Auditing · 2018-10-17 · making decisions about the company. Keeping in view, the significance of various accounting information and Financial Statements the reliability and authenticity

Auditing – I(As Per the New Syllabus 2018-19 of Mumbai University for T.Y.BBI, V Semester)

Winner of “Best Commerce Author – 2013-14” by Maharashtra Commerce Association“State Level Mahatma Jyotiba Phule Excellent Teacher Award 2015-16”

Lion Dr. Nishikant JhaICWA, PGDM (MBA), M.Com., Ph.D., D.Litt. [USA],

CIMA Advocate [CIMA UK], BEC [Cambridge University],International Executive MBA [UBI Brussels, Belgium, Europe],

Recognised UG & PG Professor by University of Mumbai.Recognised M.Phil. & Ph.D. Guide by University of Mumbai.

Assistant Professor in Accounts & HOD, BAF, Thakur College of Science & Commerce.Visiting Faculty in JBIMS for MBA & K.P.B. Hinduja College for M.Phil. & M.Com.,CFA & CPF (USA), CIMA (UK), Indian & International MBA, CA & CS Professional

Course.

CA Baijul Anand MehtaSET. A.C.A., M.B.A., D.T.M., M.Com.

Assistant Professor in AccountsThakur College of Science & Commerce.

CA. Swati GuptaA.C.A., M.Com., D.F.M., UGC Net,

Assistant Professor in Accounts at ThakurCollege of Science & Commerce.

Ashok

ISO 9001:2008 CERTIFIED

© Authors

No part of this publication may be reproduced, stored in a retrieval system, ortransmitted in any form or by any means, electronic, mechanical, photocopying,recording and/or otherwise without the prior written permission of the authors andthe publisher.

First Edition : 2018

Published by : Mrs. Meena Pandey for Himalaya Publishing House Pvt. Ltd.,“Ramdoot”, Dr. Bhalerao Marg, Girgaon, Mumbai - 400 004.

Phone: 022-23860170, 23863863; Fax: 022-23877178E-mail: [email protected]; Website: www.himpub.com

Branch Offices :New Delhi : “Pooja Apartments”, 4-B, Murari Lal Street, Ansari Road,

Darya Ganj, New Delhi - 110 002.Phone: 011-23270392, 23278631; Fax: 011-23256286

Nagpur : Kundanlal Chandak Industrial Estate, Ghat Road,Nagpur - 440 018.Phone: 0712-2738731, 3296733; Telefax: 0712-2721216

Bengaluru : Plot No. 91-33, 2nd Main Road Seshadripuram,Behind Nataraja Theatre, Bengaluru - 560 020.Phone: 080-41138821; Mobile: 09379847017, 09379847005

Hyderabad : No. 3-4-184, Lingampally, Besides Raghavendra SwamyMatham, Kachiguda, Hyderabad - 500 027.Phone: 040-27560041, 27550139

Chennai : New No. 48/2, Old No. 28/2, Ground Floor, Sarangapani Street,T. Nagar, Chennai - 600 012. Mobile: 09380460419

Pune : First Floor, “Laksha” Apartment, No. 527, Mehunpura,Shaniwar Peth (Near Prabhat Theatre), Pune - 411 030.Phone: 020-24496323, 24496333; Mobile: 09370579333

Lucknow : House No. 731, Shekhupura Colony, Near B.D. Convent School,Aliganj, Lucknow - 226 022.Phone: 0522-4012353; Mobile: 09307501549

Ahmedabad : 114, “SHAIL”, 1st Floor, Opp. Madhu Sudan House, C.G. Road,Navrang Pura, Ahmedabad - 380 009.Phone: 079-26560126; Mobile: 09377088847

Ernakulam : 39/176 (New No. 60/251), 1st Floor, Karikkamuri Road,Ernakulam, Kochi - 682011.Phone: 0484-2378012, 2378016; Mobile: 09387122121

Bhubaneswar : Plot No. 214/1342, Budheswari Colony,Behind Durga Mandap, Bhubaneswar - 751 006.Phone: 0674-2575129; Mobile: 09338746007

Kolkata : 108/4, Beliaghata Main Road, Near ID Hospital, Opp. SBIBank, Kolkata - 700 010. Phone: 033-32449649;Mobile:07439040301

DTP by : RajaniPrinted at : Rose Fine Art, Mumbai. On behalf of HPH.

PREFACE

It is a matter of great pleasure to present this new edition of thebook on “Auditing I” to the students and teachers of Bachelor ofCommerce (Accounting & Finance) started by University of Mumbai.This book is written on lines of syllabus instituted by the University.The book presents the subject matter in a simple and convincinglanguage.

The syllabus contains a list of the topics covered in each chapterwhich will avoid the controversies regarding the exact scope of thesyllabus. The text follows the term-wise, chapter-topic pattern asprescribed in the syllabus. We have preferred to give the text of thesection and rules as it is and thereafter, added the comments with theintention of explaining the subject to the students in a simplifiedlanguage.

While making an attempt to explain in a simplified language,mistake of interpretation might have crept in. This book is an uniquepresentation of subject matter in an orderly manner.

We welcome constructive suggestions to improve. This is astudent-friendly book and tutor at home. We hope the teaching facultyand the student community will find this book of great use.

I am extremely grateful to Shri K.N. Pandey of HimalayaPublishing House Pvt. Ltd. for their devoted and untiring personalattention accorded by them to this publication.

