AUDITING SEMESTER-IV WWW-POFFILES.ie ODUCTION WWW.PDFFILES.IN 1 4. Meaning of Auditing Auditing implies the examination of books of accounts and related documents of an organisation in order to correctly estimate their accuracy, completeness and regularity. Such an examination is carried out by a competent and unbiased person with the help of evidences, documents, information and explanations given to him. For example, ifa person goes o a doctor to have himself examined, the doctor, only after a thorough examination of his body, gives his report asto whether he is healthy or not, and if not, what is the ailment he is suffering from. In the same manner, a businessman gets his books of accounts examined by a doctor of books of accounts (i.e. the auditor) who, aftera thorough examination ofthe books, gives hisreport as to whether ornot they givea true and fair view of the state of affairs of the business, and if not then what are the errors, deficiencies and faults in them. @ 2. Origin and Development of Auditing The English word ‘Auditing’ is derived from the Latin word ‘Auditor’, which literally means ‘to hear’. In ancient Greece and Rome, accountants used to be appointed in order to maintain the records of the government treasuries. These accountants used to go to prominent judges to get their accounts certified and used to recite their accounts in front of those judges. These judges, upon hearing the accounts, used to give their decisions as to whether the accounts were authentic or not. Inancient times auditing was merely concerned with listening, The scientific technique of book-keeping was first propounded in 1494. The father of this technique, Lucea Pacialo, published a paper on the Double Entry System in which he also discussed the rights and duties of an auditor. Slowly the double entry system became popular among business organisations. However, in the field of auditing the first revolution came about in the year 1844 when in England, through the Companies Act, the preparation of a Balance Sheet by companies and getting the same audited was given legal recognition. In the beginning the company used to appoint one of its members as the auditor, and for this he was not required to have any auditing qualifications. In such a situation, the person used to take the help of accountants in his work. Soon it was felt that the auditor should bea person who has complete and comprehensive inowledge of accounts. Because of this only in 1888 the Institute of Chartered Accountants was set up in England with the aim of preparing qualified accountants and qualified auditors. InIndia, the history of auditing begins from the Ist of April 1914, when the Companies Act of 1913 came into force. This Act made it mandatory for every company to get its yearly accounts audited and also spelt out the qualifications of a person to become an auditor. It also empowered all the state governments to issue certificates of eligibility for appointment as auditors to persons who possessed. complete knowledge of the double-eniry system. Apart from this, those people holding certificates from the Association of Accountants and Auditors in Britain were also declared as qualified for appointment asment of Bombay first started the system of .d the holding of this diploma was holder of such a diploma could be auditors in India. Among the state governments, the Governt awarding the ‘Government Diploma in Accountancy’, an considered as sufficient qualification for appointment as auditor. The appointed as auditor in any state in India. Until the year 1932, it was the responsibility of the state governments fo prepare competent auditors. However thereafter, the Central Government also started laying emphasis on the issue and cave outwith the Auditors’ Certificate Rules, which provided for the granting of the designation of R.A. or Registered Accountant, After acquiting this designation a person could be appointed as an auditor. “Thereafter, the demand for ‘professional autonomy’ also gained force and the government, on the 1st of May, 1948, set up an Accountancy Experts Committee. The committee submitted its report on ‘4th of July, 1948 in which itrecommended that an ‘Institute of Chartered Accountants’ should be set up through a legal enactment. ‘The government accepted the recommendations of the committee and in 1949 passed the Chartered Accountants Act, 1949. Under this Actthe Institute of Chartered Accountants of India was setup in Delhi. This Act came into force from the Ist of July, 1949. With the passing of this Act the control, organisation and direction of the profession passed from the hands of the Central Government into the hands ofan institution known as The Institute of Chartered Accountants of India, formed under the said ‘Act. Thereafter, in order to become an auditor a person had to be a member of the institute, and could get certificate of ‘Chartered Accountant’ only after clearing the examinations conducted by the institute. ‘The management of the institute is in the hands of a committee. The committee consists of 24 ‘members from among the fellow members ofthe institute. Apart from these the Central Government also appoints six nominees to the committee. This committee is responsible for running and management of all the affairs of the institute. ‘The institute maintains a register ofits members. There are two kinds of members ofthe institute: (i) Associates: They ate members of the institute and their names appear in the register of members. They are entitled to use the suffix A.C.A. (Associate of the Institute of Chartered Accounts of India) after their names. (i) pate fe ae penn et become fellow members of the institute on the fulfilment of ; continuing in practi isteach Tee en ee! gS fe years, payment of the Chartered Accountants) after their name. Onthe Istof April, 1956, the new Compan : companies audited t also dealtindepth with the righ’, duties and remorctelton ot eke the qualification of an auditor is ith Yesponsibilities of auditors. As far as concerned it has made no change from the only a chartered accountant can become an auditor. Previous Act. However, now (Fellows of the Institute of(b) Summary and Analysis 5. Examining the Work of the Book-keeper. 6. Preparing Trial Balance 7. Preparing Trading and Profit and Loss Account 8. Preparing Balance Sheet ‘9, Passing Adjustment Entries and Rectification of Errors, {c) Examination of Records 10. Examining the Work of the Accountant. © 6.1 Book-Keeping Book-keeping is the art of recording business transactions in the books of accounts. It is mainly concerned with the primary books of accounts and the ledger. Book-keeping includes tasks such as posting business transactions in the Journal and the Ledger, totalling them and obtaining the balances. Such work is usually done by junior clerks as doing itdoes not require in-depth knowledge of accountancy. In Western countries such as America, England, etc., this work is increasingly being performed with the help of computers. @ 6.2 Accountancy Accountancy is a much wider term than book-keeping and the latter is considered a part of accountancy. tis seid that, “Accountancy begins where book-keeping ends.” From this it's clear | thatthe facts that emerge from book-keeping are analyzed in accountancy. In this manner’ ‘accountancy inelves activities such as examination of primary books of accounts, preparation of Trial Balance, Prof ani Loss Account and Balance Sheet, passing adjustment entries, rectification of errors, etc. Even though the basis of accounting is book-keeping, the work of accountancy requires greater competence, inteligence and responsibly. Hence, itis usually given to a qualified and dependable person known as aan cnsevantent It should be kept in mind, that i is not necessary forthe accountant to be a Chartered ecantant, Unlike the auditor, he does not submit any report to the owners after completing his work, que though he may be submitting accounting reports to the management from time to time, @ 6.3 Auditing ‘The scope of auditing actually begins when the work of accountancy comes io an end. Where accountancy ends, auditing begins. Hence, auditing is completely separate from book-keeping and scountaney. Auditing is a. critical examination of the books of accounts on the basis. of vouchers, documents, information and explanations. After conducting the audit the auditor has to give areport, and he has to clarify whether or not the Profit and Loss Account and Balance Sheet ofthe organisation a® & pee and fair view ofthe state of affairs. It must also be kept in mind thatthe auditor should have complete nowledge of the principles of accounting and he must be a Chartered Accountant. © 6.4 Investigation Investigation is an in-depth examination and inspection of the final accounts, books of accounts and other affairs of a business, with a pre-determined objective, which may be ordered by the owners of the business or other patties, depending upon the situation. Such an examination usually takes place in certain specific situations, for example, purchase of a business, becominga partner in a firm, givinga loan to somebody, purchasing shares ina company, etc, While conducting an investigation it is assumed that the books have already been audited.ae aia Os eae m 7. Difference between Book-keeping and Accountancy In olden times accountancy and book-keeping were considered as one and the same, and the two words were synonymous. However, with the growth in business, transactions also grew, resulting in a change in accounting beliefs, and as a result of this change accountancy and book-keeping were differentiated. This differentiation is on the following basis. S.No._| Basis of Difference’ Book-keeping Accountancy 1 tions in the primary books of accounts and posting them in the ledger. Transaction Involves recording business transac- Involves an examination of the entries of transactions in the primary books of accounts and theit posting in the ledger. a i Total and Balance | Involves totalling the ledger and | Involves posting the ledger account the work of the accountant. 2 taking balances of various ledger | balances in the Trial Balance. accounts 3. | Final Accounts Preparation of Final Accounts does | Involves the preparation of Final not come in the purview of Accounts (Profit and Loss Account and book-keeping. Balance Sheet). 4 ‘These accounts are not Involves rectification of errors included in book-keeping, and passing adjustment entries. 5. Book-keeper is not responsible for | Accountant can be held responsible for the work of book-keeping, since book-keeping is a part of accounting. @ 8. Difference between Accountancy and Audit The following are the main difference between accountancy and auditing ng WWW.PDFFILES.IN Auditing Auditing includes in its scope, examination of the work of accountancy, sos to ensure that the Profit and Loss Account and Balance Sheet have been prepared as per tales, and whether they depict a correct view of the profit or loss and state of affairs of the organisation The aim of auditing is to certify the correctness and truthfulness of the accounts, S.No.| Basis of Accountancy Difference 1. | Function | Accountancy includes in its scope tasks such as examination of the work of book-keeping, preparing Trial Balance, preparing Final Accounts, rectification of errors and passing adjustment entries. 2, | Object The object of accountancy istoanalyse the accounts with the aim of finding out the result of the business activities and the [ financial postion ofthe organisation 3, | Beginning — } Accountancy begins where book- keeping ends. The work of auditing begins where the work of accountancy ends.needs or those objects without which a person can stay alive, but the non-availability of which may not increase his working capability and, in some cases, may also decrease his working capacity. @ 10.1 Accounting as a Necessity WWW.PDFFILES.IN In today’s industrial age accountancy is considered a necessity by one and all. At one time, when businesses were small and had few employees, having goodwill was not necessary for doing business, and accounting was not considered necessary; accountancy was considered a luxury, and its use was limited to larger business houses, However, the industrial revolution brought about a lot of progress in the field of business. With an increase in the goodwill of business, the number of banks and insurance companies also increased. New industries, new modes of transportation and new ways of thinking brought about a revolution in the field of business. Business was being done ata much larger scale. Sole proprietorships, partnership firms, and companies were being set up and much larger amounts of capital were being invested. Asa resultmodern techniques of accounting were adopted. The following arguments can be given in favour of accountancy being a necessity. (1) Limited Memory Power: Today, in business a number of transactions take place everyday. Due to the limited memory power of humans, itis not possible for a person to remember all the business transactions, and hence it becomes necessary to record these transactions in the books of accounts. (2) Knowledge of Actual Position of the Business: Every businessman wants to know that aftera certain period what was the profit or loss earned by him during that period and what is the present financial state of affairs of his business. In order to generate this information it is necessary to maintain books of accounts. (8) Proof in Court: Ifa businessman has properly maintained his books of accounts, then if the need arises, they may be produced as evidence in court, in case of a dispute between the business parties, (4) Knowledge of Debtors and Creditors: Only by maintaining books of accounts it is possible to know the various debtors and creditors of the business, The books of accounts may also prove helpful as evidence while recovering amounts due to the business with the help of courts. (8) Proof in Case of Insolvency: In case of continued losses, if business is ina position thatt is unable to pay its creditors, then the owner can present his books of accounts in the court and, on the basis of them, get himself declared as insolvent. (6) Helpful in Assessment of Tax: For the determination of liability of various taxes such as income tax, sales tax, etc. the income tax or sales tax officers often call for the books of accounts as evidence. Hence, for fulfilment of this objective accountancy is indespensible. (7) Comparative Study Possible: If any businessman has Properly maintained his accounts then he can compare the profits or losses, income and expenses, sales and purchases, etc, with corresponding figures of the previous year. This may also be beneficial to him for planning for the future (8) Convenience in Borrowing: A businessman often requites funds from time to time in. order to expand his business or in times of economic difficulty. He can obtain these funds fromdepartments, who examine the accounts of the departments and corporations of the concerned state government and submit their report to it InIndia, the Comptroller and Auditor General has been granted the right to examine the books of accounts of central government, state governments and other government institutions under Article 149 of the Indian Constitution, in which the rights and duties of the auditor have also been specified. 1 12. Basic Concepts of Auditing The basic concepts of auditing serve as the background to auditing. As per Martz and Sharaf, the following are the basic concepts of auditing: (1) Independence: The auditor should be completely free of any pressure from the management and should do his work competently and with a free mind. He should examine the accounts and documents without any personal bias and in an impartial way. While ‘conducting the examination he should neither favour nor be biased against anybody. (2) Evidence: Evidence is the foundation of auditing. The auditor does his work and examines and certifies the books of accounts only on the basis of evidence produced before him. Hence evidence should be conect, sufficient and reliable. Usually, evidences are derived from the vouchers and other documents relating to the accounts. Apart from these, an auditor can also assimilate appropriate and sufficient evidence through inquiry, observation and explanation. (8) Due Audit Care: While performing the work of auditing the auditor should always be on the alert and should exercise due diligence in order to detect frauds and errors. Hence, the auditor is expected to display proper competence, caution and alertness while doing his ‘work. This concept is the yardstick for measuring the work of the auditor and serves asa guide to him in dispensing his duties. (4) Ethical Conduct: Like other professions, auditing also has its own code of conduct which contains rules for its practice. Hence, every auditor should adhere to the code of conduct so that he cannot be held guilty of professional misconduct. In this way the code of conduct protects the people in the auditing profession against moral turpitude and misconduct towards each other. WWW.PDFFILES.!N (5) Fair Presentation: This includes the following concepts: (i) Accounting propriety: This implies that the financial statements have been prepared according to the universal concepts of accounting and that they depict a true and fair view of the financial position of the business. (ii) Adequate disclosure: This implies that the financial statements and the auditor's report provide complete and correct information about the financial situation of the organisation to the owners as well as other parties. i) Audit obligation: This implies to the actual responsibility of the auditor towards his client and his implied responsibility towards other parti The auditors responsible and answerable only tothe client, but his work and reports also used by ther people, and hence, he should present his views appropriately, so that there is no ambiguity in deriving any conclusions on the basis of his report.& 13. Auditing Principles Normally, the word ‘principle’ implies a universal truth, fi auditing can also be considered universal abasic rule ora tule specified in relation to ‘a particular activity. In the same manner the basic principles o i truths. Hence ‘the principles of auditing’ are the basicrules which tell usabout the objective ofthe audit as well asthe ways to achieve those objectives, In the words of Arthur W. Holmes, “Audit principles are basi truths, which ae indicative of he objectives of auditing. The audit priniples also suggest the manner in which the objectives of the audit are to be accomplished”. In this manner, the principles of auditing provide us wit accounts and financial statements in order to establish their trut! rules for the examination, verification and confirmation of accounting ‘A few of the basic principles of auditing are as follows: (1) Principle of Independence: The work of auditing should be separate and independent from the work of accounting. In the audit, the accounts should be examined in an h ways to examine and investigate the fhfulness. These principles also include independent and unbiased manner. (2) Principle of Objectivity: The work of auditing should be based on the related evidences and should be done in an unbiased manner. (8) Principle of Materiality: This principle emphasises that the auditor should examine ‘material transactions as well as probable frauds and errors in much greater depth. (4) Principle of Full Disclosure: As per this principle, the client should provide the auditor with all available records, evidencesand explanations and the auditor should also declare the results of his examination in a clear and unambiguous manner, @ 13.1 Audit Procedures Audit Procedures include all those tasks which are accomplished during the examination of ee in procedures have to be followed in order to achieve specific objectives with the eerie ee of accuracy. The auditor chooses the audit technique keeping in mind the nature of bushes nt oe een He demands various information and documents from his client in relation to the assets, liabilities and oth i icrantan te tee 'et’_matters of the business and, with the help of these, he @ 13.2 Audit Techniques While conducting an audit, the techni si en an ett hing pts nar ni performance ofthe examination of books of accounts. ll the techniques use aur re tne methods of objectives are included in aut techniques. In other words, we can say thar aay nent achieve the audit methods employed by the auditor during the duration of the audit ir mace ee oo niguesinclude all the evidence. An audit technique itself does not provide any evidence for arancn ger the necessary the evidence can be obtained, and based on such evidence the auditor gine a et OY its application books of accounts. Such evidence may be inthe form of vouchers oe span ns SPeEific opinion on the The following are a few examples of important audit techniques + See HDED (1), Physical verification (2). Physical inventory (3) Verification of available evidences.(4) Review of the work of book-keeping, (5) Examination of source of documents. (6) Examination of accounts (7) Conducting inquiries. (8) Examination of subsidiary accounts. (9) Establishing correlation between various factors. WWW.PDFFI (10) Analysis of financial statements. LES.IN @ 13.3 Relationship between Principles, Procedures and Techniques ‘The principles, procedures and techniques of auditing are very closely related to each other. In every audit the plan for examination work is made on the basis of audit principles, and this plan is always inaccordance with the benchmarks for accuracy for the audit. According to the plan, the audit procedures are followed and audit techniques are applied for assimilation of evidences. In order to make the audit techniques effective and efficient, they are modified and improved from time to time. It should be kept in mind that the audit techniques applied are in confirmation with the audit procedures being followed. The adoption of all the techniques of auditing gives us an exact view of the extent of correctness. of the accounts. For example, purchase of goods is always a debit; this is a principle. In relation to this the assimilation of the purchase order, goods received note and invoice, and physically verifying the goods is the procedure and verifying their truthfulness and correctness is the audit technique. In the same manner, if the auditor is auditing credit sales, then he will go. through the stages of principle, procedure and technique as follows: Principle: All credit sales in the relevant period should be recorded in the books of accounts. Procedure: Keeping this principle in mind the auditor will determine the audit procedure, in ‘which he will decide that the sales order, invoice, goods despatched book and the entries in the books of accounts should be examined. Technique: Procuring evidence by vouching, checking, entries in the primary accounts books and other auditing techni @ 14. Qualities of an Auditor inspecting, verifying, evaluating, the liques and examining the same. {mn India, a person can workas an auditor only ifhe has received a degree of Chartered Accountant from the Institute of Chartered Accountants of India, However, apart from legal and business Qualifications, a person should also possess the following qualities in order to do the work of auditing efficiently and effectively: (1) Complete Knowledge of Book-keeping and Accountancy: Itisvery important foran auditor to be well versed with the theoretical and book-keeping, Heshould be awate ofthe various aspects and techniques ofaccountancy and book-keeping. In the absence of such knowledge the auditor will not be able to conclude whether the accounts of the organisation are correct ot not. (2) Knowledge of Nature of the Business: The aucltor should have complete knowledge about the nature of business of the organisation whose accounts he is auditing, He should be familiar not only with the basic nature of the business ofthe organisation whose books he ic ating rather heshould have complete and comprehensive knowledge about llits special practical aspects of accountancy andaspects. In this context, it would be benefici before commencing the audit ! (8) Knowledge of Various Acts: The auditor should possess inowlede of al coer as well as the amendments being made in them from time to time, Some of the economic enactments are as follows: (a) The Partnership Act. (b) The Companies Act. (c) The Income Tax Act. (a) The Factory Act (e) The Sales Tax Act. (The Sale of Goods Act (g) The Contract Act (h) The Negotiable Instruments Act. (4) Expert in the Work of Auditing: The auditor should be an expert in the work of auditing Such expertise is achieved through complete knowledge and actual practising of the knowledge. (5) Impartial and Honest: The auditor, in order to dispense his duties, should not be influenced by any person, ditectly or indirectly. He should do his work with complete honesty and should not certify to anything whose truthfulness he is not sure. While remaining unbiased and honest, he should state all tue facts in his report. (6) Industrious, Vigilant and Clever: Itis very necessary for an auditor to be industrious, since in order to detect frauds and errors in the accounts of a business an auditor has to putin } a lot of hardwork. While doing his work he should always be vigilant and alert and he should display his competence and intelligence while doing his work. (7) Practical: During the continuance of the audit, the auditor often requires several explanations and information from the employees of the organisation, and usually people who have committed frauds are reluctant to give the auditor such information and explanations. Hence, an aucltor has to be practical when demanding such information and sent ed ny a mn iedbloctroadoenenioace: | pale, iy oct Sheved, oo thapetson giving it Politeness, humility and restrain on the part of the auditor. Hence, itis very ne it a Ty necessary for the auditor to have these personal fal for him if he inspects the organisation himself (8) Independent and Fearless: The auditor should examine the of the accounts in an independent and unbiased manner. He should not try to hide any frauds or errors detected by him. He sh truth due to pressure. (9) Secrecy: The auditor has the right to access and examine all the business. Hence, during the course of the audit he comes to kno organisation which are confidential. The auditor should not disci party correctness and truthfulness should also be fearless and ‘ould not turn away from the books of accounts of the 'w a lot of things about the lose these things to any third(10) qu) 15, Types of Au Not Unduly Suspicious: An auditor should not be unduly suspicious, and should not do any thing which gives rise to unnecessary felines of suspicion. He should never begin the examination assuming that the accounts will contain frauds and errors. He should not atiticise anybody merely on the basis of suspicion and should give due opportunity to employees to substantiate their statements Ability to Express Himself Clearly and Influentially: The auditor should always resent his report in a brief yet influential manner. However, by being ‘brief’ it does not imply that he may resort to use of terms having ambiguous meaning, thus giving rise to suspicious in the minds of the reader. The auditor should possess the quality of being able to say what he wants to say in few yet unambiguous words. lors Lawrence R. Dicksee has classified auditors into the following three categories: a (2) 3) Amateur Auditor: Amateur auditors are those auditors who are not competent in the ‘work of auditing. Usually, such people work on a honorarium merely asa hobby, and due to this they are not able to put in effort and hard work into the audit. Getting the books of ‘accounts audited by such people may result in losses to several different parties. They are also known as Honorary Auditor. Professional Auditor: These auditors are recognised by the Institute of Chartered Accountants of India. Infact, they are competent and approved auditors. Today, usually all business and commercial undertakings such as sole proprietorship concerns, partnership. firms and companies usually appoint professional auditors only to get their books audited. These auditors are not the employees of anybody, and are appointed through a contract, for a reasonable consideration and fora reasonable period. Government Auditor: A government auditor is one who audits the books of accounts of the government. The senior most officer in the audit department of the Indian Government is known as the Comptroller and Auditor General of India. He is the person who audits the accounts of the various offices of the Government of India. A comprehensive description of Government auditors is included in the Audit Code. WPOFFILES my Questiens @ |. Short Answer Type Questions 1 2. 3. 4, 5. “Accounting is necessity while auditing is luxury for a business enterprise.” Do you agree? State briefly the essential qualities of an auditor, ‘What are the Basic Concepts of Auditing? Discuss Auditas Luxury. (CDLU2015) How does Accounting differ from Auditing? Explain any three pointOBJECT IMPORTANCE AND LIMITATIONS OF AUDITING WWW.PDFFIES. IN @ 4. Objects of Auditing The main objective of an audit is to examine the books of accounts and establish their completeness, correctness and fairness, so that the auditors in a position to certify as to whether the Profit and Loss Account depicts a true and fair view of the net profitand that the Balance Sheet depicts and true and fair view of the financial position of the business. By saying that the accounts should be correct and fair we mean that there should be no frauds or errors (whether intentional or not) remaining undetected in them, Hence the detection of frauds and errors can be considered as a subsidiary objective of an audit. In fact, without detecting the frauds and errors, the truthfulness and correctness of the accounts cannot be certified. Hence, before studying the objectives of auditing itis very necessary to gain knowledge about the various kinds of frauds and errors that may have been committed in the books of accounts Spicer and Pegler and Walter W. Wig have presented their views on the objectives of auditing as follows “The main objective of an audit is to verify the books of accounts prepared by the client and his employees, Even though defection of frauds and errors is also an objective of auditing, it should be considered only a subsidiary objective of auditing From the point of view of convenience the objectives of auditing can be divided into three categories as is clear from the following chart Objects of Auditing T. Main Object |, Subsidiary Objectives TH, Other Objects Obtaining Knowledge about || 1. Detecting errors, 2. Mainsining mor pressure on the employees. tin cree — and |/2, Detecting frauds, 2 Sateaig oak truthfulness of the account atistying Governmen . : 3. Prevention of frauds and errors. officials 3. Legal compliance.