AUDITING
C lass: B.Com
Course Instructor: Mr .Tahir Abbas
Before Mid-Term Outline:
Audit
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Introduction
Nature & scope
Objectives of an audit
DISTINCTION BETWEEN ACCOUNTING AND AUDITING
Advantages and Disadvantages of audit
Internal Control
o Internal Audit
o Internal check
o Internal control for cash, store, purchases & sales department
Types of Audit
o Continuous, Interim & Final audit
o Features, Advantages and Disadvantages of each type of audit
o Auditing Programs, Test checking, Audit working papers, Audit Notes Book
Vouching
o Techniques & Application
Verification
o Verification of assets & Liabilities
Auditor
o Appointment & Qualification
o Rights, Duties & Liabilities
o Professional Ethics
1. INTRODUCTION -AN OVERVIEW OF AUDITING:
As society become more complex, there is an increased likelihood that unreliable
information will be provided to decision makers. There are several reasons for this:
remoteness of information, voluminous data and the existence of complex exchange
transactions. As a means of overcoming the problem of unreliable information,
The decision-maker must develop a method of assuring him that the
Information is sufficiently reliable for these decisions. In doing this he must
Weigh the cost of obtaining more reliable information against the expected Benefits.
A common way to obtain such reliable information is to have some type of verification
(audit) performed by independent persons. The audited information is then used in the
decision making process on the assumption that it is reasonably complete, accurate and
unbiased.
ORIGINAND EVOLUTION
The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days an
auditor used to listen to the accounts read over by an accountant in order to check them.
Auditing is as old as accounting. It was in use in all ancient countries such as Greece, U.K.
and India.
The original objective of auditing was to detect and prevent errors and frauds. Auditing
evolved and grew rapidly after the industrial revolution in the 18th century with the growth
of the joint stock companies the ownership and management became separate.
The International Accounting Standards Committee and the
Accounting Standard board of the Institute of Chartered Accountants of
India have developed standard accounting and auditing practices to guide the accountants
and auditors in the day to day work
DEFINITION
The term auditing has been defined by different authorities.
According to Prof. L.R.Dickse:
"Auditing is an examination of accounting records undertaken with a view to establish
whether they correctly and completely reflect the transactions to which they relate”.
R. K. Mautz:
"concerned with the verification of accounting data, with determining the accuracy and
reliability accounting statement and reports."
 Nature & Scope of Audit
SCOPE OF AUDIT:The term "Scope of Audit" means the audit procedure which is considered necessary for the
achievement of desired objectives. The auditor should keep in view the following points :
1. Legal Conditions :While determining the scope of audit and auditor should follow the rules and regulations
applicable on the audit work.
2. Validity of Data:The auditor should use various methods to test the validity of data. He should confirm that
data provided in the financial statement is reliable.
3. Cover All the Aspects:The auditor should cover all the functions of business, know all its working any aspect
related to financial statement may not be ignored. A business is small or large auditor
should cover all the areas.
4. Comparison:The auditor can compare the accounts record with the financial statement to know the true
picture. He determines whether the relevant information is properly communicated or not.
5. Apply His Skill:While preparing the report, an auditor should apply his professional skill and experience to
prove that figures and facts.
6. Sufficient Record:The auditor checks that record and relevant data is sufficient. He also uses other tests and
verification procedure.
7. Judgement:The auditor also considers the judgement of the management made in preparing the
financial statements. The auditor must have the quality of judgement when he fails to find
the data in the books of account.
8. Internal Check:It is not possible for the auditor to check each and every voucher and transaction, so he
should try to rely on internal check system. He is also bond to make guess work on the basis
of available data.
9. Persuasive Evidence:The auditor his opinion as true fair instead of cent percent correct because the available
evidence is persuasive. The personal judgement also affects the value of any items.
10. Misstatement Problem:-
Due to the limitations of audit sometimes some material misstatements remain
undiscovered. So statement does not show the exact view of operations.
 OBJECTIVES OF AUDITING
There are two main objectives of auditing. The primary objective and the secondary
or incidental objective.
