Auditing Introduction
- 1. Auditing Introduction: Definition-General Objectives of Auditing-Advantages and Limitations of Auditing-Auditing and Investigation- Qualification of an Auditor – Auditors Vis-a Vis Errors and Frauds. Various types of audit-Continuous audit-Final Audit- interim audit-Balance Sheet audit-Merits and Demerits.
- 2. System of check Upon persons In the course of work Receipts and expenditure of money belonging to others Household accounts of early rulers kept by at least two persons Mauryan, Greek and Roman empires: fool-proof system of control over public revenue and expenditure Origin of auditing
- 3. Renaissance in Italy ; rapid growth in industry and trade. Multitude and complexity of transactions ; necessitated independent and expert review of the accuracy and reliability of business records. Advent of joint stock company, marketing separation between ownership and management of business were other reasons Cont.…….
- 4. Statutory recognition for Professional Accounting; British Business Companies Act 1862. With main objective of “detection of fraud”. In US, (1900)-ascertaining of ‘actual financial condition and earning of an enterprise’ In India Followed British Model The Joint Companies act of 1857- Provision for annual audit of companies (Optional) Compulsory audit – Companies Act ,1913 Maintenance of books of accounts Contents of the balance sheet Qualifications, duties and rights of an auditor, procedure of appointment Cont.…..
- 5. 1918 - Govt. of Bombay training of professional accountants with name Government Diploma in Accountancy (GDA) 1930 - Accounting Profession brought under Central Government . Post- Independence developments 1949- Enacted Charted Accountants Act - Set up Institute of Chartered Accountants of India (ICAI) - Controlled and Managed by council - Standards of education, training, professional conduct and discipline - Issued statements on auditing, standard auditing practices (SAPs) and Accounting Standards (AS) The companies act, 1956 - additional provisions for maintenance of accounts and audit, cost audit –companies, certain assessees- audit under Income tax Act 1961 Cont.…..
- 6. Increase in size and complexity of business organisations Divorce between ownership and management Legislative control Judicial pronouncements Statements and standards by professional bodies Electronic data processing Development of Auditing
- 7. Derived from Latin word “Audire” which means ‘to hear’. Auditing is the verification of financial position as disclosed by the financial statements. It is an examination of accounts to ascertain whether the financial statements give a true and fair view financial position. Auditing is the intelligent and critical test of accuracy, adequacy and dependability of accounting data and accounting statements profit or loss of the business. Meaning of Auditing
- 9. Institute of Chartered Accountants of India: Auditing is systematic and independent examination of data, statements, records, operations and performances (financial or otherwise) of an enterprise for a stated purpose. Definition
- 10. Classified under two heads: 1) Main objective 2) Subsidiary objectives Objectives of Auditing
- 11. Main Objective: Main objective of auditing is to form an independent judgement and opinion about the reliability of accounts and truth and fairness of financial state of affairs and working results.
- 12. 1. Detection and prevention of fraud: Fraud refers to intentional misrepresentation of financial information. Fraud may involve: a. Manipulation, falsification or alteration of records or documents b. Misappropriation of assets. c. Suppression of effect of transactions from records or documents. d. Recording of transactions without substance. e. Misapplication of accounting policies 2. Detection and prevention of errors: Auditing ensures that there is no mis-statement in the financial statements. Errors can be detected through checking and vouching thoroughly books of accounts, ledger accounts, vouchers and other relevant information. Subsidiary objectives:
- 13. a. Audited accounts help a sole trader in knowing the value of the business for the purpose of sale. b. Dispute over correctness of profits can be avoided. c. Shareholders, who do not know about day-to- day administration of the company , can judge the performance of management from audited accounts. d. It helps management in detecting and preventing errors and frauds. e. Management gets advice on financial affairs from the auditors. Importance of Auditing
- 14. f. Long and short term creditors depend on audited financial statements while taking decision to grant credit to business houses. g. Taxation authorities depend on audited statements in assessing the income tax, sales tax and wealth tax liability of the business. h. Audited accounts are useful for the government while granting subsidies etc. i. It can be used by insurance companies to settle the claims arising on account of loss by fire. j. Audited accounts serve as a basis for calculating purchase consideration in case of amalgamation and absorption. k. It safe guards the interests of the workers because audited accounts are useful for settling trade disputes for higher wages or bonus. Cont.…….