I gratefully acknowledge and express my sincere thanks to thefollowing people without whose inspiration, support, constructivesuggestions this book would not have been possible

Mr. Jitendra Singh Thakur (Trustee, Thakur College) Dr. Chaitaly Chakraborty (Principal, Thakur College) Mrs. Janki Nishikhant Jha

Authors

SYLLABUS

Revised Syllabus of Courses of B.Com. (Banking and Insurance) Programme atSemester V with effect from the Academic Year 2018-2019

Elective Courses (EC)Auditing-I

Modules at a GlanceSr. No. Modules No. of Lectures

1. Introduction to Auditing 152. Audit Planning, Procedures and Documentation 153. Auditing Techniques and Internal Audit Introduction 154. Auditing Techniques: Vouching 085. Auditing Techniques: Verification 07

Total 60

Sr.No.

Modules Units

1 Introduction to Auditing Basics

Financial Statements, Users of Information, Definition of Auditing,Objectives of Auditing – Primary and Secondary, Expression of Opinion,Detection of Frauds and Errors, Inherent limitations of Audit. Differencebetween Accounting and Auditing, Investigation and Auditing.

Errors and FraudsDefinitions, Reasons and Circumstances, Types of Error – Commission,Omission, Compensating error. Types of frauds, Risk of Fraud and Errorin Audit, Auditors Duties and Responsibilities in Case of Fraud

Principles of AuditIntegrity, Objectivity, Independence, Skills, Competence, Work Performedby Others, Documentation, Planning, Audi Evidence, Accounting Systemand Internal Control, Audit Conclusions and Reporting

Types of AuditMeaning, Advantages and Disadvantages of Balance sheet Audit, InterimAudit, Continuous Audit, Concurrent Audit and Annual Audit.

2 Audit Planning, Procedures and Documentation

Audit PlanningMeaning, Objectives, Factors to be Considered, Sources of ObtainingInformation, Discussion with Client, Overall Audit Approach.

Audit ProgrammeMeaning, Factors, Advantages and Disadvantages, OvercomingDisadvantages, Methods of Work , Instruction before Commencing Work,Overall Audit Approach

Audit working PapersMeaning, Importance, Factors Determining Form and Contents, MainFunctions/Importance, Features, Contents of Permanent Audit File,Temporary Audit File, Ownership, Custody, Access of Other Parties toAudit Working Papers, Auditors Lien on Working Papers, Auditors Lienon Client's Books

Audit NotebookMeaning, Structure, Contents, General Information, Current Information,Importance.

3 Auditing Techniques and Internal Audit Introduction

Test CheckTest Checking Vs Routing Checking, Test Check meaning, Features,Factors to be Considered, When Test Checks Can be Used, Advantages,Disadvantages and Precautions.

Audit SamplingAudit Sampling, Meaning, Purpose, Factors in Determining Sample Size -Sampling Risk, Tolerable Error and Expected Error, Methods of SelectingSample Items, Evaluation of Sample Results, Auditors Liability inConducting Audit Based on Sample.

Internal ControlMeaning and Purpose, Review of Internal Control, Advantages, AuditorsDuties, Review of Internal Control, Inherent Limitations of InternalControl, Internal Control Samples for Sales and Debtors, Purchases andCreditors, Wages and Salaries. Internal Checks Vs Internal Control,Internal Checks Vs Test Checks.

Internal AuditMeaning, Basic Principles of Establishing Internal Audit, Objectives,Evaluation of Internal Audit by Statutory Auditor, Usefulness of InternalAudit, Internal Audit Vs External Audit, Internal Checks Vs InternalAudit.

4 Auditing Techniques: Vouching

Audit of IncomeCash Sales, Sales on Approval, Consignment Sales, Sales ReturnsRecovery of Bad Debts written off, Rental Receipts, Interest andDividends Received, Royalties Received.

Audit of ExpenditurePurchases, Purchase Returns, Salaries and Wages, Rent, InsurancePremium, Telephone Expenses, Postage and Courier, Petty CashExpenses, Travelling Commission, Advertisement, Interest Expenses.

5 Auditing Techniques: Verification Audit of Assets Book Debts / Debtors, Stocks

Auditors General Duties; Patterns, Dies and Loose Tools, Spare Parts,Empties and Containers, Quoted Investments and Unquoted Investment,Trade Marks/Copyrights, Patents, Know-how, Plant and Machinery, Landand Buildings, Furniture and Fixtures.

Audit of LiabilitiesOutstanding Expenses, Bills Payable, Secured loans, Unsecured Loans,Contingent Liabilities

PAPER PATTERNMaximum Marks: 75Questions to be set: 05Duration: 2 1/2 Hrs.

All Questions are Compulsory Carrying 15 Marks each.

Q. No. Particulars Marks

Q.1 Objective Questions*

(A) Sub Questions to be asked 10 and to be answered any 08

(B) Sub Questions to be asked 10 and to be answered any 07

(*Multiple choice / True or False / Match the columns/Fill in the

blanks)

15

Q.2

Q.2

Full Length Practical Question

OR


15

15

Q.3

Q.3


OR


15

15

Q.4

Q.4


OR


15

15

Q.5

Q.5

(A) Theory Questions

(B) Theory Questions

OR

Short Notes

To be asked 05

To be answered 03

8

7

15

Note: Practical question of 15 marks may be divided into two sub questions of 7/8 and 10/5Marks. If thetopic demands, instead of practical questions, appropriate theory question may be asked.

