Chapter 1

Introduction to Auditing
*Evolution of Auditing * Objects of Auditing * Types of Auditing

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Introduction to Auditing
Definition of Audit:
The word audit is derived from the Latin word audire which means to hear. In past times, whenever the owner of a business suspected fraud, they appointed certain persons to check the accounts. Such persons sent for the accountants and heard whatever they had to say in connection with the accounts. According to J.R. Batliboi, a renowned authority on accounting and auditing defines auditing as an intelligent and a critical scrutiny of the books of account of a business with the documents and vouchers from which they are written up, for the purpose ascertaining whether the working results for a particular period, as shown by the Profit and Loss Account, as also exact financial condition of that business, as reflected in the balance sheet are truly determined and presented by those responsible for their collection.

Objects of an Audit:
(A)Main

Objective : (Expression of expert opinion)

Business concerns prepares balance sheet, P&L accounts to disclose the operating results of the period covered in the statement. These financial statements are submitted to the auditor for his checking and comment. Based on his checking in these respects, the auditor expresses his opinion about the quality of the financial statements and the true and fairness of the financial position and operating results of the enterprise, as disclosed in the balance sheet and P&L account respectively.

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(B) Secondary Objective: (Detection & Prevention of Errors)

1.

Clerical Errors: These errors are committed in posting, totaling and balancing. This errors can be subdivided into

(a) Errors of Omission: Where a transaction has not been recorded in the books of account either wholly or partially. It will not be easy to detect the error and it will not affect the trial balance. For example, purchases or sales have entirely been omitted to be entered and therefore there is neither a debit nor a credit entry exists. However, vouching of purchases and checking of stock book will show this type of error.
(b)

Errors of Commission: When a transaction has been recorded but has been wrongly entered in the books of original entry or posted in the ledger, errors of commission is said to have been made. For instance, a purchase of invoice for Tk.1,250 was entered in the purchase book as Tk.1,520. The main idea may be to misappropriate cash, in connection with the seller of the goods. Therefore, vouching should be done very carefully in order to detect such an error or fraud.
Errors of Principle: This type of errors occur when the entries are not recorded according to the fundamental principle of accountancy, e.g., wrong allocation of expenditure between capital and revenue, ignoring the outstanding assets and liabilities. Such errors may be committed either intentionally or unintentionally. Therefore, it is very important for an auditor to pay particular attention towards this type of errors. It can be detected only by a searching inquiry and independent checking. Compensating Errors or Off-setting Errors: A compensating error or off-setting error is one which is counter-balanced by any other error or errors. For example, Rahims account was to be debited for Tk.100 but was debited for Tk.10 while Karims account was to be debited for Tk.10 was debited for Tk. 100. Thus, both the account s have been debited for a total sum of Tk.110. However, an overcasting of an account may be counter-balanced by under-casting of another account to the same extent. These errors are most dangerous and are difficult to guard against. This type of error will not be detected by the trial balance and it will not affect the P&L Account as well.
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2.

3.

4.

Errors of Duplication: Such errors arise when an entry in a book of original entry has been made twice and has also been posted twice.

(C) Detection and prevention of Fraud: Fraud means false representation or entry made intentionally or without belief in its truth with a view to defraud somebody. The following are the main ways in which fraud may be detected:
i. Embezzlement of cash: In order to discover fraud the auditor should check the debit side of the cash book with rough cash book, salesmans report, counterfoils of the receipt book, reference to the vouchers, wages sheet, salary book and invoices. ii. Misappropriation of goods: This type of fraud is very difficult to detect especially when the goods are less bulky and higher value. Proper methods of keeping accounts in regard to purchases and sales, periodical stock taking, comparing the percentage of gross profit to sales of two periods will help to avoid misappropriation of goods. iii. Fraudulent manipulation of Accounts: This type of fraud is more difficult to discover as it is usually committed by directors or managers or other responsible officials with the object of (a) showing more profits than what actually they are in order to show to the shareholders more profits and thus maintain the confidence of the shareholders and later on sell them at high price by declaring higher dividends. Otherwise, to show the financial position of the business better than what actually it is. (b) by under-valuation or over-calculation of assets and liabilities. (c) by not providing any depreciation or providing less depreciation. (d) by showing fictitious sales or purchases or returns in order to show more profits or less profits whatever the case may be.

Evolution of Audit:
Modern auditing started in existence from the middle ages. It was an Italian, Luka Pacialo, who first published his Essay on double entry system of book-keeping for the first time in 1494. He mentioned and described the duties and Responsibilities of an auditor. It became popular and widely practiced in eighteen century during the Industrial evolution.

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Types of Audit:
The audit may be classified into six different ways are given below:
1.Legislative

Control-Statutory audit: Each country has its Auditor General. To audit the accounts of municipalities, universities, government banks, joint stock companies, insurance companies auditors are appointed by the constitution. The audit report of the Auditor General is laid before the Parliament for a debate on it.
2.Relation

of Auditor with the Management: The external auditor submits his report to the appointed authority e.g., shareholders of the company. Generally, the external auditor verifies the truth and fairness of financial information as reflected in financial statements of the business entity. On the other hand, internal auditor is usually appointed by management of the company. The internal auditor is not completely independent.
3.Periodicity

of Audit:

i. Continuous Audit: The auditor visits his clients at regular or irregular intervals during the financial year and checks each and every transaction. ii. Periodical Audit or Final Audit or Complete Audit: The auditor visits his client only once in a year and goes on checking the accounts until the audit work for the whole of the period is completed.
4.Subject 5.i.

matter of Audit: It may be complete audit or partial audit.

Financial Audit, ii. Cost Audit, iii. Operational Audit & iv. Management Audit.

6.Coverage Audit:

7. Manner of Checking: i. Standard Audit, ii. Balance Sheet Audit & iii. Vouch and Post Audit.

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Distinction between Accountancy and Auditing: 1. The book-keeper record the entries in the original books of account, the accountant analysis the accounts, prepares the trial balance, profit & loss account and balance-sheet whereas the auditor checks the books of account. 2. An accountant has to record the transactions in the books of account whereas an auditor has to check and verify such transactions and accounts prepared by an accountant. 3. The book-keepers or the accountants have not to find out whether there have been any errors or frauds. In contrast, the auditor has to detect such errors and frauds and to look if the balance-sheet and profit and loss account represent a true and fair view of the entity.

Advantages of an Audit:
1. Errors and frauds are located at an early date and no attempt is made in future to commit such frauds. Someone is rather careful not to commit any error or fraud as the accounts are subject to audit at regular intervals and hence they would be detected. 2. The auditing of accounts keeps the accounts clerks regular and vigilant as they know that the auditor would complain against them if the accounts are not prepared up to date or if there is any irregularity. 3. If a new partner is to be taken or one of the partners retires or dies, the audited balance-sheet will be a good basis to estimate the value of the goodwill thus avoiding the chances of dispute. 4. In the case of fire, the insurance company may settle the claims on the basis of the audited accounts of the previous year. 5. Money can borrowed easily from the commercial banks on the basis of the audited balance-sheet. 6. If the business is to be sold, price can be fixed on the basis of the audited balance-sheet. ---------END---------

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