannot be paid out of capital. If the Memorandum of
Articles of Association gives such power, it should be considered as invalid and ultravires.
Consequences of payment of dividend out of capital as upheld in various cases are:
i. The directors who pay dividend knowing fully well that such dividends are paid out of capital
shall be personally liable to make good the losses arising from such payments – London and
General Bank, (1895).
ii. If the members receive dividends knowing fully well that such dividends are being paid out of
capital, they have to indemnify the company to the extent of the amount of dividend received
by them – Moxham V. Grant (1900).
 iii. Liability of the directors for payment of dividend out of capital ceases, when the capital
having been eroded for such payment gets replenished out of subsequent profit – Boaler Vs.
The Watchmaker’s Aliance and Others (1903).
2. Provisions of Companies Act 2013: The Companies Act has not given any mandate that the capital
of a company should remain intact. But the Act has also not permitted a company to return capital to
the shareholders in the form of dividend, Section 123 (1) of the Act has specified following sources
for payment of dividend:
i. Current profits,
ii. Past profits i.e., credit balance in the profit and loss account brought forward,
iii. Fund provided by the Government for the purpose of dividend payment.
iv. Free reserve of the company after fulfilling some conditions as stipulated in the Companies
(Declaration and Payment of Dividend) Rules, 2014.
Accordingly, dividend cannot be paid out of any source other than the above as specified by the law.
If dividend is paid out of capital, the directors would commit an offence under the Act and shall be
liable to make good the amount so paid as dividend to the company.
3. Conclusion: Payment of dividend out of capital leads to reduction of capital. But reduction of share
capital cannot be done without observing some legal formalities as per section 66 of the Companies
Act, 2013.
Payment of dividend out of capital has not been made legally permissible for protecting the interest
of creditors who should have priority over shareholders in respect of getting back capital. Moreover,
allowing that practice would not have been in the interest of growth and survival of the company.

77. What is capital profit? Give example. Can dividend

be paid out of Capital Profit? ****
Payment of dividend out of capital profits
The profit earned by a company may generally be classified into two categories namely (a) revenue profit
and (b) capital profit.
The profit which is earned in the normal course of business is called revenue profit. This profit arises out of
regular business activities in every year.
On the other hand, the profit which does not arise in the normal course of the business is called capital profit.
This profit arises out of some event which does not come under the regular activity of the business.
Transactions of capital nature generally result in such profit. This income is not regular income and arises
only occasionally. The examples of the income are (a) profit on revaluation of fixed assets (b) profit on issue
of shares at a premium (c) profit on redemption of debenture at a discount (d) profit on re – issue of forfeited
shares (e) profit prior to incorporation, etc.
Now whether capital profit can be distributed as dividend may be considered from three different angles,
these are:
1. Legal aspect: According to Section 123(1) of the Companies Act, 2013, dividend can be paid out of
‘profit’. But it is stated nowhere in the Companies Act whether capital profit is available for
distribution of dividend. The capital profit does also belong to the company. So, there is no legal
constraint for payment of dividend out of capital profit. However, the following points may be
noted in this regard.
 i. The capital profit which arises due to issue of shares at the premium cannot be distributed as
dividend as per Sec. 52 of the Companies Act, 2013. In this Section the different uses to
which this profit may be applied have been categorically mentioned.
ii. The profit arising on re – issue of forfeited shares has to be transferred to capital Reserve.
iii. Similarly, the profit earned prior to incorporation cannot be considered as distributable profit
as the company has not been in existence during this period and hence no dividend can be
paid out of the same.
2. Legal Decisions: The issue of payment of dividend out of capital profit was dealt with in two
noteworthy cases i.e. Lubbock V. British Bank of South America (1892) and, Foster V. New
Trinidad Lake Asphalt Co. (1901).
The following conditions are, based on those judgements, required to be fulfilled before
distribution of capital profit as dividend:
 The Articles of Association must authorise such distribution.
 This profit must be realised in cash on actual sale of fixed assets. The profit arising out of
mere revaluation of fixed assets is not available for dividend purpose.
 The capital profit must exist as surplus after revaluation of all assets and liabilities.
 Other capital loss, if any, must be compensated and payment of dividend out of capital profit
must not render the company unable to meet outside liability.
 It must be ensured that payment of dividend does not lead to capital erosion of the business in
any way.
3. Commercial Expediency: The earning of capital profit does not reflect the actual profitability of
the company. It is a kind of windfall gain and is not expected to recur. So, it would not be very
prudent to pay dividend out of capital profit. Rather, this profit should be kept in the business for
adjusting future capital loss, setting off loss on issue of shares and debenture of simply for
strengthening working capital position.

78. Can dividend be paid out of current revenue profit

before writing of depreciation?*****
Payment of dividend out of profit without writing off depreciation on fixed assets
Fixed assets are those assets which are intended to be used in the business over a long period of time. They
are not meant for resale. Now the question whether dividend can be paid out of profit without providing for
depreciation can be discussed under the following heads.
1. Judicial Pronouncements: That depreciation is a charge against profit and should be provided
before declaration of dividend was not recognized by court earlier. Thus, in Wilmer Vs.
Mcnamara& Co. Ltd (1895) case, it was held that making provision for depreciation should be
necessarily be a precondition for declaration of dividend out of current profit. In Crabtree Vs.
Crabtree(1912) case, the learned Judge declared that depreciation must be provided on plant and
machinery only when the manufacturing business is intended to be carried on for an indefinite period
of time. Thus, it implies that depreciation need not be provided on fixed assets like building or
furniture before declaration of dividend out of current profit.
2. Provision of the Companies Act: The section 123(1) of the Act, 2013 has also made it
compulsory to make provision for depreciation before declaration of dividend.
 3. Commercial Prudence: Fixed assets are used in the process of revenue generation. The service
potentiality of the fixed assets is not everlasting, rather it gradually declines while in use. So
proportionate cost of fixed asset corresponding to the service used up in the revenue generation
should be treated as expense to be matched against that revenue for income determination. Unless
the expired cost of fixed asset is considered as depreciation, the profit will be inflated and the true
worth of the business cannot be comprehended from the balance sheet as the fixed assets will remain
overvalued. So, the purpose of financial statements will be defeated. The most dangerous
consequence of non-provisioning of depreciation is the possibility of capital erosion of the business
through payment of dividend out of inflated profit. This is nothing but return of capital to
shareholders unnoticed. The continuity of business is, therefore, threatened. So, it is always prudent
to make provision for depreciation regardless of the fact whether dividend is declared or not.
Whether dividend can be paid out of current profit without setting off past losses can be discussed under the
following three heads.

