Auditing M.

Pavithra
UNIT – 1
INTRODUCTION TO AUDITING
THE WORD ‘AUDIT’
 Before Industrial Revolution, a businessman himself records the transaction.
Therefore, there was no necessity to check the transaction by another
person. But after Industrial Revolution, volume of transactions increased
hence need to appoint staff for doing business activities as well as the
accounting work was required. Financial transactions are recorded in the
books of accounts. Where accounting ends, auditing starts.
Cont….

 The transactions of public companies have to be checked by a third party as there were
no special staff to check these transactions. The accounts were read before some
impartial and experienced persons, ordinarily ‘Judges’ known as ‘Auditor’. They here
accounts written by accountants and express there opinion about the correctness of
the accounts. Thus the term ‘Auditor’ literally means ‘Hearer’ that is one who hears
the accounts.

 The word ‘Audit’ is derived from the ‘Latin’ word ‘audire’ which means to hear. The
person who does the work of examination of books of accounts is called as an auditor.
Introduction
Meaning

 The word Audit is derived from the latin word “Audire” which means to hear

 Examination of accounts

 It is a scientific examination of books, vouchers and other financial and legal

records in order to verify and report on the facts regarding the financial
condition disclosed by the balance sheet and profit revealed by Profit and
Loss account.
Definition

 “Auditing is an examination of accounting records undertaken with a view to

an establishing whether they correctly and completely reflect the
transactions to which they relate”. – L.R.Dicksee

 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
Difference Between Auditing and Accountancy
Accountancy Auditing
 Concerned with examining the accounts.
 Concerned with preparation of accounts.
 Is an independent person.
 Is an employee.
 Appointed /reappointed at the AGM by the shareholders of
 Appointed by the management.
the company;
 Need not have the knowledge of auditing.
 Be endowed with a thorough knowledge of accounting and
 The work of accountant is influenced and affected auditing.
by the interference of the management.
 Acts independently and his work is free from any
 Maintenance of accounts is inevitable to run a interference.
business.
 Auditing is not inevitable except under certain
circumstances auditing is made compulsory by certain
Statutes like Companies Act, Income Tax Act, etc.
Objective of Auditing
 There are two objectives of Auditing

Objectives

Primary Secondary

Primary Objectives:

 To verify the accounts and statements to confirm their accuracy and ascertain that the
financial statements show a true and fair view of the state of affairs of the concern

 To examine the internal control and internal system

 To check for fraud or errors that could be committed by the employees or the management
Secondary Objectives of Auditing
 Detection and prevention of Errors

 Detection and prevention of Frauds

Errors

Human mistakes made unknowingly in recording, posting or calculating

Types of Errors

 Error of Omission

 Error of Commission

 Error of duplication

 Error of Compensation

 Error of Principle
Frauds and its types

Frauds

Mistakes or false representation of recordings made intentionally for the sake of

owner’s interest.

Types of Fraud

 Misappropriation of Cash

 Misappropriation of Goods

 Manipulation of Accounts
Examples of Fraud under Manipulation of
books of accounts

 Recording fictitious sales

 Omission of sales

 Over valuation of stock

 Undervaluation of stock

 Recording fictitious expenses

Importance Of Auditing
 Helps a sole trader in knowing the value of the business for the purpose of sale.

 Dispute over correctness of profits can be avoided.

 Helps Share holders 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 advise 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.
Cont….

 Taxation authorities depend on audited statements in assessing the income

tax, sales tax and wealth tax liability of 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 are useful.

Scope of Audit
 Systematic review of organization’s activities

 Assessment of performance

 Identifying opportunities for improvements

 Application of new methodology for further actions

The purpose of auditing is to bring to the notice of the administration the drawbacks in the
rules and regulations and lapses and to suggest possible ways and means for the execution of
plans and projects with a greater expedition, efficiency and economy. Scope of auditing is also
related to costing records. It is not only confined to financial records, but also covers:

• Cost audit

• Management audit

• Government audit
Disadvantages of Auditing
 Express only opinion

 No control over past activities

 Opinion cannot be given on managerial efficiency

 Lack of proper care and skill

 Chances of Undisclosed errors and frauds

Types of audit
1. Based on ownership
 Audit of Proprietorship: The owner takes the decision of appointing the auditor and the
auditing work will depend upon the agreement of the audit between the owner and the
auditor.

 Audit of Partnership: In order to avoid misunderstanding between the partners

partnership accounts are audited. Auditor is appointed upon a mutual consent of all
partners with their rights, duties and liabilities defined in the agreement.

 Audit of Companies: The Companies act 2013 mandates joint stock companies to audit
their accounts from a qualified auditor and many amendments have been made in
companies act 1956 and 2013 regarding the powers, duties and liabilities of the auditor.
Cont…..
 Audit of Trusts: The trustees are appointed to manage the property and business of trust.
Income of the trust is distributed to the beneficiaries. The Public trust act and the trust
deed mandates auditing of trust accounts as there are chances of frauds and
misappropriation of incomes.

 Audit of Accounts of Co-operative Societies: Co-operative societies are established under

Cooperative societies act, 1912. The auditor should have a thorough knowledge on the acts
and by-laws of cooperative societies. The registrar of cooperative societies shall audit their
accounts or anyone appointed by the registrar shall audit once in every financial year.

