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Principles and Practices of
Auditing
Unit 2 – Preparations &
Procedures of Audit
Topics covered under this chapter.
• Preparations & Considerations by Auditor before commencement of Audit
• Audit Program
• Audit Note Book
• Audit working papers
• Audit Files
• Adoption of distinctive ticks
• Audit in depth
• Routine checking
• Test checking
Preparations and Considerations by the Auditor before
commencement of Audit
• Verification of Appointment – Auditor has to confirm whether his appointment
is properly made or not. If appointment is not proper, he can claim
remuneration, if he is appointed by shareholders, he has to see whether the
procedure specified under Section 224, is properly followed or not. If he is
appointed by directors he has to go through the resolution made by the court.
• Verification of Memorandum – It deals with external affairs of the company.
Out of its clauses, the information written under Objects Clause, Liability Clause
and Capital Clause is useful to Auditor.
• Verification of Articles – It deals with internal affairs of the company. It includes
calls on share, transfer and transmission of shares, reserves and payment of
dividend.
Preparations and Considerations by the Auditor before
commencement of Audit
• Verification of Prospectus – Auditor should refer this to obtain information
relating to minimum subscription, preliminary expenses, underwriters
commission and terms of issue.
• Verification of Contract Deeds – On account of legal entity, company can enter
into contracts. Auditor should refer to these contract deeds to know about
names of parties to the contract, contract prices and other terms of contract.
• Verification of Certificate of Incorporation and Certificate of Commencement
of Business – In case of first audit of the company, Auditor should refer to COI &
COC issued by Registrar of Companies, to confirm that the company is formed in
accordance with Companies Act.
Preparations and Considerations by the Auditor before
commencement of Audit
• Verification of Internal Check System – ICS means arrangement of staff in
such a way where work done by one clerk automatically gets checked by
the other staff. Well planned ICS minimizes scope for frauds and errors. A
good ICS reduces the work load of an Auditor.
• Verification of List of Key Positions – Auditor should refer to
organizational chart of the company and obtain names, rights, duties,
specimen signatures of staff members employed at such key positions.
• Verification of List of Offices – Auditor has to obtain and verify the list of
offices or branches situated at various locations along with complete
address for communication.
Preparations and Considerations by the Auditor before
commencement of Audit
• Verification of List of Books – Auditor should obtain the list of books maintained by
the company. It includes books such as Statutory or Mandatory books, Statistical or
Optional books, Cost records and financial reports.
• Verification of Financial Statement – Auditor should get copies of previous 2 or 3
years financial statements long with Audit Reports. By going through them, he will get
an idea with respect to profitability, financial position and previous Auditor’s opinion.
• Verification of Central Government Permission – In certain cases, company has to
obtain permission from central government for carrying out audits. In such cases,
Auditor has to check whether permission is received or not.
Audit Program
• Planning of audit work is called Audit Program.
• It shows division of audit work among audit staff.
• It represents an outline of procedure to be followed to support an opinion
on financial statements.
• It is the auditor’s plan of action and it is specifically designed for each
audit.
• It provides a plan of the work of examination and a set of audit
procedures.
• Auditor should draft out a program according to the requirement of each
case as to what work is to be done by senior or junior staff and the time by
which the work is to be finished.
• After preparation of audit program, audit work can be commenced.
Audit Note Book
• A note book which is prepared by the audit staff to note down all the
unclear queries which they may find in the course of audit and requires
further clarification and explanation is known as Audit Note Book.
• It contains information regarding day to day work performed by the audit
staff on any particular date.
• Notes about all types of errors, difficulties and unclear queries or points to
be discussed with the auditor or clients and the points which are to be
incorporated in the report are noted down.
• It is prepared with the objective to make the future audit work easier.
• It serves as a proof by the auditor to get clearance over the cases if the
auditor has been accused for negligence.
Audit Working Papers
• They are a set of documents which record all audit evidence obtained
during financial statements auditing, internal management auditing,
information systems auditing and investigations.
• They are used to support the audit work done in order to provide assurance
that the audit was performed in accordance with the relevant auditing
standards.
• These papers show whether the audit was properly planned, carried out, if
there was adequate supervision, whether the appropriate review was
undertaken, whether the evidence is sufficient and appropriate to support
the audit opinion.
• They are the property of the auditor and these documents may be in the
form of flow chart, manual, narrative note, checklist or questionnaire.
Audit Files
• A good filing and indexing system of audit working papers is very
important.
• It provides complete information and helps in doing cross references for
any audit issues.
Types of Audit Files are:
• Permanent Audit File
• Current Audit File
Permanent Audit File
• Information concerning legal and organizational structure of the entity.
• Extracts of documents with significant matters like agreements,
arrangements, minutes.
• A record of study of internal and accounting control of the entity.
• Copies of management letters issued to auditors.
• Copy of communication with retiring auditors.
• Copies of audited financial statements of previous years.
• Analyses of significant ratios and trends.
• Important audit observations of earlier years.
• Notes on critical accounting policies.
