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AUDITING: INTRODUCTION
Evolution
The word „Audit‟ is derived from the Latin word „Audire‟ i.e. to hear.

Early developments in India

1. The Joint Companies Act, 1857 – provided for optional annual audit.
2. The Companies Act, 1913 – provided for compulsory audit by GDA (Government
Diploma in Accountancy) holders.

Post-independence developments in India

1. The Chartered Accountant Act 1949 was enacted.
2. The Institute of Chartered Accountants of India was established under this act.
3. The Companies Act, 1956 – provided for compulsory audit by an independent qualified
person.

Meaning / Important features

Auditing is
1. Critical examination of books, statements
2. By an independent qualified person
3. On the basis of proper evidence
4. To express his opinion / as to the truth and fairness / of assertions in statements and
financial accounts.
Book keeping, Accounting and Auditing
a. Book keeping includes
1. Recording the financial transactions in subsidiary books viz. Cash book, Purchase book,
sales book, journal, etc.
2. Posting from subsidiary books to main books (ledger).
3. Totaling and balancing of books and accounts.
b. Accounting includes
1. Checking the book-keeper‟s work
2. Preparing Trial Balance
3. Passing rectification and adjustment entries
4. Preparing final accounts
c. Auditing is critical examination of books and statements
Basis of Difference Accounting Auditing
01. Concerned with Collection, Classification, Analytical and critical
Summarization & Commu examination of books and
-nication of financial data statements
02. Purpose Measures Profit/Loss and Comment upon the validity of
financial soundness measurement
03. Person Employee Independent
04. Remuneration Fixed by Management By members in AGM
05. Period of appointment Regular appointment Year to year appointed
06. Knowledge Not specific Specific e.g. C.A.
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07. Report No To submit to members
08. Appointment Employers By shareholders in AGM
09. Starting It starts where book Its starts where accounting ends
keeping ends
10 Nature of Work Constructive Analytical
Audit Theory: AAS -1
Audit Postulates → Audit Principles / Concepts → (AASs) Audit Standards → Audit
Procedures (Act to be performed) → Audit & Assurance Techniques (method used)

Postulate Concepts / Principles SA

1. Conflict of Interest between Skill & Competence 200
auditor and prepares
2. Act only as auditor Integrity, Objectivity and 200, 220, 240
while giving opinion Independence
3. Adhere to professional Confidentiality 230
obligations
Work Performed by 200, 299, 600
others 610, 620

4. Financial data is verifiable Documentation 240

5. Past will hold True for Audit Planning 210, 300
future also
Audit Evidence 320, 500, 501,
505, 520, 530,
580

6. Satisfactory system of Internal Existence of reliable 400, 401

Control increase reliability Internal Control System

7. Fair Presentation Audit Conclusions 700,

SRC 4410
Audit Report SRS 4400
SRE 2400

DIFFERENCE BETWEEN AUDIT STANDARD AND AUDIT PROCEDURES

Basic Audit Standard Audit Procedures
(i) Meaning A guideline An act to do.
(ii) Applicability Uniform for all type of Vary from Organisation to
organization organization
(iii) Continuity Same unless notified Change over time i.e.
different in Mannual
accounting and computerized
accounting

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DIFFERENCE BETWEEN AUDIT PRINCIPLES AND AUDIT TECHNIQUES
Basic Audit Principles Audit Techniques
(i) Meaning Basic framework Different methods used
(ii) Application Universal Vary according to situation

AUDITING: OBJECTIVES

Main Object Subsidiary Object

Verification of Accounts and I. Detection and Prevention of
Financial statements with a view TO Frauds
FORM AN OPINION
01. Examine the system of Internal a. Embezzlement or Misappropriation
Check of cash
02. Check arithmetical accuracy b. Misappropriation of goods
03. Verify the authenticity and validity of c. Falsification of accounts
transactions with supporting evidence
04. Ascertain whether proper distinction II. Detection and Prevention of
between Capital and Revenue made Errors
05. Confirm existence and ascertain a. Error of omission
values of Assets and Liabilities
06. Verify if all statutory requirements b. Error of commission
complied with
c. Error of duplication
d. Compensating errors
e. Error of principal
By doing above auditor is able to f. Procedural errors
form an opinion on the truth and
fairness of accounts and statements

Auditing and Assurance Standard (AAS) 4 Revised

“The Auditor’s responsibility to consider Frauds & Errors in an audit of financial
statements”
1. Prevention / detection of errors / frauds is responsibility of Management.
Implementation & Continuous operation of an adequate internal control system can
reduce, not eliminate possibility of errors / frauds.
2. Audit is examination of books and statements to detect material mis-statement.
3. Planning and performance of audit should be done with assumption of existence of
errors and frauds.
4. Risk of error & fraud is increased, if:
a. Internal Control System is weak
b. Integrity and Competence of Management is doubtful
c. Unusual internal pressure e.g. paucity of working capital, need of rising trend of
profit
d. Unusual transaction at the year-end
e. Problem in obtaining sufficient evidences
5. Fraud:
- Suspicion of fraud – information management
- Confirmed fraud – disclose in report
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 - Suspicion is not confirmed –due as per accepted accounting standards
- Unable to complete the engagement – take legal advice
- Subsequent discovery – not liable
6. How auditor can avoid responsibility for subsequent discovery of Error/fraud:
a. He should adhere to basic principles of audit
i. Work with requisite skill and competence
Contd…2
(2)
ii. Proper documentation of important matters
iii. Audit consistent with internal control system
7. Modify / Replace existing procedure to reduce the (re) occurrence of errors & frauds
(suspected)Confirmed errors should be corrected; fraud should be duly reflected in
books

DIFFERENCE BETWEEN ERROR AND FRAUD

Basis Error Fraud
(i) Meaning (i) Error is an unintentional (i) Fraud refers to
mistake in the measurement intentional misstatements
or presentation of financial which is material to
information financial statements
(ii) Intent Error is unintentional (ii) Fraud is committed with
an intention to derive some
personal gain
(iii) Object of Gain (iii) No (iii)Yes, personal gains to
employee in case of fraud
by employees; manipulation
of financial results is gain to
Management.
(iv) Possibility of detection (iv) More (iv) Less: Management
makes deliberate attempts
to conceal it.
(v) Auditors duty (v) Rectification (v) Disclosure

AUDITOR IS A WATCHDOG, NOT A BLOOD-HOUND (Auditor’s Duty)

Auditor is a watchdog, which means he has to look after the interests of those who are the
owners of the business. He should make every effort to protect interests of his clients by
detecting errors and frauds. He should conduct all this honestly and tactfully.
Duty of auditor is not as that of bloodhound. He is fully justified in believing the tried servants
of the company and is entitled to rely upon their representation, provided he takes reasonable
care. He is not supposed to cause any harm to the persons whose work he has to certify.

Case Laws:
Kingston Cotton Mills Co. (1896)
Westminster road construction and Engineering Co. (1932)
Hedley Byrne and Co. Ltd. V. Heller and Partners Co. Ltd. (1963)
Capro‟s (1990)

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 AUDIT PROGRAMME
AUDIT PROGRAMME
Meaning
It is a written scheme of the exact details of the work to be done by the auditor and his staff
in connection with a particular audit. Before commencing the audit the auditor outlines the
whole procedure from the preliminary stage till the finalization of audit report and his signature
thereon.

Features
1. Set of procedures
2. Invariably in black and white
3. Auditor‟s plan of action
4. Distributes work among the audit staff
5. Helps in completing work within time
6. Avoids duplication

Contents
1. Name of the company
2. Nature of company‟s work
3. Date of commencement of audit
4. Tentative period of audit exercise
5. Review of internal check system
6. Accounting System followed by the company
7. Preparation of audit report
8. Instructions by last year‟s auditor in his audit report
9. Period wise detail of checking of Sub Books, Ledger etc. – By whom

Limitations
1. Work may become too mechanical
2. Loss of initiative by an audit assistant
3. An audit programme may not be rigid

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 AUDIT NOTEBOOK
Meaning
It refers to record of information gathered or experienced prior to or during the course of an
audit
While conducting an audit, the audit staff comes across certain points which requires further
clarification, explanation and investigation, he records the same in a diary maintained for the
purpose known as audit notebook

Contents
1. Audit programme
2. Review notes – points needing further explanations
3. Audit queries
4. Important balances e.g. Cash and Bank
5. Extracts from documents – Memorandum, Articles, Agreements, Contracts, Minutes of
various meetings
6. Accounting Statistics – number of vouchers and entries for each page in the books. It helps
in knowing whether the staff is wasting time and also for an increase in auditor‟s fees

Advantages
1. Records all significant matters
2. Ensures uniformity
3. Helps in knowing the extent of work completed
4. Source of information i.e. points to remember
5. Facilitates finalization of audit report
6. Helps in tracing deviations from the audit programme
7. Easily alterable
8. Helps in judging the efficiency of staff
9. Helps an auditor to prove that he has not worked negligently

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 INTERNAL CHECK / INTERNAL AUDIT / INTERNAL CONTROL

Internal Check

Meaning Check imposed on the day-to-day transactions, where by the work of one
person is automatically and independently checked by another person
Object 1. Prevention and early detection of Errors & Frauds
2. To ensure accuracy
Process 1. Division of labour
2. Allocation of authority
3. Proper method of recording
Care 4. One clerk does not perform single task from beginning to end.

