AUDITING

Unit I

INTRODUCTION -AN OVERVIEW OF AUDITING:

Economic decisions in every society must be based upon the information available at the time the decision is made. For example, the decision of a bank to make a loan to a business is based upon previous financial relationships with that business, the financial condition of the company as reflected by its financial statements and other factors. If decisions are to be consistent with the intention of the decision makers, the information used in the decision process must be reliable.

Unreliable information can cause inefficient use of resources to the detriment of the society and to the decision makers themselves. In the lending decision example, assume that the barfly makes the loan on the basis of misleading financial statements and the borrower Company is ultimately unable to repay. As a result, the bank has lost both the principal and the interest. In addition, another company that could have used the funds effectively was deprived of the money. As society become more complex, there is an increased likelihood that unreliable information will be provided to decision makers. There are several reasons for this: remoteness of information, voluminous data and the existence of complex exchange transactions 3 as a means of overcoming the problem of unreliable information, the decision-maker must develop a method of assuring him that the information is sufficiently reliable for these decisions. In doing this he must weigh the cost of obtaining more reliable information against the expected benefits. A common way to obtain such reliable information is to have some type of verification (audit) performed by independent persons. The audited information is then used in the decision-making process on the assumption that it is reasonably complete, accurate and unbiased.

ORIGIN AND EVOLUTION

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 Mesopotamia, 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.

The original objective of auditing was to detect and prevent errors and frauds Auditing evolved and grew rapidly after the industrial revolution in the 18^th 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 objective of audit shifted and audit was expected to ascertain whether the accounts were true and fair rather than detection of errors and frauds.

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 main objective of audit shifted to ascertaining whether the accounts were true and fair rather than true and correct. 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 The International Accounting Standards Committee and the Accounting Standard board of the Institute of Chartered Accountants of India have developed standard accounting and auditing practices to guide them. Accountants and auditors in the day to day work 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 computerised accounts

DEFINITION

The term auditing has been defined by different authorities.

1. 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."

2. Prof. L.R.Dicksee. "Auditing is an examination of accounting records undertaken with a view to establish whether they correctly and completely reflect the transactions to which they relate.

3. The book "an introduction to Indian Government accounts and audit" "issued by the Comptroller and Auditor General of India, defines audit “an instrument of financial control. It acts as a safeguard on behalf of the proprietor (whether an individual or group of persons) against extravagance, carelessness or fraud on the part of the proprietor's agents or servants in the realization and utilisation of the money or other assets and it ensures on the proprietor's behalf that the accounts maintained truly represent facts and that the expenditure has been incurred with due regularity and propriety. The agency employed for this purpose is called an auditor."

FEATURES OF AUDITING

· Audit is a systematic and scientific examination of the books of accounts of a business.

· Audit is undertaken by an independent person or body of persons who are duly qualified for the job.

· Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown by the balance sheet.

· Audit is a critical review of the system of accounting and internal control.

· Audit is done with the help of vouchers, documents, information and explanations received from the authorities.

· The auditor has to satisfy himself with the authenticity of the financial statements and report that they exhibit a true and fair view of the state of affairs of the concern.

· The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions and examine correspondence, minute books of share holders, directors, Memorandum of Association and Articles of association etc., in order to establish correctness of the books of accounts.

OBJECTIVES OF AUDITING

The objective of an audit is to express an opinion on financial statements. The objectives of the audit can be categorized into (i) primary objectives and (ii) subsidiary objectives.

Primary Objectives of Audit

The main objectives of the audit are known as primary objectives of the audit.

They are as follows:

1. Examining the system of internal check.

2. Checking arithmetical accuracy of books of accounts, verifying posting, casting, balancing etc.

3. Verifying the authenticity and validity of transactions.

4. Checking the proper distinction between capital and revenue nature of transactions.

5. Confirming the existence and value of assets and liabilities.

Subsidiary Objectives of Audit

These are such objectives which are set up to help in attaining primary objectives.

They are as follows:

1. Detection and prevention of errors.

2. Detection and prevention of frauds.

3. Under-or over-valuation of stock.

Types of Audit

3 primary types of audit performed by CPAs are; (1) financial audit, (2) operational audit, and (3) compliance audit.

The latter two services are often called audit activities, even though they are most similar to assurance and attestation services.

Types of Audit are:

1. Financial Audit.

2. Operational Audit.

3. Compliance Audit.

1. Financial Audit

Financial audit, also known as external audit and the statutory audit, involves the examination of the truth and fairness of the financial statements of an entity by an external auditor who is independent of the organization by a reporting framework such as the IFRS.

Company law in most jurisdictions requires an external audit on an annual basis for companies above a certain size.

2. Operational Audit

The operational audit also referred to as internal audit, is a voluntary appraisal activity undertaken by an organization to assure the effectiveness of internal controls, risk management, and governance to facilitate the achievement of organizational objectives.

Unlike an external audit, whose scope is primarily restricted to matters that concern the financial statements, the scope of work of an internal audit is very broad and can encompass any matters which can affect the achievement of organizational objectives.

3. Compliance Audit

In many countries, companies are required to conduct specific audit engagements other than the statutory audit to comply with the requirements of particular laws and regulations.

Other Types of Audit

In addition to the primary types of audits discussed above, there are some other types of audits, which are discussed below:

Forensic Audit

The forensic audit involves the use of auditing and investigative skills to situations that may involve legal implications. Forensic audits may be required in the following instances:

§ Fraud investigations involving, misappropriation of funds, money laundering, tax evasion, and insider trading.

§ Quantification of loss in case of insurance claims.

§ Determination of the profit share of business partners in case of a dispute.

§ Determination of claims of professional negligence relating to the accountancy profession.

Public Sector Audit

Public sector audit involves the scrutiny of the financial affairs of the state-owned enterprises to assess whether they have been operated in the way which is in the best interest of the public.

Whether standard procedures have been followed to comply with the requirements in place to promote transparency and good governance (e.g. public sector procurement rules).

Public sector audit, therefore, goes a step further than the financial audit of private organizations which primarily focuses on the reliability of financial statements.

Tax Audit

Tax audits are conducted to assess the accuracy of the tax returns filed by a company and are therefore used to determine the amount of any over or under assessment of tax liability towards the tax authorities.

Information System Audit

An information system audit involves the assessment of the controls relevant to the IT infrastructure within an organization. Information system audits may be performed as part of the internal control assessment during the internal or external audit.

Environmental & Social Audit

Environmental & Social Audits involve the assessment of environmental and social footprints that an organization leaves as a consequence of its economic activities.

The need for environmental auditing is increasing due to a higher number of companies providing environment and sustainability reports in their annual report describing the impact of their business activities on the environment and society and the initiatives taken by them to reduce any adverse consequences.

Value-For-Money (VFM) Audit

Value-for-money .audit involves the assessment of the efficiency, effectiveness, and economy of an organization’s use of resources.

Value-for-money audits are increasingly relevant to sectors that do not have profit as their main objectives such as the public sector and charities.

They are usually performed as part of an internal audit or public sector audit.

Management Audit

A management audit is an independent appraisal activity for the review of the control of managerial functions to ensure compliance with the organizational objectives, policies and procedures and management methods and purposes.

Audit Programme

An audit programme is a detailed plan of the auditing work to be performed, specifying the procedures to be followed in verification of each item and the financial statements and giving the estimated time required.

An audit programme is a detailed, written statement designed by the auditor indicating the work to be performed by the audit assistants, specifying the time limit for completion of work, instructions and guidance to the audit staff. In short, it is a tool for planning, directing and controlling the audit work.

An audit programme is a detailed plan of the auditing work to be performed. It specifies the procedures to be followed in the conduct of audit more efficiently. The auditor outlines the whole procedure of audit from beginning till the finalization of audit report. Audit programme is generally contained in the audit notebook.

Prof. Meigs defines an audit programme as, “an audit programme is a detailed plan of the auditing work to be performed, specifying the procedures to be followed in verification of each item and the financial statements and giving the estimated time required.”

Features (or) Characteristics of an Audit Programme

The features of an audit programme may be of the following:

1. It is a set of procedures to be adopted to conduct the audit more efficiently.

2. It is a written scheme designed by the auditor.

3. It is a blue print of the audit work.

4. It facilitates delegation of work, based on the capabilities of audit staff.

5. It acts as evidence in future for the audit work being performed.

6. It specifies the work to be done by the audit staff, the manner and time limit for completion of the work.

Objectives of Audit Programme

The following are the objectives of audit programme:

1. To provide clear instructions to the audit assistants specifying the nature of work to be performed and fixing the time span for completion of each work.

2. To facilitate coordination among various parts of audit work.

3. To ensure uniformity in the performance of audit work and to avoid duplication and repetition of work.

4. To attain a fair allocation of work among audit team.

5. To fix responsibility and accountability of each audit assistant.

6. To serve as a guide for planning the audit work in future.

7. To serve as evidence in future showing the date of completion of audit work, methods or procedures undertaken, persons involved in completion of audit work etc.

Contents of an Audit Programme

The following are the details of an audit programme:

1. Name of the client.

2. Nature of operations and business of client.

3. Review of system of internal check.

4. Date of commencement of audit work.

5. Duration of audit work.

6. Accounting system followed in client organization.

7. Review the report of the previous auditor.

8. Review the remarks, instructions or objections raised in the previous audit report.

9. Examine the various ledger accounts and subsidiary books.

10. Examine the statutory books and registers, profit and loss account, and balance sheet.

Advantages of an Audit Programme

An audit programme can give the following advantages:

1. Helps in Estimation and Division of Work: Audit Programme helps in estimating the quantum of audit work in advance and also helps in dividing the work among the audit assistants based on their capabilities.

2. Helps in Fixation of Responsibility: It enables to fix responsibility on the audit assistants by clearly defining the scope of work.

3. Helps in Future Planning: Audit programme serves as a basis for planning the audit work for subsequent year.

4. Serves as a Guide: It serves as a valuable guide for the audit staff in execution of the audit work for succeeding years.

5. Valuable Evidence: It serves as an evidence for the work done as initials of those who have done the particular work are appended to it. The auditor can produce the audit programme as a proof when a charge of negligence being brought upon him.

6. Uniformity: It provides for uniformity in audit work as the same work will be done every year.

7. Continuity: When an audit staff goes on leave others can continue the work by referring to the audit programme, hence, audit programme provides for continuity of work.

8. Coordination: If facilitates coordination and helps in supervising the work of the audit staff.

Disadvantages of an Audit Programme

The disadvantages that may be experienced by conducting audit as per predetermined audit programme are -

1. Mechanical: When audit work is conducted mechanically every year based on the audit programme, it causes monotony and boredom to the auditor and audit staffs.

2. No Quality in Work: The audit staff will be more interested to complete the work in time rather than to maintain any standard in the work.

3. Loss of Initiative: Audit staff cannot take their own decisions and they are compelled to comply with the audit programme. Hence, an efficient audit clerk loses his initiative and interest as he cannot make any suggestions.

4. Rigidity: A rigid and inflexible audit programme cannot be laid for all types of business. During the course of audit, new areas to be verified may come to the notice of the audit staff. Unless the audit programme is revised, such areas may escape from auditing.

5. Shelter for Inefficient Staff: Inefficient audit staffs conceal their mistakes or weakness on the basis of audit programme. Hence, it provides shelter for inefficient audit staff.

6. Unsuitable: Pre-determined audit programme is not suitable for small business organizations.

Routine checking in auditing (Objects, Advantages and Disadvantages)

Whatever may be the size, constitution and nature of activities and transactions of a business, there are certain records and books which are common to all types of business organizations.

The checking of such common records and books which is carried on by the auditor as a matter of routine is known as routine checking in auditing. Routine checking involves normally four types of functions:

(i) Checking of casts, sub casts, carry-forwards and other calculations in the books of original entry;

(ii) Checking of postings into the ledgers;

(iii) Checking of casts and balances of various accounts in the ledger; and

(iv) Checking of transfer of balances from the ledger on to the trial balance.

