320 FP–FA&A

Lesson 10
Concept of Auditing

LESSON OUTLINE
LEARNING OBJECTIVES

– Introduction The basic purpose of auditing is to confirm the

authenticity of books of accounts prepared by an
Accountant. It is well known saying that “where
– Meaning of Audit
the function of Accountant ends, audit begins to
determine the true and fair picture of such
– Principal aspects to be covered in audit
accounts”.

– Benefits of auditing Audit is performed to ascertain the validity and

reliability of information. Examination of books
of accounts with supporting vouchers and
– Limitations of auditing
documents in order to detect and prevent error
and fraud is the main function of auditing. Auditor
– Review Questions
has to check the effectiveness of internal control
system for determining the extent of checking to
– Investigation
be done for carrying out the audit. Other than
internal control system auditor has to follow
– Difference between Auditing and certain other principal aspects of auditing. Audit
Investigation safeguards the financial interest of persons not
associated with the management like partners,
– Lesson Round UP shareholders, etc. Auditing also have some
inherent limitations such as the obtained
evidences are persuasive rather than conclusive.
– Glossary
Investigation and auditing are two different areas
not linked with each other.
– Self-Test Questions
In this lesson, you will learn the meaning of audit;
principal aspects of auditing, Benefits and
Limitations of audit and what is investigation and
how it is different from auditing.

I’m not suggesting there are any errors at all. I’m saying that without a proper audit, there’s no way to be
sure.
Pete Williams
 Lesson 10 Concept of Auditing 321

INTRODUCTION

Evolution of Auditing
The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days a person used to listen
to the accounts read over by an accountant in order to check them. He was known as auditor. Auditing is as old
as accounting and there are signs of its existence in all ancient cultures such as Mesopotamia, Greece, Egypt.
Rome, U.K. and India. Arthasashthra by Kautilya detailed rules for accounting and auditing of public finances.
Audit is performed to ascertain the validity and reliability of information. Examination of books of accounts with
supporting vouchers and documents in order to detect and prevent error and fraud is the main function of
auditing. The goal of an audit is to express an opinion on the financial or non-financial areas. Audit safeguards
the financial interest of persons not associated with the management like partners or shareholders, acts as a
moral check on the employees and prevents from committing fraud. However, due to constraints, an audit seeks
to provide only reasonable assurance that the statements are free from material error. In case of financial audit,
a set of financial statements are said to be true and fair when they are free of material misstatements. But
recently, argument that auditing should go beyond just true and fair is gaining momentum in view of recent
frauds by high profile organizations in connivance with the reputed audit firms.
Traditionally, audits were mainly associated with gaining information about financial systems and the financial
records of a company or a business. However, recently auditing has begun to include non-financial subject
areas, such as safety, security, information systems performance, and environmental concerns. With non-profit
organizations and government agencies, there has been an increasing need for performance audit, examining
their success in satisfying mission objectives of business
In India the Companies Act, 2013 made audit of company accounts compulsory. With the increase in the size of
the companies and the volume of transactions the main objective of audit shifted to ascertaining whether the
accounts were true and fair rather than true and correct. Hence the emphasis was not on arithmetical accuracy
but on a fair representation of the financial efforts. The Companies Act, 2013 also prescribed for the first time the
qualification of auditors. After the independence in year 1956, Company Act, 1956 was implemented and detailed
provisions were made in Act regarding Audit and auditors. Recently Companies Act, 2013 has been implemented
w .
st
e April, 2014 and this contains detailed provisions about statutory audit, Cost Audit, Internal Audit and
. f 1

Secretarial Audit.

MEANING AND DEFINITIONS OF AUDITING

It is a bit difficult to give a precise definition of word audit in a word or two, originally its meaning and use was
confined merely to cash audit and the auditor had to ascertain whether the person responsible for the maintenance
of accounts had properly accounted for all the cash receipts the payment on behalf of this principle. But the
word, audit, had a wide usage and it now means a thorough scrutiny of the books of accounts and its ultimate
aim is to verify the financial position disclosed by the balance sheet and the profit and loss account of a company.
The following are the some of the definitions of audit given by some writers
Lawrence R. Dicksee – “An audit is an examination of accounting records undertaken with a view to establishing
whether they correctly and completely reflect the transactions to which they purport to relate.”
Taylor and Perry – “Audit is defined as an investigation of some statements of figures involving examination of
certain evidence, so as to enable an auditor to make a report on the statement.
F.R.M De Paula – “An audit denotes the examination of Balance Sheet and Profit and Loss Account prepared by
others together with the books of accounts and vouchers relating there to in such a manner that the auditor may
be able to satisfy himself and honestly report that, in his opinion, such Balance Sheet is properly drawn up so as
322 FP–FA&A

to exhibit a true and correct view of the state of affairs of the particular concern according to the information and
explanations given to him and as shown by the books”.
Prof. Montgomery – “Auditing is a systematic examination of the books and records of business or other
organization, in order to ascertain or verify and to report upon the facts regarding its financial operations and the
result thereof.”
Spicer & Pegler – “Audit such an examination of the books of accounts and vouchers of a business, as will
enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair
view of the state affairs of the business, and whether the profit and loss account gives a true and fair view of the
profit or loss for the financial period according to the best of his information and explanations given to him and as
shown by the books, and if not, in what respect he is not satisfied”.
Institute of Chartered Accountants of India (ICAI) defines Auditing as – “Auditing is defined as a systematic
and independent examination of data, statements, records, operations and performance of an enterprise for a
stated purpose. In any auditing situation, the auditor perceives and recognizes the propositions before him for
examination, collect evidences, evaluates the same and on this basis formulates his judgement which is
communicated through his audit report”.
In the close scrutiny of the different definitions we found that there are different ways of expressing the concept
of auditing but having lot of similarity therein.
The meaning of an Audit contains
(i) An intelligent and critical examination of the books of accounts of business.
(ii) It is done by an independent qualified person.
(iii) It is done with the help of vouchers, documents, information and explanations received from the clients.
(iv) The auditor satisfies himself with the authenticity of the financial accounts prepared for a particular
period.

