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AUDITING
S.NO. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 S.A. 200 200A 210 220 230 240 250 260 299 300 315 320 330 402 500 505 510 520 530 540 STANDARDS ON AUDITING AND NUMBER Basic principles governing an audit Objectives and scope of the audit of an financial statements Terms of audit engagement Quality control for audit work Audit documentation The auditors responsibility to consider fraud and error in an audit of financial statements Consideration of laws and regulations in an audit of financial statements Communication of audit matters with those charged with governance Responsibility of joint auditors Planning an audit of financial statements Identifying and assessing the risk of material misstatements through understanding the entity and its environment Audit materiality The auditors responses to assessed risk Audit considerations relating to entities using service organizations Audit evidence External confirmations Initial engagements- opening balances Analytical procedures Audit sampling Auditing of accounting estimates , including fair value accounting estimates and related disclosures Related parties Subsequent events Going concern Written representations Using the work of another auditor Relying upon the work of an internal auditor Using the work of an expert The auditors report on financial statements Comparatives

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Newly issued Newly issued

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550 560 570 580 600 610 620 700 710

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CHAPTER-1 INTRODUCTION TO AUDITING

MEANING OF THE GENERAL PURPOSE FINANCIAL STATEMENTS: {2005 nov.8 (a)} The term financial statements are also called as annual accounts of the any entity which gives information about the financial statement of entity as well as the working results of the entity. 1. Statement of the performance profit and loss account, income and expenditure account 2. Statement of financial statement-balance sheet 3. Statement of movement of funds- fund flow statement and cash flow statements * Entities interested in financial statements Users Management Shareholders /proprietors Lenders, banks and financial inst company Suppliers Customers Government tax Workers companies to be given away Purpose for day to day decision making to analyze the performance to determine the financial position of the to determine the credit worthiness to know the general business viability to ensure prompt collection of direct and indirect to assure the reasonable profit is earned by the As bonus Requirement for audit The stakeholders of the organization require having a reasonable assurance regarding the financial statements those they:
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1. Have been prepared and presented as per the requirements of the law. 2. Reflect the true and fair view of the position of the enterprise. Definition of auditing :Systematic and independent Examination of data , statements, records, operations, and performances Financial or otherwise Of an enterprise For a stated purpose In simple form auditing is: Examination of financial statements Collection and evaluation of evidences Reporting about truth and fairness of the financial statements Providing certain economic information

Basic aspects of assurance that the auditor has to satisfy with: 1. Books: the financial statement are drawn with the entries made in the books of accounts 2. Evidence: the entries in the books of accounts are supported by adequate documentary Evidence enclosed 3. Full inclusion: all entries have been considered in the process of preparation of financial statement. 4. Clarity: the information conveyed by the statements is clear 5. Disclosure: the financial statement are properly classified, described and disclosed in accordance with A.S. And applicable laws 6. Truth and fairness: the financial statements should reflect the true and fair picture of the financial position of the entity.

Basic principles governing an audit ( SA 200) {Nov. 2000 ,Nov.2002 , Nov.2003, Nov. 2006, Nov. 2008} These are those basic principles that should be considered in mind by the auditor while conducting the audit of any company. These principles are: (1) Integrity, objectivity and independence: he should be straight forward , professionally honest and sincere towards his work . he should be fair and unbiased towards his objectivity , he must be of impartial attitude . he should maintain
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compatibility in his integrity and objectivity , he should not make any compromise towards any one of them. (2) Confidentiality: he should keep his ears and eyes open and his mouth close. He should maintain the confidentiality of the information obtained by him during the course of his audit, he should not disclose the information to the third party, unless the consent of the client company is obtained by the auditor regarding this or the disclosure is specifically required by law. (3) Skills and competence: the audit work and report should be prepared with due care by persons who have adequate training , experience and competence which is acquired through technical knowledge, education, formal courses conducted by qualifying examination and practical work done under proper super vision . (4) Work performed by others (SA 299,600,610,620): the authority can be delegated but the responsibility cannot be delegated, so when auditor delegates his work to his subordinates, or use the work performed by others, he continues to be responsible for the work done and forming and expressing his opinion on financial statement i.e. why he should carefully direct, supervise, and review work delegated to assistants. He should obtain reasonable assurance that the work performed by other auditors or experts is adequate for his purpose. (5) Documentation (SA 230, 500): the auditor should make proper documentation regarding audit matters as to provide proper evidence that the audit was carried out in accordance with the basic principles. (6) Audit planning (SA 300): the auditor should plan his work to enable him to conduct an effective audit in an efficient and timely manner. the plans should be based on the knowledge of clients business and must flexible enough so that they can be revised as and when necessary , plan should cover: (a) Acquiring knowledge about the clients business, accounting system and internal control procedures (b) Establishing expected degree of reliance (c) Determining the nature, timing, and scope of audit procedures to be performed. (d) Coordinating the work to be performed (7) Audit evidence (SA 500): the auditor should obtain sufficient and appropriate audit evidence through the performance of substantive and compliance procedures to enable him to draw reasonable conclusions there from , on which to base his opinion on financial statement (a) Compliance procedures : these are tests designed to obtain reasonable assurance that those internal controls a on which audit reliance is to be placed are in effect

(b) Substantive procedures : these are designed to obtain evidence as to the completeness, accuracy and validity of the data produced by the accounting system (8) Accounting system and internal control: the auditor should gain an understanding of the accounting system and related internal controls. The internal controls ensure that the accounting system is adequate and all the accounting information is duly recorded. He should study and evaluate the operations that those internal controls on which he wishes to rely in determining the nature, timing and extent of other audit procedures. (9) Audit conclusions and reporting: he should review and assess the conclusions draw from the audit evidences obtain and from his knowledge regarding the business of the entity as the basis for the expression of his opinion on the financial statement The audit report should contain a clear written expression of opinion on the financial statement . it should comply with the legal requirement,

Objectives of the audit ( SA 200 A*)

Audit procedures

Compliance procedures ( to be implemented by the mgmt.

Substantive procedures

Accounting system

Internal control system

Analytical review (ratios, trends, and comparisons)

Tests and cheks( vouching and verification).

Primary objective : Reporting expression of the opinion This SA states that the objective of an audit of financial statements prepared within a framework of recognized accounting policies and practices and relevant statutory
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requirements , is to enable an auditor to express an opinion on such financial statement Incidental/ secondary objective: detection and prevention of fraud and errors and to make recommendations to prevent those frauds. Responsibility of the management to 1. To safeguard assets 2. To prevent frauds and defalcations 3. By designing and implementing a suitable internal control system The auditor is only a watchdog not a bloodhound ( Kingston Cotton Mills co. 1896) He should bear in mind the possibility of the existence of fraud or any other irregularities in the accounts. He cannot be believed upon to ensure the discovery of all the frauds and errors. But where the auditor has a suspicion that some fraud or error may exist which could result in material miss statement, he should extend his audit procedures to conform or do away his suspicion i.e. at this moment of time his secondary objective becomes the primary objective. Process of achievement of audit objectives achieved by the auditor : 1. Review of internal controls: A critical review of the system of book- keeping, accounting records, work process and internal check existing within the company 2. Enquiries and test: making enquiries and test as to the reliability of records as a basis for preparation of accounts 3. Applying audit processes: performing audit procedures and technique like vouching and verification, examination in depth , analytical reviews , conformations etc to obtain evidences 4. Financial statements review: review of the firm and the content of the financial statement to ensure compliance with legal requirements and also disclosure of the true end fair view of the affairs of the enterprise.
Different types of audits.
Based on objective Statutory audit Internal audit Cost audit( sec 233B) Tax audit sec 44AB Government audit Special audit 233A Based on the organization structure Companies Statutory corporations Banks Partnership firms Co-operative society Trust 6 scope Based on time and Continuous audit Concurrent audit Interim audit Final audit Balance sheet audit

7 Energy audit/ environmental audit H.U.F.

Types of audit reports ( SA 700) Unqualified / Qualified report Clean report He concludes that He gives an financial opinion on the statement -1.give truth and fairness a true and fair of financial view statement, subject 2. the financial to : statement are 1. Certain negative prepared as per remarks GAAP.s 2. Observations 3. financial 3. Qualifications statement comply i.e. the financial with the statutory statement are not requirements representing true 4. any change in and fair view to the accounting some extent principles have been properly disclosed in the financial statement

Adverse / negative report He concludes that financial statement do not present a true and fair view of the state of affairs and the working results of an entity

Disclaimer of opinion He is unable to form an opinion about the matters contained in the financial statement

It s expressed when the effect of Such report is a limitation is so generally issued material that the by the auditor auditor is not been when a qualified able to obtain the report is not sufficient and enough to disclose appropriate audit the misleading evidence and thus nature of the unable to express financial his opinion on the statement the financial statement

The independent audit of financial statements relieves management of its responsibility. Discuss The above phrase is not correct because the ultimate responsibility lies with the management. The auditor only certifies the compliance with the laws and regulations is done . (A) It is the management responsibility to maintain the adequate accounting system and appropriate selection of accounting policies and the safeguarding of assets, as well as the preparation of accounts should be as such which reflects the true and fair view of the organization. (B) The auditors role is only confined to the framing an independent opinion whether the financial statement represents the true and fair view of the enterprise, prepared by the management of the enterprise.
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(C) Hence the audit of financial statement does not relieve the management of its responsibility.

The auditors responsibility to consider fraud and error in an audit of financial statements.(SA 240) Difference between error and fraud :-

Fraud Practice of deception or artifice with the intention of cheating or injuring another Intention It is a willful misrepresentation ,a deliberate concealment of a material fact or the failure to disclose a material fact Purpose No intention of Intention of putting the other putting the other party party at any at a disadvantage disadvantage Classification 1. Clerical Misappropriation errors of cash and goods 2. Error of Teeming & principle lading 3. Errors of Forgery of Duplication vouchers and bills 4. Compensating errors Window 5. Procedural errors dressing Falsification of accounts Basis Meaning Detection Through scrutiny of accounts self- revealing errors can be detected
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Error Unintentional mistake or missdescription in the books of accounts or record It is innocent and not deliberate and made through ignorance

By due care and diligence and by use of proper internal control checks on the part of

auditor

1. 2. 3. 4. 5. 6.

Circumstances of fraud and error Ignorance of employees Carelessness of the staff engaged in accounting work Desire to conceal material facts Prejudice or biasness of management Desire of evading tax Intentional effort by the managerial authority

Categories of errors

Self revealing errors -also known as apparent errors as their existence becomes apparent during the course of preparation of accounts Un- intentional -innocent or non-deliberate mistake due to ignorance Unconcealed Similar to unintentional error and ascertained on a basic review of accounts Errors affecting the trial balance One-sided error of commission or omission

Non self revealing errors - Do not reveal them during the course of audit. They can be find out only after detailed and specific examination Intentional -deliberate and purposive mistake i.e. fraud Concealed Series of errors committed to hide the earlier errors and ascertained after a careful scrutiny. Errors not affecting the trial balance Compensating errors , complete omission

Errors of commission {1998 Nov., 2001may}: It means that transaction is recorded wrongly or incorrectly in the books. The error may be posting errors, casting errors, carry forward errors, duplication errors. These errors have an effect on the trial balance (if single sided), and not affect the trial balance (if double sided) these errors
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affect the profit as well if error includes any nominal account. If errors are not deliberately concealed then can be detected by normal audit procedures

Errors of omission: It means that a transaction is not recorded in the books of accounts, either wholly or partially. They may be one sided or double sided errors, complete omission will not affect trial balance. Partial omission will be detected by the auditor through regular audit procedures Errors of principle: It rises when a transaction is basically recorded in the books in an incorrect manner. Such errors will not affect trial balance, but will affect net profit if involve nominal a/c. Such errors are detected by audit procedures like ARP, Ledgers scrutiny. Compensating errors: It is that error which is counter balanced by another error or errors, so that it is not disclosed by the trial balance. It is difficult to detect. If it involves in income & expenditure a/c then it will affect profit but if it involves only assets & liabilities a/c then profit will not be affected. Various forms of fraud: 1. Manipulation, falsification or alteration of records of documents. 2. Misappropriation of assets. 3. Suppression or omission of transaction. 4. Recording of transaction without substance (actual proof). 5. Wrong application of accounting policies.