Internal Audit

Meaning 1. Continuous Review / Appraisal

2. Of work, operation and records of firm
3. By a separate staff called Internal Auditors
Object 1. To prevent or minimise the possibilities of errors, frauds and irregularities
2. To assure management that Internal Check System is effective
Process 1. Scope of Internal Audit to be decided by management
2. Skilled staff appointed
3. Regular review and reporting to management

Internal control

Meaning 1. It includes Internal Check and Internal Audit

2. It also includes Financial and Administrative Control
Object 1. Objects of Internal Check
\ 2. Objects of Internal Audit
3. Financial Control
a. For safeguarding assets, and
b. For reliabilities of records e.g. Standard Costing, Budgetary
Control, Self Balancing Ledger, and Bank Reconciliation Statement.
4. Administrative Control
a. For operational efficiency
b. For Management‟s authorisation of transaction e.g. Time and
Motion Study, Performance Report and Quality Control
Process 1. Plan of Organization – providing for appropriate division of
responsibilities: Operational & Record Keeping, Custody and Accounting of
Assets
2. Proper system of written authorisation – General and Specific, and
Record Procedure to provide reasonable control over
Assets/Liabilities/Expenses/Income
3. Sound Practices of Administration – to help in avoiding questions,
discourage shift of responsibility
4. Competent and Trustworthy Personnel
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 Contd…2

(2)
Difference Between

Basis Internal Check Internal Audit

1. Meaning Integral part of routine Independent appraisal
2. Object Prevent Error / Fraud Detect Error / Fraud
3. Staff No separate staff Separate staff needed
4. Nature of work Continuous activity Post-mortem
5. Timing During course of transaction After work is over
6. Device To do work To check work
7. Function Line Function Staff Function
8. Orientation Procedure Oriental Control Oriental

Difference Between

Basic Internal Check Internal Control

1. Meaning Check imposed on day-to-day It includes Internal Check and
transaction, so that work of Internal Audit and other forms
one is automatically and of Financial and Administra-
independently checked by tive Control
other
2. Wider term Does not include Internal Includes Internal Check
Control
3. Object To prevent and early detection
To safeguard assets of
of Error and Frauds company against losses and
avoid Fraud, Error, Waste,
Inefficiency
4. Process Involves division of labour, Involve plan of organisation,
allocation of authority and proper system of written
proper recording authorisation, sound practice
of Administration and trust
worthy Personnel

Can Auditor Rely on a system of Internal Check - Extent?

1. Yes, auditor can rely upon system of Internal Check
2. If efficient system of Internal Check- he can rely more.
3. What is efficient system: a. Soundness of system of Internal Check
b. The manner in which it is carried out.
4. How to check effectiveness: - Few test checks
5. If
a. Either no system of Internal
Check Auditor has to carry detailed
checking of all transactions
b. Or after test check, Internal
Check System is found 9
defective
Important: Effective systems of Internal Check reduces work not responsibility.
Contd…3
(3)

INTERNAL CHECK SYSTEM FOR WAGES

Through such a system, effort should be made both to detect as well as to prevent such errors
and frauds. Such a system has basically the following objectives:
 Avoiding the inclusion of dummy workers in the wage list.
 Payment of wages for only the right work due to the right worker.
 Record all deductions properly.
 Avoid fraudulent manipulation of the undistributed or unclaimed wages, if any.
For this system of Internal Check following recommendations are made:
 Maintaining proper Time Records, even including overtime records if any.
 Maintaining proper Piecework records if wages are to be paid on Piece Work Basis.
 Preparation of wage sheet. This work should be done by more than one person. Separate
wage sheets should be prepared for Time Workers and Piece Workers. Wage sheets should
be checked by properly authorised officers and should also be signed by them thus
according their approval to them.
Wage payment also should be done under the supervision of some responsible officers. Wage payments, if through
cash, should be against proper identification of the worker. Special care must be taken regarding absent and casual
workers.

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 Classification Of Audit

Classification Of Audit

On the basis of organisational structure On the basis of conduct of audit

Private Audit Government Audit Internal Audit Statutory/ Compulsory Audit

-- No -- No

Audit of Audit of Audit of Audit of Institution

Sole Traders Partnership Firms Individuals clubs etc.

Statutory Co-operative Trust Audit Banking Insurance Electricity

Company Society Audit Company Company company
Audit Audit Audit audit

Continuous Audit

Annual or Periodical Audit

Partial Audit

Balance Sheet Audit

Cost Audit

Management Audit

Operational Audit

Interim Audit

Cash Audit
__
Tax Audit

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 Contd…2
(2)

CLASSIFICATION OF AUDIT

1. ON THE BASIS OF ORGANISATIONAL STRUCTURE

(A) Private Audit

(i) Audit of Sole Trader: - The owner himself takes the decision to get the
accounts audited. Auditing work will depend upon the agreement of audit and
the specific instructions given by the proprietor. It will be safe for auditor to
get the agreement in writing.

(ii) Audit of Partnership Firm: - Auditors are appointed by the mutual consent
of all the partners. Rights, duties and liabilities of the auditor are defined in
the mutual agreement and can be modified by the partners. It will be in the
interest of auditors to get in writing the nature and scope of his work, to avoid
any dispute later on and must refer to the deed of partnership. In the absence
of partnership deed or any term which is not defined in the deed, the auditor
may refer to the „Partnership Act 1932‟.

(iii) Audit of Individual: - Auditor‟s scope of work will depend upon the
agreement with his client.

(iv) Audit of other institutions not covered by any law: - Auditors are
appointed by the governing bodies. Audited accounts are helpful in getting
grants and other aids from such authorities.

(B) Government Audit

Government Departments Statutory Government

Corporation Companies

(i) Audit of Government Departments

1. Article 149 of constitution empowers the Comptroller and Auditor General to
perform duties and exercise power
2. Duties / power of C & AG specified under the comptroller & Auditor General
(Duties, Power and conditions of service) Act – 1971.
3. Article – 150: C & AG, besides exercising audit control, also to prescribe the
form in which accounts to be maintained by union / state etc.
4. Article – 151: The report of C & AG relating to accounts of

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 UNION: -
- To be submitted by union president.
- Lay before each house of parliament.

STATE: -
- To be submitted to Governors.
- Lay before state Legislature. Contd…3
(3)

(ii) Audit of Statutory Corporations: - Set up under special Act.

1. Normally Act itself provides for Audit by C & AG.
2. In case like LIC, SBI etc provisions of Audit by CA
3. In SBI/ IDBI – Auditor appointed by RBI.
In Industrial Finance Corporation – One appointed by IDBI.
-Other appointed by Shareholders
In FCI –Appointed on advice of C & AG.
In LIC – Appointed by previous approval of central Govt.
4. Power of Auditors is defined in the act under which the Corp. was brought into
existence.

(iii)Audit of Government Companies:

1. Government company – In which at least 51% of paid up share capital, is held
by: a. Central Government, b. One or more State Government, c. by Central
Government/ State Government/ one or more Government Company (s) /
Corporation owned or controlled by central Government / subsidiary of
Government Company
2. Auditor appointed by Company Law Board on advice of C & AG.
3. More comprehensive audit as compared to mere verification of financial
statement. It covers: - System of accounting, internal control, maintenance of
Production & Manufacturing Account, Cost Accounts, Profit & Loss Account,
Balance Sheet and their general review
Township, manpower, service units, analysis of accounts to indicate capital
formation, growth & funds flow of Company.
4. C & AG may also conduct supplementary test Audit.
5. Copy of report by Auditor of Government Company:
To C & AG, who has right to comment upon it, to supplement it
The report along with comments placed in AGM.

(C) Internal Audit: - Discussed earlier

(D) Statutory Audit: - When audit made compulsory by Law.