1. Primary objective:
As per Section 227 of the Companies Act
1956, the primary duty (objective) of the auditor is to report to the owners whether
the balance sheet gives a true and fair view of the Company’s state of affairs and the
profit and loss A/c gives a correct figure of profit of loss for the financial year.
i. Examining the system of internal check.
ii. Checking arithmetical accuracy of books of accounts, verifying posting, costing,
balancing etc.
iii. Verifying the authenticity and validity of transactions.
iv. Checking the proper distinction of capital and revenue nature of transactions.
v. Confirming the existence and value of assets and liabilities.
vi. Verifying whether all the statutory requirements are fulfilled or not.
vii. Proving true and fairness of operating results presented by income statement and
financial position presented by balance sheet.
2. Secondary objective:
It is also called the incidental objective as it is incidental to the satisfaction of the
main objective. The incidental objective of auditing is:
i. Detection and prevention of Frauds, and
ii. Detection and prevention of Errors.
I.
Detection and prevention of errors
Errors are those mistakes which are committed due to carelessness or negligence or
lack of knowledge or without having vested interest. Errors may be committed
without or with any vested interest. So, they are to be checked carefully. Errors are
of various types. Some of them are:
* Errors of principle
* Errors of omission
* Errors of commission
* Compensating errors
II.
Detection and prevention of frauds
Frauds are those mistakes which are committed knowingly with some vested interest
on the direction of top level management. Management commits frauds to deceive
tax, to show the effectiveness of management, to get more commission, to sell share
in the market or to maintain market price of share etc. Detection of fraud is the main
job of an auditor. Such frauds are as follows:
* Misappropriation of cash
* Misappropriation of goods
* Manipulation of accounts or falsification of accounts without any misappropriation
 DISTINCTION BETWEEN ACCOUNTING AND AUDITING
Points of difference
Accounting
Auditing
1. Meaning
2. Nature
3. Objects
4. commencement
It is recording of all the day
to day transactions in the
books of accounts leading
to preparation of financial
statements.
It is concerned with
finalisation of accounts.
The object is to ascertain
the trading results.
It involves various financial
statements. It involves
maintenance of books of
accounts. It does not go
beyond books of accounts.
It is the critical examination
of the transactions
recorded in the books of
accounts.
It is concerned with
establishment of reliability
of financial statements.
The object is to certify the
correctness of financial
statements.
It depends upon the
agreement or upon the
provisions of law. It goes
beyond books of accounts.
5. Scope
Accounting prepares profit
and loss account and
balance sheet and other
statements as per the
instruction of auditor
6. Staff
An accountant is a staff of
An auditor is an
an organization and draws
independent person who is
the salary from the business appointed for specific
period and gets a sum of
remuneration.
An accountant does not
Auditor checks the books of
accounts considering their
fairness as well as
complying with the
provision of company act or
not.
7. Preparation Of
Report
8. Responsibility
prepare report after the
completion of his task but he
has to give information to
the management when
needed.
An accountant remains
responsible to the
management
Auditor needs to prepare
and present report after
the completion of his
work to the concerned
authority.
An auditor is responsible
to the owners or
shareholders.
 ADVANTAGES AND DISADVANTAGES OF AUDIT
Advantages of Auditing
Assurance of true and fair accounts
An audit provides an assurance to the investors, government, lenders, creditors,
owners, management etc. That the final account presented shows the true and fair
picture of the profit and losses and financial position of the concern
True and fair balance sheet
The user of final accounts can be sure that the assets and liabilities disclose true and
fair view of financial position of the concern, it’s neither more nor less, and it’s free
from window dressing or secret reserve.
True and fair profit and loss account
the user of final accounts should be sure that the profit and loss account show true
amount of profit or less as it is.
Tally with books of accounts
the audited final accounts should tally with the books of accounts of the concern. So
it can be easy to calculate the taxable income without going through all the
transactions.
As per law
the audited final accounts should be prepared as per the rules and guidelines laid
down by law.
Disclose all material facts
the audited final accounts should disclose all material facts, thus users can rely on
them for making useful decisions of lending, investing etc.
Detection of errors and frauds
it is assumed that the audited final accounts are free from errors and frauds, the
auditor with his expertise knowledge would detect the errors and fraud so as to
show the true figure of final accounts.
