INTRODUCTION TO AUDITING.

The practice of auditing existed even in the Vedic period. Historical records show
that Egyptians, Greeks and Roman used to get this public account scrutinized by
and independent official. Kautaly in his book “arthshastra” has stated that “all
undertakings depend on finance, hence foremost attention should be paid to the
treasury”.
Auditing as it exists today can be associated with the emerging a joint stock
company during the industrial revolution. The company’s act of 1956 gives
regulations regarding the audit work.

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 correct view of
the state of affairs of the business according to his best of the information given to
him and as shown by the book.
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 a 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 its 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. 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.
b. 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.
c. 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.
 d. 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.
e. Clerical Errors; A clerical error is one which arises on account of
ignorance, carelessness, negligence etc.

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. Manipulation of Accounts: this is finalizing accounts with the intention of
misleading others. This is also known as “WINDOWS DRESSING”. 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 cab 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 probel 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. Interium 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. It’s called partial audit. E.g.: 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. 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:
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 its easier to prepare
interim account.
7. It increases the efficiency and accuracy in the accounts.

DISADVANTAGES:
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.

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. A chance 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 common 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.

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
throughout the year. of accounting year.
2. No prescribed qualification is 2. He must be the member of Institute of
required to 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
company. professional.
4. An accountant gets regular salary for 4. He gets remuneration for his
his work. professional work. Audit fees.
5. Accounting is concerned with 5. Its concerned with verification of
recording of business transactions accounts prepared by the accountant.
systematically. 6. Auditing succeeds accounting.
6. Accounting proceeds, auditing.

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”.

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 1. He is a professional auditor
employee of the company. appointed by the company who is not
an employee.
2. His duties, rights and responsibilities 2. The scope of audit work liabilities,
are determined by management. duties 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 5. He is independent of the
the management. management.
6. To become an internal auditor 6. An independent auditor must have
professional qualification is not professional qualification as per the
necessary. act.
7. Internal Auditor ensures that the 7. the internal auditor comment on the
system of accounting is efficient. true 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 9. It’s a periodic process.
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 1. It is independent appraisal of
allocated in such a way that the operation and records of the
work of one person is automatically company.
checked by another.
2. The purpose of IC is to prevent 2. The purpose is to detect errors and
minimize possibilities of errors and frauds that are already committed.
frauds.
3. IC doesn’t require separate staff. It 3. It requires separate staff employed
represents only the arrangement of only for this purpose.
duties.
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 5. It begins when the accounting
of transactions. process ends.
 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
especially to the accounting beyond accounting department.
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 1. Verification examines the
entries relating to assets and liabilities
transactions recorded in appearing in the Balance
books of accounts. Sheet.
 2. Vouching is done 2. It takes place at the end of
throughout the year. the year.
3. Vouching is bases on only 3. Verification is based on
documentary examination. personal as well as
documentary examination.
4. It does not include 4. It includes valuation.
verification.
5. Vouching is normally done 5. It1 is done by the auditor
by audit assistant. himself.

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 1. It certifies the correct value of
existence, ownership and title to assets. the asset at the date of the
BS.
2.Verification is done or both assets and 2. Usually only values of assets
liabilities. are certified.
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
evidence. upon the 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. If 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. Tests 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 (e.g.: 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 1st 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.

AUDITOR’S REPORT / AUDIT REPORT.

The main objective of audit is to report to the owners on the true and fair
position of the business. Audit report is the medium through which an
auditor expresses his opinion on the financial state of affairs of the clients
business. It summarizes the results of the audit work conducted by the
auditor.

Importance of Audit Report.

In case of a company management is separated from the ownership share

holders appoint the auditor to check the accounts and submit a report to
them. However, the report doesn’t guarantee accuracy of the accounts.
The auditor is neither a guarantor nor an insurer. In one of the cases it was
held that “the auditor must not be held liable for not tracing fraud, when
there is nothing to arouse their suspicion and when those frauds are
perpetrated by the trusted servants of the company”.

The auditor is expected to act honestly with reasonable skill and care. Audit
report is an extremely significant document as share holders rely upon it.
The auditor will be guilty of professional misconduct if he deliberately fails
to disclose material facts known to him. Conceals misstatements and fails
to obtain necessary information to complete his audit.

TYPES OF AUDIT REPORT.

1. Clean Report: Its also known as Unqualified Report. It is given by the
auditor if he is satisfied with the fairness of Balance Sheet and Profit
and Loss account with all the contents of the financial statements and
he is satisfied with evidences, documents and explanation given by
his clients.

Specimen of Clear Report.

To,
The Share Holders of ABC Ltd.

We have audited the attached Balance Sheet of ABC Ltd as on

31.03.2009 and also Profit and Loss account annexed there to for the
year ended on that date.
1. We have obtained all the information and explanation which to the
bet of our knowledge and belief were necessary for the purpose of
audit.
2.Proper books of accounts are required by the law have been kept
by the company so far as it appears from our examination of books
and proper return adequate of our audit have been received from
branches not visited by us.
3. The Balance Sheet and P&L account dealt with by his court are in
agreement with the books of accounts and returns.
4. In our opinion and the to the best of our information and according
to the explanation given to us the said Balance Sheet together with
the notes thereon given the information required by Act of 1956 in
manner so required and gives a true and fair view.

Date: Signed
Place: (Name,
partner XY Associates)
Charted
Accountant.

2. Qualified Report: When the auditor is not satisfied with the accounts
presented to him if he finds any discrepancy in the recording of the
transaction, if he thinks that the Balance Sheet and P&L account do
not exhibit true and fair view of the business then he submits
Qualified Report.

It means he submits his report with certain qualification (observation)

a qualified report may be submitted in many cases such as improper
valuation of assets, inadequate or excess depreciation, not following
accounting standards etc.

The company Act doesn’t lay down any specific requirement

regarding the manner in which the auditor should qualify his report. It
should not lead any confusion to the reader. Before submitting a
qualified report he should discuss the issued with that of the
management. He should see that qualified report is free from
ambiguity, vague statements etc.

Specimen of Qualified Report.

To,
The Share Holders of ABC Ltd.

We have audited the attached Balance Sheet of ABC Ltd as on

31.03.2009 and also the P&L account of the company for the year
ended on that date and report that:
1. We have obtained all information and explanation which to the best
of our knowledge and belief were necessary for the purpose of our
audit.
2. In our opinion proper books of accounts as required by law have
been kept by the company so far as appears from our examination of
the books subject to the comments given here under:-
In the absence of stock register, adjustments relating to balances on
the registers have been accepted on the basis of management
decision.
3. The Balance Sheet and P&L account dealt with by the report are in
agreement with the books of accounts and returns.
4. Subject to the qualification given below in our opinion and to the
best of our information and according to the explanation given to us
the accounts together with the notes there on and documents
 attached there to give the information required by the company’s Act
of 1956 in the manner so required and give a true and fair view.
a. The provision for depreciation of fixed assets is inadequate.
b. Stock has been valued at market price which is higher than the
cost price.

Date: Signed
Place:
(Name,partner XY Associates)
Charted
Accountant.

Audit under Computerized Environment.

