What Is Auditing? Definition, Types & Importance
- 1. What Is Auditing? Definition, Types & Importance Auditing originates from the Latin term “Audire”, which means “to hear,” - just as in ancient times auditors used to listen to officers and people of authority to confirm the validity of their words. Over the years, the role of auditing evolved to verifying written reports: specifically, the financial records of individuals and businesses. By definition, auditing is an official inspection and verification of the credibility of financial reports. Audits can be conducted by either a business’s management as an internal control process or by the government, in case they notice suspicious financial activity. In recent years, advancements in technology have greatly facilitated the auditing process, with tools like Deskera ERP playing a significant role. Deskera ERP is a comprehensive enterprise resource planning software that streamlines business operations, including accounting and financial management. This integration aids auditors by providing a clear and organized trail of financial transactions, thereby simplifying the verification process. Ensure Accurate and Reliable Auditing Get Expert Insights with Our Free ERP Accounting e-Book DOWNLOAD YOUR FREE E-BOOK NOW In this guide, we’ll be explaining what auditing is, why it’s so important, the different types of audits, and everything else you need to know about auditing for your small business accounting. What Is Auditing? Auditing, or a financial audit, is an official examination and verification of a business’s financial records. The main goal of auditing is to make sure that a company’s financial statements are accurate and are following regulatory guidelines. Auditing also gives investors, creditors, and other stakeholders reasonable assurance that they can rely on a company and its integrity. Now, it’s important to note that auditing doesn’t provide a complete guarantee that every digit recorded in a company’s financial reports is accurate. Auditors work within a specific, reasonable margin of error known as materiality. The volume of materiality depends on the size of the company and its reported revenue and expenses.
- 2. For small businesses, an accounting error of a few thousand dollars might be significant, but for a large corporation like Apple or Amazon, such a material mistake may be considered as a conventional mistake and not a cause for concern. Want to learn how to correctly manage and prepare your financial reports? Head over to our guide on financial reporting for small businesses. What is Auditing in Accounting? Auditing in accounting refers to the systematic examination and verification of a company's financial records and statements by an independent party. The primary goal is to ensure that these records are accurate, complete, and in compliance with relevant accounting standards and regulations. Auditing provides an objective assessment of a company's financial health and operational integrity. The key aspects of auditing in accounting are: Objective Verification Auditors independently verify financial statements and records to ensure they reflect the true financial position of the company. This involves checking the accuracy of financial transactions, balances, and disclosures. Compliance with Standards Auditing ensures that financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), as applicable. Compliance with these standards helps maintain consistency and reliability in financial reporting. Internal Controls Assessment Auditors evaluate the effectiveness of an organization's internal controls over financial reporting. This includes assessing processes and procedures designed to prevent and detect errors and fraud. Risk Management
- 3. Auditing helps identify and assess financial risks that could impact the organization. Auditors provide recommendations to mitigate these risks and enhance the overall risk management framework. Fraud Detection Auditors look for signs of fraud or financial irregularities. They conduct tests and procedures to detect any misrepresentations or intentional errors in the financial statements. Stakeholder Confidence An independent audit enhances the credibility of financial statements, providing assurance to investors, creditors, regulators, and other stakeholders. This trust is crucial for securing financing, complying with regulatory requirements, and maintaining a good reputation. Continuous Improvement Auditors provide feedback on areas where the organization can improve its financial processes and controls. This helps organizations enhance their financial practices and operational efficiency over time. Streamline and Automate Financial Operations with Deskera ERP Enhance Profitability and Productivity TRY FOR FREE NOW What is Materiality in Auditing? Materiality in auditing is a key concept that refers to the significance of an amount, transaction, or discrepancy within the financial statements. It is the threshold or benchmark used by auditors to determine the impact of potential misstatements or omissions on the financial statements and whether they could influence the economic decisions of users. Key Aspects of Materiality in Auditing The key aspects of materiality in auditing are: Quantitative and Qualitative Factors
- 4. Quantitative: Numerical thresholds, such as a percentage of net income, total assets, or revenue. For example, a misstatement amounting to 5% of net income might be considered material. Qualitative: Non-numerical factors that could affect users' decisions. These include the nature of the misstatement (e.g., fraudulent activity), the context (e.g., non- compliance with regulatory requirements), and the surrounding circumstances. Determining Materiality Auditors set preliminary materiality thresholds during the planning phase of an audit based on professional judgment and industry standards. These thresholds guide the extent and nature of audit procedures. Materiality levels may be adjusted as the audit progresses and more information is gathered. Application in Audit Procedures Planning: Materiality helps auditors decide the scope of the audit, including which accounts and transactions to examine more closely. Execution: Auditors apply materiality to identify significant misstatements. They perform tests and procedures to ensure that misstatements above the materiality threshold are detected and corrected. Evaluation: At the conclusion of the audit, auditors assess whether the aggregate of uncorrected misstatements is material and whether the financial statements as a whole are free from material misstatement. Impact on Audit Opinion If auditors find misstatements that are material and not corrected by the entity, they may modify their audit opinion to reflect this. For instance, they might issue a qualified opinion, adverse opinion, or disclaimer of opinion, depending on the nature and extent of the misstatement. Professional Judgment Determining materiality involves significant professional judgment. Auditors consider the expectations of reasonable users of the financial statements, the size and nature of the entity, and the context of the financial information. Examples of Materiality Considerations