Ways of defalcation of cash (1) Inflating cash payments (2) Suppressing cash payments (3) Casting wrong totals in cash book Window- dressing

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It means Misrepresentation of accounts with a view to present a better picture of the state of financial position of the enterprise. It is difficult to detect because it is done by the persons of high cadre & done in a systematic manner. It aims to: (1) Show more profits , to give managerial personnel more remuneration (2) Attract more loans, (3) Avoid incidence of taxes (4) Declare dividends when there are insufficient profits (5) Not declare dividends when there are sufficient profits (6) Attract potential investors

Conditions or events which increase the risk of fraud and error {97 may, 98 may} (1) Internal control faults: weakness in design of internal controls , non compliance with laid down control procedures (2) Doubts about the integrity or competence of the management : domination by one person , high rate of labour turnover, (3) Unusual pressures within the entity : heavy dependence on a single line of product , inadequate working capital (4) Unusual transaction: transaction with related parties, excessive payments for some services etc. (5) Problems in obtaining sufficient and appropriate audit evidence etc. Auditor's responsibility for detection of fraud and error { Nov.2004} (1) Audit planning : in planning the auditor should consider the risk of material misstatement of the financial information caused by the fraud and error and modify his audit procedures if any required (2) Need for additional tests : if he suspects the existence of any fraud and error , then he should consider its potential impact on financial statement , and if the effect is found to be material then he should extend his audit procedures (3) Effect on financial statement: he should make ensure that the financial statement reflects the effect of fraud and error. If he is unable to obtain sufficient evidence to dispel his suspicion, then he should consider relevant laws and regulation before expressing his opinion, he can also sought any legal advice from any expert. (4) Reporting: it involves communicating the audit matters to management, if adequate disclosure is not made by the management, there should be a suitable disclosure in his audit report.

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Scope laid down in SA 200A : (1) The scope of an audit of financial statements will be determined by the auditor having regard to : (a) Terms of initial engagements (b) The requirements of relevant legislation (c) The pronouncements of ICAI (2) Work coverage : the audit should cover all operational aspects relevant to the financial statement , the auditor should make ensure that the other source data is reliable and sufficient used for preparation of financial statement .this can be done by: (a) Evaluation of internal control (b) Audit procedures (3) Disclosure analysis: the auditor should decide that the relevant information is disclosed in the financial statement as per the applicable statutory requirements . it is done by: (a) Financial statements analysis (b) Evaluation of accounting policies (4) Effect of inherent limitation: where the auditor is of the suspicion regarding the possibility of existence of fraud and error, then he should extend his audit procedures . (5) Materiality : the auditor should exercise his professional skill & experience , in relation to the affairs of the enterprise ,those material items which affect the decision of the users of financial statement (6) Technical aspects: the auditor is not expected to perform the duties which fall outside the scope of his competence , for e.g. certain aspects are only judged by the technical experts and not by the statutory auditor (7) Restriction of scope: the terms of engagement cannot restrict the scope of auditor in relation to the matters which are prescribed by the legislation.

Principal aspects to be covered in an audit ( work to be done by the auditor ) (1) Internal control system: examination of the I.C.S. should be done, tests and enquiries are to be made, it will help the auditor in determining the degree of reliance he can place on the internal control system. (2) System review : the reviewing of system is necessary to find out whether the system is adequate and comprehensive (3) Arithmetical accuracy

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(4) Vouching: verification of authenticity and validity of transaction entered , by making an examination of the entries in the books of accounts with the relevant supporting documents. (5) Compliance: the auditor should ensure that due compliance with the relevant statues; laws and accounting principles have been made. (6) Asset and liabilities verification: verification of title, ownership and existence of assets should be done. (7) Verifying true and fair view about the profit and loss of the company. (8) Issuance of audit report Inherent limitation of an audit {Nov. 2001, 2003 may, Nov. 2005} Auditor is not an insurer : SA200 (A), points that the opinion expressed by the auditor is neither an assurance as to the future viability of the enterprise nor the efficiency or effectiveness with which management has conducted affairs of the enterprise. This is because the process of auditing suffers from the following inherent limitation: (a) Judgment /conclusion based audit report: the audit work involves the exercise of judgment , he is also required to examine the reasonableness of the judgment exercised by the management in selecting appropriate accounting policies and in preparing the financial statement (b) Nature of evidence based audit report: the audit opinion is governed by the nature of evidence obtained; the evidence so obtained is mostly persuasive in nature rather than conclusive in nature. (c) Internal control based audit: the internal control system also suffers from certain inherent limitation; it may be ineffective against fraud, involving discontent among employees or fraud committed by the mgmt. (d) Tests checking taken by the auditor: it is not possible for the auditor to conduct detailed checking , so he goes for tests checks , it would not guarantee that all types of fraud would be discovered. Inherent limitation of an audit in relation to fraud and error : {2001 november} Generally auditor is not concerned with the propriety of the business conduct ( KINGSTON COTTON MILLS ) : The propriety of business conduct means the internal affairs or the day to day decision making by the management . But now a days the auditor has to report on certain legal matters regarding the internal affairs of the business , thus he has to verify the internal affairs of the business . the
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auditor is required to examine the regularity and prudence of various decision taken by the management. Advantages of an independent audit : Independence implies that the judgement of a person is not influenced by the another person who might have engaged him or his own self interest . SA 200 lays down integrity , objectivity and independence as one of the basic principles governing an audit the auditor must be fair, honest, sincere , unbiased, impartial towards his work . he should not compromise with the integrity and objectivity of the audit work .The advantages of an independent audit are: (1) Protection of interest : it safeguards the financial interest of the person who are not directly related to the management (2) Moral check on the employees for committing defalcation , embezzlement (3) Credit Negotiation : bankers generally use audited financial statements in evaluating the credit worthiness of individual in negotiating loans. It is also useful for determining the purchase consideration for a business. (4) Trade dispute settlement: (5) Control over in efficiency (6) Tax liability settlement (7) Arbitration i.e. settling the cases out of court (8) Appraisal of various controls of the organization (9) Partnership cases (10) Assistance to government. Difference between auditing and accounting (1999 may) Particulars Accounting Auditing Meaning It is the art of recording, An audit is independent classifying and summarizing examination of financial financial information, information of an entity with a transactions and events, and view to expressing an opinion preparation of reports thereon. thereon. Objective Recording of transaction from vouchers and preparing financial statement Verification of vouchers and obtaining evidence on the true and fair view of FINANCIAL STATEMENT Mgmt. responsibility Auditors responsibility Measurement and Independent examination of communication of information to financial information prepared share holders. by the mgmt.
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Responsibility Concerns with

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Aspect of transaction.

It involves recording of financial information .

It reviews the efficiency of recording of the financial information.

Difference between auditing & investigation. (1999 may) Particulars Investigation Auditing Meaning Systematic critical and special examination of records of a business for specific purpose. Independent examination financial information of any entity with a view to expressing an opinion thereon . Voluntary Mandatory for companies, for others voluntary . Any person, who may or A CA within the may not be a charted meaning of the CAs accountant. ACT, 1949. Owners or mgmt. or Owners /shareholders of even third parties may the enterprise. appoint the investigator. Work is carried as per Work is carried on the instruction of the behalf of the owners appointing authority It is oriented towards Forming an opinion on only those queries which the financial statements are specifically laid down in the engagement letter It can extend to more One financial year than one financial year exists Not based on pre conceived notions Conclusive and Persuasive rather than corroborative evidence conclusive Financial as well as non Basically only financial financial aspects aspects Detailed and exhaustive Test check can be applied on the basis of
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Mandatory. Conducted by Appointing agency Protection of interest Scope and coverage

Period covered Pre- conceptions Evidence Aspects Extent of checking

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Form of reporting

No statutory form of reporting on investigation

reliability measure on I.C.S. Prescribed by law.

Difference between auditing and techniques of auditing (1998 may) Particulars Principles of auditing Techniques of auditing Meaning These are the These are the methods fundamental and means adopted by considerations that the auditor for direct and sustain the collection and functions of auditing evaluation of audit evidence in different circumstances Types As stated in SA 200 : (a) Physical inspection of (a) Integrity, objectivity & fixed assets independence (b) Confirmation of (b) Confidentiality debtors balances (c) Skills and competence (c) Ratios and sampling (d) Work performed by others (e) Documentation (f) Planning (g) Audit evidence (h) Accounting system and internal control (i) Audit conclusions and reporting

Variations

Not liable to change frequently, they do not vary with time or the nature of organization.

They may vary according to the circumstance , they vary with time and the nature of organization.

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Initial engagements opening balances ,( 2005 nov [2]{c}(a) ) for initial audit engagements , the auditor should obtain sufficient and appropriate audit evidence. (SA 510) 1. The closing balance of the preceding year has been correctly brought forward to the current year 2. The opening balance does not contain mis- statement that materially affect the financial statements for the current year. 3. Appropriate accounting policies have been applied consistently As per initial engagements , it is the duty of the auditor to verify the closing balance with that of the current period Therefore, exclusion of audit of closing stock from the audit programme is not the correct step only because it pertains to the preceding year , which was audited by the another auditor Hence, the auditor should verify the closing stock also.

