Auditing

Meaning and Definition of Auditing

The word Audit is derived from Latin word “Audire” which means ‘to hear’. Auditing is
the verification of financial position as disclosed by the financial statements. It is an
examination of accounts to ascertain whether the financial statements give a true and fair
view financial position and profit or loss of the business. Auditing is the intelligent and critical
test of accuracy, adequacy and dependability of accounting data and accounting statements.
Different authors have defined auditing differently, some of the definition are:

“Auditing is an examination of accounting records undertaken with a

view to establishment whether they correctly and completely reflect the transactions to which
they purport to relate.”-L.R.Dicksee

“Auditing is concerned with the verification of accounting data

determining the accuracy and reliability of accounting statements and reports.” - R.K. Mautz

“Auditing is the systematic examination of financial statements, records and

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

Objectives of Auditing
The objectives of auditing are changing with the advancement of business techniques.
Earlier it was only to check the correctness of receipts and payments. The objectives of the
auditing have been classified under two heads:

1) Main objective
2) Subsidiary objectives

Main Objective: The main objective of the auditing is to find reliability of financial
position and profit and loss statements. The objective is to ensure that the accounts reveal a
true and fair view of the business and its transactions. The objective is to verify and establish
that at a given date balance sheet presents true and fair view of financial position of the
business and the profit and loss account gives the true and fair view of profit or loss for the
accounting period. It is to be established that accounting statements satisfy certain degree of
reliability. Thus the main objective of auditing is to form an independent judgement and
opinion about the reliability of accounts and truth and fairness of financial state of affairs and
working results.

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Subsidiary objectives: The subsidiary objectives of the auditing are:

1. Detection and prevention of fraud: the one of the important subsidiary

objective of auditing is the detection and prevention of fraud. Fraud refers to
intentional misrepresentation of financial information. Fraud may involve:
a. Manipulation, falsification or alteration of records or documents
b. Misappropriation of assets.
c. Suppression of effect of transactions from records or documents.
d. Recording of transactions without substance.
e. Misapplication of accounting policies
2. Detection and prevention of errors: is another important objective of auditing.
Auditing ensures that there is no mis-statement in the financial statements. Errors
can be detected through checking and vouching thoroughly books of accounts,
ledger accounts, vouchers and other relevant information.

Importance of Auditing
Importance of auditing can be judged from the fact that even those organizations which
are not covered by companies Act get their financial statements audited. It has become a
necessity for every commercial and even non- commercial organization. The importance of
auditing can be summed in following points:

a. Audited accounts help a sole trader in knowing the value of the business
for the purpose of sale.
b. Dispute over correctness of profits can be avoided.
c. Shareholders, who do not know about day-to-day administration of the
company , can judge the performance of management from audited
accounts.
d. It helps management in detecting and preventing errors and frauds.
e. Management gets advice on financial affairs from the auditors.
f. Long and short term creditors depend on audited financial statements while
taking decision to grant credit to business houses.
g. Taxation authorities depend on audited statements in assessing the
income tax, sales tax and wealth tax liability of the business.
h. Audited accounts are useful for the government while granting subsidies etc.
i. It can be used by insurance companies to settle the claims arising on
account of loss by fire.
j. Audited accounts serve as a basis for calculating purchase consideration in
case of amalgamation and absorption.
k. It safe guards the interests of the workers because audited accounts are
useful for settling trade disputes for higher wages or bonus.

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Types of audit
Based on ownership: On the basis of ownership audit can be:-

1. Audit of Proprietorship: In case of proprietary concerns, the owner himself

takes the decision to get the accounts audited. Sole trader will decide about the
scope of audit and appointment of auditor. The auditing work will depend upon the
agreement of audit and the specific instructions given by the proprietor.
2. Audit of Partnership: To avoid any misunderstanding and doubt,
partnership audits their accounts. Partnership deed on mutual agreement between
the partners may provide for audit of financial statements. Auditor is appointed by
the mutual consent of all the partners. Rights, duties and liabilities of auditor are
defined in the mutual agreement and can be modified by the partners.
3. Audit of Companies: Under companies Act, audit of accounts of
companies in India is compulsory. Chartered accountant who is professionally
qualified is required for the audit of accounts of companies. Companies Act 1913 for
the first time made it compulsory for joint stock companies to get their accounts
audited from a qualified accountant. A number of amendments have been made in
companies Act, 1956 and 2013 regarding appointment, duties, qualification, power
and liabilities of a qualified auditor.
4. Audit of Trusts: The beneficiaries of the trusts may not have access
and knowledge of accounts of the trust. The trustees are appointed to manage
and look after the property and business of the trust. Accounts of the trust are
maintained as per the conditions and terms of the trust deed. The income of the
trust is distributed to the beneficiaries. There are more chances of frauds and mis-
appropriation of incomes. In the trust deed as well as in the Public Trust Act which
provide for compulsory audit of the accounts of the trust by a qualified auditor. The
audited accounts of the trust ensure true and fair view of accounts of the trust.
5. Audit of Accounts of Co-operative Societies: Co-Operative
societies are established under the Co-Operative Societies Act, 1912. It
contains various provisions for the regulations and the working of these
societies. Some of the states have adopted it without any change, while
others have brought certain changes to it. The auditor of the Co-operative
Society should have an expert knowledge of the particular act under which Co-
operative society under audit is functioning. He should also study by-laws of the
society and make sure that the amendments made from time to time in the by-laws
have been duly registered in the Registrar’s Office. Companies Act is not applicable
to the co-operative Societies. The Registrar of co-operative societies shall audit or
cause to be audited by some person authorized by him, the accounts of the society
once in every financial year.

