Introduction to Auditing

Meaning of Audit
• 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 gives a true
and fair view of 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,

• “Auditing is an examination of accounting records undertaken

with a view to establish 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
 SUMMARY
• Therefore, audit may be defined as:
• 1. Systematic and Scientific examination of the
books of accounts of a business, which
• 2. Is done by an independent person or body
of persons qualified for the job,
• 3. With the help of vouchers, documents,
information and explanation received from
the authorities, so that
 Procedure
• The audit is a methodical procedure of independently examining
the financial information of an entity with the aim of giving an
opinion on true and fair view. Here organisation refers to all the
entities, regardless of their size, structure, nature and form.
• Auditing is a critical, unbiased investigation of each and every
aspect of the transaction, i.e. vouchers, receipts, account books and
related documents are verified, in order to spot the validity and
reliability of the financial statement. Moreover, errors and frauds or
deliberate manipulation in accounts or misappropriation etc. can
also be detected through detailed scrutiny.
• The auditor will inspect the accuracy and transparency of the
financial information, compliance with the accounting standards
and taxes are properly paid or not.
 contd
• After the complete inspection of accounting books and
financial records, he will give an opinion in the form of
a report.
• The reporting on the true and fair view shall be made
to the person who appoints the auditor.
• The audit can be conducted internally and
externally. The task of internal audit is conducted by
an internal auditor who is appointed by the
management of the organisation for improving its
internal control systems and accounting system.
External Auditor is appointed by the shareholders of
the company.
 DUTIES
• Duties of an Auditor
To check the arithmetical accuracy of the
accounts.
To check the books of accounts with the help of
all the relevant vouchers, invoices,
correspondence, minute books etc.
To verify Profit & Loss a/c and assets and
liabilities in balance sheet show the true and fair
view.
To report to the client on the basis of his findings.
 FEATURES
• Features/Characteristics of Auditing
• It is the systematic and scientific examination of the accounts of a
business.
• It is an intelligent and critical examination of the accounts of a
business.
• It is done by an independent person or body of persons qualified
for the job.
• It is a verification of result shown by profit and Loss Account and
the state of affairs shown by Balance Sheet.
• It is a critical review of the system of accounting and internal
control.
• It is done with the help of vouchers, documents, information and
explanations received from the authorities.
 Objectives of Auditing

The objectives of the auditing have been classified

under two heads:
1) Main / primary objective
2) Subsidiary/ secondary objectives
 MAIN OBJECTIVES
Main Objective: The main objective of the auditing is
• To find reliability of financial position and profit and loss
statements.
• To ensure that the accounts reveal a true and fair view of the
business and its transactions.
• 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.
• To be established that accounting statements satisfy certain degree
of reliability.
• To form an independent judgement and opinion about the
reliability of accounts and truth and fairness of financial state of
affairs and working results.
 Subsidiary objectives:
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.
 TYPES OF ERRORS

A. Clerical Errors : Clerical errors are those which result on

account of wrong posting that is posting an item to a wrong account,
totalling and balancing. Such errors may be subdivided into:
• (i) Errors of Omission : An error of omission takes place when a
transaction is completely or partially not recorded in books of
account.
• For example, goods purchased from Narendra Kumar were not
recorded any where in account books.
• (ii) Errors of Commission : Errors of commission take place when
some transaction in incorrectly recorded ( wrongly entered) in
books of account
• For e.g. Error in writing amount in an account. For example,
debiting Prem Chand' s Account with Rs. 107- instead of Rs.
100/-.
 CONTD