- 15. Parameter of Comparison Bookkeeping Accounting Definition Bookkeeping is related to the recording, measuring, and identifying the financial data of a company. Accounting is the process wherein the company’s financial data is summarized, and a report is prepared for the same. Management Management doesn’t take any financial decisions by analyzing the records of bookkeeping. Management decides upon financial decisions after reading the summary report obtained by accounting. Purpose To store and organize the financial data of a company To analyze the financial data and make future financial decisions accordingly. Financial statement The financial statement is not prepared using the information obtained from bookkeeping. The financial statement is prepared using accounting information. Skills Bookkeeping doesn’t need the bookkeeper to have any special skill set to handle and manage the financial records. An accountant needs special skills to record, interpret, and analyze the financial data to prepare reports. Analysis No analysis is carried. Accounting uses the record from bookkeeping to analyze the financial data to prepare reports. Types Single entry and double entry. Cost accounting and managerial accounting. Employee An accountant oversees the work of a bookkeeper. An accountant that is certified doesn’t need guidance. Entry A bookkeeper records the financial data on a daily basis. The accountant prepares the financial summary at the end of the month or on a yearly basis, depending on the type of report and demands of the company.
- 19. Principles of auditing Skills and competence: Acquired through education and training. Integrity and objectivity: Integrity ; honesty and incorruptibility Objectivity; fair, impartial and unbiased Confidentiality Reliance on audit work performed by others Documentation; evidence for mode and manner of doing any work Independence Independence of auditor is crucial to his acceptability by interested third parties Independence is a state of mind
- 20. Purpose or scope of audit Statutory Non-statutory for some specific purpose Eg: Making an investment, valuation of assets and liabilities, locating error and fraud, filing of tax returns etc… Nature of business Inflow of information Critical business processes and financial reporting process Information processing / technology Organisation structure Authority-responsibility relationship within an organisation Accounting system and internal controls Responsibility of the management Audit Planning
- 21. Nature of evidence- Internal or external Type of evidence – visual, oral or documentary Adequacy of evidence Evidence cannot constitute absolute proof Audit evidence
- 22. Financial statements comply with accepted financial practices Information in financial statements is consistent with legal requirements Financial statements contain adequate disclosure of all important information Audit conclusion
- 23. Audit report expresses opinion about adequacy of information on financial position of business. Report should clearly state auditor’s opinion about state of financial affairs of business. Audit report
- 24. Auditor must work honestly, diligently and with integrity Arthur Anderson – Enron story- Lack of honesty, diligence and integrity may bring ruin to both auditor and his client. Ethical conduct
- 25. Personal qualities Statutory qualifications Chartered accountant (Chartered accountant Act of 1949) Examination conducted by Institute of Chartered Accountants Certificate to practice of accountancy Holding a certificate under the Restricted Auditor’s Certificate (Part B States) rules 1956 Qualifications and Qualities of auditor
- 26. Professional Expertise Knowledge of accounting Knowledge of cost accounting Knowledge of accounts of business under audit Knowledge of business laws Knowledge of economics Knowledge of production systems Knowledge on mathematics and statistics Knowledge of general management Knowledge of financial management Knowledge of marketing management
- 27. Honesty and Integrity Tactfulness Vigilance Judgement Responsibility Diligence Communication Common sense General qualities
- 28. For the Enterprise Regular, careful and systematic work by employees Prompt detection of errors and fraud- Acts as a moral check Reliable index to the states of affairs – easy availability of loan and credit Determination of liability for income tax, wealth- tax, sales tax etc. Easy determination of purchase consideration Basis of resolution of disputes – wages and bonus Determination of claims against insurers- loss or damage to business property Detection of weaknesses in internal check and internal control and remedial measures. Maintenance of registers and books of accounts as per legal requirements. Professional competence and experience of the auditors Advantages of Audit