79. Can dividend be paid out of current revenue profit

before writing of past capital/revenue losses?****
1. Judicial decisions: The question was dealt in various legal cases long back. But in those cases,
somewhat lenient view was taken by the learned Judges. They did not make the writing off past
losses as the precondition for payment of dividend out of profit of current year. Thus, in the case
Ammonia Soda Company Ltd. Vs. Arthur Chamberlian and other, (1918), it was held by the court
that the company might right up its assets as a result of a bonafide revaluation and might divide
current profits without making good past losses. The same view was expressed by the learned Judge
during the course of his judgment in Stapley Vs. Read Bros. Ltd (1924)
2. Provisions of the Companies Act: As per fourth proviso of sub – section (1) of section 123 of the
Companies Act, 2013 as inserted by Sec. 10 of the Companies (Amendment) Act, 2015 notified on
29th May, 2015, no company shall declare dividend unless carried over previous losses and
depreciation not provided in the previous year or years are set off against profit of the company for
the current year.
3. Business prudence: The existence of debit balance in the profit and loss account means that capital
of the business has already eroded by that extent. So, if a company which suffers from instability in
profit earning distributes its current year’s profit regularly without setting off past losses completely,
the chance of wiping out of net-worth and consequently liquidation of the business cannot be ruled
out. Therefore, it is advisable to set off the entire amount of past loss and not just the loss caused by
depreciation before distribution of dividend out of current year’s profit.
 80. What are the duties of an auditor relating to the
payment of dividend by a company?
The auditor of a company has a proper duty as regards declaration and payment of dividend. The following
are the important duties in this regard:
(a) Verification of the sources of dividend: The auditor is required to verify the sources of dividend
available for distribution. In this respect, Sections 205 and 350 of the Companies Act, 1956 and as
amended in 1960, 1974 and 1988 states that properly determined profits of the company or the amount
drawn from past reserves or any money received as guarantee for payment of dividend either from
Central Government or State Government will be available for this purpose.
(b) Examination of various documents: He should examine the documents of the company to
ascertain the rights and privileges of the various categories of shareholders and should see that the
rates of dividend are in accordance with those rights.
(c) Review of the Minute Books: He should review the Minute Books of the Directors as well as of
shareholders to know the decisions taken at the respective meetings relating to declaration of
dividend. He should confirm that the rates of dividend do not exceed the limits fixed by statute.
Moreover, he should examine the recommendations made by the shareholders in respect of rate of
dividend and subsequent approval of shareholders in general meeting.
(d) Verification of the rate of dividend: He should examine whether the account showing total
amount payable as dividend has been correctly shown calculated on the basis of paid-up capital and
the rate of dividend has been correctly determined.
(e) Determination of net dividend payable: If the dividend is not tax-free, then different types of
taxes are to be deducted at source. So before payment of dividend, income tax and other taxes
payable on the account should be deducted. The auditor should confirm that these are duly
complied with.
(f) Verification of Dividend Register: He should check the Dividend List with the help of Register of
Members in order to ascertain that the total amount of dividend payable has been correctly
calculated.
(g) Examination of Bank Account: If a separate Bank Account is opened for the purpose of dividend
payment, then the auditor has to verify whether an adequate amount of money has been transferred
from General Bank Account to this Specific Bank Account. Then, he should check the Bank Pass
Book of the Dividend Account with the Dividend warrants which have been returned and duly
cancelled.
(h) Examination of Dividend Payment: He must ensure that dividend has been paid or the dividend
warrant has been posted within 42 days from the date of declaration.
(i) Verification of Unclaimed Dividend : He should ensure that dividend remaining unpaid has been
duly transferred to a special account known as 'unpaid dividend account' within seven days after
expiry of forty-two days as is required by Section 205(A) of the Act. He should also confirm that
the unclaimed dividend has been shown as a liability in the Balance Sheet.
(j) Examination of the Unpaid Dividend Account: The amount of dividend not claimed by the
shareholders should be verified with the amount remaining unpaid in the bank account.
(k) Verification of the Payment to Real Claimant: After opening an unpaid dividend account if a
shareholder claims for payment of dividend, the auditor should ensure that payment out of
unclaimed dividend account has been made to the right person.
(l) Examination of Deposit into General Revenue Account: Where any amount remains unpaid or
unclaimed for a period of 3 years after transfer to Unpaid Dividend Account, such amount has to be
finally transferred to the General Revenue Account of the Central Government. Such transfer should be
verified with the list submitted to Government and the receipt of the Reserve Bank for the amount.
(m) Verification of compliance of the rules contained in Table A: the company does not have its own
Articles of Association, it should follow the different clauses contained in Table-A of Schedule I to the
Act and the auditor should ensure that the rules have been duly complied with.
 81. What is meant by interim dividend? What could be
the duty of an auditor in connection with such
The dividend which is paid by the company before the accounts for the year is prepared, audited and adopted
in the annual general meeting is called interim dividend. It is paid in between two annual general meeting.
As per Sub – section (35) of Section 2 of the Companies Act, 2013, interim dividend is part of dividend and
accordingly all provisions relating to ‘dividends’ is now applicable to interim dividend also. Hence, the
depreciation for the full year has to be provided before declaring interim dividend. Moreover, the provisions
relating to transfer of profit to reserve, also apply to interim dividend. The decision to pay interim dividend is
taken by the Board subject to authorisation of Articles when it becomes sure about the adequacy of profit for
the whole year.
It is to be noted that the interim dividend, being part of dividend as per the Companies Act, will be
considered as debt and thus ‘not revocable’ except when its distribution would amount to capital reduction.
The amount of interim dividend must be deposited in separate bank accounts within five days from the date
of its declaration.
Section 123(3) of the Companies Act, 2013 has permitted the Board of Directors of a company to declare
interim dividend during any financial year out of the surplus in the profit and loss account and out of the
profits of the financial year in which such interim dividend is sought to be declared.
The proviso to subsection 3 specifically states that in case the company has incurred loss during the current
financial year, up to the end of the last quarter before the date of declaration of the interim dividend, then the
rate of interim dividend shall not exceed the average rate of dividends declared by the company during the
last three financial years.
Factors to be considered in a decision on interim Dividend
Interim dividend is declared and paid before the end of accounting year. The management is then yet to
know the results of operations of the business. Therefore, a great deal of care and caution should be taken by
the management before taking such decision. It has to be ensured that payment of such dividend does not go
against the interest of the company. So following points are to be considered in this connection:
i. Whether profit earned till date from the beginning of accounting year is sufficient to justify the
payment of interim dividend. For this purpose up – to date interim accounts, should be prepared and
got audited by the auditor. It should be noted that in pursuance of Sec. 123(1), depreciation for the
full year should be charged and some percentage of profit as deemed necessary should be transferred
to reserve before distributing dividend.
ii. What is the expected amount of profit to be earned during the rest of the accounting year? Any
possible occurrence of events affecting the future profitability should be considered.
iii. Whether all contingent liabilities have been duly considered.
iv. Whether any asset is required to be revalued.
v. Whether the payment of interim dividend will have any adverse effect on the working capital
position. For this the project cash flow should be prepared for the year.
vi. What were the rates of interim dividend and final dividend during the last few years?
vii. What is shareholders’ expectation from the management regarding rate of interim dividend and
what will be the possible effect on the share price, if their expectation is not fulfilled?
viii. What should be the final rate of dividend? This point should be considered because rate of interim
dividend should always be kept lower than final rate of dividend.
 82. What is meant by unclaimed/unpaid dividend? What
could be the duty of an auditor in connection with such
Unclaimed dividend means any dividend the warrant in respect thereof has not been encashed or which has
otherwise not been claimed. Once dividend is declared by the company, it becomes the liability of the
company and the dividend warrant should be dispatched by it within thirty days of such declaration. But very
often the shareholders fail to encash the warrant on time after receiving the same. Such dividend yet to be
claims by the shareholders is known as unclaimed dividend.
Unclaimed dividend needs to be distinguished from unpaid dividend. Unpaid dividend is the dividend in
respect of which dividend warrant has not been dispatched by the company within 30 days from the date of
declaration of the dividend.
AUDITOR’S DUTY REGARDING UNPAID/UNCLAIMED DIVIDEND
The duties of auditor regarding unpaid/unclaimed dividend are as follows:
1. Enquiry: If the dividend remains unpaid due to default of the company to dispatch cheque or
dividend warrant, he will enquire into the reasons of such failure.
2. Obtaining list: The auditor will obtain a statement from the company showing the names of
shareholders, number of shares held by each and the amount of unpaid or unclaimed dividend to
be paid to each person.
3. Examination of amount: The amount shown as unpaid dividend should be vouched with reference
to members’ register, dividend register, bank pass book, returned cheque or dividend warrant, etc. he
will ensure that amount shown in unpaid dividend account has been correctly ascertained.
4. Deposit in a scheduled bank: The auditor will see whether the amount of unpaid or unclaimed
dividend has been transferred to a special account in any schedule bank called “Unpaid Dividend
Account” within seven days after the expiry of thirty days from the date of declaration of dividend.
He will apprise the management of the consequence of failure to make such deposit.
5. Examination of interest and fine: If the company fails to transfer the unpaid dividend to a special
account in a scheduled bank, he will see whether correct amount of interest and fine have been paid
by the company. If they are not yet paid, the auditor will see whether they have been provided in
accounts.
6. Disclosure: The auditor will ensure that unpaid dividend has been disclosed in the balance sheet
under the head “Other current Liabilities” or “Other Non-current Liabilities” depending upon
whether they have remained unpaid for a period up to one year or more.
7. Transfer to Government fund: The auditor will see whether the money transferred to Unpaid
Dividend Account and remaining unpaid or unclaimed for a period of seven years from the date of
such transfer, has been deposited along with interest accrued into investment. Education and
Protection Fund set up by the Central Government. Simultaneously, he will ensure that Unpaid
Dividend Account has been debited in the book of the company.
 83. “Information and means of information are by no
means equivalent terms”:-Explain
The above remark is a part of the judgement given by Mr. L. J. Lindley as regards the liability of auditor in the
case of London and General Bank Ltd. The learned judge made his comments that a person whose duty is to
convey information to others does not discharge that duty by simply giving them so much information as is
calculated to induce them or some of them to ask for more. Information and means of information are by no
means equivalent terms.
An auditor conducts his work as an agent of the shareholders of a joint stock company. Hence, if any suspicion
arises in his mind as regards accounts and if he does not get adequate explanation from the officers of the
company in order to remove the suspicion, then the auditor must bring this fact to the shareholders. It would
not be enough for him to inform his suspicion to the directors and officers of the company since he is not
regarded as an agent of the directors. Therefore, it is the duty of the auditor to inform the shareholders clearly
of the necessary information.
As per provisions of the Companies Act, the auditor has a duty to present information correctly to the owners
about the financial position of the business. The facts or information are to be presented in the report in
unambiguous language so that nobody will face any difficulty to make it out. He should never present such an
information to the shareholders that will arouse inquiry. As such, if it is found that the auditor mentions such
information in his report that the readers, in order to understand its significance, are required to get more
information, then it appears that the auditor does not discharge his duties properly. In other words, he cannot
discharge his duty by supplying the source of information. If he does so, he will do at his peril and runs the
very serious risk of being held judiciously.
The fact of the case was that the Bank had advanced large sums to the customers by way of loans and
overdrafts on current accounts but the security lodged for them was quite insufficient. The interest on loans
was duly brought into credit in the books but as a matter of fact, the interests were never realised. This resulted
into heavy losses to the bank and its consequent liquidation. The auditor of the Bank was fully aware of the
insufficiency of proper security and that adequate provisions were not made in respect of doubtful debts. The
auditor, however, had brought this fact to the notice of directors who refused to alter the accounts. In his report
he merely stated, "The value of the assets shown by the Balance Sheet is dependent upon realisation." From
such type of remark nothing can be known properly in respect of the assets of the business. It can only arouse
curiosity to know more information. In fact, the auditor should have to mention in his report clearly as to
whether that specific asset could be realised at all or not.
So, the auditor was held guilty for misfeasance for not disclosing the material fact to the shareholders that he
was not satisfied with the accounts of the company.
As regards the liability of an auditor, there is no difference of opinion between the legal experts and
professional experts. There is no doubt that the auditor should be cautious and careful in respect of his duty.
He must state in his report all material facts and information relating to accounts. If any suspicion arises and
difference of opinion is found between him and the officers in respect of information as disclosed in accounts,
he will never hesitate to state unambiguously the fact in his report.
 84. "The auditor of a limited company is always liable to any
person who relies on his report and suffers any loss
thereby."
— Do you agree with the statement? Discuss fully with
A question arises as to whether the auditor can be held liable to any third party who relies on his report and
suffers any loss thereby. It is argued that there is no privity of contract between the auditor and the third party
and so, the auditor has no duty to such a third party and hence he cannot be held liable. This question may be
taken up from two points — (i) whether he has any liability to a third party for negligence of duty and (ii)
whether he has any liability for committing fraud.
(a) Liability for negligence: The auditor has a contractual relationship with his client. A contract is made
between the auditor and his client to perform a specific function. The auditor should perform this function with
reasonable care, skill and honesty. But while performing his duty, if he shows any negligence and his client
suffers thereby, the auditor can be held liable. And as he has no contract with the third party, he owes no duty
to such third party and so, he
Again, if a misleading statement had been made in the Prospectus issued by a company and if the auditor had
authorised the issue of such a prospectus, he can be held liable for damages to third party which had purchased
shares of the company on the basis of such a misleading statement even though there might not have been
privity of contract between the two. The Institute of Chartered Accountants in England and Wales also feels
that the auditor may be held liable to third parties in limited sense.
(b) Liability for frauds: The third parties can, however, hold liable in case there has been any fraud on the
part of the auditor. Even if there is no contractual obligation between the auditor and die third parties, the latter
can sue the auditor if his report is of such a nature as amounts to fraud. Though the action for negligence
cannot be brought against him, but sometimes the negligence may amount to fraud and he may be sued for
that.
Lastly, it may be pointed out that though he has no liability to the third party, he cannot deny that he has a
moral responsibility. As such, considering the concern of the third parties, the auditor has a duty to perform his
function in respect of examination of accounts with reasonable care and skill.
(i) London Oil Storage Co. Ltd. vs. Seear Hasluck & Co. (1904): From the facts of the case, it is known
that in view of not verifying petty cash in hand an action was brought against the auditor. It was held that if the
auditor fails to verify the various assets shown in the Balance Sheet, he shall be held liable for negligence of
duty. The auditor shall be responsible for the loss suffered by the company.
(ii) Arthur E. Green & Co. vs. The Central Advance and Discount Corporation Ltd. (1920): It was found
in the case that unrealised debt has been shown as asset in the Balance Sheet. No proper provision was made
for such unrealised debts. The auditor did not verify this and report to the shareholders. The position of
unrealised debt was such that for verification of Sundry Debtors Account, an intense probe was required.
Without doing it, he accepted the statement given by the directors. For this, he showed his negligence to the
company and its shareholders.
In view of the above discussions, it can be concluded that it is the fundamental duty of an auditor to verity
thoroughly the different accounts with reasonable care and skill. After thorough verification by means of
vouchers, documents, statements, etc. with reasonable care and skill, if any fraud remains undetected, the
auditor could not be held liable. Otherwise, it can be certainly said that he would be held liable.
 85. "An auditor has no liability for negligence in the
conduct of an honorary audit". Comment*
Whenever an auditor enters into an agreement with his client for conducting audit of accounts, he owes a
duty to him to exercise reasonable skill and care in his work. If he fails in his duty, he will be held liable for
damage caused to his client for such failure. The situation will not change even if the auditor undertakes his
assignment without any fees. He is supposed to exercise the same degree of professional skill and care as is
expected of him under the given circumstances. The fact that he is an honorary auditor will not permit him to
be careless and negligent in his work. He is as much responsible for negligence or misfeasance as a paid
auditor. Even he can not escape his liability on the plea that the contract is null and void as there is no
consideration received by him from the client. If he desires to be free from liability, he should not undertake
the job. But once a job is under-taken and audit report is submitted, the honorary auditor will be as much
responsible as the paid auditor. This was held in the case Fairdeal Corporation Vs. K. Gopalkrishan Rao
(1957).

