Introduction To Auditing

1. Introduction To Auditing

2. Origin of Audit:
• The word 'Audit' is originated from the Latin word 'audire' which means 'to
hear'. In the earlier days, whenever there is suspected fraud in a business
organization, the owner of the business would appoint a person to check the
accounts and hear the explanations given by the person responsible for
keeping the account and funds. In those days, the audit is done to find out
whether the payments and receipt are properly accounted or not.
• Auditing originated over 2000 years ago when, firstly Egypt and later in
Greece, Rome and elsewhere.

3. Definition of Auditing:
• An audit may then be said to be such an examination of the books,
accounts and vouchers of a business, as shall enable the auditor to
satisfy himself whether the balance sheet is properly drawn up, so as
to give a true and fair view of the state of affairs of the business, and
that the profit and loss account gives a true and fair view of profit or
loss for the financial period, according to the best of his information
and the explanations given to him as shown by the books ; and if not
in what respects he is not satisfied”

4. Auditing Differentiated From Accounting
Accounting Auditing
1. It means maintaining the books of accounts 1. It means examining the accounts and reporting on
their accuracy
2. The spade of work is done by the accountant to
enable the auditor to give a finishing touch
2. The auditor’s work begin where the accountant’s
work ends.
3.The accountants prepares the financial statements 3.Audit is entail preparation and submission of report
on the checking and examination of the accounts etc.
4.No prescribed qualifications are legally required 4. It is mandatory that an audit of a public limited
company must be a chartered accountant.

5. Types of Auditor’s reports:
• Unqualified Report: An unqualified opinion is issued when the
independent auditor believes that the company's financial statements
are sound; that is, the statements are free from material
misstatements.
• Qualified Reports: An qualified opinion is issued when the
independent auditor believes that the company's financial statements
are unsound; that is, the statements consist certain
misrepresentations and not showing the true and fair picture
regarding some matters.

7. Types of Audit:
1. Financial Statement Audit
2. Operational Audit
3. Compliance Audit

8. Types of Audit:
Financial Statement Audit:
A financial statement audit is the examination of an entity's financial statements,
which have been prepared by its management/directors for shareholders and other
interested parties outside the entity, and of the evidence supporting the information
contained in those financial statements. It is conducted by a qualified, experienced
professional who is independent of the entity, for the purpose of expressing an
opinion on whether or not the financial statement provide a true and fair view of the
entity’s financial performance and its financial positions
“Financial Statement Audit is mostly or often carried out by external auditor”.

9. Types of Audit:
Operational Audit:
•An operational audit involves a systematic examination and evaluation of
an entity’s operations which is conducted with a view of improving the
efficiency and effectiveness of the entity.
•Such audit are usually initiated by the management.
•They are conducted by internal or external auditors.
•An operational audit may apply to the organization as a whole or to an
identified segment, such as a subsidiary, division or department.
•Objective of such audit is to increase the operational efficiency and
effectiveness of an entity.

10. Types of Audit:
• Compliance Audit:
The purpose of a compliance audit is to determine whether an entity
has acted in accordance the procedures or regulations established by
an authority, such as the entity’s management or a regulatory body.

11. Objects of an Audit:
• The main objects of an audit are classified as under:
1.The detection and prevention of errors or mistakes.
2.The Detection and Prevention of Fraud.
3.Expression of independent opinion on accounts.
4.Moral Check.

12. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Clerical Errors: Due to wrong posting such errors may occur. Money received from
Microsoft credited to the Siemens's account is an example of clerical error. Even though the
account was posted wrongly, the trial balance will agree. We can classify clerical errors as
below:
Following the kinds of Clerical Errors.
a) Errors of Omission: If any traction is completely omitted, then it is an error of omission.
When there is no record of transactions in the books of original entry or omission of posting in
the ledger could lead to such errors. Sales not recorded in the sales book or omission to enter
invoices in the purchase book are examples of Errors of Omission.
For Example
If the goods worth of Rs 10,000 are sold to “A” on credit and if this transaction is omitted
completely or left out. If the raw material worth of Rs 20,000 purchased and transaction is
omitted to enter into the purchase books.

13. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Clerical Errors:
b) Errors of Commission: These consist of incorrect additions, wrong
postings and entries.
Example: if the goods worth of Rs 20,000 sold to “B” on credit, but in
place of “B”, “C’s” account is debited then the error is committed.

14. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Clerical Errors:
c) Compensatory Error:
Compensatory errors are such errors which are committed while posting or recording
of a transaction, an error is committed and the same error is again committed in
another recording or posting, Such error is termed as compensatory error.
Examples:
Goods sold to “Y” for Rs 5,000 on credit though the recording is correctly done, but posting
is done only Rs 500 instead of Rs 500, Similarly goods sold to “Z” for Rs 500 on credit,
is posted in “Z’s” account as Rs 5,000, This would be a compensatory error without
affecting the trail balance.

15. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Clerical Errors:
d) Trail Balance errors:
These may consist of casting error in trail balance, omission of a balance
while extracting balance from books of account to trail balance or even
posting an amount incorrectly or wrong side.
Example: unearned revenue are recognized as a service revenue in
unadjusted trail balance.

16. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Errors of Principle: By and large there are three types of errors
generally considered as errors of principle. These are
a) Incorrect Allocation.
b) Incorrect Valuation of Assets.
c) Omission of Outstanding Assets and Liabilities.

17. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Errors of Principle:
a) Incorrect Allocation: This occurs when correct distinction
between revenue expenses and capital expenses is not strictly
maintained.
Capital Expenses: When the benefits can be derived for more than
one year of for longer period of time, such expenses are termed as
capital expenses, such as purchase of building and machinery etc.
Revenue Expenses: Where benefits are derived only for a shorter
period or less than one year such expenses are known as Revenue
expenses are also forming the part of current year’s profit and loss

18. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Errors of Principle:
b) Incorrect Valuation of Assets:
Current Assets are not valued at the cost or market price whichever
is lower. Fixed Assets are not valued at the cost less depreciation
etc.

19. Objects of an Audit:
1. The detection and prevention of errors and mistakes.
• Errors of Principle:
c) Omission of Outstanding Assets and Liabilities:
For Example: Prepayments are ignored and the amount are charged
off to the profit and loss, outstanding expenses in respect of
rent,salaries,commission etc. are ignored.

20. Objects of an Audit:
2. The Detection and Prevention of Fraud:
A) Window dressing: Is the way of presenting the financial data in
a much better position than the original position. It is known as
window dressing. Some of the reasons for doing window dressing
are as follows:
1. To win the confidence of share holders
2. To obtain further credit
3. To raise the price of shares in the market by paying higher
dividend so that shares held may be sold
4. To attract prospective partners or shareholders.
5. To win the confidence of shareholders.

21. Objects of an Audit:
2. The Detection and Prevention of Fraud:
b) Secret Reserves: In secret reserves, accounts are
prepared in such a way that they disclose worse picture than actually
what they are. The objectives of preparing accounts in this way are:
1. To conceal the true position from the competitors.
2. To avoid or reduce the tax liability
3. To reduce the price of shares in the market by not paying dividend
or paying lower dividend so that the shares may be bought at a much
lower price.

22. Objects of an Audit:
2. The Detection and Prevention of Fraud:
c) Misappropriation of goods:
Companies handling with high value goods are pray to this kind
of misappropriation. Without proper records of stock inward and stock
outward, it is difficult for the auditor to find out such fraud. Periodical
and surprise checking of stock and maintaining the proper record of
inward and outward movement of stock can reduce the possibility of
such fraud

23. Objects of an Audit:
2. The Detection and Prevention of
Fraud:
d) Misappropriation of Cash:
Since the owner has very limited control over the receipt and
payments of cash, misappropriation or fraud in cash is very common
specially in big business organizations. Cash can be misappropriated
by various ways as mentioned below:
a. Recording fictitious payments
b. Recording more amount than the actual amount of payment
c. Suppressing receipts
d. Recording less amount than the actual amount of payment

24. Objects of an Audit:
3. Expression of Independent Opinion on Accounts:
After the audit has been completed, the auditor should submit his
report, in which auditor has to give an independent opinion to the
fairness of the information given in the reports.

