Auditing - Introduction

In ancient days, the owners of the business verify their accounts by expert accountants or
book keepers to detect errors and frauds. Even the Kings and Zamindars used to listen from
the accounts regarding receipts and payments of their kingdom.

At the end of Fifteenth Century due to revival in Italy, there was a rapid growth in industry,
trade and commerce. The principle of double entry system was introduced by Luca Pacioli, a
famous Italian mathematician. Besides cash transactions, credit transactions are recorded in
books, as a result complexity of accounts was increased.

As a result of Industrial revolution in England in the Eighteenth century, there was a

substantial increase in the volume of business. A rapid increase in commercial activity,
emergence of banking, insurance, joint stock companies and growing activities in the
Government sector led the need for audit of accounts.

The technological development, globalization of business, complex business

environment, requirement of the interested parties regarding true accounts, necessity
of the government to get audited accounts for different purposes have influenced
auditing to be used as a fact-finding tool and have caused a greater responsibility in
the technique, scope, professional, legal, moral and ethical responsibilities from the
auditors.

Meaning of Auditing

The term ‘Audit’ is derived from the Latin word, “Audire”, which means, ‘to hear”.
Auditing is a detailed and critical examination of books of accounts and support
documents to verify whether the financial statements which include Profit and Loss
Account and Balance Sheet
represent a true and fair view of the state of affairs of the business concern.

It is the verification of financial position as it is disclosed by the Balance Sheet and the Profit
and Loss Account. It is an examination of accounts to ascertain whether the Balance Sheet
and the Profit and Loss Account give a true and fair view of financial position and Profit or
Loss of the business. For this purpose, all the business transactions and the manner in which
these are recorded must be examined.

Auditing is the intelligent and critical test of accuracy, adequacy and dependability of
accounting data and accounting statements. It is concerned with examination of accounting
data to determine the extent of accuracy of Profit and Loss account and the Balance sheet
prepared from such data.
Definition of Auditing
The Institute of Chaartered Accountants of India describes audit as “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 there on”.
Spicer and Pegler defines auditing as, “such an examination of books of accounts and
vouchers of a business as will enable the auditor to satisfy the Balance Sheet is properly
drawn up so as to give a true and fair view of the state of affairs of the business, whether the
Profit and Loss account gives a true and fair view of the profit and loss for the financial
period, according to the best of his information and explanation given to him to him as shown
by the books, and if not, in what respect he is not satisfied.”

Meaning – Auditor
The person who checks the accuracy of the books of accounts and expresses an opinion on
the financial statements of the business concern is called as an Auditor. The person who is a
Chartered Accountant holding Certificate of Practice from the Institute of Chartered
Accountants of India is referred to as an Auditor. Auditors enjoy a distinctive professional
status in the society because of specialized functions of auditing.
Functions of an Auditor
The following are the functions or basic aspects to be covered by the auditor in the course of
audit. They are:
Examination: Auditor should examine the accounting system to ensure about their
appropriateness.
Books: Check the books of accounts to ensure the arithmetical accuracy.
Evidence: The auditor should examine documentary evidence to support the
entries in the books of accounts.
Full Inclusion: Check whether all entries in the books of accounting have been
taking while preparing financial statements.

Properness: Examine whether information contained in financial statements is

proper and it does not contain any fraudulent entry.

Verification of Assets and Liabilities: Check the existence, valuation and

disclosure of all assets and liabilities in financial statements.

Statutory Compliance: Verify the compliance of financial statements with the

relevant statutory authorities.
Disclosure: Examine whether the information in financial statements is disclosed
properly as per accounting principles.

Truth and Fairness: Check whether financial statements represent a true and fair
view of profit or loss and of assets and liabilities of the business concern.
Qualities of an Auditor:- An auditor must have the following qualities:-

1. He/she must have complete knowledge of general accounts, income tax, cost
accounting etc. He/she should be aware of the latest development of the technique of
accounting.
2. He/she should not pass any transaction unless he/she knows that it is correct. It is
possible when sh/she knows thoroughly well the principles of accounting.
3. He/she should be able to grasp quickly the technical detail of the business whose
accounts he/she is auditing.
4. He/she should not show his/her proud of his/her qualification or position.
5. He/she should be quite familiar with the company and mercantile laws and must be a
complete master of the principles of auditing.
6. He/she must be honest. He/she must not certify what he/she does not believe to be
true.
7. He/she must not be influenced directly or indirectly by other in the discharge of
his/her duties.
8. Some times he/she is put in a very awkward position, when his/her duty to his/her
client is opposed to his/her own interest. In this case he/she must have the courage to carry
out his/her duty faithfully and honestly. It will pay in the future.
9. He/she must be prepared to resign rather than sign a balance sheet, which he/she
knows that it does not give the true and correct position.
10. He/she should not disclose the secrets of his/her client.
11. He/she should have the tact to put intelligent questions to extract full information.
12. He/she must not adopt an attitude of suspicion.
13. He/she must be prepared to hear arguments and must be reasonable.
14. He/she must be able to write the report clearly, correctly and forcefully.
15. He/she must have a thorough training in business organization, management and
finance.
16. Last but not least, he/she should have common sense.
Qualification of Company Auditor:- As per section 226 of companies act, a person should
not be qualified for appointment as an auditor or a public or private company unless he is a
chartered accountant within the meaning of the Chartered Accountant Act,1949.