86. Outline the provisions of the Companies Act relating

to branch audit.***
Section 228 governs the audit of branch offices. Provisions of this section are as follows:
1. Appointment [Sec. 228(1)]: The following persons are eligible for appointment as branch auditors –
In case of local branches:
(a) The company’s Auditor u/s 224, or
(b) A person qualified for appointment as an auditor u/s 226.
In case of Foreign Branches:
(a) Apart from persons eligible to audit local branches, an accountant duly qualified to act as an auditor
in accordance with the laws of the foreign country in which the branch office is situated can conduct
audit.
In the 2013 Act, no separate section has been introduced for audit accounts of branch office. Section 143
which deals with powers and duties of auditors and auditing standards also covers branch audit.
Subsection 8 of the section 143 has made no change in the requirement of appointment of branch auditor.
Thus, the company auditor appointed u/s 139 or any other person qualified for appointment under section
141 can be appointed as branch auditor.
2. Appointment of persons other than company auditor as Branch Auditor [Sec. 228(3) (a) ]:
(a) General Meeting: The decision to appoint any person other than the Company Auditor as Branch
Auditor should be taken at a General Meeting.
(b) Authorization to Board: The General Meeting may authorize the Board of Directors to appoint
such an auditor in consultation with Company’s Auditor.
Subsection 8 of section 143 of the 2013 Act requires that the branch auditor not being the company auditor
will be appointed in the same way as company auditor is appointed u/s 139. Thus, the new Act has not made
any provision for authorization to Board for appointment of branch auditor.
3. Rights, Powers and Duties of Branch Auditor [Sec. 228(3)]:
(a) Auditor’s Powers: He will exercise the same powers and duties in respect of branch office audit as
enjoyed by the company’s statutory auditor in respect of the company’s audit.
(b) Reporting: He will prepare a report on the accounts of branch examined by him and forward the
same to the company’s Auditor who shall deal with it in the manner required to prepare or finalise
his report.
 (c) Remuneration: He is entitled to receive such remuneration as the company in General Meeting or
the Board may fix.
As per the Companies (Audit and Auditors) Rules, 2014, the branch auditor will have same rights and duties
as applicable to statutory auditor under subsections (1) to (4) of Sec. 143 of 2013 Act. Additionally, the
branch auditor, as per this Rules, shall be responsible for reporting of fraud to the Central Government to
the extent it relates to the concerned branch.
4. Rights of Company Auditor [Sec. 228(2)]:
The Company Auditor shall have the following rights when the Branch accounts are audited by another
auditor:
(a) To visit Branch office, if deemed necessary for the performance of his duties, and
(b) To have access at all time to the books, accounts and vouchers maintained at the Branch Office.
(c) To have access to such copies of and extracts from the books and accounts of foreign branches of
banking companies as have been transmitted to the head office in India.
Neither section 143(8) of the Act, 2013 nor the Companies (Audit and Auditors) Rules, 2014 has given the
Company auditor the right to visit the Branch office and to have access to the books, accounts and vouchers
maintained at the branch office. As per section 143(8), the company auditor shall deal with the report sent
by the branch auditor in such manner as he considers necessary.
5. Exemption from audit of branch [Sec. 228(4)]:
The Central Government is empowered to make rules to exempt Branch offices from audit. The
Companies (Branch Audit Exemption) Rule, 1961 provides that a branch office is exempted from audit if
it satisfies the following conditions –
(a) The company carries on any manufacturing, processing or trading activity;
(b) The Branch office should have an “average quantum of activity” that does not exceed the higher of
the following two
1. Rs. 2, 00,000
2. 2% of the average of the total turnover of the company;

87. What is Joint Audit? Discuss in brief.**

When more than one Firm/Individual are appointed to conduct a statutory audit, it is called Joint Audit. In
other words joint audit implies statutory audit of a firm conducted by more than one statutory auditor. It is
the usual practice of big companies and corporations with divergent and widespread activities to appoint
several Chartered Accountants as joint auditors. Joint audit ensures pooling together the resources and
expertise of more than one firm of auditors in conducting audit which is otherwise very difficult or
impracticable for a single firm. The Companies Act, 1956, is silent about joint audit. However, SA 299,
“Responsibility of Joint Auditors”, has laid down principles in respect of joint audit.
Advantages of Joint Audit:
1. Joint audit ensures pooling and sharing of expertise of two or more auditors.
2. The quality of performance in joint audit becomes much better.
3. The joint auditors can mutually consult in respect of critical issues in the course of audit. So, the audit
becomes more effective.
4. It reduces workload of the auditors.
5. The client is assured of the improved performance from joint auditors.
6. In respect of multi-national companies, the audit work can be spread using the expertise of local firms
which are in a better position to deal with detailed work and the local laws and regulations.
7. The audit can be carried out with much lower costs.
8. A sense of healthy competition is developed among joint auditors for better performance.
Disadvantages of Joint Audit:
1. There may arise co-ordination problems between auditors in conduct of work.
2. Joint audit may lead to psychological problem when firms of different standing are involved.
3. The superiority complexes of some auditors may invite problems in the conduct of audit.
4. There may be lack of clear definition of responsibility in joint audit.
5. Areas of common concern may be neglected.
6. Uncertainty about the liability for the work done may crop up.
7. The fees are to be shared by the joint auditors.
8. Difference of opinion among the joint auditor may cause delay in submission of audit report.
Principles to be followed in joint audit
The SA299, “Responsibility of Joint Auditors”, as issued by ICAI has laid down following principles in
respect of joint audit:
A. Division of work among the joint auditors
1. Manner of division: The joint auditor should, by mutual discussion, divide the work among
themselves.
2. Common areas: Certain areas which cannot be logically divided would be covered by all joint
auditors.
3. Documentation: The division of work among Joint Auditors as well as the areas of work to be
covered by all of them should be properly documented and preferably communicated to the
entity.
B. Co-ordination
When a Joint auditor comes across matters which are relevant to the areas of responsibility of other joint
auditors and should deserve their attention, he should communicate the same to all other joint auditors in
writing.
C. Responsibility of the Joint Auditor
i. In respect of audit work divided among the joint auditors, each joint auditor is responsible
only for the work allocated to him.
ii. Proper execution of audit procedure is the separate and specific responsibility of the joint
auditor concerned.
iii. When the audit work is not divided among the joint auditors and is carried out by all, the
joint auditors are jointly and severally responsible.
iv. When some decision in respect of audit is taken by all the joint auditors, they will be all
jointly and severally responsible for the appropriateness of that decision.
v. All the joint auditors are jointly and severally responsible for examining that the financial
statements of the entity comply with the disclosure requirements of the relevant statute.
D. Reliance on other joint auditor’s work
Each joint auditor is entitle to rely upon the other joint auditors for bringing to his notice any
departure from generally accepted accounting principles or any material error notice in the course of
audit.
E. Reporting Responsibilities
Normally, the joint auditors are able to submit one audit report agreed and signed by all. Where
the joint auditors are in disagreement with regard to any matters to be covered by the report, each
one of them should express his own opinion through a separate report. A joint auditor is not bound
by majority view.
 Unit VI:
Audit Report and Certificate ((Marks 10)
Definition – Distinction between Report and Certificate- Different Types of
Report Contents of Audit Report (As per Companies Act and Standards on
Auditing) True and Fair View – Concept
Materiality – Concept and Relevance