Routine checking is, therefore, a type of simple checking but it is quite a significant part of the auditor’s duty. As a rule, this simple checking done in a routine way can reveal the clerical errors and fraud of a very ordinary nature.

The work becomes of a mechanical nature. Thus, routine checking can verify the arithmetical accuracy of the entries made in the books of accounts. It can help in checking, casting and postings and, as such, can ensure that no alterations are made in the figures after they have been checked and ticked accordingly.

Advantages:

(i) The books of original entry can be thoroughly checked and the errors and fraud can be easily detected.

(ii) Postings (i.e., matters taken from records made in the books of original entry to the ledger) can be checked.

(iii) The checking of castings and postings done in routine checking is the very basis upon which the final results of audit depend. Hence, it helps in the checking of final accounts ultimately.

(iv) In short, it reveals the errors and fraud of a simple nature and, if done with care and caution, it helps in the verification of the arithmetical accuracy of the entries.

(v) Routine checking is a simple job which can be done easily by a person with an ordinary knowledge of accounts.

(vi) It is the simplest device for audit work.

Disadvantages:

Routine checking is practically a mechanical process and hence, it can cause monotony to those who are entrusted with this task.

Only minor cases of fraud can be detected by routine checking. Major items of fraud cannot be brought to light.

There appears to be a lot of difficulty in tracing out compensating errors and errors of principle.

Routine checking is not always considered important in the audit of a business where self-balancing system is used.

Test Checking

Test checking is a process of selecting and checking of a few transactions from a large volume of transactions.

Test checking is a process of selecting and checking of a few transactions from a large volume of transactions. If the entries checked are found to be correct then the auditor assumes that the remaining entries are also correct. The technique is based on the theory of sampling which is commonly used as a statistical method. Checking each and every transaction that occurs during the year is both redundant and uneconomical for the auditor. Therefore, the auditor verifies and examines a few representative transactions in order to obtain sufficient appropriate audit evidence to base his opinion. Test checking reduces the volume of work of the auditor, if in test checking, the auditor finds that the records checked by him are correct then no further detailed checking is carried out.

Applicability of Test Checking

Test checking can be applied in the following situations:

1. When there are large volumes of identical or routine transactions.

2. When transactions are large.

3. When the auditor has to certify the accounts quickly after the close of the accounting period.

4. When the auditor has past experience about the nature of transactions of the clients organisation.

5. When a satisfactory system of internal control and check system exist.

Advantages of Test Checking

Test checking can give the following advantages:

1. Reduces Volume of Work: The work of an auditor is reduced considerable as he checks only few transactions, extra time available can be utilised for concentrating on areas of considerable importance.

2. Reduces Time and Cost: Test checking is one of the technique which reduces time, cost and energy of both the auditor and the client.

3. Quick Completion of Audit Work: Test check enables the auditor to complete the work quickly as the auditor checks only a few or limited transactions.

4. Effective Means of Checking: Test checking can be effective if the auditor selects the transaction to be checked carefully.

5. Scientific Assessment of Risk: The risk of material misstatement in the financial statement is assessed by the auditor in a scientific manner by drawing samples and studying them in detail.

6. Serves as a Guide: It serves as a guide for the auditor to arrive at conclusion regarding the true and fair view of the state of affairs of business.

Disadvantages of Test Checking

Test checking can give the following dsiadvantages:

1. No Scientific Approach: It is a traditional auditing technique where no scientific approach is used in selecting the samples, hence the results drawn on it tends to be incorrect.

2. Risk cannot be measured: It is not possible to measure the amount of risk involved.

3. Complicated Transactions are not Checked: The audit assistants select only simple transactions for checking and complicated transactions are left omitted.

4. Carelessness of the Client’s Staff: The client’s staff is aware that the auditor will not check all their work hence they become careless.

5. Possibility of Errors and Frauds Remain Undetected: When test check is adopted by the auditor there are possibility of errors and frauds left undetected.

6. Unsuitable when there is no System of Internal Check: The auditor cannot adopt test check when there is no proper system of Internal check and control in operation.

7. Unsuitable for Small Business Concerns: Test checking is not suitable for small business concerns as the number of transactions involved is not large.

DISTINCTION BETWEEN ACCOUNTING AND AUDITING

We may find the following differences in them:

· Meaning:-
Accounting: Accounting means the maintaining of the books of accounts.
Auditing: Auditing means examining the books of accounts and reporting means to report about their accuracy.

· Performance of Work:-
Accounting: Accountant job is performed by the accountant.
Auditing: Auditing job is performed by the auditor.

· Appointment:-
Accounting: Accountant is appointed by the management.
Auditing: Auditor is appointed by the share holders.

· Nature of Job:-
Accounting: Accountant job is a mechanical nature.
Auditing: Auditor job is not so mechanical in that sense.

· Qualification:-
Accounting: For the accountant no specific qualification is required.
Auditing : For the auditor specific qualification is required

· Responsibility:-
Accounting: Accountant responsibility is fixed by the management.
Auditing: Auditor responsibility is fixed by law.

· Submission of Report:-
Accounting: Accountant is not required to submit any report.
Auditing: Auditor is required by law to submit the report.

· Fixation of Rights:-
Accounting: Rights and duties of accountant are fixed by the management.
Auditing: Rights and duties of an auditor are fixed by the law.

· Time:-
Accounting: In case of accounting, period is usually one year.
Auditing: The period of auditing is usually less than one year.

· Purpose:-
Accounting: Accounting purpose is to show the financial position of the business.
Auditing: Auditing verifies the true picture of the financial statement.

· Record / Data:-
Accounting: Accounting is related with the present record.
Auditing: Auditing is related with the past record.

· Employment:-
Accounting: Accountant is a permanent employee.
Auditing: Auditor is not a permanent employee.

· Reward:-
Accounting: Accountant reward is called salary.
Auditing: Auditor reward is called fee.

· Liability:-
Accounting: After preparing the final accounts accountant has no liability.
Auditing: Auditor has liability after presenting the audit report.

· Importance:-
Accounting: Accounting is necessary for every business.
Auditing: Auditing is not necessary for every business.

· Rules:-
Accounting: Accounting is not governed by code of conduct laid down by the institute.
Auditing: Auditing is governed by the charted accountant code of conduct.

· Evaluation:-
Accounting: The accountant cannot determine the efficiency of its own function.
Auditing: Auditor also cannot determine the efficiency of its own function but he can determine the efficiency of all the business.

· Methods:-
Accounting: Accounts uses the method of valuation and depreciation.
Auditing: The auditor uses manual and computerized method.

· Knowledge:-
Accounting: Accountant must have the knowledge of accountancy.
Auditing: Auditor must have the knowledge of accounting as well as auditing.

· Removal:-
Accounting: Accountant can be removed from his job at any time.
Auditing: Auditor cannot be removed till the completes his period of appointment.

· End and Start:-
Auditing begins where accounting ends.

Auditing Vs Investigation

1 Meaning

Auditing: Auditing is concerned with examining the accounts and reporting on financial statements.

Investigation: Investigation is the examination of accounts of a business for special purpose.

2 Objective

Auditing: The objective of Auditing is to express an opinion on the financial statements of the concern.

Investigation: Investigation is done for some specific purpose.

3 Compulsion

Auditing: It is compulsory in case of Joint stock companies.

Investigation: It is not compulsory

4 Period

Auditing: Auditing is done at the end of the financial year.

Investigation: Investigation can be done over a period of years.

5 Conduct

Auditing: Audit is conducted on behalf of the owners of the company

Investigation: Investigation is conducted on behalf of outsiders and owners at some times.

6 Scope

Auditing: It has a narrow scope

Investigation: It has a wide scope

7 Appointment

Auditing: An auditor is appointed by the shareholders or directors or by Government.

Investigation: An investigator is appointed by the outsider.

8 Report

Auditing: Auditor has to give a report about the true and fair view of the final accounts.

Investigation: The Investigator gives a report on the basis of conclusion and enquiries. Expression of the opinion is not necessary.

9 Qualification

Auditing: Only Chartered Accountants are qualified to conduct audit.

Investigation: An investigation need not be conducted by a Chartered Accountant.

10 Process of Work

Auditing: Investigated accounts are not audited in ordinary course.

Investigation: Generally audited books of accounts are taken up for investigation.

DIFFERENCE BETWEEN BOOK KEEPING AND ACCOUNTANCY AND AUDITING

Following are the differences between book keeping, accountancy and auditing:-

1. Book keeping as an art of recording the business transactions in the books of original entry and the ledgers. Accountancy means compilation of accounts in such a way that one is in position to know the state of affairs of the business. The auditing means the verification of vouchers to find out their accuracy and give true and fair view in respect of final accounts.

2. The primary work is done by the book keeper and accountant while finishing touch is given by the auditors.

3. Where the work of an accountant ends, the work of auditor begins.

4. A book keeper and an accountant has to record the transaction in the books of accounts while an auditor has to check and verify such transactions and accounts and send a report to the persons who appointed him.

5. The book keeper or the accountants are the employee of the business firm while the auditor is an independent identity.

6. The accountant can give the information to the management as per the records maintained by them. Normally, he does not give and suggestion or advice to management while the auditor can give suggestions or advice on the basis of their finding from the accounts records.

7. Auditor should be a qualified accountant i.e. chartered accountant but in case of accountant it is not compulsory. He/she may or may not be a chartered accountant.

Auditor Definition: Qualities and Types of Auditors

An auditor is not bound to be defective, or to approach his work with suspicion, or with the foregone conclusion that there is something wrong.

He is a watchdog but not a bloodhound. He is justified in believing servants of the company and is entitled to rely upon their representations, provided he takes reasonable care.

An auditor is not bound to assume when he comes to do his duty that he is dealing with fraudulent and dishonest people if circumstances of suspicion arise he has to probe them to the bottom.

Qualities of an Auditor

An efficient auditor must have certain qualities besides Professional qualification. He needs to carry out the audit efficiently and smoothly.

1. An auditor needs to be well versed in the fundamental principles and theory of all branches of accounting, e.g., general accounting, cost accounts, income-tax, etc. A person can’t audit the accounts unless he knows how to prepare them. He should be aware of the latest development of the technique of accounting so that he may modify his procedure of work.

2. He should not pass a transaction unless he knows that it is correct. This is possible only when one knows thoroughly well the principles of accounting.

3. He should be able to grasp quickly the technical details of the business whose accounts he is auditing. If possible, he should pay a visit to the works of his client, before he commences his work.

4. He should be prepared to seek elucidation on technical questions rather than show a false pride or fear of displaying his ignorance.

5. He should be quite familiar with the company and mercantile laws and must be complete master of the principles of auditing.

6. He must be tactful and scrupulously honest. He must not certify what he does not believe to be true, and he must take reasonable care and skill before he believes what he certifies is true.

7. He must not be influenced, directly or indirectly, by others in the discharge of his duties.

8. Sometimes he is put in a very awkward position when his duty to his client is opposed to his interests, in which case he must have the courage to carry out his duty faithfully and honestly, even if such a step harms him. In the long run, this policy will be of immense value to him. He will acquire a reputation for his honesty, which will bring more business to him.

9. He must be prepared to resign, rather than sign a balance sheet, which he knows does not exhibit a true and fair view of the state of affairs of the concern and thus give a false report.

10. He should not disclose the secrets of his clients.

11. He must have the tact to put intelligent questions to extract full information.

12. He must not adopt an attitude of suspicion.

13. He must be prepared to hear arguments and must be reasonable.

14. He must be vigilant, cautious, methodical and accurate.

15. He should have the ability to write the report, correctly, concisely and forcefully.

16. He should have an understanding of the general principles of economics.

17. He should have thorough training in a business organization, management, and finance.

18. Last but not least, he should have “Common Sense”.

Types of Auditors

Auditors carefully examine financial records so they can evaluate an entity’s financial position and the authenticity of its data.

