Audit, Auditing and Auditor

Origin:
The term audit is derived from Latin word ‘audire’ which means to hear. In olden
times whenever the owner of the business suspected fraud, they appointed certain
person to check the accounts. Such person sent for the accountants and “heard”
whatever they had to say in connection with accounts. In olden times whenever the
owner of the business suspected fraud, they appointed certain person to check the
accounts. Such person sent for the accountants and “heard” whatever they had to say
in connection with accounts.

The origin of auditing can be traced to Italy. Around the year 1494, Luca Paciolo introduced
the double entry system of bookkeeping and described the duties and responsibilities of an
Auditor.

Auditing is as old as accounting. It was in use in all ancient countries such as

Mesopotamia, Greece, Egypt, Rome, U.K. and India. The Vedas contain reference to
accounts and auditing. Kautilya's Arthasashthra emphasized the importance of
accounting and auditing.

The Indian Companies Act, 1913, prescribed for the first time the qualifications of an
Auditor. The Government of Bombay was the first to conduct related courses of study such as
the Government Diploma in Accountancy (GDA).

The Auditor’s Certificate Rule was passed in 1932 to maintain uniform standard in
Accountancy and Auditing. The Chartered Accountant Act was enacted by the Parliament of
India in 1939. The Act regulates that a person can be authorized to audit only when he
qualifies in the examinations conducted by The Institute of Chartered Accountants of India.
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Definition:
“An Audit is an examination of accounting records undertaken with a view to
establish whether they correctly and completely reflect the transactions they purport to
relate”.
-Laurence R. Dicksee

Definition contains:

– An intelligent and critical examination of the books of accounts of business.

– It is done by an independent qualified person.
– It is done with the help of vouchers, documents, information, and explanations received
from the clients.
– The auditor satisfies himself with the authenticity of the financial accounts prepared for a
particular.
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"Auditing is a systematic examination of the books and records of business or other

organization, in order to ascertain or verify and to report upon the facts regarding its
financial operations and the result thereof."
-Prof. Montgomery
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Who is an Auditor:
An auditor CPA (Certified Public Accountant) or CA (Chartered Accountant) is a
person appointed by a company to execute an audit and inspect the books of accounts.
Auditors typically work standard office hours, Some overtime, and weekend working
at busy times or the end of the financial year.
Auditors form an opinion about the company’s financial statements. Whether the
report depicts an accurate and fair view of the financial statements. Their primary
objective is to protect businesses from fraud, inconsistency in accounting methods,
among other things.

Role of an Auditor:
The auditors’ role in a company is to assist the business in maintaining its financial reliability by
reviewing and verifying financial statements. The goal of auditors includes risk controlling and
supervisory compliances. Some of the significant roles an auditor plays in an organization
include.

• The auditor may satisfy himself with the authenticity of financial accounts prepared for
a fixed term and ultimately report that
• Balance Sheet exhibits the true and fair view of the state of affairs.
• Profit and Loss accounts reveals the true and fair view of the profit or loss for the
financial period; and
• The accounts have been prepared in conformity with the law.
• Make sure to follow the police rule regulations diligently.
• Compiling, cross-checking, and evaluating accounts report statistics.
• Protect organization reputation by keeping information confidential.
• Auditors assist the investigating officer

Duties of an Auditor:
The primary responsibility of auditors is to prepare company financial reports and statements.
This financial report and statement include correct and truthful information about the company’s
financial situation.

• 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.
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Scope of Auditing:
a. Accounting and Internal Control Examination: Assessing whether the
system of accounting and internal control is adequate and appropriate for the
organization.

b. Arithmetical Accuracy: Checking the mathematical accuracy of the books

of accounts through posting, casting, and balancing procedures.

c. Authenticity of Transactions: Verifying the validity and authenticity of

transactions by comparing entries with supporting documents.

d. Distinction between Capital and Revenue Items: Scrutinizing the

classification of items into capital and revenue categories, ensuring they
correspond to the appropriate accounting period.

e. Verification of Assets: Conducting a detailed examination of the ownership,

existence, and value of assets listed in the balance sheet.