CHAPTER -2 AUDIT EVIDENCE (SA 500) MEANING (2001 nov7(I) , 2000 may ) :- It refers to any information, oral , written , obtained by the auditor during the course of the audit to arrive at the conclusion on which he bases his opinion. On the financial statement . it can be as a proof for his opinion, conclusions. e.g.: sales/ purchases invoices, debit / credit notes, letters from management, correspondence from third parties, NEED OF AUDIT EVIDENCE: Basically the main need of the audit evidences is: For formation of judgment :

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As per SA 200 Basic principles governing an audit an auditor needs to obtain sufficient and appropriate audit evidence for framing his opinion, these audit evidence are collected by the auditor by the use of compliance procedure and substantive procedures, these will enable the auditor to draw reasonable conclusions there from on which he should base his opinion on the financial statement For deciding about the nature of evidence to be obtained : He should evaluate the evidence whether they are sufficient and appropriate, before he draws any conclusions there from. SUFFICIENT denotes quantity and APPROPRIATE denotes quality. i.e. the audit evidence should be complete in all respect. To support his opinion expressed by him on the financial statement Proving his negligence in the court of law The audit evidence are the property of the auditor He has a lien on the evidences collected by him

The audit evidence can be classified into INTERNAL EVIDENCE and EXTERNAL AUDIT EVIDENCE ,on the basis of source of collection Difference between internal evidence and external evidence ( 1998 may , 2008 nov) Sino. Basis 1 Meaning Internal evidence Created , used and retained External evidence Originates outside the clients organization i.e. out of the control of client company They are generally prepared in the ordinary course of business. They are considered more reliable as compared to

Uses for accounting

Uses for the auditor

They are generally not a direct document in relation to accounting Reliability of such evidence depends upon the
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effectiveness of the internal control system

Examples

internal evidence as they are obtained by the outside parties who are not directly interested to the business of thee company. These are Came from created by the outside parties management for e.g. for e.g. invoices purchases issued to the invoices , lease customer, wage agreements , sheets , minute bank statements books etc. , customer conformations etc

Meaning of Direct confirmation ( SA 505 External Confirmation) : This is a procedure obtaining external evidence in respect of balances of sundry debtors / creditors at a particular date .The request for confirmation requires confirming the balances , which should be as per the clients books of accounts . in case the balance does not agree with the corresponding balance in the partys books of accents , the party is further required to give either the full detail of the facts regarding the transaction , if available with him . Procedure of direct Confirmation : (1) Preparation of list of sundry debtors/ creditors who are to be inquired (2) Scrutiny of list of debtors/ creditors about full inclusion , nature of the parties, materiality, and the relationship of the client with the parties (3) This final list is forwarded to the client by the auditor to issue letters for obtaining confirmations regarding balances (4) Client sends the letters to each party with a request to confirm the balance due , as shown in the letter . these letters may be of two types ( 2003 may)

Letters having positive approach (i.e. balance to be confirmed in

Letters having negative approach (i.e. balance to be confirmed only if

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any situation ) it disagrees with the partys books) (5) All the confirmation should reach directly to the auditor and not the client. (6) After receiving all the confirmations the analysis is done by the auditor

Advantages of obtaining direct confirmation : (1) Letters of representation is received from the management in this regard constitute corroborative evidence for the amount of debtors/ creditors as stated in the balance sheet. (2) Independent evidence so obtained from third parties can be matched with the internal evidence available with the auditor (3) This procedure is followed when the internal control system is inefficient or ineffective.

Analytical procedure( SA 520) :- As per SA 520 analytical review means study of significant RATIOS, TRENDS AND COMPARISONS , i.e. calculating various ratios and studying trends of various items and making investigations for unusual fluctuations . The analytical review is the part of auditors substantive procedures. (a) Type of tests to be applied in Analytical Reviews : (1) Comparative analysis: comparisons of the entitys financial information with prior periods, anticipated financial results, budgets, forecasts etc. (2) Financial Ratio Analysis : it includes relationship among elements of financial information i.e. gross profit ratio , turnover ratio , (3) Predictive estimate analysis : (4) Inter-firm Analysis (5) Key non financial ratios (b) Purpose of analytical review : (1) To assist the auditor in planning the nature , timing and extent of other audit procedures to be applied by the auditor (2) To use substantive audit procedures when there is requirement of more than tests of details , to reduce his detection risks (3) To provide evidence as to the completeness, accuracy and validity of data produced by the accounting system (4) To review overall financial statements in the final stage of audit

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(c) Obtaining audit evidence The auditor can apply compliance test as well as substantive test . - Compliance procedures Substantive procedures Designed to obtain reasonable assurance Designed to obtain evidence as to that those internal control on which audit completeness, accuracy and validity reliance is placed are in existence, are of data effective and operated. Audit procedure adopted in obtaining audit evidence (Nov. 98) : There are two types of audit procedures for obtaining audit evidence . They are compliance procedures and substantive procedures. Compliance procedures: (a) It is related with the internal control system and the accounting system of any entity (b) It is the responsibility of the management (c) Designed to obtain reasonable assurance that the internal control system on which auditor has relied is in existence and effective (d) It is basically a check on the: (I)existence of internal control system (ii) effectiveness of the internal control system (iii) continuity of the effectiveness of the internal control system. Substantive procedures (99 nov8(iii), 2004 may) : (a) They are applied by the auditor after applying the compliance procedure. (b) These are the responsibility of the auditor (c) Designed to obtain evidence about the completeness, accuracy and validity of data produced by the accounting system. (d) These are of two parts : Analytical Reviews ( ratios, trends and comparisons) and Test of details . (e) These procedures are carried out in detail on all aspects of financial statements. Assertions as to which an auditor is mainly concerned about while carrying out substantive procedures {2008 may 3(a) } : (a) Existence : That an asset or any liability exists at a given date (b) Rights & obligations : The asset is right of any entity and liability is an obligation
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(c) Occurrence : The transaction , that had taken place is related to the concerned entity (d) Completeness : That the transaction recorded is completed in all respect (e) Valuation : The asset or liability is recorded at an appropriate carrying value (f) Measurement : Transaction is recorded in the proper amount and allocation is done for the proper period . (g) Presentation : That the transaction is disclosed , classified and described with the acceptable accounting policy and legal requirement .

Methods of obtaining audit evidence ( 2003 may, 2001 nov ) : (A) Inspection : Inspection involves examination of records , documents of tangible assets. Inspection of records and documents provide evidence as to the different degree of reliability depending on their nature and source and the effectiveness of internal control . (B) Observation : it relates to witnessing a process or procedure being performed by other . the auditor does not make any inspection himself but he remains physically present and only observe the work carried out by others for verifying the procedure. (C) Inquiry and confirmation: seeking appropriate information whether oral or written, from knowledgeable person inside or outside the entity (D) Computation: checking the arithmetical accuracy of source documents or accounting records and performing independent arithmetical calculations. (E)Analytical reviews : studying ratios , trends and investigations of unusual fluctuations . Best audit evidence : No suspicion

Suspicious circumstances

First available evidence ( prima facie audit )

Corroborative evidence ( compelling evidence)

Reliability of audit evidence ( 2001 nov 7 (iii) , 2008 may): It depends on the source and nature of audit evidence : External evidence is more reliable than internal evidence . Internal evidence is reliable if internal control system is satisfactory Written evidence is more reliable than oral evidence.

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Principles useful in assessing the reliability of audit evidence (2001 ) : The auditors judgment as to the sufficient and appropriate audit evidence is based upon several factors (a) Degree of risk of misstatement (b) Materiality of item (c) Existence / suspicion of existence of fraud or error. (d) Types of information available (e) Trends indicated by analytical review procedures (f) Experience gained during previous audit

Consistency in audit evidence : It refers to the similarity in the audit evidence , collected through different sources . it assures the auditor regarding the sufficiency and appropriateness of the audit . if the evidence are found to be inconsistent than the auditor should extend his audit procedures . Reliance on analytical review procedures ( 2003 nov 8(c)): (a) Materiality of items involved : In certain immaterial items , comparison with previous figures give sufficient audit evidence , while in certain circumstances the ARP is not sufficient , and the auditor has to carry out the tests of details to find sufficient audit evidence. (b) Other audit procedures : When all other audit procedures are directed in the same direction than the analytical review procedures give confirmatory evidences. (c) Accuracy of prediction : if the expected results of analytical procedures can be predicted with reasonable accuracy , then such procedures are found to be more reliable (d) Nature of risks : (SA 315 , SA330 ) : the effect of analytical procedures also depends on the assessment of inherent and control risks . Inherent and control risk are inverse to each other i.e. if the inherent risk is low than control risk is high and vice versa.

Certain Concepts

(A)

Accrual concept :

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This concept states that revenue and cost are recognized as they are earned or incurred and not when money is actually received or paid. It takes into account Incomes receivable , Income received in advance , Expenses payable , Prepaid expenses. Periodicity this system records the transaction , events and circumstances occurring during a particular accounting period True and fair this system gives financial statement a true picture of the companys profitability and the state of affairs of the company Fundamental accounting assumption as per AS -1 on disclosure of accounting policies this accrual system is one of the fundamental accounting assumption . If this system is not followed then a proper disclosure is required. Section 209 of the companies act states that a company shall not be deemed to maintain proper books of accounts in case they are not maintained on accrual basis. (B) Concept of Above the line & Below the line

ABOVE THE LINE : it is that part of profit and loss account wherein the profit or loss is determined after ( I ) crediting all the revenues , gains, and profits , ( ii ) debiting all the expenses and charges attributable to the period . BELOW THE LINE it is that segment of P&L a/c wherein the adjustments, appropriation , utilizations of profits are expressed for e.g. partners interest on capital , dividend distributed, transfer to reserves . it can be said as P&L adjustment a/c , P&L appropriation a/c . (C ) Fundamental accounting assumption : As per AS-1 Disclosure of accounting policies following are the generally accepted fundamental accounting assumption: (a) Going concern : It is considered that the operations of the enterprise are to be continued in the foreseeable future. It is seemed that the enterprise has neither the intention , nor the necessity of liquidation of curtailing materially the scale of his operation . (b) Consistency: it is assumed that the accounting policies are consistent from one period to another (c) Accrual ; all revenues and cost are recognized as a when they are incurred or earned whether the money is actually paid or received in cash or not.

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There is no need of separate disclosure of above FAAs in financial statements, if they are followed while preparing financial statements, but if any of the FAAs is not followed than there is a requirement of separate disclosure . Major considerations in selection and application of accounting policies : The prime consideration in the selection of any accounting policy by an entity is that the financial statement prepared and presented on the basis of such accounting policy should present a true and fair view of the state of the affairs of the company . The major consideration is: (1) Prudence: the concept of prudence states that in view of uncertainty attached to the future events , profits are not anticipated and recognized only when they realized though not necessarily in cash, but provision should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate. (2) Substance over form : the accounting treatment and presentation in financial statements of transaction and events should be governed by their substance and not merely by legal form . that means detail analysis should be done (3) Materiality : the financial statement should disclose all material facts , the knowledge of which might influence the decision of the user of the financial statements.

Change in accounting policies : In case of change in accounting policies followed by the management , then the mgmt. as well as the auditor should look into following matters : As per AS-1 , the accounting policies are those which refers to the specific accounting principles and the methods of applying those principles adopted by the enterprise in the preparation and presentation of financial statements Consistency is one of the FAAs i.e. there should be consistency in the preparation of financial statements. AS-5 permits changes in accounting policies only in exceptional circumstances : (a) If it is required by the statue (b) Compliance with an accounting standard (c) If change would result in more appropriate presentation of the financial statements of the enterprise

Any change in the accounting policy , which has a material effect on the financial statements , should be disclosed.
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Concept of independence of auditor: Independence implies that the judgment of a person is not influenced by the person who might have engaged him or his own self interest . SA 200 lays down integrity , objectivity and independence as one of the basic principles governing an audit the auditor must be fair, honest, sincere , unbiased, impartial towards his work . he should not compromise with the integrity and objectivity of his audit work . In order to ensure independence the law has laid down certain disqualifications in sec 226 (3) of companies act for a CA to act as an auditor of the company . The relationship maintained by the auditor shall be such that no reasonable man can doubt his objectivity and integrity .

