INTRODUCTION TO AUDITING.

Meaning of Audit:
The word audit is derived from the Latin word “AUDIRE” which means to hear. Initially auditor
was a person appointed by the owners to check account whenever the suspected fraud, he was to
hear explanation given by the person responsible for financial transactions. Emergence of joint
stock companies changed the approach of auditing as ownership was pestered from management.
The emphasis now is clearly on the verification of accounting date with a view on the reliability
of accounting statement.

Definition:
Spicer and Peglar define auditing as:
• “An examination of the books, accounts and vouchers of a business’s
• shall enable the auditor to satisfy himself
• whether or not the balance sheet is properly drawn up so as to exhibit a true and Fair view
of the state of affairs of the business
• and that the profit and loss account gives true and fair view of the profit/loss for the
financial period,
• according to the best of the information given to him and as shown by the book.
• And if not, in what respect he is not satisfied.”
Mautz: defines auditing as being “Concerned with the verification of accounting data with
determining the accuracy and reliability of accounting statements and reports.”

The international auditing practices committee defines auditing as “the independent examination
of financial information of any entity whether profit oriented or not and irrespective of size/legal
form when such an examination is conducted with a view to express an opinion thereon”.

Scope of Audit.
The scope of audit is increasing with the increase in the complexities of the busines. It is said that
long range objectives of an audit should be to serve as a guide to the management future decisions.

Today most of the economic activities are largely conducted through public finance. The auditor
has to see whether these larger funds are properly used. The scope of audit encompasses
verification of accounts with an intention of giving opinion on its reliability. Hence it covers cost
audit, management audit, social audit etc. It should be remembered that an auditor just expressed
his opinion on the authenticity of the account. He has no power to take action against anybody, in
this regard it said that “an auditor is a watch dog but not a blood hound”.

Objectives of Auditing.
Auditors are basically concerned with verifying whether the account exhibit true and fair view of
the business. The objectives of auditing depends upon the purpose of his appointment.

Primary Objective.
The primary objective of an auditor is to respect to the owners of his business expressing his
opinion whether account exhibits true and fair view of the state of affairs of the business. It should
be remembered that in case of a company, he reports to the shareholders who are the owners of
the company and not tot the director. The auditor is also concerned with verifying how far the
accounting system is successful in correctly recording transactions. He had to see whether accounts
are prepared in accordance with recognized accounting policies and practices and as per statutory
requirements.

Secondary Objective:
The following objectives are incidental to the main objective of audting.
1. Detection and prevention of errors: errors are mistakes committed unintentionally because
of ignorance, carelessness. Errors are of many types:
a. Error of Principle: These are the errors committed by not properly following the
accounting principles. These arise mainly due to the lack of knowledge of accounting. Eg:
Revenue expenditure may be treated as Capital Expenditure.
b. Clerical Errors; A clerical error is one which arises on account of ignorance, carelessness,
negligence etc.
i. Errors of Omission: These are the errors which arise on account of transaction into
being recorded in the books of accounts either wholly partially. If a transaction has
been totally omitted it will not affect trial balance and hence it is more difficult to
detect. On the other hand if a transaction is partially recorded, the trial balance will
not agree and hence it can be easily detected.
ii. Errors of Commission: When incorrect entries are made in the books of accounts
either wholly, partially such errors are known as errors of commission. Eg: wrong
entries, wrong Calculations, postings, carry forwards etc such errors can be located
while verifying.
iii. Compensating Errors: when two/more mistakes are committed which counter
balances each other. Such an error is know an Compensating Error. Eg: if the amount
is wrongly debited by Rs 100 less and Wrongly Credited by Rs 100 such a mistake
is known as compensating error.
iv. Error of Duplication: when transactions are recorded twice in the books of original
entry

Location of Errors: It is not the duty of the auditor to identify the errors but in the process of
verifying accounts, he may discover the errors in the accounts. The auditor should follow the
following procedure in this regard.
1. Check the trial balance.
2. Compare list of debtors and creditors with the trial balance.
3. Compare the names of account appearing in the ledger with the names of accounting in the
trial balance.
4. Check the totals and balances of all accounts and see that they have been properly shown
in the trial balance.
5. Check the posting of entries from various books into ledger.

2. Deduction and Prevention of Fraud: A fraud is an Error committed intentionally to deceive/

to mislead/ to conceal the truth/ the material fact. Frauds may be of 3 types.
a. Misappropriation of Cash: This is one of the majored frauds in any organisation it
normally occurs in the cash department. This kind of fraud is either by showing more
payments/ less receipt.
The cashier may show more expenses than what is actually incurred and misuse the extra
cash. Eg: showing wages to dummy workers. Cash can also be misappropriated by showing
less receipts
 Eg: not recording cash sales. Not allowing discounts to customers. The cashier may also
misappropriate the cash when it is received. Cash received from 1st customer is misused
when the 2nd customer pays it is transferred to the 1st customer’s account. When the 3rd
customer pays it goes forever. Such a fraud is known as “Teaming and Lading”. To prevent
such frauds the auditor must check in detail all books and documents, vouchers, invoices
etc.
b. Misappropriation of Goods: here records may be made for the goods not purchase not
issued to production department, goods may be used for personal purpose. Such a fraud
can be deducted by checking stock records and physical verification of goods.
c. fraudulent financial reporting: Involves manipulation or falsification of records. Can be
done by not recording transactions, by recording dummy transactions or misapplication of
accounting policies.
Can take form of Window dressing or secret Reserve. this is finalizing accounts with the
intention of misleading others. It is very difficult to locate because its usually committed
by higher level management such as directors. The objective of WD may be to evade tax,
to borrow money from bank, to increase the share price etc.
To conclude it can be said that, it is not the main objective of the auditor to discover frauds and
irregularities. He is not an insurance against frauds and errors. But if he finds anything of a
suspicious nature, he should probe it to the full.

ADVANTAGES OF AUDIT:
1. Audited account are detected as an authentic record of transaction.
2. Errors and frauds are detected and rectified.
3. It increases the morale of the staff and thus it prevents frauds and errors.
4. Because of his expertise the auditor may advise on various matters to his clients.
5. An auditor acts as a trustee of his shareholders. Hence he safeguards their financial interest.
6. For taxation purpose auditing of account is amust.
7. In case of any claim is to be made from the insurance company only audited account should
be submitted.
8. Even in case of partnership firm auditing of accounts helps in the settlement of claim at the
time of retirement/death of a partner.
9. Auditor account helps in managerial decisions.
10. They are useful to secure loan at the of amalgamation, absorption, reconstruction etc.
11. Auditing safeguards the interest of owners, creditors, investors, and workers.
12. It is useful to take certain financial decisions like issuing of shares, payment of dividend etc.