Current Audit File (audit files of a single period)
• Correspondence relating to acceptance of annual engagement.
• Minutes of Board meeting relevant to current year.
• Audit program
• Analyses of transactions and balances
• Record of nature, timing & extent of audit procedures carried out & their
results.
• Evidence that the work of assistants had been supervised & reviewed
• Copies of communication with experts, other auditors, third parties.
• Copies of letters or notes on audit matters communicated to the client,
including terms of engagement / material weakness internal control.
• Conclusions reached on significant audit matters.
• Copies of financial information reported – audit reports issues.
Adoption of distinctive ticks
• Distinctive ticks of different colors should be adopted for Additions,
Postings, Ledger Balances, Carry Forwards etc.
• The significance of these ticks should not be made known to the clerks of
the client, lest they know about the secret meaning and defraud the auditor.
• The same kind of tick should not be used for every firm and for the same
kind of transactions or for all the visits.
• Special ticks should be used for figures which are erased or altered.
• Pencil figures entered by the clients should not be accepted by the auditor
and the auditor should refuse to commence his work until these figures are
inked.
Auditing in depth
• It is a method according to which a few selected transactions are
subjected to a thorough scrutiny in forming an opinion as regards the
accuracy of the data so scrutinized.
• The auditor has to examine a few transactions in detail, from the origin
of the transactions to their conclusion.
• Every record maintained relating to a particular transaction is
scrutinized.
• The objective is to see whether a very efficient internal check and control
system is in operation.
• This principle is possible in large firms but is not suitable for small firms.
• This will help the auditor to find out the weak points of the existing
accounting procedures and provide required suggestions for
improvement.
Routine Checking
• It involves checking of common records and books which is carried on by
the auditor as a matter of routine.
• It includes checking of books of original entry, postings in the ledgers,
balances in the ledgers, transfer of balances from ledger to trial balance.
• It helps the auditor in finding out certain errors and frauds.
• It can disclose only clerical errors and some simple frauds.
• Only occasionally it may help in detecting errors of principle.
• For detecting clever frauds and errors of principles an auditor has to go
beyond routine checking.
Test Checking
• Testing and test checking means to select and examine a representative
sample from a large number of similar items.
• In big business houses where the number of transactions to be checked is
very large and the time at the disposal of the auditor is little, a few
transactions may be checked at random. Such a check is called test check.
• All the transactions need not be checked. This method of checking the
accounts will minimize the work of the auditor.
• The auditor should be very careful in relying upon the test check.
• He should apply these checks if he is fully satisfied that the internal check
system prevalent is efficient and no suspicion arises in his mind.

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Unit 2 Preparations Before Auditing

  • 1. Principles and Practices of Auditing Unit 2 – Preparations & Procedures of Audit
  • 2. Topics covered under this chapter. • Preparations & Considerations by Auditor before commencement of Audit • Audit Program • Audit Note Book • Audit working papers • Audit Files • Adoption of distinctive ticks • Audit in depth • Routine checking • Test checking
  • 3. Preparations and Considerations by the Auditor before commencement of Audit • Verification of Appointment – Auditor has to confirm whether his appointment is properly made or not. If appointment is not proper, he can claim remuneration, if he is appointed by shareholders, he has to see whether the procedure specified under Section 224, is properly followed or not. If he is appointed by directors he has to go through the resolution made by the court. • Verification of Memorandum – It deals with external affairs of the company. Out of its clauses, the information written under Objects Clause, Liability Clause and Capital Clause is useful to Auditor. • Verification of Articles – It deals with internal affairs of the company. It includes calls on share, transfer and transmission of shares, reserves and payment of dividend.
  • 4. Preparations and Considerations by the Auditor before commencement of Audit • Verification of Prospectus – Auditor should refer this to obtain information relating to minimum subscription, preliminary expenses, underwriters commission and terms of issue. • Verification of Contract Deeds – On account of legal entity, company can enter into contracts. Auditor should refer to these contract deeds to know about names of parties to the contract, contract prices and other terms of contract. • Verification of Certificate of Incorporation and Certificate of Commencement of Business – In case of first audit of the company, Auditor should refer to COI & COC issued by Registrar of Companies, to confirm that the company is formed in accordance with Companies Act.
  • 5. Preparations and Considerations by the Auditor before commencement of Audit • Verification of Internal Check System – ICS means arrangement of staff in such a way where work done by one clerk automatically gets checked by the other staff. Well planned ICS minimizes scope for frauds and errors. A good ICS reduces the work load of an Auditor. • Verification of List of Key Positions – Auditor should refer to organizational chart of the company and obtain names, rights, duties, specimen signatures of staff members employed at such key positions. • Verification of List of Offices – Auditor has to obtain and verify the list of offices or branches situated at various locations along with complete address for communication.
