It is a presentation on basic introduction to the subject of Auditing. This is published only for education and information purpose.

1. Principles and Practices of
Auditing
Unit 1 - Introduction to Audit

2. Topics covered under this chapter.
• Origin of Audit
• Meaning
• Definition
• Purpose and Functions of Audit
• Factors responsible for growth of Auditing
• Advantages & Limitations of Audit
• Difference between Book Keeping, Accountancy and Audit
• Objects of Audit – Primary and Secondary Objectives

3. Topics covered under this chapter.
• Errors and Location of Errors
• Position of Auditors in relation to Errors and Frauds
• Different types of Audit and their advantages
• Statutory Audit, Partial Audit, Cash Audit, Interim Audit, Balance
Sheet Audit, Cost Audit, Occasions Audit
• Investigation – Meaning
• Difference between Investigation and Auditing
• Investigation regarding business purchase and investments

4. Origin of Audit
• Historical records show that Egyptians, Greeks and Romans used to
get their public accounts scrutinized by an Independent Official.
• Need felt during the Industrial Revolution (mass production &
economies of scale)
• Creation of Monitoring Authority (review & correction mechanism)
• Emergence of Appraisal Agencies (external firms)
• Grew as an independent and professional medium
• A class by itself and self regulated discipline

5. Meaning
• Derived from Latin word – “Audire” which means “to hear”
• An Auditor – An Individual appointed by the company owners to
check accounts whenever they suspected fraud, to hear the
explanation given by the person responsible for financial transactions.
• Luca Pacialo – Italian Mathematician – In 1494 – first to mention and
describe the duties & responsibilities of an Auditor
• Object of an audit was mainly to see whether the accounting party
has properly accounted for the receipts and payments of cash

6. Definition of Auditing
• ICAI – The independent examination of financial information of any entity,
whether profit oriented or not, and irrespective of its size or legal form,
when such examination is conducted with a view to expressing an opinion
thereon.
• Montgomery, a leading American Accountant – “Auditing is a systematic
examination of the books and records of a business or other organization, in
order to ascertain or verify, and to report upon the facts regarding its
financial operations and the results thereof”.
• Comprehensive Definition – It is an examination of the accounting books
and the relative documentary evidence so that an auditor may be able to
find out the accuracy of figures and may be able to make report on the
balance sheet and other financial statements which have been prepared
from there.

7. Purpose of Auditing
• To conduct careful examination of books of accounts, documents,
records and vouchers
• To gather and test the evidence for framing an opinion
• To give expert advice for improving efficiency and productivity
• To express an opinion on the quality of financial statements
• To review operations and performances connected with non financial
areas
• To serve as a guide to the management to take future decisions
• To understand the usage and allocation of funds

8. Features and Functions of Auditing
• A Systematic and Scientific examination of the books of accounts
• Involves inspecting, comparing, checking, reviewing, ascertaining,
scrutinizing and verifying the vouchers supporting the transaction
• Implies the verification that is the physical inspection of the assets and
liabilities of the business as shown in the balance sheet
• Examination of the books of accounts prepared by the employees of
the company and examined by an independent person or body or
persons
• Carried out periodically – quarterly, half yearly, annually

9. Features and Functions of Auditing
• Prepared on the basis of documentary evidence such as invoices,
receipts, vouchers and other accounts related ledgers
• Made for the purpose of ascertaining whether the financial figures
found in the books of accounts and the financial statements are
authentic, properly authorized and accurate
• Requires the Auditor to express his opinion about the truth and
fairness of the financial statement
• Applies to business concern as well as non business concern

10. Factors responsible for growth of Auditing
• Rising importance of Quality, Transparency and Independence
• Increase in size of business (level of operations)
• Dynamic nature of business (change in technology & processes)
• Need for effective fraud detection and risk management procedures
• Legislation and regulatory requirements (corporate governance)
• Competition from competitors (operational efficiencies & cost
effectiveness)
• Impact of IT (computerization of operations & controls)

11. Advantages or Merits of Auditing
• Verification of the books of accounts and financial statements
• Discover and prevent errors or mistakes
• Discovery and prevention of frauds or fraudulent activities
• Acts as a moral check on the employees of the company
• Provides independent opinion about the business condition
• Protects the interest of shareholders
• Acts as a check on Directors or Management
• Provides valuable and expert advice on process & procedures of
accounts

