PRACTICAL AUDITING

( REFERENCE NOTES – UNIT I )

ACCORDING TO REVISED SYLLABUS

OF
UNIVERSITY OF MADRAS

Ms. B. BINDU SINGH

ASSISTANT PROFESSOR
DEPARTMENT OF COMMERCE - GENERAL
A.M. JAIN COLLEGE
MEENAMBAKKAM, CHENNAI.

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 PRACTICAL AUDITING
UNIT I : Introduction

1. Auditing - Meaning & Definition - Distinction between Auditing and Accounting -Objectives -
Advantages and Limitations – Scope of audit.
2. Classifications of Audit.
3. Audit Planning - Meaning.
4. Audit Programme - Meaning - Objectives and Contents.
5. Audit Note Book – Contents - Usefulness of Audit Note Book.
6. Audit working papers – Meaning - Ownership and Custody.
7. Test checking and Routine checking - Meaning.
8. Internal control - Meaning - Definition - Objectives - Techniques for evaluation of IC.
9. Internal check - Meaning – Objectives.
10. Internal Audit - Difference between Internal control, Internal check and Internal Audit .

Meaning and Definitions

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.

 According to Spicer and Pegler, ―An audit may be said to be such an examination of the books,
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 the affairs of the business,
and whether the profit and Loss Accounts gives a true and fair view of profit or loss for the financial
period, according to the best of his information and the explanations given to him and as shown by
the books and if not, in what respect he is not satisfied‖.

 ―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
IMPORTANCE OF AUDITING
 Audited accounts help a sole trader in knowing the value of the business for the purpose of sale.
 Dispute over correctness of profits can be avoided.
 Shareholders, who do not know about day-to-day administration of the company, can judge the
performance of management from audited accounts.
 It helps management in detecting and preventing errors and frauds.
 Management gets advice on financial affairs from the auditors.
 Long and short term creditors depend on audited financial statements while taking decision to grant
credit to business houses.
 Taxation authorities depend on audited statements in assessing the income tax, sales tax and wealth
tax liability of the business.
 Audited accounts are useful for the government while granting subsidies etc.
 It can be used by insurance companies to settle the claims arising on account of loss by fire.
 Audited accounts serve as a basis for calculating purchase consideration in case of amalgamation
and absorption.
 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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 DISTINCTION BETWEEN ACCOUNTING AND AUDITING
Criterion Accounting Auditing
Accounting is keeping records of the Auditing is critical examination of the
Definition financial transactions and preparing financial financial statements to give an opinion
statements on their fairness
Continuous with daily recording of financial Periodic process and carried out after
Timing
transactions the preparation of final accounts
Beginning Starts where book-keeping ends Starts where accounting ends.
Concentrates on the current financial Concentrates on the past financial
Period
transactions and activities statements
All transactions, records and statements
Coverage Final financial statements and records.
having financial implications
Level of Very detailed and captures all details related Uses financial statements and records
Detail to financial transactions and records on sample basis.
Type of Checking details related with all financial Carried out through test checking or
Checking records sample checking.
To accurately record and present all To verify the accuracy of the financial
Focus
financial transactions and statements. statements
To determine the financial position, To add credibility to the financial
Objective
profitability and performance. statements
Legal Status Governed by Accounting Standards Governed by Standards on Auditing
Performed by Accountants Auditors.
Carried out by an external person or
Status Carried out by an internal employee
independent agency
Appointment By the management By the shareholders
Some specific qualification is
Qualification Specific qualification is not compulsory
compulsory
Remuneration Salary Auditing fee
Remuneration
By the management By the shareholders
Fixation
Scope Determined by the management Determined by the relevant laws
Necessary for all organizations in the day-to- Not necessary in the day-to-day
Necessity
day or routine operations operations
Deliverables Financial statements e.g. Balance Sheet, Audit Report
Report
To the management To the shareholders
Submission
Accountants may make suggestions for the
Auditor usually does not make
Guidance improvement of accounting and related
suggestions
activities
Liability Ends with the preparation of the accounts After submission of the audit report
Shareholders‘
Accountant does not attend Auditor may attend
Meetings
Professional Accountant is not usually prosecuted for Auditor can be prosecuted for
Misconduct professional misconduct professional misconduct
Removal By the management By the shareholders

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 OBJECTIVES OF AUDITING
1. Primary Objective:
The Primary objective of the auditing is to find reliability of financial position and profit and loss
statements. The objective is to verify and establish that at a given date balance sheet and the profit &
loss account presents true and fair view of financial position of the business for the accounting period.
Thus the main objective of auditing is to form an independent judgement and opinion about the
efficiency and accuracy of accounts and truth and fairness of financial state of business.

2. Secondary objectives:

A.) Detection and Prevention of Fraud

Fraud means false representation or entry made intentionally or without being in its truth with a view
to defraud somebody. Fraud may involve:
o Manipulation, falsification or alteration of records or documents
o Misappropriation of assets.
o Suppression of effect of transactions from records or documents.
o Recording of transactions without substance.
o Misapplication of accounting policies

Types of Fraud

1. Misappropriation of Cash : (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 amounts on the payment side of the Cash Book
than what has been actually paid.

2. Misappropriation of Goods : This type of fraud is very difficult to detect especially when the
goods are less bulky and are of higher value.

3. Fraudulent Manipulation of Accounts : This type of fraud is more difficult to discover as it is

usually committed by directors or managers or other responsible officials. Such a fraud is committed
with the following two objects :-
 Window Dressing: In window dressing, accounts are manipulated in such a manner to reveal a
much better and sound financial position of the business than what actually it is, in order to
mislead the outsiders by inflating the profit, or to borrow money by showing a better position, etc.
 Secret Reserves: Accounts are prepared in such a manner that they disclose a worse financial
position than the real. The real picture of the business is concealed and a distorted one is
revealed to reduce or avoid the payment of income tax or to mislead a prospective buyer of the
business etc.

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B.) Detection and prevention of Errors:
Errors are the carelessness on the part of the person preparing the books of accounts or committing
mistakes in the process of keeping accounting records. 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, totaling and balancing. Such errors may again 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 anywhere in account books.
(ii) Errors of Commission Errors which are not supposed to be committed or done by
carelessness are called as Error of Commission. Such errors arise in the following ways:
(1) Error of Recording, (2) Error of Posting, (3) Error of casting, or Error of Carry-forward.
Following are the examples of such errors :
 Debiting or crediting one account instead of the other. These two errors do not affect the
agreement of Trial Balance,
 Wrong balancing of an account.
 Error in writing amount in an account. For example, debiting Prem Chand‘s Account with Rs. 107-
instead of Rs. 100/-.
 Casting of the same amount to two accounts.
 Posting of an amount on the wrong side.
 Posting in one account and omitting of posting in the other account.
 Error in carrying forward the total of a subsidiary book or an account from one page to the other.
These errors affect the agreement of Trial Balance.

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 a capital
expenditure, say expenses incurred in constructing a godown, may be treated as a revenue
expenditure or vice versa.

c). Errors of Compensation:- 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
neutralized by that of another on credit (or debit) side. For example Rani‘s account was to be debited
with Rs.10, but it was debited with Rs. 100 similarly Shyam‘s account was debited with Rs. 10 instead
of Rs.100. Both these errors compensate each other‘s deficiency and will not affect the agreement of
the Trial Balance.

d). Errors of Duplication: Errors of duplication arise when an entry in a book of original entry has
been made twice and has also been posted twice. These errors do not affect the agreement of trial
balance, hence it can‘t located easily. Example: Amount paid to Anbu, a creditor for Rs. 75,000
wrongly accounted twice to Anbu‘s account.

Advantages of Auditing
A. For Business itself :
 The financial position of a business can be examined by an independent and qualified auditor.
 Helps in quick discovery of errors and frauds .
 Moral check on the Employees
 Loans and credit can easily be obtained from banks and other money lenders.
 The business itself enjoys better reputation due to audited accounts.
 Advice to the management in proper decision making.
 Audit is useful in case of a business managed by some agent or representative of its owner.
 Uniformity in accounts if the accounts have been prepared on a uniform basis, accounts of one year
can be compared with other years and future trends may be detected.

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 B. For the owners of Business:
 If the business is owned by a sale trader, he can rely well on the audited accounts.
 In case of partnership firm, its partners can utilize the audited accounts to settle their disputes in
regard to adjustment of capital and valuation of goodwill at the time of admission, retirement and
death of a partner.
 In case of a joint stock company, Shareholders living at distant places can rely on audited accounts
and can be sure of their investment being safe with the company.
 In case of a trust, its trustees can easily make their position clear before others by getting the
accounts audited by an outside auditor.
C. For others:
 Income Tax authorities generally accept the profit & loss account that has been prepared by a
qualified auditor.
 In case of fire, flood and the like unexpected happenings, the insurance company may settle the
claim for loss or damages on the basis of audited accounts of the previous year.
 The taxation authorities rely on audited accounts for the purpose of imposing sales tax, wealth tax,
expenditure-tax etc.
 The audited accounts forms a basis to determine action in bankruptcy and insolvency cases.
 The future trends of the business can be assessed with certainty from the audited books of accounts.

Limitations of Auditing

1. Gives only Opinion: After the completion of audit, an auditor gives only the opinion regarding true
and fair view of the books of accounts and financial position of the business. Therefore, an auditor is
not an insurer; he does not give guarantee regarding financial reflections of the business.
2. Chances of Undisclosed Errors and Frauds: An Auditor has to depend on many financial data
and statements supplied by the management which may be wrong or misleading. Therefore, there
may be some undisclosed errors and frauds in the books of accounts.

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3. Lack of Proper Care and Skill: Often it is seen that an Auditor does not apply proper care and
skill to verify the books of accounts and take it as a routine matter. As a result, the books of accounts
do not reflect true and fair view of the financial position of the business.
4. No Evaluation of Managerial Efficiency: An Auditor is not an advisor, therefore, he cannot give
his opinion regarding managerial efficiency because every concern has its own policy, procedures
and practices.
5. Not Preventive: Audit is a post-mortem examination. The work of audit starts after the completion
of transactions recorded in the books of accounts. Therefore, audited accounts can prevent the future
activities but not the past.

Scope of Auditing
Legal Requirements
The auditor can determine the scope of an audit of financial statements following the requirements of
legislation, regulations or relevant professional bodies.
Entity Aspects
The audit should be organized to cover all aspects of the entity as far as they are relevant to the
financial statements being audited.
Reliable Information
The auditor should obtain reasonable assurance as to whether the information is reliable and
sufficient as the basis for the preparation of the financial statements.
Proper Communication
The auditor should decide whether the information is properly communicated in the financial
statements.
Evaluation
The auditor assesses the information by making a deep study and evaluation of accounting systems
and internal controls to determine the nature, extent, and timing of other auditing procedures.
Tests
Auditing checks the reliability and sufficiency of the information through the tests, inquiries and
other verification procedures of accounting transactions and account balances.
Comparison
The auditor can compare the accounting records with financial statements to check that the same has
been processed for preparing the final accounts of a business concern.
Judgments
The auditor determines whether the relevant information is properly communicated by considering the
judgment that management has made in preparing the financial statements, accordingly.

CLASSIFICATION OF AUDIT
Audit may be classified into three categories mainly; - (a) Classification on the basis of organization;
and (b) Classification on the basis of functions (c) Classification on the basis of Approach

A. CLASSIFICATION ON THE BASIS OF ORGANIZATION

1. Statutory Audit
In case of many undertakings, audit is made compulsory under statute because these undertakings
are established by statute. The audit of their accounts is termed as statutory audit
a.) 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. This department is headed by the
Comptroller and Auditor General of India who is assisted by different officials at various levels.
b.) Non-Government Audit
(i) Company Audit: It is legally compulsory for joint-stock companies in India to get their accounts
audited by an independent professional auditor and subsequent amendments have made
tremendous changes in the rights, duties, powers etc., of an auditor.

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(ii) Audit of Trusts: Trusts are usually created for the benefit of the weak and helpless sections.
Therefore the trustees are made responsible to look after the property and to maintain accounts. But
in a large number such accounts are very often misleading. To avoid such a situation appointment of
auditors is done to check the accounts of the trusts.
(iii) Audit of other institutions: There are corporate bodies such as electricity and gas companies
and other set of public bodies in the name of public corporations, for example, Reserve Bank of India,
Industrial Financial Corporation, etc.; which work according to the various Acts passed for the
purpose. All these institutions fully recognise the significance of a professional audit which is
compulsory for them.

2. Voluntary Audit – Private Audit.

a.) Audit of the accounts of Sole Trader: The appointment of an auditor in case of a proprietary
concern rests absolutely on the proprietor. His rights, duties and nature of work will depend upon the
terms given in the agreement. Such an auditor must get clear instruction in writing by his client as to
what he has to do and how he has to proceed so that he can be held responsible for any charge of
negligence and by producing the agreement, he can protect himself against such a charge.
b.) Audit of the Accounts of partnership Firms: In case of a partnership firm, the auditor is
appointed by agreement between the partners. His rights, duties and liabilities are also defined by
mutual agreement and can be subjected to modification.
c.) Audit of the accounts of other individuals and institutions: There are other individuals, e.g.,
rent collectors, estate managers, etc., who have large income and huge expenditure. The qualified
auditors are appointed by these individuals in order to verify various accounts prepared by the
accountants.

B. CLASSIFICATION ON THE BASIS OF FUNCTIONS

1. External Audit
This type of audit is usually conducted to fulfill the requirement of the provisions of law. Qualified
chartered accountants can be appointed as external auditors. He is an independent professional who
does not have any such relationship with the enterprise.

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 Features of external audit
 External audit is usually conducted by an independent qualified auditor.
 In the normal course, this type of audit is conducted periodically.
 The purpose of external audit is to see whether financial statements give a true and fair view of
the financial position and result of the concern.
 The external auditor can work independently, and enjoys better status.
 The Indian Companies Act, 1956 and other statutes provide the area of responsibilities and
functions of the external auditors.
 The auditor must have a professional qualification.
 This type of audit is conducted mainly for safeguarding the interest of owners, shareholders and
other parties who do not have knowledge of day-to-day operation of the organizations.
2. Internal Audit
Internal audit is conducted by specially assigned staff within the organization. It is an audit through
which a thorough examination of the accounting transactions as well as the system according to
which these transactions have been recorded is conducted.
Features of internal audit
 The internal audit system is considered to be a part of the management control system.
 Internal audit often differs in its scope and emphasis. It is more managerial than accounting.
 The nature and extent of checking also depends on the size and type of the business
organization.
 It embraces not only the audit of various operational activities in the organization but also includes
the audit of management itself.
 The function of internal audit can be considered as an integral part of the internal control system.
 Internal audit is continuous in nature. The work starts after the transactions are completed.
 Generally the internal audit is conducted by the permanent staff of the organization. Sometimes
outside agencies may be asked to conduct internal audit.
 The existence of internal audit is a help to the external auditor.

Differences between External Audit and Internal Audit

Criterion External audit Internal audit
It is conducted with a view to check
It is conducted for reporting on the reliability adherence to norms and established
1. Nature
and fairness of the financial statements. procedures and protects the assets of
the organization.
The auditor must possess specific
No specific qualification is required to
2. Qualifications qualification as prescribed by the respective
be possessed by the internal auditor.
statute.
This type of audit must be complete in all
3. Scope of The scope of work of the internal audit
respects. Its scope cannot be curtailed in
work is determined by the management.
any way by the management.
The object of this type of audit is to protect The basic objective of internal audit is
4. Purpose the interest of the owners and other parties to improve performance, efficiency and
related to the enterprise. profitability of the enterprise.
The external auditors are usually appointed
5. Appointment The internal auditor is appointed by the
by the owners and in some cases by the
of an auditor management.
government.
The internal auditor is an employee of
The auditor is an outsider and independent
the organization. He is bound by the
6. Status person. He is not under any rules and
rules and regulations of the
regulations of the organization.
organization.
External audit may be periodical or Internal audit is continuous in nature. It
7. Continuity
continuous in nature. is carried out throughout the year.

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 C. CLASSIFICATION ON THE BASIS OF APPROACH

BASED ON TIME
1. Continuous Audit or Detailed Audit:- A continuous Audit is one where the auditors staff is occupied
continuously on the accounts the whole year round, or where the auditor attends at intervals, fixed or
otherwise, during the financial year.
Advantages of Continuous Audit : Disadvantages of Continuous Audit:
 Easy and quick discovery of Errors and frauds  Alteration of figures
 Quick presentations of accounts  Dislocation of client‘s work
 Keeps the client‘s staff regular  Expensive
 Moral cheek on the client‘s staff  Queries may remain
 Audit staff can be kept busy  Mechanical work

2. Periodical or Final or Complete Audit:- That system under which the auditor takes up his work of
checking the books of account and other related documents, only at the end of the accounting period
when the transactions for the whole period are completely recorded, balanced and a Trading profit and
Loss Account and the Balance Sheet have been prepared, is known as periodical or final audit.
Advantages :
 The work of audit does not present any inconvenience as the auditor comes only once a year.
 It is less expensive and more useful for small business concerns.
 In periodical audit the work of the auditor can be finished quickly and within a reasonable time.
 The audit work does not become mechanical for the auditor.
 Undue collusion is not established between the auditor and the clerks.
Disadvantages :
 In periodical audit, detailed checking of accounts is not possible.
 There is a greater chance of errors and frauds in accounts as the auditor visits his client only once a
year.
 If such an audit is undertaken in large concerns it takes more time to complete the audit

Distinction between continuous Audit and final Audit

(i) Under continuous audit, the auditor or his staff, for the purpose of checking the accounts, visits his
client‘s at regular or irregular interval during the financial year. On the other hand, in case of final audit,
he visits the client only at the end of the accounting period.
(ii) In continuous audit, the audit work is carried on almost simultaneously with the recording of
transactions, while in final audit, accounts are audited much after their recording.
(iii) Continuous audit is commenced and carried on before the close of the financial period to which it is
related. While final audit is undertaken when all the accounts have been recorded, balanced and a
Trading and Profit and Loss Account and the Balance Sheet have been prepared.

3. Interim Audit:- Interim audit is one which is conducted in between the two annual audits for some
interim purpose, say, to enable a company to declare an interim dividend. This kind of audit involves a
complete checking of the accounts prepared by a company for a part of the year to the date set of
interim accounts, say, quarterly or half-yearly accounts.
Advantages :
 This audit is helpful when the publication of interim figures becomes necessary.
 With interim audit, the final audit can be completed easily and within short period of time.
 Errors and frauds can be more quickly found and detected during the course of the year.
 It helps in exercising moral check on the staff of the client.
Disadvantages :
 There is greater possibility of altering figures in the accounts which have already been audited.
 Interim audit involves additional work as the audit staff will have to prepare notes after finishing the
interim audit.

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 Distinction between Continuous Audit and Interim Audit
(i) In case of continuous audit, the auditor undertakes the audit work for the whole financial year at
intervals according to client‘s own need and convenience, while in interim audit, the audit, work is
done only up to a definite date.
(ii) Under continuous audit, verification of Assets and Liabilities is done at the close of the financial
year, but under interim audit, this work is done at the time of audit.
(iii) When continuous audit is done, the trial balance is not to be prepared necessarily at intervals, but in
case of interim audit, the trial balance has to be prepared.
(iv) The auditor has to give the report at the close of financial year when continuous audit is done, but in
case of interim audit, such a report is to be submitted at the time of audit.

BASED ON SCOPE
1. Complete Audit:- It is one which is taken up at the close of the financial period, when all the accounts
have been balanced and final accounts have already been prepared.
Advantages
 Inexpensive Disadvantages
 Quick completion of audit  Delay in presentation of accounts
 Minimum chances of alteration  Preparation of interim accounts
 Less disturbance in client‘s work  Possibility of undetected errors and frauds
 Preparation of audit schedule  Fixation of audit programme
 Requirement of small establishment

2. Partial audit
It is a kind of audit where the work of the auditor is curtailed. The auditor is asked to check a few books.
For example, In case of a very big proprietary concern, it may not be possible for the proprietor himself
to disburse all payments and if he suspects misappropriation of cash, he may appoint an auditor to
check only the cash book. When an auditor is appointed to conduct partial audit, he must make it clear
in his report that he has performed partial audit as per the instructions of the client.
Advantages
 It serves the specific interest of the client.
 Scope for quick service, as he has to deal with only one or two aspects of business transactions.
 Critical analysis of the books of account relating to a particular item is made possible.
 It may act as a moral check on the part of persons who intend to falsify accounts.
Disadvantages
 The conduct of this type of audit is strictly restricted under the Companies Act.
 The audit report does not reflect the financial position of the business as a whole.
 This type of audit is conducted only for a particular purpose.

BASED ON OBJECTIVE
1. Balance Sheet Audit :- Under such an audit, the auditor checks capital, reserves, assets, liabilities,
etc., given in the Balance Sheet. Those items of Trading and Profits and Loss Account are also
checked which have a bearing on the Balance Sheet items. This type of audit is more popular in USA
than in England and other European countries.
Advantages
 This type of audit furnishes different information relating to over-capitalization, under-capitalization,
over-trading and under-trading of the business.
 It establishes proper relationship between assets and liabilities of the business.
 It guides different parties interested in the affairs of the business in taking business decisions.
Disadvantages
 It lacks in disclosing certain material information needed to evaluate different measuring bases.
 Balance sheet reflects the financial position of the business only at a given point of time. Events
occurring after balance sheet date may affect materially the process of decision.

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  Comparison between the two periods may be drawn, but the causes for the change of figures
between the two periods are not stated.
2. Occasional Audit:- An audit which is conducted occasionally, that is, once a while whenever the need
arises and the client desires it to be undertaken. For ex: the audit is not compulsory for partnership
business but whenever the need arises, the owners can get the accounts audited.
Advantages
 The client can know its actual financial position on the date when the books of accounts are audited.
 It brings satisfaction in the mind of the client that the audited accounts are accepted by all.
 Impartial view can be expressed through the procedure of audit.
 It can be profitably used in small concerns.
Disadvantages
 The conduct of this audit brings some confusion about the authenticity of final audit in a big concern.
 It is expensive to operate.
 The books of accounts may not be available according to the requirement of audit procedures.

3. Standard Audit
Standard audit can be defined as a ―complete check and analysis of certain items and contingent upon
effective internal check, appropriate test checks on remaining items, the whole of work being in
accordance with general auditing standards.‖
Advantages
 Development of new auditing standards in view of changing socio-economic condition can be made
possible through scrutiny of auditing standards so far established.
 It controls the nature and extent of documents and evidences which are obtained through the
procedure of an audit.
 It influences the audit programme.
 The destructive criticism often made by the general public that the management, in collusion with
auditor, distorts the financial statements may be rooted out through the application of standard audit
procedures.
Disadvantages
 It is very difficult to bring all organizations under the same accounting practices for the uniform
application of standard audit.
 The application of a particular standard procedure to different organizations having different
standards may invite chaos instead of development.
 Standards are always subject to change of circumstances, nature and environment of business.
 Finally, setting up a standard narrows the development of standard.

CLASSIFICATION ON THE BASIS OF AUDIT DIMENSION

Management Audit
Management audit is a comprehensive critical review of all aspects of the management process. In fact,
it is a tool of management control. It covers all areas of management like planning, organising, co-
ordination, control etc. In short, management audit is a guide which helps in improving the efficiency of
the management.
Cost Audit
Cost audit is an effective means of control in the hands of the management to have an idea about the
working of the costing department of the organisation and to suggest ways and means for its smooth
running. It is the detailed checking as well as the verification of the correctness of the costing
techniques, systems and cost accounts.
Cash Audit
In the olden times, a person was appointed to check cash transactions only, i.e. whether the person
responsible for recording cash receipts and payments on behalf of the business owner has done his job
properly or not. Hence it was merely a cash audit. So, when an audit of all items of cash book, is
conducted it is known as cash audit.

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Tax Audit
Tax audit refers to audit of incomes or expenses or specific claims of deductions or exemptions for the
purpose of assessment of income tax.
Human Resource Audit
Disclosure of information regarding human resources in the annual report of the company may help a
lot to the investors in framing an opinion whether to invest or not.
System Audit
System audit is concerned with that method of checking, which is directed to ascertain whether the
accounting practices are up-to-date and economical and whether the existing practices are required to
be changed so as to do the work better, quicker and at less cost under the present conditions.
Propriety Audit
Propriety audit ensures that the public money has not been utilized for the benefit of a particular person
or section and all transactions have been activated for the best interest of the concern itself.
Performance or Efficiency Audit
Efficiency audit provides the means to appraise the performance of the enterprise and to diagnose the
weakness of the enterprise.
Environmental Audit
Environmental audit is an excellent management tool for relating productivity to pollution. In broader
sense, environmental auditing is the examination of accounts of revenues and costs of environmental
and natural resources, their estimate, depreciation and values recorded in the books of accounts.
Social Audit
The objective of social audit is to bring to light for public knowledge how far an organization has
discharged its responsibility to the society and to make an assessment of the social performance of an
organization.
Energy Audit
Need for conservation of energy is the most important parameter of modern day world. Energy audit is
focused to see whether right amount of energy, both organic and inorganic, is used by the enterprises
and there occurs no avoidable loss or waste of energy due to human indifference.
Secretarial Audit
A secretarial audit assures that the legal requirements of the corporate body have been duly complied
with and in time.
AUDIT PROCESS
An audit is a professional service to a client. Before commencing audit, an auditor must prepare himself
well. Preparation for an audit relates to audit planning, preliminary preparations by the auditor, audit
programme, audit note book, audit working papers, audit evidence, commencement of a new audit, test
checking, and routine checking.

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 AUDIT PLANNING

 Audit planning is the process of deciding in advance what is to be done, who is to do it, how it is to be
done and when it is to be done by the auditor in order to have an effective and efficient completion of
audit.
 Audit planning can be done only when, the auditor is having knowledge of the business of the client.
 Audit plans should cover knowledge about client‘s accounting systems and policies, internal control
procedures and coordinating the work to be performed.
 Plans should be flexible so that they can be developed or revised as and when required by the auditor.

The main objectives of audit planning are to ensure the following:

 That the auditing work is conducted efficiently and profitably
 That high standards of audit works are maintained, so that the risk negligence is minimized
 It is important that audit should be carefully planned to ensure that correct number of staff with
appropriate level of seniority are available when they are required.
 In case of large audits, the work must be planned so that maximum work is done on an interim basis
during the year. This has the double advantage of employing staff effectively throughout the year and
ensuring that the only audit work that is remaining at the year end is the work that could not be
performed earlier.

The auditor should prepare his audit plan after taking into consideration the following factors:
 Statutory requirement under the assignment
 Terms and conditions of engagement
 Nature and timings of reporting
 Significant audit areas
 Applicable legal provisions
 Reliability of accounting and internal control system
 Existing accounting practices followed
 Areas requiring special attentions
 Size of the company and nature of its operations.
 Accounting system, internal control and adherence to standard.
 Environment in which the company operates.
 Previous experience with the client; and
 Knowledge of client‘s business.

Benefits (or) Advantages of Audit Planning

 Accomplishment of Objectives
 Identification of Problems
 Timely Completion of Work
 Facilitates Coordination
 Better Audit Work

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 AUDIT PROGRAMME
Meaning & Definition
An audit programme is a detailed, written statement designed by the auditor indicating the work to be
performed by the audit assistants, specifying the time limit for completion of work, instructions and
guidance to the audit staff. In short, it is a tool for planning, directing and controlling the audit work.
Audit programme is generally contained in the audit notebook.

Features (or) Characteristics of an Audit Programme

 It is a set of procedures to be adopted to conduct the audit more efficiently.
 It is a written scheme designed by the auditor.
 It is a blue print of the audit work.
 It facilitates delegation of work, based on the capabilities of audit staff.
 It acts as evidence in future for the audit work being performed.
 It specifies the work to be done by the audit staff, the manner and time limit for completion of the work.

Objectives of Audit Programme

 To provide clear instructions to the audit assistants specifying the nature of work to be performed and
fixing the time span for completion of each work.
 To ensure uniformity in the performance of audit work and to avoid duplication and repetition of work.
 To attain a fair allocation of work among audit team.
 To fix responsibility and accountability of each audit assistant.
 To serve as guide and as well as evidence in future, showing the date of completion of audit work,
methods or procedures undertaken, persons involved in completion of audit work etc.

Types of audit programme

1. Predetermined audit programme: It offers procedural guideline or to serve as a ‗check off list‘. For
this reason, this predetermined audit programme is also known as tailor-made audit programme.
2. Progressive audit programme: The progressive form of audit programme is known as ‗skeleton‘ form
of audit programme. It sets forth briefly general scope, character and limitations of audit work.

Contents of an Audit Programme

1. Name of the client.
2. Nature of operations and business of client.
3. Review of system of internal check.
4. Date of commencement of audit work.
5. Duration of audit work.
6. Accounting system followed in client organization
7. Review the report of the previous auditor.
8. Review the remarks, instructions or objections raised in the previous audit report.
9. Examine the various ledger accounts and subsidiary books.
10. Examine the statutory books and registers, profit and loss account, and balance sheet.

Advantages of audit programme

1. Assurance of completion of work Disadvantages of audit programme
2. Information about work-progress 1. Loss of initiative
3. Simplification of work allocation 2. Want of flexibility
4. Guidance to the staff 3. Rigidity in programme
5. Defense against charge of negligence 4. Unsuitable for small concerns
6. Division of responsibility 5. No scope of changes
7. Final review of work 6. Concealment of incapacity of staff
8. Helpful to the new employees

Steps to be taken to overcome the disadvantages of written audit programme

1. Educating the audit staff 3. Rotation of work
2. Revision of audit programme 4. Overall supervision

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 AUDIT NOTEBOOK

Meaning & Definition

Audit Note Book is a register maintained by the audit staff to record important points observed, doubtful
queries, errors, explanations and clarifications to be received from the clients. It also contains definite
information regarding the day-to-day work performed by the audit clerks. In short, audit note book is
usually a bound note book in which a large variety of matters observed during the course of audit are
recorded. The note book should be maintained clearly, completely and systematically.

