Introduction to Auditing, Objectives, Needs of Auditing,

Auditing & Corporate
Governance
BY SANJUKTA MOHANTY

The word audit is derived from Latin word audire which means ‘to hear’.
Auditing is a critical examination of the records and books of account of a business by an
independent qualified person for ascertaining the authenticity and the accuracy of entries
appearing in the books of account and financial statement.
Auditing is a systematic and scientific examination of the books of accounts of a business. It is an
independent examination of data, statements, records, operations and performances of a
business.

Example:
Suppose, you have started a business and at the end of the year the actual profit of your
business is Rs. 3, 00,000. The amount of salary paid for the year was Rs. 2, 00,000 but the
accountant entered Rs. 20,000 instead of Rs 2, 00,000. In this case the profit and loss account
will show a profit of Rs. 2,80,000. If you file income tax return on the basis of your books of
account, you have to pay excess tax of Rs. 1,80,000. Again if you take any decision on the basis of
your books of accounts, it may be wrong. To ensure that these things do not happen, checking of
books of accounts is necessary before taking any decision or before submission of accounts to
any Government Authority. This checking of books of accounts is called Auditing.

Definitions of Audit
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.

Features of Auditing
Verification of the results shown by the profit and loss account and the state of affairs as
shown by the balance sheet;
Undertaken by an independent person or body of persons who are duly qualified for the job.
Critical review of the system of accounting;
The auditor has to satisfy himself with the authenticity of the financial statements and report
that they exhibit a true and fair view of the state of affairs of the concern;

Objectives of Auditing
Primary Objectives:
To report whether the Balance Sheet gives a true and fair view* of the company's state of
affairs.
To report whether the P/L Account gives a correct figure of profit or loss for the financial year.
True and Fair View
A “true and fair view” is the crux of an audit opinion as given by an Auditor. It means that the
financial statements under review (audit) are materially accurate and have been prepared using
consistent and acceptable accounting policies so that proper decision could be made. It means
that there are no misstatements or errors of such magnitude that they render the statements
useless to a user or would cause a user to make an incorrect decision.

Expression of expert opinion: - The main objective of auditing is to verify the accounts and
records and to report to the owners of the business whether the profit and loss account and the
Balance sheet have been properly drawn up according to the requirements of law, and whether
they exhibit a true and fair view of the profit and the financial position of the business.
To ensure that the primary objective of audit is achieved, an auditor must:
(a) Examine the Internal Control and Internal Check.
(b) Verify whether all the books of accounts as required by law are kept.
(c) Verify whether proper accounting principles and procedures are followed.
(d) Check the arithmetical accuracy of the books of accounts.

(e) Verify the authenticity and validity of the transactions.
(f) Confirm the existence and the values of the assets and liabilities by physical verification.
(g) Find out whether the financial statement is properly drawn up.
(h) Report whether the profit and loss gives a true and fair view of the profit or loss for the year
and Balance sheet gives a true and fair view of the financial position of the business at the end
of the financial year.

Secondary Objectives:
Detection and Prevention of Frauds and Errors
Detection and prevention of Errors: - Errors refer to unintentional misstatements in the records
or books. Errors are two types namely (1) Clerical or technical errors and (2) Errors of principle.
Clerical Errors: - Clerical errors refer to all types of errors committed on account of clerical
mistakes. They are (a) Errors of omission (2) Errors of Commission (3) Compensating errors and
(4) Errors of duplication. Errors of Omission: - An error of omission is one which arises when a
transaction has been omitted to be recorded in the books of accounts either wholly or partially.
An error of omission may be an error of complete omission or an error of partial omission. An
error of complete omission does not affect the agreement of the trial balance, as both the
aspects of the transaction are omitted from the trial balance, they cannot be detected easily.

They can be detected only by an intensive checking of the subsidiary books, and the postings
from the subsidiary books to the ledger. On the other hand, an error of partial omission affects
the agreements of the trial balance, as only one of the aspects of the transactions is omitted
from the trial balance, it can be detected easily.
Errors of Commission: - Errors of commission refer to errors committed in the process of posting
from the subsidiary books to the ledger accounts, casting, carry forward and balancing of ledger
accounts. Some of the errors of commission will not affect the agreement of the trial balance.
They cannot be detected easily. Only a thorough checking of the subsidiary books and posting to
the ledger can help to detect these errors.

