Business Function Accounting & Auditing

1. Business Function
Accounting and Auditing
By- Ms.Shivani Naik Devrukhkar,
ASSISTANT PROFESSOR, (MBA, MCOM,
PGDHE, NET, B.ED)

2. Accounting and Auditing
Function
Definition of Accounting
The definition given by the American Institute of Certified
Public Accountants (‘AICPA’) clearly brings out the meaning
of accounting. According to it, accounting is “the art of
recording, classifying and summarizing in a significant
manner and in terms of money, transactions and events
which are, in part at least, of a financial character and
interpreting the results thereof”.

3. Attributes/Features of Accounting Function
The definition brings out the following as attributes of accounting :
(i) Accounting is an art. Accounting is classified as an art, as it helps
us in attaining our aim of ascertaining the financial results, that is,
operating profit and financial position through analysis and
interpretation of financial data which requires special knowledge,
experience and judgment.
(ii) It involves recording, classifying and summarizing. Recording
means systematically writing down the transactions and events in
account books soon after their occurrence. Classifying is the
process of grouping transactions or entries of the same type at one
place. This is done by opening accounts in a book called ledger.
Summarizing involves the preparation of reports and statements
from the classified data (ledger), understandable and useful to
management and other interested parties. This involves
preparation of final accounts namely profit and loss account and
balance sheet.

4. Attributes/Features of Accounting Function
(iii) It records transactions in terms of money. All transactions are
recorded in terms of common measure i.e. money which increases the
understanding of the state of affairs of the business.
(iv) It records only those transactions and events which are of financial
character. If an event has no financial character then it will not be
capable of being measured in terms of money ; it will not be,
therefore, recorded.
(v) It is the art of interpreting the results of operations to determine the
financial position of the enterprise, the progress it has made and how
well it is getting along.
(Source: The Institute of Company Secretaries of India)

5. Steps in Accounting
Accounting has the following stages:
(i) The transactions of a business that have, at least in part, a financial
character are identified and recorded.
(ii) The recording is done in a manner which identifies the different
classes and types of transactions.
(iii) The resulting records are summarized in such a way that the
owners or other interested parties in the business can see the overall
effects of all the transactions. The statements prepared by the
summarizing process are known as financial statements which will
show the profit or loss made by the business over a period of time and
the total capital employed in the business. Such financial statements
are used by management to make business decisions.

6. Branches of Accounting
Accounting has three main forms or branches viz. financial accounting,
cost accounting and management accounting.
(i) Financial Accounting: It is concerned with record-keeping directed
towards the preparation of trial balance, profit and loss account and
balance sheet.
(ii) Cost Accounting: Cost accounting is the process of accounting for
costs. It is a systematic procedure for determining the unit cost of
output produced or services rendered. The main functions of cost
accounting are to ascertain the cost of a product and to help the
management in the control of cost.
(iii) Management Accounting: Management accounting is primarily
concerned with the supply of information which is useful to the
management in decision-making, increasing efficiency of business
and maximizing profits

7. Functions of Accounting
(i) Keeping Systematic Records: Accounting is done to keep a
systematic record of financial transactions.
(ii) Protecting and Controlling Business Properties: Accounting helps to
see that there is no unauthorized use or disposal of any assets or
property belonging to the firm, because proper records are maintained.
Accounting will furnish information about money due from various
persons and money due to various parties. The firm can see that all
amounts due to it are recovered in due time and that no amount is paid
unnecessarily.
(iii) Ascertaining the Operational Profit/Loss: Accounting helps to
determine the results of the activities in a given period, usually a year,
i.e. to show how much profit has been earned or how much loss has
been incurred. This is done by keeping a proper record of revenues
and expenses of a particular period and then matching the revenues
with the corresponding costs.

8. Functions of Accounting
(iv) Ascertaining the Financial Position of the Business: Balance sheet
is prepared to ascertain the financial position of the firm at the end of a
particular period. It shows the values of the assets and the liabilities of
the business entity.
(v) Facilitating Rational Decision Making: Accounting facilitates
collection, analysis and reporting of information at the required point of
time to the required levels of authority in order to facilitate rational
decision making.

9. Advantages of Accounting
(i) Maintenance of Business Records: All financial transactions are
recorded in a systematic manner in the books of accounts so that there
is no need to depend upon on memory. It is impossible to remember
the business transactions which have grown in size and complexity.
(ii) Preparation of Financial Statements: Proper recording of
transactions facilitates the preparation of financial statements i.e. the
trading and profit and loss account and balance sheet.
(iii) Comparison of Results: Accounting information when properly
recorded can be used to compare the results of one year with those of
earlier years so that the significant changes can be analyzed.
(iv) Decision Making: Accounting information helps the management to
plan its future activities by preparing budgets and coordination of
various activities in different departments.