This requires experience not only in all types of accounting practices but also in various tax, laws and financial regulations governing the use of certain documents.

While it takes a highly trained accountant to work as an auditor, there are different types of auditors with different audit aims.

Several types of auditors conduct these procedures.

Types of Auditors are;

1. Independent/External Auditors: Profesional Audit services providors.

2. Internal Auditors: Company’s own in-house expert auditors to maintain internal control and audit the company’s internal activities.

3. Government Auditors: Auditors that are working with various government agencies; where why audit internal agency audit and/or audit the corporations by court order or government law.

4. Forensic Auditors: They are hired to play Sherlock. Auditors that specialize in crimes and are used by law enforcement organizations.

Independent/External Auditors

Independent auditors are usually Chartered Accountants (CAs) who are either individual practitioners or members of public accounting firms who render professional auditing services to clients.

In general, licensing involves passing the uniform CA examination and obtaining practical experience in auditing.

Internal Auditors

Internal auditors are employees of the organization they audit. This type of auditors is involved in an independent evaluation of evidence, called internal auditing, within an organization as a service to the organization.

The objective of internal auditing is to assist the management of the organization in the effective discharge of its responsibilities.

Government Auditors

Government auditors are employed by various local, state, and federal governmental agencies.

At the federal level, the three primary agencies are the General Accounting Offices (GAO), the Internal Revenue Services (IRS), and the Defense Contract Audit Agency.

Forensic Auditors

Forensic auditors specialize in crimes and are used by law enforcement organizations when financial documents are involved in a crime.

This does not necessarily mean the crime was financial (although this can be the case) but rather that the law enforcement organization needs to track money used to find out where it began or ended up.

Conclusion

The roles of auditors are intertwined with the evolution of the auditing theory itself, as auditing evolved based on circumstances the evolution directly influence the functions and the entire practice of auditors.

Generally Accepted Auditing Standards (GAAS)

GAAS: An Overview

Short for Generally Accepted Auditing Standards, GAAS refers to a set of systematic guidelines used by auditors while performing audits on companies’ financial statements, thus ensuring the consistency, accuracy, and verifiability of the actions and reports produced by an auditor.

As explained by Investopedia, by depending on GAAS, auditors can reduce the possibility of missing material info. The Generally Accepted Accounting Standards are categorized into the following sections:

1. General standards include:

i. The auditor must possess sufficient technical training as well as proficiency to carry out the audit.

ii. The auditor must sustain independence (in fact and appearance) in intellectual attitude in every matter associated with the audit.

iii. The auditor should essentially exercise due professional care during audit procedures and the preparation of reports. Moreover, the auditor should assiduously perform the audit and mention the misleading info, if any, in the reports.

2. Standards of fieldwork

i. The auditor should plan adequately the work besides properly supervising any assistants.

ii. The auditor must get sufficient understanding of the company and its environment, also counting its internal control, to evaluate material misstatement risk (either due to error or fraud), and designing the nature, timing, and extent of future audit procedures.

iii. The auditor should get sufficient audit evidence by carrying out audit procedures to give a reasonable basis for an opinion related to financial reports under audit.

3. Standards of reporting

i. It is essential for the auditor to report whether the financial statements are accessible in accordance with GAAP.

ii. The auditor should essentially recognize in the auditor’s report the circumstances wherein such principles have not been observed consistently in the current period as related to the previous period.

iii. On determining the informative disclosures not being reasonably adequate, the auditor should state the same in his report.

iv. It is essential for the auditor to either express an opinion on financial statements or state that an opinion cannot be expressed in the auditor’s report.

Each of these sections is beleaguered with the requirements that must be congregated by the auditor and the subject company.

Audit Planning

Audit planning is required for an Auditor to conduct an effective and efficient audit. Target of audit planning should be about the following −

Time budgets
Recruitment of audit staff
Schedule about date of audit procedure

Base of Audit Planning

Audit planning should be based on the following −

Complete accounting knowledge of client’s business
Reliability of internal control system
Programming of audit procedures and
Co-ordination of staff

· The steps in planning an audit include (Planning Procedures):

1. Basic discussions with the client about the nature of the engagement and the client's business and industry are performed first, and the auditor meets the key employees, or new employees of a continuing client. The overall audit strategy or the timing of the audit may be discussed, but don't discuss specific audit procedures.

2. Review of audit documentation from previous audits performed by the accounting firm or a predecessor auditor (if the latter makes these audit documentation available) will assist in developing an outline of the audit program.

3. Ask about recent developments in the company such as mergers and new product lines which will cause the audit to differ from earlier years.

4. Interim financial statements are analyzed to identify accounts and transactions that differ from expectations (based on factors such as budgets or prior periods). The performance of such analytical procedures is mandatory in the planning of an audit to identify accounts that may be misstated and that deserve special emphasis in the audit program.

5. Non-audit personnel of the accounting firm who have provided services (such as tax preparation) to the client should be identified and consulted to learn more about the client.

6. Staffing for the audit should be determined and a meeting held to discuss the engagement.

7. Timing of the various audit procedures should be determined. For example, internal control testing needs to be performed early in the engagement, inventory counts need to be performed at or near the balance sheet date and the client representation letter cannot be obtained until the end of the audit fieldwork.

8. Outside assistance needs should be determined, including the use of a specialist as required (a tax practitioner or an information technology (IT) professional) and the determination of the extent of involvement of the internal auditors of the client.

9. Pronouncements on accounting principles and audit guides should be read or reviewed to assist in the development of complete audit programs fitting the unique needs of client's business and industry.

10. Scheduling with the client is needed to coordinate activities. For example, client-prepared schedules need to be ready when the auditor is expected to examine them, and the client needs to be informed of dates when they will be prohibited from accessing bank safe deposit boxes to ensure the integrity of counts of securities held at banks.

INTERNAL CONTROL

INTRODUCTION

Internal control is another important area of auditing. Internal control refers to a number of checks and controls exercised in a business to ensure its efficient and economic working. In this unit you will learn the meaning and objectives of internal control and internal check. You will also learn various system of internal check and generally understand audit in respect of computer environment.

MEANING AND DEFINITION OF INTERNAL CONTROL

Internal control is an important tool of management. It assists the management in the performance of its various functions. It means the built in cross-checks in the system supplemented with proper supervision and internal audit carried out by the staff appointed by the organisation These days business has been become more complex both in nature and size and the management finds it difficult to get correct information about the various aspects of the business. Internal control assures the management that the information supplied to it is reliable and accurate. The Internal controls are exercised to ensure the accuracy and the reliability of accounting data and other records, to identify weaker areas of operation and to improve them to increase operational efficiency of the business, to safeguard its assets and to ensure orderly conduct of business. The American Institute of Public Accountants has defined internal control as the plan of organisation and all the co-ordinate methods, and measures adopted within a business to safeguards its assets, check the accuracy and the reliability of its accounting data, promote operational efficiency and encourage adherence to prescribed managerial policies. A system of internal control extends beyond those matters which relate directly to the function of the accounting and financial departments. The Institute of Chartered Accountants of England and Wales defines internal control as "internal control means not only internal check or internal audit, but the whole system of control financial and otherwise, established by management in order to carry on the business of the company in an orderly manner, safeguard its assets and secure as far as possible accuracy and reliability of its records".

If we analyze the above definitions it would be evident that internal control is a broad term with a wide coverage. It consists of a number of checks and controls which are exercised in a business to ensure its efficient and economic working. Thus internal control involves sort vigilance and directions over important matters like budget and finance, purchase and sales and internal administration by the management. Every business enterprise is expected to devise a suitable system of internal control in order to carry on the business in an efficient and orderly manner. These controls are accounting control, budgetary control, statistical analysis and internal checks and internal audit. In simple words, it means number of checks and controls over the various activities of a business. Generally, a system of internal control will include all those measures which assist business enterprises to fulfil the following objectives.

Objective of internal control

• To minimize, if not completely eliminate, wastage and inefficiencies in business operations and to safeguard the assets of the business.

• To ensure high degree of accuracy and reliability of accounting data and promote operational efficiency.

• To measure how far the policies of the management are being implemented, and

• To evaluate the efficiency of performance in all aspects of business activities and to highlight the weaknesses.

INTERNAL AUDIT

Internal audit is described as the verification of the operations within the business by a specially assigned staff. It is an important tool of management to evaluate the correctness of records on a continuous basis in an organisation. The term internal audit has been defined as "an independent appraisal of activity” within an organisation for review of operations as a basis of service to management. It is a managerial control which functions by measuring and evaluating the effectiveness of other controls. According to Howard F. Stettler, "internal auditing is an independent appraisal activity within an organisation for the review of operations as a service to management.” The overall objective of internal auditing, therefore, is to assist the management in the effective discharge of their responsibilities by furnishing them with objective analysis, appraisals, recommendations and pertinent comments concerning the activities reviewed. In short internal audit assures the management that the system of internal check and other types of controls are effective in design and operation. Thus, internal audit is a thorough examination of the accounting transactions to ensure that-

• The transactions are properly recorded.

• The accounts are maintained systematically

• There is no possibility for manipulation of accounts or misappropriation of property of the business.

In modern times, an internal auditor carries a new task. The traditional function of checking the arithmetical correctness of the accounts with the help of vouchers and documents and verification of few items such as stock, cash and fixed assets is not sufficient. The duty of internal auditor now is to chart the procedure, examine the efficiency and work on programs of improvement of assessing the effectiveness of controls. He is expected to plan and arrange his task for effective functioning, set clear objectives of his own section, phase his objectives, gain the confidence of the management and demonstrate the value of his functions in areas of performance.

The internal audit is carried out generally in the same manner as is followed for a professional audit. However, it varies in form from enterprise to enterprise according to its size and specific needs. It is installed in large organisation and is carried out by the salaried staff who are qualified to conduct professional audit. Being the employee of the organisation he has to ensure that there is no waste in the organisation. Internal auditor has to follow the provisions of law, standard auditing practices and procedure prescribed for professional auditors and by the professional bodies controlling the audit system in the country. At the same time internal auditor must be aware of the policies and programs of the enterprise he should be professionally competent to carry out a detailed examination of the working of the business. Equipped with professional expertise and knowledge of the business, he will be in a better position to make the internal audit system more effective.

Objectives of internal audit

The main objectives of internal audit are as under:-

• To verify the correctness and authenticity of the financial records and statistical records presented to the management.

• To ensure that the standard accounting practices are strictly followed in the organisation.

• To facilitate early detection of errors and frauds.

• To ensure that all the transactions have been carried out under a proper authority and by persons authorised for the same in the business.

• To review the systems of internal check from time to time to advice the management on improvement of the system and to undertake special investigation for the management.

• To confirm that the liabilities have been incurred by the organisation for legitimate activities.

Thus, efficiency of internal audit depends on the efficiency of the staff employed for the purpose; internal audit can be effective only if the internal auditor is given wider authority to investigate the transactions not only from financial angles but also from other organizational activities.

Internal auditor should report directly to the top management. He must operate independently of the accounting and other staff. He must be given an independent status as an important functionary and a part of the management.

INTERNAL CHECK

Internal check is a system enforced in business under which the recording of business transactions is arranged in such a manner that the work of one staff member will automatically be checked by others in the course of recording of transaction itself. Spicer and Pegler have defined a system of internal check as "an arrangement of staff duties whereby no one person is allowed to carry through and record every aspect of a transaction such that without collusion between two or more persons. Fraud is prevented and at the same time possibilities of errors are reduced to a minimum". De Paula has defined internal check as "a continuous internal audit carried on by the staff itself by means of which the work of each individual is independently checked by other member of the staff."

Thus, under internal check system the staff duties are so arranged that no one person is allowed to record every aspect of the transactions and the entire work is distributed among the various members of the staff in such a manner that the work of one person is automatically checked by others.

The essential elements of internal check are as under-

• Existence of checks on day to day transactions.

• The check is to be carried out continuously as a part of the routine system.

• The work is divided among the staff and each staff is assigned a specific task.

