UNIT 1

INTRODUCTION TO
AUDITING
Introduction:
Auditing is as old as accounting. The
historical records show that ancient
Greeks, Romans used to get their
accounts audited. The Vedas contain
reference to accounts and auditing.
Arthashastra by Koutilya highlighted
detailed rules for accounting and
auditing of public finances.
The word audit is derived from Latin word “AUDIRE”,
which means “To hear” that is in ancient times, when ever
frauds were suspected proprietors of the business used to
appoint some experienced and impartial persons to check
the correctness of the accounts.
The hearing from the book keepers about the accounts
relating to the business came to be known as Audit and
the persons, who heard from the book keepers, came to
be known as auditors.
Meaning of Auditing:
Auditing means “detailed examination of books of accounts of an
organization for a given period, by an independent and qualified
person, who with the help of vouchers, documents and information
given, reports whether the profit or loss accounts shows real profit
or loss position and balance sheet exhibits a true and fair state of
affairs of the business or not”.
In other words “auditing is concerned with verification of accounting
and financial records with view to determine their accuracy and
reliability”.
Definitions of Auditing:
“Auditing is concerned with the verification of
accounting data determining the accuracy and reliability of
accounting statements and reports.” — R.K. Mautz

“Auditing is an examination of accounting records

undertaken with a view to establishing whether they
correctly and completely reflect the transactions to which
they purport to relate.” — L. R. Dicksee
Objectives of Auditing:
1. PRIMARY OR MAIN OBJECTIVES

• To verify and establish that at a given date balance sheet and

P&L A/c presents true and fair view of financial position of the
business.
• To check whether the books of a/c’s kept according to Act and
are true and fair.

2.SUBSIDIARY OR ANCILLARY OBJECTIVES

a. Detection and prevention of errors
b. Detection and prevention of frauds
2. a) Detection and prevention of errors:
An error is an unintentional mistake or misdescription in the books of accounts or records.
Types of errors:
• Errors of principle: The error of principle means recording the transaction violating the accounting policies and procedures.

•Errors of Omission: Occurs when an entry has not been recorded although a
transaction has occurred during that period.
•Errors of Commission: An error occurs when a bookkeeper or accountant records a
debit or credit to the correct account but to the wrong subsidiary account or ledger.
•Compensating Errors: Compensating error is when one error has been
compensated by an offsetting entry that's also in error
•Errors of Duplication: when an accounting entry is duplicated, it's debited or
credited twice for the same entry.
b) Detection and prevention of frauds:

Fraud refers to intentional misrepresentation of financial

information by one or more individuals among management,
employees or third parties.
Types of Frauds:
A. Misappropriation of cash
• Misappropriation or embezzlement of cash
• Misappropriation of Goods
B. Fraudulent manipulation of accounts
Different ways of manipulation of accounts:
Window dressing
Secret reserves
Over valuation of assets
Provision of more depreciation on fixed assets
Characteristics of Auditing:
1. Audit is crucial review of the system of accounting and internal control.
2. Audit is an organized and scientific examination of the books of accounts of a
business.
3. Audit is undertaken by an independent person or body of persons who are duly
qualified for the job.
4. Audit is a verification of the results shown by the profit and loss account and the
state of affairs as shown by the balance sheet.
5. Audit is done with the help of vouchers, documents, information and explanations
received from the authorities.
6. The auditor has to satisfy himself with the authenticity of the financial statements
and report that they exhibit a true and fair view of the state of affairs of the concern.
7. The auditor has to inspect, compare, check, review, scrutinize the vouchers
supporting the transactions and examine minute books of shareholders, directors
etc., in order to establish correctness of the books of accounts.
Distinction between Book keeping, Accountancy and Auditing:

Basis Book keeping and Auditing

Accountancy
1. Period Done continuously Generally undertaken at the
throughout the year end of the financial year

2. Nature of It is constructive in It is analytical and critical in

work approach approach

3. Recording It is concerned with Concerned with the

of business current recording of examination of past
transactions business transactions transactions
4. Detection The book keepers and Auditors are required to
of frauds accountants are not detect frauds
expected to detect frauds
6. They are paid regular salaries Auditors are given fee for the
Remuneration specific work done

