Auditing : UNIT 1

Lalatendu Mishra

Origin of Auditing

In ancient days, it was confined to public accounts only

The Egyptians, the Romans and the Greeks

Development of trade and commerce: need for recording

transactions
Luca Paciolo, an Italian mathematician
He is referred to as "The Father of Accounting and
Bookkeeping" and he was the first person to publish a
work on the double-entry system of book-keeping

Origin of Auditing

He introduced double entry book keeping

Capable of recording all types mercantile transactions

The scope of an auditor enhanced

Auditing In India

Maurya dynasty
Kautilya Arthasastra: mentioned about the accounting and
auditing practice
Associated with large scale production following the
Industrial revolution

The formation of numerous joint stock company

Mandatory for all corporate bodies

Meaning and Definition of

Auditing

The word audit takes its origin from Latin ' audire'
means to hear
In middle age , the auditor was a person appointed by the
owner whenever they suspected fraud
To check the accounts and to hear explanation given by
persons responsible financial transaction

Auditing Definition: narrow

concept
Montgomery: A systematic examination of books and
records of a business or other organization in order
to ascertain or verify and to report upon the facts
regarding the financial operations as a result
thereof

Auditing Definition: narrow

concept
Spicer and Pegler an audit may be said to be such an
examination of books, accounts and vouchers of a
business as will enable the auditors to satisfy that
the balance sheet is properly drawn up , so as to
give a true and fair view of the state of affair of the
business and whether profit and loss account gives a
true and fair view of profit and loss for the financial
period according to the best of his information and
explanation given to him and as shown by the books
and, if not, in what aspect he is not satisfied

Auditing Definition: narrow

concept
I. The object of an audit is verification of accounting data
and report on the reliability of the financial statement
II.The auditor collects and evaluates the evidence contained
in the books, accounts and vouchers
III.The auditor should express his opinion through an audit
report
IV. These difination limit the scope : not including to verify
cost accounting

Auditing Definition: narrow

concept
V. It does not include any evaluation process in which non
financial data is used: management audit
VI. It did not recognize the fact that evidence can be
obtained from other sources: tax records, direct
confirmations from debtors and others

Auditing in a broad sence

The institute Of Chartered Accountants of India Auditing
is a systematic and independent examination of data,
statements, records, operations and performance( finance
or otherwise) of an enterprise for a stated purpose. In any
auditing situation, the auditor perceives and recognises
the propositions before him for examinations, collects
evidence, evaluates the same and on this basis,
formulates his judgment which is communicated through
his audit report

Auditing in a broad sence

Systematic: fully planned, auity plan, logical sequence

Independent: no influence from the client or anybody else

Data, statement, records, operations and performance:

scope( financial and non financial)
Stated purpose:clearly defined
Perceives and recognizes the propositions before him for
examinations: what he has to prove

Auditing in a broad sence

Collects evidence, evaluates the same:depending on

proposition and professional knowledge skills.
Formulates his judgment which is communicated through
his audit report: the format and contents of audit report
depend upon many factors including the type of audit,
statutory requirements and purpose of audit

Book-keeping
It is concerned with systematic recording of transactions in
the books of original entry and their posting to ledger
It involves:

Journalising

Posting to ledger

Totaling of accounts

Balancing

Accountancy
Accountancy begins, where book-keeping ends.
It involves

Preparation of trial balance

Preparation of trding and profit and loss account

Preparation of balance sheet

Making rectification and adjustment entries

Auditing
Auditing begins where accountancy ends

Distinction between accounting

and auditing

Meaning and
object:analyses events
and transaction

Scope:
It does not cover qualitative
factor within it ambit

It analyses and examines

financial data

In wider scope, it is
concerned with qualitative
factor (example
government)

Distinction between accounting

and auditing
Source of authority
Authority from the
organizational hierarchy

Internal
auditor:
employee
of
organization

an
the

Financial auditor from the

letter of engagement
Qualification:
Not to be a chartered
accountant

Should be a Chartered
accountant

Distinction between accounting

and auditing
Nature of work
constructive

analytical

Duration
Through out the year

At the end of the year or

through out the year

Distinction between accounting

and auditing
Basis of remuneration:
monthly

Fixed amount as per

agreement with his client

Level of knowledge:
An accountant is not
required to have
knowledge of audit
techniques and

Accounting as well as audit

technique

Types of Auditing
Classification on the basis of Organization structure
1. Private audit
2.Government audit.
3. Statutory audit

Private audit
Private audit are carried out at the behest of the interested
parties and not to fulfill statutory requirement. The terms
and conditions between the client and the auditor defines
the scope of letter's work
Advantages to the sole proprietor

Ensures reliability of the reliability of the books of

accounts
Helpful in certain situation: examples settling insurance
claims, for obtaining loan from banks , for settling tax
disputes

Private audit
Advantage to partnership firm

A basis for reliance on financial statement

Avoiding/solving possible disputes among partners

Helps in dealing with third parties such as banks,

insurance companies, Governments etc.