Moral check on employees
Auditing techniques such as verification, vouching of cash, assets, stock etc. act as a
moral check on the employees, this forces them to keep the accounts up-to-date and
free from errors and frauds.
Advice to concern
Auditor can also advise the client about internal control, taxation, finance,
accounting system etc.
LIMITATIONS OF AUDITING
All transactions cannot be checked
it is not possible for an auditor to check each and every transaction; he has to check
them on sample basis
Evidence is not conclusive
Audit evidence is not conclusive in nature the confirmation of debtors is not
conclusive evidence that all amount will be collected, the conclusions are persuasive
rather than conclusive.
Not easy to detect some frauds
it’s not easy for an auditor to detect the deeply laid frauds which involves acts
designed to conceal them such as forgery, false explanation, and not recording
transaction and so on.
Audit cannot assure about profitability or efficiency of management
Even though the accounts are audited it doesn’t mean that the user can take granted
the future profitability or prospects of concern as audit don’t comment on efficiency
of the management.
Rely on experts
the auditor has to rely on experts like lawyers, engineers, valuers etc. for estimation
of contingent liability and valuation of fixed assets.
Chapter no. 2
Internal Control
 Internal Audit
DEFINITION of 'Internal Audit'
The examination, monitoring and analysis of activities related to a company's operation,
including its business structure, employee behaviour and information systems. An internal
audit is designed to review what a company is doing in order to identify potential threats to
the organization's health and profitability.
Function of Internal Audit
Step 1: Establish the Authority of Internal Audit
Establish the authority of the internal audit activity and review the definition of internal
auditing.
Step 2: Interview Leadership
Interview senior management and board of directors/audit committee chairmen to build
rapport, to ensure those at the top have a clear picture of the internal audit function, and to
clarify expectations of all. Use this opportunity to quickly learn and address what
management and the board view as the greatest risks to the organization, while keeping in
mind issues, problems, and opportunities that have already been identified. Develop a
system for cataloguing such information, including date and name of person interviewed for
quick reference in the future.
Step 3: Understand Benchmarking Needs
Understand "benchmarking" needs, i.e., industry, specialty groups, organizations with same
staff size, etc. Ask senior management who they consider to be leaders and laggards in your
organization's market niche.
Step 4: Review Policies and Procedures
Obtain and review your organization's written policies and procedures, especially the policy
pertaining to management's responsibility to control the organization.
Step 5: Discuss Control Issues
Discuss with external auditors open and closed internal control issues, which they may have
identified during their reviews.
Step 6: Develop the "Audit Universe"
Start to develop the "audit universe," or the list of all auditable entities.
Step 7: Develop Risk Assessment
Develop a risk assessment for your organization. This should be a macro-level assessment,
which includes both external and internal risk factors.
Step 8: Develop Charter for Internal Audit
Develop a charter for internal audit. Ensure that both senior management and the audit
committee review and approve the charter.
Step 9: Build the Budget
Build the budget, including personnel and travel.
Step 10: Hire Staff and Develop Training Plan
Hire your staff and develop a plan for staff training. Ensure your staff covers the range of
expertise needed based on your risk assessment.
Step 11: Ensure Complete Cooperation
Ensure that senior management notifies other departments of your existence and calls for
complete cooperation.
 Internal Check
It is an arrangement of duties of members of staff in such a manner than the work
performed by one
person is automatically and independently checked by the others.
According to ‘F.R.M.De PAULA’,
“Internal check means practically a continuous internal audit carried on by the
staff itself, by means of which the work of each individual is independently checked by other
members of the
staff.”
According to ‘D.R. DAVAR,’ “Internal check is a system or method introduced with defined
instructions given to
staff as to their sphere of work with a view to control and verification of their work and also
maintenance of
accurate records as the ultimate aim.”
OBJECTIVES OF INTERNAL CHECK
1. To exercise moral pressure over staff.
2. To ensure that the accounting system produces reliable and adequate information.
3. To provide protection to the resources of the business against fraud, carelessness and
inefficiency.
4. To distribute the work in such a business transaction is left unrecorded.
5. To allocate duties and responsibilities of each clerk in such a way that he may be held
responsible for particular fraud or error.
