INTRODUCTION TO AUDITING

The practice of auditing existed even in the Vedic

period. Historical records show that Egyptians,
Greeks and Roman used to get this public account
scrutinized by and independent official. Kautaly in
his book arthshastra has stated that all
undertakings depend on finance, hence foremost
attention should be paid to the treasury.
Auditing as it exists today can be associated with
the emerging a joint stock company during the
industrial revolution. The companys act of 1956
gives regulations regarding the audit work.

Meaning of Audit

The word audit is derived from the Latin word

AUDIRE which means to hear. Initially auditor
was a person appointed by the owners to check
account whenever the suspected fraud, he was
to hear explanation given by the person
responsible for financial transactions. Emergence
of joint stock companies changed the approach
of auditing as ownership was pestered from
management. The emphasis now is clearly on
the verification of accounting date with a view on
the reliability of accounting statement.

Definition
Spicer

and Peglar define auditing as An examination of the books, accounts and

vouchers of a businesss shall enable the auditor to satisfy himself whether or not
the balance sheet is properly drawn up so as to exhibit a true and correct view of
the state of affairs of the business according to his best of the information given to
him and as shown by the book.

Mautz:

defines auditing as being Concerned with the verification of accounting

data with determining the accuracy and reliability of accounting statements and
reports.

The

international auditing practices committee defines auditing as the

independent examination of financial information of any entity whether profit
oriented or not and irrespective of size/legal form when such an examination is
conducted with a view to express an opinion thereon.

Scope of Auditing

The scope of audit is increasing with the increase in the

complexities of the business. It is said that long range objectives
of an audit should be to serve as a guide to the management
future decisions.

Today most of the economic activities are largely conducted

through public finance. The auditor has to see whether these
larger funds are properly used. The scope of audit encompasses
verification of accounts with a intention of giving opinion on its
reliability. Hence it covers cost audit, management audit, social
audit etc. It should be remembered that an auditor just
expressed his opinion on the authenticity of the account. He has
no power to take action against anybody, in this regard its said
that an auditor is a watch dog but not a blood hound.

Objectives of Auditing

Auditors are basically concerned with verifying whether the account

exhibit true and fair view of the business. The objectives of auditing
depends upon the purpose of his appointment.

Primary Objective.
1. Promoting Efficiency
2. Promoting Accuracy
. The primary objective of an auditor is to respect to the owners of his
business expressing his opinion whether account exhibits true and fair
view of the state of affairs of the business. It should be remembered
that in case of a company, he reports to the shareholders who are the
owners of the company and not tot the director. The auditor is also
concerned with verifying how far the accounting system is successful in
correctly recording transactions. He had to see whether accounts are
prepared in accordance with recognized accounting policies and
practices and as per statutory requirements.

Secondary Objectives

Detection and prevention of errors: errors are mistakes committed

unintentionally because of ignorance, carelessness. Errors are of many
types:
Errors of Omission: These are the errors which arise on account of transaction into

being recorded in the books of accounts either wholly partially. If a transaction has been
totally omitted it will not affect trial balance and hence it is more difficult to detect. On the
other hand if a transaction is partially recorded, the trial balance will not agree and hence
it can be easily detected.
Errors of Commission: When incorrect entries are made in the books of accounts either
wholly, partially such errors are known as errors of commission. Eg: wrong entries, wrong
Calculations, postings, carry forwards etc such errors can be located while verifying.
Compensating Errors: when two/more mistakes are committed which counter balances
each other. Such an error is know an Compensating Error. Eg: if the amount is wrongly
debited by Rs 100 less and Wrongly Credited by Rs 100 such a mistake is known as
compensating error.
Error of Principle: These are the errors committed by not properly following the
accounting principles. These arise mainly due to the lack of knowledge of accounting. Eg:
Revenue expenditure may be treated as Capital Expenditure.
Clerical Errors; A clerical error is one which arises on account of ignorance, carelessness,
negligence etc.

Location of Errors: It is not the duty of the auditor to identify

the errors but in the process of verifying accounts, he may
discover the errors in the accounts. The auditor should follow
the following procedure in this regard.

Check the trial balance.

Compare list of debtors and creditors with the trial
balance.
Compare the names of account appearing in the ledger
with the names of accounting in the trial balance.
Check the totals and balances of all accounts and see
that they have been properly shown in the trial balance.
Check the posting of entries from various books into
ledger.

