Accounting and Auditing
Concept of Auditing
Principle Aspects Covered by Auditing
It is very important to accurately determine the financial position of an organization. This is
why auditing is done to double check the accounts system, and gain assurance of the accuracy
of the financial statements of an organization. Now, let us take an in-depth look oF what is
auditing and the principle aspects covered by it.
What is Auditing?
Auditing, specifically financial auditing is the examination of a business’s financial records
to determine their accuracy and their adherence to the accounting standards and other
applicable rules.
In India, the ICAI (Institute of Chartered Accountants of India) has a list of Standards of
Auditing that lay out the rules, procedures, methods etc about auditing, both internal and
external. In all, there are 35 of these Auditing and Assurance Standards (AAS) as of now.
Browse more Topics under Concept Of Auditing
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Meaning and Definitions of Auditing
Basic Principles Governing an Audit
Advantages and Limitations of Audit
Investigation vs Auditing
Principle Aspects Covered by Auditing
1] Review of all Systems
The primary objective of any audit is the review of all systems and procedures that relate to
the accounting and financial processes. The auditor must first understand the system and its
functionality before he started with the audit of the final statements of accounts. It will be the
base of the entire auditing exercise.
2] Review of the Internal Controls
The effectiveness of the organizations internal control system will dictate the scope of the
audit. If the internal controls of the company are in place and very effective, then the auditor
can rely on the system. Then he need no go through the accounts very minutely.
However, if on the other hand the internal controls are not effective, the auditor has to go
through the accounts with a fine tooth comb. And as per CARO 2003, it is compulsory for the
auditor to review the internal control system.
3] Arithmetical Accuracy
The auditor must also routinely check the accuracy of the books of accounts. This includes
checking the arithmetical accuracy of the books, by ensuring the posting of the entries is
perfect.
4] Accounting Principles
The auditor must ensure that proper distinction is made between the capital and revenue
transactions. All financial transactions must be properly categorized as either revenue or
capital transactions. The auditor must also check the items of both income and expenditure
for their accuracy.
5] Verification of Assets
The auditor must physically verify all the assets of the company. So he must check all the
legal documents, certificates, official statements etc. to analyse the ownership of all assets.
The auditor will also have to ensure no assets have been left out of the balance sheet either.
6] Verification of Liabilities
The auditor must also verify all the liabilities of the organization. Again he will inspect all
documents, letters, certificates etc. If necessary he can ask third parties for confirmation as
well.
7] Vouching
Every financial transacting leaves a paper trail. The auditor has to examine these supporting
documents to check the existence and accuracy of these transactions. This is known as
vouching. For example the organization has shown an electricity expense of 12,000/-. Then
the auditor must inspect the electricity bill to cross check this transaction.
8] Statutory Compliance
It is the duty of the auditor to check that the financial records of the company are in
compliance with all the laws, rules and regulations in effect at any given time. So he must
make sure that the accounts are in compliance with the Companies Act 2003, Income Tax Act
1961 etc.
Solved Question for You
Q: If the company has a very strong internal control system, then ____ checking is necessary.
a.
b.
c.
d.
less
more
both
none of the above
Ans: The correct answer is A. If there is already a strong internal controls system, then the
auditor may rely on it and stringent checking of accounts is unnecessary.
Basic Principles Governing an Audit
Auditing is a systematic and scientific procedure of inspection of the financial statements of
an organization. And like any scientific procedures, the audit also has certain principles and
rules that govern it. These principles are the Standards of Auditing or the Auditing and
Assurance Standards (AAS). Let us now take a look at some basic principles governing an
Audit.
Basic Principles Governing an Audit
SA- 200 describes the nine basic principles that govern the procedure of auditing. It lists out
the roles and responsibilities of the auditor and his general code of conduct during an audit.
We will look into these principles in brief.
1] Integrity, Independence and Objectivity
The auditor has to be honest while auditing, he cannot be favoring the organization. He must
remain objective throughout the whole process, his integrity must not allow any malpractice.
Another important principle is independence. So the auditor cannot have any interest in the
organization he is auditing, which allows him to be independent and impartial at all times.
2] Confidentiality
The auditor has access to a lot of sensitive financial information of the organization. It is
important that he respect the confidential nature of such information and documents.
He cannot disclose any sensitive information to any third party unless it is a requirement by
law. And he must also be very careful with documents, certificates etc. that the organization
entrusts to him.
3] Skill & Competence
The auditor must be experienced and trained in the procedures of auditing, i.e. must be
qualified as an auditor. And as a professional, he must be up to date on recent changes,
announcements, rules etc.
If necessary he can undergo training and workshops to stay up to date with the recent auditing
and accounting procedures. For example, after GST was introduced, auditors had to update
their knowledge.
4] Work Performed by Others
The scope of audit at times can be very vast. So an auditor has employees, delegates and
other people who work under him.