FEATURES OF AUDITING
1. Audit is a systematic and scientific examination of the books of accounts of a business;
2. Audit is undertaken by an independent person or body of persons who are duly qualified for the job.
3. Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown
by the balance sheet.
4. Audit is a critical review of the system of accounting and internal control.
5. Audit is done with the help of vouchers, documents, information and explanations received from the
authorities.
6. The auditor has to satisfy himself with the authenticity of the financial statements and report that they
exhibit a true and fair view of the state of affairs of the concern.
7. The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions
and examine correspondence, minute books of share holders, directors, Memorandum of Association
and Articles of association etc., in order to establish correctness of the books of accounts.

Objectives of Auditing
The objectives of auditing may be classified into two parts:
1. The primary objective
 Lesson 10 Concept of Auditing 323

2. The secondary or incidental objective.

Primary objective – As per Section 143 of the Companies Act 2013, the primary duty (objective) of the auditor
is to report to the owners that the accounts, financial statements give a true and fair view of the state of the
company’s affairs as at the end of its financial year and profit or loss and cash flow for the year and such other
matters as may be prescribed.
Secondary objective –It is also called the incidental objective as it is incidental to the satisfaction of the main
objective. The incidental objectives of auditing are:
(i) Detection and prevention of Frauds, and
(ii) Detection and prevention of Errors.
Detection of material frauds and errors as an incidental objective of independent financial auditing flows from
the main objective of determining whether or not the financial statements give a true and fair view. As the
Statement on auditing Practices issued by the Institute of Chartered Accountants of India states, an auditor
should bear in mind the possibility of the existence of frauds or errors in the accounts under audit since they may
cause the financial position to be mis-stated. Fraud refers to intentional misrepresentation of financial information
with the intention to deceive. Frauds can take place in the form of manipulation of accounts, misappropriation of
cash and misappropriation of goods. It is of great importance for the auditor to detect any frauds, and prevent
their recurrence. Errors refer to unintentional mistake in the financial information arising on account of ignorance
of accounting principles i.e. principle errors, or error arising out of negligence of accounting staff i.e. Clerical
errors.

Basic principles governing an audit

SA 200 “Basic Principals Governing an Audit”, describes the basic principles which govern the auditor’s
professional responsibilities and which should be complied with wherever an audit is carried. They are described
below:
(i) Integrity objectivity and independence: An auditor should be honest, sincere, impartial and free from
biasness. He should be a man of high integrity and objectivity.
(ii) Confidentiality: The auditor should respect confidentiality of information acquired during the course of
his work and should not disclose the information without the prior permission of the client, unless there
is a legal duty to disclose.
(iii) Skill and competence: The auditor must acquire adequate training and experience. He should be
competent, skillful and keep himself abreast of the latest developments including pronouncements of
ICAI on accounting and auditing matters.
(iv) Work performed by others: If the auditor delegates some work to others and uses work performed by
others including that of an expert, he continues to be responsible for forming and expressing his opinion
on the financial information.)
(v) Documentation: The auditor should document matters which are important in providing evidence to
ensure that the audit was carried out in accordance with the basic principles.
(vi) Planning: The auditor should plan his work to enable him to conduct the audit in an effective, efficient
and timely manner. He should acquire knowledge of client’s accounting system, the extent of reliance
that could be placed on internal control and coordinate the work to be performed.
(vii) Audit evidence: The auditor should obtain sufficient appropriate evidences through the performance of
compliance and other substantive procedures to enable him to draw reasonable conclusions to form an
opinion on the financial information.
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(viii) Accounting System and Internal Control: The management is responsible for maintaining an adequate
accounting system incorporating various internal controls appropriate to the size and nature of business.
The auditor should assure himself that the accounting system is adequate and all the information which
should be recorded has been recorded. Internal control system contributes to such assurance.
(ix) Audit conclusions and reporting: On the basis of the audit evidence, he should review and assess
the audit conclusions. He should ascertain:
1. As whether accounting policies have been consistently applied;
2. Whether financial information complies with regulations and statutory requirements; and
3. There is adequate disclosure of material matters relevant to the presentation of financial information
subject to statutory requirements.
The auditor’s report should contain a clear written opinion on the financial information. A clean audit report
indicates the auditor’s satisfaction in all respects and when a qualified, adverse or a disclaimer of opinion is to
be given or reservation of opinion on any matter is to be made, the audit report should state the reasons thereof.