7. Qualification Need not to be chartered Auditors should be chartered

accountants accountants

8. Knowledge May or may not have the Must have the knowledge of audit
knowledge of audit techniques techniques and procedures
and procedures

9. Accountancy They cannot take up both Auditors can take up both

and Audit work accountancy and audit work accountancy and audit work

10. Code of This work is not governed by Auditing work is governed by code
conduct any code of conduct prescribed of conduct prescribed by the ICAI
by any professional body
Basic Principles of Audit:
1. Principle of Honesty
2. Principle of Impartiality
3. Principle of Planning
4. Principle of Secrecy
5. Principle of Evidence
6. Principle of Consistency
7. Principle of Legal Frame Work
8. Principle of Working Paper Preparation
9. Principle of Internal Control
10.Principle of Report
RELATIONSHIP OF AUDITING WITH OTHER
DISCIPLINES
PREPARATION BEFORE COMMENCEMENT OF NEW AUDIT

1. Receiving
appointment letter.
2. Communication
with the existing
auditor
3. Acceptance of
appointment

4. Ascertaining the
scope of audit

5. Knowledge about
the organization
 6. Knowledge about
accounting system

7. Knowledge of
technical details

8. complete list of
principal officers
9. Observation of the
previous auditors
report
10. Instructions of the
client
 PREPARATIONS BEFORE THE CONDUCT OF AUDIT

Receiving Appointment Order

The auditor needs to receive the appointment order in case of a limited company from
the directors or shareholders and if it is a partnership needs to be obtained from one
of the partners.
Communication with the existing auditor
He has to find out whether continuous audits have been carried out in the
organization, If the internal auditors are appointed he needs to communicate with
them and try to understand how the audits carried on in the previous years
Acceptance of Appointment Order
In the appointment order, there will be a mention of the duties, powers, rights, and
liabilities of the auditor which the auditor has to accept before he starts the audit
work.
• Scope of Audit:
Determine the specific area, process, or system that will be the focus of the audit. This
could be financial statements, internal controls, compliance with regulations,
operational processes, or any other aspect of the organization.
• Knowledge about organization
The auditor should know about the nature of the business, the old and new location of
the business, the names of directors/partners, etc.
• Knowledge of the accounting system
He should completely obtain the list of books and documents maintained in the office,
the accountancy system followed, and accounting records.
• Knowledge of technical details
If the business of the client is technical, he should fully acquaint himself with the
technical nature of the transactions Even though an auditor is not expected to be a
technical expert he should make necessary inquiries from his client about the technical
details of the business.
• Complete list of principal officers
The auditor must obtain the names of the directors/partners and the particulars of the
work controlled by each of them as well as the scope of their authority.
• Observation of the previous audit report
The auditor should obtain the copies of annual accounts of the previous year together
with the auditor’s report. It will enable him to know the state of affairs of the company
during the year.
• Inspect the company documents
MOA, AOA, and Minutes of the meeting of directors and the shareholders in case the
company has to be verified. He should also study the prospectus, underwriting
contracts of debenture deeds, leases, and other important agreements.
 Types of audit

Types of
Audit

1. On the basis 2. On the basis 3. On the basis of 4. On the basis of

of the conduct of specific degree of organizational
of audit objective independence structure

a. Continuous
audit a. Cash audit a. External audit
b. Final audit b. Cost audit b. Internal audit a. Statutory audit
c. Balance sheet c. Management b. Voluntary audit
audit audit c. Government audit
d. Interim audit d. Special audit
e. Partial audit e. Operational audit
f. Occasional f. Performance audit
audit
g. Propriety audit
 ON THE BASIS OF CONDUCT OF AUDIT

Continuous audit
• An audit, where the books of accounts are verified throughout
the year, either at regular or irregular intervals and the
financial statements of the business are examined at the end
of the year.
Advantages Disadvantages

