Auditing study material for b.com final year students

Principles and Practice of
Auditing

Introduction
The word audit is derived from a Latin word
“audire” which means to “hear”.
• It refers to the verification and examination of
accounts to ascertain whether the balance sheet
and profit and Loss account give a true and fair
view of the financial position and profit or loss of
the business.

Origin And Development
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, Egypt, Rome, U.K. and India. The
Vedas contain reference to accounts and auditing. Arthasashthra
by Kautilya detailed rules for accounting and auditing of public
finances.

Cont.
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
shareholders who were the owners needed a report from an
independent expert on the accounts of the company managed by
the board of directors who were the employees.
The original objective of auditing was to detect and
prevent errors and frauds.

Development
In India the companies Act 1913 made audit of company
accounts compulsory. With the increase in the size of the
companies and the volume of transactions the objective of audit
shifted and audit was expected to ascertain whether the accounts
were true and fair rather than detection of errors and frauds.
Hence the emphasis was not on arithmetical accuracy but on
a fair representation of the financial efforts the companies Act
1913 also prescribed for the first time the qualification of auditors.

Cont.
The later developments in auditing pertain to the use of
computers in accounting and auditing.
In conclusion it can be said that auditing has come a long
way from hearing of accounts to taking the help of computers to
examine computerized accounts.

Meaning
The general meaning of an audit is a planned
and documented activity performed by qualified
personnel to determine by investigation,
examination, or evaluation of objective
evidence, the adequacy and compliance with
established procedures, or applicable
documents, and the effectiveness of
implementation.

Definition
Simple Definition:-
“Audit is an examination of accounts & records which is
carried out by vouching the evidences, supporting various
transactions; by such an examination it is ascertained that the
Balance Sheet gives a true & fair view of the state of affairs of
business & the Profit & Loss Account gives a true & fair view
of the profit or loss of business.

Cont.
Spicer and Pegler:-
"Auditing is such an examination of books of accounts and
vouchers of business, as will enable the auditors to satisfy
himself that the balance sheet is properly drawn up, so as to give
a true and fair view of the state of affairs of the business and that
the profit and loss account gives true and fair view of the
profit/loss for the financial period, according to the best of
information and explanation given to him and as shown by the
books; and if not, in what respect he is not satisfied."

Cont.
R.K.Mautz:
“ Auditing is concerned with the verification of
accounting data determining the accuracy and
reliability of accounting statements and reports.”

 It is a thorough, intelligent, systematic and critical
examination of accounting data.
 Art & Science Both
 Verification of the results
 The Auditor has to satisfy himself with the authenticity
 It is conducted in an unbiased manner by an
independent person with the requisite qualification.
 The examination of accounts may be made throughout
the year or periodically.
 It is done with the help of relevant records, vouchers,
documents, information's and explanations from
authorities.

 The auditor has to satisfy himself and report whether
or not:
i)The profit & loss account reveals true and fair view of
profit and loss of the period.
ii)The balance sheet exhibits a true & fair view of financial
position of the business.
iii)Books of accounts have been maintained and accounts
have been prepared as per the provisions of law.
 It may also include the audit of non-financial matters
like audit of policies, operations, efficiency etc.

Scope of Auditing
The scope of audit is increasing with the increase in the
complexities of the business. It is said that long range objectives of
an audit should be to serve as a guide to the management future
decisions.
Today most of the economic activities are largely conducted
through public finance. The auditor has to see whether these larger
funds are properly used. The scope of audit encompasses
verification of accounts with a intention of giving opinion on its
reliability. Hence it covers cost audit, management audit, social
audit etc. It should be remembered that an auditor just expressed
his opinion on the authenticity of the account. He has no power to
take action against anybody, in this regard its said that “an auditor
is a watch dog but not a blood hound”.

Cont.
1. Legal Requirements
2. Entity Aspects
3. Reliable Information
4. Proper Communication
5. Evaluation
6. Test
7. Comparison
8. Judgments
9. Work
10. Evidence
11. Misstatement

Principles of Auditing
Fundamental principles of Auditing
1. Integrity, Objectivity and Independence
2. Confidentiality
3. Skill & Competence
4. Responsibility of work performed by others
5. Documentation
6. Planning
7. Audit Evidence
8. Accounting system & Internal Control
9. Audit Conclusions
10. Audit Report

Auditing study material for b.com final year students

Objectives of Auditing
Primary
Objective
Verification
of a/c
B/S shows
true & fair
state
P & L a/c
shows true
& fair state
Secondary
Objective
Detection &
Prevention
of Frauds
Detection &
Prevention
of Errors
Other
Objectives
Moral
Check
Complaince
of Co.'s Act
To create
trust in
Govt.

