Concept of Auditing

The word 'audit' is derived from the Latin word 'audire' which means 'to hear'. In the olden days whenever the proprietors of a business concern suspected fraud, they appointed a person to check the accounts and to hear the explanations given by the persons responsible for keeping the accounts.

The audit during those days was interested in ascertaining whether the persons responsible for maintaining amounts had properly accounted for all receipts and payments to his principal and to locate frauds and errors. It was merely a cash audit.

However, the object of the modern audit is not confined to cash verification but to report .on financial position of the undertaking as disclosed by its Balance Sheet and the Profit and Loss Account. It is very difficult to give a precise definition of the term 'auditing'.

Some of the definitions given by different writers are as follows :

According to Montgomery, a celebrated author, "auditing is a systematic examination of the books and records of a business or the organisation in order to ascertain or verify and to report upon the facts regarding the financial operation and the result thereof.

Lawrence R. Dicksee – “An audit is an examination of accounting records undertaken with a view to establishing whether they correctly and completely reflect the transactions to which they purport to relate.”

Spicer & Pegler – “Audit such an examination of the books of accounts and vouchers of a business, as will enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair view of the state affairs of the business, and whether the profit and loss account gives a true and fair view of the profit or loss for the financial period according to the best of his information and explanations given to him and as shown by the books, and if not, in what respect he is not satisfied”.

Features of auditing-

• It is clear that auditing is the systematic and scientific examination of the books of a accounts and records of a business so as to enable the auditor(independent qualified person) to satisfy himself that the Balance Sheet and the Profit and Loss Account are properly drawn up so as to exhibit a true and fair view of the financial state of affairs of the business and profit or loss for the financial period.
• In order to report on the financial health of the business, the auditor will have to go through various books of accounts and related evidence (external and internal) to satisfy himself about their accuracy and authenticity.
• Audit is done with the help of vouchers, documents, information and explanations received from the authorities.
• 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-

• Primary objective-

As per Section 143 of the Companies Act 2013, the primary duty (objective) of the auditor is to report to the owners that the accounts, financial statements give a true and fair view of the state of the company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other matters as may be prescribed.

• Secondary objective-

It is also called the incidental objective as it is incidental to the satisfaction of the main objective. The incidental objectives of auditing are:

(i) Detection and prevention of Frauds, and

(ii) Detection and prevention of Errors

Detection and Prevention of Errors :

Errors are of various types which are discussed below:

 I . Clerical Errors : Such an error arises on account of wrong posting. For example, an amount received form R is credited to S.

Though there is wrong posting still the trial balance will agree.

Clerical errors are of three types as follows:

a) Errors of Commission : These errors are caused due to wrong posting either wholly or partially of the amount in the books of original entry or ledger accounts or wrong calculations, wrong totaling, wrong balancing, and wrong casting of subsidiary books. For example, Rs. 2000 is paid to a supplier and the same is recorded in the cash book. While posting to the ledger, the supplier's account is debited by Rs. 200. It may be due to carelessness of the clerk. Most of the errors of commission are reflected in the trial balance and these can be discovered by routine checking of the books.

b) Errors of Omission : Such errors arise when the transactions are not recorded in the books of original entry or posted to the ledger. For example, sales are not recorded in the sales book, or omission to enter invoices in the purchase book. For example, Rs. 5,000 is paid to a supplier. The entry in the cash book is made on the credit side but posting to the supplier side is omitted. Errors due to entire omission will not affect the trial balance whereas error due to partial omission will affect the trial balance and can be detected.

 c) Compensating Errors : When two or more errors are committed in such a way that the result of these errors on the debits and credits is nil, they are referred to as compensating errors. For example, A's account which was to be debited for Rs. 200 was credited for Rs 200 and similarly, B's account which was to be credited for Rs. 200 was debited for Rs. 200, These two mistakes will nullify the effect of each other. Both the sides of the trial balance are equally affected. As such, these errors are difficult to locate unless detailed investigation is undertaken.

Errors of Principle : Such errors are committed when some fundamental principle of  accounting is not properly observed in recording a transaction. For example, if I +ere is incorrect allocation of expenditure or receipt between capital and revenue or when closing stock is over-valued. Though trial balance will not disagree, the Profit and Loss Account may be very much affected. Sometimes, such errors are committed deliberately to falsify the accounts or unintentionally due to lack of knowledge of sound principles of accounting. Thus, a thorough examination is to 'be done to locate such errors.

Frauds-

Frauds can take place in the form of manipulation of accounts, misappropriation of cash and misappropriation of goods. It is of great importance for the auditor to detect any frauds, and prevent their recurrence. Errors refer to unintentional mistake in the financial information arising on account of ignorance of accounting principles i.e. principle errors, or error arising out of negligence of accounting staff i.e. Clerical errors.