However, the auditor will continue to be fully responsible for the work done by these people
working for him. So the auditor must carefully supervise and review such work and be
reasonably sure of the accuracy of such work.
5] Documentation
In most cases the auditor maintains an audit notebook, an audit plan and auditing file. It is
important the auditor keeps a record of important documents with respect to his audit work,
as it is evidence of the work the auditor has done. And the client is inclined to these
documents and files if he wishes to inspect the work.
6] Planning
An audit plan allows the auditor t plan out his work and enables him to be more efficient and
timely. Every audit plan is different as it has to be customized according to the type of
organization, the kind of business they conduct, the scope of the audit, the efficiency of the
internal controls etc.
7] Audit Evidence
The auditor must collect enough evidence to support his final opinion. This collection of such
evidence is done by compliance and substantive procedures. There are two sources of this
evidence – internal and external. Also, external sources of evidence are always more reliable.
8] Accounting Systems and Internal Controls
The auditor has to assure that the accounts of the organization are accurate and represent a
true and fair picture of the financial status of the company. Also, the auditor must ensure that
all material information has been recorded in the accounts. Testing the internal controls
system is also important as it helps determine the same.
9] Audit Conclusions and Reporting
After the auditor collects all evidence he must now form his opinion on the basis of the
following criteria,
i.
ii.
iii.
all relevant accounting standards were applied at all times
financial statements are in compliance with all regulations and statutory requirements
all material information has been disclosed
Solved Question for You
Q: What is a clean audit report?
Ans: After the auditing procedure, the auditor must give his opinion via an audit report. A
clean audit report means the auditor is fully happy with the accounts. He thinks they are a
true and fair representation of the financial status of the organization. The opposite of a clean
report is an adverse or qualified report or a disclaimer.
Meaning and Definitions of Audit
Once we complete preparing the final statements and accounts for the year the accounting
process is over. However, we still cannot be completely certain of the accuracy of these
accounts. This is when the concept of auditing comes in. Let us see the audit meaning and
features of an audit.
Audit Meaning
The word “audit” is a very generic word, it essentially means to examine something
thoroughly. But we will be learning about auditing as it relates to accounting and the finance
world. So audit meaning is the thorough inspection of the books of accounts of the
organization.
This involves the examination of vouchers and the verification of various assets of the
organization. And the person who carries out such an audit is known as the auditor.
The International Federation of Accountants has given the following definition of an audit,
“audit is an independent inspection of the financial information of any organization, whether
profit-oriented or not profit-oriented, irrespective of its legal form, status or size when such
examination is conducted with a view to express an opinion thereof”.
The one important thing to remember is that an audit is a close inspection of the books of
accounts, but it does not absolutely guarantee error-free books. The auditor only expresses his
opinion on the accuracy of the books, he does not give his opinion on the financial status of
the company or predict its future.
If he is satisfied with the examination then he will state that the financial accounts are true
and fair, which means they are absent of any material misstatement. But this is not an opinion
about the financial status of the company.
(source – ipleaders)
Features of an Audit
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Auditing is a systematic process. It is a logical and scientific procedure to examine the
accounts of an organization for their accuracy. There are rules and procedures to
follow.
The audit is always done by an independent authority or a body of persons with the
necessary qualifications. They have to be independent so their views and opinions can
be totally unbiased.
Once again, an audit is the examination of all the books of accounts and financial
information of the company. So it is essentially a verification of the final accounts of
the organization, i.e. the profit and loss statement and the balance sheet at the end of
the financial year.
Auditing is not only the review of the books of accounts but also the internal systems
and internal control of the organization.
To conduct the audit we need the help of various sources of information. This
includes vouchers, documents, certificates, questionnaires, explanations etc. He may
scrutinize any other documents he sees fit like Memorandum of Association, Articles
of Associations, vouchers, minute books, shareholders register etc.
The auditor must completely satisfy himself with the accuracy and authenticity of the
financial statements. Only then can he give the opinion that they are true and fair
statements.
Solved Question for You
Q: What are the main types of functional audits?
Ans: The main types of functional audits are,
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Propriety Auditing
Efficiency Auditing
Operational Auditing
Voucher Auditing
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Statutory Auditing
Social Auditing
Cost Auditing
Advantages and Limitations of Auditing
Auditing is the process of inspecting the books of accounts to authenticate their accuracy and
reliability. It is an important process to the company itself, the government, the investors,
creditors, shareholder etc. They all rely on audited accounts to make important decisions. Let
us now take a look at the advantages of auditing and the disadvantages of auditing in some
detail.
Advantages of Auditing
1] Assurance to the Owners/Investors
One of the biggest advantages of auditing is that it offers assurances to the owners, investors,
shareholders etc. The owners of the business will be assured about the accuracy of their
books of accounts.
They will be satisfied with the workings of their various departments and the overall
efficiency and profitability of their business operations. It is the same case with investors,
who will find assurance in the books of accounts after auditing.