88. Define auditor’s report & auditor’s certificate.*

Auditor’s Report
The audit report is a document through which the auditor conveys his opinion on the financial statements of
the entity. It provides the auditor’s evaluation about accounts maintained in the organization and lets the
members know his opinion on the reliability and fairness of financial statements.
The audit report is the end product of audit work. After completing the audit of organization’s financial
statements, the auditor prepares his report where he expresses his opinion about the validity and reliability of
financial statements. The audit report should be clear, unambiguous and specific. As it was held by Lord
Justice Lindley in London and General Bank case (1895) an auditor who gives the shareholders “the means
of information” and not information does so at his peril and runs the serious risk of being held judicially to
have failed to discharge his duty. Thus, the audit report must state categorically whether financial statements
have been prepared in accordance with an acceptable financial reporting framework applicable to the entity
and in compliance with the relevant statutory requirements and whether they reflect a true and fair view
about the entity.
The auditor can also express any reservation or give additional information that he thinks necessary to give
in his report. For example, if the auditor disagrees with the organization about the valuation of an asset and
he believe that this has a substantial impact on the financial statements, he should state that in his report.
While preparing the audit report, the auditor should keep in mind what information it should contain. SA
700, Forming an opinion and Reporting on Financial Statements issued by the Institute of Chartered
Accountants of India has stipulated some basic elements to be included in the auditor’s report. So, the auditor
must prepare his report in this standard framework.

Auditor's Certificate
The document through which the auditor confirms certain facts or vouchsafes the accuracy of certain figures
is called auditor’s certificate. It does not contain any opinion of the auditor. Rather, it gives guarantee of
absolute accuracy and correctness of the information contained in it. For example, an auditor may certify the
daily circulation figure of a newspaper or consumption quantity imported steel. In order to certify the facts
he goes through all the documentary evidence made available to him. After minutely examining the
documents when he becomes certain about the correctness of the figures or information, he certifies it.
 89. Distinguish between ‘Auditor’s report’ and
‘Auditor’s certificate’.*********

Point of Distinction Audit Report Audit Certificate

1. Meaning An audit report is an expression of A certificate is a written
opinion made by the auditor on the confirmation of the accuracy of
“true and fair view” of financial the facts stated therein and does
statements. not involve any estimate or
opinion. It vouch safes certain
facts or matters.
2. Scope The audit report covers the entire The certificate is sought for some
financial matters of the entity for a specific matters like raw-material
particular accounting period. The consumption, stock valuation,
scope of audit report is statutorily value of import, work load
determined and vast. distribution etc. The certificate
may not be made for an
accounting period.
Nature Audit report is an independent and In certification the auditor has to
unbiased opinion expressed by the verify certain exact facts. As he is
auditor on the reliability and fairness concerned primarily with
of financial statements. He has to arithmetical accuracy, there is
consider numerous professional very limited scope to apply logic
pronouncements and apply logic and and judgement.
judgement on several subjective
issues concerning economic matters
of the entity to arrive at his
conclusion.
3. Responsibility The auditor may not be held Certification gives guarantee
responsible for what has been opined about the correctness or otherwise
by him in his exercised reasonable of the statement. The auditor will
skill and care in his audit work. be held responsible if there is any
mistake in the
certification.
4. Parties Concerned Audit report is meant for all the Certificate is usually sought by
stakeholders of the entity namely external parties namely
shareholders, management, bankers, Government and loan providers.
creditors, Government etc.
5. Criticism The audit report may contain In certification, the auditor has to
criticisms as well as suggestions of state categorically whether the
the auditor. statement is true or false. Here,
neither any suggestion nor
criticism is made.
6. Time of Submission Generally, audit report is submitted A certificate is submitted as and
by the auditor after the expiry of when required.
financial year.
 90. What are the characteristics of a good audit report?
A good audit report should have following characteristics:
(a) Simplicity: Simplicity is considered as one of the characteristics of an audit report. The language used
in the report should be clear and understandable so that concerned parties cannot face any difficulty to
comprehend it.
(b) Information based: The audit report should be based on factual information and not on any guesswork
or presumption. If any information is not available to him, he will state the fact clearly.
(c) Firmness: The scope of the work i.e. types of work done by the auditor should be clearly mentioned in
the report. Moreover, the auditor should clearly state whether the books of account exhibit a true and
fair view of the state of affairs of the business.
(d) Unambiguous: The report should be clear-cut and precise. It should always avoid any word with
double-meaning.
(e) Unbiased: The opinion expressed by the auditor in the audit report should be free from influence of any
quarter.
(f) Logic based : His assertion regarding any matter should be based on logic and not on mere hypothesis
(g) Objectivity: It is needless to say that the report should be based on objective evidence. Opinions
formed on the basis of information and evidence not measurable in terms of money should not be placed
in the audit report.
(h) Relevant: The report should disclose all relevant informations which are supposed to be known by the
users but are not contained in the financial statements disclosures.
(i) Consistency: Consistency in presenting accounting information should be observed. An audit report will
be considered good if it takes into consideration as to the consistency in adopting the method of
valuation of assets.
(j) Mention of condition: If the report is a qualified one, the reasons for qualifications should be
clearly expressed in the audit report.
(k) Accepted principles: The audit report should be based upon the facts and figures that are kept in
accordance with generally accepted principles of accounting.
(l) Pointing mistakes: The report should highlight all material misstatements appearing in the financial
statements,
(m) Brief: The audit report should be brief and to the point. However, conciseness should not be at the cost
of clarity.
(n) Critical and not reprimanding : The auditor should critically refer to the weak areas of the
organisation, but such criticism should be always constructive and not reprimanding in tone,
(o) Addressee: The report should address the person or persons who appointed him to conduct the audit. In
case of company, however, the report should always be addressed to shareholders even when he might
be appointed by Board of Directors.
(p) Signature, address and date: The report should be signed by the auditor with date stating the location of
his office.
 91. What are the different types of audit report?*******
Based on the opinion expressed by the auditor, the auditor’s may be of two types namely:
i. Clean or unmodified audit report, and
ii. Modified audit report
Modified audit report may be of following types—
 Qualified audit report
 Adverse audit report
 Disclaimer of opinion report
 Audit report with an ‘Emphasis of matter’ paragraph and ‘other matter’ paragraph.
There is another type of audit report namely partial or piecemeal audit report which is, however,
very uncommon.

1. Clean or Unqualified Report:

When an auditor gives his positive opinion in his report about the reliability and fairness of financial
statements without any reservation, his report is called clean or unqualified report. It is generally written as
‘in our opinion and to the best of our information and according to the explanations given to us, the balance
sheet, profit and loss account and cash flow statement give a true and fair view of the state of affairs,
working results and cash flows…’ An auditor makes a clean or unqualified report when he is satisfied with
various matters such as,
i. He has got reasonable evidence in support of all material transactions;
ii. All entries have been passed according to generally accepted accounting principles and
relevant accounting standard;
iii. The financial statements correspond to the books of accounts;
iv. The accounting estimates made by management are reasonable;
v. The information presented in the financial statements is relevant, reliable, comparable and
understandable;
vi. All relevant information have been disclosed.

2. Qualified Audit Report:

When an auditor expresses is opinion in his audit report subject to some reservations he is said to have
qualified his report. In other words, his assertions in the qualified report regarding fairness of financial
statements depend upon some conditions. As for example, if the auditor does not agree with his client
regarding treatment of an item such as subsidy or gratuity, he may qualify the report stating ‘subject to the
above, we report balance sheet shows a true and fair view…’While qualifying his report, the auditor should
keep in mind the materiality of the matter. Unless the amount is significant, the auditor need not qualify his
report. The reason of qualification should always be clearly stated in the report under the heading “Basis for
Qualified opinion”. When the auditor gives qualified opinion, he should use the heading “Qualified opinion”
for the opinion paragraph. “Basis for Qualified opinon’ and “Qualified opinion” paragraphs should be in
italics under Sec. 227(3)(e) of the Companies Act.
|3. Adverse Report:
An adverse report is the report in which the auditor categorically states that profit and loss account and
balance sheet do not exhibit a true and fair view of the state of affairs and working results of the company.
Generally extreme cases like non-provision or under provision of depreciation, taking fictitious sales etc.
compel the auditor to give negative or adverse report. An adverse report should be given by the auditor, only
when he has strong and convincing evidence to support his conclusion. He should disclose all the reasons of
adverse report.
4. Report with Disclaimer:
Very often it may not be possible for a statutory auditor to collect all informations which are necessary for
expressing an opinion on the financial statements. This situation may arise because of incomplete accounts
submitted by the client or reluctance of client to furnish requisite informations or explanations as sought by
him. When the auditor is to submit such inconclusive audit report because of reasons beyond his control,
such report is called a report with disclaimer. When the auditor is to submit a report with disclaimer he
should give the justification for such disclaimer in his report.
5. Compartmental or Piecemeal Opinion or Report:
When the auditors fails to report on the working results and the state of affairs of the entity in totality and
consequently restricts his opinion to certain matters only, it is called piecemeal audit report. For example, an
auditor may be unable to give an opinion on whether the accounts of the entire concern are true and fair, but
he may be able to give an opinion that the branch accounts are true and fair on the basis of the branch audit
reports. The reason of giving such partial report should be indicated in the audit report.