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 6. Government Audit: Audit of government offices and departments is covered
under this heading. A separate department is maintained by government of India
known as Accounts and Audit Department. This department is headed by the
Comptroller and Auditor General of India. This department works only for the
government offices and departments. This department cannot undertake audit of
non-government concerns. Its working is strictly according to government rules and
regulations.

Based on Time: On the basis of time the audit can be of following types:

1. Interim Audit: When an audit is conducted between two annual audits, such
audit is known as Interim audit. It may involve complete checking of accounts for a
part of the year. Sometimes it is conducted to enable the board of directors to
declare an Interim dividend. It may also be for the purpose of dealing with interim
figures of sales.
2. Continuous Audit: The Continuous Audit is conducted throughout the year
or at the regular short intervals of time.
“A continuous audit involves a detailed examination of all the transactions
by the auditor attending at regular intervals say weekly, fortnightly or monthly,
during the whole period of trading.” - T.R. Batliboi
“A continuous audit is one where the auditor or his staff is constantly
engaged in checking the accounts during the whole period or where the auditor or
hiss staff attends at regular or irregular intervals during the period.” -R.C Williams

Advantages of continuous Audit:

a. Complete checking of all the records: Since the audit is

carried out throughout the year, sufficient time is available for detailed
checking. Any enquiry and doubt arising in the course of audit can be
tackled in a better way.
b. Proper planning: Auditor can plan his audit work in a systematic
manner. He can evenly spread his work throughout the year. It will improve
efficiency of auditor.
c. Early detection of frauds and errors: The work of auditor
becomes easier for detecting frauds and errors, otherwise it will involve more
time.
d. Up-to-date accounts: The efficiency of account staff will increase
and their work will be up-to-date and accurate.
e. Valuable suggestions: Continuous audit will help the auditor to
understand the technicalities of business. This will help the auditor to make
suggestions for the improvement of business.
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 f. Preparation of interim accounts: Interim accounts can be
prepared without much delay. It will help the Board of Directors to declare
interim dividend.

Disadvantages of Continuous Audit:

a. Expensive: It is an expensive system as it may not suit the budget

of small organizations.
b. Dislocation of routine work: Frequent visits by auditor may
dislocate the smooth flow of office work.
c. Alteration of Figures: after the accounts have been audited, the
figures may be fraudulently altered by the staff.
d. Losing link in the audit work: As the work is not completed
continuously, the auditor may lose continuity and certain questions and
inquires may be left unanswered.
3. Final Audit: Final Audit means when the audit work is conducted after the close
of financial year. A final audit is commonly understood to be an audit which is not
commenced until after end of the financial period and is then carried on until
completed.
4. Balance Sheet Audit: Balance Sheet Audit relates to the verification of
various items of balance sheet such as assets, liabilities, reserves and surplus,
provisions and profit and loss balance. The procedure under this audit is to follow a
backward process. First the item is located in balance sheet, and then it is located in
original record for the purpose of verification.

Based on Objectives: On the basis of objectives the audit can be of following types:

1. Internal Audit: It implies the audit of accounts by the staff of the business.
Internal audit is an appraisal activity within an organization for the review of the
accounting, financial and other operations as basis for protective and constructive
service to the management. It is a type of control which functions by measuring and
evaluating the effectiveness of other types of control. It deals primarily with
accounting and financial matters but it may also properly deal with matters of
operating nature.
2. Cost Audit: Cost Audit is the verification of the correctness of cost accounts
and adherence to the cost accounting plans. Cost Audit is the detailed checking
of costing system, techniques and accounts to verifying correctness and to
ensure adherence to the objectives of cost accounting.
3. Secretarial Audit: Secretarial Audit is concerned with verification
compliance by the company of various provisions o Companies Act and other
relevant laws. Secretarial audit report includes
a. Whether the books are maintained as per companies act, 2013.

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 b. Whether necessary approvals as required from central
Government, Company law board or other authorities were
obtained.
4. Independent Audit: Is conducted by the independent qualified auditor.
The purpose of independent audit is to see whether financial statements give
true and fair view of financial position and profits. Mainly it is for safeguarding
the interest of owners, shareholders and other parties who do not have
knowledge of day-to-day operations of organization.
5. Tax Audit: Now-a-days tax audit has become very important to ascertain
the accuracy of tax related documents. Tax audit mostly covers income returns,
invoices, debit and credit notes and various current and fixed assets. Tax audit
is an innovation of 21st century. It has added one more chapter to the practice
of auditing. Tax audit ensures the validity and credibility of tax related
documents.