The process of account has undergone rapid changes in the recent years.
The recording of business transaction has changed from Manual System to
Computerized system. Computers are used for processing all kinds of
accounting information. Useful to the management in its function of
decision making. Most of the companies follow computerized accounting
system to record, process and present accounting transactions. An auditor
should see how efficient is the accounting information system is. It should
be remembered that a computer does not take decision on its own, but only
facilitate the process of decision making. Hence, the efficiency of
accounting information system depends upon the knowledge of people
related to it regarding computerized accounting.

Limitations or Problems associated with the computerized accounts.

1. In case of computerized accounts the auditor may not go for in depth
auditing. In other words, he may not go to the original data to vouch and
verify.
2. Knowledge of computer is a major deficiency in our country.
3. Each type of business has its own method of computerized auditing.
This makes the auditor’s work more difficult.
4. Documentation is completely different in case of computerized
accounting which requires complete knowledge of input and output
document.

Its therefore necessary that an auditor needs to be familiar himself with

computerized accounting system and its environment. He has to review the
system of internal control prevailing in existence, in recording, transmitting
and processing of the data.

Internal Control System Under Computerized Audit:

The auditor should study the internal control system existing in a business
where computerized accounting is followed. He should verify allocation of
duties, systems of authorization etc.
Its necessary to identify and decide the extent to which the internal control
is reliable. It should be understood that computerization of accounts does
not eliminate errors and frauds. Its advisable that he management should
consult the auditor while installing the system of computerized accounting.
This helps the auditor to satisfy himself as to its adequacy from the point of
view of audit work. The control systems may be of the following types:

a) Organizational Controls:
It is necessary to have an effective control system at various levels of
organization. Eg: A programmer can always manipulate facts if he
desires to do so, if the organization has a weak control system.

Its advisable to divide the work in such a manner that functions like
programming, system design and analysis, testing, operating etc are
assigned to different people. It is always necessary that the programmer
does not have access to the data files.
b) Control Over Documentation, Testing etc:
This includes preparation of flow chart, instruction to operations etc. the
control should be in such a manner that no alteration is allowed in
programmes without authorization. For new programming and changing
the existing programme a proper procedure should be laid out.

c) Input Control:
Quality of output depends upon the quality of input. It must be ensured
that only authorized, accurate, and complete input data are fed into the
system. Errors in these areas results in unreliable output.
control over creation of original documents to overcome the entry errors
or error and frauds at the input level. Companies can develop a system
of indentifying such errors at the entry level only before original
documents are forwarded to data processing centre. A senior officer
should review the documents to ensure their correctness.

d) Control over handling and movement of Original Documents:

To prevent loss of document either at data processing centre of while
transferring them to the following controls are suggested:
i) Documents should be sent in a well defined process or routing system.
ii) The document sourced from one department should be consecutively
numbered.
iii) It should be verified whether number of documents sent agree with
the number of documents processed.
 UNIT -5 Audit of Limited Companies and Others
COMPANY AUDITOR
According to Section 224 of the Companies Act, every company whether
private or public must appoint an Auditor or auditors to audit the final
accounts. The provisions relating to the appointment of auditor are as
follows:
1. Board of Directors:
The first auditor of a newly floated company is appointed by the board of
directors, within one month of registration of the company. Such an
auditor or auditors shall hold office till the conclusion of the first annual
general meeting.
The directors are also empowered to fill a casual vacancy of an auditor if
it is not caused by resignation. The auditor so appointed shall hold office
till the conclusion of the next annual general meeting. But in case, if the
vacancy is caused by the resignation of an auditor, it shall only be filled
by the company in its annual general meeting.

2. Annual General Meeting:

The auditor or auditors are appointed in the annual general meeting
under the following circumstances:
1) If the board of directors fail to appoint an auditor, the shareholders
shall make an appointment in the annual general meeting.
2) Every company shall at each annual general meeting appoint an
auditor to hold office from the conclusion of that meeting until the
conclusion of the next annual general meeting.
3) The company has to give intimation to the auditor so appointed within
seven days of his appointment.
4) The auditor so appointed shall within 30days of the receipt of intimation
from the company regarding his appointment, has to inform the
registrar of the company in writing whether he has accepted or refused
the appointment.
In every annual general meeting the appointment of the company’s
auditor is made by the simple majority of votes by the present members.

3. Central Government:
According to section 224 (3), if the auditor has not been appointed in the
annual general meeting, the company has to inform within seven days to
the Regional Director to whom the Central Government’s power to
appoint an auditor in such an event has been delegated under section
637.
 The said application must disclose in sufficient detail the reasons why the
company could not appoint the auditor at its general meeting. In the case
of default, the company and every officer of the company who is in default
shall be punishable with a fine which may extend to Rs.500 as per
section 224(4).

Appointment of Auditor by Special Resolution.

In 1974, Companies Act 1974 was amended by adding sub section A to
section 224. After that, in some cases, the appointment of auditors or
auditor requires special resolution. That is in case of a company, in which
not less than 25% of the subscribed share capital is singly or jointly held by.
a. A public financial institution or a government company or the central
government or any state government or
b. Any financial or other institution established by any provincial or state
Act in which a state government holds not less than 51% of the
subscribed share capital or
c. A nationalized bank or an insurance company carrying on general
insurance business.

In the above mentioned circumstances, the appointment of an auditor shall

me made by passing a special resolution (that is 75% or more of the
members present should agree for the resolution). If not, it shall be deemed
that the appointment has not been made and the central government will
get the right under section 224(3) of the Companies Act to make an
appointment.

Compulsory Reappointment.
Section 619 of the Companies Act specifies that in the case of government
companies, the appointment or reappointment of an auditor by the central
government can be made only on the advice of the comptroller and Auditor
General of India.
In other cases, that is, whether auditors are appointed by the board of
directors in the annual general meeting or by he central government, the
retiring auditors are compulsorily reappointed, unless
1. He is not qualified for reappointment.
2. He has given a notice in writing to the company of his unwillingness, to
be reappointed
3. Where a notice has been given or an intended resolution to appoint
some other person in the place of the retiring auditor and by reason of
death, in capacity or disqualification of that person or of all the persons
as the case may be, the resolution cannot be proceeded with or
4. A resolution has been passed at that meeting, appointing somebody
instead of providing expressly that he shall not be reappointed. This is
as per section 224(2) of the Companies Act.

Ceiling on Number of Audits

In 1974, a group of young charted accountant, academicians and other
sections of the public argued that the opportunities of professional practice
are concentrated in the hands of a few well established and leading
chartered accountants of the country. They demanded this monopoly be
liquidated in the general interest of the profession thereby providing an
opportunity to young chartered accountants also to earn their living.
Therefore, the companies act was amended in 1974, by introducing section
224 (1- B). This came into effect from February 01, 1975 to ensure a more
equitable distribution of audit work among all the practicing chartered
accountants and to avoid the concentration of audit work in few leading
firms of chartered accountants.
Therefore, according to section 224( 1-B) of the Companies Act, no
individual and no partner of the firm of auditors shall hold office as auditors
of more than 20 companies of which not more than 10 be companies with
paid up share capital of Rs.25 lakhs or more.