CONTENTS

1. Introduction to Auditing 1 – 26

2. Audit Planning, Procedures and Documentation 27 – 45

3. Auditing Techniques 46 – 64

4. Internal Audit 65 – 72

5. Vouching 73 – 91

6. Verification 92 – 118

University Question Paper 119 – 121

Chapter 1

Introduction to Auditing

1.1 BASIC1. Financial Statement:

It is said that Auditing begins where Accountancy ends. As astudent of Finance, you know that every economic unit, with orwithout profit motive, maintains Books of Accounts to record thefinancial transactions and prepare financial statements. TheInternational Accounting Standards committee has defined the term“Financial Statements” to cover Balance Sheets, Profit and LossAccounts or income statements, statements of changes in financialposition, notes and other statements and explanatory material whichare identified as part of the financial statement. Financial Statementsreflect the financial position and performance of any organization.Generally, users of accounting information through FinancialStatement fall into two categories:

(a) Internal managers who use the information for day to dayoperating decisions.

(b) External parties, such as investors, banks, suppliers, andGovernment authorities, etc., who use the information formaking decisions about the company.

Keeping in view, the significance of various accountinginformation and Financial Statements the reliability and authenticityof the Accounts must be ensured. Auditing plays an important role inensuring the authenticity of accounting data. A person who conductsaudit is called auditor. The Auditor expresses his opinion abouttruthfulness and fairness of the Financial Statements through an auditreport

2. EvolutionThe word “audit” has been derived from the Latin word

“audire” meaning “to hear”, “listen”or “give credence to”. In ancient

1

2 Introduction to Auditing

days an Auditor used to listen to the accounts read out by theaccountant in order to check them.

Auditing was used in all countries such as Mesopotamia, Egypt,Greece, Rome, U.K., and India. The Egyptians, the Greeks and theRomans used to get their public accounts audited. Audit of accountsof private house was rare. Even in India, Auditing was used from thetimes of Vedas, Ramayana and Mahabharata. Basically accountingand auditing had their origin in the need for the government tocontrol the income and expenditure of the state and the army.

The Industrial Revolution in the 18th century and also advent ofjoint stock companies increased the number and complexity ofbusiness transactions. In these companies management andownership was different. The director manages these companies butthe real owners were the shareholders. This gave stimulus to thedevelopment of auditing process.

Due to increase in the number of companies, Companies Actmade it compulsory to audit the book of accounts and give report tothe real owner, i.e., shareholders. In India, Companies Act, 1913,made it compulsory of audit of accounts. After independence theCompanies Act, 1956, enlarged the scope of auditors work and apower transferred to the Institute of Chartered Accountants of Indiathrough Chartered Accountants Act 1949. Presently only a practicingChartered Accountant can act as a company auditor.

3. DefinitionsDifferent experts and association have defined Auditing

varyingly. Let us discuss and understand some of the importantdefinitions:

The International Auditing Practices Committee defines Auditingas “The independent examination of financial information of any entity,whether profit - oriented or not and irrespective of its size, or legal form,when such an examination is conducted with a view to expressing anopinion thereon.”

Auditing and Assurance Standard (AAS-1) by ICAI:“Auditing is the independent examination of financial

information of any entity, whether profit-oriented or not, andirrespective of its size or legal form, when such an examination isconducted with a view to expression an opinion thereon”

Introduction to Auditing 3

According to Ronald Irish“Auditing in its modern concept, is a scientific and systematic

examination of books, vouchers and other financial and legal recordsin order to verify and report upon the facts regarding the financialcondition disclosed by the balance sheet and the net income revealedby the profit and loss account.”

4. Objective of Auditing“The main object of an audit is to ascertain that the Balance Sheetand Profit & Loss Account of an undertaking is showing true and fairview of its financial positions and earnings.” However, objectives ofaudit can be divided into two different parts:

(a) Primary objectives(b) Secondary objectives

(a) Primary objectives/Basic objectivesThe main or primary objective of Auditing is to find out the

reliability and validity of the financial statements so as to renderopinion on the truthfulness and fairness of the presentations in thosestatements. The auditor has to give an opinion on financialstatements whether they are true and fair view, i.e., whether

(a) Balance sheet shows true and fair view of the concern,(b) the profit and loss accounts give a true and fair view of the

profit or loss of the concern,(c) all the material facts has been disclosed,(d) the organization has followed all the compliance with regarding

to legal requirement and(e) Final accounts are made according to the recognized accounting

principles and auditing standards laid down by professionalbodies, like ICAI.

(b) Secondary objectives/Incidental objectivesThe secondary objective of audit is to detect and prevent the

errors and frauds. An error is generally taken to be innocent and notdeliberate. Where it appears to be willfully made, it assumes thecharacter of a fraud.

The term “fraud” refers to an intentional act by one or moreindividuals of management, employees or outsiders, severally or


jointly, involving the use of deception to obtain an unjust or illegaladvantage.

It is not an objective of an audit to give a guarantee that all iswell with the concern. A clean audit report does not imply that themanagement is efficient.

5. Inherent Limitation of Auditing1. Test check: Due to test check all the transactions are not

checked because of this many errors and frauds are notdetected.

2. An auditor has to depend on the expert: In manycircumstances, auditors has to depend on the experts likelawyers, valuers, engineers. Circumstances may be likeestimation of contingent liabilities, valuation of fixed assetsetc. …

3. No future assurance: Audit is basically concerned with thepast, it never predicts anything on the future or give anyassurances on efficiency of the management.

4. Postmortem of accounts: Auditing begins where accountingends. The job of an auditor starts where an accountantfinishes his task of preparation of accounts. Naturally, theauditor has to rely on different information and explanationsgiven to him by the Accountant. In the process many times,misstatement of facts remain undiscovered even after theaccounts have been audited.

