Define an ‘Audit’ and state the various objects of an audit. Or ‘Two main objects of an audit are detection and prevention of errors and frauds. ’ Comment. Can auditing prevent them? Ans1. The word ‘Audit’ is derived from the Latin word ‘audire’ which means ‘to hear’.
In olden times whenever the owners of a business suspected fraud, they appointed certain persons to check the accounts, who used to hear these accounts and express their opinion about their correctness or otherwise. Such persons were known as ‘auditors’. Thus, the term ‘auditor’ means literally ‘hearer’, i. e. , one who hears and is used ever since the days when public accounts were accepted and approval on the basis of hearing the accounts read. The original object of an audit was to see whether the accounting party has properly accounted for the receipts and payments of cash. If cash has been embezzled who did it and what was the amount.
It was mainly an audit of cash book. The main object of modern audit is to fine out whether the balance sheet shows true and fair view of the state of affairs of a company and is drawn-up according to the Companies Act. Spicer and Pegler have defined, ‘An audit may be said to be such an examination of the books, accounts and vouchers of a business as will enable the auditor to satisfy that the balance sheet is properly drawn-up so as to give a true and fair view of the state of the affairs of the business and whether the profit and loss account gives a true and fair view of the profit or loss for the financial period.
According to the best of his information and the explanations given to him and as shown by the books and if not in what respect he is not satisfied. The Institute of Chartered Accountants of India describes audit as the independent examination of financial information of any entity, whether profit-oriented or not and irrespective of its size or legal form, when such examination is conducted with a view of expressing an opinion thereon. To conclude audit may be defined as : 1. An intelligent and a critical examination of the books of accounts of a business which, 2. s done by an independent person or body of persons qualified for the job, 3. with the help of vouchers, documents, information and explanations received from the authorities so that, 4. the auditor may satisfy himself with the accounts : (i) balance sheet shows a true and fair view of the concern, (ii) profit and loss account shows true and fair view of profit or loss. Objects of an audit – Discovery of errors and frauds and its prevention is not the main objective of audit. Objectives of Audit
Main Objective Secondary Objective Expression of expert opinion Detection and prevention of errors and frauds Main objective – Expression of expert opinion, the business prepares balance sheet to show its financial position. It also prepares profit and loss account for the financial period. These are given to the auditor for checking. He checks whether the facts shown in the balance sheet and profit and loss account are true and prepares a report called audit report and express his opinion.
Secondary objective : Detection and prevention of errors – Errors are normally innocent but sometime errors which might appear at first sign, as innocent are ultimately found to be due to fraudulent in manipulation, and therefore, auditor may pay special attention to every error. The following are various types of errors : (1) Errors of Omission – The error of omission is one where a transaction is not recorded in the book of accounts either wholly or partially. (2) Errors of commission – When a transaction has been recorded but has been wrongly entered in the ledger, it is called error of commission.
Such error may be intentional or unintentional vouching should be done carefully to detect such errors. (3) Errors of principle – When the principle of accounting are not followed in recording entries. It can be detected by independent checking and inquiry. (4) Compensating errors – A compensating error is one which is counter balanced by other error or errors. This is the most dangerous type of error. This type of error will be detected by the trial balance. It may or may not affect the trial balance and will not be detected easily.
Detection and prevention of fraud – Fraud is really a false representation or entry which is made always intentionally. Fraud may be of two types. Fraud Misappropriation of Manipulation of Account Cash Goods Misappropriation of cash – There is a greater chance of misappropriation of cash in big business. In a big business strict control must be exercised over cash. There must be system of checking the work of one clerk automatically by another. Such a system is known in auditing as internal check. Cash may be misappropriated by ) cash received may not be recorded, ii) less amount recorded, iii) more payments may be shown, iv) bogus payments may be shown. The auditor should check cash book, rough cash book vouchers, wage sheets, invoice, agent returns etc. Misappropriation of goods – Fraud may be in respect of goods. This type of fraud is very difficult to detect when the goods are less bulky and are of higher value. Proper stock taking methods and detailed checking by the auditor can bring fraud to light. Fraudulent manipulation of accounts – This type of fraud is most difficult to discover.
This is mostly committed by higher levels of management. It may be committed to show more profits than the actual ones to get (i) more commission, (2) to obtain credit, (3) to sell shares to show less profit, (i) to purchase shares in the market at lower price, (ii) to reduce income tax. The accounts may be falsified by not (i) providing depreciation, less/more depreciation, (ii) by under valuation or over valuation of assets and liabilities, (iii) by showing, fictitious sales or purchases, (iv) by charging revenue. Expenditure to capital account etc. The falsification of accounts is termed as windows dressing.
Auditor duty : The duty of an auditor is very significant in relation to the detection and prevention of error and fraud. Q. “An auditor is a watch dog and not a blood hound. ” Comment. (Imp. ) Ans. The auditor should exercise care and skill while detecting errors and fraud. He should make intelligent and careful enquiry. His job is over if he feels that he had made inquiry and was tactful. If to the best of his knowledge care and skill, he certifies the accounts as correct, he cannot be held responsible for errors or fraud which is still there in the accounts.
The decision in the Kingston Cotton Mills Company case makes clear that an auditor is a watch dog and not a blood hound. There are two important points : (a) Firstly, an auditor is a watch dog. He is to protect the interest of the owners and should try to find out errors and frauds in the accounts. (b) Secondly, he is not a blood hound. It is not part of his duty to take those task who have been found guilty of committing errors and fraud. However, when there are circumstances arousing his suspicion, he must be doubly alert.
He must change his audit procedures and do detailed checking, the auditor is not expected to apply in his duty nothing more than reasonable skill and diligence as would be exercised by a professional of his cost egory. He is expected to do the audit according to generally accepted auditing practices. Q. “Accounting is a necessary while auditing is a luxury. ” Discuss the advantages of auditing. Ans. The old controversy that “accountancy is a necessity while auditing is luxury” is over now in the present set up of the business world. The advantages of audit are : 1) It ensures the correctness of the accounts to a large extent. The truth and fairness of account is certified. (2) Errors and frauds can be discovered quickly. (3) A regular audit makes the staff alert and vigilant. (4) Comparision of accounts from year to year is possible. (5) Helpful in obtaining additional capital or borrowing money from banks or other sources. (6) In case of loss by fire the compensation may be claimed from the insurance company on the basis of audited accounts. (7) The auditing help in the valuation of assets and goodwill. (8) Audited accounts are more reliable as evidence in the court of law. 9) The audited accounts are accepted by tax authorities. (10) It instile confidence in the minds of investors and other. (11) Auditor may give expert advice to accounts. (12) The audited accounts are more helpful in the settlement of accounts between the partners. Auditing may be luxury for smaller concern because of high cost of auditing but in fact it is not a luxury for majority books of accounts audited. It is compulsory for joint stock company under the Companies Act, 1956. Q. “Personal traits of an auditor are imprisonment for the successful conduct of audit. Comment. Ans. The auditor – The person who conducts an audit is known as the auditor. After due examination of accounting records and statements in the form of an opinion a report is prepared by the auditor and is presented to the person who appoints the auditor, e. g. to the shareholders in the case of a company. In India only Chartered Accountants are professionally qualified for the audit of accounts of companies. Functional classification of auditors – On the basis of functional division, auditors can be classified as follows : 1. External auditors 2. Internal auditors 1.
External auditors – External auditor are those person who practice the professional of accountancy having qualifies in profession examination and are internal vis-a-vis the organization of which they audit the account. They are appointed by the owners of the organization, e. g. by the shareholders in case of a company. When external auditor is appointed under a particular statute, such auditor will be known as the statutory auditor. Their scope of work is determined by the statute under which they have been appointed. An auditor is generally referred to as independent external auditor. 2.