Concept of true & fair: It is a fundamental concept in auditing . This phrase states that the auditor is required to express his opinion as to whether the state of affairs and financial results of the entity as ascertained by him are truly and fairly represented in accounts under audit. The auditor should examine that all assets & liabilities , incomes and expenses are stated as per relevant accounting principles and policies. SEC 211(5) : this provides that the accounts of a company shall be deemed as not disclosing a true and fair view , if they do not disclose any matter which is required to be disclosing by virtue of schedule VI of companies act . SEC209(3) : states that a company shall not be deemed to be maintaining proper books of accounts to show a true and fair view when these were not prepared as per accrual system of accounting . The auditor has to check that no material asset is omitted , and neither of the assets should be under valued/ over valued according to the applicable accounting policies.

Chapter -3 Audit process : it refers to the series of activities performed by the auditor in the formulation of audit opinion on the financial statement of the enterprise . Steps in the audit process : (1) Preliminary knowledge of the business :
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(2) Preparing audit plan / program (3) Applying methods to control the quality of the audit work. (4) Evaluation analysis of the internal control system (5) Collection of audit evidence by applying substantive tests. (6) Examining documentary evidences and validity of the transaction (7) Verifying statutory provisions, rules and regulation governing an audit (8) Verification of ownership , existence and title of assets and the determination of the nature of liabilities . (9) Applying overall tests and analytical reviews. (10) Scrutiny of Financial statements . Audit techniques : it denotes those skillful methods applied by the auditor for collection and accumulation of audit evidence . these are (1) Vouching (2) Verification (3) Posting / casting checking (4) Scrutiny (5) Conformations (6) Bank reconciliation Difference between Audit procedure and Audit techniques ( 1998 may, 2006 may, 2007 may) Audit procedures Audit techniques It is a wide framework of the manner of conducting the audit work . the procedures are comprised of so many techniques It refers to the method employed for carrying out the audit procedures

Procedure of selection of best audit procedure : The selection of appropriate audit procedure and audit technique in a particular circumstance depends upon several factors. (1) Nature of evidence to be collected : There are multiple techniques available for the collection of audit evidence. The auditor should ensure that audit evidence obtained from different sources should be alignment with each other . (2) Possibility of fraud and error : (3) Degree of reliability on internal control system (4) Coordination among the procedures

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(5) Selection of the appropriate audit procedures and the audit technique depends upon the matter of professional experience and judgment. Knowledge of the business: (2004 may, 2009 may) It is a frame of reference within which the auditor exercises the professional judgment and understands the business of the entity and he uses the information so obtained by him in - Assessing risks and identifying the problems - Planning and performing the audit work effectively and efficiently - Evaluating the audit evidences - Providing quality services to the client

In performing the audit work , he should obtain knowledge of the business , which enable him to identify and understand the events , transactions and practices that , in his judgment may have a significant effect on the financial statements or on the examination or audit report. Before accepting the engagement : the auditor would obtain the preliminary information After accepting the information : more detailed information would be obtained by him Audit staff should be equipped with all the information suitable for carrying out the audit work He should make the effective use of the knowledge so obtained by him about the business.

The sources of obtaining knowledge about the business: previous experience discussions with several people like , directors, internal auditor , legal advisors, publications like surveys , trade journals , legislations, financial newspapers visits and inspections company documents like minutes of the meetings, budgets, charts, marketing and sales plan.

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Areas where the auditor make use of the knowledge of the business to make informed judgments: (1) Assessing inherent and control risks (2) Develop the overall audit program , and audit plan (3) Analyzing the audit evidence for its appropriateness. (4) Identifying related party transaction , and unusual circumstances (5) Appropriateness of accounting policies. (6) Determining the materiality of event . Matters to be considered by the auditor in obtaining knowledge of business.(2005 may) (a) General economic factors i.e. level of economic activity , interest rates , govt. policies (b) About the industry concerning the clients business like, the product market conditions, seasonal activities , product technology, key ratios, legislation frameworks. (c) Information about the client business: (1) About Management & Ownership: structure and ownership of the organization, capital structure, management plans, sources of financing , composition of board of directors, management committee , (2) Details about the product, market, suppliers , expenses and operations (3) Details of financial performances. (4) Various legislations.

Audit planning SA 300 : The planning of the audit work should be done in an effective and efficient manner . As per SA 200 BASIC PRINCIPLES GOVERNING AN AUDIT , the audit planning has been categorized as one of the basic principles which are to be taken into account while conducting an audit. The audit planning should be continuous throughout the period of engagement and must be flexible enough so that they can be further developed and revised as necessary . Following things are to be covered in audit plan: 1. Acquiring knowledge about the clients accounting policies, and internal control procedures 2. Establishing the expected degree of reliance on the internal control system of the clients business 3. Determining the nature , timing and extent of audit procedures to be performed
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4. 1. 2. 3. 4. 5. 1. 2. 3. 4. 5.

Establishing coordination among the things to be performed . Objectives of audit planning : Ensure that appropriate attention is given to thrust areas Ensure the identification of potential problems Ensure the effective completion of work Ensure effective utilization of articled assistants Ensure proper coordination among the work done by other experts and auditors. Factors to be considered by the auditor in making audit planning : Complexity of the audit Previous experience with the client Environment of operation Knowledge about the clients business Discussions with the client regarding the audit planning , and significant matters as he deems necessary as per his past and professional experience

Audit program ( 2006 nov): It is - detailed plan of work - set of instructions , techniques and procedures - prepared by the auditor - followed by the assistants or by the auditor himself - while carrying out an audit This is a plan of work which provides the basis for the supervision and control of audit work . Audit considerations for the purpose of making audit program ( 2008 nov) (1) To operate within the scope and limitation of assignments (2) Determine the reasonable evidence and best evidence (3) Consider the possibility of errors (4) Coordinate the procedures to be applied Advantages of preparing audit program : (1) It specifies the extent and manner of checking (2) The audit work can be planned and phased (3) The work can be supervised effectively (4) The assistants to be selected properly (5) It acts as a guide for future audit planning
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(6) The fixation of responsibility is easy (7) It acts as a basis for forming an opinion (8) Audit program becomes a record for the work done Disadvantages (1) The audit work is performed mechanically, no special reference for ad-hoc circumstances (2) There is rigidity in program (3) The audit staff feels a false sense of security regarding all the things being taken care of. (4) Sometime the initiative by the audit staff is discouraged (5) The audit procedures are sometime undertaken without taking into account their suitability. These disadvantages can be overcome by taking suitable precautions by the auditor : (1) Suitability : The auditor should consider whether the audit program is in alignment with the factors related to the organization (2) Review of internal controls :The auditor can spot the weak aspects of the internal control system , and revise his program (3) Considering changed business operation and new lines of business , and recast and modify the programs accordingly. (4) Participative approach : the auditor should encourage his audit staff to make open suggestions (5) Flexibility : the audit programs should be revised time to time so that it can be changed into material changes (6) Minimum requirements : it should include the minimum tests to be applied by the staff and should also include the surprise checks, which increase the interest in audit work.

Assurance by the auditor that the audit work is conducted systematically : The following control points to be considered necessary to ensure that the audit work is carried out in an efficient and systematic manner: (1) Regularity in audit work (2) Recording of time (3) Completeness of daily scheduled work (4) Confidentiality
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(5) Documentation (6) Audit stamp (7) Review and reporting

Audit working papers : (SA 230) : Meaning ( 98 may) : As per SA 230 DOCUMENTATION , the audit working papers refer to the documents prepared or obtained by the auditor and retained by him in connection with the performance of the audit Importance of audit working papers ( 2002 may, 2003 nov, 2007 may): Working papers are important to the auditor to: - Aid in planning and performing the audit - Aid in the supervision and review of the work - Provide evidence of the audit work to be performed to support the auditors opinion - Record and demonstrate the audit work from year to year - Plan the timing and extent of the audit procedures - Draw conclusions from the evidence obtained - Provide guidance to the audit staff - Fix responsibilities on the audit staff members - Act as evidence in a court of law 1. 2. 3. 4. Factors which define the form and contents of audit working papers : Nature of engagement Form of auditors report Nature and complexity of the clients business Nature and condition of clients record and degree of reliance on internal control system of the entity 5. Needs in particular circumstances for direction, supervision and review of work performed by the assistants . 1. 2. 3. 4. Contents of audit working papers : Constitutional documents Contents of minute books , Contents of financial statements Letter of engagement
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5. Letter of weakness 6. Audit queries , conformations, etc 7. Letter of representations .. The extent of documentation is a matter of professional judgment . Features of audit working papers : 1. Designed and properly organized 2. It facilitates the delegation of work 3. The working papers should be completely detailed so as to develop understanding of the audit 4. The working papers should record the audit plan , nature , timing and extent of audit procedures .

Type of audit working papers Permanent audit file Current audit file Permanent audit file ( 1997 may, Nov., Nov .2005 ): Information concerning the legal and organizational structure of the entity Extracts or copies of important legal documents, agreements, minutes relevant to the audit Record and study of the evaluation of internal controls Financial statements copies of the previous year Significant ratios and trends of earlier years Copies of management letters Communication with the retiring auditors Significant policies used and the changes if any made by the management Significant audit observations Current audit files Correspondences Copies of matters in the minutes of BOD meeting , general meeting Record of nature , timing and extent of audit procedures Evidence that the work performed by the assistants was supervised and reviewed Copies of letters or notes concerning audit matters Conclusions obtained by the auditor
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1. 2. 3. 4. 5. 6. 7. 8. 9. 1. 2. 3. 4. 5. 6.

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7. Copies of financial information being reported, and the reports Auditors lien Meaning of lien : It can be expressed as a right of a person for lawful possession of somebody else property on which he has worked. This is a right to retain property of some other person. Meaning of auditors lien : The auditor exercises lien on the books of the client and documents , if the client company fails to pay his fees to him for the work done by him on the books of accounts. The books must belong to the client , must have come into auditors possession by the clients authority and not by any illegal means , he must have done some work on the books, the fees on the non payment of which the lien is exercised , must be outstanding. As per SA 230 AUDIT DOCUMENTATION , the working papers are the property of auditor . the auditor at his own will can make extracts or copies of such working papers available to client. Audit note book ( 2001 nov, 2008 may) Meaning : It is a book in which the matters observed during the course of the audit are recorded , it contains several queries and points that require clarifications, explanations, ,and the manner in which they are finally settles so as to help in future if such similar circumstances arises. Structure : it is divided into two parts 1. General information record 2. Special points observed during the course of audit ( current information )

General information includes: Nature of the business carried on Memorandum and articles of association, partnership deeds etc. A list of Books of accounts Particulars of the system of accounts Important contracts, collabourations, royalty contract etc.

- Current information includes :

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- Audit queries - Mistakes or irregularities observed during the course of audit - Important information about the company, or for future references - Special points requiring considerations

Continuous audit (Nov .2001 ): It is that kind of audit in which the auditors staff continuously engaged in checking the accounts of the client the whole year round . interim audit is also a part of continuous audit. Advantages 1. Errors and frauds are discovered earlier in comparison to final audit 2. Possibilities of frauds are reduced 3. More time is available to the auditor for continuous check 4. Auditor remains in continuous touch with the clients business and affairs. 1. 2. 3. Disadvantages Possibility of alteration or modifications in the figures by the client Examination of any item may be overlooked It is a good deal of waste of time and effort .

