1.1 Introduction meaning and objectives of Auditing Types of audit Internal audit Audit Process Audit programme Audit and books Working papers and evidences consideration for commencing an audit Routine checking and Test checking Intern Check System Internal Control Internal auditing.

UNIT 1

Introduction

1.1 Introduction: meaning and objectives of Auditing; Types of audit; Internal audit, Audit Process: Audit programme; Audit and books Working papers and evidences; consideration for commencing an audit, Routine checking and Test checking Intern Check System: Internal Control, Internal auditing.

Introduction: meaning and objectives of Auditing

The term auditing is derived from the Latin word ‘Audrie’ which means to hear. The original objective of auditing was to detect and prevent errors. In India the companies act 1913 made audit of company accounts compulsory.

According to Spicer and Pegler “Auditing is such an examination of books of accounts and vouchers of business, as will enable the auditors to satisfy himself that the balance sheet is properly drawn up, so as to give a true and fair view of the state of affairs of the business and that the profit and loss account gives true and fair view of the profit/loss for the financial period, according to the best of the information and explanation given to him and as shown by the books; and if not, in what respect he is not satisfied”.

Prof. L.R.Dicksee. "auditing is an examination of accounting records undertaken with a view to establish whether they correctly and completely reflect the transactions to which they relate”.

OBJECTIVES OF AUDITING

There are two main objectives of auditing. The primary objective and the secondary or incidental objective.

a. Primary objective – as per Section 227 of the Companies Act 1956, the primary duty (objective) of the auditor is to report to the owners whether the balance sheet gives a true and fair view of the Company’s state of affairs and the profit and loss A/c gives a correct figure of profit of loss for the financial year.

b. Secondary objective – it is also called the incidental objective as it is incidental to the satisfaction of the main objective. The incidental objective 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.

Types of audit

Audit is the examination or inspection of various books of accounts by an auditor followed by physical checking of inventory to make sure that all departments are following documented system of recording transactions. It is done to ascertain the accuracy of financial statements provided by the organisation.

Continuous Audit

According to spicer and pegler “A continuous Audit which is also known as detailed Audit is one where the auditors staff is occupied continuously on the accounts the whole year round, or where the auditor attends at intervals, fixed or otherwise, during the currency of the financial year, and performs an interim audit; such audits are adopted where the work involved is considerable, have many points in their favour, although they are subject to certain disadvantages.” Thus, a continuous audit involves the conducting of audit of accounts throughout the year at regular intervals, fixed or otherwise, of say, one month or months. The accounts in such a case are subjected to audit as and when they are prepared. Such an audit is necessary only for big business houses.

Continuous Audit is applicable in case of following business concerns:

(i) Where final accounts are prepared just after the close of the financial year, as in the case of a bank.

(ii) Where the transactions are many in number and thus it becomes necessary to get them audited at regular intervals.

(iii) Where the system of internal check in operation is not satisfactory.

(iv) Where the statements of accounts are prepared after every month or quarter to be presented.

(v) Where sales effected are very large.

2. Interim Audit

Interim audit is one which is conducted in between the two annual audits for some interim purpose, say, to enable a company to declare an interim dividend. This kind of audit involves a complete checking of the accounts prepared by a company for a part of the year to the date set of interim accounts, say, quarterly or half-yearly accounts.

3. Balance Sheet Audit

A balance sheet audit is an evaluation of the accuracy of information found in a company's balance sheet. After a balance sheet audit, you can use the analyses to detect irregularities or weaknesses in your company's accounting system.

Under such an audit, the auditor checks capital, reserves, assets, liabilities, etc., given in the Balance Sheet. Those items of Trading and Profits and Loss Account are also checked which have a bearing on the Balance Sheet items. For example, the purchase of goods on credit will increase the liabilities to creditors, increase the stock and will be shown in the Trading Account as an increase in purchases and closing stock. So this item will have to be verified. This type of audit can be successful in those business concerns where efficient system of internal check and control is in operation. Such an audit is popular in U.S.A.

Concurrent audit:

Usually concurrent audit is conducted for bank branches, depending upon the quantum of advances given. It also depends upon bank to bank and their risk taking capability. Concurrent audit is conducted to monitor day to day bank operations so that all the compliances and security measures are being followed. Concurrent audit involves daily account opening checking, cash balance, income leakage, BCP & DRP analysis, NPA tracking, laws compliance compliance, various authorisations and all.

In some particular banks, scope of concurrent audit is very well defined to focus on the areas they are most concerned with. Now a days more and more branches are coming under the review of concurrent audit due to alarming rise of NPAs in all banks. So now banks are hiring more and more concurrent auditors to ensure their operational efficiency and profitability.

Annual Audit

Kind of audit whether the author verifies the account at the end of every financial year. This is a common audit and is mostly used by small organisations.

Internal audit

MEANING

SA 610 issued by the Institute of Chartered Accountants of India (ICAI) defines Internal Audit as follows: Internal audit is a separate component of internal Control established to determine whether other Internal controls are well designed and properly operated.