12. Advantages or Merits of Auditing
• Very useful in settling disputes or legal matters
• Audited financial statements are very useful in obtaining loans from
financial institutions
• Fire insurance claims and fraud claims can be settled on the basis of
previous years financial accounts
• It helps in smooth valuation and assessment of company property
during the sale of business
• Audit reports provide correct information and financial status of the
organization
• Helps investors in assessment of companies to make investments
• Assessment of tax becomes easy for the tax department

13. Limitations or Demerits of Auditing
• Non detection of certain errors or frauds
• Dependence on explanation and information given by the responsible
employees
• Conflicts or differences of opinion with auditor, accountants or
management
• Effect of inflation on financial statements
• Management may use corrupt practices to influence the process
• No assurance can be given by auditors about company’s future
profitability and prospects
• Certain non monetary facts cannot be measured
• It may not display the current values of the assets and liabilities

14. Difference between Book Keeping, Accountancy
and AuditingBookKeeping
•1. Recording of
business
transactions in
the books of
original entry
and ledgers.
•2. Done by
Junior Clerk or
Automated
Machines.
Accountancy
1. Preparation of
trial balance to
ascertain
arithmetical
accuracy of the
entries made in
the books of
accounts.
2. Carried out by
Accountants.
Auditing
1. Analytical and
critical examination
of the books of
accounts and
financial statements
to establish
authenticity and
correctness of the
entries found.
2. Undertaken by
Qualified Auditors.

15. Difference between Book Keeping, Accountancy
and AuditingBookKeeping
3. Records and
maintains daily
business
transactions in
the ledger books.
4. Not governed
by any
recognized
professional
body.
Accountancy
3. Measures and
communicates
working results &
financial position
of the company.
4. Not governed
by any
recognized
professional
body.
Auditing
3. Reviews the
measurements
and
communication
of working
results.
4. Governed by
standards laid
down by ICAI.

16. Difference between Book Keeping, Accountancy
and AuditingBookKeeping
5. Based on daily
recording of
business
transaction.
6. Required to
record day to day
business
transactions in
prescribed
manner.
Accountancy
5. Based on
current recording
of business
transaction.
6. Required to
prepare books of
accounts and not
expected to find
frauds.
Auditing
5. Retrospective-
Based on past
transactions.
6. Required to
find frauds and
provide
suggestions.

17. Objects of Audit – Main or Primary
• Examining the system of internal check
• Checking arithmetical accuracy of books of accounts, verifying
posting, costing, balancing
• Verifying the authenticity and validity of transactions
• Checking the proper distinction of capital and revenue nature of
transactions
• Confirming the existence and value of assets and liabilities
• Verifying whether all the statutory requirements are fulfilled or not
• Proving true and fairness of operating results presented in books of
accounts

18. Objects of Audit – Subsidiary or Secondary
• Detection and Prevention of Errors
• Detection and Prevention of Frauds
• Under or Over Valuation of Stock
• Provide accurate and complete information to Income Tax Authorities
• Satisfy the Provisions of the Company’s Act

19. Types of Errors
• Errors of Omission – A transaction has not been recorded in the books of
account either wholly or partially
• Errors of Commission – A transaction has been recorded but has been
wrongly entered in the books of original entry or in ledger
• Errors of Principle – When entries are not recorded according to the
fundamental principles of accountancy
• Compensating Errors – Also known as off setting error, is a type of error
which is counter balanced by any other error or errors
• Errors of Duplication – An entry in a book of original entry has been made
twice and has also been posted twice

20. Location of Errors
• Check the totals of the trial balance
• Compare the names of accounts in the ledger with the names of accounts
in the trial balance
• Total the list of debtors and creditors and compare them with the trial
balance
• Compare the items of the trial balance with the items of the trial balance
of the previous year to see if any item has been omitted
• Totals of some subsidiary books (Cash, Purchases & Sales Book) may not
have been transferred to the trial balance. Re-check the totals of these
books.