Final audit : It begins when the books of accounts are closed after completion . it depends upon the size and nature of the business and the extent of checking. Advantages : 1. Avoids the loose ends 2. Possibility of figures being altered is also avoided 3. Division of work is important 1. 2. 3. Disadvantages It may delay the audit work Difficulties may arise in the allocation of audits because of work pressure Detection of fraud and error is takes time

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SA 220. QUALITY CONTROL FOR AN AUDIT WORK The audit firm should implement quality control policies and procedures Explain. (2002 nov, 2007 nov) The following are the objectives of the quality control policies to be adopted by an audit firm : (A) Professional requirements as per SA 200 (B) Skills and competence is required to enable them to fulfill their responsibility (C) Assignment is to be done to that person who has the required capability and skills. (D) Delegation and proper supervision should be done at all levels to maintain quality (E)Consultation with experts within or outside the firm is to be made as necessary (F) Acceptance and retention of clients (G) Monitoring should be done on a continuous basis (H) Communication of quality control policies to personnel so that they can understand and implement it. Factors to be done before delegation of work (a) Consider professional competence of assistants (b) Delegation must be such as to provide a reasonable assurance that such work will be performed by a due care and diligence. Duties of auditor towards the work delegated to assistants : (a) Proper direction should be given to the assistants (b) Proper monitoring and supervision is to be done by the auditor over the staff (c) Review of the work is to be done by another person of same caliber. Matters to be reviewed on timely basis : (1) Overall audit plan and audit program (2) Assessment of inherent and control risks (3) Documentation of the audit evidences (4) Proposed Financial statements (5) Certain additional procedures . Audit materiality (SA 320):The auditor should consider materiality and its relationship with audit risk while conducting an audit .

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The information is material if its mis-statement could influence the decision of the user taken on the basis of such financial information . It depends on the size and nature of item , judged in the certain cases of mis statement Audit risk.: it is the probability that the auditor may give an in appropriate opinion on the financial statements that is materially mis stated . Such risks may exist at overall level . Three components of audit risk are inherent risks, control risks, detection risks Stratified random sampling : under this method , the population is divided in different strata . each stratum is treated as if it was a separate population and a sample is treated as if it were a separate population . the number of groups in which the population is to be divided is based on the auditors judgment . this method is appropriate for highly diversified population. Representation by management (SA 580) : The purpose of this SA is to establish standard regarding : (1) Use of management representations as audit evidence (2) Procedures to be applied for evaluating and documenting management representations (3) Actions to be taken if management refuses to provide appropriate representations . Letter of weakness : When the auditor comes across any weakness in the control points , he issues the letter of weakness : (1) The auditor does compliance procedures to ascertain that the internal control system exist in the entity , it works effectively ,it works continuously in the entity during review period (2) The lapses in the operation of internal control too are reported in the communication of weakness (3) It is like a report issued by the auditor ,stating the weakness in the internal control mechanism., it also suggests measure by which the weakness in the system be corrected and the internal control system can be made better protected . Letter of engagement: A letter of engagement refers to the letter written by the auditor to his client in order to avoid any misunderstanding between them. Normally the objective and scope of an audit and auditors duty and obligations are laid down in various statutes like companies act , RBI regulation for bank or regulations and announcements of ICAI . in such a case to explain the terms of audit engagements by a letter by the auditor to the client is only informative . The purpose of Sa (210 ) is to

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establish standard on the : (a) agreeing with the terms of engagement with the client , and (b) how the auditor should respond if the client request for changes in the terms of audit engagement .

Chapter-4 Internal Control ( Including EDP environment ) Meaning of Internal control: the system of internal control may be defined as the organizational plan and all the methods and procedures adopted by the management of an entity to assist in achieving the following : (1) Efficient and orderly conduct of the business operations (2) Strict adherence to management policies (3) Safeguarding of assets (4) Prevention and detection of frauds and errors (5) Timely and accurate completion of accounting records and financial information The internal control function all directly and indirectly related control aspects like internal audit and internal check .it is designed in such a manner so that to see that all other internal control functions are properly working or not . Thus internal control encompasses : (a) Accounting controls (b) Administrative controls (c) Internal audit What are the aims of internal controls : (1) Authorization of transactions to be executed (2) To ensure that all the transactions are properly recorded with the correct amount and in the appropriate accounts., and in the current accounting period. (3) The accounting is being done with the appropriate accounting policies and practices (4) To check any unauthorized access of assets . (5) Ensure that the recorded assets are reasonably verified and compared with the existing assets ,and the differences if any should be dealt accordingly. Features of good internal control system :
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(1) Proper organization structure : A good internal control system should involve segregation of duties in such a manner that errors or fraud cannot take place , proper division of duties with respect of access to assets , authentication of transactions (2) Scheme of authorization and procedures : All the transactions should be duly verified , authorized and recorded by the respective official responsible for that . (3) Internal check: the procedure of accounting should be so designed so that no single person should be held responsible for the whole transaction . there should be a system of prompt and independent verification of individuals work through cross check and reconciliations . (4) Suitable personnel : there should be the appointment of competent and efficient personnel , so that the system operates efficiently .He should be adequately qualified as per the requirement of the job. (5) Internal audit system : internal audit constitutes a separate component of internal control system undertaken by the staff which checks whether the internal controls are well designed or not and whether they are operating in the best possible manner .

Meaning of internal check : (1) It is a part of overall internal control system which is mainly concerned with the job allocation and staff organization aspects of the internal control system (2) It refers to check on routine transactions or day to day transactions (3) The work of one person is complementary to the work of another person (4) The main objective of setting of internal control system is the early detection and prevention of errors and frauds . (5) It is such a system of book keeping where no one person is responsible completely for the execution of the transactions. General considerations in framing the system of internal check ( 2001 may, 2006 may): (1) Different hands: all the work done by any single person will certainly come under the review of another , hence no one person should be solely responsible for carrying out the complete part of the transactions (2) Job rotation : there should be movement in duties of the staff time to time so that there should be no monotony in the work.
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(3) Compulsory leave : every member in the staff should be encouraged to go for leave at least once in a year . In this way those, some of frauds which were deliberately concealed by the workers can be revealed when they are on leave. (4) Delegation of powers : the financial and administrative powers should be distributed very judiciously , and the manner in which these powers are exercised should be reviewed time to time . (5) Asset book differentiation and Asset verification : the person having the physical custody of the asset should not be allowed to access the books of accounts. The asset should be physically inspected s well time to time so as to maintain a control check . (6) Use of mechanical devices : devices like automatic cash register, time keeping machine etc . should be maintained . (7) Physical verification / stock taking : staff from all the departments , besides the stores staff at the time of stock taking so as to check the overall review (8) Review of accounts : procedures should be laid down for periodical verification and testing of different sections of accounting records to ensure their accuracy . Meaning of INTERNAL AUDIT : The internal audit is the review of various operations of the company and its records by the staff specifically appointed for this purpose . The review may be periodical or may be even continuous. The internal auditing is an independent appraisal function , established within an organization to examine and evaluate its activities as a service to the organization The internal auditing function assist the members of the organization in the effective discharge of their responsibilities by providing them with analysis , appraisals, and information on the activities reviewed .

Internal auditing

Operational audit Audit of various activities , compliance procedures etc. compliance

Management audit audit of proper authority , with policies etc.

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Objectives of internal audit : (1) To verify the accuracy and authenticity of the financial accounting and statistical records presented to the management. (2) To ascertain that the standard accounting practices are consistently followed by the organization (3) To establish that there is proper authority for every acquisition, retirement and disposal of assets (4) To confirm that the liabilities have been incurred only for the genuine or legitimate activities of the organization (5) To analyze and improve the system of internal check (6) For prevention and detection of errors and frauds (7) To make special investigations for the management (8) To serve as a means bringing new ideas in the attention of management (9) To review the overall operations of the internal control systems (10) To bring material deviation and non compliances to the procedures in the notice of the management (11) To locate weak and unnecessary areas of the organization so as to make the system effective and economical (12) To review the reliability and efficiency of information (13) To review the utilization of available resources (14) To review whether the goals and objectives of the companies are accomplished . EXAMINATION IN DEPTH: It is an examination of few selected transactions from the beginning to the end through the entire flow of transactions . this examination includes studying the recording of transactions at each stage and judging whether the person who has exercised the authority , in relation to the transaction was fit to do so or not . the selection must be correct and proper. A sample size may be small but must be the representative of the universe of transaction. Infect the size depends upon the level of confidence of auditor , there is inverse relation between them. If the examination in depth is done properly than it can reveal the proper functioning as well as the malfunctioning of the transaction in the clients accounting system. Independence of internal auditor : (1) The concept of independence is very important in auditing. It is useful to internal auditor and internal auditing both.

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(2) Internal auditing is an independent , objective assurance and consulting activity formed to increase the value of operations of organizations. (3) Functions of the management are evaluated by the Internal Auditor at different levels. (4) Board of directors are directly made responsible for the independence of the internal auditor through audit committees (5) Internal auditor can communicate and share his views easily . (6) Internal auditor is made subordinate to the lower level , his independence will be affected and this will affect his functioning and effectiveness.

CHAPTER -5 AUDIT IN AN EDP ENVIORNMENT The use of computer significantly affects the organization, controls, flow of documents, and manner of information processing . under an EDP environment , the approach and techniques to be followed by an auditor are would be different than those to be followed in a manual environment , yet the principles of auditing remains constant . The principal objective of the auditor is to ensure that the accounts on which the auditor is reporting show a true and fair view of the state of affairs at a given date and the results for the period ended on that date . Thus these can be achieved through audit by : (1) Evaluation of the system of internal controls (2) Making certain tests, Enquiries and confirmations. (3) Examination of books of accounts . The overall objective remains same , whether it is done through manual accounting or in an EDP environment , BUT the processing and storage of financial information changes , which ultimately affect the reliability of internal control. In an EDP audit the TRIAL BALANCE always tally , but it does not necessarily means that the work of an auditor m becomes simpler.

