Unit 1
Introduction
Q1) Explain Auditing.
A1)
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.
Q2)Explain types of audit.
A2)
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.
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.
Q3) Explain audit process.
A3)
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.
Q4) Explain audit programme.
A4)
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.
For the purpose of programme construction, the following points should be kept in view:
Advantages of an Audit Programme
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.
Q5) Explain audit process and programme.
A5)
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.
7. 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.
8. 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.
9. 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.
10. 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
11. 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.
12. 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:
Advantages of an Audit Programme
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.
Q6) Explain audit and books.
A6)
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:
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.
Q7) Explain working papers and evidences.
A7)
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
2. Evidence about Transactions During The Year
3. Evidence about Year-End Balances Of Assets & Liabilities
Essentials Of Good Audit Evidence:-
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:
Working papers are varied in nature. They may be recorded on paper or on electronic or other media. Examples include:
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:
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:
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:
The current file normally includes:
Q8) Explain consideration for commencing an audit.
A8)
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:-
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-
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-
Q9) Explain Routine checking.
A9)
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
Features
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:
Q10) Explain test checking.
A10)
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.
IMPORTANCE
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:
ADVANTAGES
DRAWBACKS
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
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.
Q11) Explain internal auditing.
A11)
Internal audit
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
SCOPE / FUNCTIONS OF INTERNAL 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. |
Q12) Explain internal control.
A12)
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.
- 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.
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:
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.
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. | |