Detection of errors and frauds Very expensive

Moral check Time consuming

Work efficiency Inconvenience

Early presentation Alteration of figures

 PERIODICAL/FINAL/ANNUAL AUDIT
An audit, where the auditor takes up his work of checking the books
of accounts at the end of the accounting period, when the
transactions for the whole year are completely recorded and
financial statements have been prepared.
Advantages Disadvantages

Less expensive Auditor does not get sufficient time to

check all the books of accounts
Less time consuming Auditor does not impose a moral check on
the accounting staff to keep the books of
accounts up-to-date and accurate
Does not cause inconvenience It does not help them in preparing interim
accounts in time
Less scope for alteration of figures Auditor does not get an opportunity to
familiarise himself with all the aspects of
the clients business.
• Complete audit
The auditor is required to check each and every transaction
recorded in the books of accounts. He has to examine each and
every voucher, document or correspondence relating to the
transaction
This type of audit is not possible for large sized organisations.

Partial audit
• It is the kind of audit, where the work of auditor is curtailed. That is
the auditor is asked to check and verify only few books of accounts
for a particular work.
• For instance, auditor may be asked to check only the cashbook to
detect misappropriation of cash. It may be noted that partial audit is
not permitted in case of companies.
 Interim audit
• It is a kind of audit, which is done between the two annual
audits with a view to find out the interim profits.
• It is done for the purpose of declaring interim dividend to the
shareholders.

Advantages Disadvantages
The final audit can be completed very Figures may be altered in the a/c’s,
soon, if there has been an interim audit. which have been already audited

Errors and frauds can be detected easily Increases work of the auditor
and quickly

It imposes a moral check on the staff of It is expensive

the client
• Occasional audit
It is kind of audit which is carried out whenever the clients
desires it and whenever there is need..

• Balance sheet audit

It is a type of audit which concentrates mainly on the
verification of the items in the balance sheet such as capital,
reserves and provisions, profit and loss account balance,
assets and liabilities of business.
 II. ON THE BASIS OF SPECIFIC OBJECT

Cash audit
Cash audit involves the evaluation of all the cash transactions of the
organisation for a given period of time. It is type of audit, under which only the
cash receipts and payments are audited in detail by the auditor along with
vouchers and documents.

Cost audit
Cost audit simply means audit of cost records, it refers to detailed checking and
verification of correctness of cost accounts, costing technique and system. It is
an independent and critical examination of the various records maintained by
the company by the cost auditor to ascertain whether cost of the product
manufactured by the company have been correctly determined in accordance
with the correct costing principles.
Management Audit
• Management audit involves the review of managerial
aspects like organizational objective, policies, procedures,
structure, control and system in order to check the
efficiency or performance of the management over the
activities of the company.
• Performance audit
It is a procedure for analysing the profits and losses of different
economic activities carried on by a business unit , the auditor examines
the growth of the organization in terms of production, sales and
profitability of the organisation. The purpose of this audit is to evaluate
and compare the optimum returns with the amount of capital invested.

• Proprietary audit
It aims at examining the allocation of resources and also ascertaining whether
there is any violation of legal, economic or financial aspects of the
organization. This audit ensures the public money has not been utilized for
the benefit of a particular person or a community.
Special Audit
When the affairs of the company are not being managed, according to
the sound business principles, the central govt is empowered to
appoint a special auditor to audit the company’s working and its state
of affairs. such audit is known as special audit.

Operational Audit
It involves intelligent examination of the various operations of the different
functional areas of business, and observing the weakness, lapses,
inefficiency in operations and suggesting ways for strengthening the
system.
 III. ON THE BASIS OF DEGREE OF INDEPENDENCE OF AN AUDITOR

1.Independent or External audit

• External auditors are independent firms that inspect the accounts of
an entity and render an opinion on whether its statements confirm to
GAAP and present fairly the financial position of the company and the
results of operation.
• The external auditor’s primary obligation is to users of financial
statements outside the organisation.