- 5. Size: A $10,000 error in a small business might be material, whereas the same amount might be immaterial for a large corporation with billions in revenue. Nature: A small misstatement that leads to a breach of debt covenants or changes a profit into a loss can be material, regardless of its size. Impact: Errors that impact key performance indicators or compliance with regulatory requirements might be considered material due to their potential effect on users' decisions. Importance of Materiality Decision-Making: Helps ensure that financial statements provide a true and fair view, enabling users to make informed economic decisions. Efficiency: Allows auditors to focus their efforts on areas that have the most significant impact on the financial statements. Regulatory Compliance: Ensures that financial reporting meets legal and regulatory requirements, avoiding potential penalties and legal issues. Materiality is fundamental in auditing as it shapes the audit approach, influences the assessment of audit findings, and ultimately affects the audit opinion. It ensures that audits are both efficient and effective in providing reasonable assurance that the financial statements are free from material misstatement. The Importance of Auditing Credibility and Reliability With an internal auditing system, your business can create accurate and reliable financial reports through which you can gain insights on which segments or product lines are performing best and how to properly allocate resources. Additionally, regular auditing will make your shareholders trust that your accounts are true and fair and that it’s safe to invest in your business. Preventing Payroll Errors and Fraud If the government audits your financial statements and finds that your business has been manipulating its financial health, or hiding revenue and losses, you’ll likely deal with severe fees and legal punishments. Your business will also acquire a bad reputation, and you will most likely lose reliability in the eyes of your customers and stakeholders.
- 6. Recurring internal audits by a professional auditor or accountant of the company play an important role in detecting these fraud cases before they become substantial and problematic. Having a rigorous auditing system set in place alone prevents and scares employees or vendors from attempting a scheme to defraud your business in the first place. Payroll errors are common due to manual data entry, even with automation. Regular audits not only catch mistakes and prevent fraud, such as ghost employees, but also help avoid government penalties for financial manipulation, safeguarding the business's reputation and stakeholder trust. Implementing a robust internal audit system deters potential fraud, making it a crucial preventative measure. Main Types of Audits Audits can be classified into several types, each serving a different purpose and focusing on various aspects of an organization’s operations and financial health. Here are the main types of audits: Financial Audit Definition: A financial audit is an examination of an organization's financial statements and related operations to ensure they are accurate and conform to accounting standards. Purpose: To provide assurance that financial statements are free of material misstatement and to give stakeholders confidence in the organization's financial integrity. Who Conducts It: External auditors (e.g., certified public accountants) or internal auditors. Internal Audit Definition: An internal audit is conducted by an organization's own staff to evaluate the effectiveness of its internal controls, risk management, and governance processes. Purpose: To identify areas for improvement, ensure compliance with policies and regulations, and safeguard assets. Who Conducts It: Internal auditors employed by the organization. Compliance Audit
- 7. Definition: A compliance audit assesses whether an organization adheres to external laws, regulations, and internal policies. Purpose: To ensure that the organization is following legal and regulatory requirements and internal guidelines. Who Conducts It: External auditors, regulatory agencies, or internal auditors. Operational Audit Definition: An operational audit evaluates the efficiency and effectiveness of an organization's operations and procedures. Purpose: To identify opportunities for operational improvements and cost savings. Who Conducts It: Internal auditors or external consultants. Information Systems Audit Definition: An information systems audit examines an organization's IT infrastructure, policies, and operations. Purpose: To ensure the integrity, confidentiality, and availability of information systems and data. Who Conducts It: IT auditors, internal auditors, or external specialists. Forensic Audit Definition: A forensic audit investigates financial records to detect and prevent fraud, embezzlement, or other financial misconduct. Purpose: To gather evidence for legal proceedings and to uncover financial irregularities. Who Conducts It: Forensic accountants and auditors with specialized training. Tax Audit Definition: A tax audit examines an organization's or individual’s tax returns and financial records to ensure accuracy and compliance with tax laws. Purpose: To verify that taxes have been correctly reported and paid. Who Conducts It: Tax authorities (e.g., the IRS) or internal tax auditors. Environmental Audit Definition: An environmental audit evaluates an organization's compliance with environmental regulations and the impact of its operations on the environment.