The following are the three distinct types of fraud −

• Misappropriation of Cash
• Misappropriation of Goods
• Manipulation of Accounts

Basic principles governing an audit

SA 200 “Basic Principals Governing an Audit”, describes the basic principles which govern the auditor’s professional responsibilities and which should be complied with wherever an audit is carried. They are described below:

The auditor’s report should contain a clear written opinion on the financial information. A clean audit report indicates the auditor’s satisfaction in all respects and when a qualified, adverse or a disclaimer of opinion is to be given or reservation of opinion on any matter is to be made, the audit report should state the reasons thereof

PRINCIPAL ASPECTS TO BE COVERED IN

BENEFITS OF AUDIT

LIMITATIONS OF AUDIT

Modes of Audit

An auditor may conduct audit on continuous, periodical or interim basis. Let us discuss them in detail :

Continuous Audit-

A continuous audit is one, where the auditor's staff attends to the checking of the accounts work .at appropriate intervals, say, weekly, fortnightly or monthly during an accounting period. In this system, the audit proceeds as accounting progresses. Continuous audit is followed in big organisations where numerous transactions of varied nature are to be checked and where the audited accounts must be ready immediately after the close of the financial year.

Advantages –

1 facilitates detailed & exhaustive checking of the accounting records

2 Errors and frauds are quickly detected and

3 it exercises moral check on the staff of the

4 can give proper attention to all the relevant points necessary for efficient performance of his job

 5 presented to the shareholders soon after the close of the financial year without any wastage of time.

 6 It facilitates preparation of interim accounts when the question of declaration of ' interim dividend arises.

Disadvantages

1 Figures of the accounts already checked by the audit staff can be tampered with by the staff of the client.

2 Audit staff may not complete the work on each audit. As a result, they may forget to clear off the queries or to follow the work left on the last visit.

3 Continuous audit is not economical for small enterprises.

4 Accounting work of the client may be dislocated by frequent visits of the auditor and thus, lots of inconvenience ]nay be caused to the client.

Periodical or Final Audit

A periodical or final audit is one where the auditor takes up the audit work only at the close of the financial year when all the accounts are balanced and a trading and profit and loss account and the balance sheet are prepared. In the case of such an audit, the auditor visits his client only once a year and completes the entire audit work at one stretch. This form of audit is convenient and useful especially in the case of small business houses. "

Advantages

1 Auditor attends to the work at a particular time and completes the whole work at one stretch.

2 There is no danger of the client's staff being changing the figures

3 There is no dislocation in accounting work and inconvenience to the client's staff

4 Periodical audit is less expensive and as such it is specially suitable for small business houses.

5 There is no possibility of losing the thread of work of the auditor since the entire work is completed in one stretch.

Disadvantages

1 As the detailed checking is not possible there are greater chances of errors and frauds remaining undetected.

2 The presentation of audited accounts to the proprietors especially in case of Junior Stock Company is delayed and as such declaration of dividend is also delayed,

3 Periodical audit is not suitable in case of big business houses.

 Interim Audit

 It refers to an audit which is conducted for n part of the accounting year for some specific purpose, such as, declaration of an interim dividend by  Joint Stock Company, In other words, it is an audit which is conducted in between the two annual audits. This' kind of audit involves a complete audit of the accounts prepared for a part of the year.

Advantages

• Interim audit facilitates the work of final audit.
• This audit is helpful when preparation of interim accounts becomes necessary for the purpose of declaration of interim dividend.
• Errors and frauds can be detected more quickly.
• This type of audit exercises moral check on the staff of the client since it is conducted during the course of the financial year.

Disadvantages

• Chances of altering figures in the accounts which have already been audited cannot be ruled out.
• Since the audit staff  are required to make additional notes after the completion of interim audit, it puts much strain on the audit staff.
• Interim audit involves additional time and work.

Types of Audit-

Statutory Audit-

Statutory Audit is often called financial Audit. Independent financial audit is generally conducted to ascertain whether the Balance Sheet and Profit & Loss Account presents a true and fair view of the financial position and working result of the organization under audit.

The owners (shareholders), therefore, need assurance that the financial statements prepared by the management are reliable. The opinion of the auditor – an independent expert – assures the owners about the reliability of the financial statements.

Sections 139 to 147 under chapter X of the Companies Act, 2013 contain provisions regarding statutory audit and auditors.

Section 139 contains that at the first annual general meeting every company shall appoint an individual or firm as it auditor who will hold office from the conclusion of that meeting till the conclusion of the sixth annual general meeting.

Section 141 contains that a person shall be eligible for appointment as an auditor of a company only if he is a chartered accountant and in case of a firm whereof majority of partners practising in India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company.

Section 143 which contains provisions regarding powers and duties of auditors contains that the statutory auditor shall make a report to the members of the company on the accounts and financial statements examined by him.

Internal Audit

 Section 138 of the Companies Act, 2013 contains provisions regarding internal audit. As per Companies Act, 2013, certain class or classes of company as may be prescribed shall appoint an internal auditor who will conduct an audit of the functions and activities of the company and make a report thereon to the Board of Directors.