 Government Audit: A separate department is constituted to audit the accounts of

government organisations known as Accounts and Audit department headed by the
Comptroller and Auditor General of India.
Based on Time

 Interim Audit

 Continuous Audit
Advantages of continuous Audit

 Complete checking all of the records:

 Proper planning:
 Early detection of frauds and errors:
 Up-to-data accounts:
 Valuable suggestions:
 Preparations of interim accounts:
Disadvantages of Continuous Audit

 Expensive

 Dislocation of routine work

 Alteration of Figures

 Loosing link in audit work

 Final Audit

 Balance Sheet Audit

Type of Audit based on Objective
 Internal Audit:

It implies the audit of accounts by the staff of the business. Internal audit is an appraisal activity within an
organization for the review of the accounting, financial and other operations as the basis for protective and
constructive service to the management. It is a type of control which functions by measuring and evaluating
effectiveness of other types of control.

 Cost Audit: It is the verification of the correctness of cost accounts, detailed checking of costing system,
techniques and ensure adherence to the costing principles.

 Secretarial Audit: It relates to the verification of compliance to various provisions of companies act by the
companies. It reports on

• Whether the maintenance of books are as per the companies act

• Whether the approvals from the central government, company law board and other authorities were duly
obtained.
Cont…

 Independent Audit:

 Tax Audit:
Audit Planning
Meaning

Planning is required to complete the audit effectively within the specified time. Audit planning is a 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 efficient and effective completion of work.

Audit planning can be done only when, the auditor is having knowledge of the business of the client. It helps in

accomplishment of objectives of audit and enables the auditor to cover different aspects of audit work in a

systematic manner within a time frame. It enhances the quality of audit work.

Contents of Audit Plan:

Audit plans should cover knowledge about client’s accounting system 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
Benefits of Audit Planning

An efficient and effective audit plan provides the following benefits:

 Accomplishment of Objectives

 Identification of problems

 Timely completion of work

 Facilitates coordination

 Better audit work

Factors affecting Audit Planning

 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

 Knowledge of client’s business

Audit Note book
Meaning

 Diary or register maintained by the audit assistants to take note of the errors identified and doubts that has
aroused during the course of work and that needs to be clarified.

 Includes points that is to be given in the audit report

Contents:

 List of books of accounts maintained

 Names, duties and responsibilities of officers

 Particulars of missing vouchers

 Points that needs clarification and explanation

 The that needs to be discussed with the auditor

 Ledger balances and working notes

 Points to be part of auditors report

Audit Working papers
 Working papers are auditors evidence of compliance with generally accepted
auditing standards and of the decision respecting all procedures necessary in
the circumstances unique to the audit engagement.
Objectives of Audit working papers
 Represent the volume of work performed

 Records the extent to which accounting principles and standards are adopted in
preparing the accounts

 Evidence against charge of negligence

 Guide for future examinations

 To know the weakness in the internal check in the operation and accounting system

 Assists in coordinating the work of audit staffs

 Assists planning and performance of audit work.

Qualities of an Auditor
 Only the qualified chartered accountant can be appointed as auditor of a limited company.

 The auditor must have thorough knowledge of principles and practice of all aspects of
accountancy. He must be familiar with all systems of accountancy in use.

 He should have adequate knowledge of financial management, industrial administration and

business organization.

 He must have thorough knowledge of audit case laws as per the various cases decide by the
courts in and outside India.

 He should be able to understand the technical details of business whose accounts he is going
to audit.
Contd…..
 An auditor must be honest i.e. He must certify that he does not believe to be true and he
must take reasonable care and skill before he believes what he certifies is true.

 He must act impartially and not influenced by others, directly or indirectly while
discharging his duties.

 He should be hard working, systematic and methodical.

 He must have capacity to hear arguments of others.

 He should have adequate skills and courage to write audit report correctly clearly and
concisely.

 He should not disclose the secrets of his client.

Qualifications of an Auditor

 A person shall be eligible for the appointment of an auditor of a company only

if he is a chartered accountant.

 Where a firm including a limited liability partnership is appointed as an

auditor of a company, only the partners who are chartered accountants shall
be authorized to act and sign on behalf of firm.
Disqualifications of an Auditor:
The following persons shall not be eligible for the appointment as an auditor of a company

 An officer or employee of the company.

 A person who is a partner, or who is in employment or an officer or employee of the company.

 A person or a firm who, whether directly or indirectly has business relationship with the company,
or subsidiary of such holding company or associate company of such nature as may be prescribed.

 A person whose relative is director or is in the employment of the company as director or key
managerial personnel.

 A person who is in full time employment elsewhere or a person or a partner of a firm holding
appointment as its auditor, if such persons or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than 20 companies
Appointment of Auditor

Appointment of Auditor in case of Sole proprietor

• Appointment done by the owner of the business
Remuneration of an Auditor (sec 142)

 shall be fixed in its general meeting or in such manner as may be determined

therein

 The Remuneration under sub section (1) shall, in addition to the fee payable
to an auditor, include the expenses, if any, incurred by the auditor in
connection with the audit of the facility extended to him but does not include
any remuneration paid to him by any other services rendered by him at the
request of the company.
Removal, Resignation of an Auditor
The Auditor appointed under section 139 may be removed from his office before expiry of his
term

 only by a special resolution of the company after obtaining the previous approval of the
central Government.

The Auditor who resigns from the company

 shall file within a period of thirty from the date of resignation, a statement in a prescribed
form with the company registrar,

 the auditor shall also file such statement with the comptroller and auditor –general
indicating the reasons and other facts as may be relevant with regard to his resignation.
Rights of an Auditor

 Right to Access books of accounts

 Right to obtain the information and explanation

 Right to receive notice

 Right to sign audit report

 Right to seek legal and technical advice

 Right to remuneration
reference

 http://www.brainkart.com/article/Disadvantages-of-Internal-Control_37583/