Private audit
Advantage to partnership firm

A basis for reliance on financial statement

Avoiding/solving possible disputes among partners

Helps in dealing with third parties such as banks,

insurance companies, Governments etc.

Private audit
Advantage to partnership firm

A basis for reliance on financial statement

Avoiding/solving possible disputes among partners

Helps in dealing with third parties such as banks,

insurance companies, Governments etc.

Private audit
Advantages to individual and non-profit organization

Protecting the assets and ascertaining the liability

Helps in dealing with third parties

Serves as a basis for relying on other person

Government Audit
Meaning and scope:
A controlling measure of public accounting of Government
funds
Audit of public enterprises
Public enterprises are classified under three categories such
as departmental undertaking, statutory corporations
financed by Government and government companies set
up under Companies Act

Government Audit
Who Conducts: the Accounts and Audit Department of the
Government of India headed by the Comptroller and
Auditor general of India (CAG)
Submission of Audit Report:
1.The President or Governor of the state for being laid
before Parliament or the state legislative of the State.
- wasteful expenditure, non-observance of rules, cases of
financial impropriety etc.

Difference between audit of a

limited company and audit of a
firm

Appointment of
auditor

Accounting
treatment and
disclosure of
various items of
financial
statement

Board of director,
the Central
Government or
the Comptroller
and Auditor
General
In accordance
with the Act

Sole proprietor or
partner

Specific
instruction of
the client

Difference between audit of a

limited company and audit of a
firm

Report

Submitted before
the shareholder

As per the terms

of appointment

Classification on the basis of

specific objective
1.Independent financial audit:
2.Internal Audit: An independent appraisal activity within
an organization

Independent audit vs Internal

Audit
Object

Ascertain the
truthfulness and
fairness of state
of affairs

Review financial
and non
financial
operation

Statutory status

compulsory

Not mandatory

Independent audit vs Internal

Audit
Appointment of
auditor

Appointed by the
owners or
shareholders

Appointed by the
management

Duties

Statute or letter
of engagement

management

Independent audit vs Internal

Audit
Periodicity

Annual or on a
continuous
basis

Continuously i,e.,
throughout the
year

Classification on the basis of

specific objective
3.Cost Audit: Cost audit is the verification of the
correctness of cost accounts and of adherence to the cost
accounting plan.
- auditing conducted within the meaning of the Cost and
Works Accountant Act 195

Classification on the basis of

specific objective
4. Management Audit: Management is an audit to
examine, review and appraise the various policies and
actions of the managemnet
- not compulsory
-comprehensive and critical review of all aspect of
performance

Classification on the basis of

specific objective
Tax Audit : an examination of financial records to access
the correctness of calculation of taxable profit, to ensure
compliance with provisions of the Income-tax Act 1961
and also ensure fulfillment of conditions for claiming
deductions under sections 44AB
- accounts audited by an accountant nominated by the
Commissioner of Income-tax.

Classification on the basis of

specific objective
Secretarial Audit: To ensure that full and adequate
compliance to various legal requirement
Duties to be discharged: The whole time company secretary
Every listed company has to appoint as a compliance officer
Statutory Status: compulsory for companies having paid up
share capital, of two crore rupees( mandatory to appoint
whole time company secretary)
Companies with paid up working capital of rupees ten lakhs
or more but less than rupee two crores are required to
engage the service of a secretary in whole time practice and

Classification on the basis of

specific objective
Social Audit:
Social accounting is concerned with the development of
measurement systems to monitor social performance in
the community development, human resource, physical
resource and environmental contribution, and product or
service contribution
Social Audit: an examination of these measurements to
verify records of social performance

Classification on the basis of

specific objective
Environment Audit:It is a management tool comprising a
systematic, periodic and objective evaluation of how well
organization, management and equipment are performing
to safeguard the environment.
Regulatory requirement as well as perceived by the
management
Environment audit report termed as environmental
statement( 30th Sept before the State Pollution Board)
Auditor: technical knowledge,knowledge of environmental
lawl

Classification on the basis of

specific objective
Performance Audit or Efficiency-cum-performance
Audit:
Main facets:
Economy audit: quality and quantity at minimum cost
Efficiency Audit:relationship nbetween input and output
Effectiveness audit:the extent a program or a project has
achieved its goal or other intended benefits

Classification on the basis of

specific objective
Propriety Audit: An examination of actions and decisions
to find out weather they are in public interest and meet
standards of proper conduct
No leakage of revenue or wastage of funds by mistake or
fraud
CAG/ Government audit