92. Discuss the elements of auditor’s report as specified

by Standard on Auditing.**
According to SA 700 (revised), “Forming an opinion on the Financial Statements”, the auditor’s report shall
be in writing. It has mentioned the following elements of Audit Report.
1. Title: The auditor’s report shall have a title that clearly indicates that it is the report of an
independent auditor.
2. Addressee: The auditor’s report shall be addressed as required by the circumstances of the
engagement.
3. Introductory paragraph: The introductory paragraph in the auditor’s report shall:
i. Identify the entity whose financial statements have been audited;
ii. State that the financial statements have been audited;
iii. Identify the title of each statement but comprises the financial statements;
iv. Refer to the summary of significant accounting policies and other explanatory information;
and
v. Specify the date or period covered by each financial statement comprising the financial
statements.
4. Management’s responsibility for the financial statements: This section of auditor’s report
describes the responsibility of the management for the preparation of the financial statements in
accordance with the applicable financial reporting framework.
5. Auditor’s responsibility: The auditor’s report shall state that responsibility of the auditor is to
express opinion on the financial statements based on the audit.
6. Auditor’s opinion: When expressing an unmodified opinion on financial statements, the auditor’s
opinion shall state that the financial statement give a true and fair view.
7. Signature of the auditor: The auditor’s report is signed by the auditor in his personal name
mentioning the membership number assigned by ICAI. Where the firm is appointed as the auditor,
the report is signed in the personal name of the auditor and in the name of the audit firm stating the
registration number of the firm.
 8. Date of the Auditor’s Report: Auditor’s report shall be dated. It informs the users of the auditor’s
report that the auditor has considered the effect of events and transactions of which the auditor
become aware and that occurred up to that date.
9. Place: The report shall name a specific location, which is generally the city where the audit report is
signed.

93. Discuss the content of auditor’s report as specified

by companies act.****
Every limited company is under obligation to get their accounts audited by a qualified auditor as per
Companies Act, 2013. The auditor, after examining the books of accounts prepares his audit report which is
submitted in the Annual General Meeting for perusal and consideration of shareholders. Sec. 143 of the Act
has stipulated in details the matters required to be stated by the auditor in his report. These provisions are as
follows:
1. True and Fair View of Financial Statements [Sec. 143(2)]: Section 143 (2) requires the auditor to
state in his report whether in his opinion and to the best of his information and according to the
explanation given to him, the accounts give a true and fair view:
i. In the case of balance sheet, of the state of affairs of the company as at the end of the year;
ii. In the case of Profit and Loss Account, of the profit or loss for the year;
iii. In the case of the cash flow statement, of the cash flow for the year.
2. Information and Explanation [Sec. 143 (3)(a)]: The auditor’s report shall state whether he has
sought and obtained all the information and explanations which to the best of his knowledge and
belief were necessary for the purpose of his audit and if not, the details and the effect of such
information on the financial statements.
3. Proper Books of Account [Sec. 143(3)(b)]: The auditor’s report shall state whether, in his opinion,
proper books of account as required by law have been kept by the company so far as appears from
his examination of those books and proper returns adequate for the purpose of his adult have been
received from branches not visited by him.
4. Branch Auditors Report [Sec. 143(3)(c)]: The auditor’s report shall state whether the report on the
accounts of any branch office audited by a person other than the company’s auditor has been
forwarded to him and how he has dealt with the same in preparing his audit report.
5. Books and Financial Statements [Sec. 227(3) (d)]: The auditor’s report shall state whether the
company’s balance sheet and profit and loss account dealt with in the report are in agreement with
the books of account and returns.
6. Compliance with Accounting Standards [Sec. 143(3)(e)]: Whether in his opinion, financial
statements comply with the accounting standards.
7. Adverse comments [Sec. 143(3)(f)]: The auditor’s report shall state, the observations or comments
of the auditor, which have any adverse effect on the company’s functioning.
8. Director’s Disqualification [Sec. 143(3)(g)]: The auditor’s report shall state whether any Director is
disqualified from being appointed as Director u/s 164(2).
9. Adverse remark on maintenance of accounts [Sec. 143(3)(h)]: The auditor shall state in his report
any disqualification, reservation or adverse remark relating to the maintenance of accounts and other
matters connected therewith.
 10. Comment on the inadequacy of financial control system [Sec. 143(3)(i)]: The auditor’s report
will state whether the company has adequate internal financial controls system and comment on the
operating effectiveness of such system.
As per Notification dated 14th October, 2014, issued by Ministry of Corporate Affairs, this
requirement will be applicable for the financial years commencing on or after 1st April, 2015.
However, the auditor of a company may voluntarily include this statement in his report for the year
commencing on or after 1st April, 2014 and ending on or before 31st March, 2015.
11. Reasons of negative reply [Sec. 143(4)]: If any of the matter referred to in Sec. 143(2) & 143(3) are
answered in negative or with qualifications he must mention the reasons in his report.
12. Compliance with C & AG direction [Sec. 143(5)]: In case of a Government company, the auditor’s
report shall include:
i. The direction, if any, issued by the C & AG regarding the manner of audit of accounts;
ii. The action taken on such direction and the impact thereof on the company’s financial statements.
13. CARO Matters [Sec. 141(11)]: The auditor’s report shall include a statement on the matters
prescribed under the Companies (Auditor’s Report) Order (CARO) 2015.
14. Other matters to be included in the auditor’s report: As per Rule 11 of the Companies (Audit and
Auditors) Rules, 2014, the auditor’s report shall also include the auditor’s views and comments on
the following matters, namely.
i. Whether the company has disclosed the impact, if any, of pending litigations on its financial
position in its financial statement;
ii. Whether the company has made provision, as required under any law or accounting standards,
for foreseeable losses, if any, on long term contracts including derivative contracts;
iii. Whether there has been any delay in transferring the required amounts to the investor Education
and Protection Fund by the Company.

94. Explain the concept of true & fair view.*****

Section 129(1) of the Companies act, 2013 requires that Balance sheet and profit & Loss A/c of a company
should reflect a true and fair view of the state of affairs and profit & Loss of the company respectively.
However, the term “True and fair view” has not been defined in the Act. It is supposed that Financial
Statements will reflect a true and fair view when they are prepared according to generally accepted
accounting principles and they are disclose all relevant information as required by Schedule III of the
Companies Act, 2013. It is to be noted that disclosure requirement as per Schedule III is minimum. The
objective of Financial Statements is to cater to the information needs of various groups of people. So, if any
information seems vital and is likely to influence the judgement and decision of the user of the Financial
Statements, it should be disclosed in the Financial Statements though it may not be legally required to do so.
Therefore, what will constitute “True and Fair view” will depend upon circumstances of cases.
In this connection it may be mentioned that the phrase ‘true and fair’ was inserted in the Act by replacing the
phrase “true and correct”. The term ‘true and correct’ was used to mean that Financial Statements should be
only arithmetically correct and they should correspond to figures in the books of accounts. Thus, the auditor
could without dispute accept the fact of over depreciation or under – depreciation if they were correctly
recorded in the books and Financial Statements were prepared accordingly. So the auditor would be spared
even though the Financial Statements did not give a true and fair view in this case.
Another extreme view was that “true and correct” indicated exactitude or precision of figures. This was,
however, untenable as some items of the Balance Sheet is based on estimates e.g., the amount of depreciation
is based on estimates only. To do away with this incongruity, the amount of depreciation is based on
estimates only. To do away with this incongruity, the phrase “True and Correct” was justifiably replaced by
“True and Fair”. It is now the duty of auditor to go beyond the mere verification of arithmetical accuracy.

Factors determining “True and Fair” view

i. Financial Statements of the company have been drawn up in conformity with the requirements of
Companies Act.
ii. Relevant information have been properly disclosed.
iii. Financial Statements disclose fairly the actual financial position and working results, i.e. there is
neither a overstatements nor a understatement; there is neither window – dressing of balance sheet,
nor secret reserve in the balance sheet.
iv. All unusual, exceptional and non – recurring items have been clearly disclosed.
v. Financial Statements have been prepared and presented in conformity with generally accepted
accounting principles.
vi. Accounting principles and procedures which were followed in the previous years have also been
followed in the current year.
vii. Events occurring after the balance sheet date but before submission of audit report have been duly
considered in financial statements when they are likely to influence the decision of users.
viii. Financial Statements are conveying information unambiguously. As has been held in many legal
cases Financial Statements should give information and not means of information.

o, the phrase “True and Fair View” has extended the duty of an auditor to a great extent. He will not conduct
mere mechanical comparison of items in the financial statements with the entries in the books of account.
Rather, he should conduct audit more analytical to ensure that Financial Statements as prepared by
management can really cater to the information needs of outside users sincerely and fairly.