1. Shareholders/Management can‟t make audit optional and cannot restrict scope of

audit.
2. Conducted by duly qualified person i.e. CA, not suffering from any Disqualification.
3. Right/ duties/ liabilities are governed by Law, and so can‟t be curtailed by
shareholder/management.
4. Independent Auditors is representative of shareholders and not to sub serve the
interests of management.
5. It can‟t be partial/ incomplete audit.
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 (A) Company Audit: - As per Companies Act 1956.
(B) Cooperative Society Audit: - As per Cooperative Societies Act.
(C) Trust Audit: - Governed by the respective Acts.
(D) Banking Co. Audit: - Governed by Banking Companies Regulation Act
1949.
Contd…4
(4)

(E) Insurance Co. Audit: - Governed by Insurance Act 1938.

(F) Electricity Co. Audit: - Governed by the provision of Electricity
(Supply) Act 1948 and Indian Electricity Act 1910.

2. ON THE BASIS OF CONDUCT OF AUDIT

(A) Continuous Audit: -

1. Meaning: Audit staff constantly engaged.
2. Suitable: Where final accounts quickly needed.
- Large number of transactions.
- Internal check system is not satisfactory.
- Management requires monthly/ quarterly results.
3. Advantages: Early discovery of errors & frauds.
- Close and extensive checking.
- Audit staff becomes familiar with technical details.
- Quick and accurate accounts at end or in between.
- Regularity of work among client‟s staff.
4. Disadvantages: Figures may be changed after Auditing
- Incomplete work in previous audit may leave.
- Accounts staff gets interrupted
- May lead to collusion, so that errors/ frauds deliberately ignored
- Costly time consuming.
5. Safeguards: Plan visit if accounts staff has completed work
- List of left work, and restart from this sheet.
- No alteration without Auditors knowledge & initials
- Fraud prone areas should be re-examined at Year-end.
- If collusion is likely, audit staff should be rotated.

(B) Periodical/ Annual/ Final/ Completed Audit: -

1. Meaning: Done at the end of year
2. Suitable: For small concerns.
3. Advantages: Economical, less time consuming, No work can be left as lost thread,
collusion chance minimized.
4. Disadvantages: not fit for large concerns, detailed checking not possible, Errors/frauds
may go undetected, delay in presentation of final accounts.

DIFFERENCE BETWEEN CONTINUOUS AUDIT AND FINAL AUDIT

Basis of Difference Continuous Audit Final Audit

01. Meaning Audit staff constantly Done at the end of year
engaged.
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02. Cost Heavy Less costly
03. Suitability For large concerns For small concern
04. Time During the year also Only after closed of year
05. Interim result It helps in it It does not help
06. Detection of Error / Early during the year Late after closed year
Fraud
07. Prevention of Possible No
Errors / Fraud
08. Verification of Cash / Stock verified during No
assets during the the year
year
09. Thoroughness Detailed Limited

(C) Partial Audit: - To Audit certain type of transaction or transaction during particular part of
year.

(D) Balance sheet Audit: -

1. Mainly followed in USA.
2. Audit in reverse order.
3. Partial Audit of special/ unorthodox Revenue transactions as compared to pervious year
final accounts.
(E) Operational Audit: - To make recommendations for improvement of profitability. To help
in achieving other objects like workers satisfaction, Improvement in Company‟s image.
Contd…5
(5)

(F) Interim Audit: Between two annual audits, involves complete checking for a part of Year,
to declare interim dividend or to declare interim figure of sales.

(G) Cash Audit: - Audit of receipt and payments made by cash & bank.

(H) Tax Audit

(I) Cost Audit

(J) Management Audit

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 VOUCHING
VOUCHERS
1. Meaning of Voucher: any document which evidences a transaction Example: money
receipt, Bank pay in slip, invoice, correspondence
2. Types: Primary and collateral
Primary voucher: Original evidence of a transaction e.g. Balance confirmation, Purchase
invoice, Bank Statement
Collateral voucher: Secondary / Supporting evidence e.g. Copies of sales invoice, receipt
issued to debtors, resolution passed
3. Requisites:
Adequate – relevance and authenticity
Reliable – Manner of preparation, date, authorised, filing
Competency – Depends upon the place of origin, whether passed through internal check
4. Examination:
1. Consecutively numbered, carefully preserved, genuine and complete
2. Addressed to the client organization, dated properly, correctly calculated and total,
properly stamped for payment exceeding Rs. 5000/-
3. Cancelled by rubber-stamp or initials for it is inspected
4. Duplicate or missing voucher need independent investigation
5. Over writing / erasion /Alteration should be signed by maker and duly authorised

VOUCHING
Meaning
1. Every entry is supported by voucher.
2. No voucher is unrecorded in books.
3. Transaction is genuinely concerned with business
4. Amount is accurately recorded recorded in appropriate account, correctly on correct
date.
Objects of vouching:
1. Voucher is legally valid i.e. authentic, properly dated, addressed to business, not fraudulent
2. Processed through effective system of internal check
3. Properly authorised by competent authority
4. Transaction is genuinely concerned with business.
5. All transactions correctly recorded in books of accounts.

CUT-OFF-TESTS OR ARRANGEMENT
Auditor should examine transaction for
a. A few days previous to the end of period
b. Some period of time subsequent to the end of period
To ascertain
1. Transactions entered prior to end of period belong to subsequent year
2. Transactions entered in sub sequent period actually belong to year under audit
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According to SAP auditor should satisfy himself by examination and test. Checks that‟.
a. Goods purchased (for which property transferred) has been provided for
b. Goods purchased and provided for has been included in inventories
c. Goods sold have been excluded from inventories and credit has been taken for sale
Contd…..2
(2)
Importance of Vouching
1. Vouching is the essence of auditing
2. It will help in discovering all errors & frauds, how so ever cleverly committed.
3. a. 100% vouching is not necessary.
b. Concentrate audit tests on a scientifically selected number of transactions
c. If vouching of those transactions on depth-test basis reveals a broad compliance with the
system of internal control
d. Auditor may formulate his opinion on validity of similar remaining transactions.
4. In following cases vouching of selected transaction is not o.k.
c. Poor system of Internal control
d. Small enterprises
e. Where specialized transaction takes place application of sampling technique would be
inappropriate e.g. major capital expenditure, purchase of investment, rent and dividend
received

Vouching of Cash Transaction:

2. Object: To ensure
a. That all receipts from all sources are accounted for,
 Every precaution should be taken by means of internal check
 To make it difficult to misappropriate the receipt
b. That every payment has been
 Properly authorized
 Is a bonafied business expense
 Properly recorded in books
 The payee has actually received the amount

2. Vouching of Cash Receipts

(a) Opening Balance: From last years audited balance sheet
(b) Cash Sales:
1. Cash memo should be pre-numbered
2. Each cash memo should be accounted for; all copies of cancelled cash memo should
be preserved.
3. Cash memo to be checked with Daily Sales Register
4. Calculation of carbon copy of cash memo, Daily Sales Register, summaries should
be independently checked.
5. Daily summary of sales man, cashier and delivery clerk to be cross checked
6. Cash sales can also be checked with stock register and cash deposited in bank
7. If more discount is allowed, must be properly authorised.

(c) Receipt from Debtors:

(1) Serially pre-numbered receipts to be issued. Each receipt to be accounted for, all
copies of cancelled receipt to be preserved.
(2) Daily total of receipts should be checked with Cash Book
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 (3) Be alert to the possibility of “Teeming & Lading or Lapping” by checking counter
foil of receipt, pay in slip, party account, etc.
(4) Check for heavy cash discount, if authorised
(5) Independent Balance confirmation
Contd…..3

(3)

(d) Fresh Loans Taken:

1. Check if empowered to borrow legally
2. Check for security offered, also if properly disclosed in Balance Sheet
3. Check for time, mode and rate of payment of interest if properly provided for TDS
(e) Return of loans given earlier:
1. Check with receipt issued counter foil
2. Also check with pay in slip for deposit in bank
3. Check for terms of repayment, due date, receipt of interest etc.
(f) Bills Receivables:
1. To be checked with B/R Book
2. Discounted/Duly matured B/R should be checked with Bank statements
3. Proper entry for dishonored / renewal/ endorsed B/R
4. Remaining B/Rs should be physically checked in safe custody.
5. Special attention to B/R having matured but remaining unpaid
6. Contingent liability note for discounted B/R.
(g) Rent: Terms of agreement, counter foil of receipt issued, liability for repair municipal
tax / insurance, due date. If number of properties: check property wise, month wise and
also see proper authentication for vacant period
(h) Sale of Investment: With broker advise, stock market quotations, also check
investments in hand physically with Register of valuation
(i) Interest: related to loans, B/R, Bonds, investment, check with agreement, note,
instrument, counter foil of cheque received, see accounting with reference to period,
outstanding, not yet due, entitled to receive
(j) Dividend: Check with counter foil of cheque received, bank pay in slip, E. C. S.
(k) Hire Purchase: With agreement, counter foil of receipts issued, check for down
payment, interest rate, terms, proper accounting for installment due and paid
(l) Commission: Check agreement, calculation, party account from whom commission is
received
(m)Sale of old fixed Asset: Minute Book, resolution, correspondence, checks for method of
discarding, inspection, sale procedure – tender, notice etc., also check accounting for
depreciation, profit / loss on disposal, unexpired benefits, proceeds not credited to
revenue
(n) Insurance Claims: Check with copy of claim lodged, correspondence, covering /
counterfoil of claim received, expenses / receipt in same / related account
(o) Royalty received: Examine term of agreement, correspondence with the lessee,
calculation, counter foil of receipt issued by us, mode, date of payment, proper
accounting for outstanding or advances
(p) Subscription: With Subscription register, counter foil of receipt issued

