INTRODUCTION TO AUDITING BY ADITYA VISHWANATHA ANKITA JAIN SJCC

AAS 1 – BASIC PRINCIPLES GOVERNING AN AUDIT Integrity, objectivity, independence Confidentiality (exception- regulatory requirement) Skills & Competence Work performed by others Documentation Planning-nature, timing & extent of audit procedures Audit evidence Accounting system & Internal control Audit conclusions & reporting

Integrity, objectivity, independence

Confidentiality (exception- regulatory requirement)

Skills & Competence

Work performed by others

Documentation

Planning-nature, timing & extent of audit procedures

Audit evidence

Accounting system & Internal control

Audit conclusions & reporting

FUNDAMENTAL ACCOUTING ASSUMPTIONS Going concern Consistency Accrual system ACCOUNTING POLICIES-CONSIDERATIONS Prudence Substance over form Materiality

FUNDAMENTAL ACCOUTING ASSUMPTIONS

Going concern

Consistency

Accrual system

ACCOUNTING POLICIES-CONSIDERATIONS

Prudence

Substance over form

Materiality

THE AUDIT PROCESS- PHASE I Audit Proposal Assessment of the Proposal Acceptance of the Audit Proposal Letter of Appointment Letter of Engagement

Audit Proposal

Assessment of the Proposal

Acceptance of the Audit Proposal

Letter of Appointment

Letter of Engagement

PHASE II – PLANNING Gathering of Preliminary Information regarding nature of business, flow of activities of the entity Broad Planning of the Audit

Gathering of Preliminary Information regarding nature of business, flow of activities of the entity

Broad Planning of the Audit

PHASE II – PLANNING Evaluation of Accounting System and Internal Control Assessment of Audit Risk Framing of Audit Programme

Evaluation of Accounting System and Internal Control

Assessment of Audit Risk

Framing of Audit Programme

PHASE III – EXECUTION OF AUDIT Compliance Test Documentation Modification of Audit Programme, if required

Compliance Test

Documentation

Modification of Audit Programme, if required

PHASE III – EXECUTION OF AUDIT Clarification, Explanation,Conformation Review of Financial Statement Management Representation

Clarification, Explanation,Conformation

Review of Financial Statement

Management Representation

PHASE IV - REPORTING Formulating Audit Conclusions Preparation of Audit Report Discussion with the Management Dating of the Audit Report Signing of the Audit Report

Formulating Audit Conclusions

Preparation of Audit Report

Discussion with the Management

Dating of the Audit Report

Signing of the Audit Report

COMPLIANCE & SUBSTANTIVE PROCEDURES Tests of control Effectiveness of design & effectiveness of operation of controls upon which the auditor has placed reliance Tests of detail (analytical procedures) Completeness, validity & accuracy of account balances & underlying classes of transaction

Tests of control

Effectiveness of design & effectiveness of operation of controls upon which the auditor has placed reliance

Tests of detail

(analytical procedures)

Completeness, validity & accuracy of account balances & underlying classes of transaction

DOCUMENTATION Audit programme Detailed pan Description of work to be done Specifying procedures to be followed Part of current audit file Audit Working Papers Planning and performing audit Supervision & review of audit work Evidence of audit Permanent and current files Audit Note Book Permanent record Any matter observed Evidence tool Provision of MOA & AOA Error or fraud Management representations

Audit programme

Detailed pan

Description of work to

be done

Specifying procedures

to be followed

Part of current audit file

Audit Working Papers

Planning and performing

audit

Supervision & review of

audit work

Evidence of audit

Permanent and current

files

Audit Note Book

Permanent record

Any matter observed

Evidence tool

Provision of MOA

& AOA

Error or fraud

Management

representations

AUDIT RISK INHERENT RISK No internal controls CONTROL RISK With the present accounting & internal control system, a particular misstatement will not be prevented/detected/corrected on timely basis DETECTION RISK An auditor’s substantive procedures will not detect an existing misstatement

INHERENT RISK

No internal controls

CONTROL RISK

With the present accounting & internal control system, a particular misstatement will not be prevented/detected/corrected on timely basis

DETECTION RISK

An auditor’s substantive procedures will not detect an existing misstatement

RELATIONSHIP BETWEEN DIFFERENT TYPES OF RISK The shaded areas relate to Detection risk HIGHEST HIGHER MEDIUM LOW HIGHER MEDIUM LOW MEDIUM LOWER MEDIUM LOWER LOWEST HIGH AUDITOR’S ASSESSMENT OF INHERENT RISK MEDIUM HIGH AUDITOR’S ASSESSMENT OF CONTROL RISK

AAS 28- AUDITOR’S REPORT ON FINANCIAL STATEMENTS Title- Auditor’s report Addressee – appointing authority Introductory para Scope para Opinion para Date of report Place of signature Auditor’s signature Unqualified opinion Qualified – ‘subject to’ or ‘except for’ Disclaimer – not able to obtain sufficient appropriate audit evidence Adverse – misleading/incomplete nature of financial statements