PRINCIPAL ASPECTS TO BE COVERED IN AUDITING

The following aspects are required to be covered by an auditor while doing audit of any organization. The
principal aspects can also be called the functions of audit:
(i) Review of System and Procedures: Review of system and procedure is the primary function of auditing
exercise. First an auditor needs to understand the system and procedures adopted by the entity to go
further in the auditing exercise.
(ii) Review of Internal Control System: Review of internal control system is very important for the auditor
as the effectives of internal control system will determine the extent of checking to be done by the
auditor. The compliance test and substantive procedures performed by the auditor will determine the
effectiveness of internal control system. If internal control system is effective, less checking is required
and vice-versa. Moreover As per Company Audit report Order, 2003 also an auditor need to comment
on the effectiveness of Internal control system in the organization so the review of internal control is
necessary for carrying out the Auditing exercise.
(iii) Routine Checking/ Arithmetical Accuracy: It is the duty of the auditor to check the arithmetical accuracy
of the books of account by checking the proper posting and balances of the books of accounts.
(iv) Accounting Principles: Auditor has to ascertain whether proper distinction has been made between
the item of capital and revenue nature and also whether the item of income and expenditure of a
particular period has been adjusted in the books of accounts of that accounting period.
(v) Books and Statements: Auditor has to compare the balance sheet and profit and loss account or other
statement with the books of accounts and supporting vouchers to ascertain that the final accounts have
been made in accordance with the underlying records.
(vi) Verification of Assets: It is the duty of the auditor to physically inspect the assets and their recording in
the books of accounts and verify the legal and official documents to ascertain the existence, ownership,
possession, classification and valuation of assets of an entity.
(vii) Verification of Liabilities: It is the duty of the auditor to inspect the books of accounts and verify the
legal and official documents to ascertain the existence, obligation, completeness, valuation and disclosure
of liabilities of an entity.
(viii) True and Fair View: The auditor has to give its opinion whether the financial statements depicts the true
and fair view of the state of affairs of the organization.
 Lesson 10 Concept of Auditing 325

(ix) Statutory Compliance: Auditor has to ensure that all the statutory requirements has been complied by
the entity like provisions of Income Tax Act, Companies Act and other acts if any applicable has been
complied by the organization.
(x) Reporting: The auditor has to report to the authority appointing him for conducting audit whether the
financial statements of accounts examined actually reveals true and fair view of the state of affairs and
of the profit or loss earned during the period by the organization.

BENEFITS OF AUDIT
(i) Satisfaction of Owner: It is because of audit that the owner will be satisfied about the business operations
and working of its various departments.
(ii) Detection and Prevention of Errors and Frauds: The errors whether committed innocently or deliberately
are discovered by the process of audit and its presence prevents their occurrence in the future. No one will try to
commit an error or fraud as the accounts are subject to audit and hence they will have a fear of being detected.
Just like errors, frauds are discovered by audit and its presence minimizes future possibility if not eliminated
totally.
(iii) Verification of Books: Another advantage of audit is the verification of the books of accounts, this helps in
maintaining the records up to date at all times.
(iv) Independent Opinion: Auditing is very useful in obtaining the independent opinion of the auditor about
business condition. If the accounts are audited by an independent auditor, the report of the auditor will be true
and fair in all respects and it will be of extreme importance for the management of the company.
(v) Moral Check: The process of audit will establish a check on the minds of the staff working in the business
and they will not be able to commit any irregularity, as they will have a fear and will also be aware that the
accounts will be examined in the near future and that action would be taken against them if any irregularity is
discovered. Thus the audit prevents the happening of any irregularity before it starts and the staff hence becomes
more active and responsible. The fear of their getting caught act as a moral check on the staff of the company.
(vi) Protection of the Rights and Interests of Shareholders: Audit helps in protecting the interests of
shareholders in case of joint stock company. Audit gives assurance to the shareholders that the accounts of the
company are being maintained properly and their interest will not suffer under any circumstances.
(vii) Reliance by Outsiders: Outsiders like creditors, debenture holders and banks etc. will rely on the books of
accounts and financial statements of the business if they are audited by an independent authority (external
auditor).
(viii) Ensures Compliance with Legal Requirements: Audited statements are necessary to fulfill certain legal
requirements e.g. listing requirements of stock exchange etc.
(ix) Reinforce and Strengthen Internal Control: Since auditing exercise involves the review of internal control
system, an auditor will identify the gaps in internal control system and can suggest the necessary changes in the
internal control system.
(x) Loan Facility: Money can be borrowed easily on the basis of audited balance sheet from financial institutions.
If accounts are audited the true picture will be visible to banks and it will be easy for them to issue loans as early
as possible.

LIMITATIONS OF AUDIT
Besides having various benefits, there are some inherent limitations of auditing. These are as follows :
(i) Higher Cost Burden: Due to Higher Cost Burden, the auditor limits his scope of work to selective
testing or sampling thus in depth checking of books of accounts is not possible.
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(ii) Based on test checks. Generally an auditing exercise is based on test checking. Inferring a result on
the basis of test check always need not to be true.
(iii) Insufficient Time: Generally an auditor needs to release the report up to a specified timeline. Sometime
this timeline become a constraint for an auditor in carrying out the auditing exercise effectively. This time
constraint may affect the amount of evidence that can be obtained concerning events and transactions
after the balance sheet date that may have an effect on the financial statements. Moreover, there is a
relatively short time period available for resolving uncertainties existing at the financial statement date
(iv) Inconclusiveness of Evidences: The evidences obtained by an auditor are persuasive rather than
conclusive. For example, an architect’s certificate of valuation for a newly constructed building of a
client may not be conclusive evidence of the correct value of building.
(v) Based on Estimates: Estimates are an inherent part of the accounting process, and no one, including
auditors, can foresee the outcome of uncertainties. Estimate range from the allowance for doubtful
accounts and an inventory obsolescence reserve to impairment tests of fixed assets and goodwill. An
audit cannot add exactness and certainty to financial statements when these factors do not exist.
(vi) Based on the Information provided by the Management: The audit opinion is based on the information
provided by the management. Hence, outsiders cannot fully rely on the auditor’s report.