- 8. Purpose: To ensure compliance with environmental laws and to promote sustainable practices. Who Conducts It: Environmental auditors or external environmental consultants. Performance Audit Definition: A performance audit assesses whether an organization is achieving its objectives effectively, efficiently, and economically. Purpose: To evaluate the performance of programs and initiatives and recommend improvements. Who Conducts It: Internal auditors or external performance auditors. External Audit Definition: An external audit is an independent examination of an organization's financial statements and related operations by external auditors. Purpose: To provide an unbiased opinion on whether the financial statements present a true and fair view of the company's financial position and performance. It ensures accuracy, completeness, and compliance with accounting standards and regulations. Who Conducts It: Certified public accountants (CPAs) or external auditing firms. Surveillance Audit Definition: A surveillance audit is a periodic review conducted to ensure that an organization continues to comply with specific standards and maintains the required certifications. Purpose: To monitor ongoing compliance with standards (e.g., ISO 9001 for quality management systems) and to identify areas for continual improvement. Who Conducts It: Certification bodies or external auditors who initially granted the certification. IRS Audit Definition: An IRS audit is an examination of an individual's or organization's tax returns and financial records by the Internal Revenue Service (IRS) to ensure accuracy and compliance with tax laws. Purpose: To verify that the taxpayer's income, deductions, credits, and other tax- related information are reported correctly and comply with the tax code. Who Conducts It: IRS agents or tax auditors. Payroll Audit
- 9. Definition: A payroll audit is an examination of an organization's payroll processes and records to ensure accuracy and compliance with labor laws and internal policies. Purpose: To verify that employees are compensated correctly, payroll taxes are calculated and remitted accurately, and to identify any discrepancies or potential fraud. Who Conducts It: Internal auditors, external auditors, or specialized payroll auditing firms. Each type of audit provides unique insights and helps organizations improve different aspects of their operations, ensuring overall health and compliance. 5+ Auditing Tips 1. When conducting an internal audit, make sure that you have a clear goal about what you’re looking to achieve. Ask yourself why you’re conducting the audit, and what actions you’re going to take depending on the result. 2. Internal auditing involves reviewing a huge pile of information. To avoid wasting time, prioritize processes that require immediate auditing, based on the audit’s goal. 3. Make sure you’ve claimed valid business deductions. Keep all of your expense receipts, and don’t mix up your expenses as business deductibles. 4. Know your accounting cycle. The accounting cycle is the multi-step process that analyses and records your financial data, and translates them into financial statements. By following it accordingly, you’re keeping accurate, up-to-date journal entries of your transactions, complying with federal regulations, and avoiding government audits. 5. Use the right tools. A great way to do this is by streamlining your processes with cloud-based accounting software like Deskera. With Deskera, you can automate most of your accounting tasks like journalizing transactions, calculating payments, or generating financial statements. Say goodbye to most of your typical accounting errors, eliminate fraud, and fear nothing in case you’re ever audited by the government. Try the software out yourself right away, with our completely free trial. How Can Deskera Help You With Auditing? Deskera ERP can significantly aid the auditing process in several ways: Deskera ERP can help your business with auditing through real-time data access, automated financial reporting, comprehensive record-keeping, compliance and regulatory support, and more.
- 10. 1. Real-Time Data Access: Deskera ERP provides real-time access to financial data, ensuring that all records are up-to-date and accurate. Auditors can quickly retrieve the necessary information without delays, enhancing the efficiency of the audit process. 2. Automated Financial Reporting: The software automates the generation of financial reports, reducing the manual effort and potential for human error. These reports are crucial for auditors as they provide a clear and concise overview of the company's financial health. 3. Comprehensive Record-Keeping: Deskera ERP maintains detailed records of all financial transactions, including sales, purchases, expenses, and payroll. This comprehensive record-keeping is essential for auditors to verify the accuracy and completeness of financial statements. 4. Audit Trails: The system creates an audit trail for every transaction, documenting who made changes, what changes were made, and when they were made. This feature helps auditors trace the history of transactions and identify any discrepancies or unusual activities. 5. Compliance and Regulatory Support: Deskera ERP helps businesses comply with various financial regulations and standards by ensuring that all financial processes and reports meet legal requirements. This compliance support is vital for auditors to confirm that the business adheres to relevant laws and regulations. 6. Internal Controls: The software includes features for setting up internal controls, such as approval workflows and access permissions. These controls help prevent unauthorized access and ensure that financial data is handled appropriately, making the auditing process more reliable. 7. Data Security: Deskera ERP employs advanced security measures to protect financial data from breaches and unauthorized access. Auditors can be assured of the integrity and confidentiality of the data they are reviewing. 8. Integration with Other Systems: Deskera ERP can integrate with other business systems and applications, ensuring that all financial data is consolidated in one place. This integration facilitates a more comprehensive audit by providing a complete picture of the company's financial activities. By leveraging these features, Deskera ERP helps streamline the auditing process, making it more efficient, accurate, and reliable. This ultimately leads to better financial management and transparency for businesses. Streamline and Automate Financial Operations with Deskera ERP Enhance Profitability and Productivity TRY FOR FREE NOW Auditing FAQs
