PRINCIPLES AND PRACTICE OF AUDITING.

B. COM 6TH
SEMESTER.
PRINCIPLES AND PRACTICE OF AUDITING.
1
ABHISHEK D K, COMMERCE LECTURER.
UNIT 2:
INTERNAL CONTROL:
Internal Control:
Meaning:
It is a process designed by management of an entity to provide reasonable assurance that an
entity achieves its objectives in the following categories:
1. Reliability of financial reporting,
2. Effectiveness and efficiency of operations and
3. Compliance with applicable laws and regulations.
It is a means by which an organization’s resources are directed, monitored and measured. It
plays an important role in detecting and preventing fraud and protecting the organization’s
resources, both physical and intangible.
Definition:
According to W.W. Bigg, “Internal Control is best regarded as indicating the whole system of
controls, financial and otherwise, established by the management in the conduct of a business,
including internal check, internal audit and other forms of control”.
American Institute of Certified Public Accountants defines “Internal Control comprises the
plan of organization and all the co-ordinate methods and measures adopted with in a business
to safeguard its assets. Check the accuracy and reliability of its accounting data, promote
operational efficiency and encourage adherence to prescribed managerial policies”.
Objectives:
1. Assets Protection:
The assets are the backbone of any business. These assets are in the custody of some
specific officers of the business. The internal control system checks the valuation and
protects the assets of the business.
2. Accurate Record:
The main objective of the internal control is to maintain all records and transactions of
the business according to the Generally Accepted Accounting Principles (GAAP).

B. COM 6TH
SEMESTER.
2
3. Follow Policies:
The purpose of internal control is to follow policies of management. The policies are
guidelines for obtaining the business objectives. All employees try their best to
follow the rules of the game.
4. Prevention of Errors:
The purpose of internal control is to prevent errors. There may be unintentional
mistakes due to overwork or carelessness. There is normal work load with every
person. Others check the work of one person.
5. Prevention of Frauds:
The purpose of internal control is to prevent fraud. It is an intentional
misrepresentation of financial information b one or more individuals among
management, employees or their parties.
6. Reliable Record:
The purpose of internal control is to maintain reliable accounting record. The equal
distribution of work among the employees provides complete and reliable record, as it
is free from errors and frauds.
7. Reduces Workload:
The purpose of internal control is the reduction of workload. The effective internal
control can be useful for auditors. They can check few items and remaining items
will be treated as checking by the auditor.
8. Location of Errors:
The purpose of internal control is the location of errors. There are many types of
errors which may be found in the accounting record. The internal control procedures
are useful to locate the errors in accounting.
9. Detection of Fraud:
Detection of Fraud is the purpose of internal control. The compliance procedures and
substantive procedures can be applied to detect the fraud. Basically, it is a
management responsibility.
10. Record of Expenditures:
Same way the internal control system keeps the records of all the expenditures of the
business and there are fewer chances of errors and frauds.

B. COM 6TH
SEMESTER.
3
11. Recording of Transactions:
Due to the internal control system, all the transactions are recorded properly in the
correct account in the proper period.
12. Preparation of Statements:
Another objective of the internal control is to ensure about the preparation of the
financial statements (Balance Sheet / Profit and Loss A/c) at the proper time.
Internal Check:
Meaning / Definition:
According to De Paula, “An internal check means practically a continuous internal audit
carried on by the staff itself, by means of which the work of each individual is checked by the
members of the staff”.
Objectives of Internal Check:
1. To allocate duties and responsibilities of every clerk in such a way that he may be
held responsible for a particular error or fraud.
2. To minimize the possibilities of errors, frauds or irregularities.
3. To detect errors or frauds easily if it is committed, as there is a provision for
independent checking in internal check.
4. To enhance the efficiency of clerks through assignment of duties based on the
principle of division of labour.
5. To distribute the work in such a way that no transaction is left unrecorded.
6. To prepare final accounts with ease and efficiency as an efficient system can make
accounts more reliable.
7. To exercise moral pressure over staff.
8. To prevent misappropriation of goods or cash by any clerk, etc.
Principles of Internal Check:
1. Sufficient staff:
The principle of internal check is sufficient staff. The employees can be appointed
according to the workload. The management can determine the amount of work,
which is distributed among the departments. The persons are hired to perform heir
duties. The overloading can creates trouble for management.