They can be detected only by an intensive checking of the subsidiary books, and the postings
from the subsidiary books to the ledger. On the other hand, an error of partial omission affects
the agreements of the trial balance, as only one of the aspects of the transactions is omitted
from the trial balance, it can be detected easily.
Errors of Commission: - Errors of commission refer to errors committed in the process of posting
from the subsidiary books to the ledger accounts, casting, carry forward and balancing of ledger
accounts. Some of the errors of commission will not affect the agreement of the trial balance.
They cannot be detected easily. Only a thorough checking of the subsidiary books and posting to
the ledger can help to detect these errors. Capital expenditure recorded as revenue expenditure
or vice versa, capital receipt recorded as revenue receipt or vice versa is examples of errors of
principle. Errors of principle will not affect the agreement of the trial balance. Only a detailed
and intensive checking will reveal these errors.

Detection and prevention of frauds: - It is intentional or willful representation or deliberate
concealment of material fact with a view to deceive, cheat or mislead somebody. Fraud may be
broadly classified into three types. They are
(1) Misappropriation of cash
(2) Misappropriation of goods
(3) Manipulation of accounts

PROCEDURE TO BE FOLLOWED TO
DETECT ERRORS
Following procedures may be adopted by the auditor to detect the errors.
1. Check the opening balances from the balance sheet of the last year.
2. Check the posting into respective ledger accounts
3. Check the total of the subsidiary books.
4. Verify all the castings and the carry forwards.
5. Ensure that the list of debtors and creditors tally with the ledger accounts.
6. Make sure that all accounts from the ledger are taken into accounts.
7. Verify the total of the trial balance.

8. Compare the various items from the trial balance with that of the previous year.
9. Find out the amount of difference and see whether an item of half or such amount is entered
wrongly.
10. Check differences involving round figures as Rs. 1,000; Rs. 100 etc.
11. See where there is misplacement or transposition of figures that is 45 for 54; or 81 for 18
etc.
12. Ultimately careful scrutiny is the only remedy for detection of errors.

THE AUDITOR’s Position and duty in regard to detection and prevention of errors and
frauds
1. Examine all aspects of the finance.
2. Vouch all the receipts from the counterfoils or carbon copies or cash Memos, sales mart
reports etc.
3. Check thoroughly the salary and wages register.
4. Verify the methods of valuation of stocks.
5. Check up stock register, goods inwards notes, goods out wards books and delivery challan
etc
6. Calculate various ratios in order to detect fraudulent manipulation of accounts

7. Go through the details of unusual items
8. Probe into the details of the problems when there is a suspicion.
9. Exercise reasonable skill and care while performing the duty.
10. Make surprise visit to check the accounts.

Need for Auditing
Getting Authentic Accounts: The external agencies / internal members, who use the Financial
Statements, need an assurance that Financial Statements have been prepared and presented
correctly and reflect the true & fair view of the enterprise. Hence an independent examination
of the Financial Statements is called for. This gives rise to the need for Auditing.
Reliable for tax purpose: Sometimes audit is compulsory as per some specific laws, e.g. Tax
Audit (as per the Income Tax act), Statutory Audit (as per the Companies Act) etc.
Detection of errors and frauds
Ensuring Efficiency

Introduction to Auditing, Objectives, Needs of Auditing,

Types of Audit
Private Audit: This audit is conducted without any legal obligations then it is called private or
Non- Statutory audit.
Government Audit: This audit is conducted in the various categories of public enterprises like
state or central government or local authorities.
Statutory Audit: This Audit is conducted compulsorily as per the Law.
Financial Audit: It is an independent audit conducted to evaluate the financial reports and
statements of any organization.
Internal Audit: It is an independent and continuous evaluation and review of accounting books
and other operations in any organization.
Cost Audit: This audit deals with the verification of cost records and checking on the adherence
to cost accounting plans, policies and procedures.