2.Internal audit
• Internal auditing considers the examination; monitoring and activities
related to a company’s operation, including its business structure,
employee behaviour and information systems.
 IV. ON THE BASIS OF ORGANISATION
STRUCTURE
1. Statutory audit
It refers to the audit of accounts of a business unit compulsorily
under the provisions of a statute or law. It is carried out in joint
stock companies, Banking companies, Insurance companies,
etc.
Features:--
• Compulsory under law
• Independent and complete or full audit
• External audit
• Should be conducted by a qualified auditor
2. Voluntary or Private audit

Where the audit is not compulsory under any statue, but is

undertaken by the owners voluntarily to get the benefits of audit,
such audit is known as private or voluntary audit. It is carried out by
Sole trading concerns, Partnership firms, other individuals.

3. Government audit

It refers to the audit of accounts of government departments and

offices, government companies and statutory corporations.
 AUDIT NOTE

An audit note book is a book, register or diary maintained by

the audit staff during the course of audit for recording his
observations during the course of audit. Like …
The points to be discussed with the senior audit clerk or
auditor,
The points which require further clarifications, explanations,
and investigation.
 The enquiries made and the replies received thereto.
 CONTENTS OF AUDIT NOTE

Generally the following information is incorporated in audit note book:

1. Nature of the business.
2. Organization structure of the enterprise.
3. Names of principal officers, their powers, duties and responsibilities.
4. Instructions from the management regarding the audit. List of
books maintained by the business.
5. The systems of internal check and internal audit in force in the
business.
6. The system of accounting followed in the business.
7. Technical details and terms used in the business.
8. Extracts from minutes and contracts.
9. Provisions of the memorandum and articles of
association affecting the accounts and audit.
10. Extracts from all correspondence entered into with
the bankers, debtors, and creditors.
11. Queries made and replies received.
12. Dates of commencement and completion of audit.
13. Complete record of the exact nature of the work done.
14. Progress of the audit work.
15. Record of suggestions made by the audit staff.
16. Particulars of errors and fraud discovered.
17. Particulars of all documents, vouchers and invoices.
18. Points which are to be discussed with the senior audit clerk or
the auditor.
19. Important points which required further explanations and
clarifications & Points to be included.
20. Notes which may used in audits of future.
• 21. Extracts from various certificates given by the officials and
bankers.
• 22. Totals and balances of important books of accounts already
checked and bank reconciliation statement.
• 23. Particulars of missing vouchers the duplicates of which have
to be obtained.
• 25. A copy of audit program.
 OBJECTIVES OF AUDIT NOTE

Various objectives of Audit Note Book are:

i. To know about the nature of business.
ii. Detection and prevention of frauds and errors effectively.
iii. To make the future audit work easier.
iv. To know the facts where clarification and explanation are essential.
v. To check the list of debtors and creditors.
vi. To present as a proof by the auditor to clearance over the cases.
 ADVANTAGES OF AUDIT NOTE

a) It helps the auditor to have a record of important points which

arise during the course of audit.
b) It is helpful in the preparation of audit report.
c) It is helpful in assessing the efficiency, ability and sincerity of
the audit staff.
d) It can serve as evidence in the court of law, if a suit is filed
against the auditor for negligence of duty.
 DISADVANTAGES OF AUDIT NOTE

a) If it is not prepared carefully and properly, it can not be used in a

court of law as an evidence of negligence on the part of the
auditor.
b) It promotes a fault-finding attitude in the minds of the audit
staff. It may create misunderstanding between the staff of the
client and audit staff.
c) The audit note book is of great importance to the auditor. The
importance of maintaining the audit note book is emphasized by
many case laws.
 AUDIT WORKING PAPERS

• Audit working papers are the written private materials

which an auditor prepares for each audit. They
describe the accounting information which he has
received from his client, the methods of examinations
used, his conclusions and financial statements.
 ESSENTIALS OF WORKING PAPERS

1. The working papers should be prepared in a standard

form i.e. the subject matter should arranged under
various headings and sub-headings.
2. Paper of good quality should be used for working
papers, as they are subject to frequent handling.
3. Paper used should be of uniform and convenient size,
so that the working papers can be filed easily and
properly.
4. The working papers should be quite clear and self explanatory.
5. The information contained in the working papers should be
accurate.
6. The notes made on the working papers should be legible and
neat.
7. The details included in the working papers should be relevant.
Irrelevant details should be avoided.
 FUNCTIONS
i) Helpful in making genuine audit report
ii) Uses as evidence
iii) Direction to auditing procedure
iv) Check the weakness of internal control
 ADVANTAGES OF AUDIT WORKING
PAPERS