B. COM 6TH
SEMESTER.
4
2. Division of work:
It is a principle of internal check. The management can determine the total amount of
work. The whole work is divided among departments. The heads of such department
are responsible for completion of work according to timetable.
3. Co-ordination:
It is a principle of internal check. All departmental managers are bound to co-
ordinate with other in order to achieve organizational objectives. When there is a
fault in one department, the work of other department suffers. The objectives cannot
be achieved. Internal check determines the degree of co-ordination among the
managers.
4. Rotation of duties:
It is a principle of internal check. The workers feel bore by doing the same work from
year to year. There is a need of rotation of duties. It is in the interest of concern as
well as employees. The efficiency is improved due to change in duties.
5. Recreation leave:
The recreation leave is a principle of internal check. The employee can enjoy
recreation leave. It is necessary for mental health. He cannot commit fraud as the
new employee in his place can disclose the matter. The internal check system can
work in the interest of business. The weakness in / of one person is disclosed due to
leave.
6. Responsibility:
It is a principle of internal check.
7. Automatic machines:
The principles of internal check are that machines must be used to do accounting
work if permissible. The machines can do a lot of work without delay. The changes
of fraud and errors are reduced to a minimum. The working of machines improves
the efficiency of accounting staff.
8. Checking:
The principle of internal check is to check the work of other employees. Many
persons perform the work. The officers can put his signatures to verify the work done
by his subordinates. In this way, one work passes many hands. The changes of errors
and fraud are minimized due to checking and counter checking.

B. COM 6TH
SEMESTER.
5
9. Simple:
The principle of internal check is simple. The employees can understand the working
of internal check system. A person can work under the supervision of other
employees. The line of authority moves from top to bottom level. All workers can
understand their duties in the organization.
10. Documents classification:
The classification of documents is the principle of internal check. The business
documents are prepared, collected, recorded and placed in proper files. The index is
prepared to compile the data. The filing system is useful to place the latter. In case of
need, the documents are terraced at once.
11. Dependent work:
It is a principle of internal check. The work of one employee is dependent upon
others. One work passes to the hands of two or three persons till it is complete.
Another person checks the passes (work) done by one person. No person is all in all
to start and complete the transactions.
12. Harmony:
The principles of internal check are harmony among the employees and departments.
The understanding is essential for business goals. The management is to achieve
other social and national objectives. The harmony is basis for successful internal
check.
Auditor’s position with regards to Internal Check:
1. First of all, an auditor should satisfy himself about the working of proper internal
check / control system.
2. He should examine carefully the system of internal check before deciding the scope
of work he would do.
3. If the auditor is satisfied about the effectiveness of internal control, then he should
check the efficiency and its existence by checking various items from different places.
After it, he may pay more attention or care to other important parts of this work.
4. If the auditor feels that internal control system is not satisfactory then he should check
those accounts where errors are likely to exist.

B. COM 6TH
SEMESTER.
6
5. If the internal control system cannot conform or satisfy to the auditor, then he should
report the client in writing.
6. If auditor feels that overall system is satisfactory but certain sections of the system
appear to be inadequate, then he should inform the client about the dangers.
7. The auditors should also give suggestions that how weaknesses can be removed if he
is asked by the client.
Internal Check as regards Cash Sales:
1. Counter Sales Book:
The salesman can sell products over the counter. The sales book can be prepared on
the basis of cash memos issued by the staff.
2. No cash handling:
The sales staff should not handle cash. All cash receipts must be handled over to the
cashier. Accountant can make entries in the books of accounts. Another person can
deposit cash.
3. Cash Register:
It is maintained in large retail shops. There is a need of secrecy for its working. The
main equipment and attachments must work without any interference from employees.
4. Checking copies:
The auditor can check carbon copies of cash sales. The copies can be used as a basis
of determining total sales for a particular period.
5. Receipt of goods:
The goods are handled over to the customer along with cash memo. The sales officer
must check and sign the cash memo at the time of delivery of goods. One copy is
kept for determining total sales.
6. Sales summary:
The sales summary must be prepared and sent to sales manager. The sales summary
must be prepared and sent to sales manager. The sales summary must tally with the
cash received from customers.
7. Cash verification:

