PRACTICAL AUDITING - INTRODUCTION

SEMESTER:V

22UCOME55-2: Practical Auditing

 

 

Introduction                                                                         

Meaning and Definition of Auditing - Nature and Scope of Auditing - Accountancy and Auditing, Auditing and Investigation - Objectives of auditing - Limitations of audit - Advantages of audit – Classification of audit. 

Meaning of Auditing

The word Audit is derived from Latin word “Audire” which means ‘to hear’.  Auditing is the verification of financial position as disclosed by the financial statements.  It is an examination of accounts to ascertain whether the financial statements give a true and fair view financial position and profit or loss of the business.  It is a systematic, intelligent, scientific, critical and thorough examination of books of accounts of a business by an independent or body of persons qualified for the job

Definition of Auditing

L.R.Dicksee - “Auditing is an examination of accounting records undertaken with a view to establishment whether they correctly and completely reflect the transactions to which they purport to relate.”

Montgomery – “Auditing is a systematic examination of the books and records of a business or. Other organization, in order to ascertain or verify and report upon the facts regarding its financial. Operation and the result thereof.”

Nature and Scope of Auditing

The Nature and scope of an audit is the determination of the range of the activities and the period of records that are to be subjected to an audit examination. The auditor can determine the scope of an audit of financial statements in accordance with the requirements of legislation, regulations or relevant professional bodies. It can be briefed as follows:

 

1.       SYSTEMATIC AND SCIENTIFIC EXAMINATION OF BOOKS

 Auditing is a systematic and scientific examination of the books of accounts and financial statement.

 

2.       INSPECTION, CHECKING, VERIFICATION AND SCRUTINY

Auditing involves inspecting, comparing, checking, reviewing, ascertaining, scrutinizing, examining and verifying the vouchers supporting the transactions.

 

3.       VERIFICATION OF ASSETS AND LIABILITIES

Auditing implies even the verification i.e., the physical inspection of the assets and liabilities of the business as shown in the Balance Sheet.

 

4.       EXAMINATION OF THE BOOKS OF ACCOUNTS

 Auditing is the examination of the books of accounts of a business prepared by others by an independent person or body of persons.

 

5.       EXAMINATION OF BOOKS OF ACCOUNTS BY A QUALIFIED PERSON

Auditing has to be done by a qualified person and have knowledge about Auditing.

 

6.       EXAMINATION ON THE BASIS OF DOCUMENTARY EVIDENCES

Auditing has to be done with the help of documentary evidence like invoices, receipts, vouchers, debit note, credit notes and other documents and the information and explanations given by the person in charge of maintenance of accounts.

 

7.       PERIOD OF EXAMINATION

Auditing or examination of the accounts of the business may be made throughout the year or periodically.

 

8.       EXAMINE AUTHENTICITY AND ACCURACY

Audit examination is made for the purpose of ascertaining whether the financial figures found in the books of accounts and the financial statements are authentic and accurate.

 

9.       APPLIES TO BUSINESS AND NON-BUSINESS CONCERN

Auditing is necessary for all economic unit or organization. It may be business or non-business concern.

 

10.   EXPRESSION OF OPINION

Here the auditor has to report to the person who have appointed him for auditing

 

Accountancy and auditing

BASIS	ACCOUNTANCY	AUDITING
Meaning	Accounting is concerned with preparation of financial statements such as trading, profit and loss account and balance sheet	Auditing is concerned with analytical and critical examination of the books of accounts and financial statements.
Objective	The main objective of accounting is to ascertain the financial position at the end of the financial period.	The main objective of auditing is to verify and certify the correctness of accounts and financial statements. prepared by the accountant
Scope	The scope of accounting work is mainly the preparation of the financial statements and their analysis and interpretation	The scope of auditing work is defined by the agreement between the auditor and his client
Qualification	An accountant need not be a Chartered Accountant	An auditor must be a Chartered Accountant
Commencement of Work	When Book-keeping records are completed, they become they become available for the beginning of works of accountancy. In other words, Accountancy starts where book-keeping ends.	The work of auditing starts, only when the work of accountancy has been completed. In other words, where accountancy ends auditing starts.
Expert	An accountant need not be expert in the work of auditing	An auditor must have thorough knowledge of principles of  accountancy otherwise he cannot perform his job satisfactorily
Working period	Accounting work is under - taken throughout the year.	Auditing is generally done at the end of financial year.
Nature of Employment	An accountant is a permanent employee of the business concern.	An auditor is not a permanent employee of the concern. He may be changed from year to year.
Report	An accountant is not required to submit a report to the proprietor of the concern when the accounting works is over.	An auditor is required to submit the report to the proprietor after the completion of his audit works.
Types of Transactions	Accounting is current recording of business transactions	Auditing is essentially the examination of past recorded transactions.