OBJECTIVES

Review of accounting system and Internal controls

Examination of Accounting controls

Examinations of Operational controls

Physical verification

SCOPE / FUNCTIONS OF INTERNAL AUDIT

Monitoring of internal control

Examination of financial and operating information

Review of operating activities

Review of compliance with laws and regulations

Risk management

Governance

BASIC PRINCIPLES GOVERNING INTERNAL AUDIT

Standard on Internal Audit (SIA) 2, Basic principles Governing Internal audit, issued by the Council of the Institute of Chartered Accounts of India lays down the following:

(SAME AS THE PRINCIPLE OF AUDIT)

INTERNAL AUDIT VS. EXTERNAL AUDIT

TOPIC	INTERNAL AUDIT (IA)	STATUTORY AUDIT (SA)
Voluntary / Compulsory	IA is Voluntary	SA is compulsory under law e.g. under Companies Act.
Appointment	Internal Auditor is appointed by the management itself.	Statutory Auditor is appointed by the shareholders of a Company.
Status	Internal Auditor is an employee of the concern.	Statutory Auditor is an independent outside expert.
Responsible & reports to	Internal Auditor is responsible and reports to management.	Statutory Auditor is responsible and reports to shareholders.
Scope of duties	Management decides the scope of duties of internal Auditor. It includes non accounting matters.	Duties of statutory auditor are laid down by law (e.g. Companies Act) its scope limited to accounting matters.
Removal	Internal auditor can be removed by the management on its own.	Statutory Auditor can be removed by shareholders only if approved by central Government.
Objectives	IA aims to review the internal control system of concern.	SA aims to report to shareholders whether the accounts are true and fair.
Period	IA is continuous.	SA is normally periodical or annual.
Qualifications	No qualifications are prescribed by law for an Internal Auditor.	Qualifications are prescribed by law for Statutory Auditor.
Liability for Negligence	Internal Auditor is liable only to management and not to shareholders or third parties.	Statutory Auditor is liable to shareholders and in some cases to third parties also.

INTERNAL AUDIT VS. INTERNAL CHECK

TOPIC	INTERNAL AUDIT	INTERNAL CHECK
Aims	Aims to determine whether other internal controls are working properly.	Aims to distribute responsibilities and work to help cross-checking.
Part of	Part of internal control.	Part of Internal control.
Separate staff	Separate staff is appointed to carry out internal audit.	No separate staff is appointed to carry out Internal Check.
When	Internal audit is done after the work is complete.	Internal Check is done during the work.
Purpose	Internal audit may detect errors or frauds.	Internal check may prevent errors or frauds.

Audit Process: Audit programme

Audit process

1. One must take care to ensure that nothing is missed in the process which needs to be followed to achieve the audit objective. The following audit process in that order may be taken as a specimen:

2. Formulating audit plan and laying down broad framework for conducting the work and method to ensure control over the quality of work.

3. Examination and evaluation of the nature, extent and efficacy of the system of internal control. The nature, extent and timing of substantive procedures, would depend upon the extent of satisfaction an auditor obtains after evaluating the internal control system. The determination of extent of test checking would also depend upon the same.

4. Ascertaining the arithmetical accuracy of the books of account by checking posting, casting, crass-casting, carry forwards, opening and closing balances, etc.

5. Examining the documentary evidence (both internal and external) and the authority in support of the transaction, i.e. vouching.

6. Checking the validity of transactions with reference to:

a) Provisions affecting the accounts and audit in any Act or Rules;

b) Rules and regulations governing the constitution and management of the organisation i.e., the memorandum and articles of association in the case of a company, partnership deed in the case of a firm, trust deed in the case of a trust and bye-laws in the case of a co-operative society;

c) Minute books for appropriate sanction of the transactions by competent authority;

d) Other legal documents such as the prospectus, returns submitted to legal authorities, contracts and agreements e.g., vendors’ agreement, lease agreement, selling agency agreement, collaboration agreements, etc; and

e) Well recognized accounting principles and practices e.g., distinction between capital and revenue, accrual system of accounting, valuation principles, etc.

7. Ensuring that there is adequate disclosure of information and, in particular, the annual accounts are prepared in such a manner as to convey the real picture about the assets and liabilities and of the operating result (profit or loss) of the organisation. For this purpose, the auditor must conform to the prescribed legal requirement, if any, as to the form of accounts and have due regard to the best current accounting practice. Reference to Schedule III of the Companies Act, 2013 in case of companies and compliance with accounting standards will have to be seen.

8. Verification of existence, ownership, title and value of the assets and determination of the extent and nature of liabilities.

9. Scrutiny of the accounts to establish reasonableness, consistency and compliance with the legal requirements.

10. Application of various overall checks in order to test the overall reliability of the accounting records and the statements and to see whether the results of overall checks corroborate the findings already made.

11. Determination of the significant accounting ratios and subjecting the accounts to ratio analysis to locate the areas showing departure from the expected state of affairs .Audit and books Working papers and evidences consideration for commencing an audit, Routine checking and Test checking Intern Check System: Internal Control, Internal auditing.

Audit programme

It is desirable that in respect of each audit and more particularly for bigger audits an audit programme should be drawn up. Audit programme is nothing but a list of examination and verification steps to be applied and set out in such a way that the inter-relationship of one step to another is clearly shown and designed. In other words, an audit programme is a detailed plan of applying the audit procedures in the given circumstances with instructions for the appropriate techniques to be adopted for accomplishing the audit objectives.

To start with, an auditor having regard to the nature, size and composition of the business and the dependability of the internal control and the given scope of work, should frame a programme which should aim at providing for a minimum essential work which may be termed as a standard programme. This programme may be altered in case of any abnormal situations.

2. The assistant engaged in the job should be encouraged to keep an open mind beyond the programme given to him. He should be instructed to note and report significant matters coming to his notice, to his seniors or to the partners or proprietor of the firm engaged for during the audit.

3. There should be periodic review of the audit programme to assess whether the same continues to be adequate for obtaining requisite knowledge and evidence about the transactions.