Internal Auditors – Internal auditors are internal to the organization in which they are appointed to perform the specific work. They may be professionally qualified. They are appointed by the management. The scope of work is also specified by the management. They may be appointed on contract basis or employee to undertake auditing of book and records scope of internal auditor may extent even beyond the financial accounting and may include investigation, production audit, performance audit etc. even though the internal auditor is an employee yet he must be independent to the extent practicable.
The basic foundation of any type of auditing whether of external envisages (demands) that the auditor must be independent of the activity for which he is activity for which he is going to conduct an audit. Qualities of an auditor – Following are some qualities which an auditor must have in himself : 1. Integrity –Integrity means auditor should be honest, sincere and straight forward in his approach to his profession work. Integrity is of utmost important not only for individual auditor but for the entire auditing profession. 2.
Independence – Independence means that the auditor should not subordinate his judgement to that of client or any other person. Auditor should be free of any such interest as might affect his independent subsequent-consciously independence must be real and evident. 3. Objectivity – The view of auditor should be fair, unbiased and impersonal. His opinion should be based on an objective consideration of facts. He must be fair and must not allow prejudice or bias to over ride his objectivity. 4. Logical utilities – Auditor must have a logical approach, as basic too is of the auditing are derived form logic.
Auditor should have the capacity to analyze and interpret problems and facts. He should be able to make logical conclusions about the course of action to be followed. 5. Awareness – Auditor should be aware of various encondic legal technological factors as well as other professional developments. Awareness on regular basis is required. Only then he will be able to conduct an effective audit a changing environment. 6. Communication abilities – While conducting an audit, auditor interacts with various officer and staff of the organization well as with other people.
To put forth his the views, inquiries, recommendations etc. auditor must be proficient in communication whether written or oral. 7. Tactfulness – During the course of audit, auditor deals with many people namely officers and staff of the organization under audit. Co-auditor his assist etc. auditor must be able to not offend them and also maintaining his position firmly. 8. Technical competence – It relates to knowledge of the auditors about the following subjects that will contribute to competence of auditor : ? Auditing ? Accounting ? Information technology ? Law ? Economics ? Business finance Behavioral science. 9. Confidentiality – Auditor must respect the confidentiality of information acquired in the course of his work. He should not disclose any information to a third party without legal duty or without proper authority. In addition to above an auditor should be hard working systematic and methodical. He should have capacity to hear the arguments or views of others. In the words of Lord Justice Lindley : “An auditor must be honest, i. e. he must not certify what he does not believe to be true and must not reasonable care and skill before he believes that what he certifies is true. ” Q.
What are the limitations of auditing ? Ans. Inherent limitations of audit – The opinion expressed by auditor is neither an assurance as to future viability of the enterprise nor the efficiency or effectiveness with which management has conducted the affairs of the enterprise. Further, the process of auditing is such that it suffers from certain inherent limitations, i. e. the limitation which can not be overcome irrespective of the nature and extent of audit procedures. Following are inherent limitations : 1) Auditor’s work involves exercise of judgement, e. g. in deciding the extent of audit procedures to be followed. ) Much of evidence available to auditor an enable him to draw only reasonable conclusions there from. The audit evidence obtained by an autodor is generally persuasive in nature rather than conclusive. 3) Generally, the entire audit process is dependent on existence of an effective system of internal control. Inherent limitations of internal control system also contribute to inherent limitations of audit. 4) There is also likelihood that some material mis-statements of the financial information resulting from fraud and error, if either exists, may not be detected.
A part from above mentioned inherent limitations following are some other limitations which should also be considered : a) Auditing is considered as a post-mortem examination. b) Auditing is considered as a mechanical work lack of audit. Program as per desired situation will contribute to drawbacks of auditing. c) Dependence of auditors on the opinion of experts in regard to some technical matters should be keep in mind. d) Success of audit depends on the sincerity with which auditor performs his duties. Q. Expalin the relationship of auditing with other disciplines.
Ans. 1. Relationship with accounting – Auditing is closely associated with accounting that many people consider auditing as an integral part of accounting. Auditing reviews the financial statements which are nothing but a result of the over all accounting process. It naturally calls on the part of auditor to have a thorough and sound knowledge of generally accepted principles of accounting before he should review the statements. Accounting is concerned with recording of the transactions and preparation of statements of accounts.
Auditing involves a detailed and critical examination of accounts prepared by other. In fact auditing begins, where accounting ends. (2)Relationship with law – the relationship between auditing and law is very close one. Auditing involves examination of various transactions from the view-point of whether or not these have been properly entered into, it necessities that an auditor should have a good knowledge of business laws affecting the entity. He should be familiar with Law of Contracts, Company Law, Income Tax Act, Excise and Customs Law, Negotiable Instruments Act etc.
The rights duties and reporting responsibilities of a company auditor are prescribed under the Companies Act. Even where the appointants of an auditor is not in pursuance of legal requirements, the provisions of certain laws are relevant, e. g. in determining whither a sale transaction is complete and can be records as such in books of accounts. Auditor will have to take into account the provisions of the ‘Sale of Goods Act’. (3)Relationship with economics – Auditing is also related to economics auditors should have knowledge of economics.
In fact, auditing is the process of collection and evaluation of evidence for the purpose of reporting on economic information, economic information forms the subject-matter of the auditor’s work. All transactions are economic facts which the accountant measures quantitavely in monetary tem and auditor seek to give his opinion thereon, auditors are more concerned with micro-Economics rather that macro-economic. Auditor is exprected to be familiar with the over all economic environment in which client is operating. (4)Relationship between statistics and mathematics – Auditing has a close relationship with statistics and mathematics.
Static’s deal with collection classification tabulation and interpretation of data. Auditor examines the statistical system and to auditing as the auditor is also expected to have knowledge of statistical sampling so as to arrive at meaningful conclusions. The knowledge of mathematics is also part of the auditor particularly at the time of verifications of inventories. (5)Relationship with Behavioural Science – Behavioural Science expalins why people behave the way they do it important for the auditor to understand the behavioural patterns of the people.
The financial auditor though deals with the figure contained in financial statements yet or management auditor is expected to deal with human beings rather than financial figures. The knowledge of the human behaviour is indeed very essential for an auditor so as to effectively discharge his duties. (6)Relationship with Ethics – Auditing has good relationship with ethics too. Ethical aspects are the foundation of entire accounting profession rests. The auditor has certain ethical responsibilities relating to proper conduct.
To ensure that auditor conduct themselves in an ethical manner, most professional accountancy bodies have laid down elaborate rules defining the boundaries of ethical conduct. Therefore, in anditing, ideas of ethics and ethical conduct are very important. (7)Relationship with logic – The discipline of auditing itself is a logical construct and everything in auditing must be bound by the rules of logic. the auditing approach and its basic tools are derived from logic which is concerned with law we determine whether conclusions are valid or invalid.
The process of auditing is basically dependent on the process of logic. In fact, auditing has its reads. In logic on which it depends heavily for ideas and methods. Q. ”Although, auditing and acounting are related they are distinct from each other. ” Evaluate the above. Ans. Auditing and acounting – Auditing is so closely associated with accounting that many people consider auditing as an integral part of accounting. Auditing and accounting are very closely related to each other, yet they are different. In fact, auditing starts where accounting ends. Accounting |Auditing | |Accounting starts where book keeping ends. |Auditing starts where accountancy ends. | |No formal qualification is mandatory for being an accountant. |Auditor must a qualified C. A. | |It is constructive in nature. |It is analytical in nature. | |Accountant is the employee of the business appointed. |Auditor is an independent outsider on a contract of business for| |Accountant is paid monthly salary. |a year. | |Accountant works is conducted throughout the year. Auditor gets a fixed amount as per contract with the client. | |Account is not required to submit a report on prepared account. |Audit may be conducted at end of years or throughout the year. | | |Addition sub-units report about correctness and present of | | |accounts audited by him. | Q. Write a short note on concept of true and false view. Ans. Concept of true and fair – The concept of true and fair is a fundamental concept in auditing.