TYPES OF AUDIT:

1. Statutory Audit: any audit carried on as per the requirement of law is called as a statutory
audit. eg: all companies have to get their accounts audited as per the provision of the company’s
Act of 1956.
2. Periodical/ Annual Audit: it is a kind of audit where the auditor verifies the account at the
end of the financial year. He starts the audit work after the closure of financial year. This is a
common audit and is mostly used by small organizations.
3. Interim audit: its an audit conducted in the middle of the accounting year before the accounts
are closed. In other words any audit conducted between two financial audit is known s interium
audit. The objective is to get periodical results, to declare interium dividend.
4. Partial Audit: when an auditor is asked to audit only a part of the account system. Its called
partial audit. Eg: he may be asked to audit only the payment side of cash book.
5. Balance sheet audit: it’s a kind of partial audit and is concerned with the verification of only
those items appearing in the Balance Sheet. It is more popular in the USA. Infact while
verifying BS items the auditor verifies/ checks all related items/accounts.
6. Cost audit: cost audit is defined as the verification of cost accounting records. Data and
techniques for its accuracy and authenticity. It gets as effective managerial tool for the
detection of errors and frauds in cost accounting records. The companies act implies the central
government to order cost audit incase of specifies companies.
7. Management audit: Management audit may be defined as a comprehensive examination of
an organizational structure of a company, institution/government and its plans and objectives
it means of operations and use of human and physical facilities. The main objective of mgt
audit is to see how far the objectives of mgt are fulfilled. It aims to ascertain whether sound
mgt prevails throughout the organisation and evaluates its efficiency in the system of its
operation.
8. Concurrent audit: an audit or verification of transactions or activities of an orgnisation
concurrently as the transactions/activities takes place. Helps to verify authenticity within
shortest possible time after the same takes place. Similar to internal audit. It was introduced by
RBI in October 1993
9. Continuous audit: a continuous audit is one in which the auditor visits his clients office at
regular intervals through out the year to verify the account. The objective of CA may be-
a. To get final account audited immediately after the closure of accounting year.
b. When the business is very large.
c. When interval control system is into effective.
d. When regular final accounts are required.

Advantages of Continuous audit:

1. Errors and frauds are discovered and rectified quickly.
2. The chances of fraud are reduced.
3. The workers will be careful in their work.
4. Continuous audit acts as a valuable morale check on the staff.
5. Final audit becomes easier and faster.
6. If the company wants to declare interim dividend it’s easier to prepare interim account.
7. It increases the efficiency and accuracy in the accounts.

Disadvantages of continuous audit:

1. After the auditor’s visit is over, alternative may be made.
2. It affects the regular work.
3. Its not suitable for small organizations.
4. The auditor may loose the line of work if he does not complete his work in a visit.
Precautions to be taken for continuous audit:
1. He should record important balances, totals etc and verify the same in his next visit.
2. Strict instructions should be given prohibiting the alteration of figures after checked by
the auditor.
3. For each visit special ticks should be used.
4. Its always better to verify the nominal account at the end of the year.
 5. An exhaustive audit programme must be prepared.
6. He should ensure that normal working is not affected.
7. As far as possible, he should pay surprise visits.

Principles of Audit
A] Integrity, Independence, and Objectivity:
The inspector must be candid while during the audit process; he can’t be inclining toward
the association. He should stay objective all through the entire cycle, and his trustworthiness
should not permit any negligence.

Another significant rule is autonomy or independence, and the examiner can’t have any
interest in the association he is inspecting, which permits him to be autonomous and fair-
minded consistently.

B] Confidentiality:
The auditor comes across a great deal of sensitive monetary data of the association. It is
significant that he regards the classified genre of such data and archives.

He can’t uncover any delicate data to any outsider except if it is a necessity by law. What’s
more, he should likewise be extremely cautious with archives, authentications, and so forth
that the association shares with him.

C] Skill and Competence:

The examiner should be capable and prepared in the strategies of auditing, for example, he
should be qualified as an examiner. Furthermore, as an expert, he should be aware and
upgrade on the latest changes, declarations, rules, and so forth.

In the event that is important, he can go through preparing and prepare to keep up to date
with the new accounting and auditing methodology. For instance, after GST was presented,
auditors needed to refresh their insight.

D] Work Performed by Others:

The extent of an audit on occasion can be extremely immense. So an auditor can utilise his
representatives, delegates, and others who work under him.

Be that as it may, the reviewer will keep on being completely liable for the work done by
these individuals working for him. So the evaluator should cautiously oversee and audit such
work and be sensibly certain of the precision of such work.

E] Documentation:
Much of the time, the examiner keeps a review notepad, a review or audit plan, and an
evaluating document or an audit file. It is significant the auditor tracks significant reports for
his review work, as it is proof of the work the evaluator has completed. Also, the customer is
leaned to these reports and records, assuming he wishes to examine the work.

F] Planning:
A review plan permits the inspector to arrange his work and empowers him to be more
proficient and ideal. Each review plan is distinctive as it must be redone as indicated by the
 type of association, the sort of business they lead, the extent of the review, the productivity
of the inside controls, and so forth.

G] Audit Evidence:
The auditor should gather sufficient proof to help him in his last assessment. This assortment
of such proof is finished by substantive and consistency systems. There are two origins of
this proof – inward or internal and outer or external. Likewise, external resources of proof
are, in every case, more dependable.

H] Accounting Systems and Internal Controls:

The inspector needs to guarantee that the records of the association are exact and address a
valid and reasonable image of the monetary status of the organisation. Likewise, the
examiner should guarantee that all material data has been recorded in the accounting
records. Testing the inside controls framework is likewise significant as it decides something
very similar.

I] Audit Conclusions and Reporting:

After the examiner gathers all proof, he should now shape his viewpoint based on the
accompanying standards:
▪ All applicable bookkeeping guidelines were applied consistently.
▪ Budget reports are consistent with all guidelines and legal prerequisites.
▪ All material data has been revealed.

