CHAPTER 1
INTRODUCTION TO AUDITING
Introduction :
The term audit is derived from the Latin word ‘audire’ which means
‘to hear’. In early days an auditor is used to listen to the accounts read
over by an accountant in order to check them and express his opinion
regarding the correctness of accounts.
Meaning : Auditing is the verification of the accuracy and correctness of
the books of accounts by independent persons qualified for the job and not
in any way connected with the preparation of such accounts. It is an
intelligent and critical examination of the books of accounts and other
documents through checking, vouching and verification.
Definition
•
ICAI defined auditing as “an independent examination of the financial
statements of an entity whether profit oriented or not and irrespective of
its size or legal form and such an examination is conducted to comment
whether the financial statements are showing a true and fair view”.
•
“Audit is defined as an investigation of some statements of figures
involving examination of certain evidence, so as to enable an auditor to
make a report on the statement.” –Taylor and Perry
Importance of Auditing
 Detection of frauds - It's a major reason for business auditing. The
auditor compares the accuracy of each financial transaction with the
financial book. By doing this auditor check the all transaction has
been recorded as per accounting principle and the main thing is that
they can detect the fraud in the organization. It’s the obligation of the
auditors to provide the suggestion and recommendation action in
order to prevent fraud.
 Transparent Financial Report - Auditing identifies the unknown
area of risk and errors. Bank’s, stakeholders and other financial
institutes ask the financial statement of the business. If your
business financial statement is audited by a qualified and
independent auditor so it increases the 90% chance to get
investment quickly. Because an audited financial statement is more
reliable in comparison to an unaudited financial statement.
 Enhancement In controlling - A qualified auditor audits the work of
the business organization to check how it’s doing and if there any
loophole, errors, risk area, fraud, etc. what if auditors found any
mistakes, frauds they mention in the auditing report along with the
suggestion. Based on the audit report, business management takes
action to prevent frauds.
 Helpful In Future Planning - Every business owner wants to grow
their business year after year. To do effective planning and make
decisions, Accurate value of the business finance is required. The
auditing provides the full insight of the business finance that is very
helpful for business owners in future planning and decisions.
 Valuation of the Assets - In audit ensure the value of the assets
after the assets verification. The auditors verify the current value of
the assets is recorded in the balance sheet or not.
 Profit and Loss - Financial audit gives a summary of all work that is
very helpful to determine the exact reason for the profit and loss. It’s
essential for a business owner to enhance the business strength
and generate more profit.
 Proper Evaluation
Of Investment - Business invests money in
various sources. Auditing provides the proper valuation regarding all
investments of the business. Auditing provides the exact value of the
profit and loss from the investment and most important current &
future risk from the investment.
Limitations of Auditing
1. Non-detection of errors/frauds:- Auditor may not be able to detect
certain frauds which are committed with malafide intentions.
2. Dependence on explanation by others:- Auditor has to depend on the
explanation and information given by the responsible officers of the company.
Audit report is affected adversely if the explanation and information prove to be
false.
3. Dependence on opinions of others:- Auditor has to rely on the views or
opinions
given
by
different
experts
viz
Lawyers,
Solicitors,
Engineers,Architects etc. he cannotbe an expert in all the fields And He
may be required to do test checking.
4. Conflict with others: - Auditor may have differences of opinion with the
accountants, management, engineers etc. In such a case personal
judgment plays an important role. It differs from person to person.
5.Effect of inflation : - Financial statements may not disclose true picture
even after audit due to inflationary trends.
6. Corrupt practices to influence the auditors :- The management may use
corrupt practices to influence the auditors and get a favourable report
about the state of affairs of the organisation.
7. No assurance :- Auditor cannot give any assurance about future
profitability and prospects of the company.
Types of Auditing
1. External Audit:
The external audit refers to the audit firms that offer certain auditing
services, including Assurance Services, Consultant
Services, Tax
Consultant Services, Legal Services, Financial Advisory, and Risk
Management Advisory. The best example of external auditing services is
the services these big four audit firms provide, including KPMG, PWC, EY,
and Deloitte. External auditors are normally referred to as audit staff who
are working in audit firms. The positions are ranked from audit associate,
and senior auditors to audit partners, and managing partners.
These kinds of firms are sometimes called CPA firms as they are required
by law to hold a CPA qualification/certificate to run an audit firm and
issue audit reports
2. Internal Audit:
Internal audit activities normally cover internal control reviewing,
operational reviewing, fraud investigation, compliant reviewing, and other
special tasks assigned by the audit committee or BOD.
Internal Auditing is an independent and objective consulting service
designed to add value to the business and improve the entity’s operation.
It provides a systematic and disciplined approach to evaluating and
assessing risk management, internal control, and corporate governance.
3. Forensic Audit:
The forensic audit is normally performed by a forensic accountant who
has the skill in both accounting and investigation.
Forensic Accounting is the type of engagement undertaking the financial
investigation in response to a particular subject matter. The findings of the
investigation normally are used as evidence in court or conflict resolution
among the shareholders.