10. Advantages of Accounting
(v) Evidence in Legal Matters: Properly recorded accounting
information can be produced as evidence in a court of law.
(vi) Provides Information to Interested Parties: Interested parties like
owners, creditors, management, employees, customers, government,
etc. can get financial information about the organisation.
(vii) Helps in Taxation Matters: Income tax and/sales tax authorities
depend for taxation matter on the accounts maintained by the business.
(viii) Valuation of Business: When the business is to be sold, the
accounting information can be utilized to determine the proper value of
business.

11. Auditing Function
Source: Institute of Chartered Accountants of India

12. Auditing
Lawrence R. D – “An audit is an examination of
accounting records undertaken with a view to
establishing whether they correctly and
completely reflect the transactions to which
they purport to relate.”
Taylor and Perry – “Audit is defined as an
investigation of some statements of figures
involving examination of certain evidence, so
as to enable an auditor to make a report on the
statement.

13. Institute of Chartered Accountants of India (ICAI) defines Auditing as –
“Auditing is defined as a systematic and independent examination of data,
statements, records, operations and performance of an enterprise for a stated
purpose. In any auditing situation, the auditor perceives and recognizes the
propositions before him for examination, collect evidences, evaluates the
same and on this basis formulates his judgement which is communicated
through his audit report”. In the close scrutiny of the different definitions we
found that there are different ways of expressing the concept of auditing but
having lot of similarity therein.
The meaning of an Audit contains
(i) An intelligent and critical examination of the books of accounts of business.
(ii) It is done by an independent qualified person.
(iii) It is done with the help of vouchers, documents, information and
explanations received from the clients.
(iv) The auditor satisfies himself with the authenticity of the financial accounts
prepared for a particular period.

14. Features of Auditing
1. Audit is a systematic and scientific examination of the books of accounts of
a business;
2. Audit is undertaken by an independent person or body of persons who are
duly qualified for the job.
3. Audit is a verification of the results shown by the profit and loss account
and the state of affairs as shown by the balance sheet.
4. Audit is a critical review of the system of accounting and internal control.
5. Audit is done with the help of vouchers, documents, information and
explanations received from the authorities.
6. The auditor has to satisfy himself with the authenticity of the financial
statements and report that they exhibit a true and fair view of the state of
affairs of the concern.
7. The auditor has to inspect, compare, check, review, scrutinize the vouchers
supporting the transactions and examine correspondence, minute books of
share holders, directors, Memorandum of Association and Articles of
association etc., in order to establish correctness of the books of accounts.

15. Objectives of Auditing
Primary objective – As per Section 143 of the Companies Act 2013, the
primary duty (objective) of the auditor is to report to the owners that the
accounts, financial statements give a true and fair view of the state of the
company’s affairs as at the end of its financial year and profit or loss and
cash flow for the year and such other matters as may be prescribed.
Secondary objective –It is also called the incidental objective as it is
incidental to the satisfaction of the main objective. The incidental objectives
of auditing are:
(i) Detection and prevention of Frauds, and
(ii) Detection and prevention of Errors.

16. Functions of Auditing
(i) Review of System and Procedures: Review of system and procedure
is the primary function of auditing exercise. First an auditor needs to
understand the system and procedures adopted by the entity to go
further in the auditing exercise.
(ii) Review of Internal Control System: Review of internal control system
is very important for the auditor as the effectives of internal control
system will determine the extent of checking to be done by the
auditor. The compliance test and substantive procedures performed
by the auditor will determine the effectiveness of internal control
system. If internal control system is effective, less checking is
required and vice-versa. Moreover As per Company Audit report
Order, 2003 also an auditor need to comment on the effectiveness of
Internal control system in the organization so the review of internal
control is necessary for carrying out the Auditing exercise.

17. Functions of Auditing
(iii) Routine Checking/ Arithmetical Accuracy: It is the duty of the auditor to
check the arithmetical accuracy of the books of account by checking the
proper posting and balances of the books of accounts.
(iv) Accounting Principles: Auditor has to ascertain whether proper
distinction has been made between the item of capital and revenue nature
and also whether the item of income and expenditure of a particular period
has been adjusted in the books of accounts of that accounting period.
(v) Books and Statements: Auditor has to compare the balance sheet and
profit and loss account or other statement with the books of accounts and
supporting vouchers to ascertain that the final accounts have been made
in accordance with the underlying records.
(vi) Verification of Assets: It is the duty of the auditor to physically inspect
the assets and their recording in the books of accounts and verify the legal
and official documents to ascertain the existence, ownership, possession,
classification and valuation of assets of an entity.