- 29. For sole proprietary business ; Audited statements provide as a proof of all business transactions have been duly accounted for, and there is no error or fraud. Partnership firms; evidence of proper management of the affairs of business by the active partners and employees of the firm. Joint stock company; shareholders can satisfy themselves that the affairs of the company are being smoothly run and their investment is safe Trusts, co-operative societies : Evidence for the beneficiaries / members etc. that their interests are being properly and efficiently looked after. For others: Banks, Insurers, tax authorities Advantages: For owners of the enterprise
- 30. Conceptual restriction. Post-mortem on prepared accounts Dependence on inside information In adequate or faulty external evidence Application of faulty techniques Formation of faulty judgement Limitations of auditing
- 31. According to SAP -4, “Fraud and Error” issued by ICAI, an error may be defined as any unintentional mistake or mis-conception in the books of account or records whether by way of –(a) mathematical or clerical mistakes in the records and data ; (b) oversight or misinterpretation of facts ; or (c ) misapplication of accounting policies. An error is generally taken to be innocent and not deliberate. Where it appears to be wilfully made, it assumes the character of a fraud. Errors and Frauds
- 32. Errors may be classified as 1. Clerical errors which may be two types a) Errors of omission b) Errors of commission 2. Errors of principle 3. Compensating errors 4. Errors of duplication
- 33. CLERICAL ERRORS RECORDING OF ORIGINAL ENTRY POSTING A TRANSACTION TO THE LEDGER TOTALLING OR BALANCING OF A LEDGER ACCOUNT
- 34. ERRORS OF COMMISSION Where a transaction recorded incorrectly partially or fully. Where a transaction has been incorrectly posted to the ledger Where ledger accounts are incorrectly totalled or balanced Where an error is made in entering balances in the trial balance
- 35. ERROR OF PRINCIPLE Where items of revenue expenditure are shown as capital expenditure Where the identity of an item of expenditure is camouflaged Where an expenditure is shown as benefit granted Where valuation of assets is not as per generally accepted accounting principles
- 36. Compensating errors: It results in compensating or blacking out, either wholly or partially, the effect of other errors. Errors of duplication: It occurs when the same transaction is recorded twice in the books of original entry.
- 37. How to detect errors Check and recheck the totals of the trial balance. Divide the amount of difference in the trial balance by 2 ( check for the same amount of items o debit side has been wrongly entered in the credit side and vice versa) Confirm transfer of all ledger accounts’ balance have been transferred to the trial balance. Ascertain on the basis of the nature of certain accounts. Check the totals of various ledger accounts Check correctness of all entries in the original books of account. Check opening balances of the accounts Make an year wise comparison of items of trial balance Check journal entries whether total of debit = total of credit If the errors are still not located, it may be due to Difference is divisible by 9; misplacement of figures If error of a round sum; mistake of totalling
- 38. A fraud includes any deception , cunning or trickery with an intention to deceive or cheat another. Essential elements of a fraud False material representation Representation made with the for-knowledge of its falsity or without any knowledge of its truth. Intended to be acted upon by the persons to whom it has been made. Concerned persons have relied and acted on the basis of the representation. Concerned persons have suffered a loss as a result of so relying and acting Detection and Prevention of fraud
- 39. SAP-4 “Fraud and Error”, Fraud may be committed Misappropriation or embezzlement of cash Non-recording of cash sales Making false entries in the accounts of customers Entering cash received from one customer against another. Showing payments against purchase never made Non- recording of credit notes for purchase returns. Non- recording of bills of exchange discounted Non recording of cash received against unusual sales Non- recording of unusual money receipts such as donations Recording payments which are never made. Types of fraud
- 40. Detection of fraud: Compare entries in the cash book with rough cash book, counterfoils in the money receipt book and original evidence in the form of vouchers, invoices, salary register, wage sheet etc.
- 41. Misappropriation of goods Committed by recording purchases of large quantities than actually supplied and by appropriating the balance quantity in each case for unlawful personal gain. Detected by proper maintenance of accounts as to purchase and sales, regular stock taking, strict check on incoming and outgoing goods and periodic comparison between the percentage of gross profit to sales in respect of different periods.
- 42. Fraudulent manipulation or falsification of accounts Makes or causes a false entry in the business records Alters, erases, removes or destroys a true entry in violation of his duty Prevents the making of a true entry or causes omission thereof. It is done to overstate or understate the profits or financial position.