- 11. 1. What Does an Auditor Do? Auditors are specialists who evaluate and review your company’s finances to make sure they’ve been kept accurately and comply with legal requirements. Auditors can also act as advisors and suggest risk management or cost-saving actions. 2. What Triggers Tax Audits? Some of the main reasons why the government conducts tax audits include math errors, failing to report a part of your income, claiming a lot of charitable donations, deducting too many business expenses, and more. 3. What Happens During an IRS Audit? There are three resolutions to an IRS audit: agreement, disagreement, or no change. By agreeing, you confirm that changes need to be made and agree with the proposed amendments made by the IRS agents. By disagreeing, you do not accept the proposed amendments and as a result, you can either choose to file for an appeal or discuss a dispute mediation. In case there’s no change, your information is examined, reviewed, and confirmed, and nothing will happen. 4. What is Auditing in Business? Auditing in business involves a thorough examination of financial records, operations, and internal controls to ensure accuracy, compliance, and integrity. It helps verify financial information, improves internal controls, supports decision-making, detects fraud, helps in complying with regulations, and provides assurance to stakeholders. 5. What Do Accountants Do? Accountants play a vital role in managing financial information for businesses and individuals. They handle tasks such as preparing financial statements, recording transactions, analyzing financial data, and ensuring compliance with tax laws and regulations. Accountants also provide financial advice, help with budgeting and forecasting, conduct audits, and assist in strategic planning. Overall, their expertise contributes to sound financial decision-making and the efficient operation of organizations. Key Takeaways
- 12. And that’s a wrap! Here’s a quick recap of the main points we’ve covered: Auditing is the process of reviewing and confirming your financial reports. Audits verify that you’ve created accurate and reliable financial reports and that no fraudulent activities are happening within the business. Auditing serves as a crucial tool for detecting and preventing fraud, by identifying irregularities and discrepancies in financial statements. Through transparent and accurate financial reporting, auditing helps build trust among stakeholders, including investors, creditors, and regulators. By providing reliable financial information and insights, auditing supports informed decision-making and strategic planning within organizations. Various types of auditing, such as financial, internal, compliance, operational, and forensic audits, serve specific purposes in assessing different aspects of an organization's operations and financial health. Internal audits are made by qualified auditors within the business, external audits are conducted by external third parties, whereas government audits are tax reviews by the IRS. Materiality is a critical concept in auditing, defining the threshold above which missing or incorrect information in financial statements could significantly impact users' decisions. It guides auditors in determining the scope of their examination and assessing the significance of identified issues. Deskera ERP plays a vital role in streamlining the auditing process by providing comprehensive financial management features. With Deskera ERP, businesses can maintain accurate and up-to-date financial records, automate reporting processes, and ensure compliance with accounting standards and regulations. Auditing Origin and Evolution – History of Auditing In the early stages of civilization, the methods of maintaining accounts were very unrefined. The person used to listen to the accounts read over by an accountant to check them, he was known as the auditor. History of Auditing Auditing is as old as accounting, and there are signs of its existence in all ancient cultures such as Mesopotamia, Greece, Egypt, Rome, UK, and India. Arthashastra by Kautilya detailed rules for accounting and auditing of public finances. In olden days the key purpose of audits was to gain information about the financial system and records of the business.
- 13. However, recently auditing has begun to include non-financial subject areas such as safety, security, information system performance and environmental concerns. With the non-profit organization and government agencies, there has been an increasing need for performing an audit, examining their success in satisfying mission objectives of the business. Auditing Origin and Evolution The auditing origin can be traced back to the 18th century, when the practice of large scale production developed as a result of the Industrial Revolution. Systems of checks and counter checks were implemented to maintain public accounts as early as the days of ancient Egyptians, Greeks and Romans. The last decade of the 15th century was a crucial period during which a great impetus was given to trade and commerce by Renaissance in Italy, and the principles of double entry bookkeeping were evolved and published in 1494 at Venice in Italy by Luca Paciolo. This system of accounts was quite capable of recording all types of mercantile transactions. The Industrial Revolution of England was another landmark in the history of trade and commerce. The industrial revolution led to a significant expansion in the volume of trading transactions which compelled the use of more money, and the ordinary trader was enforced to combine with the partnership with others. Consequently, a big enterprise was framed in the form of partnership firms and joint- stock companies. This growth of business enterprises before and after the revolution accompanied an improved accounting system. Besides British Companies made stockholders realize that an independent and impartial audit could well protect their interest. Such developments had a direct effect on the evolution of the practice of auditing, but the audit of business accounts could not be standard until the 19th century. A Royal Charter incorporated the Institute of Chartered Accountants in England and Wales on May 11, 1880. The key purpose of this incorporation was to prepare Auditors. In January 1923, the British Association of Accountants and Auditors got established, and a person could be fully competent to work as a professional auditor after clearing this exam.