95. Explain the concept of Materiality.****

The concept of materiality plays a very significant role in the entries process of accounting. It is considered
in all stages from recording to classification and presentation of financial information. AS – 1 defines
material items as relatively important and relevant items i.e., the items the knowledge of which would
influence the decisions of users of financial statements. Whether or not the knowledge of an item would
influence the decisions of users of financial statement depends upon the circumstances of each case.
SA – 320 on “Materiality in Planning and performing on Audit” requires an auditor to consider the concept
of materiality both in planning and performing audit. If an item is considered material, the auditor has to
depend on more reliable evidence to assess its validity. He has also to ensure that such items are properly and
distinctly disclosed in the financial statements.Guiding factors in determining the materiality of items
The concept of materiality is a relative term. What may be material in one circumstance may not be material
in another. So it is not possible to lay down precisely, either in terms of specific items or in terms of
amounts, what could be material in all circumstances.
The following general considerations may be useful while determining the materiality of an item.
1. Relative Context: Materiality of an item can be judged in a relative context. For example, legal
expenses of Rs. 1 lakh may be a material item in a small firm but it may not be considered material
in a large firm.
2. Percentage Criterion: Percentage criterion may be applied in determining the materiality of an
item. As for example, Part – II of Revised Schedule VI to the Companies Act, 1956 requires that any
expenses exceeding one percent of total revenue of the company or Rs. 1,00,000 whichever is
higher, shall be shown as a separate and distinct item under an appropriate account head in the
statement profit and loss and shall not be combined with any other item to be shown under
miscellaneous expenses.
3. Effect on Profit and Loss: An item may be considered material if it has a significant impact on the
profit or loss of the firm. Even an item of small value will become material if its wrong treatment
converts a small loss into a profit or vice – versa.
4. Position in Relation to the Group: Materiality of an item should be judged in relation to the group
to which it belongs, for example for any item of current asset in relation to total current assets and
any item of current liability in relation to total current liabilities.
5. Comparison with Previous year’s figure: Very often comparison with previous year’s
corresponding figure throws light about the materiality of an item. For example, other income of Rs.
1.0 lakh this year may appear material when compared with previous year’s other income of Rs. 10
lakhs.
6. Any Deviation from Statutory Requirement: Any deviation from statutory requirement, however
minor it may be, is likely to render an item material. For example, a payment of Rs. 100 to directors
as remuneration in excess of statutory limits may be material. Similarly, a small inaccuracy may be
considered material if it creates or eliminates a prescribed solvency margin.
7. Nature of Transaction: Transaction of abnormal or non – recurring nature may be considered
material even though the amount involved is not very significant.
8. Cumulative effect of small and insignificant items: Individual non – material items might have a
significant cumulative effect. For example, a minor leniency in compliance with travelling rule of
the company in individual cases may have a material impact on total travelling expenses.
9. Estimation error in determinable amounts: If the amount of an item can be determined precisely
and objectively, even a small error in the same may be considered material. On the other hand, if the
amount of an item is subject to estimation and judgement, a minor difference from the estimate
made by the auditor may not be considered material.
Thus, several factors have to be kept in mind by the auditor to judge whether an item is material or
not in giving or distorting the true and fair view of the financial statements. An erroneous judgement
will lead to inappropriate opinion on financial statements. He has to ensure that all material items
have been properly and correctly recorded in the accounts and disclosed separately and distinctly in
the financial statements.
 Unit 7:
Other Trust Areas (Marks 10)
Cost Audit – Concepts, Objectives Relevant Provisions of Companies Act
Management Audit - Concepts, Objectives, Advantages
Tax Audit – Concepts, Objectives, Legal Provisions
Social Audit – Propriety Audit – Performance Audit – Environment Audit (Concepts only)

96. What is cost audit? Describe the objectives.*********

Cost audit is the independent verification of cost records maintained in manufacturing and mining industries.
It is conducted with a view to ascertaining whether cost records of the company are being maintained as per
cost accounting principles, plans and procedures. The cost auditor verifies cost statements to report on true
and fair view of cost of production and to highlight areas of inefficiency and wastage, extent of
underutilization of capacity and causes of production bottlenecks.

Objectives of Cost Audit:

The objects of cost audit are two folds which have been discussed as follows:
A. General objects:
i. To see whether there is any error of principle of cost accountancy and frauds committed in
cost accounts.
ii. To verify the correctness and propriety of recorded events and transactions in the cost
records.
iii. To see that value of closing finished stock and work in progress have been correctly
ascertained.
iv. To ensure that total costs of each product, process and operation have been correctly
ascertained.
v. To help the management by bringing their notice to inefficiencies and wastages in the use
of man, money, materials and machines.
vi. To see that data and information furnished to various Government Agencies are authentic
and reliable.
vii. To see whether actual costs incurred are within budget or standard and to exercise control
over costs by analyzing the reasons of adverse variances.
viii. To see whether any undesirable practice has been adopted by the management.
ix. To provide the Government with necessary cost data and information.
x. To render suggestions to management for improvement in performance.
B. Social objects
i. Increasing national income: To enhance national income of the country by
providing necessary counseling for increasing productivity.
ii. Price fixation and price control: To enable the Government to exercise control
over product price by providing necessary cost data.
iii. Better utilization scarce resources: To ensure optimum utilization of scarce resources
of the country by suggesting change in product mix.
 iv. Guard against evasion of tax: To enhance the tax revenue of the Government by
preventing the tendency of undervaluing work-in-progress and stock-in-trade and including
artificial costs in the computation of cost of production.
v. Cost consciousness: To create cost consciousness in the minds of all members of the
society engaged in the various activities of nation whether in public or private sector.
vi. Benefits of customers: To benefits the customers by helping the Governments as well as
industry to reduce price.
vii. Foreign Exchange Earning: To help in the earning of foreign exchange by
enabling industries to penetrate in foreign market with goods at reduced price.
viii. Employment generation: To create new employment opportunities by ensuring investment
of surplus fund.

97. Discuss the advantages/need/Importance of Cost

Audit from the view point of the Management.****
The need for audit of cost accounts is now being growingly felt in industry. It has got vast potentiality
particularly in the context of wastage and inefficiency, under – utilization of capacity, low productivity,
corporate sickness, rising price and slow pace of economic development. In fact, the thought that the cost
audit is superfluous when financial audit is conducted in an organization, is not at all justified. While
financial audit has great role to play in its respective field, cost audits acts as an effective tool of control in
the hands of management. It also renders invaluable services to shareholders, customers, government and to
the society at large. The need for audit of cost accounts can be understood from the following services
rendered by it:
i. Increasing productivity: Cost audit highlights wastage and inefficiency in the manufacturing
operation of the business. It also emphasizes on the optimum capacity utilization. This leads to an
improvement in the productivity level of the business.
ii. Decision making: Cost audits provides vital data based on which management can take various
policy decisions such as make or buy, selection of product mix, pricing policy, etc. So managerial
efficiency is enhanced by cost audit.
iii. Utilization of resources in alternative channels: By showing the best alternative avenues for
channeling resources, cost audit increases shareholders return.
iv. Setting of standard: The audited costs can be used by associations of various industries for
compiling standard cost of the product against which the individual firm may compare their actual
cost.
v. Customer’s benefit: By ensuring efficient and effective utilization of resources, cost audit
enhances value added on input. This added value can be enjoyed by all and definitely some
portion of it can be passed on to customers by way of reduced price of product.
vi. Arresting corporate sickness: By creating cost consciousness in the minds of all employees,
cost audit can definitely go a long way reducing the magnitude of industrial sickness, now
plaguing our economy.
vii. Extending tariff protection: The government can take decisions regarding extension or abolition
of tariff protection based on audited cost structure of various companies.
 viii. Control over monopolistic price: Very often it is seen that a monopoly firm fixes price of its
product at its whims ignoring customer’s interest altogether. This tendency can be curbed by the
government based on the audited cost structure of that company.
ix. Earning foreign exchange: Home industry cannot penetrate into foreign market without quality
goods at reduced prices. Cost audit, by ensuring optimum utilization of resources, can help the
industry in this regard.
x. Creation of employment opportunities: By eliminating wastage and thereby generating
additional fund, cost audit helps to make new investment which is the crying need of the country
for solving the present unemployment problem.
Cost audit has now passed its embryonic stage. Its importance is now being gradually understood
by the captains of industries and also by the Government. That is why, government of our country
has been gradually brining important manufacturing as well as servicing industries under the
purview of cost audit.

98. Discuss the provisions of the companies act,

2013 regarding cost audit.**
Provisions of the companies act, 2013 regarding cost audit:
The Companies Act, 2013 has made following provisions relating to cost audit.
1. Maintenance of Cost Records: As empowered by Subsection (1) of Section 148 of the
Companies Act, 2013, the Ministry of Corporate Affairs issued Companies (Cost Records and
Audit) Rules, 2014 which was effective from 1.4.2014. But these Rules were very complicated
and difficult to implement in many large companies because of providing for a stringent threshold
in terms of net worth or turnover of companies. So, in order to do away with this situation, the
Ministry has subsequently issued Companies (Cost Record and Audit) Amendment Rules, 2014 on
31.12.2014 The amendment has required companies engaged in the production of goods and
services as mentioned below to maintain cost records for such goods and services provided
their overall turnover from the products and services is rupees thirty five crores or more during the
immediately preceding financial year:
2. Applicability of cost audit
i. Every company under regulated sector shall get its cost records audited if the overall annual
turnover of the company from all its products and services during the immediately preceding
financial year is rupees fifty crore or more and the aggregate turnover of the individual
product or services for which cost records are required to be maintained is rupees twenty
five crore or more.
ii. Every company under non-regulated sector shall gets its cost records audited if the overall
annual turnover from all its products and services during the immediately preceding
financial year rupees one hundred crore or more and the aggregate turnover of the individual
product or service for which records are required to be maintained is rupees thirty five crore
or more.
3. Cost Auditor: As per sub-section (3) of section 148, only a cost accountant in practice is eligible to
conduct cost audit. This subsection also requires him to comply with ‘Cost Auditing Standards’
issued by the Institute of Cost Accountants of India.
4. Disqualification: Following persons are not eligible to become cost auditors:
i. Persons as mentioned under section 141(3)
ii. Auditor of the company appointed u/s 139 i.e. the company auditor cannot be cost auditor.
5. How to maintain cost records: Rule 5 has stipulated the
i. Companies required to maintain cost records will maintain such records in form CRA-1 in
respect of each of its financial year commencing on or after 1.4.2014.
ii. The cost records shall be maintained on a regular basis in such a manner as to facilitate
calculated of unit cost of production of operations, cost of sales and margin for each of its
products and activities on monthly or quarterly or half yearly or annual basis.
iii. The cost records shall be maintained in such a manner as to enable the company to exercise
control over various operations and costs to achieve economies in utilization of resources.
6. Appointment of cost auditor: Rule 6 has required that
i. Every company which is to get its cost record audited as per this order, shall appoint a cost
auditor within one hundred eighty days of the commencement of every financial year.
ii. The company shall inform the cost auditor of his or its appointment and file a notice of
such appointment with the Central Government within a period of thirty days of the Board
meeting in which such appointment is made or within period of 180 days from the
commencement of a financial year, whichever is earlier, through electronic modede in form
CRA-2.
iii. The cost auditor shall continue in such capacity till the expiry of 180 days from the closure
of the financial year or till he submits his cost audit report.
7. Duties and Powers: The rights and duties of the cost auditor are same as enjoyed by the statutory
auditor u/s 143.
8. Submission of cost audit report: The rule 6 of the order has provided that
i. The cost auditor shall submit his report to the Board of Directors along with his or its
reservations or qualifications or observations or suggestion, if any in form CRA-3 within
180 days from the closure of the financial year.
ii. The company covered under these rules shall within a period of 30 days from the date
receipt of cost audit report, furnish the Central Government with such report along with full
information and explanation on every reservation or qualification contained therein in form
CRA-4.