21. Position of Auditors in relation to Errors and Frauds
• It is responsibility of management to prevent errors and frauds
• Auditor is not liable for any subsequent discovery of misstatement of
financial information resulting from errors and frauds, if he carried out his
duty according to the generally accepted auditing practices
• If any errors or frauds are discovered by the Auditor during his audit, he
must see that the errors are corrected and the effect of fraud on financial
information of the statements is properly reflected, simultaneously
bringing this to the notice of the concerned
• Auditor need not sniff for errors and frauds, but if he smells something
about it, he should not leave them carelessly, he may enlarge his extent
of checking and if required, he may modify checking procedures
accordingly

22. Different types of Audit & their advantages
• Statutory Audit
• Partial Audit
• Cash Audit
• Interim Audit
• Balance Sheet Audit
• Cost Audit
• Occasions Audit

23. Statutory Audit
• It refers to the audit of accounts of a business enterprise carried out
compulsorily under the provision of a Statute of Law.
• Any audit carried on as per the requirement of law is called as a Statutory
Audit.
• All Companies have to get their accounts audited as per the provisions of
the Company’s Act of 1956.

24. Advantages of Statutory Audit
• In case of Joint Stock Company, SA enables the shareholder to know the
truth and fairness of the assertion made by the management in the
financial statements of the Company
• In case of a Trust, SA protects the interest of the beneficiaries against
possible frauds by the trustee and also protects the interest of the trustee
who may not possess adequate knowledge of the principles of accounting
or the trust laws
• In case of a Co-operative Society, SA helps or serves to maintain proper
books of accounts and check frauds committed by the managing
committee and protect the members

25. Partial Audit
• An audit which is conducted considering the particular area of accounting
is called Partial Audit
• Under PA, audit of all books of accounts is not conducted
• Company may conduct audit of any transaction – Cash, Stock, Debtor,
Creditor etc.
• An Auditor should conduct audit of that transaction as per the scope
determined by the agreement
• He signs the report clearly stating that the engagement is Partial Audit

26. Cash Audit
• It is a type of accounting audit that focuses on cash transactions
conducted between an identified start date and end date.
• This type of audit may be considered full or partial, depending on
whether only certain transactions are evaluated or if every cash
transaction relevant to the audit period is scrutinized.
• Purpose of a CA is to ensure that all investigated transactions have
been conducted in compliance with Generally Accepted Accounting
Procedures and that the transactions were in accordance with the
policies and procedures of the company involved.

27. Advantages of Cash Audit
• It focuses on the type of cash deposits or contributions that are
received and how they are recorded in the accounting records.
• Along with addressing cash receipts, it will look closely at any type of
disbursements made as cash transactions, making sure those
disbursements are properly documented and were done with proper
authorization.
• It will make sure that the receipts and disbursements involved line up
so that the amount of cash that is shown as being on hand or deposit
is justified by the combination of cash transactions.

28. Interim Audit
• An audit which is conducted in between the two annual audits with a
view to find out interim profits to enable the company to declare an
interim dividend is known as Interim Audit.
• It is an audit conducted during the fiscal year usually as a means of
minimizing the work and time involved in concluding the audit after
the fiscal year.

29. Advantages of Interim Audit
• It is very useful to publish interim figures
• Helps in detection of errors and frauds in time
• Acts as a moral check on staff / employees, they may not commit
frauds as IA can happen anytime during the year
• Smoothen the process of final audit
• Helps in implementation of suggestions by Auditor
• Preparation of proposed interim dividends made easy
• Entry / Exit of a partner – correct position of company is determined
• Useful to management in fixing the selling price of goods and services

30. Balance Sheet Audit
• It is an evaluation of the accuracy of information found in a company’s
balance sheet.
• It involves a number of checks as auditors conduct this evaluation based
on supporting documents.
• Involves verification of the value of assets, liabilities, the balances of
reserves and provisions and the amount of profit earned or loss suffered
by a firm during the year.
• It is a condensed statement that shows the financial position of an entity
on a specified date, usually the last day of an accounting period.
• It is used to detect irregularities or weaknesses in a company’s accounting
system.