© I. Main Objects a “The main object of auditing is to gain knowledge about the correctness, fare and ipa saat the accounts Ifthe audit only provides us wit information as to whether the accounts @eP! plete and correct in all respects, then the ide ir ition as to whether the accounts are C¢ ee cca oad of this reason that the auditor should keep in object t be considered as achieved. Its because Fa eae adseera report as itis basically on these the aspects of truthfulness, fairness and accuracy in mind while drafting his factors that he is required to comment in his report @ Il. Subsidiary Objects | ‘The objects which help in attaining the main object are known as subsidiary objects. The subsidiary objectives of auditing are as follows: (1) Detection of errors. (2) Detection of frauds. (3) Prevention of errors and frauds. (1) Detection’ af Exrors: The majority of errors are committed due to negligence or lack of knowledge. However, sometimes upon greater in-depth examination it may come to light that some errors have been committed deliberately with the intention of committing fraud. Such errors effect the truthfulness and accuracy of the Profit and Loss Account and Balance Sheet, which is one of the main objects of auditing. Hence, the auditor should conduct in-depth examination of the following errors. (a) Errors of Omission. (b) Errors of Commission (c) Compensatory Errors. (d) Errors of Principle. (e) Errors of Duplication (a) von ie eee ae ae is completely ‘omitted from being recorded . in error is known as an error of omission. In case a business man completely forgets to record a transaction in the primary books of accounts, then the question of posting the entry doesn't arise at all. Hence, an error of omission has no effect on the Trial Balance as the entry doesn't appear in the books of seas Hence, despite the fact that the Trial Balance is tallied, the books of accounts ee eee goods worth % 300 from Ramesh, but did Balance will tally, each side of the Til Balance vi oy Scie oe - ae = a bes ‘omission. An error of complete omission is mui hate : case both debit and credit sides of the transacti recorded in the books of accounts, Sern che BeeErrors of partial omission are easier to locate as the two sides of the Trial Balance do not tally in such a case. In order to detect errors of omission it is necessary to have a good system of internal check and also an in-depth examination by the auditor. (b) Errors of Commission: Such errors occur when a transaction is wholly or partially recorded wrongly in the books of accounts, These errors include wrong entries, wrong totalling, wrong posting, errors in carrying over balances or totals from one page to another, etc. Such errors may also be complete or partial, Partial errors are usually thrown up by the Trial Balance, however, a complete error is more difficult to detect as the Trial Balance remains tallied. If while making entries in the day book or in any account an error is committed, then the same error is likely to continue during posting in the Ledger Account. Hence, even though the Trial Balance is taillied, the error will remain in the books of aecounls, For examples, if we purchase goods worth € 5,400/- and make an entry of % 4,500/- then this is a major error. However, this error will not effect the Trial Balance and both the sides of the Trial Balance will tally. Hence, it requires a great deal of caution, alterness and intelligence on the part of the auditor in order to detect errors which do not effect the Trial Balance. Such errors are fewer in case cof companies employing Self Balancing system of maintaining accounts. (c) Compensatory Errors: Two o more than two such errors usually occur ata time, and in such a manner that they balance out the effect of each other. Hence when the error in ‘one account balances out an errorin another account, then such errors are referred to as compensatory errors. Such errors do not have any effect on the Trial Balance, even though they may have an effect on the Profit and Loss Account. Such errors may be different in nature but they are always the same in amount. For example, if Mohan’s accountis debited with & 20 instead of € 200 and in Vinods account instead of € 20, 200 are debited, then even though both the accounts will be incorrect, itwill have no effect on the balancing of the Trial Balance. Compensatory errors can be detected only through an in-depth examination by the auditor, as such errors can sometimes go undetected for long periods WWW.PDFFILES.IN (d) Errors of Principle: Such errors occur due to the lack of knowledge about the Double Entry System of book keeping and standard accounting principles, Such errors inciude wrong classification between income and capital, entering items of income and expenditure in personal accounts, wrong valuation of assets etc. For example, if € 1000/- spent on the extension of building are debited to Repair A/c. In the same manner % 500/- paid to the Landlord are debited to the Landlords account instead of Rent A/c, Such errors have no effect on the Trial Balance even though they may effect the Profit and Loss Account. Normally, such errors are committed unknowledgly even though they may be committed intentionally with the aim of manipulating the account. The nature of such errors depends upon the specific situation. (e) Errors of Duplication; Such errors usually occur when the same transaction is ‘entered twice in the primary books of accounts and is also posted twice in the ledger. For ‘example, if & 1,000/: are received from Mohan and the same entry is recorded twice in the books of accounts and is also posted twice into Mohan’s account, then such an error eelisan error of duplication. Such errors normally occur due to negligence. Infact such an error is only a kind of error of commission, The auditor can detect such errors through routine checking The above mentioned errors can be detected in the following ways: (1) Location of Errors: Detection of errors when the total of the Trial Balance does not tally is not the job of the auditor. His job is mainly to examine the truthfulness, fairness and accuracy of the books of account. Tallying the Trial Balance is the work of the accountant. Only if the accountant is incapable of tallying the Trial Balance can this work be entrusted to the auditor. In such case the auditor works in the capacity of an account and is entitled to additional remuneration for doing such work. ‘When the accounts which the auditors to audit contain errors due to which the Trial Balance does not tally, the auditor should take the following steps in order to tally the Trial Balance: (i) Checking the Totals of the Trial Balance: In case the Trial Balance does not tally it may be because of an error in totalling, hence, first of al he should total both sides of the Trial Balance very carefully. (ii) Finding the Amount of Difference: Ifthe total of the Trial Balance does not tally then the first step should be to find the difference between the two sides, that is amount with which the Debit side exceeds or falls short of the Credit side and vice versa. (ii) Halving the Amount of Difference: The amount of difference should be halved and itshould be checked if there is any balance equivalent to the amount. It may be possible that an amount may have been entered on the wrong side by mistake. If even then the difference cannotbe located, then the amount of difference should be divided by 9. Ifthe amount is completely divisible by 9 then it means that there is an error in the transportation of digits. For example, the difference between 928 and 289 is 639 which is exactly divisible by 9. Hence, the errors isan error of transportation of numbers. Such errors occur very frequently. (iv) Checking of Journal: Each and every entry in the Journal should be checked so as to ensure that the debit and credit sides of each entry in the Journal are equal and that all entries in the Journal are entered in the Ledger. (v) Checking of Subsidiary Books: All the subsidiary books should be examined soasto ensure that there is no amount which has been entered in the subsidiary book from the waste book. Apart from this, the totals of subsidiary books should also be checked, (vi) Checking of Posting of Subsidiary Books: All the subsidiary books should be checked so as to ensure that there are no entries which are remaining to be posted, This can be ensured by checking the L-F (Ledger Folio) column of each entry as entries which have not been posted would not contains any ledger folio in the LF column (vii) Checking the Balances of Ledger: The ledgers should be examined so as o ensure that all the ledger balances have been included in the Trial Balance. It may happen that the Tiial Balance was not tallying due to non inclusion of balances of one or more accounts. The balances being carried forward should also be checked.(viii) Checking of Opening Entries: While examining the primary books of account, it should be ensured that all the opening balances brought forward in the current year are tallied with the Balance Sheet of the previous year, since opening entries are passed only on the basis of financial statements of the previous year. (ix) Comparison with Last Year's Trial Balance: If these isa lot of difference in the Trial Balance then it should be examined in comparison with the Trial Balance of the Pervious year, and if there is a major difference in any amounts in the two Trial Balances, the same should be examined in detail. any balance has been omitted from being recorded in the Trial Balance, the same can also be thrown up during the ‘comparison of the two Trial Balances. Here, it should be kept in mind that a tallied Trial Balance does not mean that there are no discrepencies in the books of accounts. In order to detect the discrepencies, the auditor should conduct in-depth examination using his competence and intelligence. (2) Detection of Frauds: The detection of frauds is also one of the objectives of auditing Frauds are those inaccuracies and errors which are committed intentionally and with the aim of harming the organisation. Mistakes and errors in the books of accounts which have been committed in a planned manner and with the view of deceiving others are known as frauds Frauds are always committed by intelligent and scheming people, and hence it is very difficult to detect frauds. Itis necessary for the auditor to have a knowledge about the various kinds of frauds. Frauds WWW.PDFFILES ttf Intentional Mistakes [Coir eae aoa. Misappropriation or Misappropriation of Manipulation of Embezzlement of Cash Goods Accounts, According to Dicksee, “The detection of frauds in an important part of the duties of an auditor. An auditor who is able to detect frauds is better than an auditor who is unable to do so. From the point of view of convenience, frauds can be divided into the following categories: (a) Misappropriation or Embezzlement of Cash: It is much easier to misappropriate cash as compared to goods due to the quality of cash being high in value and low in volume. Hence, the person committing the fraud is most interested in the embezzlement ofcash. Itis very easy to smuggle cash out of the business and it cannot be detected even by the watchman at the gate, whereas in the case of smuggling out goods the chances of getting caught are much higher as compared to the chances of getting away with it. Cash can be embezzled or misappropriated in the following ways (i) Not recording extraordinary receipts of cash in the books of accounts and defalcating with the same.(ii) Embezaling cash by not recording cash sales in the books of accounts (ii) Showing the goods sent on sale or return basis or though VPP. as returned and embezzling the cash received for the same, (iv) Making fictitious entries in the customers account relating to discounts, returns, bad debts and embazzsling the cash received from them. (v) Juggling receipts, i.e. embezzling the amount received from a debtor, and recording the cash received from another debtor in his account, and the cash received from a third debtor into the second debtor's account. This is also referred to a ‘lapping’ or ‘teeming and lading’. In this way, a certain sum of money always remains in the hands of the embezzlers. (vi) Stealing cheques and other negotiable instruments. (vii) Embezzling the income eared by the organisation and showing the same as still receivable. (viii) Making entries for false donations and charity or embezzling the funds. (ix) Not recording the receipts from sale of old and non-useable goods in the books of accounts, for example, sale of old newspapers, etc. (x) Not showing a loan received in the books of accounts. Making false bills for purchase of goods and other expenses and embezzling cash. (xi) 1um possible ficticious (xii) Embezzling the amount of wages by entering the mai names in the wage sheets for the payment of wages. In order to detect embezzlement of cash, the auditor should examine every receipt of cash and the voucher of every cash payment in detail. He should tally the invoice of every sale and purchase with the Cash Book, and in case of there being any suspicions, apply all such techniques as he deems fit. (b) Misappropriation or Embezzlement of Goods: Normally, it has been noticed that the owners of business organisations lay more emphasis on detecting embezzlement of cash as compared to detecting embezzlement of goods. Hence, some employees consider the misappropriation of goods to be safer than misappropriation of cash. The ‘misappropriation of goods is more prevalent in organisations where goods are smaller in size but mio expensive. It is also very prevalent in government organisations. The misappropriation of goods can take place in the following ways: {i) Stealing goods from the store. (ii) Inconnivance with some ‘customers, issuing i issuing fictitious credit: emheatlsig i sone lit notes in their names, but (ii) ‘ane cert Purchases, embezzling the goods before the same reach the godown (iv) Using the organisation's goods for personal purposes, (v) Removing certain goods on account of purchase returns and it in the books of accounts. ese (vi) Not entering the goods received as Sales Returns in the books of ‘embezzling the same. seule andSy ult, In order to detect cash “The detection of misappropriation of goods is very diffi ! detaleation the auditor has to examine the cash book in detail alons with the salesman's report and the receipt counterfos. In the same manner, in order to detect the triceppropriation of goods, he has to evolve an appropriate contro! technique on the movement of goods. The misappropriation of goodscan be checked through the use of fan organised accounting system, adequate controls on purchase and sales, and adoption of system of periodic inspection of goods. (€) Manipulation of Accounts: The accounts can be manipulated by embezzling goods vr cash, The misappropriation of goods and cash is usually committed by 'ower level mployees, whereas manipulation of accounts is usually done on the behest of the managers, owners or other responsible officers of the organisation ‘are recorded in the books of accounts in ‘This is a kind of fraud in which the transactions such amanner as to present an incorrect picture ofthe state of affairs of the business. As a result ofsuch frauds, both the Profitand Loss Account and the Balance Shee! become ficers responsible for the manipulation incorrect, but the objective of the of accomplished. ‘Accounls are usually manipulated with the following objectives: WWW.PDFFI! ES.1N (i) Saving of income and sales tax. me (i) Hiding the true picture of the business from competitors Gi) Enhancing profits with the aim of earning a higher amount of commission payable on the basis of profits. Gaining advantage in case of possible sale of the business, declaring lower profits swith the aim of declaring lower dividends and paying lower bonus to employees. (v)_ Maintaining the rate of dividends. (vi) Obtaining loans. ‘Accounts may be manipulated in the following manner: {i) Notclaiming depreciation on assets, or claiming depreciation on assets at lower or higher ratio. (ii) Under-valuing or over-valuing the assets and liabilities. ‘Showing ficltious expenses, or not showing actual expenses [Not including an income in the books of accounts. (v) Treating capital expenditure as revenue or treating revenue expenses as capital (vi) Showing false sales and purchases, or sales and purchase returns. Not showing the eamed income or showing previously eared income as the income of the current year. (vill) Creating secret reserves. (ix) bore acotktniiaasl i.e. showing the state of the business as being better (iv) (iii) (wii)are EEE The detection of frauds relating the manipulation of accounts isa very tough job because they are committed in a planned manner and by the very people who are responsible for the prevention of frauds and are considered to be dependable and honest. In order to detect such frauds the auditor should duly vouch and verify all the assets. Vouching and verification are the blood-hounds of the auditor with the help of which he can detect frauds. (3) Prevention of Frauds and Errors: Itis impossible for the auditor to put a complete end to all frauds and errors. However, due to the moral pressure exerted by the auditor, frauds and errors can be reduced to a large extent. The auditor while auditing the books should keep in mind the kinds of frauds and errors that usually are found in the books of accounts and should examine each transaction in the books of accounts from a moral perspective. A good and strong system of internal check plays avery important role in the prevention of frauds and errors. In fact, the prevention of frauds and errors isin the hands of the employees and the auditor can only give suggestions so as to reduce frauds and errors to a great extent. Even though frauds can be detected, efforts should be made to minimise the possible opportunities for a person to commit fraud, since prevention is always better than cure. Sometimes frauds are committed so cleverly and intelligently that it becomes extremely difficult to detect them, However, ifthe auditor examines the transactions in detail such frauds can be detected to a large extent. This is one of the objectives of getting the accounts audited ¢@ Ill. Other Objects (i) Moral Pressure on Employees: When the employees are aware of the fact that their work shall be examined by an independent person, it works as an indirect pressure on them and hence they work with much greater regularity, efficiency and caution. They don’t do any wrong deed or commit negligence in their work. Asa result, the possibility of frauds and errors is reduced by itself. (ii) Satisfying Government Officials: Legally, it is not mandatory for a sole proprietorship concern and a partnership firm to get their books of accounts audited. Even then, these organisations often get their accounts audited, with the main aim of preventing arbitrary assessment of tax by the tax authorities. (iii) Fulfilling Legal Requirements: It has been made legally mandatory for certain kinds of organisations to get their books of accounts audited, such as public trusts, companies, insurance companies, banks, etc. For such organisations, it is necessary to comply with the requirements in relation to audit as specified in the relevant legal enactment. @ 2. Difference Between Error and Fraud There is only one similarity between frauds and errors, and thatis in both the situations the accounts of the organisation don't depict the true and fair view of the state of affairs, However, there are some differences between the two which are as follows:Objects, Importance... “ WWW.PDFFILES.IN- = S.No. | Basis of Errors Frauds Difference 1. | Awareness The person committing the error is not | The person committing the fraud is fully aware that he is doing so. aware of what he is doing. 2. | Intention Error are usually committed | The person committing the fraud does unintentionally and by chance, since the | so knowingly and with the intention of person committing the error doesn't | deceiving others. intend to do so. 3. | Reason Errors usually occur due to negligence | aude are always committed cautiously and cannot be committed without ‘exercise of proper caution, iz Planning orPlot | People usually plan to reduce the | Incase of a fraud a person first hatches a amount of errors being committed by | plot to commit the fraud and then puts them, the same into action Result The result of errors is not certain and | The result of fraud is certain and it is may be beneficial or harmful for the | beneficial for one party and harmful for organisation, the other. 6. | Crime Human beings commit mistakes and | Fraud is committed intentionally and hence committing errorsisnotacrime. If | hence is a crime which cannot be errors are committed even after due | forgiven L diligence then they may be forgiven. 7. | Detection The detection of errors is comparatively | The detection of frauds is very difficult since the person committing the fraud does so with proper planning,@ 4, Advantages of Audit Intoday’sagewhen businesses and industries are operating on such alarge scale, itis obvious that the importance of audit has increased. With the increase in capital invested in business and industry, and the separation in ownership and management, the need of audit has come out even more clearly. Every external party, whether he be a lender, ora income tax or sales tax officer, or a perspective buyer of the business, considers audited accounts to be more reliable than unaudited ones. Apart from this, audited accounts are also better acknowledged by courts as evidence as compared to unaudited accounts, and arealso helpful in obtaining licences. Hence, al big business whether they are sole proprietorship concems partnership firms, get their accounts audited. The audit of the accounts of a company has been made ‘mandatory by law. In business, auditing is equally important for every kind of business, and that is whyHe ea TREE even those businessmen for whom it is not compulsory to get their accounts audited, are getting their accounts audited, The various advantages of audit are as follows: (1) General Advantages: The general advantages of audit are as follows: (i) Knowledge of the Actual Position of the Business: Through an audit the actual position of the business comes to light. The owners: ‘ofthe business are assured that the results being shown by the Profit and Loss Account and Balance Sheet are correct. Detection of Frauds and Errors: During the examination of accounts in the course of the audit, the frauds and errors contained therein also come to light. This also reduces the chances of frauds and errors being committed in the future. (iii) Moral Pressure on Employees: When the employees are aware of the fact that their work is going to be examined by an independent person, there is an indirect fear among them, and they do their work with much greater regularity, competency and caution. They do not have to do any thing wrong or be negligent. Asa result of this the possibilities of frauds and errors being committed are also reduced. (iv) Alertness among Employees and Management: Audit makes the employees and the management more alert as it results in healthy criticism of their work. The employees become more disciplined and adopt better policies and procedures. Work gets completed as per schedule. The control exercised through the audit also hel; reducit myuption and judging the honesty and capability of employees. WWW. PORE ES We (v) Proper Valuation of Business: If any business is to be sold or in case a firm is to be converted into a company, then audited accounts are helpful in proper valuation of the business and the valuation of goodwill. In fact, audited accounts are considered more dependable than unaudited ones. (vi) Increase in Goodwill: Public puts greater faith in accounts of organisations who get their accounts audited, which enhances the goodwill of the business. The increase in goodwill makes it very easy for the organisation to obtain loans from banks and other financial institutions. (vii) Helpful in Receiving Compens: case of accidents such as fire, theft, ete., audited accounts are mote helpful in receiving compensation from insurance companies. (viti) Helpful in Assessment of Tax: Assessment of tax is much easier on the basis of audited accounts otherwise officers usually define tax liability arbitrarily. Hence, audited accounts are helpful in preventing arbitrary assessment of tax. Helpful in Getting Declared as Insolvent: When the state of the business becomes so bad, that its iabilties exceed its assets, then the businessmen often wants to be declared as insolvent so that he may be relieved of his liabilities. In such cases, the description provided by audited accounts serves as a better evidence in courts. (x) Helpful in Formulating Dividend and Bonus Plan: The audit of accounts certifies the truthfulness of the Profit and Loss Account, and as a result it becomes easier to declare and distribute dividends as well as proper disbursement of bonus is facilitated. This is because the shareholders and the workers consider the audited accounts as correct and have faith in (ix) them.(xi) Availability of Valuable Suggestions: The auditor from time to time keeps on giving suggestiosn to his client regarding book-keeping and accountancy, so as to prevent frauds and errors. Apart from this, the suggestions of the auditor are also useful in other business matters Il. Advantages to Various Organisations: (1) To Sole Proprietorship Concerns: Apart from the above benefits, audit has the following advantages in case of a sole proprietorship concern: (i) Proof in Court: If in any business dispute any fact is to be established through the books of accounts, then audited accounts can be produced as evidence in courts. The former Chief Justice of India, M. Hedayatullah, observed, “When accounts certified by an auditor are produced in court, then the judge is assured that the accounts are true.” Helpful in Conversion of Business into Partnership: In case a sole proprietor wants to convert his business into a partnership firm, i.e. wants to take in another person as a partner in his business, or himself wants to become a partner in another firm, then audited accounts prove very helpful. Comparative Study Possible: In case the accounts for a number of years need to be compared, on the basis of the audit reports of the said years the accounts of one year can be compared with those of another. This makes a comparative study of profits and losses or income’ and expenditure possible. (iv) Helpful in Assessment of Wealth Tax: If the sole proprietor has a lot of assets, and upon his death taxes are to be paid upon his wealth, audited accounts prove very helpful, (v) Helpful in Assessment of Income Tax and Sales Tax: While determining the liability for income tax and sales tax the concerned officers lay much greater reliance upon audited accounts. (2) To Partnership Firms: Apart from the above described general advantages, audit has the following advantages in case of a partnership firm: (i) Mutual Confidence among Parties: Normally, all the partners do not participate in the day-to- day running of the business of the firm. If the accounts of the partnership firm have been audited, it helps in building mutual confidence among the partners. In case the firm also has sleeping partners, the audit of the accounts of the firm becomes even more necessary since the sleeping partners do not have complete information about the business of the firm. Hence, audited accounts reduce the chances of disputes at the time of division of profits among the partners, and the work of the firm can proceed without any hindrance. Gi) (ii) Helpful in Valuation of Business and Goodwill: In case of admitting a new partner into the business of the firm, orat the time of retirement or death of a partner, the valuation of the business, and the valuation of its assets and liabilities and the goodwill of the firm, is greatly facilitated if the accounts have been auditedi) Peaceful Settlement of Accounts: At the time of dissolution of the firm, the assets and liabilities of the firm can be divided among the partners in a peaceful manner on the basis of audited accounts. (3) To a Joint Stock Company: The advantages of audit to a joint stock company, apart from. the general advantages mentioned above, are as follows: (i) Confidence among Shareholders in Management: A company has a system of representative management. The management of the company is in the hands of a few selected shareholders (the directors). The remaining shareholders do not participate in the management of the company. Hence, the managers of the company with the help of getting the accounts audited assure the shareholders that they have been working properly and that they have not misused their position in the company in any manner. (ii) Easy Availability of Investment: A company accumulates capital by issuing shares and debentures to the public. The public has faith on audited accounts and it is on the basis of the same that it invests capital in the company. (iii) Helpful in Declaration of Dividends: Since audit certifies the profits of the company, hence at the time of declaration and distribution of dividends no suspicious are aroused. The auditor certifies in his r t the dividend has been declared and distributed at an appropriate rate. .PDFFH.ES.IN (iv) Facilitates Amalgamation, Absorption and Reconstruction of Companies: ‘Whenever, companies are amalgamated, absorbed or reconstructed, then deciding the purchase consideration is greatly facilitated by audited accounts. In such situations, audited accounts are considered to be more reliable (4) To other Parties: Audit has the following advantages for other parties: (i) When any property is placed in a trust for the benefit of a_particular person then the trustee, in order to present in front of others that he has done the work of the trust honestly, gets the accounts of the trust audited. udited accounts of a business are helpful for an insurance company when the amount of Joss is to be estimated in case of a fire. The insurance companies on the basis of the audited accounts of the organisation can find out whether the claim filed by the organisation is correct or not. This becomes very difficult in case the accounts have not (i been audited. (iii) Banks and other money lending institutions can take decisions as to whether or not to lend money to a particular organisation on the basis of audited accounts. If any external person wants to purchase an organisation, then audited accounts are very helpful in deciding the purchase consideration. In case the accounts have been audited and certified they serve as a basis for the purchasers to decide upon the {iv) purchase consideration. ‘Audited accounts are very helpful for government employees. While levying sales tax, (v) income tax, wealth tax and expenditure tax.