UNIT 5 - Recent Trends in Auditing

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UNIT 5

RECENT TRENDS IN AUDITING

Cost Audit
It is an audit process for verifying the cost of manufacture or production of any article, on the
basis of accounts as regards utilisation of material or labour or other items of costs, maintained
by the company.
In simple words the term cost audit means a systematic and accurate verification of the cost
accounts and records and checking of adherence to the objectives of the cost accounting.

Objectives of Cost Audit


1. To establish the accuracy of costing data. This is done by verifying the arithmetical accuracy
of cost accounting entries in the books of accounts.
2. To ensure that cost accounting principles are governed by the management objectives and
these are strictly adhered in preparing cost accounts.
3. To ensure that cost accounts are correct and also to detect errors, frauds and wrong practice
in the existing system.
4. To check up the general working of the costing department of the organization and to make
suggestions for improvement.
5. To help the management in taking correct decisions on certain important matters i.e. to
determine the actual cost of production when the goods are ready.
6. To reduce the amount of detailed checking by the external auditor if effective internal cost
audit system is in operation.

Objectives of Cost Audit


1. General objectives,
2. Social objectives.
General objectives of Cost Audit
1. Detection of errors and frauds.
2. Verification of the adequacy of the books of accounts and the accounting system.
3. Correct valuation of work-in-progress.
4. Verification of the total cost of each product, process, operation, and job.
5. Verification of inter-company transactions and the reasonableness of the price charged for
inter-company transfers.
6. Verification of statistical statements and other records to be submitted to the Directorate
General of Technical Development, and Central Excise so as to see that these are reconciled.
7. Providing assistance to the management by bringing out the deficiencies to its notice and
thereby avoid inefficient use of resources like capital, labour, raw material, etc.
8. Advising the management for the adoption of alternative courses of action by preparing the
cost plans.

Social Objectives of Cost Audit


1. Protection of the interest of the investors and other shareholders.
2. Efficient utilization of resources.
3. Ensuring quality of the functioning of the corporate management.
4. Overall improvement in the socioeconomic structure.

Advantages of Cost Audit


• To The Management
1. Cost audit helps in detection of errors and frauds.
2. The management gets accurate and reliable data based on which they can make day-to-day
decisions like price fixation.
3. It helps in cost control and cost reduction.
4. It facilitates the system of standard costing and budgetary control.
5. It helps the management in inter-unit / firm comparison.
6. It enables the management to identify loss making propositions.

• To The Government
1. Cost audit ensures efficient functioning of the industry. This in turn, nurtures a healthy
competition among the different companies and paves a path for fast progress.
2. It helps in identification of sick units and enables the Government to make relevant
decisions.
3. It helps in fixing prices in the case of essential commodities and checking undue profit
earning.
4. It enables to take decisions as to granting of subsidies, incentives and protection to various
industries.
5. It helps to take decisions as to levies, duties and taxes.
• To the Society
1. Cost audit enables the Government to fix prices of essential commodities. This safeguards
the interests of the society.
2. Cost audit enables the Government to keep a check on undue profiteering by the
manufacturers and avoids artificial price rise due to monopolistic tendencies.

• To the Shareholders

1. Cost audit reveals whether any of the products of the company are making losses. Thus
though the company making an overall profit, a loss making line may eat up the
company’s profits. This is brought to the notice of the shareholders and the management
is forced to take remedial measures, thereby making optimum utilisation of resources.
2. Cost audit ensures that the shareholders get a fair return on their investments.

Disadvantages of Cost Audit


1. Holding a Cost Audit can be expensive. This is because a company will often bring in an
independent auditor who are normally charging higher price.
2. A Cost Audit can be a long process which will likely involve more time. This extra time and
effort can impact an employee's day to day routine work.
3. If a Cost Audit is carried out in order to find fraudulent activity it can take a long time by
which time people stealing could have covered their tracks.
4. Cost Audits involve a large amount of estimation and so there is the possibility that figures
will be incorrect and if record keeping from the company is not good to start with then
inaccuracies will arise.