Title- Auditor’s report

Addressee – appointing authority

Introductory para

Scope para

Opinion para

Date of report

Place of signature

Auditor’s signature

Unqualified opinion

Qualified – ‘subject to’ or ‘except for’

Disclaimer – not able to obtain sufficient appropriate audit evidence

Adverse – misleading/incomplete nature of financial statements

GUIDANCE NOTE ON INDEPENDENCE OF AUDITORS Independence of mind & Independence in appearance Independence of mind- acting with integrity, professional skepticism & exercise objectivity Independence in appearance- avoidance of facts & circumstances Self Interest threats-direct financial interest Self Review threats- review of an earlier judgement or conclusion Advocacy threats- promoting client’s opinion Familiarity threats- close relationship

Independence of mind & Independence in appearance

Independence of mind- acting with integrity, professional skepticism & exercise objectivity

Independence in appearance- avoidance of facts & circumstances

Self Interest threats-direct financial interest

Self Review threats- review of an earlier judgement or conclusion

Advocacy threats- promoting client’s opinion

Familiarity threats- close relationship

GUIDANCE NOTE ON 227(3)(e) and (f) of the companies act, 1956 Clause (e) – the auditor’s report shall state in thick type or in italics the observations/comments of the auditors which have any adverse effect on the functioning of the company. Clause (f) – whether any director is disqualified from being appointed as director u/s 274(1)(g) Defaulting company= public company has not filed annual accounts and annual returns for any continuous 3 financial years commencing on/after 1/4/99 or Failed to Repay its deposit or interest thereon on due date or redeem its debentures on due date or pay any dividend and such failure continues for one year or more

Clause (e) – the auditor’s report shall state in thick type or in italics the observations/comments of the auditors which have any adverse effect on the functioning of the company.

Clause (f) – whether any director is disqualified from being appointed as director u/s 274(1)(g)

Defaulting company= public company has not

filed annual accounts and annual returns for any continuous 3 financial years commencing on/after 1/4/99 or

Failed to Repay its deposit or interest thereon on due date or redeem its debentures on due date or pay any dividend and such failure continues for one year or more

DIVIDENDS-sec 205 Can be declared out of – current yr profits after depreciation; past yr profits after depn; aggregate of the above; money provided by central/state govt in this behalf In view of public interest, the central govt may exempt any company from providing depn before declaring os paying dividends Past losses: amt equal to the loss or depn for the year of loss, whichever is less, is set off from the current yr

Can be declared out of – current yr profits after depreciation; past yr profits after depn; aggregate of the above; money provided by central/state govt in this behalf

In view of public interest, the central govt may exempt any company from providing depn before declaring os paying dividends

Past losses: amt equal to the loss or depn for the year of loss, whichever is less, is set off from the current yr

Only registered shareholders are entitled to dividend; preference dividend is to be paid before euity dividend Dividend in abeyance- sec 206A Dividend is payable only in cash Must be paid within 30 days from the date of declaration

Only registered shareholders are entitled to dividend; preference dividend is to be paid before euity dividend

Dividend in abeyance- sec 206A

Dividend is payable only in cash

Must be paid within 30 days from the date of declaration

QUALIFIED OPINION We have audited….. Except as discussed in the following paragraph. We conducted our audit in accordance with…… We did not observe the counting of the physical inventories as at 31 st march,2008 since that date was prior to the time we were appointed as auditors of X ltd. Owing to the nature of the entity’s records, we were unable to satisfy ourselves as to inventory quantities by other audit procedures. In our opinion and to the best of our information and according to the explanations given to us, subject to the effects of such adjustments, if any, as might have been determined to be necessary had we been able to satisfy ourselves as to physical inventory quantities. The financial statements give a………

We have audited…..

Except as discussed in the following paragraph. We conducted our audit in accordance with……

We did not observe the counting of the physical inventories as at 31 st march,2008 since that date was prior to the time we were appointed as auditors of X ltd. Owing to the nature of the entity’s records, we were unable to satisfy ourselves as to inventory quantities by other audit procedures.

In our opinion and to the best of our information and according to the explanations given to us, subject to the effects of such adjustments, if any, as might have been determined to be necessary had we been able to satisfy ourselves as to physical inventory quantities. The financial statements give a………

ADVERSE OPINION We have audited the attached B/S of…, as at 31 st march…, and also the P & L a/c for the year ended on that date annexed thereto. These financial statements are the responsibility of the mgnt. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with… In our opinion and to the best of our information and according to the explanations given to us, because of the effects of the matters discussed in the preceding para(s), the financial statements do not give a true and fair view in conformity with the accounting principles generally accepted in India: In the case of B/S, of the state of affairs of the company as at In the case of P&L a/c, of the profit/loss for the year ended on that date.

We have audited the attached B/S of…, as at 31 st march…, and also the P & L a/c for the year ended on that date annexed thereto. These financial statements are the responsibility of the mgnt. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with…

In our opinion and to the best of our information and according to the explanations given to us, because of the effects of the matters discussed in the preceding para(s), the financial statements do not give a true and fair view in conformity with the accounting principles generally accepted in India:

In the case of B/S, of the state of affairs of the company as at

In the case of P&L a/c, of the profit/loss for the year ended on that date.