‘emaneeRTERSRER NTIS (vi) in (vi) The court, in any case, can also rely upon audi present one’s case better in front of courts by presenting audited acco Limitations of Audit The work of the auditor is to certify the accounts prepared by the client or his employees. He is appointed in order to examine the books of accounts and to certify as to whether they have been prepared, as perrules and regulations and thatthe Profit and Loss Account and the Balance Sheet depict a tru and fair view ofthe financial postion ofthe business. Hence, ifthe audifor i satisfied as 0 the Profit and Loss Account and Balance Sheet of an organisation, and during the course of the audit does not come across anything to the adverse, then he certifies the fairness and correctness of the Profit and Loss Account and the Balance Sheet. Despite the exercise of utmost diligence, caution and competence on the part of the auditor, come frauds and errors in the books of accounts may escape getting detected. Hence, before reaching any conclusions on the basis ofthe auditor’steport the following limitations of audit must be kept in mind: (1) Auditing is not a Conclusive .d accounts as evidence. One can wuntsas evidence Proof of the Honesty of Employees: Ifthe organisation has a system of internal checkin place, and the auditor is satisfied with the ‘working of the same, thon he may certify the accuracy of the accounts by resorting to test checking. In 2 system of internal check also, two or more people can team up and commnit fraud, and such foucke may not come t6light during the audit. Hence, getting the accounts auditted doessit certify thatthe emplovees ofthe organisation have worked honesty throughout the perioe under review. (2) Auditing doesn't Guarantee centsper-cent Accuracy: Normally, large organisalicis have avery large numberof transactions during the financial yea. Hence, itis not possblefor the auditor to examine each and every transaction in detail, nor is it viable in terms of wastage oftime, eflortand money. In such cases the auditor resorts to test checking and hence itis only natural that some frauds and errors may temain undetected. (8) Minor things are not Paid Attention: The auditor, during the course of his examination gives full tention only to matters related to Profit and Loss Account and Balance Sheet. He does not pay much attention to small transactions or transactions entered into by the lowe: Setfof the organisation, Hence, itis possible that a few irregularities may remain undetected at the lower levels, despite the audit. (4) Certain Frauds may Remain Undetected: Despite the exercise of due diigenct competency and efficiency on the part of the auditor, intentional and pre-planned frauds committed by the top managers or other responsible employees of the organisation may escape getting detected. (5) Auditor does not Understand the auditor examines the accounts of organisation in a variety of fields, it is not necessar him to understand the nature of each and every transaction. Hence, it is not possible for the auditor to cerlfy as to whether a particular transaction makes business sense or not. During the course of audit, transactions are examined from the legal point of view and not from the the Nature of all Business Transactions. Even though y for point of view of appropriateness. (6) Auditor Merely Expresses his Opinion: The auditor merely expresses his opinion on the ‘accounts of the organisation, By expressing his opinion that the Profit and Loss Account andBalance Sheet are correct does not mean that there can be no irregularity in the books of accounts. Even though he gives his opinion after due examination, he is also human, and human beings make mistakes (7) Auditor does not Enjoy Practical Freedom: Even though an auditor is considered to be an independent person, since his rights, duties and responsibilities have been specified by the Companies Act. 2013, in practice the managers of the company always appoint their own Persons as the auditors of the company. The auditor is influenced by the management of the company, and hence is not able to conduct a completely independent examination of the books of accounts and give his report on the same. 2 Questieng @ I. Short Answer Type Questions 1. What is auditor's responsibility with regard to detection of frauds and errors? 2. What is the auditor's responsibility with regard to prevention of frauds and errors? 3. Explain four advantages of audit. 4. Explain two limitations of auditing (CDi 2015) 5. Explain other objects of auditing @ II. Long Answer Type Questions 1. Is it a part of the auditor's duty to trace and locate the difference in the books? What steps should he take in order to trace an error? 2, State the auditor's position (duties and responsibilities) with regard to errors and frauds. 3. Discuss the advantages and limitations of audit. (CDLU 2015) WWW.PDFFILES. Ivcl Ue late TYPES OF AUDIT Audits can be classified on the following two bases: I. According to the Organisation of Business, and IL, According to Practicality I. According to the Organisation of the Business: Audits can be classified into the following categories: 1. Statutory Audit 2. Private Audit 3. Government Audit 4. Internal Audit. Il. According to Practicality: Audits can be classified into the following categories on the basis of practicality. 1. Complete Audit. 2. Partial Audit. 3. Continuous Audit. 4. Periodical, Annual or Final Audit. 5. Interim Audit. 6. Cash Audit. 7. Cost Audit. 8. Management Audit, The classification of audit can also be depicted with the help of the following chartCLASSIFICATION OF AUDITS [_ According to the Organisation of Business ‘Accord cording to Practicality i .. Statutory Audit Private Audit | [ Government Audit | [Internal Audit _ Company Audit ] ‘Audit of Trusts ‘Audit of other Individuals ‘Audit of Sole ‘Audit of Partnership |[ Audit of other individu: Proprietorship Concerns Firms = ¥ ¥ ¥ v ¥ ¥ ¥ ¥ Complete] | Pariat ] [Continous || Periodic ][Interim ][ Cash || Cost] | Management Audit Audit ‘Audit ‘Audit |] Audit |] Audit _}|_Aucit Audit @ |. According to the Organisation of Business ‘According to the organisation of the business whose books are au the following categories (1) Statutory Audit: Certain organisations are established under specific legal enactments: and their workings also governed by the provisions ofthe enactments. Itislegally mandatory for such organisations established under various enactments to get their accounts audited. Hence, an audit of an organisation which is legally mandatory under any) enactmentisknown as statutory audit. In such an audit, the scope of the audit, the qualifications and disqualifications of the auditor, the rights and duties of the auditor, the remuneration of the auditor and other audit-related matters are usually specified in the enactments under which the organisations are established, Inrelation toa statutory audit, the can theightsand duties of the aud be enhanced by mutual agreement. He compulsory audit, It is mandatory for th audited: (i) doint Stock Companies registered under the Companies ct, 2013 ran ered under the Banking Comp: ia wmed by the Insurance Cor der the co-operativ dune @ — idited, audits can be divided into ved by an agreement, Not itor be reduced in any manner even though thesameray mice, such an audit is often also referred to 2% following organisations '° related enactment cannot be alter get their accounts revious Act ” " Act, (ii) Banking companies cov ane: (iii). Insurance companies gover ariusstates (iv) Co-operative societies registere40 nt ted to religic (W) Public and Charitable trusts registered under various enacimes ts related to religion. (vi) Local governments and local authorities. (vit Public Truss registered under the Public Trusts Act ations which are not under any legal (2) Private Audit: The audit of accounts of organ! i compulsion to get their accounts audited is known as. private audit. Miche ornoto get the audit done depends upon the organisation. That is why such an au nse em voluntary audit, In such an audit the duties and righ ofthe auditor ae determined on the basis ofthe audit agreement, Some of the important objectives of such audits are detection of faction of government officials, nu * issessment of sales tax and income tax satisf Svea bel viits depend! upon the instructions of the appointor. Such etc, Normally, the limits of such at sruits can be further divided into the following three categories (a) Audit ofa Sole Trader's Accounts: Its notleselly compulsory forasole trader to get it of the accounts of a sole trader depends upon his his accounts audited, and the auc d personal wishes. Which and how many accounts are 10 be examined, is also decided by him. Also the scope ofthe audit, his rights and duties, and all other matters are decided on the basisof the contract between the sole, proprietor and the auditor. Itis necessary for the auditor to clarify allconcltions before commencing his work, and he can commence his work ony after receiving his orders in writing otherwise, in case of any mishap in the future, he may be held liable. a Partnership Firm: The audit of accounts of a partnership itm is not mandatory Audit of the Account of firm is also optional since the audit of accounts of a partnership fi from the legal point of view However, normally most firms get their accounts audited in order to determine the share in the profits of the various partners. The partnership deed ‘alco in some cases provides for the audit of accounts. The rights and duties of the auditor are decided on the basis of mutual agreements, and hence it becomes very necessary fr the auditor to examine these agreementsin great detail. In the absence ofa specificagreement, the auditor should study the provision of the Indian Partnership Act, 1932, in detail. Firms usually get their accounts audited in order to settle accounts related disputes among the partners. (c) Audit of other Individuals and Institutions: It often becomes necessary for a person having a very large volume of income and expenditure to get their accounts audited. The audit of accounts of such persons helps them in assessing the honesty of their employees who maintain their accounts and also aids in the assessment of income tax and expenditure tax. Audit of accounts is also beneficial for people acting through agents such as rent collectors and estate managers etc, some institutions, such as clubs and public welfare societies, also get their accounts audited : 3) ace ee ney Seen of government departments and institutions is Department for audiingthe accounts Sb bye te ah a ee Se ee stank Sree departments. The chief officer of this President of India, under the powers aia eel ote cit ees According to Artie 149 ofthe Constttion of India Feces at neue baeor g i India, the Comptroller and Auditor has such a (b)(a) rights and duties in relation to the accounts of the central goverment, state governments or any other government departments, as may be determined by the Parliament or any enactment passed by the Parliament, The Comptroller and Auditor General has a number of units working under him, which audit the accounts of various government departments. Each such unit consists of a number of senior and junior employees. Here, it must be kept in mind that government auditors are not qualified as is the case of public accountants, and hence they cannot be appointed as auditors of any other public institution. Such employee auditors work only for government departments on the basis of departmental rules and regulations. In every state also there is a separate office of the Accountant General, reporting to the Compiroller and Auditor General of India, which audits the accounts of state government departments. The state governments also have a Local Fund Audit Department which audits the accounts of municipal authorities, panchayat committees gram panchayats, etc. According to Article 151 of the Indian Constitution, the Comptroller and Auditor General of India, submits his report on the accounts of the Central Government to the President of India, and this reportis then tabled in both the Houses of Parliament. The report on the accounts of the state government is presented to the State Governor and is tabled in the State Legislative Assembly. Internal Audit: Some institutions are organised in such a way that like other employees it also appoints auditors asits employees. This is usually due to the reason that the organisation thinks it necessary to appoint auditors as employees in order to prevent frauds and errors and manipulation of accounts. These auditors are permanent auditors and receive salary like all other employees. In this manner, the periodic examination of the accounts of an organisation, by its employees appointed in the capacity of auditors is known as internal audit. People possessing ordinary qualifications who are normally appointed as accountants can do this work. It is not necessary for such auditors to posses the degree of a Chartered Accountant. The main aim of such an auditor is to examine the accounts with the aim of removing any in accuracy or irregularity contained therein and strengthening the system of internal control. Internal Auditors do not submit a report on the accounts to the appointor, as isin the case of an external auditor, but they keep on giving suggestions to the management for the improvement of the accounts. Internal Audit will be discussed in greater detail in a later chapter. @ II. According to Practicality Wy, According to practicality audits can be divide qa) (2) “Po, (0 the following categories: Fey & Complete Audit: Ifall the books of accounts of an organisation relating to a specific Ply are examined in detail, so that no transaction or account or other related documents remain unexamined, then such an audit is known as a complete audit, In such an audit every transaction, entry, book, total, balance, vouchers, deed and documents: examined. Such an audit is legally compulsory in the case of a company. Partial Audit: When, instead of examining all the books of accounts of a particular organisation, only a specific part of the books ‘of accounts or only the books of: mete salt particular period are examined, then such an audit is known as a partial audit. Examples @Auditing ook or examining the ember and January. Partial audit is and nor will any auditor not practical. No appointor would like to get a partial audit a nd aeave ae agree to do it. Partial audit is resorted to only for the achievement of a spec SS anand auditor is asked to conduct a partial audit then he should specify in his repo ee any based upon a partial ‘examination of the books of accounts. If he does not “i = aerate person suffersany damage on the basis of the said report then the auditor shal such person for such damages. (8) Continuous Audit: The examination of th jor cash be such audits are examining only the purchase book, sales book oF = h books of accounts only for the months of November, Des .¢ books of accounts by the auditor throughout the year or atiregular or regular intervals is known as.a.continvow audit. In iianaepes a continuous audit the auditor is occupied in examining the complete books of accounts at regular or iregular intervals. Such an aut is also referred fo 25 2 detailed audit or a running audit. Some prominent experts have defined continuous audit as under: According to R.G. William, “A continuous audit is one where the auelior and his staff is aeently engaged in checking the accounts during the whole period, or where the audlor or his staff attends at regular intervals during the period.” Spicer and Pegler define a continuous audit as “one where the auditor's staff is occupied continuously on the accounts the whole year round, or where the auditor attends at intervals xed or otherwise during the currency ofthe financial yea, and performs an interim audit" According to W.W. Bigg, “A continuous audit is one where the auditor's staff is constantly engaged in checking the accounts during the whole year round.” From the above definitions itis clear that a continuous audit is one that starts at the beginning of the financial year and goes on till the end of the year. Visits of the auditor depend on his convenience or the necessity or urgency of the audit being done. The other aspect of such audit is that the auditor's staff keeps on auditing the accounts at fixed intervals — like weekly, fortnightly or monthly — and the auditor gives his report at the end of the year. In other words, continuous auditing implies auditing the accounts of a business periodically at regular or inregular intervals when the accounts are being written. (8.1) Suitability Though continuous audit is not mandatory by law, its usage is found to be helpful in the following circumstances: @ Where the Size of the Business is Large: A large business has large-scale production and buying and selling of raw materials or finished products. As such, since the number of transactions is la ge, there is a lot of ac mic aces tell Wich butiears ‘counting to be done. Continuous Where the Final Accounts are Re quired Early: enter, the Balance Sheet and the Profit aoe bate ae eatliest after the closing of the finan nncial_year— like banks, companies. Conti i eee " panics. Coninuousaudtng comes very handy for such bance Cone ause the audit is almost over by the los end of the year, and th an koe cea year, ie balance sheet, profit and " 'ecount and other relevant reports are available when required, es ss Account are required at the‘Types of Audit — bel ete Checking System is Unsatisfactory: In such enterprises the tata one nai necessary, and there is no system for such checking or where natn one satisfactory and test checking cannot be relied upon, continuous ints becomes very useful (iv) Where Intensive Checking is Necessary: In enterprises where there have been defalcations or misappropriation of funds in the previous years, it becomes important that there is intensive checking of the accounts. Continuous auditing provides the answer in such cases, (v) Where Int Accounts Need to be Prepared: In enterprises where interim accounts — monthly, quarterly, half-yearly or of any other type — of sales, purchases or production need to be prepared, continuous auditing becomes very useful (3.2) Advantages of Continuous Audit The advantages of continuous audit are as follows: WWW.POFF" ES.IN (i) Detailed and Intensive Checking Possible: Since the audit goes on throughout itis possible to have a detailed and intensive checking of the accounts as and the year, when required. Early Detection of Errors and Fraud: As atesult of detailed and intensive checking, any error or fraud (or pre-fraud manipulation) comes to light. In case the audit is delayed and is done only atthe closing of the financial year, the dishonest employees ‘anipulate the accounts to the detriment of the enterprise. (ii) get an opportunity to m: (iit) Knowledge of the Working Procedure: Having been acquainted with the company’s work procedure, the auditor has afr idea ofthe strength and weakness of the company, which h to the management in decision-making. 1 Effect on Employees: The fact that a company's accounts ae being aucited Mora iy and that any discrepancy willbedetected has.a positive mora effecton the ess writ the result that the accounts are scrupulous and up-to-date, This has a a ’ positive moral effect on the employees Since accounting and auditing are done sentation of Final Accounts . Eat oa, there is no time gap in the presentation ofthe final accounts at the end simultaneously, .e can pass on to the management and which may be very helpful (iv) of the year. in Audit: The auior has convenience in his work—he ean easily tally (vi), Convenient sign the same to his helpers for authentication. In this manner, the the acco ot have extra lad on his head when he has to give the final report aoe vation of Interim Accounts: When the directors of a company want o Early Preparatio ‘a company {0 its shareholders or the public during a formance of ject the er poedto have interim accountstodo that, Continuous auliting helps (vii) Earl proj financial yeas, them do that. asa(viii) Valuable Suggestions by Auditors: Since the auditor is conversant with the ‘company’s accounting throughout the year, he is in a position to pinpoint the technical and other deficiencies in the accounting methods and can make valuable suggestions in this regard, which can result in an improvement in the accounting procedures (3.3) Disadvantages of Continuous Audit Following are the disadvantages of continuous audit: (i) Alteration in Figures: In continuous audit, the books of account are open after the audit. As such, the figures in the books of account can be altered. The employees of the company know that what has been audited will not be audited again; and dishonest employees or accountants may tamper with the figures. (ii) Break in the Continuity of Work: The auditor comes many times during the year to check the accounts. This breaks the routine or the ‘Thread of Work’ of the employees. There is also the possibility of the investigation being incomplete in some respect. ) Expense: Continuous audit is only feasible and possible for big undertakings. Small enterprises cannot make use of such audit because of the expense involved (i (iv) Mechanisation of Work: Work is mechanised in continuous audit, and the auditor's staff takes less interest init. The results that the quality of work is jeopardised. The staffis aware that the end of year is far off, and they become slow and careless — which reduces the quality of their output. (v) Dependence on Employer's Staff: During the audit, at times the auditor's may not be in a position to pinpoint the discrepancies in accounting and amy depend on the employers staff — which means that the employer's staff too has to spend time on the audit. (Wi) Less Moral Effect: The auditor's staff visit the establishment time and again, and ge's acquainted, even friendly, with the employer's staff. Relationships are established between the two, which might lead to their collaboration in any defalcation or discrepancy. (vii) Preparation of the Detailed Note: To foreclose the possibility of any tampering of figure after the audit, the auditor's staff has to make and keep detailed notes of the audit in the notebooks (3.4) Precautions The disadvantages of continuous audit may not be there in ll cases, but the possibilities The following precautions are necessary to avoid the disadvantages of continuous audi () Instructions to Employees: The employer must warn the staff that no change is made in the figures of the account after the audit. In case a change is required to be made, it must be made through a new entry in the journal, and not by deleting ot changing the figures (ii) Use of Secret Tick Mark: To ensure thatthe figures in the accounts are not tampered with, the auditor can use a secret tick mark which is not known to the employees. If anychange is required to be made in the figures, it may be made with a coloured pencil or in a different coloured ink. (iii) Use of Notebook: Important details, major totals in the accounts, and amended or rewritten figures must be noted in a notebook. These can be of use later. (iv) Checking of Impersonal Accounts: Impersonal accounts must be checked at the time of the final audit because the possibility of defalcation is more in such accounts. The possibility of false entries in such accounts is more in other accounts. (v) Systematic Programme: The auditor must have a systematic programme of work and split the investigation of accounts into various parts. So far as possible, one part of the audit should be completed in one sitting so that the continuity is not broken. The accounts are thoroughly investigated in this manner. | (vi) Preparation of Progress Table: The audit should be done according to a progress table prepared before hand wherein the items audited should be marked as and when the audit is completed. (vil) Change in Audit Staff: The auditor's staff visiting the establishment should be changed from time to time so that close personal relationships between the auditor's and the employer's staff do not develop and there is no collaboration between the two. i (A) Periodical Audit: At the end of the financial year when the accounts have been finalised, j the checking of accounts at the employer's premises is termed as Periodical Audit. Since the checking is normally at the end of the financial year, it is also called Annual or Final Audit. Another name for such audit is Balance Sheet Audit because the audits initiated after the preparation of the balance sheet. WWW.PDFFILES.IN According to De Paula, ‘A periodical audit is one where the auditor does not attend until the end ofthe period of the accounts when the whole of the checkingis affected at one time.” According to Dicksy, periodical audit is one which is started after a specified period to which itis related. Such an audit does not have the advantages of a continuous audit Itcan be deduced from the above definitions that the auditor visits the place of work of the employer after the completion ofa specified period and keeps on investigating the account till y such time as all accounts related to the period have been scrutinised. 4.1) Suitability or Periodical Audit Periodical audit is suitable for enterprises with the following characteristics: (i) Where the Business is Small: If the business is a small enterprise and the transactions are not too many, it is best to have a periodical audit of accounts. (ii) Where Interim Accounts are not Required: Periodical audit is suitable for businesses or institutions where interim accounts or accounts during the financial year are not required at short notice (iii) Where Final Accounts are not Required at Short Notice: Such institutions or enterprises in which the final accounts are not required immediately at the close of the financial year or at short notice thereafter can use the periodical audit system.