Self study Questions under Module I:

1. Users of Financial Statements
2. Window Dressing
3. Secret Reserves
4. Limitations of auditing

MODULES - II
AUDIT PLANNING (SA 300)

Meaning

Planning in auditing encompasses developing an overall plan for the expected scope and conduct
of the audit and developing and audit programme showing the Nature, timing and extent of audit
procedures

Aspects to be covered:

1. Acquiring knowledge of client’s business – accounting system, policies and internal

control procedures
2. Establishing the expected degree of reliance on internal control
3. Determining and programming the nature, timing and extent of the audit procedures to be
performed; and
 4. Coordinating the work to be performed
Changes in audit planning:

• Planning is a continuous process and changes in conditions or unexpected results of audit

procedures may cause revisions of overall plan as well as the detailed audit programme
• It is necessary to document reasons of significant changes in audit planning
Importance of planning:

1. To devote appropriate attention to important areas

2. Identify and resolve potential problems on timely basis
3. Properly organized and managed audit
4. Assists selection of engagement team members with requisite capabilities and
competence
5. Co-ordination of work done by auditors of components and experts
6. Facilitating direction and supervision of Engagement Team
DOCUMENTS TO BE OBTAINED FORM THE CLIENT BEFORE COMMENCING THE
AUDIT:

1. Letter of appointment
2. MOA and AOA in case of company, partnership deed in case of firm
3. Organization charts
4. List of places of business
5. List of directors, partners and all the authorized officers
6. List of books of accounts and other relevant records
7. Internal control system manual and internal auditor’s report if any
8. Draft of final accounts along with schedules and groups
9. Past annual accounts and reports
10. Extracts form minute books
11. List of relatives of directors, interested persons etc
Preparation before commencement of the audit:
An auditor after receiving the appointment letter should communicate his acceptance/otherwise in
writing to the company. The following steps are necessary to commence the audit work:

1. If it is not a statutory audit, he should find out the exact nature and scope of his duties i.e.,
whether he has to audit the account/prepare accounts also.
2. He should inform his clients to close all the books of account and keep them ready for
verification.
3. He should acquaint himself with the nature of his client business.
4. He should examine the efficiency of the internal control system.
5. He should obtain the names of directors their power duties etc.
6. He should obtain a complete list of all books and documents maintained by the clients.
7. He should obtain a copy of previous year’s audit report.
8. He should go through various documents like MOA, AOA, prospectus etc.
Audit Programme: before commencing the audit he should plan his work so that is over without
delay. For this purpose the auditor chalks out a detailed programme explaining the procedure to
be followed for audit. It explains the work to be done by the audit staff. an audit programme is
defined as “a detailed plan of the auditing work to be performed, specifying the procedure to be
followed in verification of each item in the financial statements, and giving the estimated time
required’.
Hence an audit programme is a statement giving instructions and guidance to the audit staff as to
the audit procedure. It arranges and distributes the work among the audit staff.

ADVANTAGES:
1. It provides the audit staff clear instructions about their duties.
2. It promotes division of work in a well organized manner.
3. It helps the auditor to monitor the progress of the work.
4. It will be easier to fix responsibilities for omissions and commissions.
5. It serves as a valuable evidence for the work done.
6. It serves as a guide for future audit.
7. It ensures that audit process in a systematic manner.
8. It eliminates inefficiency and saves time.
9. Incase if any audit assistant goes on leave, his work can be easily continued by others.
10. It avoids duplication of work.

Disadvantages of Audit Programme.

1. The audit work becomes mechanical.
2. It kills the creativity of the audit staff.
3. Chances of work not done properly/ high as the scope is to be completed within a scheduled
time.
4. A rigid programme may not be suitable for all kinds of business.

The above disadvantages can be minimized if the audit programme is made more flexible and audit
staff encourages to go beyond the work mentioned in the audit programme. The auditors should
also periodically review the programme in the light of experiences gained in the previous year. He
should impress upon the audit staff. The audit programee is only guidance and they should use
their initiatives, intelligence and comman sense at all times during the course of the audit.
Audit Note Book: an audit note book is one of the most important document maintained by the
auditor. It is defined as a record used mainly in recording audit, containing data on work done
and comments made. Audit Note book contains information regarding the day to day work
performed by the audit staff, notes about errors, explanations required etc. the auditor can use it
as an authentic evidence in the court if there is any case against him.

Contents of Audit Note Book:

1. Nature of business and important documents such as MOA, AOA, Partnership deed etc.
2. List of books of accounts.
3. List of officials, their duties and responsibilities.
4. Copy of the audit programme.
5. Information on missing receipts, vouchers etc.
6. Details of errors discovered.
7. Explanations sought from the officials.
8. Points to be included in the audit report.
An audit note book should be preserved by the auditor as it contains valuable information in
respect of the work done by its staff.

Audit Working Papers:

Audit working papers are those papers which contain essential facts about accounts, which are
being audited. Its defined as the file of analysis, summaries, comments and correspondence build
up by the auditor during the course of audit.
The auditor maintains papers as supporting evidence to the audit work. The institute of chartered
accountants of India states that “an auditor is expected to maintain evidence of work done by him
and his staff”.
Usually, audit working papers contains a copy of the trial balances, schedule of debtors and
creditors, reconciliation statements important correspondence etc.

Purpose of maintaining working paper:

1. They show the extent to which accounting principles and auditing standards have adhered to.
2. They provide the required support for the auditors report.
3. They also reveal the efficiency with which the audit work was done.
4. They can be used as evidence in the court to defend himself against negligence in his duty.
5. They help the auditor in finalizing his report quickly.
6. They help the auditor to understand the efficiency of the accounting system, internal check
system etc.

Working papers should be clear complete, and contain the necessary information so that they may
be of maximum utility. They should be properly organized, documented and signed. In this regard
its said hat “an auditor is often judged by the quality of the working paper prepared by him under
his guidance”.
working papers are confidential documents hence he should not disclose the facts to others. Doing
so results in professional misconduct. Working papers should be preserved properly because they
are important documents.

content of permanent file:

1. Memorandum and Articles of Association of the company or the Partnership Deed case of a
Firm, the Trust Deed in case of a Trust.

2. Study and Evaluation of internal Control System by way of questionnaires, flow charts etc.

3. Description of accounting policies and system.

4. Copies of audited accounts of earlier years.

5. Analysis of Ratios, Trends etc. in earlier years.

6. Letters to management by the auditor containing observations on earlier audits.

7. Communication with the previous auditor and his reply.

8. Notes on discussions with the client in respect of –

 • nature of business, management, organisation and activities.
• laws, rules, regulations etc. applicable to the client.
• financial or accounting problems.
• nature of accounting system, policies or internal control.
• scope and timing of audit examination.
Content of current file:

A Current (Temporary) Audit File contains the following details pertaining to the audit of the
current year

1. Letter of Appointment for the current year and its acceptance.

2. Documents obtained from the client before commencement of audit e.g. Organisation Chart,
List of Authorised Officers, List of places of business, List of books, Internal Control Manual
and Internal Auditor's reports, List of products, List of relatives etc.

3. Audit Plan.

4 Audit Programme.

5. Analysis of transactions and balances.

6. Audit procedures (vouching, verification etc.) performed, the points raised (queries), how the
points were solved, the explanation or documents obtained while solving the queries and the
conclusions drawn. This forms the major part of the file or the "Audit Note Book"

7. Evidence of review and supervision of the work of the assistants.

8. Copies of correspondence with the Joint or Branch Auditors and experts

9. Copies of correspondence with the client containing observations on audit, weakness in

internal control etc.

