BASICS OF AUDITING

1. Financial Statement – Statement showing the financial position of any entity.

FS includes Balance Sheet, Profit & Loss account, Cash Flow Statement, Statement of Changes in
Equity, Notes to Accounts(Significant Accounting policy)

2. Who is responsible for the preparation of FS?

Management & Those Charged with Governance (TCWG) is responsible for the preparation of FS

3. Name some USERS OF FS.

4. To enhance the reliability, credibility of FS, prepared by Management, it should get verified, examined
by an INDEPENDENT THIRD PARTY. Such independent third party is called AUDITOR

5. AUDITOR – Person who conducts the audit of FS.

6. FS prepared by Mgmnt – Follows AS/ Ind AS

FS audited by Auditor – Follows SA (Standards on Auditing)

7. Auditing - According to SA 200, Basic Principles Governing an Audit,

• an audit is independent examination of financial information
• of any entity,
• whether profit oriented or not, and
• irrespective of its size or legal form,
• when such examination is conducted with a view to expressing an opinion thereon”.
The term “audit” has been derived from the Latin word “audire” which means ‘to hear’. In early days,
the person appointed to check the accounts, used to hear the explanations required from responsible
officers and that’s why, he was called as an “auditor

8. Independence – Judgement of a person is not subordinate to the wishes of another person. Not under
the influence of any. {not dependent / not related / not under influence / without bias}

9. Objective of Independent Auditor {SA 200}

(i) To obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error,
thereby enabling the auditor to express an opinion on whether the financial
statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework; and

(ii) To report on the financial statements, and communicates as required by the

SAs, in accordance with the auditor’s findings’’

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 Primary Objective: The main objective of an audit is to determine whether the financial
statements present a ‘’ true & fair view’’ of the financial position and financial performance
of a business during the period

Secondary Objective: The auditor is also responsible for detecting frauds and errors in the
books of accounts and financial records of the client’s business. Such detection of frauds
and errors is called the secondary objective of audit because the primary responsibility for
safeguarding the business assets rests with the management
10. Assurance – Means confirmation.
Three types of Assurance
• Reasonable Assurance – High Level of assurance but not Absolute assurance
• Absolute Assurance - 100% Confirmation
• Limited Assurance – Lower level of assurance. Auditor provides limited assurance in case of
review of FS.

11. Materiality – Anything which influences the mind of the users of FS is called Materiality

12. Misstatement – Difference between “What is “& “What should be”. (Knowledge purpose)
Difference between Reported ACPD & required ACPD (exam purpose)
ACPD = Amount, classification, Presentation & Disclosure

13. Applicable Financial Reporting framework (AFRF) – framework adopted by the management for the
preparation of financial statement, which is widely accepted and is as per the regulations.

14. True & fair – Phrase used by the auditor express his opinion on the truth & fairness of FS.

15. Audit Evidence – Information / Documents collected by the auditor on the basis of which he expresses
his opinion
16. Audit evidence should be SUFFICIENT AND APPROPRIATE. Sufficiency denotes quantity and
appropriateness denotes quality. Hence Auditor needs Sufficient & Appropriate Audit evidence (SAAE)
to express his opinion.

17. Types of Audit Evidence

Internal Evidences
These are evidences collected from within the organisation. For example, sales invoices,
counterfoils of cash memos, goods received notes, credit notes and debit notes, etc
External Evidences

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 These are evidences collected from outside sources. For example, quotations, confirmation from
debtors and creditors, etc

18. Methods to collect Audit Evidences (IICORA)

Inspection - It consists of examining records, documents, or tangible assets. Inspection
of records and documents provides evidence of varying degrees of reliability depending
on their nature, source and the effectiveness of internal controls over their processing.
Inquiry - Inquiry consists of seeking appropriate information from a knowledgeable
person inside or outside the entity
Confirmation - Confirmation consists of the response to an inquiry to corroborate
information contained in the accounting records.
Computation - It consists of checking the arithmetic al accuracy of source documents
and accounting records or performing independent calculations
Observation - It consists of witnessing a process or procedure being performed by
others.
Reperformance & recalculation – Independent Performance of internal control by
auditor is reperformance and checking the arithmetical calculations is called
recalculations
Analytical Review - It consists of studying signific ant ratios and trends and
investigating unusual fluctuations and items.

19. Audit Procedures – Procedures by which an auditor collects audit evidence is called Audit procedure
Procedure by which an auditor reduces the audit risk is called audit procedure.
20. Audit Risk – Risk that an auditor expresses an inappropriate audit opinion when the FS are materially
misstated.

21. Types of Audit Risk – Inherent Risk, Control risk, Detection risk

22. Inherent risk - This refers to the possibility of material misstatement due to complex transactions or
even due to organised fraud

23. Control Risk - This refers to the possibility of material misstatement due to ineffective design,
implementation and maintenance of internal control system. Thus, a sound internal control system
significantly reduces this risk. internal control can reduce but cannot eliminate the risk completely
because of its inherent limitations.

24. Detection risk - This refers to the possibility that the audit procedures applied by the auditor to
reduce the audit risk to an acceptably low level will not be able to detect a misstatement which, either
individually or in aggregate, may be material

25. Risk of Material Misstatement – Risk that FS are materially misstated prior to audit is called RMM

26. AR = IR x CR x DR
RMM = IR x CR
AR = RMM x DR

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 27. Risk Assessment Procedure = Procedure by which an auditor identify & Assesses RMM through
understanding the entity & its environment.

28. Further Audit procedure – Procedure by which an auditor controls & manages detection risk is called
FAP.

29. Compliance Procedure or Test of Control – Procedures by which an auditor checks the operating
effectiveness of the internal controls implemented by the management, & to see whether it is operating
throughout the period.

30. Professional Scepticism - Attitude of questioning mind, critical assessment of Audit evidence & being
alert to conditions that indicate possible misstatement.
{Nothing to be accepted blindly}

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