4. The utility of the audit programme can be retained and enhanced only by keeping the programme as also the client’s operations and internal control under periodic review so that inadequacies or redundancies of the programme may be removed

5. As a basic feature, audit programme not only lists the tasks to be carried out but also contains a few relevant instructions, like the extent of checking, the sampling plan, etc. So long as the programme is not officially changed by the principal, every assistant deputed on the job should unfailingly carry out the detailed work according to the instructions governing the work.

6. An audit programme consists of a series of verification procedures to be applied to the financial statements and accounts of a given company for the purpose of obtaining sufficient evidence to enable the auditor to express an informed opinion on such statements.

For the purpose of programme construction, the following points should be kept in view:

a) Stay within the scope and limitation of the assignment.

b) Determine the evidence reasonably available and identify the best evidence for deriving the necessary satisfaction.

c) Apply only those steps and procedures which are useful in accomplishing the verification purpose in the specific situation.

d) Consider all possibilities of error.

e) Co-ordinate the procedures to be applied to related items.

Advantages of an Audit Programme:

It provides the assistant carrying out the audit with total and clear set of instructions of the work generally to be done.

It is essential, particularly for major audits, to provide a total perspective of the work to be performed.

Selection of assistants for the jobs on the basis of capability becomes easier when the work is rationally planned, defined and segregated.

Without a written and pre-determined programme, work is necessarily to be carried out on the basis of some ‘mental’ plan. In such a situation there is always a danger of ignoring or overlooking certain books and records. Under a properly framed programme, the danger is significantly less and the audit can proceed systematically.

The assistants, by putting their signature on programme, accept the responsibility for the work carried out by them individually and, if necessary, the work done may be traced back to the assistant.

The principal can control the progress of the various audits in hand by examination of audit programmes initiated by the assistants deputed to the jobs for completed work.

It serves as a guide for audits to be carried out in the succeeding year.

A properly drawn up audit programme serves as evidence in the event of any charge of negligence being brought against the auditor. It may be of considerable value in establishing that he exercised reasonable skill and care that was expected of professional auditor.

Disadvantages of Audit Programme

The work may become mechanical and particular parts of the programme may be carried out without any understanding of the object of such parts in the whole audit scheme.

The programme often tends to become rigid and inflexible following set grooves; the business may change in its operation of conduct, but the old programme may still be carried on. Changes in staff or internal control may render precaution necessary at points different from those originally decided upon.

Inefficient assistants may take shelter behind the programme i.e. defend deficiencies in their work on the ground that no instruction in the matter is contained therein.

A hard and fast audit programme may kill the initiative of efficient and enterprising assistants.

All these disadvantages may be eliminated by imaginative supervision of the work carried on by the assistants; the auditor must have a receptive attitude as regards the assistants; the assistants should be encouraged to observe matters objectively and bring significant matters to the notice of supervisor/principal.

Audit and books Working papers and evidences

Audit notebook

An audit note book is usually a bound book in which a large variety of matters observed during the course of audit are recorded. It is thus a part of the permanent record of the auditor available for reference later on, if required. The audit note book also provides a valuable help to the auditor in picking up the links of work when the concerned assistant is away or the work is stopped temporarily because in it are recorded along with observations, the various queries, explanations obtained and evidence seen, while queries remaining undisputed of would be noted for follow up. It is more satisfactory in some ways, however, to use loose sheets for entering queries and notes which, subsequently, on being punched, may be filed in a special query file maintained for each client or along with the clients’ accounts and papers, separately for each year.

Significant matters observed during the course of audit, a record of which should be kept in the Audit Note Book:

Audit queries not cleared immediately e.g. missing receipts, vouchers, etc.

The mistakes or irregularities observed during the course of audit e.g. cases of failure to comply with the requirements of the Companies Act, 2013 or the provisions contained in the Memorandum or Articles; a change in the basis of valuation of finished inventory and work-in-progress or in the computation of depreciation; failure to provide adequate depreciation, etc.

Unsatisfactory book-keeping arrangements, costing method, internal or financial administration or organization.

Important information about the company which is not apparent from the accounts.

Special points requiring consideration at the time of verification of final accounts.

Important matters for future reference.

Specimen of entries in an Audit Note Book to indicate the manner in which entries in those books ought to be made:

Queries-Vouchers-Cash Book Payment

Voucher	Account Debited		Query	How disposed of
38	Advertisement	2,01,600	Managing Director’s sanction required	Sanction obtained
107	Rent	81,500	Rent bill & receipt required	Receipt & bill obtained
306	Das & Co.	5,23,474	Receipt required	Party reminded
42	Machinery	15,49,160	Board’s sanction required	Sanction obtained minute dated 10-1-15
89	Stores	37,403	Invoice required	Party reminded
128	Raw material	83,457	Rates for items (I) & (ii) are different from those on the purchase order	Items of the quality ordered not being available, a better quality was accepted under purchase officer’s approval.

The making of intelligent enquiries on the accounts under audit is an important part of the work of an auditor. However, to guard against the client’s staff being required to provide explanation and information which are unnecessary or which could be ascertained otherwise junior members of the audit staff should be allowed to raise audit queries only after obtaining the prior approval of the senior in charge.

The audit notes constitute important evidence of matters considered by the auditor during the course of the audit, some of which may not find a place in his report submitted to the shareholders or directors, for the reason that on the basis of an explanation given to him by the management, he, on being satisfied, decided to drop them. As such, audit notes can be an important defense for the auditor in the event of an action for negligence in the discharge of his duties being subsequently brought against him.