4. Vouching of cash payment:

(a) Opening balance:
 Bank column may have credit balance
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  Check with previous year audited Balance Sheet
 Also check as per bank statement, if difference, see bank reconciliation statement
and date of clearing / credited in next year
Contd….4

(4)

(b) Cash Purchase:

1. See only net amount, after trade discount, but before adjustment of advance is
entered.
2. Check with cash memo, challan, goods inward book prepared by store keeper,
inspection report
(c) Payments to creditors: Check with receipt issued by creditor, see the purpose for
payment, advance should accounted properly, discount adjustment in full & final
payments, excess paid to be recovered.
(d) B/P: Vouching with B/P Book, also check cancelled B/P, if paid then bank statements
(e) Loans: Receipt of parties, mortgage deed & other documents, Provisions relating to
power of Ltd. Co. for loans to directors etc, if duly complied with, proper accounting for
interest received/receivable, per terms of agreement
(f) Return of loan taken: with the receipt issued by receiver, also see if charge, if any, on
assets is cleared, proper accounting for interest
(g) Purchase of investment: with brokers bought Note. Physical verification of investment
should be in the name of company
(h) Plant & Machinery: Invoice, challan, octroi and import duty, installation, proper
classification of capital & revenue and accounting for exchange fluctuation
(i) Purchase of land & Building:
Power of attorney : General Power of Attorney (GPA)
: Sale agreement
: Receipt
: Will
Lease hold: Lease agreement / deed
Free hold: Conveyance (sale) deed
(j) Acquisition of copyrights and patents: Receipt issued by seller agent‟s note,
agreement of acquisition / purchase, All incidental expenses / any R&D expense for self-
development should be capitalised.
(k) Payment of Agents commission: Agreement, receipt and salesman statement to be
checked.
(l) Director’s Fee: for board meeting. Check A/A, check directors‟ signature for attending
meeting and for receiving money
(m)Rent Payment: Rent agreement, rent receipt
(n) Payment Under HPA: HPA, Receipts, interest/installment accounting.
(o) Insurance Premium: Policy/cover note, insurance premium receipt
(p) Traveling expenses: Either fixed, Check rules and applicability or reimbursement of
actual expenses, check bills, tickets, etc, proper calculation/sanctioning

Of CASH PAYMENTS
(q) Directors Traveling Expenses: For directors meeting or other purpose. Check A/A ,
meeting attendance register, check receipt of payments.
(r) Interest on Loan: Terms of loan agreement, due date, rate
(s) Dividends: Board Resolution. AGM Minutes, counterfoils of dividend warrant
19
 (t) Income Tax: Challan for advance tax, self-assessment tax, demand.

Contd…5

(5)

(u) Excise Duty: Goods can be cleared only if it is paid. Excise challan, receipt, excise
record can be checked, also check rules for application, rate, calculation
(v) Repair to assets: Bill, receipt, job-sanction by authorised person, Fitness / ok report by
technical person, proper accounting depending upon miner / major repair.
(w) B/R discounted & dishonored: Bank Advise and actual dishonored bill, Drawee
account debit by B/R & charges.
(x) Salaries: Salary bill paid by responsible person, Attendance records, appointment of
1wnew employees, check also for major fluctuations, proper deductions, calculations
(y) Wages: Fraud etc possible in following ways:
1. Inclusion of dummy workers or left workers in workers register (name)
2. Payment shown for absent time (time)
3. Payment at higher rate (rate)
4. Lesser amount of deduction (deduction)
a. There should be effective internal check in preparing wage sheet
b. Each column should be filled by different person for records and initialed
c. Dummy workers / extra time can be cross checked with gatekeeper records/ time
allocation card
d. Disbursement should be department wise, in presence of officer
e. Special check for causal workers, overtime.
(z) Petty cash: Verify actual petty cash-in hand, Vouchers serially numbered, cash
transferred recorded on same day, proper supporting evidence and proper head of
expense, imprest system may be followed.

VOUCHING OF TRADING TRANSACTIONS

Credit Purchases:
(a) There should be effective internal control
(b) Bill addressed to client, properly dated, checked for calculation
(c) Goods have actually been received-check with challan and Goods inward book and also as
per purchase order
(d) No Duplicate bill entered, also 2nd payment entered, can‟t be detected by balance
confirmation, but by checking of receipt of customers.
(e) Running bills not entered differently, properly checked
(f) Duplicate invoices duly cancelled and not passed for payment
(g) Cut- off transactions checked.
(h) Price charged as per quotation/price List/Purchase order

Purchases Returns:
Proper system of Debit note raising with regard to quantity, rate, calculation and date/period of
recording in Return book

20
 Goods received on approval (i.e. Sale or return) basis
Record of goods received in separate memoranda records, no entry for purchases on goods
receipt, but on decision to buy, not to be included in stock till approval
Contd…6
(6)

Goods received on consignment basis

Separate stock memoranda record, not to included in stock

Credit Sales:
1. Access the effectiveness of internal check
2. Sales memos, serially numbered, preserved. Loose Bill generation to
be avoided, change / Alteration duly authorised.
3. Proper accounting for excise duty / sales etc
4. Every goods outward per G O Book, stores records, challan should
have been invoiced-Qty, rate, and calculation
5. Enter after trade discount, in period under audit.

Sales Returns: Proper system of credit Note after inspection / authorization, Verify G/I
Register and store records

Goods Sold on approval: Separate memoranda stock record, to be included in sellers stock
until buyer‟s approval received or time allowed has expired.

Goods Sent on Consignment basis: Separate stock record, check from Performa invoice,
adjustment for Loading, entry of sale if consignee has sold goods. if unsold to be included in
consignors stock

B/R Book: Checked matured with cash / Bank Book, dishonored with party a/c, pending B/R to
check physically, discounted bill to be shown in contingent liability till maturity, proper entry
for discount, noting charges etc.

B/P Book: Paid Bills with cash / Bank, In Party a/c, outstanding bills in Liability

VOUCHING OF LEDGER

Purchases Ledger
(a) Check opening balance with last year balance sheet – list of Creditors.
(b) Posting from Cash Book, Purchases Book, Purchases Returns Book, Bills Payable book,
Journal.
(c) See correct amount is posted to correct account on correct side
(d) Check total, Balancing of each account, carried forward, brought forward
(e) Check continuity of bill number, in credit side of ledger account
(f) Check reference to bill number, when account is debit
(g) See composition of closing balance
(h) Specifically check the closing debit balance, for any goods in transit
(i) Balance confirmation from the suppliers.

Sales Ledger
21
(a) Opening balance
(b) Posting
(c) Total, carried forward, brought forward, balancing
Contd…7
(7)

(d) Reference to invoice number, credit note

(e) Special check for credit balance
(f) Provision/entry for Bad & Doubtful Debts, time barred.