Characteristics of an EDP Accounting & Auditing.:

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(1) Skills and competence : The auditor should possess adequate knowledge of the computerized processing system in order to plan and conduct an audit . He should also have the knowledge of effect of EDP system on its study and evaluation of internal control in EDP environment . on the other hand , if the auditor does not have knowledge of the EDP system than he would not be in position to conduct the audit effectively and efficiently. (2) Work performed by experts /other auditor / assistants : The auditor is never able to delegate his responsibilities, and if he so desires than he should have complete knowledge of EDP system , and he must ensure that the work performed by the auditor is or experts is adequate for this purpose. (3) Audit planning :The auditor should obtain an understanding about organization structure of the IT activities and the extent of dispersion of duties and the significance of computer processing in each accounting applications . first of all the relevant information relating EDP environment should be collected by the auditor , like hardware ,software and processing applications used by the entity , ,nature of processing data retention , system of implementation , degree of reliance placed on EDP controls review of EDP functions, i.e. , how , where and when to do the various jobs . planning of the use of correct audit procedures to be followed by the auditor , use CAAT ( computer assisted audit techniques ) (4) Accounting system and internal control : The auditor should acquire knowledge about the accounting system followed by the entity , like flow of transactions, which is also called as transaction trail , data retention , data authorization , data modifications, and data alternations etc. the auditor should use general EDP controls and specified accounting application controls. (5) Audit evidences: the auditor should study the effect of compliance and substantive procedures to be applied by him with that of the CAAT ( computer assisted audit techniques) to be followed as because three main items are absent in an audit in an EDP environment

Nature of processing in an EDP environment : EDP environment differ from manual environment in several ways . OR why are CAATs are required in an EDP audit ? (1) Lack of input data /documents in a manual accounting system a transaction is recorded on the basis of supporting document , e.g. vouchers, receipts, etc. however such documents may not always be available in case of computerized accounting
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system , where some data may be entered directly into the system without supporting documents, for egg in an online system , sale transaction may be fed into the computer directly, without there being any supporting documents , similarly some transaction may be generated by the system itself based on programs egg . credit of interest on customer accounts, credit / debit of certain rebates , discount etc . (2) Lack of visible transaction trail / audit trail : The transaction trail refer to the successive stages in the recording of a transaction in the books of accounts through which the auditor may be able to trace the accounting entries in the books back to their initiation and vice versa . in a manual accounting system, there is generally a transaction trail for every transaction. The AUDIT TRAIL is a trail or the flow of transaction / activities available to An auditor with the help of source document , entries in the prime books of accounts, posting in the ledger and finally the preparation of financial statements , in an manual system, while in the case of an EDP system this is not available to auditor, as once the entry is done in the computer , its flow is not visible. The audit trail is basically a link between few records or path for audit. It refers to a situation where it is possible to relate the original input with the final output . In an EDP system however it is not necessary that every transaction is supported by a source document and its posting in the principal book is made only after the related entry has been made in the prime book. . the auditor may find that the transaction trail found is mostly in the machine readable form and it may exist only for a limited period . thus there is need to have a system whereby an electronic trail is maintained by retaining appropriate data regarding various transaction . Source documents entry in the prime books accounts ( financial statement) posting in the principal books of

(3) Lack of visible output : In some EDP system the result of processing may not be printed or may be printed only in summary form . the lack of visible output may , in many cases , results to the need to access data retained in files readable only by computer . (4) Ease of data access and computer programs: in a computerized system , data and computer program may be easily accessed and altered at the computer or through terminals at remote locations thus unless appropriate controls are established , there is an increased opportunity for unauthorized access to, and alterations/ modifications, of data and programs

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Organizational structure in an EDP environment : The characteristics of an EDP organization are as follows : (1) Concentration of functions and knowledge : In an EDP environment , the number of person involves d in the processing of information is significantly lower than that in a manual system . this means that certain conventional controls which are based on segregation of incompatible ( those which should be assigned to different persons in order to minimize the possibility of preparation or concealment of errors or frauds) function may not exist or may be less effective . it often happens the certain personnel acquire specialized knowledge of the source and of the processing of data and distribution and use of output . they may be in a position to alter/ modify program of significant data fort nay unauthorized use / more multinational purposes. Many computer frauds are known to have occurred because of this reason . (2) Concentration of program and data : The organizational structure in an EDP environment is generally such that mist program and data are concentrated at one location i.e. the central computer installations, or at a few locations as in the case of distributed data processing system. It is therefore easier to access data and program, alter them or modify them . Uses of CAATs : (1) Tests of details of transactions and balances (2) Analytical review procedures (3) Compliance test of general EDP controls (4) Compliance test of EDP application controls Design and procedural aspects : The various design and procedural aspects in an EDP environment is quite different then manual environment : The installation of computer operating system has created both benefits and problem to the auditor . Discuss.(2004 may,99 may,98 nov)

(1) Consistency of performance : the computer executes work exactly it is programmed therefore there is more consistency than manual audit. But it should be important there are proper internal controls on EDP programs are established .the emphasis is given on checking unusual transactions , inspire of checking large volume of transactions, in an EDP audit.

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(2) Programmed control procedures : some internal control procedures are so incorporated in an EDP system that they are not visible while some are reviewed through manual procedures .thus a program can have automatic checks inbuilt so that they can check those transactions exceeding certain limits .similarly password and ;login id controls can be used for protection of data from unauthenticated access. (3) Updating of multiple computer files : a single transaction which is fed into the EDP system , automatically updates all the related records of the transaction, while this is not being done in manual system .this facility of EDP ensures that all the records are updated .Similarly if any erroneous input is made than whole the records will get effected. (4) System generated transactions : the setup of the EDP system should be such hat the certain transactions should be automatically generated by the system itself, on the basis of preauthorized terms without being evidenced by visible input documents . for e. g automatic calculations of discounts, interest, rebates etc. (5) Vulnerability of data and program storage media : the data and programs are stored in a portable or fixed length storage media , which is susceptible to intentional or accidental destruction , to theft loss , to computer viruses etc. .The vulnerability of EDP system requires extensive internal controls to overcome these problems Thus it is quite clear that the EDP system provides an opportunity as well as challenge to the Auditor .

Internal controls in an EDP environment ( 98 nov, 2002 nov, 2003 may ) The internal control in an EDP setup is based on the same principles as in the manual audit however there are some special controls available in EDP setup. Internal controls which are special to an EDP setup include both manual and computer generated procedures these are classified into two parts : (1) General EDP controls (2) EDP application controls : Evaluation of General EDP controls : The main purpose of establishing general EDP controls is to control overall EDP activities . these are generalized controls and not meant for any particular EDP activity . (1) Organizational controls : some of the functions which are usually segregated in a manual system cannot be segregated in an EDP system . this is because the persons involved in processing of information are significantly reduced in an EDP environment. It is important that the EDP function is so organized that incompatible
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functions are segregated to the extent possible. The exact organizational function of the EDP system differs from organization to organization and the nature of applications. Following duties are segregated in large EDP system : (a) A system analyst : he is a person who is responsible for the design of the new system and modifications in the existing system (b) A programmer :he is the person who writes and tests a program based on the system design and modifications made in the existing system (c) A computer operator : he is responsible for processing the transactions through the system in accordance with the instruction set forth developed by the programmer (d) A librarian : he maintains the custody of programs , transaction files and other related records (2) System development and documentation or maintenance controls : the discussion with the auditor regarding designing of the controls over development ,testing and the documentation of the system software and various application programs , and auditors suggestions , reports of test runs etc. should be reviewed by the system analyst before they are put into actual use. Strict control should be there on changes in program and program files should be read only and every change should be properly authenticated. (3) Computer operation controls /access controls :the unauthorized use of data and programs should be controlled by use of password , , different users should be given different rights , he system should be used for authorized purpose only by the authorized person only - of the authorized program and data only (4) Hardware controls: the system should have inbuilt facility of prevention and detection of errors including the processing errors . it should perform (a) Diagnostic check : checking of the proper functioning of various components and peripheral devices (b) Parity check: checking the transfer of data between input-output devices (c) Dual read and read after write check: (d) Echo check : sending back data to the original terminal where it is compared with the original data (5) Procedural control for file retention and protection: there should be adequate procedures to protect program and data files from deliberate or accidental loss and to retain them in such a manner that they can be recovered or reconstructed in the event of loss or destruction some commonly used procedures applied for the file retention and protection are: (a) Back up and recovery procedures : like Business Continuity Planning , there should be a planning of EDP system continuity and this can be done through:
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Off site back up of programs and data Maintaining copies of data and programs Off-site processing like Hot site, Cold site, Warm site and Mobile site etching the event of disaster Inbuilt system of retaining two versions of a computer file ( current version , and the immediate version ) (b) Environmental controls : control over temperature , humidity , dust , to ensure reliable functioning of the EDP system. (6) Error routine : all the errors should be properly identified and a record of such errors and their correction should be documented properly. The auditor should properly look into the corrections of such errors as to find out the reasonability of internal controls.

Evaluation of specific application controls : The EDP applications are divided into three stages input , processing , and output . the auditor should evaluate the controls at all three stages separately, as the audit trail is not available to the auditor in EDP system Audit trail makes it easier to control an audit the system since it allows the system to trace the transactions from input to the output. Thus an audit trail can be maintained by retaining the appropriate data regarding various transactions . (1) Input controls : the control over input is quite important because if the input is not properly authorized and incomplete then the output will surely be ineffective. Therefore , all the transactions should be properly authorized before processing , all the transactions should be converted into machine readable form and should be recorded in the computer files accurately, transactions should not be lost, added, duplicated or improperly changed , all the incorrect transactions should be rejected and resubmitted on a timely basis. The auditor should consider following points : (1) Authorization for processing : documents should be under proper authorization by the appropriate personnel. And in case of online transactions where it is not possible to check authorization all the time when the data is entered , the password protection should be used, and the system should have inbuilt system of automatic checks. (2) Batch numbering : to ensure that no batch is lost during the transmission , the serial number of slips should be checked for their continuity. And each of the input documents should be given a separate serial number. (3) Pre-processing review: to check the completeness and correctness of data (4) Batch control totals : obtaining assurance about the completeness of the data
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(5) Check- digit : to protect against the transposition and transcription errors (6) Edit test : Number of test check are available : (a) Validity checks comparison of input data with the valid data (b) Format test checking the contents of specified fields of input to check whether their format is correct or not (c) Completeness test : checking all data fields (d) Limit test: checking data fields for determining whether the quantity or amounts therein is within defined limits . (2) Processing controls: the processing controls should be effective so as to ensure that all the transactions are properly processed by the computer, any of the transaction is not lost, added , duplicated , nor improperly changed. And all the processing is being done on timely basis by the proper use of latest version of programs. Controls ensuring the completeness and accuracy of the processing can also be applied . this can also be checked by reperforming some of the checks manually. (3) Output controls : The output controls are needed to ensure that : (a) The results of processing are accurate (b) Only the authorized persons are able to access the output (c) The access of output is done by the authorized persons only on timely basis. Problems faced by auditors in an EDP environment : (1) High speed (2) Concentration of duties (3) Impact of poor systems (4) Misuse of facilities Special considerations in case of data processed through computer service centers: Some of the organization use computer service centre for data processing because their size and scale of operations do not support the establishment of their own computer systems. The process of getting data processed through computer service centre is as follows: (a) Entity delivers its data to centre in the form of source document (b) Centre then maintain permanent file of the organization (c) Then it process the input data with the master files and provides the user with the final output documents Auditors responsibility : the auditor may not be able to satisfy himself fully about the operations and controls of the service centre. He has to concentrate on clients internal
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controls. He should check the accuracy of the transactions processed at the centre on sampling basis . He may also decide to use test data . test packs, and audit software. He should also assess the degree of control over the maintenance of master files. He should ensure that all the exceptional reports are received from the computer service centre AUDIT APPROACHES AVAILIBLE TO THE AUDITOR IN EDP SYSTEM ( 98 may, 98nov, 99nov, 2002may,2003, 2005may,2005nov,2006may, 2007nov) : There are three approaches to EDP auditing : (1) Auditing around the computer (2) Auditing through the computer (3) Auditing with the computer Auditing around the computer (Black Box technique): (a) This helps in forming of an audit opinion ,where the existence of computer is not taken into account . (b) Computers are merely treated as mechanical book keeping aids. (c) The main focus of the audit is to compare the input vouchers with the system outputs to get audit assurance. (d) Computers are mere treated as a system provide the printouts of the transactions (e) No regard is paid to the data transformation capacity of the computer (f) The main advantage of around the computer is its simplicity because it uses generalized software that is well tested and widely used. . * Disadvantages: (a) It is not beneficial for large and complex organizations , only suitable for small organizations. (b) It is not possible for the auditor to assess the degradation in the system in case of change in environment Auditing through the computer (a) The auditor takes the computer as the target of audit . it is treated as a live and dynamic device, which has added value to the process of auditing. (b) He can use the computer to test the program logic and program controls existing within the system and records produced by them . (c) There are three methods of auditing through the computer : Tests data : This is a special set of input data , prepared specifically to test a program or a set of programs of the entity under audit
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Controlled processing: This means that processing run is undertaken using a already tested program under the control of the auditor Computer audit programmed: The auditor uses computer programs for testing and evaluating the system of internal control, and validity of transactions processed by EDP . Areas where auditing through computer is done : (a) Where computer processes and produces a large volume of output. (b) Where the significant part Internal Control System are embodied in the computer system itself (c) Where the problem is logically complicated Advantages : (a) Auditor has increased power to effectively test am computer system (b) The range and capability of tests to be performed increases (c) Auditor acquires greater confidence about the accuracy of data . Disadvantages (a) Highly expensive (b) Need for extensive technical EXPERTISE Although there is no need of disadvantages because it is the most popular approach of auditing. Auditing with the computer: When the computer is used for processing various tasks , it becomes an audit tool and is known as auditing with the computer or Computer Assisted Audit Techniques (CAAT) Generally audit software available for the purpose , which can be used in the computer system by the client. Alternatively, separate program may be written for each client .