B. COM 6TH
SEMESTER.
7
The sales officer can check the cash memo for the day. The sales summary should be
examined. The cash collected must tally with the cash memo as well as total sales
summary for the day.
8. Cash deposits:
The cashier should not deposit the cash into the bank account. The total cash must be
handed over to the accountant who should make arrangement for deposit of cash.
9. Sales discount:
The sales discount rate can be examined from the price list. The discount must not be
in excess of the rates stated in the list. The discount allowed should be posted to the
sales discounts. The sales manager must approve the discount.
Internal Check as regards Purchases / Cash Purchases:
1. Supply of requisition:
Whenever goods are needed in any department of the company, the head of the
department should send the purchase requisition to the purchase department. He
should mention the quality, quantity of the item and the time by which the goods must
be supplied.
2. Purchase order:
It should be given in writing. It should be given on printed and numbered forma. It
should be recorded in the purchase book.
3. Copies of purchase order:
There should be three copies of each purchase order. One copy should be sent to
suppliers. One copy to the store clerk and one should remain with purchase
department.
4. Comparisons:
One copy of the received good note will be sent to the purchase department. Purchase
department will compare the quality and quantity with the invoice.
5. Invoice checking:
Each invoice on receipt should be checked by responsible officer with the purchase
department. Purchase department will compare the quality and quantity with the
invoice.
6. Inspection:

B. COM 6TH
SEMESTER.
8
Before storing the goods, these should be inspected and quality should be tested.
7. Purchase returns:
In case of any defect, it should be immediately reported to the purchase department.
Purchase department may take up the case. All return outwards (purchase returns)
should be duly authenticated as toils correctness.
8. Invoice recording:
Each invoice should be consecutively numbered and properly filed.
9. Payment:
A responsible officer should pass on the payment of invoices. Before signing the
cheque, he should assure himself about the correctness of the account.
10. Proper record:
Proper Record of purchase should be maintained in writing. All the officials and
officers who are involved in the purchase, their initials must be taken.
Internal Check as regards Payment of Wages:
In large organizations, expenses on wages will form one of the major portions of expenses.
The chances of frauds are also high in this regard. In this background, a good system of
internal check assumes significance:
a. Frauds might be in the form of recording more wages than actually paid.
b. Payment of wages to dummy/ghost workers.
c. Recording wages for which no payment has been made, etc.
The design of internal check system should try to prevent the above fraud.
The internal check system can be divided by splitting the whole process of wage payments
into three parts:
1. Maintenance of wage records:
a. While maintaining the wage records, a separate responsible official should
take care of this function. He should maintain time cards, piece-work records
and overtime records.
b. He should see that only names of genuine workers are included in the wage
records.

B. COM 6TH
SEMESTER.
9
c. The time records should be maintained in-tact by entering the time of entry of
the worker and the time of leaving. Time card and attendance card should be
punched every day by each worker. Out pass cards should also be properly
maintained.
2. Preparation of wage sheets:
a. The wage payable to each worker should be properly recorded against his
name regarding piece work, the piece rates and agreements are to be properly
recorded.
b. The wage-sheets should be prepared on the basis of time-cards, piece-work
cards, overtime cards, pass-out slips, attendance register and job cards.
c. While preparing the wage sheet, two or three persons are to be entrusted with
the work. The wage sheets should contain the name, wage payable, number of
days worked, total wage payable deductions against advance, PF and other
statutory deductions, net amount payable and signature columns. The wage
sheet should be scrutinized by some responsible officer after it is completed.
d. Three copies of wage sheets should be prepared and one copy to be sent to
cash section for payment, one to accounts department for record and one to be
maintained by the wage department.
3. Payment of wages:
a. While paying the wages to the workers, the cashier should obtain the signature
of each worker. The signature should be verified if needed. The identity cards
may be examined in case of suspicion. Each worker should be present in
person to receive the wage. Foreman can assist the cashier in wage payment.
b. After the disbursement of wages, the wage sheet must be certified by the
responsible official of the organization for having fully paid the wage to
workers.
Internal Audit:
Meaning:
It is a type of audit conducted by the own staff of the organization specially assigned for that
purpose. In this type of audit, thorough examinations of the accounting transactions as well
as the system according to which transactions are recorded are conducted. It is done to verify