The auditor is required to express his opinions to whether the state of affairs and the result of the entity as curtained by him in the course of his audit are fairly represented in the accounts audit. Section 211(5) of the Companies Act, 1956 provides that the accounts of a company shall be deemed as not disclosing a true and fair view if they do not disclose any matters which are required to be disclosed : ? By virtue of provisions of schedule VI of the Companies Act. ? By virtue of a notification of government modifying the term ‘true and fair’ has not been defined in any legislation.
What constitutes a true and fair view is a matter of judgement of auditor in particular circumstances of a case. An auditor has to see that : a) Profit and Loss Account and Balance Sheet have been prepared as per provisions of schedule VI of Companies Act. b) All unused exceptional or non recording items have been properly disclosed. c) No material asset is omitted. d) Material liabilities are properly disclosed. e) The assets are neither under valued nor overvalued. f) Accounting policies have been followed consistently. UNIT 2 TYPES OF AUDIT Q. What is meant by continuous audit? And to what class of business is it applicable?
State briefly the advantages and disadvantages of such an audit. Suggest precaution to guard against the disadvantages (objections) to a continuous audit. Ans. A continuous audit is an audit which involves a detailed examination of the books of account at regular intervals say the auditor visits at regular intervals and check each and every entry. According to Spicer and Pegler, “A continuous audit is one where the auditors is staff occaped 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 audit. Applicability of continuous audit – This type of audit is specially applicable to the following business : (1) Where the volume of transactions is large. (2) Where the final accounts are prepared first after the close of the financial year. (3) Where accounts are be presented to management for decision making at regular intervals. (4) Where a good and efficient system of internal check does not exist. Advantages of continuous audit : a) Errors and frauds can be discovered quickly. b) Auditor is able to get technical details of the business. ) Quick presentation of accounts at the end of the year. d) Auditor visits at regular intervals to keeps client’s staff regular. e) Moral check on the client’s staff. f) Detailed checking increases efficiency in audit work. g) Interim accounts can be prepared when required. h) Audit staff can be kept busy throughout the year. Disadvantages of continuous audit : 1. Expensive- It is an expensive type of audit. 2. Alteration of figures- Audited figures may be altered by dishonest clerk and frauds may be perpetrated. 3. Client work is dislocated because of the frequent visits of the auditor. . The audit check may lose the thread of the work. 5. The work of the auditor becomes mechanical. 6. Chances of collusion between accounts and audit staff. 1. No alteration allowed. The auditor should give instruction that no alteration should be made in audited accounts without bringing it to his notice. 2. Alteration by rectifying entry. If alteration is necessary, it should be made by passing rectifying entry only. 3. Prepare well drawn detailed audit programme. 4. A note should be made in the audit note-book regarding any queries which have been replied properly. . Checking of one book should be completed as far as possible at one visit to avoid loose ends. 6. The auditor should put a secret tricks and codes to guard against alteration of figures. 7. The audit of impersonal general ledger should be conducted at the time of final audit. 8. The auditor should pay surprise visits so that the clerks of the clients may not know the exact date of the visit of the auditor. 9. Before the auditor begins the work at the next visit, he should glance over any alteration which does not bear his secret trick. Q. ‘Every business entity should have an annual audit by a qualifies auditor. To forego an audit because of its cost or false economy. ” Evaluate the statements. Ans. Advantages of an audit – 1. If safefuards the financial interests of persons who are hot associated with the management of the entity, whether they are the partners or shareholders. 2. It acts as a moral check on the employees, from committing defalcation or embezzlement. 3. Audited accounts are of great help in the settlement of accounts at the time of admission or death of a partner in organisation. 4.
Auditing reviews of various controls in the organizations and reports weakness, inadequacies etc. in them. 5. Auditer accounts are useful for government while granting subsidies. 6. Money can be borrowed from banks or other financial institutions if accounts of business are audited. 7. Audit ascertains whether the necessary books of accounts have been properly kept and help the clients in making good the deficiencies in this respect. 8. Government may require audited and certified statements before it gives assistance or issues a license for a particular trade. 9.
Audited statements of accounts are help in setting liability for taxes, negotiating loans and for determinating the purchase consideration for a business. 10. they are useful for setting trade disputes for higher wages or for bonus. 11. Claims due to fire, theft and accident can be estimated from audited accounts and also be well-settled. 12. Errors and frauds in accounts are detected and preventive measures can be taken in time. 13. Audit helps in detection of wastages and losses to show the different ways by which there might be checked especially those occur due to inadequacy of internal control and internal checks.
Q. Distinguish between internal audit and external audit. Ans. |Internal Audit |External (Statutory) Audit | |Auditor will be appointed management of the entity. |A appointment of auditor will be made by the owners, e. g. | |Scope of the work will be defined by appointing auditiority. |shareholder. | |Report will be submitted to the management. |Scope is defined by law. | |Objective is to review financial and non financial operations as|Report will be submitted to owners of entity. |a service to management. |Objective is to ascertain the truthfulness and fairness of state| |Responsibility of auditor is to report to the management on the |of affairs of entity. | |compliance of procedures with the following : |Responsibility of auditor is to express audit opinion on the | |Accounting |true and fair view of the financial statements. | |Financial | | |Administrative control. | Q. Write short notes on (1) Interim audit (2) Final audit. Ans. (1) Interim audit – An audit conducted between two annual audits is called interim audit. It is always carried out with an interim purpose for example for declaration of interim dividends. Interim audit does not enjoy statutory status though generally carried out by professionally qualified auditors. Advantages : 1. It helps in quick detection and rectification of errors and frauds. 2. It exercises an effective check on staff of the enterprise. . The final audit can be completed in a short span of time. Disadvantages : a) The client’s staff may be after the books of accounts, after checking thereof. b) The audit is uneconomic for small sized concerns as a great deal of time and effort is required. c) The staff conducting an interim audit has to made extensive notes as to the figures in the books of accounts. This causes an unnecessary increase in their work. (2)Final audit – the term final audit refers to situtation where the audit work is commenced only after the expiry of the period to be covered by audit.
It is commonly understood to be an audit which does not begin until the books have closed at the end of accounting period and there after is carried on continuous until completed. Advantages : a) The possibility of figures being altered after work has been done is also avoided. b) Allocation of work for staff also becomes easier. c) There is no loss of link in the work as the entire audit is completed in a single continuous session. d) Periodical audit economical and suitable particularly for small sized business units. e) Use of statistical sampling techniques, test checking leads to time and reduction.
Disadvantages : a) There will be a delay in presentations of final account because work commences only in after the financial year. b) Accounts can not be subjected to a detailed checking because the work is to be completed in a short time. ‘ c) For lack of detailed checking errors and frauds may continue to remain undetected. Q. Distinguish between continuous audit and final audits. Ans. |Continuous Audit |Final Audit | |It is carried on at regular/irregular intervals. Audit is completed in a single continuous session after the | |More suitable for big scaled or medium sized organisations. |close of the financial year. | |All aspects of vouching and verification are carried out in |Suitable only for small sized organisation. | |details. |Use of statistical sampling techniques and test checks is made. | |Early detection and correction of frauds and errors can be made. |Frauds and errors may remain undetected. | Q. Write short note on balance sheet audit. Ans. Balance Sheet audit – Balance sheet audit means limited audit in which all the balance sheet items are verified.
It may be noted that balance sheet audit is not confined to balance sheet items only where ever appropriate, tests are applied on those profit and loss account items which are directly related to assets. Balance sheet audit is most suitable for those organisations which have an effective system of internal controls or where mechanized accounting system is in operation. However, balance sheet audit provides the auditor with lesser assurance then a normal audit since the scope of the auditor’s examination is limited. An auditor has to : 1. Examine partneship agreements, MOA, AOA etc. 2.