• The work of each staff though independent is complementary to the work of another.

The system of internal check is increasingly recognised by the auditor specially when the size of the concern is large. The existence of effective internal check system relieves the external auditor of detailed checking to a larger extent. The extent to which an external auditor can depend upon the system of internal check is based on the procedural tests applied by him to find out the effectiveness of the system. However the auditor can not be relieved of his responsibility if he was found guilty of negligence regardless of the fact that he had tested the internal check in existence in the organisation before he had accepted it as correct.

Objectives of internal check

• To reduce chance of fraud and errors that may be committed by any member of the staff and make it more difficult. If any fraud is to be committed two or more persons must collude together.

• To detect fraud and errors easily and correct them promptly.

• To exercise moral pressure among the members of the staff.

• To allocate duties and responsibilities of every person in such a way that he can be taken to task for any lapse on his part.

• To increase overall efficiency of the members of the staff by assigning duties based on the principle of division of labour.

• To have an accurate and reliable record of all business transactions.

Essentials of good internal check system

• No single staff shall have absolute control over recording of all the aspects of business transactions by himself.

• The same staff shall not be allowed to have access to all books of accounts as well as physical custody of the assets.

• Each member of the staff should be made responsible for a specific work.

• All officials and employees holding responsibility towards cash, securities or stock should be encouraged to proceed on annual leave to prevent the concealed fraud.

• The duties of the members of the staff should be changed from time to time.

• Attempt should be made to introduce mechanical devices to prevent mis-appropriation of cash.

• Each transaction should pass through a definite route and through several hands.

• All books, vouchers, documents should be classified and made available for easy reference.

• Proper record must be maintained of the incoming and outgoing of goods from the business premises.

• Self balancing ledger system should be introduced to make the system more efficient and effective.

• No undue importance should be given to any staff member and too much reliance on any staff member should be avoided.

• Division and allocation of duties among the staff members must provide for an automatic check by others.

Unit II

Audit Procedures

Audit Procedures are steps performed by auditors to get all the information regarding the quality of the financials provided by the company, which enable them to form an opinion on financial statement whether they reflect the true and fair view of organisation financial position. They are identified and applied at the planning stage of the audit after determining audit objective, scope, approach, and risk involved.

Types of Audit Procedures

Inspection – Inspection is the most commonly used method. Under this auditor checks every transaction/ document as against written steps, procedures so as to ensure accuracy.
Observation – Under this technique of audit, the auditor usually tries to inspect others doing/ performing a particular process. For e.g. An auditor may observe steps followed in processing GRN against goods purchased.
Confirmation – This type is applied to ensure the correctness of financial statement either from internal sources within auditee organisation or from external sources.
Recalculation – Under this audit method, the auditor usually crosses checks information presented by the client. This is generally used in case of checking mathematical accuracy.
Reperformance – Using this procedure, the auditor re-perform entire process is performed by the client so as to find out gaps, audit findings, etc.

VOUCHING

Vouching is the examination of transactions of a business together with documentary and other evidence of sufficient validity to satisfy an auditor that such transactions are in order, have been properly authorized and are correctly recorded in books.

Objects of Vouching

1. Authentication of accuracy and truth of book keeping entries.

2. Satisfaction of entries of business transactions.

3. Knowing the transactions unrelated with business.

4. Authentication of transactions.

5. Essence of auditing.

The auditor must take care of following while vouching.

1. Proper filing of vouchers in serial order.

2. Adoption of test check methodology for examining vouchers.

3. Comparison of evidences with accounting entries.

4. Voucher must be in name of the person or business whose account is audited.

5. It must be related with business transactions.

6. Voucher should relate to period under audit.

7. It must be in printed form.

8. The amount and calculations in voucher must be checked.

9. Voucher must be signed, authenticated and duly stamped.

Vouching of Cash Book Cash Receipts:

(i) Internal check should be examined.

(ii) Issue of receipts and use of receipt books should be checked.

(iii) System of depositing the receipts into bank should be checked.

(iv) Auditor must obtain the list of all memorandum books like cash diary, Kuchi Rokar Bahi, Pucci Rokar Bahi, etc.

(v) Vouchers must be serially numbered and the name, amount date in vouchers must tally with the accounting records.

(vi) Accounting records unsupported by vouchers must be probed.

(vii) Soiled, unissued or cancelled receipts should not be torn but checked along with counterfoils.

Important points while vouching Cash Payments.

1. Actuality of payment.

2. Payment relates to audit year.

3. Payment for business

4. Payment to right person

5. Right amount to be paid.

6. Payment must be due with regard to date.

7. Authorization of payment.

8. No payment for ultravires acts

9. Legitimacy of payment

10. Correct accounting.

Vouching Sales Book

1. On the basis of copies of sales invoices.

2. Help from other books like orders received book, goods outward book, correspondence, etc.

3. Intensive examination of goods sold of the end of the year and beginning of new year.

4. Recording of only actual sales.

5. Help from statements of accounts of debtors.

6. Audit of totals and postings of sales book.

Vouching of Sales Returns Book

1. Vouching the records on the basis of copies of credit notes.

2. Checking of goods inward book and correspondence.

3. Examination of the records at the commencement of the next year.

4. Totals and ledger posting of sales returns to be carefully examined.

Vouching Purchases

1. Examination of purchase book on the basis of invoices.

2. Record of lost vouchers.

3. Help from goods inward book, challan form and packing notes.

4. Checking of totals & postings on the basis of invoices goods inward books, purchase order, challan form, goods receipt notes.

Vouching of Purchases Returns Book

1. Checking entries of purchases returns book on the basis of credit notes.

2. Tallying with goods outward book.

3. Checking the totals and postings in ledger.

Vouching of Journal

1. Opening entries shall be vouched with the balance sheet of previous year.

2. Closing entries to be vouched by checking the ledger postings.

3. Rectification entries must be checked thoroughly and must be countersigned.

4. Adjustment entries relating to outstanding and prepaid expenses, unearned income and accrued income must be vouched on the basis of relevant documents.

5. Transfer entries must be backed by proper authority.

6. Bad debts must be vouched on the basis of authorization and relevant correspondence with the debtors.

7. Consignment transactions must be checked by the account sale received from the agent.

Vouching Ledger Postings

1. Methodology of vouching, i.e., checking the ledger postings on the basis of entries in books of original entries.

2. Persons vouching the accounts.

3. Recording the errors.

4. Vouching the balances of accounts

5. Test checking of ledger postings.

6. Vouching of different ledgers – purchase ledger, sales ledger, etc.

Vouching of various receipts

1. Cash Sales & Credit Sales: Voucher, date, serial no., account head, sales invoices, charging of sales tax and excise duty, copy of delivery order, sales order, rates, quantity and authorization by sales/ marketing manager.

2. Receipt from debtor: Cash/Bank receipt voucher, date, serial no., account head, copy of invoice, sales order, rates quantity party ledger, bank statement, sales register.

3. Other Income (Interest dividend, etc): Bank receipt voucher, date, serial no., account head copy of dividend warrant, interest warrant. TDS certificate, rates paid up value, investment register, bank book, bank statement.

4. Loan received: Receipt voucher, date, serial no., account head, (secured/unsecured) loan agreement, hypothecation or pledge deed, rates of interest, principal amount, resolution of board of directors, bank statement, ledger.

5. Rent Received: Cash/Bank receipt voucher, date, serial no., account head, rent agreement, rent receipt, TDS certificate, prepaid or outstanding rent, bank statement, ledger.

6. Sale of Investment: Voucher, account head, broker’s note, copy of demat account, rate, quantity, bank statement, investment ledger.

7. Bills Receivable Discounted: Voucher date, account head, discounting charges, copy of B/R, bank advice, noting charges, bank statement/book, BR register.

8. Sale of Fixed Assets: Receipts voucher, sale agreement, sale value and wdv, authorization by BOD, fixed assets register, bank statement.

9. Royalty Received: Receipt voucher, account head, copy of agreement, TDS certificate, rates and quantity explored, produced or sold, royalty register, ban statement.

10. Insurance Claim: Receipt voucher, account head, copy of intimation of claim copy of sanction, loss assessors report, verify the amount of claim, insurance claim register, bank statement.

11. Recovery of Bad Debts: Voucher, account head, debtors control account, commission to factor, bank book, statement or list of bad debts written off in previous years.

12. Miscellaneous receipts (subscriptions amount received from, agents etc): Voucher, counter fails of receipts, bank pass book, membership register, statements of agents, etc.

Vouching of Payments:

1. Purchase of Goods: Payment voucher, purchase order, builty, material received note, inspection report, bank statement, rates, quantity and terms of purchases, stores ledger, goods inward register, authorization, cash purchase register.

2. Payment to Creditors: Receipt by customer, statement of account, invoice copy, discount and allowances, and other deeds.

3. Salaries & Wages: Payment voucher, attendance register, salary sheet, wage roll, time keeping record, bank statement, PF, ESIC, overtime sheets, cash book or bank book, ledger,

4. Payment for Acquisition of Assets: Payment voucher, account head, sale/purchase agreement, title deed, bank statement, transfer deed, valuer certificate, stamp duty, broker’s statement, auctioneer’s note, fixed asset register, cash/bank book, authorization by BOD, Articles of association, etc.

5. Payment of Taxes (Income Tax, Sales Tax): Computation of tax, copy of challan of advance tax, TDS certificates, challan of self-assessment tax, return, etc.

6. Travelling Expenses: Voucher tour program, schedule, TADA rules, expense voucher, receipts, etc.

7. Preliminary Expenses: Memorandum & Articles of association, registry, Cheque no., bills & receipts, rate of stamps, vouchers, etc.

Verification of Assets & Liabilities

Verification is the process of substantiation involved in proving that a statement account or item is accurate and stated properly. It is an enquiry into the value, ownership & title, existence and possession, and presence of any charge on the assets as stated in the balance sheet.

Objects of Verification

1. Picture of true position.

2. Correct valuation.

3. Not exceeding the actual.

4. Not less than actual.

5. Existence and possession.

6. Ownership and title.

7. Without fraud or irregularity.

8. Arithmetical correctness.

9. Correct presentation in the balance sheet.

Position of Auditor as regards valuation of assets

An auditor is not a valuer or a technical expert. So, he has to rely upon the valuation made by directors, partners, technical experts, surveyors, etc. However, he must ensure that the valuation is fair and reasonable and based upon some accepted principles.

Verification of fixed assets

(i) Goodwill

(a) Existence: Whether purchased or acquired. Self-generated goodwill is not said to be in existence.

(b) Records: Check the fixed asset register.

(d) Valuation and proper amortization as per AS-14, i.e. 5 years.

(e) Proper presentation and disclosure.

(ii) Freehold Properly: Which is in the name and title of owner.

(a) Ownership: Check the sale deed.

(b) Mortgage: Check the mortgage deed.

(d) Revenue expenses regarding repairs and maintenance should be written off in P & L Account.

(e) The auditor must enquire into the existence, valuation and presentation in balance sheet.

(iii) Leasehold Property: It has two owners and both have qualified rights over it. The following points to be considered:

(a) Ownership: Lease deed should be examined.

(b) Mortgage: Relevant deed should be perused.

(d) Existence, valuation and presentation B/S to be checked.

(iv) Plant & Machinery

(a) Existence: Physical verification to be conducted, additions and deductions to be checked.

(b) Records: Check the fixed asset register.

(d) Revenue and capital expenditure should be properly accounted for.

(e) Proper presentation and disclosure under the schedule of fixed assets.

(v) Furniture, fixture and fittings: The auditor has to verify the existence, records, changes, ownership, valuation, presentation and disclosure in the balance sheet, along with depreciation.

(vi) Motor Vehicles: The auditor has to verify the existence, fixed asset register, log books, invoices, registration book, incidental charges like insurance and road tax, depreciation, licences etc.

(vii) Copyrights, patents, trademarks, loose tools: Check the existence ownership, valuation, presentation in balance sheet, respective registers, write off etc.