(4.2) (iv) Conve (iv) Where the Internal Checking System is Satisfactory: Institutions or enterprises that have an internal checking system and the system is reasonably satisfactory can do with periodical audit. Periodical audit can also be used by institutions or enterprises where detailed and intensive internal checking is not required. Advantages of Periodical Audit The advantages of periodical audit are listed in what follows: (i) No Alteration of Figures: Once the periodical audit starts, it goes till it is completed. As such, there is no fear of alteration of figures. (ii) Saving of Time: The audit is completed quickly and at one time after itis taken up. All books of accounts, vouchers, etc. are available to the auditor, with the result that not much time is tequired to complete the audit. This saves a lot of time of the auditor’sand the employer's staff. (iii) Less Expense: The expense in a periodical audit is much less than in a continuous audit because the auditor visits the employer only on the expiry of the specified period and completes the audit. As such, the expense involved is much less, \ce: Periodical audit is convenient for both the auditor and the employer's staff. The staff does not have to attend to the auditor's queries the whole year round, and is only needed during the audit period, The auditor too does not have to depute his staff for the whole year — which makes it convenient for all. (v) Continuity of Work: Another important advantage of periodical audit is that there is no interruption in the continuity of work. Once the audit is undertaken, it goes on tillitis, ‘ completed. Also since the audit is undertaken at the end of the financial year, there isno interruption in the work for the whole year as is the case in continuous audit where the employer's work is continuously disrupted because of the frequent visits of the auditor and his staff. (vi) No Moral ill Effect on Employees: In continuous audit, the auditor's staff frequently visits the employer's establishment and develops close relations will the latter's staf, which might lead to a collaboration between the two to cover-up any defalcation ot discrepancy. This is unlikely to happen in a periodical audit where there is no constant touch between the employer's and auditor's staff. (4.3) Disadvantages of Periodical Audit The disadvantages of periodical audit are: (i) No Detailed or Intensive Checking: Most establishments get the periodical audit done at the end of the financial year. At this time both the owner of the business and the auditor are very busy and cannot spare much time. As a result, there is no detailed o" intensive checking of accounts and many defalcation and discrepancies remain undetected. (ji) Delay in Detection of Errors and Frauds: Since errors or frauds are detected only at the end of the year, they can only be amended or set right after the year is over. Such amendment or detection becomes complicated because the effect of such errors offrauds has been carried forward for a considerable period. At times it may even be difficult to identify the person who has committed the fraud because the person have left the job and be not traceable. (iii) Less Moral Effect: Since the employees of the enterprise know that the result of their performance will be judged only once at the end of the financial year, their performance gets deterioted. Their moral values are affected and they become careless and negligent, and may even become corrupt (iv) Delay in Audit Report: Because the audit is undertaken after the accounts have been finalised at the end of the year, there is inordinate delay in the audit report, and the company cannot declare the di idend due to the shareholders in time. (v) Unsuitable for Large-Scale Business: In a large-scale business where the number of transactions is very high, periodical audit is not feasible because it becomes unmanageable to audit the huge amount transactions accumulated during the year. (vi) Absence of Timely Advice: In continuous audit, the auditor keeps on checking the ‘books of account from time to time throughout the year and give valuable suggestions to the company's management. As periodical audit is only at the end of the financial vear, it becomes impossible for the auditor to give such advice or suggestions to the management. (4.4) Differences between Continuous and Periodical Audit WWW.PDFE" FS I} S.No. Basis of Difference Continuous Audit Periodical Audit Time of Audit ‘The audit continues at regular or irregular intervals throughout the year. ‘The audit commences after the finalisation of the books of accounts at the end of the financial years and continuous till itis completed Nature of Checking ‘The checking of accounts is detailed and intensive. Intensive and detailed checking is not possible. Only test checking is possible. Suitability The audit is very suitable for large-scale business undertakings with a multitude of transactions, The audit is suitable for small business undertakings. Errors and Frauds Is a detailed and intensive checking and, as such, there is very little possibility of frauds or errors being undetected, Even after the completion of the audit, the possibility remains that frauds and errors have not been detected, This cost is high because the auditor has to do a lot of work, The cost is low because itis once-in-a-year job,AUDIT PROCESS AND AUDIT PROGRAMME 1. Preparation before Audit WWW.PDFFILES.IN In the present day and age before beginning any task one has to make proper preparations relating to the same, i.e., make a plan. Work done without ‘proper preparation seldom achieves the desired success. For example, if person wants fo go on a vacation with his family, there are a number of matters ‘on his mind such as when to go? How to go? How many days should they stay there? Where to stay? What should be the mode of transportation, etc. He plans keeping all these in mind and makes due preparations, and only after doing all that is he able to achieve success. In the same manner the auditor should also make some preparations before commencing his audit work. What he is to do depends upon the circumstances in which he was appointed. Before commencing the audit work the auditor has to clarify certain basic facts. Ifthe auditor has been auditing the accounts of the organisation over a number of years, then he becomes aware of a number of facts relating to the business. Sometimes in relation to certain facts the auditor may refer to the file containing previous year audit documents and make preparation for the audit work on that basis, but if he is auditing the accounts of the organisation for the first time, then before commencing his work he has to receive a variety of information from the management Hence, before commencing the audit, the auditor should assimilate information relating to the following matters: (1) Scope and Nature of Work Assigned: Before commencing the audit work, the auditor should determine the scope of the audit, ¢., whether only a part ofthe books of accounts is to be audited or the complete books of accounts are to be audited. The scope of the audit depends upon the contract between the auditor and his appointor and the terms and conditions in his appointment letter, However, in case of a statutory aut the scope of the audit is specified by law and it can only be enhanced by the appointor and the auditor, and cannot be reduced. If the auditor is also entrusted with the work of preparing the Trial Balance, Profit and Loss Account, etc. then he does such work in the capacity of an accountant and he is entitled to get additional remuneration for the same. (2) Objectives of the Audit: Before commencing the audit the auditor should find out as to what was the objective of the appointor in getting the books of accounts audited. Such information is very necessary when the audit is being conducted for the first time. Ifthe books are being audited by the same auditor over a number of years, then there is no special need for the auditor to enquire about the objectives every time.Auting (3) (4) 6) (6) . (8) (9) Nature and Technical Features of Business: Before commencing the audit, the auditor should obtain complete knowledge about the nature of business of the organisation and other technical details, what are the goods being traded? From where are the goods being bought and sold? What are its income and expenditure sources, investment policies etc. Even organisations in the same line of trade do not function alike, and hence the auditor should have knowledge of all facts which are specific to the organisation. The nature and quantity of such specific information depends upon the nature of the organisation. Knowledge of Accounting System: The auctor should also have knowledge about the accounting system being followed by the organisation since insurance companies, banks, nies, cinemas, electricity companies, educational institutions and other joint stock compat and maintain different books of institutions all employ different , methods of accounting ‘accounts Hence, the auditor should always keep in mind the weaknesses of the system of accounting being adopted. Study of Various Documents: The auditor should have complete knowledge about any law relating to the organisation whose accounts he is auditing. He should also study the rules and reaulations ofthe organisation, in accordance with which the work of the organisation is caried out, for example, in the case of a company he should study the memorandum and articles of association, and in the case of a partnership firm he should study the partnership deed. By studying such basic regulations he can become acquainted with the style of functioning of the organisation. Hence the in-depth knowledge and study of all rules and regulations is very necessary for the auditor. List of Books of Accounts: The auditor should obtain a lis of all the books of accounts being maintained by the organisation as well as the names of the people who are maintaining the same. Apart from this he should also obtain alist of all legal and other important books of record being maintained by the organisation. Study of System of Internal Check: Before commencing his work the auditor should ‘conduct an in-depth examination of the internal Check system of the organisation. He should assess how effective the system of check actually is. Internal check system is a system on the basis of which the total work in the organisation is divided in such a manner, that the workis ‘examined simultaneously as itis being done. Ifthe division of work is faulty, the occurrence of frauds and errors in the accounts increases. Hence, the auditor should assess whether the Internal Check System is satisfactory or not, and if not then he should keep the same in mind while determining the scope of his audit techniques. Knowledge of Previous Year's Final Accounts: Ifthe organisation has been in existence over the last few years, then the auditor should examine the Profit and Loss Account, Balance Sheet, the report on the accounts and other related documents. He should examine as to whether or not any adverse fact was brought to light in the same. If the previous auditor has pointed out any deficiencies or defects in his report, then the auditor should lay special ‘emphasis on those points while doing his work. Period of Audit: The auditor should also find out the period pertaining to which the books of accounts are to be audited. Normally, audit is conducted once in a year however, in special circumstances the books pertaining to a much larger or smaller period may be audited.10) (11) Audit Process nd Aude. Instructions to Employer: After obtaining the above information the auditor should issue instructions to his appointor, in respect of the following matters’ (i) The books should be totalled and the Trial Balance and final accounts be prepared. (ii) All the vouchers should be arranged serially (iii)_Lists of Debtors and creditors be prepared (iv) Lists of Bad and Doubtful Debts be prepared (v) Lists of outstanding expenses, prepaid expenses and accrued incomes be prepared. (i) List of stocks be prepared and the method of valuation be specified (vii) List of investments be prepared and their costs also be specified, (vill) A list of vouchers relating to transactions and goods returned by various branches, agents and other related organisations be prepared, WWW PDFFILES.WY (ix) A complete detail of Permanent Capital Expenditure be prepared. (%) A list of deferred revenue expenditure be prepared. (xi) A list of documents which the auditor is entitled to examine, be prepared (xii) A list of all directors containing their names and addressees be prepared The auditor gets information on all the above matters from his employer. This information is needed by him from time to time during the continuance of his audit. Hence, it becomes necessary for the auditor to prepare as Audit Memorandum Note Book, in which all useful information and explanations should be recorded. A major advantage of such a note book is that the auditor is freed from the nuisance of approaching the management again and again for information. Division and Distribution of Audit Work: An auditor audits the accounts of a number of organisations. Hence, in order to complete the entire work within the specified time the division and distribution of work becomes necessary. Every Chartered Accountant has certain assistants for training known as Articled Clerks. Among these assistants, those who are experienced are known as seniors and those who are not so adept and experienced are known as juniors. Its only through the distribution of work between the senior and junior tants that the completion of work becomes possible, The junior clerks have to work under the guidance of the seniors. There are no universal principles of division of work, and it depends upon the needs of the particular audit. Normally, matching of vouchers, with the subsidiary books, examination of the posting of the ledger, examination of totals and balances, tallying the Trial Balance etc., are usually assigned to the junior assistants. On the other hand the examination of outstanding expenses, examination of method of provision for depreciation, provision for bad and doubtful debts, valuation of assets and liabilities, etc. should be entrusted to senior assistants. Both the assistants have to work under the auditor. It should be kept in mind, that the success of the examination depends to a great extent on the division of work.sss However, in all circumstances, the final responsibility is that of the auditor because the teport on the accounts is made by him and contains his signature. (12) Audit Programme: Finally, after obtaining all prior information, the auditor sh, formulate a programme for doing his work containing how he will o about his work and thy division of work among various people. finay ™ 2. Audit Programme © 2.1 Meaning ‘An audit programme is a detailed plan of work prepared by the auditor for the supervision ang control of his assistants, before actually beginning the audit. Hence, an audit programme is a ‘Systematic, detailed and writen plan of the audit techniques to be adopted, on the basis of which the auditor and hi, staff proceed with their auditing work, The main objective of preparing an audit plan is to maintain ain between the various tasks involved in the audit work. For example, before starting with the building werk the building contractor considers various factors such as the plan of the building, the duration in which the work is to be completed, the way in which it is to be proceeded with, the number of labourers to be employed ete, Similary, an auditor makes a plan of the work to be done or constructs a frame work otis programme, and proceeds with the auditing work within this frame work © 2.2 Definitions A few experts have defined audit programme as follows:- (1) In the words of Howard Settler, “An audit programme is an outline of all procedures tobe followed in order to arrive at an option concerning the clients financial statements" (2) As per Arthur W. Holmes, “An audit programme is a flexible, planned procedure of examination.”” (3) According to W.W. Biggs, ‘An audit programme is 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.” | (4) According to Spicer and Pegler, “In order to bring in uniformity and to ensure that all that which needs to be done has been done, it becomes necessary to prepare a programme. Inthe programme, the clerk responsible for a particular part of the work, signs against the same upon completion. In this manner the employer can also get information about the progress of work and work still incomplete.” On the basis of the above definitions audit programme can be appropriately defined as follows: “In order to complete the audit of the accounts of the client in an efficient manner and within the specified time, while maintaining uniformity in work, the plan that is prepared for performing the workol the audit is known as an audit programme.” © 2.3 Analysis of Above Definition (i) The audit programme should be descriptive so that all that needs to be done during the audit can be analysed. In the plan after each aspect ofthe work, space is left for the signature ofthe clerk assigned for doing the same (ii). The plan is always in writing and is prepared by the auditor.(it) The main aim of the plan is to ensure that the work of the audit proceeds in an efficient manner, is completed within the specified time, there is uniformity in the work done and ensuring that no part of the audit is left incomplete. © 2.4 Objectives An audit programme is prepared with the following objectives: (i) Preparing a specific framework for the auc work within the specified period, work so that itis possible to complete the audit (i) pion of work among the assistants so that each person is aware of what he is supposed to lo. iii) Being aware of the progress of work done by employees. (iv) In case any employee leaves during the audit, then assigning the same work to the person replacing him. (v) Removing the possibility of any work being leftout. (vi) Fixing the responsibility of employees. © 2.5 Types of Audit Programmes Audit programme are of the following two kind: (1) Standard Programme. (2) Tailor-made Programme. (1) Standard Programme: An audit programme based on a standard format is known as a standard auditing programme. This documentis used uniformly in all audits, and there is no need for the auditor to prepare a separate audit programme for each audit. Such a programme is also referred to as a fixed or predetermined or a planned programme. Such programme may be suitably modified in order to accommodate the specific problems of a particular business, WWW.PDFT TS (2) Tailor-made Programme: A tailor-made programme is one which is prepared separately for each organisation keeping in mind the nature of business, nature of transactions, method of accounting, efficiency of internal control etc. Such a programme is more practical and flexible as compared to a standard programme © 2.6. Preparation of an Audit Programme Or Essentials of A Good Audit Programme Every auditor prepares an audit programme according to his convenience and keeping in mind the nature of the business. The auditor can get certain standardised programme for every kind of accounts, such standardised programmes may be altered according to the situation and need. The success of an efficient auditor depends largely upon the audit programme, hence the auditor should formulate the audit programme very carefully. While preparing an audit programme the following things must be kept in mind: (1) In Writing: The audit programme should always be in writing in order to avoid any misunderstandings between the auditor and his employees in the future, When there is 2 lllAuditing (2) (3) (4) 6) (6) (7) (8) written audit programme the auditor's staff need not enquire again and again about the work, to be performed by them. Clarity: While drafting the audit programme it should be ensured that itis simple and clear, so that every person concerned with the programme can understand it easily. Ambiguity in the programme results in hindrances in the audit work and waste of the time and efforts, Division of Work: The audit programme should be in accordance with the departments in the organisation so that work may be assigned and responsibility may be fixed among the staff on the same basis, While dividing the work the auditor should be completely aware of the level of competence of his staff, since only then will be able to assign work in accordance with the capabilities of the person. The division of workshould be done keeping the business of the organisation and various other aspects of the work to be done in mind, so that the work may be completed successfully and no part of the work escapes examination by the auditor. Flexibility: The audit programme should be flexible, so that in case of a change in circumstances, there is no problem in altering the programme. During the course of the audit, some circumstances do arise due to which work cannot proceed according to the plan and minor deviation have to be made. Hence the programme should be such that minor alterations can be made in it. Policies and Provisions: While formulating the audit programme, the related policies and provisions having bearing on the audit work should be kept in mind, such as, Memorandum and Articles of Association in the case of a company and the partnership deed in case of a partnership concern. In order to prepare a good audit plan it is necessary that the books of accounts being maintained by the organisation, the method of accounting being used, the internal check system etc. be kept in mind and efforts should be made to reduce the deficiencies in the same. Object Oriented: The audit programme should be in accordance with the objectives of the organisation so as to maintain co-ordination in the work of the organisation and complete the audit smoothly and within the specified time. Unless the audit programme has these qualities, it is of no practical use. Previous Reports: While drafting the audit Programme the final accounts and auditors reports of past years should be looked into, since by doing so many facts which are important from the point of view of the audit will come to light. Department-wise: A separate audit programme should be prepared for each department and sub-department of the organisation. Apart from this different audit programmes should also be prepared depending upon the nature of work. For example, different audit programmes should be prepared for cash, purchases, sales, etc. By doing so one can obtain important information and explanations from the employees of the organisation in a smooth manner.@ 2.7 Specimen of an Audit Programme Financial Books Time Auditor's taken on | Cost at hourly the Job | rate of the Employees. 1. Cash Book (a) Cashing (b) Posting (€) Vouching (a) Bank Reconciliation Statement, Gusluzba os new (b) Posting vy (elven Www. PoF™" EB.IN 3. Bills Register (a) Casting (b) Posting peek 4, Purchase Day Book (a) Casting (b) Posting (c} Vouching 5. Journal (a) Casting (b) Posting (6) Vouching 6, Verification of Final Accounts 7. Netification of Schedules © 2.8 Advantages of an Audit Programme ‘The following are the advantages of having an audit programme: (1) Distribution of Work according to Ability: By makingan audit programme, the auditor assigns work to his staff according to their abilities so thatthe work can be completed fastand well since a person who is adept in his work does the work very quickly. (2) Determination of ‘Responsibility: The responsibility of each employee is determined on the basis of the programme. Hence, every person does his work with a lot of caution and diligence since in case of there being an error, he shall be held responsible. (3) Evaluation of Progress: The audit programme also functions asa kind ofa progress chart. Dueto there beinga written programme, the auditor can assess the progress ofthe work being done by his employees from time to ime, He can find out what all has been done and what stil nemains to be done. By doing so he can also examine the efficiency of his employees (4) Uniformity in Work: The audit programme for a year can be prepared very easily by looking into the audit programmes prepared for the past years. This has two benefits. ItAuditing ce alll ensures uniformity in the audit work, and itprevents unnecessary waste of time in formulating ‘an audit programme from scratch. No effect of Changes in Employees: If during the course of the audit due to any reason ° s, then it is not difficult for another person to take any employee has to go on leave, or t over the work as the audit programme serves as his guide. Hence, the new incumbent can easily complete the work by following the audit programme. Proof in Court: In case of any dispute between the client and the auditor, and a charge of negligence being levied on the auditor, then the auditor can produce the audit programme in the court as proof in his defence. (7) Saving of Time: By working according to a predetermined plan, many of the problems that may crop up while doing the work are solved automatically. Hence, the unnecessary lose of time in thinking and understanding things can be saved. (8) Simultaneous Work indifferent Business: Many organisations can be audited simultaneously, and efficiently since the audit programme makes it clear that what is to be done and how many people and how much time is required for doing the same. This information makes it possible for the auditor to conduct the audit of several organisation simultaneously. (9) Complete Checking Possible: By having a prior written programme, for the audit work, no field of examination remains untouched and hence the auditor is satisfied that a complete examination has been conducted, (10) Facility in Control: Having an audit programme facilitates control over the audit worksince the division of work and responsibilities are specified before hand. This increases the efficiency of the audit staff and reduces the chances of negligence and errors, © 2.9 Disadvantages of an Audit Programme The following are the main disadvantages of having an auc programme: (1) Work becomes Mechanical: Since the work of the audit is completely according to the audit programme, the taf does the work mechanically which leads to monotony and the staf become negligent and inefficient in doing theit work 6) have to work according to the audit programme. Hence, this docs rot give them any Eportunity to display their capability and intelligence. As a result, eapable employees also lose their enthusiasm in doing the work. (3) Lack of Moral Influence: Due to uniformity in the audit, the employees ofthe organisation are already aware of the aspects being looked into, Hence, they do their workin apre-planned ‘manner, and the moral pressure ofthe aul on the employees is greatly reduce! (4) Difficult to Detect Frauds: Having an audit programme makes the work monotonous and mechanical. This makes the detection of frauds even more difficult sine doing so requires a very imaginative and thorough examination (6) Lack of Elasticity: Since the audit programme is formulated in advance, it becomes dificult to make changes in itin accordance with changes in circumstances. Hence. it lacks flexibility.‘Audit Process and Audit... (6) Uniformity is Harmful: The same kind of programme cannot be applied to every business. Ithecomes necessary to change the audit programme in accordance with the structure of the business. Hence, the same audit programme cannot be used for every organisation all the time. (7) Nom-disclosure of Efficiency: Inefficient auditors try to cover up their efficiencies by relying upon the audit programme. I an auditor is negligent in doing his work, then he tries to defend himself by showing the audit programme. The audit programme is a proof that the auditor has done all his work, and hence his in efficiency cannot be proved. © 2.10 Remedies or Elasticity in Audit Programme WWW Perce re int The above mentioned disadvantages of an audit programme make it amply clear that the audit programme should notbe rigid. In other words, the same audit programme cannot be used for the audit of every organisation ice in reallity the way of working and circumstances of each organisation are different. hence, an audit programme will be useful only when there is scope for making alterations in it in accordance with change in circumstances., It is also appropriate that in order to motivate competent employees, suggestions based on their experience should also be incorporated in the programme Appropriate alterations and additions make the audit programme more flexible and ate also helpful in the successful completion of the audit work, hence, the audit programme should always be flexible otherwise there is danger of the audit work becoming mechanical in nature. The auditor should always consult his subordinates. He should listen to their problems and take proper steps to remove the same after taking due advice from them. He should take care that the work of his subordinates does not become mechanical. He should make it clear to his. staff that the audit programme is only for their guidance. In case the subordinates at any point, find the programme inappropriate, they may make the necessary changes in it. However, it should be kept in mind that there should not be too frequent changes in the audit programme, otherwise it will defeat its objective. @ 3. Audit Notebook During the audit, the auditor comes across a number of points on which clarifications may be requited in the future, or which may be useful in the future. The auditor cannot always remember all these things and hence every auditor, while conducting the audit, keeps a notebook, known as the Audit Note book for his personal use in which he records important information relating to the audit. Sometimes, the auditor records the important information on plain papers, and these are referred to as audit notes. However, itis always better to maintain the information in a notebook. The auditor maintains a separate notebook for each organisation, in which he records important facts about the organisation and his ‘comments on the same. This note book is also helpful while auditing the same organisation again. © 3.1 Contents of Audit Notebook Itis very difficult to say anything conclusive about the contents of the audit notebook. Itis prepared. according to the requirements of the particular audit. However, the audit note book normally contains the following information: 1. Abrief description of all legal documents such as, in the case of a company the memorandum, and Articles of Association, Minute books, contracts ete, and in case of a partnership firm the partnership deed. 2. A copy of the audit programme.© 4. Routine Checking Every business maintains some or the other sort of books of accounts and these are examined ona daily basis. The daily examination of these books and accounts is known as routine checking. Routing checking means checking of arithmetical accuracy of books of original entry and ledgers with a view tg detect frauds and errors. Routine checking establishes the arithmetical accuracy of the accounts, What Does Routine Checking Include? Routine checking includes the following tasks: 1. Checking the various calculations such as totals, sub-totals, balances carried forward ete . 2. Examining the entries in the ledger with those in the books of original entry. us accounts 3. Checking the balances of v 4. Checking the balances cartied from the ledger into the Trial Balance. Objects of Routine Checking 1. Establishing the arithmetical accuracy of the books of accounts. 