According to section 226(2), a person holding a certificate under Restricted Auditors

Certificate (Part – B states) Rules,1956, is also qualified t act as an auditor of a company.

However, the Central Government may grant, renew, suspend or cancel and make other rules
for such certificates by notification in the official Gazette.

Disqualification of Company Auditor:- Following are the disqualification of a company

auditor:-

1. An auditor can not be a body corporate.

2. An auditor can not be an employee of officer of the company.
3. A person who is a partner or who is in the employment of an officer of the company,
can not be the auditor of the company.
4. A person who is indebted to the company for an amount exceeding one thousand
rupees, can not be the auditor of the company.
5. A person who is a member or a director of a private company or partner in a firm
which is the managing agent or the secretaries and treasurers of the company, can not be the
auditor of the company.
6. A person who is a director or holder of shares of more than 5% in nominal value of
the subscribed share capital of any body corporate which is the managing agent or the
secretaries and treasures of the company, can no be the auditor of the company.

Objectives of an Audit

The objective of an audit is to express an opinion on financial statements.

To give the opinion about the financial statements, the auditor examines the financial
statements to satisfy himself about the truth and fairness of financial position and operating
results of the enterprise.
There are certain inherent limitations of audit examination.
It would not be possible for the auditor to discover all errors and frauds, in the financial
statements due to the limitations of his checking.
Such discovery is not the main objective of the audit. In this light, the objectives of the audit
can be categorized into (i) primary objectives and (ii) subsidiary objectives.

Primary Objectives of Audit

The main objectives of the audit are known as the primary objectives of the audit. They are as
follows:

1. Examining the system of internal check.

2. Checking arithmetical accuracy of books of accounts, verifying posting, casting,
balancing etc.
3. Verifying the authenticity and validity of transactions.
4. Checking the proper distinction between capital and revenue nature of transactions.
5. 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 by income statement and financial position presented by the
balance sheet.
Subsidiary Objectives of Audit
These are such objectives which are set up to help in attaining primary objectives. They are
as follows:
Detection and prevention of errors
Errors are those mistakes which are committed due to carelessness or negligence or lack of
knowledge or without having vested interest. Errors may be committed without or with any
vested interest.
So, they are to be checked carefully. Errors are of’ various types. Some of them are:

 Errors of principle.
 Errors of omission.
 Errors of commission.
 Compensating errors.

Detection and prevention of frauds

Frauds are those mistakes which are committed knowingly with some vested interest in the
direction of top-level management.
Management commits frauds to deceive tax, to show the effectiveness of management, to get
more commission, to sell a share in the market or to maintain the market price of share etc.
Detection of fraud is the main job of an auditor.
Such frauds are as follows:

 Misappropriation of cash.
 Misappropriation of goods.
 Manipulation of accounts or falsification of accounts without any misappropriation.

Under-or over-valuation of stock

Normally such frauds are committed by the top level executives of the business. So, the
explanation is given to the auditor also remains false.
So, an auditor should detect such frauds using skill, knowledge, and facts.
Other objectives
 To provide information to income tax authority.
 T6 satisfy the provisions of the Companies Act.
 To have a moral effect.

Various types of Auditing used By Companies

Review and investigation of financial statements and reports are called auditing. The reports
and statements can be of any nature like revenue reports, expense reports, management
account records etc.

The results of audits are shared with external and internal stakeholders. They may also be
shared with government and banks or even public if the need presents itself. The
classification of auditing depends on different types and levels of assurance of the audit. It
depends on the objective, purposes, scope, use etc. While few audits are done to enhance and
improve procedures, others are necessitated by various organizations as a part of their
scrutiny process.

1) Internal audit
As the name suggests this type of audit is performed to determine the internal activities of the
company and is carried out by internal or external stakeholders. It is an independent process
which may or may not be reported to the management. The main function of internal audit is
to determine whether or not the internal functions are working properly.

A special investigation, fraud, complaint, or operational review are a few things that are
covered by the internal audit. The general report of internal audit contains an opinion on
feedback along with the list of findings during auditing and its implications on the working.
The final part of internal audit contains recommendations for the findings that could help
benefit the organization. Post-approval from the management the steps may be applied in the
company.

2) External Audit
When an external form is employed to perform auditing, it is known as an external audit.
Services like tax, legal, consulting and sales audit may be performed by external firms. It is
one of the most common types of audit found in many firms. To stay neutral and unbiased,
many companies conduct external audits with third party firms.