(viii) Investments

(a) Ownership: name of client, pledge or lien of investments, Classification: trade or non-trade, long term, short term, stock in trade.

(b) Physical verification: obtain relevant certificates, etc.

(d) Valuation and disclosure: Current investments should be valued at lower of cost or fair market value. Long term investments should be valued at historical cost of acquisition.

(ix)Inventory

Classification of inventory: Stores and spare parts, loose tools, raw materials, material in process, finished goods, waste or by products. Existence and records in the stock register to be verified. Right of ownership: Invoices, documentary evidence to be checked.

Valuation: According to AS-2, valuation is done on cost or NRV whichever is lower. Method is FIFO or weighted average and method is not changed, unless required. Presentation and disclosure in Balance Sheet.

(x)Debtors, Loans and Advances

List of debtors to be obtained.

Correspondence with debtors.

Inquiry into discount and bad debts, provision for bad debts.

Securities.

Presentation and disclosure in Balance Sheet.

Classification of debtors according to age, security and reliability, bad and doubtful.

Loans and Advances: Names & Amounts involved. Terms and Conditions of loan. Regularity of repayment. Steps for recovery/repayment of overdues.

Verification of Liabilities

Steps for verification

1. Examination of records .

2. Direct confirmation procedure.

3. Examination of disclosure.

4. Analytical review procedure.

5. Obtaining Management Representations.

The nature, timing and extent of substantive procedures to be performed is a matter of professional judgement of the auditor which is based on the auditor’s evaluation of the effectiveness of the related internal controls.

Audit Report – Basics, Format and Content

For any enterprise, the audit report is a key deliverable which shows the end results of the entire audit process. The users of financial statements like Investors, Lenders, Customers, and others base their decisions and plans on audit reports of any enterprise. An audit report is always critical to influencing the perceived value of any financial statement’s audit.

The auditor should be careful in issuing the audit report as there is are a large number of people placing reliance on such report and taking decisions accordingly. The report should be issued by being unbiased and objective in discharging the functions.

NOTE: The threshold limit of Rs 1 crore for a tax audit is proposed to be increased to Rs 5 crore with effect from AY 2021-22 (FY 2020-21) if the taxpayer’s cash receipts are limited to 5% of the gross receipts or turnover, and if the taxpayer’s cash payments are limited to 5% of the aggregate payments.

Contents of an Audit Report

The basic structure of an audit report as prescribed by the Standards on Auditing is as follows:

Heading	Brief of contents
Title	Title should mention that it is an ‘Independent Auditor’s Report’.
Addressee	Should mention clearly as to whom the report is being given to. For example Members oMentions that it is the Management’s responsibility to Prepare the Financial Statements. f the company, Board of Directors
Management’s Responsibility for Financial Statements
Auditor’s Responsibility	Mention that responsibility of the Auditor is to express an unbiased opinion on the financial statements and issue an audit report.
Opinion	Should mention the overall impression obtained from the audit of financial statements. For example Modified Opinion, Unmodified Opinion
Basis of the Opinion	State the basis on which the opinion as reported has been achieved. Facts of the basis should be mentioned.
Other Reporting Responsibility	If any other reporting responsibility exists, the same should be mentioned. For example Report on Legal or Regulatory requirements
Signature of the Auditor	The engagement partner (auditor) shall sign the audit report.
Place of Signature	The city in which audit report is signed.
Date of Audit Report	Date on which the audit report is signed.

Other headings being basic and self-explanatory in nature, we need to understand the about the opinion part precisely. This part forms the basic crux of an audit report.

Opinion in an Audit Report

There are primarily two kinds of opinions issued by an auditor in his / her audit report:

Unmodified Opinion (also called Unqualified report)
Modified Opinion (also called Qualified report)

1. Unmodified Opinion

Issued for any audit where the auditor is satisfied that the financial statements present a true and fair view of the operations and transactions in an enterprise during the period.

An audit report with an Unmodified Opinion is also known as a ‘Clean Report’. An Unmodified report develops confidence among users of Financial statements and annual reports of an enterprise.

It provides an impression that the financial statements are reasonably free from any misstatements and results as appearing there are true and fair.

2. Modified Opinion

Whenever the auditor has specific findings during his / her audit and concludes that an Unmodified Opinion cannot be issued due to the nature of findings, a Modified Opinion is issued in the audit report.

There are two basic reasons due to which an auditor concludes on issuing a Modified Opinion:

Based on the audit and evidence, finds out that the financial statements contain a certain degree of material misstatements.
Unable to obtain sufficient and appropriate evidences to conclude that the financial statements are free from material misstatements.

There are three kinds of modified opinions which are issued according to the findings and circumstances:

A. Adverse Opinion

B. Qualified Opinion

C. Disclaimer of Opinion

A. Qualified Opinion

Qualified Opinion is given in a situation where:

The auditor concludes that misstatements are material but the impact is not so high that it would render the whole financial statements unacceptable; or
The auditor is unable to obtain sufficient or appropriate audit evidence but concludes that there are indications of misstatements in the financial statements (but the degree is not high).

Example of a Qualified Opinion paragraph in audit report:

In our opinion, except for the incomplete disclosure of the information referred to in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Companies Act, 2013, in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:

In case of the Balance Sheet, of the state of affairs of the company as at March 31, XXXX;
In case of Profit and Loss Account, of the profit/loss for the year ended on that date; and
In case of the Cash Flow Statement, of the cash flows for the year ended on that date.

B. Adverse Opinion

An Adverse opinion shall be issued by the auditor where he concludes that on the basis of evidence obtained and procedures performed, there are material misstatements in the financial statements and the impact of the same is high.

Example of a Qualified Opinion paragraph in audit report:

In our opinion, because of the omission of the information in the Basis for Adverse Opinion paragraph, the financial statements do not give the information required by the Companies Act, 2013, in the manner so required and also, do not give a true and fair view in conformity with the accounting principles generally accepted in India:

In case of the Balance Sheet, of the state of affairs of the company as at March 31, XXXX;
In case of Profit and Loss Account, of the profit/loss for the year ended on that date; and
In case of the Cash Flow Statement, of the cash flows for the year ended on that date.

C. Disclaimer of Opinion

A Disclaimer of Opinion is to be issued by an auditor in cases where the auditor concludes that he / she is not able to obtain sufficient and appropriate evidences. In such scenario, the auditor is not able to form an opinion and thus, disclaims form providing an opinion on the financial statements. The impact of material misstatements and degree of the same is high enough.

Example of a Draft Disclaimer of Opinion:

We were engaged to audit the financial statements of ABC Private Limited (“the entity”) which comprises the Balance Sheet as at March 31, XXXX, the statement of Profit and Loss, (the statement of changes in equity) and statement of Cash Flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.

We do not express an opinion on the accompanying financial statements of the entity. Because of the significance of the matters described in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain sufficient and appropriate audit evidence to provide a basis for an audit opinion on these financial statements.

Emphasis of Matter paragraph in an Audit Report

In a situation where the auditor concludes that it is important to draw the attention of users of the financial statement to a particular reported item, he/she may include an Emphasis of Matter paragraph in his / her audit report. In this case, the auditor is not required to modify his / her opinion. The paragraph is added when the issue is not a key audit matter and only requires disclosure for a better understanding of the financial statements.

Example of circumstances where the auditor shall include Emphasis of Matter paragraph in audit report:

To inform users of financial statements that the same has been prepared under a special purpose framework;
The auditor discovers some facts after the date of an audit report and the auditor issues new or amended audit report.
Uncertainty about the future outcome of an ongoing litigation.

Auditor’s Certificate

The term certificate refers to a written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion.

An Auditor’s certificate is a written confirmation of the accuracy of the facts relating to the accounts for a particular time or to a specific matter, which does not involve any estimate or opinion.

An auditor’s certificate represents that he has verified certain precise figures and is in a position to vouchsafe their accuracy as per an examination of documents and books of accounts.

Certification of the statutory report, certification of share transfer, certification of the value of imports and exports of a company, etc. are some of the examples of auditor’s certificate.

Form of Auditor’s Certificate

If the auditor is satisfied with the accuracy of the foregoing items, he should give his certificate in connection with the correctness of the prescribed items given in the statutory report.

The form of auditor’s certificate is as follows:

“We, the undersigned, being the auditors of the company hereby certify that so much of this report as related to the shares allotted, the cash received in respect of such shares and the receipts and payments of the company are correct.”

Place and date

Chartered Accountants

Differences between Auditor’s Report and Certificate

Points	Auditor’s report	Auditor’s certificate
1. Nature	It is an expression of opinion about the account.	It is a confirmation of correctness and accuracy about some matters.
2. Basis of audit	The report is based on assumptions and estimations.	The certificate is based on actual figures and facts.
3.Criticism	There may be criticism about the report.	There is no scope of criticism about the certificate.
4. Scope	The scope of the report is large.	Its scope is limited.
5. Scope of advice	In the scope there is a scope of giving constructive advice in the company.	No scope of constructive advice Exists in case of a certificate.
6. Time of issue	After the end of each accounting, the year report is mandatory.	A certificate is not mandatory in every year.
7. Liability of auditor	As a report is merely an opinion, if it is not correct, the auditor may not be held responsible.	In case of the wrong certificate, the auditor will be held responsible.

Unit III

Company Audit

The companies Act, 1956 requires the compulsory audit of every Joint Stock Company and therefore, an auditor is to be appointed to do the job and submit his report to the shareholders of the Company. After the appointment of the auditor is made, the auditor has to go through some preliminaries before starting the actual work of audit.

The Preliminaries

The Preliminaries are:

1. To see whether his appointment is in order and legal. To ensure it, he should...

(a) where he is appointed as first auditor, get a copy of the resolution by the directors about his appointment;

(b) where he is appointed in place of retiring auditor, he should enquire from the retiring auditor in writing, whether due notice was given to him and also the circumstances under which he retired, and also if the retiring auditor has any objection to his accepting the appointment. Failure on the part the auditor shall be treated as a breach of professional etiquette.

(c) Where his appointment is made by the shareholders in annual general meeting, he should procure a copy of the shareholders resolution regarding his appointment and inform the Registrar within 30 days whether he is accepting the appointment.

(d) Where he is appointed in a casual vacancy, by the directors, he should obtain a copy of the director's resolution to this effect.

2. He should obtain a certified list of all the books in use in the Company as also the important documents:

(a) Memorandum of Association: he should carefully go through this document, especially, its Objects Clause and see whether any transaction is not ultra vires the Memorandum. In case there is any, the same be brought to the notice of the shareholders by him. He should also see whether the Issue of Share Capital is within the limits of the Authorized Capital of the Company and according to the Companies Act. Where the Authorized Capital has been increased, he should procure a copy of the resolution. He should carefully examine all the provisions of the Memorandum relating to the accounts of the company.

(b) Articles of Association: He should carefully go through the document and satisfy himself regarding —

(i) the issue of share capital and its sub-divisions;

(ii) the payment of underwriting commission and brokerage on shares;

(iii) the amount of minimum subscription, specified in the Articles;

(iv) the call dates and the amount of the calls;

(v) the rate of interest to be charged on Calls-in-arrears and the rate of interest to be paid on calls-in-advance;

(vi) Rules regarding Forfeiture and re-issue of forfeited shares;

(vii) Borrowing powers of the company; and the directors;

(viii) Rules regarding reorganization of the share capital; (ix) Rules regarding appointment, remuneration, powers and duties of the auditor in addition to the statutory powers and duties;

(x) The appointment, remuneration, removal, rights and duties of the directors and various officers of the company;

(xi) Rules regarding meetings;

(xii) Voting powers of the shareholders;

(xiii) Accounts and audit of the company;

(xiv) dividends and reserves;

(xv) Rules regarding the reorganization of the share-capital.