5. Inherent limitations of internal control system: An auditorbefore expressing his opinion mostly relies on the internalcontrol system of the enterprise. Internal control is theoverall control environment established by the Managementof an enterprise for effective and efficient monitoring andcontrol of its operation. Internal control goes beyond theaccounting functions of the organization and incorporatesboth accounting and administrative controls.


1.2 ERRORS AND FRAUDErrors

Error of Principle Clerical Error

Error of Duplicity

Error of Commission

Error of Omission

Compensating Error

The accounting errors based on their nature can be of the followingtypes:

1. Clerical Errors2. Errors of Principle1. Clerical Errors: The errors which are committed by

accounting clerks are called clerical errors. These errors arecommitted in the process of recording financial transactions.These take place due to the carelessness of the clerkresponsible for recording financial transactions. Clericalerrors are also called technical errors. The principal types ofclerical errors are as follows:

(a) Errors Of Omission: The errors committed by notrecording a transaction either in the book of originalentry or in the ledger book are errors of omission. Suchan omission may be either complete or partial.Complete Omission: Complete omission takes place if atransaction is not recorded in the journal at all. Forexample, goods sold to Mr. A for ` 10,000 were notrecorded in the sales book at all. A complete omission oftransaction may occur due to many reasons such as salesinvoice misplaced or lost.


Partial Omission: Partial omission occurs if a financialtransaction is recorded only partially. For example,partial error of omission occurs if goods sold to Mr. Afor ` 4000 is recorded in sales book but failed to beposted in John's account.

(b) Errors of Commission: The errors which are committedwhile recording or posting a transaction are called errorsof commission. Errors of commission may take placeeither in the journal or in the subsidiary books or in theledger. Such errors include posting wrong amounts,posting on wrong side of accounts, wrong totaling orcarrying forward, and wrong balancing. For example, ifpurchase of goods for `10,000 is entered as `1000 in thejournal or in the ledger, such error is called errors ofcommission.

(c) Compensating Errors: Compensating errors refer to two ormore errors which mutually compensate the effects of oneanother. If one error balances the effect of another error,then the two errors are called compensating errors. Forexample, goods sold for ` 5000, but wrongly posted to thecustomer's account as ` 500. Similarly, goods purchasedfor ` 5000, but by chance, wrongly posted to the supplier'saccount as ` 500 . The errors in the personal account arecompensated by each other, as ` 4500 short on the debitside of the customer's account and on the credit side of thesupplier's account.

(d) Errors of Duplication: Errors of duplication are thoseerrors which arise because of double recording. Doubleposting of a transaction from journal or subsidiary booksto ledger also create such errors. For example, goodssold to Mr. A, but this transaction is wrongly enteredtwice or more in the sales book or wrongly posted twiceor more in John's account then it is called the errors ofduplication.

2. Errors of Principle: Errors of principle are those errorswhich occur by violating the principles of accounting. Errorsof principle may occur due to wrong allocation betweencapital and revenue expenditure, or wrong valuation ofassets. For example, debiting the wage account instead ofmachinery account for the wage paid to the mechanics used


for the installation of machine and debiting the customer'saccount instead of cash account for the cash sales made.Errors of principle may also occur due to wrong valuation ofassets by higher level staff.

2. Procedures to Detect Errors:The Auditor should follow the following procedures to detect

errors:1. First start with the checking of the opening balance with the

last year audited balance sheet.2. After checking of opening balance start verifying the journal

entry and then checking of posting into respective ledgeraccounts.

3. Then verify the subsidiary books.4. Verify all the casting and carry forwards.5. After that verify trial balance.6. Compare the current year trial balance with the last year’s

trial balance.7. Calculate the totals of both the side of trial balance, if

difference is found then divide the difference amount with2, the figure which you arrive at start to find the amountin the ledger. Take for example difference in the trialbalance is ` 20,000 than divide the amount with 2, so theamount you arrived at is `10,000 start finding`10,000 inthe ledger.

3. Frauds:Fraud means intentional misrepresentation of financial

information by management, employee or third parties.Frauds may be of following types:

1. Fraud through defalcation.(a) Misappropriation of cash(b) Misappropriation of goods

2. Fraud through accounts(a) Not recording a transaction(b) Recording a dummy transaction


1. Frauds through defalcation: Following are the method ofdefalcation involving misappropriation of cash or goods

A. Misappropriation of cash(a) Misappropriation of cash receipt by not recording the

same,(b) By suppressing the cash by either not recording the cash

or showing them as credit sales,(c) Showing payment twice in the cash book(d) By teeming and lading procedure that is cash received

from one debtor is appropriated and deficiency in thataccounts of debtors is made good, when cash is receivedfrom second debtor and the deficiency in the seconddebtor is made good when cash is received from thirddebtor and so on…

B. Misappropriation of goods:(a) Goods may be misappropriated by showing dummy sales,(b) Goods are actually received in the organization but are

shown as not received and goods are misappropriated.2. Fraud through accounts

(a) Not recording a transaction: These types of errors areintentional like sales take place but not shown in thebooks of accounts.

(b) Recording Dummy transaction: Examples of these typesof errors are showing wages or salary in the dummyworkers accounts.

4. Circumstances indicating Errors and FraudThe circumstances indicates that there may exist errors or fraud:

(a) Management is in the hand of single person,(b) Internal control in the organization is either weak or does

not exist at all,(c) Turnover of the accounting staff is very high,(d) Professionals in the organization like lawyers or auditors

are changed very frequently,(e) Depending on the few products or few customers,(f) Working capital in the organization is inadequate,


(g) In the need of issue of shares, financial picture is to beshown in better position,

(h) Investment in the product line which is subject to rapidobsolences,

(i) There are many transaction with associates, relatedparties etc.,

(j) Organization is making excessive payment for services,(k) Vouchers which are available for audit is not duly

authorized or supporting document for the same isnot available.