Meaning of Investigation                                       

Investigation is considered to be an enquiry which is conducted for establishing a specific truth or fact about that entity. Investigation implies an enquiry into the accounts and records of a business concern.  In other words, the purpose of such enquiry is to ascertain the true financial position of the normal business concern or its normal profit earning capacity or the extend of frauds.

Investigation  and auditing

BASIS	INVESTIGATION	AUDITING
Meaning	Investigation is done for some specific purpose according to the necessity of the situation	The object of audit of account is to ascertain whether the balance sheet of the concern shows the true and fair view of the state of affairs of the concern or not
Legacy	The investigation of books of accountant records is not legally compulsory	Audit is compulsory in case of Joint Stock Companies
Objective	Investigation is a thorough examination of books of accounts for a particular period	In case of Audit, it is usually carried out in the form of test checking
Period	Investigation of books of records and records may cover three to seven years	Audit of books of Accounts is for six months or for a full year
Time of conduct	Investigation is usually carried on when the books of account are already subjected to regular audit.	It is not so with regard to audit except in the case of special audit of a Joint Stock Company under section 233A of the Companies Act, 1956
Initiating Party	Investigation may be carried out on behalf of proprietor or on behalf of the third parties	Audit is carried out on behalf of the proprietor of the business concern.
Necessity	The investigation report is prepared according to the necessity of situation	The audit report is prepared according to the Act.
Performed by	Performed by investigators or forensic accountants who may have specialized skills in examining specific issues. Such as detecting fraud, irregularities, or specific concerns.	Performed by auditors, usually certified public accountants (CPAs) or chartered accountants (CAs), who are trained to systematically review financial statements

 

 

 

 

Objectives  of  Auditing

The objective of an audit may be classified as

1.       Primary Objective

2.       Subsidiary Objective

3.       Specific Objective

 

1.      Primary Objective

To ensure that the primary objective of audit is achieved, an auditor must ;

a)      Examine the Internal Control and Internal Check.

b)      Verify whether all the books of accounts as required by law are kept.

c)       Verify whether proper accounting principles and procedures are followed.

d)      Check the arithmetical accuracy of the books of accounts.

e)      Verify the authenticity and validity of the transactions.

f)       Confirm the existence and the values of the assets and liabilities by physical verification.

g)      Find out whether the financial statement is properly drawn up.

h)      Report whether the profit and loss gives a true and fair view of the profit or loss for the year and Balance sheet gives a true and fair view of the financial position of the business at the end of the financial year.

 

2.      Subsidiary Objective

   Subsidiary objectives of auditing are :

                    I.            Detection and Prevention of errors

                  II.            Detection and Prevention of frauds

Detection and Prevention of errors (I)

Errors refer to unintentional mis-statements in the records of books. Errors are two types namely

a)      Clerical or Technical errors

b)      Errors of Principle

 

a)     Clerical (or) Technical errors

Clerical errors refer to all types of errors committed on account of clerical mistakes.

They are :

 

                    i.            Errors of omission

An error of omission is one which arises when a transaction has been omitted to be recorded in the books of accounts either wholly or partially. An error of omission may be

 

a) Complete omission

b) Partial omission

 

                  ii.            Errors of Commission

Errors of commission refer to errors committed in the process of posting from the subsidiary books to the ledger accounts, casting, carry forward and balancing of ledger accounts.  Some of the errors of commission will not affect the agreement of the trial balance.

 

                iii.            Compensating errors

When the effect of one error is counter balanced, set off or compensated by another error, the errors are known as compensating errors or offsetting errors. Compensating errors do not affect the agreement of the trial balance, as they are counter balanced or set off.

 

                 iv.            Errors of duplication

Errors of duplication arise when an entry in a book of original entry has been made twice and also been posted twice

 

b)     Errors of  Principle

An error of principle arises when the generally accepted principles of accountancy are not observed, while recording a transaction in the books of account

 

Detection and Prevention of Fraud (II)

It is intentional or willful representation or deliberate concealment of material fact with a view to deceive, cheat or mislead somebody. Fraud may be broadly classified into three types. They are

(a)    Misappropriation of cash

Misappropriation of cash means the fraudulent appropriation of cash belonging to another person by whom it has been entrusted

 

EG :  ^ By misappropriating the receipt by not recording the same in the Cashbook.

         ^  By entering lesser amount on the counterfoil.

         ^  By recording fictitious or false cash purchase and pocketing the amount.

(b)   Misappropriation of goods

This type of fraud is very difficult to detect especially when the goods are less bulky and are of higher value. Proper methods of keeping accounts in regard to purchases and sales, stock, taking, periodical checking of stocks, comparing the percentage of gross profit to sales of two periods, necessity for collusion will help to avoid misappropriation of goods.