Classification on the basis of

Time
Continuous Audit
Annual Audit
Interim Audit
Balance Sheet Audits

Classification on the basis of

Scope of Audit
Complete Audit:
Partial Audit
Detailed Audit

Classification on the basis of

Scope of Audit
Complete Audit: check all transaction, totals, balances and
book of accounts with the help of relevant voucher,
documents, correspondence etc.
Partial Audit: some of the records and books or a part of
books for whole or part of the period
Detailed Audit: An audit which starts with the books of
prime entry and ends with the balance sheet

Objectives of Audit

Primary or Main Objective

Secondary Objective

Specific Objective

Primary or Main Objective

Expression of opinion as to the truthfulness and fairness of
financial statement
Statements comply with

Accounting principles

Relevant legislation

Correctly extracted from the books

Secondary Objective
Detection and Prevention of Fraud and Error
Error
a) Clerical error
i) error of omission
ii) error of commission
b) Error of principle

Secondary Objective
c)Compensating Error
d) Error of duplication

Fraud
Fraud refers to intentional misstatement
a) Employee fraud
b) Management fraud
- manipulation, falsification or alteration of books
of account
-omission of the event or information
- misapplication of accounting policy

Advantages of Auditing
To the owners

Serve as basis for relying on financial statement

Serve as a check on the integrity of person at the
helm of affairs

To other

To the employees: negotiating higher or bonus

To potential creditors( creditors and suppliers)provides a data base for taking credits

Advantages of Auditing

To analyst: ( underwriter and credit rating agency)

supplies information to them
The monitoring agencies:( regulatory agencies such
as SEBI and stock exchange)

To the Management

Serve as a basis for establishment of and

improvement in control system
Help in dealing with lenders, insurers, Government
and such other third parties

Advantages of Auditing

Ensure compliance with legal requirements in

certain situation
Serve as a basis for determining amount receivable
or payable in certain circumstances

Limitations of Auditing

Conceptual restriction

Obstructs work

Minimization and not elimination of errors

Inconclusiveness of evidence

Exercise of judgment

Inherent limitation

Audit Process
Planning the Audit
Conducting Audit
Reporting the Finding

Planning of Audit

Obtain knowledge of client's business , industry,

accounting system and internal control system

Development of over all plan

Prepare audit program

Consideration for commencing

an audit
1) Initial enquiries:: industry data: ownership, management
and operation
2)communication with previous auditor: why not to accept
the audit
3)Sending engagement letter to clarify work agreement:
Content- objective and scope
-Responsibility of management for financial statement

Consideration for commencing

an audit
Fraud and error
Unrestricted access to record and information
extent of involvement of other auditor, internal auditro,
client staff, experts
4) Acquiring knowledge of client's business or business
review
Annual report
Minutes of meetings

Consideration for commencing

an audit
Internal auditors
Policy and procedure manuals
Trade journals , magazines
Relevant publication by the ICAI and other profess
bodies
Discussion with management/ client
Visits to client's premises and plant facilities:

Audit Program
A logically planned examination specifically the audit
procedures to be applied in given circumstances for
accomplishing the audit objectives, giving an estimate
time required to finish a particular work and laying down
responsibilities of members of audit team
-the procedure to implement the audit plan

Development of Audit Program

Factors consider for audit program
i) Internal Control System: extent of substantive testing
ii)Nature of client activity:audit resource like time and
audit staff
iii)Cost-benefit

Advantages of an Audit
Programme
i) Provide clear cut instruction
ii)Provide a total perspective
Iii) Provide a tool for efficient distribution of work
iv) Assist in fixing responsibility for work done
v) Helps in assessing progress work
vi) Serves as evidence against charge of negligence
vii) Serves as a basis for subsequent revision

Disadvantage of Audit Program

i)Audit work becomes mechanical and rigid: without proper
understanding of audit process
ii) Shields inefficient staff and reduces the initiative of
efficient staff

Audit Notebook
It is maintained by the audit assistant
It is a written and systematic record of queries made by
them and replies there to

Content of Audit note book

i) Technical detail about business
ii) Queries
iii)Fraud and Error
iv) Notes regarding system of maintaining accounts
v)Name of officials who certify bad debt, depreciation etc
vi)Total number of ledger accounts
vii)Points to be included in audit report
Viii) important matters for future reference.

Advantages of audit note book

I) important matters related to audit work may be easily
remembered
ii) ensure continuity of audit work
ii) serves as proof against charge of negligence
iv)serves as a guide in framing future program

Working Paper
The continuous link between the client's accounting records
and the auditor's report
- It constitutes all documents prepared or obtained and
retained by the auditor

Functions/Advantages of Audit
working paper
i)Organizing and conducting audit
ii)Supervising and reviewing the work of assistant
iii)Substituting the audit report