10. Extracts of important resolutions from Minute Books.

11. Letters of confirmation from parties, banks, lenders etc.

12. Trial Balance, Final Accounts, Schedules and Groupings for current year.

13. Certificate (representations) from management regarding closing stock, verification of fixed
assets, value of current assets and so on.

14. Audit Report along with details of how each conclusion was reached.

OWNERSHIP OF WORKING PAPERS:

The auditor who collects information through working papers for his audit work. Usually claims
that he is the owner of the working papers. On the other hand the company claims that the auditor
was appointed by and he only acts as its agent. Hence, all the documents that the auditor had
collected should belong to the company several cases have been referred to the courts regarding
the ownership in one of the cases it was decided that the working papers belong to the auditor
because he was an independent professional and not an agent of the client. In another case also, it
was held that the working papers belong to the auditor.

Auditors Lien:
The auditors if has into been paid his audit fees has the right to keep the books of accounts and
other related documents in his possession till his dues are paid. Such a right is known as Auditors
Lien.
Differences between Accounting and Auditing.

Accounting Auditing
1. It’s a continuous process carried out 1.It’s a one time activity after the closure of
throughout the year. accounting year.
2. No prescribed qualification is required to 2. He must be the member of Institute of
be an accountant. Chartered Accountants of India to become an
auditor.
3. An accountant is a employee of the 3. An auditor is an independent professional.
company.
4. An accountant gets regular salary for his 4. He gets remuneration for his professional
work. work. Audit fees.
5. Accounting is concerned with recording of 5. Its concerned with verification of accounts
business transactions systematically. prepared by the accountant.
6. Accounting precedes, auditing. 6. Auditing succeeds accounting.

Usually an auditor confines his work only to the verification of accounts. In small organizations
he may also be asked to finalize accounts. In this case he acts both as an accountant and as an
auditor but the audit work commences only when the accounting work is over. Hence, its said that
“Audit begins where accounting ends”.

AUDIT EVIDENCE (SA 500 – AS GIVEN IN CLASS)

DISTINGUISH BETWEEN INTERNAL EVIDENCE AND EXTERNAL EVIDENCE

AUDIT PROCEDURES (SA 520)

1. compliance procedure – to obtain evidence from internal control i.e. whether

• Controls exists
• Controls are effective
• Controls are operative
2. substantive procedure
• Vouching
• Checking posting
• Checking casting
• Ledger scrutiny
• Verification
• Grouping
• Disclosure
AUDIT TECHNIQUES (METHODS)
• inspection
• observation
• inquiry
 • confirmations
• computation
• analytical review

MODULE – III
Test check Vs. Routine check
 AUDIT SAMPLING
The extent of the checking to be undertaken is primarily a matter of judgment of the auditor,
there is nothing statutorily stated anywhere which specifies what work is to be done, how it is to
be done and to what extent. It is also not obligatory that the auditor must adopt the sampling
technique. What he is to do is to express his opinion and become bound by that.
To ensure good and reasonable standard of work, he should adopt standards and techniques that
can lead him to an informed professional opinion
Meaning:
According to SA 530 “Audit sampling”, ‘audit sampling’ refers to the application of audit
procedures to less than 100% of items within a population of audit relevance such that all
sampling units have a chance of selection in order to provide the auditor with a reasonable basis
on which to draw conclusions about the entire population.
The factors that should be considered for deciding upon the extent of checking on a sampling
plan are following:
(i) Size of the organisation under audit. (ii) State of the internal control. (iii) Adequacy and
reliability of books and records. (iv) Tolerable error range. (v) Degree of the desired confidence
Approaches to Sampling
Audit sampling can be applied using either non-statistical or statistical sampling approaches.
Statistical sampling is an approach to sampling that has the random selection of the sample
items; and the use of probability theory to evaluate sample results, including measurement of
sampling risk characteristics. A sampling approach that does not have above characteristics is
considered non-statistical sampling.
 INTERNAL CHECK.
The term internal check implies that the work of various members of the staff is allocated in such
a way that the work done by one person is automatically checked by another. It is defined as “such
an arrangement of book keeping routine where in errors and frauds are likely to be prevented or
discovered by the very occupation of book keeping itself’.
Internal check is a system under which accounting methods and details of an establishment are
laid out that the accounts and procedures are not under the absolute and independent control of
any one person or the contrary the work of one employee is complementary to that of another.

The system of IC is based upon the principle of division of labor, where in performance of each
individual is automatically checked by another. This is possible by properly allocation the work
and integration of function of the employees in such a manner their work complements each others.

OBJECTIVES OF INTERNAL CHECK:

1. Eliminates frauds and errors to prevent misappropriation of goods in cash.
2. To encourage specialization of labor.
3. To reduce the time spent on a particular work.
4. To exercise moral pressure over staff members.
5. To make accounting system more reliable.

Points to be Considered in Framing a Good Internal Check.

1. No single employee should have independent control over any important aspect of the
business. In other words the work of employed should be automatically received by another.
2. The duties of the employees should be changed from time to time without prior notice.
3. Employees who control physical assets should not have assets to goods of account.
4. It’s better to follow a system of self balancing ledger.
5. Account must be periodically verified.
6. The allocation of work must be carefully done and the position must be reviewed
periodically.
7. While stock taking the pricing and evaluation of stock should be done by the people who are
not connected to stores department.
8. A cashier should not be in charge of maintaining accounts complete bank transactions etc.
Internal check and the Auditor:

The auditor before starting audit work evaluates the system of internal check. If it is efficient he
may avoid detailed checking of the transactions and he can carry out a few test check of the
transactions to what extent should an auditor rely upon the system of internal check will depend
upon the degree of effectiveness with which, the system is followed as well as the size of the
business. If the internal check system is inefficient, he had to check in detail all transactions. It
should be remembered that even if the internal check system is efficient he should still test its
existence and efficiency.
Efficient internal check system reduces his work but not his responsibility. If in the process of examination
of accounts if he finds any weakness in his system, he should report it to his client. Thus the existence of
a good internal check system may help an auditor to a great extent, but does not reduce his legal liability.
If any fraud is discovered subsequently he may be held quietly of negligence. He can’t defend himself
saying that he relied upon the efficient internal check system that existed in the business.

Internal check regarding CASH SALES.