2. Tocheckwhether the entriesin the primary books of accounts have been posted correctly, and whether the accounts have been balanced correctly or not. 3. Through the use of special symbols ensuring of that the figures are notaltered after the audit. During routine checking a number of symbols are used, hence some people also refer to it as tick work or check making. The following precautions should be exercised in relation to the use of symbols: (i) The symbol should be small and clear. (ii) Different symbols should be used for different tasks. (ii The symbols should be putin colour different from that in which the accounts are being maintained. (iv) The use of the symbols should be kept secret. (v) Itis better to change the colour of the symbols from year to year. Where the symbol is marked is also very important. Normally for the checking of posting the symbol is placed to the left side of the amount showing that the same has been checked and, once the amount has been vouched, the symbol is placed to its right. Once the totals are checked the symbol is placed below it Itis very important that the placement of symbols should be decided before hand, While auditing these symbols should always be kept in mind in the same manner as we keep the road while walking, words while talking, and our pockets while purchasing, In all the above situations a small carelessness can produce a large amount of problems and complexities. Advantages of Routine Checking Routine checking is simple work and can be done by a person possessing ordinary qualifications, Even though it is simple, it is very important since it forms the basis of the Auditor's Report. Routine Checking ensures that there is no arithmetical eror inthe accounts and that the posting has been done correctly. Through it simple frauds can be detected easily, and even ifthe amounts have been altered theycan be easily detected through the use of symbols. In brief, the following are the main advantages of routine checking ()_ Simple: Routine checking is very simple and a person possessing ordinary qualifications can do it. Hence, such checking is usually done by the lower level staff. Knowledge of Arithmetical Accuracy: Through routine checking arithmetical inaccuracies in the books of original entry can be easily detected Knowledge of Accuracy of Postings: Through routine checking the postings in the ledger accounts is also checked and any error in the same can be easily detected. Detection of Errors and Frauds: Due to the special emphasis on the examination of the Primary books of accounts and the ledger, errors and frauds can be detected easily, Even then itis not possible to detect errors of principle through routine checking, Change in Figures come to Light: A number of symbols are used in routine checking, and the meaning of all these symbols is confidential. Hence, itis not possible to alter the figures after the audit. Even then if the figures have been altered they can be detected easily. Helpful in Checking of Final Accounts: With the thorough examination of the books of original entry and ledger, the examination of the books of original entry and ledger, the examination of Trading and Profit and Loss Account and Balance Sheet becomes much easier. Hence, routine checking is the basis for the examination of final accounts. © Disadvantages of Routine Checking WWW.PDFFILES.IN Even though routine checking has many advantages, it has a few disadvantages also which ate as, follows: (2) @) (4) (5) ©) (1) Haste and Carelessness in Work: Since the working of routine checking is often done hastily and in a careless manner, errors often remain undetected, which makes the final examination worthless. (2) Work becomes Mechanical: This checking is totally mechanical and hence the work becomes very monotonous. This work is usually done by unqualified employees, who often do not understand their responsibilities fully (3) Non-disclosure of Errors of Principle: Since routine checking is done by employees possessing ordinary qualifications they are not able to detect errors of principle and compensatory errors and hence such errors often go undetected (4) Planned Frauds are not Detected: Routine checking cannot detect planned and systematic frauds and hence only small and inconsequential errors are detected. (5) Fall in the Quality of Work: Employees often consider such work as a mere formality and hence do it hastily and carelessly, and hence the desired results of such checking cannot be achieved. ®@ Conclusion Routine checking is very important for the audit and the final examination is based on routine checking only. If the work of routine checking is carried out under the supervision of a senior employee, its disadvantages can be removed. Whether the auditor examines any transaction in detail or only apart of i depends upon the degree of success of the internal control system in the organisation. In this context iti necessary to say that through routine checking only clerical mistakes and ordinary frauds canbe detected‘Auditing Itis much more difficult to detect errors of principle and properly’ planned frauds, for which the auditor has to conduct in-depth investigation and has to review all original records. © 2. Test Checking When instead of examining each and every transaction contained in the books of accounts, only few chosen transactions are examined in detail, itis referred to‘as test checking. In test checking the auditor does not examine all the accounts relating to every transaction, rather he analyses a few representative transactions of every category and on the basis of such examination expresses his opinion on the complete accounts. Ifthe selected transactions are found to be correct, itis assumed that the remaining transactions shall also be correct. According to Prof. Miz, “Testing and test checking implies that from the large transactions of the same category a few transactions are chosen and examined in detail.”” In large business organisations, the number of transactions is very high and hence it is not feasible for the auditor to analyze each and every transaction in detail. Complete and in-depth examination is impractical since it would result in waste of time and money. In such a situation test checking is more suitable. For example, while vouching for credit sales a few transactions (for a particular week or month) may be examined, or the transactions for a few months selected on the basis of sampling method may be examined, or the transactions with only a particular business organisation may be examined. If the transactions so examined are found to be correct, the auditor assumes that the remaining transactions will also be correct. © Elements or Characteristics of Test Checking The following are the main characteristics of test checking: (1) Sampling: Test checking is based on the principles of random sampling. In it, a few representative transactions are selected and are examined in detail. If during the examination, the representative accounts are found to be correct, then all remaining accounts are also assumed to be correct. (2) Representative: The transactions selected during test checking are representative of all the transactions. They should include transactions of all kinds, relating to different. ‘employees and also year round transactions. (3) Scope: In the situation of frauds and errors coming light during test checking, the scope of checking may be widened and if need be a comprehensive examination may also be undertaken. (4) Standards: Itis very dificult to determine the the standards for test checking beforehand. The suitability and limits of test checking are determined by the aucltor himsell, keeping in mind the particulars of each specific organisation. . Internal Check: The success of test checking depends upon the efficiency ofthe internal check system. Ifthe intemal check system ofthe organisation is weak it becomes necessary to undertake a comprehensive examination. (6) Object: The main objective oftestcheckingis to free the auditor rom conducting an in-depth examination. The time so saved may be used by the auditor for examining other important (5) transactions.@ Advantages of Test Checking ‘The main advantages of test checking are as under: (1). Saving of Time: In test checking instead of checking each and every transaction only a few representative transactions are examined, and this saves a lot of time. (2) Reliable Results: The transactions examined are representative transactions which represent the characteristics of the whole. Hence, the results of test checking are quite reliable. (3) Audit of Many Institutions Possible: If the auditor examines each and every transaction comprehensively, it takes up a lot of his time and efforts. hence, the time saved by the auditor by resorting to test checking may be used by him for auditing many other organisations and thus increase his business. (4) More Emphasis on Internal Check: Test checking is based on the internal check system, since it can be resorted to only in those organisations where the internal check system is satisfactory, Hence more emphasis is laid on internal check system and the auditor also gives the owner of the business suggestions as to how to remove the deficiencies in the internal control system. (5) Early Completion of Audit Work: In test checking, instead of analysing each and every transaction, only a few transactions are analysed, and as a result the audit work is completed much faster. Hence, it is beneficial to the auditor and the work of the client is also not disturbed due to the audit for a very long time. © Disadvantages of Test Checking WWW.PDFFILES.IN (1) Frauds and Errors may Remain Undetected: In test checking only a certain part of the accounts are examined. Hence, errors and cleverly committed frauds may remain undetected since they may be contained in transactions which have not been chosen for examination. (2) Carelessness by Employees: The employees of the organisation also start feeling that since their complete work is not going to be checked, why put in so much effort? Once such thinking creeps into the minds of the employees, itis but natural that they will become more careless. (3) Unsatisfactory Repo! After the examination the report submitted by the auditor is of not tion since the opinion of the auditor is based on the examination ofonly apart of the accounts. Hence, itis butnatural thatthe report will not be satisfactory. (4) Increase in Auditor's Responsibility: Even though through test checking the work of the auditor is reduced, his responsibility is increased since he is also responsible for transactions which have net been examined by him. © Precautions While test checking if the following precautions are exercised, then the checking can be more satisfactory and effective: (1) To Select Representative Entries: As far as possible representative entries from each book of account should be selected. In other words the transactions selected for test checking should be representative of the complete accounts, only then can satisfactory results be derived from test checking. The selection of representative transactions should be kept totally secret from the employees of the client.Auditing t: Efforts should be made that the wo, Yh k should be Subject to Tes ee examined ‘The work of no clerk should escape examination sine is and ertors. f Different Perl to different periods of time. Acc should be selected. Book, Transfer Book and credit entries in hy sis, rather each and every entry should bp (2) Each Employees of each and every c may encourage fraud (a) Selection of Entries of examination should pertain periods of time for each book of accounts (4) Thorough Checking: The entries in Cash kb Journal should not be examined on atest check be examined. Those transactions for which detailed examination is specified under any provision and entries giving ise to suspicious should be examined in much greater detail (6) Entries of Opening and Closing Months should be Checked in Detail: The entries ¢j the fist and lst months should be checked in greater numbers since es HOT odjutiery re maden the last month. The examination of accounts ofthe ist and last month isalso very important from the point of view of detection of frauds and errors. (6) Random Selection: The representative transactions should be selected on a random bass ‘The samples for examination should be changed from year to year. pt for a few situations, the auditor should always conduct ‘duce his work but it does net in any way absolve him of his fods: The entries chosen for inspection ang counts pertaining to differ, In conclusion, we can say that, exc: in-depth examination. Test checking may re responsibilty. © Test checking and Auditor's Responsibility suditor whether he resorts to test checking ornot While conducting the audit itis totally up to the at ‘The auditor can resort to test checking while doing the audit work because in India, the Institute e Character Accountants of India, considers this technique to be appropriate and hence has granted ‘eeognition tothe same. However, there isno provision for absolving the auditor from the non-detectionaf frauds and errors due to the adoption of test checking. If ue to the adoption of test checking the cent suffers any loss, and a charge of negligence is levied on the auditor in the courts, then the auditor in his defence cannot argue that he had adopted the test checking technique and hence he is innocent. n this manner, by adopting test checking the auditor can reduce his work content but he cannot reduce his responsibility © 3. Audit in Depth ‘The detailed examination of any transactions in all its aspects from the starting to the end is known asaudit in depth. Auciting in depth is usually resorted to in large organisations having a large numberof transactions. In this all the entries in the accounts are not examined, rather a few selected transactions re examined and verified in all its aspects. Auditing in depth is based upon the technique of test checking, While auditing the accounts of a large business it becomes impossible for the auditor to examine each and every transactions. Hence be researches the reliability and efficiency of the internal check system. Along with that, he selects a few important transactions for verification based on random sampling, and these transactions are then analysed in detail Example: If an expensive machine has been purchased for the business and the payment hes been made through an account payee cheque, then the transaction can be examined by the auditor on he basis of the cheque issued to the seller. Such a checking will be routine checking, For in-depth examinatio”‘Audit Process and Audit. all aspects of the transaction will have to be examined and. 7 2 eto be examine i sd documents and accounts will also have to be checked and the following related documents and 1. Whether the purchase of the machine has been authorised or not, for this the minutes of the board meeting should be checked, Thecopy of the purchase order issued forthe purchase ofthe machine should be examined. ‘The invoice received from the seller should be checked. ‘The machine purchased should be checked and inspected. ‘The installation expenses of the machine should be examined The payment made to the seller should be vouched The entries made in the Plant Register and the books of accounts should be examined. _ The examination conducted in the above manner is known as ‘in-depth examination’ or ‘audit in depth’. Such examination is applicable for a few number of transactions only. @ 4, Overall Check Acomprehensive examination of the accounts is known as overall check. Overall check includes all those procedures used by the auditor to detect the inaccuracies in the books of accounts which were not detected during routine checking NAaRoON For example, through routine checking it is not possible to find out whether all amounts due from debtors have been received or not. Its also not possible so ensure through routine checking whether all liabilities that had been provided for have been paid or not. Insuch a situation the auditor has to rely upon. overall check and may correspond with the debtors directly and ask them for confirmation of their balances. In the same manner from the rent receipts only it cannot be checked whether the rent for the complete property rented out has been received or not, and whether the rent so received has been duly adjusted or not. In order to check it completely, a complete test of all properties rented out should be prepared specifying whether the rent is receivable on a monthly, quarterly or yearly basis and also the rent that has been received from various tenants, A similar list should be prepared for all investments also as it will also show whether all dividends and interest have been received or not One examination technique very prevalent these days is establishing correlation within various accounting ratio. This technique is also included in overall check. For example: by comparing the Gross Profit Ratio of the current year with that of the previous year we can find out whether the stock has been valued properly, whether sales have gone up or not, whether the cost of raw material has gone up or come down, etc. WWW.PDFFILES.IN Questiens ® |. Short Answer Type Questions 1. Explain three features of a good audit programme. (CDLU2015) 2. Anaudit programme to be serviceable must be elastic. Explain.Ul INTERNAL CONTROL, INTERNAL CHECK AND INTERNAL AUDIT @ 1. Internal Control © 1.1 Meaning The system of control of all aspects ofthe business and its transactions is known as internal control. Normally, internal control implies controlling the internal work of the business in such a manner that profits are maximised and the possibility of manipulation, frauds, forgery etc. are minimised. The system controls each aspect of the business in a planned manner and through this system all activities of the business, whether economic or non-economic, are controlled. Apart from control relating to research, personnel and administration all other controls relating to the accounts are included in internal control Internal control does not mean only internal check and internal audit but the whole system of control, financial and otherwise established by the management in order to carry on the business of the company in an orderly manner, safeguard its assets and secure as per as possible the accuracy and reliability of its records, Hence, whatever be the kind of control, whether economic or related to the management of the concer itis included in internal control. The word internal control is used in the wider sense and includes all other controls such as internal audit, internal check etc. © 1.2 Defini The following are a few of the important definitions of internal control:- (1) According to Spicer and Pegler, “Internal conirol is best regarded as indicating the whole system of control, financial and otherwise, established by the management in the conduct of business, including internal check, internal audit and other forms of control.”” (2) According to Howard Stettler, “Internal check and internal audit comprise the principal ‘means by which business management maintains internal control over the extensive activities and operations for which it is responsible.” (3) As per W.W. Bigg, “Internal control is best regarded as indicating the whole system of controls, financial and otherwise, established by the management in the conduct of the business, including internal check, internal audit and other forms of control.” ns .Auditing Intemal Control can be divided into the following three parts with each part being equally important (1) Organisational Control (2) Accounting Control (3) Administrative Control. (i) Organisational Control: For any kind of organisational control it is necessary tp understand the organisational structure and the mutual relationships among the various divisions or departments. By doing so the auditor can define the scope of his work and can proceed with the actual audit. Hence, itis the duty of the auditor to understand the structure of the organisation very clearly. He should plan his work only after knowing who all are the officers in the organisation and what are their responsibilities. (ii) Accounting Control: This includes various kinds of controls such as Accounts Control, Standard Cost Control, Budget Control, etc. It is not necessary to describe each of these in detail here. (iii) Administrative Control: Administrative control is needed in order to maintain efficiency in the work done in the office. Examples of administrative controls are Cost Financial Control, Control Accounts, ete All such controls meant for maintaining the total accounts in relation to personal ledgers, using machines for examining cash receipts, for the accounting of wages, using of time recording clocks for the accounting of time, ete., are included in internal control. If the internal control system has been implemented success fully it makes the work of the auditor a ot easier and the need for routine checkingis also reduced. Through internal control adequate emphasis is laid on the assets of the business, the accounts of the business, management policies ete., and this increases the efficiency of the business. © 1,3 Object of Internal Control The following are the main objectives of internal control. (1) Providing for the safety of the assets of the business by comparing the actual assets with those being shown in the books of accounts from time to time, and ensuring that only persons duly authorised by the management have access to the assets. (2) Examining the accuracy of the accounts and ensuring that transactions are being recorded correctly. (3) Establishing responsibility centres and establishing the responsibility in relation to every activity. (4) Comparing the standards set by Internal Control with the actual activities and establishing and removing the deviations therein, (5) Ensuring compliance with the policies of the management and ensuring that transaction are ing entered into in accordance with the methods prescribed by the management, (6) Increasing the efficiency of work, by increasing the efficiency of material, labour, plant and capital and improving the running of the business,Internal Control, Internal Check... @ 1.4 Basic Principles of Internal Control In order to make internal control effective, the following two basic principles should be kept in mind: (1) Accounting of Assets: The work physically utilising any asset should be separated from the work of accounting for the same. (2) Division of Work: The division of work between employees should be such that work done by one is automatically checked by another, ie, the result of the work done by one should match the result of work done by another, Hence internal control is a system through which the functioning of a business organisation can be made more controlled, efficient and useful, @ 1.5 Forms of Internal Control ‘The system of internal control and its actual structure is decided by the management. Iti the job of the management cadre to decide how the workis to be divided and what is the amount of controlling each task requires. As far as the auditor is concerned he starts his work only after studying the internal control system thoroughly, and only then doeshe prepares his work schedule. The following are the various forms of internal control: (1) Cash Control: There are three main tasks relating to cash, namely: (i) receiving cash, (ii) paying cash, and (iii) maintaining cash balance. All three tasks are very important and itis necessary to have clear written instructions for employees dealing in cash. The correct and just division of responsibility among employees ensures that work proceeds smoothly and there are no alterations among the employees. Normally, cash is embezzled by two or more than two employees acting together, and this fact should be kept in mind while planning and dividing responsibility. (2) General Financial Control: General financial control includes the system of maintaining accounts, efficient control of employees (leading and supervision), cordial relationship with employees etc. A system of financial control is necessary for every organisation whether large or small. (3) Control regarding Trade Transactions: This includes transactions such a sales, purchases, etc. There should be clear and specific regulations for the purchase and sale of goods, only then can the pilferage of goods be eliminated. Purchase of goods, receipt of goods, protection of goods in hand and maintaining accounts of the same are all very important tasks, and even a litle laxity in them may result in misappropriation of goods. In the same manner as sales, there should also be a proper system for the sale of goods such as the right to sell goods, the custody of goods and for maintaining the accounts for the sale “There should also be proper systems for accounting for purchase and sales returns, (4) Control regarding Employees’ Remuneration: Even if there is a small lapse in the system of paying salaries and! wages to the employees of the organisation, cash can be misappropriated very easily. hence there should be a proper system consisting of clear regulations and efficient techniques in elation to this task. Special orders relating to increases in salaries or wages, deduction and recovery of advances should be clearly adhered to.‘Auditing (6) Control regarding Fixed Assets: The majority of the capital in the organisation i usualy invested in fixed assets. Such assets are usually very costly and hence there is greate possibilty of committing fraud in elation to such assets. There should be adequate contolen provision for depreciation et. the tight to receive fixed assets, proper system of accounting, provi aanisation depicts true and fair view ofthe state of affairs The fraud in relation to investments is usually commited 1ess should devise a special system so that the balance sheet of the or (6) Control regarding Investment: by high ranking officials and hence the owners of the ‘busin for controlling investments. Control regarding Stock: Stock includes raw material, work in progress and finished ” goods. In elation to stock the control system in each organisation is different. There should be ‘an appropriate system for controlling the receipt of goods, issue of goods and safety of the goods in stock. In every organisation physical stock taking should be carried out at a fixed interval. @ 1.6 Internal Control and Auditor Before relying completely upon the system of internal control the auditor should first check the level of efficiency. For doing this he should acquaint himself with the organisation chart of the organisation, the performance manwal, the plan of work allocation and the actual physical handling of work, Hence, the auditor should examine the internal control system in detail. During this examination, he should lay special ‘emphasis on the following aspects: (1) The auditor should study the production, business and administrative activities and should also study the nature of activities of receipt and despatch of goods and cash. (2) The auditor should study the methods of book keeping and accountancy. In this context, the system for receipt of goods, cash and other assets should be examined. Also special emphasis should also be given on the payment of cash so as to insure that cash is not paid without the receipt of any goods or services. In the same manner it should be ensured that no gods or services have been rendered to any person without receiving payment for the same. The internal control system should also be examined in relation to the entries being made in the books of accounts. The balance in the accounts of various persons and organisations should be tallied with those in total accounts, Through the selection of representative items in the accounts, the actual operation of the internal control system should be checked. Through the use of procedural tests, the nature and causes of inaccuracies should be found out so as to establish to what extent the accounts present a true and fair view of the state of affairs of the business. ‘A good and effective system can reduce the work-load of the auditor but it does not reduce his responsibility in any manner. To what extent the auditor depends upon the system of internal control, depends upon the circumstances of the organisation and the nature of transactions 8) (4) (5) ® 2. Internal Check @ 2.1 Meaning Internal check is a system in which all the transactions of the organisation and the related vided among he employees in such a manner that the work clone by one employee is accounting works diInternal Control, Internat Check examined independently by another employee. According to this system, the work is divided among the employees according to their capabilities and in such a manner that no single employee does any task or transaction from the start to the end. In this manner, the complete accounting work in respect of any transaction is not allotted to any single person from the start to finish. For example, in an educational institution the work of collecting fees from students in allotted in such a manner that one clerk collects fees from only from commerce students, a second clerk collects fees only from arts students. The fees collected bby these clerks is entered into the books of accounts by a different clerk and a different clerk goes to deposit the money into the bank. Ifany employee commits any error or fraud in his work itis immediately detected by the employee examining his work. In this manner, in a system of internal check each transaction is examined also side by side, and as a result unless two or three employees are not working in collusion, it becomes very difficult to commit frauds © 2.2 Definition Internal Check has been defined differently by different experts. The definitions given by a few prominent experts have been given below: (1) According to Spicer and Pegler, ‘A system of internal check is an arrangement of staff duties whereby no one person is allowed to carry through and record every aspect of a transaction, so that without collusion between two or more persons, fraud is prevented and at the same time the possibilities of errors are reduced to a minimum.” (2) In the words of LR. Dicksee, “Internal Check may be defined as such an arrangement of the accounting routine that errors and frauds are automatically prevented or discovered by the very operation of the book-keeping itself.” (3) According to De Paula, “An internal check means practically a Continuous Internal Audit, carried on by the staff itself, by means of which the work of each individual is independently checked by the other members of the staff.” Based upon the above definitions internal check can be appropriately defined as follows: Internal check system is a system of management according to which all the transactions and accounting work is divided in such a manner, that no single employee is able to record all aspects of any transaction and the work done by one employee is regularly checked by another employee so that it ‘becomes difficult to commit frauds and errors and even if they are committed, they can be detected easily. © 2.3 Features of Elements of Internal Check ‘On an analysis of the above mentioned definitions of internal check the following facts come to light (1) This technique is an integrate part of the complete system of internal control. (2) Thistechnique is related to the division of work among the people maintaining the accounts. (3) In this technique, no single employee records any transaction from the beginning to the end. (4) Inthis technique, the work done by every employee is examined independently by another employee. (5) In this technique, the work done by one employee is complementary to the workdone by another employee. (6) The aim of this technique is to develop an automatic system for detection of frauds and errors.