The investigation covers several areas: fraud investigation, crime
investigation, insurance claims, and disputes among shareholders.
4. Statutory Audit:
Statutory audit refers to an audit of financial statements for the specific
type of entities required by law or local authority.
For example, all banking sectors require their financial statements to be
audited by qualified audit firms authorized by their central bank.
5. Financial Audit:
Financial audit refers to the audit of the entity’s financial statements by an
independent auditor where audit opinion will be provided on those
financial statements after auditing works are done.
A financial audit is normally performed by an external audit firm that
holds a CPA and is normally performed annually and at the end of the
accounting period. This type of audit is also known as financial statements
auditing.
6. Tax Audit:
A tax audit is a type of audit that performing by the government’s tax
department or tax authority.
A tax audit could be performed as the result of in-compliant found by a
government agency or the schedule set by the government tax
department.
Performance audit -Performance audit refers to an independent
examination of a programme, function, operation or the management
systems and procedures of a governmental or non-profit entity to assess
whether the entity is achieving economy, efficiency and effectiveness in
the employment of available resources.
Social audit - A social audit is a formal review of a company's endeavour,
procedures, and code of conduct regarding social responsibility and the
company's impact on society. A social audit is an assessment of how well
the company is achieving its goals or benchmarks for social responsibility.
Propriety audit- Propriety audit may be described as an audit of the
actions and decisions of the executives. The focus of such an audit is on
the financial discipline, the authority structure, efficiency, rules and
regulations and the protection of public interest.
Cash audit- in this only the cash receipts and payments are audited in
detail by the auditor.
Special audit- an audit other than the annual audit of accounts of the
company, conducted in special circumstances is called special audit. The
central govt has the power to call for such audit in special cases.
Joint audit- when two or more persons or firms of chartered accountants
jointly undertake the audit work of a company it is called joint audit. Joint
audit is adopted to conduct the audit work effectively and quickly.
Balance sheet audit- A balance sheet audit is an evaluation of the
accuracy of information found in a company's balance sheet. It involves a
number of checks, per the auditor's balance sheet audit checklist, as
auditors conduct this evaluation based on supporting documents.
Objectives of Auditing
The objectives of auditing may be classified into two :
1. Primary or main objective and
2. Secondary or incidental objectives
1. Primary Objective : The primary objective of audit is to verify the
accounts and to report whether the profit and loss account and
Balance Sheet are properly drawn and they depict a true and fair
view of the state if affairs of the concern.
 Check the arithmetical accuracy of the books of accounts.
 Examine the system of internal check.
 Verify the authenticity and validity of the transactions with the
relevant documents.
 Ensue that proper distinction is made between the items of
capital and revenue nature.
 Verify and value the assets and liabilities.
 Verify that all the statutory requirements as regards books of
accounts have been complied with.
2. Secondary objectives : While conducting audit certain errors and
frauds are detected by the auditor. So detection of errors and frauds
are included in the
secondary or incidental objectives of auditing. They are :
a. Detection of errors
b. Detection of frauds
c. Reporting to the Management
d. Prevention of errors and frauds.
Qualities of an auditor
As a statutory requirement an auditor should be a Chartered
Accountant. Besides he should possess the following qualities.
1. An auditor should be well versed with the latest principles and
practices of all aspects of accounting.
2. He should have a thorough knowledge of cost accounting.
3. He should be fully aware of the technical details of the working of
the organisation.
4. He should have thorough knowledge of different laws such as
Companies Act, Banking Regulation Act, Income Tax Act etc…
5. He should be familiar with mercantile laws.
6. He should have good knowledge in economics.
7. He should have good knowledge in industrial management ,Financial
management , etc..
8. He should be familiar with different audit case laws,
9. He should be a man of noble behaviour, honest, impartial and not be
influenced by others while performing audit duties.
10. He should be cautions, vigilant, hardworking, et..
11. He should possess high moral standards and should not sign a
statement which is not true and fair.
12. He should seek clarification wherever the information provided is
not satisfactory.
13. He should have the courage and ability to write his report clearly,
correctly and concisely.
14. He should be a man of integrity and independence.
15. He should not keep a suspicious attitude while checking the books of
accounts.
16. He should not disclose the secrets of his client.
17. He should have common sense.
BASIS
FOR
ACCOUNTING
COMPARISON
AUDITING
Meaning
Accounting
means
systematically keeping the
records of the accounts of
an
organization
and
preparation of financial
statements at the end of
the financial year.
Auditing means inspection of the
books of account and financial
statements of an organization.
Governed By
Accounting Standards
Standards on Auditing
Work
performed by
Accountant
Auditor
Purpose
To show the performance,
profitability and financial
position of an organization.
To reveal the fact, that to which
extent financial statement of an
organization gives true and fair
view.
Start
Accounting starts where
bookkeeping ends.
Auditing starts where accounting
ends.
Period
Accounting is a continuous
process, i.e. day to day
recording of transactions
are done.
Auditing is a periodic process.