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While applying both the types of audit procedures, auditor uses different techniques some of
which are part of the audit process. These techniques are called audit techniques. It is important
to note that audit techniques are used during the audit procedures. For example, Vouching is a
procedure where evidence collection techniques like inspection are used. Similarly audit
techniques like totaling, cross-checking the totals, checking the posting of total to another ledger
etc. might be applied by auditor to collect the evidence. Hence audit technique is a part of audit
procedure.
1. Posting –
Posting means:
These days this technique is of no relevance as books of account are computerized and
software automatically transfers accurate figures to ledger etc.
2. Bank reconciliation statement
• It is prepared to find out whether any discrepancy exists in the bank statements obtained
from the bank and the bank account as shown in the books of account. Frauds and errors
like the following can be traced through Bank reconciliation statement:
-Amount might have been transferred from your company’s account to another
account by fraudulent employee of the Bank.
4. Casting
• It is checking of totals of various books of account, if books are kept manually to check
arithmetical accuracy. Now a days, due to the use of computers, this has lost much of
relevance.
• Still one can use the technique of totalling in case of manually prepared bills, vouchers,
invoices etc.
• These are tests to find out whether all the transactions of the period are recorded
(assertion of completeness) and whether only valid transactions have been recorded.
• For example, auditor might obtain the sales invoice file and trace each of them to books
of account. If he finds any invoice not recorded in the books, the assertion of
completeness is not proved. If he finds any future period transaction recorded, the
validity of the transaction is questioned.
6. Surprise Checks
If physical verification or examination is done without prior information to the Management,
it is called as Surprise Check. An element of surprise is experienced by management or the
employee in such cases. Surprise check is used in physical verification of cash, security
items, inventory etc. Surprise check can unearth frauds. Surprise check is also useful in
finding effectiveness and continuity of internal controls.
7. Examination in depth
It means verifying a particular process from beginning to end. For example, the auditor might
start with the quotation stage in case of sales process and trace the flow of transactions till the
customer pays the dues. This type of examination in depth is very useful to find out the
weaknesses in internal control and usually is used as technique in Compliance procedure.
Analytical procedures:
We have studied how this procedure is used as technique in collecting evidence. It is also
treated as audit procedure itself because of its peculiar nature i.e. the analytical feature which
collects evidence not available through other two procedures.
Important to note here is this procedure is not a substitute for Tests of details and need not be
relied upon by auditor at times.
(a) To assist the auditor in planning the nature, timing and extent of other audit procedures;
(b) As substantive procedures when their use can be more effective or efficient than tests of
details in reducing detection risk for specific financial statement assertions;
(c) As an overall review of the financial statements in the final review stage of the audit.
The extent of reliance that the auditor places on the results of analytical review procedures
depends on materiality of the items involved, assessment of inherent and control risks of
businesses.
To identify areas of potential risk and accordingly plan the nature, timing and extent of
his auditing procedures.
(3) For an overall review of the financial information at or near the completion of the audit-
to form an overall opinion about the consistency of the financial information as a whole
with his knowledge of the entity’s business and relevant economic conditions.
The extent of reliance that the auditor places on the results of analytical procedure depends
on the following factors:
• For example, when inventory balances are material, the auditor does not rely only on
analytical procedures in forming conclusions. However, the auditor may rely solely on
analytical procedures for certain income and expense items when they are not
individually material;
(b) Other audit procedures directed towards the same audit objectives
• For example, other procedures performed by the auditor in reviewing the recoverability
of accounts receivable, such as the review of subsequent cash receipts, might confirm or
dispel questions raised from the application of analytical procedures to an aging schedule
of customer’s accounts;
(c) Accuracy with which the expected results of analytical procedures can be predicted
• For example, the auditor will ordinarily expect greater consistency in comparing gross
profit margins from one period to another than in comparing discretionary expenses, such
as research or advertising.
• For example, if internal control over sales order processing is weak and, therefore,
control risk is high, more reliance on tests of details of transactions and balances than on
analytical procedures in drawing conclusions on receivables may be required.
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2. Describe the responsibility of the management and auditors for
the frauds and errors committed.
The primary responsibility for the prevention and detection of fraud and error rests with
the management of an entity. The respective responsibilities of management may vary
from entity to entity. Certain areas where management is responsible are:
o To set the proper tone, create and maintain a culture of honesty and high ethics,
o To establish appropriate controls to prevent and detect fraud and error within the
entity.
o To see that the integrity of an entity’s accounting and financial reporting systems.
o To see that appropriate controls are in place, including those for monitoring risk,
financial control and compliance with the laws and regulations.
o To establish a control environment and maintain policies and procedures to assist
in achieving the objective of ensuring, as far as possible, the orderly and efficient
conduct of the entity’s business.
o To implement and ensure the continued operation of accounting and internal
control systems, which are designed to prevent and detect fraud and error.