Scope of Cost Audit


The cost audit extents to the verification and checking of the following areas:
1. Services
• Utilization of power, fuel, water, steam and electricity and that of material, labour and
other costs like overheads allocated to the service department.
2. Wages and Salaries
• Maintenance of employment and attendance records, overtime and idle time records,
allocation of wages and salaries among various departments and those connected with
the capital work.
3. Overhead
• The overheads like production, administration, selling and distribution should be
allocated on a reasonable basis. The cost auditor ensures a fair and equitable distribution
of overheads between various departments, reconciliation of the cost records with that
of financial records, overhead recovery rates, and basis for allocation of cost between
fixed and variable.
4. Depreciation
• Maintenance of fixed assets registers with quantitative details, situation, method of
calculating depreciation, allocation of depreciation in respect of the common assets.
5. Production
• Daily production reports, summaries from daily to monthly, monthly to yearly and
comparison with past records and budgeted targets including abnormal losses, work in-
progress, etc.
6. Work-in-Progress
• Maintenance of records viz., job cards, work order, cost ledger, etc. and their valuation
method.
7. Stock Verification
• Inventory records for stock – both finished and unfinished products, spares and stores,
tools, machinery spares, etc, their values, issue procedure and balances.
8. Utilization of Capacity
• Plant utilization and capacity utilization are not considered in detail in financial audit.
Under this category the cost auditor’s examination covers the following aspects – total
available hours, standards hours, planned hours, and actual hours worked. Practical
capacity, standard capacity, expected capacity, and actual capacity utilized.

Tax Audit
• Tax audit, is aimed at evaluating whether an individual or company has accurately filed
the income tax returns of an assessment year. An external agency is mandated to assess
returns filed from income, deductions and expenditures and other rules as mentioned
by the Income Tax Act, 1961. The tax audit process simplifies the computation of tax
returns.

Now-a-days tax audit has become very important to ascertain the accuracy of tax related
documents. Tax audit mostly covers income returns, invoices, debt and credit notes and various
current and fixed assets. Tax audit is an innovation of 21st century. It has added one more
chapter to the procedure of auditing. Tax audit ensures the validity and credibility of tax related
documents.
The financial statements are certified by the auditor for truth and fairness of operating results
and financial position of the business. These are meant for general purpose being used by the
owners, creditors, banks and other interested parties. Sometimes a specific information my
required by certain people which may not be available in these statements

Objectives of tax audit


• Tax audit is conducted to achieve the following objectives:
1. Ensure proper maintenance and correctness of books of accounts and certification of
the same by tax auditor
2. Reporting of observations/discrepancies noted by tax auditor after a methodical
examination of books of account
3. Reporting prescribed information such as tax depreciation, compliance of various
provisions of income tax law etc. This in turn enables and also saves time of tax
authorities in verifying the correctness of income tax return filed by the taxpayer such
as total income, claim for deductions etc.
• Here’s why tax audit is necessary:
1. An analysis of the accuracy of income tax returns filed in an assessment year by
individuals and companies, and maintenance of records by the Chartered Accountant.
2. Reporting of findings by the tax auditor after a detailed analysis of
accuracies/inaccuracies in tax returns filed.
3. Reporting essential details regarding compliance, tax depreciation, etc., as per the laws
for income tax. This streamlines the processes for the income tax authorities in
calculation and assessing the accuracy of the income tax return filed by the individual
or company.
4. Checks frauds and malpractices in filing income tax returns.

Tax Audit Report Filing Process

1. The Chartered Accountant assigned for conducting tax audit of an individual or an


organisation has to present the tax audit report online, using his/her official login
credentials.
2. The taxpayer also has to mention the relevant information about their Chartered
Accountant in their login platform.
3. Once the tax audit report is uploaded by the auditor, it has to be either accepted or
rejected by the taxpayer on their login portal. If the taxpayer rejects the tax audit report,
the entire process has to be repeated until the tax audit report is accepted by him/her.
4. Tax audit report has to be filed on or before the pre-determined due date of filing income
return, i.e., 30th November of the subsequent assessment year for taxpayers who have
engaged in an international transaction and 30th September of the subsequent
assessment year for other taxpayers.