REVIEW QUESTION
1. The evidence obtained by an auditor is __________rather than conclusive.
2. The term ‘Audit’ originated from the Latin word “audire” means _________.
3. Auditing can be defined as an _______________ examination of records (financial
or non-financial).
4. If internal control system is effective, ___________ checking is required and vice-
versa.

INVESTIGATION
The investigation is related to critical checking of particular records. Investigation is done when a lapse already
exists to pin point the reason and person involved in it so that responsibility for such lapse could be fixed
whereas audit is a process to check whether the accounts are properly maintained as per required norms
following all the procedures etc. and to point out any lapses in this line. The purpose of auditing and investigation
is different.

DIFFERENCE BETWEEN AUDITING AND INVESTIGATION

PARTICULARS INVESTIGATION AUDITING
1. Meaning Investigation implies systematic, critical An audit is independent examination of
and special examination of the records financial information of any entity, when
of a business for a specific purpose. such an examination is conducted with a
view to expressing an opinion thereon.
2. Mandatory Nature Voluntary Mandatory for Companies. For others, it
is voluntary.
3. Conducted by Any person, who may not be a A Chartered Accountant within the
 Lesson 10 Concept of Auditing 327

Chartered Accountant. meaning of the Chartered Accountants

Act 1949.
4. Appointing Agency Owners or Management or even third Owners/Shareholders of the enterprise.
parties may appoint the investigator.
5. Protection of Work is carried out from the viewpoint Work is carried out on behalf of the
Interests of the appointing agency. owners, even if the power of appointment
is delegated to say, Board of Directors.
6. Scope and Coverage Specific – Seeks to answer only those General – when compared to
questions laid down in the engagement investigation – seeks to form an opinion
letter. on the Financial Statements.
7. Period Covered Not necessarily restricted to a financial Generally a period of one financial year.
year. It can extend for a period
consisting of a number of years.
8. Pre conceptions Its essence lies in going into the matter Audit is not based on suspicion unless
with some pre-conceived notion suited circumstances exist to arouse suspicion.
to the objective.
9. Evidence Seeks conclusive and corroborative Much of audit evidence is persuasive
evidence. rather than conclusive.
10. Form of Reporting There is no statutory form of The matters to be covered in the audit
investigation report. report are sometimes prescribed by law.

LESSON ROUND UP
– An Audit is an independent examination of financial or non-financial information of any entity; when
such an examination is conducted with a view to express an opinion thereon.
– Principal Aspects to be Covered in Audit: internal control system, review of system and procedures,
accounting principles, books and statements, verification of assets, verification of liabilities, true and
fair view, statutory compliance and report.
– Benefits of Audit: satisfaction of owner, detection and prevention of errors and frauds, verification of
books of accounts, independent opinion, moral check, protection of the rights and interests of
shareholders, ensures compliances with legal requirements, reinforce and strengthen internal control
system and reliance by outsiders
– Limitations of an Audit: Audit involves higher cost, audit involves reasonable length of time, based on
test checks, evidence obtained by an auditor are persuasive rather than conclusive, auditors cannot
determine the appropriateness of accounting estimates because of uncertainties involved in it and
audit is based on information provided by management.
– Difference between Investigation and Auditing: Investigation implies systematic, critical and special
examination of the records of a business for a specific purpose whereas audit is an independent
examination of financial information of any entity, when such an examination is conducted with a view
to expressing an opinion thereon.

GLOSSARY
Connivance Agreement on a secret plot, collusion
Persuasive Intended or having the power to induce action or belief, convincing.
328 FP–FA&A

Conclusive Forming an end or termination; especially putting an end to doubt or question;

“conclusive proof”; “the evidence is conclusive”
GAAP Generally Accepted Accounting Principles, a collection of rules and procedures and
conventions that define accepted accounting practice; includes broad guidelines as
well as detailed procedures.
Statutory Relating to or created by statutes; “statutory matters”; “statutory law”. Statute means a
law enacted by a government.
Corroborative To strengthen or support with additional evidence.

SELF-TEST QUESTIONS
1. What is the meaning of Auditing?
2. What are the principal aspects to be covered in auditing?
3. Why the need of auditing arises and what are benefits of auditing?
4. “The evidences obtained by the auditor are persuasive rather than conclusive”. Explain.
5. What do you mean by investigation and how it is different from auditing?