Impersonal Ledger: Contain Nominal / Real / Capital etc. accounts

 Check opening balance (except in nominal accounts)
 Posting, total, carried forward, brought forward, balancing

Outstanding Assets:
(a) Income receivable e.g. Rent Receivable outstanding, Dividend declared but not received,
interest accrued but not received
(b) Prepaid expenses: e.g. Insurance, Rent, Rates & taxes, subscription
(c) Deferred Revenue expenses: Preliminary expenses, under writing commission, Discount /
loss on issue of Share / Debentures, expenditure of advertisement campaign

Outstanding Liabilities:
Unpaid liability e.g. Wages, Audit Fee, Commission, Freight & cartage etc.
Unearned income received in advance: Subscription, Rent

Contingent Liabilities:
(a) May or may not arise
(b) Pending court cases award
 Workmen compensation
 Government dues
 Third parties cases
(c) Unexpired letter of credit or guarantee
(d) Uncalled capital
(e) BOE discounted

EXAMINATION QUESTIONS

Q.1 “In vouching payments, the auditor close not merely seek proof that money has been
paid away”. Elucidate
Q.2 “Vouching is the backbone of auditing”. Explain this statement. State general consideration
to be born in mind by the auditor while vouching cash transactions
Q.3 “What is vouching? How is it different from verification discussing the duty of the auditor
with regard to vouching?
Q.4 “What is the meaning of vouching? What are its objects?
Q.5 “Explain the objectives of vouching and the consideration to be kept in mind while
examining a voucher

22
VOUCHING

1. Payments of goods purchased

2. Preliminary expenses
3. Salary Paid
4. Contingent liabilities (Vouching/Verification)
5. Purchase of quoted investment ( “ )
6. Cash sales
7. Wages
8. Rent paid
9. Dividend paid
10. Receipts from Debtors
11. Land and Building
12. Dividends from investment
13. Receipts-Side of Cash Book
14. Sale of investment
15. Petty Cash Book
16. Remuneration to Directors

23
 Verification
Verification and valuation of asset and liabilities
According to SAP issued by ICAI, it covers.
1. They exist, 2. They belong to client, 3. They are in possession of client or his authorised
representative, 4.They are not subject to undisclosed encumbrances or lien, 5. They are stated in
balance sheet at proper amount in accordance with sound accounting principles, 6. They are
recorded in account (this will include scrap and waste).

Basis Vouching Verification

1. Nature of work To examine entry relating to To examine assets & liability.
transaction.
2 Where to check In books of accounts Appearing in balance sheet

3. Time Can be done during the year Only at the end of year
4. Basis Based on documentary Based on personal as well as
evidence documentary examination
5. Valuation Vouching does not include Where as verification includes
valuation valuation
6. Personnel Audit staff can perform Auditor should perform with
Technical experts

Verification of Liabilities: According to SAP

1. The credit balances appearing are really liabilities
2. All Liabilities, unsecured loans are to be disclosed in financial statement
3. They are properly valued
4. They are properly classified and disclosed.

Confirmation Vs verification:
Confirmation is affirmation from third party to auditor

Inspection / Verification of tangible asset includes counting, weighing, quality evaluation.

Auditor can physically verify following items:

2. Cash

3. Bills Receivable

4. Marketable Securities

5. Stock

6. Stores & Spares

7. Investment

24
 8. Plant & Machinery

9. Land & Building

Verification

2. Patent Rights: A patent is an official document, which secures to its inventor an exclusive
right for years to make or sell his invention.
a. To verity with certificate granting such rights or, if purchased, the assignment deed to be
checked.
b. To see that patents are registered in clients name and are his property
c. To see that patents are not lapsed (normal is 16 years), to see that there is timely
renewal.
d. Initial fee paid should be capitalised, and life/term annual renewal fee treated as
expenditure.
b. If many patent rights, prepare list with full details i.e. date of acquiring, registration
number, unexpired period
c. Patent to be valued at cost less depreciation (due to lapse of time, obsolescence, out of
fashion article).

3. Trade mark: “A trade mark is a distinctive mark attached to goods offered for sale in the
market so as to distinguish the same from similar goods and to identify them with a
particular Trademark”
a. Examine: an assignment deed duly endorsed by the office of the Registrar of trademarks.
b. Acquisition expenses – capital; Renewal payment – revenue
c. Valuation – at cost less depreciation
4. Copyright: A copyright is the exclusive legal right to reproduce, publish and sell the matter
and form of a literary, musical or artistic work. The period of copyright is life+50 years after
death of author.
a. Examine agreement between author and publisher
b. Acquisition cost to be capitalised.
c. Valuation is not stable because they loose value by passage of time. If sale of
publication is Nil or very small it should be completely written off. To be shown in
Balance Sheet at cost less written off.
5. Goodwill:
a. Payment for earning more than normal profit
b. Shown when purchased Goodwill, Dissolution of Partnership, Revaluation of Assets etc.
c. Value to be shown-either what is paid, or paid-Net-Assets
d. To be shown at cost / raised less written off.

25
EXAMINATIONS QUESTIONS

Q.1 What do you understand by verification of assets. An auditor is not a valuer yet he is intimately
concerned with the valuation of assets and liabilities. Explain the statement with reference to
important case laws.
Q.2 What is verification of assets and liabilities? State the duties of an auditor regarding the valuation
and verification of stock-in-trade
Q.3 What is the object of verification of assets? How for is the auditor responsible as regards
their valuation?

VERIFICATION

1. Stock –in- trade

2. Cash at bank
3. Plant and Machinery
4. Goodwill
5. Patents
6. Contingent Liabilities (Vouching/Verification)
7. Purchase of a quoted investment ( “ )
8. Loans raised from financial institutions
9. Trade debtors
10. Furniture and fittings
11. Creditors
12. Bills receivable
13. Freehold property
14. Investment in securities

26
 APPOINTMENT OF COMPANY AUDITOR
FIRST AUDITOR U/S 224 (5)
 By Board of Directors.
 Within one month of date of registration of company
 Shall hold office until the conclusion 1st AGM
 Naming first Auditor in Article of Association is not valid

SUBSEQUENT AUDITOR U/S 224(1)

Every Co. shall appoint Auditor(s)
1. At each AGM
To holds office from conclusion of that meeting until the conclusion of next AGM
2. And within 7days, give intimation to Auditor
3. Auditor to communicate his Acceptance or refusal to Registrar within 30 days of receipt of
communication u/s 224 (1-A)
4. If Auditor does not accept appointment, ICAI says another meeting to be convened

APPOINTMENT BY CENTRAL GOVERNMENT U/S 224(3)


no auditor appointed at an AGM
 Central Government may appoint
 Company to give notice to Central Government within 7days of non-appointment
 Fail to give notice –500 fine per day

APPOINTMENT AGAINST CASUAL VACANCY U/S 224(6)

 Due to death, insanity or insolvency etc.
 BOD can fill
 To hold office till conclusion of next AGM
 Vacancy due to resignation or refused to accept is not CASUAL vacancy

APPOINTMENT BY SPECIAL RESOLUTION U/S 224-A

 Where 25% or more capital held by (on date of AGM)
 Public Financial Institution, Government Company, State Government Bank, Insurance
Company
 Auditor appointed by special Resolution
 If not appointed by special Resolution, Centre Government is empowered

COMPULSORY RE - APPOINTMENT: U/S 224(2)

Retiring auditor, by what so ever authority appointed, will be re-appointed except:
1. He is not qualified for re-appointment
2. He has given written notice of unwillingness
3. Company has passed resolution
 To appoint some other in his place
 To expressly not to re-appoint him
4. Resolution to appoint other auditor was given, but due to death of such other person,
resolution could not be proceeded with

27
 Contd: - 2

(2)

APPOINTMENT OF AUDITOR OF GOVERNMENT COMPANY

1. Government Company extended to a Company in which 50% or more paid up share capital
is held by Central Government, State Government, Government Corporation singly or /
jointly
2. Auditor appointed by Central Government
3. On the advice of CAG
4. CAG direct how audit to be conducted
5. CAG may also conduct Supplementary or Test Audit
6. Auditor should submit a copy to CAG

JOINT AUDITOR: -
1. In large concern like banking, Insurance Company
2. Each one is liable jointly for entire audit.
3. To avoid it, specifically state in report the extent of work done.

BRANCH AUDITOR: -
1. The Central Government may exempt / withdraw exemptions – branch audit.
2. Appointed in General Body Meeting or BOD authorised to appoint after consulting main
CA
3. Branch Auditor has same power and duties as Company‟s Auditor.
4. To submit report to main Auditor, who shall deal with the report in such manner as he
considers necessary, while preparing his report
5. Remuneration as per terms of appointment in GBM or BOD.