Sales over the counter. The following is the internal check system regarding sales over the
counter.
1. Each counter should have a separate salesman.
2. Each salesman should be given a separate sales memo book. Usually different color is used
for different counters,
3. Sales memo should be prepared by the salesman in 4 copies.
4. The sales memo is checked by another clerk before being handed it over to customer. A copy
is retained by the clerk.
5. Payment is made at the cash counter.
6. One copy of cash memo is returned to the internal duly stamped as cash paid 2 copies are
return the cashier.
7. The cashier records days total sales in cash sales register.
8. Every salesman should prepare total sales summary of the respective counters. At the end of
the day total sales as recorded by salesman, total cash received and total sales as per register
must agree with each other.

Postal Sales:

A separate register should be maintained to record details of postal sales. Cash may be received
either with order (cwo) or at the time of delivery (cod). Proper records will be made in this regard
for cash received and due. Usually, goods are sent by VPP (value payable post). The sales register
must be checked in detail by a senior officer.

Sales by Traveling Agents:

1. Traveling salesman should not be allowed to issue final receipts to customers.
2. Amount received must be remitted to H.O. account on daily basis.
3. Salesman should not be allowed to deduct their expenses or commission from the sale
proceeds.
4. The salesman should submit periodical sales report which must be examined in detail.

Internal check regarding Wages:

In a large organization, expenses on wages with 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 following internal
check system is suggested in this regard.

1. Maintaining Time Records: A department is in charge of recording the time spent by the
workers should be constituted as far as possible. Manual system of time keeping must be
avoided. This brings down the fraud regarding the payment of wages for which no work is
done.
The time keeping check and the foremen should separately prepare the time recorded sheet
recording the name of the worker, time of entry, names of absentees etc.
In case if the workers are paid on piece rate system proper system of time booking must be
followed each worker should be given a job and counter assigned by the supervisor.
In case if workers work overtime, the overtime slips must be issued which is authorized by the
concerned official. No worker should be allowed to work Over Time if he is not authorized to
do so.

2. Preparation of Wage Sheets:

Large scale organizations should evolve in an internal check system in such a manner that the
chances of over payment, under payment, wrong payment to workers are minimized and
 prevented. Preparation of wage sheets should be the responsibility of a separate department.
Separate wage sheets should be maintained for workers under time rate system and price rate
system.
Two clerks should examine the time and price wage records. Over time records etc another
clerk should be in charge of preparing wage sheets of individual works. The 4th clerk checks
the calculations deduct amount for PF, IT, etc to arrive at net amount to be paid to workers.
All officials involved in the process, should sign the statements which will be approved by the
work manager/ the production manager.

Payment of Wages: a person is not involved either in maintaining time records preparation of
wage sheets should be in charge of payment of wages. Usually the cashier in the accounts
department will allot the wages, according to the information given by the wage sheet. As far
as possible wages should be distributed personally to the workers who sign the Wage Register.
Absentee workers should be paid through others workers only after written authorization is
received. A list of unpaid wages should be prepared after the distribution of wages. If there are
casual workers, payment should be made to them separately on a different day.

Internal Check as Regards Purchase.

The purchase dept, will be responsible for proper control over purchases as far as possible.
Purchases must be centralized for the purpose of internal check. The purchase process may be
divided as:
1. Purchase.
2. Storage.
3. Issues of Materials.

1. Internal Check regarding Purchase of Materials: The concerned dept, head will send
requisition letter to the purchase dept, for each dept, a separate file must be maintained
for requisitions. Based on the requisition the purchase committee, purchase dept, calls for
tenders from approved suppliers. These tenders must be opened by the purchase
committee and the least bidder will be chosen.
Purchase order has to be sent to the selected suppliers. Usually, purchase order will be
prepared by the purchase dept, a copy of which will be sent to the supplier, second to the
stores, third to the accounting dept, and the fourth is retained by the purchase dept.
When goods are received the stores keeper inspects them and compared with the
purchase order. If goods are acceptable he enters them in goods inward book and issues
the acceptance letter. A copy of the acceptance letter will go to the accounts dept, which
will again compare goods approved letter with the purchase order. The accounts manager
if satisfied authorizes for its payment.
2. Internal Check Over Storage of Goods: The stores keeper should maintain proper
records, regarding storage of goods. He usually maintains bin cards and stores ledger
surprise.
3. Internal Check as regards to issue of Materials: Materials should always be issued
against material requisition note. After each issue, and purchase proper record must be
made in bin cards and stores ledger.

Internal Control:
Internal control is a broad term which is normally used to control financial and non-financial
activities. It involves a number of checks and controls exercised in a business to ensure efficient
and economic working.

Definition:
Internal Control is defined as “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.
Objective advantages of Internal Control:

1. From the clients point of view.

a. Internal control system provides authentic and reliable data useful to take business
decisions.
b. It safeguards the physical and non-physical assets in the form of records, documentation
etc.
c. It promotes operational efficiency, by preventing waste, duplication of work and
inefficient use of resources.
d. A good system of internal control provides that the company follows the procedures and
rules as required by the law.

2. From auditors point of view.

An auditor evaluates a system of control before commencing an audit work his work
becomes easier if the control system is efficient. He can also decide whether detail
verification is necessary or not.

Disadvantages of Internal Control:

1. It involves expenditure which may not be affordable by the small organizations.
2. Internal control is concerned with routine transactions many times unusual transactions may
be over looked.
3. The system of internal control may be weakened due to inefficiency in handling of the
system.
4. There are chances of diverse objectives among employees in the departments and staff in
charge of internal control.
5. Management may manipulate the operation of internal control system.

Elements, features characteristics principles of a good Internal Control System:

An effective internal control system should have the following factors:
1. Competent and trust worthy staff: people in charge of internal control system must be
reliable and highly competent about the work. Lack of knowledge and dishonesty will spoil
the efficiency of the system.
2. Records of financial and other organizational plans: A good internal control system must
have good documentation system. Filing, recording, classifying, etc will help in this regard.
3. Segregation of duties: normally, there should be a separate department for internal control
this reduces frauds, bias etc. normally, a clerk in charge of accounting function should not be
in charge of assets also.
4. Supervision: proper reviewing of the operations of the company regularly makes the control
system effective.
5. Authorization: all transactions must be properly authorized. In other words, the authority of
each person should be well defined.
6. Sound practices: the company should have well established procedures, policies, delegations
organizational manuals etc.
7. Internal Audit: it’s a part of internal control and it should be independent of internal check.
8. Accounting Controls: proper accounting information systems should be established so that
the information relating to accounts is properly collected, recorded and accounts prepared.