 

(c)    Manipulation of accounts

Manipulation of accounts means  falsification of accounts without any misappropriation of cash or goods. It implies presentation of accounts more favorably than what they actually are.

Manipulation of accounts may be done in any of the following ways :

 

§  Non provision of depreciation on fixed assets.

§  Provision of less depreciation on fixed assets

§  Provision of more depreciation on fixed assets

§  Over valuation of asset

§  Window dressing

 

3.      Specific Objective

Audit which is conducted on specific area is called specific audit. Such as,

·         Operations audit

·         Cost audit

·          Management audit etc.

 

 

Advantages  of  Auditing

1.       Advantages of Auditing to the business enterprise and Management

2.       Advantages of Auditing to the Owner of the business

3.       Advantages of Auditing to Others

 

1.       Advantages of Auditing to the business enterprise and Management

a)      Ensure Correctness

Audit ensures the accuracy or correctness of the books of accounts.

 

b)      Ensure Authenticity

Audit ensures the authenticity and reliability of the financial Statements.

 

c)       Rectification

Audit helps in the detection and rectification of errors and frauds.

 

d)      Ensures Legal Requirements

Audit helps the enterprise and management to ascertain whether the legal requirements are complied with.

 

e)      Liability determination

Liability of an enterprise as to income tax, wealth tax, and value added tax etc can be easily determined on the basis of audited accounts.

 

f)       Increases Reputation

A business can enjoy better reputation, if its accounts are audited by an independent professional auditor.

 

g)      Acts as a Evidence

Audited accounts are more reliable as evidence in the courts of law.

 

h)      Finds Purchase Consideration

Facilitates calculation of purchase consideration.

 

 

2.       Advantages of Auditing to the Owner of the business

a)      For Sole Trading Concern

In the case of a sole trader, auditing assures him that all business transactions have been duly accounted and there are no errors or frauds. It also helps him to know the true facts about the business.

 

 

b)     For Partnership Firm

In the Case of Partnership firm, audited accounts serve as an evidence of proper management of the affairs of the business. Audited accounts are helps in the valuation of goodwill and settlement of accounts on the admission, retirement or dead of a partner. Again Audited accounts minimize the chances of disputes among the partners.

 

c)      For Joint stock Company

 In the case of a joint stock company, audit of accounts assures the shareholders that the affairs of their company are smoothly and their investment is safe. The shareholders of a company can value their shares on the basis of audited accounts.

 

d)     For Co-operative society

In the case of a co-operative society or a trust, audit assures the members or the beneficiaries that the affairs of the society or trust are conducted properly and their investment are looked after properly.

 

3.       Advantages of Auditing to the Others

a)      For Lenders

 Lenders can depend on audited financial statements while taking a decision to grant credit to the business concern.

 

b)     For Tax authorities

Tax authorities can depend on audited statements in assessing sales tax, income tax and wealth tax of business.

 

c)      For Tax authorities

Audit of accounts safeguards the interests of the workers and is helpful in the settlement of claim for higher wages and bonus.

 

d)     For Insurance Company

Insurance company can rely on audited accounts to settle claims in respect of damage or loss of any business asset by fire, theft etc

 

e)      For Joint stock Company

Audited accounts create confidence in the minds of investor’s joint stock company

Limitations  of  Auditing

a)      Non-detection of errors or frauds

Auditor may not be able to detect certain frauds which are committed by the clients.

 

b)     Dependence on explanation by others

Auditor has to depend on the explanation and information given by the responsible officers of the company. Audit report is affected adversely if the explanation and information prove to be false.

c)       Dependence on opinions of others  

Auditor has to rely on the views or opinions given by different experts viz Lawyers, Solicitors, Engineers, Architects etc, he cannot be an expert in all the fields.

 

d)     Conflict with others

Auditor may have differences of opinion with the accountants, management, engineers etc. In such a case personal judgment plays an important role. It differs from person to person.

 

e)      Effect of inflation

Financial statements may not disclose true picture even after audit due to inflationary trends.

 

f)       Corrupt practices to influence the auditors

The management may use corrupt practices to influence the auditors and get a favourable report about the state of affairs of the organization.

 

g)     No assurance

Auditor cannot give any assurance about future profitability and prospects of the company

 

h)     Inherent limitations of the financial statements

Financial statements do not reflect current value of assets and liabilities. Many items are based on personal judgments of the owners. Certain non-monetary facts cannot be measured. Audited statements due to these limitation cannot exhibit true position.

 

i)        Detailed Checking not possible

Audit cannot check each and every transaction. He may be required to do test checking.

 

 

Classifications  of  Auditing

Audit can be classified on  different ways :

 

1.       Classification of Audit on the basis of Organization structure

2.       Classification of Audit on the basis of Degree of independence of the auditor

3.       Classification of Audit on the basis of method or approach to audit work or on the basis of extent of work to be performed or on the basis of conduct of audit.