Objectives:
I. Main/ Primary Objective:
a. To verify and express an opinion as to whether at
a given date balance sheet presents a true and
fair financial position and profit & loss account
gives a true & fair view of the profit and loss for
that accounting period.
b. To verify that accounting systems are correctly
adopted and accounts are prepared according to
the recognized accounting policies and practices
prescribed by law.

II. Subsidiary/Secondary Objectives:
i. Detection and Prevention of Frauds
ii. Detection and Prevention of Errors
i. Detection and Prevention of Frauds:
Fraud refers to an intentional and deliberate
misrepresentation of accounting information for a
financial gain. They are intended to deceive, to
mislead or to conceal the truth or the material
frauds.
They can be of the types:
a. Misappropriation/ Embezzlement of cash.
b. Misappropriation of Goods.
c. Manipulation of Accounts

Detection & Prevention of Frauds
Misappropriation
Of Cash
Of Goods
By Employees
Manipulation of
A/c
Showing more
Profits
Showing less
profit
By Top
Management

ii. Detection and Prevention of Errors:
An error is an unintentional mistake in the books of
accounts or records whether by way of:
a. Clerical or mathematical mistake.
b. Oversight or misrepresentation of facts or
c. Misapplication of accounting policies.
Classification of Errors:
1. Error of Principle
2. Error of Omission
3. Error of Commission
4. Error of Duplication
5. Compensating Errors

Detection & Prevention of Errors
• trasanction is to be left out to register,
partial entry of one transaction
Error of Omission
• Rs. 1500 recorded as Rs. 5100
Error of
Commission
• omission to post, posting wrong side & amount to an
a/c, double posting, totalling mistake, balance b/d &
c/f
Clerical Error
• fundamental principle of Accountancy
& Auditing
Error of Principle
• two errors together which will be
resulted in trial balance, B/S will agree
Compensating
Error

Functions of Auditing
1. Accounting control
Audit is an instrument of accounting control. The truth and
fairness of the accounting information is controlled and checked
by auditing activities.
2. Safeguard
Audit acts as a safeguard on behalf of the proprietor/s
(whether an individual or a group of persons) against cost
control, carelessness or fraud on the part of the proprietors’
agents or servants in the realisation and utilisation of his/their
money and other assets.

Cont.
3. Assurance
Audit assures on the proprietors’ behalf that the accounts
maintained truly represent facts and expenditure has been incurred
with due regularity and propriety.
4. Assessment
Audit assesses the adequacy of the accounting system in
order to ascertain its effectiveness in maintaining accounting
records of an organization.
5. Review
Audit carries out a review of the financial statements to know
whether the accounting records are in agreement with those
statements.

Cont.
6. Reporting tool
Audit is a tool for reporting on the financial statements as
required by the terms of the auditors’ appointment and in
compliance with the relevant statutory obligations.
7. Practical subject
Auditing is a practical subject. It is something that people do.
How it is done today is a result of long history of marginal
changes and responses to new commercial and legal developments
over the centuries with the most rapid progress in the last few
years.

Advantages of Auditing
A. Businessman's point of view:-
1. Detection of errors and frauds
2 . Loan from banks
3. Proper valuation of investments
4 . Proper valuation of assets
5. Government acceptance
6. Suggestions for improvement
7. Better Reputation
8. Uniformity in accounts
B. Investor's point of view
1 . Protects interest
2. Moral check
3. Builds reputation
4. Good security
Contd……………..

Cont.
C. Other Advantages
1. Audited account are detected as an authentic record of
transaction.
2. Errors and frauds are detected and rectified.
3. It increases the morale of the staff and thus it prevents frauds
and errors.
4. Because of his expertise the auditor may advise on various
matters to his clients.
5. An auditor acts as a trustee of his shareholders. Hence he
safeguards their financial interest.
6. For taxation purpose auditing of account is a must.
Contd…………...