2. Responsibility of auditors
Internal Auditors are also responsible for frauds and errors in that they have to check for
their existence and suggest better internal controls.
External auditors though not primarily responsible to detect frauds and errors, are still
responsible to take care to verify the strength of internal control to prevent and detect
frauds, existence of symptoms of fraud. Hence indirectly they are also responsible for
controlling frauds.
Thus it is important to note here that internal controls are very important in detecting
frauds and errors of any kind. Those who are establishing internal controls should have
sufficient knowledge of different types of frauds or symptoms frauds that might occur in
particular business.
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3. Go through the following case and give your analysis of the situations with respect to
Satyam debacle.
Ans: See story of Satyam chief quits, admits faking financial results:
Customers are going to do rigorous due diligence and risk management analysis of their
offshore suppliers, said John C. McCarthy, vice president and principal analyst at Forrester
Research. Companies that are likely to come under the closest scrutiny are family-run and
midsized suppliers, McCarthy added.
The company ran into opposition from investors in December when it announced plans to
acquire two construction companies in which Ramalinga Raju's family have a considerable
stake.
Customers are going to be more careful in evaluating their suppliers, but this is not going to
turn into a backlash against Indian outsourcers, said Kapil Dev Singh, country manager at
IDC India. One case like Satyam will not make all Indian outsourcers lose the credibility
that they have built over the years, he added.
IDC India, however, warned that the fast growth pace in the outsourcing industry may
bring distortions that need to be checked. Companies have to balance growth with financial
discipline, Singh added.
India's National Association of Software and Service Companies (Nasscom) was quick to
distance itself from Satyam, although Ramalinga Raju was a former chairman of the
association. "This is a stand-alone case of failure of corporate governance and it is critical
that it be viewed in this light," Nasscom said in a statement on Wednesday.
While the law will take its course, this incident is particularly unfortunate as the Indian IT-
BPO industry had set very high standards of ethics and corporate governance, Nasscom
added.
Satyam's troubles are likely to be an opportunity for other Indian outsourcers who will now
make a pitch for Satyam's customers, said Forrester's McCarthy.
Customers will not switch business overnight, but they will start asking around, particularly
as there are other vendors in India that can offer similar services, he added.
The key issue for Satyam's customers will be the real financial position of the company.
"[Satyam] is running a lot of people's SAP systems, and customers can't watch and let them
flop around until they die a slow death," McCarthy said.
In the run-up to Raju's disclosure of the tampering with the company's accounts, there were
a number of reports that Satyam would be a takeover target. Forrester, for example, said
last week that there would be management and governance changes and even potentially
the outright sale of the company.
That could take time now, as any investor would be nervous about how much the
company's books have been fiddled with, McCarthy said.
India's securities regulator, Securities and Exchange Board of India has ordered an
investigation into the Satyam episode.
The revelation this week of major financial fraud at leading Indian IT company Satyam
Computer, has been characterized as India’s Enron and prompted dire warnings it will
inflict serious damage to the country’s surging IT sector and its portfolio of international
companies who have outsourced business processes to it. Both assessments have merit.
There will be short-term damage. Foreign investors who may have bought in to Satyam via
its listing on the New York high-technology exchange NASDAQ, will certainly be worried.
But in the long-term, far from being a disaster, the Satyam debacle may prove a watershed
that will bring better corporate governance and as well as regulatory oversight to Indian
companies. No market has ever grown up without scandal. Satyam inflated revenues almost
certainly because, though billed as India’s fourth largest IT company, its management was
simply unable to keep up with the stellar growth of rivals. Rather than admit failure, they
fixed the figures.
This is, therefore, a wake-up call. It is as N.R. Narayan Murthy, founder of Satyam’s larger
rival Infosys, says undoubtedly a failure of corporate governance. Business history has
demonstrated that in boom times when companies are growing fast, prudential controls and
proper regulatory compliance can fall by the wayside. No doubt disgraced Satyam
Chairman Ramalinga Raju, who has admitted the irregularities, hoped new business would
be won that would in the end allow the gaping hole in the accounts to be filled. But with the
international downturn came an end to strong new business flows and thus nemesis. The
only point to Raju’s credit is that he has admitted the fraud and said he is prepared to take
the consequences.