18. Functions of Auditing
(vii) Verification of Liabilities: It is the duty of the auditor to inspect the books
of accounts and verify the legal and official documents to ascertain the
existence, obligation, completeness, valuation and disclosure of liabilities of
an entity.
(viii) True and Fair View: The auditor has to give its opinion whether the
financial statements depicts the true and fair view of the state of affairs of the
organization. Lesson 10 Concept of Auditing 325
(ix) Statutory Compliance: Auditor has to ensure that all the statutory
requirements has been complied by the entity like provisions of Income Tax
Act, Companies Act and other acts if any applicable has been complied by
the organization.
(x) Reporting: The auditor has to report to the authority appointing him for
conducting audit whether the financial statements of accounts examined
actually reveals true and fair view of the state of affairs and of the profit or
loss earned during the period by the organization.

19. Benefits of Auditing
(i) Satisfaction of Owner: It is because of audit that the owner will be
satisfied about the business operations and working of its various
departments.
(ii) Detection and Prevention of Errors and Frauds: The errors whether
committed innocently or deliberately are discovered by the process of
audit and its presence prevents their occurrence in the future. No one
will try to commit an error or fraud as the accounts are subject to
audit and hence they will have a fear of being detected. Just like
errors, frauds are discovered by audit and its presence minimizes
future possibility if not eliminated totally.
(iii) Verification of Books: Another advantage of audit is the verification of
the books of accounts, this helps in maintaining the records up to date
at all times.

20. (iv) Independent Opinion: Auditing is very useful in obtaining the independent
opinion of the auditor about business condition. If the accounts are audited by an
independent auditor, the report of the auditor will be true and fair in all respects
and it will be of extreme importance for the management of the company.
(v) Moral Check: The process of audit will establish a check on the minds of the
staff working in the business and they will not be able to commit any irregularity,
as they will have a fear and will also be aware that the accounts will be examined
in the near future and that action would be taken against them if any irregularity
is discovered. Thus the audit prevents the happening of any irregularity before it
starts and the staff hence becomes more active and responsible. The fear of their
getting caught act as a moral check on the staff of the company.
(vi) Protection of the Rights and Interests of Shareholders: Audit helps in
protecting the interests of shareholders in case of joint stock company. Audit gives
assurance to the shareholders that the accounts of the company are being
maintained properly and their interest will not suffer under any circumstances.

21. (vii) Reliance by Outsiders: Outsiders like creditors, debenture holders
and banks etc. will rely on the books of accounts and financial statements
of the business if they are audited by an independent authority (external
auditor).
(viii) Ensures Compliance with Legal Requirements: Audited statements
are necessary to fulfill certain legal requirements e.g. listing
requirements of stock exchange etc.
(ix) Reinforce and Strengthen Internal Control: Since auditing exercise
involves the review of internal control system, an auditor will identify the
gaps in internal control system and can suggest the necessary changes in
the internal control system.
(x) Loan Facility: Money can be borrowed easily on the basis of audited
balance sheet from financial institutions. If accounts are audited the true
picture will be visible to banks and it will be easy for them to issue loans
as early as possible.

22. Enron Case study
As 2002 began, energy trader Enron Corp. found itself at the center of one of
corporate America’s biggest scandals. In less than a year, Enron had gone from
being considered one of the most innovative companies of the late 20th century to
being deemed a byword for corruption and mismanagement.
Enron was formed in July 1985 when Texas-based Houston Natural Gas merged
with InterNorth, a Nebraska-based natural gas company. In its first few years, the
new company was simply a natural gas provider, but by 1989 it had begun trading
natural gas commodities, and in 1994 it began trading electricity.
The company introduced a number of revolutionary changes to energy trading,
abetted by the changing nature of the energy markets, which were being
deregulated in the 1990s and thus opening the door for new power traders and
suppliers. Enron tailored electricity and natural gas contracts to reflect the cost of
delivery to a specific destination–creating in essence, for the first time, a
nationwide (and ultimately global) energy-trading network.