Scope of Internal Control or Areas of Internal Control:

1. General financial Control: It’s concerned with control over all finance functions i.e.,
planning, acquiring and investing funds and management of profits. It deals with accounting
supervision recording etc of the finance department.
2. Cash Control: it’s concerned with proper control over receipts payments and balance of cash.
The control system must ensure that misappropriation of cash is prevented.
3. Control over wages: this includes maintenance of time records, wage records, and payment
to workers. The main area of concern in this regard is the check payment to wages for the work
not done and misappropriations of cash.
4. Control over purchases: the system of internal control regarding purchases should be
developed in such a manner that purchasing accounting, handling and issuing of goods are
properly controlled.

Internal Audit:
Large scale organizations usually develop a system to review their activities to identify areas of
non performances. Internal audit is a tool used in this regard.

Definition:
Internal auditing involves a continuous critical review of financial and operating activities by a
staff of auditors functioning as full time salaried employees.

Objective of Internal Audit:

1. To comment of the effectiveness of the internal control system in force and means of
improving it.
1. To verify correctness accuracy and authenticity of the records presented to management.
2. To facilitate early detection of errors and frauds.
3. To ensure that standard accounting practices are followed.
4. To ensure that assets are properly acquired, safeguarded and accounted for.
5. To investigate in the areas as requested by the management.
6. To see that exhibited liabilities are valid.

Advantages of Internal Audit:

1. Internal Audit makes the system of internal control more effective and efficient.
2. It makes the auditor’s work more simple.
3. Errors and Frauds are detected early.
4. It increases the morale of the employees.
5. Employees will be more careful as their work will be audited immediately.

Disadvantages of Internal Audit:

1. Small organizations cannot afford to have internal audit system as it’s expensive.
1. The regular work of the organization will be affected.
2. Internal auditor acts as a staff manager hence there are chances of differences of opinion
between the internal auditor and the employees of the company.

Difference between Internal and Independent Audit:

Internal Independent.
1. An internal auditor is a regular employee of 1. He is a professional auditor appointed by
the company. the company who is not an employee.
2. His duties, rights and responsibilities are 2. The scope of audit work liabilities, duties
determined by management. etc are explained by concerned statutes.
3. He is appointed by the management. 3. He is appointed either by shareholders or
by govt.,
4. It’s not compulsory. 4. It is compulsory for all companies.
5. Internal auditor acts as an advisor to the 5. He is independent of the management.
management.
6. To become an internal auditor professional 6. An independent auditor must have
qualification is not necessary. professional qualification as per the act.
7. Internal Auditor ensures that the system of 7. the internal auditor comment on the true
accounting is efficient. and fair view of business.
8. An internal auditor reports to the 8. The Internal Auditor reports to the
management. shareholders.
9. Internal audit is a continuous process. 9. It’s a periodic process.

To conclude, it can be said that “the internal auditor’s responsibility is to the management and he
is not a servant of the independent auditor. His scope will be decided by the management and eh
should be free to communicate to the external auditor but should not involve himself with the work
of independent auditor.

Difference between internal checks and internal audit:

Internal Check Internal Audit.

1. It is an arrangement of duties allocated in 1. It is independent appraisal of operation and
such a way that the work of one person is records of the company.
automatically checked by another.
2. The purpose of IC is to prevent minimize 2. The purpose is to detect errors and frauds
possibilities of errors and frauds. that are already committed.
3. IC doesn’t require separate staff. It 3. It requires separate staff employed only for
represents only the arrangement of duties. this purpose.

4. IC is a continuous process. 4. The Internal auditor has to report

periodically about various inefficiencies
and suggest improvements.
5. IC begins along with the recording of 5. It begins when the accounting process ends.
transactions.
6. It is devices of doing the work. 6. It is a device for monitoring the work.
 7. Scope of Internal Check is limited 7. The scope of internal audit goes on beyond
especially to the accounting department. accounting department.

Internal check in a Department Store:

A department store is a large scale retail organisation working on self service basis selling the daily
requirements of the customers. These are centrally located and attract customers.

Operation of Department Stores:

As the name itself suggests a dept., store is divided into many small departments, each department
offering a specific product line. These depts., are headed by supervisors assisted by stock
assistants. While the accounting departments, takes care of recording all transactions, in the cash
dept, will be in charge of receipts and payments of cash. As it operates on self service basis cash
is paid by the customer at the counter.

Internal Check as regards Purchase.

Goods are to be purchased as per the order of the G.M. The General Manager prepares purchase
order based on the requisition notes sent by the supervisor. No supervisor should be given
independent charge of purchase. A copy of the purchase order is sent to the accounting department
and stores dept., when once the goods are received the store keeper verifies them with the order
and approves for payment. The accounts department makes the payments after verifying the
Purchase order and goods.

Internal Check regarding Cash Receipts.

usually the cash counters are computerized which brings down the human errors. The customers
make the payments directly at the counter. The counter clerk prepares the bill and receives the
cash. Chances of error and fraud are less as goods are coded and price is mentioned against codes.
As far as petty cash expenses are concerned, the cashier should be in charge of petty cash expenses,
which are recorded on daily basis. The goods are delivered after verifying the bill.
 Verification and Valuation of Assets and Liabilities.

Verification:
Verification is a process carried out to confirm the ownership valuation and existence of items at
the balance sheet date.
Spicer and Pegler define verification as, “the verification of assets implies an inquiry into the
value, ownership and title, existence and possession and the presence of any charge on the
assets.
It is also defined as a process by which the auditor substantiate the accuracy of the right hand
side of Balance Sheet and must be considered as having 3 distinct objects, i.e., verification of the
existence of assets, the valuation of assets and authority of their acquisition.
The auditor is required to report whether the Balance Sheet exhibits the true and fair view of the
business. For this, he has to examine and ascertain the correctness of money value of assets
and liabilities as shown in the Balance Sheet. In the case of London Oil Storage Company Ltd, it
was held that it is the duty of the auditor to verify the existence of assets, stated in the Balance
Sheet and that he will be liable for any damage suffered by the client, if he fails in this duty.
The Institute of CA of India, states that the verification of assets should be aimed at establishing
their:
a. Existence
b. Ownership
c. Possession.
d. Free from Encumbrance.
e. Proper recording and proper verification.

Difference Between Verification and Vouching.

1. Vouching Proves the accuracy of book entries but certification on balance sheet can be made
only after verification.
Vouching Verification
1. Vouching examines the entries 1. Verification examines the assets and
relating to transactions recorded in liabilities appearing in the Balance
books of accounts. Sheet.

2. Vouching is done throughout the 2. It takes place at the end of the year.
year.
3. Vouching is bases on only 3. Verification is based on personal as
documentary examination. well as documentary examination.
4. It does not include verification. 4. It includes valuation.

5. Vouching is normally done by audit 5. It1 is done by the auditor himself.

assistant.