 

4.       Classification of Audit on the basis of Specific objective.

 

 

1.       Classification of Audit on the basis of Organization structure

 On the basis of organization structure, audit may be classified into three types. They are

a)      Statutory Audit

b)     Government Audit

c)      Private Audit

 

a)      Statutory Audit

Statutory audit refers to the audit of accounts of a business enterprises carried out compulsorily under the provisions of a statute or law.

 

b)      Government Audit

Government audit refers to the audit of accounts of Government departments and offices, Government companies and statutory or public corporations. Government audit may be further classified into three types:

 

·         Audit of government departments and offices.

·         Audit of government companies.

·         Audit of statutory corporations registered as statutory corporations.

 

c)      Private audit or Voluntary audit

Where an audit is not compulsory under any statute, but is undertaken by the owners voluntarily to get the benefit of audit, the audit is called private audit

 

2.       Classification of Audit on the basis of Degree of independence of the auditor

a)      Internal Audit

b)     External Audit

 

a)      Internal audit

Internal audit is a continuous and systematic review of the accounting, financial and other operations of a concern by the staff specially appointed for the purpose. In other words, it is the audit of accounts by the staff specially appointed for the purpose.

 

b)     External audit

Audit conducted by independent qualified person and examines the books of accounts and report to the management.

 

 

3.       Classification of Audit on the basis of method or approach to audit work or on the basis of extent of work to be performed or on the basis of conduct of audit.

Under the classification of basis of method or basis of conduct of audit, audit may be classified into seven types. They are

a)      Continuous audit

b)     Final audit or annual or periodical audit

c)      Interim audit

d)     Balance sheet audit

e)      Complete audit

f)       Occasional audit

g)      Partial audit

 

a)      Continuous audit

Continuous audit is one where the auditor's staff is occupied continuously on the accounts whole the year round and performs interim audit. It is generally applicable to banking company and insurance company.

 

b)     Final Audit

It is an audit carried out after the preparation of financial statement. It is an audit where the auditor takes up his work of checking the books of accounts only at the end of the accounting year. In this case, the audit work is commenced and completed in a single uninterrupted session.

 

c)      Interim Audit

It is an audit conducted between two annual audits. In other words, it is the audit conducted in the middle of the financial year. It is carried out for some specific purpose for declaring interim dividend, ascertaining interim profit.

 

d)     Balance sheet audit

Balance sheet audit is a type audit which concentrates mainly on the verification of the items in the balance sheet such as capital, reserves, profit and loss account balance, liabilities and provisions and all the assets of the business.

 

e)      Complete Audit

Complete audit is a kind of audit under which all the records and books of accounts are audited by auditor.

 

f)       Occasional Audit

An occasional audit is an audit which is conducted once a while, whenever the need arises. In other words, it is a kind of audit which is not conducted on regular basis, but is conducted for a special event, time or purpose

 

g)     Partial Audit

It is a kind of audit the scope of which is limited one. It is carried out in respect of only a part of the books of accounts of a business, for a part of whole of the period.

 

4.       Classification of Audit on the basis of Specific objective.

Under this Classification audit may be further classified into nine types.

They are

 

a)      Cash audit

b)     Special audit

c)      Operational audit

d)     Proprietary audit

e)      Efficient audit

f)       Tax Audit

g)      Cost audit

h)     Management audit

i)       Social audit

 

a)      Cash Audit

It is a type of partial audit which is undertaken for only cash receipts and cash payment.

 

b)     Special Audit

It is a kind of audit with some special object in view. It is a fact finding enquiry.

 

c)      Operational Audit

It is an efficient examination of the various operations of the different functional area of business.

 

d)     Proprietary audit

It is an audit in which various actions and decisions are examined to find out whether in public interest and whether they meet the standard of conduct.

 

e)      Efficient audit

It is an evaluation of overall efficiency and performance of an organization

 

f)       Tax Audit

It means audit for tax purpose. Audit required to be carried out of income tax act of 1961.

It is conducted by certified Chartered Accountant.

 

g)     Cost Audit

It is a thorough examination of the cost accounting records of a company by a cost auditor to ensure that they are accurate and they also follow to the cost accounting principles, procedures and plans.

 

h)     Management Audit

It is the critical examination, scrutiny and appraisal of plans, policies, procedures, objectives, means and operational area of the organization. It is the audit of managerial actions and decisions. It is the audit of activities of various levels of the managers.

 

i)        Social Audit

Social audit is a systematic study and evaluation of a business enterprise's social performance as distinguished from its economic performance. Social audit is intended to evaluate the social performance or social contribution of a business organization. TISCO firstly adopted.