Verify the ownership of all assets included in balance sheet. 3. Verify that all the liabilities are included and at proved amounts. 4. Carefully examine all the adjusting and closing entries or other necessary entries to the preparation of balance sheet. UNIT 3 INTERNAL CONTROL AND INTERNAL CHECK Q. Explain and distinguish internal control, internal check and internal audit. Ans. Internal control – Internal control is best regarded as the whole system of controls, financial and other established by the management to conduct a business including internal check, internal audit and other form of control.
Thus, internal control is – (i) a system of controls, (ii) controls are over financial and non-financial areas, (iii) the mechanism of control is internal check and internal audit. The basic objective of internal control is : (i) Efficient and proper conduct of accounting transactions. (ii) Safeguarding the assets of company. (iii) Prevention of errors and their detection. (iv) Accounts becomes completely regular and reliable. Internal control beside accounting may also be administrative to ensure the adherence to management policy in various areas of business operations.
An auditor is mainly concerned with good accounting capacity control of internal control system. Internal check. Internal check is a technique of internal control. It is a method of organizing the accounting systems of a business concern where the duties of different clerks are arranged, in such a way that the work of one clerk is automatically checked by another so the possibilities of errors and frauds are minimized unless there is a collusion between the clerks. Internal control is exercised in the form of internal check and Internal audit. Internal check is concerned with designing automatic checks.
Internal audit is critical appraisal of functioning various operations of the business. Internal audit is the independent appraisal of activity within an organization for the review of accounting, financial and other business practices as a protective and constructive aim of management. It is a type of control which functions, by measuring and evaluating the effectiveness other type of control. Internal audit in fact is an independent appraisal activity within an organization for the review of accounting, financial and other operations as a basis for service to the management.
The work is done by a separate set of staff who may or may not have professional qualification. The functions of internal auditor are same as that of an auditor. He has to see that business is carried efficiently and resources are not wasted. He has to report to the management on policy matters. Thus, internal control is the whole system of control. Internal check and internal audit are its two important parts : To sum up it can be shown as Internal Control Administrative orAccounting Control Management Control (Exercised by management)InternalInternal CheckAudit
Q. What is meant by the term internal check? What are its objects, advantages and disadvantages. What are the special features of an efficient system of internal check? To what extent an auditor should depend on internal check system? Ans. In a big business, the work connected with the preparation of accounts is distributed amongst the various members of the staff. The reason is simple. If one person is made responsible to finish a particular work from the beginning to the end, there is a great scope for errors and fraud. This situation is to be avoided.
Internal check system is an arrangement of staff duties whereby no one person’s allowed to carry through and to record every aspect of fraud is prevented and at the same time the possibilities or error are reduced to a minimum. Thus, it is clear that the importance of an efficient system of internal check is quite great. The system provides for an independent and automatic. Hence, internal check is an arrangement of duties in a business done in such a way that all the duties connected with the accounting work are properly allocated so that one person may not be in a position to do single in job from beginning to the end.
Work of one person may be checked automatically and independently by another. Objectives of internal check – (1) Early detection of frauds, (2) Prevention of errors and fraud, (3)To enhance the efficiency of clerks in a business as the system is based on the principle of division of labour, (4) The work distributed in such a way that no business transaction is left to record, (5) To exercise moral control over staff. Advantages of internal check system – The following are the advantages of internal check system : 1. It help in the proper distribution of work between different members of the staff. 2.
Errors and frauds can be discovered quickly. 3. Internal check increases the ? 4. A moral check is exercised over the clerks. 5. The auditor can perform audit by simple checking. 6. The accounts of the business becomes accurate. 7. Final accounts can be prepared quickly. 8. The responsibility of the staff can be fixed. Disadvantages (Limitations) – Internal check system has following limitations : 1. It can be applied to a large concern only. 2. The auditor may not carry on a through checking and certain important irregularity may not discovered. 3. The clerks of a business become quick and not so serious. . It is very expensive. To provide a safeguard against its disadvantages it is essential to take these steps. Fundamentals of good system of internal check : The following are some important rule of making the system of internal check efficient and successful : (i) Allocation of work amongst the clerks should be proper, duties and right clearly defined. (ii) No single person should be allowed to do a job solely by himself from the end. (iii) Similar nature of work should be given to same person. (iv) There should be automatic checking of the work of one clerk by another. v) Division of work should not be expensive. (vi) No clerk should be relied upon too much. (vii) Self-balancing system should be applied. (viii) Labour saving devices calculating machines, cash register, time recording machines should be made use of. (ix) There should be proper system of filling vouchers etc. (x) A responsible officer should receive letters etc. (xi) All the cash received should be sent daily to the bank. (xii) No one should be permitted to take away any goods without proper sanction. (xiii) Job relating to bad debts, returns, allowance etc. hould be performed under strict control. (xiv) Person dealing with cash, securities etc. should be encouraged to go on leave at regular intervals. (xv) Payment of wages, valuation of stock, sales etc. should be done under the supervision of a responsible person. (xvi) Last but not least the duties of various employees should be rotated (changed) from time to time. To what extent an auditor should depend on the internal check system – The answer to this will depend upon the size of the business. It is true that if there is an efficient system of internal check the work of an auditor becomes easy and simple.
First of all the auditor should examine the system of internal check. (a) He should call for a brief statement from his client regarding the internal check system in operation. (b) He should examine the system in the light of the size and nature of the business to find out whether it is good or not. (c) He should find out the possibilities of errors and fraud to examine its reliability. The above examination can help the auditor in real assessment of the internal check system. If the system is not defective auditor can depend upon it. The auditor should examine the system very carefully.
It is true that a good system can be of great help to the auditor. But if the system is defective and has some weakness. He should carry on a detailed checking of the books of accounts. If the auditor does not care of for these short-coming and fail to detect irregularity, he will be held responsible. Can a good internal check system reduce the liability of an auditor? The answer is no. The existence of good or efficient system of internal check can reduce, to a great extent, the work of the auditor but does not reduce his liability. But if the system is defective his work becomes very difficult.
Whatever may be the situation, the auditor is wholly and solely liable. Thus, a good and efficient system of internal check of much help to the auditor but is no way a device to relieve him of check is of much help to the auditor but is no way a device to relieve aim of his responsibility. To what extent should be depend upon the system, will depend upon the system will, depend upon the circumstances of each particular case and his own skill, experience and judgement. UNIT 4 VOUCHING AND VERIFICATION Q. Define vouching and explain its objects and importance. Vouching is the essence or backbone of auditing.
What points should be kept in mind while vouching? Ans. It is an important duty of an auditor to certify the transaction entered in the books of accounts. The accountant is responsible for recording entries in the books of account. The question arises how and on what basis such entries have been passed. The auditor’s duty is to check these entries, only then he can certify the accounts as correct and free from any error or fraud. The entries are recorded by the accountants in the books of original entry on the basis of a proper documentary evidence only. There should be no entry. Every voucher must be recorded in the books.
When an auditor verify the (a) authority, (business) authenticity of the transaction and gives a report that the accounts are correct, complete and there is no errors or fraud, he has to see entries by proper documentary evidence. This is called vouching. According to DePaula, vouching does not mean merely the inspection of receipts with the cash book but includes the examination of receipts with the transaction of a business, together with documentary and other evidence of sufficient validity to satisfy an auditor that such transactions are in order have been properly authorized and are correctly recorded in the books.
Objects of vouching – The objects of vouching are – (1) All transactions connected with the business have been recorded in the books of accounts. (2) No transaction have been left to record. (3) Transactions are duly authorized. (4) Transactions which are not related with the business have been recorded. (5) There is genuine documentary evidence for each transactions and is available with the business. Importance of vouching – Vouching is very important part of an audit work. It consists of checking the entries in the financial books with the help of available documentary evidence, e. . , vouchers, contracts, invoices etc. It is a basis for checking accounts. The transactions are checked with reference to documentary evidence. No vouching should be left unrecorded in the financial books, the auditor has to satisfy himself with regard to vouchers before he certifies, profit and loss account and balance sheet shows true and fair state of affairs of business. Vouching must be done with care and caution. Vouching is an indispensable tool carry on further audit work. It is called backbone of auditing.