Filling of Casual Vacancies [Section 224(6)]

1. A vacancy caused by the resignation of an auditor shall only be filled by
the members in the annual general meeting.
2. If a casual arises for any other reason (that is, death, insanity or
insolvency) it can only be filled by the board of directors.
3. An auditor appointed to fill up the casual vacancy shall hold office until
the conclusion of the next annual general meeting of the company.
Qualification of Auditor.
According to Section 226(1) and 226(2) of the Companies Act, the
prescribed qualifications of an auditor are as follows:
1. A person who is a chartered accountant within the meaning of the
Chartered Accountant’s Act 1949.(Section 26(1)]
2. A person who holds a certificate under the Restriction Auditors
Certificate Rules 1956 is also qualified to act as an auditor of a
company. Such persons are also known as certified auditors and are
always subject to rules made in this behalf by the central government
[section 226(2)]
The central government in empowered to frame rules relating to granting
renewals, suspension or cancellation of such certificates.
Disqualification of a Company Auditor.
According to section 226(3) of the Companies Act, the following persons
shall not be appointed as auditors of a company.
1. A body corporate.
2. An officer or an employee of the company.
3. A person who is a partner in the business.
4. A person who is indebted to the company for an amount exceeding more
than Rs.1000/- or who has given any guarantee or provided any security
in connection with the indebtedness of any third person to the company
for an amount exceeding Rs.1000/-.
If an auditor, after his appointment becomes a subject of any of the above
mentioned disqualifications, he shall be deemed to have vacated his office
forthwith.

Removal of an Auditor.
1. The first auditors appointed by the directors prior to the first annual
general meeting of the company may be removed by the members in the
annual general meeting even if there tenure of office has not expired.
The general meeting may in their place, appoint any other person, notice
for whose nomination has been given by any member not less than
14days before the date of the meeting.
2. In any other case, the auditor may be removed from office before the
expiry of his term by the company in the annual general meeting after
obtaining the previous approval of the central government in this behalf.
This provision is as per section 224(7) of the Companies Act.
3. But section 225 of the Companies Act makes special provisions in this
respect, in order to safeguard the interests of an independent auditor
against unfair and unjust removal at the hands of an unscrupulous
management.

The procedure so laid down is as follows:

a. Special notice of intention to make such resolutions to remove the
existing auditor must be given to the company by the shareholder not
less than 14days before the annual general meeting.
b. On receipt of such a notice, the company must forthwith send a copy to
the retiring auditor.
c. The retiring auditor has the right to send a representation to the
company which he can ask the company to send to the shareholders.
d. If a copy of the representation is not sent to the members, either
because it was received too late to be thus sent, or because of the
 default of the company, the auditor may insist that the representation
shall be read out in the meeting.
e. The auditor, who is proposed to be removed, has the right to attend the
general meeting where his removal is to be discussed. He also has the
right to speak at such a meeting.
f. As a matter of professional conduct, the auditor so appointed in place o
another should communicate with the retiring auditor in writing before
accepting the appointment. If he does not do that, he may be held liable
for disciplinary action as per the regulations of the Institute of Chartered
Accountants of India.

Remuneration of an Auditor.
1. The general rule is that the appointing authority is authorized to fix the
remuneration f an auditor as per Section 224(8)
2. In the case of a new company where the auditors are appointed by the
board of directors, the remuneration will be fixed by the board of
directors.
3. Similarly, if an auditor is appointed to fill a casual vacancy the
remuneration will be fixed by the board of directors.
4. When an auditor is appointed by the Central Government the
remuneration will also be fixed by the Central Government.
5. If the auditor’s appointed at the annual general meeting, the
remuneration is also fixed at the annual general meeting.
6. Remuneration includes the sum paid by the company in respect of the
auditor’s expenses.
7. Where the auditor is reappointed in the next annual general meeting, the
amount fixed in the previous year is considered for the currency year
also, if nothing more is specifically provided as remuneration in the
current annual general meeting.
8. A part from the routine audit work, if a chartered accountant is entrusted
with the work of taxation, writing up of the account books and other
professional services then the auditors and the board of directors can fix
up the remuneration mutually for the additional work. Moreover, the
sanction of the share holders is not needed for the same.
9. Any remuneration paid for services other than routine audit work should
be explained in the Profit and Loss account separately as under:
i. Remuneration as an Auditor of the company.
ii. In the capacity of an adviser in respect of:
a. Taxation representation.
b. Company Law matters
c. Management Services.
 d. Internal Auditing
e. Other professional services and
f. For travelling and out of pocket expenses.

Rights of Company Auditors.

According to Section 227(7) of the Companies Act, a company auditor has
the following rights.
1. Right of Access t Books of Accounts:
As per Section 227(1) of the Companies Act every auditor of the
company has the right to access at all times to the books of accounts
and vouchers of the company, whether kept at the head office of the
company or elsewhere.
Under section 209(1) (d), a company auditor has the right to examine the
cost records also which are required to be maintained by certain
companies relating to production sales, stores etc.
2. Right to Obtain Information and Explanations:
An auditor can call for any information or explanation from different
officers of the company which he may think necessary for the
performance of his duties.
Under section 221, apart from the auditor’s right to obtain information
and explanation it is the duty of every officer of the company to furnish
without delay the information to the company auditor.
The power is so wide; the decision as to what information and
explanation is left entirely to the discretion of the auditor. If the directors
or officers of the company refuse to supply some information on the
ground that in their opinion it is not necessary to furnish it, then the
auditor has the right to mention that in his audit report.
3. Right to Receive Notices and Other Communication Relating to
General Meetings and to attend them.
According to section 231, of the companies act an auditor of a company
has the right to receive notices and other communications relating to the
general meetings in the same way as that of the members of the
company.
Similarly an auditor also has the right to attend any annual general
meeting and also to be heard at those meetings which he attends and
which concerns him as an auditor.
The auditor also has the right to make a statement or explanation with
regard to the accounts he has audited. But he auditor is not expected to
answer questions in the general meeting.
4. Right to Visit Branches.
 According to section 228 of the companies act the auditor of the
company has the right to visit the branch office or offices of the
company.
He can also audit such accounts of eh offices of the company provided
that there is not qualified auditor to audit the accounts of the branch
office or offices of the company, in such cases, the auditor has the right
to access at all times to the books of accounts and vouchers that the
company maintains at branch office or offices.
Moreover section 226 of the companies act provides that in case of the
company gets the branch accounts audited by some of the local
auditors, even the auditor has access at all times, to the books, accounts
an vouchers of the company and he can also visit the branches, if he
feels necessary.
5. Right to Correct Any Wrong Statement.
The company auditor is required to make a report to the members of the
company on the accounts examined by him of the final accounts and the
related documents which are laid down before the company in the
general meeting.
Similarly, the auditor can advice the directors to amend their system of
maintaining accounts. If the suggestions are not carried out, he has the
right to refer the matter to the members and also to report that in the
audit report.
6. Right to sing the Audit Report
As per section 229 of the companies act only the person appointed as
auditor of the company or where a firm is so appointed, only a partner in
the firm practicing in India, may sign the audit report or authenticate any
other document of the company required by law to be signed.
7. Right to Being Indemnified.
Under Section 633 of the Companies Act, an auditor is considered to be
an officer of the company and he has the right to be indemnified out of
the assets of the company against any liability incurred by him in
defending himself against any civil and criminal proceedings by the
company if it is proved that the auditor has acted honestly or the
judgment is delivered in his favor.
8. Right to seek Legal and Technical Advice.
The company auditor has the full right to seek the opinion of the experts
and to take their legal and technical advice so as to discharge his duties
efficiently.
9. Right to Receive Remuneration.
 As per Section 224(8) of the Companies Act, the company auditor has
the right to receive remuneration provided he has completed the work
which he has undertaken to do so.