The audit notebook may be in two parts:

 For keeping a record of general information as regards the audit as a whole
 For recording special points which have been observed during the course of audit of the accounts of
different years

Objectives of audit notebook

1. Facilitates future audit
2. Documentary evidence
3. Helps in preparing audit report
4. Settlement of audit queries
5. Evaluation of work

Contents of audit note book

1. A list of books of accounts maintained by the clients
2. The names of the principal officers, their powers, duties and responsibilities
3. The technical terms used in the business
4. The points which require further explanations
5. The particulars of missing vouchers, the duplicate of which have to be obtained
6. The mistakes and errors discovered
7. Total or balances of certain books of accounts, bank reconciliation statement etc.
8. Notes and queries which might be required at a subsequent audit
9. The points which have to be incorporated in the audit report
10. Any matter which requires discussions with the senior officials or with the auditor
11. Accounting method followed in the business
12. Date of commencement and completion of audit
13. Provisions in the Articles and Memorandum of Association affecting the accounts and audit
14. Abstracts from minutes, contracts etc. having a bearing upon accounts
15. Particulars of accounting and financial policies followed

Advantages of Audit Note Book

1. Facilitates Audit Work
2. Preparation of Audit Report
3. Serves as Documentary Evidence
4. Serves as a Guide
5. Evaluating Work of Audit Staff
6. Fixation of Responsibility
7. No Dislocation of Audit Work

Disadvantages of Audit Note Book

1. Fault-finding Attitude
2. Misunderstanding
3. Improper Preparation
4. Adverse Effects on Subsequent Audits

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 AUDIT WORKING PAPERS

Meaning & Definition

Arnold W. Johnson - ‗‘ Audit working papers are the written private materials, which an auditor prepares
for each audit. They describe the accounting information which he receives from his client, the methods
of examination used, the conclusions (and reasons thereof) and the financial statements.‖
Thus, all the documents gathered or prepared by auditors during the course of an audit constitute audit
working papers, but broadly these are two types:
 Working papers prepared by the auditor himself, like audit note book, audit program, details of queries
made and their explanations thereof.
 Working papers collected by the auditor from the client, like schedule of debtors and creditors,
management representations, confirmations etc.,

Purpose / Objectives of working papers

1. They show the extent of adherence to accounting principles and auditing standards.
2. They are useful as evidence against the charge of negligence.
3. They assist the auditor in co-ordinating and organizing the work of audit assistants.
4. They ensure the possibility of quick preparation of audit report.
5. Through the working papers, the auditor can know the distribution and accomplishment of work.
6. Measurement of the efficiency of the assistants can be done with the help of working papers.
7. They can be used as permanent record for future references.
8. They can act as a means to give training to the audit clerk.
9. They provide a means to control the ongoing audit work.
10. Working papers assist the auditor in forming an opinion on the financial statements.

Contents of working papers

Auditing and Assurance Standards (AAS 3) issued by the Institute of Chartered Accountants of India
states working papers should record the auditors plan, the nature, timing and extent of the audit
procedure performed and the conclusions obtained from the evidence. In general audit working papers
consists of the following:
1. Schedule of Debtors, Creditors and bank statement.
2. Correspondences and balance confirmations from Debtors, Creditors and bankers.
3. Correspondences from legal advisors and statutory authorities.
4. Certificates of officials with regard to bad debts.
5. Certificate from valuers for valuing stock-in-trade and investments.
6. Certificate confirming cash balance.
7. Certificate from authorized person with regard to outstanding assets and liabilities, etc.
8. Bank Reconciliation statement.
9. Adjusting entries.
10. Copies of the minutes of the meeting of directors and shareholders.

Objectives of Audit Working Papers

 Planning and Organizing Audit Work
 Support for Auditor‘s Opinion
 Division of Labour
 Use as a Permanent Record
 Basis for Evaluation and Training of Audit Staff

Importance (or) Advantages of Audit Working Papers

 Planning the Audit Work
 Helps in Fixing Responsibility
 Helps in Drawing Conclusions
 Helps in Preparing Audit Report
 Documentary Evidence
 Permanent Record

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 OWNERSHIP AND CUSTODY OF WORKING PAPERS

Meaning & Definition

 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 his 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.
 In many cases, it was held that these papers belonged to the auditor and not to the client.
 According to the views of the Institute of Chartered Accountants of India (AAS-3), working papers are
the property of the auditor. The auditor may, at his discretion, make portions of or extracts from his
working papers available to his clients.

Responsibility on protection and preservation of working papers

Whosoever is in the possession of working papers should be responsible for their safe custody. These
should in no case be shown to a third party except with the permission of the client. As the working
papers are prepared in respect of the client‘s business, they should be treated as top secret and should
be preserved in all circumstances and at all times. After the audit report has been prepared and
delivered to the client, these papers may be filed and preserved for a period of time sufficient to meet
the needs of his practice and satisfy any pertinent legal or professional requirements of record
retention.
TEST CHECKING
Meaning & Definition
 The term ‗test checking‘ stands for the method of auditing, where instead of a complete examination of
all the transactions recorded in the books of accounts only some of the transactions are selected and
verified. The underlying intention is to test some of the transactions to form an opinion for the whole.
 According to Prof. Meig ―test checking means to select and examine a representative sample from a
large number of similar items‖.

Objectives of test checking

Accounts of large organizations usually include an enormous number of transactions. But the auditor is
not in a position to check each and every transaction within the limited time and due to the constraint of
resources available to him. So, the basic objective of test checking is to draw a valid conclusion by
undertaking examination of some transactions as sample from the large number of transactions and
thereby save time and cost.

Factors to be considered or Precautions to be taken before taking test-checking technique

 The nature of transactions should be carefully considered for determining the extent of test checking.
 If the internal control system is found to be sound, the auditor may adopt test checking determining
the suitable sample size.
 The extent of checking to be adopted should depend upon the materiality of the items.
 Previous experience should also be considered while determining the extent of test checking.

Advantages
 It is one of the best techniques of auditing through which cost of audit can be reduced.
 It can ensure the speed of audit work.
 It easily locates the deficient areas and helps to conclude as to the acceptability of financial records.
 It is a labour saving device.
 It acts as a guide to the auditor to arrive at a conclusion regarding the true and fair view of the state
of affairs of the business.

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 Disadvantages
 It will prove inefficient where internal check and control system are not operating or found ineffective.
 It is not suitable for small concerns.
 It will show incorrect results if the samples are not proper representatives of the population.
 It does not offer any consistency in selecting the percentage of check adopted by all concerns.
 It is not applicable in case of diversified transactions.

Auditor’s duty regarding test checking

Test checking is a short-cut method of audit. It curtails costs and time of audit. But it involves risk on the
part of the auditor. If some errors or frauds which escaped the notice of the auditor because of sample
checking are detected subsequently, the auditor may be held liable for negligence. He must carefully
consider the circumstances for determining the sample size. He must bear in mind that test checking is
just like a double-edged sword. If it is used properly and with reasonable care and caution, it will not
hurt the auditor, i.e. the auditor will not be held responsible for any error or fraud left undetected.
However, if the tool is applied indiscriminately and negligently, he will not be spared for errors and
frauds detected subsequently.

ROUTINE CHECKING
Meaning & Definition
Routine checking is a total process of accounting control. Examination of the totaling and balancing of
the books of prime entry, ledger accounts and trial balance prepared with those balances.
In short, the routine checking is concerned with ascertaining the arithmetical accuracy of casting,
posting and carry forwards. For the purpose of confirming the arithmetical accuracy and detecting
frauds and errors of very simple nature, this method is adopted as basic to all types of audit work. The
scope of application of routine checking depends upon the nature and size of the organization as well
as the effectiveness of the internal check and control system.

Objectives
 To ensure the arithmetical accuracy of the books of accounts
 To form the basis of vouching
 To prevent alteration of figures
 To increase reliability of financial statements
 To detect errors and frauds

Advantages
 It is the simplest form of audit work.
 Errors and frauds of simple nature can be detected very easily.
 The books of accounts can be thoroughly checked.
 It is the basis of checking the final account as it helps in checking castings and postings.
 Arithmetical accuracy of all the transactions can be confirmed by this method.
 It offers an opportunity to train the new entrants to the profession.

Disadvantages
 It is not considered as an important part of audit work where self-balancing system is maintained.
 As the audit staff is engaged in same type of work the possibility of becoming monotonous may grow
 Negligence of work, taking the advantage of internal check system, is frequent.
 It fails to detect errors and frauds arising from the fraudulent manipulation in accounting principles.

Auditor’s duty regarding routine checking

Although routine checking is a monotonous and time consuming process and is not very effective in
detecting planned fraud, the auditor cannot skip it. The auditor will first evaluate the internal control and
internal check system existing in the organization. Based upon his evaluation, he will determine the
extent of routine checking to be adopted. Computerization of accounting system obviates the necessity
of casting carry forward, posting from journal to ledger etc. So, the auditor will determine his duty after
examining the degree of computerization.

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 INTERNAL CONTROL

Meaning & Definition

Internal Control refers to the process of control exercised by the management either financial or non-
financial to ensure proper accounting of business transaction and reliability of records. Internal control
has a wide coverage which includes checks and controls exercised to ensure efficient and effective
functioning of the business organisation. In other words, it is a process implemented by the
management to provide the following:
1. Proper accounting and reliability of records,
2. Effectiveness and efficiency of business operations, and
3. Compliance with laws and regulations.
Auditing Practices (SAP-6) of Institute of Chartered Accountants of India: ―Internal control system refers
to the whole system of controls, financial or otherwise, established by the management in the conduct
of a business including internal check, internal audit and other forms of control.‖

Divisions of Internal control

1. General Financial Control
2. Cash Control
3. Employee Remuneration
4. Trading Transactions
5. Fixed Assets.
6. Stock maintenance
7. Investments
Internal Control Process

I Identifies and assesses the risks that may prevent it from achieving the desired objectives.
Examples of the risks include management override, inadequate transaction processing and
inappropriate accruals.
Designs and implements a control environment that sets the tone for the organization and its
commitment to financial competencies to mitigate risk.

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 Designs and implements control activities—including authorizations, completeness tests and
reconciliations—to further mitigate risks.
Develops an effective information and communication process that enables relevant parties to
understand their control responsibilities and ensures management receives timely and relevant reports
that facilitate effective investigation and decision making.
Monitors the effectiveness of its internal control system.

Objectives of Internal Control

1. Compliance: To have compliance with law and accounting practices that is generally accepted and
followed in the country. The accounting process also needs to be in compliance with these.
2. Reliance: To increase the reliance on the internal systems, accounting practices should be followed
by the organization, so that the chances of frauds are reduced.
3. Safeguarding: To safeguard the organization‘s accounts, employees and assets by formation of
fool-proof policies, rules and regulations.
4. Security: To provide security to customers, employees and property of the organization. Physical
security systems like security guards, locks and anti-theft devices are used for providing protection.
5. Increased Efficiency: To assist in human resource and performance management, and to
keep proper control over business activities to achieve maximum levels of efficiency.
6. Evaluation: To evaluate the accounting system for proper authorization of transactions.
7. Review and Correction: To review the working of the business, locate weak points in operations
and to take corrective measures for proper working.
8. Authorization: To provide proper authority for purchase, sale, valuation, verification and possession
of assets.
9. Delegation: To provide for division of duties among the employees where all staff members work
cohesively.
10. Accurate Planning: To ensure that the auditor‘s and the accountants of the organization make all
the financial reports correctly and to ensure that financial planning is done accurately.
11. Resource Utilization: To ensure that all the resources, i.e., man, material, money and machines of
the organization are optimally used.
12. Safeguarding of Resources: To protect the resources of the organization against mismanagement
or fraud and to ensure that the company‘s activities are in accordance with laws and regulations.
13. Setting future Corporate Goals: An efficient system of internal control helps the organization in
goal setting. However, the organization should have certain policies, rules and regulations in place to
achieve the preset goals.

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Advantages & Disadvantages of Internal Control

Advantages of Internal Control

1. Detection of Errors and Frauds: Internal control systems are structured in such a way that work
done by one employee in a process is checked by another without knowledge of the former. In such an
environment, any fraud committed is brought to light unless there is collusion among fraudsters.
2. Time Saving: Auditor can test check or sample check the transactions to ensure reliability, and
accuracy of entries in the books. Hence, he can complete his audit work and prepare financial
statements within the prescribed time.
3. Minimum Scope for Errors and Frauds: Each employee does only a limited work assigned to him,
moreover, consciousness of his work being independently checked by another keeps him to be always
alert at work. In such a context, chances for commission of error or fraud are lesser.
4. Operational Efficiency:
It facilitates fixation of accountability, error – free work performance, accuracy reliability and authenticity
of entries and eradicate inefficiency, fraud, theft, etc. and enables the management to assess the
performance of employees. All these collectively contribute to enhance the operational efficiency of
organization as a whole.

Disadvantages of Internal Control

1. Organizational Structure: Deficiencies in organizational structure make internal control ineffective.
2. Size of the Organization: Small organizations have very low levels of internal control, which are
almost negligible due to more interference by owners and management.
3. Unusual Transactions: The internal control procedures normally fail to keep a check on unusual
transactions.
4. Costly: The implementation of internal control procedures and processes involves incurring costs in
terms of time, effort and resources.
5. Abuse of Power: Members at the top-level management may override or interfere with control.
6. Collusion of two or more People: It may lead to internal controls being over- ridden.
7. Obsolescence: Control system may become redundant with passage of time if not updated with
change in the size and nature of business.
8. Human Error: Internal control fails as there is possibility of human errors.
9. Frequent follow-up measures: Follow-up procedures need to be frequent to ensure its
effectiveness, which is extremely time-consuming.

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Principles or Requirements of Good Internal Control System

1. Well-designed Accounting System: Internal control should provide for a well designed accounting
system. The financial and accounting activities must be separated. For example, person who is
responsible in handling cash (cashier) and the person who accounts cash (accountant) should be done
by two different persons.
2. Competent Personnel: In any internal control system, personnel are the most important element.
When the employees are competent and efficient in their assigned work, the internal control system can
be worked and operated efficiently and effectively even if some of the other elements of the internal
control system are absent.
3. Division of Work: This refers to the procedure of division of work properly among the employees of
the organization.
4. Separation of operational responsibility from record keeping. In order to ensure reliable records
and information, record-keeping function is separated from the operational responsibility of the
concerned department.
5. Separation of the custody of assets from accounting: To protect against misuse of assets and
their misappropriation, it is required that the custody of assets and their accounting should be done by
separate persons.
6. Supervision: Directors should review the company‘s financial operations and position at regular and
frequent intervals.
7. Sound Practice: Sound practices of administration require that established procedures, policies and
delegation of responsibility should be open to all employees of the organisation. This helps in avoiding
questions, attempts to shift responsibility for unsatisfactory performance etc.
8. Internal Audit: Internal audit is a part of the whole system of internal control. It is the
examination of accounts of a business concern by its employees specially appointed for the
purpose. It is an independent appraisal of activity within an organization for the review of
accounting, financial and other business practices.

Kinds of Internal Control

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1. Preventive Controls: Preventive controls are designed to discourage errors or irregularities from
occurring. They are proactive controls that help to ensure departmental objectives are being met.
Examples of preventive controls are: Segregation of Duties, Approvals, Authorizations, and
Verifications, Security of Assets
2. Detective Controls: They are designed to find errors or irregularities after they have occurred.
Examples of detective controls are: Reviews of Performance, Reconciliations, Physical Inventories, and
Audits
3. Corrective Controls: Corrective controls target at the correction of errors and irregularities as soon
as they are detected.

Scope of Internal Control System.

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.
Administrative Controls : These comprise the plan of organization that are concerned mainly with
operational efficiency

Auditor’s Duty in Evaluating the System of Internal Control

1. Understanding the System: The auditor should understand the control system by discussing with
personnel at various levels in the organisation.
2. Determining the Reliability: It is the duty of an auditor to establish a basis or degree of reliance on
the system of control.
3. Determining the Adequacy: The auditor should apply various compliance tests in order to
determine the adequacy of internal control system.
4. Review and Evaluation: Auditor should critically review and evaluate the internal control system to
determine the efficiency of its operations. If there is a good system of internal control the work of an
auditor becomes easy.

Methods or Techniques of Evaluating Internal Control System

1. Narrative Record or Memorandum Approach: It is a complete and exhaustive description of the

system. It is appropriate in circumstances where a formal control system is lacking, like in case of small
businesses. Gaps in the control system are difficult to identify using a narrative record.
2. Check List: It is a series of instructions that a member of the audit staff is required to follow. They
have to be signed initialled by the audit assistant as proof for having followed the instructions given. A
specific statement is required for every weakness area.

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 3. Flow Chart: It is a pictorial representation of the internal control system depicting its various
elements such as operations, processes and controls, which help in giving a concise and
comprehensive view of the organization‘s working to the auditor. A complete flow chart would depict the
process of raising documents, personnel involved in doing so, the flow of documents through various
departments, maintenance of records, flow of goods and consideration, and dealing with results. The
internal control evaluation process becomes easier through a flow chart as a broad picture of all the
controls involved can be gauged in a glimpse.
4. Internal Control Questionnaire: This is the most widely used method for collecting information
regarding the internal control system and involves asking questions to various people at different levels
in the organization. The questionnaire is in a pre-designed format to ensure collection of complete and
all relevant information. The questions are formed in a manner that would facilitate obtaining full
information through answers in ―Yes‖ or ―No‘‘.

INTERNAL CHECK
The term internal check refers to allocation of duties to the employees in an organization in such a way
that the work of one person is automatically and independently checked by the other person from the
beginning to the end. It denotes such an arrangement of duties among the staff that the work performed
by one individual is independently checked by another in the routine course, such that errors and frauds
are prevented or discovered. Under the system of internal check, care is taken to ensure that no one
person handles a transaction completely from beginning to end and the work of every person is in the
ordinary course checked by another person.

Definition
 According to L.R. Disksee, ―Internal Check is an arrangement of accounting routine that errors and
frauds are automatically prevented or discovered by the very operation of book-keeping itself.‖
 According to Spicer and Pegler, ―A system of internal check is an arrangement of staff duties whereby
no one person is allowed to carry through and to record every aspect of the transaction, so that, without
collusion between two or more persons, fraud is prevented and at the same time the possibilities of
errors are reduced to the minimum‖.

Principles (or) Features of Good Internal Check System

1. Division of Work: Division of work refers to dividing the total work among various staffs is such a
way that no single person is allowed to perform the work from the beginning to the end. The work
should be allocated to the employee based on the capacity and capability of each person.

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2. Authority and Responsibility: Authority, duties and responsibilities of each person should be
clearly defined and there should not be any overlapping or duplication of duties and responsibilities of
any person.
3. Automatic Check: Work allocated to the staff should be in such a way that the work performed by
one person is automatically checked by another person.
4. Rotation of Employees: A good system of internal check should provide for transfer or rotation of
employees from performing one work to another at frequent intervals.
5. Proper Training to Employees: An effective system of internal check should carefully select the
employees to the organization. The employees should be properly trained and clear instructions should
be given to them to perform their work in an effective and efficient manner.
6. Proper system of Filling: Internal check system should provide for proper system of filling
vouchers, correspondences etc. in a systematic manner.
7. Periodical Review: The system of internal check should at frequent intervals (be reviewed) and
suitable changes should be introduced.
8. Usage of Electronic Equipment: The system of internal check should provide for usage of labour
saving electronic devices such as calculating machines, personal computers, time recording clocks,
book-keeping machines etc. The proper training should also be given to the employees for using these
devices.

Objectives of Internal Check

1. Early Detection of Errors and Frauds: The main objective of internal check is to detect and prevent
the occurrence of errors and frauds at an early stage. This is possible as the work of each and every
person is independently checked.
2. Minimization of Errors and Frauds: It is one of the primary objectives of internal check. As the
work performed by each individual is checked by another person, there is a check on the work of
dishonest person. Hence, the possibility of errors and frauds are minimised to a greater extent.
3. Division of Work: Internal check provides for proper division of work based upon each and every
person‘s skill, ability, specialisation and effectiveness.
4. Fixation of Responsibility: The total work is divided into smaller units and assigned to different
persons. Each and every person knows what is expected from him/her and he/she will be held
responsible for any errors or fraud which takes place in it. Internal check provides for clear
determination of responsibility.
5. Reliability of Records: The system ensures that the books of accounts and other records
maintained provides reliable source of information.

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Advantages of Internal Check
1. Proper Distribution of Work: Internal Check helps in proper distribution of work between
employees based on their qualification and experience. It enables the employees to perform the work
efficiently.
2. Detection and Prevention of Errors and Frauds: The main object of internal check is to minimize
the occurrence of errors and frauds, as no individual person does the work from the beginning to the
end and the work of one person is checked by another person.
3. Increases Efficiency: A good system of internal check, increases the efficiency of work of
employees as the right work is allocated to the right person taking into account his skill and experience.
4. Determination of Employees Liability: Internal check system clearly determines the
responsibilities of the employees. Hence, the liability of the employees can be easily fixed due to
irregularities or negligence caused by the employee.
5. Proper Maintenance of Books of Accounts: Internal check system helps to maintain proper
records and ensures accuracy of the entries in the books of accounts.
6. Easy and Quick Presentation of Final Accounts: Internal check enables quick presentation of final
accounts i.e., Profit and Loss Account and Balance Sheet immediately after closing of the accounting
period.
7. Facilitates the Auditor: When there is an effective internal check system the statutory auditor can
rely on the system. He can avoid detailed checking of transactions. He can select limited sample of
transactions. This enables him to finish the audit work within time.
8. Increases Profitability: Overall efficiency and economy of operations leads to increased earnings
for the owners of the enterprise.

Disadvantages of Internal Check

1. Expensive: The system of internal check is more expensive and time consuming.
2. Not Applicable for Small Organization: This system is not applicable for small organization where
there are only few employees. Only large organization having number of departments and complexity of
jobs can get benefit of this system.
3. Monotonous for the Workers: As same work is done by the employee‘s day after-day the job
becomes boring and the employees lose their creativity.

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 4. Risky for the Auditor: When the auditor lies on the system of internal check and does not conduct
tests he will be charged for negligence. complexity of jobs can get benefit of this system.
5. Disorder in Work: If the system is not fully organized and if there is any failure in the system, it
creates disorder and confusion hence, chances of errors and frauds increases.
6. Chances of Collusion: Though internal check system protects errors and frauds but in reality there
may be chances of collusion between two or more employee to indulge in frauds or malpractices.

Duties of an auditor with Regards to Internal Check System

1. To Obtain Written Statement: An auditor should obtain a written statement about the working of the
internal check system from the business concern.
2. To Examine the System in Operation: The auditor should carefully examine the existence and
operation of the internal check system.
3. To Identify the Weakness: The auditor should identify the weakness of the system which will result
in occurrence of errors and frauds taking place.
4. To Suggest for Improvements: If the system of internal check is ineffective, the auditor should
make suggestions to strengthen the system of internal check.
5. To Analyse the Extent of Reliance: The auditor should carefully analyse the extent to which he can
rely on the effectiveness of internal check. If the system of internal check is effective, he can check
sample transactions thus devoting his attention on other important audit work.

INTERNAL AUDIT
Meaning & Definition
 Audit which is conducted internally, i.e., within the organisation on behalf of the management is called
as Internal Audit. The person who conducts such an audit is called as Internal Auditor.
 Internal auditor need not be a Chartered Accountant and need not possess the qualifications prescribed
by the Companies Act. The appointment, scope of work, remuneration etc. of an internal auditor are
determined by the management.
 The internal auditor works as a part of the employee and is remunerated in the form of salary by the
management. Internal auditor works on a continuous basis verifies the transactions that takes place in
a company and after examination submits a report to the management called as Internal Audit Report.
According to Watter B. Meigs ―Internal auditing consists of a continuous critical review of financial and
operating activities by a staff of auditor‘s function as full-time salaried employees‖

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Objectives of Internal Audit

1. Verify the Accuracy of Accounts: The primary aim of internal audit is to verify the correctness and
accuracy of the financial records and accounts that are being presented to the management.
2. Detection of Errors and Frauds: Internal auditor has to adopt suitable techniques and measures to
detect errors and frauds, which are likely to be committed in the organization.
3. Review the Internal Check and Control System: The auditor has to review and comment on the
effective function of the internal check and internal control system within the organization.
4. Verify the Assets of the Company: Internal auditor should verify the existence of the assets and
should verify that assets are purchased or sold or replaced only with the approval of an authorized
person and verify whether proper measures are taken to protect or maintain the assets.

5. Verify the Liabilities: The internal auditor has to verify that the liabilities incurred by the organization
are legitimate and they are likely to be incurred for the organizational activities.
6. Adherence to Accounting Standards: Internal auditor has to ensure that the Accounting Standard
practices followed by the organization are strictly adhered.
7. Review the Managerial Functions: Internal auditor has to review the managerial functions of an
organization and has to report on them to the management.

Scope (or) Functions of Internal Auditor

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1. Evaluating of Accounting and Administrative Control: Internal auditing ensures effective and
efficient system of accounting control, standard costing, budgetary control and all other controls.
2. Protection of Assets: Internal auditing besides ensuring proper accounting and custody of
companies asset‘s it is concerned with the protection of the assets.
3. Compliance with Established Policies and Procedures: It is concerned with reporting to the
management about the compliance of predetermined policies, procedures and standards of
performance.
4. Reliability and Validity of Reports: Internal auditing ascertains the reliability of financial and
operating reports prepared throughout the enterprise.

Advantages & Disadvantages of Internal Audit

Advantages:
1. Detection of Errors and Frauds: Internal audit is a continuous and critical examination of books of
accounts and records of the organization; hence errors and frauds can be easily detected and
prevented.
2. Quick Presentation of Accounts and Reports: Transactions and postings in the books of accounts
reviewed on a regular basis, which facilitates quick presentation of accounts and reports to the
management. It also enables the external auditor to finalize the accounts quickly as the external auditor
relies on the report submitted by the internal auditor.
3. Advisory Services to Management: Internal auditor who possess in depth knowledge of the
business organization provides advisory services to the management like introduction of new product,
improving the system of internal check and control to operations, etc.
4. Proper Co-ordination and Control: Internal audit coordinates the various operational or functional
areas of business. It is the duty of the internal auditor to appraise and evaluate the efficiencies of the
various control systems established in the organization. Hence, internal audit enables proper control
and coordination in the organization.

Disadvantages:
1. High Cost: The cost of establishing and operating an internal audit is very expensive.
2. Unsuitable for Small Organization: Internal audit due to involvement of high cost is not suitable for
small organizations.
3. Unreliable Opinion: Internal auditors are employees of the organization and hence the report given
by them may not be true and fair. Often, external auditor has reservations about the opinions expressed
by the internal auditor.
4. Ineffectiveness: When the records of operations are not checked immediately after they are
completed or when there is time lag between two audits, internal audit may become ineffective.
5. Lack of Expertise: Internal audit staff lacks the required skill and expertise as they are not
professionally qualified chartered accountant.
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 DISTINCTION BETWEEN INTERNAL CHECK, INTERNAL AUDIT & INTERNAL CONTROL

Criterion Internal Check Internal Audit Internal Control

Audit which is
The term internal check refers Internal Control refers to
conducted internally,
to allocation of duties to the the process of control
i.e., within the
employees in an organisation exercised by the
organisation on behalf
in such a way that the work of management to ensure
of the management by
one person is automatically proper accounting of
the employees of the
and independently checked by business transactions
organization appointed
the other person from the and reliability of records.
Meaning specially for this
beginning to the end and it Internal control has a
purpose, to review the
ensures that no one person wide coverage which
operations and to offer
handles a transaction includes checks and
suggestions to improve
completely from beginning to controls exercised to
the efficiency is called
end and the work of every ensure efficient and
as Internal Audit. The
person is in the ordinary effective functioning of
person who conducts
course checked by another the business
such an audit is called
person. organisation.
as Internal Auditor.
Formulation and circu-
Safeguarding or minimising Detecting and reporting lation of management
errors and frauds in actions errors and frauds and principles and policies
transactions and records, and irregularities regarding and effective and
Purpose
profacting assets. So as to assets committed, if any speedy execution there-
ensure the efficient running of detection and of with the help of
business. prevention activity- internal checking and
internal audit activities.
Rather restricted to formulation
Limited to a continuous
and working of proper
internal system of Wider in scope than
accounting and other
checking financial and internal check and in-
Scope operational systems and
non-financial operations ternal audit as specified
reporting or offering
and reporting to internal above.
suggestions to appropriate
top management.
internal authorities.
Spreads through the
Proceeds simultaneously with Commences after process of internal
Periodicity initiation of transactions and transactions are com- checks upto taking ac-
ends with recording thereof. pleted and recorded. tion on internal audit
reports.
Internal staff with no spe- Specially qualified and
cialised knowledge or skill but skilled audit staff as a
Personnel Top management
with clearly defined division of part of internal person-
each work. nel.
Accountable to departmental / Accountable to senior or Accountable to
Accountability
branch / unit-heads. top management. owners/stakeholders

************
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 PRACTICAL AUDITING

( REFERENCE NOTES – UNIT II )

ACCORDING TO REVISED SYLLABUS

OF
UNIVERSITY OF MADRAS

Ms. B. BINDU SINGH

ASSISTANT PROFESSOR
DEPARTMENT OF COMMERCE - GENERAL
A.M. JAIN COLLEGE
MEENAMBAKKAM, CHENNAI.

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 PRACTICAL AUDITING

UNIT - II : Vouching and Verification

Vouching - Meaning and Definitions – Objectives - Trading Transactions – Audit of Ledger--Scrutinizing of
ledgers – Vouching of cash Receipts and Payments – Vouching of outstanding Assets and
Liabilities – Verification - Meaning - Objectives and Process – Valuation of Assets and liabilities –
Distinction between Verification and Valuation.

VOUCHING
Meaning
The process of examining the documentary evidence to ascertain the accuracy and authenticity of
entries in the books of accounts by the auditor is called as „Vouching‟. Vouching means a careful
inspection of all original evidences supporting the transaction e.g. invoices, statements, receipts, etc., in
order to ascertain the real accuracy, authenticity and validity of the transactions. It confirms that the
amount specified in the voucher has been posted to an appropriate account which will disclose the
nature of the transaction. Therefore, vouching is referred as the very essence of auditing. It helps an
auditor in establishing the truth of entries appearing in the books of accounts.
Definition
According to Ronald A Irish – “Vouching is a technical term which refers to the inspection of
documentary evidence supporting and substantiating a transaction”.
“Vouching means testing the truth of items appearing in the books of original entry.” – J.R. Batliboi
“Vouching is an act of comparing entries in the books of accounts with documentary evidence in
support thereof.” – Dicksee

Objectives of Vouching
1. All the transactions which are connected with the business have been recorded in the books of
accounts properly.
2. To verify that all transactions recorded in the books of accounts are supported by documentary
evidence.
3. The vouchers which support the entries are legally valid from the view point that they are authentic,
addressed to the business and properly dated.
4. To verify that no fraud or error has been committed while recording the transaction in books of
accounts.
5. The vouchers have been processed carefully through various stages of internal check system.
6. While recording the transactions whether distinction has been made between capital and revenue
items.
7. Whether accuracy has been observed while totaling, carrying forward and recording an amount in
the account.

VOUCHER
Documentary evidence in support of any business transaction is called as a Voucher. It may be a
receipt, invoice, bill, cash memo, bank pay-in-slip, counterfoil of a cheque, correspondences,
agreements, resolutions passed in the meeting etc. Voucher gives information about the nature and
source of the transaction, its value and authority. It substantiates the entries in the book of accounts
and confirms the genuiness of the transaction. All vouchers relating to the business transactions should
be carefully preserved and properly filed.

Types of Voucher
There are two types of Voucher. They are - 1. Primary Voucher 2. Collateral Voucher
 Primary Voucher − Original copy of written supporting document is called primary voucher. Examples
of primary voucher are purchase invoice, cash memo, bills, confirmation of balances, bank statements,
contracts, etc.
 Collateral Voucher − Copies of supporting documents which are not available in original are collateral
voucher like duplicate or carbon copy of sale invoice.
On the basis of sources of documents, vouchers can again be of two types. Internal vouchers &
External vouchers.

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 Internal vouchers Vouchers originating within the organisation are known as internal vouchers. For
example, sales invoices, minutes book of board meetings, material requisition slip etc.
 External vouchers Vouchers originating from the outside sources are known as external vouchers.
For example, mortgage deed, bank statement etc.