The above are a few important clauses relating to specific matters. Where a company does not have its own Articles of Association, Table A of the Companies Act will apply. The auditor cannot escape his liability on the plea that he did not go through the Articles of the Company or he is unaware of them. (Leeds Estate Building and Investment Society Ltd. v. Shepherd, 1887). The auditor should also carefully note the changes made, if any, in the Articles.

(c) Prospectus: Prospectus is an important document. The auditor should examine it to ascertain usually the same points as stated in the Articles. In case of the fist audit of the company, he should peruse it very carefully in order to examine the contracts entered into with the vendors, if there are any such contracts, with the third parties, with the underwriters and brokers. Prospectus also states the information regarding the issue of shares at discount, the amounts payable on application, allotment, calls etc. In the subsequent audits, perusal of Prospectus is not necessary.

(d) List of Books: Auditor should ask the company to submit a list of all the books of account, statistical and statutory books maintained by the company. Important books are kept at the Registered Office of the company.

(e) contracts: The company might have entered into contracts with the vendors in case of purchase of assets, with the underwriters and brokers and promoters. The auditor should go through all these contracts carefully. Where a statement is given in the Prospectus of the company relating to these contracts, the auditor should see that such statements are correct and the account books have recorded these entries correctly.

(f) Minute Books: Minute Books are statutory Books (Section 193). Every Company maintains three types of Minutes Books—

(i) Minute Book of the Shareholders' Meetings;

(ii) Minute Book of the meetings of the Board of Directors; and

(iii) Minute Book of the various committees appointed by the Board of Directors.

Minute Books are kept in the form of bound books. The auditor should see that the minutes as recorded in the minute books have been certified by the Chairman of the meeting. The audit of the Minute Books helps the auditor in vouching various transactions e.g., adoption of the annual accounts, calls on shares, directors fees and expenses, appointment of first auditor and his remuneration and authorization of capital expenditure etc.

(g) Last balance Sheet, Profit & Loss Accounts and Audit Reports: The auditor should inspect these documents in order to confirm the balance therein are correctly recorded in the new books. Perusal of the last audit report may give some important information useful to the auditor in his work of audit. He should also see whether the recommendations of his predecessor have been properly carried out. The previous audit reports help the auditor in understanding the working of the company. The minute book of the shareholders will also help him in getting important information regarding the adoption of accounts.

(h) Certificate of Incorporation and Commencement of Business: By examining the certificate of Incorporation the auditor can ascertain the date of the formation of the company. He should examine the Certificate to commence business in case of public limited company.

(i) System of Internal Check: The auditor should obtain a written statement from a responsible officer regarding the system of internal check, internal audit and the system of accountancy adopted by the company.

He should also obtain a list of the officers of the company and the jobs assigned to them. This information shall help him in the quick disposal of queries. In case of any doubt of a transaction, the concerned officer may be contacted for getting the necessary information.

(j) Audit Report: Section 227 (2) of the Companies Act, requires a report on the accounts audited by the auditor, to be submitted by him to the Shareholders of the company. The auditor thus has to prepare an audit report on the accounts audited by him and on every balance sheet and profit and loss account and other documents declared by law to be annexed to the balance sheet or the profit and loss account. The report is placed in the Annual General Meeting during the tenure of the auditor. The report is addressed to the shareholders and is sent to the Secretary of the Company. It is duly signed by him. The auditor should sign the report only after being satisfied that the accounts are being approved by the Board and signed by the Directors, before they are submitted to him for his report. (Section 215)

According to Section 227 (2) of the Companies Act, the auditor's report state—

1. Whether, in his opinion and to the best of his information and according to the explanation given to him, the accounts give the information required by the Act and give a rue and fair view of the state of the company' affairs in the case of the balance Sheet as at the end of the financial year and in the case of the Profit & Loss Account for the financial year.

2. Whether he has obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit.

3. Whether in his opinion. Proper books of account, as required by law have been kept
by the company so far as appear from the examination of those books and proper returns adequate
for the purpose of his audit have been received from branches not visited by him.

4. Whether the report on the accounts of any branch office audited under section 228, by a person other than the Company's auditor has been forwarded to him as required by clause (e) of sub section (7) of that Section and how he had dealt with the same in preparing auditor's report.

5. Whether the company's balance sheet and profit and loss account dealt with by the report are in agreement with the books of account and returns.

The report should also include a statement on such additional matters as specified by the Central Government u/s 227 (4-A) of the Companies Act, i.e., the central Government is empowered to direct by a general order or specified order that in the case as specified companies, the auditor’s report shall include a statement on such matters as may be specified in its order. With this provision the Central Government now may direct the auditor to examine the specified problems which is in the interest of the members and report thereupon. Thus, through the auditor the Government may bring to the information of the shareholders a fact or a point, which it feels necessary and in their best interest.

Qualification of Company Auditor: - As per section 226 of companies act, a person should not be qualified for appointment as an auditor or a public or private company unless he is a chartered accountant within the meaning of the Chartered Accountant Act,1949.

According to section 226(2), a person holding a certificate under Restricted Auditors Certificate (Part – B states) Rules,1956, is also qualified t act as an auditor of a company.

However, the Central Government may grant, renew, suspend or cancel and make other rules for such certificates by notification in the official Gazette.

Disqualification of Company Auditor: - Following are the disqualification of a company auditor: -

An auditor cannot be a body corporate.
An auditor cannot be an employee of officer of the company.
A person who is a partner or who is in the employment of an officer of the company, cannot be the auditor of the company.
A person who is indebted to the company for an amount exceeding one thousand rupees, cannot be the auditor of the company.
A person who is a member or a director of a private company or partner in a firm which is the managing agent or the secretaries and treasurers of the company, cannot be the auditor of the company.
A person who is a director or holder of shares of more than 5% in nominal value of the subscribed share capital of anybody corporate which is the managing agent or the secretaries and treasures of the company, cannot be the auditor of the company.

Qualities of an Auditor: - An auditor must have the following qualities: -

He/she must have complete knowledge of general accounts, income tax, cost accounting etc. He/she should be aware of the latest development of the technique of accounting.
He/she should not pass any transaction unless he/she knows that it is correct. It is possible when he/she knows thoroughly well the principles of accounting.
He/she should be able to grasp quickly the technical detail of the business whose accounts he/she is auditing.
He/she should not show his/her proud of his/her qualification or position.
He/she should be quite familiar with the company and mercantile laws and must be a complete master of the principles of auditing.
He/she must be honest. He/she must not certify what he/she does not believe to be true.
He/she must not be influenced directly or indirectly by other in the discharge of his/her duties.
Sometimes he/she is put in a very awkward position, when his/her duty to his/her client is opposed to his/her own interest. In this case he/she must have the courage to carry out his/her duty faithfully and honestly. It will pay in the future.
He/she must be prepared to resign rather than sign a balance sheet, which he/she knows that it does not give the true and correct position.
He/she should not disclose the secrets of his/her client.
He/she should have the tact to put intelligent questions to extract full information.
He/she must not adopt an attitude of suspicion.
He/she must be prepared to hear arguments and must be reasonable.
He/she must be able to write the report clearly, correctly and forcefully.
He/she must have a thorough training in business organization, management and finance.
Last but not least, he/she should have common sense.

Appointment of Company Auditor

Every company, whether public or private company, must appoint an auditor to audit its account.
The Board of Directors are empowered to appoint the first auditors of a company who shall hold office until the conclusion of the first annual general meeting. Such powers must be exercised by the board within one month of the date of registration of the company.
If the board fails to exercise this power, the company in general meeting may appoint the first auditor.
Every company shall, at each annual general meeting, appoint an auditor or auditors to hold office from the conclusion of that meeting until the conclusion of the next annual general meeting and shall within seven days of the appointment, give intimation thereof to every auditor so appointed unless he is a retiring auditor.
An auditor so appointed unless he is a retiring auditor, shall within 30 days of the receipt from the company of the intimation of his appointment, inform the Registrar in writing that he has accepted/refused to accept the appointment.
In the case of government companies, special provisions have been made by section 619. The auditor of such company shall be appointed or re-appointed by the Central Government on the advice of the Comptroller and Auditor General of India.

Re-appointment of an Auditor: – At the annual general meeting, the retiring auditor by whatever authority appointed (board, annual general meeting or central government) shall be re-appointed except the following cases: -

If he/she is not disqualified for re-appointment.
If he/she has given a notice in writing of his/her unwillingness to be re-appointed.
A resolution is passed to that effect that he/she shall not be re-appointed or that somebody else be appointed at his/her place.
Where a notice has been given to appoint someone else and the resolution can be proceeded with, on account of death, incapacity or disqualification of the proposed auditor.

Appointment of Auditor by Special Resolution: – In the case of company in which 25% or more of the subscribed capital is held. whether singly or jointly by: _

Public financial institution or a Government company or the Central Government or any State Government or
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
A nationalized bank or an insurance company carrying on general insurance business, the appointment of re-appointment (at each annual general meeting) of an auditor shall be made by special resolution.

If the company fails to pass a special resolution, it will be assumed that the company is without an auditor. In such a case the Central Government shall have power to fill the vacancy.

If 25% of the subscribed capital of the company is held by the specified institution on the date of the annual general meeting at which the special resolution is to be passed, it will suffice to attract the provision of section 224A.

Removal of Company Auditor: - The auditor may be removed from the office before the expiry of his term in the following cases: -

Removal of First Auditor: – When the first auditor is appointed by the board of directors before the first annual general meeting, such auditor may be removed by the members in general meeting. The general meeting may, in their place, appoint any other person whose nomination notice has been given by any member not less than 14 days before the date of meeting.
Removal of Other Auditor: – In any other case, the auditor may be removed from the office before the expiry of his tenure only by the company in its general meeting after obtaining the previous approval of the Central Government.
Section 225 of the companies act has laid down the following procedures for removal of auditors: -

A special notice of intention to move such resolution to remove the existing auditor must be given to the company by the shareholders, not less than 14 days before the annual general meeting.
A copy of such resolution shall be forthwith sent to the retiring auditor.
The retiring auditor has got a right to make written representation to the company.
His representation should not exceed a reasonable length and he can request the company to notify such representation to the members of the company.
In case the copy of representation has not been sent to the members because it was received too late or because of the company default, the auditor may request that this representation may be read out in the meeting.
The auditor has got a right to attend the meeting where his removal is being discussed.

Rights and Powers of Company Auditors

According to Section 227(7) of the Companies Act, a company auditor has the following rights:

1. Right of Access Books of Accounts: As per Section 227(1) of the Companies Act every auditor of the company has the right to 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. Under section 209(1) (d), a company auditor has the right to examine the cost records also which are required to be maintained by certain companies relating to production sales, stores etc.

2. Right to Obtain Information and Explanations: An auditor can call for any information or explanation from different officers of the company which he may think necessary for the performance of his duties.

Apart from the auditor’s right to obtain information and explanation it is the duty of every officer of the company to furnish without delay the information to the company auditor. If the directors or officers of the company refuse to supply some information on the ground that in their opinion it is not necessary to furnish it, then the auditor has the right to mention that in his audit report.

3. Right to Receive Notices and Other Communication Relating to General Meetings and to attend them: According to section 231, of the companies act an auditor of a company has the right to receive notices and other communications relating to the general meetings in the same way as that of the members of the company.

Similarly, an auditor also has the right to attend any annual general meeting and also to be heard at those meetings which he attends and which concerns him as an auditor.

The auditor also has the right to make a statement or explanation with regard to the accounts he has audited. But he auditor is not expected to answer questions in the general meeting.

4. Right to Visit Branches: According to section 228 of the companies act the auditor of the company has the right to visit the branch office or offices of the company.

He can also audit such accounts of eh offices of the company provided that there is not qualified auditor to audit the accounts of the branch office or offices of the company, in such cases, the auditor has the right to access at all times to the books of accounts and vouchers that the company maintains at branch office or offices.

Moreover section 226 of the companies act provides that in case of the company gets the branch accounts audited by some of the local auditors, even the auditor has access at all times, to the books, accounts a voucher of the company and he can also visit the branches, if he feels necessary.