6. To minimize the chances of errors, frauds or irregularities in the business based on the
principle of division of labour.
7. To detect errors and frauds easily if it is committed, because in an efficient internal check
system, there is based on the principle of division of labour.
8. To detect errors and frauds easily if it is committed, because in an efficient internal check
system, there is a provision for independent checking.
ESSENTIAL CHARTERISTICS/PRICIPLES OF A GOOD SYSTEM OF INTERNAL
CHECK
1. Responsibility:
Responsibility of each individual must be properly defined and fixed. The work of the
business should be allocated amongst various clerks in such a manner that their duties and
responsibilitiesare clearly and judiciously divided.
2. Completion:
The work should be divided in such a way that no single person is allowed to complete the work
solely by himself from the beginning to the end. However, there should be no duplication of work.
3. Rotation of employees:
A good system of internal check should not allow person having custody of assets to have access to
the books of account. A system of transfer or rotation of employees from one seat of work to anther
must be followed by the business.
4. Automatic check:
A good system of internal check must provide for an automatic checking of the work of
one clerk by the other.
5. Reliance:
No clerk of the business should be relied upon too much.
6. Safeguards:
Safeguards should be prescribed to keep un-used cheque books, files and securities etc.
7. Supervision:
A strict supervision should be exercised to ensure that the prescribed internal checks and
procedures are fully operative.
8. Periodical review:
The system of internal check be reviewed from time to time to introduce improvements.
ADVANTAGES OF INTERNAL CHECK
some of the widely accepted advantages of an efficient system of internal check are as follows.
1. FOR THE BUSINESS
a. Proper division of work: Internal check entails a proper and rational distribution of work
among the members of staff of the enterprises keeping in view their individual qualifications,
experience and area of specialization.
b. Detection of errors and frauds: since no individual worker is allowed to handle a job
completely from the beginning to the end, and the work of each clerk is automatically checked by
the other, this heaps in the early detection and discovery of errors and frauds and the possibilities of
the commission of errors and frauds can be minimized.
c. Increased efficiency coupled with economy: A good system of internal check increase the
efficiency of work among the staff and leads to overall economy.
d. Moral check: knowledge of subsequent checking of each employees work by others, acts as a
great check to commission of errors and frauds.
2. FOR THE AUDITOR
a. Quick preparation of final accounts: The Profit & Loss Account and the Balance Sheet are
prepared without any loss of time.
b. Convenience to Auditor: Where an organization is operating system internal check, the
statutory auditor may conveniently avoid detailed checking of the transactions. He may apply a few
tests here and there and can relieve himself from detailed checking.
3. FOR THE OWNER
a. Accuracy of the accounts can be relied upon: if there is a system of internal check the owner
of the concern may rely upon genuineness and accuracy of the accounts.
b. Increase in profits: Overall efficiency and economy in operations result in more profits—thus
ensuring larger dividends for the owners or shareholders.
DISADVANTAGES OF INTERNAL CHECK.
Following are some of the disadvantages of a system of internal check.
1. Costly for small business: A system of Internal check system quite expensive especially for
small business houses.
2. Quality is sacrificed for Promptness: In an internal check system quality of work declines
because the clerks of the business attach greater importance to become quick and do not care if in
the process their work gets sub standardised.
3. Carelessness among high officials: The possibility of some of the responsible and high officials
being complacent, increases as they believe, though not always rightly, that under a sound system of
internal check nothing can go wrong.
4. Disorder in the working of a business. In the absence of a proper organized system of
internal check there will be chaos and disorder in the working of business.
5. Risky for an auditor: If the auditor does not apply tests and procedure his own and if he relies
on the output of the system his work cannot be free from irregularities if the system itself proves to
be defective.

INTERNAL CHECK: WITH REGARD TO CASH, STORE, PURCHASES AND SALES
DEPARTMENT:
 CASH SALES:
Cash Sales are of three types:
a. Sales at Counter / Counter Sales
b. Sales by travelling Salesmen.
c. Postal sales.