(7) Inthis technique, the work of book-keeping and accountancy is mechanised to th possible extent. © 2.4 Objective of Internal Check The following are the main objectives of internal check: 1 Maximup, (1) To prevent frauds and errors: The main objective of internal check is to establish a system which makes fraud impossible or very dificult to commit and hence employees are dissuaded against commiting frauds. Inthe same manner the prevention of errors is also one of objectives since inthis technique there is provision for compulsory examination of work done by one employee by another. (2) Determination of responsibility: The determination of responsibilities of employees is also one of the objectives of internal check. In this. system work is divided in such a manner sp that in case of frauds and errors the related officers can be held responsible, (3) To prevent omissions in accounting: The aim of this ‘system is to bring about discipline in accounting so that no transaction is omitted from being recorded in the books of ‘accounts, (4) To increase the efficiency of employees: The aim of the intemal ‘check system isto divide the work into various parts and assigning it to those employees who are efficient in doing such work. In this manner, this system is also adopted in order to increase the efficiency of employees, (5) Quick preparation of final accounts: The aim of this technique to p repare an tment in such a way that the accounting work can be done in an efficient and error free manner, and at the end of the financial year the final ‘accounts can be prepared as quickly as possible (6) To case the audit work: The internal check system is also adopted in order to auclt work easier. In organisations where this system is implemented the auditor ca test checking in his examination, © 2.5 Features of An Efficient Internal Check System Every business has its own individual chara business, the technique of intemal check adopted is technique of internal check which can be adopted in every organisation frauds and erors the technique of intemal check should have the following quali, (1) Clear division and distribution of duties an among the employees of the organisation or unit should be such that thei responsibilities and authority are clearly defined so that there is no scope of ink among the employees, and in case of errors, the concemed em (2) Sudden change in duties: One employee should not cleristics. Due to the dissimilarities in the make the in resort to nature of n each organisation is different. There is no uniform However, in order to prevent 'd responsibilities: The division of work ir duties, lerference iployee can be held liable. be allowed to work on the same book of account for a very long period of ime. The work should be rotated among the employees, however, such rotation should be done keeping in mind the nature of the work and the ceumstance ofthe busines It is also deskable that the rotation of dle i done sudden and without prior information to the employees.(3) (4) (5) (6) 7) (8) (9) (10) qa) (12) (13) Accounting for a single transaction by various persons: No transaction should be recorded from the beginning to the end by the same person, and the work for completing the various parts of the job should be allotted to various different people. Automatic checking: No employee should be blindly trusted and the work of every employee should normally be checked by one or more persons. Such examination should be automatic and continuous. Personal supervision: The accounts relating to receipt and payment of cash, receipt and despatch of goods and the valuation of stocks should be personally supervised by senior and responsible officers. Cash control: Adequate control should be maintained at all time on the receipt and payment of cash, In order to do this — (i) the cash collected on a particular day should be dep day, ted into the bank on the same (ii) the employees managing cash should not have access to the books of accounts, (iii) the seller of goods and people making entries in the books of accounts should not be authorised to receive cash, and, (iv) as far as possible payments should be made through cheque. Goods Control: The system for ordering purchase of goods, receipts of goods, and despatch of goods to various departments should be tightly controlled. No employee should be allowed to take any goods outside the organisation without proper authorisation. Accounting Control: As far as possible the self balancing system should be adopted for ‘maintaining accountsand labour saving devices such as accounting machines, cash registers, time recording machines, etc. should be used to the maximum extent possible, Correspondence System: The mail received in the organisation should also be opened by a responsible officer All necessary letters, registries, money orders, ete. should be handed over to the concerned people only after they have been duly entered in the register. In case cheques, drafts ete. are received through mail they should be crossed before they are handed over to the cashier. Compulsory Leave: Sometimes employees do not take any leave or take very few leaves because they may have committed certain frauds or manipulations which they do notwant to be detected. Hence, every employee should be sent on leave at least once in a year and in his absence his work should be checked. Correspondence with Debtors and Creditors: There should be regular correspondence swith all debtors and creditors from time to time in order to find out whether their accounts in the books of the organisation are corrector not. The answers received from them should be examined by the top officials Fixed Rules: Certain special transactions such as bad debts, allowances, returns commission, uniting off assets, et, should be accounted for sully in accordance with predetermined rules. Filing System: There should be a proper system for filing all comespondence, documents and files. ALEGRE@ Internal Audit @ (A) Meaning of Internal Audit The periodic checking of the accounts of an institution or a company from time to time by its internal auditors is called Internal Audit. This implies that the accounts are examined by a person who is on the staff of the company or the institution. An internal auditor functions more like an accountant than an auditor, and many organisations have such auditors on their staff because they want that there should not be any errors or frauids in their books of accounts. An internal auditor gets a salary like any member of the staff and need not necessarily be a Chartered Accountant. The internal auditor examines only the ‘accounts of the employer and need not submit any report © Definitions of Internal Audit According to Meigs, “Internal auditing may be defined as the staff function of organised investigation and appraisal of accounting, financial and operating activities within a company for the purpose of aiding the top management in efficient administration of the enterprise.” ‘According to the Institute of Internal Auditors, “Internal audit is an independent appraisal activity within an organisation for the review of accounting, financial and other operations as a basis for service management. It is conducted by regular employees of a business concern.” The above definitions make it clear that intemal audit is the examination of books of accounts which is conducted by the salaried staff of a business known as internal auditors throughout the year. @ Objects of Internal Au ject of internal audit is to maintain the working capability of accountancy. Itis meantto The main obj .d reasonably and all actions are done ensure that the principles of accounting are followed adequately an as per the laws of accountancy. The main objectives of internal audit are: (i) To examine the work done by employees who are responsible to maintain the accounts, (ii) To immediately detect errors or frauds in the accounts. (ii) Toensure thatall actions are carried out as per the accepted principles, rules and procedures. (iv) To locate the shortcomings, if any, and take the necessary steps to set them right. at the enterprise functions smoothly and according to the stipulated plan. of the employees. {tin the organisational structure. The Internal Auditor (v) To ensure ths (vi) To keep an eye on the performance (vil) To make suggestions for improvement must ensure that (a) the internal {b} the defined management policies are being followed. ate protection for the assets and accounts of the organisation. ‘curred by the concerned staff on their activities is reasonable and fair, structure of the organisation is effective to the optimum. {o) there is adequi (d) the expenses in and the accounts maintained give a fair and true picture of the state of affairs. (e)auaiung evens @ Importance of Internal Audit Internal audit is of special importance to large organisations. It provides an independer: to evaluate the performance of the entemprise examination of the activities and accounts and enables one at any point of time. Internal audit is a means to solve the problems of management and aid the development efforts. It is also a means to pinpoint the shortcomings in the management of an enterprise and prevent any loss because ofthat. Besides this, it improves the accounting of the enterprise and is of much help in the final audit. In other words, internal audit is a management control that overses the functioning of an enterprise, and measures and ensures its progress. tat the assets of the enterprise are adequately Internal audit acts as a guard and ensures th same. It ensures that the expenses incurred by the safequarded and proper accounts are maintained for the concerned staffare reasonable and the accepted procedures are followed by the staff in the performance ot their duties and the accounts representa fair picture of the same. At the same time itis a surveillance of the ing aware that they will be answerable to the management, act with caution and are not staff who, be ternal careless to make mistakes or be imesponsible. In other words, internal audit is an integral part of control The Company Law Board, under Section 227(4A) of the Companies Act, has made an announcement which has made the Internal Audit all the more important. © Qualifications of Internal Auditor ‘The qualifications of an internal auditor, unlike those of an external auditor, have not been defined because internal audit is not covered by the provisions of prevalent legal system. The qualifications of internal auditor depend on the internal scenario of the enterprise and the decision of the management. tis not essential that an internal auditor should be a Chartered Accountant or a Cost Accountant. However ‘many organisations, specially large organisations, prefer to employ only a qualified Chartered Accountant ot a Cost Accountant as an Internal Auditor. © Requisites of an Efficient Internal Audit Department The Internal Audit Department can function efficiently only if it has the following requisites: (1) Adequate and Competent Staff: The Internal Audit Department must have adequate and competent staff to function effectively. The staff should not only be adequate in number, it ‘must also be qualified and conversant with the techniques and practices of internal audit. tis also desirable that there is arrangement for initial training of the staff. - (2) Sufficient Freedom: Itis of prime importance that an internal auditor has enough freedom toworkaecontingto a plan. He izan employee athe company, and hes to report to another senior employee. As such, he cannot function with the kind of freedom that an external iditor can. Nonetheless, i W i auditor can. Nonetheless, the internal auditor must have adequate freedom in the following areas: (a) Freedom to Plan: He must have full freedom to plan his work, and then to work according to his plan. He must be free to select the techniques that he will employ i checking and confirming the various accounts that come under his purview: May be he needs to obtain the general approval for his plan of action from the management, but such approval should be forthcoming and not be an obstacle. ia(b) Freedom to Report: If the internal auditor is required to make his report to a junior employee of the company, then all employees senior to the one he is reporting to will have access to his report and may try to intervene and curtail his freedom of action. \deally the Internal Auditor should be required to submit his report to the Board of Directors so thatthe top management becomes aware ofthe sate of affairs and he is not subjected to any pressure by the junior staff (©) Freedom regarding Division of Duty: The staff of the Internal Audit Department must function only under the direct control of the Internal Auditor who must have the freedom to assign such duties as he may think appropriate to the staff members. ‘taining these freedoms depends on the integrity and competence of the Internal Auditor. A competent and resourceful auditor will normally have no problem in having these freedoms @ Procedure of Internal Audit The scope of internal audit in any organisation is very wide, and to handle the task in an efficient manner, the Internal Audit Department. needs to plan a procedure which should include the following: (i) Whatever has to be investigated must be clearly defined. (i) After this, the policy, technique and the procedure of control needs to be formulated (iii) The next step would be to select some transactions of the subject being examined. Care should be taken that the transactions selected are representative of the whole. (iv) The transactions selected should be thoroughly examined from the beginningto the end. The examination should include the examination of documents and vouchers, confirmation from the employees ofthe organisation and third partes, and also the nature ofthe relationships between the parties. {y) The rors examined should be classified into major errors and other errors. The major errors should be examined in detail and their causes, effects and the people responsible for them should be traced. (ui) In the end a teport ofthe examination should be submitted to the management. The report Should not be too long since busy managers do nat have enough time toread lengthy reports, but this does not mean thatthe reports should be so short that they become meaningless. ‘The report should be writen in such a manner that provides the management complete information on the deficiencies of the system so that the same can be removed by the latter. © Advantages of Internal Audit The advantages of internal audit are: (i) Internal audit defines the policies and procedures of an enterprise and ensures that the same are adhered to in the day-to-day functioning of the enterprise. It draws the management's sttention to the discrepancies, if any, in the defined policies and procedures. (ii) It helps in planning the business activities, defining the procedures so that they are profit-oriented, preparing statements with respect to tax payments and helping in the overall control of the business.(iii) Because of there being a continuous checking, the prospect of any error or fraud in the books of accounts is substantially reduced (iv) Internal audit helps in the erosion of capital because the Internal Audit Department keeps a constant watch on the factors that lead to capital erosion. (v)_ Intemal audit makes the internal control of an organisation easier and more effective. (vi) It provides the necessary and useful data to standardise the functions of the organisations employees by underlining such functions and making suggestions from time to time so that the performance of employees is improved. Disadvantages of Internal Audit ‘The disadvantages of internal audit are: (i) Ifthe employees doing the internal audit are unhappy or not satisfied with the organisation's management, or if the work-environment is not good, their services shall not be helpful. (ii) Internal Audit Departments can only be established in big organisations because of the cost factor. Small enterprises cannot afford to have such departments. (iii) It has been observed that internal auditors might connive with the management to the detriment of the financial position of the organisation. (iv) There is specified qualification laid down by law for an internal auditor. As such, the possibility exists that those appointed as internal auditors may not be qualified for the job. (v)_ Internal audit is not as detailed and comprehensive as statutory or external audit. The auditors are the employees of the organisation and, as such, function according to the wishes of the management.™ 1. Meaning ‘Asa rule, whenever any goods are bought, the seller of goods issues a receipt to the buyer which 2s a description of the goods purchased, the price paid and other relevant details. In auditing, such ipt is called a voucher. An individual buyer may not attach any importance to such receipt and may even throw it in a dust bin, but a voucher is an important document for a business organisation and is carefully filed. All transactions in the books of account are based on such receipts which vouch for the authenticity of the transactions. As such, there should be no entry in the books of accounts without its voucher, and there should be no voucher without its entry. This is meant to examine the results of 2 transactions recorded in the books of accounts. © 1.1 Definitions Some leading authorities have defined vouching as under: (i) According to J.R. Batliboi, “Vouching means testing the truth of the items appearing in the books of original entry. (i), Arthur W. Holmes defines vouching as “the examination of the underlying evidence which is in support of the accuracy of a transaction. The process of vouching is intended to substantiate an entry by proving authority, ownership, existence and accuracy.” (iii) According to Lawrence R. Dicksee, “Vouching refers to the examination of entries made in the account books, with the documents, on the basis of which the accounts have been voritten. (iv) In the words of Ronald A. Irish, “Vouching is a technical term which refers to the inspection of documentary evidence supporting and substantiating a transaction.”” (v) Joseph Lancaster has this to say about vouching: “Itis often thought that vouching consists of the mere examination of the vouchers or documentary evidence with the book entries. This, however, is quite wrong, for vouching comprises such examination of the ledger entries as will satisfy the auditor that not only the entry is supported by documentary evidence, but it has been properly made in the books of accounts.” On the basis of the above, vouching may be defined as an examination of the entries made in the « of accounts on the basis of vouchers and check the authenticity of the vouchers. The purpose of examination is to ensure that entries made in the books of accounts are correct, reasonable and such authorised.‘The various definitions of vouching highlight to following characteristics: (i) Scrutinizing of Entries with Vouchers: In vouching, the entries made in the books of accounts ate scrutinized on the basis of relevant vouchers. Vouchers help in verifying the authenticity of the entries made in the relevant accounts of the business. (i) Documentary Evidence is the Basis of Vouching: The main basis of vouching is documentary evidence. An auditor needs to examine the relevant vouchers to certify the authenticity of the entries made in the books of accounts. The vouchers must be originals (not copies) and related or pertinent to the entries, and must be authentic. (ii) Examination of Entries by Going behind the Transaction: The purpose of vouchingis to ensure that: (a) the transaction is related to the business of the enterprise, (b) the transaction is duly and correctly recorded in the relevant books of account, (c) the transaction amount is correct and accurate, (d) the transaction has been made by a duly authorised employee of the concern. In other words, the auditor or the examiner does not confine himself to the entries in the books of accounts; he goes beyond to the source of the transaction to establish the authenticity of the vouchers. (iv) Routine Checking is a Part of Vouching: Routine checking is a part of vouching. In fact, vouching starts with routine checking, and one complements the other. (v) Vouching is the Backbone of Auditing: Vouching is the backbone of auditing, and helps in uncovering serious malpractices or frauds. An auditor needs to be extra careful while he does vouching for a concern. @ 1.2 Difference between Vouching and Routine Checking {As discussed in the previous chapter, routine checking involves examining the primary books of accounts and adding up the figures, carrying forward the figures so added and posting the same to arrive at the balances in the accounts. The auditor uses distinct ticks in routine checking and tries to establish genuineness of records, ie. the costs are correct, the postings are correctly made and that there are no alternations after such postings. Vouching, on the other hand, helps in verifying the authenticity and accuracy in the primary books of accounts. Routine checking merely clarifies the arithmetical accuracy of the accounts; it does not shed any light on the correct presentation of accounts or on the accounts being authentic and there being no malpractices in the accounts. In such situation, the auditor needs to take recourse to vouching, which uncovers the hidden faults in accounting. As a result, the auditor is in a position to pinpoint the deficiencies or malpractices in the system. Besides this, it becomes clear whether the relevant transactions in the accounting year have all been recorded, or any have been left out — and if so, why. Routine checking is a part of vouching. Vouching includes routine checking —just as it includes checking of casting, postings, carry forwards, balancing and other calculations in the books of original entry. ® 1.3 Objects of Vouching Following are the main objects of vouching: (i) To ascertain that all transactions connected with the business have been recorded in the books of accounts, and that nothing has been left unrecorded.clse. The situation of vouching in the auditing process is also the same. If the vouching is weak, i.e. if vouching has not been done properly, then the correctness, accuracy and truthfulness of the audit cannot berelied upon. Such an auditis pointless and will not succeed. Auditing without vouching is like a building without a foundation which can fall to the ground any moment. Henee, it is not an exaggeration to consider vouching the ‘essence’ of auditing, . @ 2. Voucher @ 2.1 Meaning Voucher is the documentary evidence that authenticates the transaction entered in the books of accounts. Whenever somebody buys anything from the market, the seller gives him a receipt or cash memo, which is a proof of the transaction that is made, and on the basis of which both the buyer and the seller make an entry in their books of accounts. Thus, the documents that are used to record a transaction in the account books are called vouchers. A voucher is the documentary evidence of a transaction. It can be a receipt, an invoice, a bill or any other documentary evidence @ 2.2 Definition Scholars have defined a voucher as follows: (i) According to Arthur W. Holmes, transaction.”” (ii) Lancaster defines a voucher “as a documentary evidence by which the accuracy of the entries may be substantiated.” According to Ronald A. Irish, “A voucher may be a receipt, an invoice, an agreement, a materiel requisition slip or, in short, any suitable written evidence which confirms a written voucher is any documentary evidence in support of a (i transaction."” (iv) In the words of J.R. Batliboi, “A voucher may be defined as a documentary evidence of an entry appearing in the books of accounts.” ‘The above definitions highlight the following characteristics of a voucher. (a) A voucher is a written document (b) Any entry in the books of accounts is made on the basis of a voucher. {c). Vouchers are presented as evidence of the accounts. (d) Vouchers describe the details of a transaction. {e) Vouchers help in certifying the authencity and correctness of accounts. © 2.3 Kinds of Vouchers Vouchers may be of the following kinds. (1) Primary Vouchers: A written evidence in original of any transaction is called a primary voucher, e.g. an invoice is the written evidence of a purchase and a receipt is the evidence of having made a payment. (2) Subsidiary Voucher: Incase the primary voucher is notavailable, copies thereof or related documents ate produced in support, or subsidiary evidence is made available to establish the authenticity of the transaction to the satisfaction of the auditor. Such evidence is called asubsidiary voucher. Purchase order, bill of lading, packing notes, etc. are the examples. subsidiary vouchers which are the outcome of the primary voucher. At times, the auditor may require to examine the subsidiary or collateral evidence even when the primary voucher is available. For example, the auditor may want to satisfy himself that, in case of. ‘$00ds purchased on credit, no discount was allowed when the payment for the goods was made. In such a cace the auditor would require to examine the purchase order, the related correspondence (if any), the Primary voucher and other related documents. @ 2.4 Examination of Vouchers Voucher is the basis of vouching, and the auditor does his scrutiny of the books of accounts by examining the related vouchers. But the vouchers can also be falsified or fabricated, or they may be produced more than once to support a default in the account books. The vouchers may also not be related to the business, and may be personal vouchers of any member of the staff or other officer of the company The auditor needs to examine not only that there is an entry in the account books with respect to a voucher, he also needs to ascertain that the entry made in the account books is correct and relevant to the business of the enterprise. In case the voucher is unrelated to the business or is incorrect, the entry in the ‘books of accounts will become invalid. For this reason the auditor needs to be very careful in his examination of vouchers. The auditor needs to keep in mind that: (i) The voucher is issued to the organisation or its owner. (ii) Itis related to the business of the organisation or enterprise. (iii) If the voucher is in the name of any officer, partner or employee of the enterprise, the transaction for which the voucher has been made is related to the business of the enterprise. (iv) The voucher is made on a printed form. (v) The voucher is dated, and the date is related to the transaction recorded in the books of accounts (vi) The voucher is consecutively numbered and is filed serially and in order of entries in the account books, (vii) The amount in the voucher both in figures anc words. (vili) The voucher is signed by the person who has received the payment and is duly stamped. (ix) The voucher bears a revenue stamp if the amount involved is more than & 500. (x). The voucher is signed by a person who is authorised to do so (xi) Ifa voucher requires some special scrutiny, the auditor should proceed cautiously and use special ticks for its checking, (xii) ‘The amount and description in the voucher must tally with the same in the books of accounts where the transaction is recorded. (xii) The vouchers which have been inspected by the auditor should be cancelled by a stamp so that they are not produced again. The auditor should not take any help from any member of the staff of the client while youching the entries by checking vouchers (xv) Sofaras possible ell vouchers eating toa particular account shouldbe checked inone siting ras a continuous process. (xiv)(xvi) nee saa te about the authenticity of a voucher, the auditor should get in touch tganisation and clarify all doubts. (xvii) The auditor should prepare a list of all missing vouchers and receipts, satisfy himself with tegard to the reasons for their being missing and demand their duplicate copies. (xviii) Test checking should be resorted to only when the auditor is satisfied that the internal check system is in operation. (xix) While auditing the accounts, if the auditor feels that there is need for any additional information about any vouchers, he should note it down in the ‘audit book’ and get the required information later. (xx) In case there is any specific provision in the partnership deed or the memorandum of association with respect to vouching, the auditor should abide by such provision. @ 2.5 Vouching of Cash Book Cash book is the most important financial book for a business concern, and as such, vouching of the cash book assumes added importance. Most errors and frauds are the result of misappropriation of cash which is done by manipulating the receipts and payments. The auditor, therefore, must be extra careful in checking the items of cash and ensure that no receipt or payment of cash is unrecorded in the cash book and that no fictitious payment has been entered in it. In general, the audit of cash book is done with the following ends in view. {i) Toascertain whether or notall receipts and payments have been recorded in the cash book. (ii) To ensure that no irrelevant or fraudulent payment has been made. (ii) To ascertain whether or not the receipts and payments have been correctly recorded (iv). To verify whether or not the cash in hand and cash at bank are correct, ‘There are two columns in a cash book: (a) Cash Receipts and (b) Cash Payments © (a) Vouching of Receipt Side of Cash Book Vouching of the Receipts side of a cash book is more complicated as compared to the vouching of the payments side because the evidence of receiptsisnot direct ince the payment ofsuch receipts is mace by other parties and the entries in the cash book are made internally. Spicer and Pegler have explained thisin the following words: “From the auditor's point of view the operation of vouching of receipts is more dificult than vouching of payments since only indirect evidence can, as a rule, be obtained.” The auditor, therefore needs to be extra careful in checking receipts in a Cash Book. He must keep in mind the following: (1) Internal Checking: The auditor needs to satisfy himself that the internal check system in and reasonably reliable. He needs to understand the rules and regulations making records thereof and dealing with banks, etc. This becomes necessary to ensure that there is no misappropriation of funds, which can only be done by a thorough examination, He may, for example, check a few items at random and if he finds them to be in order and free from irregularities, he has reason to assume the remaining ones will be correct. (2) List of Receipts: The auditor need: amount of cash thereof is recorded in operation is good in vogue for issuing receipts, Is to examine that all receipts received in a day and the a List of Receipts, and that the same are recorded in theDiary or the Rough Cash Book, and later in the Cash Book. He must check the two from time to time. (3) Reconciliation of Cash Books: At the start of the audit, the auditor should examine the Rough Cash Book or the Diary and compare it with the Cash Book, because there is always the possibility that some items recorded in the Rough Cash Book might not have been recorded in the Cash Book. (4) Receipt Issue System: Another point to be noted by the auditor is that there is a Receipy Issue System, and a proper control over the use of Receipt Book. He should keep in mind the following points: (i) That all receipts are on printed forms. (ii) That there is a counterfoil or carbon copy of each receipt,. (ii) That all receipts and Receipt Books are separately and consecutively numbered, (iv) That the particulars in the receipt, i.e, the date, amount, name, etc., are the same as recorded in the Cash Book. (v) Blank Receipt Books must be in the custody of an authorised and responsible member of the staff. (vi) The receipt must be signed by the authorised member(s) of the staff. (vii) There should be no other signature on the receipt except that of the authorised signatory (vill) If there isa system under which a receipt accompanies the receipt of cash, such a receipt (usually known as a delivery note) should be properly signed before its return to the customer, (ix) There should be a strict observance of the system of keeping the counterfoil or carbon copy of each receipt. (%) Incase a receipt is written wrongly or has to be cancelled for any reason, it should not be taken out of the Receipt Book, and the word ‘Cancelled’ should be written on the receipt (5) Bank Deposit System: In case the receipts are deposited in the bank, then the total of the receipts deposited should be reconciled with the bank's pay-in-slips. It also needs to be checked that the counterfoils of the bank's pay-in-slips are duly signed and stamped by the bank's officer. (6) Al by the Rules: In case there are any other rules in vogue for granting receipts making records thereof or dealing with the bank, these should strictly be adhered to. Important Items of Receipts Side (Debit Side) (1) Cash Sales: The system of internal check of cash sales is of utmost importance in a business. The effectiveness of the internal check system in operation, therefore, needs to be ensured The auditor should check the carbon duplicates of the cash memos with the summaries of cash sales. He should compare the Sales Abstract with the Cash Analysis and then check uP the cash Book. In case the auditor detects any discrepancy, he should immediately inform the client.