Duties of Company Auditor.

The various duties of the company auditor are as follows:
1. To make special enquiries and investigation: in connection with the
following matters under section 227(1-A) of the Companies Amendment
Act 1965.
A company auditor shall enquire:
a. Whether loans and advances made by the company on the basis of
security have been properly secured and whether the terms of which
they have been made are not prejudicial to the interests of the
company or its members.
b. Whether the transactions which are not supported by any fact or
evidence, though recorded in the books are not prejudicial to the
interests of the company.
c. Whether personal expenses have been charged to the revenue
account.
d. Whether it has stated in the books of accounts of the company that
any shares have been allotted for cash and whether cash has
actually been received in respect of such allotment, and if no cash
has actually been received, whether the position as stated in the
account books and the Balance Sheet is correct and regular.
2. Duty to make a Report to the Shareholders.
Under Section 227(2, 3, 4 & 5) of the Companies Act, the auditor shall
report to the share holders about the accounts examined by him. The
report so mentioned shall contain the following.
a. Whether in his opinion, the Profit and Loss Account referred to in his
report exhibits a true and fair view of the profit or loss.
b. Whether in his opinion, the Balance Sheet referred to in his report is
properly drawn up, so as to exhibit a true and fair view of the state of
affairs of the business according to the best of his information and
explanations given to him and as shown by the books of accounts.
c. Whether he has obtained all the information and explanation which to
the best of his knowledge and belief were necessary for the purpose
of his audit.
d. Whether in his opinion, proper books of accounts as required by law
have been kept by the company and proper returns adequate for the
purpose of his audit have been received from branches he visited or
not.
 e. Whether report on branch accounts audited under section 28 by a
person other than the company’s auditor has been forwarded to him
as required by clause (c) sub section (3) of that section and how he
had dealt with the same in preparing the auditor’s report.
f. Whether the company’s Balance Sheet and Profit and Loss Accounts
dealt with by the report are in agreement with the books of accounts
and returns.
If the answer to any of the above mentioned questions is in the
negative, the auditor should submit his report accordingly.
3. Duty to comply with the Directives of the Central Government.
It is the duty of the auditor to comply with the various directives issued to
the auditor of the joint stock companies from time to time to give specific
reports on the financial accounts of the companies.
For example in 1975 it was made compulsory for some of the specified
companies which are engaged in any of the below mentioned activities
to conduct cost audit, that is, those companies engaged in
a. Manufacturing, mining or processing.
b. Supplying and rendering services
c. Trading
d. Business of financial investments, chit funds, nidhi or mutual benefit
societies.
4. Duty to sign the Audit Report.
As per section 229 of the companies’ act 1956, it is the statutory duty of
the company auditor to sign the report prepared by him. Only a partner
practicing in a firm in India can sign the audit report for and on behalf of
a partnership firm practicing as chartered accountants.
5. Duty to give a Statement in the Prospectus.
As per section 56(1) of the companies act, the prospectus issued by an
existing company shall contain a report from the auditor of the company
regarding
a. Profits and losses during the previous year.
b. Assets and liabilities of the company and its subsidiaries and
c. The rate of dividend paid by the company in respect of each class of
shares in the company for each of the five financial years preceding
the issue of prospectus.
So it is the statutory duty of the company auditor to submit his report
containing the above mentioned points.
6. Duty to Certify the Statutory Report.
According to section 165(4) the auditor of the company has to certify the
statutory report regarding the shares allotted by the company, the cash
received in respect of shares, and the receipts and payments of the
 company. The statutory report should also be certified as correct by two
directors, one of whom shall be managing director.
Every company shall within a period of not less than one month and not
more than 6months from the date which the company is entitled to
commence business has to conduct a general meeting of the members
of the company which is known as the statutory meeting.
7. Duty to make a declaration of Solvency, if the company Goes into
Voluntary Winding up
When a company goes into voluntary winding up, then a declaration of
solvency is to be made by the directors of the company. Under section
488(1) of the Companies Act, this declaration is to be accompanied by
the report of the auditor of the company under the section 488(2) of the
companies act. So it is the duty of the auditor to make such reports.
8. Duty to produce information and to assist the investigation, if any
investigation is conducted regarding the working of the company.
Under section 240(6) (b), it is the duty of an auditor to preserve and
produce to the inspector or any other person authorized by him in this
behalf with the previous approval of the central government, all books
and papers of or relating to the company or as the case my be, of
relating to the other body corporate which are in their custody or power
and other wise to give to the inspector all the assistance in connection
with the investigation which they are reasonably able to give.
9. Duty to perform the contract
It is the duty of the auditor to discharge the duties according to the terms
of contract between the auditor and the party who has appointed him. It
is to be remembered that the scope of statutory duties of a company
auditor cannot in any way be curtailed. But on the other hand, the scope
of duties of the auditor can be enlarged by passing a resolution at the
annual general meeting making a provision in the Articles of Association
of the company. If so, it is the duty of the auditor to perform the
additional work.
10. Duty to care and caution.
The auditor is appointed in the capacity of an expert, therefore, he must
act honestly and exercises cure care and caution in the performance of
his duties. The auditor can never give ignorance as an excuse for
defense. So the auditor must prove that in the course of his audit work,
he has employed skills that would reasonably be applied by any other
auditor.

Special Audit of Companies.

As per section 233 A of the companies act, the central government has the
power to direct special audit in the following cases for a specified period.
That is, when the central government is of the opinion.
1. That the affairs of any company are not being managed in accordance
with sound business principles or prudent commercial practices or
2. That any company is being managed in a manner likely to cause serious
injury or damage to the interests of the trade, industry or business to
which it pertains or
3. That the financial position of any company is such as to endanger its
solvency.
Auditor appointed under this section under the above mentioned
circumstances are known as Special Auditors. Special audit is entirely
different from investigation as per section 235. For example: the audit
firm Lovelock and Lewies was asked by the central government to
conduct a special audit for ITC company for which they audited the
accounts and to submit a report when the ITC scam was reported.

Powers and Duties.

The powers and duties of the special auditors are identical to the rights and
duties of a company auditor as specified in section 227.

Remuneration.
Although the special auditor is appointed by the Central Government his
remuneration is paid by the company as determined by the Central
Government.

Report
Special auditors have to submit their report to the Central Government to
take necessary action as per the provisions of the Companies Act. But if
the Central Government does not like to take any action on the submitted
report within four months, in that case, the central government will send the
copy of the report or its relevant extracts with comments to the company to
be circulated to the members or to put such copy or extracts in the
company’s next annual general meeting.