VOUCHING OF TRADING TRANSACTIONS

Vouching of Credit Purchases
While vouching credit purchases the auditor should examine and see the following points.
i. There should be proper record for all purchase orders. A duplicate copy of the order is kept in office
for record.
ii. A copy of purchase order shall be send to the Accounts Department.
iii. All goods received should be recorded on goods received note; a copy of it should be sent to
Accounts Department.
1. The auditor should see that only credit purchases of the goods are recorded in purchase book.
2. The purchases book can be verified from purchase invoices, copies of orders placed, goods received
note, goods inward book, copies of challans from suppliers.
3. The quantity mentioned in the invoice must be same as is shown in the purchase order.
4. The price charged by the supplier must be as per quotation/pricelist of the supplier.
5. The supplier bill must be in the name of business and for the period under audit.
6. While vouching the purchase vouchers, each voucher should be stamped or initialed after
examination, so that it could not be produced again.
7. Any purchase, made not for the purpose of business of the client, must not be debited to purchase
account.
8. Duplicate invoices must not be entered in the purchase book if original invoices have already been
recorded.
9. The auditor should be more careful while vouching the purchase made in the first and last month of
the accounting period, because sometimes the purchase of last year may be included in the purchases
of first month of current year or purchases of the last month of current year may be recorded in the
next.

Vouching of Purchase Returns

While vouching the purchase returns the following points should be taken into consideration:-
1. He should see that a Debit note has been sent to the supplier or credit note has been received from
the supplier.
2. The quantity returned as per the return note must correspond with storekeeper‟s record, return
outward register and gatekeeper‟s outward register.
3. The amount showed in the credit note should be verified.
4. He should be careful about the recordings of purchases return in the current year. Sometimes the
profits of current year may be manipulated by recording current year‟s purchases return in the
subsequent year.
5. The purchases return of the first month and last month of the Accounting year should be vouched
carefully, to detect any manipulation of amounts.

Vouching of Credit Sales

1. The sales register should be examined with copies of sales invoices. The sale of capital items should
not be recorded in the sales book, otherwise the profits will be inflated.
2. Test check should be applied on the calculations made in sale invoices.
3. The totaling and the castings of sales book should be verified.
4. Sales Tax, duties collected thorough sales invoices must be recorded under separate accounts.
5. It should be verified that all sales invoices are prepared on the basis of challans and then sales
invoices are entered in sales book and from there, posted to their respected accounts.
6. Sales made in the current year must be recorded under that year and shall not be treated as sales of
subsequent year.
7. All cancelled sales invoices must be kept together for verification by auditor, who should see that
cancelled invoices are properly treated in the books.
8. The statement of accounts should be verified by getting confirmations from the customers.

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 Vouching of Sales Returns
The Auditor should pay special attention to the following while vouching the sales return
1. Date on which the goods are actually retuned.
2. Credit note or Debit note of sales return.
3. Gatekeeper‟s receipt book.
4. Return inward register.
5. Stores records.
6. Corresponding entry for the return of goods in customer‟s account.
7. Goods returned should form the part of closing stock at cost price or market price whichever is less.

Vouching of Goods sent on consignment basis

The goods sent on consignment basis by principal to his agent should not be considered as sale. Only
when the goods are sold by the consignee, the entry for sale should be made in the books. The goods
sent on consignment still lying with the consignee should be taken into closing stock. A separate book
should be maintained to show the record of goods sent on consignment basis. At the end of the year an
account sale is received by the consignee, indicating the goods sold by him and balance of closing
stock of goods sent on consignment basis. The auditor should verify the goods sent on the
consignment basis from proforma invoices, goods outward register, correspondence with consignee
and account sales.

VOUCHING OF PERSONAL LEDGER ACCOUNTS

All personal accounts are opened under this category. In big organizations where the number of
transactions is quite high, a personal ledger may further be split up into two more ledgers −
 Purchase ledger
 Sales ledger

PURCHASE LEDGER (Creditors)

Purchase ledger is verified from the following −
 Creditor balances of last year
 Cash Book and Bank Book
 Purchase register
 Purchase return book
 Bills payable book
 Journal and other relevant books
An Auditor should carefully verify the following −
 Posting of all vouchers in ledger account should be done without any omission.
 Verification of all opening balances should be properly checked with last year‟s balance sheet.
 If the creditor balance shows debit balance it may be due to advance payment made to him, the
Auditor should confirm whether the material against advance is received or not.
 Periodical statements of creditor should be reconciled.
 Examination of internal control system.

SALES LEDGER (Debtors)

Sales ledger will be verified from the following −
 Debtors‟ balances of last year
 Cash book and bank book
 Sales register
 Sales return book
 Bills Receivable book
 Journal and other relevant books
Auditor should carefully verify the following −
 Posting of all vouchers in ledger account from cash and bank book, sales register, bills receivable
register, sales return register and journal should be verified.
 Verification of opening balances, castings, balances carried forward should be carefully examined.
 Credit balance of the debtors‟ account may represent the advance received against the supply of
goods; the Auditor should examine and confirm whether any material is supplied against it or not.
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 Periodical reconciliation of account from debtors should be done without any fail.
 Provision for doubtful debts and bad debts should be done.
 Review and examination of credit policy should be made from time to time.
 Checking of posting in ledger account from subsidiary book.
 Checking of calculations.
 Reviewing truthfulness of debtor balances in customer account.
 Reviewing of Internal Control System.

VOUCHING OF IMPERSONAL LEDGER ACCOUNTS – CASH TRANSACTIONS

Vouching of cash receipts (Receipt side)
1. Cash sales: In vouching cash sales, cash register should be fully checked with carbon copies of
cash memos. Then, the auditor should verify the daily deposits of cash received in the bank dates of
the cash and the date on which the receipts are recorded in cash book must be same. Where the cash
memos are cancelled, all copies including the original copy duly cancelled should be kept in the book.
Where a company has a discount policy, if more discount is allowed in a transaction it must be
approved by a responsible officer.
2. Cash received from the debtors: The auditor should verify amount received from debtors from the
counterfoils or carbon copies of the receipt issued to the customers. All these receipts should be
serially numbered. Amount should be entered in the cash book on the day when received. Discount
allowed to customers should be authorized by a responsible officer. Sometimes correspondence made
with customer can also be verified.
3. Loans: While vouching the loans received, the terms and the conditions contained in the agreement
should be verified. If the loan is secured what security has been offered, whether the fact has been
disclosed in the balance sheet.
4. Bills receivable: Bills receivable book maybe verified because the various details regarding the bills
matured and discounted are available in it. Auditor should check the amount received with the bank
statement. Some bills might have become due but no amount has been received. Whether the entry for
the dishonor of such bill has been made.
A verification of the bills discounted should be made. Whether, entry for discount has been made. Such
bills should appear as contingent liability in the balance sheet; if the date of maturity is after the date of
balance sheet.
5. Sale of Investment: If the sales have been affected through a bank, the auditor should examine the
bank advice to know the various details. Sometimes the investment is sold through the broker. Broker‟s
sold note or commission should be examined to verify the sale proceeds and commission charged by
the broker.
If the investments are sold at cum-dividend price, auditor should see that proper apportionment has
been made between capital receipts and revenue receipts.
Sometimes the investments are made against specified funds. Profit or loss on sale of such
investments must be transferred to such funds account.
6. Sale of Fixed Assets: Sale of fixed assets may be vouched with minute book of board of directors,
correspondence, agents‟ sale account and sale contract. It should be seen that proper account has
been credited. Any profit arising on the sale of asset shall be credited to revenue account which is not
available for distribution of dividends. If any expense on the sale of assets is paid, the sale proceeds of
the asset should be reduced by such amount and the balance should be credited to asset account. It
must be seen that sale of fixed assets has been sanctioned by the authorized person or committee.

Vouching of cash payments (payment side)

1. Cash Purchases: good purchased are actually received by store keeper. Cash memos can be
compared with goods inward book to verify the goods received. Only the net amount (after trade
discount) should be entered in the books.
2. Payment to creditors: Should be examined with the receipts issued by the creditors. The receipts
should indicate the purpose for which the payment has been made. If the payment is made in full and
final settlement of account, the balance should be accounted for as discount received. Where the
payment is made in excess of the bill, either the excess payment is in advance or the payment is made
by mistake, which should be recovered back from the creditor.

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 3. Bills payable: Bills payable honored on the date of maturity and is returned by the payee after
receiving the payment. These bills should be cancelled after being paid. Bills payable paid can be
vouched with bills book. If the payment is made by the bank, bank statement or pass book can be
examined to verify the payment of bill
4. Wages: Wages paid and calculated for various months should be compared. If the wages of
particular month differ from the preceding month, the auditor should look into the reasons for difference.
Random checking of wages calculations should be made. The auditor should see the proper record is
maintained for unpaid wages, deductions for any advance taken by the worker should also be verified,
and deductions made from the wages should also be entered in the proper account. Special attention
should be given to the payments made to casual workers.
5. Payment of Salaries: In vouching the payment of salaries following points are important
a. Auditor should check salary register with the entries made in the cash book
b. He should examine carefully alterations in the amount of deductions on account of fines, funds,
loans, insurance etc.
6. Purchase of Investment: The auditor should compare the investment purchased with Broker‟s
Bought Note. If possible, physical verification of investments should be made. Investments must be in
the name of the company. Where the investments are purchased at cum-interested price, interest
included in the purchase price should be debited in the interest account and the balance in investment
account. Later on when the interest is received on the investment, it should be credited in the interest
account.
7. Rent paid: The auditor should verify the payment of rent from the agreement. The ret voucher
should be supported by rent receipt from the landlord. It should be seen that payment of rent is
sanctioned by responsible officer.
8. Loans: Auditor should be that the loan voucher should be supported by the receipt given by the
party. Further details regarding terms and condition of the loan can be verified from the loan
agreement. It should be seen that installment of loan along with interest are received in time. Mortgage
Deeds and other documents should also be examined.
9. Interest on Loan: Auditor should verify that rate of interest on loan does not differ from the terms
and conditions of loan agreement. Debenture interest can be verified from debenture interest book. All
the payments of interest must be supported by vouchers and receipts.

VOUCHING OF IMPERSONAL LEDGER ACCOUNTS (GENERAL)

All the nominal account, real account and capital account fall under impersonal ledger accounts.
Income and expenditure account (nominal accounts) transferred to profit and loss account. Capital
account, real accounts, debtors and creditors account are transferred to balance sheet. Following
steps are involved in the audit of impersonal ledger account −
 Opening balances should be verified from last year‟s Balance Sheet.
 Timely posting of balances of subsidiary books (Sales Book, Purchase Book, Sales Returns Book,
Purchase Returns Book) to ledger accounts.
 Checking of totals and castings.
 Checking of balances transferred to trial balances, debit and credit side of trial balance should be
tallied.
 Checking of adequacy of internal control system in organization.

OUTSTANDING ASSETS
It is necessary to include some expenses and income in current year though passing adjustment
entries to show the correct profit or loss of the company. Therefore it is must for an Auditor to check
each and every outstanding entries. Following are outstanding assets −
Prepaid Expenses
These expenses are paid in advance for next coming year(s), hence should not be debited to profit and
loss account of current year to arrive at true financial results.
For example; Insurance of Fixed assets is normally paid on annual basis and if we paid insurance
premium in the month of October for one year, then insurance for this current year will be calculated
from October to March and from April to September it will be treated as prepaid insurance. Prepaid
insurance will be shown as prepaid expenses under the head of current assets in the balance sheet.

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 Auditor should vouch every nominal account to confirm whether correct amount of expenses is debited
to profit and loss account or not. Other examples of prepaid expenses are −
 Rent Rates and Taxes
 Subscription
 Annual maintenance Contract, etc
Income Receivable
Following are the examples of Income Receivable −
 Interest accrued but not due or received
 Taxation claims
 Commission
 Declared dividend by company yet to receive
All the above income should be included in the Profit & Loss account of the year to arrive at a correct
figure.
Deferred Revenue Expenditure
The examples of deferred revenue expenditure have been described below −
 Preliminary Expenditure: Preliminary expenditure is incurred at the time of incorporation of a new
company. These expenses are of heavy amount and are incurred mainly for promotional reasons.
Nature of these expenses are capital but not actually represent any asset, hence should be written off
from profit and loss account over a period of 3 to 10 years in equal installments.
 Advertising and Sales Promotion: These expenses are incurred at the time of establishing new
business or at the time of introduction of any new product in the market. These expenses are shown as
assets in Balance sheet and should be written off in profit and Loss account over a numbers of
accounting periods.
 Heavy Repairs: Expenses of heavy repairs of fixed assets shall not be debited to profit and loss
account of year in which these expenses incurred but it should be spread to number of years like other
deferred revenue expenses. Heavy amount of expenses is incurred on repair of Plant & Machinery due
to increased production capacity of the plant or to maintain current production capacity of machine
which is very old and need some heavy overhauling or repairing to increase it life.
Other examples of deferred revenue expenses are −
 Discount allowed on debentures
 Experimental expenditure
 Research & development expenses
 Development expenses on mines

OUTSTANDING LIABILITIES
There are some expenses and liabilities that come up in due course of business; these are due for
payment but not paid till the end of accounting period in question. The Auditor should see all those
expenses and liabilities and all these expenses should be included in profit and loss of the current year
to arrive at the true profit or loss of the firm.
Following are the main examples of outstanding expenses and liabilities −
Audit Fees
Audit fees are debited to profit and loss account of the same year for which audit is conducted. No
doubt main audit work start after the close of financial year and finalization of financial statements are
done in next financial year but it is a widely accepted practice to do so. It is also argued that audit fee
should be debited to the profit and loss account in the next year in which the audit work is actually
performed. In the first case, audit fees will be debited and the audit fees payable will be credited.
Purchases
In case where the purchased goods are received in the current financial year and invoices for the same
are received in next year, purchase should be debited and outstanding liabilities should be credited.
Rent
Rent on factory premises, office building, godown, etc. is payable on monthly basis. The Auditor should
confirm that any unpaid amount of rent for the last month of the financial year or any other month of
financial year in question should be added to rent of the current year and the rent payable should be
shown as current liabilities.
Commission on Sales
Commission on sales is payable to agent, director or salesmen on the basis of sales. Auditor should
check the following −

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 Sale agreement
 Rate of commission
 Calculation of commission
 Agent account to know advance payment to agent, commission due and commission payable.
 Applicability of TDS on it and to check whether TDS is deducted at due rate before making payment or
not. Whether TDS is deposited in time or not.
 After adjusting all the above, if there is any amount that is payable to the agent, it will be shown in
current liabilities as commission payable and if any excess amount is paid that will be shown as current
asset representing the amount recoverable from the agent.
Interest
The Auditor should carefully examine the interest on loan from bank, loan from outsider parties,
unsecured loan, financial institutions, term loan and interest on debentures. He should see that the
provision for interest payable should be duly provided in the books of accounts according to the
applicable rate of interest.
Salary and wages
Salary and wages for the last month of the accounting year is normally paid in the next financial year.
The Auditor should confirm that the salary and wages for last month should be debited to salary and
wages account and credited to salary & wages payable account.
Carriage and Freight
Transporters normally provide bills for transportation charges after closing of financial year. It is a duty
of an Auditor to take these expenses in the current financial year creating liabilities for the same.

VERIFICATION
Meaning
Verification means the act of assuring the correctness of value of assets and liabilities in the
organization. It refers to the examination of proof of title and their existence or confirmation of assets
and liabilities on the date of Balance Sheet. It usually indicates verification of assets of any
organization, which can be done by examination of values, ownership, existence, possession of any
assets and also ensures that the assets are free from any charge. In simple words, verification means,
„proving the truth or confirmation‟.
Definition
Spicer and Pegler defines Verification as, “An inquiry into the value, ownership and title, existence and
possession and the presence of any charge on the asset”.
J. R. Batliboi defines it as, “The auditor must satisfy himself that assets really existed at the date of the
Balance Sheet and were free from any charge and that they have been properly valued”.
The Institute of Chartered Accountants of India defines verification as, “It aim at establishing (a)
existence, (b) ownership,(c) possession, (d) freedom from encumbrances, (e) proper recording, (f)
proper valuation”.
Objectives
The objectives of verification are as follows:
1. To show the correct value of assets and liabilities.
2. To know whether the Balance Sheet exhibits a true and fair view of the state of affairs of the business.
3. To find out the ownership, possession and title of the assets appearing in the Balance Sheet.
4. To find out whether assets are in existence.
5. To detect frauds and errors, if any while recording assets in the books of the concern.
6. To find out whether there is an adequate internal control regarding acquisition, utilization and disposal
of assets.
7. To verify the arithmetic accuracy of the accounts.
8. To ensure that the assets have been properly recorded.
Process of Verification:
 Valuation of assets at its proper value
 Ownership and title of the assets
 Confirmation about the existence of the assets
 Satisfaction about the condition that they are free from any charge or mortgage.

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 Auditor’s Duty Regarding Verification
The auditor of a business is required to report in concrete terms that the Balance Sheet exhibits a true
and fair view of the state of its affairs. In other words, he has to examine and ascertain the correctness
of the money value of assets and liabilities appearing in the Balance Sheet and this examination is
known as verification of assets and liabilities. Therefore, an auditor has to keep in mind the following
points while verifying the assets:
 Ensuring the existence of assets.
 Acquiring the assets for business.
 Legal ownership and possession of the assets.
 Ensuring the proper valuation of assets.
 Acquiring the assets for business.
 Legal ownership and possession of the assets.
 Ensuring that the assets are free from any charge.

VALUATION
Meaning and Definition
Valuation means to set the exact value of an asset on the basis of its utility. Valuation forms an
important part of the everyday audit. It is because the accuracy of balance sheet depends much upon
how correctly the estimation of the value of various assets and liabilities has been made. Both over-
valuation and under- valuation of assets and liabilities would exhibit wrong picture of the financial affairs
of a concern. The auditor has to see that the assets and liabilities appearing in balance sheet have
been exhibiting their proper value i.e. neither they have been over-valued nor under-valued.

METHODS OF VALUATION OF ASSETS

1. Cost price: The price which is paid for the acquisition of an asset is known as cost price, of course
the expenses incurred in the purchase of an asset and its installation in its cost price.
2. Market value: A value which an asset can fetch in the market when sold is known or termed as
Market value.
3. Standard Cost Method: Some of the business organizations fix the standard cost on the basis of
their past experience. On the basis of standard cost, they make valuation of assets and present in the
Balance Sheet.
4. Book Value: A value at which an asset appears in the books of accounts is known as its book value.
It is usually the cost less depreciation written off so far.
5. Going Concern value or Conventional value or token value or Historical value: It is equivalent
to the cost less reasonable amount of depreciation written off. No notice is taken of any fluctuation in
the price of the assets. Reason for this is that these assets are acquired for use in the business and not
for sale.
6. Residual Value: A value which will be realized in the market and received from the sale of an asset
it is known as its realizable Value.
7. Scrap Value: A value which is obtained from the asset if it is sold as scrap.

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IMPORTANCE OF VERIFICATION AND VALUATION OF ASSETS

Assets and liabilities are very important aspects of every business concerns. To show the exact
financial position of the concern, one of the main work of an auditor is to verify the assets and liabilities.
An auditor should satisfy himself about the actual existence of assets and liabilities appearing in the
Balance Sheet are correct. If Balance Sheet incorporates incorrect assets, both Profit and Loss account
and Balance Sheet will not present a true and fair view. So, verification and valuation of assets is very
important for business and their importance is highlighted below.

1. Showing the Actual Financial Position

2. Ascertaining the Real Position of Profit or Loss:
3. Increase Goodwill
4. Assures Safe Investment to Shareholders
5. Easy for Sale
6. Easy to Get Loan
7. Easy to Get Compensation

VERIFICATION AND VALUATION OF DIFFERENT ASSETS

For the purpose of convenience we may divide the assets in the following categories

VERIFICATION AND VALUATION OF FIXED ASSETS

Fixed assets of are of permanent nature with which the business is carried on and which are held for
earning income and not for re-sale in the ordinary course of the business. It is a long-term tangible
property that a firm owns and uses in its operations to generate income. Fixed assets are not converted
into cash or consumed within a year. They are also called as Capital Assets.

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 1. Freehold property
Verification
 The auditor should inspect the title deed and see that they appear to be in order. He should obtain a
certificate from the legal advisor of the client confirming the validity of the title to the property.
 He should also verify that the conveyance deed has been duly registered as required by the Indian
Registration Act and the particulars to be endorsed thereon have been duly endorsed.
 If the property is mortgaged, the title deed would be in the possession of the mortgage. A certificate
to this effect should be obtained.
 In the case of property built or created by the client himself, the auditor should ensure that proper
capitalization of materials, labour and overhead is done.
Valuation
 The original cost and any improvement thereon should be checked with original deed and receipt. It
is also seen that all expenses incurred on registration, brokerage or other legal fees have been duly
capitalized.
 The cost of buildings should be depreciated at appropriate value, depending upon the quality of their
structure and the use, which is being made of them.
 The auditor should check the expenditure on repairs so as to exclude such expenditure from capital
cost.
 In respect of property built by the client, contractor‟s bill and other relevant accounts should be
referred.

2. Leasehold property
Verification
 The auditor should inspect the lease or assignment thereof to ascertain the amount of premium, if
any, paid for securing the lease and its terms and conditions.
 The auditor should also see whether the lease has been duly registered.
 He should also verify that all conditions prescribed by the lease are being duly complied with.
 He should confirm the writing off of any legal expenses incurred to acquire the lease.
Valuation
 The value of the leasehold property should be checked from the lease deed. Any addition or
expansion thereon should be examined by reference to the contractor‟s bills and other supporting
papers.
 The auditor should ensure that the provision for any claim that may arise under the dilapidation
clause on the expiry of the lease has been made.
 He should see that the cost as well as legal expenses incurred to acquire the lease is being written
off at an appropriate rate over the unexpected term of the lease.
 He should also check the accounting of leasehold property to ensure that it is maintained separately.

Verification and Valuation of Buildings

Land means a long -term asset that refers to the cost of real property exclusive of the cost of any
constructed assets on the property. The value of land has an appreciated value and is not subject to
depreciation. Buildings will be depreciated over their useful life of the asset.
Verification
 The auditor should examine the title deed of buildings to see whether the client holds the title on the
balance sheet date. If the building has been mortgaged, the title deed will be in the possession of the
mortgagee from whom a certificate should be obtained.

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 He should see the appropriate lease deed, if the building is leasehold, to ascertain the cost,
amortization etc.
 He should also ensure that all conditions in the lease deed have been fulfilled by the client.
 The auditor should ensure that the relevant particulars of buildings have been entered in the fixed
assets register maintained by the client.
Valuation
 The auditor should verify the original cost of the building by reference to the deed of conveyance. If
the building is constructed by the client, he should verify the original cost by reference to the
contractor‟s bill.
 He should also verify that appropriate depreciation has been provided against the building. In case
no depreciation is provided on the building, a note to this effect should be given in the profit and loss
account.
 He should see that the buildings have been valued at cost less depreciation. In case of a company,
the requirements of Schedule VI have to be complied with.
 If any revaluation has taken place, the auditor should look into the basis of revaluation and ensure
that the disclosure of the same has been made.

Verification and Valuation of Plant and Machinery

A plant is an asset with a useful life of more than one year that is used in producing revenues in a
business‟s operations. Plant is recorded at cost and depreciation is reported during their useful life.
Verification
 The auditor should call for the plant register or detailed break up schedule of plant and machinery.
For the balance appearing in the balance sheet, he should identify the specific items and check the
details thereof.
 In the case of a company, the management is duly bound to physically verify the plant and
machinery and the auditor should ask for the related working papers for his examination.
 The additions and disposals during the year should be verified with reference to the purchase
invoices and other appropriate documents.
 The auditor should verify some of the important items of plant and machinery on test check basis.
Valuation
 The cost price of any plant or machinery plus any cost of installation will be vouched with supplier‟s
invoices and other supporting documents.
 The auditor should see that proper depreciation has been provided during the year.
 He should check as to whether any of the items has been disposed off or sold during the year. If so,
he should satisfy that it was properly authorized and the sale proceeds credited to plant and
machinery account. Any capital profit made should be transferred to capital reserve.
 The auditor should also verify that the plant and machinery have been properly shown under fixed
assets in the balance sheet.

Verification and Valuation of Furniture’s and Fixtures

They are items of movable equipment that are used to furnish an office. Examples are chairs, desks,
shelves, book cases, filing and other similar items.
Verification
 The auditor should ascertain whether a register is maintained for furniture and fixtures detailing the
nature of the item, its acquisition cost, location, code number etc.
 He should also verify whether the furniture and fixtures bear on them the code numbers allotted.
 He should inquire whether physical verification of the furniture and fixtures has been carried out by
the management and if so, he should examine the working papers.
 The auditor should verify physically some of the important items of furniture and fixtures on test
check basis.
Valuation
 The auditor should satisfy that the furniture and fixtures have been properly depreciated and value
written off for damaged or unserviceable items,
 He should see that the cost of furniture and fixture has been properly ascertained and recorded in
the books of accounts.

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 He should enquire whether any of the items have been disposed off or sold during the year. If so, he
should check that it was properly authorized and the sale proceeds credited to furniture and fixture
account. Any capital profit made therein should be transferred to capital reserve.
 The auditor should also verify that furniture and fixtures have been properly shown under fixed
assets in the balance sheet.

Verification and Valuation of Motor Vehicles

Verification
 The auditor may call for a schedule of motor vehicles and compare it with the motor vehicles register
maintained.
 He should also examine the registration document for each vehicle. He should compare the
registration number and description given in the registration document with the particulars shown in
the ledger account or motor vehicle register.
 If the vehicle is registered in the name of a person other than the client, the auditor should inspect
the letter confirming the arrangement and ascertain that there is no charge on the vehicle in favour of
such person.
 The auditor should also check the insurance premium receipts to ensure that the vehicles are fully
insured against accidents, theft etc.
Valuation
 The motor vehicles are to be valued at cost less depreciation.
 The cost price of any motor vehicle will be vouched with supplier‟s invoices and other supporting
documents. However, he should see that expenditures on repair have been charged to profit and
loss account and not added to its cost.
 The auditor should verify the adequacy of the depreciation. It is a common practice for the motor
vehicles to be written off over the mileage they are expected to run.
 He should also verify that the motor vehicles have been properly shown under fixed assets in the
balance sheet.

Verification and Valuation of Assets Acquired Under Hire Purchase System

Verification
 The existence of the assets acquired can be confirmed by physical verification of the assets by the
auditor or by reviewing the working papers of physical verification of fixed assets done by the
management.
 The company is not the owner of the asset till the last installment under hire purchase agreement
has been paid. However, the possession right of the asset can be verified by reference to the hire
purchase agreement.
 A default in payment of the hire purchase installment entitles the hire vendor to take back the
possession of the asset. So, the hire purchase agreement has to be examined to ascertain the
nature of encumbrances.
 The auditor should also see that the asset purchased is included in the fixed asset register.
Valuation
 Fixed assets are generally valued at cost less depreciation. So, the auditor will have to examine the
hire purchase agreement and the price list to ascertain the cash cost of the asset.
 Depreciation should be deducted and the auditor should ensure that the rate normally charged by the
company on same or similar assets has been applied on a consistent basis.
 The auditor should confirm the proper recording of assets acquired under hire purchase agreement.
The interest element in the installments should be charged off to revenue.
 The assets purchased on hire purchase agreement may also be shown at the capital value of
installments paid to date. In that case also, the depreciation at the normal rate for the full period on
the cash value will have to be charged.

VERIFICATION AND VALUATION OF INVESTMENTS

An investment is a monetary asset purchased with the idea that the asset will provide income in the
future or will later be sold at a higher price for a profit. Investments include Government securities,
shares, debentures, etc.

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The investments are classified as – (1) Quoted Investments, and (2) Unquoted Investment
Quoted Investment
A company‟s share is said to be “lists”, or “Quoted” if its share can be traded on a stock exchange, i.e.,
Public Limited Companies.
Unquoted Investments
A company share is said to be “unlisted” or “unquoted” if its stocks that are not listed on a stock
exchange and so have no publicly stated price. Here, Investments are difficult to value, for example,
shares that have no stock exchange listing i.e. Private Company etc.
Verification:
The auditor should verify the details of the schedule of investment by applying tests e.g. financial
journals and newspapers should be consulted for checking the market rates. The securities themselves
may be consulted or the broker‟s notes may be examined for checking the cost etc.
The auditor should verify the amount of interest or dividends ass have already have been declared
before the date of the balance sheet, should be taken into account as outstanding ones.
Valuation:
If investments are to be held as a fixed asset for the purpose of earning interest/dividend; these are to
be valued at cost which includes brokerage and stamp duty paid in regard there to.
But if the investments are held as current assets, these assets should be valued at cost or market price
whichever is less. The auditor may come across the situations where the market Value is much below
the cost of acquisition of investments. Ordinarily he should ignore a temporarily fall in the market value,
but where the fall in value seems to be of a permanent nature, he should see that adequate
depreciation is provided by passing the required entries.

VERIFICATION AND VALUATION OF WASTING ASSET

It is also known as depleting assets, wasting assets are of a fixed nature but depleted or consumed
gradually. The process of earning income causes depletion or exhaustion in the value of the assets.
Mines, Oil wells, Quarries are some of the examples of wasting assets.
There is a difference between fixed assets and wasting assets.
1. The Fixed assets are replaceable, whereas wasting assets is irreplaceable after its useful life is over.
2. The value of fixed assets decreases due to normal wear and tear, i.e., depreciates with time and use
or due to obsolescence while the value of wasting assets declines as a result of gradual exhaustion or
reducing stock.
Verification and Valuation
The auditor should confirm in this regard, the value of the wasting assets in the Balance Sheet is
reduced by the estimated amount of yearly depletion. In other words, a wasting asset appears in the
Balance Sheet as its estimated diminished value.

VERIFICATION AND VALUATION OF FICTITIOUS ASSETS

The assets which do not have physical existence are called as Fictitious Asset. Assets, which have no
market values, are known as fictitious assets. They are shown in the Balance Sheet on the asset side
of it under the head “Deferred Revenue Expenditure”.
Examples of fictitious assets are - Preliminary Expenses incurred at the time of formation of the
company, Development Expenses, Debenture Discount, Amount spent on special advertisement
campaign, Brokerage, Underwriting Commission and deferred revenue expenditure.

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 Verification and Valuation
1. Auditor should verify that expenses incurred are properly authorised by a responsible person.
2. He should ensure that fictitious assets are treated as deferred revenue expenditure. Deferred
Revenue Expenditure means temporary capitalization of revenue expenditure with the ultimate object of
spreading the amount over several future years to which benefit of such expenditure will be available.
3. The auditor should confirm that the asset is disclosed in the Balance Sheet at the amount of
expenditure incurred less amount written off.

VERIFICATION AND VALUATION OF FLOATING ASSETS OR CURRENT ASSETS

Current assets are those which are utilized or converted into cash within one year period. Current
Assets are also known as floating or circulating assets.

Cash in hand
The main cash and petty cash in hand are to be physically verified at the closing hours on the last day
of the financial year.
Verification
 The most common practice in verifying cash balance is to obtain a certificate from the accountant
about the actual cash balance in hand at the date of the balance sheet.
 The auditor should verify the cash in hand by actually counting it on the close of the business on the
date of the balance sheet.
 In certain cases, if the client is maintaining an unduly large balance of cash in hand consistently, the
auditor should make a surprise check to ascertain whether the actual cash in hand agrees with the
balances as shown by the books.
 As far as cash in transit is concerned, the auditor should verify this balance with the help of proper
documentary evidences and correspondence.
Valuation
 If the cash-in-hand is not in agreement with the balance as shown in the books, it should be the duty
of the auditor to call for an explanation.
 Often postage and other stamps are taken with the cash in the balance sheet. The auditor should
confirm the balance of postage and stamps by physical counting only.
 He should also check the system of making payments and safety arrangements provided for the
protection of cash balance.
 In case cash is maintained at the local branches and the auditor is unable to pay visit to the branch,
he may ask the branch manager to deposit the balance of cash in the bank on the balance sheet
date.