(2) (3) (4) So ouUnE Canecneig ati The possibilities of fraud or misappropriation are more in cash sales. The auditor, therefore, must be extra careful in vouching cash sales. As Laneaster has very aptly put it,. “Vouching of sales is more difficult than that of purchases” Vouchers: Carbon duplicates of cash memos, salesmen's abstracts, cashier's summaries. Cash Received from Debtors: In the first place, itis necessary to ensure that the staff who receives cash from the debtors is not involved in making the statements of such receipts. Whatever amount is received from the debtors is acknowledged by a receipt which is issued. The cash received from debtors can be vouched by referring to the counterfolls of the receipts issued to them. The auditor should pay special attention to the discount allowed to customers and the bad debts that are written off. He should acquaint himself with the method and rate of granting discount. The discount rates should not exceed the percentage that has been predefined. The auditor should enquire who has the authority to write off bad debts and if these are written off by the authorised person. Thisis important because cash received can be misappropriated by writing off the whole or a part of the debit balance as a bad debt. Vouchers: Receipt counterfoils, details of the account, correspondence and authorisation certificates of concerned officials. Amount Received from Bills Receivable: The auditor needs to check the cash receipts of the bills receivable for which the relevant amounts have been received and Bills Receivable Book with the Cash Book and the Pass Book. He should also scrutinise the rebate that has given on bill received prior to the due date, and make sure that rebate given on such bill conforms to the accepted norms of the business. The amount deducted as discount or rebate on these bills should be debited in the Discount Account, The auditor needs to pay special attention to the bills that have matured but the amount of the bills has not been received, and should get a certificate from the authorised person that the payment has not been received. He should investigate further to make sure that the dishonoured or retired bills have not been paid and that there is no discrepancy or misappropriation. Vouchers: Bill Receivable Book, Cash Book, Pass Book. Income from Interest and Dividend: Interest and dividend are receivable from different sources and, as such, their vouchers are also different, Interest is normally received from: (i) Investments, (i) Loans and (ii) Deposits in Banks, The rate of interest on investments and security is a fixed rate and should be checked with the help of the counterfoils of interest terest received on a loan given to a borrower, the relevant coupons. In the case of int agreement between the borrower and the business should be checked to determine the rate of interest, At the same time it should be checked whether or not the interest received has been recorded in the account books on the relevant dates. Ifthe interest is received on fixed depositsin the bank, such income should be vouched with the Bank Pass Book or the Interest Statement that can be obtained from the bank. In case of receipt of dividends, three vouchers, namely: counterfoils, share certificates, dividend warrants and letters received along with the cheques need to be examined. If such ‘collected through the bank, the Pass Book needs to be referred to. The auditor income isshould make sure that the income so received or accrued has been accounted for in the books of accounts and the Balance Sheet. Vouchers: Pass book, agreements, schedule, counterfoils, dividend warrants. (8) Rent Received: To vouch the rent received, it is necessary to examine the relevant lease deeds or tent agreements, and ascertain the amount of rent payable and the provision regarding repairs. The auditor should check the counterfoils of the rent receipts issued to the tenants. If any agents are appointed to collect rent, the accounts or statements submitted by them should be checked. The auditor needs to be particularly careful to check the outstanding rent because the rent might have been received but shown as. outstanding and the rent amount may have been received but shown as outstanding and the rent amount may have been misappropriated. In case there is any Rent Register or Rent Roll, the auditor should make use of it. If there are any deductions in the rent received — for example, for repairs of house or property tax, etc., — the auditor should check to ascertain that these are genuine and reasonable Vouchers: Lease deeds and agreements, rent rolls, accounts received from agents, counterfoils, correspondence. (6) Commission Received: Asa general rule, there is an agreement between the business and the parties from whom the commission is receivable. The rate of the commission payable can ‘be found from such agreement, and the amount of commission paid can be ascertained from the Statement of Commission. The entries made in the Cash Book can be vouched from the counterfoils of receipts. If the commission has been received in respect of goods received on consignment, the amount of commission should be vouched by comparing it with the copy of the account sale sent to the consignor. In case it is necessary, the auditor can make the required calculations himself Vouchers: Commission agreement, statement of commi: correspondence. n, receipt counterfoils, (7) Subscription Received: The receipt that is given when a subscription is received should be confirmed by checking the relevant counterfoil. The amounts of subscriptions received can be vouched with the help of the subscriptions Register and receipt counterfoils. The auditor should also check the subscriptions received in advance and the outstanding subscriptions at the end of the accounting year. Vouchers: Register of subscriptions, counterfoils, correspondence. (8) Proceeds of Hire Purchase : The auditor needs to examine the Hire Purchase Agreement to ascertain the duration of the agreement, the amount of instalments payable by the close of the accounting period. It should be kept in mind that the instalment is not credited to Sales Account — it has to be properly apportioned between sales and interest. Vouchers: Hire purchase agreement, receipt counterfoils, correspondence (9) Proceeds from Sale of Investments: Investments are normally sold through brokers. The brokers send a sold note that contains the details of the amounts received from the sale and the commission chargeable by the broker. Vouching the sale proceeds of investments is done by the sold note of the brokers. Its therefore important to check the brokers’ sold note. Incase10) 11) 12) 13) 14) 15) Routine Checking and Vouching there is any agreement or correspondence related to the sae of investments, it should be also be examined. ifthe investments have been sold cum-dividend, it should be ascertained that the dividend has been received and apportioned between capital and revenue. In case the sale of investments is ex-dividend, the relevant entry must be checked by the auditor. Vouchers: Broker's sold note, receipt counterfoils, correspondence. Receipts from Sale of Other Assets: Whenever the fixed assets of a business are sold, they are sold through: (i) a sales representative or a broker and (ii) an auction of the assets. In case the sale is through the medium ofa sales representative or a broker, itcan be vouched by examining the note of the broker or the sales representative. Ifthe sale of assets is by auction, the auctioneer’s note needs to be examined to vouch the transaction. Besides this, if a Sale Deed or a Contract of Sale is the medium, such deed or contract should be examined by the auditor. Thus the auditor can scrutinise the sale proceeds of assets by the broker's or auctioneer’s note, or the sale deed or sale contract. Vouchers: Broker's or auctioneer’s note, sale deed or contract, correspondence. Claims Received Under Insurance Policy: In case of any claims received under an insurance policy, the vouching is done by examining the insurance policy, the claim letter, the ‘accounts rendered by the valuer and insurer, and the correspondence between the client and the insurer. Vouchers: Report of the valuer and insurer, correspondence, Bank Pass Book. Refund of Income Tax: While vouching the refund of income tax, the auditor should ensure that the amount so received is duly entered in the account books of the business. Besides this, the claim for such refund, related correspondence and the statement of the tax authority should also be examined. Vouchers: Claim for tax refund, related correspondence, ete. Bad Debts Recovered: Under the provisions of the Insolvency Act, when a person or a business is declared to be insolvent, the court appoints a liquidator who takes over the assets of the insolvent, and pays the creditors of insolvent proportionately to their credit from the money realised from the sale of the assets taken over. The amount so received by a creditor is called Bad Debt Dividend. Vouching for the recovery of bad debts is done by examining the dividend letters, receipts and related correspondence. Vouchers: Dividend letters, receipts, correspondence. Receipts from Sale of Shares: In order to vouch such receipts the auditor should use the register of members, or the allotment register and the share register. In this context, he should also refer to the ‘Minute Books’ of the meetings of Board of Directors. Remittance from agents: Every agent makes out a detail of his account and sends it to the organisation. Normally, the detail is forwarded to an employee, in every organisation, who examines these details minutely and thereafter makes entries in the Cash Book based on these details While examining amounts received from agents, the auditor should consider the detail received from the agent as the voucher, and tally it with the entries in the Cash Book. Vouchers: Correspondence with agents, details received from agents,atts (16) Other Receipts: The documents related to such receipts should be eae Ls cease such documents are not available, the auditor should correspond with the concerned parties to vouch such receipts. ®@ (b) Vouching of Payment (Credit) Side of Cash Book . \ While examining the authenticity and correctness of any payment _made, i et to have evidence of the payment having been made. A receipt by the person who has received tl e payment te evidence of the payment having been made. Like there are possibilities of the receipt of an amount not being entered in the Cash Book, of a lesser amount than what has been received being entered, the possibilities exist that the payment made to a third party may not be correctly recorded, or the amount recorded may be more or less than what has actually been paid. Normally, it is accepted that examining a receipt is enough evidence that the payment has been made. This is not always correct. In vouching payments, the auditor should not merely seek proof that the money has been paid away; he also has to examine that the amount paid is reasonable, is paid to an authorised person and is duly and correctly recorded in the Cash Book. Besides this, he should make sure that the accepted norms have been adhered to. The auditor should pay special attention to the following while vouching payments. (1) Authenticity of Payment: The auditor should check the receipts of the payments made, and also ensure that the payments have actually been made. (2) Payment to Proper Person: The auditor must also check that the payment has been made to the right person or organisation, and that such person or body had the right to receive the payment. The payment can be made to a wrong person, especially when such payment is being made to workers. Each receipt of payment must have the receiver's signature. (3) Payment being Duly Authorised: Each payment must be duly sanctioned by an authorised person. In large businesses, such authority is vested in different people for different limits of payment. The auditor must ensure that payment made is within the authority limit of the person who has authorised to make the payment (4) Amount Paid being Correct: The auditor has also to check that the amount paid is correct. He must tally the amount in words and in figures, and counter check the same with the Cash Book, (5) Proper Voucher: Each payment must be supported by a proper voucher, like a receipt ora cash memo. (6) Revenue Stamp on Voucher: The auditor should bear in mind that any receipt for & 500 ‘or more must havea revenue stamp on it to be valid. There are some exceptions to this, which are as under: (a) Receipts that are issued by a government body. (b) Receipts which are issued for a payment without consideration (c) Receipts which are issued by a co-operative society, (7) Payment being Related to Business: Only such payments can be recorded in the account books that are related to the business of the enterprise. Any personal payments made by the Proprietor, the management or any employees not permissible to ‘be recorded in the account books of the enterprise.iO tang ERIFICATION OF ASSETS AND LIABILITIES 1. Meaning of Verification Vetication is a technique of auditing in which the auditor certs the assets and liabilities as jsoun inthe Balance Sheet by actual checking or any other technique ‘Assets’ means that, on the date of the Balance Sheet, such assets were present in the organisation, he ownership ofthese assets was with the organisation, they have been valued propery they are fee of any change on them, ete. The owner or owners of an organisation need to know wheth. books is correct or not, and also whether the assets and liabilities (as described in the Balance Sheet) are Present inthe organisation or not. Therefore, an auditor's job does not get over with vouching because fom the vouchers the auditor can only determine that the aforesaid assets should be with the organisation but he cannot determine whether such assets are present in the organisation on the date of the Balance Sheet, or that the organisation has a right on them. It is Possible that an asset is actually Purchased, the relevant voucher for purchase is available but it can also happen that such asset has been fol! before the Balance Sheet date, or has been stolen or has been deposited as a security and an rappropriate investment is made for the same. Therefore, on the basis ofa voucher, an auditor cannot determine that on the date of the Balance Sheet an asset is actually present in the organisation. This information can be obtained by verification. (¢ 1.1. Definitions 1er the profit or loss as shown by the Various experts have defined verification in the following ways: (1) According to Spicer and Pegler, “The verification of assets implies an enquiry into the value, ownership and title, existence and possession, the presence ofany change on the assets,” (2) According to Joseph Lancaster, “The verification of asseis is a process by which the auditor substantiates the accuracy ofthe right-hand.-side of the balance sheet and must be considered 4s having three distinct objects: (a) the verification of the existence of assets, (b) the valuation Of assets, and (c) the authority for their acquisitions.” (3) According to J.R. Batliboi, “The duty of an auditor in verifying the assets is two-fold. He must satisfy himself that they really existed at the date of the balance sheet and were free from any change and that they have been properly valued. In verifying the liabilities he has tosee that all liabilities have been inserted at their proper figures and that no liability has been omitted.” On the basis of the above definitions the following conclusions can be drawn in relation to verification (i) The assets were actually present in the organisation on the date of the Balance Sheet. (ii) The right and ownership of the assets was with the organisation. (iii) Theassets were acquited after due authorization for the purpose of carrying on the business, (iv) No charge exists on the assets and, if any charge does exist, the same is mentioned in the Balance Sheet and that other than this no charge exists on the date of the Balance Sheet (v) The assets have been correctly valued keeping into mind their physical conditions . (vi) The values of the assets mentioned in the Balance Sheet are correct. (vii) All liabilities are shown at their amounts and all liabilities have been included, © 1.2 Objects of Verification The main objectives of verification are as follows:- (1) Checking of Arithmetical Accuracy: Verification aims at determining the arithmetic accuracy of the accounts relating to assets and liabilities. (2) To Ascertain the Existence: One of the main objectives of verification is to ascertain that, at the date of the Balance Sheet, an asset is actually present in the organisation or not because itis possible that on the date of the Balance Sheet such assets may not be actually present (3) Ownership and Title: The objective of verification is to determine that the assets as shown in the Balance Sheet belong to the organisation and the organisation has the absolute right use them. (4) Knowledge of Fraud and Irregularity: Verification is also essential to determine that no fraud or irregularity has occurred in relation to the assets and liabilities of the organisation (5) Proper Valuation: Verification is also necessary to determine whether the assets and liabilities have been correctly valued as per the principles of book keeping and accounting ot not and the valuation technique is the same as the previous year. (6) True and Fair view of Balance Sheet: The objective of valuation is to certify that the Balance Sheet gives a true and fair view of the financial position, The auditor has to clearly state in his report that the Balance Sheet gives a true and fair view of the financial position of the business and this he can determine only with the help of verification. (7) Real Position of Assets and Liabilities: Verification is also used to find out whether the assets are true of any charge or mortgage or not and all assets and liabilities have been disclosed in the Balance Sheet and no assets or liabilities have been concealed. In this way the assets and liabilities not belonging to the organisation are not included in the Balance Sheet 1.3 Importance and Advantages of Verification Normally, itis believed that vouching is the basis for auditing, but by vouching only the fact that an ‘set can be purchased is established. On the other hand verification includes the existence of the asset ad the right of ownership of the organisation is established. Apart from this, the authority and sponsibility for various assets is also verified. By vouching it cannot be established that at the date of the 40jance Sheet the assets were present in the business or organisation because itis possible that an asset is phased and proof forthe same is available but at the date of the Balance Sheet it has either been sold pestroyed, orisgivenasa security orulized foran legal investment. Therefore, verification of assetsis sential to establish that all the assets were existing with the organisation on the date of the Balance et, they were not subject to any charge and were properly valued. Verification cannot be considered to less important than vouching. Lancaster explains the importance of verification, “an appropriate uucher for an asset is not an absolute evidence of its existence.” Therefore, it is clear that the above ues cannot be clarified with a voucher. This inadequacy of vouching cannot be overcome with the help verification. In the same manner, liabilities should be verified to determine that the liabilities as stated the Balance Sheet are correct, legitimate, belong to the organisation and have been valued correctly. this can be found outonly by verification. Therefore, verification isan important technique of auditing, The other benefits available from verification are as follows: (1) The truth and. faimess of assets and liabilities can be verified (2) Any fraud and embezzlement of assets can be found out. (3) In case the assets have been over-valued in the past, the same can be found out by verification. (4) The correct value of work-in-progress and closing stock can be determined. (5) Assurance for receipt of payment can be obtained by the creditors. proper verification of the business of the organisation encourages the investors to invest money it 1.4 Difference between Vouching and Verification Alter understanding the meaning and objective of verification the difference between vouching verification should also be understood. Verification, like vouching, is also a technique of auditing but main points _of differences between the two are as follows: .No.| Basis of Vouching Verification Difference Nature Vouching involves checking the entries | Verification is concerned with the assets entered in the principal books of accounts. | and liabilities as stated in the Balance ‘The objective of vouching is to establish | Sheet. The objective of verification is to the truth, relevancy, authorization and | vouch for the existence, ownership, Policies applied for the various entties in | valuation and accuracy of the assets and the books. liabilities. Scope The valuation of assets and liabilities is | Valuation of assets and liabilities is a vital outside the scope of vouching. part of verification. Basis ‘The entries in the books of accounts are | Various items as stated in the Balance verified on the basis of the voucher. Sheet are verified either by physical verification or by looking at the relating documents,With the help of vouching, the aucitor can determine that the aforesaid assets should belong to the organisation but he cannot determine whether on the date of the Balance Sheet such assets were actually present in the organisation and the ‘organisation had a right on them. With the help of verification, information regarding any sale, distruction oF ileal investment of assets till the date of the Balance Sheet can be determined. Vouching can be done any time after the transactions are recorded in the books of accounts Verification can be done only after allthe accounts have been prepared, \Vouching is a part of verification Verification is not a part of vouching Vouchingis primarily done by audit clerks. Verification is done by the auditor himself or his senior partner ference between Verification and Valuation Verification Valuation Verification means clarifying the existence, valuation, existing obligations ‘and accuracy of the items stated in the Balance Sheet Valuation involves a critical examination of the pre-determined values of the assets by the auditor on the basis of accounting principles and conventions. The assets are verified by the auditor himself. The auditor can obtain the help of an expert for the valuation of assets, Verification is done by the auditor himself or his senior partner. Valuation is done by the management of an organisation but the accuracy ofthis valuation is done by the auditor. The auditor is responsible for the verification of assets. The auditor cannot give a guarantee for the vahtation of assets as determined by the expert 4. | Utility 5. | Time 6._| Status Performance e115 IS.No.| Basis of Difference 1. | Meaning 2. | Advice | By Whom 4. | Guarantee or Responsibility 5. | Evidence Adequate physical and documentary evidence is available for verification. Very litle actual proof is available for valuation therefore the auditorhastorely toa very large extent on the estimates of the management. @ 1.6 Difference between Vouching, Valuation and Verification The main points of distinction between vouching, valuation and verification are as follows: (1) Meaning: Vouching involves the verification of the books of accounts with the help of the relevant vouchers Valuation is used to determine whether the assets are shown at their actual value in the Balance Sheet or not, Verification involves vouching for the value, ownership, existence and right on the assets liabilities. and(2) Subject Matter: Vouching is always done for the principal books of accounts. On the other hand, seein and valuation is done forthe items stated in the Balance Sheet. ® Fe maudl Vos normally done by a senior clerk because itis a part of the routine wor ion is normally done by th - ‘ Verification is done by the auditor himself y the management or technical experts. (a) Time: ee is basic function and is carried out through out the year. Verification and valuation is done after the preparation of the Balance Sheet but some assets are valued on the last date of the financial year like cash, bills, securities, stock etc. (6) Evidence: In vouching the direct ot indirect proof is present on the basis of which the accounts are verified. The auditor has to rely on the certificate of the management for valuation of assets since not much proof for the same can be obiained, Proof can be obtained for verification also (6) Scope: The scope of vouching is limited because the verification of assets and liabilities is outside its scope. Valuation is influenced by the going concern value and is subject to certain principles. Valuation is a part of verification. In verification the physical existence of assets and liabilities is verified. Verification has a wider scope than valuation since valuation is a part of verification. 