Auditing Fundamentals

Auditing : UNIT 1
Lalatendu Mishra

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Origin of Auditing
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In ancient days, it was confined to public accounts only
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The Egyptians, the Romans and the Greeks
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Development of trade and commerce: need for recording transactions
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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
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He introduced double entry book keeping
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Capable of recording all types mercantile transactions

The scope of an auditor enhanced

Auditing In India
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Maurya dynasty
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Kautilya Arthasastra: mentioned about the accounting and auditing practice
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Associated with large scale production following the Industrial revolution
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The formation of numerous joint stock company
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Mandatory for all corporate bodies

Meaning and Definition of Auditing
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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
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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

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”

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

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”

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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

●
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
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Posting to ledger
●
Totaling of accounts
●
Balancing

Accountancy
Accountancy begins, where book-keeping ends.
It involves
●
Preparation of trial balance
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Preparation of trding and profit and loss account
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Preparation of balance sheet
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Making rectification and adjustment entries

Auditing
Auditing begins where accountancy ends

Distinction between accounting and
auditing
●
Meaning and object:analyses
events and transaction
It analyses and examines financial
data
In wider scope, it is concerned with
qualitative factor (example
government)
Scope:
It does not cover qualitative factor
within it ambit

auditing
Source of authority
Authority from the organizational
hierarchy
Internal auditor: an employee of the
organization
Financial auditor from the letter of
engagement
Should be a Chartered accountantQualification:
Not to be a chartered accountant

auditing
Nature of work
constructive analytical
At the end of the year or through out
the year
Duration
Through out the year

auditing
Basis of remuneration:
monthly Fixed amount as per agreement with
his client
Accounting as well as audit technique
Level of knowledge:
An accountant is not required to have
knowledge of audit techniques and
procedures

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
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 Board of director, the
Central Government
or the Comptroller
and Auditor General
Sole proprietor or
partner
Specific instruction of
the client
In accordance with the
Act
Accounting treatment
and disclosure of
various items of
financial statement

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
Not mandatorycompulsoryStatutory status

Appointment of auditor Appointed by the
owners or
shareholders
Appointed by the
management
managementStatute or letter of
engagement
Duties

Periodicity Annual or on a
continuous basis
Continuously i,e.,
throughout the year

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

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

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.

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 obtain a “ sectretarial compliance certificate”

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

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

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

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
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Primary or Main Objective
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Secondary Objective
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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
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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
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Serve as a check on the integrity of person at the helm of affairs
To other
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To the employees: negotiating higher or bonus
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To potential creditors( creditors and suppliers)- provides a data base
for taking credits

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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
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Serve as a basis for establishment of and improvement in control
system
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Help in dealing with lenders, insurers, Government and such other
third parties

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Ensure compliance with legal requirements in certain situation
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Serve as a basis for determining amount receivable or payable in
certain circumstances

Limitations of Auditing
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Conceptual restriction
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Obstructs work
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Minimization and not elimination of errors
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Inconclusiveness of evidence
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Exercise of judgment
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Inherent limitation

Audit Process
Planning the Audit
Conducting Audit
Reporting the Finding

Planning of Audit
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Obtain knowledge of client's business , industry, accounting system
and internal control system
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Development of over all plan
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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

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

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: forming an opinion, planning subsequent
audit and helpful to new or inexperience staff
ii)Supervising and reviewing the work of assistant
iii)Substituting the audit report: evidence and adequate documentation serves as
basis for issuing an opinion

Auditing Fundamentals

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