5. Right to Correct Any Wrong Statement: The company auditor is required to make a report to the members of the company on the accounts examined by him of the final accounts and the related documents which are laid down before the company in the general meeting.

6. Right to sign the Audit Report: As per section 229 of the companies act only the person appointed as auditor of the company or where a firm is so appointed, only a partner in the firm practicing in India, may sign the audit report or authenticate any other document of the company required by law to be signed.

7. Right to Being Indemnified: Under Section 633 of the Companies Act, an auditor is considered to be an officer of the company and he has the right to be indemnified out of the assets of the company against any liability incurred by him in defending himself against any civil and criminal proceedings by the company if it is proved that the auditor has acted honestly or the judgment is delivered in his favour.

8. Right to seek Legal and Technical Advice: The company auditor has the full right to seek the opinion of the experts and to take their legal and technical advice so as to discharge his duties efficiently.

9. Right to Receive Remuneration: As per Section 224(8) of the Companies Act, the company auditor has the right to receive remuneration provided he has completed the work which he has undertaken to do so.

Duties and Liabilities of a Company Auditor (Section 227):

Duties towards the shareholders:

1. Report shareholders about true and fair state of affairs of the company

2. State that balance sheet and profit and loss a/c give all information required by law

3. State that balance sheet and profit and loss a/c agree with the books of account

4. State that balance sheet and profit and loss a/c agree with accounting standards

5. State that he has obtained all the necessary information

6. State whether the company has maintained all books as required by law;

7. State the reasons of qualification in his report

8. State that he has received the audit report on the branch accounts audited by other auditor and how he has dealt with the same in preparing his report

9. Auditor shall state in his report whether:

a) The loans taken are properly secured and the terms of loans are not against the interests of the company

b) Loans given are shown as fixed deposits and the terms of loans are not against the interests of the company

10. Transactions recorded as book entry are not against the interests of the company

11. Personal expenses of directors have not been charged to revenue a/c of company;

12. The company fulfils the requirements of CARO 2003.

Duties towards Company:

1. Prospectus: According to Sec 56, the auditor is required to certify profits or losses, assets & Liabilities and dividend paid etc in the prospectus.

2. Statutory Report: Section 165 requires that the auditor has to certify the statutory report.

3. Public Deposits: Section 58AA requires the auditor to report about whether the company has followed all rules and guideline of RBI in regard to public deposits or not.

4. Signature on Audit Report: Section 229: It is duty of auditor to sign on his report.

5. Insolvency (Section 488): If the company wants itself to be declared insolvent, it is duty of auditor to prepare profit and loss a/c for the current period.

Duties towards Government:

1. CARO-2003: The auditor has to report para-wise that the company has fulfilled all the requirements of CARO-2003.

2. Assist the Investigation u/s 237: It is duty of auditor to assist the investigation ordered by the CG u/s 237.

Duties towards General Public:

1. His office is of confidence and faith. He must be reliable in all respects.

2. He should reveal all material information regarding the state of affairs of the company to the company as well as to the general public.

3. While issuing prospectus u/s 56, he should see that the prospectus does not include any misleading information or material.

Who fixes remuneration of an Auditor?

In case an auditor is appointed by the company directors or the Commission, the directors or the Commission, as the case may be, shall fix the remuneration. In all other cases, by the company members in general meeting or in such manner as the general meeting may determine.

Audit Report – Basics, Format and Content

Contents of an Audit Report

The basic structure of an audit report as prescribed by the Standards on Auditing is as follows:

Heading	Brief of contents
Title	Title should mention that it is an ‘Independent Auditor’s Report’.
Addressee	Should mention clearly as to whom the report is being given to. For example Members oMentions that it is the Management’s responsibility to Prepare the Financial Statements. f the company, Board of Directors
Management’s Responsibility for Financial Statements
Auditor’s Responsibility	Mention that responsibility of the Auditor is to express an unbiased opinion on the financial statements and issue an audit report.
Opinion	Should mention the overall impression obtained from the audit of financial statements. For example Modified Opinion, Unmodified Opinion
Basis of the Opinion	State the basis on which the opinion as reported has been achieved. Facts of the basis should be mentioned.
Other Reporting Responsibility	If any other reporting responsibility exists, the same should be mentioned. For example Report on Legal or Regulatory requirements
Signature of the Auditor	The engagement partner (auditor) shall sign the audit report.
Place of Signature	The city in which audit report is signed.
Date of Audit Report	Date on which the audit report is signed.

Other headings being basic and self-explanatory in nature, we need to understand the about the opinion part precisely. This part forms the basic crux of an audit report.

Opinion in an Audit Report

There are primarily two kinds of opinions issued by an auditor in his / her audit report:

Unmodified Opinion (also called Unqualified report)
Modified Opinion (also called Qualified report)

1. Unmodified Opinion

Issued for any audit where the auditor is satisfied that the financial statements present a true and fair view of the operations and transactions in an enterprise during the period.

An audit report with an Unmodified Opinion is also known as a ‘Clean Report’. An Unmodified report develops confidence among users of Financial statements and annual reports of an enterprise.

It provides an impression that the financial statements are reasonably free from any misstatements and results as appearing there are true and fair.

2. Modified Opinion

There are two basic reasons due to which an auditor concludes on issuing a Modified Opinion:

Based on the audit and evidence, finds out that the financial statements contain a certain degree of material misstatements.
Unable to obtain sufficient and appropriate evidences to conclude that the financial statements are free from material misstatements.

There are three kinds of modified opinions which are issued according to the findings and circumstances:

A. Adverse Opinion

B. Qualified Opinion

C. Disclaimer of Opinion

A. Qualified Opinion

Qualified Opinion is given in a situation where:

The auditor concludes that misstatements are material but the impact is not so high that it would render the whole financial statements unacceptable; or
The auditor is unable to obtain sufficient or appropriate audit evidence but concludes that there are indications of misstatements in the financial statements (but the degree is not high).

Example of a Qualified Opinion paragraph in audit report:

In case of the Balance Sheet, of the state of affairs of the company as at March 31, XXXX;
In case of Profit and Loss Account, of the profit/loss for the year ended on that date; and
In case of the Cash Flow Statement, of the cash flows for the year ended on that date.

B. Adverse Opinion

Example of a Qualified Opinion paragraph in audit report:

In case of the Balance Sheet, of the state of affairs of the company as at March 31, XXXX;
In case of Profit and Loss Account, of the profit/loss for the year ended on that date; and
In case of the Cash Flow Statement, of the cash flows for the year ended on that date.

C. Disclaimer of Opinion

Example of a Draft Disclaimer of Opinion:

Emphasis of Matter paragraph in an Audit Report

Example of circumstances where the auditor shall include Emphasis of Matter paragraph in audit report:

To inform users of financial statements that the same has been prepared under a special purpose framework;
The auditor discovers some facts after the date of an audit report and the auditor issues new or amended audit report.
Uncertainty about the future outcome of an ongoing litigation.

Auditor’s Certificate

The term certificate refers to a written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion.

An auditor’s certificate represents that he has verified certain precise figures and is in a position to vouchsafe their accuracy as per an examination of documents and books of accounts.

Certification of the statutory report, certification of share transfer, certification of the value of imports and exports of a company, etc. are some of the examples of auditor’s certificate.

Form of Auditor’s Certificate

If the auditor is satisfied with the accuracy of the foregoing items, he should give his certificate in connection with the correctness of the prescribed items given in the statutory report.

The form of auditor’s certificate is as follows:

Place and date

Chartered Accountants

Differences between Auditor’s Report and Certificate

Points	Auditor’s report	Auditor’s certificate
1. Nature	It is an expression of opinion about the account.	It is a confirmation of correctness and accuracy about some matters.
2. Basis of audit	The report is based on assumptions and estimations.	The certificate is based on actual figures and facts.
3.Criticism	There may be criticism about the report.	There is no scope of criticism about the certificate.
4. Scope	The scope of the report is large.	Its scope is limited.
5. Scope of advice	In the scope there is a scope of giving constructive advice in the company.	No scope of constructive advice Exists in case of a certificate.
6. Time of issue	After the end of each accounting, the year report is mandatory.	A certificate is not mandatory in every year.
7. Liability of auditor	As a report is merely an opinion, if it is not correct, the auditor may not be held responsible.	In case of the wrong certificate, the auditor will be held responsible.

Audit Committee

In laymen’s terms, it’s comprised of approximately five individuals who are usually from outside of the organization itself. Their primary responsibility is to provide an objective and unbiased view of the organization’s practices. The purpose of the audit committee being comprised of members from outside of the organization is to ensure that the audit process is neutral by removing the conflict of interest.

Businesses use internal committees when they want to verify that their managers and financial analysts are using the correct internal protocol for financial reporting items like; business regulations, accounting policies, and risk management policies. Typically, organizations will rely on this committee to help create financial reporting procedures as well. The advantage of these audit committees is that they have helped companies to run substantially smoother since their initial instalment.

Unit IV

Cost Audit: Unique Feature and Concept

It is an audit process for verifying the cost of manufacture or production of any article, on the basis of accounts as regards utilisation of material or labour or other items of costs, maintained by the company. In simple words the term cost audit means a systematic and accurate verification of the cost accounts and records and checking of adherence to the objectives of the cost accounting.

As per ICWA London’ “cost audit is the verification of the correctness of cost accounts and of the adherence to the cost accounting plan.”

The ICWAI defines cost audit as “system of audit introduced by the government of India for the review, examination and appraisal of the cost accounting records and attendant information required to be maintained by specified industries"

From above definition of cost audit, it is clear that cost audit is a systematic examination of cost accounts to verify correctness of cost accounting records.

As per the section 233 B of Company Law 1956, there is the provision for cost audit. Under this section, cost audit is compulsory for all the public and govt. companies which are associated with the processing and production. If their aggregate value of net worth exceeds 5 crores or total sale exceeds 20 crores, the cost audit is must.

Objectives of Cost Audit

The following are some of the objectives for which cost audit is under taken:

1. To establish the accuracy of costing data. This is done by verifying the arithmetical accuracy of cost accounting entries in the books of accounts.

2. To ensure that cost accounting principles are governed by the management objectives and these are strictly adhered in preparing cost accounts.

3. To ensure that cost accounts are correct and also to detect errors, frauds and wrong practice in the existing system.

4. To check up the general working of the costing department of the organization and to make suggestions for improvement.

5. 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.

6. To reduce the amount of detailed checking by the external auditor if effective internal cost audit system is in operation.

Unique Feature of Cost Audit:

The audit of cost accounts has attained its present status in the statute book of our country through a gradual process of industrial development and socio-economic expectations. During World War I, a large number of firms were given contracts by the Government “on a cost-plus basis”, and the defence establishments used to verify and investigate the costs structure.

The statutory cost audit started in the year 1965 when the Companies Act, 1956 incorporated the provision for cost audit in clause (d) to Section 209 and to Section 233B. This provision was made on the basis of recommendations from Vivian Bose Commission, Dutta Commission and Shastry Committee, where it was thought necessary to institute proper cost accounting system in the industrial sector of our economy.

They felt that the financial audit had its own limitations to satisfy the Government, shareholders and public with regard to the valuation of inventory, cost of goods produced and sold, and work-in-progress.

In addition to Section 233B of the Companies Act, 1956 the Cost Audit (Report) Rules, 1996 came into existence prescribing the time and manner and the format of the Cost Audit Report. The unique features of statutory cost audit can be best understood by the purposes it serves and the potentials it possesses.

Advantages of Cost Audit:

To The Management

1. Cost audit helps in detection of errors and frauds.

2. The management gets accurate and reliable data based on which they can make day-to-day decisions like price fixation.

3. It helps in cost control and cost reduction.

4. It facilitates the system of standard costing and budgetary control.

5. It helps the management in inter-unit / firm comparison.

6. It enables the management to identify loss making propositions.

To The Government

1. Cost audit ensures efficient functioning of the industry. This in turn, nurtures a healthy competition among the different companies and paves a path for fast progress.