SPECIAL AUDITOR: -
1. By central Government
2. Remuneration paid by Company
3. Appointed in following situations:
a. Affairs not managed properly as per prudent commercial practices.
b. Company‟s working may cause serious damage to trade, industry or business
c. Company‟s financial position is such as to endanger its solvency.
4. Report to Central Government

Appointment of new auditor in place of a retiring auditor u/s 225

1. Special notice ‘that retiring auditor shall not be re-appointed` must by sent to member of
Company
2. Company must forward a copy of notice to retiring auditor
3. Any representation from retiring auditor
a. Company must state in notice to member that representation is received from auditor
b. Company should send a copy of representation to every member
c. If representation is not send, auditor can insist „to read` the representation
d. If is not necessary to read of court stays
4. If auditor has right to attend GM, in which removal is discussed. He can also speak there.
Removal of first auditor
- Possible by member in meeting Permission of Central Govt. not necessary.
28
 Contd: - 3
(3)

Removed of subsequent auditor

 An ordinary resolution.
 Prior permission of Central Government

Qualification u/s 226

1. He is Chartered Accountant with Chartered Accountant Act, 1949
2. A holder of certificate i.e. States Auditor
3. A firm, in which all partner Chartered Accountant

Restriction on Number of Auditor ship –

 Maximum 20 companies
 Maximum 10 companies having paid up share capital of 25 Lacs or more out of total 20
companies
 Partnership firm 20/10 companies per partner
 Partner excludes person who is full time appointment

Disqualification u/s 226(3)

1. A body corporate
2. An Officer/Employee of company
3. A person who is Partner/employee of Officer/Employee of Client Company
4. A person indebted for Rs. 1000 plus
5. A person disqualified for subsidiary, holding and subsidiary of same holding company

Remmuneration is to be fixed
- by appointing authority.
- by BOD - in case of 1st auditor.
- by member - in case of subsequent auditor.
- by Central Govt. in case of Govt. Co.
- by CAG if auditor appointed with its advice.

29
 RIGHTS OF COMPANY AUDITOR

1 Right to access to books of account u/s 227 (1)

 Free and complete access
 At all times during normal business hours
 To all books, (financial, accounting, statutory and statistical) account, voucher,
documents, correspondence, agreement etc.
2 Right to obtain information and explanation u/s 227 (1)
 Information and explanation
 From officers of company
 Which auditor thinks necessary to perform duties
 U/S 221 every office is bind to furnish information without delay
3 Right to inspect branch accounts u/s 228 (2)
 Even if branch audited by other auditor
 Principal auditor has right
a. to visit branch
b. to audit
c. to access all books and accounts etc.
 In case of banking company, Auditor does not have right to visit abroad branches
4. Right to receive notices u/s 231
 Every notice, which member is entitled to receive
 Can attends meeting and make Statement/Explanation
 No duty to answer any question
5. Right to sign the audit reports u/s 229
 Only he or P/N of firm can sign
 He can recommend changes in Accounting system
 Recommendation if not acted upon can be reported
6. Right to seek legal and technical advises
 Advice needed in performance of conduct of audit
7. Right to be indemnified
 Out of assets of Company, for his non- guilty.
8. Right to receive remuneration u/s 224 (8)
 Also out of pocket expenses, as agreed.

Auditor’s lien
What is lien – Right to retain?
2 On books of accounts – No – as auditor
3 On books of account – Yes – as unpaid accountant or auditor
30
4 On working paper – Yes – as auditor
5 On corresponds
a. Auditor to client – Yes – as auditor
b. Client to Auditor – Yes – as Auditor
c. Auditor to Third Party
i. If acting as agent of Co. – No – as Auditor
ii. If acting in profession capacity to discharge duties – Yes – as Auditor

DUTIES OF COMPANY AUDITOR

A. Statutory Duties to make report to share holder.Adverse comments in THICK or ITALICS
type

a. Whether accounts give interpretation required by act.

b. Whether Balance Sheet gives true & fair view of company‟s affair whether Profit Loss
gives true & fair view of profit.
c. Whether he has obtained all information/ explanation.
d. Proper „books of accounts maintained and proper return received from branches not
visited.
e. Reports on accounts of branches forwarded to him.
f. Balance Sheet, Profit & Loss Account is in agreement with accounts and returns/income
g. Balance Sheet, Profit & Loss Account comply with Accounting Standards u/s 211 [3(c)]
h. Whether any director is disqualified for appointment u/s 274(1)(g).
i. Whether cess u/s 441 A paid
B. Duties u/s 227 (1A): - He has to inquire whether:
2. Loans and advance made by company are properly secured and not prejudicial to interest
of company
3. Transaction represented merely by entry is not prejudicial to interest of Co.
4. Shares/debentures etc. Not sold below purchase price, in case of non- investment
company
5. Loans/Advances made shown as deposits.
6. Personal expenses charged to revenue.
7. Cash received against shares allotted.
 No report necessary unless auditor has any special comments to make u/s 227(1A) If answer
is in negative or with qualification, auditor has to state reasons for the answer
C. Duties U/S 227 (4A)
In exercise of powers conferred by section 227 (4) of the Act, the Central Government In
consultation ICAI has issued the Companies (Auditors Report), Order, 2003.

CARO applies to
a. Manufacturing, mining or processing.
31
b. Supplying and rendering sServices.
c. Trading, and.
d. Financing, chit fund etc.
Auditor has to give detailed comment on matters specified in order:
 On fixed assets valuation, location, records, purchase procedure etc.
 Material purchase procedure, internal control, scraps, by – joint produce.
D. Other duties under the company’s act:
1. To sign audit report u/s 229
2. To report on certain matter included in prospectus u/s 56(1)
3. To report on certain matter relating to accounts and allotment of Shares, required to be
included in statutory report u/s 165(4)
4. To give a report to be attached with declaration of solvency, If Co. going in voluntary
winding up u/s 488(2)
Contd: - 2
(2)

5. To preserve and produce books, paper and to give all assistance to inspector,
investigater, in connection with investigation u/s 240(v) (b)
6. Duty to attend (not vote) audit committee meeting of Public Ltd. Co. having paid
up share capital of 5 crore or more u/s 292A.
E. Contractual duties: - As per terms of contract
F. Duty of care: - Honest and exercise reasonable skill and care.
G. Duties in Relation to mandatory Accounting standards.
H. Duty to know duties: Read A/A
I. Professional Duties: - To communicate with previous auditor.

32
 LIABILITIES OF COMPANY AUDITOR
LIABILITY

For Negligence Under Co.‟s Act Under Other Statutes

Contractual Liability Civil Liability Liability under Indian Panel Code

Towards Company Criminal Liability
Toward Third Parties Liability under the Income Tax Act 1956

Liability the Professional Misconduct

Other Cases
A. CONTRACTUAL LIABILITY for negligence towards company
1. Negligence means
Failure to exercise reasonable skill and diligence , which he is employed to do, as an auditor.

2. Liability arises
i) Therefore, if an auditor is guilty of negligence in the execution of his duty, he may
be held liable to make good any damage amongst other things.
ii) An auditor is not liable even though the company has suffered a loss if it can be
proved that he was not negligent in the performance of his duties.
iii)Any clause in the agreement between the company and the auditor whereby the
auditor is freed from liability-has been declared void.
33
3. Legal Cases
-Leeds Estate Building & Investment Co. Vs. Shepherd – A/A not see – liable
-London Oil Storage Co. Ltd. Vs. Seear Hasluck & Co. – Petty Cash not verified –
Liable
-AE Green Co. Vs. The Central Advance and Discount Corp. Ltd. - Time Barred debts
not reported - Liable

B. LIABILITY for negligence towards third parties

1. Doctrine of privity.
Only Contractual Liability towards clients. Liabilities towards third parties does not
arise from contractual relationship.
Kingston Cotton Mills – stock certificate
(1951) Candler V Crane Christmas & Co. – lost investment –majority
2. Erosion of doctrine of privity –
based upon following principles of law i) doctrine of holding out
ii) Notion of Proximity
(1963) Hedley Byrne – Cr. Report by Bank – loss
3. Extension of Proximity – on basis of reasonable foresight
JEB Fastners Ltd. V Mark Bloom & Co. (1981)
- Liable towards 3rd party whose existence he does not know even at the time of
audit for pecuniary losses.
Contd…2
(2)
4. Proximity and Reasonableness
Caparo Industries Plc V Dickman – Three principles laid down
- auditors was under a duty to prevent those damages
- auditor knows that Fin Stmt will be used by plaintiff
- duty not extended for subsequent transactions.

C. CIVIL Liability under the companies Act, 1956.

1) Under Section 62, where a prospectus is issued inviting persons to subscribe for shares or
debentures of a company, an accountant is liable in respect of an untrue statement purporting to
be made by him as an expert to pay compensation to every person who subscribes for any
shares or debentures on the faith of the prospectus for any loss of damages he may have
sustained by reason of having untrue statement included therein.