f. Verification of Liabilities: Properly verifying the liabilities of the

organization as stated in the balance sheet.

g. Comparison of Financial Statements: Comparing the balance sheet, profit

and loss account, or other statements with available records to ensure they
are consistent.

h. Checking the Results: Verifying the results presented in the profit and loss
account to ensure they are true and fair.

i. Statutory Requirements: Confirming that the organization has fulfilled all

statutory requirements and legal formalities in recording financial
transactions and preparing financial statements.

j. Appropriate Reporting: Providing appropriate reports to relevant

stakeholders to explain whether the examined statements of accounts reflect
a true and fair view of the organization's state of affairs and profit and loss.
These procedures help ensure the accuracy, reliability, and compliance of
financial information, thereby enhancing transparency and accountability within
the organization.
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Objectives of Audit/Auditing:

| Primary Objective:

– Examine Financial Statements: to examine an organization’s financial statements to

ensure they are complete and accurate.
What auditor does?
o Examines if the financial data is correct and all account balances are accurate.
o Uses supporting documents to verify that all reported transactions are authentic.
o Confirms if the reported assets and liabilities actually exist by cross-checking the
values to supporting documents.
o Gives an expert opinion stating whether the financial statements are fair and
accurate.

– Evaluate Organizational Operations: The next objective is to check the

organization’s operational processes and procedures. This is to identify any areas of
improvement.
What the Auditor Does?
o Checks the operational process to see if the company can improve the efficiency
of the operations.
 o Ensures the company maintains the required product/service quality and has
excellent customer satisfaction.
o Provides inputs to help the business enhance its safety measures and prevent any
accidents.
o Finds cost-saving opportunities that won’t lead to any compromise in product
quality.

– Ensure Legal Regulations: The next audit objective is to check whether an

organization is following all specified laws, regulations, or internal policies.
What the Auditor Does?
o Ensures the organization complies with relevant laws and government regulations,
including taxation policies.
o Assesses if the firm is also adhering to the industry-specific standards.
o Confirms that all departments are consistently following internal policies and
procedures.
o Identifies areas of non-compliance that may pose legal or financial risks.
o Makes sure that the company also complies with any signed contractual
obligations.

– Evaluate Effectiveness: In this primary objective, the auditor has to evaluate the
effectiveness of the organization’s programs, projects, or activities.
What the Auditor Does?
o Evaluates if the internally maintained records are effective and identify if there are
any deviations in internal and reported records.
o Measures key performance indicators (KPIs) to determine the program’s
performance.
o Evaluates how the firm has allocated resources to align them with their priorities
and goals.
o Measures the tangible results of the program, such as improved services or
stakeholder benefits.
o Examines the program’s sustainability over the long term.

| Secondary Objective:

– Detection and Prevention of Error: Errors refer to unintentional mis statements in

the records or books. Errors are two types namely:
o Clerical or Technical Error:
i. Error of Omission: arises when a transaction has been omitted to be
recorded in the books of accounts either:
 Wholly (does not affect the agreement of the trial balance and
cannot be detected easily.) or
 Partially (affects the agreements of the trial balance and can be
detected easily)
ii. Error of Duplication: arise when an entry in a book of original entry has
been made twice and also been posted twice.
 iii. Error of Commission: refer to errors committed in the process of posting
from the subsidiary books to the ledger accounts, casting, carry forward
and balancing of ledger accounts.
iv. Compensation Error: When the effect of one error is counter balanced,
set off or compensated by another error. They do not affect the agreement
of the trial balance.

o Errors of Principle:
 arises when the generally accepted principles of accountancy are not
observed.
 They will not affect the agreement of the trial balance.
 Example: Capital expenditure recorded as revenue expenditure or vice
versa, capital receipt recorded as revenue receipt or vice versa

– Detection and Prevention of Fraud: It is intentional or wilful representation or

deliberate concealment of material fact with a view to deceive, cheat or mislead
somebody.
o Misappropriation of cash: Misappropriation of cash is done by:
 theft of cash receipts, petty cash, cheques, negotiable instruments,
 showing fictitious (false, fake) payments to workers, creditors, etc.
misappropriation of cash is very easy.

o Misappropriation of goods: The misappropriation of goods is easy in case

of a business which produces or deals in goods of high value and less bulky. It
is not easy to detect the misappropriation of goods.
 Issuing false credit note to customers for sales returns and such goods
are misappropriated.
 Goods may be stolen by employees from the godowns.

o Manipulation of Accounts: Generally committed by upper level of

management (Managers, Directors, Board of directors) to mislead certain
parties within or outside the business. It usually involves large amounts,
and it is intentional.