Audit notes can also serve as a guide in framing audit programmed in the future as they indicate the weaknesses in the system of the client which specially need to be watched.

Also, it is desirable that the audit notes, whether they are kept in a book or in loose sheets, should bear a reference to the particular item of work in the audit programmed, and as far as practicable, all notes relating to the particular work in the programmed should be kept together in the systematic order.

Audit evidence

The Auditing Standard on Audit Evidence SA(500) issued by the Institute of Charted Accounting of India (ICAI) deals with the nature of audit evidence and the procedures and techniques used to obtain evidence. Auditor needs to obtain evidence is respect of the following basic matter-

1. Internal controls

2. Transactions during the year and

3. Balance of Assets and Liabilities at the end of the Year.

Such evidence must be sufficient, relevant and reliable.

1. Evidence about Internal Controls:

Existence:- Auditor should ascertain whether Internal Control exist in the concern or not.

Effective:- Auditor should obtain evidence whether the internal control are effective or not.

Operative:- Auditor should obtain evidence whether the internal control actually operated during the relevant accounting years.

2. Evidence about Transactions During The Year

Occurrence:- Auditor should obtain evidence proving that a transaction actually took place.

Complete: - Auditor should obtain evidence to ensure that there are no unrecorded transaction assets or liabilities.

Amount: - Auditor should obtain evidence to ensure that a transaction is recorded in the books for the right amount.

Disclosure: - Auditor should obtain evidence to ensure that a transaction is recorded in the books and disclosed in the final account as per the recognized accounting policies and practices and the provision of law.

3. Evidence about Year-End Balances Of Assets & Liabilities

Existence:- Auditor should obtain evidence to ascertain whether an assets or a liability actually exists as at the year end.

Right and Obligations:- Auditor should obtain evidence to ascertain whether an asset is legally owned and a liability is legally owned by the concern at the year end.

Valuation:- Auditor should obtain evidence to ensure that an asset or a liability is shown in the balance sheet at the right value.

Diclosure:- Auditor should obtain evidence to ensure that the assets and liabilities are disclosed in the balance sheet as per the recognised accounting policies and practices, and the provision of law.

Essentials Of Good Audit Evidence:-

Sufficient Evidence:- Sufficient evidence means adequate evidence in terms of its quantity or extent.

Relevant Evidence:- Audit evidence must be relevant to the matter being checked. Thus ,if transactions in stock book for receipt and issue are being checked, relevant evidence would be Goods Received Notes, Delivery Chalans ,etc.

Reliable Evidence:- No evidence can be 100% reliable or conclusive . It is said audit evidence is normally persuasive rather than conclusive in nature. Auditor must see whether the evidence obtained is reliable or not. Reliability of audit evidence depends upon its source and its nature.

Internal Evidence V/S External Evidence.

Feature	Internal Evidence	External Evidence
Nature	Internal evidence is one which has been created within the client’s organization.	External evidence, on the other hand is one which originates from outside the client’s organization. A document issued by a person with whom some business transactions had been entered into or who was paid or was advance an amount constitutes such evidence.
Example	Examples are sales invoices, employees time reports, inventory reports, wages sheets, counterfoil of receipts, purchase requisition, minute books etc.	Examples are payee’s, purchase invoices, lease agreement, bank statement, cancelled cheques, insurance policies, mortgage deeds etc. These documents are prepared in the normal course of business activities of the organization an form part of its records.
Sources	Internal evidence is created and retained within the organization.	External evidence is obtained from outside parties.
Reliability	Internal evidence is considered less reliable considered less reliable than external evidence.	External evidence is considered more reliable than internal evidence.

Audit working papers

The audit working papers constitute the link between the auditor’s report and the client’s records. According to SA-230 , Audit Documentation refers to the record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached (terms such as “working papers” or “work papers” are also sometimes used). The objects of an auditor’s working papers are to record and demonstrate the audit work from one year to another.

Audit documentation serves a number of purposes:

a) Assisting the engagement team to plan and perform the audit.

b) Assisting members of the engagement team responsible for supervision to direct and supervise the audit work, and to discharge their review responsibilities in accordance with SA 220.

c) Enabling the engagement team to be accountable for its work.

d) Retaining a record of matters of continuing significance to future audits.

e) Enabling the conduct of quality control reviews and inspections in accordance with SQC 1.

f) Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements.

Working papers are varied in nature. They may be recorded on paper or on electronic or other media. Examples include:

a) Audit programmers.

b) Analyses.

c) Issues memoranda.

d) Summaries of significant matters.

e) Letters of confirmation and representation.

f) Checklists.

g) Correspondence (including e-mail) concerning significant matters.

The auditor may include abstracts or copies of the entity’s records (for example, significant and specific contracts and agreements) as part of working papers. Working papers, however, is not a substitute for the entity’s accounting records. The auditor need not include in audit documentation superseded drafts of working papers and financial statements, notes that reflect incomplete or preliminary thinking, previous copies of documents corrected for typographical or other errors, and duplicates of documents. Oral explanations by the auditor, on their own, do not represent adequate support for the work auditor performed or conclusions the auditor reached, but may be used to explain or clarify information contained in the working papers.

The foundation of all working paper can be traced to:

a) The basic constitutional documents like Memorandum and Articles of Association, Partnership Deed, Trust Deed, etc.;

b) The contents of the minute books;

c) The contents of the balance sheet and the statement of profit and loss; and

d) The letter of engagement.

Form and Content of Working Papers: Working papers should record the audit plan, nature, timing and extent of auditing procedures performed, and the conclusions drawn from the evidence obtained.