5. Auditors’ Responsibility for Errors and FraudICAI has spelt out the responsibility of an audit for errors and

fraud in ASS 4.1. Basic Responsibility of Management: It is basically the

responsibility of the management to detect and prevent fraudin the books of accounts. It is for the management to preventand detect fraud and errors in the system.

2. Incidental Objective: Basic objective of the audit is to statewhether accounts are true and fair, but with the basicobjective of auditor’s incidental objective is to state that theaccounts are free from fraud and errors. While doing theaudit the auditor should not only audit but also keep in mindthat the books are true and fair, and free from major errorsand fraud.Basic idea behind is that auditor has taken a reasonable carefor detecting errors and fraud. Though he is not responsiblefor errors and fraud but he should not fail in his duty to findout errors and fraud.If during the audit auditor does see that there exists errorsand fraud in the books then he should take a reasonable stepto rectify it. If there is error, auditor should rectify it andconfirm it. If there is fraud, then he should state it in theaudit report.

1.3 PRINCIPLES OF AUDITThe concept of separation of management from ownership

fuelled the growth of this profession. The owners who could not


participate in the day to day management of the enterprise wanted anassurance that the financial information prepared by the managementis reliable. An audit provides such an assurance and enhances thecredibility of the information. The role of audit can be depicted asfollows.

1. Integrity, Objectivity and Independence: Integrity impliesan attitude of straightforwardness, honesty, sincerity,uprightness and reliability.

2. Confidentiality: Auditor should not disclose the informationacquired in the course of audit to any one, unless it is a legalor professional duty to do so and consented by the client.

3. Skills and Competence: Audit should be conducted bypersons who possess due professional skill and care. who are adequately trained. with experience and competence.

4. Planning: Planning helps an auditor to conduct an audit inan effective, efficient and timely manner. Planning includes:Acquiring knowledge about the client's business, gaining anunderstanding of the accounting system and revision of planas and when required.

5. Work Performed By Others: An auditor cannot do all thework by himself. The work is done either through hisassistants or other professionals, but he continues to beresponsible for forming and expressing an opinion on thefinancial statements. While delegating the work to others, hewill be entitled to rely on the work performed by them,provided he exercises adequate skill and care and is notaware of any reason to believe that he should not have sorelied.

6. Audit Evidences: An auditor should obtain sufficient(quantum) appropriate (relevance and reliable) auditevidence through the performance of compliance andsubstantive procedures.

7. Documentation: An auditor should document matters,which are important in providing evidence that the audit wasconducted in accordance with the basic principles governingan audit. The auditor should maintain the documents for a


reasonable period of time to meet the demands of hispractice

8. Audit Conclusions and Reporting: Auditor drawsconclusions on the basis of review and assessment of theaudit evidence obtained; and his knowledge of the business,to form his opinion on the financial statements.

9. Assessing the Accounting System and Internal Control:An auditor should assess the accounting system to ensurethat the system is adequate to record all the accountinginformation.

1.4 Types of Audit

1. Balance Sheet Audit:A balance sheet audit is an audit of the accounts on the balance

sheet. These audits usually focus heavily on the cash, accountspayable, accounts receivable and inventory. Land, buildings,intangible assets and long-term investments are very difficult tomisrepresent. Accounts payable and receivables, however, can beeasily misstated in either direction. Inventory can easily be misstatedeither by mistake or on purpose. Fortunately, inventory figures areeasily verified with a little legwork.

Procedure to conduct Balance Sheet Audit:

1. First step to conduct the balance sheet audit is to evaluate theinternal control of the organization. It must be evaluated inthe following manner:

(a) Whether internal control is effective.(b) Whether the internal controls are in proper operation.

2. Auditor should carry out verification of assets and liabilitieson sample basis.

3. After verifying assets and liabilities auditor should inspectdocuments with regards to assets and liabilities.

4. Auditors should vouch such transactions which are importantaccording to the auditor.

5. Auditors should himself satisfy about the valuation of assetsand liabilities.

6. Proper presentation of assets and liabilities are made in thefinal accounts.


7. Auditors should physically verified assets and investment; healso has to examine addition or deduction in the fixed assetsand investments.

8. Auditors should verify debtors and creditors balances byobtaining confirmation and statements of accounts,regarding debtors auditor has to verify how the provision hasbeen made for doubtful debts, credit limit, etc.,

9. Auditor should physically verify the cash balance and stock.10. A contingent liability has to be checked with the help of

proper document.11. After verifying items in the balance sheet start to compare it

with the previous year or start comparing it with the ratioslike current ratio, debtors’ ratio, debt equity ratio, etc.

2. Interim auditAn interim audit is conducted in-between two annual audits.

The objective is to ascertain and declare interim figures, for somespecific purpose like declaration of interim dividend. Interim audithelps in early completion of annual audit. However, it is expensive,because it involves additional work on the part of company’s staff aswell as auditor.

Interim audit being conducted:1. Quarterly results: Public limited companies listed on the

stock exchange having declared their quarterly results.Before publishing the results, interim audit is beingconducted.

2. Interim dividend: Companies which declares interimdividend has to conduct interim audit.

3. Sale or acquisition of business: In case sole proprietor whoproposed to sold the business has to conduct interim auditfor the purchase consideration

4. Changes in the firm: In case of partnership firm, audit isnecessary in the case of retirement of the partner oradmission of partner, sale of firm, etc.