Cont.
7. In case of any claim is to be made from the insurance
company only audited account should be submitted.
8. Even in case of partnership firm auditing of accounts helps in
the settlement of claim at the time of retirement/death of a
partner.
9. Auditor account helps in managerial decisions.
10. They are useful to secure loan at the of amalgamation,
absorption, reconstruction etc.
11. Auditing safeguards the interest of owners, creditors,
investors, and workers.
12. It is useful to take certain financial decisions like issuing of
shares, payment of dividend etc.

Limitations of Auditing
Truly speaking, an audit should have no limitations of its
own. It is designed to protect the interest of all parties who are
interested in the affairs of the business. If there be any
shortcoming arising there from, it may be due to its narrow
scope of application in its related field of operation and un
extended definition of the concept.
Auditing suffers from the following shortcomings:
1. Want of complete picture
The audit may not give complete picture. If the accounts are
prepared with the intention to defraud others, auditor may not be
able to detect them.

Cont.
2. Problems of dependence:
Sometimes the auditor has to depend on explanations,
clarification and information from staff and the client. He may or
may not get correct or complete information.
3. Post-mortem examination:
Auditing is a post-mortem examination. There is no use of
such examination when events have already been occurred.
4. Existence of errors in the audited accounts:
It is not possible for the auditor in all cases, to check each
and every transaction of an organization. As a result, there may
be error in the audited accounts even after the checking by the
auditor.

Cont.
5. Lack of expertise:
Auditor has to seek opinion of experts on certain matters on
which he may not have experts knowledge. The auditor has to
depend upon such reports which may not always be correct.
6. Diversified situations:
Auditing is considered to be a mechanical work. Auditors
may not be in a position to frame audit programme, which can be
followed in all situations.
7. Quality of the auditor:
Success of audit depends on the sincerity with which the
auditor has performed his duties. The same audit work can be
done by two different auditors with difference in sincerity.

Cont.
8. Existence of defective policies
The auditor can only report on the truth and fairness of the
financial statements. But other defects, i.e. defects relating to
management and control may not be possible to be covered by
the auditor.

TYPES OF AUDIT
On the basis of
Organisation
Statutory
Non-
statutory/volu
ntary
On the basis of
Function
Internal
External/Inde
pendent
On the basis of
Approach
Time basis
Continuous
Interim
Periodical/F
inal
Scope basis
Complete
Partial
Objective
basis
Balance
Sheet
Occasional
On the basis of
Dimension
Tax
Management
Cost
Secretarial

Types of Audit
 Statutory Audit: any audit carried on as per the requirement of law is called as a
statutory audit. eg: all companies have to get their accounts audited as per the
provision of the company’s Act of 2013.
 Periodical/ Annual Audit: it is a kind of audit where the auditor verifies the
account at the end of the financial year. He starts the audit work after the closure of
financial year. This is a common audit and is mostly used by small organizations.
 Interium audit: its an audit conducted in the middle of the accounting year before
the accounts are closed. In other words any audit conducted between two financial
audit is known as interium audit. The objective is to get periodical results, to declare
interium dividend.
 Partial Audit: when an auditor is asked to audit only a part of the account system.
Its called partial audit. Eg: he may be asked to audit only the payment side of cash
book.
 Balance sheet audit: it’s a kind of partial audit and is concerned with the
verification of only those items appearing in the Balance Sheet. It is more popular in
the USA. In fact while verifying B/S items the auditor verifies/ checks all related
items/accounts.

Types of Audit
 Cost audit: cost audit is defined as the verification of cost accounting
records. Data and techniques for its accuracy and authenticity. It gets as
effective managerial tool for the detection of errors and frauds in cost
accounting records. The companies act implies the central government to
order cost audit incase of specifies companies.
 Management audit: Management audit may be defined as a
comprehensive examination of an organizational structure of a company,
institution/government and its plans and objectives it means of operations
and use of human and physical facilities. The main objective of mgt audit is
to see how far the objectives of mgt are fulfilled. It aims to ascertain whether
sound mgt prevails throughout the organisation and evaluates its efficiency
in the system of its operation.
 Continuous audit: a continuous audit is one in which the auditor visits his
clients office at regular intervals through out the year to verify the account.
The objective of CA may be-
 To get final account audited immediately after the closure of accounting year.
 When the business is very large.
 When interval control system is into effective.
 When regular final accounts are required.