2] Errors and Frauds
An error is something that is done without the intention to fraud the company, it is an
innocent mistake. Fraud, on the other hand, is deliberate. During the process of auditing, both
errors and frauds are discovered. Auditing also helps prevent such errors and frauds. It creates
a fear of being detected.
So auditing helps us minimize the risks of errors and frauds in our books of accounts but does
not eliminate the risk entirely. There is always the chance that the error may go unnoticed,
and the fraud is very cleverly hidden so may go undetected.
3] Independent Viewpoint
If the auditor is an external auditor, the business can get a second opinion on their financial
statements and their financial standing as well.
An external auditor will closely inspect the books and be completely true and fair in his
opinion as he has no hidden agenda. If he says the accounts are true and fair, it has a lot of
weightage with the company and the investors.
4] Moral Check
One of the other advantages of auditing is that the staff and the workers of the company do
not try to steal or defraud the company. They are under constant scrutiny since they know
that the accounts will be audited. Any irregularities can be identified during such an audit,
and they will be caught eventually. This helps the staff in being honest and responsible at all
times.
5] Stakeholders Confidence
After auditing stakeholders like creditors, investors, banks, debenture holders etc. can rely on
the books of accounts with more confidence. And so after auditing by an independent
authority, the financial statements have more credibility.
Limitations of Auditing
1] Cost Factor
A very thorough and detailed audit would be a costly affair. It is not cost effective. So the
auditor has to limit the scope of his audit and use techniques like sampling and test checking.
2] Time Factor
Auditors generally work on a very specific timeline. Sometimes this is due to statutory
requirements. This means he has to audit a whole year’s accounts in a few weeks. Hence
insufficient time is one of the main limitations of auditing.
3] Inconclusive Evidence
Generally, the audit evidence the auditor collects is persuasive in nature, not conclusive in
nature. So there is never cent percent conclusive evidence in most cases while auditing.
This is one of the major limitations of auditing. There also a lot of use of estimates in
accounting. The auditor cannot measure or comment on the exact accuracy of these estimates.
He has to rely on his knowledge.
Solved Question for You
Q: Auditing helps in securing loans from banks. True or False?
Ans: This statement is in fact, true. Audited statements are a necessity when availing loan or
credit facilities from banks. The banks are more assured about the financial position of the
company and can sanction loans accordingly.
Investigation vs Auditing
Auditing is the general check to verify the accuracy of the accounts. But in certain cases, a
more in-detail look is required into specific areas. This is what we call an investigation which
forms a part of forensic accounting. So let us further study the concept and differences of
auditing and investigation.
Forensic Accounting and Investigation
Sometimes a business needs to find out all the facts behind a particular situation or scenario,
and thus conducts a thorough investigation into the matter. When the issue is related to
finance or accounting in any way, we use forensic accounting process of investigation. It
basically entails a critical examination of the books of accounts.
For example let us say in the process of auditing, the company has discovered the possibility
of fraud. Then we will call a qualified accountant to conduct an investigation.
He then will try and investigate the character of the fraud, the level of breach, the amount of
the loss, the source of the fraud etc. Then the company can work on closing any loopholes for
future security,
There are various methods to conduct an investigation. These include many of the same
techniques involved in auditing such as searching, research, observations by the investigator,
inquiries, inspections etc.
Differences between Auditing and Investigation
Often many people confuse the terms auditing and investigation and use them
interchangeably. However, they are two very distinct terms. Learning about the points of
differences between auditing and investigation will help us understand both the concepts
better.
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In auditing, we will inspect and audit the entire books of accounts and subsequently
write a report on it. In an investigation, however, the focus is on the critical
examination of a specific fact to learn the whole truth about the matter.
Another point of difference between auditing and investigation is their nature.
Auditing is more of a general and basic examination of the accounts. An
investigation, on the other hand, is more of in-depth scrutiny. In fact, the investigation
starts with a negative outlook, i.e. they acutely look for frauds and errors.
In most cases, auditing occurs annually, once a year. An investigation is only done
when a situation calls for it.
The evidence is auditing is always persuasive in nature. But in an investigation, the
evidence must be conclusive and decisive. There can be no doubt about its surety.
In some cases, auditing is compulsory or mandatory according to the law. This is
known as a statutory audit and is done according to the standards of auditing. It is
performed by external auditors. However, the investigation is never obligatory.
As per the rules of the ICAI, only by qualified Chartered Accountants can perform an
audit. And in case of a company, the appointment of the auditor can only be done by
shareholders. But any qualified accountant can perform an investigation. He must be
an expert in his field. Shareholders/management appoint the auditor.
Solved Question for You
Q: Is the scope of auditing and investigation the same?
Ans: No, the scope of auditing and investigation is very different. The scope of auditing is for
the auditor to examine the financial accounts and give his opinion on them. The scope of the
investigation is to seek answers and explanations for specific questions or problems.