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Features of Auditing:

These features highlight the significance and role of auditing in financial management and
accountability:

a. Accounting Control: Auditing serves as a mechanism to ensure the accuracy and

fairness of accounting information by scrutinizing and verifying financial records.

b. Safeguard: Auditing acts as a safeguard for the owners or stakeholders against

misuse, negligence, or fraudulent activities concerning their assets and resources.
 c. Assurance: It provides assurance to the owners that financial accounts reflect
accurate information and that expenditures are incurred with due regularity and
propriety.

d. Assessment: Auditing assesses the effectiveness of the accounting system to

determine whether it adequately records and reports financial transactions.

e. Review: Auditing involves reviewing financial statements to confirm that they align
with the underlying accounting records and accurately represent the organization's
financial position.

f. Reporting Tool: Auditing serves as a reporting tool, fulfilling the requirements

specified in the auditor's appointment terms and complying with relevant statutory
obligations.

g. Practical Subject: Auditing is a practical discipline, involving real-world application

and adaptation to evolving commercial and legal landscapes. It has evolved over
centuries, with significant advancements in recent years, reflecting changes in
business practices and regulatory requirements.

These features collectively emphasize the integral role of auditing in maintaining

transparency, accountability, and trust in financial reporting and management processes.

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Advantages of Auditing:
Auditing offers several advantages from various perspectives:

[From a Legal Point of View:]

a. Filing of Income Tax Return: Qualified auditor-prepared profit and loss accounts are
generally accepted by income tax authorities, simplifying the process of filing income tax
returns.

b. Borrowing of Money from External Sources: Audited balance sheets enhance

credibility and facilitate borrowing from external sources like financial institutions, which
often require audited financial statements for loan approvals.

c. Settlement of Insurance Claims: Insurance companies may settle claims based on

audited accounts from previous years, providing a reliable basis for compensation in
cases of unforeseen events like fire or flood.

d. Sales Tax Payments: Sales tax authorities typically accept audited books of accounts,
easing the process of sales tax payments.

e. Action against Bankruptcy: Audited accounts serve as a basis for determining actions in
bankruptcy and insolvency cases, aiding stakeholders in making informed decisions.
[From an Internal Control Point of View:]

a. Quick Discovery of Errors and Frauds: Regular audits facilitate the early detection of
errors and frauds, discouraging their recurrence and ensuring the accuracy and integrity of
financial records.

b. Moral Check on Employees: The auditing process encourages vigilance among

accounting personnel, as they know that auditors will report any discrepancies or
irregularities.

Advice to Management:

a. Consultation with Auditors: Management may seek advice from auditors on

technical matters, though it's not the auditor's primary duty to provide advice.

b. Uniformity in Accounts: Audited accounts prepared uniformly enable easy

comparison between different accounting periods, helping identify discrepancies and
investigate their causes.

[From External Affairs Point of View:]

a. Settlement of Accounts: Audited accounts aid in settling the accounts of a deceased

partner or in resolving other external financial matters.

b. Valuation of Assets and Goodwill: Audited financial statements provide a reliable basis
for valuing assets and goodwill in the event of a business sale.

c. Assessment of Future Business Trends: Future business trends can be assessed with
certainty using audited books of accounts, aiding in strategic planning and decision-
making.

These advantages underscore the importance of auditing in ensuring financial transparency,

accountability, and informed decision-making for all stakeholders involved.