Penalty for Non-compliance of Tax Audit


• Non-compliance of tax audit regulations by taxpayers attracts a penalty of whichever is
lower from the following:
0.5% of total sales or
Turnover or
Gross receipts or
Rs. 1,50,000
• A penalty is waived only when a taxpayer is able to show a reasonable cause for non-
compliance. If the account books of a business is not audited, then the assessee has to
pay penalty. In case of a delay in completing audit and submitting the report on time, a
0.5% of the turnover maximum up to Rs. 1.5 lakh has to be paid as penalty. If there is
a genuine reason for delay or non-filing of audit report, then as per Section 273B, no
penalty will be applicable. Among the permitted reasons are:
Delay caused by resignation of the tax auditor
Delay caused by death or physical inability of the partner responsible for accounts
Delay caused by labour issues such as strikes or lock-outs
Delay caused by loss of accounts due to theft or fire, or incidents that are not under the
assessee’s control
Natural calamities

MANAGEMENT AUDIT
Meaning and Definition
Management audit is attempt made to evaluate various management functions and process. A
detailed and critical review of all the objectives, policies, procedures and functions of
management is made with a view to bring about an overall improvement in managerial
efficiency.
According to Leslie R. Howard, “ An investigation of a business from the highest level
downward in order to ascertain whether sound management prevails throughout, thus
facilitating the most effective relationship with outside world and the most efficient
organization and smooth running of internal organization.”
According to W.P. Leonard, “A comprehensive and constructive examination of an
organization structure of a company, institution or a branch of government or of any
component thereof such as division or department, and its plans and objectives, its means of
operations, and its uses of human and physical facilities.”
Thus it can be simply stated that management audit, on the basis of established standards,
examines, reviews and appraises the various policies and actions of management.

Objectives/Aims of management Audit


1. To ensure that sound objectives are set by the management.
2. To reveal any irregularity or defect in the process of management and to suggest
improvements to obtain the best results.
3. To ensure that the management objectives are achieved.
4. To help various levels of management in the effective discharge of their duties.
5. To assist management in achieving coordination among various departments.
6. To help to achieve the efficiency of management.
7. To assist management in establishing good relations with the employees and to elaborate
duties, rights and liabilities of entire staff.
8. To evaluate the performance by comparing inputs with outputs (human and physical both).
9. To ensure most effective relationship with the outsiders and the most efficient internal
organization.
10. To recommend changes in the policies and procedure for a better future.

Advantages of Management Audit


1. It helps management in preparation of plans, objectives and policies and their efficient
achievement.
2. It helps management in taking vital decisions for maximization of profits. 3. It helps the
management in strengthening its communication systems within and outside the business.
4. It helps in evaluating the performance of management in various areas and measures to
improve it.
5. It can help management in preparation of budgets and resource management.
6. It can help management in training of personnel and marketing policies.

Disadvantages of Management Audit


• Management audit involves high cost and it is suitable only to big organizations.
• Management audit may create a fear in the minds of the executives and may curb their
initiative and innovation.
• The management auditor may lack independence and may simply take instructions from
the top management.
However, an organization can utilize management audit effectively to improve its various
functional areas.

Need/importance of Management Audit:


The statutory auditor is not required to examine the policies of management and their
implementation or whether any improvement in the efficiency of management can be made. In
these days a report on all these matters is very important to the business. The management
auditors are appointed to advise the management on various matters related to management.
These persons examine the various aspects of management and evaluate the actual performance
by comparing it with predetermined standards. Such auditors may or may not be from the field
of accountancy. They advise management on the matters relating to performance of various
departments as well as of the organization as a whole.
• The management may conduct management audit periodically to review the efficiency
of managers. The results may be used to provide incentives to staff.
• The management audit reveals irregularities and defects in the working of management
and suggests the ways to improve the efficiency of management. It concentrates on the
results and does not examine whether procedures have been followed or not.
• The government may ask for management audit of sick industrial units with a view to
examine the efficiency of management. It may be conducted to find whether the
sickness is due to functioning of management or the circumstances beyond the control
of management. On the basis of report of management auditor, the government may
decide to take over to sick units.
• It can be said that management audit is a guide which helps in improving the efficiency
of management.

Appointment of Management Auditor


A team of experts should be appointed to conducted management audit. It can’t be expected
that an individual can possess expertise in all management’s fields; therefore, an expert in each
field of management should be included in the team of management auditors. Such team should
have full cooperation from the top level management to enable it to conduct the audit smoothly.
The members of management audit team should have a proper training and expert knowledge
of science of management. A wide experience of actual work situations will be added to the
advantage. The audit of the management involves an appraisal of activities of organization; the
auditor must study the organization and its plan in detail.
The internal auditors may be regarded as suitable persons for conduct of management audit
because they are familiar with the internal workings of management. Sometimes it is desirable
to have O & M experts as management auditors. All will depend on the scope of management
audit which the management has to decide.