The Liabilities of a Company Auditor.

1. Civil Liability of an Auditor for negligence.
The liabilities of an auditor to pay damages are known as Civil Liabilities.
Every auditor in the performance of his job is expected to exercise
reasonable care and skill as per the circumstances, because the
shareholders of the company appoint the auditor as their agent and
 therefore, he must exercise reasonable degree of skill and care in the
performance of his duties. If not, the auditor will have to face the
consequences.
Therefore, we can conclude that an auditor can be held liable for
negligence of his duty if it is proved that
a. There has been a negligence in the performance of his duty and it
may be due to the absence of requisite professional skills or failure to
exercise it.
b. There happens to be a loss or damage as a result of his negligence
and
c. The loss was suffered by his client.
However, the court has the power to grant relief, wholly or partly to
an auditor. We can also present the situation as given below.
1. Loss without negligence and
2. Negligence without loss.
a. Liability of the Auditor for Mis-statements in the Prospectus.
As per section 65 of the companies act 1956, an auditor may be held
liable for damages suffered by those persons who subscribed to the
shares or debentures of a company or debentures of a company
proposing in the faith of the prospectus, which included auditor’s report
containing some untrue statements or facts. The auditor and every
person who has authorized the issue of the prospectus shall be
punishable with imprisonment for a term which may extent of 2years or
with fine, which may extend to Rs. 5000 or with both, for the damages
sustained directly resulted from those untrue statements. For the
purpose of this clause, even those statements shall be taken to be
untrue which are misleading in form and the context in which they are
included.
But the auditor can escape from his liability if he is able to prove:
i. That he withdrew his consent in writing before the delivery of the
copy of the prospectus for registration.
ii. That he withdrew his consent in writing from such a prospectus on
coming to know of the untrue statement by giving a reasonable
public notice before the allotment of shares.
iii. That he was competent to make the statement and that he has
reasonable grounds to believe up to the time of allotment of the
shares, that the statement was true or he relied upon the opinion of
an expert whose name he has quoted in his certificate.

b. Civil Liability of an Auditor for Misfeasance.

 By misfeasance we mean breach of trust or duty imposed by law for
negligence in the performance of duties, which results in some loss or
damage to the company. If an auditor does something wrong in the
performance of his duties resulting in financial loss to the company he
is guilty of misfeasance.
As per section 543 of the companies act. The liquidator can bring the
suit in the name of the company against the auditor, that is “in the
course o winding up of a company, it appears that any officer, including
eh auditor or any other person associated with the promotion or the
management of the company has misapplied or retained wrongfully,
any property of the company or is guilty of breach of duty, he can be
held liable for the damages caused to the company”
But section 633 grants relief to directors, officers, and auditors of the
company against liability in respect of negligence, default, breach of
duty, misfeasance or breach of trust. But for getting any relief there
under, it must be proved by the person concerned.
a. That he has acted honestly.
b. That he has acted reasonably and
c. That having regard to all the circumstances of the case, he ought
fairly to be excused.

2. Criminal Liabilities of a Company Auditor.

The auditor of a company becomes criminally liable for various offences

during the course of his audit. Criminal liability of an auditor will arise
when he is found to be guilty of willful non compliance under the
provisions of law. Under the criminal liabilities, he may be imprisoned,
fined or punished with both as per the companies act, income tax act,
and the Indian Penal Code. Criminal liability of an auditor arises from
errors in the performance of audit.
The auditor can be held criminally liable under:
1. The Companies Act.
2. The Income Tax Act.
3. The Chartered Accountant Act

a) Criminal Liabilities under the Companies Act.

i. Section 233
If the auditor does not comply with the requirement of section 227
and 229 as to make of his report, of signing or authenticating any
document and if such default on his part is willful, he shall be
punishable with fine which may extend to Rs. 1000
ii. Section 240
If the auditor of a company doesn’t give the required assistance to
an inspector appointed by the central government to investigate into
the affairs of the company, the auditor of the company is punishable
with imprisonment up to 6months or fine up to Rs.2000 or both. For
persistent default a further fine at Rs. 200 per day may also be
charged.

iii.Section 242
When on the basis of the report submitted by an inspector, the
central government takes action and prosecutes any person
connected with the affairs of the company is required to assist the
prosecution. If he does not do so, he is guilty of contempt of court
and punishable to the extent of imprisonment for 6months of fine of
Rs 500 or both.
iv.Section 477
When the company is wound up, the auditor is subjected to a
private examination by the court and is also liable to return to the
court any books and documents of the company in his possession.
If he does not appear before the court he can be arrested.
v. Section 478
On an application from the official liquidator, the auditor of a
company is liquidation can be publicly examined in high court. Notes
of the examination shall be taken down in writing and that should be
signed by the auditor which may thereafter be used as evidence
against him in any other civil or criminal proceedings.
vi.Section 539
If an auditor destroys, mutilates, alters, falsified or secretes or is a
partly to the destruction mutilation alteration or falsification or
secreting of any books papers or securities or makes or is a party to
the making of any false or fraudulent entry in any register books of
accounts or documents belonging to the company, he shall be
punishable with imprisonment for a term which may extend to
7years and also be fined.
vii. Section 545
The court may direct the liquidator of a company in winding up to
prosecute the auditor if he is found guilty of any criminal offence in
relation to the company.
viii. Section 628
An auditor is also liable to criminal prosecution, if he in any return,
certificate, balance sheet, prospectus, statement or any other
 document required by or for the purpose of the act makes a
statement.
1. Which is false in any material, particularly knowing it to be false.
2. Which omits any material fact knowing it to be material.
The punishment on conviction is imprisonment for a term which may
extend up to 2years and shall also be fined.
ix.Section 629
If any person including an auditor intentionally gives false evidence
upon nay examination up on oath or solemn affirmation authorized
under the act or in any affidavit, deposition or solemn affirmation in
or abut he winding up of any company under he act, he shall be
punishable with imprisonment for a term which may extend to seven
years and shall be liable to fine also.
Conclusion.
If the Articles of Association or any special agreement between the
company auditor and the company contains any provision which
exempts the auditor from any of the above legal liabilities for
negligence, defaults, misfeasance, breach of trust, breach of duty etc
it shall be considered void. However, according to section 633 the
company can indemnify such officers including he company auditor
for any of the losses suffered by him.

b) Criminal Liabilities under the Income Tax Act.