Preparation before the Commencement of
Audit
1. Receiving Appointment Letter.
2. Communicate with the existing Auditor
3. Acceptance of appointment.
4. Ascertain the scope of duties.
5. Knowledge about the Organization.
6. Knowledge of the Accounting system.
7. Knowledge of technical details
8. Complete list of Principal Officer’s.
9. Observation of the previous auditor’s report.
10. Instructions to the Client.

Audit Note Book:
 It is a diary or register maintained by audit staff to
note errors, doubtful queries and difficulties, which are
required to be clarified with the client or the chief
auditor.
 It also records important points to be included in the
Auditors report.
Contents of an Audit Note Book:
1. A list of books of accounts maintained.
2. The names, duties and responsibilities of
principal officers.
3. The particulars of missing receipts and vouchers.

4. Mistakes and errors detected.
5. The points requiring clarifications &
explanations.
6. Accounting method followed in the
business.
7. The points to be part of the Auditor’s
report.
8. Various totals and balances.
9. Extracts from the minutes and contracts.
10. Date of Commencement and
completion of the audit.

Objectives of Audit Notebook
1. The audit notebook of current year will help the
auditor for starting audit for next year.
2. It provides evidence about the extent of work
done by the auditor.
3. It helps in preparation of audit report.
4. It helps the auditor to know about the progress
of audit work and the efficiency of his staff in
audit work.
5. It also helps the auditor for the settlement of
audit queries.

Audit Working Papers:
 Audit working papers refer to the audit papers
which records the audit evidence resulting from
the audit work performed to provide support for
the auditor’s opinion including the
representation.
Contents of Audit Working Papers:
1. Audit programme
2. Audit notebook.
3. Correspondence done between auditors and
debtors, creditors and bank.
4. Copies of debtors and creditors.
5. A copy of the audit report.
6. Schedules of item like depreciation, inventories
and important queries with explanation.

Audit Programme
 It is the auditor’s plan of action.
 It provides a plan of the work of examination
and a set of audit procedures specifically
designed for each audit.
 According to Howard Stettler, an Audit
Programme is an “ Outline of all procedures to
be followed in order to arrive at an option
concerning the client’s financial statements.”

Types of Audit Programme:
1) Fixed audit Programme:
 Includes audit procedures applicable to every
possible audit situation.
 It is very rigid and it is difficult to follow the same
programme for many years.
 The audit team do not have any role to play in this
audit programme.
2) Flexible audit Programme:
 It does not give an exact procedure to be followed
and can be changed according to the needs of
situation.
 It only gives an outline of the scope, nature and
limitations of the audit assignment.
 There is scope for initiative by the audit staff.

Advantages of Audit Programme:
a. The auditor will be certain of the work executed by the
audit staff.
b. Audit assistants know their clear cut duties.
c. Fixing of the responsibility of audit assistants is
becomes easier.
d. It serves as an evidence, if any action is taken for
negligence in the performance of his duties.
e. Continuity is not lost even if the person on duty is
changed.
Limitations of Audit Programme:
a. The task becomes mechanical, initiative and efficiency
gets affected.
b. The task may be completed hurriedly to complete it
within the scheduled time.
c. It is not useful in the audit of small organizations.
d. Inefficient audit assistants may get benefited.

Recent Trends in Auditing
A) Tax Audit:
Tax audit can be defined as “an examination of financial records to
assess correctness of calculation of taxable profits, to ensure
compliance with the provisions of the Income Tax Act and also to
ensure fulfillment of conditions for claiming deductions under the tax
act.”
Compulsory tax audit U/s 44AB
1) In case the total sales,(turnover) or gross receipts exceeds Rs.40 lakhs of
a business in the previous year.
2) If gross professional receipts exceeds Rs.10lakhs in the previous year in
the case of profession.
3) In case of business, if the profits and gains from the business are deemed
to be the profits and gains of a person under certain sections, it is
obligatory on the part of such person to get the accounts audited by a
specified date and submit the prescribed details and report of such audit in
the prescribed form duly signed and verified by an accountant.