TRIAL BALANCE IN AN EDP SYSTEM ALWAYS TALLIES , THUS THE WORK OF AN AUDITOR BECOMES SIMPLER (1) It is correct to say that in an EDP environment , the trial balance always tally , but it is not correct to say that audit in such an environment is simpler. (2) Some errors of omission, compensating errors , commission errors, principal errors always remain in the books even though the trial balances tallies .

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(3) Generally tallying of trial balance means its arithmetical accuracy but the audit objective of expression of opinion on the true and fair view of the financial statements and not just the arithmetical accuracy. (4) The nature of transactions which are recorded is very complex, accounting aspects have become multi-faceted, due to emergence of new concept like lease finance , options and futures etc. (5) While auditing , besides trial balance , there are many more issues like estimation of depreciation, valuation of inventories, etc. such issues require the exercise of skill and care of the auditor (6) It can be analyzed , that the audit of the tallied trial balance require more time than an audit where the trial balance does not tally.

Problems which are encountered while shifting from manual based accounting records to computer based accounting records (1) Visual observations : Visual observations are more difficult because of the speed with which the system operates. Even the slowing down of the system will of no value to the auditor because of his inability to understand the electronic pulses and the information stored in an electronic media. (2) Internal storage :It is a representative of the information in electronic form inside the computer, as a result of this the auditor is unable to observe the processing of data to determine whether the procedures are being followed (3) Changes in programs : changes in programs used for processing the data can be brought about without the knowledge of the auditor (4) Disappearance of the audit trail : in a computerized information system where data are being entered directly into the system of the auditor faces the problem of partial; elimination of audit trail (5) High level languages : a major problem is that the source code listing provided to the auditor may not agree with the object code used by the computer for processing .

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The company audit Every company has to appoint an auditor to get its books of accounts audited. The auditor acts as an agent of the shareholders. He submits his report to the shareholders about the finances of the company, this is the main reason of compulsory audit of books of accounts of a limited company. Qualification of auditors : Section 226(1) : A person is qualified for appointment as the auditor of a company only if he is a Chartered Accountant within the meaning of Chartered Accountant Act 1949. A firm where all the partners practicing in India are qualified for appointment as auditors, it may be appointed by the firms name. In such case any partner so practicing can act in the name of a firm. However an individual chartered accountant being the sole proprietor can not be appointed as auditor in the name of the firm . Section 226(2) The holder of the certificate under the Registration Auditors Certificate, Rules 1956 shall be entitled to be appointed as auditor of the company. Such certified auditors are subjected to the rules framed in this behalf by the Central Government . Section 226(3) The following persons shall not be qualified for appointment as auditor of the company: (1) A body corporate (2) An officer or employee of the company (3) A person who is a partner , or who is in the employment of an officer or employees of the company .
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(4) A person who is indebted to the company for an amount exceeding Rs.1000 , or who has give any guarantee or provided any security in connection with the indebtedness of any third person to the company for an amount exceeding Rs.1000. Indebtedness of upto Rs. 1000 would not be considered as disqualifications . (5) A person holding any security of the company which carries voting rights. Section 226 (4) A person shall not be qualified for appointment as an auditor of a company if he is , by virtue of the above disqualifications , disqualified for appointment as an auditor of any other body corporate which is that companies subsidiary of a holding company or a subsidiary of that companys holding company or would be so qualified if the body corporate were a company . Section 226 (5) An auditor, who after his appointment become subject to any of the above disqualifications, shall be deemed to have vacate his office his office as an auditor.

Appointment of auditors Section 224 (5) Appointment of first auditors The BOD should appoint the first auditor within one month of the registration of the company. The auditor should hold office until the conclusions of the first AGM . Appointment of the first auditor will be by valid resolutions at the board meeting , merely naming them in the articles of associations will not be recognized as appointment under the act. In case the board does not exercise the power in this regard, the company in the general meeting shall appoint the first auditor. But whether appointed by the board or by the company, information to the first auditor about his appointment as such is not a necessary condition. The first auditor is
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also not required to inform the Registrar about his acceptance or refusal of the said appointment.

Section 224(1) Appointment by company i.e. Shareholders except in case of first auditors, every company shall at its AGM appoint an auditor or auditors who will hold office as an auditor from the conclusion of the meeting until the conclusion of next AGM. Section 224(2) According to this section at any general meeting, a retiring auditor by whatsoever authority appointed shall be reappointed unless: (a) He is not qualified for re appointment . (b) Ha has given the company a notice in writing of his unwillingness to be reappointed (c) A resolution has been passed at the meeting appointing somebody else instead of him or providing expressly that he shall not be reappointed ; or (d) Where notice has been given of an intended resolution to appoint some person in place of a retiring auditor and by reason of death , incapacity of disqualification of that person or of all persons , as the case may be, resolution can not be proceeded with. (e) No written certificate has been obtained from, the proposed auditor to the affect that the appointment or reappointment , if made will be in accordance with the limits specified in subsection(1B )of section 224. The appointment is valid only from the conclusion of one meeting upto the conclusions of the next meeting. Where an auditor is appointed for any other period , his function during the shortened period will not be lawful and he shall not be entitled to any remuneration for the same. But if the next general meeting is not be held within the period prescribed by section 166, the auditor(s) shall continue to hold office till such meeting is held and concluded. Where such meeting is adjourned to a later date, the auditor(s) shall hold office till the conclusion of the adjourned meeting . Section 224(3) Appointment by Central Government Where at any general meeting , no auditors are appointed or reappointed within 7 days of such a meeting , the company shall intimate this information to the Central
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Government , who may appoint a person to fill the vacancy. If the company fails to give this intimation to the CG , the company and every officer in default shall be punishable with a fine which may extend to Rs 5000. Under section 619 , the Comptroller and Auditor General of India may appoint or reappoint the auditor of a government company . Section 224(6) Appointment in case of casual vacancy If vacancy is caused due to : Resignation then it is filled by the company in general meeting. Any other reason - then by the Board of Directors. While any such vacancy continues the remaining auditor or auditors , if any , may continue to act as the auditor / auditors. Any auditor appointed in a casual vacancy shall hold office until the conclusion of the next AGM. Casual vacancy caused by the resignation of auditor can only be filled by the shareholders in the general meeting, to preserve the independence of the auditor. It may happen that the auditor has resigned due to abuse of authority or financial impropriety by the management. If in the general meeting he is found honest, then he may be said to reconsider his decisions . Section 224 (A): Appointment by special resolution : In case of a company in which not less than 25% of the subscribed share capital is held , whether singly or in combination, by: (a) A public financial institution, or a government company or the Central Government or any State government or (b) Any financial or other institution established by any Provincial or State Act , in which a State Government holds not less than 51 % of the subscribed share capital., or (c) A nationalized bank or an insurance company carrying on general insurance business. The appointment or reappointment at each general meeting of the company , of an auditor(s) shall be made by a special resolution
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If the company fails to pass such a special resolution for making the appointment of auditor(s), it shall be deemed that the auditor or auditors had not been appointed by the company, at its AGM. In such case, the Central Government may appoint a person to act as the auditor of the company. Section 224 A (2) Failure to pass special resolution : It shall be deemed that no auditor has been appointed by the company, and therefore the provision of section 224(3) will become applicable Section 224 (1B) Ceiling on number of audits : Section 224(1B) introduces a ceiling on the number of companies of which a firm or person could act as auditor. Accordingly, an auditor cannot hold the audit of companies in excess of the specified number of 20 companies , out of which not more than 10 companies shall have a paid up capital of Rs 25 laths or more. In the case of a firm of Chartered Accountants having two or more partners, the specified number shall be counted per partner of the firm. If there are three partners, the firm can hold the audit of 60 companies of which not more than 30 companies shall have a paid up capital of Rs 25 laces or more. When one person is a partner in more than one firm , that person shall be considered only once for the ceiling purposes. He can hold upto 20 audits. The specified number does not include : (a) Branch audit. (b) Special audits (c) Audit of non-corporate bodies (d) Audit of corporation setup under separate Act (e) Audit of foreign companies (f) Private companies The audit of non profit making organizations and company limited by guarantee and having share capital are to be taken into account for calculating specified number . A company in full time employment elsewhere can not do company audit. The total limit is 30 including private companies Even a branch audit is included but the appointment should be under Section 228.
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Section 224(7) Removal of auditor before the expiry of the term . First auditor May be removed by the members in general meeting. It is not necessary that the auditor has completed or not the term of his appointment. The GM may also appoint any other person nominated by any member of the company in his place . In any other case If the auditor is removed before the expiry of his term than this can be done by the GM after obtaining prior approval of the Central Government in this behalf. The rights of the auditor as per the provisions of section 225 will be attracted , i.e. to make and get the representation circulated among shareholders and the right of being heard in GM

Section 224 (8) Auditors remuneration : Appointed by BOD :- remuneration is also fixed by BOD , the resolution may also empower the Chairman or MD. Appointed by shareholders : - remuneration is determined by the shareholders in AGM , sometime the shareholders may delegate the power to BOD, Chairman, MD etc. Appointed by the Central Government : -remuneration is fixed by the Central Government Appointed by the C&AG of India : - the remuneration or the manner shall be determined by the company in GM. When a retiring auditor is reappointed and the resolution does not determine the remuneration than he will get the same remuneration as he was getting previously. The P&L account shall contain or give by way of note , a detailed disclosure in regard to the amount paid to the auditor , whether as fees , expenses or otherwise for services rendered . Appointment or removal of auditors Section 225 (1)
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The special notice shall be required to pass the resolution at an AGM appointing a person as an auditor in the place of retiring auditor or providing expressly that the retiring auditor shall not be reappointed. Section 225(2) Sending the special notice to the retiring auditor Section 225(3) The retiring auditor on receipt of a copy of such a special notice, may make representations in writing to the company. Such representations should not exceed a reasonable length. He may also request the company to circulate his representations to the members of the company. The company must circulate such representation to the members unless the representations are received by the company too late. A notice of the resolution must be given to the members stating also the fact of the representation having been made. If a copy of the representation is not sent to the shareholders either because they are received too late or because of the default of the company , the auditor may require that the representation must be read out at the meeting. the auditors right to be heard orally will not get affected . If the Company Law Board on application of either of the company or of any person claiming to be aggrieved, has satisfied that this right has been abused to secure needless publicity for defamatory purpose, copies of representation need not be read out or sent out at the meeting. Section 225(4) These provisions shall also apply to the removal of First Auditor appointed by BOD. When a new auditor is appointed in place of the retiring auditor, the company within 7 days of the meeting should intimate to the new auditor about his appointment who in turn should inform the Registrar within 1 month of the receipt of the intimation, in writing that he as accepted or refused to accept appointment. The new auditor should also communicate in writing to the retiring auditor before accepting the audit. Failure to do so will constitute a professional misconduct. Section 227 Powers and duties of auditor