Management Audit: This audit deals with the appraisal and review of management plans, policies
and procedures.
Tax Audit: It is conducted as an examination of financial records to assess concreteness of tax
calculation in compliance with the provisions of the Income tax Act.
Social Audit: It is the assessment of the social performances of a firm in the society to which it
belongs.
IT Audit: It objects to examine and evaluate the information technology infrastructure, policies and
operations of an organization.
Concurrent Audit: This is the one where the auditing is done at regular intervals in any accounting
year in order to check the books of accounts.
Annual Audit: This audit takes place at the end of an accounting year. This takes place after all books
of accounts are balanced and compilation of accounts is over.
Interim Audit: This is an audit which is conducted in between two annual audits or as and when
required.

ADVANTAGES OF AUDIT: -
Audit offers several advantages. They are:
1. Advantages of Audit to the business enterprise and Management
(1) Audit ensures the accuracy or correctness of the books of accounts
(2) Audit ensures the authenticity and reliability of the financial statements.
(3) Audit helps in the detection and rectification of errors and frauds.
(4) Audit helps the enterprise and management to ascertain whether the legal requirements are
complied with
(5) Audit point out the weakness of the existing system of internal check and internal control.
(6) Audit examination makes the employees in charge of accounts and records vigilant, regular
and up- to –date in their work.
(7) Loans and credit facilities can be easily obtained by a concern on the basis of audited accounts.

(8) Liability of an enterprise as to income tax, wealth tax, and value added tax etc can be easily
determined on the basis of audited accounts.
(9) A business can enjoy better reputation, if its accounts are audited by an independent
professional auditor.
(10) Audited accounts are more reliable as evidence in courts of law.
(11) Facilitates calculation of purchase consideration.
(12) The insurance claim can be easily determined on the basis of audited accounts.
(13) Audited accounts serve as a basis for solving the disputes as to higher wages.
(14) Comparison of accounts from year to year becomes easier since the accounts are uniformly
prepared.

2. Advantages of audit to the owners of the business:
(1) In the case of a sole trader, auditing assures him that all business transactions have been duly
accounted for and there are no errors or frauds. It also helps him to know the true facts about the
business.
(2) In the case of partnership firm, audited accounts serve as an evidence of proper management
of the affairs of the business. Audited accounts are help in the valuation of goodwill and settlement
of accounts on the admission, retirement or death of a partner. Again audited accounts minimize
the chances of disputes among the partners.
(3) In the case of a joint stock company, audit of accounts assures the shareholders that the affairs
of their company are smoothly and their investment is safe. The shareholders of a company can
value their shares on the basis of audited accounts.

(4) In the case of a co – 0p society or a trust, audit assures the members or the beneficiaries that
the affairs of the society or trust are conducted properly and their investment are looked after
properly.
3. Advantages of Auditing to others:
(1) Lenders can depend on audited financial statements while taking a decision to grant credit to
the business concern.
(2) Tax authorities can depend on audited statements in assessing sales tax, income tax and wealth
tax of the business.
(3) Audit of accounts safeguards the interests of the workers and is helpful in the settlement of
claim for higher wages and bonus.

(5) Insurance company can rely on audited accounts to settle claims in respect of damage or loss
of any business asset by fire, theft etc.
(6) The purchaser of a business can easily calculate the amount of purchase consideration on the
basis of audited accounts.
(7) Audited accounts create confidence in the minds of investors in a joint stock company.
Limitations of Auditing: -
Generally following are the Limitations of auditing
1. Non-detection of errors or frauds: - Auditor may not be able to detect certain frauds which
are committed by the clients.

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 cannot be an expert in all
the fields
4. Conflict with others: - Auditor may have differences of opinion with the accountants,
management, engineers etc. In such a case personal judgement 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.
8. Inherent limitations of the financial statements: - Financial statements do not reflect current
values of the assets and liabilities. Many items are based on personal judgement of the owners.
Certain non-monetary facts cannot be measured. Audited statements due to these limitations
cannot exhibit true position.
9. Detailed checking not possible: - Auditor cannot check each and every transaction. He may be
required to do test checking.
10. Auditing is a post mortem examination of accounts.

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