Purpose of Tax Audit:
The purpose of Tax Audit is to ensure that books of
accounts have been maintained in accordance with the
provisions of the Income Tax Act.
B) COST AUDIT
The term cost audit refers to the audit of cost records. The
cost auditor is appointed to check the cost accounting
records in order to ascertain their accuracy. Cost audit acts
as an effective managerial tool for the detection of errors,
frauds, inconsistencies and irregularities in cost accounting
records.

Objectives of cost audit
1. To establish the accuracy of costing data by verifying the
arithmetical accuracy of cost accounting entries in the books of
accounts
2. To ensure that cost accounting principles are governed by the
management objectives and these are strictly adhered in preparing
cost accounts.
3. To ensure that cost accounts are correct and also to detect errors,
frauds and wrong practice in the existing system.
4. To check up the general working of the costing department of the
organizations and to make suggestions for improvement.
5. To help the management in taking correct decisions on certain
important matters i.e to determine the actual cost of production
when the goods are ready.
6. To reduce the amount of detailed checking by the external auditor
if effective internal cost audit system is in operation.

Advantages of Cost Audit
A. Advantages of cost audit to the management
1. Provides reliable cost data for managerial decisions
2. Helps management to regulate production
3. Effective managerial tool in detection of errors, frauds and
irregularities so that reliable and smooth functioning of the
system in continued.
4. Reduced the cost of production through plugging
loopholes relating to wastage of material, labor, O/H’s.
5. Can fix the responsibility of an individual.
6. Improves efficiency of the orgn as a whole and constant
review of methods and procedures.

B. Advantages of cost audit to the shareholders
1. Ensures proper records of purchases, utilization are
maintained and expenses on various items.
2. Also makes sure industrial unit has been working
efficiently and economically.
3. Enables shareholders to determine whether or not they
are getting a fair returns on their investments. It reflects
managerial efficiency or inefficiency.
4. Cost audit ensures true picture of company’s state of
affairs. It reveals whether resources like plant and
machinery are being properly utilised or not.

C. Advantages of cost audit to the society
1. It tells true cost of production. From this consumer may
know whether market price of the article if fair or not.
Consumer is saved from exploitation.
2. Cost audit improves the efficiency of industrial units and
thereby assists in economic progress of the nation.
3. Since price increase by industry is not allowed without
justification as to increase in cost of production,
consumers can maintain their standard of living.

D. Advantages of cost audit to the Government
1. Cost audit assists tariff board in deciding whether tariff
protection should be extended to a particular industry or
not.
2. It helps to ascertain whether any particular industry should
be given any subsidy in order to develop that industry.
3. It provides reliable data to the government for fixing up
setting prices of commodities.
4. It helps government to take necessary measures to
improve efficiency of sick industrial units.
5. Cost audit can reveal any fraudulent intentions of the
government.

C) Management Audit
Meaning and Definition
• Management audit is an emerging concept of auditing. It is
an evaluation of all activities of the all departments with a
view to provide appropriate suggestions to management to
help their work.
• It is a future oriented task which evaluates timely in all
level of management.
• Main objective of management audit is to improve profit
earning capacity, work of management, objectives of
program, social objectives and human resource
development so organisational goal can be easily attained.
It refers to existence of control system, compliance of rules
and regulations, process of managerial decisions.

Functions of Management Audit
1. It identifies objectives of an organisation, if not setup
earlier.
2. It allocates overall objectives of an organization in small
parts.
3. It reviews structure of organization and asset of
organization and decides whether goals can be obtained
or not.
4. It examines all scope of work and liability centres.
5. It provides valuables suggestions to management after
evaluation of above facts.

Objectives of Management Audit
1. To formulate goals of the organization.
2. To ensure fulfillment of goals.
3. To help management to improve activities and procedures.
4. To help all members of the management to make effective
discharge of their duties.
5. To help in the improvement of profits.
Advantages of Management Audit
1. Provides information about strong and weak points of
management.
2. Provides suggestions to management.
3. Helps to provide suggestions to attain organisation goals.

Disadvantages of Management Audit
1. Management auditor cannot understand the practical
problems. So, the suggestions provided by them are
theoretical but not practical.
2. Scope of management audit is vague. So, it does not help
to achieve specific goal.
3. Generally, it gives more emphasis on maintaining books of
accounts rather than concentrating on other factors. So, it
consumes time of farsighted management.

Auditing study material for b.com final year students

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