As per subsection (7) of section 148, the Central Government may ask the company to furnish
further information and explanation within a specific period if it thinks it necessary.
9. Company’s Duty: The duty of the company shall be to give all assistance and facilities to the cost
auditor for auditing the cost records of the company.
10. Casual vacancy: The sub-rule (3A) of Rule 6, as incorporated in the Amendment, has stipulated that
any causal vacancy in the office of a cost auditor, whether due to resignation, death or removal, shall
be filled by the board of directors within thirty days of occurrence of such vacancy and the company
shall inform the central government in form CRA-2 within thirty days of such appointments of cost
auditor.
11. Liability for default: As per Section 148 (8) if any default in complying with the provisions of this
section takes place
 i. On the part of the company, the company shall be punishable with the fine from Rs. 25000
to Rs 500000 and every officer who is in default shall be punishable with imprisonment for
the term upto one year or with fine from Rs. 10000 to Rs. 100000 or with both.
ii. On the part of the cost auditor, he will be punishable with fine from Rs. 25,000 to Rs
5,00,000. He is also liable to refund the remuneration already received by him and pay for
damages to the company or any third party adversely affected by his report.
12. Exemption in certain cases: The requirement of cost audit shall not be applicable to company.
i. Whose revenue from expects, in foreign exchange, exceeds seventy five percent of its total
revenue or
ii. This is operating from a special economic zone.

99. What do you mean by Management audit? What are

its objectives?**
Management audit
Management audit can be defined as constructive and comprehensive appraisal and review of management
plans, policies and procedures. Management audit is concerned with the assessment of efficacy and
soundness of management to lead the business to its goals. It critically reviews all aspects of management
performances and prescribes ways and means for its improvements. Sometimes management audit has been
described as Board level audit so as to distinguish it from below Board level audit which is called operation
audit.
objectives
The main objectives of management audit are:
To review the plans and policies as formulated by management
To assist the management in running the administration most efficiency and effectively.
To make the management cautious and careful in the decision making process.
To make recommendations for carrying out necessary changes in plans and policies so that
objective of the business can be achieved
To pinpoint the problems causing ailment of the company and to recommend how to overcome
them.
To assist the management in better corporate governance practices so that shareholder’s wealth
remains protected
To bring in creativity and farsightedness in the management.
To see whether there is any conflict between various plans and policies and to bring about
harmonization between them.
 100. Distinguish between Cost Audit &
Management Audit?*******

Points of distinction Cost Audit Management Audit

Definition Cost audit is the verification of the Management audit is constructive and
correctness of cost records and adherence comprehensive appraisal and
to the cost accounting principles plans examination of organization structure of
and procedures concern, its plans, means of operation
and use of resources.
Auditors Qualification The cost Auditors as per Companies Act Management auditor need not
1956 must be a Cost Accountant under the necessarily be a qualified accountant. A
meaning of Cost and Works Accountant person with special ability and
Act 1959, and in case of non-availability knowledge can conduct management
of cost accountant, must be a chartered audit.
Accountant.
Objective Its main objective is to ascertain the The objective of management audit is
reliability and fairness of cost records to see whether the company is being
and cost statements. run efficiently or inefficiently,
prudently or imprudently and to
show ways and
means of improvement of performance.
Periodicity Cost audit, if ordered by the Central Management audit is not done for
Government is to be conducted for the any such fixed period. It may cover
particular year specified in the order. from one to three or four years.
Statutory provision Cost audit, is conducted as per section 233 There is no such provision of
(B) of the companies Act in a management audit in the Companies
manufacturing, mining or processing Act, it is done as per requirement of
industry if specifically ordered by Central management.
Government.
Reporting Since cost audit is conducted as per order As management audits is conducted
of Central Government, its report is at the behest of management, its
submitted to the central government report is submitted to the
with a copy to management for their
management. perusal and taking corrective actions
Coverage Cost audit is mainly concerned with Management audit may cover all
production or service function important areas of the organization
namely production function,
Administrative function, marketing etc.
 101. Write a short note on tax audit****
Concept of Tax Audit
Statutory audit is done primarily keeping in view the information requirements of shareholders. But there are
also other stakeholders who are interested in the financial information of the entity. One such stakeholder is
Tax Authority who wants to know the correct income of the assessee from tax-point of view. With this
objective the Income Tax Act, 1961 has contained a number of provisions requiring tax audit of an entity.
Tax audit can be defined as “an examination of financial records to assess correctness of calculation of
taxable profit, to ensure compliance with provisions of the Income Tax Act and also ensure fulfillments of
conditions for claiming deductions under the income Tax Act.”
Types of Tax Audit
Tax audit under the Income Tax Act can be broadly summarized under the following three heads:
i. Compulsory tax audit under section 44AB
ii. Tax audit for various deductions and exemptions
iii. Selective tax audit under section 142(2A)

Provision of Income Tax Act, 1961 for Tax Audit u/s 44AB
The provisions for compulsory tax audit u/s 44AB are as follows:
1. Applicability: Tax audit is compulsory for the following categories of assessee:
i. Assessee carrying on any business whose total sales turnover or gross receipts exceed
Rs.1.00 crores in the previous year
ii. Assessee carrying on profession where gross receipts in the previous year exceed Rs. 25
lakhs
iii. Assessee carrying on business referred to u/s 44D, 44AE, 44AF, 44BB, 44BBB, and
declaring lower income than prescribed under those sections.
2. Qualification to conduct tax audit: The audit shall be conducted by an ‘Accountant’ as
explained u/s 288 of the Income Tax Act, 1961. This Section defines accountant as follows:
i. A Chartered Accountant within the meaning of the Chartered Accountants Act, 1949
holding certificate of practice
ii. Auditor of a company under section 226(2) of the Companies Act. It is to be noted that by
the virtue of a resolution of the council of the Institute of Chartered Accountant of India,
with effect from 1.4.2005, a member in part-time practice is not entitled to perform tax audit.
3. Disqualification of Tax auditor:
i. A Chartered Accountant who has written the books of the assessee
ii. A Chartered Accountant who is an employee of the assessee or of a concern under the
same management
iii. Internal auditor who is an employee of the company.
4. Removal of Tax Auditor: There is no specific procedure for removal of tax auditor u/s 44AB of
the IT Act. However he can be removed by the management for valid ground e.g. delay in
submission of report.
5. Filling of Tax audit report: The tax audit report along with return of income must be furnished to
income-tax authority by the specified date i.e. 31st October of relevant assessment year.
6. Penalty for non-compliance: In case of failure of an assessee to get his accounts audited as per
Section 44B or to furnish the tax audit report with return of income, a penalty equal to 0.5% of
 total sales or gross receipts as the case may be, or Rs. 1.00 lakh, whichever is lower, shall be
imposed u/s 271B of the Income tax Act.
7. Ceiling on the number of audits:
i. A Chartered Accountant shall not accept more than 45 tax audit assignment in a financial
year.
ii. In case of partnership firm, the specified number of forty five tax audit assignment shall be
counted for every partner of the firm.
8. Form of Report: the audit report shall be submitted in the following forms.
Nature of person Audit report Statement particulars

A. In case of a person who carries Form No. 3CA Form No. 3CD
business profession and who is requir
by or under any law to get his accoun
audited
B. In case of a person who carries Form No.3CB Form No. 3CD
business or profession but not being
person referred to above

102. What is social audit? What are its objectives?*******

The functioning of a firm in the society involves social costs. There are some social costs or detriments to
society for which it has to make payments, e.g. cost of material, energy, labour etc. Again there are some
social costs for which it is not required to make any payment. Examples of this category of social costs are
pollution of environment, spread of diseases, dislocation of inhabitants of a locality etc. So it is but natural to
expect that firm should spend a portion of its revenue for the benefit of society. The service to society should
be commensurate with costs or detriments which it causes to the society. If the firm ignores this duty, its
existence in the society will not be justified. In the backdrop of this development, the concept of social audit
has emerged. Social audit can be defined as the assessment of the social performance of a firm in the society
to which it belongs. It verifies whether a firm is discharging its social obligations commensurate with social
costs or detriments to the society caused by its operation. The National Association of Accountant’s (NAA)
Committee on Accounting for Corporate Social Performance has identified four major areas of social
performance on which the auditor should compile data and information for assessment:
(a) Community Development: Activities that are undertaken for the benefit of general public e.g., housing,
health service, eradication of illiteracy, food programmes etc.
(b) Human Resources: Activities undertaken for the well-being of the employees e.g., training programme,
improvement of work conditions, education for staff children etc.
(c) Physical Resources and Environmental Contribution: Activities directed towards prevention of
environmental pollution, spread of diseases, depletion of scarce natural resources etc.
(d) Product or service contribution: Activities such as consumer protection, product safety, warranty
provision and product quality.
Objectives of Social Audit:
Objectives of social audit are:
1. To ensure that investment of shareholders is safe and secured and they get a adequate return on their
investment.
2. To see that the company has taken reasonable steps to control pollution and to reduce environmental
hazard.
3. To see that scarce natural resources are being judiciously and optimally used in the firm.
4. To verify that Government is being properly compensated in the form of various types of taxes against
various infrastructural facilities like road, police, fire service etc.
5. To see whether the company is in continuous search of reducing the costs of production and improving
the quality of products.
6. To see that interest of consumers is duly protected.
7. To verify whether the interest of creditors and investors have been duly protected by the firm.
8. To see that safety of workers has been duly ensured and necessary arrangements have been made for
their welfare, education and training.
9. To see that employer and employee relationship is good and congenial.
10. To ensure that the company is not adopting any unfair trade practices.
11. To see that adequate compensation has been paid to the inhabitants displaced due o the establishment of
units by the company.
12. To verify whether adequate measures for community development have been taken by the entity.