- 14. Auditing Definition: Auditing is the procedure in which a qualified individual examines the books of accounts and assemble the evidence to form an assessment and convey their point of view to the responsible person or the management by submitting the audit report at the end of the financial year. The term “Audit” is borrowed from the Latin word “Audire”, i.e. to hear. In ancient times when the person who has possession of business suspected fraud, they assign particular individuals to inspect the accounts, such individuals were appointed as an accountant and perceived what they had to say in respect of accounts. From the above statement, it is precise that auditing or audit consists of three elements. They are as follows: Books of Accounts Auditor Approaches and measures of audit Content: Auditing 1. Types of Auditing 2. Objectives of Auditing 3. Advantages of Auditing 4. Conclusion Types of Auditing An audit can be categorized under various groups on a distinct basis. Types of auditing based on different aspects are as follows:
- 15. On the basis of Organization In this class, the audit is classified on the basis of the nature of the company for which auditing task is initiated. It consists of the following types: 1. Audit Enforced by Law These are the organizations which are enforced by the law to get their accounts audited every year: Companies ruled by the Companies Act,2013 Banking organizations ruled by the Banking Regulation Act,1949 Electricity supply corporations ruled by the Electricity Supply Act,1948 Co-operative Societies certified beneath the Cooperative Societies Act,1912 Civic or humanitarian trusts enrolled beneath distinct Religious and Endowment Acts. Specified entities beneath distinct sections of the Income Tax Act,1961 Certified Clubs, associations, etc. enrolled beneath Societies Registration Act, 1960
- 16. 2. Audit Under Voluntary Class Certain organizations which perform voluntary audit: Proprietorship concern Partnership organization Hindu undivided family Federation of individuals Non-profit organization. On the basis of Function Under this class, the audit is categorized on the basis of practical actions of the auditor. Altogether, this class of audit is based on the auditor’s work involved in an audit. It consists of the following types: External Audit Internal Audit On the basis of Practical Approach The categorization of audit beneath this class includes practical access to the work. It consists of the following types: Continuous Audit Interim Audit Partial Audit Periodical Audit Complete Audit Balance sheet Audit Standard Audit On the basis of Audit Dimension In this class, the audit is categorized on the basis of the dimension of the audit. It consists of the following types: Management Audit Cost Audit Tax Audit Human Resource Audit System Audit
- 17. Proprietary Audit Efficiency Audit Environment Audit Social Audit Cash Transaction Audit Government Audit Secretarial Audit Energy Audit Objectives of Auditing The Indian Institute of Chartered Accountants (ICAI) in its Auditing and Assurance Standard-2 (AAS-2) specifies the following objectives of auditing: The purpose of an audit of books of accounts, inclining a structure of identified accounting policies, practices and appropriate statutory obligations, if any, is to authorize an auditor to articulate a point of view on such financial statements. The auditor’s point of view helps in determining the true and fair view of the economic condition and functioning outcomes of a company. The auditor must be an autonomous body who is authorized
- 18. to examine the enterprise, its records and financial statements inclined from an enterprise and therefore, create a point of view on the efficiency and preciseness of the financial statements. The elementary target of auditing is to facilitate to harmonize that the books of accounts displays a true and fair view or not. Thus, the auditing is performed to build-up effectiveness and certainty in the accounts before putting them in front of the shareholders and administration. It provides authentic information about the economic position of the business, which may help the overall management of the business enterprise. For the attainment of the elementary objectives of auditing, the following ancillary objectives are to be required: Disclosure of errors Disclosure of frauds Avoidance of errors Avoidance of frauds Besides, errors which occur because of innocence and negligence, are of three types: Clerical error Compensating error Error of principles Again, clerical errors are of two types: Error of omission Error of commission However, the frauds which occur with a purpose to gain something by some influencing methods, they are of three types: Exploitation or misuse of cash Exploitation of goods Manipulation of accounts. Advantages of Auditing The job of an auditor is of great significance for all affected parties. The auditor should produce his audit report accurately and efficiently based on
- 19. the information and real figures. If this is concluded, the subsequent advantages may be anticipated from the auditing: From Legal Point of View Income Tax Return Filling Income tax experts usually affirm the profit and loss statement that has been processed by a certified auditor, and they don’t go into specifics of the statement. Financing Money from Outside Sources Money can be financed conveniently on the basis of audited books of accounts from the outside sources. Nearly all financial institutions approve a loan on the basis of audited financial statement. Settlement of Insurance Claim In the event of flood, fire and alike unanticipated circumstances, the insurance company pays the claim for loss or destructions based on audited accounts of the preceding years.
- 20. Payment of Sales Tax Sales tax experts may often acknowledge the audited financial statement. Action Against Bankruptcy The audited financial statement provides a base to decide the action in bankruptcy and deterioration cases. From Internal Control Point of View Fast Revelation of Errors and Frauds Errors and frauds are positioned at an initial date so that eventually no effort is made to carry out such frauds, as one will be moderately attentive not to carry out an error or a fraud as the financial statement are accountable to regular audit. Moral Check on the Personnel The auditing of financial statement manages the accounting clerk regular and aware as they realize that the auditor would object adjacent to them if the appropriate accounts are not inclined or if there is any distortion. Advice to the Management The management can ask the auditor for a consultation on certain technological points, despite the fact it is not the responsibility of an auditor to provide such consultation. Uniformity in the Accounts If the books of accounts have inclined on a consistent base, accounts of one year can correlate with the accounts of other years, and if there is any conflict, the origin of conflict may be investigated. From External Affairs Point of View Settlement of Accounts The audited financial statement would expedite the arrangement of accounts of a departed or dead partner. Valuation of Assets and Goodwill If the business is getting bankrupt, there may not be much difficulty regarding estimation of assets and goodwill as the financial statement is audited earlier by an auditor. Future trend of the business The expected flow of the business can determine with assurance from the audited financial statement.