A qualified chartered accountant or the auditor of the company can
act as authorized representative and may attend the Income Tax
Authority or the Appellate Tribunal in connection with the proceedings
under the Income Tax Act.
a. Section 288
This section provides that if a person who is convicted of an
offence in connection with taxation proceedings will be disqualified
from representing an assesse. The commissioner of Income Tax
has been empowered to determine the period of such
disqualification.
If the council of the Institute of Chartered Accountants of India finds
that any chartered accountant is guilty in his professional
misconduct, default in taxation etc. the institute can also declare
him disqualified for certain specified period.
b. Section 277
As per this section 2years imprisonment may be imposed on the
auditor if he auditor submits knowingly any false statements in the
form of accounts for the preparation of income tax returns.
 c. Section 278
As per this section any person who induces in any manner any
other person to make and deliver to the income tax authorities,
some false statements or declaration relating to chargeable income
tax, highlighting the fundamental principle of criminal law that any
person who aids, counsels or procures the commission of an
offence is liable to be punishable with rigorous imprisonment for a
minimum period of 3months and maximum of 3years with fine. In
case the amount of tax to be evaded is in excess of Rs. 100000 the
minimum and maximum period of rigorous imprisonment will be
6months and 7 years maximum with fine.
c) Criminal Liabilities of an Auditor under the Chartered
Accountants Act 1949.
1. If a person not being a chartered accountant within the meaning of
chartered accountants act of 1949 acts as an auditor of a company
and signs any documents, then he may be held liable for criminal
prosecution under section 29 of the chartered accountants act 1949.
The punishment for this is fine which may extend to Rs.1000 on first
conviction and with imprisonment extending to 6months or fine
amounting to Rs.5000 or both on any subsequent conviction.
2. According to Part III of the first schedule of Chartered Accountants
Act 1949 a member of the institute whether in practice r not, shall be
deemed to be guilty of professional misconduct if he:
a. Includes in any statement return or form to be submitted to the
council any particulars knowing them to be false.
b. Not being a fellow styles himself as fellow
c. Does not supply he information called for or does not comply with
the requirements asked for by the council or any of its committees.
3. Auditors Liabilities to Third Parties.
Besides the client, the creditors, bankers, prospective share
holders, tax authorities etc depend fully upon the final accounts
certified by the auditor and do different dealings with the company.
The liability of an auditor towards third parties can be discussed
under 2circumstances.

a. For Frauds.
If in case there is any fraud on the part of the company’s auditor,
the third parties can however hold him liable. This 3rd party can
sue the auditor if the report of the auditor is of such a nature, as
amounts to fraud, even in there is no contractual obligation
between the auditor and the 3rd party.
 It was decided in the case of Derry Vs Peek (1882) that the auditor
can be held liable to 3rd partied only when the following facts are
proved against him.
i. That the statement or balance sheet signed by the auditor was
materially untrue
ii.That the statement or the Balance Sheet was made an intention
that a 3rd party should act on it.
iii. That the auditor knew that the statement of balance sheet was
untrue.
iv. That the 3rd party acted upon such a statement and
consequently suffered a loss.
v.That the auditor gave his consent for the inclusion of such a
statement in the prospectus.

b. For Negligence.
An auditor in general is not liable to 3rd parties for negligence of
duty as no contractual obligation exists between the auditor and
the 3rd party. As he is not appointed by them, he owes no duty
towards them and hence there is no question of any type of
liability.

DISTINCTION BETWEEN PROFIT AND DIVISIBLE PROFITS:

One should clearly understand the difference between these two terms. All
the profits of a company are not divisible. Only those profits, which can be
legally, distributed in the form of dividend to the shareholders of the
company are called as Divisible Profits. There is no definition of the term
divisible profit in the companies act.
There are two main principles which he observed before declaring
dividends to the shareholders:
1. In every case, dividend must be paid in accordance to the provisions of
section 205 of the companies act and of the company’s memorandum
of association and articles of association. If the articles of association
of a company are silent on this matter, dividend must be paid
according to Regulations 85 and 94 of table A schedule 1 appended to
the companies act.
2. Dividends should not be paid at the cost of creditors or debenture
holders of the company.

BASIC CONSIDERATIONS FOR DIVISIBLE PROFITS:

There are many factors involved in calculation the divisible profits.
However, the following basic considerations must be followed for an
amount to be legally distributed as dividends. They are:
1. Memorandum and Articles of association of the company.
If the provisions contained all the articles and memorandum of
association of the company are silent about this (that is determination of
divisible profits) then schedule 1, clause 85 to 94 will apply. These are
as follows:
Clause 85: this clause says, the company in general meeting may
declare dividend, but no individual shall exceed the amount
recommended by the board.
This means that the authority to recommend dividend is the board of
directors, but the declaration as to final dividend is within the jurisdiction
of the general meeting of the shareholders. However, the general
meeting cannot increase the amount of dividend as recommended by
the board. If the board doesn’t recommend any dividend in any year, the
shareholders in general meetings can’t on their own declare it.
Declaration of final dividend constitutes an enforceable debt against the
company and it cannot be revoked.
Clause 86: this states that the board may from time to time pay to the
members such interim dividends as it appears to be justified by the
profits of the company.
But unlike final dividend doesn’t not create a debt against the company,
and the board may subsequently revoke the resolution and cancel the
announcement.
Clause 87:
1. The board may before recommending any dividend set aside out of
the profits of the company, such sums as it thinks proper, as reserve
or reserves which at the discretion of eh board be applicable for any
purpose t which profits of the company may be properly applied,
including provisions of the meeting contingencies or for equalization of
dividends, an pending such application may at the like discretion
either be employed in the business of the company or be invested in
such investments as the board may from time to time think fit.
2. The board may also carry forward any profit which it may think
prudent not to divide without setting them aside as reserve. The
meaning of this clause is that the company has the right to create any
reserve or reserves before recommending any dividend.

Clause 88: according to this clause a company may pay dividend in

proportion to the amount paid up on each share. If unequal amounts
 have been paid up on some shares, the dividend may be unequal
among different shareholders. However in the absence of such a clause
in the articles of a company, members will be entitled to dividend in
proportion to the nominal value of the shares and not in proportion to the
amount paid in respect of each share.
Clause 89: the board may deduct from any dividend payable to any
member, all sums of money if any presently payable by him to the
company on account of calls or otherwise in relation to shares of the
company.
Clause 90:
1. Any dividend, interest or other money payable in cash in respect of
shares may be paid by cheque or warrant sent through the post
directly to the registered address of the holders and in the case of
joint holders, to the registered address of that one of the joint holders
who is first named on the register of members, or such person and to
such address as the holders or joint holders may in writing direct.
2. Every such cheque or warrant shall be made payable to the order of
the person to whom it is sent.
Clause 91:
Any one of two or more joint holders of a hare may give effectual
receipts for any dividends bonuses or other money payable in respect of
such share.
Clause 92: notice of any dividend that may have been declared shall be
given to the persons entitled to share therein, the manner mentioned in
the act.
Clause 93: no dividend shall bear interest against the company.

2. Provisions of the Company’s Act.

Out of current profits: depreciation must be provided by the company,
before declaring any dividend out of the current profits. It is also
important that in respect of financial year ending after 28th December
1960, the arrears of depreciation must also be provided for before
declaration or payment of dividend.
Company’s amendment act 1974 says that the company should also
transfer the prescribed percentage of profits (that is not exceeding 10%)
to its reserves before declaring dividends. The company can also
transfer a higher percentage of its profits in accordance with the rules
framed by the central govt., in this regard. However, no amount needs to
be transferred to the reserves where the rate of dividend is 10% or less.
Out of past Reserves: section 205 A(3) of the companies act, provides
that in the event of inadequacy or absence of profits in any year,
 dividend may be declared by the company for that year out of the
accumulated profits earned by the company in the previous year and
transferred to reserves, if the following conditions are satisfied:
1. The rate of dividend declared by the company shall not exceed the
average rate at which dividend was declared by it in 5years
immediate.
2. The balance of the reserves which may remain after declaring such
dividend shall not fall below 15% of its paid up share capital.
Amount provided by the Central Government.
A company may also declare dividend out of the amount provided by
the central govt., or a state govt., for he payment of dividends in
pursuance of a guarantee thereof.