2. It helps in identification of sick units and enables the Government to make relevant decisions.

3. It helps in fixing prices in the case of essential commodities and checking undue profiteering.

4. It enables to take decisions as to granting of subsidies, incentives and protection to various industries.

5. It helps to take decisions as to levies, duties and taxes.

To the Society

1. Cost audit enables the Government to fix prices of essential commodities. This safeguards the interests of the society.

2. Cost audit enables the Government to keep a check on undue profiteering by the manufacturers and avoids artificial price rise due to monopolistic tendencies.

To the Shareholders

1. Cost audit reveals whether any of the products of the company are making losses. Thus though the company making an overall profit, a loss making line may eat up the company’s profits. This is brought to the notice of the shareholders and the management is forced to take remedial measures, thereby making optimum utilisation of resources.

2. Cost audit ensures that the shareholders get a fair return on their investments.

Disadvantages of Cost Audit:

1. Holding a Cost Audit can be expensive. This is because a company will often bring in an independent auditor who are normally charging higher price.

2. A Cost Audit can be a long process which will likely involve more time. This extra time and effort can impact an employee's day to day routine work.

3. If a Cost Audit is carried out in order to find fraudulent activity it can take a long time by which time people stealing could have covered their tracks.

4. Cost Audits involve a large amount of estimation and so there is the possibility that figures will be incorrect and if record keeping from the company is not good to start with then inaccuracies will be arising.

Tax Audit

A tax audit is an examination of your tax return by an outside agency to verify that income and deductions filed are accurate. The income tax law asks the taxpayers to get the audit of accounts of their business or profession done according to provision of income tax law.

The provisions for tax audits in India are covered under section 44AB of the Income Tax Act, 1961. The definition of tax audit as per incometaxindia.gov.in is the audit conducted by the chartered accountant of the accounts of the taxpayer in pursuance of the requirement of section 44AB. The chartered accountant then prepare the audit report and submit their findings in Forms Nos 3CA/3CB and 3CD.

What is the objective of Tax Audit?

§ Report the requirements of Form No 3CA/3CB and 3CD

§ To ensure the book of account and other records of assessee are properly maintained.

§ Book of account accurately reflect the income of tax payers and deduction are correctly declared.

§ Facilitate the administration of tax laws by proper presentation of accounts before tax authorities and considerab1ly save the time of assessing officers in carrying out routine verification.

Who should get their books Audited?

A person is required to get his books of accounts audited by chartered accountant as per section 44AB if he satisfies any of the following conditions

§ An individual carrying on business and his/her total sales, turnover or gross receipts (as the case may be) for the financial year exceeds 1 crore. As per ICAI guideline- turnover is the aggregate value for which sales occured or services are rendered. It also includes all applicable taxes on such goods or services.

§ A person carrying on profession and gross receipts in profession for the year exceed Rs 25 Lakhs

Penalties for not getting the accounts audited as required by section 44AB

According to section 271B, the assessing officer may impose penalty if assessee is failed to file tax audit report as required under section 44AB. The penalty shall be lower of the following amounts:

§ 5% of total sales, turnover or gross receipts (as the case may be), in business in such years or years

§ 5% of the gross receipts in profession, in such year or years

§ Rs 1,50,000

Management Audit

Management audit is audit of the management. It is similar to operational audit in several aspects. However, management audit concentrates more on the inefficiencies and weaknesses of the management.

“Management audit can be defined as an objective and independent appraisal of the effectiveness of managers and the effectiveness of the corporate structure in the achievement of company objectives and policies. Its aim is to identify existing and potential management weaknesses within an organization and to recommend ways to rectify these weaknesses”. – CIMA Official Terminology.

Management Audit is the systematic and dispassionate examination, analysis and appraisal of management’s overall performance. It is a form of appraisal of the total performance of the management by means of an objective and comprehensive examination of the organization structure, its components such as department, its plans and policies, methods of process or operation and controls, and its use of physical facilities and human resources

Objectives of Management Audit

The following are the important objectives.

1. To identify the weaknesses and inefficiencies of management in different functional areas, such as production, sales, finance etc.

2. To analyses the different ways to overcome the inefficiencies, or weaknesses.

3. To critically review the organization structure.

4. To evaluate the ways for improving the management efficiency and to select the best are the some of the objectives of management audit.

Scope of Management Audit

Management audit may cover a specific functional area or all the functional areas such as. Sales, Inventory, Production, Purchase, Personnel, Finance, Administration, etc.

In management audit, experts from various fields –

§ examine the organizational structure, Plans and Objectives, Policies, Systems and Procedures, Methods of control, Standards fixed for performance and the method of evaluation of results.

§ report on the defects, weaknesses and irregularities observed by them during their examination.

§ make suggestions to improve the efficiency and performance of the management.

Advantages of Management Audit

1. Management audit helps in decision making areas such as make or buy, closing down of an unit, acquisition of a business, etc.

2. It also helps in assessing the efficiency of the executives. It serves as a moral check on the executives.

3. Management audit suggests ways to utilize the resources of the organization effectively.

4. Management audit helps in rehabilitation of sick units.

5. Management audit report is jointly reported by experts &om various fields.

6. The opinions and suggestions of a group of experts on the functioning of the organization are possible only through management audit.

Disadvantages of Management Audit

1. Management audit involves high cost and it is suitable only to big organizations.

2. Management audit may create a fear in the minds of the executives and may curb their initiative and innovation.

3. The management auditor may lack independence and may simply take instructions from the top management.

However, an organization can utilize management audit effectively to improve its various functional areas.

Qualities of a Management Auditor:

A management auditor should have the following specific qualities:

(i) Ability to understand and gauge business problems.

(ii) General understanding of the organisation.

(iii) Expert knowledge on the principle of delegation of authority, management by objective, management by exception, management planning and control and the different budgetary systems, and those of internal control devices (viz. flow chart, flow of work, analysis of work scheduling, use of computer, etc.).

(iv) Sufficient knowledge and experience in preparing various reports for presentation.

(v) General understanding of different laws—general laws, company law, tax laws FERA, MRTP, etc. that affect the functioning of the whole of the organisation.

(vi) Background knowledge about—Engineering, Statistics, Costing, Management accounting, Financial accounting, Industrial psychology, Managerial economics, etc.

(vii) Tactfulness, perseverance, and lastly—pleasing and dynamic personality.

Functions of a Management Auditor:

Comp-field has categorized three broad functions of a management auditor:

1. (To) furnish guidance in the development of format and related instructions pertaining to revenue and expense budgets for each responsibility centre.

2. (To) review or give guidance in the preparation of complete statements of the performance standards and yardsticks for measurement applicable to each major decisions or performance area. The auditor should carefully examine each set of statements to make sure that they are consistent with policies, plans, procedures and standards established at higher levels of responsibility e.g. assure that they are compatible with and properly support the company wide profit budget.

3. (To) critically examine and refine the units of measurement commonly applied in each major performance or decision area. In this regard the auditor should help management in pinning down and inter-relating the performance standards and measurements with the operating responsibilities of each person affected.”

Thus, the functions (or services) of a Management Auditor may embrace the following aspects:

(i) Formulation of plan and policy:

He should ensure that “accounting, economic and other data needed by the management in constructing its basic policy framework” — are supplied by the management services unit.

(ii) Decision-making process:

He should take into account the outcome of the decisions previously applied and see that the decisions are based on—management by objectives, management by exception, management information services.

(iii) Designing organisational authority structure:

He should assist in the flow of information among different functional managers (responsibility-wise).

(iv) Measuring and evaluating business performance:

He should concentrate on key functions or operations in the profit-making process.

(v) Tax-planning and budgeting:

He should appraise the appropriateness of tax implications, and those of different information and data needed for budget preparation.

(vi) Improving communication system:

He should guide in the flow of internal communication (between various departments) to strengthen the organisation structure, and in the flow of external communication (e.g. market conditions, legal requirements, social accounting, competitors’ standing, economic trends, etc.) with a view to strengthening the progress of the business.

The role of a Management Auditor in the co-ordination (or harmonisation) of the functions of planning, organising, controlling and appraising of business, is crucial. This can be best explained by a chart below.

A management auditor should have the following general considerations to:

1. Indicate source, nature and basis of data.

2. Stick to essential information; that is, not matters of general knowledge.

3. Avoid gathering data acquired during a previous study, except when a change in the data presents new evidence.

4. Obtain the complete details where cost is an important factor.

5. Look for irregularities, uncertainties, conflicts and possible disagreements about plans, objectives, functions, systems and operations.

6. Be alert for weaknesses in organisation systems, methods, controls, operations and personnel.

7. Substantiate all data by verification through actual observation, examination or test checks.

8. Watch out for inaccurate, incomplete, inadequate and unnecessary reports, forms and statements.

9. Determine compliance of policies and procedures by checking performance.

10. Seek out methods for improvement.

11. Note areas and functions for greater effectiveness in performance.

12. Be on the lookout for inadequate protective and preventive methods.

13. Determine whether or not responsibilities are being appropriately discharged.

14. Look into the matters of cost-effective utilisation of all resources—human, physical financial and national, including the scarce resources and utilities of public nature.

15. Take note of fluctuations in production, work-loads and services.

16. Ascertain the ultimate use (i.e. utility aspects) of each activity, record and report in order to determine value or necessity.

17. Look for problems, bottlenecks, waste, unnecessary work or function, poor coordination, low morale, inadequate motivation and other defects in all functions and areas under study.

Meaning and Objectives of Interim Audit

Interim Audit

An audit which conducted in between the two annual audits with a view to find out interim profits to enable the company to declare an interim dividend is known as Interim Audit. It is a kind of audit which is conducted between the two periodical or balance sheet audits.

Objectives of Interim Audit

1. To know profit or loss of interim period.

2. To distribute interim dividend.

3. To get loan on the basis of interim account.

4. To get information about the financial position of interim period.

Auditing B.com 601 Notes

Primary Objectives of Audit

Subsidiary Objectives of Audit

Types of Audit

1. Financial Audit

2. Operational Audit

3. Compliance Audit

Other Types of Audit

Forensic Audit

Public Sector Audit

Tax Audit

Information System Audit

Environmental & Social Audit

Value-For-Money (VFM) Audit

Management Audit

Audit Programme

Routine checking in auditing (Objects, Advantages and Disadvantages)

Test Checking

Auditing Vs Investigation

DIFFERENCE BETWEEN BOOK KEEPING AND ACCOUNTANCY AND AUDITING

Auditor Definition: Qualities and Types of Auditors

Qualities of an Auditor

Types of Auditors

Independent/External Auditors

Internal Auditors

Government Auditors

Forensic Auditors

Conclusion

Generally Accepted Auditing Standards (GAAS)

Audit Planning

Base of Audit Planning

Types of Audit Procedures

Audit Report – Basics, Format and Content

Contents of an Audit Report

Opinion in an Audit Report

1. Unmodified Opinion

2. Modified Opinion

A. Qualified Opinion

B. Adverse Opinion

C. Disclaimer of Opinion

Emphasis of Matter paragraph in an Audit Report

Auditor’s Certificate

Form of Auditor’s Certificate

Differences between Auditor’s Report and Certificate

Audit Report – Basics, Format and Content

Contents of an Audit Report

Opinion in an Audit Report

1. Unmodified Opinion

2. Modified Opinion

A. Qualified Opinion

B. Adverse Opinion

C. Disclaimer of Opinion

Emphasis of Matter paragraph in an Audit Report

Auditor’s Certificate

Form of Auditor’s Certificate

Differences between Auditor’s Report and Certificate

Unique Feature of Cost Audit:

Management Audit

Objectives of Management Audit

Scope of Management Audit

Advantages of Management Audit

Disadvantages of Management Audit

Qualities of a Management Auditor:

Functions of a Management Auditor:

Comments

Post a Comment

Popular posts from this blog

Auditing MCQs

Marketing of Banking Services M.Com. BI 08 MCQs