Procedure:An interim audit is conducted as part of an audit that is carried

out while the accounting period of the full audit is still in process.Financial statements of this nature are in a time frame of less than ayear. An interim account may occur quarterly, so it does not producefinal results as the fiscal year end would but gives an idea as to howthings are going and where they are heading.

Advantages of Interim Audit1. Interim audit is good where the publication of the interim

figure is necessary.2. The final audit can be completed very soon, if there has been

an interim audit.3. Errors and frauds can be detected more quickly during the

final audit.4. There is moral check on the staff of the client as the accounts

are checked, say after three or six months in the interimaudit.

Disadvantages of Interim Audit1. Figures may be altered in the accounts which have already

been audited. It will mean that the audit staff will have toprepare notes when they finish the interim audit.

2. Interim audit is an additional work because final audit mustbe conducted after conducting this audit too.

3. Auditors does two audit during the year so audit becomesexpensive.

3. Continuous AuditContinuous auditing is the independent application of

automated tools to provide assurance on financial, compliance,strategic and operational data within a company. Continuous auditinguses a set of tools to assure the internal control system is functioningto prevent fraud, errors and waste. The “continuous” aspect ofcontinuous auditing and reporting refers to the near realtime capability for financial information to be checked and shared.Not only does it indicate that the integrity of information can beevaluated at any given point of time, it also means that theinformation is verified constantly for errors, fraud and inefficiencies.


Each instance of continuous auditing has its own pulse. Theinternal management chooses for evaluation depends on thefrequency of updates within the accounting information systems.Analysis of the data may be performed hourly, daily, weekly,monthly, etc., depending on the application.

Business where continuous audit is applicable where no satisfactory system of internal check is in operation. where the volume of the transactions is very large. where it is desired to present the account just after the close

of the financial year, as in the case of a bank. where the statements of accounts is required to be presented

to the management after every month or quarter.Advantages:1. Easy to quick discovery of errors: Errors and frauds can be

discovered easily and quickly as the auditor checks theaccounts at regular intervals and in detail. As a auditor visitsthe client after a month or two or so on, the number oftransactions will be small and hence, the errors will bedetected easily and quickly.

2. Knowledge of technical details: Since the auditor remainsmore in touch with the business, s/he is in a position to knowits technical details and hence can be of great help to her/hisclients by making valuable suggestions.Quick presentation of accounts: As most of the checkingworks are already performed during the year, the finalaudited accounts can be presented to the shareholders soonafter the close of the financial year at annual general meeting.

3. Keeps the client's staff alert: As the auditor visits theclients at regular intervals, the clerks are very regular inkeeping the accounts up to date. They will see that there isno inaccuracy or frauds as it would be detected by theauditor at the next visit.

4. Moral check on the client's staff: If the auditor payssurprise visit, it will have a considerable moral check on theclerks preparing the accounts as they do not know when theauditor may pay a visit to check. Moral check will be morevaluable to make staff alert and careful.


Disadvantages of Continuous AuditIn spite of the above mentioned advantages of a continuous

audit, there are certain drawbacks of such audit and which are asfollows:

1. Alteration of figuresFigures in the books of account which have already beenchecked by the auditor at previous visit, may be altered by adishonest clerk and the frauds may be committed.

2. Disturbance of client's workThe frequent visits by the auditor may disturb the work ofthe client and cause inconvenience to the latter.

3. ExpensiveContinuous audit is an expensive system of audit because anauditor devotes more time. So, company needs to pay moreamount as remunerations to an auditor.

4. Queries may remain outstandingThe audit clerk may lose the thread of work and the querieswhich s/he wanted to make may remain outstanding as theremight be a long interval between two visits.

5. Extensive note takingExtensive note taking may be necessary in order to avoid anyalterations in the figures after the audit.

4. Concurrent AuditConcurrent audit is a systematic and timely examination of

financial transaction on a regular basis to ensure accuracy,authenticity, compliance with procedures and guidelines. Theemphasis under concurrent audit is not on test checking but onsubstantial checking of transactions. The concept of concurrent audithas been introduced to reduce the time gap between occurrences oftransaction and its overview or checking. The concurrent audit servesthe purpose of effective control as it is normally conducted byexternal agencies like chartered accountant’s firms.

The main objectives of concurrent audit include that anyviolation of procedure is brought to light. Ascertaining whethersanction for advances and expenditures is taken from competentauthority. Examining books of accounts records and registers to


ensure that they are maintained in accordance with the prescribedsystems. Ensuring compliance of laid down systems, procedures andpolicies.

5. Annual AuditAnnual audit is done at the end of the financial year when

finalization of accounts has been completed and books of accountsclosed. After completion of accounts, the management of enterprisecalls auditor to commence the audit. Generally annual audit iscompleted in one interrupted session.

Advantages1. There is no loss of links in the audit work as entire audit is

completed in a single session.2. The audit work does not disturb the day to day accounting

works of client because annual audit starts only after closingof accounts.

3. Annual audit is economical and suitable to smallorganizations.

4. As in the case of continuous audit, there is little slope ofcollusion between auditor’s and client’s staff members.

Disadvantages1. Due to shortage of time, an in-depth checking of accounts is

not possible.2. This audit is not suitable for large organizations where

transactions are more and complicated

1.5 MISCELLANEOUS

Quality of AuditorsTo be successful, an auditor should possess certain desirable

qualities, besides having his formal qualification. His qualificationrequires that he should be a qualified chartered accountant. Besides,he should possess the following qualities:

1. Tactfulness2. Cautious approach3. Firmness.


4. Good temperament5. Integrity etc.He should be tactful in doing the job of auditing. While auditing,

he should be cautious. He should have integrity and independence.He should posses the knowledge of common business laws.