Cash at Bank
Verification
 The auditor should compare the balances as shown in the passbook with the balances as shown in
the cash book.

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 The auditor should prepare a bank reconciliation statement or should check the statement prepared
by the client in order to ascertain the correct bank balance.
 He should obtain a balance confirmation certificate from the bank at the close of the year.
 He should also obtain separate certificate for fixed deposit account, current account and savings
bank account from different banks to confirm total deposits in different banks.
Valuation
 In order to ascertain the current position with regard to cheques issued but not yet presented or
cheques deposited but not collected, the auditor should confirm through cash book and passbook
figures.
 Where amounts are deposited in foreign banks under exchange control regulations, the fact is to be
disclosed.
 Where amounts are kept in different reserve accounts in the banks in order to avail deductions under
Indian Income Tax Act, the fact should also be disclosed.
 The auditor should also ensure that the bank balances are properly disclosed in the balance sheet
according to Schedule VI of the Companies Act.

Stock in trade
Stock-in-trade or Inventories is the life-blood of a business. Inventories or Stock- in-trade normally
includes the following: Raw-Materials, Work-in-Progress, Semi-Finished Goods, Finished Goods,
Consumable Stores and Spare Parts, Loose-Tools.
Verification: It is practically impossible for auditor to physically verify each item of the stock in hand
because of various reasons i.e. limited time and the lack of technical knowledge. Therefore the auditor
has to rely upon test checks to ascertain the accuracy of stock in trade
Valuation: The stock in trade being a floating asset should be valued at cost price or market price
whichever is less.
The cost price can be calculated from any of the
following methods
a. Unit cost method
b. Average cost method
c. First in first out method (FIFO)
d. Last in first out method (LIFO)
e. Highest In first out (HIFO)
f. Base stock method
g. Adjusted selling price method
h. Standard cost method.

Prepaid Expenses
Verification
 The auditor should verify the receipts for pre-payments, i.e. expenses paid during the period for
future financial periods.
 The amount of prepaid expenses should be shown in the asset side of the balance sheet under
current assets. The auditor should assure that it has been shown properly in the balance sheet.
 Prepaid expenses for the last accounting period should be properly adjusted. The auditor should see
the expenses paid in the last year pertaining to the current accounting year have been properly
adjusted.
 The auditor should also check the adjustments made in the next year, if possible, against the prepaid
expenses made during the year.

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 Valuation
 The auditor should check the calculations for ascertaining the portion of expenses belonging to the
next period by reference to the contract or other documents.
 In respect of rent, rates and taxes, the auditor should check the payment vouchers and satisfy that
allocation to carry forward has been made on time basis.
 In respect of insurance premium, the auditor should also confirm that the carry forward allocation has
been made on the basis of the terms of policy and the premium paid.
 In case of prepaid sales commission, where salesmen are allowed to take payments out of future
earnings, the auditor should examine the statement of sales to determine the commission earned.
Sundry Debtors
A person who receives goods or services from a business in credit or does not make the payment
immediately and is liable to pay the business in the future is called a Sundry Debtor. Businesses use an
account to track these transactions and they are called as Sundry Debtor account or Accounts
Receivable.
Verification
 Existence of book debts can be verified by examining the books of account and satisfying that the
entries therein are supported by proper sales documents.
 Balance of book debts should be sent to the debtors for their confirmation, which will also establish
the existence of the book debts.
 The examination of debtor‟s ledgers with related sales documents and correspondence with debtors
will confirm the ownership of book debts.
 The auditor should also enquire whether there is any dispute on any of the balances included in
sundry debtors. In this case, the documents regarding dispute should be examined.
Valuation
 Usually the balances shown in the debtor‟s ledger supported by sales documents represent the value
of book debts.
 The auditor should call for the lists of book debts and debts written off and arrive at the conclusion
about adequacy of write off and provision for doubtful debts.
 The confirmation of balances by debtors will help establish the valuation of book debts.
 It should be ensured by the auditor that sundry debtors are valued only at realizable value.

Bills Receivables
The bills of exchange that a company will receive payment for in the future, and the part of the
Company's accounts that shows these bills. Bills receivable form part of a company's assets
Verification
The auditor should examine the bills receivable book and prepare a schedule of all those bills
receivable, which have not yet matured before the date of the preparation of the balance sheet.
 Where the number of bills is large and are kept with the bankers for collection, the auditor should
obtain a detailed certificate from the bank to ascertain the clear position about the bills.
 Any contingent liability in respect of the bills that are discounted or endorsed but remain outstanding at
the time of audit should be maintained as a footnote of the balance sheet.
 The bills which have been dishonoured before the due date of the balance sheet should not be
included in the balance sheet as “bills receivable in hand” as they are no longer assets.
Valuation
The auditor should see that the bills are properly drawn, stamped and duly accepted and are not
overdue. In case of renewal of any bills, the auditor should compare the new bill with the old bill.
 Sometimes, the bills might have matured and honoured subsequent to the date of the balance sheet,
but prior to the date of the audit. The auditor should check the cash received as shown in the cash
book of the next year.
 If the bills have been retired before the date of the balance sheet, the proceeds thereof should be
checked by reference to the cash book.
 For the bills discounted prior to the date of maturity when the date of maturity is to fall after the date
of balance sheet, the discount on such bills must be properly apportioned between periods covered
by two separate financial years.

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 VERIFICATION AND VALUATION OF INTANGIBLE ASSETS
They are long-term resources of an entity, but have no physical existence. They derive their value from
intellectual or legal rights, and from the value they add to the other assets.

1. Goodwill:
Goodwill is an intangible concealed asset, which represents the earning capacity of the business. It
arises because of several reasons such as special popularity of a particular place, attractiveness of the
goods dealt in, the popularity of the firm and reputation of the owners of the business enterprise etc. It
also refers to the monetary value of reputation of a business. Since, goodwill is not tangible; it does not
call for physical verification. The Goodwill is shown in company‟s Balance Sheet under the head Fixed
Assets. Goodwill is a valuable asset if the concern is profitable. On the other hand, it is, valueless if the
concern is in loss. Goodwill is to be verified and valued in the following manner.
Verification: Where goodwill has been purchased along with a running business, the same should be
verified from the agreement with the vendor showing the price paid for it. But when the amount is not
specially fixed, the goodwill is the amount for the purchase of the business over the net assets taken
over.
It should be verified that the goodwill has been recorded in the books of accounts only when some
consideration in money or its equal has been paid for.
In case of partnership the auditor should verify the changes made in the goodwill account from time to
time on the basis of provisions made I the partnership deed.
Valuation: There are several methods of valuation of goodwill. However, goodwill should not be
recognized in the accounts unless it is purchased. Regarding valuation of goodwill, an appropriate
method is to be adopted to write the cost down out of the available profits and in this way, it should be
ensured that the capital of the business is represented by tangible assets only.

2. Patents:
According to the Patent Act 1970, “A patent is an official document that guarantees to the inventor an
exclusive right for a term of years to make, use or sell his invention”.
Verification: The Auditor should examine the patents with the help of certificate which have granted
such patent rights. The auditor should also ensure that the patents are registered in the name of client
Valuation: patents must be valued at cost less depreciation. The patents should be written off in a
period of sixteen years after which the right automatically lapses unless the term is extended.

3. Copyrights:
Copyright refers to the exclusive right to produce or re-produce or authorise for doing certain acts
specified in the Copyright Act, 1957, in respect of some kind of literary, dramatic, musical, computer
programme, cinematograph film, sound recording or artistic works. It is the legal right given to an
author, which prohibits the publication of the work by other persons.
Verification: In verifying the copyrights, auditor should inspect the agreement between the auditor and
the publisher.

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 Valuation: Generally the value of the copyright is not stable because copyrights lose their value by
passage of time. In the balance sheet copyright must be shown a cost less amounts written off from
time to time.

4. Trademarks:
A registered and legalized brand name or brand mark is what is known as Trade Mark. It provides a
better protection for goods and services and for the prevention of use of fraudulent marks.
Verification: Trademarks can be verified by examining the assignment deed duly endorsed by the
office of the registrar of trademarks. In case they have been purchased from others, the auditor should
vouch the expenditures incurred in connection with their acquisition e.g. registration fees, payments
made to designers etc.
Valuation: The valuation method is the most suitable method valuation of trademarks. It should be
seen that trademarks are properly valued and shown in balance sheet.

VERIFICATION AND VALUATION OF CONTINGENT ASSETS

The contingent assets are those which may arise on the happening of an uncertain event. As a general
practice, contingent assets are not recorded in the balance sheet because that would imply taking
credit for revenue which has not accrued. But it is logical as the contingent liabilities are shown in the
balance sheet the contingent assets should also be shown. The Companies Act does not require
disclosure of contingent asset in the balance sheet. However, if contingent assets have a significant
value, it may be advisable to disclose such assets in a note to the balance sheet.

As regards valuation of contingent assets, it may be noted that ordinarily no valuation would be
required. However, if such assets were disclosed by way of a note, a proper valuation based on the
related contract would be made. Where full realization of such assets is doubtful even on the face of
contingency occurring, it would be safer to value the assets on a realizable basis.
Following are the examples of Contingent Assets −
 Claim for the refund of the Income Tax, Sales Tax, Excise Duty, etc.
 Uncalled share capital of the company.
 Claim for infringement of a copy right.

VERIFICATION AND VALUATION OF LIABILITIES

The verification of liabilities is of equal importance as that of an asset. The auditor has to satisfy himself
that all liabilities whether existing or contingent have been properly determined and disclosed in the
balance sheet. In case liabilities are overstated or understated, the balance sheet will not represent a
fair view of the state of affairs of the company. Therefore, the auditor should ensure the following:
 That liabilities shown in the balance sheet are actually payable
 That all liabilities are properly recorded in the books

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 That the recorded liabilities are payable for the legitimate operations of the business, and
 That the nature and extent of contingent liabilities has been disclosed in the balance sheet by way of
a footnote.
For the purpose of applying verification technique, we may divide the liabilities into the following three
categories:
 Fixed or long term liabilities, viz. share capital, debentures, long term loan from bank and other
financial institutions etc.
 Current liabilities, viz. sundry creditors, bills payable, bank overdraft etc.
 Contingent liabilities viz. disputed liability of income tax suits pending for damages.

VERIFICATION AND VALUATION OF FIXED OR LONG TERM LIABILITIES

Verification and valuation of capital

Share Capital
In case of partnership firm, the auditor should verify the liability on account of the capital with the
help of partnership deed; pass book and the cash book.
In case of a company auditor should examine the memorandum of association to verify the
information as to the maximum capital the company is authorized to raise. He should also ascertain the
amount of called up in respect of each class of shares and also ascertain how many shares of each
class are allotted as fully paid. Auditor should also specify the sources from which the bonus shares are
issued i.e. capitalization of profits are reserves for share premium accounts. He should also ensure that
capital profit, if any on issue of forfeited shares, has been transported to capital reserve.
Reserves and Surplus
Reserves and Surplus is that portion of current profits or of accumulated profits which is not distributed
as dividend, but is kept separate for purposes of meeting some known or unknown liabilities or for
fulfilment of future needs. Reserves and surplus are appropriation out of profits. The auditor should
verify that the reserves and surplus are shown on the liability side of Balance Sheet with footnotes and
verify entries in the Profit and Loss Appropriation Account.

Verification and valuation of Debentures

Debenture means a document issued by a company to raise finance. It is an acknowledgement of a
debt which is given under the common seal of the company.
a. Debenture trust deed‟ should be inspected and with its help, the debenture account in the ledger
should be examined.
b. If necessary, the auditor can obtain a certificate from the debenture holders.
c. Since the debentures are supposed to be redeemed, the auditor should see the arrangements for
their redemption.
d. The debenture may be issued at par or at premium.
e. The auditor should see the details as given in the Register of Mortgages and charges.

Verification and valuation of long term loans

A company can obtain loans from banks and other financial institutions on the basis of security
provided. For the purpose of verification of long-term loans, they can be classified under two broad
categories:
1. Loans against security of fixed assets
2. Loans against security of stock
a. Loans against security of fixed assets
 The auditor should examine the memorandum and the Articles of Association to see whether the
company is empowered to borrow money against fixed assets.
 He should scrutinize the loan account in the ledger and the documents relating to the fixed assets.
 He should also examine the mortgage deed and find out whether the mortgage is properly executed.
 He should enquire whether the lender has a right to lend money against such security.
 The auditor should also obtain confirmation from the lender for the amount of loan.
 He should see whether principal is being repaid as stipulated and whether interest on loan is paid
regularly as per the terms of loans as prescribed in CARO.

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 b. Loans against security of stock
 The auditor should inspect the receipts of the godown keeper if the loan has been taken against the
godown keeper‟s receipts.
 If the stocks are at dock or in bonded warehouse, the dock warrant or the warehouse certificate duly
endorsed in favour of the lender should also be examined.
 The auditor should see that the rent for the warehouse has been paid by the client regularly. If it has
not been paid, adequate provision should have to be made for the purpose.
 He should also obtain a certificate from the lender showing particulars of securities deposited and
confirm that the same has been correctly disclosed and duly registered with registrar of companies
and recorded in the register of charges.
 The auditor should verify the authority under which the loan has been raised. In the case of a
company, only the Board of Directors is empowered to raise a loan or borrow from a bank.
 He should also confirm that the restraint as contained in Section 293 of the Companies Act as
regards the maximum amount of loan that a company can raise has not been contravened.

VERIFICATION AND VALUATION OF CURRENT LIABILITIES

Current liabilities are those liabilities which are payable within one year.
Trade creditors
A person who gives a benefit without receiving money or money‟s worth immediately but to claim in
future is a creditor.
 The First task the auditor is to ask for schedule of creditors.
 The purchase ledger should be checked with the books of original entry, invoices and credit notes etc.
 Discount on creditors should be checked with reference to creditor‟s account.
 If any debt Is found unpaid for a longer period of time any enquiry should be made since it is possible
that instead of paying to the creditor the amount might have been misappropriated
Bills Payable
Bill refers to bill of exchange. Bills payable means bills accepted for the credit purchases made. The
amounts on bills are payable at the due dates.
 The auditor should get a statement of bills payable and compare it with the bills payable book and
bills payable account.
 For the bills which have been met after the date of the balance sheet but before the date of audit, he
should examine the cash book and bank passbook.
 The bills payable already paid should be checked from the cash book and the auditor should
examine the returned bills payable.
 He should also ensure that the bills which have been paid are not recorded as outstanding.
 He should get confirmation in respect of amounts due on the bills accepted by the client that are held
by them.
 He should reconcile the total of the bills payable outstanding at the end of the year with the balance
in the bills payable account.
Bank Overdraft
It is a line of credit extended by a bank to its account holder to withdraw money in excess of the
balance in his account up to a specified limit. It is a current liability as the business concern, i.e., being
an account holder is liable to repay the amount to the bank.
 The auditor should examine the overdraft agreement with the bank in order to ascertain the terms
and conditions of overdraft and the maximum limit thereon.
 The Memorandum of Association in case of a company should be examined to ascertain the
borrowing powers of the company and any limitations thereon.
 The auditor should verify the minutes of the Board meeting to assure that the bank overdraft
borrowing is being authorized by the Board.
 If the client is a company and if the overdraft is against any security, the auditor should see whether
the charge created was registered with the registrar of companies, if required.
 The auditor should also obtain the confirmation certificate from the bank in respect of amount of
overdraft at the close of the year.

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 The auditor should also check whether interest on overdraft has been duly accounted for.
 The auditor should also confirm that the amount overdrawn is within the maximum limit sanctioned
by the bank.
 It is to be seen whether any security was offered for the overdraft in terms of agreement, depending
on which the overdraft is to be classified as secured or unsecured.
Provision for Taxation
 The auditor should ascertain the tax liability and check the computation of the assessable profit and
loss account. Thus, adjustments affecting taxable profit must be carefully scrutinized.
 He should also go through earlier completed assessment in order to know what sort of adjustments
were actually made in the past.
 He should also check the amount of advance tax paid and the calculations thereof. Advance tax is
required to be verified in order to provide the liability of future taxation.
 If income tax return has already been filed before the date of audit, the auditor should also check the
copy of the income tax return.
 The auditor should ensure the amount of overall provision on the date of the balance sheet having
adequate regard to the figure of provision of the year, the advance tax paid, past provision made and
assessment orders in respect thereof received up to the date of audit, pending appeals and refunds,
if any.
 He should also obtain a certificate from the tax practitioner regarding the amount of tax payable.

Outstanding expenses
It is a line of credit extended by a bank to its account holder to withdraw money in excess of the
balance in his account up to a specified limit. It is a current liability as the business concern, i.e., being
an account holder is liable to repay the amount to the bank.
 The auditor should ask for the list of outstanding expenses from the client classified on the basis of
nature of expenses.
 He should verify the supporting documents evidencing the outstanding expenses.
 He should also verify the basis of estimation of outstanding expenses, if they are provided on an
estimated basis.
 He should check the cash book of the previous year in order to see that the usual outstanding
expenses have been paid off by the time of audit.
 He should also ensure that no outstanding expenses have been paid which have not been provided
in the account. If paid, he should check the adjustment entries passed for this purpose.
 He should compare the list of outstanding expenses of the current year with that of the previous year
to identify any major deviations.
 The auditor should also ensure that no usual outstanding expenses have been left out to be
provided.
 He should also confirm that outstanding expenses have been shown under current liabilities in the
balance sheet.

VERIFICATION AND VALUATION OF CONTINGENT LIABILITIES

A contingent liability is not an actual liability but which will become a liability on the happening of an
event in future. Simply stated, contingent liability is not an actual liability but will become a liability on
the happening of an event in the future. For example, if any person filed a suit against company,
possibilities are there, it may be in favor of company or it may be against the company, in case it will
decide against the company, company has to pay such amount of suit as the court decides. Therefore,
contingent liabilities are said to be possible liabilities.
In case of above, no actual provision is made in the books of account but as a footnote of Balance
sheet, it is compulsory to show the probable amount of liabilities.
The examples of contingent liabilities are as follows:
 Discounting of bills receivables
 Pending suits for damages or compensation
 Disputed liability on account of income tax
 Guarantee given by the bank on behalf of the company.

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DISTINCTION BETWEEN VOUCHING, VERIFICATION AND VALUATION
Vouching Verification Valuation
Meaning Vouching is a process of Verification is a process Valuation is a process
comparing the entries in which proves the which certifies the correct
the books of accounts existence, ownership and value of the assets and
with the bonafide title to the assets. liabilities at the date of
vouchers. balance sheet.
Subject Vouching is made of the Verification on the other Valuation is also made of
matter entries recorded in the hand is made of assets assets and liabilities
books of original entry and and liabilities appearing in appearing in the balance
their posting in the ledger. the balance sheet at the sheet at the end of the
end of the year. year.
By Whom Vouching is done by the Verification on the other Valuation on the other
senior auditor and audit hand is done by the hand is done by the
clerks. auditor himself or his auditor himself or his
associates. associates.
When Vouching is done after the Verification on the other is Valuation on the other is
entry of transactions in the done at the end of the done at the end of the
account books. financial year when the financial year when the
final accounts are to be final accounts are to be
prepared. prepared.
Evidence In vouching , bonafide Verification is made on the In valuation an auditor
vouchers are sufficient basis of evidence such as has to depend upon the
evidence for vouching. the title deeds, receipts certificates of the
and payments etc. owners/directors.

DEPRECIATION
Meaning
The gradual diminition, loss or shrinkage in the utility value of an asset due to wear and tear in use,
effluxion of time or obsolescence is called as depreciation.
Definition
According to Spicer and Pegler, “depreciation may be defined as the measure of exhaustion of the
effective life of an asset from any cause during a given period”.
Causes for depreciation
The causes of depreciation can be classified as – (1) internal causes, and (2) external causes.

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Internal causes:
1. Wear and tear: the value of capital assets like plant, machinery, building etc. Decrease in value due
to constant use. The wear and tear of an asset depends on the usage of asset.
2. Exhaustion: certain assets like plantations and livestock lose their value with lapse of time as they
are being used or consumed. These assets have a definite period of life after which they exhaust in
value and become useless.
3. Depletion: natural resources such as mines, quarries and oil wells are of a wasting character and
are called as wasting asset. These assets loose their value due to extraction of oil, depletion of
minerals and metals. Thus, the value of wasting assets declines due to gradual exhaustion.
4. Deterioration: deterioration means erosion in value of those assets which have a very short period
of life. The fall in value of those assets refers to depreciation.
External causes:
External factors which cause depreciation include passage of time, obsolescence, permanent fall in
market value and due to weather and accidental calamities. These factors are not connected to the
inherent nature of the asset.

Objectives of providing depreciation

The need for charging depreciation arises due to the following objectives:
1. To ascertain the true cost of production
2. To ascertain correct income
3. To show a true and fair view of financial position
4. To comply with legal requirements
5. To accumulate funds for replacement of asset
6. To keep capital intact
7. To plan tax liability

Different methods of charging depreciation

1. Straight line (or) fixed instalment method

This is the oldest and simplest method of charging depreciation. The life of the asset is estimated and
depreciation is written off equally over the life of an asset. The amount of depreciation is such that the
book value of the asset is reduced to zero at the end of life of the asset.

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2. Diminishing or written down value method
In this method depreciation is charged at a fixed percentage on the reducing balance of the asset every
year over the useful life of the asset. The amount of depreciation goes on decreasing every year. This
method is very useful for plant and machinery where additions and extensions take place very often.
3. Annuity method
Annuity method considers both the value of asset and the amount of interest on the investment made in
the fixed asset. Besides, interest, a fixed amount of depreciation is calculated on the basis of
depreciation from annuity table and is charged to profit and loss account every year. The method is
precise and exact from the point of view of calculations, so it is called a scientific method.
4. Depreciation fund method
This method provides funds for the replacement of the asset at the end of its life. Every year the
amount set aside for depreciation along with the interest is again invested. The amount so invested is
debited to an account known as sinking fund investment account and these investments are shown as
an asset in the balance sheet. The amount of depreciation remains the same for the year.
The rate of interest available from investments and the time required for replacement of the assets
enables determine the amount of depreciation. The investments are sold when the asset is due for
replacement and the amount so received is used for purchasing the new asset.
5. Insurance policy method
In this method an insurance policy is purchased for the value of the asset. This policy is taken up for the
life of the asset and it matures at a time when the asset is to be replaced. The amount provided for
depreciation is paid towards insurance premium. The amount of premium remains the same in all the
years. On maturity of the policy, insurance company will pay the amount and the amount will be used
for replacing the asset.
6. Revaluation method
In this method the amount of depreciation is calculated by revaluing the asset at the end of each year.
The difference between the value of the asset at the beginning and at the end of the period is taken as
depreciation. There can be an appreciation in value too. The amount of appreciation is debited to the
asset and credited to profit and loss account.
7. Depletion method
This method is specially used for those assets which deplete with use. The cost of the assets is divided
by total workable deposits. The depreciation rate is calculated by dividing the cost of the asset by the
estimated quantity of product likely to be available. Annual depreciation will be the quantity extracted
multiplied by the rate per unit.
8. Machine hour rate method
Under this method, the life of a machine is estimated in terms of its working hours instead of years. The
total number of hours in which a particular machine will work efficiently is estimated. The estimated
number of hours is then divided by the cost of the machinery less residual value to ascertain the hourly
rate of depreciation. This method is considered more scientific and precise than either the fixed
instalment method or the reducing balance method.

AUDITOR’S DUTIES WITH REGARD TO DEPRECIATION

An auditor is not a valuer to determine the value of assets held by the company. He has to depend on
the suggestions and advice given by professional experts in determining the value and estimated life of
the asset. However, the following are the duties of an auditor in this regard.

1. Verify depreciation rates: The auditor should ensure that depreciation has been provided as per
the rates prescribed by the companies act.
2. Disclosure in financial statement: He should ascertain that adequate depreciation is charged and
properly disclosed in the profit and loss account and balance sheet.
3. Compliance with accounting principles: He should ensure that relevant accounting principles
have been followed while providing for depreciation.
4. Depreciation on purchase or sale: When assets are purchased or sold during the year, auditor
should ensure that depreciation is charged on pro-rata basis taking into account the date of purchase
or sale and the accounting period.

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5. Certification from experts: In case the depreciation charged is more than the rates prescribed, he
should examine whether same are based on professional and technical advice.
6. Consistency: Where difference rates are used for different assets, the same should be consistently
applied over the years.
7. Change in method of depreciation: In case of a change in the method of accounting for
depreciation it is recalculated from the date on which asset came into use and deficiency, if any, has
been charged to profit and loss account.
8. Adequacy of capital employed: Auditor should check whether the capital employed in the assets
is being kept intact.
9. Revaluation of assets: In case of revaluation of asset during the year he should ensure that
depreciation is charged on revalued amounts.
10. Procedure of computation: He should ensure that the procedure for calculating depreciation
complies with the provisions of companies act and income tax act.

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 PRACTICAL AUDITING

( REFERENCE NOTES – UNIT III )

ACCORDING TO REVISED SYLLABUS

OF
UNIVERSITY OF MADRAS

Ms. B. BINDU SINGH

ASSISTANT PROFESSOR
DEPARTMENT OF COMMERCE - GENERAL
A.M. JAIN COLLEGE
MEENAMBAKKAM, CHENNAI.

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 UNIT III : AUDIT AND ACCOUNTING STANDARDS
Types of Audit – Statutory Audit - Concurrent Audit - Stock Audit - Cost Audit - Secretarial Audit - CAG Audit -
Management Audit. Accounting Standards - Standards on Auditing - Standards on Internal Audit - Penal
Provisions - Role of National Financial Reporting Authority (NFRA)

TYPES OF AUDIT

STATUTORY AUDIT
The term statutory denotes that the audit is required by statute. A statute is a law or regulation enacted by the
legislative branch of the organization‟s associated government. Statutes can be enacted at multiple levels
including federal, state, or municipal.

Statutory audit, also known as financial audit, is one of the main types of audit which is to be done as per the
statutes applicable to the entity. Its primary purpose is to gather all relevant information so that the auditor can
give his opinion on the true and fair view of the company‟s financial position as on the balance sheet date.

The purpose of the statutory audit is that the auditor gives his view independently without being influenced in
any manner. He will check the financial records and provide opinion thereon in the audit report. It helps the
stakeholders to rely on financial statements. Stakeholders, other than shareholders, also get benefited from
this audit.

SECRETARIAL AUDIT
An audit is not always necessarily about accounting and financial records. An audit actually means a close
examination or review of anything – a process, records, efficiency etc.
 A Secretarial Audit is a mechanism to check the compliance of an organization to the laws, rules, regulations,
and notifications etc prevalent at the time of the audit.
 The rules and regulations around companies are very complex and ever increasing.
 The responsibilities of the directors & other managerial positions are also very complicated and crucial.
 So it is important that a Practicing Company Secretary (PCS) be hired to conduct a secretarial audit.
 PCS will ensure that all proper compliance mechanism and systems are in order.
 He ensures that all the legal and procedural requirements of the law and regulations are being met with.
 If he finds any fault he can point out to the management and they can rectify their mistakes.
Scope of the Secretarial Audit
So a Company Secretary (member of the ICSI) is appointed as a secretarial auditor usually at the beginning of the
financial year. This appointment is by the board members via a board resolution. He will then submit a report of his
audit to the same board. It is preferable to submit a report quarterly, so the company can stay on top of the
compliance requirements. Now when the auditor submits his report, he has to review the compliance of five
specific laws. This is the scope of his audit.
The five laws are as follows,
1. Companies Act 2013
2. Securities Contracts (Regulation) Act, 1956
3. Depositories Act 1956
4. FEMA 1999
5. Rules and Regulations under the SEBI Act
Other than this the auditor will also check the company‟s compliance with,
 The Secretarial Standards which the ICSI issues from time to time
 The Listing Agreement of the company with the appropriate stock exchange

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 CONCURRENT AUDIT

Concurrent audit is a systematic and timely examination of financial transaction on a regular basis to ensure
accuracy, authenticity, compliance with procedures and guidelines. The emphasis under concurrent audit is
not on test checking but on substantial checking of transactions. The concept of concurrent audit has been
introduced to reduce the time gap between occurrences of transaction and is overview or checking. The
concurrent audit serves the purpose of effective control as it is normally conducted by external agencies like
chartered accountants firms.
Scope of Concurrent audit
Concurrent audit is an examination, which is contemporaneous with the occurrence of transactions or is carried
out as near thereto as possible. It attempts to shorten the interval between a transaction and its examination by
an independent person not in its documentation. The study of various fraudulent transactions with the systems
and procedures by the bank employees which resulted in misuse of one's position. Hence, the focus of
concurrent audit is on adherence to laid down systems, procedures and safeguards.
A concurrent auditor may not sit in judgment of the decisions taken by a branch manager or an authorised
official. The concern was that this is beyond the scope of concurrent auditor. However, the auditor will
necessarily have to see whether the transaction or decisions are within the policy parameters laid down by the
Head Office, they do not violate the instructions or policy prescriptions of the RBI, and that they are within the
delegated authority and in compliance with the terms and conditions for exercise of the delegated authority. In
every large branch, which has different divisions dealing with specific activities, concurrent audit is a means to
help the in-charge of the branch to ensure on an ongoing basis that the different divisions function within laid-
down parameters and procedures.
Objectives or Importance or Advantages of Concurrent audit
The main objectives of concurrent audit include that any violation of procedure is brought to light ascertaining
whether sanction for advances and expenditures is taken from competent authority.
 Examining books of accounts records and registers to ensure that they are maintained in accordance with
the prescribed systems.
 Ensuring compliance of laid down systems, procedures and policies.
 Adequate measures are being taken in advance to prevent future frauds, etc., to avoid difficulties, which
may arise.
 To check cash, securities, etc., to ensure that they are in due order and in agreement with books.
Detection and arresting of any leakage of income, if any.
 Evaluating the quality of customer services provided and giving useful suggestions.
 Assessing overall performance of the branch while assessing productivity and profitability and to offer
useful comments on the basis of audit conducted.
 Restriction of matter discussed on the spot with the help of concerned official.
 Reporting any inefficiency in any operational level.
 Reporting any irregularity in working which may result in financial or other loss to branch.
 Reporting to appropriate levels of management for appropriate actions for remedial measures. Scrutinizing
the completeness of documents submitted for availing advances and other facilities and physical checking
of stocks and other assets at relevant places.
 To follow up with authorities to ensure timely rectification of irregularities reported which were not rectified
on the spot.
 Verify prompt timely and regular submission of the periodical and statutory returns.

STOCK AUDIT OR INVENTORY AUDIT

It is a term that refers to physical verification of a company or institution‟s inventory assets. There are types of
stock audits depending on the purpose and every stock audit will require a different approach. Inventories
normally comprise raw materials including components, work-in-process, finished goods including by-products,
maintenance supplies, stores and spare parts, and loose tools.