23. In 1999 the company launched Enron Online, an Internet-based system, and by
2001 it was executing on-line trades worth about $2.5 billion a day.
By century’s end Enron had become one of the most successful companies in the
world, having posted a 57% increase in sales between 1996 and 2000. At its peak
the company controlled more than 25% of the “over the counter” energy-trading
market–that is, trades conducted party-to-party rather than over an exchange,
such as the New York Mercantile Exchange. Enron shares hit a 52-week high of
$84.87 per share in the last week of 2000.
Much of Enron’s balance sheet, however, did not make sense to analysts. By the
late 1990s, Enron had begun shuffling much of its debt obligations into offshore
partnerships–many created by Chief Financial Officer Andrew Fastow. At the
same time, the company was reporting inaccurate trading revenues. Some of the
schemes traders used included serving as a middleman on a contract trade,
linking up a buyer and a seller for a future contract, and then booking the entire
sale as Enron revenue. Enron was also using its partnerships to sell contracts
back and forth to itself and booking revenue each time.

24. In February 2001 Jeffrey Skilling, the president and chief operating officer, took
over as Enron’s chief executive officer, while former CEO Kenneth Lay stayed on
as chairman. In August, however, Skilling abruptly resigned, and Lay resumed the
CEO role. By this point Lay had received an anonymous memo from Sherron
Watkins, an Enron vice president who had become worried about the Fastow
partnerships and who warned of possible accounting scandals.
As rumours about Enron’s troubles abounded, the firm shocked investors on
October 16 when it announced that it was going to post a $638 million loss for the
third quarter and take a $1.2 billion reduction in shareholder equity owing in part
to Fastow’s partnerships. At the same time, some officials at Arthur Andersen LLP,
Enron’s accountant, began shredding documents related to Enron audits.
By October 22 the Securities and Exchange Commission had begun an inquiry
into Enron and the partnerships; a week later the inquiry had become a full
investigation. Fastow was forced out, while Lay began calling government
officials, including Federal Reserve Chairman Alan Greenspan, Treasury
Secretary Paul O’Neill, and Commerce Secretary Donald Evans.

25. In some cases, officials said, Lay was simply informing them of Enron’s troubles,
but Lay reportedly asked for Evans to intervene with Moody’s Investors Service,
which was considering downgrading Enron bonds to noninvestment-grade status.
Evans declined.
On November 8 Enron revised its financial statements for the previous five years,
acknowledging that instead of taking profits, it actually had posted $586 million in
losses. Its stock value began to crater–it fell below $1 per share by the end of
November and was delisted on Jan. 16, 2002.
On Nov. 9, 2001, rival energy trader Dynegy Inc. said it would purchase the
company for $8 billion in stock. By the end of the month, however, Dynegy had
backed out of the deal, citing Enron’s downgrade to “junk bond” status and
continuing financial irregularities–Enron had just disclosed that it was trying to
restructure a $690 million obligation, for which it was running the risk of defaulting.

26. On December 2 Enron, which a year before had been touted as the seventh
largest company in the U.S., filed for bankruptcy protection and sued Dynegy for
wrongful termination of the failed acquisition. A month later Lay resigned, and the
White House announced that the Department of Justice had begun a criminal
investigation of Enron.
By mid-2002 the once-mighty company was in tatters. Enron’s energy-trading
business had been sold off to the European bank UBS Warburg in January.
Throughout the spring top Enron officials were subpoenaed to testify before
congressional hearings. The majority of Enron’s employees were unemployed,
and their stock plans had become almost worthless. In June Arthur Anderson was
convicted in federal court of obstruction of justice, while many other American
companies scrambled to reexamine or explain their own accounting practices. As
investigations continued into Enron’s financial dealings, government connections,
and possible involvement in California’s energy problems, it appeared likely that
the political and economic fallout would be making headlines for some time.

27. In 1999 the company launched Enron Online, an Internet-based system, and by
2001 it was executing on-line trades worth about $2.5 billion a day.
By century’s end Enron had become one of the most successful companies in the
world, having posted a 57% increase in sales between 1996 and 2000. At its peak
the company controlled more than 25% of the “over the counter” energy-trading
market–that is, trades conducted party-to-party rather than over an exchange,
such as the New York Mercantile Exchange. Enron shares hit a 52-week high of
$84.87 per share in the last week of 2000.
Much of Enron’s balance sheet, however, did not make sense to analysts. By the
late 1990s, Enron had begun shuffling much of its debt obligations into offshore
partnerships–many created by Chief Financial Officer Andrew Fastow. At the
same time, the company was reporting inaccurate trading revenues. Some of the
schemes traders used included serving as a middleman on a contract trade,
linking up a buyer and a seller for a future contract, and then booking the entire
sale as Enron revenue. Enron was also using its partnerships to sell contracts
back and forth to itself and booking revenue each time.