The form, content and extent of working papers depend on factors such as:

The size and complexity of the entity.

The nature of the audit procedures to be performed.

The identified risks of material misstatement.

The significance of the audit evidence obtained.

The nature and extent of exceptions identified.

The need to document a conclusion or the basis for a conclusion not readily determinable from the documentation of the work performed or audit evidence obtained.

The audit methodology and tools used.

Working papers should be designed and properly organized to meet the circumstances of each audit and the auditor’s needs in respect thereof. Working papers should be sufficiently complete and detailed for an auditor to obtain an overall understanding of the audit. The extent of the documentation is a matter of professional judgment since it is neither necessary nor practical that every observation, consideration or conclusion is documented by the auditor in his working papers. All significant matters which require the exercise of judgment, together with the auditor’s conclusion thereon, should be included in the working papers. The auditor should satisfy himself that these working papers have been properly prepared. Examples of such working papers are detailed analysis of important revenue accounts, receivables etc. In the case of recurring audits, some working paper files may be classified as permanent audit files which are updated currently with information of continuing importance to succeeding audit, as distinct from current audit files which contain information relating primarily to the audit of a single period.

A permanent audit file normally includes:

Information concerning the legal and organizational structure of the entity. In the case of a company, this includes the Memorandum and Articles of Association. In the case of a statutory corporation, this includes the Act and Regulations under which the corporation functions.

Extracts or copies of important legal documents, agreements and minutes relevant to the audit.

A record of the study and the evaluation of the internal controls related to the accounting system. This might be in the form of narrative descriptions, questionnaires or flow charts, or some combination thereof.

Copies of audited financial statements for previous years.

Analysis of significant ratios and trends.

Copies of management letters issued by the auditor, if any.

Record of communication with the retiring auditor, if any, before acceptance of the appointment as auditor.

Notes regarding significant accounting policies.

Significant audit observations of earlier years.

The current file normally includes:

Correspondence relating to acceptance of annual reappointment.

Extracts of important matters in the minutes of Board Meetings and General Meetings as relevant to audit.

Evidence of the planning process of the audit and audit programmed.

Analysis of transactions and balances.

A record of the nature, timing and extent of auditing procedures performed, and the results of such procedures.

Evidence that the work performed by assistants was supervised and reviewed.

Copies of communication with other auditors, experts and other third parties.

Letters of representation or confirmation received from the client.

Conclusions reached by the auditor concerning significant aspects of the audit, including the manner in which exceptions and unusual matters, if any, disclosed by the auditor’s procedures were resolved or treated.

Copies of the financial information being reported on and the related audit reports.

Consideration for commencing an audit:

Steps:- Before Commencing an Audit, the auditor must take the following steps and procedures.

1. Ascertain the type of audit i.e. statutory, continuous etc.

2. Obtain necessary document such as list of books , employees etc., and

3. Give instruction for preparation to be made by the client.

This will help the auditor to-

1. Develop the overall audit plan.

2. Prepare the Audit Programme and

3. Identify areas of audit requiring special emphasis.

Type Of Audit:-

Statutory or Voluntary:- The auditor should ascertain whether the audit is statutory or voluntary. If the audit is statutory, e.g. financial audit under the companies Act, the audit must be conducted in accordance with the provisions of the companies act. If the audit is voluntary, e.g. audit of a sole trader or a partnership firm, the auditor must know why the audit is being conducted e.g. for valuation of business at the time of sale, admission of partner and so on. This helps in defining the scope and procedure of audit.

2. Continuous or Final:- The auditor should ascertain whether the audit is continuous or final. This enables the auditor to decide the extent of checking and the types of audit procedures to be adopted.

Documents To Be Obtained From Client :-The auditor should obtained the following documents from the client before commencing the audit-

Letter to Appointment.

Memorandum and Articles of Association in case of a Company.

Partnership deed in case of a firm.

Organisational chart showing different departments and sections in the organisation and the persons in change.

Organisation Chart of the Accounts and Internal Audit department.

List of directors, partner and officers entitled to sanction payment, sign cheques and offer explanation to auditor.

List of places of businesslike. offices, branches and factories.

List of bocks of account and other relevant records.

Internal Control Manual and Internal Auditor's Reports.

Draft Final Account, Trail Balance, Groupings and Schedules.

Past Annual Account and Annual Reports.

Extracts from minute Books.

List of products manufactured and raw materials purchased.

List of relatives of directors, interested persons etc.

Instruction Of Clients To Prepare Documents :-Before actually commencing the audit ,the auditor should issue detailed instruction to the client to prepare and keeps ready-

All registers such as Cash Book, Bank Book, Sale Register, Purchase Register, Journal etc. along with voucher Files.

All ledgers duly posted and balanced.

Trail balance duly tallied.

Draft Final Account with schedules and groupings.

Schedule of Fixed Assets and Commutations Of Deprecations.

Details Of investment.

Details so cash-in-hand, cheques in transit at year end.

Bank Reconciliations and Bank Balance Confirmations.

Confirmation of balance from parties, lender, etc.

Bill-wise statement of debtors and creditor balance.

Quality Reconciliations and Statement of Closing Stock.

Details of pre-paid and outstanding expenses.

Routine checking and Test checking Intern Check System: Internal Control, Internal auditing

Test check

SA 700 (Audit Report) mentions that an audit includes examination, on a test basis, of evidence supporting the amounts and disclosures in financial statements.

Meaning

SA 500 issued by the institute of Chartered Accounts of India (ICAI) states that in forming an opinion an auditor may obtain audit evidence on selective basis. The selection may be based on auditor’s personal judgment or statistical sampling technique.