Secondary objectives

Detection and Prevention of Fraud: A fraud

is an Error committed intentionally to deceive/ to
mislead/ to conceal the truth/ the material fact.
Frauds may be of 3 types.
Misappropriation of Cash: This is one of the majored

frauds in any organisation it normally occurs in the cash

department. This kind of fraud is either by showing more
payments/ less receipt.

The cashier may show more expenses than what

is actually incurred and misuse the extra cash.
Eg: showing wages to dummy workers. Cash can
also be misappropriated by showing less receipts

Eg: not recording cash sales. Not allowing

discounts to customers. The cashier may also
misappropriate the cash when it is received.
Cash received from 1st customer is misused
when the 2nd customer pays it is transferred
to the 1st customers account. When the 3rd
customer pays it goes forever. Such a fraud is
known as Teaming and Lading. To prevent
such frauds the auditor must check in detail
all books and documents, vouchers, invoices
etc.

 Misappropriation of Goods: here records may be made for the

goods not purchase not issued to production department, goods

may be used for personal purpose. Such a fraud can be deducted
by checking stock records and physical verification of goods.
Manipulation of Accounts: this is finalizing accounts with the
intention of misleading others. This is also known as WINDOWS
DRESSING. It is very difficult to locate because its usually
committed by higher level management such as directors. The
objective of WD may be to evade tax, to borrow money from bank,
to increase the share price etc.

To conclude it can be said that, it is not the main

objective of the auditor to discover frauds and
irregularities. He is not an insurance against frauds and
errors. But if he finds anything of a suspicious nature,
he should probel it to the full.

Features of an Audit

Systematic process: Auditing is a systematic and scientific process

that follows a sequence of activities, which are logical, structured,
and organized.
Three party relationships: The audit process involves three
parties, that is, shareholders, managers, and the auditors.
Subject matter: Auditors give assurance on a specific subject
matter. However, the subject matter may differ considerably, such as
data, systems or processes and behavior.
Evidence: Auditing process, requires collecting the evidence, that is,
financial and non-financial data, and examining thereof.
Established criteria: The evidence must be evaluated in terms of
established criteria, which include International Accounting
Standards, International Financial Reporting Standards,
Generally Accepted Accounting Principles, industry practices, etc.
Opinion: The auditor has to express an opinion as to the reasonable
assurance on the financial statements of the entity.

Characteristics of Audit

Audit is a systematic and scientific examination of the books of accounts

of a business;
Audit is undertaken by an independent person or body of persons who
are duly qualified for the job.
Audit is a verification of the results shown by the profit and loss account
and the state of affairs as shown by the balance sheet.
Audit is a critical review of the system of accounting and internal control.
Audit is done with the help of vouchers, documents, information and
explanations received from the authorities.
The auditor has to satisfy himself with the authenticity of the financial
statements and report that they exhibit a true and fair view of the state
of affairs of the concern.
The auditor has to inspect, compare, check, review, scrutinize the
vouchers supporting the transactions and examine correspondence,
minute books of share holders, directors, Memorandum of Association
and Articles of association etc., in order to establish correctness of the
books of accounts.

ADVANTAGES OF AUDIT

Audited account are detected as an authentic record

of transaction.
Errors and frauds are detected and rectified.
It increases the morale of the staff and thus it
prevents frauds and errors.
Because of his expertise the auditor may advise on
various matters to his clients.
An auditor acts as a trustee of his shareholders.
Hence he safeguards their financial interest.
For taxation purpose auditing of account is a must.
In case of any claim is to be made from the insurance
company only audited account should be submitted.

ADVANTAGES OF AUDIT

Even in case of partnership firm auditing of

accounts helps in the settlement of claim at the
time of retirement/death of a partner.
Auditor account helps in managerial decisions.
They are useful to secure loan at the of
amalgamation, absorption, reconstruction etc.
Auditing safeguards the interest of owners,
creditors, investors, and workers.
It is useful to take certain financial decisions like
issuing of shares, payment of dividend etc.