It may be lengthy process in many organization. Vouching is backbone/essence of auditing – Vouching has been said to be the essence or backbone of auditing, as it is one of the most potent tools in the hands of auditors. It has been rightly stated that “sufficient completed evidential matters as to be obtained through inspection, observation, inquiries and financial statements under the examination. ” The entries may appear to be innocent on its face unless the auditor goes behind the book of account and find source of entries he cannot fine out the truth.
It is not only the mathematical accuracy of the books which is concern of the auditor but he has to go beyond it and satisfy himself that the entries are actually correct and related to the business concern and the year under audit with the help of vouching the auditor may find such entries which are contrary to facts. Various errors and frauds may be detected through vouching if it is carried out with care and intelligence. It is that vouching with auditors is able to know genuineness of transactions, their regularity and validity. Success of audit in fact depends upon vouching. That is why it called essence or backbone of auditing.
Examination of vouchers – The auditor should keep following points, while examine vouchers. Vouchers are documentary evidence in support of transaction. They may be primary-original or collateral subsidiary : 1. All vouchers should be proper numbered and filed serially and in order of entries in their books. 2. Voucher should related to the business. 3. Voucher should be properly dated. 4. Voucher should related to the period under audit. 5. The amount shown in the vouchers should be correctly calculated and totalled. 6. Amount in vouchers should be written in both words and figures. 7.
If the amount of voucher exceeds Rs. 5,000 it should be properly stamped, bears a revenue stamp of Re. 1/-. 8. Vouchers should be proporized. 9. Voucher should be cancelled after examination. 10. In case any explanation or clarification is required with respect to any voucher, the same should be noted in the audit note book to any voucher the same should be noted in the audit note book. 11. Clear distinction should be made between capital and revenue items of expenditure. 12. Suitable adjustment entries should be made in case of voucher relates to pre-payment or accrued expenses or income. 3. A pre-receipted income should not be accepted as a voucher. 14. Special attention should be paid to duplicate or missing vouchers. 15. Over writing or erasion on a voucher should not be accepted. Alteration of any kind should be supported by signature of the maker with alteration by responsible official. 16. Vouchers by way of resolutions and minutes should be examined with reference to their validity in the light of scope and limitations set out in the memorandum and articles of association, partnership deed etc. 17. Voucher should be in the name of the organisation.
Special attention should be paid to vouchers in the personal names. 18. Take the help of client’s staff very carefully. Q. What is meant by the term verification of assets? What are its objects? Ans. The auditor of a business is required to report in clear terms that balance sheet of the concern shows true and fair view of the state of affairs. In other words he has to examine and find out the correctness of the value of assets and liabilities. Verification means proving truth or confirmation about the correctness and authenticity of assets and liabilities.
Very often vouching and verification are considered to be one and the same thing. It is so, the clear distinction can be drawn between the true vouching is to examine the correctness and authenticity of transactions recorded in the books of prime entry while verification is to confirm the value of assets and liabilities as shown in the balance sheet. Auditor has not only to examine the arithmetical accuracy and bonafide of the transactions in the books of accounts by vouching only but he has also to examine that the assets recorded in balance sheet actually exist.
The fact that there is entry regarding the purchase of an asset and the asset is in possession of the concern at the date the balance sheet has. It is possible that after the asset had been purchased and all the necessary entries made in the books of accounts the assets might have been sold or mortgaged and no entry had been made regarding the facts in the account books. Spicer and Pegler, “The verification of assets implies an enquiry in the value, ownership and title, existence and possession the presence of any charge on the assets. ” Verification of assets involves the following : 1.
Comparing the ledger accounts with balance sheet. 2. Verification the existence of the assets on the balance sheet. 3. Satisfying that they are free from any charge or mortgage. 4. Verifying their proper value. 5. Assets were acquired for the business. Objects of verification – According to the “Statement of Auditing Practices” issued by Institute of Chartered Accountants of India (ICAI), the auditor’s objective in regard to verification of asset to satisfy that : (a) they exist. (b) they belong to the client or any person authorized by him. (c) they are in possession of the client or any person authorized by him. d) they are not subject of undisclosed lien. (e) they are stated in the balance sheet at proper amount in accordance with sound accounting principle. (f) they are recorded in the account (this will include scrap and waste). (1) Existence of assets – The first step is that assets are properly disclosed in the balance sheet and are actually inspection of the assets. (2) Ownership of assets – Ownership of assets may be examined with the help of documents of title. In case documents of title are held by third parties the auditor should obtain a certificate. 3) Possession of assets – The auditor should ensure that assets are in the possession of the client. (4) Proper valuation of assets – The auditors should find out that assets are properly valued in accordance with generally accepted accounting principle as determined by law and guidelines issued by the Institute of Chartered Accountants of India and standard auditing practices. (5) Proper presentation – All material assets should be properly disclosed in the balance sheet at the correct amount. Q. “An auditor is not a value yet it intimately concerned with proper valuation. ” Comment.
Or “An auditor is not a valuer. ” An auditor is intimately connected with values. ” Discuss. Or Explain fully how these two statements can reconciled? Ans. Valuation of assets is an important part of verification. The correct profit cannot be calculated unless the assets are properly valuated. Only then the balance sheet will show true and fair position of the financial affairs of a business. The valuation as such involves to ensure the correct valuation of assets while in verification the auditor has to verify the authority and existence of property also besides its valuation.
Thus, valuation means to test the exact value of an asset on the basis of its utility. It is actually the exact of money value at which an asset been shown in the books of account or in the financial statement. Normally, valuation is done after deducting depreciation for the value of an asset. If proper depreciation on assets is not provide for the result would be various serious. If the amount of depreciation charged to profit and loss account is more than actual, the profits dividend a part of which would thus, be paid out of capital. The result would that capital of the company be exhausted.
Position of an auditor regarding valuation assets – An auditor is not a valuer and cannot be expected to act as such. All that he can do is to verify the original cost price and to ascertain as far as possible that current values are fair and reasonable and are in accordance with the accepted commercial principles. According to Lancaster – “An auditor is not liable, if in the absence of suspicious circumstances he relies on trusted officials of the company. ” Kingston Cotton Mills Ltd. An auditor has been very careful and cautious in examining the valuation of assets.
The accuracy of the profit and loss account and balance sheet depends upon the accuracy of the valuation of assets. But auditor is not a valuer. He is not a technical expert who can estimate the volume of assets of different nature. He has no alternative but to depend upon the valuation made by experts directors, partners etc. But it does not mean that auditor is not responsible or he is free from his liability. If assets are incorrectly valued by the officials of the business and it entirely depends upon the report given by them. He will continue to be liable.
He must exercise his best judgement and take reasonable steps to verify the valuation of assets. He must pay special attention to the following two things : 1. How far the principles of accounting have been adopted in the valuation of assets. 2. Whatever steps are taken in the valuation of assets are based on the established auditor practices. If he is satisfied with the above two basis, he is free from his responsibility and liability. If not he must qualify his audit report to the shareholders accordingly. Again, if there is the slightest suspicion regarding the valuation, he should probe into the matter.
He should made enquiries from the responsible officials of the business. This is the only remedy before him for certifying valuation of assets. Q. How would you vouch the following? Ans. (1) Cash payments – The vouchers related to cash payments should be properly authorized, serially numbered and filed in order. In vouching payments auditor should not merely seek the proof that money has been paid away. It means that it is not merely the duty of an auditor to see that the payment has been made but he should satisfy himself that the payment : (a) has been actually made for the business itself, b) relates to the period under audit, (c) has been made to the right person, (d) is properly sanctioned, (e) is supported by the proper voucher, (f) the particulars given in the voucher tally with those of the cash book. The payment has been made but to whom and for what purpose these are some questions to be correctly answered. (2) Income from investment – In case the number or investment is large, the auditor will do well to ask his client to keep an investment register, such register shall keep the necessary details in respect of each investment account.