TEST CHECKING VS. STATISTICAL SAMPLING

When items are selected and checked on the basis of the personal judgment of auditor, it is called Test Checking. When items are selected by applying statistical techniques of sampling, random selection etc., it is called Statistical Sampling.

UNSUITABLE

The following transaction/balances are not suitable for test checking.

Opening and closing entries.

Bank Reconciliation statements.

Item recurring calculations/estimates e.g. depreciation, royalty etc.

Very important/material transactions/ balances etc.

IMPORTANCE

Full Checking Impossible

When the number of transactions is large auditor cannot check all the transactions 100%. In such cases auditor has to resort to test checks.

2. Full Checking Unnecessary

In most cases, 100% checking is unnecessary. Statements on Auditing Practices issued by the ICAI states that where an adequate system of internal control is in force, the auditor is entitled to apply test checks.

3. Extent of Checking

The extent of checking should be based on the following factors:

a) Possibility of errors and frauds.

b) Nature and materiality of item being checked.

c) Nature of the business and size of the company.

d) The system of accounting.

e) Internal controls.

f) Internal audit.

ADVANTAGES

Reduces the cost of audit.

It helps to speed up the audit work.

It helps to decide whether the financial records are reliable and to what extent.

It is a labor saving technique.

It helps auditor to arrive at a conclusion regarding the true and fair view.

DRAWBACKS

Arbitrary Selection

The selection depends upon the personal judgment of the auditor.

2. Ignores Statistical Techniques

Test checking ignores statistical techniques of sampling, random selection, risk assessment etc. Thus, auditor cannot be confident that he has selected the right sample.

3. Ignores Quality

An audit instruction regarding, say 25% checking of purchase entries, does not indicate how those 25% entries are to be selected.

4. Risks

Risk means the possibility that conclusions from test checks may be different from those based on 100% checking. Risks are of the following types –

(a) Reliance on Internal Controls

(b) Wrong Conclusions

PRECAUTIONS

Classify Transactions under proper heads

System and Procedures for a transaction right from the beginning to the end should be studied in their sequence.

The whole of the system of internal control in the areas of accounts and finance should be studied and evaluated.

A properly thought-out test check plan should be prepared.

The transactions falling under each tests-check plan should be selected in such a manner that bias cannot enter in the selection.

Auditor should identify the areas where test check may not be suitable.

AUDITOR’S LIABILITY

The test checking does not reduce auditor’s liability. If an auditor is accused of negligence, he cannot say that the items for test checking were free of errors. It is the duty of the auditor to take reasonable care and exercise his skill during an audit. Auditors must keep proper record of the test checks carried out, to help him defend his conclusions later on.

Routine checking

Routine Checking means checking of arithmetical accuracy of books of original entry and ledgers with a view to detecting clerical errors and simple frauds. It involves the

a) Checking of casting, sub casting (total, sub-totals), carry-forward, extension and calculation etc. in subsidiary books,

b) Checking of postings into the ledgers, casting of ledger account and

c) Extraction of their balance into the trial balance.

Feature;

1. Detailed Checking

Routine chewing involves detailed checking of each and every accounting step-entry in the original books, postings into the ledger and preparation of the trial balance.

2. Traditional system

It is the traditional system of audit also known as ‘vouch and post’ audit.

3. Juniors

The work is usually done by junior members of the auditor’s staff.

4. Ticks

Distinctive ‘ticks’ are used in routine checking for different purposes e.g. for totals, for posting etc. hence ‘routine checking’ is also called ‘tick-work’.

5. Routine Errors / Frauds

Routine Checking can reveal routine clerical errors / frauds.

Objectives-

The main objects of routine checking are:

1. Verification of the arithmetical accuracy of the entries,

2. Verification of the accuracy of posting of ledgers.

3. Verification of the balancing of the ledger accounts, and

4. Ensuring that no figures have been altered after checking.

Advantages

1. It is the simplest form of audit work.

2. Errors and frauds of simple nature can be very easily detected.

3. the books of accounts can be thoroughly checked.

4. It helps in checking castings and postings.

5. Arithmetical accuracy of all the transactions can be confirmed by this method.

6. It offers an opportunity to train the junior auditors.

Disadvantages

Routine Checking has the following disadvantages:

It is a mechanical and boring work

It can detect only simple arithmetical errors and small frauds.

It is time consuming and expensive.

It is unnecessary in case of a large business using information technology.

Internal control

SA 400 issued by the Institute of Chartered Accountants of India (ICAI) deals with the study and evaluation of Internal Control in connection with an audit. It defines internal Control as “all the policies and procedures adopted by the management of a concern to ensure the orderly and efficient conduct of its business.”

PURPOSE, ADVANTAGE AND OBJECTIVES

The objective of internal control i.e. accounting Controls and Operational Controls are as follows.

Accounting controls

All transactions are duly authorized, properly recorded and recorded promptly.
The accounting policies adopted by the management in respect of stock valuation, depreciation etc. are implemented.
The assets of the concern are safeguarded; the assets are not used or sold without proper authorization and are verified regularly.
Errors and frauds are prevented and detected.
The books of accounts are complete and accurate.
The final accounts are reliable and ready in time.

2. Operational or Administrative Controls

Operational Controls aim to ensure that the management policies in respect of the operations and administration of the concern are implemented. This in turn ensures that the business is conducted in an orderly and efficient manner. Examples of operational controls are Quality Control, Budgetary Control, Internal Check, Internal Audit, Quantitative Controls etc.