- 21. Conclusion Auditing or Audit is the analysis of books of accounts or the financial statement by an independent individual known as an “Auditor”, pursued by personal checking of stock to make sure that section of the organization is following chronicle system of reporting transactions. It is executed to determine the efficiency of financial statements inclined by the organization. Auditor Definition: An auditor is a body who organizes an audit process. He is the one who creates an audit report after due examination of accounting records and accounting statements of the company forming his impression/assumption regarding financial statements fairness and reliability. Content: Auditor 1. Qualification of an Auditor 2. Qualities of an Auditor 3. Responsibilities of an Auditor 4. Duties of an Auditor 5. Conclusion Qualification of an Auditor According to law, no specific qualification is recommended for the auditor in case of the proprietary concern, but in the case of the companies, the following qualification is must: 1. According to the Companies Act, 2013, a chartered accountant having a certificate of practice from the Institute of Chartered Accountants of India can be a qualified auditor of a company. 2. As per “Part B” of the State Law Act, 1953 a person holding a certificate stating that he is designated to act as an auditor. Qualities of an Auditor
- 22. Some relevant qualities that an auditor should possess are as follows: Sovereignty: The auditor should not make his decisions to the will of his clients or any other person and should keep himself free from any sympathy allegedly and prepare financial statement of the management in an impartial way. Honesty: The auditor should always maintain sincerity while operating his duties. Conversation Skills: In the course of managing a process of audit, the auditor has to collaborate with numerous officers and parties; thus, he should have excellent conversation skill. Maintain Confidentiality: The auditor should maintain the privacy of the books of accounts unless authorized by the client or enforced by the law.
- 23. Expertise: The auditor must have an awareness about the client’s business and the current economic conditions, and a consciousness about the laws such as taxation laws, companies act and partnership act. Sensitivity: The auditor has to deal with different persons while performing his duties; he has to handle his sub-ordinates as well as various clients; thus, he should have the intelligence to handle them in any situations. Coherent Skills: The auditor must have the ability to analyze and illustrate the problems so that he can appropriately handle them when faced. Responsibilities of an Auditor Following are the responsibilities of an auditor: Examination: Cross-examination of the company’s accounting system and internal control system is necessary to safeguard the record’s appropriateness.
- 24. Checking of Books: The books of accounts should be checked thoroughly by an auditor to ensure its arithmetical accuracy. Documentation: Proper documentation of the records should be maintained by the auditor after investigating documentary pieces of evidence. It helps him in gathering the appropriate information about the transactions of the business. Full Incorporation: An auditor should properly analyze whether all entries have been recorded in the books of accounts or not while preparing the financial statement. Conventionality: Examining that the books of accounts or financial statement should not contain any fraudulent or faulty entry. Authentication of Assets and Liabilities: Verification of assets and liabilities for checking their existence, valuation, completeness and disclosure in financial statements. Statutory Consent: In case of audit of general insurance companies and banks, the auditor secures the compliance of financial statements with the compatible decree. Disclosure: Auditor examines whether the data in the financial statement acknowledged adequately or not. He discloses his point of view by way of the audit report after the completion of the audit process. Facts and Integrity: Auditor ensures financial statement as a whole and serves an accurate and fair view of profit/loss, assets and liabilities of a company in the appropriate forms. Duties of an Auditor Along with the responsibilities the auditor has to perform certain duties; they are as follows:
- 25. 1. Duty to Produce an Audit Report Description to members: An auditor must generate a statement to the members, yet he is not enforced to send a report to every member. Review of the auditor’s report: The report prepared by the auditor intends to read in the general meeting of the company. The report shall be open to any member for inspection. Capacity of audit report: The audit report should reveal the accounts maintained by the auditor, i.e. profit and loss statement, balance sheet of the company and the chronicles annexed with these accounts.
- 26. 2. Duty to Produce Competent Disclosures in an Audit Report Report on Appropriate and Impartial View: The auditor shall state whether in his impression and to best of his knowledge and bestow to the description given to him, the balance sheet and profit and loss account give: The instruction prescribed by the law; and An authentic and fair view of the state of affairs of the company. Report on Principal Allegation: The audit report should state: Whether he has gathered all the material and justification. Whether from his point of view, appropriate books of accounts have been conserved. Whether in his view, all accounting standards have assembled. Whether any director who has disqualified from being appointed as a director. Report on CARO: The auditor has to address all the elements specified in CARO. Report on Precise Inquisition: This report describes: Whether loans and advances built by the company in support of security have been perfectly captured, and the circumstances on which they have been formed are not biased to the concern of the company or the members of the company. It states whether the book of entries is unfavourable to the interests of the company. Report on specific inquiries should state whether the retail price of the shares, debentures, and other guarantees held by the company is below its purchase price. 3. Duty to Give a Sense for Accomplishment The aspect in which competence is made in the auditor’s report should be as such that no allowance for doubt in the public minds. A qualification should deliver the full description and not simply create grounds for the impression of enquiry. The auditor should appraise, wherever possible, the enact of the financial statement’s capabilities, if the same is material. It states whether it is not achievable to accurately quantify the consequence of the qualifications he may use the authority estimates or indicate the sense for not appraising the requirement’s effect.