1. They provide an evidence to prove the work carried out by

the auditor and to establish the opinion or assertion made
by the auditor.
2. With the help of it, the auditor can co-ordinate and control
the audit work in a better manner.
3. They serve as the basis for the evaluation of the audit
staff. With the help of the working papers, an auditor can
find out whether his audit staff have done their jobs as per
the required standards.
4. They help the auditor to prepare his audit report easily. They
form the basis as regard the opinions or assertions made in
the audit report.
5. They serve as a guide to the auditor in succeeding audits.
6. It provides a training ground to the audit staff as to how to
make the summary of the work done by them.
7. In case of frequent changes of audit staff, the working
papers are of great help to the new staff to complete the
work.
8. They are also useful to the client to know the weaknesses in
the systems of internal check and accounting in force of the
business.
 AUDIT PROGRAM

• An audit program is an essential preliminary to an efficient

audit. Before commencing an audit work, an auditor, generally,
plans his audit work carefully, and prepares an audit program to
carry out his audit work efficiently. Audit program is drawn up
for every individual audit, because, in no two audits, the work is
identical in nature.
 MEANING OF AUDIT PROGRAM

• An Audit program is the auditor's plan of action, specifying the

work to be done, the procedures to be followed for doing the
work, the persons responsible for the completion of the work
and the duration of time within which the work has to be
completed.
 ADVANTAGES OF AUDIT PROGRAM
• 1. Audit work can be started immediately in a systematic
manner once an audit program is made ready.
• 2. It ensures that each part of audit work is completed, and
nothing is omitted.
• 3. It provides guidelines to the audit staff for the performance of
the audit work allotted to them.
• 4. It facilitates proper distribution of works among the audit
staff.
• 5. It facilitates the conduct of audit work by several audit
assistance simultaneously.
• 6. It fixes up responsibilities among the audit staff for any
omission or commission
• 7 It helps the auditor to watch the progress made by the audit
staff in the audit work. It helps the auditor to exercise effective
control over his audit staff.
• 8. It helps to complete the audit work within the scheduled time.
• 9. It helps the auditor in assessing the cost of audit.
• 10. It helps to increase the efficiency of the audit staff.
• 11. It serves as a guide for audit in succeeding years.
 DISADVANTAGES OF AUDIT PROGRAM

• 1.It makes the work of the audit staff stereotyped and mechanical.
• 2. It discourages the initiative and interest of the efficient audit staff,
as they have to simply act according to the audit program and are
not allowed to exercise their own judgment and discretion in the
performance of the audit work.
• 3. As it fixes a time limit for the completion of the audit work, the
work may be hurried up by the audit staff. Consequently, the
efficiency of the audit staff may suffer.
• 4. When there is an Audit Program, there is the danger that the audit
program may be followed from year to year without any alteration.
This will reduce the effectiveness of the audit work
• 5. A rigid audit program is useless.
 PERSONAL QUALITIES | GENERAL QUALITIES OF AN
AUDITOR

• 1. Honesty: An auditor must be honest in his work if he has to carry out his
duties successfully. He has to maintain a good moral standard.
• 2. Tactful: The auditor should be tactful in dealing with the client’s staff.
• 3. Ability to Work Hard: The auditor must have a pain taking attitude and
willingness to work hard.
• 4. Impartial: The auditor should not be influenced by any bias in discharging
his duties. He should be impartial.
• 5. Cautious and Vigilant: An auditor must be vigilant in his work. He should
always proceed with his eyes open and be alert.
• 6. Methodical: He must perform his duties methodically, and should be
thorough, and complete in his work.
• 7. Ability to Trace out Facts and Figures: Auditor should posses a realistic
attitude towards his work. He should be able to trace out facts and figures.
 Always Inquisitive: The auditor should not be suspicious. He
• 8.