Like Mercantile Law Partnership Act, Sale of Goods Act, etc.Heshould possess a through knowledge of taxation provisions prevalentin the country.

An auditor is required to critically comment upon the financialstatements. He should possess requisite expertise in that field. Heshould occupy the position of an expert in that field. He should havethorough knowledge of all accounting principles and procedures. Heshould also know the ways and means in which the business is beingconducted.

By possessing these qualities, he can become a successful andeffective auditor.DIFFERENCE BETWEEN ACCOUNTING AND AUDITING

ORDIFFERENCE BETWEEN ACCOUNTANT AND AUDITOR

Factor Accounts Auditing

1. Meaning Accounting means themaintaining of the books ofaccounts.

Auditing means examin-ing the books of acc-ounts and reportingmeans to report abouttheir accuracy.

2. Performanceof Work

Accountant job is performed bythe accountant

Auditing job is per-formed by the auditor.

3. Appointment Accountant is appointed by themanagement.

Auditor is appointed bythe share-holders, man-agement and evengovernment depends onaudit.

4. Qualification For the accountant no specificqualification is required.

For the auditor specificqualification is required.

5. Submission ofReport

Accountant is not required tosubmit any report.

Auditor is required bylaw to submit the report.


6. Fixation ofRights

Rights and duties of accountantare fixed by the management.

Rights and duties of anauditor are fixed by thelaw.

7. Purpose Accounting purpose is to showthe financial position of thebusiness.

Auditing verifies the truepicture of the financialstatement.

8. Record / Data Accounting is related with thepresent record.

Auditing is related withthe past record.

DIFFERENCE BETWEEN AUDITING AND INVESTIGATION

Purpose Auditing Investigation

1. Purpose An audit is carriedout for the purposeof ascertainingwhether or not thebalance sheet andprofit and lossaccount show trueand fair view of thestate of company'saffairs and its profitor loss

But an investigation aimsat establishing a fact or iscarried out for someparticular purpose, i.e., toknow the financialposition of the concern orthe earning capacity of theconcern, etc.

2. On Behalf An audit is carriedout on behalf of theproprietor of thebusiness

While an investigationmay be conducted onbehalf proprietors whenthey suspect any fraud intheir business or on behalfof outside parties whowish to lend money orintend to purchase busin-ess or at the instance ofthe government on therequest of the share-holders.

3. Scope An audit includesonly an exami-nation of theaccounts of abusiness

An investigation coversnot only an examinationof the accounts but alsoan inquiry into otherrelevant matters conn-ected with the purpose forwhich it is undertaken


4. Use of Techniques An audit is usuallya test checking

An investigation is amuch more thoroughexamination of the booksof accounts. It goes intothe depth of the problemand keeps on looking forfar more definite evi-dence to arrive at aconclusion so that it canfirmly substantiate.Further, investigationmay be conducted evenafter the audit of theaccounts.

5. Period An audit is relatedto only a year or sixmonths

Investigation may coverseveral years.

6.Statutory Obligation In the case of jointstock companies,audit is compulsoryunder law

There is no such statutoryobligation with regard toinvestigation.

7. Examination Use ofPolicies

In audit, an auditorhas to see whetherthe methods ofvaluation and otheraccounting policieshave been consis-tently followed ornot and he has toensure that all dis-closures have beenproperly made inthe financial state-ments

An investigation is not atall bound by accountingconventions, policies anddisclosure requirements.


Exercise:

1. Multiple choice questions.a. Audit has been derived from the latin word______________

(i) Audire(ii) Audie

(iii) Audi(iv) Aude

b. Today who can act as an auditor of the company?(i) Chartered accountant

(ii) Accountant(iii) Practicing chartered accountant(iv) 12th pass accountant.

c. Objective of an audit of financial statement is to enable theauditor to express an opinion whether financial statement areprepared in accordance with the(i) Provision of income tax.

(ii) With an identified financial reporting framework.(iii) System of double entry bookkeeping.(iv) With accounting policies laid down by the management.

d. In India, Companies Act _______ made it compulsory of auditof accounts.(i) 1956

(ii) 1972(iii) 1965(iv) 1913

e. During the audit the opening balance will be verified with(i) Current year balance sheet

(ii) Current year trial balance(iii) Last year balance sheet.(iv) Last year ledger.

f. Fraud through account can take place through(i) Not recording a transaction.

(ii) Recording a dummy transaction.


(iii) None of the above(iv) All of the above.

g. The risk of fraud increase when:(i) The auditor remain the same

(ii) Management is in the hand of single person.(iii) Cash balance is very high.(iv) Bank balances remain low.

h. Auditor can obtain the sufficient appropriate audit evidencethrough the performance of:(i) Vouching

(ii) Compliance and substantive procedures.(iii) Reading of ledger(iv) None of the above.

i. How many principles are there in AAS - 1 Principle of Audit.(i) 10

(ii) 9(iii) 8(iv) 5

j. Fraud through defalcation is:(i) Employee fraud,

(ii) Management fraud(iii) Both of the above(iv) None of the above

k. Auditing standards and auditing guidelines are issued the_____________ board.(i) Government

(ii) ICAI(iii) ICWA(iv) CSI

l. The errors which are committed by accounting clerks are calledclerical error(i) Errors of principal

(ii) Both of the above(iii) None of the above


m. Audit of Bank is which type of audit?(i) Continuous audit

(ii) Balance sheet audit(iii) Statutory audit(iv) Internal audit

n. Final audit means(i) Audit done at the beginning of the financial year.