- 27. 4. Duty to Endorse the Audit Report The audit report or any other chronicle mandatory to be signed or validated by the auditor may be endorsed by: A person selected as an auditor of the company. A firm selected as an auditor or by a partner of the firm exercising in India. Conclusion An individual who regulates an audit process is known as an auditor. He is the one who takes the responsibility of analyzing the books of records of the firm or the company, whether they are showing accurate and generous values or not. Based on these records, he prepares the audit report signed by him stating that the business activities are investigated and verified by him. 8. Objectives of Auditing Auditors are basically concerned with verifying whether the accounts exhibit a true and fair view of the business. The objectives of auditing depends upon the purpose of his appointment. Primary objective As per Section 227/143 of the Companies Act, 1956/2013, 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 account gives a correct figure of profit and loss for the financial year. The auditor is also concerned with verifying how far the accounting system is successful in correctly recording transactions and to ascertain whether the accounts are prepared in accordance with the recognised accounting policies and practices and as per statutory requirements and in his opinion, the financial statements comply with the accounting standards. Secondary Objectives The following objectives are incidental to the satisfaction of the main objective of auditing. The incidental objectives of auditing are: Detection and prevention of errors and Detection and prevention of frauds. Detection of material frauds and errors as an incidental objective of independent financial auditing flows from the main objective of determining whether or not the financial statements give a true and fair view. As the statement on auditing practices issued by the Institute of
- 28. Chartered Accountants of India states, an auditor should bear in mind the possibility of the existence of frauds or errors in the accounts under audit since they may cause the financial position to be misstated. Errors refer to unintentional mistake in the financial information arising on account of ignorance of accounting principles i.e. errors of principle, or error arising out of negligence of accounting staff i.e. clerical errors. I. Errors are mistakes committed unintentionally because of ignorance or carelessness. Types of Errors Types of Errors Details A. Errors of Omission These are errors which arise on account of the transaction being recorded in t he books of account either wholly/partially. If a transaction has been totally omitted it will not affect the trial balance and hence it is more difficult to det ect. On the other hand, if a transaction is partially recorded, the trial balance will not agree and hence it can be easily detected. B. Errors of Commission When incorrect entries are made in the books of account ei- ther wholly or p artially, such errors are known as errors of commission. e.g. wrong entries, w rong calculations, postings, carry forwards, etc. Such errors can be located w hile verifying. C. Compensating Errors When two/more mistakes are committed which nullify each other. Such error s are known as compensating errors. e.g. if in an account the amount of a tra nsactions is wrongly debited by Rs. 100 less and if in same account another t ransaction is wrongly credited by Rs. 100 less, such a mistake is known as c ompensating error. D. Error of Principle These are the errors committed by not properly following the accounting pri nciples. These arise mainly due to the lack of knowledge of accounting e.g. Revenue expenditure being treated as Capital Expenditure or vice versa. E. Clerical Errors A clerical error is one which arises on account of ignorance, carelessness, ne gligence etc. and may include one or more of the above except D. Location of Errors It is not the duty of the auditor to identify the errors but in the process of verifying accounts, he may discover the errors in the accounts. The auditor should may follow one or more of the following procedure in this regard to locate errors and to rectify same: 1. Check the trial balance,
- 29. 2. Compare supplementary totals of debtors and creditors with balances of main ledger extracted to the trial balance, 3. Compare the names of accounts appearing in the Ledger with the names of accounts in the Trial Balance, 4. Verify the totals and balances of all accounts and see that they have been properly shown in the Trial Balance, 5. Check the posting of entries from various books into ledger. 6. Check differences involving round figures such as 10, 100, 1000 etc. and whether difference is divisible by 9 which could mean interchange of figures or totalling mistakes etc. Timely careful scrutiny is the only remedy for detection of errors. II. Detection and Prevention of Fraud: A fraud is an error committed intentionally to deceive/to mislead/to conceal the truth or material facts. Frauds may be of three types. Types of Frauds Details a. Misappropriation of Cash This is one of the major frauds in any organisation and normally occurs in t he cash department. This kind of fraud takes place either by showing more payments or recording less receipts. 1. The cashier may show more expenses than what are actually incurred an d may misuse the extra cash. e.g. showing wages to dummy workers. Cash can also be misappropriated by showing less receipts. Cash received f rom 1st customer is misused, when the 2nd customer pays, it is transferred t o the first customer. When the 3rd customer pays, it is transferred to the 2n d customer. Thus the fraud goes on forever. Such fraud is called “Teeming and Lading”. To prevent such frauds, the auditor must check in detail all b ooks and documents, vouchers, invoices, etc. b. Misappropriation of Goo ds Here records may be made for the goods not purchased for/ not issued to th e production department and the goods may be used for personal purpose. S uch a fraud can be detected by checking stock records and physical verifica tion of goods. c. Manipulation of Account s This is finalizing accounts with the intention of misleading others. This is a lso known as “Window Dressing”. It is very difficult to locate, because it i s usually committed with or without the connivance of higher level manage ment. The objective of “Window Dressing” may be to evade tax, to borrow money from bank, to increase the share price, etc. Till recently, the principal emphasis was on arithmetical accuracy.