2) U/s 543 the term officer includes an auditor for the purpose of certain sections. If in the
course of the winding up of a company it appears that the auditor has been guilty of any
misfeasance or breach of trust in relation to the company, he may be held liable as an officer of
the company.
The London and The General Bank Ltd. (1895)
-The auditor pointed out in separate report to directors but not in report to shareholders
`` That no provision has been created for bad debts for loans against insufficient
security.‟‟
-Payment of dividend on basis of audited P/L was held payment out of capital.
Auditor was held liable.
Kingston Cotton Mills Co. Ltd. (1896)
-wrong stock from directors accepted- not liable
The Westminster Road Construction & Engg. Co. Ltd. (1932)
34
 -Construction WIP overvalued & liabilities understated
Auditor was HELD LIABLE
Irish Woolen Co. Ltd V Tyson (1900)
-Purchases suppressed – held liable
It should be noted that if a company has suffered any loss, it is only the company, which
has a right to file a suit against the auditor for damages.
Individual shareholders have no right to do so. In the case of liquidation of the company,
this right is that of the liquidator of the company who can bring a suit in the name of the
company against the auditors
2) U/s 633, the court may relieve an auditor if it appears to court:
 That he is not or may not be liable
 That he has acted reasonably and honestly
 That having regard to all the circumstances of the case he ought fairly not to be
executed for the negligence etc.
If the dividends have been improperly declared and paid off, on the basis of accounts
audited by him, he will be liable to refund such an amount.

D. CRIMINAL LIABILITY under the companies Act, 1956

1. According to section 63, where a prospectus issued includes any untrue statement, every
person, who authorised the issue of the prospectus, shall be punishable with imprisonment up to
2 years or a fine up to Rs. 5000 or with both unless he proves Contd…3

(3)
that he had reasonable grounds to believe the statement was true. This provision deals
with fraudulently inducing persons to invest money.
In view of these provisions of auditor should be extremely cautious while certifying any
statement on the basis of which any person may be induced to invest money.
2. U/s 233 Penalty for non- compliance by auditor with Sec 227 & 229 wilful
default in audit report
3. U/s 240 Production of document & evidence to inspector appointed by CG to investigate
Co.‟s officer.
4. U/s 477 The National Co. Law Tribunal has Power to summon person (including C.A.)
suspected of having property of co. etc in case of winding up.
5. Section 539 provides that where an auditor of a company, which is being wound up with
intend to defraud or deceive any person:
(a)Destroys, mutilates, alters, falsifies or secretes or is privy to the destruction, mutilation,
alteration, falsification or secreting of any books, papers or securities;
(b) Makes, or is privy to the making of any false or fraudulent entry in any register book of
account or document belonging to the company, he shall be punishable with
imprisonment for a term which may extend to seven years and shall also be liable to a
fine.
6. U/s 545 The court can prosecute a delinquent Officer (Including Auditor) in course of
voluntary winding up.
7. U/s 628 If an auditor in any Report, Return, Certificate, Balance-Sheet, prospectus,
Statement or any other document required by or for the purpose of any of the provisions
of the Act makes a false statement in any material particularly knowing it to be false; or
omits any material fact knowing it to be material, may be same as otherwise provided in
the Act be punishable with imprisonment for a term which may extend to two years and
may also be liable to fine.
35
E. LIABILITY under Indian Penal Code
Section 197 of the Indian Penal Code reads as follows “Whosoever issues or signs any
certificate required by law to be given or signed or relating to any fact which such certificate
is admissible by law, admissible by evidence. Knowing or believing that such certificate is
false in any material point, shall be punishable in the same manner as if he gives a false
evidence.”

F. LIABILITY under the Income Tax Act 1956

1. U/s 278 of the Act, prescribes rigorous imprisonment up to 2 years for a person who abets
or induces in any manner 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 or does not believe to be true.
2. U/s 288 a Chartered Accountants representing his clients, if found guilty of misconduct he
can be disqualified from practicing.
3. Under Rule 12A, an auditor can face imprisonment up to years for furnishing false
information.

G. Liability for Professional Misconduct

The ICAI has the power to provide for penalties where a member fails to follow the
professional code of conduct.

H. OTHER Cases
Liability of Joint Auditor
(a) An auditor should not be held responsible for the work done by the other joint auditor.
(b) In the absence of division of work auditors will be jointly and severally liable for the
work done by them.
Liability of an Honorary Auditor: is not less than that of a paid auditor.

36
 TAX AUDIT

1. u/s 44AB.a. Business : Turnover excFeeding Rs. 40 Lac

b. Profession : Receipts exceeding Rs 10 Lac.
u/s 44AD Contractor : Profit @ 8% of Gross Receipts (Not exceeding 40 Lacs)
u/s 44AE Goods Carrier : @ 3500 , @ 3150 p.m. (Not more than 10 trucks)
u/s 44AF Retail Business : Profit @ 5% of total turnover (Not exceeding 40
Lacs)
u/s 33 AB Growing / Manufacturing Tea, Coffee, Rubber plantation.
u/s 35 D Amortisation of preliminary expenses for setting up new industrial
unit.
u/s 35 E Expenditure on prospecting for Minerals (Specified in VIIth Sechdule)
to Indian Company
u/s 80 IA Residential undertaking in infrastructure facility,
Telecommunication Services, Industrial Park, Power-Generation,
Transmission & Distribution.
u/s 142(2A) & u/s 142(2D) Selective Tax Audit

37
 2. It is obligatory to receive and submit report before specified date i.e.31st October of
relevant Assessment year.
3. Penalty u/s 271 B (1/2% of Turnover or receipts) or (Rs 1Lac) lesser.
4. Ceiling – 30-tax audit per CA.
5. Appointment by Management
6. Forms of Audit Reports & Statement of Particulars u/s 44 AB, AD, AE, AF

Assessee Audit Report Statement of Particulars

Company Form 3CA. Form 3CD
Firm etc Form 3CB Form 3CD
7. Sales includes : a) Sale of scrap, Sale of bye- product,
b) Excise Duty, Sales tax, Packing, Freight ( If part of S.P.)
Sales does not include a) Trade Discount, Sales Returns
b) Excise Duty, Sales Tax, Packing Freight (if recovered
separately)
8. Gross Receipts includes
- All receipts arising from carrying on the business or profession.
- As per sec 28, profit/ Gain includes:
Profit on sale of import Licenses, cash assistance against export,
Duly drawback, Interest/ Salary/ Commission/ Bonus due to P/N
Of FFAS, Insurance claims, liquidated damages etc.

Cost Audit

Meaning
Cost audit is “the verification of the correctness of cost accounts and of adherence to
the cost accounting plan”.

Objectives
a. General Objectives
General objectives include verification of cost accounts; detection and prevention of
frauds and errors; verification of cost of each “cost units” and “cost centre”, and
providing assistance and advice to management.

b. Social Objectives
Ensuring optimum utilization of resources, determination of fair prices and
protecting interest of various parties are included in social objectives.

Importance
38
 Different group of persons, viz, management, shareholders, Government, workers,
consumers, etc., recognize the need for cost audit because of advantages associated
with it.
For managements
For shareholders
For the Government Miscellaneous

Maintenance of cost accounts records

Section 209(1)(d) empowers the Central Government to make it compulsory in case
of specified classes of companies to maintain cost records. The central Government
may order audit of cost records maintained under section 209(1)(d) in pursuance of
powers given to it by section 233B.

Qualification of cost auditor

Section 233B provides that cost audit may be conducted by a cost accountant or a firm of
cost accountants or a chartered accountant, if a notification is issued by the Central
Government.

Disqualification of cost auditor

a. Disqualification for statutory auditor contained in section 226(3) and 226(4) of the Cos.
Act 1956.
b. Holding appointment as the statutory auditor under section 224.
c. An employee or partner of the statutory auditor or an employee of any of the partners of
a firm which has been appointed as statutory auditor.
d. Internal auditor of a company.

Appointment of cost auditor

The cost auditor is appointed by the board of directors of the company on receipt of
the order of the Central Government. His appointment is subject to ceiling i.e. 10
+10 prescribed under section 224(1-B).
Contd…2
(2)
Power and duties of cost auditor
The cost auditors shall have the same powers and duties as are prescribed under
section 227(1) of the Act for auditors appointed under section 224.

Cost audit report

The Central Government has issued Cost Audit (Report) Rules, 1996 specifying the
form of the report and the additional information which should be included therein in
the form of annexure. The points on which the auditors should make his observations
and give his conclusions are set out in the Rules. The Rules have also set time limit
within which cost auditor has to send his report to the Central Government (180
days) from the end of financial year and within which the cost auditor shall give
clarification (30 days), if any, required by the Central Government on the cost audit
report. As per Rules, company and every officer of the company shall make available
with ninety days from the end of financial year cost accounting records to the cost
auditor.