25. Conduct of Audit:
• Continuous Audit
• Interim Audit
• Final Audit

26. Conduct of Audit:
Continuous Audit:
• Continuous audit is defined as one where the auditor is constantly or at (regular or
irregular) intervals engaged in checking the accounts during the period.
•Continuous audit means an audit at regular intervals thought out the accounting the year,
Generally, the audit work begins after the accounting year is over. But in case of
continuous audit, the audit work begin in the accounting year itself.
•For example: if the accounting year begins on 1st
of January 2014 and ends on 31st
of
December 2014, normally, audit work begins on January 2015 till it get finished with
auditing, but in case of continuous audit, the work would begin in January 2014 itself and
continuous at regular intervals till it is complete, Thus, in continuous audit, accounting and
auditing work is done almost side by side.
•Continuous audit, however, does not mean the audit work goes 365 days of the year. The
auditor may make periodical visits, say, every two to three months during the year. At each
visit, the work would be taken up from where it was left in the earlier visit.

27. When continuous audit is necessary.
•The volume of transaction is very large
•The accounts are required immediately after the end of accounting year
•The system of internal control or internal check is weak

28. Advantages of Continuous Audit:
•Easy and timely rectification of errors.
•Continuous check of frauds.
•Proper auditing and attention
•Quick Completion
Disadvantages of Continuous Audit:
•Expensive
•Interruption in work
•Inconvenience

29. Conduct of Audit:
• Final Audit:
An audit which is not commenced until after the end of the financial
year and then carried on until completed.
• Final audit means an audit is taken up after the end of the accounting
year. The audit work begins only after the accounting year is over,
Majority of audits are in the nature of final audit.

30. Advantages of Final Audit:
•Inexpensive
•Does not disrupt the accounts work
•Saving Of Time
•Legal Demands
Disadvantages of Final Audit:
•Delay in final accounts
•Late dividend to shareholders

31. Conduct of Audit
• Interim Audit: Interim audit is conducted in between two annual
audits with a view to find out the interim profit of the business to
enable the organization to declare an interim dividend to its
shareholders.
Advantages of Interim Audit:
• This type of audit is helpful to organizations for which publication of interim accounts is
required
• The final audit can be completed with the scheduled time, if interim audit has already
been conducted by the organization
• Errors and frauds can be more quickly detected during the course of interim audit.

32. Advantages of Auditing
• It is compulsory for all the organizations registered under the companies act must be audited. There
are advantages in auditing the accounts even when there is no legal obligation for doing so. Some of
the advantages are listed below:
• By auditing the accounts Errors and frauds can be detected and rectified in time.
• Audited accounts carry greater authority than the accounts which have not been audited.
• For obtaining loan from financial institutions like Banks etc., previous years audited accounts
evaluated for determining the capability of returning the loan
• Regular audit of account create fear among the employees in the accounts department and exercise
a great moral influence on clients staff thereby restraining them from commit frauds and errors.
• In the event of loss of property by fire or on happening of the event insured against, Audited
accounts help in the early settlement of claims from the insurance company.
• In case of joint Stock Company where ownership is separated from management, audit of accounts
ensure the shareholders that accounts have been properly maintained, funds are utilized for the
right purpose and the management have not taken any undue advantage of their position.
• To determine the value of the business in the event of purchase or sales of the business, audited
account will be the treated as the base for the evaluation.

33. Disadvantages of Audit:
1. The payment of audit fees brings extra cost burden to the organization.
2. During an audit the auditor requires the attention several company staff and therefore causes disruption.