TYPES OF AUDIT

Statutory Audit: any audit carried on as per the requirement of law

is called as a statutory audit. eg: all companies have to get their
accounts audited as per the provision of the companys Act of 1956.
Periodical/ Annual Audit: it is a kind of audit where the auditor
verifies the account at the end of the financial year. He starts the
audit work after the closure of financial year. This is a common audit
and is mostly used by small organizations.
Interim audit: its an audit conducted in the middle of the
accounting year before the accounts are closed. In other words any
audit conducted between two financial audit is known s interim audit.
The objective is to get periodical results, to declare interim dividend.
Partial Audit: when an auditor is asked to audit only a part of the
account system. Its called partial audit. Eg: he may be asked to audit
only the payment side of cash book.

TYPES OF AUDIT

Balance sheet audit: its a kind of partial audit and is concerned with the verification of
only those items appearing in the Balance Sheet. It is more popular in the USA. In fact while
verifying BS items the auditor verifies/ checks all related items/accounts.

Cost audit: cost audit is defined as the verification of cost accounting records. Data and
techniques for its accuracy and authenticity. It gets as effective managerial tool for the
detection of errors and frauds in cost accounting records. The companies act implies the
central government to order cost audit incase of specifies companies.

Management audit: Management audit may be defined as a comprehensive examination of

an organizational structure of a company, institution/government and its plans and objectives
it means of operations and use of human and physical facilities. The main objective of mgt
audit is to see how far the objectives of mgt are fulfilled. It aims to ascertain whether sound
mgt prevails throughout the organisation and evaluates its efficiency in the system of its
operation.

Continuous audit: a continuous audit is one in which the auditor visits his clients office at
regular intervals through out the year to verify the account. The objective of CA may be To get final account audited immediately after the closure of accounting year.
When the business is very large.
When interval control system is into effective.
When regular final accounts are required.

ADVANTAGES:
. Errors and frauds are discovered and rectified quickly.
. The chances of fraud are reduced.
. The workers will be careful in their work.
. Continuous audit acts as a valuable morale check on the staff.
. Final audit becomes easier and faster.
. If the company wants to declare interim dividend its easier to prepare interim
account.
. It increases the efficiency and accuracy in the accounts.

DISADVANTAGES:
After the auditors visit is over, alternative may be made.
It affects the regular work.
Its not suitable for small organizations.
The auditor may loose the line of work if he does not complete
his work in a visit.

Precautions to be taken for

continuous audit

Auditor should record important balances, totals

etc and verify the same in his next visit.
Strict instructions should be given prohibiting the
alteration of figures after checked by the auditor.
For each visit special ticks should be used.
Its always better to verify the nominal account at
the end of the year.
An exhaustive audit programme must be prepared.
He should ensure that normal working is not
affected.
As far as possible, he should pay surprise visits.

Preparation before
commencement of the audit

An auditor after receiving the appointment letter should

communicate his acceptance/otherwise in writing to the company.
The following steps are necessary to commence the audit work:

If it is not a statutory audit, he should find out the exact nature

and scope of his duties i.e., whether he has to audit the
account/prepare accounts also.
He should inform his clients to close all the books of account and
keep them ready for verification.
He should acquaint himself with the nature of his client business.
He should examine the efficiency of the internal control system.
He should obtain the names of directors their power duties etc.
He should obtain a complete list of all books and documents
maintained by the clients.
He should obtain a copy of previous years audit report.
He should go through various documents like MOA, AOA,
prospectus etc.

Relationship between Book-keeping,

Accountancy and Auditing

Book keeping: it is concerned with

recording of transactions in the books of
original entry and their posting to the
concerned ledger accounts. It involves
following activities:A) journalize the transactions
B) posting them into respective ledger
accounts
C) casting the total of ledger accounts
and finding the balances

Accountancy: it is concerned with

checking of arithmetical accuracy of
ledger accounts as prepared by the
book keeper and preparing the trial
balance available of different ledger
accounts. Finally profit and loss A/C and
balance sheet are prepared to know
the financial result and financial
position of the concern.

Auditing: when the accountancy work is

completed, an auditor is invited to check the
accounts prepared by the accountants. Auditing
begins where accountancy ends. It is duty of the
auditor to critically examine and verify the
accounts. After this, the auditor has to submit a
report of the fact whether or not the P.&L.A/C
exhibits true and fair financial result of the
organization and also the balance sheet reflects
the true and fair financial position of the
organization.