Investment and dividend received should be checked with the counterfoils of the interest and dividend coupons, where interest is received or collected through bank it shall be vouched with help of bank pass book and intimation sent by the bank. (3) Proceeds of the sale of investment – The proceeds of the sale of investment can be verifiably comparing the amount received with the receipt and account for. (4) Payment to creditors – Payment to creditors may be vouched with the receipt issued by the creditors. Money due to them can be compared with the accounts of the creditors and for goods received the invoice can be referred to.
He should check the method of comparing the statement of accounts with their actual accounts. Before passing an entry to confirm the correctness he Should refer to the relevant vouchers, i. e. minutes, contracts and other documentary evidence in support of it. (5) Wages – The vouching of wage payment is one of the most important duties of the auditor. He should find out whether there is an internal check system is in existence and how effective it is. The internal check system will enable the auditor to determine error and fraud in the wage account. If the system is good, possibilities of errors and fraud are minimized.
An auditor must satisfy himself with regard to the work of maintaining wage records, preparation of wage sheets and payment of wages. Thus, regarding vouching of wages auditor should see that (i) the wages recorded in the cash book have been actually paid, (ii) these were actually due by the business, (iii) such a payment was duly authorized. (6) Director fees – The payment of directors fee should be vouched with reference to director’s minute book, the attendance register and the receipts obtained from directors for this payment should be examined.
The auditor should also study the articles of association and see the provisions in regard to the payment of directors fees. The resolution of shareholders should also be seen to ensure that correct payment has been made. (7) Proceeds from sale of fixed assets – Whenever, fixed assets such as land, building, machinery, furniture etc. are sold, correspondence is made with the parties who are willing to purchase them. Fixed assets are usually sold through a broker or an auctioneer. If assets are sold through a broker, the broker’s sold note should be examined by the authorized person.
He should find out the profit and loss on the sale of fixed asset and its accounting treatment. (8) Bills receivable – All details about bill receivable can be available in the bills receivable book. The receipts for bill receivable can be in two ways. (i) Received from bills discounted – The bills receivable which have been discounted but have not matured at the date of the balance sheet. The cash so receive should be properly entered in the cash book. The amount deducted for discount on such bill should be separately debited to the discount account.
Contingent liability in respect of such bill should be shown on the balance sheet. (ii) Receipt from bills matured – The cash receipt from bills receivable in respect of which the amount has the bills receivable book with the cash book and the pass book. Special enquiry should be made about bills which have matured. Put the amount in respect thereof has not been such bills might have been dishonoured. It is possible that such bills might have been paid but their proceeds might have been misappropriated by the cashier. (9) Capital expenditure – Capital expenditure means money spent on acquiring fixed assets.
The auditor should see that payment is in order that it is duly authorized and that the money spent has been properly capitalized. Such expenditure requires special attention. The auditor should examine relevant vouchers (documents relating to the particular asset). (10) Patents – The auditor should incurred in acquiring it should be capitalized. The expenses incurred on experiments, research should capitalized in cash patents are secured by making experiments and research. If patents has been acquired through an agent the auditor should see that his commission is capitalized. 11) Loans – The receipts of loan should be vouched with the agreement of the tender. Auditor should see that company has raised loans as rules. He should examine that rate of interest, payable terms of repayment and the security offered. Regarding the loan given the auditor should expenses receipt given by the borrower and the loan agreement bill or exchange. He should read carefully terms regarding of interest, date of repayment of the loan and authority to them. If loan has been against mortgage, he should examine the mortgage deed and that title deed etc. (12) Bank charges – Bank charges should be vouched after examination of pass book.
Auditor should check calculation regarding commission, interest in overdraft and loan etc. (13)Insurance claim money – Insurance money received against claim from an insurance company should be checked with correspondence passing between the client and insurance company, the account rendered by the insurance company or broker. (14) Agents and traveller’s commission – The agreement with travelers and the agents should be examined to find out the terms of appointment regarding the rage commission calculation should be made and receipt given by the traveler or the agent should be examined and compared with the cash book.
The auditor should test the payment of commission by examining the orders received through the travellers. (15) Bill’s Payable – Returned bills duly cancelled should be examined. It would be sufficient evidence of the amount having been paid reference may be made to the bank pass book bills payable books. (16) Petty cash – There are greater chances of misappropriation of cash as there are no vouchers for a number of petty payments. An auditor should make an enquiry into the internal check system on the imprest system. The amount of petty cash in hands of the petty cashier should be according to the requirement of the business.
The cashier should check the petty cash at frequent intervals. The auditor should check the receipt of money by the petty cash keeper with the cash book and compare the dates. The auditor should recommend the adoption of the columned petty cash book which should be maintained on the imprest system. (17)Freight, carriage and custom duties – The statement of account regarding the payment of freight and carriage submitted by the shippers, clearing or forwarding agents together with the receipts issued by them should be vouched to see that the payment has been duly made and account for.
Q. How would you verify the following? Ans. (1) Goodwill – Represents the sum paid for anticipated future super fraud and therefore some authorities contend that cost of goodwill should be written off against the future super profit earned been purchased goodwill should be valued at cost from the financial point of view, it may be advisable that the value of goodwill should be written off but legally there are no compulsions to write off goodwill from the books of the company. In Case of goodwill it is the auditor duty to see that goodwill represents actual cost. 2) Motor vehicles – Motor vehicles Amount is to be separately maintained. the auditor should compare it with the balance sheet in which it should be clearly stated under separate head. If the number of motor vehicles is very large a separate register should be maintained. The auditor should call or a schedule of motor vehicles and compare it with the register so kept auditor should that all the vehicles are registered in the name of the client. He should further see purchases or sale, insurance premium receipt. Motor vehicles should be shown in the balance sheet at the cost less depreciation. 3) Plant and Machinery – The money spent in the acquisition of plant and machinery is shown in plant and Machinery account. The auditor should check the balance sheet with the help of ledger account and ensure that the asset is clearly stated. The auditor should examine the plant register in which particular about the cost records about sales, provision for depreciation etc. are available. It is advisable for the auditor to ask for a schedule for various plants in which details about cost depreciation etc. should be clearly given.
Auditor can verify the asset by comparing the schedule with the plant register. If a part of the asset has been purchased during the year, the invoice should be checked. If a part of the asset has been sold necessary entries, profit or loss must be verified. (4) Property – The auditor is not competent to examine the title deeds relating to a property. In such a case he should insist upon the client to get a certificate regarding their validity from the solicitor or architect or surveyor or an engineer. The property may be freehold property and lease hold property. 5) Free hold property – (i) The auditor should examine the title deed relating to the property. (ii) Correspondence and broker’s account should be examined in case it built. (iii) Builder’s, contractor’s certificates should be examined in case it built. (iv) In case the property has been mortgaged the title deeds will be with the mortgagee, the auditor should get a certificate from the mortgage regarding to possession of the title deeds and the amount of the loan. (v) Property should be shown in the balance sheet at cost, less depreciation.
While valuing the land and building it should be seen that no notice of appreciation or fall in their market value is taken into depreciation must be provided for building. (6) Leasehold property – Lease deed should be examined to find out its value and duration. The auditor it is for a period or more than one year as per the requirement of the transfer of property Act. These lease money paid should be capitalized. Any legal expenses or other expenses incurred in acquiring the lease should also be capitalized. Lease rent should be debited to the revenue account.