should always be inquisitive. He should not adopt an attitude of

suspicion.
• 9. Courage: The auditor should be bold enough to discharge his
duties. He should not certify which he doubts to be genuine.
• 10. Ability to Maintain Secrets: The auditor should have the
ability to maintain secrets and should not disclose the secrets of his
client to anybody.
• 11. Ability to Communicate: An auditor must have the ability to
prepare audit report correctly and forcefully, precisely, concisely,
and clearly.
• 12. Common Sense: An auditor should posses a good common
sense. The auditor should have a full share of the most valuable
commodity – common sense. But common sense is normally very
 PROFESSIONAL QUALITIES

• 1. The auditor must have a complete and thorough knowledge of the

principles, theory and practice of accountancy.
• 2. He should have a thorough knowledge in various legislation
regulating business such as Companies Act, the Indian Partnership
Act, Banking and Insurance Act, Sale of Goods Act, Foreign Exchange
Management Act, the Indian Contract Act, etc.
• 3.The auditor should have a thorough knowledge of the techniques of
auditing. He should be fully aware of new changes and developments
in the principles and practice of auditing.
• 4.In addition to the knowledge of commercial laws, an auditor should
have a thorough knowledge of the various provisions relating to
income tax ,wealth tax, VAT, gift tax, etc.
• The auditor should have knowledge in statistics and mathematics,
which will help him to deal with complicated problems.
• 8. He must study important judgements in audit cases, which will
help him to define the duties, responsibilities, and liabilities of an
auditor.
• 9. An auditor should have a good knowledge in business organization
and financial administration, and industrial management.
 AUDIT PLAN

• Audit planning is a major part of audit work for both internal and
external audits. Good audit planning will help the auditor to
minimize its risks, improve audit efficiency, and meet its
objective at the minimum effort.
• Auditors are required to prepare a proper audit plan to ensure
that all audit risks are identified and correct audit strategies are
deployed to detect all concerning risk areas.
 AUDIT STRATEGY

• Audit strategy is the overall approach

that auditors take to perform the audit
work.
• In this case, auditors need to establish
an overall audit strategy that sets the
scope, timing, and direction of an audit
at the planning stage.
• Auditors usually use the audit strategy
as the basis for preparing the
audit plan that would list the audit
procedures.
 Purpose of Audit Strategy
• The main purpose of the audit strategy is to minimize
the audit risks and to perform the audit in an efficient and
effective manner.
• It allows auditors to determine the number of
resources needed and what level of experience and
expertise is required in the audit work.
 AUDIT ENGAGEMENT

• An audit engagement is an agreement between an auditor and

a client to audit the client’s financial statements and accounting
records.
 AUDIT EVIDENCE
• Audit Evidence is the information that the auditor uses in arriving at
a conclusion on the basis of which he forms his opinion.
• The auditor should obtain sufficient and appropriate evidence which
enables the auditor to arrive at a conclusion and supports his
opinion.
• Evidence collected by the auditor should support the contents of its
audit report.
• Audit evidence includes information provided in books of accounts
as well as information from other sources.
• For Example – Purchase invoice and material received note prepared
by the store’s department are evidence to support the purchase.
ESSENTIALS OF GOOD AUDIT EVIDENCE
Sufficie
nt

Relevan
Reliable
t

Source
 There are some thumb rules which helps in
identifying the appropriateness of evidence
• Written (documentary) evidence is better than testimonial
evidence.
• Evidence from external sources is more reliable.
• Original documents are preferable over their photocopies.
• The auditor should have a good understanding of internal control
of the organization as it enables him to obtain relevant evidence.
• Evidence obtained by auditor through direct observation,
inspection, physical verification, and computations are better
than the evidence obtained indirectly.
 WRITTEN REPRESENTATION

• What is written representation?

A written representation letter is a form letter written by a company's outside
auditor and signed by the management of the client company. The letter
attests to the accuracy of the financial statements supplied by the company
to the auditor, and that all information relevant to the financial statements
has been disclosed to the auditor.