Auditing study material for b.com final year students

Auditing material

1. Principles and Practice of Auditing

2. Unit -1 Introduction to Auditing

3. Introduction Meaning : The word audit is derived from a Latin word “ audire ” which means to “hear”. It refers to the verification and examination of accounts to ascertain whether the balance sheet and profit and Loss account give a true and fair view of the financial position and profit or loss of the business.

4. Origin And Development The term audit is derived from the Latin term ‘ audire ,’ which means to hear. In early days an auditor used to listen to the accounts read over by an accountant in order to check them. Auditing is as old as accounting. It was in use in all ancient countries such as Greece, Egypt, Rome, U.K. and India. The Vedas contain reference to accounts and auditing. Arthasashthra by Kautilya detailed rules for accounting and auditing of public finances.

5. Cont. Auditing evolved and grew rapidly after the industrial revolution in the 18th century with the growth of the joint stock companies the ownership and management became separate. The shareholders who were the owners needed a report from an independent expert on the accounts of the company managed by the board of directors who were the employees. The original objective of auditing was to detect and prevent errors and frauds.

6. Development In India the companies Act 1913 made audit of company accounts compulsory. With the increase in the size of the companies and the volume of transactions the objective of audit shifted and audit was expected to ascertain whether the accounts were true and fair rather than detection of errors and frauds. Hence the emphasis was not on arithmetical accuracy but on a fair representation of the financial efforts the companies Act 1913 also prescribed for the first time the qualification of auditors.

7. Cont. The later developments in auditing pertain to the use of computers in accounting and auditing. In conclusion it can be said that auditing has come a long way from hearing of accounts to taking the help of computers to examine computerized accounts.

8. Auditing states

9. Meaning The general meaning of an audit is a planned and documented activity performed by qualified personnel to determine by investigation, examination, or evaluation of objective evidence, the adequacy and compliance with established procedures, or applicable documents, and the effectiveness of implementation.

10. Definition Simple Definition:- “Audit is an examination of accounts & records which is carried out by vouching the evidences, supporting various transactions; by such an examination it is ascertained that the Balance Sheet gives a true & fair view of the state of affairs of business & the Profit & Loss Account gives a true & fair view of the profit or loss of business.

11. Cont. Spicer and Pegler:- "Auditing is such an examination of books of accounts and vouchers of business, as will enable the auditors to satisfy himself that the balance sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and that the profit and loss account gives true and fair view of the profit/loss for the financial period, according to the best of information and explanation given to him and as shown by the books; and if not, in what respect he is not satisfied."

12. Cont. R.K.Mautz : “ Auditing is concerned with the verification of accounting data determining the accuracy and reliability of accounting statements and reports.”

13. Features of Auditing It is a thorough, intelligent, systematic and critical examination of accounting data. Art & Science Both Verification of the results The Auditor has to satisfy himself with the authenticity It is conducted in an unbiased manner by an independent person with the requisite qualification . The examination of accounts may be made throughout the year or periodically . It is done with the help of relevant records, vouchers, documents, information's and explanations from authorities.

14. The auditor has to satisfy himself and report whether or not: i )The profit & loss account reveals true and fair view of profit and loss of the period. ii)The balance sheet exhibits a true & fair view of financial position of the business. iii)Books of accounts have been maintained and accounts have been prepared as per the provisions of law. It may also include the audit of non-financial matters like audit of policies, operations, efficiency etc.

15. Scope of Auditing The scope of audit is increasing with the increase in the complexities of the business. It is said that long range objectives of an audit should be to serve as a guide to the management future decisions. Today most of the economic activities are largely conducted through public finance. The auditor has to see whether these larger funds are properly used. The scope of audit encompasses verification of accounts with a intention of giving opinion on its reliability . Hence it covers cost audit, management audit, social audit etc. It should be remembered that an auditor just expressed his opinion on the authenticity of the account. He has no power to take action against anybody , in this regard its said that “an auditor is a watch dog but not a blood hound”.

16. Cont. 1. Legal Requirements 2. Entity Aspects 3. Reliable Information 4. Proper Communication 5. Evaluation 6. Test 7. Comparison 8. Judgments 9. Work 10. Evidence 11. Misstatement

17. Principles of Auditing Fundamental principles of Auditing Integrity, Objectivity and Independence Confidentiality Skill & Competence Responsibility of work performed by others Documentation Planning Audit Evidence Accounting system & Internal Control Audit Conclusions Audit Report

18. Accounting vs. Auditing

19. Objectives of Auditing

20. Objectives: Main / Primary Objective : To verify and express an opinion as to whether at a given date balance sheet presents a true and fair financial position and profit & loss account gives a true & fair view of the profit and loss for that accounting period. To verify that accounting systems are correctly adopted and accounts are prepared according to the recognized accounting policies and practices prescribed by law.