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Inventories normally constitute a significant portion of the total assets, particularly in the case of manufacturing
and trading entities as well as some service rendering entities. Audit of inventories, therefore, assumes special
importance. Every business institution at least needs to perform a stock audit once a year to update and
ensure that the physical stock and the computed stock match.
Importance of stock audit
 Identify the slow-moving stock, deadstock, obsolete stock, and scrap
 Find out discrepancies between book stocks and physical stock
 Update the physical stock that matches book stock
 Make sure the proper preservation and handling of stocks
Advantages of stock audit
 To reduce cost and bottom-line
 To prevent pilferage and fraud
 As information of the accurate inventory value
 To reduce gaps in the inventory management process
 As special arrangements for third party opinion, including for agent warehouses
 As a good control mechanism in running the business.
Methods of stock audit
 Cut-off Analysis – the process where an auditor(s) examine the company‟s procedures. This involves the
test of the last few receiving and shipping transactions before conducting the physical count and transactions
that follow it. This makes sure that they are fully accounted for.
 Physical inventory counting – the process of counting every piece of inventory assets to account for them
all. An auditor usually uses technology like a bar code scanner to physically count each item.
 Inventory layers – a process taken if the company does inventory using FIFO (first-in, first-out) or LIFO
(last-in, first-out) to make sure that the recorded inventory is valid
 High-value item inventory analysis – another term used for ABC Analysis that refers to the grouping of
high value as A products, mid-tier are B, and low-value is C. It is time-saving and helps to better manage a
stockroom.
 Inventory-in-transit analysis – an analysis to track the time between the date of shipment and the date of
receipt when materials are moving between two locations or more. This audit helps to make sure that all the
items are not lost and safe while in transit
 Freight cost analysis – a process to determine shipping costs and the costs to get products from one place
to another.
 Finished-goods cost analysis – the inventory which you have completed and are ready to sell is known as
finished goods. An auditor then analyzes the value of the inventory for the current accounting period.
Procedures of stock audit
 Examination of Records
 Attendance at Stock Taking
 Confirmation from Third Parties
 Examination of Valuation and Disclosures
 Analytical Review Procedures
 Work in Progress
 Management Representations
 Documentation by the auditor

CAG AUDIT

Government and the State Government are audited. The responsibility of this falls on the Comptroller and Auditor
General of India (CAG). CAG ensures that the financial transactions of the government are executed correctly and
have the proper authorization. The focus is mainly on the expenditures done by both governments. Also,
government audits will include an audit of government and public companies as per the provisions of the
Companies Act 2013.

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The Comptroller and Auditor General is one of the few offices directly appointed by the President of
India.
Article 148 of the Constitution of India establishes the authority of this office. It states the following points in
relation to the establishment and powers of CAG:
 The Comptroller and Auditor General is appointed by the President of India and can be removed from
office only in the manner and on the grounds that a Judge of the Supreme Court is removed.
 The person appointed to this office should take an oath of office before the President or any other person
appointed by the office of the President.
 The salary, service conditions, leaves of absence, pension and age of retirement are determined by the
Parliament of India and specified in the Second Schedule such that the service conditions and salary will
not be modified to the disadvantage of the incumbent during their tenure.
 The CAG is not eligible for any further office after the end of their tenure either in the Government of India
or any State Government.
 The powers and functions of the CAG are subject to the provisions of the Indian Constitution and any Acts
of Parliament, along with the service conditions for the Indian Audits and Accounts Department. The rules
governing these would be prescribed by the President in consultation with the incumbent.
 The expenses on the administration of this office including all allowances, salaries and pensions would be
charged to the Consolidated Fund of India.
 The incumbent is appointed for a period of 6 years or until attaining the age of 65 years whichever is
earlier.
In order to be able to discharge duties effectively, certain privileges and powers which facilitate the process
of auditing have been given to this office. The following are the major powers of the CAG of India:
 The Comptroller and Auditor General or his staff can inspect any office of the organizations which are
subject to his audit. He and his staff can scrutinize the transactions of the government and question the
administration regarding the various aspects of these transactions. After scrutinizing the transactions, the
CAG may withdraw his objections or, if he finds them serious, incorporate them in his report which is
submitted to the Parliament.
 To enable the office to perform this function smoothly, he is endowed with full access to all the financial
records including books, papers, and documents. Moreover, the CAG has the freedom to ask for the
relevant information from any person or organization. His right to call for information and accounts is
statutory, as was affirmed by the order made by the Government of India in 1936 in order to enforce the
Act of 1935.
The present provision of according him free access to files and information is a practice continuing from the
past. A modification, however, was introduced in 1954 in the central government according to which, if
secret documents are involved, they are sent to the CAG by name specifically and are returned as soon as
the work is over.

Role of CAG in India

The role of this office is to uphold the provisions of the Indian Constitution and laws enacted by the Parliament
in the field of financial administration. The accountability of the executive (i.e., the council of ministers) to the
Parliament in the sphere of financial administration is secured through CAG reports. The office is responsible
to and is an agent of the Parliament and conducts audits of expenditure on its behalf.
 The CAG has „to ascertain whether money shown in the accounts as having been disbursed was legally
available for and applicable to the service or the purpose to which they have been applied or charged and
whether the expenditure conforms to the authority that governs it‟.
 The office can perform a propriety audit, that is, it can look into the „wisdom, faithfulness and economy‟ of
government expenditure and comment on the wastefulness of such expenditure. However, unlike the legal
and regulatory audit, which is obligatory on the part of the CAG, the propriety audit is discretionary.
 The secret service expenditure is a limitation on the auditing role of the CAG. In this regard, the CAG
cannot call for particulars of expenditure incurred by the executive agencies but has to accept a certificate
from the competent administrative authority that the expenditure has been so incurred under his authority.
 The Constitution of India visualizes this office to be Comptroller as well as Auditor General. However, in
practice, the incumbent officer is fulfilling the role of an Auditor-General only and not that of a Comptroller.
In other words, „the office has no control over the issue of money from the consolidated fund and many
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 departments are authorised to draw money by issuing cheques without specific authority from the CAG,
who is concerned only at the audit stage when the expenditure has already taken place.

Duties, Powers and Conditions of Service - CAG Act, 1971.

According to this act, the CAG can audit:
 All receipts and expenditure from the Consolidated Fund of India and of the states and union territories.
 All transactions relating to the Contingency Funds and Public Accounts.
 All trading, manufacturing, profit and loss accounts and balance sheets and other subsidiary accounts kept
in any department.
 All stores and stock of all government offices or departments.
 Accounts of all government companies set up under the Indian Companies Act, 1956.
 Accounts of all central government corporations whose Acts provide for audit by the CAG.
 Accounts of all authorities and bodies substantially funded from the Consolidated Fund.
 Accounts of any authority, even though not substantially funded by the government, at either the request of
the Governor/President or at the CAG‟s own initiative.

Functions of the CAG of India

The Constitution in Article 149 provides the legal basis for the Parliament to prescribe the duties and
powers of the CAG in relation to the accounts of the Union and of the States and of any other authority or
body.
The CAG Duties, Powers and Conditions of Service (DPC) Act, was passed in the parliament in 1971.
The DPC Act was amended in 1976 to separate accounts from audit in the Government of India.
The duties and functions of the CAG as laid down by the Constitution are:
 Auditing the accounts related to all expenditure drawn from the Consolidated Fund of India, consolidated
fund of every state and consolidated fund of every union territory having a Legislative Assembly.
 Audit of all expenditure from the Contingency Fund of India and the Public Account of India as well as the
contingency funds and the public accounts of states.
 Audit of all trading, manufacturing, profit and loss accounts, balance sheets and other subsidiary accounts
of any department of the Central Government and state governments.
 Auditing the receipts and expenditure of the Government of India and each state to ensure that the rules
and procedures in that regard are designed to secure an effective check on the assessment, collection and
proper allocation of revenue.
 Auditing the receipts and expenditure of the following: All bodies and authorities substantially financed from
the Central or state revenues; Government companies; and Other corporations and bodies when so
required by related laws.
 Auditing all transactions of the Central and state governments related to debt, sinking funds, deposits,
advances, suspense accounts and remittance business. He also audits receipts, stock accounts and
others, with approval of the President, or when required by the President.
 Auditing the accounts of any other authority when requested by the President or Governor. For example,
the audit of local bodies.
 Advising the President with regard to prescription of the form in which the accounts of the Centre and the
states shall be kept (Article 150).
 Submitting audit reports relating to the accounts of the Central Government to the President, who shall, in
turn, place them before both the Houses of Parliament (Article 151).
 Submitting audit reports relating to the accounts of a state government to the Governor, who shall, in turn,
place them before the state legislature (Article 151).
 Ascertaining and certifying the net proceeds of any tax or duty (Article 279). The certificate is final. The „net
proceeds‟ means the proceeds of a tax or a duty minus the cost of collection.
 Acting as a guide of the Public Accounts Committee of the Parliament. He compiles and maintains the
accounts of state governments. In 1976, he was relieved of the responsibilities regarding the compilation
and maintenance of accounts of the Government of India due to the separation of accounts from audit,
through departmentalization of accounts.

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The CAG submits three audit reports to the President:
 Audit Report on Appropriation Accounts: The appropriation accounts show the appropriation of the
money granted by the legislature to the various grants and heads of expenditure and whether the
money granted for a specific purpose has been spent for that purpose or not.
 Audit report on Finance Accounts: The Finance Accounts show the accounts of annual receipts and
expenditure during the year.
 Audit report on Public Undertakings: This report deals with the finances and expenditures of various
Public Sector Undertakings.
The President lays these reports before both the Houses of Parliament. After this, the Public Accounts
Committee examines them and reports its findings to the Parliament.

Structure of CAG’S Office

The Indian Audit and Accounts Department (IAAD) is headed by the Comptroller and Auditor General of India.
He is assisted by five Deputy Comptroller and Auditors General of India. One of the Deputies is also the
chairman of the Audit Board. Below the Deputy CAG are four Additional Deputy Comptroller and Auditors
General of India. The hierarchy in this office comprises of:
 CAG
 Deputy CAG
 Additional Deputy CAG
 Directors General or Principal Accountant General
 Principal Directors
 Directors/Deputy Directors
 Assistant Accountant General.
 Supervisory Officials – Sr. Audit/ Audit or Accounts Officers, Asst. Audit or Accounts Officer.

Audit Jurisdiction
The CAG audits the following departments and bodies:
 Union & State Governments
 Bodies or Authorities substantially financed by Government
 Government Companies
 “Entrusted” Audits
 Audit of Urban Local Bodies (ULBs) and Panchayati Raj Institutions (PRIs) –Technical Guidance &
Supervision.
COST AUDIT

Cost audit was first time introduced in 1965 in India, when the central government added Clause (d) to Section
209 and 233B of the Companies Act. Cost audit is an effective means of control in the hands of management
and it is a check on behalf of the shareholders of the company, consumers and the government. In fact, cost
audit is an audit process for verifying the cost of manufacture or production of any article, on the basis of
accounts as regards utilisation of material or labour or other items of costs, maintained by the company.
Definition
 “Cost audit is the verification of the correctness of cost accounts and adherence to the cost accounting
plans.”
 Smith and Day define cost audit as “the detailed checking of costing system, techniques and accounts to
verify correctness and to ensure, adherence to the objectives of cost accounting.”
Objectives of Cost audit
 To detect any error or fraud which might have been done intentionally or otherwise
 To ensure that the cost accounting procedures which have been laid down by the management is strictly
followed
 To verify the accuracy of costing data by checking the arithmetical accuracy of cost accounting entries in
the books of accounts
 To have full control on the working of costing department of the organisation and to suggest ways and
means for its smooth running
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 To introduce an effective internal cost-audit system in order to reduce the burden of detailed checking
work of the external auditor
 To help the management in taking correct and timely decisions on cost of production and cost variations
 To verify the adequacy of the books of accounts and records relating to cost
 To value accurately the value of work-in-progress and closing stock
 To advise the management for adoption of alternative courses of action by preparing cost plan
 To report to appropriate authority as to the state of cost affairs of the organization.
Advantages of Cost audit
To the management
 It helps in controlling different elements of cost.
 It can assess the profitability of the organisation.
 It helps to have a better inter-firm comparison.
 It is a basis of evaluation of the inter-divisional performance.
 It helps in obtaining licenses for either expansion or diversification of the various product lines of the
business.
 It can also check to control high inflationary trend of cost.
 It helps the management in finding out the correct cost of production.
 It can increase the productivity by detecting the weaker areas of cost of production.
 The inefficiencies of the employees working in the cost department may be revealed.
 Errors and frauds may be detected through efficient conduct of cost audit.
To the shareholders
 It gives guarantee of the proper maintenance of cost records.
 It can stop the capital erosion by constant watch on better plant utilisation, discontinuing uneconomic
product lines and elimination of wastage.
 Through cost audit, the decision makers get timely and proper information, which results in better
performance by the organisation.
 Cost audit also ensures fair return to shareholders on their investments.
To the consumers
 Cost audit helps in the fixation of fair prices.
 It helps the consumers indirectly in increasing their standard of living.
To the government
 It forms a basis for the assessment of income tax.
 It helps the government in fixing and regulating prices.
 It gives guidelines to improve working of uneconomic industrial units.
 It gives information to the government regarding fraudulent intentions of any company.
To the society
 Cost audit provides guidelines to the industries for improving its workings and thus renders a great
service towards the society.
 It saves the customers from exploitation by revealing them the actual cost and to know whether the
market price of product is fair or not.
 It helps the industries to improve their efficiencies and production and to reduce the prices of the
product.
Disadvantages of Cost audit
 It introduces unnecessary interference in the normal working of companies.
 It leads to duplication of work because large areas of working of financial and cost audit are common.
 It may be considered as a burden to the company because of the additional cost to be incurred on cost
audit.
 Conduct of cost audit by outsiders may be harmful to the interest of the company itself as the secrecy in
cost accounts may not be maintained.
 By introducing cost audit in certain industries, more restrictions have been imposed on the functioning of
the organisations by the government.

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 MANAGEMENT AUDIT

A management audit is an independent and systematic analysis and evaluation of a company‟s overall
activities and performances. It is a valuable tool used to determine the efficiency, functions, accomplishments
and achievements of the company. The primary objective of the management audit is to identify errors in
management activities and suggest possible changes. It guides the management to manage the operations
most effectively and productively.
Definition of Management audit
According to Taylor and Perry, “management audit is the comprehensive examination of an enterprise to
appraise its organisational structure, policies and procedures in order to determine whether sound
management exists at all levels, ensuring effective relationships with the outside world”.

Objectives of Management audit

 To reveal any irregularity or defect in the process of management and to suggest improvements to
obtain the best results.
 To assist all levels of management from top to bottom through constant watch of all operations of the
organization.
 To review the performance of the management through close observation of inputs and outputs
 To assist management in achieving co-ordination among various departments
 To assist management in establishing good relations with the employees and to elaborate duties, rights
and liabilities of the entire staff.
 To recommend changes in the policies and procedures for a better future.
 To ensure most effective relationship with the outsiders and the most efficient internal organization.
 To recommend for better human relation approach, new management development and overall
organizational plans and objectives.

Importance of Management audit

Management audit is concerned with assessment of efficiency and soundness of management to lead the
business to its goal.
 Reviews plans and policies In an organization, the management holds periodical meetings for the
review of their performance and for the assessment of their operations to know as to whether these are
performed according to the plans and policies adopted by them. But if the plans and policies are defective,
the assessment will be of no use. Hence, there should be some independent review of the plans and
policies as formulated by the management. The functions are performed by the management auditors.
 Identification of management weaknesses Management audit properly spots the inefficiencies and
weaknesses of the management. It assesses the soundness of plans adopted and the adequacy of control
system for making the plans successful.
 Proper advice to the management Management audit does not rest simply on identifying diseases. To
make proper prescription for removal of these diseases is one of the major functions of management
auditors.
 Advising the prospective investors Management audit can also be useful to a prospective investor
who is considering making a big investment in an organisation. The management auditor engaged by him
can collect such information from the organisation as will be useful in evaluating the investment decision.
 Taking over of sick industry Before deciding to take over a sick organisation, the government can order
a management audit in that organization and learn the actual causes of sickness. On the basis of the
recommendations from the management auditors, the government can take proper steps accordingly.
 Helping in foreign collaboration In case of industrial collaboration, the foreign collaborators can collect
useful information about the management and the future of the collaborating unit through management
audit and can take right decision.
 Guides the bank in sanctioning loan Before granting loan or participating in the equity capital of a
company, a bank or financial institution may get management audit conducted to ensure that their
investment in the company would be safe and secured in the hands of the management.

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 Guard against shortsighted project As the tenure of the directors is very short, they become prone to
taking decisions keeping in view only short run profit ignoring its adverse effect on the company in the long
run. Management audit can act as a guard against such possibility.

Scope of Management audit

The following are the important areas that come within the normal terms of reference of management audit:
1. Whether the basic aims and objectives of the enterprise are being fulfilled in practice
2. Whether the enterprise is being successful in adapting itself to technological change
3. Whether the management structure is suitable
4. „Whether management is efficient at all levels and to what extent economies are possible
5. Whether the policies with regard to staff recruitment and training are adequate, and whether staff morale
is satisfactory
6. Whether there is a proper communication system both upwards and downwards throughout the
enterprise including a proper management information system
7. Whether the enterprise‟s share of the market is increasing or declining and how it compares with its main
competitors
8. Whether the return on capital employed is satisfactory and how it compares with other companies in the
same industry
9. Whether the management has been able to establish good relations with the employees and how it
compares with other companies
10. Whether its relationship with the outside world is effective and whether its corporate image in the eyes of
outsiders is satisfactory

Steps of Management audit

 Examination of management performance
 Reporting defects and irregularities
 Presenting suggestions for improvement
These basic steps can further be broken down into the following stages:
1. Study of the activities
2. Detailed diagnosis
3. Determination of purpose and relationship
4. Looking for deficiencies
5. Analytical balance
6. Testing of effectiveness
7. Searching for problems
8. Ascertainment of solutions
9. Determination of alternatives
10. Seeking out methods of improvement.
The auditors conducting management audit begin their work with discussions with the management executives
and employees, then they note down their findings and make out their probable recommendations on the basis
of those findings. Finally, they submit their final report along with their recommendations.

Advantages of Management audit

 It helps the management in preparing plans, objectives and policies and suggests the ways and means
to implement those plans and policies.
 The inefficiencies and ineffectiveness on the part of the management can be brought to light.
 The techniques of management audit are not only applicable to all factors of production, but also to all
elements of cost.
 Proper management audit techniques can help the business to stop capital erosion.
 It increases the overall profitability of a concern through constant review of solvency, profitability and
efficiency position of the concern.
 It helps the top management in arriving at correct management decisions without any delay.
 It helps the management in strengthening its communication system within and outside the business.

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 It can help management in the preparation of budgets and resources management policies.
 It can also help the management in training of personnel and marketing policies.

Disadvantages of Management audit

 The introduction of management audit technique involves heavy expenditure.
 Managers will hesitate to take initiative, as the management auditor will always pinpoint some
shortcomings in the action.
 Managers will always try to keep the records up-to-date rather than improving efficiency and reducing
the costs.
 Due to ineffectiveness and inefficiency of the management auditor, in all cases, management audit
cannot provide result-oriented service.
 Management auditors are sometimes engaged in some activities detrimental to social objects of auditing,
for example, evasion of tax.

DIFFERENCES BETWEEN MANAGEMENT AND COST AUDIT

Points of Management audit Cost audit
difference

1. Scope of audit Management audit is a comprehensive Cost audit is the verification of

review of all aspects of management correctness of cost accounting data,
functions. costing techniques and system.

2. Legal Management audit is not a statutory In certain industries cost audit is

compulsion requirement. compulsory and a statutory requirement.

3. Qualification of The management auditor must be a The cost auditor must possess prescribed
auditor person having wide expertise in the field qualifications as per the provisions of the
of management and accountancy. Companies Act.

4. Area of audit The management auditor critically The cost auditor checks the cost
examines the policies, procedures and accounting data only.
the techniques of management adopted
and report on their effectiveness.

5. Periodicity It covers wide area of activities of the The cost audit is conducted for every
management and may be for more than financial year separately.
one financial year.

6. Submission of There is no time limit for the submission There is a stipulated time limit within
audit report of management audit report. which cost audit report has to be
submitted.

7. Regularity Management audit is not a regular It is a regular feature and required to be

feature. Whenever need arises, the conducted year after year.
management may decide to conduct
management audit.

8. Accountability The management auditor is accountable The cost auditor is accountable to the
to the management only. shareholders as well as to the central
government.

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 ACCOUNTING STANDARDS
Concept
 Accounting standards are the written policy documents issued by the government or other regulatory body
or expert institute covering various aspects of recognition, measurement, treatment, presentation and
disclosure of accounting transaction in the financial statements.
 Companies (Amendment) Act, 1999 has inserted new Sub-section (3C) in Section 211 which defines
“accounting standards to mean standards of accounting recommended by the Institute of Chartered
Accountants of India, constituted under the Chartered Accountants Act, 1949, as may be prescribed by the
central government in consultation with the National Advisory Committee on accounting standards
established under Section 415(1)”.
 All over the world, accounting standards are drafted, framed and implemented by professional accounting
bodies. While accounting standards in India are framed by Accounting Standard Board (ASB) of the
Institute of Chartered Accountants of India, (ICAI) International Accounting Standards (IAS) are
pronounced by the International Accounting Standard Committee comprised of representatives of member
institutes of professional accountants.

Objectives of Accounting Standards

 The objective of accounting standards is to standardise the diverse accounting policies and practices with a
view to eliminate, to the extent possible, the non-comparability of financial information and to produce
reliable accounting statements acceptable in the country.
 The use of accounting standards is well established and no one can deny the importance of accounting
standards. It is utmost necessary that these statements are compiled on the basis of accounting standards.
 Legislative attempts have been made to have accounting standards prescribed under different statutes. For
example, Companies (Amendment) Act, 1999 lay down prescribing accounting standards.
 The globalisation of business, promotion of external trade, internationalisation of financial institutions etc.
necessitated the development of accounting standards.

Importance or Advantages of Accounting Standards

1. Globalisation of business Business is a global entity in these days. Multinational companies are
working in different countries with different currency, rules and accounting practices. If every country is
allowed to follow its own practice, external trade cannot flourish. A lot of confusion will be created. The
smooth and fair flow of the global business needs international accounting standards.
2. Uniform presentation of accounts Financial accounting is not a very exact science. To some extent it
is the subject of interpretation. The presence of different concepts, conventions, customs, traditions and
practices created confusion and checked free, fair and smooth flow of financial activities. It necessitated
uniformity in the concepts, conventions and practices.
3. Removal of ambiguity Accounting is one of the important parts of business activities. It does not show
the actual financial status of the business by indicating net profit or loss only, but it also forecasts the
future trend of the business. But certain accounting terms and practices are ambiguous and confusing,
e.g. valuation of stock, methods of depreciation etc. Accounting standards are needed to remove these
different types of ambiguity.
4. Prevention of accounting scandals Ambiguity, confusion and inexactness in the meaning of
accounting terminology generate accounting scandals leading to the failure of the business. As such,
standardisation of accounting terminology is necessary for preventing misuse of accounting terminology.
5. Internationalisation of financial institutions: In these days banks and financial institutions have
assumed global status. Banks and financial institutions have got their branches in the foreign countries
also. The successful implementation of these activities needed that the financial accounting must be
standardised internationally.

Limitations of Accounting Standards

 Alternative solutions ( difficult choice between standards)
 Trend towards rigidity
 Accounting standards cannot override the statute

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 LIST OF ACCOUNTING STANDARDS
AS-1 : Disclosure of Accounting Policies
AS-2 : Valuation of Inventories
AS-3 : Cash Flow Statements
AS-4 : Contingencies and Events Occurring after the Balance Sheet
AS-5 : Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
AS-6 : Depreciation Accounting
AS-7 : Accounting for Construction Contracts
AS-9 : Revenue Recognition
AS-10 : Accounting for Fixed Assets
AS-11 : The Effects of Changes in Foreign Exchange Rates
AS-12 : Accounting for Government Grants
AS-13 : Accounting for Investments
AS-14 : Accounting for Amalgamations
AS-15 : Employee Benefits
AS-16 : Borrowing Costs
AS-17 : Segment Reporting
AS-18 : Related Party Disclosures
AS-19: Leases
AS-20 : Earnings per Share
AS-21: Consolidated Financial Statements
AS-22 : Accounting for Taxes on Income
AS-23 : Accounting for Investments in Associates in consolidated financial statements
AS-24 : Discontinuing Operations
AS-25 : Interim Financial Reporting
AS-26 : Intangible Assets
AS-27 : Financial Reporting of Interests in Joint Ventures
AS-28 : Impairment of Assets
AS-29 : Provisions, Contingent Liabilities & Contingent Assets
AS-30 : Financial Instruments: Recognition & Measurement
AS-31 : Financial Instruments: Presentation
AS-32 : Financial Instruments: Disclosures
NOTE:
 AS-8 “ Accounting for research & development” – withdrawn & merged with AS-26 “
 Intangible assets”AS-30,31 & 32 – Not notified by “Ministry of corporate Affairs”

APPLICABILITY OF ACCOUNTING STANDARDS DEPENDS ON LEVEL OF COMPANIES:

Level 1 :
 Turnover(excluding other income) of 50 crores or above
 Borrowings (including deposits): 10 crores or more
 Listed companies or companies which are in process of listing.
Level 2 :
 Turnover(excluding other income) of 40 lakhs-50 crores
 Borrowings (including deposits): 1 crores – 10 crores.
Level 3 :
 Companies other than in Level 1 &2
Note :
 Level 1 & 2 : Small & Medium Sized Companies
 All Accounting standards are compulsory for Level 1 Companies.
 AS-3,17,18,24 (only for Level 1 cos.)

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ACCOUNTING STANDARDS AND THE AUDITOR
 While discharging their attest function, the auditors are required to ensure that the accounting standards
issued and made mandatory by the Institute of Chartered Accountants of India are implemented in the
presentation of financial statements covered by their audit reports.
 In the event of any deviation from the standards it will also be their duty to make adequate disclosure in
their reports so that the users of the financial statements are made aware of such deviations.
 According to amendment made in Section 227 of the Companies Act, 1999 additional duties has been
given to the auditors to state in their reports whether in their opinion, the profit and loss account and the
balance sheet comply with the accounting standards provided in Section 211 (3C) and also the reasons for
any adverse comments or qualifications in this regard.

STANDARDS ON AUDITING
AUDITING AND ASSURANCE STANDARDS (AAS) OR (GAAS)
 The Generally Accepted Auditing Standards (GAAS) in Indian context means the Auditing and
Assurance Standards (AAS) as issued by the Institute of Chartered Accountants of India.
 In India the Institute of Chartered Accountants of India issues the auditing procedures/practices and these
are called Auditing and Assurance Standards (AAS), previously known as Standard Auditing Practices
(SAP).
 The AAS will apply whenever an independent audit is carried out; that is, in the independent examination of
financial information of any entity, whether profit oriented or not and irrespective of its size or legal form
when such an examination is conducted with a view to express an opinion thereon.
 In fact, AAS are the benchmarks by which the quality of audit performance can be measured and the
achievement of objectives can be documented.
 By using standards an auditor can determine the professional qualities necessary for effective audit
performance. In simple words, AAS are auditing standards which prescribe the way the auditing should be
conducted.
NOTE:
 GAAS (Generally Accepted Auditing Standards) are the auditing standards that help measure the
quality of audits. Auditors review and report on the financial records of companies according to the
generally accepted auditing standards.
 GAAP (Generally Accepted Accounting Principles) is a set of accounting standards that companies
must follow when reporting their financial statements. Auditors are tasked with determining whether the
financial statements of public companies follow generally accepted accounting principles (GAAP).
 While GAAP outlines the accounting standards that companies must follow, GAAS provides the
auditing standards that auditors must follow

Objectives of AAS
 AAS refer to general guidelines given by the professional bodies of accountants for conducting audit. They
indicate principles and techniques of auditing to be followed by the auditors while conducting audit in
different audit environment.
 Based on the collective deliberations and views, the professional bodies prescribe principles and
techniques of auditing. The aims of prescribing these guidelines are to ensure sound and effective auditing
practices.
 Various professional bodies of accountants in different countries have issued pronouncements on accepted
auditing practices for the guidance of their members. These pronouncements on auditing practices relate
not only to financial audit but also other types of audit namely propriety audit, internal audit, peer review
etc.
 In India the Institute of Chartered Accountants of India has been issuing a series of statements of AAS on
independent financial audit.

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Importance or Advantages of AAS
1. Codification of auditing practices These professional pronouncements attempt to codify the auditing
practices expected to be applied while conducting audit.
2. Ensure effective auditing practices These professional principles and techniques of auditing are
generally accepted as standard. The objective of prescribing these guidelines is to ensure sound and
effective auditing practices.
3. Guidance to the auditor These standards refer to general guidelines given by the professional bodies
of accountants for conducting audit. They indicate the principles and techniques of auditing to be
followed by the auditors while conducting audit.
4. Uniform presentation of accounts Auditing is not a very exact science. To some extent it is the
subject of interpretation. The presence of different concepts, conventions, customs, traditions and
practices created confusion and checked free, fair and smooth flow of auditing activities. It necessitated
uniformity in the concepts, conventions and practices.
5. Prevention of accounting scandals Ambiguity, confusion and inexactness in the meaning and
interpretation of auditing terminology generate accounting scandals leading to the failure of the business.
As such, standardisation of auditing terminology is necessary for preventing misuse of auditing
terminology.

AAS and the auditor

 It is the duty of the auditor to ensure that the audit is conducted in accordance with AAS and if there is any
material departure from the standards, the auditor should report thereon. The auditor becomes liable to the
disciplinary preceding of the Institute of Chartered Accountants of India under Clause (9) of Part I of
Second Schedule to the Chartered Accountants Act, 1949.
 The auditors in their audit report have to mention that they have conducted the audit in accordance with the
“generally accepted auditing standards”. The generally accepted auditing standards in Indian context
means the Auditing and Assurance Standards as issued by the Institute of Chartered Accountants of India.

Requirements for GAAS or AAS

Generally accepted auditing standards (GAAS) divided into the following three sections:
General Standards
1. The auditor must have adequate technical training and proficiency to perform the audit.
2. The auditor must maintain independence in mental attitude in all matters relating to the audit.
3. The auditor must exercise due professional care in the performance of the audit and the preparation of
the auditor's report.
Standards of Field Work
1. The auditor must adequately plan the work and must properly supervise any assistants.
2. The auditor must obtain a sufficient understanding of the entity and its environment, including its internal
control, to assess the risk of material misstatement of the financial statements whether due to error or
fraud, and to design the nature, timing, and extent of further audit procedures.
3. The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a
reasonable basis for an opinion regarding the financial statements under audit.
Standards of Reporting
1. The auditor must state in the auditor's report whether the financial statements are presented in accordance
with generally accepted accounting principles.
2. The auditor must identify in the auditor's report those circumstances in which such principles have not been
consistently observed in the current period in relation to the preceding period.
3. If the auditor determines that informative disclosures in the financial statements are not reasonably
adequate, the auditor must so state in the auditor's report.
4. The auditor's report must either express an opinion regarding the financial statements, taken as a whole, or
state that an opinion cannot be expressed. When the auditor cannot express an overall opinion, the auditor
should state the reasons in the auditor's report. In all cases where an auditor's name is associated with
financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the
degree of responsibility the auditor is taking, in the auditor's report.