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Limitations of Auditing:
The limitations of auditing highlighted in your provided text are important considerations in
understanding the scope and effectiveness of audits:

a. Want of Complete Picture: Audits may not uncover fraudulent activities if accounts are
intentionally prepared to deceive auditors.

b. Problems of Dependence: Auditors rely on information provided by staff and clients,

which may not always be accurate or complete.

c. Post-mortem Examination: Auditing is retrospective and may not prevent events that
have already occurred.
d. Existence of Errors: Auditors cannot check every transaction, leading to potential errors
in audited accounts.

e. Lack of Expertise: Auditors may need expert opinions on certain matters, but these
reports may not always be accurate.

f. Diversified Situations: Auditing encounters diverse situations, making it challenging to

create standardized audit programs.

g. Quality of the Auditor: Audit effectiveness depends on the sincerity and diligence of the
auditor, which can vary among individuals.

h. Existence of Defective Policies: Auditors can only report on financial statements' truth
and fairness and may not address other management and control defects.

Acknowledging these limitations helps stakeholders understand the inherent challenges in

auditing and the need for complementary measures to ensure comprehensive oversight and
accountability within organizations.

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Types of Audits:

On the basis of Organisation:

| Statutory Audit:

 Mandated by law or statute and is legally required for certain types of

organizations.
 Typically conducted for entities such as corporations, government agencies, and
non-profit organizations.
 Ensures compliance with relevant laws, regulations, and accounting standards.
 Provides assurance to stakeholders regarding the accuracy and fairness of the
financial statements.
 Helps maintain transparency and accountability in financial reporting practices.

| Voluntary/Private Audit:

 Not legally required and initiated by the organization based on its own discretion
 Undertaken for various reasons such as improving internal controls, enhancing
credibility, and obtaining financing
 Funded and organized by the organization itself.
 Scope and objectives can be tailored to meet the specific needs and goals of the
organization.
 Provides additional assurance to stakeholders and demonstrates commitment to
transparency and accountability.

**From 1985 onwards, if the private concern turnover is more than 40 lakh, audit
has been made compulsory.**

On the basis of Functions:

| Internal Audit:

 Conducted internally by the organization's own employees or a dedicated internal

audit department.
 Focuses on evaluating and enhancing the effectiveness of risk management, control,
and governance processes.
 Assesses various aspects of the organization's operations, including financial
reporting, compliance, and operational efficiency.
 Provides valuable insights and recommendations to management for improving
organizational performance and mitigating risks.
 Helps in identifying weaknesses in internal controls and implementing corrective
measures to address them.

| External Audit:
  Conducted by independent audit firms or certified public accountants (CPAs)
external to the organization.
 Primarily focused on providing an independent and objective assessment of the
organization's financial statements.
 Examines financial records, transactions, and internal controls to express an opinion
on the fairness and accuracy of the financial statements.
 Enhances the credibility and reliability of the financial information for external
stakeholders, such as investors, creditors, and regulatory authorities.
 Helps in maintaining transparency, accountability, and trust in the organization's
financial reporting processes.

Time-Based Approach:
| Continuous Audit:
– Ongoing process where auditing activities are conducted continuously throughout
the year.
– Utilizes real-time data monitoring and automated auditing techniques.
– Provides immediate detection of errors, fraud, and irregularities.

| Interim Audit:
– Conducted at specific intervals during the financial year, typically between
annual audits.
– Helps in identifying potential issues early and making necessary adjustments
before the annual audit.
– It is conducted in between two annual audits, with a view to find the interim
profits of the business.it is done is case of declaration of interim dividend.

| Periodic Audit:
– Conducted at regular intervals, usually annually, to examine the financial
statements for the entire fiscal year.
– Provides a comprehensive review of the organization's financial performance
and compliance with regulations.
– Often required by regulatory bodies or stakeholders.

Scope-Based Approach:
| Complete Audit:

– Involves a thorough examination of all financial transactions, accounts, and

internal controls.
– Provides comprehensive assurance regarding the accuracy and completeness of
the financial statements.
– Covers all aspects of the organization's operations and financial reporting.
| Partial Audit:

– Focuses on specific areas, accounts, or transactions identified as high-risk or

significant.
– Provides targeted assurance for particular aspects of the organization's
operations.
– Allows auditors to concentrate resources where they are most needed.