But it is not just the standards of corporate governance that need to be tightened, perhaps
even to the exacting levels of the US Sarbanes-Oxley legislation. The Satyam fraud took
place over a number of years, yet neither independent auditors, nor regulators spotted what
was happening. Neither can escape responsibility for what has occurred. Since unlike most
of Enron’s cheating bosses, Raju has admitted his guilt, the opportunity exists both at his
trial and at the independent enquiry that must also be held, to discover how auditors and
regulators were fooled and failed to spot years of financial irregularity.
There must be no attempt to save reputations in this investigation. A lot of people clearly
got it wrong, through ineptitude, inadequate monitoring processes or perhaps even criminal
complicity. While it is right that some individuals should pay with their jobs, it is more
important that the lessons be learned and every effort made to ensure that there would not
be another Satyam. It may even be that inadequate auditing and regulation has permitted
other companies to report false figures. These too should be exposed. There should be no
cover-ups. The greatest danger to Indian companies, not merely in the vibrant IT sector,
comes not from the unmasking of Satyam’s fraud but from any failure to deal robustly with
all the shortcomings that allowed it to happen.
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ASSIGNMENT
MBA –III SEMESTER
INTERNAL AUDIT AND CONTROL
CODE: MF 0004 – CREDITS 2
MAXIMUM MARKS: 30
Set 2
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Internal control for cash and bank transactions has been provided here by categorizing them
according to important features of internal controls discussed in Unit 1 (Section 1.5). This is also
one useful way to set up internal controls and also to evaluate them. Students are advised to
frame internal control measures in this way as to various functions of a business.
-Expenses should not be paid out of cash collected but separate cheques are to be drawn
for payment of expenses.
-IOUs (taking of money from the cash box for emergencies by employees) should not to
be allowed.
5. Supervisory controls
7. Accounting controls
8. Physical Controls
Objectives:
4. Organizing of Cash payment function like place where the payment is made, cash
counter, safe lockers etc are to be decided.
Bank Transactions:
Note: If the answers to most of the questions in this ICQ are ‘No’, it can be concluded that there
is weakness in internal control as to bank transactions. For example, for Q.9 if the answer is ‘no’
it can be concluded that the Assets like Bank Deposits are not safeguarded by the Management
and hence chances of loss of certificate etc are more.
Similarly the ICQ also provides a clue to what should be feature of internal control for a
particular area. For example Questions No 1,3 and 6 are aimed at finding out whether
Segregation of duties , an important feature of internal control is effectively used in bank
transactions.
The students can find out the underlying features of internal control in each of the questions in
the above ICQ and also in any other ICQs, in a similar manner.
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2. What is internal audit? Who can undertake internal audit in India?
Can the spouse of a CEO of a company be its statutory auditor?
Explain the conditions.
Ans: Internal Audit is undertaken mainly on behalf of Management. The auditor is appointed
by the management .The objective may be prevention and detection of fraud or error, compliance
of laws, safeguarding of assets or even achieving effectiveness or efficiency in managing the
organization through better internal control . Internal audit is a review of the operations and
records, most of the times continuously undertaken, within a business by specially assigned staff.
“Internal audit is an independent management function, which involves continuous and critical
appraisal of the functioning of an entity with a view to suggest improvements thereto and add
value to and strengthen the overall governance mechanism of the entity, including the entity’s
risk management and internal control system. ” – ICAI definition on internal audit.
“Internal auditing is an independent, objective assurance and consulting activity designed to add
value and improve an organization’s operations. It helps an organization accomplish its
objectives by bringing a systematic, disciplined approach to evaluate and improve the
effectiveness of risk management, control, and governance processes.”- Definition by Institute of
Internal Auditors of USA.
2. It is continuous activity.
3. Internal auditor provides suggestions for improvement on various matters relating to operations,
risk management, internal control system, financial reporting etc.
4. It is a combination of a consulting and assurance activity. 5. Internal audit should add value to
the organization i.e. to achieve maximum organizational effectiveness.
6. Its scope is changing from purely financial function to include nonfinancial activities.
7. Though it is an independent function it is part of management function.
Internal check is “check on day to day transactions which operate continuously as a part of the
routine system whereby the work of a person is proved independently or is complementary to the
work of another, the object being the prevention or early detection of errors or frauds”
The essential elements in an internal check are:
If the spouse of CEO of a Company is its auditor, the stakeholders might not fully rely on the
audited statements even though the spouse may have acted independently during audit.
(b) Scope of Function The external auditor should ascertain the nature and depth of
coverage of the assignment which the internal auditor discharges for management. He
should also ascertain to what extent the management considers, and where appropriate,
acts upon internal audit recommendations.