Accountancy Vs Auditing

Scope
Objectives
Status
Qualification
Remuneration
Tenure of service
Knowledge of other subjects
Ranking of activities
Time period of work
Professional control
Nature of work
Submission of report
Accountability

Relationship between auditing with

other subjects

Auditing and Accounting

Auditing and Statistics and
Mathematics
Auditing and Behavioral Science
Auditing and Law
Auditing and Economics
Auditing and Management
Auditing and Computer Applications

Limitations of auditing

Want of complete picture

Problems of dependence
Post mortem examination
Existence of errors in audited accounts
Lack of expertise
Diversified situations
Quality of the auditor
Existence of the defective policies
Most audit evidence is persuasive rather than conclusive.
For smaller companies, hiring a firm to carry out an audit
can be costly.
Investment may be discouraged by a bad auditing.

Disadvantages of audit
The main issue for accountants is there are some certain limitations to assurance services and for
that reason there is always a risk involved that the wrong conclusion will be drawn. Assurance can
never be absolute. Assurance providers will never give a certification of absolute correctness due
to the limitations set out below:

Testing is used the auditors do not oversee the process of building the financial statements from
start to finish.

The accounting systems on which assurance providers may place a degree of reliance also have
inherent limitations.

Assurance providers may sometime not test the entire item in the every subject matter.

The clients staff members may collude in fraud that can then be deliberately hidden from the
auditor or misrepresent matters to them for the same purpose.

Assurance provision can be subjective and professional judgments have to be made. For
example, about what aspects of the subject matter are the most important, how much evidence to
obtain etc.

Assurance providers rely on the responsible party and its staff to provide correct information,
which in some cases may be impossible to verify by other means.

Some items in the subject matter may be estimates and are therefore uncertain. It is impossible to
conclude absolutely that judgmental estimates are correct.

The nature of the assurance report might itself be limiting, as every judgment and conclusion the
assurance provider has drawn cannot be included in it.

It does not take into account the productivity and the skills of the employees of the business.

BASIC PRINCIPLES GOVERNING AN

AUDIT

SA 200 Basic Principals Governing an Audit,

describes the basic principles which govern the
auditors professional responsibilities and which should
be complied with wherever an audit is carried. They
are described below:
(i) Integrity, objectivity and independence: An auditor
should be honest, sincere, impartial and free from bias.
He should be a man of high integrity and objectivity.
(ii) Confidentiality: The auditor should respect
confidentiality of information acquired during the
course of his work and should not disclose the
information without the prior permission of the client,
unless there is a legal duty to disclose.

Standard on Auditing 200

(iii) Skill and competence: The auditor must acquire adequate training and
experience. He should be competent, skillful and keep himself updated of the
latest developments including pronouncements of ICAI on accounting and
auditing matters.
(iv) Work performed by others: If the auditor delegates some work to others and
uses work performed by others including that of an expert, he continues to be
responsible for forming and expressing his opinion on the financial information.
(v) Documentation: The auditor should document matters which are important in
providing evidence to ensure that the audit was carried out in accordance with
the basic principles.
(vi) Planning: The auditor should plan his work to enable him to conduct the audit
in an effective, efficient and timely manner. He should acquire knowledge of
clients accounting system, the extent of reliance that could be placed on internal
control and coordinate the work to be performed.
(vii) Audit evidence: The auditor should obtain sufficient appropriate evidences
through the performance of compliance and other substantive procedures to
enable him to draw reasonable conclusions to form an opinion on the financial
information.

(viii) Accounting System and Internal Control: The management is responsible for
maintaining an adequate accounting system incorporating various internal controls
appropriate to the size and nature of business. The auditor should assure himself
that the accounting system is adequate and all the information which should be
recorded has been recorded. Internal control system contributes to such assurance.

(ix) Audit conclusions and reporting: On the basis of the audit evidence, he should
review and assess the audit conclusions. He should ascertain:
1. As whether accounting policies have been consistently applied;
2. Whether financial information complies with regulations and statutory
requirements; and
3. There is adequate disclosure of material matters relevant to the presentation of
financial information subject to statutory requirements.

The auditors report should contain a clear written opinion on the financial
information. A clean audit report indicates the auditors satisfaction in all respects
and when a qualified, adverse or a disclaimer of opinion is to be given or
reservation of opinion on any matter is to be made, the audit report should state
the reasons thereof.