Deloitte Ernst and young are renowned names of external auditors. Use of external forms is
very common in large multinationals. The firms follow international standards of auditing
very strictly and maintain a professional code throughout the auditing procedure. It is ensured
that the firm works independently from the client so that if a conflict of interest of cause
proper procedure and action can be taken to change or withdraw the auditing procedure.
External auditors may not stick to external auditing only but some may offer services for
internal auditing also. External auditing is considered to be more professional when internal
auditing. Also, the chances of biased audits are less in case of external auditing.

3) Forensic Audit
This is a specialized type of audit which is performed by a forensic accountant who is killed
in investigation and accounting both. This is specially used in the cases where investigations
of the report may be used in the court. Forensic auditing acts as proof in that particular
subject matter and hence in this auditing is to be done by specialized accountant only.

The reason for auditing could be anything from fraud to crime or insurance claims or even a
dispute between internal or external stakeholders. Forensic auditing needs to have a
proper planning and execution while following the ethical guidelines of the finances very
strictly. It is not a very popular method of auditing in case of financial statements are of
statutory audit going to the large costs involved. Forensic auditing may only be used in the
cases where it is been made mandatory to perform it.

4) Statutory Audit
The auditing that is required by law for local authority about particular financial statements
for a specific type of entities is called statutory audit. The common examples of statutory
auditing are the that all banks’ financial statements are required to be audited my proper audit
firms which are approved by Central Bank. Statutory audit is conducted only after approval
by higher authorities and for the submission to official authorities.

5) Continuous Audit
Continuous audit or a detailed audit is an audit which involves a detailed examination of
books of account at regular intervals i.e. one month or three months. The auditor visits clients
at regular intervals during the financial year and checks each and every transaction. At the
end of the year auditor checks the profit and loss account and the balance sheet. A continuous
audit is not of much use to small firm as its accounts can be audited at the end of the financial
year without much loss of time.

Auditing in a Computer Based Environment

Introduction
Information Technology (IT) is integral to modern accounting and management
information systems. It is, therefore, essential that auditors should be aware of the
impact of IT on the audit of a client’s financial statements. Information Technology
auditing (IT auditing) began as Electronic Data Process (EDP) auditing and
developed largely as a result of the rise in technology in accounting systems. The
last few years have been an exciting time in the world of IT, auditing as a result of
the accounting scandals and increased regulations. Regardless of the computer
systems used, the audit objectives and approach will remain largely unchanged from
that if the audit was being carried out in a non-computer environment.

Audit Approach in Computeriszed Environment

Auditing Around the Computer: It is the type of auditing done in a traditional

method. The auditor summarises the input data and ignores the computer’s processing but
ensures the correctness of the output data generated by the computer, this approach is
generally referred to as “auditing around the computer”. This methodology was primarily
focused on ensuring that source documentation was correctly processed and this was verified
by checking the output documentation to the source documentation
Auditing Through the Computer: Due to the “real time” computer environments,
there may only be a limited amount of source documentation or paperwork hence
the auditor may employ an approach known as “auditing through the computer”. In
this approach, the reliability and accuracy of the results are analysed through the
computer. This involves the auditor to perform tests on the information technology
controls to evaluate their effectiveness like Compliance test, Test Packs,
Reprocessing.
Auditing with the Computer: The utilization of computer by the auditor for some
audit work and he uses some general software for the purpose of calculating
depreciation, printing letters, and duplicate checking and files comparison.
The computer is not used for all the audit work and it is done manually.

Audit Process for Computerized Accounting System

The audit process for a computerized accounting system involves the following five major
steps:

Conducting Preliminary Survey: This is a preliminary work to plan how the audit should
be conducted. The auditors gather information about the computerized accounting system that
is relevant to the audit plan. This includes an understanding of how the computerized
accounting functions are organized, identification of the computer software used,
understanding accounting application processed by computer and identification applicable
controls.

Reviewing and Assessing Internal Controls: There are two types of controls
namely general controls and application controls.
General Controls: General controls are those that cover the organization,
management and processing within the computer environment. They should be
tested prior to application controls, because if they are found to be ineffective, the
auditor will not be able to rely on application controls. General controls include
proper segregation of duties, file backup, use of labels, access control, etc.

Application Controls: Application controls relate to specific tasks performed by

the system. They include input controls, processing controls, and output controls.
They should provide reasonable assurance that the initiating, recording, processing
and reporting of data are properly performed.

Compliance Testing: Compliance testing is performed to determine whether the

controls actually exist and function as intended. This can be performed by
comparing the results to predetermined results or by processing dummy
transactions.
Substantive Testing: This is performed to determine whether the data is real.
Substantive tests are tests of transactions and balances and analytical procedures
designed to substantiate the assertions. Auditors must obtain and evaluate evidence
concerning management’s assertions about the financial statements. The auditor
must obtain sufficient competent evidential matter to provide a basis for an opinion
regarding the financial statements under audit. If sufficient competent evidence
cannot be obtained then an opinion cannot be issued.

Audit Reporting: The audit report will contain detailed information on various
aspects of their findings in the process of audit in a computerized environment.