• B. Errors of principle : Errors of Principle take place when a

transaction is recorded without having regard to the
fundamental principles of book-keeping and accountancy.
• For example if there is incorrect allocation of Expenditure or
Receipt between Capital & Revenue
• C. Compensating Errors / off setting Errors :- Compensating
errors arise when an error is counter balanced or compensated
by any other error so that the adverse effect of one on debit (or
credit) side is neutralised by that of another on credit (or debit)
side.
• For example Anil's account was to be debited with Rs. 500,
was credited for Rs. 500 similarly Sunil's account which
was to be credited for Rs. 500 was debited for Rs. 500. Both
these errors compensate each other's deficiency
 CONTD
Errors of Duplication
• Such errors arise when an entry in a book of
original entry has been made twice & had
also been posted twice.
 TYPES OF FRAUD
• These are intentional errors and wanted misrepresentations and failure
to disclose the materialistic facts to the transactions in the books of
accounts. Such as
1. Misuse of Cash: Cash is the highly exploitation asset in the business,
auditor check receipts and payments of cash in order to detect and prevent
cash embezzlement (Misappropriation) of cash.
• Cash may be misappropriated by,
• (a) Omitting to enter any cash which has been received; or
• (b) Entering less account than what has been actually received; or
• (c) making fictitious entries on the payment side of the cash book; or
• (d) entering more amount on the payment side of the Cash Book than
what has been actually paid.
 CONTD
2. Misappropriation of Goods: Fraudulent
application of goods by those who handle them
e.g. recording purchase of large quantities
receiving less quantity & then receiving the
balance privately.
Proper methods of keeping accounts in regard to
purchases and sales, stock, periodical checking
of stocks, will help to avoid misappropriation of
goods.
 CONTD
3. Fraudulent Manipulation of Accounts /Forgery Vouchers:
These are the fake evidences produced to auditor in the process of auditing.
Such must be identified by the auditor.
• This type of fraud is more difficult to discover as it is usually
committed by directors or managers or other responsible officials.
That is why the auditor should be very careful in detecting such
frauds. He should carry out the routine checking and vouching most
carefully and make searching, tactful and intelligent enquiries
• The accounts may be manipulated in a number of ways which are as
follows:
• 1. by not providing any depreciation or less depreciation or more
depreciation; or
• 2. by under valuation or over-valuation of assets and liabilities; or
• 3. by the utilization of secret reserves during a period when the concern
has made less or no profit without disclosing that fact to the shareholders
etc.
 ACCOUNTING V/S AUDITING
1. Meaning
Accounting means systematically keeping Auditing means inspection of the
the records of the accounts of an books of account and financial
organization and preparation of financial statements of an organization.
statements at the end of the financial year.
2. Governed By
Accounting Standards Standards on Auditing
3.Work performed by
Accountant Auditor
4. Purpose
To show the performance, profitability To reveal the fact, that to which extent
and financial position of an organization. financial statement of an organization
gives true and fair view.
5. Commencement
Accounting begins where bookkeeping Auditing begins when accounting ends.
ends.
6. Period
Accounting is a continuous process, i.e. Auditing is a periodic process.
day to day recording of transactions are
done
7. Nature It is concerned with establishment of
It is concerned with finalisation of final reliability of financial statement
accounts

8. Objective To certify the correctness of financial

To ascertain trading results statements.

9. Reporting An auditor submits prescribed report.

An accountant does not submit any
report.

10. Status An auditor is not an employee of an

An accountant is an employee of an organisation.
organisation.

11. Errors & Frauds Auditor cannot afford to commit errors and
Accountant may commit errors and frauds.
frauds

12. Qualfication
No formal qualification Needs prescribed qualification.
 CLASSIFICATION OF AUDIT

On the basis of Time

1) Interim audit: An audit is performed in between two

annual audits is considered as Interim audit. It can be conducted
as Quarterly or Half yearly. It may involve complete checking of
accounts for a part of the year. Normally this audit is conducted in
the large companies where huge amount of transactions are
available for audit work.
It may be also conducted to enable the board of directors to
declare an interim dividend
2) Periodical/Final audit (Year end): Here the commencement
of the audit work starts at the end of the financial year . After
preparation of final accounts of the business the auditor is called to
conduct an audit. Such type of audit is called as Final Audit. This
type of audit is best suited for small concerns, as in case of large
concerns it takes more time to complete the audit if commenced at
the end of the year. Suitable where chances of frauds are less.
3) Continuous / Detailed audit : A continuous Audit is where the
auditor and his staff are constantly engaged in checking the accounts
during the entire financial period or at regular or irregular intervals
during the period.
Generally large companies where bulk transactions were involved
will be subjected to continuous audit.
It 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.
4) Balance sheet audit: It is complete verification of all items
presented in the balance sheet. It includes verification &
valuation of assets & liabilities appearing in the balance sheet.
The auditor investigates regarding materiality, and statutory
requirements. This type of audit is successful where the proper
internal control system exists, because under this type of audit
the auditor might not follow the elaborate checking of
transactions.
Classification based on organisational structure &
Authority

A business undertaking may be owned, managed & controlled by govt. or

private individuals , & may be operated in a corporate form or non-
corporate form. The type of audits to be conducted for various
organisations, therefore should fall under the following categories.