21. II. Subsidiary/Secondary Objectives : Detection and Prevention of Frauds Detection and Prevention of Errors i . Detection and Prevention of Frauds : Fraud refers to an intentional and deliberate misrepresentation of accounting information for a financial gain. They are intended to deceive, to mislead or to conceal the truth or the material frauds . They can be of the types : Misappropriation/ Embezzlement of cash. Misappropriation of Goods. Manipulation of Accounts

22. Detection & Prevention of Frauds

23. ii. Detection and Prevention of Errors : An error is an unintentional mistake in the books of accounts or records whether by way of: Clerical or mathematical mistake. Oversight or misrepresentation of facts or Misapplication of accounting policies. Classification of Errors : Error of Principle Error of Omission Error of Commission Error of Duplication Compensating Errors

24. Detection & Prevention of Errors

25. Functions of Auditing Accounting control Audit is an instrument of accounting control. The truth and fairness of the accounting information is controlled and checked by auditing activities. 2. Safeguard Audit acts as a safeguard on behalf of the proprietor/s (whether an individual or a group of persons) against cost control, carelessness or fraud on the part of the proprietors’ agents or servants in the realisation and utilisation of his/their money and other assets.

26. Cont. 3. Assurance Audit assures on the proprietors’ behalf that the accounts maintained truly represent facts and expenditure has been incurred with due regularity and propriety. 4. Assessment Audit assesses the adequacy of the accounting system in order to ascertain its effectiveness in maintaining accounting records of an organization. 5. Review Audit carries out a review of the financial statements to know whether the accounting records are in agreement with those statements.

27. Cont. 6. Reporting tool Audit is a tool for reporting on the financial statements as required by the terms of the auditors’ appointment and in compliance with the relevant statutory obligations. 7. Practical subject Auditing is a practical subject. It is something that people do. How it is done today is a result of long history of marginal changes and responses to new commercial and legal developments over the centuries with the most rapid progress in the last few years.

28. Advantages of Auditing A. Businessman's point of view:- 1. Detection of errors and frauds 2 . Loan from banks 3. Proper valuation of investments 4 . Proper valuation of assets 5. Government acceptance 6. Suggestions for improvement Better Reputation Uniformity in accounts B. Investor's point of view 1 . Protects interest 2. Moral check 3. Builds reputation 4. Good security Contd ……………..

29. Cont. C. Other Advantages Audited account are detected as an authentic record of transaction. Errors and frauds are detected and rectified. It increases the morale of the staff and thus it prevents frauds and errors. Because of his expertise the auditor may advise on various matters to his clients. An auditor acts as a trustee of his shareholders. Hence he safeguards their financial interest. For taxation purpose auditing of account is a must . Contd …………...

30. Cont. 7. In case of any claim is to be made from the insurance company only audited account should be submitted. Even in case of partnership firm auditing of accounts helps in the settlement of claim at the time of retirement/death of a partner. Auditor account helps in managerial decisions. They are useful to secure loan at the of amalgamation, absorption, reconstruction etc. Auditing safeguards the interest of owners, creditors, investors, and workers. It is useful to take certain financial decisions like issuing of shares, payment of dividend etc.

31. Limitations of Auditing Truly speaking, an audit should have no limitations of its own. It is designed to protect the interest of all parties who are interested in the affairs of the business. If there be any shortcoming arising there from, it may be due to its narrow scope of application in its related field of operation and un extended definition of the concept. Auditing suffers from the following shortcomings: 1. Want of complete picture The audit may not give complete picture. If the accounts are prepared with the intention to defraud others, auditor may not be able to detect them.

32. Cont. 2. Problems of dependence: Sometimes the auditor has to depend on explanations, clarification and information from staff and the client. He may or may not get correct or complete information. 3. Post-mortem examination: Auditing is a post-mortem examination. There is no use of such examination when events have already been occurred. 4. Existence of errors in the audited accounts: It is not possible for the auditor in all cases, to check each and every transaction of an organization. As a result, there may be error in the audited accounts even after the checking by the auditor.

33. Cont. 5. Lack of expertise: Auditor has to seek opinion of experts on certain matters on which he may not have experts knowledge. The auditor has to depend upon such reports which may not always be correct. 6. Diversified situations: Auditing is considered to be a mechanical work. Auditors may not be in a position to frame audit programme , which can be followed in all situations. 7. Quality of the auditor: Success of audit depends on the sincerity with which the auditor has performed his duties. The same audit work can be done by two different auditors with difference in sincerity.

34. Cont. 8. Existence of defective policies The auditor can only report on the truth and fairness of the financial statements. But other defects, i.e. defects relating to management and control may not be possible to be covered by the auditor.