SUGGESTED READINGS
1. Fundamentals of Auditing – By Kamal Gupta
2. Auditing: Principles and Practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
 Lesson 11 Types of Auditing 329

Lesson 11
Types of Audit

LESSON OUTLINE
LEARNING OBJECTIVES
– Internal Audit In the last lesson the meaning, benefits and
– Advantages of Internal Auditing
limitations of audit is discussed. Here, we will see
– Benefits of Internal Auditing
the different types of audit. The requirement of
– Limitations of Internal Auditing
getting the books of accounts audited became
– Review Questions
mandatory due to legislation. The nature and
– Financial Audit
scope of audit vary due to various factors such
– Secretarial Audit
as the size of organisation, the strength of internal
– Cost Audit
control system, legal requirement etc. In internal
– Tax Audit
Audit, the books of accounts may be audited by
– Review Questions
internal department of the organisation while in
– Bank Audit
– Co-operative Society Audit other types of audit; such as statutory audit,

– Trust Audit secretarial audit, cost audit, tax audit, bank audit,

– Insurance Audit insurance audit, co-operative society audit, trust

– Partnership Audit audit, sole proprietorship audit etc. the audit is

– Sole Proprietorship Audit, etc. done by independent person. In internal audit the
– Government Audit area of work is determined by the management
– Management Audit whereas in other types of audit the area of work
– Functional Audit is determined by the legislation.
– Propriety Audit
In this lesson, you will learn the different types of
– Efficiency Audit
audit such as internal audit, financial audit, tax
– Lesson Round Up
audit, secretarial audit, cost audit, bank audit, trust
– Glossary
audit, insurance audit, etc.
– Self-Test Questions

Companies will not receive a rubber stamp certification; this is an in-depth program that requires an exhaustive
and thorough audit of one’s processes.
John Kania
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INTRODUCTION
Up to early decades of Twentieth Century, Auditing exercise was considered limited to auditing of books of
accounts i.e. finance audit, internal audit. After the advancement of trade/technology various types of audit have
come into existence i.e. operation audit, management audit, efficiency audit, propriety audit, information system
audit etc. Types of audit depend upon various factors such as the nature of work undertaken, approach used for
conducting audit, organization structure, legal requirements etc. The different types of audit have different
objectives. Here, now we will study the different types of audit along with their characteristics, merits and limitation.

TYPES OF AUDIT

AUDIT UNDER THE COMPANIES ACT, 2013

Companies Act, 2013 is focused on transparency and disclosure and gives audit its due recognition. In the new
Act, attempt has been made to cover each aspect of corporate functioning under audit by prescribing various
types of audits like internal audit and secretarial audit.

Statutory Audit
Statutory Audit is often called financial Audit. Independent financial audit is generally conducted to ascertain
whether the Balance Sheet and Profit & Loss Account presents a true and fair view of the financial position
and working result of the organization under audit. The need for financial audit arises as the control of the
company is vested in the hands of the management of the company and the financial statements are also
prepared by the management. The owners (shareholders), therefore, need assurance that the financial
statements prepared by the management are reliable. The opinion of the auditor – an independent expert –
assures the owners about the reliability of the financial statements. Similarly, investors wish to invest their
moneys in the shares of companies on the basis of their profitability and financial position. They will also place
greater reliance on financial statements if they have been audited. Other users of financial statements, e.g.,
trade creditors, banks, financial institutions, tax authorities, other government authorities, labour unions, etc.,
also place greater reliance on audited accounts.
Sections 139 to 147 under chapter X of the Companies Act, 2013 contain provisions regarding statutory audit
and auditors. Section 139 contains that at the first annual general meeting every company shall appoint an
individual or firm as it auditor who will hold office from the conclusion of that meeting till the conclusion of the
sixth annual general meeting. Section 141 contains that a person shall be eligible for appointment as an auditor
of a company only if he is a chartered accountant and in case of a firm whereof majority of partners practising in
India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company.
Section 143 which contains provisions regarding powers and duties of auditors contains that the statutory auditor
shall make a report to the members of the company on the accounts and financial statements examined by him.
The main provisions regarding statutory audit are:
• Auditor will have access to books of accounts and vouchers etc. at all times and he can seek information
from officers of the company as he may deem necessary.
• In his report he must state, besides other things, whether the financial statements represent a true and
fair view of the state of company’s affairs as at the end of the financial year.
• In case of any qualifications in the audit report, the reason for same must be stated in the report.
• Auditor is required to comply with Auditing Standards.
• In case auditor suspects any fraud, he must immediately report the same to the Central Government.
 Lesson 11 Types of Auditing 331

Internal Audit
Section 138 of the Companies Act, 2013 contains provisions regarding internal audit. As per Companies Act,
2013, certain class or classes of company as may be prescribed shall appoint an internal auditor who will
conduct an audit of the functions and activities of the company and make a report thereon to the Board of
Directors. Any chartered Accountant (except statutory auditor of the company) or Cost Account or other
professional as may be decided by the Board, can be appointed to conduct the internal audit.
According to Rule 13 of The Companies (Accounts) Rules, 2014 following class or classes of companies shall
be required to appoint an internal auditor or firm of internal auditors, namely:
(a) Every listed company;
(b) Every unlisted public company having-
(i) Paid up share capital of 50 crore rupees or more during the preceding financial year; or
(ii) Turnover of 200 crore rupees or more during the preceding financial year; or
(iii) Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore
rupees or more at any point of time during the preceding financial year; or
(iv) Outstanding deposits of 25 crore rupees or more at any point of time during the preceding financial
year; and
(c) Every private company having-
(i) Turnover of 200 crore rupees or more during the preceding financial year; or
(ii) Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore
rupees or more at any point of time during the preceding financial year:
The rules also provide that every existing company covered under above criteria in Financial Year 2013-14 shall
comply with requirements of Section 138 and Rule 13 of Companies (Accounts) Rules, 2014 before 30th
September, 2014 (within 6 months of the commencement of Section 138, i.e. 01st April, 2014).