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 AAS - AUDITING & ASSURANCE STANDARDS AS PRESCRIBED BY ICAI

AAS-1 Basic Principles governing an Audit

This Auditing and Assurance Standard was the first standard on auditing issued by the Institute. It briefly
explains the basic principles of auditor‟s professional responsibilities. These principles are, namely, integrity,
objectivity and independence, confidentiality, skills and competence, work performed by others,
documentation, planning, audit evidence, accounting system and internal control, and, finally, audit conclusions
and reporting.

AAS-2 Objective and Scope of the Audit of Financial Statements

This Standard describes the overall objective and scope of the audit of general-purpose financial
statements of an enterprise by an independent auditor. The Standards deals with the following important
aspects of an audit:
 Objective of an Audit: expression of opinion, the concept of true and fair view
 Responsibility for Financial Statements
 Scope of Audit: factors determining scope, reliability and sufficiency of audit evidence, disclosure
aspects, undiscovered material misstatements, etc.

AAS-3 Documentation
The auditor should document matters which are important in providing evidence that the audit was carried out
in accordance with the generally accepted auditing standards in India. The Standard explains as to what
constitute working papers, need for working papers and its contents. Ownership and Custody of Working
Papers.

AAS-4 (Revised) The Auditor's Responsibility to Consider Fraud and Error in an Audit of Financial
Statements
As the name indicates, the purpose of this AAS is to establish standards on the auditor's responsibility to
consider fraud and error in an audit of financial statements.
 Fraud and error and their characteristics
 Responsibility of those charged with governance
 Responsibility of management
 Responsibility of the auditor
 Indication of possible misstatement
 Evaluation and disposition of misstatements
 Effect on auditor's report Documentation
 Management representations
 Communication
 Auditor unable to complete engagement
The appendices to the AAS contain examples of risk factors relating to misstatements resulting from fraud/
error, examples of modifications in auditor's procedures, and indicators of possible fraud or error.

AAS-5 Audit Evidence

The purpose of this AAS is to establish standards on the basic principle that the auditor should obtain sufficient
appropriate audit evidence through compliance and substantive procedures to enable him to draw reasonable
conclusions there from on which to base his opinion on the financial information. The Standard also deals with
the methods of obtaining evidence, namely, inspection, observation, inquiry and confirmation, computation and
analytical review.

AAS-6 (Revised) Risk Assessment and Internal Control

The purpose of this AAS is to establish Standards on the procedures to be followed to obtain an understanding
of the accounting and internal control systems and on audit risk and its components: inherent risk, control risk
and detection risk.

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AAS-7 Relying on the Work of an Internal Auditor
The AAS establishes standards on the procedures that should be adopted by the external auditor to assess the
work of an internal auditor for placing reliance upon that work. The Standard touches upon topics like
relationship between internal and external auditor, coordination between internal and external auditor &
evaluating specific internal audit work.

AAS-8 Audit Planning

The basic objective of the AAS is to establish standards on the principle that the auditor should plan his work to
enable him to conduct an effective audit in an efficient manner and that the plan should be based on the
knowledge of the client‟s business. The AAS covers topics such as advantages of audit planning, sources of
obtaining knowledge of the client‟s business, topics on which discussion with client might be useful, factors to
consider in development of an overall plan, developing an audit Programme etc.

AAS-9 Using the Work of an Expert

The AAS explains the concept of an „expert‟, situations in which the need for using the work of an expert might
arise, factors to consider when deciding whether to use the work of an expert or not, evaluating the skills and
competence and objectivity of an expert, procedures for evaluating the work of an expert, references to an
expert auditor‟s report, etc.

AAS-10 (Revised) Using the Work of another Auditor

This AAS discusses the procedures to be applied in situations where an independent auditor (principal auditor)
reporting on the financial statements of the entity uses the work of another auditor (other auditor) with respect
to the financial statements of one or more components included in the financial statements of the entity. It
deals in detail with the procedures to be adopted by the principal auditor when using the work of the „other
auditor‟.

AAS-11 Representations by the Management

The AAS was issued to establish standards on the use of management representations as audit evidence, the
procedures to be applied in evaluating and documenting management representations, and the action to be
taken if management refuses to provide appropriate representations.

AAS-12 Responsibility of Joint Auditors

The practice of appointing more than one auditor to conduct the audit of large entities has been in vogue for a
long time. Such auditors, known as joint auditors, conduct the audit jointly and report on the financial
statements of the entity. This AAS deals with the professional responsibilities which the auditors undertake in
accepting such appointments as joint auditors. The important aspect of joint audit assignments as covered by
this AAS includes possible bases of division of work among joint auditors, coordination among joint auditors.

AAS-13 Audit Materiality

Information is material if its misstatement (i.e., omission or erroneous statement) could influence the economic
decisions of users taken on the basis of the financial information. This AAS establishes standards on the
concept of materiality and its relationship with audit risk. Accordingly, the AAS deals with aspects such as
establishment of acceptable materiality levels, relationship between materiality and audit risk, procedures to
reduce audit risk, auditor‟s plan of action, etc.

AAS-14 Analytical Procedure

"Analytical procedures" means the analysis of significant ratios and trends, including resulting investigation of
fluctuations and relationships that are inconsistent with other relevant information or which deviate from
predicted amounts. The purpose of this AAS is to establish standards on the application of analytical
procedures during an audit.

AAS-15 Audit Sampling

"Audit Sampling" means the application of audit procedures to less than 100% of the items within an account
balance. The purpose of AAS is to establish standards on the design and selection of an audit sample and the
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evaluation of sample results. The areas covered by the AAS include design of sample, audit objectives,
population, stratification, sample size and risk, tolerable and expected error, selection of sample, evaluation of
sample results, analysis of errors in the sample, projection of errors, reassessing sampling risk.

AAS-16 Going Concern

As members are aware, "going concern" is one of the fundamental assumptions underlying the preparation of
the financial statements. The objective of this AAS is to establish standards on the auditor‟s responsibilities in
the audit of financial statements regarding the appropriateness of the going concern assumption as the basis
for the preparation of the financial statements.

AAS-17 Quality Control for Audit Work

The purpose of this Standard is to establish standards on quality control policies and procedures of an audit
firm regarding audit work generally; and procedures regarding the work delegated to assistants on an
individual audit.

AAS-18 Audit of Accounting Estimates

Accounting Estimates means an approximation of the amount of an item in the absence of a precise means of
measurement. This AAS, as the name suggests, establishes standards on the audit of accounting estimates.
The AAS, accordingly, deals with such aspects, including, nature of accounting estimates, audit procedures,
reviewing and testing the process used by management, evaluation of data and consideration of assumptions,
testing of calculations, comparison of previous estimates with actual results, use of independent estimates,
review of subsequent events, evaluation of results of audit procedures.

AAS-19 Subsequent Events

Subsequent events refer to significant events occurring between the balance sheet date and the date of the
auditor‟s report. This AAS lays down the responsibility of the auditor in respect of subsequent events. It also
provides the audit procedures for identification of relevant subsequent events, for example, reading minutes;
reviewing management procedures, inquiries of management and other concerned persons etc. the Standard
also guides the auditor on his reporting responsibilities in respect of subsequent events.

AAS-20 Knowledge of the Business

This Standard establishes standards on what is knowledge of the business, why it is important to the auditor,
and to the audit staff working on an engagement. It also establishes standards on why knowledge of the
business is relevant to all phases of an audit and how the auditor obtains and uses that knowledge. The AAS
therefore deals with the relevant topics such as, obtaining knowledge of the business before and after
accepting the assignment, sources of knowledge, using the knowledge, areas affected by the knowledge of the
client‟s business etc.

AAS-21 Consideration of Laws and Regulations in an Audit of Financial Statements.

This AAS lays down standards on auditor‟s responsibility regarding consideration of laws and regulations in an
audit of financial statements. The AAS therefore deals with aspects such as responsibility of the management
for compliance with laws and regulations, audit procedures where noncompliance is discovered,
communicating/ reporting noncompliance to management/users of audited financial statements/ regulators,
and situations for withdrawal from engagement.

AAS-22 Initial Engagements-Opening Balances

"Initial engagements" mean when the financial statements are audited for the first time or when the financial
statements for the preceding period were audited by another auditor. “Opening balances” means those
account balances which exist at the beginning of the period. This AAS establishes standards regarding audit of
opening balances in case of initial engagements. The Standard, therefore, deals with audit procedures for
obtaining sufficient appropriate evidence in respect of opening balances.

AAS-23 Related Parties

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The Institute had issued Accounting Standard (AS) 18 on Related Party Disclosures. The purpose of this AAS
is to lay standards on auditor‟s responsibilities and audit procedures regarding related parties and related party
transaction, as defined in AS 18. The AAS covers areas including, existence and disclosure of related parties,
transactions with related parties, examining unidentified related party transactions, management
representations, audit conclusions and reporting.

AAS-24 Audit Considerations relating to Entities Using Service Organizations

This AAS lays down standards for an auditor whose client uses a service organization. This AAS also
describes the reports of the auditors of the service organization, which may be obtained, by the auditor of the
client. The AAS therefore first explains the concept of a “service organisation” and then goes on to describe the
considerations for the auditor of the client, obtaining necessary information from service organizations,
auditor‟s procedures in case such information is insufficient etc.

AAS-25 Comparatives
The AAS explains the concept of comparatives in financial statements, corresponding figures and comparative
financial statements. It also deals with the requirement for obtaining sufficient appropriate audit evidence in
respect of comparatives, audit procedures where prior period financial statements are unaudited, audit
procedures in case of material misstatements in comparatives or where prior period audit report contains a
modified opinion, etc.

AAS-26 Terms of Audit Engagement

This AAS establishes standards on agreeing to the terms of engagement with the client and the auditor‟s
response to a request by client to change the terms of an engagement to one that provides lower level of
assurance. The AAS discusses principal contents of an audit engagement letter, audit engagement letter in
case of audit of components, factors affecting audit engagement letter in case of recurring audits. The AAS
also extensively deals with the duties and responsibilities of the auditors in case of a change in engagement.

AAS-27 Communications of Audit Matters with Those Charged with Governance

The term “governance” as used in this AAS refers to the role of persons entrusted with the supervision, control
and direction of an entity. The AAS therefore provides guidance to auditors as to procedures to identify
relevant persons to be communicated, forms of communication, factors affecting communication, confidentiality
requirements, laws and regulations etc.

AAS-28 The Auditor's Report on Financial Statements

The purpose of this AAS is to establish standards on the form and content of the auditor‟s report issued as a
result of an audit performed by an auditor of the financial statements of an entity. The AAS deals extensively
with the concepts such as the basic elements of an auditor‟s report, what is an unqualified opinion, the concept
of modified audit report - qualified opinion, adverse opinion, disclaimer opinion, matters that affect the auditor‟s
opinion and matters that do not affect the auditor‟s opinion, emphasis of matter paragraphs, illustrative audit
reports in each case.

AAS-29 Auditing in a Computer Information Systems Environment

A CIS environment exists when one or more computer(s) of any type or size is (are) involved in the processing
of financial information, including quantitative data, of significance to the audit, whether those computers are
operated by the entity or by a third party. The purpose of this Auditing and Assurance Standard (AAS) is to
establish standards on procedures to be followed when an audit is conducted in a computer information
systems (CIS) environment. The AAS lays down standard in respect of skills and competence needed by the
auditor to conduct an audit of CIS environment, factors to consider while planning such an audit, peculiar
features of a CIS environment, assessment of risk, audit procedures to reduce audit risk, documentation in
such audits.

AAS-30 External Confirmations

This Auditing and Assurance Standard deals with an important form of audit evidence, viz., external
confirmations. For example, timing of external confirmations, design of the external confirmation request,
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nature of information being confirmed, form of confirmations - positive and negative, characteristics of
respondents, evaluation of the results of the confirmation process, management requests etc.

AAS-31 Engagements to Compile Financial Information

Ordinarily, a compilation engagement involves reducing data to a manageable and understandable form and
does not require the accountant to test the assertions underlying the concerned information. The AAS deals
extensively with objectives, basic principles, planning, documentation and procedural aspects of a compilation
engagement. The AAS also provides detailed guidance as to the reporting aspects in a compilation
engagement.

AAS-32 Engagements to Perform Agreed upon Procedures regarding Financial Information

In an engagement to perform agreed upon procedures, the auditor is usually required to give a report on the
factual findings, based on specified procedures performed on specified subject matters of specified elements,
accounts or items of financial statements. The basic purpose of the AAS is to establish standards on the
auditor‟s professional responsibilities when an engagement to perform agreed upon procedures regarding
financial information is undertaken and on the form and content of the report that the auditor issues in
connection with such an engagement.

AAS-33 Engagement to Review Financial Statements

Unlike an audit, a review engagement is based mainly on analytical procedures and inquiries conducted by the
auditor. The AAS establishes standards and provide guidance on the auditor‟s professional responsibilities and
on the form and content of the report that the auditor issues in connection with a review. The AAS deals with
issues such as scope of the review engagement, level of assurance, terms of engagement, planning,
documentation, review procedures, conclusions and reporting requirements in the review engagements.

AAS-34 Audit Evidence – Additional Consideration for Specific Items

The objective of this AAS is to establish standards on auditor‟s responsibilities, audit procedures and provide
guidance, in addition to that provided in AAS-5, “Audit Evidence”, with respect to certain specific financial
statement amounts and other disclosures. This AAS assists the auditor to obtain audit evidence with respect to
following aspects:
Part A: Attendance at Physical Inventory Counting.
Part B: Inquiry Regarding Litigation and claims.
Part C: Valuation and Disclosure of Long Term Investments.
Part D: Segment Information.

AAS-35 The Examination of Prospective Financial Information

The auditor is required to obtain sufficient appropriate evidence to determine whether Management‟s best
estimates, assumptions on which the prospective financial information is based are not unreasonable, they
have been properly prepared and presented and all material assumptions are adequately disclosed and that
they have been prepared on consistent basis with historical financial statements using appropriate accounting
principles.

STANDARDS ON INTERNAL AUDIT (SIAs)

Meaning of SIA
The Internal Audit Standard Board of the ICAI has, with other pronouncements, issued five Standards on
Internal Audit (SIAs) in November 2018. The SIAs are a set of minimum requirements that apply to all
members of the ICAI while performing internal audit of any entity or body corporate. In general terms, SIA
are set of systematic guidelines used by internal auditors to ensure the accuracy, consistency and
verifiability of their actions and reports. Like any other standard, they provide the guidance in
determining the nature, timing and extent of audit procedures that should be applied to fulfill the
objective of Internal Audit.

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Need or Purpose of SIA
To provide a benchmark for quality of services during an internal audit.
To establish uniform evaluation criteria, methods, processes and practices.
To codify the best practices in internal audit services

Framework of SIA
The Framework on Standards on Internal Audit comprises four components viz,
 The Code of Conduct
 The Competence Framework
 The Body of Standards and
 The Technical Guidance

The following internal audit related pronouncements have been issued:

 Preface to the Framework and Standards on Internal Audit
 Framework Governing Internal Audits
 Basic Principles of Internal Audit
 Standard on Internal Audit (SIA) 210, Managing the Internal Audit Function
 Standard on Internal Audit (SIA) 220, Conducting Overall Internal Audit Planning
 Standard on Internal Audit (SIA) 310, Planning the Internal Audit Assignment
 Standard on Internal Audit (SIA) 320, Internal Audit Evidence
 Standard on Internal Audit (SIA) 330, Internal Audit Documentation

BASIC PRINCIPLES OF INTERNAL AUDIT

The Basic Principles of Internal Audit are a set of core principles fundamental to the function and activity of
internal audit. The Basic Principles are critical to achieve the desired objectives as set out in the definition of
the Internal Audit, and therefore, apply to all internal audits.
♦ Scope
All internal audits shall be performed based on these basic principles, and departures from these principles
shall be appropriately disclosed in internal audit report or other similar communication.
♦ The principles can be summarised as follows:
 Independence
 Integrity and Objectivity
 Due Professional Care
 Confidentiality
 Skills and Competence
 Risk Based Audit
 Systems and Process Focus
 Participation in Decision Making
 Sensitive to Multiple Stakeholder Interests
 Quality and Continuous Improvement

SIA 210 MANAGING THE INTERNAL AUDIT FUNCTION

The Chief Internal Auditor of the company has to perform a number of activities which includes the following-
 Planning- Define the overall plan, scope and methodology of the Internal Audit on a periodic basis.
 Monitoring- Oversee and monitor various audit assignments, their proper planning, execution, reporting of
findings and subsequent closure of reported observations
 Performance- Plan, acquire, engage and review the performance, training and development of
professional staff, talent and other resources to achieve its objectives.
 External Experts- Identify, source, engage and manage external experts and technical solutions, if
required.
 Communication- Communicate and engage with all key stakeholders regarding progress and
achievement of objectives
 Improvement Programme- Develop and maintain a quality evaluation and improvement program.

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SIA 220 CONDUCTING OVERALL INTERNAL AUDIT PLANNING
SIA 220 deals with the connotations of the Overall Planning of the Internal Audit function for the whole entity.
As per Sec 13(2) of the Companies Act 2013,“The Audit Committee of the company or the Board shall, in
consultation with the Internal Auditor, formulate the scope, functioning, periodicity, and methodology for
conducting the internal audit.”
Conducting the Overall Internal Audit Planning involves the following key elements-
 Undertaken prior to the beginning of the plan period
 Comprehensive
 Directional in nature and considers all the auditable units
 Prepared by the Chief Internal Auditor
Requirements
 The Planning Process
 Knowledge of the Business and its Environment
 Discussion with Management and Stakeholders
 Audit Universe and Scope of Coverage
 Risk Assessment
 Technology Deployment
 Resource Allocation
 Documentation

SIA 310 PLANNING THE INTERNAL AUDIT ASSIGNMENT

As mentioned above, the planning is done in two phases, this standard deals with the requirement of the audit
plans to be made periodically.
Conducting the Internal Audit Assignment involves the following key elements-
 Sub-set of the Overall Internal Audit Plan
 Undertaken prior to the beginning of a particular assignment during the plan period
 Covers the manner in which a particular audit assignment will be conducted
 Prepared by the Internal Auditor responsible for the assignment
Requirements
 Alignment with the objectives of the Overall Internal Audit
 Scope, coverage and methodology of the audit procedures will form a sound basis for providing
reasonable assurance.
 Allocate adequate time and resources
 Assign appropriate skills to complex areas and issues.
 Efficient and effective manner in conducting audit procedures
 In line with the various pronouncements of ICAI

SIA 320 INTERNAL AUDIT EVIDENCE

As per the definition given in the standard, Internal Audit Evidence refers to all the information used by the
Internal Auditor in arriving at the conclusion on which the auditor‟s opinion is based.
The Internal Audit evidence includes the following-
 Information collected from underlying entity records and processes
 Information from the performance of various audit activities and testing procedures
 To allow the Internal Auditor to form an opinion on the outcome of the audit procedures completed.
Requirements
 Nature of Evidence -either from the underlying company‟s books, records, systems and processes
or through the performance of audit activities and testing procedures
 Reliability and Consistency of Evidence - Evaluate how the audit procedures need to be modified
or expanded to resolve the doubt or conflict.
 Evidence Collection and Recording Process - Meet certain basic standards of quality to achieve
internal audit objectives
 Documentation - Written policy and process on audit evidence. Details of the evidence collected,
relevance to the audit findings and opinion being formed, cross referenced to the Internal Audit
Program, where appropriate
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SIA 330 INTERNAL AUDIT DOCUMENTATION
Internal Audit Documentation” refers to the written record (electronic or otherwise) of the internal audit
procedures performed, the relevant audit evidence obtained and conclusions reached by the Internal Auditor
on the basis of such procedures and evidence
♦ Scope
This Standard applies to all internal audit assignments. The nature and content of documentation is covered in
a separate implementation guide on the subject.
♦ Objective
 Validate the audit findings
 Support the basis on which audit observations are made
 Conclusions reached from those findings
 Aid in the supervision and review of the internal audit work
 Establish that work performed is in conformance with the applicable pronouncements of the
institute of chartered Accountants of India.
Requirements
 Nature of Documentation - includes written records (electronic or otherwise) of various audit
activities and procedures conducted, including evidence gathered, information collected, notes
taken and meetings held.
 Content and sufficiency of Documentation - all significant matters which require exercise of
judgment, together with the Internal Auditor‟s conclusion
 Documentation Process - Collated and arranged logically in files as audit work papers and retained
to support the performance of the internal audits as per a written process
 Timely Completion of Documentation - compiled into internal audit files soon after the completion
of all audit procedures, while pending matters may be closed during the draft stage of audit
reporting
 Confirmation of Compliance - Written documentation policy, process on audit work papers, Work
paper files for each audit assignment

SIA ISSUED BY ICAI. ICAI HAS TOTALLY ISSUED 17 SIA. THE LIST OF THIS IS AS UNDER:
SIA No. NAME OF SIA
1 Planning an Internal Audit
2 Basic Principles Governing Internal Audit
3 Documentation
4 Reporting
5 Sampling
6 Analytical Procedures
7 Quality Assurance in Internal Audit
8 Terms of Internal Audit Engagement
9 Communication with Management
10 Internal Audit Evidence
11 Consideration of Fraud in an Internal Audit
12 Internal Control Evaluation
13 Enterprise Risk Management
14 Internal Audit in an Information Technology Environment
15 Knowledge of the Entity and its Environment
16 Using the work of an Expert
17 Consideration of Laws and Regulations in an Internal Audit
18 Related Parties

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 NATIONAL FINANCIAL REPORTING AUTHORITY ( NFRA )
The National Financial Reporting Authority (NFRA) is a body constituted under the provisions of Section 132 of
the Companies Act, 2013. The constitution of this authority is effective from 1st October 2018. The aim of the
Central Government in this regard appears to be:
 Setting up of a separate and independent regulatory body to assist in the framing and enforcement of
legislation relating to accounting & auditing and
 Improving investor and public confidence in the financial reporting of an entity.
Supposedly, the need for this authority arose as a response to various corporate scams in recent times.

COMPOSITION OF THE NFRA

The Companies Act requires the NFRA to have a chairperson who will be appointed by the Central
Government and a maximum of 15 members. The appointment of such chairperson and members are subject
to the following qualifications:
 They should be having an expertise in accountancy, auditing, finance or law.
 They are required to make a declaration to the Central Government that there is no conflict of interest or
lack of independence in their appointment.
 All the members including the chairperson who are in full-time employment should not be associated with
any audit firm (including related consultancy firms) during their term of office and 2 years after their term.

The terms and conditions relating to the appointment of the chairperson and members have not yet been
prescribed. However, the draft NFRA rules outline the following composition of the authority:
1. Chairperson is a Chartered Accountant and a person of eminence having expertise in accountancy,
auditing, finance or law;
2. Member – Accounting;
3. Member – Auditing;
4. Member – Enforcement;
5. One representative of the MCA not below the rank of Joint Secretary or equivalent (ex-officio)
6. One representative of RBI, being a member of the RBI Board is to be nominated by the RBI;
7. One representative of SEBI, being the Chairman of SEBI or whole-time member of SEBI is to be
nominated by SEBI;
8. A retired chief justice of high court or a person who has been the judge of a high court for more than 5
years is to be nominated by the Central Government,
9. President of the Institute of Chartered Accountants of India (ex-officio)
The Chairman may also invite any other person to the meeting to give their expert opinion.

ROLES, RESPONSIBILITIES AND POWERS OF THE NFRA

Prior to the constitution of this authority, the Central Government would prescribe accounting standards on the
recommendation of ICAI. The ICAI would prescribe the same only after consulting with the National Advisory
Committee on Accounting Standards who will provide their recommendations. The ICAI will now have to
consult with the NFRA and examine its recommendations in this regard. Thus the National Advisory Committee
on Accounting Standards is effectively replaced by the NFRA.

The NFRA has the following roles, responsibilities and powers:

 Make recommendations on the foundation and laying down of accounting and auditing policies and
standards;
 Monitor and enforce the compliance of the accounting standards and auditing standards:
 Oversee the quality of service of the professionals (such as auditors, CFOs, etc) and suggest measures
required for improvement in the quality of service;
 Perform such other functions related to the above.
 Investigate the matters of professional or other misconduct committed by a prescribed class of CA firms or
CAs. No other authority can initiate or continue proceedings where the NFRA has initiated an investigation.
Such an investigation can be initiated either suo moto (by itself) or on a reference made by the Central
Government.

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 The same powers as a Civil Court under the Code of Criminal Procedure, 1908, in respect of a suit
involving the following matters:
 Discovery and production of books of account and other documents, at such place and time as
may be specified by the NFRA
 Summoning and enforcing the attendance of persons and examining them under oath
 Inspection of any books, registers, and other documents of any person at any place
 Issuing commissions for the examination of witnesses or documents
 Where professional or other misconduct is proved, it shall have the power to impose the
following punishment:
 Penalty:
 For individuals a fine between Rs. 1,00,000 to 5 times the fees received;
 For firms a fine Between Rs. 5,00,000 to 10 times the fees received;
 Debarring the member/firm from practice as a member of ICAI between 6 months to 10 years as
may be decided
Any person who is not satisfied with the order of the NFRA can then make an appeal to the
Appellate Authority.

SCOPE OF THE NFRA

As discussed earlier, the NFRA has the power to investigate and also conduct quality reviews for a certain
prescribed class of companies. While the draft NFRA Rules have not been prescribed yet, they would include
the following class of companies if implemented as it is:
 Companies listed in India
 Unlisted Companies whose:
 Net worth ≥ Rs. 500 crore; or
 Paid up Capital ≥ Rs. 500 crore; or
 Annual turnover ≥ Rs. 1000 crore (As on 31st March of the preceding financial year); OR
 Companies whose securities are listed outside India
The NFRA also holds the power of investigation of a certain class of bodies corporate or persons (auditors) in
relation to matters of professional or other misconduct by a member or firm of Chartered Accountants or
auditors. In this regard, as per the draft NFRA rules, the auditors or audit firms which conduct the audit of the
following category of companies or their branches (including through the network/brand to which it belongs)
whether directly or indirectly, are covered:
 Audit of ≥ 200 companies in a year;
 Audit of ≥ 20 listed companies;
 Company or companies (whether listed or not), having:
 Net Worth ≥ Rs. 500 crores; or
 Paid up Capital ≥ Rs. 500 crores; or
 Annual turnover ≥ Rs. 1000 crores;(As on 31st March of the immediately preceding financial
year); OR
 Company or Companies listed outside India

STRUCTURE OF NFRA
NFRA shall consist of the following committees:-
i) Accounting Standards Committee,
ii) Auditing Standards Committee, and
iii) Enforcement Committee.

What are the key functions of NFRA?

Functions of Committee on Accounting Standards:

a) To examine matters relating to formulation and laying down accounting standards for consideration by
NFRA.
b) To recommend any new standard to ICAI which the Committee deems necessary to be examined for
formulation.

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c) To examine recommendations made by ICAI.
d) To recommend NFRA on the new or amended standards for its approval and to be forwarded to the Central
Government to be notified as a part of accounting standards.
e) To scrutinize the financial statements of such companies as decided by the Committee on Accounting
Standards or NFRA and to issue such reports to NFRA.
Functions of Committee on Auditing Standards:
i) To examine matters relating to formulation and laying down auditing standards for consideration by NFRA.
ii) The Committee on Auditing Standards shall monitor the compliance of auditors, audit firms and the audit
LLPs.
iii) It may investigate or review selected audit engagements including an individual or firm or an LLP.
iv) The Committee may evaluate the sufficiency of the quality control system of the auditor and manner of
documentation and communication of that system by the auditor.
Functions of the Committee on Enforcement:
i) To investigate matters relating to professional or other misconduct committed by auditor, individual, firm or
an LLP on recommendation by NFRA.
ii) The Committee on Enforcement shall complete its investigation within a period of 6 months on any matters
referred to it. In case of delay, specific time extension has to be sought by providing reasonable justifications to
NFRA.

Additional guidelines:
a) The headquarters of NFRA shall be at New Delhi,
b) The Central Government may constitute and Appellate Authority consisting of a Chairperson and not more
than two other members for hearing appeals arising out of orders of NFRA.
c) Any person aggrieved by any order of NFRA may prefer an appeal to such Appellate Authority constituted
by the Central Government.
d) The qualifications for appointment, manner of selection and terms of service of the Chairperson and other
members for appointment to the Appellate Authority are to be followed by NFRA as prescribed.
e) The Central Government may appoint a secretary or other employees for the smooth functioning of NFRA, if
it deems necessary.
f) The NFRA may be caused to maintain such books of accounts prescribed by the Central Government in
consultation with the Comptroller and Auditor General of India (CAG).
g) The accounts of NFRA must be audited and certified by the CAG together with the audit report and
forwarded to the Central Government by NFRA.
h) NFRA has to prepare an annual report stating a list of activities undertaken in a financial year and forward a
copy to the Central Government. Thereafter the audit and annual report given by CAG has to be laid before
each house of Parliament.

Conclusion
The introduction of NFRA is an important step to build up a transparent mechanism for accounting, auditing
and financial reporting. NFRA will not be just being an advisory body; instead it has been empowered to
regulate accounting standards and auditing policies along with powers to investigate certain matters related to
professional misconduct by chartered accountants in corporate bodies. Therefore, it has a huge role to play in
the field of financial reporting for effective corporate governance.

*****************

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 PRACTICAL AUDITING

( REFERENCE NOTES – UNIT IV )

ACCORDING TO REVISED SYLLABUS

OF
UNIVERSITY OF MADRAS

Ms. B. BINDU SINGH

ASSISTANT PROFESSOR
DEPARTMENT OF COMMERCE - GENERAL
A.M. JAIN COLLEGE
MEENAMBAKKAM, CHENNAI.

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 UNIT IV
PRACTICAL AUDITING
Unit IV : Auditors and Audit ReportAppointment - Procedures - Eligibility and Qualifications - Powers and
Duties - Rotation and Removal of Auditors - Resignation of Auditors - Remuneration of Auditors - Audit
report - Preparation and presentation. Auditor‘s Responsibilities and liabilities towards Shareholders, Board
and Audit Committee. Restriction on other Services.

INTRODUCTION

As per the Indian Companies Act, 2013, it is compulsory for every company, whether public or private
limited, to get its accounts audited by a qualified auditor. Therefore, it is essential that the auditor of a company
should be familiar with the provisions of the Companies Act relating to his appointment, qualifications;
disqualifications; powers; duties and rights.

Who is an Auditor?
All the government and non-government organizations have to keep track of their accounts and audit reports
as the financial year approaches. The financial statements of these firms need to be thoroughly analyzed and
assessed before submitting them to the authorized departments. This assessment of financial documents is
done by an Auditor. In case of any discrepancy in the reports, the auditor is held responsible. Thus, the
requirement of an auditor is a must for every organization.

QUALIFICATIONS OF A COMPANY AUDITOR [SEC.141 (1) & (2)]

Section 141 (1) & (2) of the Companies Act, 2013 prescribed the following eligibility and qualifications of
auditor which are as follows:
1. A person, who is a chartered accountant and holds a certificate of practice, shall be qualified to be appointed
as an auditor of a company.
2. The partners who are chartered accountants of a firm alone shall be authorized to act and sign on behalf of
the firm.