Valuation: The accuracy of B.S depends on the correctness of estimation of value of assets. A
company’s BS is not drawn for the purpose o showing what the capital would be worth if the
assets were realized and liabilities paid off. But to show how the capital stands invested. It’s the
responsibility of the auditor that items in the BS are neither over valued nor undervalued.

Auditor Position Regarding Valuation:

An auditor can obtain the certification of valuer and other competent persons. Usually, the assets
are valued by responsible officials. An auditor audits many types of companies and he can’t be
an expert to value all kinds of assets.
An auditor is not a valuer, and can’t be expected to act as such. All that he can do is to verify the
original cost price and to ascertain as far as possible the current values are fair and reasonable
and are in accordance with accepted principles.
It must be borne in mind that the actual valuations are made by officials who have a practical
knowledge of such assets and that an auditors duty is confined to testing the valuations as far as
he can and in this way satisfy himself with correctness of the BS position. However, he can’t
guarantee the accuracy of valuations.

In simple words, In the absence of suspicious circumstances he can rely on the trusted officials
of the company but this will not relive him from his responsibilities if assets are incorrectly valued.
He should exercise reasonable care and skill, analysis critically all the facts and satisfy himself
that generally accepted. Accounting principles are followed. He should not certify what he believes
to be incorrect.

Method of Valuation:
Assets may be valued in any 1 of the following methods.
1. Cost Price: Its price paid to purchase an asset including installation and other expenses
incurred to make the asset into workable condition.
2. Market Value: Its value of which an asset can fetch in the market when it is sold.
3. Replacement Value: It’s the price at which a particular asset can be replaced.
4. Book Value: It’s the value of an asset, as shown in the Balance Sheet.

Differences Between Verification and Valuation.

Verification. Valuation.
1. Verification is done to prove the existence, 1. It certifies the correct value of the asset at
ownership and title to assets. the date of the BS.
2. Verification is done or both assets and 2. Usually only values of assets are certified.
liabilities.
3. Verification is done by the auditor. 3. It’s done by the experts and responsible
officials.
4. Verification is made on the basis of 4. Valuation is made based upon the
evidence. certificate issued by the officials.

Verification and Valuation of Assets.

A. Intangible Assets:
i) Goodwill: goodwill is an intangible assets representing the value of the reputation of
the firm which enables it to earn more than normal profit. The value of goodwill varies
with the earning capacity of the business.
When a business has been purchase and goodwill is paid for the auditor should verify
the agreement with the vendors. Whenever a business is acquired, goodwill is the
difference between the value of acquisition and cost of acquisition.
Sometimes, goodwill may also be created by spending huge amounts to innovate new
products. Such goodwill is known as Deferred Goodwill. Its capitalized over a period of
time. Goodwill is shown in the books at cost less the written off amount.

ii) Patents: patent rights should be verified with the certificates granting such rights. If a
patent is purchased, he should verify the assignment deed. He should see whether the
deed is registered in the name of his client and patents are the property of the client.
The auditor should also examine whether fees paid to purchase patents are treated as
capital expenditure. If renewal fees is paid, it should be treated as revenue expenditure.
 If the client has number of patents he should get the list of patents with details such as
the date of acquisition, the period of which its acquired etc.
Patents are written off over the period of which they are acquired. Hence, they are
shown in the BS at cost less written off amount.

iii) Copy Rights: copy rights are those rights to produce or reproduce any creative work.
The auditor should verify the agreement between the holder of the copy right and his
client. Copy right is shown is BS at cost price less written off amount.

iv) Trademarks: they are registered brands. It gives the holder exclusive right to own the
brand and protect it from imitation. An auditor should verify the certificate issued by the
concerned authority, the fees paid for renewal etc trademarks are valued at cost price
less written off amount.

B. Fixed Assets.

i) Land and Building: For verifying land and building the auditor should differentiate
between free hold and lease hold properties.
a) In case of free hold land and building, the auditor should verify with the title deeds to
ensure that the property is in the name of the client.
He should check the other documents like the life encumbrance certificate etc to see
whether the property is free of any charge. If it is mortgaged he should verify the
mortgage deed. As long as the title deeds are in order the auditor can’t be held liable
for frauds. However, the auditor should obtain a certificate from the client’s legal
advisor confirming the validity of ownership.
Land is valued at cost price which includes purchase, price, commission pay
registration and legal charges, etc. it should be remembered that the land is not
depreciable assets.
On the other hand building is always valued at cost less depreciation. It should be
remembered that is to be charged even if the building is not used during the year.
In case of building under construction valuation is made based upon the architect
certificate.
b) Lease Hold Property: In case if the property is held in lease he should verify the lease
agreement and see whether its registered or not it is valued at cost less depreciation.

ii) Plant and Machinery: He should obtain a schedule of plant and machinery certified by
responsible official. It gives all details about each machinery. He should compare the
schedule with the plant register. If machinery is acquired under hire purchase he should
verify the hire purchase agreement. If the machinery is imported he should verify the
export license copy of invoice, permission of RBI from foreign exchange payment.
Plant and Machinery is valued at cost less depreciation. Depreciation rate is decided
by the management. The only duty of the auditor here is to see whether depreciation is
charged as per the provision of the IT Act.
iii) Furniture and Fixtures: Furniture is a movable asset where as fixtures becomes a part
of another asset. It any addition is made during the year, he should verify the invoice
and pass book. He should also verify the schedule of furniture and see whether they are
properly numbered and proper accounts are maintained. Repairs to furniture should be
treated as revenue expenditure and hence debited to P&L a/c. furniture is always valued
at cost less depreciation at a reasonable rate. He should verify the method of
depreciation. The amount of depreciation varies with the usage.
 Eg: Furniture used in Canteen requires more depreciation than furniture used in office.
Hence the auditor must verify carefully to satisfy himself about the adequacy of
depreciation.

Motor Vehicle: if the company has more number of vehicles he should verify the
schedule of vehicles. He should verify the registration book of each vehicle. He should
check the insurance paid on the vehicle etc. motor vehicles are valued at cost less
depreciation. He should see that reasonable depreciation is provided.

C. Current Assets.

i) Cash in Hand: Cash in hand is verified by actually accounting it on the date of Balance
Sheet. The counting must be done in front of the cashier. To avoid frauds the auditor
must ask the cashier to deposit all the cash except petty cash into bank account. This
makes verification easier. In case of temporary advances, enough care must be taken
in verifying the delays. Auditor will be held responsible for any negligence in this regard.
In the case of the London Oil Storage Co., Ltd it was found that the auditor had
committed breach of duty in not verifying the petty cash balance properly. The institute
of CA of India had clearly stated that the auditor should actually count the cash. It further
states that verification of cash should be of surprise nature and if cash in hand doesn’t
agree with the balance as shown in the Balance Sheet he should qualify his report by
mentioning the same.

ii) Cash at Bank:

The following steps are taken in verifying cash at bank:
i) Comparison of B.S as shown in the cash book and the pass book.
ii) Preparation of Reconciliation Statement.
iii) Obtaining a letter of confirmation from the bank.

iii) Bills Receivable: B/R is the acceptances given by Debtors. The objectives of verifying
bills receivable are:
i. To establish the accuracy of amounts.
ii. To know the validity of the bills.
iii. To know whether they are reliable and to see whether there is a fair disclosure in
the BS.