True and Fair View

The main object of audit is to find out whether the financial statements
prepared by a company show the true and fair view of the financial state
of affairs of a company and if not then in what respect they are not
showing. The accounts are said to be true and fair:

1. The books of account have recorded all the business transaction

correctly.
2. The books of account have been prepared according to the accepted
principles of accountancy and have followed accounting standards issued
by different regulatory bodies.
3. There are no errors and frauds present in the books of account.
4. The financial statements that have been prepared by the company are
in conformity with the books of accounts and all mandatory provisions of
companies Act and other relevant laws have been followed:
5. The profit and loss shown in the profit and loss account shows the true
and fair results of entitys operations and the value of assets and liabilities
appears in the balance sheet is showing the correct financial picture.

6. The books of accounts must disclose all material facts regarding revenue,
expenses, assets and liabilities. Material means important and essential. The
disclosure of important matters in the accounts helps the users in taking business
decisions. There should be neither suppression of vital facts nor mis-statements.

What constitutes true and fair is not defined under any law. In order to show a
true and fair view the auditor should ensure that:
1. The final accounts (Trading and Profit and loss Account and Balance Sheet)
agree with the books of accounts.
2. The closing stock is physically verified and valued properly.
3. Intangible assets like goodwill, patents, preliminary expenses or other deferred
revenue expenses are valued and written off properly.
4. Expenses/income of Capital nature is not treated as revenue and vice versa.
5. Contingent liabilities are not treated as actual liabilities and vice versa
6. Provision is made for all known losses and liabilities
7. Transactions are recorded on accrual basis, i.e. outstanding expenses, prepaid
expenses, income accrued and advance income is recorded properly
8. The exceptional or non-recurring transactions are disclosed separately in the
accounts

AUDIT AND INVESTIGATION

1. Legal binding: Audit of annual financial statements of a company is

compulsory under the Companies Act, 1956. However, Investigation is not
compulsory under the Companies act, 1956 but voluntary depending upon
necessity.
2. Object in view: Audit is conducted to ascertain whether the financial
statements show a true and fair view. Investigation is conducted with a
particular object in view, viz to know financial position, earning capacity,
prove fraud, invest capital, etc.
3. Period covered: Audit is conducted on annual basis. Investigation may be
conducted for several years at a time, say three years.
4. Parties for whom conducted: Audit is conducted on behalf of shareholders
(or proprietor, or partners). Investigation is usually conducted on behalf of
outsiders like prospective buyers, investors, lenders, etc.
5. Documents: Audit is not carried out of audited financial statements.
Investigation may be conducted even though the accounts have been
audited.
6. Extent of work: Audit is normally conducted on test verification basis.
Investigation is a thorough examination of books of accounts.
7. Report: Audit report of a company is addressed to shareholders (or
proprietors or partners). Investigation report is addressed to the party on
whose instruction investigation was conducted.
8. Person performing work: Audit is to be conducted by a person having

Generally Accepted Auditing Principles

or Auditing Assurance Standards

The International Federation of Accountants (IFA) came

into existence in 1977 and constituted International
Auditing Practices Committee (IAPC) to formulate
International Auditing Guidelines. These guidelines
were later converted into International Standards on
Auditing(ISA). Because of development in the field of
auditing at international level , the Institute of
Chartered Accountants of India(ICAI) constituted the
Auditing Practices Committee (APC) on September 17,
1982, to spearhead the new framework of Statements
on Standard Auditing Practices(SAP) and Guidance
notes to replace old SAPs issued in 1964.

In July 2002, the APC converted into an

Auditing and Assurance Standards Board
by the council of the ICAI to be in line with
the International trend. A significant step
has been taken aimed at bringing in the
desired transparency in the working of the
AASB through participation of
representatives of various segments of
the society and interest groups, such as
regulators, industry and academics.

Objectives and Importance

Codification of Auditing Practices

Ensure effective auditing practices
Guidance to the auditors
Uniform presentation of accounts
Prevention of accounting scandals
It is the duty of the auditor to ensure that audit is
conducted in accordance with the AAS. The auditor
becomes liable to the disciplinary preceding of the ICAI
under clause (9) of Part 1 of II Schedule to the CA Act,
1949. The auditor has to mention in his report that he
has conducted the audit in accordance with the GAAP,
i.e. AAS