DISQUALIFICATIONS OF A COMPANY AUDITOR [SEC.141 (3)]

The following persons shall not be eligible for appointment as an auditor of a company.
1. A body corporate, except Limited Liability Partnership.
2. An officer or employee of the company;
3. A person who is a partner of an office or employee of the company.
4. A person who is a relative or his partner of a company or holding or subsidiary company or associate
company is disqualified in the following circumstances:
 When he is holding any security, or
 When he is indebted in excess of Rs.5,00,000, or
 When he is given a guarantee or provided any security in connection with indebtedness in excess of
Rs.1,00,000.
5. A person or a firm has business relationship of such nature with a company or holding or subsidiary
company or associate company.
6. A person whose relative is a director or is in employment of the company as director or key managerial
personnel.
7. A person holding more than 20 company audit (20 company audit shall exclude one person company, small
company, dormant company, private company with paid up capital less than Rs.100 Crore).
8. A person who has been convicted by a court of an offence involving fraud and a period of 10 years has not
elapsed from the date of such conviction.
9. Any person who is engaged in consulting and specialized services.

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 APPOINTMENT OF AUDITORS [SEC. 139] AND ITS PROCEDURES

APPOINTMENT OF AUDITORS

1. Within 30 Days:
Every company must appoint its first auditor or an auditing firm within 30 days of registration of the company
during the annual general meeting or within 90 days, in an Emergency General Body Meeting by the Board of
Directors. The first auditor (or the auditing firm) appointed will hold office from the conclusion of the meeting (in
which the appointment of auditor has been made) to the time when the sixth annual general meeting is held
(five years). Therein, the auditor appointments are reviewed every sixth year.
2. Written Consent:
A written consent from the auditor, with sufficient proof to suggest that the person (or firm) qualifies the criteria
provided in Section 141 of the Act, needs to be submitted before an appointment.
3. Appointment Notice:
The company should issue an appointment notice to the auditor, and a Form, ADT- 1 is required to be
submitted with the registrar within 15 days of the meeting in which the auditor is appointed.
4. Section 139:
The companies listed in Section 139 (belonging to the class or classes of companies as mentioned in the
section) and Rule 5 of the companies (audit and auditor) rules, 2014, will not:
1. Appoint an individual as auditor for more than one consecutive five-year tenure;
2. Appoint an auditing firm for more than two terms of five consecutive years
Provided, the auditor who has finished his term will not be eligible for reappointment in the same company or
the auditing firm who has completed a two-year tenure is not eligible for appointment in the same company for
five years.
A three-year transition period is given to comply with this requirement. Although, according to the rules, the five
years is calculated with the retrospective effect.
Sections 139 to 148 of the Companies Act, 2013 give a complete and detailed summary of the role of an
auditor as well as the other requirements, such as their appointments or removal from the company payroll.

REAPPOINTMENT / RENEWAL OF AN AUDITOR

An auditor or an auditing firm will be re-appointed at the AGM, unless:

1. The auditor has shown his unwillingness to continue
2. An auditor appointment resolution has been passed at the general meeting to appoint a new auditor or an
auditing firm
3. If at the AGM, no auditor is appointed or reappointed, the existing auditor shall continue in the firm.
4. In case of death of the auditor (if it is an individual), the casual vacancy shall be filled within 30 days by the
board. He will hold office till the next AGM.
5. In case of resignation of the auditor, the casual vacancy is again filled by the BOD within 30 days, and same
approved at the meeting held within 3 months of the appointment.
6. The auditor who has resigned from the company needs to file a Form – ADT 3 stating the resignation and
the reasons for the same. If not, the auditor will be deemed responsible for the same.

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APPOINTMENT OF AUDITOR IN GOVERNMENT COMPANY

Companies Act, 2013 defines a Government Company [Section 2 (45)], "as a company in which not less than
51% of the paid up share capital is held by the Central or State Government or Governments or partly by the
Central government and partly by one or more State governments."

1. Appointment of First Auditor [Section 139 (7)]

 The first auditor of Government company shall be appointed by the Comptroller and Auditor General
of India within 60 days from the date of registration of the company.
 In case the Comptroller and Auditor General of India do not appoint such auditor within 60 days, the
Board of Directors of the company shall appoint first auditor within next 30 days.
 In case of failure of the Board to appoint the first auditor, it shall inform Members of the company who
shall appoint first auditor within 60 days at an Extraordinary General Meeting.
 First Auditor shall hold office till the conclusion of the first Annual General Meeting.
2. Appointment of Subsequent Auditor [Section 139 (5)]
The Comptroller and Auditor General of India shall appoint subsequent auditor of Government companies
within 180 days from the commencement of the financial year and who shall hold office till the conclusion of the
Annual General Meeting.
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3. Appointment in case of Casual Vacancy [Section 139 (8)]
Appointment of auditor due to casual vacancy in Government Company is filled by the Comptroller and Auditor
General of India within 30 days. If he fails to do so, the Board of Directors shall fill within next 30 days.

APPOINTMENT OF AUDITOR IN NON-GOVERNMENT COMPANY

1. Appointment of First Auditor [Section 139 (6)]

 The first auditor of a company other than a Government company shall be appointed by the Board of
Directors within 30 days from the Date of Registration of the company.
 In case of failure of the Board to appoint the auditor, it shall inform the members of the company. The
Members shall appoint the auditor within 90 days at an Extraordinary General Meeting.
 Appointed First Auditor shall hold office till the conclusion of the first Annual General Meeting.
2. Appointment of Subsequent Auditor's [Section 139 (1)]
 Every company shall appoint an individual or a firm as auditor of the company at the first Annual
General Meeting.
 The appointed auditor shall hold the office till the conclusion of sixth Annual General Meeting and
thereafter till the conclusion of every sixth meeting.
 The Company shall place the matter relating to such appointment of ratification by member at every
Annual General Meeting.
 Before such appointment is made, the written consent of the auditor to such appointment and also a
certificate from the auditor that he is eligible for appointment shall be obtained from the auditor.
 The company shall inform the appointed auditor and also file a notice of such appointment with the
Registrar within 15 days of the meeting in which the auditor is appointed.

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3. Appointment in case of Casual Vacancy [Section 139 (8)]
 Causal vacancy arises due to death or insanity or insolvency of an auditor. If an auditor is disqualified
after his appointment, he shall vacate his office as auditor. Such vacation shall be deemed to be a
casual vacancy in the office of the auditor.
 Appointment of auditor's in case of casual vacancy shall be done by the Board of Directors within a
period of 30 days.
 If vacancy is due to resignation of an auditor, such appointment shall also be approved by the company
at a General Meeting convened within 3 months of the recommendation of the Board.
 The auditor shall hold office till the conclusion of the next Annual General Meeting.

REMOVAL AND RESIGNATION OF AUDITOR

REMOVAL OF AUDITOR [SEC.140 (1)]

1. An auditor can be removed before the expiry of the term by obtaining the prior approval of the
Central Government by filling an application.
2. The Company shall hold the general meeting within 60 days of receipt of approval of the Central
Government for passing the special resolution.
3. The auditor concerned shall be given a reasonable opportunity of being heard.
 The Companies Act, 2013 lays the provision for the removal or change of auditor before the completion
of his tenure. This happens in those cases where the organization is not satisfied with the services of
the auditor. The procedure of the removal of the auditor has been given in the sub-section (1)
of Section 140 of the Act.
 The auditor concerned shall be given a reasonable opportunity of being heard. Before being removed
by the firm, the auditor is given a fair and reasonable chance of laying down reasons for his
inappropriate conduct.
 If the auditor is being removed before the completion of his term, an approval from the central
government is necessary before passing a special resolution by the company.
 The application to the Central Government has to be done in the form ADT-2 as prescribed in Rule 7 of
the Companies (Audit & Auditors) Rules, 2014. A prescribed fee provided under Section 12 of
the Companies (Registration Offices and Fee) Rules, 2014 needs to be submitted along with this
form.
 The application has to be made within thirty days of the resolution passed by the board.
 The company can hold a general meeting within sixty days of receipt of the approval of the Central

RESIGNATION OF AUDITOR [SEC.140 & (3)]

 The auditor who has resigned from the Company shall file a statement in the prescribed form stating
the reasons for his resignation to the Comptroller and Auditor General of India in case of a Government
Company and to the Registrar of Companies in case of Non-Government Companies.
 While filing the statement, reasons for resignation and other facts as may be relevant with regard to his
resignation shall also be indicated.
 In case of non-compliance, he shall be punishable with fine ranging from ₹.50,000 to ₹.5,00,000.

REMUNERATION OF AN AUDITOR (SEC 142)

1. When an auditor is appointed by the Board of Directors, (First auditors and Casual vacancy), the
remuneration is fixed by the board of directors.
2. When an auditor is appointed by the Central Government, the Central government fixes the remuneration.
3. Shareholders also fix the remuneration of an auditor in the following two circumstances.
 When the auditor is appointed in the annual general meeting.
 When the auditor is appointed by Comptroller and Auditor General.
(The remuneration may be fixed either at the annual general meeting or at any general meeting).
4. If a retiring auditor is reappointed, his remuneration continues to become unless it is decided otherwise in
the general meeting.
5. Any sum paid by the company to meet the expenses of the auditors will be included in the word

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‗remuneration‘.
6. In addition to remuneration for audit, an auditor may receive separate remuneration for rendering
consultancy services and for attending to cases pertaining to Income-tax. Such fees do not require the
approval of the general meeting.

To prevent undue influence and dependence on an audit client, Companies (Amendment) Act 2003, prescribes
a limit for the remuneration of auditor.
 As per section 226(3A) of the Act, the remuneration to an auditor from a company cannot exceed 25%
of his total income in any financial year.
 However, the provision does not apply to a small auditor whose income is less than Rest. 15 lakhs per
year and to new auditors (who have not completed first 5 years of their practice)
The Schedule VI of the Companies Act requires disclosure of the audit fees in the following format — Amount
Received.
1. as an Auditor
2. as an Advisor in the matters of taxation, management and company law,
3. Other amount as specified.

POWERS (OR) RIGHTS OF AN AUDITOR [SEC.143]

The Companies Act has conferred certain rights on auditor's so as to enable them to discharge their duties
smoothly.

1. Right to Access Books and Vouchers: Every auditor of a company has a right to access book of accounts
and vouchers of the company at all times. Vouchers include all documents, correspondence, agreements, etc.
Books include financial, accounting, statutory and statistical books of the company. The term all times means
only during the normal business hours.
2. Right to Obtain Information and Explanation:
An auditor has the right to seek information and explanation from the directors and officers of the company.
Every officer of the company must furnish the necessary information to the auditor. If the officer refuses to do
so, the auditor may report to the members of the company.

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3. Right to Sign Audit Report [Sec.145]:
The auditor has the right to sign the auditor‘s report. The auditor can also sign or authenticate any document
which the law requires to furnish.
4. Right to receive Notices and attend General Meeting [Sec.146]:
The company must send all notices and communications to the auditor relating to any general meeting. The
auditor shall attend the meeting either through himself or through his representative, who shall be an auditor.
The auditor in general meeting must be given reasonable opportunity to speak on any part of the business,
which concerns him as the auditor.
5. Right to visit Branches:
The auditor has the right to access all books and vouchers kept at the head office or at any branches of the
company. In case the accounts of branches are audited by a person other than the company‘s auditor, he shall
be entitled to visit the branch office. The company auditor can get copies of accounts certified by the branch
auditor.
6. Right to get Remuneration:
The remuneration of the auditor of a company shall be fixed in its general meeting for auditing the books of
accounts of the company. The auditor can claim remuneration from the appointing authority. At the time of
winding up of the company, he can claim remuneration as creditor of the company.
7. Right to Report to Members:
The auditor has the right and duty to report to the members of the company regarding the accounts examined
by him. He is also required to give his opinion about whether the financial statements give a true and fair
picture of the state of affairs of the company.
8. Right to seek Legal and Technical Advice:
The auditor has the right to seek expert advice in respect of legal or technical matters at the expense of the
company.
9. Right to give Suggestions to the Board: The auditor has the right to suggest some modifications in the
books of accounts to the Board. The Board should comply with the suggestions made by the company auditor.
If not, the auditor should report the same to the members. But the auditor cannot make changes in the books
of accounts of his own.
10. Right to Correct Wrong Statements: The auditor has the right to correct wrong statements made by the
directors relating to the accounts. But it should be remembered that any statement by him to this effect will not
relieve himself for any omission or incompleteness in his report.
11. Right to be indemnified:
The auditor has the right to be indemnified out of the assets of the company against any liability incurred by
him in defending himself against the civil or criminal proceedings by the company if it is proved that the auditor
has acted honestly.

DUTIES OF AN AUDITOR [SEC.143]

A. Statutory Duties
1. Duty to report to the Members [Sec.143 (3)]:
The auditor shall make a report to the members of the company on accounts and financial statements
examined by him.
The report shall state:
a. Whether he has sought and obtained all necessary information and explanations.
b. Whether proper books of accounts has been kept.
c. Whether company‘s Balance Sheet and Profit and Loss account are in agreement with books of accounts
and returns.
2. Duty to Enquire [Sec.143 (1)]:
It is the duty to inquire into the following matters:
 Whether loans and advances made by the company based on security have been properly secured and
whether the terms on which they have been made are prejudicial to the interests of the company or its
members.
 Whether transactions of the company, which are represented merely by book entries, are prejudicial to
the interests of the company.
 Whether loans and advances made by the company have been shown as deposits.
 Whether personal expenses have been charged to revenue account.

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  Whether it is stated in the books and documents of the company that any shares have been allotted for
cash, whether cash has actually been received in respect of such allotment, and if no cash has actually
been so received, whether the position as stated in the account books and the balance sheet is correct,
regular and not misleading.
3. Duty to comply with Auditing Standards [Sec.143 (9)]:
 Every auditor shall comply with the auditing standards.
 The Central Government shall notify standards in consultation with National Financial Reporting
Authority, (NFRA).
 The government shall also notify that auditor‘s report shall include a statement on such matters as
notified.
4. Duty to report on Frauds [Sec. 143 (12)]:
When an auditor suspects an offence involving fraud is being committed by officers or employees of the
company, he shall immediately report the matter to the Central Government in such manner as may be
prescribed.
5. Duty to state the reasons for qualified or negative report [Sec.143 (4)]:
In case of negative or qualified report, the reasons must be stated in the report.
6. Duty to assist investigation:
It is the important duty of the auditor to assist the investigator to investigate the affairs of the company. Further,
it is the duty of the auditor,
 To provide and preserve the necessary documents which are in his custody to the investigator, and
 To assist the investigator by providing all assistance in connection with the investigation.
7. Duty to certify Statutory Report: The auditor has to certify statutory report as correct to the extent of –
 Shares allotted by the company,
 Cash received in respect of such shares, and
 An abstract of receipts and payments of the company.
8. Duty to certify Prospectus:
It is the duty of auditor to certify a report showing statement of profits or losses and assets and liabilities of the
company and its subsidiaries. The report shall also include rates of dividend paid by the company for each of
five financial years preceding the issue of prospectus.
9. Duty to report under Voluntary winding up:
When the company proposes for voluntary winding up, directors of the company have to make a declaration of
solvency. The auditor has to certify a report upon the solvency based on the Profit and Loss Account and
Balance Sheet.
10. Duty to preserve Working Papers: It is the duty of an auditor to preserve and produce all books and
papers relating to the company which are in his custody and to assist the inspector appointed by the
government for investigation.

B. Duties under Common Law

1. Duty to be honest and exercise proper care:
The auditor should be straightforward, honest and tactful and must not be influenced by others in discharge of
his duties. He should be careful and cautious in performing his duties.
2. Duty to obtain knowledge about the company:
He should obtain detailed knowledge about the activities and affairs of the company.
3. Duty to perform additional work: The auditor besides performing the statutory duties is bound to perform
additional work by passing a resolution in the general meeting or making a provision in the Articles of
Association of the company.
4. Duty to verify assets held by the company:
It is the duty of the auditor to verify assets of the company.

C. Other Duties
1. Contractual Duties:
The auditor‘s duty will depend upon the terms and conditions of his appointment between him and the party
who appointed him.
2. Professional Duties:
The auditor has to observe the ethics given by the Institute of Chartered Accountants of India. He should
correspond with the previous auditor before accepting the assignment.

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 ROLES & RESPONSIBILITIES OF AN AUDITOR
1. The Companies Act, 2013 has made various amendments in the duties and the powers exercised by the
auditors all over the country. Every auditor can access the account statements and vouchers of the company
any time and he can ask the officials in-charge to present the documents as and when asked for.
2. He or she has to make sure that the loans and advances have been secured properly and are in the
interests of the company and its members.
3. All the transactions and statements are true and are not detrimental to the company and its rules.
4. In case of any fraud or discrepancy in the company records, the auditor should report the matter to the
higher authorities with proper evidence, failing which, he can be fined for up to Rs.25 lakhs for the error in
judgment.
5. The auditor should not provide services such as internal audits, bookkeeping, investment advisory or
banking services and so on, to the company wherein he holds the position of ‗Auditor‘ of annual financial
records.
6. He/she shall comply with the auditing standards.
7. If the auditor, company secretary or the cost accountant fails to abide by the standards, they shall be
punished with a fine amount that ranges from Rs. 1 lakh to Rs. 25 lakhs.
8. The auditor must exercise rights to access to all records in all subsidiaries if required.
9. He/she must make sure to have all the desired information, and have backups for the same, in certified
copies.
The Act prescribes several such essential responsibilities for auditors and thereby giving enough liability and
the role of the auditors to perform as per the rules set by the Act.
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 LIABILITIES OF AN AUDITOR
A Chartered Accountant is associated with the valuable profession. His primary duty is to present a report on
the accounts and statements submitted by him to members of the company. He is responsible not only to the
members of the company but also to the third parties of the company, i.e., creditors, bankers etc.

A. Civil Liability:

i). Liability for Negligence:

Negligence means breach of duty. An auditor is an agent of the shareholders. He has to perform his
professional duties. He should take reasonable care and skill in the performance of his duties. If he fails to do
so, liability for negligence arises. An auditor will be held liable if the client has suffered loss due to his
negligence. It should be noted that an auditor will not be liable to compensate the loss or damage if his
negligence is not proved.

ii). Liability for Misfeasance:

Misfeasance means breach of trust. If an auditor does something wrongfully in the performance of his duties
resulting in a financial loss to the company, he is guilty of misfeasance. In such a case, the company can
recover damages from the auditor or from any officer for breach of trust or misfeasance of the company.
Misfeasance proceedings can be initiated against the auditor for any untrue statement in the prospectus or in
the event of winding up of the company.

B. Liabilities under Companies Act

The following are the liabilities of an auditor under the provisions of the Companies Act.

(i) Liability for Misstatements in the Prospectus [Sec.35]:

An auditor shall be held liable to compensate every person who subscribes for any shares or debentures of a
company on the faith of the prospectus containing an untrue statement made by him as an expert. The auditor
shall be liable to compensate him for any loss or damages sustained by him by reason of any untrue statement
included therein. The auditor may escape from liability if he proves that:
· The prospectus is issued without his knowledge or consent.
· He withdrew his consent, in writing before delivery of the prospectus for registration.
· He should have withdrawn his consent after issue of prospectus but before allotment of shares and
reasonable public notice has given by him regarding this.

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(ii) Criminal Liability of Auditor under Companies Act:

o Untrue statement in Prospectus [Sec.34]

 The auditor is liable when he authorizes a false or untrue prospectus. When a prospectus includes any
untrue statement, every person who authorizes the issue of prospectus shall be imprisoned for a period
of six months to ten years or with a fine, which may be three times the amount involved in the fraud or
with both.
o Non compliance by auditor [Sec. 143 and 145]:
 If the auditor does not comply regarding making his report or signing or authorization of any document
and makes wilful neglect on his part he shall be punishable with imprisonment upto one year or with
fine not less than ₹. 25,000 extendable to ₹. 5,00,000.
o Failure to assist investigation [Sec.217 (6)]:
 When Central Government appoints an Inspector to investigate the affairs of the company, it is the duty
of the auditor to produce all books, documents and to provide assistance to the inspectors. If the
auditor fails to do so he shall be punishable with imprisonment upto one year and with fine up to
₹.1,00,000.
o Failure to assist prosecution of guilty officers [Sec.224]:
 An auditor is required to assist prosecution when Central Government takes any action against the
report submitted by the Inspector. If he fails to do so, he is found guilty and is punishable.
o Failure to return property, books or papers [Sec.299]:
 When a company is wound up the auditor is supposed to be present and subject himself to a private
examination by the court and is also liable to return to the court any property, books or papers relating
to the company. If the auditor does not comply, he may be imprisoned.
o Penalty for falsification of books [Sec.336]:
 An auditor when destroys, mutilates, alters or falsifies or secrets any books of account or document
belonging to the company. He shall be punishable with imprisonment and also be liable to fine.
o Prosecution of auditor [Sec.342]:
 In the course of winding up of a company by the Tribunal, if it appears to the Tribunal that an auditor of
the company has been guilty of an offence, it shall be the duty of the auditor to give all assistance in
connection with the prosecution. If he fails to give assistance he shall be liable to fine not less than ₹
25,000 extendable upto ₹.1,00,000.
o Penalty for deliberate act of commission or omission [Sec.448]:
 If an auditor deliberately make a statement in any report, certificate, balance sheet, prospectus, etc
which is false or which contains omission of material facts, he shall be punishable with imprisonment for
a period of six months to ten years and fine not less than amount involved in fraud extendable to three
times of such amount.

C. Criminal Liability under Indian Penal Code

If any person issues or signs any certificate relating to any fact which such certificate is false, he is punishable
as if he gave false evidence. According to Sec.197 of the Indian Penal Code, the auditor is similarly liable for
falsification of any books, materials, papers that belongs to the company.

D. Liability under Income Tax Act [Sec.278]

 For tax evasion exceeds ₹.1,00,000, rigorous imprisonment of six months to seven years.
 A person who induces another person to make and deliver to the Income Tax authorities a false
account, statement or declaration relating to any income chargeable to tax which he knows to be false,
he shall be liable to fine and imprisonment of three months to three years. An auditor may also be
charged in case of wrong certification of account.
 A Chartered Accountant can represent his clients before the Income Tax Authorities. However, if he is
guilty of misconduct he can be disqualified from practicing.
 An auditor can face imprisonment upto two years for furnishing false information.

E. Liability for Professional Misconduct

The Chartered Accountant Act, 1949 mentions number of acts and omissions that comprise professional
misconduct in relation to audit practice. The council of ICAI may remove the auditor‘s name for five years or
more, if he finds guilty of professional misconduct.

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F. Liability towards Third Parties
There are number of persons who rely upon the financial statements audited by the auditor and enter into
transactions with the company without further enquiry viz. creditors, bankers, tax authorities, prospective
shareholders, etc.
i). Liability for Negligence:
It has been held in the court that auditor is not liable to third parties, as there is no contract between auditor
and third parties. He owes no duty towards them.
ii). Liability for Frauds:
The third parties can hold the auditor liable, if there is fraud on the part of auditor even if there is no contractual
relationship between auditor and third parties. In certain cases negligence of auditor may amount to fraud for
which he may be held liable to third parties. But it must be proved that auditor did not act honestly and he knew
about it.

AUDIT REPORT

Audit report is the final stage of audit process. The results of the audit are communicated through audit report.
Audit report is the written opinion of an auditor regarding company‘s financial statements. Audit report is a
document prepared by an auditor to certify the financial position and accounting records of a firm.

Meaning of Audit Report

Audit report is the statement included in the financial statements. It contains the opinion of the auditor in
financial statements. The auditor reports to the shareholders who have appointed him. He has to provide his
opinion on the truth and fairness of financial statements. Thus, the auditor protects the interest of shareholders
through audit report.

Definition of Audit Report

Lancaster has defined a report as ―a report is a statement of collected and considered facts, so drawn
up as to give clear and concise information to persons who are not already in possession of the full facts of
subject matter of the report.‖
According to Cambridge Business English Dictionary, Audit report is defined as a formal document that
states an auditor‘s judgment of a company‘s accounts.
Under Sec. 143(3), auditor of a company must report to its members.
(a) The accounts examined by him;
(b) Balance Sheet, Profit and Loss Account, and Cash Flow statement, which are laid in general meeting of
a company during his tenure of office; and
(c) The document declared to be attached to the Balance Sheet and Profit and Loss Account.

FORM OF AN AUDIT REPORT

1. Title of the report
The title of audit report should help the reader to identify the report. It should disclose the name of the client.
The title distinguishes the audit report from other reports.
2. Name of the Addressee
The addressee normally refers to the person who appoints the auditor. If a company appoints the auditor, the
addressee should be shareholders. As per law, the complete address of the addressee is required. Addressee
for the statutory audit shall be shareholders and in case of Special Audit, it is Central Government.
3. Introductory Paragraph
The introductory paragraph should specify that it is the auditor‘s opinion on financial statements audited by
him. The period covered by financial statements should be stated with exact dates.
4. Scope
This part should include the matter-of-fact relating to the manner in which audit examination was made. The
audit examination should cover company‘s accounts, Profit and Loss Account, Balance Sheet and Cash Flow
Statements. The examination should be as per the relevant law. The auditor should not curtail or limit any
examination task.
5. Opinion

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The auditor‘s opinion on the books of account and financial statements examined by him is based on the
information and free from bias. The auditor has to give his opinion as follows:
 Whether the financial statements are arithmetically correct and correspond to the figures recorded in
the books of accounts.
 In case of unqualified opinion, whether the financial statements represent a true and fair view of the
state of affairs and the results of operations.
 In case of qualified opinion, if the Balance Sheet and Profit and Loss account do not present a true and
fair view, the reasons for what and where is wrong.
6. Signature
The signature part should include the manual signature of the auditor. The personal name and signature of the
auditor should be given. If the auditor is a firm, the signature in the personal name and firm name should be
given.
7. Place of Signature
This should include the location of the auditor or the auditor firm, which is ordinarily their city.
8. Date of the Report
The date of completion of the audit work should be mentioned in this section.

CONTENTS OF AN AUDIT REPORT

As per Sec. 143 of the Companies Act, the auditor‘s report shall also state—
I. 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 thereof and the
effect of such information on the financial statements;
II. 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 purposes of his audit
have been received from branches not visited by him;
III. whether the report on the accounts of any branch office of the company audited under sub-section (8) by a
person other than the company‘s auditor has been sent to him and the manner in which he has dealt with
it in preparing his report;
IV. 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;

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 V. whether, in his opinion, the financial statements comply with the Accounting Standards;
VI. the observations or comments of the auditors on financial transactions or matters which have any adverse
effect on the functioning of the company;
VII. whether any director is disqualified from being appointed as a director under sub-section (2) of section
164;
VIII. any qualification, reservation or adverse remark relating to the maintenance of accounts and other matters
connected therewith;
IX. whether the company has adequate internal financial control system in place and the operating
effectiveness of such controls;
X. such other matters as may be prescribed.

TYPES OF AUDIT REPORT

The audit report may be of the following types:

1. Clean or Unqualified Report

Clean or Unqualified report will be given by the auditor if the auditor is satisfied that the accounts, Balance
Sheet, Profit and Loss Account and Cash Flow statement do represent a true and fair view and they are
prepared in conformity with the accounting principles and statutory requirements.
2. Qualified Report
In qualified report the auditor believes that overall financial statements are not fairly stated. The reasons for
giving Qualified Report are be as follows:
i. The books of accounts, Profit and Loss Account and the Balance Sheet do not represent the true and fair
view of the state of affairs and results of the operations, due to lack of conformity with the accounting principles
and statutory requirements,
ii. The auditor is not able to verify the value and existence of certain assets,
iii. The information requested by the auditor is not furnished,
iv. Proper books of account are not maintained as required by law,
v. Part of audit examination done by other auditors.
3. Adverse or Negative Report
When there is sufficient basis for the auditor to form an opinion that the whole accounts and financial
statements, do not present a true and fair view of the financial condition and results of operation, the adverse
or negative opinion will be given. The adverse or negative report will be given on the following grounds:
 When the auditor is not satisfied with the truth and fairness of financial statements,
 Non conformity with the Generally Accepted Accounting Principles,
 Mistakes, discrepancies and material misstatement in the financial statements,
 Omission of a material disclosure.
4. Disclaimer Report
The auditor may disclaim or refuse opinion on the accounts, Profit and Loss Account and the Balance
Sheet, when he does not have sufficient information to base his opinion. In the scope and opinion paragraph,
the auditor should give disclaimer information. This may happen on the following grounds:
 The auditor has not been able to obtain sufficient information to form his opinion,
 The audit examination is not adequate to form an opinion,
 There are some material un-determined item in audit examination.

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 DIFFERENCES BETWEEN UNQUALIFIED, QUALIFIED AND ADVERSE REPORT

RESTRICTION ON OTHER SERVICES

Auditor not to render certain services

An auditor appointed under this Act shall provide to the company only such other services as are approved by
the Board of Directors or the audit committee, as the case may be, but which shall not include any of the
following services (whether such services are rendered directly or indirectly to the company or its holding
company or subsidiary company, namely:—

(a) Accounting and book keeping services;

(b) Internal audit;
(c) Design and implementation of any financial information system;
(d) Actuarial services;
(e) Investment advisory services;

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(f) Investment banking services;
(g) Rendering of outsourced financial services;
(h) Management services; and
(i) Any other kind of services as may be prescribed:

Section 144 also prohibits a company auditor from offering above non-audit services whether directly or
indirectly to the company or its holding company or subsidiary company.

As per the explanation to section 144 of companies act 2013, the term directly or indirectly shall include
rendering of services by the auditor;
 in case of auditor being an individual, either himself or through his relative or any other person
connected or associated with such individual or through any other entity, whatsoever, in which such
individual has significant influence or control, or whose name or trade mark or brand is used by such
individual;
 in case of auditor being a firm, either himself or through any of its partners or through its parent,
subsidiary or associate entity or through any other entity, whatsoever, in which the firm or any partner
of the firm has significant influence or control, or whose name or trade mark or brand is used by the
firm or any of its partners
In the last No.9 ―any other kind of services as may be prescribed‖ category, government has also kept the
option open to add additional services in future to check any conflict of interest which leads to a potential fraud.

If any other services are prescribed then that will also be included in this section and company auditor can not
render such services.

If any auditor or audit firm who or which has been performing any of the above non audit services as
mentioned above on or before commencement of this act then provisions of this section shall be complied
before closure of the first financial year after the date of such commencement.

****************************

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 PRACTICAL AUDITING

( REFERENCE NOTES – UNIT V )

ACCORDING TO REVISED SYLLABUS

OF
UNIVERSITY OF MADRAS

Ms. B. BINDU SINGH

ASSISTANT PROFESSOR
DEPARTMENT OF COMMERCE - GENERAL
A.M. JAIN COLLEGE
MEENAMBAKKAM, CHENNAI.

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 PRACTICAL AUDITING – UNIT V
Unit V : Recent Trends in Auditing
EDP Audit - Meaning - Division of auditing in EDP environment. Impact of Computerization on
Audit Approach - Online Computer System Audit - Types of Online Computer System Audit - Audit around
with the Computers - Procedure of Audit under EDP system. Green Audit – Introduction.