Secretarial Audit
Secretarial Audit is a compliance audit and it is a part of total compliance management in an organisation. The
Secretarial Audit is an effective tool for corporate compliance management. It helps to detect non-compliance
and to take corrective measures.
Secretarial Audit is a process to check compliance with the provisions of various laws and rules/regulations/
procedures, maintenance of books, records etc., by an independent professional to ensure that the company
has complied with the legal and procedural requirements and also followed the due processes. It is essentially
a mechanism to monitor compliance with the requirements of stated laws.
A Company Secretary in Practice has been assigned the role of Secretarial Auditor under section 2(2)(c)(v) of
the Company Secretaries Act, 1980.
Ever-increasing complexities of laws and responsibilities of directors (especially non-executive directors) make
it imperative that a Practicing Company Secretary (PCS) reports whether or not there exists proper compliance
mechanism and systems in the corporate structure. PCS has also to verify whether diverse requirements under
applicable laws have been duly complied with or not and if there is a need for any corrective measures or
improvement in the system.
Secretarial Audit on a continuous basis would help the company in initiating corrective measures and strengthening
its compliance mechanism and processes. It is recommended that the Secretarial Audit be carried out periodically
(quarterly / half yearly) and adverse findings if any, be communicated to the Board for corrective action.
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The multiplicity of laws, rules, regulations, etc. has necessitated introduction of a compliance management
system to ensure compliances of laws applicable to a company. This has a two-fold objective:
(a) Firstly, to protect the interests of all the stakeholders;
(b) Secondly, to avoid any legal action against the company and its management.
As of now Secretarial Audit is not mandatory on the Companies. However, it is optionally undertaken by the
companies for maintaining good Corporate Governance practices.
Secretarial Audit is a new requirement which has been prescribed under Section 204 of the Companies Act,
2013. The provisions regarding secretarial audit are as follows :
• Every listed company and other class of companies as may be prescribed is required to annex to the
Board’s Report, a Secretarial Audit Report.
• Secretarial Audit has to be conducted by a Practising Company Secretary in respect of the secretarial
and other records of the company.
• Company is required to give all necessary information and assistance to the Practising Company Secretary
to conduct the audit.
• The Board is required to provide explanation in the Board’s Report to every qualification, observation or
other adverse remark made by the company secretary in his report. The secretarial Auditor will submit
his report in Form MR- 3
As per Section 143(14), all provisions regarding rights, duties and obligations of statutory auditors shall also
apply to Company Secretary in Practice conducting secretarial audit.

Cost Audit
The Institute of Cost and Works Accountants of India defines cost audit as “a system of audit introduced by the
Government of India for the review, examination, and appraisal of the cost accounting records and attendant
information, required to be maintained by specified industries.” According to CIMA, London, cost audit is “the
verification of the correctness of cost accounts and of adherence to the Cost Accounting plan.” Thus cost audit
comprises of:
(i) The verification of the cost accounting records such as the accuracy of the cost accounts, cost reports,
cost statements, cost data, costing techniques and
(ii) Examining these records to ensure that they adhere to the cost accounting, plans, procedures and
objectives.
Ministry of Corporate Affairs has issued mandatory cost audit orders on Companies engaged in Bulk drugs,
fertilization, sugar, telecommunications, industrial alcohol, and electricity & petroleum and if in immediate previous
year aggregate value of Net Worth exceeds the specified limits.
The cost auditor has to judge :
(i) Whether the planned expenditure is designed to give optimum results.
(ii) Whether the size and channels of expenditure were designed to produce the best results, and
(iii) Whether the return from expenditure on capital as well as current operations could be improved by
some other alternative plan of action.
Cost Audit is useful for the purpose of Cost Control; Cost reduction and proper utilization of scarce resources.
Moreover, cost audit also ensures that proper records are kept as to purchases and utilisation of material and
expenses incurred on wages, overheads, etc. It also ensures that the unit has been run economically and efficiently.
 Lesson 11 Types of Auditing 333

Section 148 of the Act contains provisions regarding cost audit and contains that a cost audit wherever conducted
is in addition to statutory audit conducted under section 143.
The main provisions regarding cost audit as contained in the Act are :
• Certain class of companies engaged in the production of such goods or providing such services as may
be prescribed and which have a net worth or turnover of such amount as may be prescribed may be
directed to get their cost audit records audited.
• Cost audit has to be conducted by a Cost Accountant in Practice who is required to comply with cost
auditing standards
• It shall be the duty of the company to give all assistance and facilities to the cost auditor.
• As per Section 143(14), the qualifications, disqualifications, rights, duties and obligations applicable to
statutory auditors will also apply to a cost auditor.
·• Cost auditor has to submit his report to the Board of Directors who in turn shall file it with the Central
Government within 30 days of the receipt of the report.

OTHER FORMS OF AUDIT

Tax Audit
In India, the Income Tax Act, 1961, Section 44AB provides for the compulsory audit of the accounts of certain
income tax assessee whose turnover or receipts exceed the specified limits. The objective of such audit is to
assist the tax authorities in making the correct income tax assessment of the assessee concerned. The tax
auditor has to specifically report on certain transactions which have an effect on the income tax liability of the
assessee concerned and are, thus important to the tax authorities. The income tax act 1961 also contains
various other provisions whereby audit report is required to be submitted to get certain deductions, exemptions
etc.
As per the income tax Act, every person carrying on business whose turnover or gross receipts exceeds Rs.
1,00,00,000 (Rs. 25,00,000 if carrying on profession) in the previous year shall get his accounts audited.