103. What are the advantages of Social Audit?**

Advantages of Social Audit:
Following are the advantages of social audit:
1. Assessment of social performance: Social audit assesses the contribution made by a firm to the society. It is
possible to determine by means of social audit whether a firm is adequately compensating the society against
the costs or detriments suffered by the society due to its operation.
2. Social awareness: Very often the adverse impact on society of the operation of the firm e.g. air, water and
noise pollution or spread of diseases etc. remain hidden. It is the social audit which brings these facts to light
and compel the firm to take necessary measures for prevention of environmental degradation. So social audit
creates social awareness among the businessmen.
3. Prevention of unfair trade practice: The unfair trade practices, if committed by a business, will be revealed
by social audit. So, the magnitude of unfair trade practices which is so rampant in our society can be
significantly reduced by the introduction of social audit.
4. Establishing justifiability of a business: With the help of social audit, the justification of continuance of a
firm in the society can be established. If it is found that a firm is generating net social deficit i.e., its social
cost is more than its social benefits, it should not be allowed to function from macroeconomic point of view.
5. Allocation of scarce resources: To ensure effective allocation of scarce resources, evaluation of projects
should be done from the view point of their social costs and social benefits.
 104. What do you mean by Environmental Audit? What are its
objectives? Discuss the advantages.******
The concept of audit has undergone a sea change. It is not merely confined to accounting and finance. It has
been extended to other areas of social sciences. One such area where audit is now playing an important role
is related to environment. Environment refers to external conditions and surrounding in which people,
animals or plant live. But now this external surrounding is getting polluted day by day. Different types of
pollution which are now damaging environment are (a) Air pollution, (b) Water pollution, (c) Soil pollution
and (d) Sound pollution. Many industries are directly responsible for pollution of air, water, soil and sound.
Specially, industries like pesticide industry, tannery industry, petro-chemical industry, thermal power
generation, cement industry, Foundry industry etc. cause havoc damage to the environment. This damage,
although not completely avoidable, can be restricted to a great extent if proper measures are taken. For this
purpose, Governments of many countries have passed several environment related legislations.
Objectives of environment audit:
The main objectives of environment audit are
(i) To ensure the introduction of eco-friendly technologies.
(ii) To see whether the social costs incurred due to manufacturing process of the firm is more than offset
by the social benefits rendered by it.
(iii) To check that costs incurred for environmental protection are not mere wastage of money but are
helping to keep the environment clean and pollution free.
(iv) To see that natural resources are not being extracted and consumed in the way detrimental to the
society.
(v) To control the costs incurred on procuring the natural resources and ensure that they have been
properly classified.
(vi) To check the compliance of existing environmental related legislation.
(vii) To ensure that standard environmental practices are being followed by the firm.
Following are the advantages that can be derived from the application of environment audit:
(1) Developing Environmental Consciousness: Environment audit keeps the management alert about the
possible hazards associated with the manufacturing process. It compels them to take necessary
precautions so that the company’s operation cannot cause damage to environment beyond an acceptable
limit.
(2) Maintenance of Ecological Balance: Very often industrial activities lead to extinction of many living
things. This is happening due to ecological disbalance caused by industrial pollution. Bhopal gas leak,
Chernobyl disaster, Oil spill off the British South Coast etc. are the examples which destroyed many
living creatures including human beings. Proper environment audit can prevent recurrence of such
disasters and ensure betterment of life.
(3) Optimum utilization of scarce resources: Very often natural resources are consumed recklessly
ignoring the interest of next generation. Environment audit can ensure proper utilization of natural
resources.
(4) Preparation of environment cost budget: It can help to prepare environment cost budget by providing
necessary information required for pollution free environment.
(5) Cost effective measures: It ensures that measures taken for environment protection are cost effective
and they are not causing drainage of money from company’s exchequer.
(6) Recording and reporting of environment cost: Environment audit can ensure proper recording and
reporting of environment cost incurred by the firm. This can help the Government to frame suitable
policy regarding environment protection.
 105. Define ‘Propriety Audit’. What are its objectives
and importance?**
The term ‘propriety’ denotes appropriateness or rightness. So propriety audit can be defined as assessment of
rightness of managerial decisions in connection with various financial events or transactions of the business.
It verifies whether all transactions are being executed in the best interest of the company or not. Propriety
audit sees whether all employees exercise same degree of skill, care and caution in executing business
transactions as they are supposed to do in case of their personal transactions.
In other words, in the propriety audit it is seen whether all transactions are fair, compatible with the interest
of the company and conducted with the expected level of efficiency. It sees that no transaction results in any
personal gain for an employee. According to Eric Kohler “Propriety audit is an audit in which various
actions and decisions are examined to find out whether they agree in public interest and whether they meet
the standards of the conduct.”
Objective of Propriety Audit:
The objectives of Propriety Audit are as follows:
(i) To see that all expenditures have been incurred in the best interest of the company.
(ii) To ensure that an expenditure is not prima-facie more than what it should be under the given
circumstances.
(iii) To look into whether the important business decisions taken by the management are in conformity with
generally accepted customs and standard of conduct. In other words, propriety audit verifies whether any
executive is directly or indirectly benefitted from a business decision taken by him.
(iv) To see that no allowance such as travelling allowances or medical allowance is being used as a source
of profit by an executive.
(v) To see whether any alternative plan of action can bring in improvement or better result.
(vi) To see whether all transactions are fair, justified and able to safeguard the public interest.
(vii) To ensure that transactions can protect the capital of the entity and do not result in wastage of resources.
Importance of Propriety Audit:
The importance of propriety audit need not be over-emphasized. The present business world is characterized
by separation between management and ownership. Now the persons entrusted with the responsibility of the
management of the business come for a short period of time. After the expiry of the contractual period, they
leave the organization without taking any responsibility for their past decisions. So it is not uncommon that
top executives get involved with various types of scam for personal gains. Under this circumstance, propriety
audit renders following services:
(i) It acts as a deterrent to undertaking any transactions for the personal benefit of an executive.
(ii) It protects the assets of the business from misutilisation.
(iii) It ensures that all major decisions of the business are taken keeping in view the interest of the business.
(iv) It develops that habit in all employees to take business activities with same skill, care and sincerity as
they take in respect of their personal activities.
(v) By ensuring honesty and sincerity in business activities, it improves productivity and profitability of the
business.
Because of these invaluable services rendered by it, propriety audit cannot be dispensed with. That is why
Companies Act 1956 has been amended to incorporate provisions whereby the statutory auditor is required to
comment on the propriety of transactions of some particular nature.
 106. Define Performance Audit? What are its objectives and
importance?**
Performance audit can be defined as a systematic and independent appraisal or evaluation of the performance
of the business in its various key areas like manpower planning, work load distribution, productivity and
profitability, Job performance, cost monitoring etc. So performance audit is not concerned with verification
of books of accounts of the business. The auditor conducting performance audit is not required to report on
reliability and fairness of financial statements. Rather his objective is to enable the management to improve
the performance of the business in different key areas. By appraising performance of business in various key
areas, the auditor tries to go to the roots of inefficiency and advises management accordingly for necessary
remedial measures. In order to improve the quality of work the standard of performance and expected level
of efficiency in different key areas should be set beforehand. The management should arrange for reaching
those targets. The task of the auditor is to judge the success or failure of the management in reaching these
targets. So, it can be said that performance audit is to review whether an entity has been able to reach its
targets and achieves its standard level of performance. While conducting performance audit, the auditor will
see whether:
(i) Staff partners are balanced i.e. there is neither overstaffing nor understaffing.
(ii) Right persons have been placed at right jobs.
(iii) Incentive scheme is linked with efficiency.
(iv) Overtime is within acceptable limit.
(v) Accumulation of work is due to any bottleneck or non-availability of resources.
(vi) Productivity is monitored by management regularly and necessary steps are taken by management for
improvement of productivity.
(vii) Quality of jobs is as per customers requirement. This can be verified with reference to customers
complains, number of rejections etc.
(viii) Various profitability ratios are consistent with standard.
By examining the above areas, performance audit brings to light various inefficiencies and loopholes in the
performance of the business.
The objectives of performance audit can be summarized as follows:
(i) To ensure proper manpower planning and work load distribution.
(ii) To review the performance of key personnel of the organization.
(iii) To identify those areas responsible for low productivity and profitability.
(iv) To see that quality of product is as per requirement of the market.
(v) To see that assets of business are being properly utilized.
(vi) To improve profitability of the business.