AUDITORS DUTIES

SA 400 makes the following recommendations in this regard:

Responsibility of Management

Basically, the management is responsible for establishing and operating the Internal Control system.

2. Auditor’s Duty

The auditor’s duty is to study system, check whether the system was actually in operation during the year and evaluate the system to ascertain how much he can rely upon it.

3. Need for Evaluation

An auditor needs to evaluate internal control system to achieve the objectives.

4. Steps in evaluation

a) Understand the System: In the first stage, the auditor should understand the system of Internal Control. He can understand the system with the help of manuals, discussions with managers or the technique of Flow Charts.

b) Test Application: He should check whether the controls were actually applied in practice. He can check some transactions in depth. Thus he can take up some sales transactions and check all the documents right from the sales order to the receipt from debtors.

c) Evaluate the system: He should judge, on the basis of above tests, whether he can rely on the system and if so to what extent.

5. Communicate Weakness to Management

a) The material weakness in internal controls should be communicated to the management by the auditor. Material weakness means the absence of adequate controls that increase the possibility of errors and frauds in the financial statements.

b) Such communication should be in writing.

INHERENT LIMITATIONS OF INTERNAL CONTROL

All the objectives of internal control, listed above, may not be actually achieved, because of its following limitations.

Costs

Cost of implementing control procedure may be much more than its benefits.

2. Human Error

A control procedure may not prove effective due to human errors e.g. carelessness of employees, mis-understanding of instructions, wrong judgments etc.

3. Collusion

Even if duties are divided among different employees, they may collude (work together fraudulently).

4. Misuse

An employee responsible for a particular function may misuse his authority.

5. Manipulation by Management

Manipulation and misappropriation by top management will defeat the very purpose of internal control.

	INTERNAL CONTROL FOR SALARIES AND WAGES	INTERNAL CONTROL FOR PURCHASE	INTERNAL CONTROL FOR SALES
Division of Work	Work relating to payment of salaries and wages should be divided among different employees. Different person should employ the staff and workers, record the attendance, prepare the pay Sheet, check the Pay Sheet, make the payment and record the entries.	Work relating to purchase should be divided among different departments and employees. Thus sales and Debtors would involve the Sales Department, the stores and the account department.	Work relating to sales and debtors should be divided among different departments and employees. Thus sales and Debtors would involve the Sales Department, the stores and the account department.
Procedures	The employees should sign in the Pay sheet or Vouchers in acknowledgment of payment received. Payment to representatives of absent employees should be made only after verifying their authorization. If salaries are paid by cheques, they should be crossed “A/C payee” to prevent misuse.	Purchase department should invite tenders on the basis of purchase requisitions received from the factory or stores. Material should be received in the godown and property inspected before acceptance. Payments should be made by the Account department only after verifying the Goods Received Note and the Inspection report.	Sales department should obtain sales Orders and issue Dispatch Orders to the stores. Material should be dispatched from the godown only on the basis of such dispatch orders and after preparing delivery challans. The Sales Bills should be raised and the cash or cheques from debtors should be received by the Accounts department.
Cross-Check	The work should be divided in such a way that the related documents are prepared by different persons and automatically checked by another employee.	The work should be divided in such a way that the related documents are prepared by different persons and automatically checked by another employee.	The work should be divided in such a way that the related documents are prepared by different persons and automatically checked by another employee.
Change in Duties	The security Staff, the Personnel Staff and the Cashier should be changed from time to time.	The duties of the concerned employees (purchase officer, storekeeper) should be rotated from time to time. They may be transferred to a different location.	The duties of the concerned employees (salesman, storekeeper) should be rotated from time to time. They may be transferred to a different location. One employee should not do same work for a long time.
Annual Leave	The security staff and the cashier should be asked to go on leave at least once every year, to enable detection of errors or frauds.	The concerned employees (especially the storekeeper) should be asked to go on leave at least once every year, to enable detection of errors or frauds.	The concerned employees (especially the storekeeper) should be asked to go on leave at least once every year, to enable detection of errors or frauds.
Access to Books	The security staff should not have access to the pay sheets. The personnel Staff or Cashier should not have access to the books of accounts.	The purchase officer or Storekeeper should not have access to the books of account, such as sales Journal or ledgers.	The sales staff should not have access to the books of account, such as sales Journal or ledgers.
Proper Recording	The attendance should be recorded in the Attendance Records properly. Mechanical Time Clocks should be used to prevent errors and frauds. All payments should be properly recorded.	All goods should be properly recorded i.e. the right quantity should be entered, against the right party and on the right date.	All goods should be properly recorded i.e. the right quantity should be entered, against the right party and on the right date.
Prompt Recording	The attendance and payments should be recorded promptly in the relevant books.	The transaction should be recorded promptly in the relevant books of accounts.	The transaction should be recorded promptly in the relevant books of accounts.
Accounting policies	The payments should be recorded on the basis of the accounting policies adopted by the management.	The purchase should be recorded on the basis of the accounting policies adopted by the management.	The sales should be recorded on the basis of the accounting policies adopted by the management.
Safeguarding	The cheques signed but not handed over to the employees who may be absent should be kept in safe custody. Such as cheques or cash vouchers for unpaid salaries should be verified immediately after the ‘pay-day’	The stock in hand should be safeguarded i.e. stored safely and properly. Stock in hand should be verified regularly.	The stock in hand should be safeguarded i.e. stored safely and properly. Stock in hand should be verified regularly.
Errors and Frauds	Pay sheets, cash Book and bank book should be checked to detect errors in recording payments of salaries and wages e.g. errors of commission, errors of omission or errors of principle etc. these books should be checked to detect frauds by inflating payments, by showing payments to dummy workers etc. Payments to dummy persons may be detected by checking the attendance record, making surprise check on attendance.	Stock books should be checked to detect errors in recording purchase. e.g. errors of commission, errors of omission or errors of principle etc. stock books should be frequently reconciled with the physical stocks to detect frauds e.g. misappropriation of goods by inflating dispatches.	Stock books should be checked to detect errors in recording sales. E.g. errors of commission, errors of omission or errors of principle etc. stock books should be frequently reconciled with the physical stocks to detect frauds e.g. misappropriation of goods by inflating dispatches.
Reconciliation and confirmations	---	The Creditors accounts should be reconciled regularly. Confirmation of balances should be obtained from them at least once during year.	The Debtors accounts should be reconciled regularly. Confirmation of balances should be obtained from them at least once during year.