Qualities of a Management Auditor


The area of activities of management audit is wide; no specific qualities can be narrated for
management auditor. He must possess enough qualities to fulfill his professional obligations.
Some of the qualities of the management auditor can be described as follows.
1. He should have a good knowledge of managerial functions
2. He should be familiar with the various principles of management, planning, control,
management by objectives, and management by exception.
3. He should have a good understanding of financial statements and their preparations.
4. He should understand the working of organization and its problems.
5. He should be able to understand the objectives of organization.
6. He should be able to assess and critically examine the internal control systems.
7. He should be able to understand the nature of the product and its production process.
8. He should understand plans, budgets, rules and the procedures applied in the
organization.
9. He should have a good knowledge of financial statement analysis techniques like
standard costing, budgetary control, ratio analysis, fund flow statements etc.
10. He should be familiar with the human resources accounting, social accounting, etc.
11. He should have a good knowledge of economics, business laws, etc.

Conduct of Management Audit


Following points need careful attention before he commences his work.
1. The auditor should ensure that various objectives and goals are properly established which
are likely to help to achieve the desired results.
2. He should see that the plan laid down by management is practicable and helpful to achieve
objectives.
3. He should see that whether the organization has a well defined structure, authority lines and
responsibility areas are clear, decision making is centralized or decentralized.
4. He should verify the efficiency of information system operating in the organization.
5. To collect necessary information he should prepare a questionnaire such as:
a. Whether the resources are efficiently employed,
b. Whether plans, policies , procedures and systems are strictly followed
c. Whether the objectives are split up into target of each department.
d. Whether management by exception is possible.
e. Whether the planned and actual performance are compared at regular intervals of time.
f. Whether irregularities arise frequently, if so, who is responsible?
g. Whether the methods used in organization are satisfactory.
6. The information obtained with the help of above questions should be counter checked from
the various records and statements available in the organization.
7. To arrive at definite conclusions, the management audit has to correlate the information
collected through various means.

Distinction between Management Audit and Statutory Audit


The statutory Audit is examining the accounts as per provisions of law but management audit
is concerned with audit of performance of functions of management. Following are the points
of difference

Management Audit Statutory Audit


1. The management auditor examines the 1. Statutory Audit reports on the financial
performance of management and makes aspects of an organization indicating whether
suggestions to improve it in the future. financial statements show a true and fair
view of state of affairs for a particular period.
2. The Conduct of management audit is
optional and voluntary. There is no legal 2. The audit of financial accounts is legally
compulsion in this regard so far. compulsory for a joint stock of company.

3. The management auditor is answerable to 3. The Statutory auditor is accountable to the


management only. shareholders and authorities under the Act.

4. No qualification has been fixed for the 4. The statutory auditor must be a Chartered
management auditor. accountant and emphasis is on independent
report on financial matters.
5. The management audit is an aid to
management. 5. It is a check on management. 6. It is
conducted for a particular accounting
6. The management audit may cover more
than
Scope of Management Audit
The scope of Management Audit has no limitations. The areas of review depend on the
objectives of the business and may include :-
(a) The suitability, practicability and present compliance or otherwise of the
organization with its designated objects and aims.
(b) The current reputation of the organization in relation to the general public and within
its own particular industrial or commercial field.
(c) The rate of return on investors’ capital – whether poor, adequate or above average.
(d) Relationship of the business with its own shareholders and the investing public in
general.
(e) The ratios of operating returns and the rate of return on capital projects.
(f) The relationship between management and staff within the business.
(g) The aims and effectiveness of management at its various levels such as top level,
middle level and operational level.
(h) Financial policies and control relating to production, sales and distribution and in
other functions of the organization.

Weaknesses Revealed by Management Audit


• The weaknesses that a Management Audit might reveal may include:
(a) Weaknesses among the members of the Board of Directors.
(b) A lack of awareness among directors and managers of the objectives of the organization
and the extent to which these are being achieved, failure to define clearly the objectives and
responsibilities of individual managers.
(c) Inadequate steps taken to provide adequate finance.
(d) Lack of technical competence of managers.
(e) Retaining authority by managers for matters which ought to have been delegated.
(f) Lack of clear and identifiable management style in the organization.
(g) Lack of proper staff/management training.
(h) Failure on the part of managers to measure and assess the performance of their subordinates.
(i) Inadequacy of the management information system.
(j) Lack of enforcement of procedures and too much wastage of time in enforcing such
procedures.

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