Provisions for Depreciation.

The position as to depreciation which is compulsorily required to be
provided before declaration or payment of dividend for any financial
year may be summed up as follows:

1. For declaration of payment of dividend in respect of the current

financial year, depreciation must be provided.
2. In respect of financial year ending after 28 th December 1960, the
arrears of depreciation must be provided before declaration or payment
of dividend.
3. Under section 205(1) (c), the central govt., may if it thinks necessary
to do so in public interests, exempt any company from the requirement
of providing depreciation before declaring of paying dividend for that
year.

Past Losses:
Under section 205(1) (b) of the companies act if a company has
incurred a loss in any financial year or years after the companies
amendment act 1960, then either the amount of loss or the amount
equal to the amount of depreciation whichever is less shall be set off
against the profits of the company before dividends can be declared.
That is, that amount of depreciation forming part of past losses shall be
allowed to set off against the future profits first.

3. Provisions of the Income Tax Act:

Section 104 to 109 of the Income Tax Act provides that in the case of a
company in which public are not substantially interested, has to
distribute a specified amount of dividend as prescribed by the income tax
 act. The company would have to pay additional income tax on the
undistributed part of its income if the actual dividends fall short of the
amount so prescribed.
Provisions of the banking regulation act also affect divisible profits
section 17 of the act provides that a banking company incorporated in
India must transfer 20% of its annual profits to a reserve fund before
payment of dividend. However, the bank may obtain exemption from the
central govt., in this regard.
4. Principles of Accountancy.
Divisible profits are calculated as surplus of income over expenditure for
a given period. For this purpose all transactions are distinguished as
capital and revenue, and such a distinction is necessary from the
accountancy point of view. But a modified basis is now adopted to
calculate divisible profits, that are the differences between assets and
liabilities plus capital at the commencement of the year (i.e. net worth at
the beginning0is found out. If assets are more, there is surplus,
otherwise there will be deficiency. Similarly the deficiency or surplus at
the end of the year is calculated after considering the increase of
decrease of the capital etc. if there is surplus it is profit and if its is
deficiency there is loss. This is now well recognized principle for
determining profits.
According to the principles of accountancy it is not proper to distribute
capital profits as dividends and it is also not advisable to distribute the
profits of the current year without providing for the losses of the previous
year. Principles of accountancy also advocate that proper reserve should
be created among the shareholders by way of dividends.
5. Legal Decisions:
The provisions regarding declaring dividends is made clear with certain
legal decision, they are:

Distribution of capital profits and legal decisions:

Capital profits are not profits in the normal course of business. If a

company sells a part of the property at a cost higher than the original cost
of such assets the profits thus earned is capital profit. Similarly, premium
received on issue of shares, profits made on the re-sale of forfeited shares
etc are examples of capital profits, and thus it is clear that capital profits do
not arise in the course of business. As per the company law, such profits
should not be distributed amongst the shareholders as dividends. But the
below mentioned case decisions provides that under certain
circumstances, capital profits can also be distributed among the
shareholders of the company.
Based on the tow legal decisions regarding the distribution of capital profits,
it can be concluded that capital profits cant be distributed as dividends,
unless:
a. All the other assets have been revalued.
b. Such profits had been actually realized.
c. That the Articles of Association of the company had permitted such a
distribution and
d. Working capitals of the company should also be sufficient for the
company to carry out the business because it is always good from the
financial point of view of the company.

Auditor’s duties with regard to payment of Dividend.

1. The auditor should examine the Memorandum and Articles of

Association of the company to determine the rights of different classes of
shareholders to whom dividend has been paid.
2. Dividend can only be distributed out of profits and capital of eh
shareholders cannot be used for the purpose.
3. The auditor should ascertain whether profits set aside for the purpose of
dividend have been computed in accordance with the requirements of
section 205 of the companies act.
4. The auditor should ascertain whether the rate of dividend has been
recommended properly in the meeting of the board of directors.
5. The auditor should examine the list of shareholders with the register of
shareholders to see that the total amount of dividend payable agrees
with the dividend account.
6. The amount of unclaimed dividend should be verified with the dividend
account bank passbook and dividend warrants if any returned
undelivered.
7. The auditor should check whether the income tax has been deducted at
source.
8. The auditor should see that the dividend has been paid within the terms
of clause 88 of Table A i.e in proportion to the amount paid for shares, if
the same is incorporated in the articles of the company.
9. In case of issue of bonus share it should be ascertained that whether the
articles of eh company authorized it.
10. It should be seen that the depreciation in respect of fixed assets and
also floating assets has been provided before computation of divisible
profit.
11. It should be seen that security available to the creditors of the
company is in no way affected by the distribution of dividends.

SECRET RESERVES.

Some time a company creates a reserve, which is not shown in the balance
sheet. Such a reserve is called secret reserve. It has been defined as “any
reserve that is not apparent in the face of the balance sheet/” this is also
called Hidden Reserve or Internal Reserve or Inner Reserve.

Objections to creating secret reserves:

1. The balance sheet prepared at the end of the year will not show a true
and fair view of the state of affairs of the company as is required under
the companies act.
2. The creation of secret reserve causes loss to the shareholders who are
the real owners as they do not get their due share of profit.
3. Secret reserves might be used by dishonest directors for improper
purposes i.e., to cover up losses upon ultra vires transactions or for
indulging in speculation I the shares of the company or fraudulent
activities. All such activities may turn out to be ruinous to the company.
4. When secret reserves are created by under valuing an asset the balance
sheet will show the value of this asset at a lower figure than its real
value, then the company cannot claim from the insurance company the
full value of that asset if it is destroyed by fire. It would be a loss to the
company.
5. According to the companies act creation of secret reserves is prohibited.
Only banking companies, insurance companies and finance companies
can create secret reserves.

Auditor’s duty.
The position of the auditor in connection with the secret reserves is very
clear. He will have to disclose to the shareholders if the company has
created secret reserves. If he fails to do so, he will expose himself to risk.
At the same time he can’t certify the balance sheet of a limited company as
true and fair which is very important part of his statutory duties.
In case of financial companies such as banking companies and insurance
companies where the creation of secret reserves is not prohibited legally,
he should try to find out the necessity of creating such a reserve. He should
discuss the whole matter with the board of directors and should also satisfy
himself about the method and procedure of creating such a reserve. If he
finds that the intention of the directors is honest and the amount is also
reasonable then he should not qualify his report. He should also study the
articles of association to ascertain the legal implication of creating such a
reserve. In short, he must review the whole situation very carefully and
must ascertain the object of their creation. If he is fully satisfied he should
not object to such a creation otherwise he should disclose the facts in his
report.