  • 6. Preparations and Considerations by the Auditor before commencement of Audit • Verification of List of Books – Auditor should obtain the list of books maintained by the company. It includes books such as Statutory or Mandatory books, Statistical or Optional books, Cost records and financial reports. • Verification of Financial Statement – Auditor should get copies of previous 2 or 3 years financial statements long with Audit Reports. By going through them, he will get an idea with respect to profitability, financial position and previous Auditor’s opinion. • Verification of Central Government Permission – In certain cases, company has to obtain permission from central government for carrying out audits. In such cases, Auditor has to check whether permission is received or not.
  • 7. Audit Program • Planning of audit work is called Audit Program. • It shows division of audit work among audit staff. • It represents an outline of procedure to be followed to support an opinion on financial statements. • It is the auditor’s plan of action and it is specifically designed for each audit. • It provides a plan of the work of examination and a set of audit procedures. • Auditor should draft out a program according to the requirement of each case as to what work is to be done by senior or junior staff and the time by which the work is to be finished. • After preparation of audit program, audit work can be commenced.
  • 8. Audit Note Book • A note book which is prepared by the audit staff to note down all the unclear queries which they may find in the course of audit and requires further clarification and explanation is known as Audit Note Book. • It contains information regarding day to day work performed by the audit staff on any particular date. • Notes about all types of errors, difficulties and unclear queries or points to be discussed with the auditor or clients and the points which are to be incorporated in the report are noted down. • It is prepared with the objective to make the future audit work easier. • It serves as a proof by the auditor to get clearance over the cases if the auditor has been accused for negligence.
  • 9. Audit Working Papers • They are a set of documents which record all audit evidence obtained during financial statements auditing, internal management auditing, information systems auditing and investigations. • They are used to support the audit work done in order to provide assurance that the audit was performed in accordance with the relevant auditing standards. • These papers show whether the audit was properly planned, carried out, if there was adequate supervision, whether the appropriate review was undertaken, whether the evidence is sufficient and appropriate to support the audit opinion. • They are the property of the auditor and these documents may be in the form of flow chart, manual, narrative note, checklist or questionnaire.
  • 10. Audit Files • A good filing and indexing system of audit working papers is very important. • It provides complete information and helps in doing cross references for any audit issues. Types of Audit Files are: • Permanent Audit File • Current Audit File
  • 11. Permanent Audit File • Information concerning legal and organizational structure of the entity. • Extracts of documents with significant matters like agreements, arrangements, minutes. • A record of study of internal and accounting control of the entity. • Copies of management letters issued to auditors. • Copy of communication with retiring auditors. • Copies of audited financial statements of previous years. • Analyses of significant ratios and trends. • Important audit observations of earlier years. • Notes on critical accounting policies.
  • 12. Current Audit File (audit files of a single period) • Correspondence relating to acceptance of annual engagement. • Minutes of Board meeting relevant to current year. • Audit program • Analyses of transactions and balances • Record of nature, timing & extent of audit procedures carried out & their results. • Evidence that the work of assistants had been supervised & reviewed • Copies of communication with experts, other auditors, third parties. • Copies of letters or notes on audit matters communicated to the client, including terms of engagement / material weakness internal control. • Conclusions reached on significant audit matters. • Copies of financial information reported – audit reports issues.
  • 13. Adoption of distinctive ticks • Distinctive ticks of different colors should be adopted for Additions, Postings, Ledger Balances, Carry Forwards etc. • The significance of these ticks should not be made known to the clerks of the client, lest they know about the secret meaning and defraud the auditor. • The same kind of tick should not be used for every firm and for the same kind of transactions or for all the visits. • Special ticks should be used for figures which are erased or altered. • Pencil figures entered by the clients should not be accepted by the auditor and the auditor should refuse to commence his work until these figures are inked.
  • 14. Auditing in depth • It is a method according to which a few selected transactions are subjected to a thorough scrutiny in forming an opinion as regards the accuracy of the data so scrutinized. • The auditor has to examine a few transactions in detail, from the origin of the transactions to their conclusion. • Every record maintained relating to a particular transaction is scrutinized. • The objective is to see whether a very efficient internal check and control system is in operation. • This principle is possible in large firms but is not suitable for small firms. • This will help the auditor to find out the weak points of the existing accounting procedures and provide required suggestions for improvement.
  • 15. Routine Checking • It involves checking of common records and books which is carried on by the auditor as a matter of routine. • It includes checking of books of original entry, postings in the ledgers, balances in the ledgers, transfer of balances from ledger to trial balance. • It helps the auditor in finding out certain errors and frauds. • It can disclose only clerical errors and some simple frauds. • Only occasionally it may help in detecting errors of principle. • For detecting clever frauds and errors of principles an auditor has to go beyond routine checking.
  • 16. Test Checking • Testing and test checking means to select and examine a representative sample from a large number of similar items. • In big business houses where the number of transactions to be checked is very large and the time at the disposal of the auditor is little, a few transactions may be checked at random. Such a check is called test check. • All the transactions need not be checked. This method of checking the accounts will minimize the work of the auditor. • The auditor should be very careful in relying upon the test check. • He should apply these checks if he is fully satisfied that the internal check system prevalent is efficient and no suspicion arises in his mind.