- 43. Overstatement of profits may be done by way of Providing lower or no depreciation Over valuation of assets or understatement of liabilities Showing revenue expenditure as capital Omitting items of expenditure Accounting past or future years income in the current years’ expenditure
- 44. The practice of arranging the disposition of assets and liabilities in such a way that affairs of the business as shown in a subsequent balance sheet does not truly represent the normal financial position of the business. It may be done in any of the following ways: Recording of sales and income of the following year in the current year. Recording of goods sent on “sale on return” basis as regular sales. Entering loans given to directors and other managerial persons as repaid at the end of the year, and then showing the same as having been advanced to the same personnel. Treatment of normal revenue expenditure as deferred revenue expenditure. Provision of less depreciation on assets. Window dressing
- 45. Auditor’s position as regards fraud and errors SAP -4, “Fraud and Error” by ICAI ; responsibilities are Prevention and detection of fraud and error is the responsibility of management. Audit planning is expected to detect material misstatements Inherent limitations of auditing: sampling checking and detection of fraud is more difficult than to detect errors. Increased risk of fraud and error is due to Weak internal control system non-compliance with control procedures Doubts about integrity and competence of management Unusual internal pressures like scarcity of working capital, need of a rising profit trend etc. Unusual transactions at the year-end Problems in obtaining sufficient appropriate evidence
- 46. The auditor can avoid responsibility for any subsequent discovery of material misstatement resulting from fraud and error; Adhere to the basis principles of audit Modify the existing procedures Upon the confirmation of fraud, it should be corrected
- 47. Duty of reasonable care requires the auditor To make an intensive check of the system of internal control and check and devise his audit and testing procedure accordingly To make all verifications personally or through an experienced representative To ensure that the financial statements fully conform to the generally accepted accounting procedures and relevant legal requirements In case the financial statements disclose a situation hinting at fraud, to pursue the lead to its logical conclusion.
- 49. Audit General audit Specific audit Independent audit Internal audit Governmental audit 1. Interim audit 2. Occasional audit 3. Partial audit 4. Standard audit 5. Audit in depth 6. Post and vouch audit 7. Operational audit 8. Performance audit 9. Cost audit 10. Management audit
- 50. On the basis of method of examination • Continuous audit • Periodical / annual / Final / Completed audit • Balance sheet audit
- 51. General audit Independent audit Internal audit Governmental audit Statutory 1 . Companies 2 .Trusts 3.Co-operative societies 4. Societies registered under Societies Registration Act 5. Electricity supply companies 6. Statutory corporations Private 1. Sole Proprietorship 2. Partnership firms 3. Clubs, etc. 1. Govt. Departments 2. Statutory corporations 3. Govt. Companies
- 52. Statutory Audit Audit is made compulsory by law, it is called statutory audit Companies Banking companies Electricity supply companies Co-operative societies Public and charitable trusts Societies Corporations set up under an act of Parliament or state legislatures like LIC.
- 53. Shareholders/ owners cannot make it optional even by unanimous vote and cannot restrict scope of audit Audit conducted by qualified person The rights, duties and liabilities of an independent auditor are governed by law An independent auditor is, to all intents and purposes, not a representative of the shareholder/ owners. Audit cannot be partial or incomplete in any respect. Features
- 54. Audit, not compulsory by law, opted by the enterprise in view of the several benefits resulting from it, it is called private audit. Sole proprietorship, Partnership firms, joint Hindu family businesses etc. (tax audit is compulsory where gross turn over < Rs. 40 lacs ) Private Audit
- 55. Part of internal control operated by management Independent appraisal activity within an organisation, performed by an employee of the organisation or an outside agency, appointed for the purpose. Scope and objects of internal audit serve the interests of business organisation. Not compulsory, management defines its scope and objects:, CARO 2003 requires auditor of “specified company “ to report that its internal audit is in place and appropriate. Internal audit
- 56. Specified company A company whose paid up capital and reserve exceed Rs. 50 lakh OR Average annual turnover for the three financial years preceding the present financial year exceeds Rs. 5 crore Includes: Chit fund company “nidhi”company Mutual benefit company Finance company Investment company Manufacturing company Processing company
- 57. Does not include : Banking Company Insurance company Companies u/s 25 of companies Act Private company (Paid up capital< Rs. 25 Lakh ), Outstanding Loan <Rs. 25 Lakh or average annual revenue does not exceed Rs. 5 Crore
- 58. Study and evaluation of the adequacy and effectiveness of accounting, financial and operating control, Ascertaining the degree of compliance with predetermined policies, Plans and procedures, Accounting for business assets and measures for their safety, Examining the reliability of accounting and other data compiled within the organisation, Evaluation of the quality of performance in performance of duties assigned to individuals and departments. Keeping the management posted with objective analysis,, comments and recommendations as regards activities of the business organisation. Objectives of internal audit
- 59. A. Audit of Government departments Audit of government offices and departments is covered under this heading. A separate department is maintained by government of India known as Accounts and Audit Department. This department is headed by the Comptroller and Auditor General of India. This department works only for the government offices and departments. This department cannot undertake audit of non-government concerns. Its working is strictly according to government rules and regulations. Governmental audit
- 60. B. Audit of statutory corporations A. Audit done either by CAG or Professional Chartered Accountants c. Audit of Government companies (Govt. holds more than 51% of shares) A. Audit done by auditors appointed by Company Law board on the advice of CAG.
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