B. COM 6TH
SEMESTER.
10
the reliability and authenticity (validity) of the financial accounting and other records
presented to the management. The scope and objectives of this type of audit vary widely and
are dependent on the size and nature of the business.
Definition:
Internal Auditing consists of a continuous, critical review of financial and operating activities
by a staff of auditors functioning as a full time salaried employee.
Difference between Internal Check and Internal Audit:
Internal Check Internal Audit
1. In internal check system, work is
automatically checked.
1. In internal audit system, work is checked
specially.
2. In internal check system, checking is done
when the work is being done and mistake can
be checked at an early stage. Thus, it
involves less cost.
2. In internal audit system, the mistake can be
detected only at the end and hence,
rectification and other costs will be huge.
3. The thrust of internal check system is to
prevent the errors.
3. The thrust of internal audit system is to
detect the errors and frauds.
4. In internal check system, checking is done
when the work is being done.
4. In internal audit system, work is checked
after it is done.
5. Internal check means separation of tasks
and division of duties.
5. Internal audit means continuous audit by
the employees.
6. Internal check is a part of accounting
system.
6. Internal audit is concerned with
examination of records after their
completion.
7. Internal check is applicable throughout the
year.
7. Internal audit may not be conducted for the
whole year.
8. Internal check is concerned with
prevention of errors.
8. Internal audit is concerned with detection
of errors.
9. There is no special staff to apply internal
check.
9. There is special staff to conduct internal
audit.

B. COM 6TH
SEMESTER.
11
10. The internal check is not related to any
investigation.
10. The internal auditor may investigate
about the business activities.
Advantages of Internal Audit:
1. The biggest advantage of internal audit is that it will lead to discovery of errors and
therefore when external audit is done those errors which were discovered during
internal audit would have been rectified by them.
2. Since internal audit is done by the employees of the company, there is no additional
cost involved which again is a big advantage for a company which is doing internal
audit.
3. As internal audit is a constant procedure where records are checked regularly, it
ensures that accounting staff of a company keep the records up to date.
4. Staffs remain alert because their work shall be checked by the internal auditor. So,
accounting remains correct.
5. Internal audit helps to detect errors and frauds and provides suggestions to improve
them which help the management to take corrective action.
6. Internal audit detects the misuse of resources in time which helps to reduce
unnecessary expense.
7. Internal audit checks the efficiency of staffs which helps to increase the efficiency of
them.
8. Internal audit checks the books of accounts, detects errors and frauds and helps in its
correction which makes the act of final auditor easier.
9. Internal audit increase the morale of honest staff because evaluation of performance
of any staffs will be made at any time.
Disadvantages of Internal Audit:
1. Internal auditor’s report is not accepted by either the shareholders or tax authorities, it
is the external auditor’s report which is required to be submitted to these parties.
2. Since internal audit is done by the employees of the company, chances are that it may
be biased and therefore company cannot depend on such reports.
3. Since an internal audit is not done by the professional auditor, chances of internal
auditor not detecting the errors are high.

B. COM 6TH
SEMESTER.
12
4. Internal auditing can sometimes fail to check planned frauds. Management can lay
many tricks in order to manipulate accounts to conceal inefficiencies. These types of
frauds are not disclosed and the audited accounts will not always show a true and fair
view. If the information from management is false then there is room for fraud and
therefor internal audits can sometimes yield undesirable results.
5. Auditing can fail to disclose information of what’s happening. Background entries
may not be totally clear to audit staff and management may be vague on their
clarifications. Whether or not these things happen, an auditor still has to give his
report.
6. Another disadvantage of internal audit is that they don’t always show the true picture.
An auditor’s purpose fails when they don’t see the real business affairs; the view of
the audit is altered.
___________________________________________________________________________

PRINCIPLES AND PRACTICE OF AUDITING.

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to PRINCIPLES AND PRACTICE OF AUDITING.

Similar to PRINCIPLES AND PRACTICE OF AUDITING. (20)

More from Abhishek Kulkarni

More from Abhishek Kulkarni (16)

Recently uploaded

Recently uploaded (20)

PRINCIPLES AND PRACTICE OF AUDITING.