The lease money and other capitalized expenses should be spread over the number of years. Depreciation, insurance premium etc. should be debited to revenue account in the case of lease of building. (7) Outstanding expenses – The auditor should get a certificate from a responsible official to see that all expenses for the current year are included and that the payment for such expenses, which have not been paid, are included. (8) Bill’s payable – The auditor should verify B/P book and B/P A/c, cashbook and examine the returned bills payable confirmation from the drawee may be asked in case of suspicion.
Any charge on asset should be disclosed in the balance sheet. (9) Trade creditors – The auditor should ask for a schedule of the creditors and check it with the purchase ledger which in its turn may be checked with the books of original entry with the purchase invoices, credit notes, goods inward book, returns outward book, bills payable book, cash books etc. The auditor should see that all purchases during the year have been included in the purchases made at the close of the year.
Auditor should find out that whether all purchases made at the close of year have been credited to the supplier’s account by referring to the goods inward book and the purchase book. He may also ask for the statements of accounts from the creditors to find out that accounts are correct. Auditor should compare the percentage of gross profits with that of the previous years. If there is a significant charge auditor should enquire the reasons for the change. If the debt has not been paid for a long time, enquiry should be made.
It is possible that instead of paying to the creditor the amount might have been misappropriate. (10) Contingent liabilities – It is duty of an auditor to see that all know liabilities are brought into account at the date of the balance sheet. There may be certain liabilities which may or may not arise after the preparation of the sheet. It is, therefore, necessary that provision should be made for such unknown liabilities. Such liabilities are called contingent liabilities. Thus, a contingent liability been defined as one which may or may not arise at a future date.
A contingent liability may involve an ultimate loss – A liability in a disputed case where damages may have to be paid or it be acquisition an asset at a future date. The auditor can find out such liabilities during the course of the audit while going through the books of account, correspondence minute books etc. The amount of the contingent liability may be definite or may not be so. Example, a bill received which has been discounted might be dishonoured at the date of maturity. The auditor should see that the requirements of the Companies Act are complied with and a liabilities is shown in the balance sheet. 11) Investment – The auditor should ask for a schedule of investments. This schedule should give full particulars of the investments held by the client and compare it with accounting records. The auditor should check all the investments simultaneously and compare them that they not be reproduced again. If investments are held by any trustee on behalf of the company, the trust deed executed by a nominee should be examined. If there is no trust deed, he should get a certificate from the trustee. Auditor should see that provision of the concerned account are complied with of the act.
After verification of the existence of the investments the auditor should examine that they are properly valued at the date of the balance sheet. The basis of the valuation of investments in the balance sheet will to large extent depend upon the purpose for which they are held. The investment should be valued at cost price. (12) Stock in trade – The verification of the stock in trade at the close of the year requires a lot of care and caution. Auditor should be very careful while verifying and valuing stock in trade. Otherwise profit and loss will not show true profits/or loss of the concern.
The auditor should examine the system of internal check in operation. If there is an efficient and effective internal check system, the possibilities of errors and fraud are minimized. The method of stock taking, few items of rough stock sheets totals and balance of stock sheet, value of different items of stock, principle followed in the valuation of stock good inward register and percentage of gross profit to sale of the current year should be compared with that of the previous years are to be verified by the auditor.
The valuation of stock is normally made on the basis of cost price or market price which ever is lower. Auditor should certify the stock shown in the balance sheet. (13) Cash in hand – the auditor should visit the business house at the close of the financial year or on the following day and actually count the cash in hand and compare the balance of cash in hand with balance sheet. Another method of verification of cash in hand is to ask his client to deposit the whole of cash in hand including petty cash etc. nto the bank on the closing day and then drawing a cheque on the following day for expense etc. to reopen the cash book with cash drawn from counted. (14) Cash at bank – To verify cash at bank, the auditor should examine the bank pass book and compare it with the balance sheet or shown by the bank column of the cash book. Auditor should examine the reconciliation statement to find out the pass book balance agrees with the cash book. Auditor may also ask the client to obtain a certificate regarding the bank balance from the bank to prevent frauds in the account. 15) Book debts – According to Companies Act, book debts of a company should be shown as (i) debts considered good in respect of which the company is fully secured considered good for which the company holds no security other than the debtor’s personal security, (ii) debts considered doubtful or bad. The auditor should see that debtors have been shown properly. He should examine the ledger accounts and should obtain a certificate schedule of all debts. He should compare the schedule with the ledger accounts. Auditor should examine provision for bad and doubtful debts, discount etc. Debts written off should be examined.
Auditor may also get confirmation from the debtors. Q. Comment on the following : Auditing or an examination of books, accounts and vouchers. Ans. Meaning of auditing – An audit is an examination of the records to establish their reliability and the reliability of the statements drawn from them. In simple words, auditing may be defined or the verification of financial position as disclosed by the “balance sheet” and ‘profit and loss account. ’ “Auditing is defined as a systematic and independent examination of data, statements records operations and performance of an enterprise for a statanted purpose. As per AAS-I, “An audit is the independent examination of financial information of any entity, whether profit oriented or not prospective of its size or legal form, when such an examination economic information. ” (1) As auditor, while conducting an audit, has to satisfy himself that : (a) That accounts have been drawn up with reference to entries the book of accounts. (b) The entries in the books of accounts are adequately supported by underlying papers and document. (c) Nothing which is not in the books of accounts has bound place in the financial statements. d) None of the entries in books of accounts has been omitted in the process of compilation. (2) Reviewing the systems and procedures to find out whether they are adequate and comprehensive. (3) Checking the arithmetical accuracy of the books of accounts by the verification of postings, balance etc. (4) Examine the documentary evidence to establish the accuracy, authenticity and validity of transactions recorded. (5) Verifying that the production between capital and revenue items is made. (6) Verification of the title, existence and valuation of assets appearing in the balance sheet. 7) Examine the whether statutory requirements have been complied with. (8) Verification of the liabilities stated in the balance sheet. (9) Companies of balance sheet and profit and loss account and other statements with underlying records in order to see that they are in accordance there with. (10) Checking the results shown by profit and loss account and balance sheet see whether the results shown are true and fair. (11) Reporting to appropriate person body as to what extent accounts reveal a true and fair view of the state of affairs and of the Profits and loss account of the organization.
The auditor must examine all vouchers, invoices minutes of directors or partners. Correspondence and other documentary all vouchers to establish the nature and authenticity of transactions. He must verify that there exists a proper authority in respect of each transaction. He should also verify the form in which final accounts are drawn up. UNIT 5 AUDIT PLANNING AND DOCUMENTATION Q. Write short notes on (i) Audit Programme, (ii) Audit Note Book, (iii) Working Papers, (iv) Test Checking, (v) Consideration at the commencement of new audit. Ans. 1.
Audit Programme – Before the work of an audit is commenced the auditor should chalk out a programme as to what work is done by his assistants and by himself and the time by which the work is to be finished. The assignment for each of the assistants is to be laid down in the Audit Note Book of the assistants. There are three methods by which the programme is carried out : (a) There is a complete programme on the file from which the items to be completed by a particular assistant are ticked off, and thus, the assistant knows what he has to do and by which date each item is to be completed. b) In other cases, the auditor chalks out a programme for each assistant according to the nature of the business of the client. In this case, there is no previous chalked out programme. (c) In the third case, the auditor never prepares a programme in advance but may allow it to go as the work progresses. While preparing the programmes the auditor should keep in mind following two points : 1. The points which are common to all kinds of audits. 2. The special points relating to a particular type of audit. Advantages of audit programmes 1) The auditor is in position to know properly of the work done by his assistants. (2) The uniformity of the work can obtained as the same programme will be followed at subsequent audits. (3) Division of work amongst the different assistants is possible. (4) Responsibility of clerks can be fixed. (5) In case a clerk goes no leave, his work can be done by another clerk, who is in a position to know what has already been done. (6) In case of a charge of negligence against the auditor for not having done the work the auditor can depend himself by producing the audit programme. 7) It is a kind of guidance to the audit clerk for the work he has to perform. It is also an assurance to the auditor that the junior will not over look essential points. (8) In case, any fraud or errors has remained undetected, the responsibility for negligence can be fixed on the clerk who had performed that as his signature are affixed on the audit programme. Disadvantages of Audit programme : (1) The assistant does not apply his common sense. He perform the work mechanically. (2) An efficient clerk, losses his initiative because he adheres to the programme which has been fixed for him.