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This section deals with certain reporting requirements , and powers and duties of auditor. Section 227(1) Right to Access Books and Accounts & Vouchers Every auditor of a company shall have a right of access at all times to the books of accounts and vouchers of the company, whether kept at the head office of the company or elsewhere, and shall be entitled to exercise from the officers of the company such information and explanations as the auditor may think necessary for the performance of his duties as auditor . Section 227 (1A) Certain provision to be verified and reported Without prejudice to the provision of sub-section (1), the auditor shall inquire (a) Whether loans and advance made by the company on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the company or its members, (b) Whether transactions of the company which are represented merely by book entries are not prejudicial to the interest of the company (c) Where the company is not an investment company within the meaning section 372 or a banking company, whether so much of the assets of the company as consist of shares , debentures and other securities have been sold at a price less than that at which they were purchased by the company (d) Whether loans and advances made by the company have been shown as deposits (e) Whether personal expenses have been charged to revenue account (f) Whether it is stated in the books and papers of the company that any shares have been allotted for cash , whether cash has been actually received or not. Section 227 (2) Report by the auditor on balance sheet and profit and loss account The auditor shall make a report to the members of the company on the accounts examined by him , and on every Balance Sheet and Profit and Loss account and on every other document declared by this act, to be part of or annexed to the Balance Sheet or profit and loss account which are
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laid before the company in general meeting during the tenure of his office, and the report shall state whether , in his opinion and to the best of his information and according to the explanation given to him , the said accounts give the information required by this act in the manner so required and give true and fair view (1) In the case of balance sheet, of the state of the companys affairs as at the end of its financial year (2) In the case of profit and loss account, of profit or loss for the financial year Section 227 (3) Certain other matters to be reported by the auditor . (a) Obtaining informations and explanations : (b) Requirements as to maintaining proper books of accounts (bb) Regarding report on the company office u/s 228 (c) Agreement of companys Balance sheet and profit and loss account (d) Preparation of Balance sheet and profit and loss account as per accounting standards . (e) Observations and comments to be shown in Italic (f) Disqualifications of Directors u/s 274 (1)(g) (g) Payment of CASs duty u/s 441 and its details Section 227 (4) Reasons for the negative answers regarding section 227 (2) and clauses a, b, bb, c and d of SUB SECTION-3: Section 227 (4A) Power of the Central Government regarding inclusion of any other matters in the Auditors report Section 227 (5) Not to disclose such matters which are not required to be disclosed .

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EXPLANATIONS AND CLARIFICATONS ON CARO, 2003COMPANIES (AUDITORS REPORT) ORDER, 2003 . The Central govt. in exercise of the powers conferred , under sub section (4A) of section 227 companys act, has issued the CARO 2003. This order supersedes the earlier order issued in 1988, which was called as MAOCARO, 1988. The provision of sub section (1A) and sec. 227 (3) are applicable to all companies WHILE the CARO order issued under subsection (4A) exempts certain class of companies. The provision of subsection (1A) requires the auditor to make certain specific enquiries during the course of audit. The auditor is not require to report on any of the matters specified in the subsection unless he has any special comments to make on the said matters. If he is satisfied with the results of his enquiries , he has no further duty to report that he is so satisfied. While the CARO order requires a statement on each of the matters specified therein even if he has no comments to make on any of the matters contained in the order . THUS it is clear that the provision of sub section (4A) of section 227. The order applies to all companies except certain categories of companies specifically exempted from the application of the order. The order also applies to foreign companies The order is also applicable to the audits of branches of a company since section 228 (3) clearly defines that branch auditor has the same responsibility as the companys auditor. The order provides that it shall not apply to : (a) A banking company as defined under Banking Regulation Act. (b) An insurance company as defined under the act . (c) A company licensed to operate under section 25 of companies act. (d) A private limited company with all the following conditions to be fulfilled by that company cumulatively i.e. all the four conditions to be complied with: - Its paid up share capital and reserves does not exceed 50 laces. - It has not accepted public deposits - It has no outstanding loan of Rs 25 laces or more - Its turnover does not exceed Rs 5 core The date of coming into force of this order is 1st January 2004 . Section 229 :

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Right to sign audit report : The auditor has a right as well as duty to sign the audit report and the Balance sheet and profit and loss account including all the documents attached or annexed therewith. Only the person so appointed as auditor can sign the audit report , only a partner in the firm practicing in India can may sign the auditors report. Default by the auditor under this section is punishable under section 233. Section 230 The auditors report shall be read before the company in general meeting and shall be open to inspection by any member of the company. The auditors report need not be read out by the auditor themselves. Section 231 Right of auditor to attend general meeting Section 233A Power of central govt. to direct for special audit in certain cases : Section 233A(1) -Certain conditions to be seen by the Central Government Section 233A(2) Appointment of Chartered Accountant to be deemed to be as a special auditor. Section 233A(3)- Powers and duties of special auditor Section 233A(4)- Matters to be included in the auditors report by the special auditor Section 233A(5)- Furnishing informations and other additional informations to special auditor as require by him Section 233A(6): Dealing of the special auditors report by the central Govt. Section 233A(7) :- Payment of remuneration and other expenses of special auditor . Section 228 : Audit of the branches : As per the provision of Sec.228 of the companys act 1956 , a company should get the accounts of its branches audited by independent professional auditors. .
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Section 228 (1) :Who can be appointed as branch auditor? (1) The company auditor appointed under section 224 (2) Any other auditor possessing qualification under section 226 (3) In case of foreign branches, any of the above or an accountant qualified to act as auditor in that foreign country. The branch auditors are appointed by the BOD. If branch auditors are appointed in consultation with statutory auditor. It should not be taken that the statutory auditor is taking any responsibility in respect of such auditor unless he is aware of any reason for which such person or persons should not be appointed a branch auditors. Their appointment is subjected to terms and conditions specified by the accounting body. Section 228 (2) : Right of main auditor if audit of companys branches are done by other auditor : (a) He shall be entitled to visit the branch office, if he deems it necessary to do so for the performance of his duties as auditor . (b) He shall have a right of access at all times to the books of accounts and vouchers of the company maintained at the branch office. Section 228(3) (a) Appointment of companys branch auditor /its qualifications company is situated outside India : Where a company in general meeting decides to have the account of a branch audited otherwise than by a companys auditor, the company in that meeting shall for the audit of those accounts appoint a person qualified for such appointment as auditor of the company u/s 226. Or where his branch office is situated in a country outside India , a person who is either qualified as aforesaid or an accountant duly qualified to act as an auditor of the accounts of a branch office in accordance with the laws of that country. Or otherwise the board of directors to appoint such person in consultation with the companys auditor. (b) Powers of companys branch auditor : the person so appointed will be called as the branch auditor. He shall have the same powers and duties in respect of accounts of the branch office as the companys auditor has as per section 227. (c) Report of the companys branch auditor ; the branch auditor shall prepare a report on the accounts of the branch office, examined by him and forwards the
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same to the companys auditor, who shall in preparing the auditors report deal with them in such a manner as he considers necessary.. (d) Remuneration of companys branch auditor : the branch auditor shall receive such remuneration and shall hold his appointment subject to such terms and conditions as may be fixed either by the company in general meeting or by the board of directors if s authorized by the company in general meeting. Section 228(4) Exemption of branches from audit :- A branch of a company carrying manufacturing , processing or trading activity accounting for average quantum of activity not exceeding higher of : (1) Rs. 2 laths; or (2) 2% of the average total turnover of the company . Shall be exempt from the purview of compulsory audit of branch accounts. Section 233 B : Audit of cost accounts in certain cases : 233B(1) :- requirements as to cost audit in certain cases 233B(2) :- Appointment of auditors by Board 233B(3) :- appointment to be considered in addition to an appointment done u/s 224 233B(4) :- Power and duties of cost auditor 233B(5) :- disqualification of cost auditor u/s 226 233B(6) :- Providing facilities and assistance to cost auditor 233B(7) :- Furnishing the report to the Central govt. in requisite time 233b(8) :- Addition information required by the central govt. 233B(9):-Dealing of the cost audit report along with the additional information by the central govt. 233B(10) :- Circulation of the cost audit reports among members 233B(11) :- Default in complying with any provision . Section 617: Definition of government company A govt. company means any company in which not less than 51% of the paid up share capital is held by the central govt. , or by any state govt. (or partly by the central govt. and partly by one or more state govt.) and includes a company which is subsidiary of a govt. Company as defined earlier.
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Section 619: Appointment by C&AG of India Section 619(1) Appointment of auditors in case of govt. company is subject to the provision of sec 619, which overrides sec 224 to sec 233, dealing with appointment, etc. of the auditors in the case of non govt. companies. Section 619(2) The auditors of government company shall be appointed or reappointed by the Comptroller and Auditor General of India. However the appointment shall be subject to ceiling limits as per sec 224(1B) and (1C) Section 619 (3) :- Power of C&AG of India The C&AG of India shall have power (a) To direct the manner in which the companys accounts shall be audited by the auditor appointed in pursuance of sub section(2) and to give instruction to such auditor in regard to any matter related to the performance of his function as such. (b) To conduct a supplementary or a test audit of the companies accounts by such person as he may authorized in this behalf and for the purposes of such audit, to require information or additional information to be furnished to any person so authorized, on such matters, by such persons, and in such form, as C&AG may direct. Section 619(4) : Submission of copy of audit report to C&AG : The auditor shall submit a copy of his audit report to the C&AG, who shall have the right to comment on or supplement, the audit report in such ,manner as he may think fit . Section 619 (5) : - Placing the audit report before the AGM ; Any such comments on, or supplements to the audit report, shall be placed before the AGM of the company at the same time and in the manner as the audit report.

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Section 619B : - Provision of section 619 to apply to certain companies: The provision of section 619 shall apply to a company in which not less than 51% of the paid up share capital is held by one or more of the following or any combination thereof, and the same shall be treated as if it were a government company: (a) The central govt. or one or more govt. companies (b) Any state govt. (s) and one or more govt. companies (c) The central govt., one or more state got,(s) , AND one or more govt. companies. (d) The central govt., AND one or more corporations owned or controlled by the central got (e) The central got, one or more state got, and one or more corporations owned or controlled by the central govt. (f) One or more corporation owned or controlled by the central govt. or the state govt. (g) More than one government company .

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