While verifying the BS the auditor

a. should examine bills receivable book.
b. to see whether any bill is honored after the BS is prepared but before auditing for this
he should vouch the cash book.
c. I bills are discounted; he should vouch the cash book and should see whether it is
shown as a contingent liability in the BS with proper provision.
d. He should see that bills receivable dishonored and not renewed are not shown in the
bills receivable book.

iv) Book Debts/ Sundry Debtors: Book debts are to be classifies as good, bad and
doubtful. The auditor should see the accuracy, validity, and collectability and
confirmation letters directly from the debtors. For any balance for which no confirmation
is received, he should carefully verify the account. He should see that proper provision
is made for bad debts. Failing to do so the auditor will be held guilty for negligence.
 v) Stock/ Inventories: Stock is the life blood of the business. It consists of stores and
spares, raw materials, work in progress, and finished goods. If stock is incorrectly
recorded, verified or valued, the P&L a/c doesn’t show correct balances. It also affects
the BS if stock if overvalued profit is inflated and if its understated it encourages creation
of secret reserves.
The objective of verifying stock is to see that it exists and is correctly valued. It may not
be possible to verify the entire stock. Hence he has to go for the checks to ascertain the
accuracy of stock. In the case of Kingston cotton mills co., ltd the judge observed that,
“it is no part of the auditor’s duty to take stock, he must rely on other people for details
of stock in trade.”
It was further observed that “an auditor is not bound to b a detective. He should not start
his work with a foregone conclusion that there is something wrong. He is a watch dog
and not a blood hound to be a detective. He is justified in believing in trust worthy
servants of the company provided it takes reasonable care”.
In another case it was decided that ‘it is certainly not the duty of the auditor to take stock.
He should check the calculation with proper care’.

While verifying stock:

a. He should review the procedure for maintenance of stock and records.
b. Examine the efficiency of internal check and control system.
c. See whether stock verification process contains adequate safeguards against
possible errors and frauds.
d. Test check the physical existence of a part of the stock. Stock is valued at cost
price/ market price whichever is lower/less.

vi) Investment: It may consist of govt., bonds, shares, securities etc. The auditor should
examine whether the company is authorized to make investments. He should see
whether the legal formalities have been completed. If the investments are larger in
number he should obtain the schedule of investments certified by a responsible official.
The statement should include name of the investment date of purchase, book value,
market price, rate and date of interest, tax deducted etc. It is advisable to verify all
investment at a time. It is always advisable that the auditor should personally inspect the
investments in the case of city equitable fire insurance company limited. Where the
investments were in the possession of brokers who had pledged them, the judge
observed that “had the auditors not depended on the certificate form, their brokers and
had demanded the actual production of securities, the fraud might have been detected.
Dividend received on investment should be examined by checking the counter foils of
dividend warrants. Investments are valued depending upon the purpose for which they
are held. If they are held as fixed assets (eg: trusts) they are valued at cost price, if they
are held as current assets, they are valued at cost price or market price whichever is
less.

Miscellaneous expenses and losses:

1. Preliminary expense: all expenses incurred in the formation of a company are called
preliminary expenses. The auditor should vouch the payments made and see whether
these expenses are written off regularly. The portion of preliminary expense not written
off will be shown in the balance sheet on the assets side.
2. Discount on issue of shares and debentures: whenever shares and debentures are
issued at discount, the company shows discount amount of the asset side till it is written
off. The auditor should verify the relevant accounts and documents and see whether
discount on the issue in particular on the re issue of forfeited share is as per the provision
so act.

3. Verification of liabilities: if liabilities are not properly exhibited account do not show
fair view of the business. While verifying liabilities the auditor should ensure that:
a. all the liabilities in the Balance Sheet are actually payable.
b. They are actually recorded.
c. They have arisen out of natural business operation.
d. There is a proper disclosure.

He should obtain a certificated from the responsible official of the company about the
existence of liability. In the case of West Minster Road Construction Company limited, it
was held that the auditor must take reasonable care to satisfy himself that all liabilities
have been brought into account. It was further observed that “If the auditor finds that a
company in the course of its business was incurring liabilities of a particular kind it
becomes his duty to make specific inquiries as to the existence of such liability before
he signs his report.

i) Verification of Share Capital: Share capital constitutes the amount contributed by

the owners. He should verify the MOA, AOA, and Minutes Book of board meetings,
cash book and pass book. If the shares are issued for 1 st time (IPO) he should go for
detailed checking of all transactions. He should also verify records regarding calls in
arrears, forfeiture of shares and their re-issue.

ii) Debenture: A debenture is a certificate issued by a company acknowledging its debt

to the authorized holder. It carries a fixed rate of interest. Usually paid once in
6months. The auditor should verify the minutes of directors meeting the authorizing
the issue. He should also verify cash book, pass book etc.

iii) Loans: Loans may be either secured or unsecured. The auditors should verify the
MOA and AOA and verify the borrowing powers of the company. In case of mortgage
loans, he should see that the assets are mortgaged as per the provisions of the law.
Its advisable to get confirmation from lending institution with a respect to amount of
loan, security, interest etc.

Current Liabilities.
i) Creditors: The auditor should obtain the confirmation statement from the
creditors and compare this with the statement of creditors as sent by the
company. He should verify purchase ledgers, invoice etc. It is advisable to have
a test check of all purchases mode during the year.

ii) Outstanding Expenses: The auditor should obtain a statement of all

outstanding expenses signed by a responsible official. He should see whether
these expenses have been properly disclosed. He should ascertain the accuracy
of the accounting records.

iii) Bills Payable: Bills Payable are negotiable instruments acknowledging the debt.
He should get a statement of bills payable and compare it with the bill payable
book. If any bills payable has been paid after the balance sheet date but before
 the audit, he should verify cash book and pass book. Such bills should not be
included in the balance sheet.

iv) Contingent Liability: A future uncertain liability which is dependent on the

happening of some event is called Contingent Liability. It may or may not arise in
future. Eg: Bills receivable discounted claims against the company etc. the auditor
should see whether all contingent liabilities are disclosed in the Balance Sheet.