He may not make any suggestion. (3) Even if the audit programme is well drawn up, it may not cover everything that come up during the course of audit . (4) Every business has a varies problems of its own, and hence, a rigid programme cannot be laid down for each type of business. (5) Drawing of an audit programme may be unnecessary for a small concern. These disadvantages can be overcome by impressing upon the audit clerk that the audit programme is only a guidance and he should use his initiative and intelligence during the course of audit.
He should be encouraged to make suggestion. The audit programme should be flexible, i. e. , should be changed from time to time and made up to date according to experience and changes made in the business so that it may become a useful tool to review and prepare audit and report. It can be used for planning sussequent audit programme. 2. Audit Note Book – An audit note book is a book which is maintained by the audit clerk. During the course of audit, the clerk comes across many difficulties or new points which he has to discuss with his senior or the auditor.
He marks several inquiries which, so he thinks have not been satisfactorily answered. Lest he might forget these be noted down these in a book which is called by different name such as audit note book. Such a Book is written record of queries made replies received thereto. This book may be of great help of the auditor preparing his audit report from such a record. A separate audit note book is maintained for each concern. Contents of audit note book – Audit note book may cover following points : 1. A list of books of account maintained by the client. 2.
The names of principal officers, their powers, duties and responsibilities. 3. The technical terms used in the business. 4. The points while require for further explanation and clarification. 5. The particulars of the missing vouchers. 6. Errors and mistakes discovered. 7. Total or balances of certain books of account, bank reconciliation statement. 8. Notes and queries which might be required at a subsequent audit. 9. The points which have to be incorporated in the audit report. 10. The matters which requires discussion with the senior or with the auditor. 11.
Accounting method followed in the business. 12. Provisions of articles and memorandum of association affecting the accounts and audit. 13. Dates of commencement and completion of the audit. Utility of an audit note book – An audit note book is of great value in case a suit filed against the auditor for negligence or breach of duty. He can prove or defend himself against this charge if the points have been noted in the audit note book. An audit note book will serve the purpose of an evidence in favour of the auditor. An audit note book should be concise, clear and complete.
It can act as a guide for the clerk and will be great use in subsequent audit. 3. Working Papers – Working papers are those paper which contained essential facts about accounts so that the auditor may or may not have again to go over the accounts of his client in case he wants to refer to them later on during the course of his audit. Example : 1. Audit programme duly completed showing the nature of work. 2. The extent of checking made and initials. 3. The schedule of the debtors and creditors, fixed assets, investments etc. 4. Working trial balance. 5.
Correspondence between the auditor and debtors, creditors and banks etc. 6. Certificate regarding shock in trade and its valuation. 7. Certificate from the management that all the outstanding assets and liabilities have been included in the account etc. 8. Adjusting formal entries. 9. Abstracts from minute books. 10. Particulars of investments. 11. Particulars of queries made during the course of audit and the explanations given. Objects of working papers : 1. Working papers show in detail the work performed by auditor and supports the auditor report. 2.
The auditor can form opinion about the efficiency or other working ability of the audit clerks. 3. Working paper is permanent record. An auditor can defined himself in case a suit is filed against his negligence. 4. Working papers are prepared by the audit clerks so they are means to given training to them. 5. Working papers enable the auditor to satisfy the client about the weakness of the internal control system, inefficiency of the accountancy system. 6. Working papers help the auditor to plan for the succeeding year. 7. Working papers enable the auditor to prepare audit report without much wastage of time. . He can know that his assistants had followed his instructions. 9. Duties of audits staff can be changed with minimum dislocation and omission of any working papers. 10. Future audit work can be carried on in the same sequence on the basis of the previous working papers. Essentials of good working papers : (i) The working papers should be completed in all respects. (ii) They should be properly organized and arranged. (iii) The working papers should contain accurate information. (iv) There must be clarity in thought and experience. (v) All relevant details should be kept in the working papers. vi) Working papers should be properly preserved filed, so that they may be made variable whenever they are needed. 4. Test checking – Test checking is a substitute for detailed checking. It involves only partial checking. The auditor normally does not check completely all the records made into the books of accounts but he adopts sampling techniques. He selects a few items and if they are found correct he assumes that the rest of the entries would be correct. Thus, test checking is based on the simple rule that if a representative number of transactions selected at random by the auditor for test checking is found to e correct the remaining ones would also be correct. Thus, the whole system of test checking implies selecting and checking only a few selected transactions so as to enable the auditor to form him final judgement as to the whole set of transactions. Test checking is also known as selective verification or sampling process. The use of test checking is depend upon the system of internal check in operation. The choice for adoption of test checking will depend on the situation. Test checking should be applied and carried out intelligently and carefully otherwise it may lead to dangerous consequences.
Safeguards for the application of test checking : 1. Representative sample transactions selected should covered the whole period of audit. 2. The item that selected should be checked in detail. 3. Cash book and pass book should be checked in detail. Advantages of test checking : 1. Test checking saves time and energy. 2. Test checking is very useful and purposive provided the selection of transaction made intelligently. 3. The auditor can take different audits easily because the volume of work is reduced. 4. Definite conclusions can be drawn regarding truthness and fairness of the accounts. . Cost of conducting the audit is reduced. Disadvantages of test checking : 1. Errors and frauds may remain undetected because test checking is based on the selection of representative transactions. 2. Accounts clerk becomes careless because they know that auditor will not check their work in detail. 3. Risk and responsibility of audit increases. 4. Test checking system is not possible in an organization where internal control system exercised. To conclude test checking means to select and examine a responsible sample from a large number of similar items.
This method of checking the account minimize the work of auditor but does not reduce his liability in any way. 5. Consideration at the commencement of new audit – An audit is conducted with some definite object in view. This object should be kept in the initial stages of the audit. 1. The auditor should see that his appointment is in order. In case of joint stock companies, it is accordance with the provisions of the Companies Act. If he does not do so, he will be held liable. If he has been appointed in place of another auditor, he should inquire from the retiring auditor, the reasons for the changes. 2.
He should obtain defined instructions from his client about the nature and scope of his work and duties. Whether he is to do the accountancy work or audit work or both, by which date work is to be completed, his audit fees, time by which the audit report is to be submitted. 3. He should examine terms and conditions of his contract with management his rights, duties and liabilities. This question will not arise in case of the audit of companies because these are determined according to Companies Act itself. 4. Auditors should examine the system of accounts in operation and fine out the weakness if any in the accounting system. 5.
He should obtain the lists of books maintained by the clients, the specimen signature of the responsible officials of the company. 6. Auditor should arrange meeting with key officials before starting his work. 7. He should examine the interval check system in operation and its weak points etc. 8. He should obtain the lists of key officials of the companies, their power, duties etc. 9. He should make understanding about the technical aspect of the business with the help of technical experts. 10. He should ask the client to balance the accounts, the final accounts and the balance sheet, file the vouchers, prepare the necessary schedules. 11.
Auditor should never begin his work until the book of accounts have been balanced. 12. Auditor should obtain previous years balance sheet duly audited by the auditor, if any. 13. He should study the audit report of previous year in the case of existing company. 14. He should memorandum and articles of association of the company and prospectus in the case of new company. UNIT 6 COMPANY AUDITOR Q. State the provisions of the Companies Act, 1956 with regard to the appointment of an auditor. Ans. The audit of the books of accounts of a company has been made compulsory by the Indian Companies Act, 1956. It contains provisions regarding company