	Internal Control for Creditors	Internal Control for Debtors
Credit Limits	a) Fixed on a basis which is clearly laid down b) Approved by an officer independent of the sales department c) Checked before accepting orders from customer, and d) Reviewed from time to time.
Prompt Recording	The procedures should ensure prompt recording of the amounts due to creditors and the amounts paid to creditors.	The procedures should ensure prompt recording of the amounts due from debtors and the amounts received from debtors.
Prompt Adjustment	The amount paid to a creditor should be promptly adjusted against the relevant bill. Unadjusted amounts should be reconciled regularly.	The amount received from a debtor should be promptly adjusted against the relevant bill. Unadjusted amounts should be reconciled regularly.
Age-wise Schedule	There should be a procedure for preparing age wise schedule of creditors. The schedules should be reviewed by a senior officer.	There should be a procedure for preparing age wise schedule of debtors. The schedules should be reviewed by a senior officer.
Statements of Accounts	Statements of accounts should be prepared and periodically to all creditors. They should be prepared by a person other than the ledger-keeper and sent by yet another person.	Statements of accounts should be prepared and periodically to all debtors. They should be prepared by a person other than the ledger-keeper and sent by yet another person.
Discounts & write-offs	All materials adjustments such as discounts, allowances and rebates received, amount not payable written back etc. should be approved by a senior manager.	All materials adjustments such as discounts, allowances, rebates, and debts written off etc. should be approved by a senior manager.
Reconcile Control Accounts	There should be a system of periodic reconciliation of creditors’ balances with related control accounts.	There should be a system of periodic reconciliation of debtors’ balances with related control accounts.

Internal audit-

OBJECTIVES

Review of accounting system and Internal controls

Examination of Accounting controls

Examinations of Operational controls

Physical verification

SCOPE / FUNCTIONS OF INTERNAL AUDIT

Monitoring of internal control.

Examination of financial and operating information.

Review of operating activities.

Review of compliance with laws and regulations.

Risk management.

Governance.

INTERNAL AUDIT VS. EXTERNAL AUDIT

TOPIC	INTERNAL AUDIT (IA)	STATUTORY AUDIT (SA)
Voluntary / Compulsory	IA is Voluntary	SA is compulsory under law e.g. under Companies Act.
Appointment	Internal Auditor is appointed by the management itself.	Statutory Auditor is appointed by the shareholders of a Company.
Status	Internal Auditor is an employee of the concern.	Statutory Auditor is an independent outside expert.
Responsible & reports to	Internal Auditor is responsible and reports to management.	Statutory Auditor is responsible and reports to shareholders.
Scope of duties	Management decides the scope of duties of internal Auditor. It includes non accounting matters.	Duties of statutory auditor are laid down by law (e.g. Companies Act) its scope limited to accounting matters.
Removal	Internal auditor can be removed by the management on its own.	Statutory Auditor can be removed by shareholders only if approved by central Government.
Objectives	IA aims to review the internal control system of concern.	SA aims to report to shareholders whether the accounts are true and fair.
Period	IA is continuous.	SA is normally periodical or annual.
Qualifications	No qualifications are prescribed by law for an Internal Auditor.	Qualifications are prescribed by law for Statutory Auditor.
Liability for Negligence	Internal Auditor is liable only to management and not to shareholders or third parties.	Statutory Auditor is liable to shareholders and in some cases to third parties also.

INTERNAL AUDIT VS. INTERNAL CHECK

TOPIC	INTERNAL AUDIT	INTERNAL CHECK
Aims	Aims to determine whether other internal controls are working properly.	Aims to distribute responsibilities and work to help cross-checking.
Part of	Part of internal control.	Part of Internal control.
Separate staff	Separate staff is appointed to carry out internal audit.	No separate staff is appointed to carry out Internal Check.
When	Internal audit is done after the work is complete.	Internal Check is done during the work.
Purpose	Internal audit may detect errors or frauds.	Internal check may prevent errors or frauds.

Key takeaways –

Auditing is defined as the on-site verification activity, such as inspection or examination, of a process or quality system, to ensure compliance to requirements.

Test checking in Audit means checking a few transactions selected at random from a large number of transactions.

An internal audit offers risk management and evaluates the effectiveness of a company's internal controls, corporate governance, and accounting processes.

Sources-

1. Gupta, Kamal : Contemporary Auditing, Tata McGraw Hill, New Delhi.

4. Pagare, Dinkar : Principles and Practice of Auditing, Sultan Chand, New Delhi.

5. Sharma, T.R. : Auditing Principles and Problems, Sahitya Bhawan, Agra.

7. Tandon, B.N. : Principles of Auditing, S.Chand & Co., New Delhi.

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