Bank Audit
The huge amount of public monies handled by the banks, make it imperative that the activities of the industry are
closely monitored and regulated without strangulating the spirit of entrepreneurship. Audit forms an integral and
important part of such monitoring and regulation. The Auditors have to certify that statement of accounts of the
bank as at the closure of the financial year reveal true and fair view of the Bank’ financial position, adequate
provision for Non-Performing Asset(NPA)/bad debts has been made in the books. All expenses/income have
been duly accounted for and profit is correctly worked out. The Banking Regulation Act, 1949 contains the
provisions relating to the maintenance of accounts and their audit.

Co-Operative Society Audit

There are certain features of co-operative which are similar to those of companies. As in the case of companies,
in co operative societies also, there is a separation of ownership from manage­ment while the capital of a co-
operative society is contributed by all the members. The management of its affairs is in the hands of only some
of the members’ elected for this purpose. This necessitates an independent financial audit of accounts of co-
operative societies. Considering this, audit of co­operative societies is required by law in India. However, an
important feature of co operative societies is that, unlike most companies, the affairs of co-operative societies
are often managed by persons who do not possess adequate managerial, technical or accounting skills. The
independent financial auditors of co-operative societies are, therefore, required to report on some of these
aspects also.
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Insurance Audit
The insurance audit is an examination of the operations, records and books of account of the insurance company.
Auditor performs an audit to ensure that the customer has paid the appropriate premium for risk cover provided
to him. The auditor should be conversant with the provisions of the Insurance Regulatory and Development, Act
1999 which contains the provision of the maintenance of accounts and audit of the insurance companies.

Partnership Firm Audit

Partnership Act, 1932 does not provide compulsory audit of Partnership Firms in India. But on satisfying the
prescribed criterion, partnership firms are required to get their accounts audited under the provisions of Income
Tax Act, 1961. Many partnership firms voluntarily gets their accounts audited as audited accounts helps in
proper valuation of goodwill, distribution of share of the deceased Partner to their legal heirs etc. The audited
accounts are also useful to get the loan sanctioned from the banks. The audit should be carried out as per the
terms of partnership deed and Partnership Act.

Sole Proprietorship Audit

Like partnership firms, sole proprietary concerns are also not legally required to get their financial statements
audited by independent financial auditors but on satisfying the prescribed criterion, partnership firms are required
to get their accounts audited under the provisions of Income Tax Act, 1961. However, many such concerns get
their financial statements audited voluntarily as it helps the sole proprietor to manage its books of accounts
properly and the audited books of accounts are relied well by the statutory authority, banks, insurance companies
etc.

Government Audit
Government audit aims at ensuring that the financial transactions of the government are executed properly
under sanctions and authorities and are correctly recorded in the books of accounts. It is the duty of Comptroller
and Auditor General of India (C&AG) to audit the receipts and expenditure of the Union Government and State
Government.
Further, government audit also includes the audit of government companies conducted by C&AG in accordance
with the provisions of Companies Act, 2013 and other relevant legislations.

Management Audit
Management audit is an emerging concept of auditing. It has been originated from America. Management audit
is an act of evaluation of all the activities of all the departments with a view to provide appropriate suggestions
to the management to help their work. In other words, management auditing is a future oriented task which
evaluates timely in all the levels of management like production management, sales management etc. The main
objective of management audit is to improve the profit earning capacity, work of management, objectives of
program, social objectives and human resource development so that organizational goal can be easily attained.
It refers to the existence of control system, compliance of rules and regulations, process of managerial decisions
etc. Generally management audit/operational audit are not mandatory but it recommendatory certainly.

Functions Of Management Audit

Management audit is a difficult and complex task. It performs the following functions:
1. Management audit identifies the objectives of an organization if such objectives are not set up.
2. Management audit allocates the overall objectives of an organization in small parts.
3. Management audit reviews the structure of organization and asset of the organization and decides
whether goals can be obtained or not.
 Lesson 11 Types of Auditing 335

4. Management audit examines all the scope of work and liability centers.
5. Management audit provides valuable suggestions to the management after the evaluation of all above
facts.

Propriety Audit
Kohler has defined propriety as that which meets the test of public interest, commonly accepted customs and
standard of conduct and particularly as applied to professional performance, requirements of Govt. regulations
and professional codes . Propriety Audit would mean whether the transactions have been done in conformity
with established rules, principles and some established standard.
The Propriety Audit would mean the verification of following main aspects to find out whether:
(i) Proper recording has been done in appropriate books of accounts.
(ii) The assets have not been misused and have been properly safeguarded.
(iii) The business funds have been utilized properly.
(iv) The concern is yielding the expected results.
The system of Propriety Audit is applied in respect to Government companies Government Department because
public money and public interest are therein involved. It is an essential function of Audit to bring to light not only
cases of clear irregularity but also every matter which in its judgement appears to involve improper expenditure
or waste of public money or stores, even though the accounts themselves may be insufficient to see that sundry
rules or orders of competent authority have been observed. It is of equal importance to ensure that the broad
principles of orthodox finance are borne in mind not only by disbursing officers but also by sanctioning authorities.