(ii) Audit done at the end of the financial year(iii) Audit between two accounting year.(iv) Audit by the management.

o. Internal audit means:(i) Audit done at the beginning of the financial year.

(ii) Audit done at the end of the financial year(iii) Audit between two accounting year.(iv) Audit by the management

p. Interim audit means:(i) Audit done at the beginning of the financial year.

(ii) Audit done at the end of the financial year(iii) Audit between two accounting year.(iv) Audit by the management

q. Final audit is unsuitable for _____________ type oforganization(i) Small organization

(ii) Large organization(iii) Mid size firm(iv) None of the above.

r. Interim audit being conducted for the following reasons:(i) Quarterly results

(ii) Interim dividend(iii) Change in the firm(iv) All of the above.

s. Balance audit only include the following things:(i) Verification of assets and liabilities

(ii) Vouching of income and expenditure


(iii) Verification of expenses(iv) All of the above.

2. State whether true or false.a. Audit has been derived from the latin word audire.b. Primary objective of audit is to detect and prevent the errors

and fraudsc. The term “fraud” refers to an intentional act by one or more

individuals of management, employees or outsiders, severallyor jointly, involving the use of deception to obtain an unjust orillegal advantage.

d. In India, Companies Act 1956 made it compulsory of audit ofaccounts.

e. During the audit the opening balance will be verified with thehelp of last year’s balance sheet.

f. There are 10 principle listed in ASS1- Principles of Audit.g. The auditor should dispose of the documents to meet the

demands of his practiceh. Planning helps an auditor to conduct an audit in an effective,

efficient and timely manner.i. Auditor should disclose the information acquired in the course

of audit to anyone.j. Auditor should not possess the knowledge of common business

laws. Like Mercantile Law, Partnership Act, Sale of Goods Act,etc.

k. Auditor should act like a bloodhound and not a watchdog.l. Auditing begins where the accounting starts.

m. Audit should be systematically planned.n. Audited accounts are free from errors and fraud.o. Auditor can take the help of valuer, branch auditor, lawyer etc.p. The auditor has to give an opinion on financial statements

whether they are true and fair view.q. The errors which are committed by accounting clerks are called

error of principal.r. Bank audit is the internal audit.s. Annual audit is done at the beginning of the financial year.


t. Final audit is unsuitable for large type of organizationu. An interim audit is conducted in-between two annual audits.v. Final audit cannot be completed very soon, if there has been an

interim audit.w. A balance sheet audit is an audit of the accounts on the balance

sheetx. Internal auditors are appointed by the management.y Interim audit is not compulsory under the Companies Act.

3. Match the columnsColumn A Column B

1 Basic Principles listed inASS-1

a Intentional error

2 Fraud b Systematic recording oftransaction.

3 Manipulation of accounts c 9

4 Bookkeeping d Management fraud

4. Match the columns1 Tax Audit a Internal Audit

2 Audit by own staff b Compulsory Audit

3 Cost Audit c Done at the end of theyear

4 Statutory Audit d 44AB

5 Final Audit e S 233 B

6. Audit at regular interval f Voluntary Audit

7 Audit of proprietor g Continuous Audit

5. Check your answers1. (a) – (i), (b) – (iii), (c) – (ii), (d) – (iv), (e) – (iii), (f) – (iv),

(g) – (ii), (h) – (ii) , (I) – (ii), (j) – (i), (k) – (ii), (l) – (i),(m)–(iii), (n) – (ii), (o) – (iv), (p) –(iii), (q) – (iv), (r) – (iv),(s) – (i),

2. (a) –(T), (b) –(T), (c) – (T),(d)– (F), (e) – (T), (f) – (F),(g) – (F), (h) – (T). (i) – (F), (j) – (F), (k) – (F), (i) – (F),


(m) – ( T), (n) – (F), (o) – (T), (p) – (T), (q) – (F), (r) – (F),(s) – (F), (t) – (T), (u) – (T), (v) – (F) , (w) – (T ), (x) – (T) ,(y) – (T) , (z).

3. 1- (c), 2- (a), 3- (d), 4 - (b)4. 1 – (d), 2 – (a), 3 – (e), 4 – (b), 5 – (c), 6 – (g), 7 – (F)

6. Theory question:1. Define audit and explain its objective in brief.2. Explain and define the term audit.3. Explain the term error and fraud4. Explain various types of error found in the books of accounts.5. Explain the term errors and procedure to detect error.6. What is fraud and types of fraud?7. Explain circumstances indicating errors and fraud.8. What is advantage of audit?9. Explain the term audit and its limitation.

10 Explain the principles of audit ( AAS- 1)11. Explain some quality of auditor.12. Explain any four principles of audit.13. Explain the term “worked performed by other” in context to

auditing principle.14. Explain fraud through accounts.15. Explain the term continuous audit.16. Cases where continuous audit is applied.17. Explain the advantages of continuous audit.18. Explain the disadvantages of continuous audit.19. What do you mean by interim audit?20. Why is the interim audit being conducted?21. Explain the procedure of interim audit alone with its advantages.22. What are the disadvantages of interim audit?23. Explain in brief Balance sheet audit.24. What are the procedures to conduct Balance sheet audit.25. What do you mean by concurrent audit?


26. Explain the term internal audit.27. Explain any 5 standards on internal audit.28. What are the advantages and disadvantages of internal audit?29. Write short note – Relationship between internal auditor and

external auditor.

■■■

Documents

Auditing · 2018-10-17 · making decisions about the company. Keeping in view, the significance of various accounting information and Financial Statements the reliability and authenticity