1.7 Duties of an Auditor in relation to Verification Or General Rules of Verification The auditor has to certify the truth and fairness of the financial position of a business, therefore, he should verify the assets and liabilities as shown in the Balance Sheet. The auditor should notissue a report unless he believes that the assets and liabilities as shown in the Balance Sheet are present in the business and are free of any charge, in case they have a charge on there then the same should be explained. If, under any circumstances, the auditor issues a report without checking and verifying he would be held aly for negligence. Rules: The following rules should be followed by an auditor for verifying the assets and liabilities (1) Asfaras possible the task of verification should be done by the auditor himself. He should not obtain any help from the employees of the client. In case this is not possible, then the task of verification should be assigned to the most responsible and trustworthy member of his staff and a test check should be done on his work to establish the effectiveness of verification. (2) The title documents of the assets should be verified to establish the title and right of the client on these assets. (3) A physical verification of assets should be done on the date of the Balance Sheet or end of financial year to satisfy any doubts as to their existence. In case it is not possible to do a physical verification of any assets then a certificate certifying its existence inthe organisation should be obtained. (4) Easily exchangeable or li verified in one sitting only. (5) The incomes and expenditure incu should be seen that expenses are incurres quid assets (like stock, cheques, securities, cash, etc.) should be red for various assets should be carefully verified and it sd on existing assets only. 143(6) A certificate should be obtained from the client stating that the assets are free of any charge or if a charge exists the details of such charge. (7) Incase any asset has been given asa security then a certificate should be obtained from the concerned person and the relevant documents should be verified. (8) Incase any asset has been keptiin the custody of a person, a certificate for the same should be obtained from him. (9) A confirmation should be received for the balance receivable from the debtors. (10) ‘The appropriateness of the valuation of assets should be determined. (11) Any under-valuation of assets should be verified. Adequate provision is made for any loans which seem doubtful of recovery should also be verified. (12) Itis not possible to physically verify fictitious and intangible assets like goodwill, unearned income, prepayments, etc, Therefore the auditor should verify the same on the basis of documentary evidence available. (13) A certificate should also be obtained from the client regarding the various liabilities of the organisation specifying that the liabilities have been incurred for the business only and have been duly authorized. (14) The balance outstanding to various creditors should be verified from the confirmation letters received from the creditors. © 1.8 Auditor's Duty The duties of an auditor regarding verification can be divided into the following two pars (1) In relation to Assets, and (2) In elation to Liabilities. © (1) In Relation to Assets ‘The auditor should verify the following points while conducting a verification of assets: (i) The assets actually exist on the date of the Balance Sheet. (ii) ‘The assets belong only to the organisation and all the assets have been clearly mentioned in the Balance Sheet. There should be no assets which are not mentioned in the Balance Sheet. (iii) The valuation of assets is appropriate. (iv). The assets are in the name of the organisation and the organisation has a tight on them. (v) The assets are free of any charge or lien on them, but in case there is a charge on them the same has been mentioned clearly. (vi) made to any asset should be added to the value of the asset in the Balance (vil) Any expenditure incurred in the repairs and renewal of the asset should be debited to the profit and loss account. (viii) Adequate and appropriate depreciation is charged on the assets. (ix) Incase part of any asset is sold the auditor should verify the relevantsales, counterfoll copies of receipts and other evidence in that respect. (x) For verification of moveable assets like cash, bills, stock and securities etc, the auditor should be e present in the organisation on the date the Balance Sheet is made.APPOINTMENT, POWER, DUTIES AND LIABILITIES OF AN AUDITOR WWW.PDFFILES.IN @ 1. Introduction In the present age the importance of auditing has grown to such an extent that even organisations for whom it is not legally mandatory to get their accounts, audited consider it necessary to get their accounts audited. Whatever be the constitution of the business organisation, the job of the auditor is to examine the books of accounts. Audit is optional in case of a sole proprietorship concern ora partnership concem, but in the case of a company it is compulsory. However, all sole proprietorship concerns, partnership firms and companies want to get their accounts audited as they want to ensure that the accounts that have been maintained by them are correct and do not contain any frauds or errors. Hence, inthis chapter, we are going to dwell into the appointment, remuneration, rights and duties of the auditor {or various of business organisations. ® 2. Sole Proprietorship Concern Asole proprietorship concern is governed by no specific regulation and hence for such a business itisnot mandatory to get its accounts audited. In the absence of any legal limitations, the appointment of the auditor, his remuneration, his rights and duties and all of his related matters depend upon the personal Wishes of the sole proprietor He is the one who decides whether he wants the accounts of his concern to be audited or not. © 2.1 Appointment of Auditor Ifthe sole proprietor decides to get his accounts audited, then the auditor is appointed on the basis ofthe mutual agreement between the proprietor and the auditor, This agreement may be verbal or written, however, it is in the interest of both the parties to have a written agreement so that no dispute on the same atises in the future. If the auditor has been appointed through a written agreement, then he should torand clarify his scope of work, Hence, in case of sole proprietorship concern correspond with the prof f ‘he following points are important in relation to the appointment of the auditor. (i) the agreement of appointment, and (ii) receiving a written order specifying the scope of the Work,Remuneration: In the same manners as thete ate no legal bindings upon the Sole Proprietor ty appoint an auditor, there ae also no bindings or limitations on his remuneration. The remuneration ofthe auditor is decided by mutual agreement between the auditor and the proprietor. Rights: There is also no legal regulation relating to the rights of an auditor in the case of a Proprietorship concern, even then, normally the auditor enjoys the following rights. (i) The auditor has the right to examine all books and accounts being maintained in the sole Proprietorship concern (fi) He can ask the client for important information and explanation relating to his workin order to dispense his suspicions, (ili) He has the tight to receive remuneration as specified in the contract of appointment. (iv) If during the course of the audit his suspicious are aroused, or if he detects any frauds and errors, he can mention the same in his report. Duties: In the case of a sole proprietorship concer, the duties of the auditor have not been spelt ‘out under ay law, but morally he has the following duties: (i) Before Commencing the examination of the business, the auditor should clearly understand his rights and the scope of his work (ii) The auditor should audit the accounts of the sole proprietor with due diligence, intelligence and integrity (ii) Upon completion of the examination the auditor should submit a teport on the business duly signed by him. (iv) Sometimes, the auditor is also asked to give his advice on improvement of the technique of book-keeping. If the sole proprietor asks the auditor for any suggestion in relation to the business, the auditor should also provide the same. Such services are over and above the normal duties of an auditor. Removal: Due to the lack of any legal enactment in relation to a sole proprietorship concer, the removal of the auditor is completely dependent upon the wishes of the proprietor or the aateement between him and the proprietor. @ 3. Partnership Concern Partnership firms are governed by the Indian Partnership Act, 1932. According to this Act, itis not compulsory to get the accounts of a partnership firm audited, even then, keeping the benefits and importance of auditing in mind, firms normally get their accounts audited. Some firms, even before their formation, provide in the partnership deed, that the accounts of the fitm have to be audited. Here, it must be mentioned that even ifa firm wants to get its accounts audited, it need not appointa qualified auditor as is the case with a joint stock company, Unlike the Indian Companies Act, the Indian Partnership Act has not specified the qualifications, duties, rights and responsibilities of the auditor. Hence, the task of determining the rights, duties, etc. of the auditor is left to individual firms. Every matter is decided on the basis of the agreement between the firm and the auditor. However, it should be kept in mind that the main aim of getting the accounts of a partnership firm audited isthe same asin the case of a joint stock company, i.e. detection of frauds and errors, and certifying the truthfulness of the Profit and Loss Account and Balance Sheet. WWVLPDFFILES.INAppointment: There is no law in relation to the audit of accounts of a partnership firm. However, ibe partnership deed provides forthe auelt ofthe accounts, then an auditor has to be appointed. The «tions of appointment and the scope of the audit depend upon the agreement between the auditor sea te fT Remuneration: Generally, the remuneration of the auditor is decided (determined) by the partners. amines provision is made in partnership deed inthis regard. I there is any provision in partnership deed ring payment of remuneration to the auditor, then remuneration can be decided by mutual agreement ferween the itm and the auditor keeping in view the provisions of partnership deed. Rights: In the case of a partnership firm, the auditor has the following rights: () In ont to complete his work smoothly, the auditor has the right to study the partnership dee (ii) He has the right to see all the books of accounts of the firm. (ii) In case of his suspicious being aroused during the course of the audit he has the right to demand information and explanations from the partners. (iv) Ifany frauds or errors are detected in the books of accounts of the firm, he has the right to bring them to light. {v) The auditor has the right to receive the determined remuneration in relation to the audit work performed by him, Duties: There are also no specific guidelines in relation to the duties of auditors but normally the auditor has the following duties (i) The auditor should do his work exercising due diligence, intelligence and dedication. (ii) The auditor should keep confidential the information collected by him during the course of examination of the books of accounts and should not disclose the same to outsiders. (ii) He should study the Partnership Act, 1932 and the partnership deed, and should ensure that the provisions contained therein in relation to the books of accounts have been complied with (iv) After completion of the audit work he should submit a report to the client (firm) (v) Alter completion of the audit work he should also give necessary suggestions to the client. These suggestions may be of two kinds: (a) advice given at the request of the partners and (b) suggestions to remove the deficiencies he came across during the audit process, Removal: The auditor can be removed in accordance with the terms and conditions of appointment. ™ 4. Company company is an artificial person (organisation) brought into existence by law and having a separate legal entity. In this form of organisation the ownership and the management are separated from. each other. Apart from the information given to them by the management, the shareholders have no other Source of information about the money that they have invested in the company. In order to improve this Situation and protect the interest of the shareholders, the audit of the accounts of a company has been nade compulsory under the Companies Act. Under the Indian Companies Act, 2013, itis mandatory for@ company to get its accounts audited. Suchvan audit is known as a ‘statutory audit’, and the person appointed for conducting the audit is known as the ‘statutory auditor’. Sections 139 to 147 of the Companies Act, 2013 are of special importance for the auditor since these sections contain the provisions relating to the appointment, qualification, disqualifications, removal Temuneration, rights, uties and liabilities ofthe auditor. The Chartered Accountants Act, 1949 (Amendey in 1956) also contain certain provisions in this regard. Appointment of Company Auditors: The company auditor is appointed under the various Provisions of the Companies Act, 2013. These provisions are equally applicable for both Public and Private Companies. In the case of a Company, the auditor can be appointed: (1) by the Board of Directors, (2) by the Shareholders, WWW.PDFFILES.IN (3) by the Central Government. (1) By the Board of Directors: Inthe following circumstances the auditor can be appointed by the Board of Directors: (i) First Auditor: The first auditor of the company other than a Government Company s appointed by the Board of Directors within one month of its incorporation, such an auditor holds office till the completion of the first Annual General Meeting. (ii) Casual Vacancy: If the post of the auditor has become vacant due to a reason other than his resignation, (such as death, disqualification, etc.) before the expiry ofhis tenure, then the position may be filled in by the Board of Directors. An auditor appointed in such ‘a manner holds office only tll the end of the next Annual General Meeting. However, if the vacancy has resulted due to the resignation of the auditor, then the same can be filled up by the company only in the next Annual General Meeting, (2) By the Shareholders or Members: The following are the rules regarding the appointment of auditors by the members or share holders: (i) First Auditor: In the case of failure of the Board to appoint such auditor, it shall inform the members of the company, who shall within ninety days at an extraordinary general meeting appoint such auditor and such auditor shalll hold office tll the conclusion of fist annual general meeting. Appointment in Annual General Meeting: Section 139 of Companies Act, 2013 provides that every company shall at the first annual general meeting, appoint an individual or a firm as an auditors who shall hold office from the conclusion of the meeting till the conclusion of its sixth annual general meeting. The procedure and manner of selection of auditors by the members of the company at such meeting shall be such as may be prescribed. Thus, the auditors have a tenure of five years subject to ratification at every annual general meeting of the company. Before such appointments made, written consent of the order to such appointment has to be obtained alongwith a certificate that he satisfies the criteria for appointment as auditor as provided under Section 141 of the Act. This section permitsre-appointment of auditors by the company. (ii)(3) The company shalll inform the auditor concerned of his or its appointment, and also file a notice of such appointment with the Registrar within fifteen days of the meeting in which the auditor is appointed. Explanation: For the purposes of this Chapter, “appointment” includes re-appointment. However, sub-section (2) provides that no listed company or company belonging to such class or classes of companies, as may be prescribed, shall appoint or re-appoint: (a) an individual as auditor for more than one term of five consecutive years; and (b) an audit firm as auditor shall notbe appointed as auditor for more than two terms of five consecutive years. By the Central Government: The following are the provisions relating to the appointment of the auditor by the Central Government: (i) First Auditor: In case of a Government company or any company owned or controlled by the Central Government or by any State Government, the first auditor shall be appointed by the Comptroller and Auditor General of India (CAG) within sixty days from the date of registration of the company and in case the Comptroller and Auditor-General of India does not appoint such auditor within the said period, the Board of Directors of the company shall appoint such auditor within the next thirty days; and in the case of failure of the Board to appoint such auditor within next thirty days, it shall inform the members of the company who shall appoint such auditor within sixty days at an extraordinary general meeting, who shall hold office till the conclusion of the first annual general meeting. (ii) Subsequent Appointment: In the above mentioned companies, the Comptroller and Auditor General of India shall appoint an auditor duly qualified under the ‘Companies Act, in respect of a financial year within 180 days from the commencement of the financial year, who shall hold office till the conclusion of the annual general meeting. Reappointment of the Retiring Auditor: A retiring auditor may be re-appointed, at the annual general meeting unless: he is not disqualified for re-appointme: he has not given the company a notice in writing of his unwillingness to be re-appointed; and a special resolution has not been passed at that meeting appointing some other auditor or providing expressly that he shall not be re-appointed. Where at any annual general meeting, no auditor is appointed or re-appointed, the existing auditor shall continue to be the auditor of the company. Where a company is required to constitute an Audit Committee under Section 177 of the Act, all appointments, including the filling of a casual vacancy of an auditor shall be made after taking into account the recommendations of such Audit Committee.4 4.7 Rights or Powers of the Auditor The auditor is an independent person who does the work of the audit keeping the interests of various parties in mind. Hence, in order to be able to work independently the auditor also needs certain jghs-In order to be able to complete his work smoothly, the auditor has been granted the following rights ty section 143 of the Indian Companies Act, 2013 and the Chartered Accountants Act. (1) Right to Access the Books; Accounts and Vouchers of the Company: Under Section 148 of the Companies Act, 2013, the auditor has the right to access the books, accounts and vouchers of the company at all times, whether the same are located at the head office of the company or any branch. By ‘books of the company’ we mean those books which are being maintained by the company or those books which:are;required to be maintained by the company under any legal provision. ‘Atall times’ means during the business hours of the company. Theoretically, the auditor can go to any office of the company at any time (during business hours) for conducting the audit, without any prior notice. However, in practice, the auditor turns up for conducting the audit only on a predetermined date. Random examinations are required only when cash is to be verified, or when the auditor has to examine any frauds or irregularities in suspicious circumstances. If due to any reasons the directors prevent the auditor from accessing the books, then courts cannot order that the books be made available to the auditor but can call for a General Meeting to find out the opinion of the members on the matter. {Culf vs London and County Land and Building Company. } (2) Right to Receive Necessary Information and Explanations: According to Sections 143 and 146 of the Companies Act 2013, for dispensing his duties as the auditor, the auditor has the right to receive necessary information and explanations from the directors and officers of the company. He has also the right to determine what information and explanations are necessary for the purposes of his audit. If any explanation or information is not made available to him since the directors do not feel that the same is required by him for the purposes of fulfilling his duty, and if he does not receive a satisfactory answer to the information or explanation seeked, he has the right to mention the same in his report. (3) Right to Receive the prepared Final Accounts: The auditorhas the right to get prepared and receive the final accounts from the management of the company. The task of preparing the final accounts is not of the auditor, he merely reports upon the truthfulness and fairness of(4) (5) (6) (7) (8) (9) the same. If the management insists that the final accounts also be prepared by the auditor then he does so in the capacity of the accountant and not the auditor. For this the remuneration is also paid separately. Right to Visit the Branch Offices: According to Section 143 of the Companies Act, ifthe company has branches which have been audited by somebody other than the company, auditor, in such a situation, the company auditor has the right to inspect the accounts of the branch. Under this right, he can examine in detail the vouchers and accounts of the branches ‘of the company. If the branch of the company is situated overseas, then the auditor does not have the right to visit the same. In such a situation, the right of the auditor is limited to the right to examine the copies of books and accounts submitted by the foreign branch office to the head office. Right to Receive Notice and Attend the General Meeting: According to Section 146 of the Companies Act, 2013 the auditor has the right to receive all notices issued by the company for convening a General Meeting of the company. The auditor also has the right to attend these meetings whether or not the accounts of the company are being discussed Right to Make a Statement in the General Meeting: Under Section 146 of the Companies Act, the auditor has the right to speak in the General Meeting and speak therein order to give explanations relating to the accounts and the points mentioned by him in his report. Through this right the auditor can dispense the concems of the members and reply to the questions posed by them. However, he cannot be bound to reply to each and every question raised in the meeting, The auditor does not have the right to speak on matters other than those which concern him. WWW.PDFFILES.IN Normally, itis not necessary for the auditor to be present in each Annual General Meeting, but in the following circumstances the auditor should attend the Annual General Meeting: (i) When the is suspicious that the directors of the company are trying to hide certain financial difficulties, (ii) If there are points contained in the auditor's report which he wants to clarify, (ii) fhe has received notice ofa resolution proposing to appoint another person in his place {iv) If the company has specially invited him, ie. the directors have insisted that the auditor should be present. (v) If the auditor’s report contains certain points which may be misunderstood. Right to have Technical and Legal Advice: The auditor is by himself not an expert in every subject. Hence, if he deems necessary, then in certain specific matters he may seek the advice of other legal and technical experts in order to form his opinion. Right to Sign the Audit Report and to Certify Related Documents: Under Section 145 of the Companies Act, only the auditor, ora partner in the firm which has been appointed as the auditor in accordance with Section 141, has the right to sign the audit report. Only he has the right to certify the related documents Right to be Indemnified: Under Section 197 of the Indian Companies Act, if a matter of fraud or negligence is proceeded against the auditor, and the decision in the matter has beenin favour of the auditor, and he has been vindicated from the charges, then the expenses incurred by the auditor in defending himself have to be borne by the company, According to Section 463, the courts may also order full or partial reimbursement of the expenses incurred by him in sueh a case if he files the application for the same, regardless of the fact that the case was decided against him. (10) Right to Receive Remuneration: The auditor has the right to receive his remuneration if he has completed the work that was assigned to him. However, if he has been appointed on an annual fees, and he is removed during the year then he has the right to receive the remuneration for the whole year. Apart from the above mentioned rights, the auditor has the fundamental right to assume that each and every one of the émploliees Of the company is honest. This is based upon the principle that each emplouee is honest until it is proved that he is dishonest. The Articles of Association of the company and the directors cannot limit the rights of the auditor in ‘any manner, and nor can they be reduced in any manner whatsoever. Any provision to this effect is void ab initio. Auditor’s Lien on the Books of Accounts: The question that arises is if the auditor is not paid his remuneration, can he retain the books of accounts of the company in his custody until the same is paid to him? The Companies Act, 2013 is silent on this aspect. However, Section 128 of the Companies Act states that the books of accounts of the company should be kept at its registered office or at any other place in India as determined by the directors, and they should be available at all times, for inspection by the dtectors. Keeping the above provision of the act in mind, it is difficult to say whether the auditor has lien er the books of accounts or not. Even though the auditor does not have lien over the books of accounts, in some situations it does seem asf the auditor has lien over the books of accounts. Actually, however, itis not so. Itis compulsory for the company to keep all its books at the registered office for inspection by the shareholders. If the auditor tries to remove the books from the registered office, it is clear that he is trying to exercise lien upon them, which is wrong, ‘There are many clear court decisions in this regard that the auditor does not have the right to &ercise lien with respect to the books of accounts. If the auditor has acted in the capacity of an accountant, then he does have right of lien over the books. In the case of Herbert Alfred Balef vs. Ingram Clarke Ltd., it was held that if the nature of work of the auditor is that of book-keeping, then he the tight to exercise lien over the books. This is so because since the books have been maintained by im he is entitled to remuneration for maintenance of the same. However, modern thinking on this matter ‘different Inthe case of Sakakinalty vs. Brite Graham and Co., it was held that the auditor can exercise len over the correspondence and other documents which were prepared by him. A similar decision was ‘iven in the case of Holey, Smith and Feild vs. Valentine Tinzie. ___ The gist of the discussion is that ifthe auditor has acted in the capacity of an accountant, he has the "aht to exercise lien over the books of accounts. However, if he has acted in the capacity of the auditor, Nhe does not have lien over the books of accounts but he can exercise lien over the correspondence ther documents prepared by him during the course of the audit© 4.8 Duties of the Auditor The primary duty of an auditor is to protect the shareholders and investors against any misrepresentation in the financial matters of the company by making disclosures through their report, An auditor is, therefore, under a statutory obligation to make a report to the members on all the matters which he considers the members should be appraised. Such matters are specified in Section 143 (1) of the Companies Act, 2013. The duties of the auditor can be broadly divided into the following three categories (1) Duties under the Indian Companies Act, 2013, (2) Duties under the Charactered Accountants Act, 1949, and (8) Duties in accordance with decisions of courts. © |. Duties under the Indian Companies Act 2013 WWW.POFFILES.N According to the Companies Act, a company auditor has the following duties: (1) To Check Certain Special Points: According to Section 143 of the Companies Act, the auditor should specially check the following points: (a) Whether the loans and advances given by the company are adequately secured and whether the terms and conditions on which the same have been given are not unfavourble to the interests of the members of the company? (b) Whether transactions of the company represented only by entries in the books of accounts are prejudicial to the interests of the company? (c) If the company is an investment company as defined in Section 186, then whether the part of the assets of the company held in shares, debentures and securities have been sold at a price below their purchase price? (d) Whether the loans that have been advanced by the company have been shown as deposits? (e) Whether personal expenses have been debited to the Profit and Loss Account? (2) To Issue a Report: The auditors appointed in order to keep control over the working of the directors. The auditor has to issue his report to the shareholders since they are the owners of the business, and they are the ones who appoint him. Hence, whether the auditor has been appointed by the central government ot by the board of directors, or by the company in a General Meeting, in every situation he will issue his report to the shareholders only. Here, it should be classified that itis not the duty of the auditor to have the report personally delivered toall the members. He merely signs the report and hands it over to the company secretary and itis the duty of the company secretary to circulate copies of the report among the members, Hence, itis not the duty of the auditor to deliver the reports ‘According to Section 143 of the Companies Act, the company auditor shall issue a report on the accounts audited by him, the Profit and Loss Account, the Balance Sheet, and other documents attached thereto, and shall state that in his opinion and according to the information and explanations given to him the books of accounts depict a ‘true and fair’ view of the books of accounts of the company. He shall state in his report.