AUDIT OF EDUCATIONAL INSTITUTIONS.

(Schools and Colleges or Universities)
Generally educational institutions are run by the registered societies or the
public trusts registered under the relevant act. The audit objective of such
institutions is to determine whether financial statements give true and fair
view or the auditor may be asked to report on certain other aspects like
whether the institution has complied with requirements as to accounting
and financial records.

PRELIMINARY:
The auditor should study the following aspects:
1. Whether his letter of appointment is in order as well as any additional
work assigned to him.
2. Legal status of the institution like the society or a trust or a statutory
body under some law.
3. Study important provisions relating to accounts and audit under the
relevant law.
4. Study code of state govt., and regard to the ground-in-aid. In case of
colleges, University Grant Commission also provides grants subject to
certain conditions. The auditor should study various conditions and
procedures for such grants.
5. Examine charter, Trust Deed, or Regulations and not the provisions
particularly relating to accounts and audit.
6. In case of important decisions like delegation of financial powers,
transactions regarding fixed assets and investments etc minutes book of
various meetings of the Board of Trustees or Governing Body or
managing Committee or finance committee should be examined.
7. The auditor should obtain the various lists of books of accounts registers
and other records as well as the persons authorized to sanction and
execute financial decisions.
8. Last year’s audit report should be examined with regard to various
observations on qualifications.

INTERNAL CONTROL SYSTEM

It includes division of duties and their rotation, authorization procedures,
adequate record maintenance, responsibility for safeguarding of assets etc.
independent checks should be applied by using proper systems and
procedures. The auditor should assess various aspects of internal control
systems.
1. Are various assets like fixed assets, consumable stores and cash
verified at the regular interval of time and reconciled with the recorded
balances.
2. Whether proper system is followed for sale and purchase of assets and
investments of the institutions like proper sanctions from the appropriate
authority, obtaining quotations for fixed assets, maintain proper registers
and records etc.
3. Whether bank reconciliation statements are prepared regularly and
difference in cash book and pass book investigated?
4. Whether there is adequate internal check and internal audit system?
5. Whether the fee structures of changes therein have been approved by
the proper authority? Some time grant-in-aid is received by the
institution, in such cases the fee structure has to be in accordance with
the conditions prescribed by grant-in-aid issuing authority.
6. Whether rules regarding concession in fees and other charges are
followed, like concession allowed only after proper authorization?
7. Whether fines or charges are waived or reduced on the basis of proper
sanction?
8. They system regarding receiving fees from students, issuing fee
receipts, serial numbering of receipts, preserving counterfoils should be
verified.
9. The person receiving fees should not have any control over the cash
book.
10. The fees received daily should be deposited in the bank and no
payments should be made from such receipts.
11. All fees received should be entered in the fee register daily.
12. There should be a proper system of receiving donations. All such
receipts should be by cheque only, if not crossed, these should be
crossed immediately on the receipt thereof. When the donations are
received in kind there should be the proper system of receiving such
donations and safe custody thereof. Receipts should be issued for all
donations.
13. There should be proper procedure for the purpose of various items
like sanction and authority for purchases, inviting quotations, approval of
purchase order etc.
14. Whether a list of approved suppliers is kept ready for gods which are
to be purchased frequently like sports materials, books stationery and
laboratory equipments.
15. Whether system of making payment for purchases has been
established.
16. There should be an adequate system for recording purchases like the
register of assets and accounting records.
On the basis of strength of internal control system, the auditor will
determine audit procedures to be applied.

AUDIT OF INCOME AND EXPENDITURE.

1. The auditor should verify the counterfoil of fee receipts issued with
entered made into the fees register. The details of fees and charges
should also be examined like tuition fees, admission fees, like the fees,
examination fess, sports fees etc. the fees charged should be as per
fees structure sanctioned by the appropriate authorities.
2. Entries made the cash book should be verified with the fees register.
Any concessions have been granted these should be verified as per the
rules.
3. The statement of reconciliation of fees received and total fees receivable
should be verifies.
4. In case of hotel accommodation, the charges received for
accommodation, mess, fines etc should be examined. The counterfoils
of receipt book should be compared with hostel charges register and
cash book.
5. For donations received the receipt book should be compared with the
cash book entries. The donations received should be accounted for
under an appropriate head like specific purpose (building fund etc) or
Corpus Fund or General Purpose.
6. Grants in aid have to be accounted for properly under the head capital
receipts and revenue receipts depending on the purpose for which it has
been received.
7. It should be verified that grants received has been utilized for the
purpose it was allowed.
8. Rent received for the facilities let out temporarily should be verifies from
receipt book, cash book, sanction by authorized person, rates charged
as per rules.
9. Income from investments in approved educational institutions is not
taxable. The auditor should examine it tax deducted at source, refund
thereof has been claimed and received.
10. The interest/dividend received on investment during the year should
be verified from investment register as well as cash book. Any interest
due but not received has been duly recognized.
11. In regard to payment of salaries and allowances, it should be verified
that payments on as per terms and conditions of appointments,
computation of gross amount and deductions here from. (Income tax,
provident fund, life insurance premium, loan installment etc). The
payments of net amount should be verified from bank statement.
12. The amount of income tax and provident fund deducted from salaries
and employees own contribution to provident fund is to be verified as
being deposited with the appropriate authorities from receipts challan/
acknowledgments.
13. The auditor should verify payments made out of the grants by
comparing minutes of governing body, vouchers, cash book entries and
utilization certificates. The grants must be utilized as per terms and
condition specified by the state govt., UGC. Any grant which remains
unutilized must have been returned back to the authority.
14. The payments of scholarships should be verified by comparing terms
and conditions stipulated, vouchers, cash book entries acknowledgment
from students.
15. Expenditure on hostel facilities should be examined like purchases of
food grains, other provisions, stocks, repairs, water charges, electricity
charges, maintenance etc.

AUDIT OF ASSETS AND LIABILITIES.

1. Fixed assets purchase should be verified. If state govt., has allowed
grant for the acquisition of fixed assets, the auditor should examine the
terms and conditions of grants being complied with.
2. The auditor should examine that separate account of fixed assets are
maintained when these on acquired out of specific grants.
3. Depreciation should be properly charged on all the fixed assets. The rate
of depreciation is decided by the management on the basis of useful life
of fixed assets. Sometimes it may be decided to charge depreciation as
per the provision of Companies Act.
4. The auditor should physically verify investments. The documents related
to sale and purchase of investments should be examined. As per the
Indian Public Trust Act in case of public trusts, investments can be made
only in specified securities. All such requirement for the acquisition of
investment should be complied with. The correspondence with the donor
should be examined when investments are received as a donation.
5. The security deposits received from the students should be examined.
The refund of security deposit should be examined from the
acknowledgment received from the students.
6. The financial statement should be examined form the view point that
separate statement of accounts for provident fund, building fund, sports
fund etc.
7. The stock of stationery equipments and furniture should be carefully
verified.
8. The staff provident fund should be verified and it should be seen that it is
invested as per rules.
9. All the assets and liabilities should be properly exhibited in the balance
sheet.