35. Types of Audit Statutory Audit : any audit carried on as per the requirement of law is called as a statutory audit. eg : all companies have to get their accounts audited as per the provision of the company’s Act of 2013. Periodical/ Annual Audit : it is a kind of audit where the auditor verifies the account at the end of the financial year. He starts the audit work after the closure of financial year. This is a common audit and is mostly used by small organizations. Interium audit : its an audit conducted in the middle of the accounting year before the accounts are closed. In other words any audit conducted between two financial audit is known as interium audit. The objective is to get periodical results, to declare interium dividend. Partial Audit : when an auditor is asked to audit only a part of the account system. Its called partial audit. Eg : he may be asked to audit only the payment side of cash book. Balance sheet audit: it’s a kind of partial audit and is concerned with the verification of only those items appearing in the Balance Sheet. It is more popular in the USA. In fact while verifying B/S items the auditor verifies/ checks all related items/accounts.

36. Types of Audit Cost audit : cost audit is defined as the verification of cost accounting records. Data and techniques for its accuracy and authenticity. It gets as effective managerial tool for the detection of errors and frauds in cost accounting records. The companies act implies the central government to order cost audit incase of specifies companies. Management audit : Management audit may be defined as a comprehensive examination of an organizational structure of a company, institution/government and its plans and objectives it means of operations and use of human and physical facilities. The main objective of mgt audit is to see how far the objectives of mgt are fulfilled. It aims to ascertain whether sound mgt prevails throughout the organisation and evaluates its efficiency in the system of its operation. Continuous audit : a continuous audit is one in which the auditor visits his clients office at regular intervals through out the year to verify the account. The objective of CA may be- To get final account audited immediately after the closure of accounting year. When the business is very large. When interval control system is into effective. When regular final accounts are required.  

37. Preparation before the Commencement of Audit 1. Receiving Appointment Letter. 2. Communicate with the existing Auditor 3. Acceptance of appointment. 4. Ascertain the scope of duties . 5. Knowledge about the Organization. 6. Knowledge of the Accounting system. 7. Knowledge of technical details 8. Complete list of Principal Officer’s. 9. Observation of the previous auditor’s report. 10. Instructions to the Client.

38. Audit Note Book: It is a diary or register maintained by audit staff to note errors, doubtful queries and difficulties, which are required to be clarified with the client or the chief auditor. It also records important points to be included in the Auditors report. Contents of an Audit Note Book: 1. A list of books of accounts maintained. The names, duties and responsibilities of principal officers. 3. The particulars of missing receipts and vouchers.

39. 4. Mistakes and errors detected . 5. The points requiring clarifications & explanations. 6. Accounting method followed in the business. 7. The points to be part of the Auditor’s report. 8. Various totals and balances. 9. Extracts from the minutes and contracts. 10. Date of Commencement and completion of the audit .

40. Objectives of Audit Notebook The audit notebook of current year will help the auditor for starting audit for next year. It provides evidence about the extent of work done by the auditor. It helps in preparation of audit report. It helps the auditor to know about the progress of audit work and the efficiency of his staff in audit work. It also helps the auditor for the settlement of audit queries.

41. Audit Working Papers: Audit working papers refer to the audit papers which records the audit evidence resulting from the audit work performed to provide support for the auditor’s opinion including the representation. Contents of Audit Working Papers: Audit programme Audit notebook. Correspondence done between auditors and debtors, creditors and bank. Copies of debtors and creditors. A copy of the audit report. Schedules of item like depreciation, inventories and important queries with explanation.

42. Audit Programme It is the auditor’s plan of action. It provides a plan of the work of examination and a set of audit procedures specifically designed for each audit. According to Howard Stettler , an Audit Programme is an “ Outline of all procedures to be followed in order to arrive at an option concerning the client’s financial statements.”

43. Types of Audit Programme: Fixed audit Programme: Includes audit procedures applicable to every possible audit situation. It is very rigid and it is difficult to follow the same programme for many years. The audit team do not have any role to play in this audit programme . 2) Flexible audit Programme: It does not give an exact procedure to be followed and can be changed according to the needs of situation. It only gives an outline of the scope, nature and limitations of the audit assignment. There is scope for initiative by the audit staff.

44. Advantages of Audit Programme : The auditor will be certain of the work executed by the audit staff. Audit assistants know their clear cut duties. Fixing of the responsibility of audit assistants is becomes easier. It serves as an evidence, if any action is taken for negligence in the performance of his duties. Continuity is not lost even if the person on duty is changed. Limitations of Audit Programme : The task becomes mechanical, initiative and efficiency gets affected. The task may be completed hurriedly to complete it within the scheduled time. It is not useful in the audit of small organizations. Inefficient audit assistants may get benefited.