DISCLAIMER OF OPINION We were engaged to audit the attached B/S of … as at 31 st march,…. And also P & L a/c for the year ended on that date annexed thereto. These financial statements are the responsibility of the entity’s management. ( Omit the sentence stating the responsibility of the auditor). (the para discussing the scope of the audit would either be omitted or amended according to the circumstances) (add a para discussing the limitation) We were not able to observe all physical inventories and confirm accounts receivable due to limitations placed on the scope of our work by the entity. Because of the significance of the matters discussed in the preceding para, we did not express an opinion on the financial statements

We were engaged to audit the attached B/S of … as at 31 st march,…. And also P & L a/c for the year ended on that date annexed thereto. These financial statements are the responsibility of the entity’s management. ( Omit the sentence stating the responsibility of the auditor).

(the para discussing the scope of the audit would either be omitted or amended according to the circumstances)

(add a para discussing the limitation)

We were not able to observe all physical inventories and confirm accounts receivable due to limitations placed on the scope of our work by the entity. Because of the significance of the matters discussed in the preceding para, we did not express an opinion on the financial statements

SPECIMEN AUDIT PROGRAMME

Q 1 C is partner in ABC Associates, Chartered Accountants. Analyse whether disqualification provisions are attracted in the following cases: C is indebted for an amount exceeding Rs 1000. Can C be appointed as an auditor in his individual name? The firm is indebted for > 1000. Can C be appointed as an auditor in his individual name? Ans When a firm is appointed as auditor, each partner is deemed to be so indebted When a firm is indebted, each partner is deemed to be so indebted In both the cases disqualification will apply

Q 1

C is partner in ABC Associates, Chartered Accountants. Analyse whether disqualification provisions are attracted in the following cases:

C is indebted for an amount exceeding Rs 1000. Can C be appointed as an auditor in his individual name?

The firm is indebted for > 1000. Can C be appointed as an auditor in his individual name?

Ans

When a firm is appointed as auditor, each partner is deemed to be so indebted

When a firm is indebted, each partner is deemed to be so indebted

In both the cases disqualification will apply

Q 2 At the AGM of navkar ltd, Om is appointed as the auditor. Om refuses to accept the audit. The company holds another general meeting and appoints a new auditor Ans Refusal to accept appointment in the first AGM implies that no auditor has been appointed at the AGM. Therefore central govt has the power to appoint an auditor u/s 224(3)

Q 2

At the AGM of navkar ltd, Om is appointed as the auditor. Om refuses to accept the audit. The company holds another general meeting and appoints a new auditor

Q 3 The company recorded on 31.3.04 a sale of goods to the tune of Rs 10000 to A & Co ltd, a sister concern and recognized a profit of Rs 2500. On April 1,2004 a purchase of the goods of the same description amounting to Rs 10000 from A co was found to be recorded.

Ans The auditor should enquire whether such transactions are merely book entries and whether such entries are prejudicial to the interests of the company. In this case the sale and purchase are intended to boost up the profits. The auditor should report the matter to the members

Ans

The auditor should enquire whether such transactions are merely book entries and whether such entries are prejudicial to the interests of the company.

In this case the sale and purchase are intended to boost up the profits.

The auditor should report the matter to the members

Q 4 which of the following will you include for the purpose of calculation u/s 224(1)(B)? government companies Sec 25 companies Unlimited liability company Special audit Tax audit Joint audit Foreign company audit Internal audit Private company audit Branch audit Audit of Statutory corporation Investigation Guarantee companies having no share capital Yes Yes Yes No No Yes No No No No No No no

government companies

Sec 25 companies

Unlimited liability company

Special audit

Tax audit

Joint audit

Foreign company audit

Internal audit

Private company audit

Branch audit

Audit of Statutory corporation

Investigation

Guarantee companies having no share capital

Yes

Yes

Yes

No

No

Yes

No

No

No

No

No

No

no

Q 5 A newly set up pvt ltd manufacturing company has incurred the following expenditure during its construction period. It intends to capitalize the expenses. Comment Foreign tour expenses of directors for purchasing plant and machinery Expenditure incurred for acquisiton of an asset should be capitalised as a part of the cost of the asset. But if they fail to pruchase the Plant & Machinery it has to be treated as deferred revenue expense and shown under miscellaneous expenses

Foreign tour expenses of directors for purchasing plant and machinery

Non technical staff’s salary during the period of installation of Plant & Machinery It represents indirect expenditure related to acquisition/construction and is incidental thereto and should be capitalised as part of acquistion/construction cost.

Non technical staff’s salary during the period of installation of Plant & Machinery

It represents indirect expenditure related to acquisition/construction and is incidental thereto and should be capitalised as part of acquistion/construction cost.

Other sundry expenses such as Stationery, printing, postage, telephones etc Such expenses are also indirectly related the construction and are incidental thereto and therefore it is recommended that the same be capitalised as a part of construction cost .

Other sundry expenses such as Stationery, printing, postage, telephones etc

Such expenses are also indirectly related the construction and are incidental thereto and therefore it is recommended that the same be capitalised as a part of construction cost .