Efficiency Audit
In essence, efficiency indicates how well an organization uses its resources to produce goods and services. It
focuses on resources (inputs), goods and services (outputs), and the rate (productivity) at which inputs is used
to produce or deliver the outputs. To understand the meaning of “efficiency”, it is necessary to understand the
following terms: inputs, outputs (including quantity and quality), productivity, and level of service.
Inputs are resources (e.g., human, financial, equipment, material, facilities, information, energy and land) used
to produce outputs
Outputs are goods and services produced to meet client needs. Outputs are defined in terms of quantity and
quality and are delivered within parameters relating to level of service
Quantity refers to the amount, volume, or number of outputs produced.
Quality refers to various attributes and characteristics of outputs such as reliability, accuracy, timeliness, service
courtesy, safety, and comfort.
Productivity is the ratio of the amount of acceptable goods and services produced (outputs) to the amount of
resources (inputs) used to produce them. Productivity is expressed in the form of a ratio such as cost or time per
unit of output.
Efficiency is a relative concept. It is measured by comparing achieved productivity with a desired norm, target, or
standard. Output quantity and quality achieved and the level of service provided are also compared to targets or
standards to determine to what extent they may have caused changes in efficiency. Efficiency is improved when
more outputs of a given quality are produced with the same or fewer resource inputs, or when the same amount
of output is produced with fewer resources.
Efficiency audit refers to comparing the actual results with the desired/projected results. It is directed towards
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the measurement of whether plans have been effectively executed. It is concerned with the utilisation of the
resources in economic and most remunerative manner to achieve the objectives of the concern. It comprises
of studying the plans of organisation, comparing actual performance with plans and investigating the reasons
for variances to take remedial action

LESSON ROUND UP
In this lesson, we have discussed various types of audit such as internal audit, financial audit, secretarial
audit, cost audit, tax audit etc.
– Internal Audit- Internal audit is an evaluation and analysis of the business operation conducted by the
internal audit staff. It is the part of overall system of internal control established in an organization.
– Objective of Internal Audit- proper control, accounting system, help management, working review,
asset protection, internal check, fair statements, check error, detect fraud, determine liability, help in
independent audit, performance appraisal, provide suggestions, new ideas, use of resources, accounting
policies, special investigation.
– Benefits of Internal Audit- proper accounting system, better management, progressive review, effective
control, assets protection, division of work, no error and fraud, fixing responsibility, helps external
auditing, performance improves, investigation, proper use of resources.
– Limitations of Internal Audit- staff shortage, time lag, error, responsibility, duties.
– Financial Audit- Independent financial audit is generally conducted to ascertain whether the balance
sheet and profit & loss account present a true and fair view of the financial position and working result
of the organization under audit.
– Secretarial Audit- Secretarial Audit is a process to check compliance with the provisions of various
laws and rules/regulations/procedures, maintenance of books, records etc., by an independent
professional to ensure that the company has complied with the legal and procedural requirements and
also followed the due process. It is essentially a mechanism to monitor compliance with the requirements
of stated laws. A Company Secretary in Practice has been assigned the role of Secretarial Auditor
under section 2(2)(c)(v) of the Company Secretaries Act, 1980.
– Cost Audit- A system of audit introduced by the Government of India for the review, examination, and
appraisal of the cost accounting records and attendant information, required to be maintained by specified
industries.
– Tax Audit: The objective of such audit is to assist the tax authorities in making the correct income tax
assessment of the assesses concerned.
– Bank Audit: The Banking Regulation Act, 1949 contains the provisions relating to the maintenance of
accounts and their audit.
– Co-Operative Society Audit: The management of the affairs of the co-operative societies is in the
hands of only some of the elected members. This necessitates an independent financial audit of accounts
of co-operative societies.
– Insurance Audit: Insurance Regulatory and Development, Act 1999 contains the provision of the
maintenance of accounts and audit of the insurance companies.
– Partnership Firm Audit: At present, partnership firms in India are not legally required to get their
financial statements audited. Still, many firms get their financial statements audited
– Sole Proprietorship Audit: Like partnership firms, sole proprietary concerns are also not legally required
to get their financial statements audited by independent financial auditors.
 Lesson 11 Types of Auditing 337

– Government Audit: It is the duty of Comptroller and Auditor General of India (C&AG) to audit the
receipts and expenditure of the Union Government and State Government.
– Management Audit: It is a structured review of the systems and procedures of an organization in
order to evaluate whether they are being conducted efficiently and effectively.
– Propriety Audit: Under this type of audit, the expenditure is analyzed with a view to ascertain the
cases of improper, avoidable or in fructuous expenditure even though the expenditure has been incurred
in conformity with the existing rules and regulations.
– Efficiency Audit: Efficiency audit or performance audit is a form of audit which is being carried out for
ascertaining the efficiency/performance of a system/process/input.

GLOSSARY
Constructive Arm Improve or promote development
Independence Free from the influence, guidance, or control of another or others; self-reliant:
an independent mind.
Practicing Company The member of ICSI who hold certificate of practice.
Secretary
Check An action or influence that stops motion or expression; a restraint

SELF-TEST QUESTIONS
1. What are the types of audit? Explain in brief.
2. What is meant by Internal Audit and what are its benefits and limitations?
3. What is meant by Financial Audit?
4. What is the difference between Internal Audit and Financial Audit?
5. What is Secretarial audit and who can be appointed as secretarial auditor?
6. What are the objectives of secretarial audit?
7. What do you mean by tax audit and on whom it is applicable?
8. What is cost audit and explain its usefulness in brief?

SUGGESTED READINGS
1. Fundamentals of Auditing – By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu