A Project On Auditing

Introduction about auditing

Auditing means to inspect, examine, checking, investigate, scrutinize, company accounts. Auditing
is a systematic examination and verification of firms books of accounts, transactions records, other
relevant documents and physical inspection of inventory by qualified accountants called auditors.
Economic decisions in every society must be based upon the information available at the time the
decision is made. For example, the decision of a bank to make a loan to a business is based upon
previous financial relationships with that business, the financial condition of the company as
reflected by its financial statements and other factors. If decisions are to be consistent with the
intention of the decision makers, the information used in the decision process must be reliable.
Unreliable information can cause inefficient use of resources to the detriment of the society and to
the decision makers themselves.

In the lending decision example, assume that the barfly makes the loan on the basis of misleading
financial statements and the borrower Company is ultimately unable to repay. As a result the bank
has lost both the principal and the interest. In addition, another company that could have used the
funds effectively was deprived of the money. As society become more complex, there is an
increased likelihood that unreliable information will be provided to decision makers. There are
several reasons for this: remoteness of information, voluminous data and the existence of complex
exchange transaction As a means of overcoming the problem of unreliable information, the
decision-maker must develop a method of assuring him that the information is sufficiently reliable
for these decisions. In doing this he must weigh the cost of obtaining more reliable information
against the expected benefits.

A common way to obtain such reliable information is to have some type of verification (audit)
performed by independent persons. The audited information is then used in the decision making
process on the assumption that it is reasonably complete, accurate and unbiased.
 The term audit is derived from the Latin term ‘audire,’ which means to hear. In early days an
auditor used to listen to the accounts read over by an accountant in order to check them Auditing
is as old as accounting. It was in use in all ancient countries such as Mesopotamia, Greece, Egypt.
Rome, U.K. and India. The Vedas contain reference to accounts and auditing. Arthasashthra by
Kautilya detailed rules for accounting and auditing of public finances. The original objective of
auditing was to detect and prevent errors and frauds Auditing evolved and grew rapidly after the
industrial revolution in the 18th century With the growth of the joint stock companies the
ownership and management became separate.

The shareholders who were the owners needed a report from an independent expert on the
accounts of the company managed by the board of directors who were the employees. The
objective of audit shifted and audit was expected to ascertain whether the accounts were true and
fair rather than dedection of errors and fraud. The primary purpose of the audit is to confirm the
authenticity of books of accounts prepared by an accountant. It simply refers to the evaluation of
business book of accounts and vouchers. It is done to make sure whether all financial transactions
are recorded accurately. It is the process of a detailed examination of financial records of the
business to checks their accuracy and whether they follow the prescribed rules and regulations. It
reveals errors from books of accounts of organizations.

It aims at checking fairness of financial records and prevention of frauds. This examination is
totally unbiased and conducted by independent person. The person doing auditing should be
qualified for job to perform it with accuracy. This can be performed either by internal employees
of business or the person who are external to business. Auditing is conducted continuously at
regular intervals by auditor. The audit is an intelligent and critical examination of the books of
accounts of the business. Auditing is done by the independent person or body of persons qualified
for the job with the help of statements, papers, information and comments received from the
authorities so that the examiner can confirm the authenticity of financial accounts prepared for a
fixed term and report that: • The balance sheet exhibits an accurate and fair view of the state of
affairs of concern; • The profit and loss accounts reveal the right and balanced view of the profit
and loss for the financial period.
The accounts have been prepared in conformity with the law. Thus, it will be seen that the duty of
an auditor is much more than a mere comparison of the balance sheet and accounts with the books.
But, apart from doing this, he has to satisfy himself according to his information and the
explanations given to him

The origin of auditing can be traced to Italy. Around the year 1494, Luca Paciolo introduced the
double entry system of bookkeeping and described the duties and responsibilities of an Auditor.

Auditing in India

Let us now understand the growth of auditing in India. The Indian Companies Act, 1913,
prescribed for the first time the qualifications of an Auditor. The Government of Bombay was the
first to conduct related courses of study such as the Government Diploma in Accountancy (GDA).

The Auditor’s Certificate Rule was passed in 1932 to maintain uniform standard in Accountancy
and Auditing. The Chartered Accountant Act was enacted by the Parliament of India in 1939. The
Act regulates that a person can be authorized to audit only when he qualifies in the examinations
conducted by The Institute of Chartered Accountants of India.

Following are a few other points related to Auditing in India –

• Members of Institute of Cost and Works Accountant of India are authorized to conduct cost
audit according to Section 233-B of the Companies Act, 1956.
• Companies Act 1931 was replaced by Companies Act 1956.

• An Auditor can be appointed only by a special resolution as per section 224 The Companies
(amendment) Act, 1974.
According to accounting historian John L. Carey, a former administrative vice president of the
AICPA (known before 1957 as the American Institute of Accountants), audits were required by
law in England as early as 1845 to protect shareholders from “improper actions by promoters and
directors.” But there was no organized profession of accountants or auditors, no uniform auditing
standards or rules, and no established training or other qualifications for auditors, and they had no
professional status. Interestingly, however, auditors were required under British law to be
stockholders in order to have a stake in the audit client entity, a common interest with those that
they were engaged to protect, but be independent in other significant respects (The Rise of the
Accounting Profession: From Technician to Professional, 1896–1936, AICPA, New York, N.Y.,
1969, pp. 17–18).
So prior to the 1930s, the direction and scope of auditing was solely determined at the discretion
of the auditor; until the enactment of the federal securities laws, it was clearly focused primarily
on the detection of fraud, a subject that continues to receive a great deal of attentionIn his brief,
historical editorial message of February 2015, “Then and Now—A Celebration of 85 Years of The
CPA Journal,” (https://bit.ly/3mFBXWL), Editor-in-Chief Richard

H. Kravitz pointed out that the “most important crossroads, of course, was the enactment of the
Securities Acts of 1933 and 1934, and the establishment of the Securities and Exchange
Commission (SEC).” As Kravitz mentions, another landmark event near the end of that decade
was the highly publicized McKesson & Robbins audit scandal, which led to an SEC investigation
and inspired the 1939 issuance of the first authoritative auditing standard, Statement on Auditing
Procedure (SAP) 1.

Because of the vast wealth of detailed, scholarly, and well-documented research available covering
this long, rich, and complicated history, this article, of practical necessity, is not an exhaustive,
academic analysis such as are several of the sources cited but rather is greatly summarized and
comprises only highlights as necessary in the author’s judgment to keep it interesting and readable.
Unfortunately, due to these limitations, many significant details, events, and developments were
unavoidably omitted.

The Early Beginnings of Financial Auditing—Pre-1930

According to accounting historian John L. Carey, a former administrative vice president of the
AICPA (known before 1957 as the American Institute of Accountants), audits were required by
law in England as early as 1845 to protect shareholders from “improper actions by promoters and
directors.” But there was no organized profession of accountants or auditors, no uniform auditing
standards or rules, and no established training or other qualifications for auditors, and they had no
professional status. Interestingly, however, auditors were required under British law to be
stockholders in order to have a stake in the audit client entity, a common interest with those that
they were engaged to protect, but be independent in other significant respects .The Rise of the
Accounting Profession: From Technician to Professional, 1896–1936, AICPA, New York, N.Y.,
1969, pp. 17–18). So prior to the 1930s, the direction and scope of auditing was solely determined
at the discretion of the auditor; until the enactment of the federal securities laws, it was clearly
focused primarily on the detection of fraud, a subject that continues to receive a great deal of
attention.

One of the earliest and most widely used comprehensive, influential, and durable (albeit
nonauthoritative) sources of “practical” guidance for U.S. auditors was Auditing Theory and
Practice, by Robert H. Montgomery, first published in 1912 and later known simply as
Montgomery’s Auditing (the latest version, the 13th edition, was published in 2008). Prior to 1912,
however, the principal source of auditor guidance in the United States was an American edition of
a work first published in 1892 by English professor Lawrence R. Dicksee, entitled Auditing: A
Practical Manual for Auditors, re-edited in 1909 by Montgomery. Unprophetically (or not),
Montgomery wrote in the preface to the 1905 American edition of Dicksee’s work: “It cannot be
expected that any hard and fast rules will ever prevail, nor is it desirable that the personal element
in an audit should be superseded by instruction prepared in advance.
” So at the dawn of the 20th century, Montgomery was campaigning against rules-based auditing
standards and checklist-driven audits―way ahead of his time! The U.S. federal income tax on
individuals had a rocky start during the Civil War (with the Revenue Act of 1861); it was not made
permanent until 1913 when the 16th Amendment to the Constitution was ratified. A 1% tax on
income of corporations went into effect in 1909.

Because of the relative insignificance of the early income tax, and despite the then primitive stage
of development of the auditing profession, Montgomery asserted in the 1912 preface to the first
edition of his auditing text that auditing was “the most important branch of accountancy.”

At first, “even though the first income tax rates were low and collections were minimal the mere
existence of an income tax affected the accounting profession almost immediately” (Ray M. Some
field and John E. Easton, “The CPA’s Tax Practice Today―and How It Got That Way,” Journal of
Accountancy, Centennial Issue, May 1987, AICPA, p. 169). Accordingly, in a new preface to his
second edition in 1916, Montgomery recognized that the “income tax is here to stay,” and he
referred to “the growing importance and complexity of the subject,” but he did not modify his
earlier statement that auditing was “the most important branch of accountancy” (Auditing Theory
and Practice, 2d ed., The Ronald Press).
 Objectives of Auditing

The objective of an audit is to express an opinion on financial statements. The auditor has to verify
the financial statements and books of accounts to certify the truth and fairness of the financial
position and operating results of the business,It is to be established that accounting statements
satisfy certain degree of reliability. Thus the main objective of auditing is to form an independent
judgement and opinion about reliability accounts and truth and fairness of financial state of affairs
and working results.

The broad objectives of audit are:

(i) to provide an unbiased, impartial and objective assessment of the reliability and fair
presentation of the financial activities and financial position of the Government in their
accounts;
(ii) to provide an assessment of the due observance of the laws, rules, procedures and systems
in keeping with the financial interests of and propriety in the functioning of the
Government; and
(iii) to provide an assessment of the achievement of economy, efficiency and effectiveness
(value for money) in the implementation of the mandated activities of the Government

Therefore, the objectives of audit are categorized as primary or main objectives and secondary
objectives.

Primary Objectives

The primary or main objective of audit is as follows:

To Examine the Accuracy of the Books of Accounts 1.

An auditor has to examine the accuracy of the books of accounts, vouchers and other records to
certify that Profit and Loss Account discloses a true and fair view of profit or loss for the financial
period and the Balance Sheet on a given date is properly drawn up to exhibit a true and fair view
of the state of affairs of the business.
Meaning of Books of Accounts

· Books of Accounts mean the financial records maintained by a business concern for a
period of one year. The period of one year can be either calendar year i.e., from 1st January to 31st
December or financial year i.e., from 1st April to 31st March. Usually, business concerns adopt
financial year for accounting all business transactions.

Books of accounts include the following: ledgers, subsidary books, cash and other account books
either in the written form or through print outs or through electronic storage devices.

To 2. Express Opinion on Financial Statements

After verifying the accuracy of the books of accounts, the auditor should express his expert opinion
on the truthness and fairness of the financial statements. Finally, the auditor should certify that the
Profit and Loss Account and Balance Sheet represent a true and fair view of the state of affairs of
the company for a particular period.

Meaning of Financial Statement

Financial Statement means the statements prepared at the end of the year taking into account the
business activities that took place for a year, for example, transactions that takes place in a business
concern from 1st April to 31st March.

Components of Financial Statement

Elements of Financial Statements include the following:

· Assets: Assets include cash and bank balance, value of closing stock, debtors, bills
receivable, investments, fixed assets, prepaid expenses and accrued income.

Liabilities: Liabilities include capital, profit and loss balance, creditors, bills payable,
outstanding expenses and income received in advance.

· Revenue: Revenue includes sales, collection from debtors, rent received, dividend, interest
received and other incomes received.

· Expenditure: Expenditure includes purchases, payment to creditors, manufacturing and

Secondary Objectives

The secondary objectives of audit are: (1) Detection and Prevention of Errors, and (2) Detection
and Prevention of Frauds.

Detection And Prevention of Errors

The Institute of Chartered Accountants of India defines an error as, “an unintentional mistake in
the books of accounts.” Errors are the carelessness on the part of the person preparing the books
of accounts or committing mistakes in the process of keeping accounting records. Errors which
take place in the books of accounts and the duty of an auditor
CLERICAL ERROR 1.

Errors that are committed in posting, totalling and balancing of accounts are called as Clerical
Errors. These errors may or may not affect the agreement of the Trial Balance.

Types of Clerical Errors:

(A) Errors of Omission:

When a transaction is not recorded or partially recorded in the books of account is known as Errors
of Omission. Usually, it arises due to the mistake of clerks. Error of omission can occur due to
complete omission or partial omission.

(1) Error of Complete Omission: When a transaction is totally or completely omitted to be

.(2) Errors of Partial Omission: When a transaction is partly recorded, it is called as “Error of

Partial Omission”. Such kind of errors can be detected easily as it will affect the agreement of the
Trial Balance.

(B) Errors of Commission:

Errors which are not supposed to be committed or done by carelessness is called as Error of
Commission. Such errors arise in the following ways:

(1) Error of Recording,

(2) Error of Posting,

(3) Error of casting, or Error of Carry-forward.

(1) Error of Recording: The error arises when any transaction is incorrectly recorded in the
books of original entry. This error does not affect the Trial Balance.
(2) Error of Posting : The error arises when a transaction is correctly journalised but wrongly
posted in ledger account.

(3) Error of casting, or Error of Carry-forward: The error arises when a mistake is committed
in carrying forward a total of one page on the next page. This error affects the Trial Balance.

ERROR OF DUPLICATION

Errors of duplication arise when an entry in a book of original entry has been made twice and has
also been posted twice. These errors do not affect the agreement of trial balance, hence it can’t
located easily.

ERROR OF COMPENSATION (or) COMPENSATING ERRORS

When one error on debit side is compensated by another entry on credit side to the same extent is
called as Compensating Error. They are also called as Off-setting Errors. These errors do not affect
the agreement of trial balance and hence it cannot be located.

ERROR OF PRINCIPLE

An error of principle occurs when the generally accepted principles of accounting are not followed
while recording the transactions in the books of account. These errors may be due to lack of
knowledge on accounting principles and concepts. Errors of principle do not affect the trial balance
and hence it is very difficult for an auditor to locate such type of errors.

In the process, audit aims to, (i) Safeguard the financial interest of the taxpayer (ii) Assist the
Parliament or State/Union Territory legislature in exercising the financial control over the
executive; and (iii) Watch the various authorities of the State set up by, or under, the constitution
act in regard to all financial matters in accordance with the constitution and the laws of parliament
and appropriate legislatures and the rules and orders issued there under. In pursuance of the
statutory responsibilities entrusted to the Comptroller and Auditor General, he is the sole authority
to decide the nature and extent of audit to be conducted by him or on his behalf. Accordingly, in
regard to certain financial transactions of a secret nature, the Comptroller and Auditor General has
agreed to modify the scope of audit to the extent prescribed in each case. It is the function of the
Executive Government to make financial rules and orders and put in place an adequate internal
control mechanism that will guard against misuse of public funds. It is the duty of audit not only
to verify that the administrative departments properly apply these internal controls but also to point
out weaknesses, if any, as may be noticed in the functioning of the control mechanisms. The
Executive Government and not the Indian Audit and Accounts department is responsible for
enforcing economy in the expenditure of public moneys. It is however, the duty of Audit to bring
to notice wastefulness in public administration and infructuous expenditure and any such criticism
may be included in the Audit Reports .