Objective-Based Approach:
| Balance Sheet Audit:
– Primarily focuses on verifying the accuracy and reliability of the balance sheet
accounts, including assets, liabilities, and equity.
– Emphasizes the assessment of financial position and the valuation of assets and
liabilities.

| Occasional Audit:
– Conducted in response to specific events or circumstances, such as mergers,
acquisitions, or suspected fraud.
– Addresses unique or irregular situations that require independent examination
and assurance.

| Standard Audit:
– Follows established auditing standards and procedures to assess the organization's
compliance with regulatory requirements and accounting principles.
– Provides regular assurance on the organization's financial statements and internal
controls.

On the basis of Audit Dimensions:

a. Tax Audit: It ensures that organizations comply with tax laws and regulations,
reviewing tax returns and financial records to verify accuracy and completeness in tax
reporting.

b. Management Audit: This audit evaluates how effectively management decisions

and strategies are implemented, examining processes, procedures, and controls to
identify areas for improvement in organizational performance.
c. Human Resource (HR) Audit: It assesses HR practices and policies to ensure
alignment with organizational goals, reviewing aspects such as recruitment, training,
performance management, and employee relations.

d. System Audit: This audit focuses on examining IT systems, networks, and controls
to ensure data integrity, confidentiality, and availability, safeguarding against
cybersecurity threats and vulnerabilities.

e. Proprietary Audit: It emphasizes protecting intellectual property rights and

confidential information, reviewing policies and procedures to prevent unauthorized
disclosure and misuse of proprietary assets.

f. Performance Audit: This audit evaluates the efficiency and effectiveness of

programs and operations, assessing whether resources are used efficiently and whether
desired outcomes are achieved.

g. Environmental Audit: It examines an organization's impact on the environment,

reviewing compliance with environmental regulations, assessing pollution prevention
measures, and identifying opportunities for sustainability improvements.

h. Social Audit: This audit assesses an organization's social responsibility efforts,

including community engagement, philanthropy, diversity and inclusion initiatives,
and ethical business practices.

i. Cash Audit: It verifies the accuracy of cash transactions and balances, ensuring
proper controls and safeguards are in place to prevent fraud and misappropriation of
funds.

j. Energy Audit: This audit evaluates energy consumption patterns, identifies areas for
energy efficiency improvements, and recommends strategies to reduce energy costs
and environmental impact.

k. Secretarial Audit: It ensures compliance with legal and regulatory requirements

related to corporate governance, reviewing board procedures, shareholder
communication, and regulatory filings to maintain transparency and accountability.

Special Audit
A special audit, also known as an investigative or forensic audit, is conducted in response to
specific circumstances such as suspected fraud or financial irregularities. It involves a
detailed examination of financial records and internal controls beyond the scope of
regular audits. Special audits are typically carried out by external auditors or forensic
accounting firms to ensure independence. The findings are documented in a report and may
be used as evidence in legal or regulatory proceedings. These audits are crucial for
uncovering and addressing financial misconduct and ensuring compliance with laws and
regulations.

• Conducted by central government for some special purpose.

 • Under section-233 A of companies act,1956, a central government appoint special
auditor under following circumstances:
• Management of company is detrimental to the interest of shareholders of the
company.
• When financial position is continuously deteriorating.

• Business principles are not followed.

Auditor Is Watchdog, Not A Blood Hound

Case: Kingston cotton mills company (1986)

"An auditor is not bound to be detective and to work with their suspicion, that there is
something wrong. He is a watchdog not a blood hound. He is justified in believing
tried servant of the company and is entitled to rely upon their representation provides
he takes reasonable care”.
Auditor is Watchdog, not a Blood Hound it means as the dog always think about the
owner as it the same way an auditor always thinks about the owner of the company. It
is the responsibility to find true and fair value of the business and gives all the details
(errors and frauds) of nil the business. But this task is so difficult because people tried
who arise fraud in the company gives wrong information to the company.
Duty of the auditor is not to harm the other person. He is always sincere, systematic,
honest, truthful, and tactful. An auditor has a professional knowledge and expert in
own field. In case of any unwanted situation. The remedial action has to come from
the owner of the entity. He has to discharge his responsibility by informing about the
irregularity found in the audit.