• Statutory Audit
• Is one that is authorised by and compulsory under a statute or law which
lays down or prescribes in definite terms the nature, scope and extent of
audit and also the auditor’s qualifications, duties and rights, e.g., in the
case of a company including a government company or public sector
enterprise/undertaking and other organisations or public corporations
governed by special statutes.
➢ Where undertaking are formed under the statute or laws, audit for such undertakings
is made compulsory under the statutes that govern them
➢ An audit undertaken under any statute or law is called statutory audit
➢ Audit is compulsory under statute in the following cases:
• Government Audit
• The Government maintains a separate department in the name of accounts and
audit department which performs the audit of its different departments and
offices.
• Audit of Government departments performed under statutory regulations
made compulsorily by government of India called as Accounts and Audit
Department General of India. On the basis of these provisions the
Government departments must conduct such audits. Only Officers of the
Government can works for accomplish the audit of the Government
departments

• The duties and liabilities of such auditors are not defined by statue. They are
not public auditors and hence can not be appointed auditors for public
concerns. They are meant for Government departments and as such, they
work according to departmental rules and instructions.
Joint stock companies incorporated under the companies act , 2013

➢The shareholders are the actual owners of a company & they appoint
the directors to supervise overall affairs of the company.
➢All joint stock companies are required to get their accounts audited
by an independent auditor, so that the owners may get assurance
about the reliability of the financial statements prepared by the mgmt.
➢People invest in shares of a company on the basis of profitability,
ratio analysis & financial position of the company.
➢Persons who are affected by financial statements like financial
institutions ,banks , trade creditors , income tax, excise and other
revenue authorities also do rely on audited financial statements.
➢In view of all above factors statute has made it compulsory for all
joint stock companies to get their accounts audited.
Cooperative societies registered under the Cooperatives societies Act
➢ Every cooperative society has to get it registered with
the Registrar of Cooperative societies of the state
concerned under cooperative societies Act 1912.
➢ Being a registered body a cooperative society is also
regarded as an entity distinct from its members.
➢ All members contribute capital of a cooperative society
but mgmt of its affairs is entrusted to a few members
elected for this purpose.
➢ This substantiates the requirement of an independent
financial audit of accounts of cooperative society
➢ The appointment of auditor for a cooperative society is
made by the registrar of cooperative societies.
➢ The auditor conducts the audit & submits his report to
the Registrar & to the society
Besides companies & cooperative societies, Audit is
mandatory requirement in respect of the following
institutions.
a) Public & charitable trusts registered under the
relevant Acts.
b) Banking companies governed by banking
companies (Regulation) Act, 1949
c) Insurance companies governed by the insurance
Act 1938
d) Public sector undertaking (PSUs),local
authorities,& Govt. financial institutions
established under the special Act or Law.
• Private Audit / Non Statutory Audit
is not obligatory under any legal provision; it depends on the
discretion of the owners of a business or other interested
individuals or private bodies and is governed by the terms of
contract between the auditor and his clients.
It is not mandatory under the statute or law.
It is undertaken in view of several benefits they are as follows:
1. Audit of sole Proprietorship
➢ Audit of sole proprietor is optional
➢ This business is owned, managed & controlled by an individual.
➢ He individually decides whether to get the books of account
audited or not.
➢ The auditor obtains clear instructions from the owner regarding the
nature& scope of audit to be undertaken.
2.Audit of partnership firm

Partnership Act 1932 does not require partnership firm to get their
financial statement audited.
Still many partnership firms provide for audit of their books of account
The auditor is not appointed under any statute but by an agreement
between partners & auditor for the same exists.
The auditor should draw attention on the following points.
a) Partnership Act , 1932
b) Partnership deed which is the most important document
c) Nature of business
d) Names & address of all partners
e) Capital introduced
f) Partners profit sharing ratios.
g) Interest on capital payable to partners , if any.
3. Audit of accounts of other entities
There are some other institutions where financial statements
are not required to be audited by an independent auditor
under any statute or law.
Viz. clubs, libraries, Hospitals, schools, colleges, other
educational institutions & Hindu Undivided Family.
 Based on scope
1. Complete Audit
➢ the auditor is required to check each & every transaction record in
the books of accounts.
➢ He has to examine each & every voucher, document or
correspondence relating to the transaction.
➢ This type of audit is not suitable for large firms.

2. Partial Audit
➢ The auditor is not required to examine all the books of accounts.
➢ Only a part of the accounts or some transactions as desired by the
clients may be scrutinized .
➢ Auditor has to state the area covered by the audit.
➢ This audit is not convenient when the audit is legally required
• 3. Detailed audit
• The business transactions are examined in detail by the auditor.
• Certain transactions are traced through various stages from the
beginning to their end with the help of available evidence.
• This technique of examination is called Audit In Depth
• Example : detailed audit of purchase of goods for inventory would
consist of tracing the transactions.
• Requisitioning the goods , ordering the goods,
• receiving the goods ordered & preparing the payment voucher
 Qualities of an Auditor
The Auditor must possess the following qualities: ( refer to the elaborated points)
• Only the qualified chartered accountant can be appointed as auditor of a limited
company.
• The auditor must have thorough knowledge of principles and practice of all aspects
of accountancy. He must be familiar with all systems of accountancy in use.
• He should have adequate knowledge of financial management, industrial
administration and business organization.
• He must have thorough knowledge of audit case laws as per the various cases
decided by the courts in and outside India.
• He should be able to understand the technical details of business whose accounts
he is going to audit.
• An auditor must be honest i.e. He must certify that he does not believe to be true
and he must take reasonable care and skill before he believes what he certifies is
true.
 contd
• He must act impartially and not influenced by
others, directly or indirectly while discharging
his duties.
• He should be hard working, systematic and
methodical.
• He must have capacity to hear arguments of
others.
• He should have adequate skills and courage to
write audit report correctly clearly and
concisely.
• He should not disclose the secrets of his client.
 Advantages of Audit
• 1. Detection & prevention of errors & frauds become easier
➢ Errors & frauds can be located & rectified at an early & initial stage.

• 2. Audited accounting information

➢ Greater reliability & authenticity
➢ Mgmt. exercises a great deal of subjectivity in preparing financial statements & allocating
resources entrusted to it in operating the entity.
➢ Audit provides reasonable assurance that Mgmt. representations on these activities are
authentic.

• 3. Acceptability by the authorities

➢ Audited accounts are readily acceptable by the income tax , sales tax & other statutory
body.

• 4.Professional advice available

➢ Independent auditors also render services other than auditing.
➢ They do tax work, act as Mgmt. consultants advice on internal control system in operation
& prepare reports required by govt. agencies
 contd
• 5.Speedy processing of loan
➢ Financial institutions consider audited accounts genuine &
authentic & this helps them in speedy processing of loan
proposals.
• 6.Settlement of disputes.
➢ In case of partnership firm dispute among partners over
such matters as profit sharing , settlement of claim incase
of retirement/death of a partner may be less likely to arise
when accounts are duly audited. All partners can easily
trust audited accounts.
 contd
• 7.Facilitates calculation of net worth & goodwill of
business
➢ In case of Sale over of business as a going concern by
other party, audited accounts carry greater reliability
deciding out the net worth of business & goodwill.
➢ A perspective purchaser of a business may place more
confidence in audited accounts as evidence of past
profitability
➢ Auditing function therefore plays an important role in
verifying whether an organisation is profitable or not
or whether its financial position is sound or not.
 contd
• 8.Settlement of insurance claims
• Audited accounts are likely to have more credibility &
helps in early settlement of insurance claims in case of
loss by fire,
• 9.Useful to compare the financial performance
• 10.Keeps accounts department vigilant
• Regular audit of accounts keeps the accounts dept. not
only up-to-date but also careful & vigilant.
• 11. Identifies the weak areas
• Reviews the internal control system & identifies the weak
areas. Helps mgmt.
• to get over the weakness & achieve their goal within
stipulated time & at reasonable cost.
 Limitations of auditing
• 1. Lack of complete picture—The audit may not give
complete picture. If the accounts are prepared with the
intention to defraud others, auditor may not be able to
detect them.
• 2. Problem of Dependence—Sometimes the auditor has
to depend on explanations, clarification and information
from staff and the client. He may or may not get correct or
complete
information.
• 3. Existence of error in the audited accounts—Due to time
and cost constraints, the auditor can not examine all the
transactions. He uses sampling to check the transactions.
As a result, there may be errors & frauds in the audited
accounts even after the checking by the auditor.
 contd
• 4. Exercise of judgement—The nature, timing and extent
of audit procedures to be performed is a matter of
professional judgement of the auditor. The same audit
work can be done by two different auditors with
difference in sincerity & personal judgement.
• 5. Diversified situations—Auditing is considered to be a
mechanical work. Auditors may not be in a position to
frame audit programme which can be followed in all
situations.
• 6. Lack of Expertise—In some situations, an auditor has to
take opinion of experts on certain matters on which he
may not have expert's knowledge. The auditor has to
depend upon such reports which may not be always
correct.
 CONTD

7. Limitations of internal control—The auditor can only report

on the truth and fairness of the financial statements. But other
problems relating the management and control may not be
possible to be covered by the auditor. Examples of such
problems or limitations of internal control are cast-
ineffectiveness, manipulations by management, etc.

8. Influence of management on the auditor—The auditor is

influenced by the doings of those in management. The reason is
that he is appointed by the share holders and directors who pay
him remuneration or fee
 Basic Principle’s Governing An Audit

• (i) Integrity, Objectivity and Independence:

• The auditor should be straightforward, honest and
sincere in his approach to his professional work.
• He must be fair & must not allow prejudice or bias to
overcome his objectivity.
• He should maintain an impartial attitude and both be,
and appear to be free of any interest which might be
regarded, whatever its actual effect on being
incompatible with integrity and objectivity.
• It lays down standards of ethical conduct for auditors. It
highlights the true nature of an auditor’s function.
 contd
• (ii) 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.
• confidentiality is not only a matter of non-disclosure.
• It implies that the auditor should neither use nor appear to use
the information acquired in the course of audit for personal
advantage or for the advantage of third party.
 contd
• (iii) Skill and Competence:
a) The audit should be performed and the report
prepared with due professional care by persons
who have adequate training, experience and
competence in auditing.
b) The auditor requires specialised skills &
competence which are acquired through a
combination of general education, technical
knowledge obtained through study & formal
courses concluded by a qualifying examination
recognised for this purpose.
 contd
• (iv) Work Performed by Others:
• A) When the auditor delegates work to assistants or uses work performed
by other auditors and experts, he will continue to be responsible for
forming & expressing his opinion on financial information.
• however , he will be entitled to rely on work performed by others provided
he exercises adequate skill and care and is not aware of any reasons to
believe that he should not have so relied (there is nothing to doubt).
• B) The auditor should carefully direct, supervise and review work
delegated to assistants and obtain reasonable assurance that work
performed by other auditors or experts is adequate for his purpose.
• This principle deals with the auditor’s duties & responsibilities when he
a) Delegates work to assistants.
b) Uses work performed by other auditors.
c) Uses work performed by experts.
 contd
• v) Documentation:
• The auditor should document matters which are important in providing
evidence that the audit was carried in accordance with the basic principles.
• Maintenance of adequate documentation ( working papers) helps the
auditor in proper planning, performance, supervision & review of audit
• Adequate documentation also provides an evidence of the audit work
performed.
• (vi) Planning:
• Planning enables the auditor to conduct and effective audit in an efficient
and timely manner.
• Primarily, planning should be based on the knowledge of the client’s
business.
• Plans should be further developed and revised as necessary during the
course of the audit.
 Audit Planning and procedure
• Process:
• Step 1 - Identification of the objectives of the Audit
– Determine audit objectives
• Step 2 -Collection of evidence relevant to the audit
objectives
– Obtain knowledge of the business
– Obtain understanding of accounting system
– Determine the nature, timing & extent
– Perform detailed procedure
• Step 3 - Formation of judgement on the basis of evaluation
– Evaluate the results of the audit procedures
– Report whether the financial statements are true and fair
 Auditing techniques
• Inspection of documents & records
– Passbook
– Statement prepared by clerks
– Register showing receipts & payments
– Counterfoils/pay-in-slips
– Aspects to be examined : authentic, appropriate, authorised.
• Physical inspection of tangible assets
– Timing the inspection
– Methods - Cash in hand v/s bank, stock verification in factory & storage.
– Incase of financial audit – using formulae on spread sheet to counter verify.
• Observation
– Laid down guidelines for stock verification, observe competence of persons to whom work is assigned
etc
• Inquiry – to collect evidence, to understand system, use questionnaires
• Confirmation – from Drs, Crs thru confirmation letters
– Confirmation can be positive or negative
• Retracing the book keeping procedures
– Checking totals, balances & carry forward
• Analytical procedures
– Comparison of last year records, inter-period comparison, analyse relation ship between different
tasks and data.
 Internal audit & control
• Objectives:
– Adherence to policies and procedures laid down by
management
– Safeguarding assets
– Prevention and detection of fraud & errors
– Accuracy & completeness of records
• Types
– Accounting controls
• Segregation & rotation of duties
• Authorisation of transactions
• Maintenance of records
• Safeguarding of assets
• Independent checks on performance
– Administrative controls
 Stages
• Study of the accounting system
• Testing compliance with prescribed control
– Inspection of documents & records
– Observation & enquiry
• Evaluation of Internal control system(efficacy)
– Check flowcharts
– Communication system
– Internal control questionnaires.