SALES AT COUNTER / COUNTER SALES:
The following procedure may be of great use in regard to cash sales:
i) A specific number, name or work may be allotted to every salesman.
ii) Every salesman is supplied with a separate book containing blank copies of cash memo.
iii) Cash memos should be printed in numerical sequence.
iv) Cash memos are printed in different colours for salesman at different counters.
v) When the sales man sells goods to a customer he prepares four copies of the Cash Memo.
These copies are checked by the senior clerk.
vi) Three copies of the cash memo are handed over to the customer and the fourth is
retained by the salesman.
vii) The customer should hand over three copies of the cash memos to the cashier, who
alters collecting the amounts and recording it in his cash register, returns two copies to the
customer duly stamp marked “cash paid”.
viii) So the cashier collects the amount and records it in his cash register.
ix) The customer should present two copies of the cash memos at the counter where the
goods purchased by him are to be delivered.
x) Here the customer will get the goods purchased by him are to be delivered to him.
Sales by Travelling Salesmen:
In big business houses, generally Travelling salesmen are employed to push. So the
following
precautions must be taken.
i. Travelling salesmen should be issued with pre-numbered, rough receipt books.
ii. Final receipt against receipt of cash by travelling salesman should be issued either from
the branch or headoffice to which the salesman is attached.
iii. Customers should be asked to contact the head office or branch office if the final receipt
is not mailed tothem within a stipulated period.
iv. Travelling salesmen should be instructed to remit the entire cash collected by them to
the head office or branch office to which they are attached, without making any deduction
towards salary or commission payable to them.
v. Head office or branch office should regularly send the statement of accounts to keep
them
Postal Sales or Value Payable Post(V.P.P) sales:
The following points should be noted in this regard.
i. There should be a separate register to record sales by post of VALUE PAYABLE POST.
ii. When cash is received against V.P.P sales, it should be entered in the V.P.P register and
then it should be posted to the cash book.
iii. Separate bank pay-in-slips should be used to deposit cash received against post sales.
iv. An offer should be deputed to check carefully this register an special attention should be
given to those
goods that have been returned and those against which payments has not been received .
v. Cash book and orders received should be checked and order received should be properly
filed too.
 INTERNAL CHECK WITH REGARD TO CASH PURCHASES
Requisition: The procedure for issuing purchase requisitions should be specified. The
head of the department, who is in the need of goods, should fill in a requisition slip duly
signed and then should send it to the purchases department. The details about the
quantity, is quality and the time by which the goods must be supplied be clearly
mentioned in the requisition slip.
Enquiry: Purchase department makes an enquiry about the terms and conditions of
purchases from different suppliers. For this purpose tender are generally invited. But,
who shall open and accept the tenders, should be clearly specified. At a rule, the lowest
tender should be accepted and accordingly a decision be taken.
Purchase Order: The Purchase Department places orders which should be recorded in
the Purchase Order book. Four copies of purchase order should be prepared. One copy
will be sent to the vendor, second to the store department, third copy to the Accounts
department and fourth one will be retained by the purchase department itself. A
responsible officer should review the purchase order, before signing by the authorized
person or director.
 INTERNAL CHECK WITH REGARD TO STORES (STOCK)
The Stores Department has the charge of preserving and issuing stores to different
departments. Proper control of stores is very much essential to prevent pilferage (small
theft) and misuse. Therefore, the internal check system in relation to stores must be
given careful attention.
The following general rules may be followed to ensure effective check on the stores.
i. LOCATION OF STORES: Store should be located at a convenient place. It should have
proper stores facilities so that goods may not be misplaced, misused or wasted.
ii. RECEIPTS OF STORES: On receiving stores, the Stores Department will prepare a
“Goods Received Note’ intriplicate.
One copy will be sent to the Purchase Department.
Second copy will be sent to Accounts Department.
The third will be retained by the Stores Department itself.
All the details about stores should be noted on the note. Stores should be properly
checked after their receipt.
iii. PRESERVATION OF STORES:
Goods received should be stored at their allotted racks.
The system of Bin Cards should be used to show the receipts, issues and balance of
stores. Such Bin Cards may be kept hanging on the places where stores are preserved.
Stores inventory software may be used on computer for item stored.
Chapter no.3
Types of Audit