45. Recent Trends in Auditing Tax Audit: Tax audit can be defined as “an examination of financial records to assess correctness of calculation of taxable profits, to ensure compliance with the provisions of the Income Tax Act and also to ensure fulfillment of conditions for claiming deductions under the tax act.” Compulsory tax audit U/s 44AB In case the total sales,(turnover) or gross receipts exceeds Rs.40 lakhs of a business in the previous year. If gross professional receipts exceeds Rs.10lakhs in the previous year in the case of profession. In case of business, if the profits and gains from the business are deemed to be the profits and gains of a person under certain sections, it is obligatory on the part of such person to get the accounts audited by a specified date and submit the prescribed details and report of such audit in the prescribed form duly signed and verified by an accountant.

46. Purpose of Tax Audit: The purpose of Tax Audit is to ensure that books of accounts have been maintained in accordance with the provisions of the Income Tax Act. B) COST AUDIT The term cost audit refers to the audit of cost records. The cost auditor is appointed to check the cost accounting records in order to ascertain their accuracy. Cost audit acts as an effective managerial tool for the detection of errors, frauds, inconsistencies and irregularities in cost accounting records.

47. Objectives of cost audit To establish the accuracy of costing data by verifying the arithmetical accuracy of cost accounting entries in the books of accounts To ensure that cost accounting principles are governed by the management objectives and these are strictly adhered in preparing cost accounts. To ensure that cost accounts are correct and also to detect errors, frauds and wrong practice in the existing system. To check up the general working of the costing department of the organizations and to make suggestions for improvement. To help the management in taking correct decisions on certain important matters i.e to determine the actual cost of production when the goods are ready. To reduce the amount of detailed checking by the external auditor if effective internal cost audit system is in operation.

48. Advantages of Cost Audit A. Advantages of cost audit to the management Provides reliable cost data for managerial decisions Helps management to regulate production Effective managerial tool in detection of errors, frauds and irregularities so that reliable and smooth functioning of the system in continued. Reduced the cost of production through plugging loopholes relating to wastage of material, labor, O/H’s. Can fix the responsibility of an individual. Improves efficiency of the orgn as a whole and constant review of methods and procedures.

49. Advantages of Cost Audit B. Advantages of cost audit to the shareholders Ensures proper records of purchases, utilization are maintained and expenses on various items. Also makes sure industrial unit has been working efficiently and economically. Enables shareholders to determine whether or not they are getting a fair returns on their investments. It reflects managerial efficiency or inefficiency. Cost audit ensures true picture of company’s state of affairs. It reveals whether resources like plant and machinery are being properly utilised or not.

50. Advantages of Cost Audit C. Advantages of cost audit to the society It tells true cost of production. From this consumer may know whether market price of the article if fair or not. Consumer is saved from exploitation. Cost audit improves the efficiency of industrial units and thereby assists in economic progress of the nation. Since price increase by industry is not allowed without justification as to increase in cost of production, consumers can maintain their standard of living.

51. Advantages of Cost Audit D. Advantages of cost audit to the Government Cost audit assists tariff board in deciding whether tariff protection should be extended to a particular industry or not. It helps to ascertain whether any particular industry should be given any subsidy in order to develop that industry. It provides reliable data to the government for fixing up setting prices of commodities. It helps government to take necessary measures to improve efficiency of sick industrial units. Cost audit can reveal any fraudulent intentions of the government.

52. C) Management Audit Meaning and Definition Management audit is an emerging concept of auditing. It is an evaluation of all activities of the all departments with a view to provide appropriate suggestions to management to help their work. It is a future oriented task which evaluates timely in all level of management. Main objective of management audit is to improve profit earning capacity, work of management, objectives of program, social objectives and human resource development so organisational goal can be easily attained. It refers to existence of control system, compliance of rules and regulations, process of managerial decisions.

53. Functions of Management Audit It identifies objectives of an organisation , if not setup earlier. It allocates overall objectives of an organization in small parts. It reviews structure of organization and asset of organization and decides whether goals can be obtained or not. It examines all scope of work and liability centres. It provides valuables suggestions to management after evaluation of above facts.

54. Objectives of Management Audit To formulate goals of the organization. To ensure fulfillment of goals. To help management to improve activities and procedures. To help all members of the management to make effective discharge of their duties. To help in the improvement of profits. Advantages of Management Audit Provides information about strong and weak points of management. Provides suggestions to management. Helps to provide suggestions to attain organisation goals.

55. Disadvantages of Management Audit Management auditor cannot understand the practical problems . So, the suggestions provided by them are theoretical but not practical. Scope of management audit is vague. So, it does not help to achieve specific goal. Generally, it gives more emphasis on maintaining books of accounts rather than concentrating on other factors. So, it consumes time of farsighted management.

56. End of Unit 1