Relationship between cost audit and financial audit

39
 Basis of Difference Financial audit Cost audit
1. Compulsory for Limited companies by the Certain cases of limited
Companies Act, 1956 companies carrying on
manufacturing or mining
business which are required
to maintain cost accounts
under section 209(1)(d) and
to get their accounts audited
under section 233B
2. Object To ascertain a true and fair Ascertain whether cost
view of the state of affairs accounts present a fair view
and working results of a of the cost of production of
business products
3. Regularity Conducted every year Conducted only if the Central
Government makes an order
for a particular year and for
the company specified under
such order
4. Relationship with Collection and evaluation of Determining the propriety
Transactions evidence to substantiate the and efficiency of business
transactions recorded transactions
5. Verification of stock Properly shown and valued Adequacy or otherwise of the
for the purpose of Balance level of the stock in
Sheet accordance with the need of
the enterprise
6. Appointment of auditor By Shareholders in General By BOD with previous
Meeting. In some cases by approval of Central
BOD, CAG, CG Government
7. Submission of report To Shareholders of To Central Government, and
Company a copy to Company

Management Audit

Meaning
Management audit is an independent review and investigation which is concerned
with identification of those functional and operational areas where management has
failed to achieve the required external standards of performance and with evaluation
of management decision making with the aim of monitoring and improving the total
efficiency and effectiveness of the organization.

What to do in Management audit?

The steps involved in the process of management audit are:
1. Identifying the objectives of the business
2. Segregation of overall objectives
3. Review of organization structure
4. Identification of responsibility centre
5. Review of performance of each responsibility centre
6. Reporting

40
Importance of Management audit
(i) Improving efficiency and effectiveness of the organization

(ii) Assessing the efficiency of management

a) Granting loan or participation in equity
b) Reviving stick units
c) Foreign collaborations

Appointment of Management Auditor

The shareholders or board of directors of a company may appoint the management
auditor. He must have sufficient knowledge of accountancy, financial administration
and management. The terms and conditions of appointment and other aspects of
audit work should be clearly mentioned in letter of appointment.

Audit Report
The audit report should be clear and unambiguous and, preferably, should be divided
into sections.

Contd…2

(2)

Difference between Management Audit and Cost Audit

S. No. Basis Management Audit Cost Audit

(i) Definition Management Audit is a Cost Audit is verification of

comprehensive and critical
review of all aspects of
management process
(ii) Statutory Requirement Management Audit is not a
statutory requirement
(iii) Scope The management auditor critically
examines the policies and
objective of management, reports
on their suitability and may give
suggestions
(iv) Period under audit Management Audit covers wide
area of management activities and
may be for more than one
financial year
(v) Appointment of auditor The management auditor is
correctness of cost accounts and of
the adherence to cost accounting
plan
Cost Audit on the other hand is a
statutory requirement
It is narrower in scope since the
cost auditor confines himself to
check cost accounts only
Cost Audit is conducted for every
financial year separately
The cost auditor, on the other hand,
41
 appointed either by board of
directors or shareholders
(vi) Qualification of auditors Management auditor‟s
qualifications are not prescribed
by law, but he must be a person
having wide experience and
knowledge in field of
accountancy, management and
financial administration
(vii) Submission of audit report Management auditor is required
to submit the audit report to the
management within the time
period mutually agreed upon
is appointed by board of directors
with the prior approval of the
Central Government
Cost auditor must posses certain
requisite qualifications .
Cost auditor has to send his report
to Central Government and a copy
to the management of the
company within 180 days from the
end of the financial year to which
the cost audit report relates

Difference between Management audit and Statutory audit

Basis of Difference Management audit Statutory audit

1. Definition Comprehensive and critical
An Audit which is
review of all aspects of authorized, governed and
management process made compulsory under any
statute
2. Scope Determined by engagement Determined by the statute
letter
3. Period under audit More than one financial Only one financial year
year
4. Appointment of auditor Board of directors or As per statute‟s provision
shareholders
5. Qualification of auditor Not prescribed by law Laid down under statute

AUDIT REPORT

Meaning
An audit report contains the opinion of the auditor as regards the representations made
in the financial statements and matter relevant thereto.
It is not a certificate.

Purpose
(2) To report to the persons who have appointed him
(3) His opinion regarding the truth and fairness of financial statements

Contents
(1) Identify the persons to whom it is addressed
(2) In accordance with GAAP (Generally Accepted Accounting Principles)
(3) True & fair view of state of affairs, profit / loss, sources & application of funds etc.
(4) Any other statutory requirements (e.g. – school, hospital, bank, etc.)

Types of Reports / Opinion

(a) Unqualified – satisfactory, in conformity with accounting principles and statutory
requirements. Clean
42
(b) Qualified – (i) Uncertainty – prevents him from forming an opinion
(ii) Disagreement – conflicts with the financial statements
It is given when –
 Lack of conformity with GAAP
 Inadequate disclosure
 Biased statements
 Non – maintenance of proper books of accounts
 Part of the audit by some other auditor
 Contraventions of companies act

(c) Adverse / Negative – accounts and financial statements as a whole do not present a true and
fair view
 Substantial departure from accounting principles
 Omission of a material disclosure

(d) Disclaimer – sufficient information to serve as the basis of opinion is not available

Characteristics of a good report

1. Sincerity of purpose
2. Clarity of thoughts
3. Accuracy
4. Simplicity
5. Brief
6. Coherent

List of Standards of Auditing Practice

SAP-1 Basic Principles Governing an Audit
SAP-2 Objective and Scope of the Audit of Financial Statements
SAP-3 Documentation
SAP-4 Fraud and Error
SAP-5 Audit Evidence
SAP-6 Study and Evaluation of the Accounting System and Related Internal
Controls in connection with an Audit
SAP-7 Relying Upon the Work of an Internal Auditor
SAP-8 Audit Planning
SAP-9 Using the Work of an Expert
SAP-10 Using the Work of Another Auditor
SAP-11 Representations by Management
SAP-12 Responsibility of Joint Auditors
SAP-13 Audit Materiality
SAP-14 Analytical Procedure
SAP-15 Audit Sampling
SAP-16 Going Concern
SAP-17 Quality Control for Audit Work
SAP-18 Audit of Accounting Estimates
43
 SAP-19 Subsequent Events
SAP-20 Knowledge of Business
SAP-21 Consideration of Laws and Regulations in an Audit of Financial
Statements
SAP-22 Initial Engagement – Opening Balances
SAP-23 Related Parties

COMPARISON OF ISAs

Comparison of International Standards on Auditing (ISAs), issued by the

International Federation of Accountants with Relevant Pronouncements of
the ICAI, issued as Statements on Standard Auditing Practices (SAPs) and
Guidance Notes

44
1.
2.
AAA
S. No. ISA
No.
100
120
Title of the ISA
(as of July 1, 2000)
Assurance Engagements
Framework of International
Relevant Pronouncement of the ICAI
(as of 26th September 2001)
Project under progress
Framework of Statements on Standard
Standards on Auditing Auditing Practices and Guidance Notes
on Related Services.
3. 200 Objective and General SAP 1 and SAP 2
Principles Governing an Audit
of Financial Statements
4. 210 Terms of Audit Engagements Guidance Note on Audit Engagement
Letters
5. 220 Quality Control for Audit SAP 17
Work
6. 230 Documentation SAP 3
7. 240 Fraud and Error SAP 4
8. 250 Consideration of Laws and SAP 21
Regulations in an Audit of
Financial Statements
9. 300 Planning SAP 8
10. 310 Knowledge of the Business SAP 20
11. 320 Audit Materiality SAP 13
12. 400 Risk Assessment and Internal Proposed SAP is under preparation
Control
13. 401 Auditing in a Computer Basic draft of the study has been placed
Information Systems for consideration of the Auditing
Environment Practices Committee
14. 402 Audit Considerations Relating Proposed SAP is under preparation
to Entities using Service
Organization
15. 500 Audit Evidence SAP 5
16. 501 Audit Evidence-Additional Separate Guidance Notes on Audit of
consideration for Specific Investments; Inventories; Debtors;
Items Loans and Advances; Liabilities
17. 505 External Confirmations Guidance Note on Audit of Debtors,
Loans and Advances
18. 510 Initial Engagements-Opening SAP 22
Balances
19. 520 Analytical Procedures SAP 14
20. 530 Audit Sampling and Other SAP 15
Selective Testing Procedures
21. 540 Audit of Accounting Estimates SAP 18
22. 550 Related Parties SAP 23
23. 560 Subsequent Events SAP 19
24. 570 Going Concern SAP 16
25. 580 Management Representations SAP 11
26. 600 Using the Work of Another SAP 10
Auditor
27. 610 Considering the Work of SAP 7
Internal Auditing
28. 620 Using the Work of an Expert SAP 9
29. 700 The Auditor‟s Report on Proposed SAP is under preparation
Financial Statements
30. 710 Comparatives Proposed SAP is under preparation
31. 720 Other Information in As per the decision of the Council, the 45
Documents Containing preparation of the SAP has been kept in
Audited Financial Statements abeyance for the time being
46