- 30. The Companies Act, 1956 required the auditor to state inter alia whether the statements of account are true and fair. This is what we can take as the present day audit objective. There has been a shift of emphasis from arithmetical accuracy to the question of reliability of the financial statements. The Companies Act, 2013 (section 143) now requires the auditor to express his opinion on whether the financial statements comply with the accounting standards. It is not the main objective of the auditor to discover frauds and errors. But if he finds anything of a suspicious nature, he needs to make a detailed enquiry and verification report his findings. The provisions of the Companies (Audit and Auditors) Amendment Rules, 2015 issued in December 2015 require inter alia (These rules get amended from time to time (last amendment came in effect from April 1, 2021) 1. Reporting by statutory auditor to Central Government for frauds which involve/ are expected to involve individually an amount of Rs. one crore or above. 2. In case of fraud involving lesser than above amount, statutory auditor has to report the matter to the audit committee/Board of the Company. 3. Features of Auditing Sr. No . Details A Audit is systematic and scientific examination of the books of account of a business/non -business entity. B Audit is a verification of the results shown by the Profit & Loss Account and the state o f affairs as shown by the Balance Sheet. C Audit is a critical review of the system of accounting and Internal control. D Audit is on-site verification activity, such as Inspection or examination of process or qu ality system, to ensure compliance to regulatory and other laid down requirements. E Audit is undertaken by an independent person or body of persons who are duly qualifie d for the job. F Audit is done with the help of vouchers, documents, information and explanations recei ved from the authorities of a business/non-business entity to evaluate evidence, docume ntation and economic aspects of a financial transaction. G The auditor has to satisfy himself about the authenticity of the financial statements and r eport as to whether the same exhibits a true and fair view of the state of affairs of the co ncern.
- 31. H The auditor has to inspect, compare, check, review, scrutinise the vouchers supporting t he transactions and examine correspondence, minutes book of shareholders, directors, Memorandum of Association and Articles of Association, bye laws etc., in order to esta blish correctness of the books of account. 9. Advantages and Inherent Limitations of Audit The public good derived from auditing is reasonable assurance that financial statements and disclosures are free from material misstatements. The following advantages from various view points are derived from audit: 1. Business Point of view 2. Investors Point of view 3. Others Point of view (I) Advantages of Audit Sr. No. Business Point of view Investors Point of view Other Advantages 1 Detection of errors & fr aud Protects interest Evaluates Financial Status 2 Helps in Loan Formalit ies Moral check Listing of shares/payment of dividend 3 Builds reputation Proper valuation of invest ments Settlement of claims and Settlement of ac counts 4 Proper valuation of ass ets Good Security Evidence in court as Audited accounts are treated as an authentic records of transact ion. 5 Government acceptanc e as it facilitates taxatio n. Updated position of accoun ts available then and there Facilitates calculation of purchase conside ration
- 32. (II) Limitations of Auditing The inherent limitations are: 1. First of all, the auditors work involves exercise of judgment, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgment and estimates made by the Management in preparing financial statements. Further much of the evidence available to the auditor can enable him to draw only reasonable conclusions therefrom. The audit evidence obtained by an auditor is generally persuasive in nature rather than conclusive in nature. Because of these factors, the auditor can only express an opinion. Therefore, absolute certainty in auditing is rarely attainable. There is also a likelihood that some material misstatements in the financial information resulting from fraud or error, if either exists, may not be detected. 2. The entire audit process is generally dependent upon the existence of an effective system of Internal Control. Further, it is clearly evident that there will always be some risk of an internal control System failing to operate as designed. No doubt, the Internal Control system also suffers from certain inherent limitations. Any system of Internal control may be ineffective against fraud involving collusion among employees or fraud committed by management. Certain levels of management may be in a position to override controls, for example, by directing subordinates to record transactions incorrectly or to conceal them, or by suppressing information relating to transactions. Sr. No. Limitations of Auditing Details 1 Non-detection of errors and frauds Auditor may not be able to detect certain frauds whic h are committed with mala fide intentions. 2 Dependence on explanations by ot hers Auditor may not be able to find out misrepresentation s if any given by others if they are given with a view t o conceal fraud detection. 3 Dependence on opinions of others Auditor has to rely on the views or opinions given by different experts viz. Lawyers, solicitors, engineers, a rchitects, etc. He can’t be an expert in all the fields. 4 Conflict with others Auditor may have difference of opinion with the acco untants, management, engineers, etc. In such a case, h is personal judgment plays an important role. It differ s from person to person.
- 33. Such inherent limitations of internal control system also contribute to inherent limitations of an Audit. 5 Effect of inflations Financial Statements may not disclose the true pictur e even after the audit due to inflationary trends. (as st atements are prepared on historical cost basis) 6 Corrupt practices to influence the a uditors The management may use corrupt practices to influen ce the auditors and get a favourable report about the s tate of affairs of the organisation. 7 No assurance Auditor can’t give any assurance about future profita bility and prospects of the company. 8 Inherent limitations of the financia l statements Financial statements do not reflect the current values of the assets and liabilities. Many items are based on personal judgment of the owners. Certain non-moneta ry facts may also distort the true position. 9 Detailed checking not possible Auditor can’t check each and every transaction.