(c) Technical Competence The external auditor should ascertain that internal audit work is
performed by persons having adequate technical training and proficiency. This may be
accomplished by reviewing the experience and professional qualifications of the persons
undertaking the internal audit work.
(d) Due Professional Care. o The external auditor should ascertain whether internal audit work
appears to be properly planned, supervised, reviewed and documented. An example of the
exercise of due professional care by the internal auditor is the existence of adequate audit
manuals, audit programmes, and working papers.
• Evaluating Specific Internal Audit Work o Where the external auditor intends to rely upon
specific internal audit work as a basis for modifying the nature, timing and extent of his rocedures,
he should review the internal auditor's work, taking into account the following factors :
The scope of work and related audit programmes are adequate for the external auditor's
purpose.
The work was properly planned and the work of assistants was properly supervised, reviewed,
and documented.
Sufficient appropriate evidence was obtained to afford a reasonable basis for the conclusions
reached.
Conclusions reached are appropriate in the circumstances and any reports prepared are
consistent with the results of the work performance
Any exceptions or unusual matters disclosed by the internal auditor's procedures have been
properly resolved.
The external auditor should document his conclusions in respect of the specific work which he
has reviewed.
Thus the internal audit is being conducted more out of necessity than out of legal requirement or
to comply with the laws.
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3. From the following case of the accounting standards, as appeared in the Hindu Business
Line, on 30th April, 2007, State what are the implications of adopting International
Accounting Standards with regard to corporate.
Ans: Accounting Standards:
Globalization of business has led to complex business transactions. Accountancy is the language
of business. Hence if this language is misunderstood or misinterpreted lot of harm can be done to
all stakeholders. Thus it is necessary that the financial reporting process is properly regulated.
Hence standardization of accounting principles and policies is necessary while presenting
financial statements to a stakeholder who might be in different part of the world than where the
business is situated.
Accounting Standards are written policy documents issued by expert accounting bodies or
by Government or other regulatory bodies.
Accounting Standards are those principles, concepts or conventions which have been codified by
the “accounting and auditing practice regulation authorities” of a nation or by internationally
constituted accounting or auditing bodies.
The International Financial Reporting Standards (IFRSs) are a new set of Accounting Standards
issued by the International Accounting Standards Board (IASB).
All these Accounting Standards ultimately deal with a specific accounting transaction, issue or
event and stipulate how this issue, event, transaction or item is to be dealt or presented in the
books of account or financial statements.
Most of the Accounting Standards issued by these bodies have become benchmarks or
mandatory.
For example, if an Indian company or a bank transacts in various countries it is not sufficient that
it complies the Accounting Standards or GAAPs of India. It has to comply with international
accounting standards and sometimes the accounting standards of a country in which it operates,
say US GAAPs.
Thus there is every need to know more about know the global accounting standards and GAAPs
of various countries in these days of globalization.
There have been major changes in financial reporting in India since the
economic reforms and globalization began in the early 1990s. Among others,
the following forces are important-
In the last decade, there have been significant changes to Indian laws and regulatory
requirements relating to accounting and governance. The major developments are briefly as
follows:
• It is the premier institute of India, set up under an act of parliament and has been
empowered to regulate accounting and audit profession in India.
• Its members, popularly called as Chartered Accountants, are qualified to undertake audit
of companies in India as well as to provide many audit services like Tax audits under
Income Tax Act 1961.
• In India ICAI has been issuing Accounting Standards based on International Accounting
Standards since the beginning. India started issuing Accounting Standards in 1977. So far
it has issued 29 Accounting Standards.
• Even earlier to that, ICAI had been issuing Guidance Notes and providing Expert
Opinions to its members regarding complex accounting matters where no standards exist.
• The accounting standards issued by ICAI have been adopted by the Government and the
Department of Company Affairs has stipulated that these Accounting Standards are
required to be complied by Companies in India in the preparation of financial statements.
• The ICAI also has directed its members to report on the non-compliance of these
standards in the companies that are being audited by them.
b) National Advisory Committee on Accounting Standards:
In 1999, the Companies Act, 1956 was amended to provide for setting up a National Advisory
Committee on Accounting Standards (NACAS) to advise the Government on the formulation of
Accounting Standards.
ICAI has been issuing Accounting Standards since 1977. These Standards though not an exact
copy of International Accounting Standards, are similar to IAS in many cases. Though these
standards were only 15 till year 2001, between 2001 and 2005 14 new standards have been
issued in the post-Enron era.
Indian business has gone global in a big way in recent years, which is clearly reflected in more
companies setting up overseas arms, raising money from the market and acquiring companies.