AUDITING IN A COMPUTER BASED ENVIRONMENT

Introduction
In recent years there has been a rapid development in the use of computers as a means of producing
financial information. This development has created certain problems for the auditor in that although general
auditing principles have not been affected, it is sometimes necessary to use specialised auditing procedures
and techniques. Information Technology (IT) is integral to modern accounting and management information
systems. It is, therefore, essential that auditors should be aware of the impact of IT on the audit of a client‟s
financial statements. Information Technology auditing (IT auditing) began as Electronic Data Process (EDP)
auditing. As a result of this, there has emerged from within the accounting profession a group of electronic
data processing (EDP) audit specialists, equipped with sufficient technical expertise to make an intelligent
analysis of complex computer audit situations.
EDP Audit - Meaning
Electronic Data Processing (EDP) refers to the input, processing and output of information. EDP is often
called Information Services or Systems (IS) or Management Information Services (MIS). The information
processed is used and evaluated during an audit.

DIVISION OF AUDITING IN EDP ENVIRONMENT

ORGANISATIONAL REVIEW / COMPUTER INSTALLATION REVIEW
Organisational review is the review of the organisational controls within the computer installation itself. The
organisational review seeks to establish that there are no serious internal control weaknesses within the
installation, which could throw doubt on the validity of the information produced. Adopting this approach, the
auditor should seek to establish that six key controls operate within the installation. These controls are as
follows:

1. Controls by management over the activities of the EDP function

The degree of control which general management should exercise over the EDP department will depend both
upon the nature and complexity of the business and the complexity of the computer installation.
 The EDP manager should report directly to senior management.
 All significant aspects of EDP activity should be regularly reported.
It should therefore be ascertained that the person to whom the EDP Manager reports is a member of the
senior management team and has sufficient authority to ensure that the department will receive adequate
support and effective management.
The auditor should also enquire into the manner in which the activities of the department are reported to
senior management. Ideally, a monthly control report should be prepared, which should include the following
information:
 An analysis of computer usage, showing productive and non-productive time separately
 A manpower allocation report
 A report on projects under development
 An analysis of expenditure against budget

2. Controls to ensure the continuing existence of EDP facilities

Arrangements should exist within every EDP installation, which attempts either to eliminate or to minimise the
possibilities of EDP facilities being completely destroyed by any reason. These arrangements are significant

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in that the loss of certain vital information could seriously disrupt an organisation‟s general business and
profitability.
The auditor should enquire into the existence of the following controls:
1. Insurance cover
 Loss of equipment
 Loss of file devices
 Reconstruction of files (i.e. the cost of reconstituting the data from external sources)
 Consequential loss
 Employee fidelity
2. Emergency precautions
3. Stand-by facilities - Back-up copies of files, programmes & documentation and Master-files
4. Equipment

3. Safeguarding of the client’s records

The division of duties within the EDP department and the general procedural arrangements should be such
that the records of the client are not exposed to any undue risk of loss or corruption, either accidental or
deliberate. The auditor should therefore direct his attention to the following aspects of internal control:

a. Division of Auditing in the EDP environment: In common with other departments of the
organisation, the extent to which duties can be divided between the staff within the EDP department
depends to a very large extent upon the size of the department.
Ideally, the following duties should be carried out by separate individuals:
 Data initiation (outside the EDP department)
 Data Control (within the EDP department)
 Data preparation (entering and verifying)
 Job scheduling
 Operation of the computer
 Maintenance of programmes and the file library
 Systems development
 Programming of new systems
It should be emphasized that the full division of duties as listed above will only be found in very large
institutions. Small installations, for example, rarely employ a file librarian and frequently combine the
activities of systems development and programming.

b. Storage of information, files and programmes Procedural controls should be such that files and
input and output data should not be accessible to unauthorized persons. The following matters warrant
particular attention:
 Files should always be stored securely, preferably in a separate file library.
 Access to the files should be limited to authorized personnel only.
 Output should not be accessible to visitors to the department.
 Systems and programme documentation should be stored securely.

c. Processing of files: As stated earlier, files should always be processed on a generation basis, thus
ensuring that a copy can always be re-created should be the current edition of the file be either lost or
destroyed. The auditor should enquire into the number of generations of master files that are kept and
should access the adequacy of the storage arrangements for each generation.

d. Procedures to prevent accidental overwriting of files Operating procedures should incorporate

controls designed to prevent the accidental overwriting of files. The auditor would normally expect to
find the following procedures in operation:
 Files should be subject to retention period checks on set-up i.e. the file label has a date
imprinted on it, before which the file may not be overwritten or erased.
 Files should be written both internally and externally.
 Files should be stored in an orderly fashion to prevent accidental selection of the incorrect file.
 Operators should be given details of file labels before processing, so that operating problems
can be resolved.

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e. Amendments to programmes Strict control should be exercised over amendments made to existing
programmes. This is not only to safeguard fraudulent manipulation or suppression of data, but also to
ensure that costly amendments are not made without first establishing that they are both desirable and
necessary.
 The auditor should ensure the following
 Operators are instructed only to accept amendments, which have been authorized, by either the
EDP manager or the operations manager.
 Amended versions of programmes are thoroughly tested before implementation.
 All programme amendments are recorded in the relevant programme documentation, the back-up
documentation and also in a central record of all amendments.

4. Control over the data passing through the EDP department

Control over data submitted for processing is of vital concern to the auditor. The controls established within
each system, such as control total checks and validation checks should be examined in detail by means of
separate audit reviews of each individual system. Additionally, the auditor should examine as part of his
installation review the general standard of controls, which are in operation within the EDP department,
particularly within the data control section. There are three main areas of control to which the auditor
should direct his attention. These are as follows:
a. Controls maintained by user departments In all batch-processing installation, it should be regarded
as a cardinal rule that all user departments should maintain strict input controls over the data, which
they submit for processing.
The type of control maintained will clearly vary according to the nature of the business and the
individual requirements of each system. During his installation review the auditor should therefore
ascertain whether or not (i) all data is batched before it is submitted for processing, (ii) user
departments are required to maintain input/output controls in the form of batch total summaries, and (iii)
there are indications that these user controls are effective.
b. Data control function within the EDP department A data control section invariably exists in all but
the smallest of installations. Its functions are to receive data from user departments, assemble it into a
state ready for processing and to monitor its progress through the various stages of processing.
 A data control section does exist within the EDP department.
 Staff within the data control section do not have other duties, which give rise to internal control
weaknesses.
 Authorization controls exist which ensures that all authorized data is received form users and
that only authorized data is accepted for processing.
 A record is maintained of all data received and of its progress through processing
 Control totals are balanced to output after processing.
 The data control section exercises anticipatory control over the receipt of data from users.
c. Storage arrangements within the EDP department There should be secure storage arrangements,
both during and outside normal working hours, for the following
 Unprocessed data in the data control section
 Data in the record room
 Data in the job assembly area (if any)
 Input documents after processing
 Output documents after processing
 Undistributed output.

5. Controls over the operation of the computer

The procedural controls relating to the operation of the computer should also be reviewed, the object being to
ensure that there are no internal control weaknesses, which could give rise to the mis-processing of data.
The points to be considered during this aspect of the review are as follows:
a. Number of operators present during processing Ideally, there should always be two operators
present during processing. This means that collusion would have to exist before data could be
deliberately copied, manipulated or destroyed. If two or more operators are employed, the auditor
should ensure that adequate cover arrangements exist in the event of holidays, sickness, extended
shifts and lunch or tea breaks. In such a situation, the rotation of operators‟ duties is also of
significance.

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b. ‘Hands-on’ testing There should invariably be a rule, within all except the smallest of installations,
that system analysts and programmers are not allowed to access the computer operating area, other
than for „hands-on testing‟. Hands-on testing is the term used to describe the situation where the
programmer tests out, on the computer, programmes which he is writing and developing.
c. File library From an internal control point of view, it is clearly preferable that files and programmes are
stored in a separate file library. Where such library exists, it should be under the control of a file
librarian. Operators should not have access to this library.
d. Review of operators’ activities It should be an accepted principle within the installation that
operators‟ activities should be recorded and reviewed. The manner in which this is carried out will vary
according to the nature of the installation.
e. Access to the operating area Clear access to the operating area should be subject to rigid security.
The auditor should therefore ensure the following.
 Unauthorized persons cannot gain access to the operating area either during or outside
normal working hours.
 Checks exist which ensure that operators do not bring unauthorized files or work into the
operating area.
 It is not possible for operators to remove files or work from the operating area without
authorization.

6. Control over the resources, assets and liabilities of the EDP department
To contribute his review of the computer installation, the auditor should conduct a review of the internal
control surrounding the general activities of the EDP department. The points that should be covered within
this area of review are as follows:
a. Protection of confidential information Controls should exist which ensure that confidential
information is adequately protected. Such controls will take one or other of the following forms:
 Attendance of users during the processing of sensitive applications
 Security grading of printouts, with a corresponding restriction of distribution
 If machine time is sold, special precautions relating to the protection of files, programmes
and data whilst visitors are in the operating area
b. Development of new systems and applications Procedures within the department should ensure
that computer systems are only developed in situations where there is a genuine need for them and
that they are developed along practical and commercial lines. The controls surrounding systems
development should therefore ensure the following:
 Feasibility studies are always carried out before new applications are authorized and
undertaken. Such studies should have regard to all the relevant factors including: obtaining
user‟s co-operation proving a need for the application setting realistic time-scales for
implementation etc.
 Systems and programmes under development are reviewed at critical stages during their
development. It is clearly essential that systems, when developed, are acceptable to all
concerned. Reviews should therefore be carried out as follows:
i. Users should approve the system before development begins.
ii. Auditors should be involved before programming begins to ensure that acceptable
control standards are incorporated into the system.
iii. The system analysts should review all programmes before they are compiled.
iv. The programmer should extensively test the programmes.
v. The analyst should review the results of programme testing.
vi. The user department should formally authorize the system as ready for
implementation
c. Sale of machine time/data conversion facilities If computer time and/or operating facilities are sold
on anything more than an occasional basis, controls should exist to ensure that all income is duly
received. The auditor should therefore enquire into the following:
 The system surrounding the invoicing and collection of revenue.
 The rates charged and the comparison of these rates against commercial bureau
charges.
d. Cost control over the activities of the EDP department The auditor should establish that there is
an adequate form of review over the activities of the EDP department. As a corollary to this enquiry, it is

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 appropriate to enquire under this heading into the detailed mechanics of cost control. In particular, the
attention should be paid to the following factors:
 Any cost accounts prepared by the EDP department
 The reconciliation of these cost accounts to the main financial accounts
 The comparison of actual costs against budget
 The means by which management review variances

COMPUTER SYSTEM REVIEW

Having completed his review of the installation and satisfied himself as to the adequacy or otherwise of the
design and operation of the various procedural controls, the auditor will be in a position to review in detail the
design and operation of each of the individual systems. His approach to this task will be similar to that
employed in any other system based audit, which include the following:

1. Documenting the system

The task of documenting a computer system is not dissimilar from that of documenting any other accounting
system. In fact, the auditor is invariably aided in his work in that he will normally find that the system has
already been well documented by the analysts who designed the system.
The amount of documentation, which will be available, will clearly vary from installation to installation. In some
cases it will be necessary to supplement the documentation with the auditor‟s own notes and flowcharts,
whereas in other cases the notes and flowcharts provided by the client will prove sufficient.
The documentation will need to be assembled in a manner, which will facilitate an evaluation of the system on
the „key question‟ principle. Clearly, no hard and fast rules can be laid down, but it will normally be convenient
to use the outline system flowchart as the principal record of the system and to supplement this flowchart with
the following four main schedules:
 Schedule of input types
 Schedule of master files
 Schedule of intermediary files
 Schedule of reports printed
The outline system flowchart, together with the four main supporting schedules, should provide the auditor
with the bulk of the information, which he requires for his evaluation of the system.

2. Evaluating the system

Having completed his documentation of the system, the auditor can proceed with his evaluation of the internal
controls operating within the system.
He will do this by means of an internal control questionnaire. The questionnaire should seek to establish that
the following seven key controls operate:
 That it is possible to trace transactions through each stage of processing, i.e. a satisfactory audit
trial exists.
 That there are controls, which prove prima facie that transaction data, is processed correctly.
 That there are adequate controls to protect standing data.
 That controls exist to ensure that all authorized, and only authorized data is processed.
 That adequate control is exercised over rejections and resubmission of corrected data for
reprocessing.
 That the system provides adequate management information and that it is broadly suited to its
purpose.
 That the system is adequately documented.

3. Designing the audit programme

Having documented the system and having evaluated the controls operating within the system, the auditor will
be in a position to design his audit programme.
It should be emphasized that the principles involved are identical to those in any other system-based audit,
namely that the auditor is seeking to assess and test the operation of the system, so that he can rely on the
information produced by the system.
If he can satisfy himself as to the reliability of the system, this does not of course obviate the necessity for
balance sheet verification work. Thus, even though the auditor is satisfied as to the operation of the computer
systems, it will still be necessary to verify, for example, purchase ledger balances against circulars and
statements and stock ledger balances against physical stock counts.

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Transaction and Weakness Test
The principles to be employed in designing computer system audit tests are again similar to those employed
in designing audit tests in respect of manual or mechanized systems. If the answer to a key question is
positive and the auditor is satisfied that no fundamental internal control weakness exists, and then he
imposes a transaction test to establish that the system is operating satisfactorily. If, however, the answer to a
key question is negative, he imposes special weakness test to assess the significance of that weakness. If at
the conclusion of those tests he is satisfied that no major error could occur, he reports the weakness to the
management and continues with normal balance sheet verification work. If he thinks that a major error could
occur, he must then impose additional verification tests or perhaps qualify the audit report.
It is not practical to specify a standard audit programme, which can be used in all cases where no major
weakness has been identified. It is, however, possible to give an indication of the normal tests, which would
be included in a transactions audit programme where there is no loss of audit trial.

Loss of Audit Trial

The tests indicated above deal with the basically simple situation where all information is processed in batch
form and where it is possible to link the input directly with output.
However, losses of and changes in traditional audit trials are encountered increasingly in the more advanced
computer applications. A typical example would be a large public company with a sales ledger comprising
over half a lakh balances. It would be impractical to print out a full list of balances each month, so the control
totals are printed, together with certain exception reports, such as overdue balances. There is, therefore, no
output report against which the auditor can compare input.
A commonsense attitude should be adapted to losses of audit trial of this nature. The auditor must adapt his
technique to suit the situation. A number of choices are open to him including some sophisticated techniques.
Techniques used in these circumstances include the following:
 Arranging for special printouts of additional information for the auditor‟s use. This often involves an
additional suite of programmes, which are activated at the auditor‟s request.
 Clerical re-creation, i.e. to verify a sales total when no detailed listings have been produced, the
copy invoices can be add-listed and the totals compared against the computer reports.
 Testing on a total basis, ignoring individual items.
 Use of a computer audit programme to directly interrogate the magnetic file and printout information
specifically selected by the auditor.
 Use of a test pack to test the correct processing of data.
 Relying on alternative tests.

APPROACHES TO EDP AUDITING

The auditing procedures in an Electronic data processing environment includes audit planning, risk
assessment, audit testing and is achievable by auditing with the computer, auditing through the computer
and auditing around the computer.

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1. Auditing Around the Computer (Black box approach): It is the type of auditing done in a traditional
method. The auditor summarizes the input data and ignores the computer‟s processing but ensures the
correctness of the output data generated by the computer, this approach is generally referred to as “auditing
around the computer”. This methodology was primarily focused on ensuring that source documentation was
correctly processed and this was verified by checking the output documentation to the source documentation.
Under this approach, the auditor considers the computer as a black box and as a result the application
system processing is not examined directly.
Usually the auditors adopt this approach of auditing around the computer, when any of the following
conditions are fulfilled.
 The system itself is very simple.
 The system is batch-oriented.
 The system uses generalized software, which is well tested and used widely by many concerns.
The basic advantage of auditing around the computer is its simplicity. The auditors having little technical
knowledge of computers can be trained easily to perform the audit.
However, this approach is also not free from defects. There are two major limitations to this approach.
 Firstly, the type of computer system where it is applicable is very restricted. It should not be used in
those systems having complexity in terms of size or type of processing.
 Secondly, the auditor cannot assess very well the likelihood of the system degrading if the
environment changes. The auditor should be concerned with the ability of the concern to adjust with a
changed environment. Systems can be designed and programmes can be written in certain ways so
that a change in the environment will not disturb the system to process data incorrectly or for it to
degrade quickly.

2. Auditing Through the Computer (White box approach): Due to the “real time” computer environments,
there may only be a limited amount of source documentation or paperwork hence the auditor may employ an
approach known as “auditing through the computer”. In this approach, the reliability and accuracy of the
results are analyzed through the computer. This involves the auditor to perform tests on the information
technology controls to evaluate their effectiveness like Compliance test, Test Packs, Reprocessing.
The main advantage of this auditing approach is that the auditor has increased power to effectively test a
computer system. The range and capability of tests that can be performed increases and the auditor acquires
greater confidence that data processing is correct. By examining the system‟s processing the auditor can also
assess the system‟s ability to cope with environment change.
The main disadvantage of this approach is the high cost sometimes involved and the need for extensive
technical expertise when systems are complex. However, these disadvantages are really spurious if auditing
through the computer is the only viable method of carrying out the audit.
3. Auditing with the Computer: The utilization of computer by the auditor for some audit work and he uses
some general software for the purpose of calculating depreciation, printing letters, and duplicate checking and
files comparison.
The computer is not used for all the audit work and it is done manually.

PROCESS OF AUDIT UNDER EDP SYSTEM

The audit process for a computerized accounting system involves the following five major steps:
1. Conducting Preliminary Survey: This is a preliminary work to plan how the audit should be conducted.
The auditors gather information about the computerized accounting system that is relevant to the audit plan.
This includes an understanding of how the computerized accounting functions are organized, identification of
the computer software used, understanding accounting application processed by computer and identification
applicable controls.
2. Reviewing and Assessing Internal Controls: There are two types of controls namely general controls
and application controls.
 General Controls: General controls are those that cover the organization, management and
processing within the computer environment. They should be tested prior to application controls,

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 because if they are found to be ineffective, the auditor will not be able to rely on application controls.
General controls include proper segregation of duties, file backup, use of labels, access control, etc.
 Application Controls: Application controls relate to specific tasks performed by the system. They
include input controls, processing controls, and output controls. They should provide reasonable
assurance that the initiating, recording, processing and reporting of data are properly performed.

3. Compliance Testing: Compliance testing is performed to determine whether the controls actually exist
and function as intended. This can be performed by comparing the results to predetermined results or by
processing dummy transactions.
4. Substantive Testing: This is performed to determine whether the data is real. Substantive tests are tests
of transactions and balances and analytical procedures designed to substantiate the assertions. Auditors
must obtain and evaluate evidence concerning management‟s assertions about the financial statements. The
auditor must obtain sufficient competent evidential matter to provide a basis for an opinion regarding the
financial statements under audit. If sufficient competent evidence cannot be obtained then an opinion cannot
be issued.
5. Audit Reporting: The audit report will contain detailed information on various aspects of their findings in
the process of audit in a computerized environment.

PROCEDURE OF AUDIT UNDER EDP SYSTEM

In any engagement, the primary role of the auditor is to examine the truth and fairness status of an entity‟s
financial statements as prepared by a professional accountant with a view of expressing an independent
opinion. The following is the procedure of audit under EDP system.

 Planning
 Risk Assessment
 Testing
 Fieldwork
 Reporting
 Follow-up

Planning
Planning an audit entails ascertaining the total strategy to be followed for the audit engagement. It is
essential that the auditor adequately plans the audit as it is of tremendous benefits. In considering the
overall audit strategy, ISA 300 obliges that the consequence of Information Technology on the audit
procedures, including the obtainability of data and the anticipated use of CAATs be considered by the
auditor.
Risk Assessment
The auditor needs to understand its client‟s business environment as this would help the auditor in
evaluating the possibilities of misstated material items. In a bid to understand the firm and its business
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environment, the auditor must understand the firm‟s information system as well as the related business
processes relevant to financial reporting and communication. IAS 315 clearly defines an entity‟s information
system to consist of infrastructure (physical and hardware components), software, people, procedures and
data.
The information system relevant to financial reporting objectives is one which is made up of processes that
initiate record, process and report firm‟s transactions and ensures that related assets, liabilities and equity
are properly accounted for. The ability of management to make proper decisions in the control and
management of a firm‟s activities and to prepare reliable financial reports is determined by the quality of
information generated by the system.
Testing
The auditor has a charge to plan and device responses to the possibilities of misstated material items as
pointed out by IAS 315. This is usually done by using substantive and compliance tests. The use of CAATs
would enable the auditor carry out more extensive testing of electronically processed transactions. ISA 330
requires that the auditor plans and executes additional audit procedures, the timing, nature and extent of
which would be dependent and responsive to the risks of material misstatement already assessed.
Fieldwork
The dirty work takes place in the fieldwork stage. One way to expedite this process is to have an audit
liaison assigned to the project.
Reporting
The reporting phase compiles all the information that has been discovered
Follow-up
Finally, if there are any discrepancies, it's important to follow up to correct and improve on procedures and
processes.

IMPACT OF COMPUTERIZATION ON AUDIT APPROACH

 High speed in work
 Disappearance of manual reasonableness
 Concentration of duties
 Shifting of internal control base
 Human-computer interaction or Man-Machine interface
 Impact of poor system
 Low clerical error
 Exception reporting

SPECIAL TECHNIQUES FOR AUDITING IN AN EDP ENVIRONMENT

As in the case of manual systems, auditing in an EDP environment is done for the following purposes:
1. To study and evaluate the system through which the information under audit is generated, including
the various internal controls in the system.
2. To carry out appropriate substantive procedures.
Due to the special characteristics of an EDP environment, auditors often use the computer for performing
several compliance procedures as well as substantive procedures. The techniques, which involve the use of
the computer for audit purposes, are known as „Computer assisted audit techniques‟ (CAATs).

What are CAATs?

Computer assisted audit techniques involve the use of computers in the process of an audit rather than
limiting it to an entirely manual approach. CAATs are defined as computer based tools and techniques, which
facilitate auditors to increase their personal productivity as well as that of audit function. CAATs are software
tools for auditors to access, analyses and interpret data and to draw an opinion for an audit objective.

Need for CAATs

Statement on AAS-16 states that effectiveness and efficiency of audit procedures may be improved through
use of CAATs. CAATs may be used in performing various auditing procedures, including the following:
 Tests of details of transactions and balances
 Analytical procedures
 Tests for general controls

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  Sampling programmes to extract data for audit testing
 Tests of application controls
 Re-performing calculations performed by the entity‟s accounting system
Guidance note on CAAT issued by the Institute of Chartered Accountants of India describes CAATs as
important tools for the auditor in performing audits. During the course of audit, the auditor has to obtain
sufficient, relevant and useful evidence to achieve the audit objectives effectively. Audit findings and
conclusions are to be supported by appropriate analysis and interpretation of the evidence.
In auditing a computerized environment where all significant operations are computerized, it may be
impractical to perform audit completely and with assurance unless the auditor uses CAATs for collection and
evaluation of audit evidence by performing both compliance and substantive tests. By using CAATs, it is
possible for the auditor to perform audit more effectively and efficiently and also have greater assurance on
the audit process.

Considerations in the use of CAATs

When planning an audit, the auditor may consider an appropriate combination of manual and computer
assisted audit techniques. In determining whether to use CAATs, the factors to be considered include the
following:
 The IT knowledge, expertise and experience of the audit team
 The availability of CAATs and suitable computer facilities and data
 The impracticability of manual tests
 Effectiveness and efficiency and
 Time constraints
Before using CAATs the auditor considers the controls incorporated in the design of the entity‟s computer
system to which CAAT would be applied in order to determine whether, and if so, CAAT should be used.

TYPES OF CAATS
CAATs can be broadly categorized into the following three types:
1. Generalized audit software (GAS) These are also referred as Package Programmes. GAS refers
to generalized computer programmes designed to perform data processing functions such as
reading data, selecting and analyzing information, performing calculations, creating data files and
reporting in a format specified by the auditor. GAS is standard off-the-shelf audit software, which
can be used across enterprises and platforms.

2. Specialized audit software (SAS) These are also referred to as Purpose-Written programmes.
They perform audit tasks in specific circumstances. These are specifically written for performing
audit tests for specific type of applications. These programmes may be developed by the auditor,
the entity being audited or an outside programmer hired by the auditor. In some cases, the auditor
may use an entity‟s existing programmes in their original or modified state because it may be more
efficient than developing independent programmes.

3. Utility software These are used by an entity to perform common data processing functions, such
as sorting, creating and printing files. Utility software also includes utility programmes available in
system programmes for performing debugging or analysis of various aspects of usage/access.
These programmes are generally not designed for audit purposes but can be used for performing
specific tests.
CAATs and more specifically audit software have the potential to enable auditors to recognize computer
as a tool to assist them in the audit process. Audit software give auditors‟ access to data in the medium in
which it is stored, eliminating the boundaries of how it can be audited. Once the auditors accept and learn
how to use audit software, they will be in a better position to create value addition in their audit. The greatest
barrier in promoting use of audit software is failure to recognize opportunities to use audit software for audit.
Understanding and recognizing how CAATs can be used and knowing how to use audit software is most
critical to its effective use.
Using audit software enhances the effectiveness of audit and enables the auditor to provide better
assurance to their clients. In an increasingly computerized environment, it is critical for the auditor to move
from ticks to clicks and learn to harness the power of computers for audit. Using audit software as their tool
for auditing digitized data, auditor can shift focus from time consuming manual verification audit procedures to
intelligent analysis of data to provide assurance to clients and manage audit risks.

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 GREEN AUDIT
The term “Green” means eco-friendly or not damaging the environment. This can acronymically be called as
“Global Readiness in Ensuring Ecological Neutrality” (GREEN). Green Audit can be defined as systematic
identification quantification, recording, reporting & analysis of components of ecological diversity &
expressing the same in financial or social terms. “Green Auditing”, an umbrella term, is known by another
name “Environmental Auditing”. It aims to analyze environmental practices within and outside of the
concerned sites, which will have an impact on the eco-friendly ambience.

The rapid urbanization and economic development at local, regional and global level has led to several
environmental and ecological crisis. Therefore, the purpose of the present green audit is to identify, quantify,
describe and prioritize framework of Environment Sustainability in compliance with the applicable regulations,
policies and standards.

Meaning of Green Audit:

Green audit is a way to show businesses what type of carbon footprint they are leaving on the planet, while
also giving them ways to reduce it. Green audit involves the inspection of a company to assess the total
environmental impact of its activities, or of a particular product or a process.

For example, a green audit of a manufactured product looks at the impact of production, including energy use,
and the extraction of raw materials used in manufacture, use of the raw material which may cause pollution
and other hazards, and waste disposal, potential of recycling.

The green audits are tools, that organizations use to identify their environmental impacts and assess their
compliance with applicable laws and regulations, as well as with the expectations of their various
stakeholders. It also serves as a means to identify opportunities to save money, enhance work quality,
improves employee health, safety and morale, reduce liabilities and achieve other form of business values.

This concept has got its origin in recent past and suddenly got acceleration due to heavy industrial traffic
which ends with unaccountable emission resulting pollution. Due to growth in population, needs has
increased. Needs of humans can only be met by installing industries. The increase in industries has not only
supplied the need of humans but also had been damaging the environment by emitting carbon components.
The provision for environmental impact assessment prior to allowing an industry to setup is the first step to
ensure that the project or industry will not harm the environment. But still the production and operation
process will have some impact on environment. That post-production assessment of impact of environment is
the motto of Green Audit.

Main Objective of Green Audit :

· Geographical Location
· Floral and Faunal diversity
· Meteorological parameter
· Energy Consumptions
· Waste disposal system
· Ambient Environmental Condition
· Awareness & Training on Sustainability

Objectives of Green Audit: (based on main objectives)

1. To ensure development along with safeguarding the environment.
2. To reduce energy consumption to foster environment.
3. To ensure compliance with present legislations of the State and other legal requirements.
4. To physically ensure installation of devices that reduce pollution and authentication of such devices by
competent authority.
5. To ensure optimum utilization of resources.

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6. To see whether provisions are made for liabilities arising out of unintentional pollution related damages and
their compliance in cases so arose.
7. To ensure that sufficient precaution has been taken by the industry to protect the employees of the
industries from pollution resulting from it.
8. To suggest improvement in the system to promote safe and clean environment.

The people employed in the industry are directly associated with the environment of the industry and are
exposed to many types of diseases specific to industries or occupational diseases e.g. Asbestosis, coal
worker‟s pneumoconiosis, carpal tunnel syndrome, lead poisoning.

Green Audit Process:

The audit process will differ from industry to industry, as different industries give different outputs and are
having different operation processes. So there will be broad plans to carry out the Green Audit:

1. To understand the industry and its specific effect to environment.

2. To compare the statements of the industry with standard performance indicators obtained.
3. To find whether relevant clearances from different departments/ministries have been obtained or not. Eg.
Environment Clearance from Pollution Control Boards, Ministry of Environment and Forest, Water drawls
permission etc.
4. To find consumption per unit of produce to see whether loss of energy caused.
5. To assess inefficiency, bottlenecks which are energy consuming.
6. To see all Compliance of Environmental Laws has been made.
7. To inquire regarding the pollution effect with the Civil Society of nearby region.
8. To find whether the industry has complied with all commitments and assurances given in MoU regarding
environment.
9. To suggest measures to improve energy efficiency and anti-pollution measures.

Besides, there will be industry specific variation in audit, there will also be variation in audit process from
country to country as per the requirements of the existing legislation of that country.

TYPES OF GREEN AUDIT:

On the basis of frequency such audit is of two types:
a. Concurrent/Cyclical Audit
It is mainly conducted by entity‟s environmental unit segment/outside consultants or combination of both on a
scheduled cycle of occurrences.
b. Single Special Purpose Audit
It is intended for special purpose and normally conducted by outside agencies. Such audit is not carried out
on regular basis. It is generally undertaken in response to a special need.

On the basis of scope, objectives, risk assessment such audit may be categorised as:
1. Compliance Audit:
Reviews level of compliance with relevant environmental and safety standards.
2. Performance Audit:
Tests the environmental impact of programmes, EMS, compliance with environmental laws etc.
3. Transactional Audit:
It assesses the environmental risks and liabilities of land/facilities before a real estate acquisition or divesture
of business. It is important as both the buyers and sellers want to know the extent of any liabilities due to
environmental contamination.
4. Product/Activity Audit:
It is the audit of specific products/processes and their distribution to determine the requirements to make them
environmentally friendly and to confirm that they are meeting products and chemical restrictions. Such audits
also assess packaging materials for their recyclability.
5. Issues Audit:
Assesses the corporate performance in a particular area (e.g. Oil and Natural Gas Corporation‟s impact on
habitats or impacts on Sundarban for potential chemical factory in Nayachar of West Bengal)

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6. Risks Audit:
Considers occupational health and safety/risks to employees and public.
7. Energy and Waste Audit:
Evaluates usages of energy with alternative sources and tracks the reasons of wastes, risks involved etc.
8. Process and Safety Audit:
Evaluates whether policies, processes, monitoring, appraisal, documentation etc. are in place. It also
considers present/potential hazards and risks arising from processes.
9. Quality Audit:
Tests the total quality management (TQM) from the perspectives of environment.
10. EMS Audit:
Examines whether given facility meets EMS standards (viz., ISO 14001, EMAS).
11. Baseline Audit/Future Scenario Assessment:
Helps to identify potential environmental problems in addition to current one and intends to assess the
probability/intensity of organisation‟s ability to respond to new challenges.

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