31. Cost Audit
• It is the verification of cost accounts and check on the adherence to cost
accounting plan.
• It ascertains the accuracy of cost accounting records to ensure that they in
conformity with cost accounting principles, plans, procedures and
objectives.
• Verification of the accuracy of the cost accounts, cost reports, cost
statements, cost data and costing techniques.
• Aims to identify the undue wastage or losses and ensure that costing
system determines the correct and realistic cost of production.
• Provides useful information to the management regarding regulating
production, economical method of operation, reducing cost of operation
and reformulating cost accounting plans.

32. Advantages of Cost Audit
• Management will get reliable data for it day to day operations like price fixing,
control, decision making
• A close and continuous check on all wastages will be kept through a proper
system of reporting to management
• Inefficiencies in the working of the company will be brought to light to facilitate
corrective action
• System of budgetary control and standard costing will be greatly facilitated
• Helps in the detection of errors and fraud
• Reliable check on the valuation of closing stock and work in progress
• Assists government to fix the price of the contract at a reasonable level
• Facilitates in settlement of trade disputes

33. Occasions Audit
• It is conducted when there is need of it.
• The owners can decide to check their accounts occasionally.
• The audit period is not regular but on certain occasions audit becomes
due.
• It is concerned with improving the quality of products, reduction of
product cost, health & welfare of employees, fair wages, prices, profits,
energy & material conservation, population control, water treatment &
cleanliness, etc.
• Purpose is to check the reliability of the books of accounts for
compilation of final accounts and balance sheet, it is not a special type of
audit but it’s a part of whole audit.

34. Investigation – Meaning
• An inquiry into the accounts of a business for a special purpose.
• It is an examination of the books of accounts of a business to know its
actual financial position or earning capacity.
• Taylor and Perry – “Investigation involves inquiry into facts behind the
books and accounts, into the technical, financial and the economical
position of the business or organization”.
• It is a kind of special audit with a limited or extended scope according to
the purpose for which it is conducted.

35. Difference between Investigation and Auditing
Auditing1. Conducted on behalf of
Shareholders or Proprietors.
2. It is compulsory for a
Company.
3. Carried out periodically –
quarterly, half yearly & annually.
4. Regular statutory procedure.
5. Audit Report – Management.
6. Auditor – Mentions his
satisfaction/concerns of the
books of accounts on compliance
matters.
Investigation
1. Conducted on behalf of
outsiders who intend to
purchase the business or wish to
lend money.
2. It is not compulsory.
3. Carried out only if required.
4. It is a Special enquiry.
5. Investigation Report –
Interested Authorities.
6. Investigator - Shares his
findings and recommendations
with the client.

36. Investigation regarding business purchase
• Why does the vendor sell the business? Is it a genuine case of sale?
• Whether it is worthwhile to purchase the business.
• What is the trend of the business? Statement for past years.
• Whether the assets have been properly valued and sufficient depreciation
has been provided on these assets.
• Whether the company goodwill is appropriately valued.
• Whether sufficient provision has been made for bad / doubtful debts.
• Whether the liabilities have been properly valued and that they have not
been shown at a lower figure.
• Whether the accounts have been previously audited. Examine Auditor’s
report.

37. Investigation regarding business purchase
• Whether the working capital is sufficient and reserves are adequate.
• Whether the plant and machinery are old or new.
• Whether any technical knowledge or skill is required for the business to be
taken over. Whether client possesses such a skill.
• Whether trade restrictions have affected recent purchases and sales.
• Whether there is much competition in the business which is proposed to be
taken over.
• Whether the vendor will be allowed to carry on the same type of business.
• Whether the customers are a set of friends of the vendor who will cease
patronizing the business after it has been sold to his client.

38. Investigation regarding investments
• Investigator will do Valuation of shares for investment purposes.
• On the basis of the Average Profits in the previous years.
• On the basis of the Net Assets of the Company.
• Generally valued at market price or book value.
• Study the conditions prevailing in the money market.
• Ascertain the level of dividends payable and security of amount invested
in the purchase of shares.
• Memorandum of Association and Articles of the Company must be
scrutinized to ascertain the rights of different classes of shareholders.
• Sometimes, based on findings, Auditor is asked to fix the fair value of the
shares to be paid by the shareholders.