The coming years will only see an increase in the number of companies getting more globalised
in their operations. In such a scenario, there is a pressing need for adoption of global Accounting
Standards (AS), says Mr R. Narayanaswamy, Professor of Finance and Control at IIM-
Bangalore.
Speaking to Business Line on the wide-ranging implications of adopting global AS and how it
can benefit corporates and the country as a whole, he urges the shift towards these standards as
they have "wide international recognition because of their quality, coverage and acceptability.
Indian companies can communicate cost-effectively with the rest of the world if their financial
statements comply with global standards."
According to him, investors — especially from overseas — customers, suppliers and employees
will then have more faith in the numbers that the companies churn out. Other benefits include
lower cost of raising equity and debt capital, greater liquidity for shares and lower bid-ask
spreads. "All of these result from reduced information asymmetry between managers and
outsiders."
Global Standards
Currently, the standards and other pronouncements issued by the IASB and FASB are the two
systems that are competing for this status. Would such a move entail dismantling of national AS
structures such as the ASB of the ICAI? Mr Narayanaswamy, a PhD in Accounting from the
University of New South Wales, Sydney, clarifies that a country that adopts international
standards examines them for conformity with national laws and practices. "We would still need a
national accounting standard-setter with superior technical and financial resources."
He cites the example of the Australian Accounting Standards Board, which continues to exist
and play an important role, though Australia has adopted IAS/IFRS. There are no international
standards that do not apply to India, he adds. On the Indian system of AS generation, which
involves authorities and organisations such as the RBI, the SEBI, the ICAI and the CBDT, the
biggest problem is multiplicity, "which happened mainly because the accountants were slow and
lukewarm in their response. For a long time, I have been making a case for an independent
accounting standards body with full-time members."
After all, accounting is too serious a matter to entrust to accountants, he quips.
No Monitoring
On a more serious note, Mr Narayanaswamy, a member of the ICAI, the ICWAI and the ICSI,
expresses concern that there is little effective monitoring of reporting entities following the
mandatory AS.
"I doubt if anyone is monitoring compliance. Both the SEBI and the MCA do not have the kind
of technical staff they need. This is a task that the ICAI cannot do satisfactorily, because there
are obvious conflicts."
According to him, the Securities Exchange Commission (of the US) provides an excellent model
for high-quality monitoring of all corporate filings. In the UK, the Financial Reporting Review
Panel raises important questions and in many instances gets the statements amended. These are
worthy of emulation, he adds.
On the gaps in Indian GAAP, and how they can be plugged, he says: "We do not have a set of
Indian standards dealing with financial instruments, but the exposure drafts have been out for a
while. There is no standard on business combinations; the one that we have — AS 14 — deals
only with amalgamation, but businesses largely come together by means of inter-company
investments."
According to him, some of our standards are "very much out of date and need to be reworked,"
especially those relating to revenue recognition, leases and presentation of financial statements.
To most readers of annual reports, AS references may be abstruse. So, how does a company go
about effectively communicating to the business reader the effect accounting standards have on
reported financial performance?
"The lay reader needs assurance that managers prepare financial statements faithfully in
accordance with high-quality AS and the company's auditors are satisfied with the statements."
But, increasingly, standards seem to getting more complex and addressing the needs of
professional analysts and investors more than shareholders. "This is because business
transactions are getting more complex."
He adds: "For example, to be able to understand the standards on financial instruments, stock
options, pensions or segments, the reader should have a good knowledge of business and
financial operations. However, management should make its point in plain English."
Mr Narayanaswamy is all for accountants understanding how business organisations work.
"Accounting follows business. So, it would be useful for accountants to understand how new
products are developed, how projects are managed, what drives M&As, how tax planning relates
to business planning, or how risk is managed using financial instruments such as derivatives."
According to him, providing comparisons with other jurisdictions, and then explaining reasons
for any differences in AS, is another way of igniting interest in standards. Another "appealing
method" is using published annual reports and media reports to illustrate the difference between
good and bad accounting.
Can changes in the law give AS a boost? "A simple way would be to empower shareholders by
allowing private shareholder litigation against company management and auditors. As the
company and securities laws stand now, only the company can sue its managers and auditors for
damages for their failure to show due care and diligence in their work, " says Mr
Narayanaswamy whose current research interests include corporate disclosure policy, earnings
management and strategic cost management.
Since shareholders cannot sue even though they are the real losers in company failures, he wants
them to be allowed to take care of their interests. "That would be a major step forward, though I
am not for class action suits at the moment."
Equally important is strengthening the corporate governance system, especially independent
directors and audit committees, improving audit quality and independence, and reforming the
legal regime.
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